Ghana: Banking with caution

As a result of limited global integration, a strong reliance on domestic deposits and a risk-averse regulatory framework, Ghana’s banking sector has weathered the global financial crisis largely unscathed. In fact, most of the sector’s key indicators improved over the course of 2010.

According to the Bank of Ghana (BoG), the country’s central bank, the banking system remained well capitalised, profitable and liquid throughout the last year. Total assets saw a year-on-year increase of 23.9% by December 2010 while deposits rose by 31.7% during the same timeframe. Meanwhile the sector’s capital adequacy ratio was recorded at 25.6% in October 2010, comfortably exceeding the 10% minimum requirement.

On the back of higher revenues from cocoa and gold production, government promises of nationwide infrastructure development and the emergence of a domestic oil industry, bankers remain upbeat about the prospects for growth in 2011.

However, one significant challenge that may limit the expansion of financial services is the high level of commercial interest rates. The latest BoG ranking of interest rates ending January 31, 2011 revealed that the average rate for business loans comes in at 30%, over three times higher than the rate for deposits.

One reason for this is the number of non-performing loans on the books. These grew from 16.2% by the end of 2009 to 17.6% at the end of last year. The problem is largely due to the lack of an effective credit registration process, which keeps bankers in the dark on clients’ credit-worthiness and consequently leads to loan defaults.

Other reasons include the high level of overhead costs – through branch expansion, loan chasing and expensive human capital – and loan loss provisioning driven by delays on the part of the government in paying its bills.

In an effort to encourage competitive pressure on commercial lending rates, the BoG has followed an inflation-targeting policy since 2009. From the outset the strategy seemed to have a significant impact on inflation, with this dropping to 8.58% in December 2010, an 18-year low. The monetary policy rate has decreased by five percentage points since late 2009 to its current rate of 13.5%. The policy’s marginal impact on interest rates has led industry lobby groups to call for more effective regulations to force down the cost of financing.

Nana Owusu Afari, president of the Association of Ghana Industries (AGI), the country’s most powerful industrial lobby group, told local media that, “high lending rates would impede economic growth in the country, reduce profit margins of companies and increase unemployment.”

As a result, the AGI has called for immediate action on behalf of the commercial banks, the BoG and the government. Among the proposed regulatory amendments, the AGI has urged banks to adopt more stringent methods in conducting due diligence.

It also called for further collaboration between banks and the credit reference bureau, highlighted the need for a reduction in reserve requirements and a commitment from the government to pay contractors within 90 days or, if delayed beyond this time period, to pay interest. It also suggested that the government reduce borrowing to less than 10%, increasing capacity for private sector financing within the banking system.

Another proposal offered by the AGI is the creation of a lending rate band, effectively capping the margin of commercial lending rates. This option is receiving considerable attention due to the immediate results it would offer and its potential (and controversial) impact on access to credit.

Opponents claim that this would lead to a more restrictive environment, as banks would be unwilling to take on the added risk. They argue that this would hit small businesses that survive on SME- and micro-financing schemes particularly hard.

Furthermore, the high interest rates on fixed financial assets – such as treasury bills, with returns steadily hovering between 12% and 13% – would offer an investment-buffer for banks, decreasing the pressure to reduce their commercial rates.

One measure that the BoG has already taken is to increase in capital requirements for banks to GHS60m ($39.35m). The deadline for foreign-owned banks was the end of 2009. Locally owned banks, however, have until the end of 2012 to comply.

Besides deepening the financial sector and encouraging its role in national economic development, the move is intended to promote consolidation. Kwesi Amissah Arthur, governor of BoG, suggested in early December 2010 that, “domestic banks have to seriously consider their options and consolidate their positions through mergers or open up for acquisitions.” This, in turn, would create a downward pressure on overhead costs and encourage due diligence criteria, thus spurring a drop in the cost of financing.

Nevertheless, even if the capital requirement raise achieves its intended aims, it will not be an immediate fix. Caution remains the name of the game in Ghana’s banking sector and the depth and pace of its growth will depend on the continuity of the country’s solid macroeconomic performance.

Despite a slight deterioration in the strength of the cedi since the start of 2011, the BoG expects a return to solid economic fundamentals before the end of the first quarter of this year. This should, in turn, encourage the banking sector to increase lending and do more to help meet the financing needs of the local business community.