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24.08.2019 Feature Article

The BoG Financial Sector Clean Up: An Economic Bubble Ready To Burst

Where BoG Got It Wrong
The BoG Financial Sector Clean Up: An Economic Bubble Ready To Burst
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Waking up to see the incessant collapse of financial institutions by the central bank in Ghana, I have observed and listened widely to the run of debates and blame slogans that seem one sided for me. We need to play the two sides of the coin fairly. Every Central bank has the ultimate duty of care to protect public deposit and preserve the public confidence in the financial sector and anytime this duty of care is neglected there will be financial crises. This role cannot be transferred to the financial firms that are actually regulated by the central bank.

It is the legal mandate of every central bank to serve as a ''Lender of Last Resort'' during financial instability; providing liquidity to financial institutions or markets to help calm financial panics.

But the coiling question is whether Bank of Ghana's current approach of collapsing insolvent financial institutions defines the ''lender of last resort'' or not. It's amazing to still grow up to see City bank and JP Morgan Chase among the top banks in the USA currently. Actually they were key members of the Wall Street banks that caused the Stock Market Crash (the 1929 Great Depression) .

Why weren't these banks collapsed then? And why have we collapsed ours?

I guess this is a good question for BoG and a musing to kick start your mood into the thinking rhythm of this writing.

We should therefore not accept only the clean-up among the financial firms but we should also be more concern of a total clean up at the central bank itself and demand for a structural solution. Until then, the BoG clean up as recovery will be incomplete and sufficiently weak which can create what I describe as economic momentum bubbles ready to burst.

I will try my best to prove where Bank of Ghana (BoG) got it wrong especially with their clean up approach if only you read to the end. I am glad that you are reading this and at this point, I humbly ask you to take away any political and misconception lens, if any, to enable you to appreciate the truth and facts. Every historic account I give herein is going to be my analyses tool for my inferences.

The Summary
In 2017, the Bank of Ghana (BoG) started an exercise to clean up and strengthen the financial sector as a result of mismanagement and unavailability of the stated capitals by the financial institutions. Consequently, a total of 420 financial firms are gone; 9 banks, 15 Savings and loan, 39 microcredits, 8 Finance house, 347 MFI and 2 Non-Bank. According to BoG reports, this collapse stemmed from six (6) major behavioural traits namely;

Levels of capital held by some of the companies were in violation of the minimum capital requirement Act 920

Weak corporate governance
Improper use of Depositors' Fund
Excessive Risk Taking
Creative Accounting practices
Persistence Regulatory
Before I continue, I would like you to take some glass of water whiles I take you back to two (2) major historic account of the financial sector in the USA that gained the largest Global attention; the 1929 Great Depression and the 2007 Great Recession. The purpose of this article is to help you understand the factors that have the potential to cause financial crashes using historic account and to unfold where Bank of Ghana (BoG) got it wrong.

The Causes & Repercussions Of The 1929 Great Depression:

The Great Depression that engulfed the financial and economic sector of the USA, although happened ninety (90) years ago, is still re-echoed anytime bank failures are experienced elsewhere. This is due to two (2) distinguishing characteristics; its severity and its length (1929 -1940): with repercussions of over 10,000 failed banks in the USA.

The 1929 Great Depression started as a Stock Market Crash that later led to total financial sector failures in the USA. Let me take you back to how it all started. In 1919, the American government decided to raise fund from the public through Liberty Bonds. Bonds herein, simply means loans taken by government from the public. The liberty bonds concept was a success and led to a new investment culture in the USA. Don't forget, The Gold Coast Securities Ltd and Data Bank founded by Dr. Paa Kwesi Ndum and Hon Ken Ofori Atta respectively were the first firms to introduce such investment culture in Ghana in 1990 and 1993.

The Wall Street Firms saw the opportunity to also issue similar bonds on the NYSE to raise funds from the public to fund their banks. Actually, The Wall street is a small but powerful elite group of bankers in USA, doing business with each other in a society closed door to the general public. The entry of the wall street firms started the beginning of manipulation and violation of policy regulations of the NYSE. They were so influential to the extent that they play a key part in keeping government policies and regulations at a minimum; subverting disclosures. Although investors (public) were happy trading on the stock market, there were growing concern as the years grew. Decades on, Paul Welbeck broke ranks with the Wall street and issue a bleak warning but he was totally ignored. The reckless and subverting nature of Wall street bankers during those days actually caused the Stock Market Crash which consequently led to the Great depression. Kindly take note that the key bankers at Wall Street who led the aforementioned bonds were Charles from National City Bank and Thomas Lamont from JP Morgan;

Never before since has economic crises has been so bad or lasted so long. To this day, there have been competing theories to what caused the Great depression; some say it was due to growing inequalities, others say increasing consumer debts, margin loans and stock market losses, panic due to bank failures, the stinginess of Federal reserve policies and the Smoot-Hawley Tariff.

Important fact to note is that during the Great Depression in USA, economic output went down by 25% - the largest drop ever, and unemployment also reached a staggering 25%.

As 40% of the nation's banks failed, the price of goods also fell. The depression was at its worse in the collapse of 1920-1933, but the subsequent recovery was sufficiently weak and inconsistent that conventionally, the entire 1930s are spoken of as the depression Decade. The then President of the USA happens to be Franklin D. Roosevelt whose vision and attempt to salvage the situation debatably led to recession and more harm although some of his policies were prudent.

The 2007 Financial Crises (The Great Recession)
The 2007 financial crisis is the breakdown of trust that occurred between banks the year before the 2008 financialcrisis. It was caused by the subprimemortgage crisis, which itselfwas caused by the unregulated use of derivatives. This timeline includes the early warning signs, causes, and signs of breakdown. It also recounts the steps taken by the U.S.Treasury and the FederalReserve to prevent an economiccollapse. Despite these efforts, the financial crisis still led to the GreatRecession.

The Role and Policy Tools of Central Banks
Globally, all central banks have the sole responsibility of ensuring Macroeconomic Stability and Financial Stability. Nonetheless, there is a third role namely Financial Regulation and Supervision but in Ghana, this is done solely by Bank of Ghana (BoG) but in other countries like the USA, it is carried out by the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) together with FED. And by ensuring that the aforementioned roles are carried out effectively, Central banks use the following policy tools;

o Monetary Policy
This tool helps to ensure macroeconomic stability: In normal times, central banks adjust level of short-term interest rate to influence spending, production, employment, and inflation.

o Provision of liquidity
Used for financial stability: central banks provide liquidity (short-term loans) to financial institutions or markets to help calm financial panics, serving as the ''lender of last resort''.

The Financial Panic induced by Bank Of Ghana
Financial Panic is simply sparkled by a sudden loss of confidence in one or more financial institutions, leading the public to stop funding those institutions through, for example deposits. Panic can cause widespread bank runs, restriction on depositors' access to their funds, bank failures, stock market crashes and economic contractions. In order to halt panic, in the case of Ghana's financial panic, the best Bank Of Ghana should have done was to activate their ''Lenders of Last resort'' tool to help provide short term liquidity support to replace losses of deposits or other private sector loans, preventing the failures of solvent but illiquid firms and even in the worst case insolvent but illiquid firms. There were so many solvent firms who were illiquid during period and all BoG could have done was to give them such support.

The argument is not how many times BoG has given them such support but the emphasis must be placed on the current situation that demands such support to salvage the financial sector and ultimately the economy. Per information by BoG and KPMG assessment report, some banks like Unibank were solvent but illiquid. The collapse of Unibank actually began the financial panic in Ghana after UT Bank. Imagine BoG activated the ''Lender of last resorts''. Just imagine, considering the size of Unibank. I'm sure the narrative would have changed. I can go on and on and demonstrate to you that there were a good number of banks that were solvent but illiquid and hence needed such support during the panic to survive.

Dr. Addison's' Clean Up Strategies & Its Repercussions

Obviously, the financial clean-up by BoG unknowingly or knowingly created these financial panics. Most economist and financial analyst can't be sure if this approach by Dr. Addison will ultimately salvage the financial sector. There have been different competing theories and I'm not surprise about this. We must be careful of the kind of economic momentum we are creating for businesses and the sector as result of responsive strategies such as consolidating illiquid banks and collapsing others in the name of clean ups at a huge cost of the tax payers. According to BoG, we need GHc21 billion in order to effectively deploy these clean up strategies. This amounts to about 50% of our annual Budget.

In 1933, during the Great depression, President Franklin D. Roosevelt (FDR) initiated a new deal program to fix the economy of the USA. He came up with policies that had a ''push-pull effect'', some encouraging recovery and others preventing it. In fact, the reason why the Depression lasted as it did was because of FDR's new deal programs. His program spent millions of dollars and employ millions of people to stimulate the economy by raising both prices and wages. He didn't know that artificially raising wages raises labor cost which then causes business to hire few or no workers at all. The FDR program prevented the natural forces of competition from pushing the prices down and pushing worker's productivity up.

The FDR program's result among many others informed us to be much concern about Dr. Addison's financial clean up approach. An approach that has laid off over 4,000 workers, collapsed 420 financial institutions, locked up over a million depositors fund, affected several other businesses and caused Government to budget GHc 21 billion. We actually don't need any smart economist to tell us the carried negative effect this will have on both small and large businesses on both the formal and informal market. A potential consequent Stock Market crashes in Ghana is inevitable. The SEC and GSE commission are going to experience influx of poor performances on the Ghana stock exchange as well as likely stock market crashes. Unemployment is going to reach a staggering high and economic output can shoot very low if proper initiatives are not implemented to recover the economy and restore the public confidence.

The Need for Structural Reforms at BoG
According to BoG own report that gave six (6) major reasons that caused the collapse of the 420 financial firms; it is obvious that BoG had regulatory and supervisory failures; a palpable negligence of duty of care to ensure proper financial regulation and supervision. Just as the board or top management of these failed banks are held responsible for any fraudulent deals in violation of any financial regulation, we must, for any serious forward thinking nation, hold the bank of Ghana responsible for weak monitoring and poor supervision. We are very aware of Bank of Ghana's quarterly visitations to the premises of these financial institutions; auditing their operations and /or books to ascertain regulatory conformity and the authenticity of their financial reporting whiles assessing their capital adequacy.

This alone should inform us that BoG was sleeping at the job, conniving and manipulating or better still never did anything with the audit reports of these quarterly exercises. These reports are supposed to help identify early signs or warnings of insolvency issues. Some heads at BoG will have to roll. Our central bank needs a proper structural solution. To me, they haven't been proactive and prudent enough in salvaging our financial sector.

The Way Forward: The Deposit Insurance Scheme
In every financial sector, bank failures are inevitable. This is a clear indication that the ongoing clean up exercise will never prevent future bank failures. And we must know this truth. For this reason, I have been among , advocating for proper implementation of the Ghana Deposit Insurance Scheme since 2017. You can read my publications on it

The best way to prevent financial panic in Ghana is to insure depositors fund. This has an ultimate power to preserve public confidence during any bank failures.

The USA is the country that has experienced the worse financial crises in the world and it is not a surprise that they happened to be the second country after Czechoslovakia to officially enact deposit insurance to protect depositors from losses by insolvent banks. In 1933 the Glass–Steagall Act established the Federal Deposit Insurance Corporation (FDIC) to insure deposits at commercial banks.

Ghana needs to establish such Deposit Insurance Corporation that will ensure that all deposit from the public are insured by the financial institutions and automatically act as the receiver to all failed financial institutions. The current panic and bank runs would have been brought to calm in a matter of a day if the Ghana Deposit Insurance Corporation was established and is in operation.