Ghana Banks Victims Of Their Own Success?

Ghana’s banking sector has been quietly but steadily building up its assets, and is now poised to reap the rewards of an economy in rude health and expected to improve even more as oil revenues vitalise other sectors. But, as Valerie Noury argues, sweeping changes in the sector could see smaller institutions running for cover.

For two years now, the Ghanaian banking sector has been riding the crest of a burgeoning economic wave. Fitch Ratings recently raised Ghana’s long-term issuer default rating to B+ on the basis of the country’s declining inflation rate which restricted the government’s borrowing and budget deficit to 10% this year, down from 14.5% in 2008. The country also expects Standard & Poor’s to follow suit. The latter had previously cut the country’s rating from B+ to B, mainly due to a lack of clarity in the management of the government’s oil revenues but also due to its sizeable fiscal deficit.

Ghana’s Finance and Economic Planning Minister, Dr Kwabena Duffuor, reflected this sense of optimism when he described the country’s macroeconomic indicators as “the best ever”. He remarked, “Yes. Our macro indicators are the best ever … We are borrowing locally at 10.4%. Two years ago it was 25%. Our foreign exchange reserves have gone up from $2bn to almost $5bn in the same period. Inflation has gone down to single-digit figures. And the cedi has been stable since August 2009. So why wouldn’t our rating improve?”

The Ghanaian economy was listed as the world’s fastest-growing economy in 2011 by EconomyWatch, based on data from the IMF’s tracker of GDP growth in constant prices in national currencies. The economic growth predicted for 2011 is a whopping 20%.

Yet these positive trends may lead to a change of strategy for Ghana’s banks which are likely be forced, due to increasing competition, into lowering their interest rates, reducing margins, expanding their capital market services and offering more sophisticated products. If they fail to adjust to this rapidly changing environment, there is a growing risk for local banks that a wave of consolidation will be in the offing sometime in the near future. This risk has arisen as a result of the positive trends in the Ghanaian banking scene whereby the main lenders in the country managed to achieve returns on equity (ROEs) of 30% to 35% in the years leading up to 2009. Manifestly things changed in 2009 when the global economy slowed considerably; yet there was an upswing in 2010, when GDP expanded by 7.7% and once more paved the way for more positive developments to come in the Ghanaian financial system.

The discovery of precious crude

In 2007, Ghana discovered huge offshore crude oil reserves, the Jubilee Fields, which were estimated at the time to contain up to 3bn barrels. Much of the current exuberant GDP growth is off the back of this discovery which, understandably, generated as much excitement for bankers as for the rest of the economy. The sound basis for this excitement is undeniable since the Jubilee fields represent some of the richest and largest oil deposits discovered in recent years, with long-term prospects pointing to annual oil production generating around $1bn in revenue.

With this blessing comes the heavy burden of responsibility for Ghana’s government, as it faces fears that the country will suffer the notorious ‘oil curse’ faced by the many petro-rich nations. However, many experts remain positive on the ability of Ghana to manage these new resources. In contrast to many oil-rich African nations, such as Nigeria where oil revenues account for around 92% of GDP, Ghana has a much more diversified economy that earns much of its foreign currency from gold and cocoa.

A consequence of this new industry in Ghana is a considerable spur to business for everyone, even smaller local banks which often lack the balance sheets to support the large structured deals which typically accompany such a sector. These smaller players often find a niche in supporting enterprises such as fertilisers and plastics, which are made from the by-products of oil extraction. Many experts are already predicting a rapid boom in such industries in the years to come. Transport facilities and real-estate developments needed for workers around the oil rigs have also given banks new projects to finance.

It is not only the oil industry that is fuelling the banking boom. Other industries are also rapidly expanding along with the economy, including tourism, healthcare and financial services – developments all avidly followed by a fast-growing middle class, who are increasingly demanding more financial products, from mortgages to loans.

Agricultural investment in Ghana is also facing a renaissance, as less than a quarter of arable land is cultivated and most farming currently is simply at the mercy of the rains, giving rise to opportunities to invest in much-needed, yield-enhancing, irrigation infrastructure.

Retail banking still seen as too risky

Banks are still demonstrating a reluctance to invest in retail banking. It is estimated that Ghanaian banks accrue only 20% to 40% of their earnings from retail banking, making most of their profits from corporate clients. In part this is due to practical credit risks, such as the country still not having reference bureaus or a national identity system, which means that if people do not service their debts there may well be no consequences for them, in practice, as they could evade detection relatively easily.

The government has recently passed a law which will make it easier for banks to realise collateral from borrowers who have defaulted, although progress in this area is still somewhat slow and risks for banks are perceived to remain too high. Ghana represents a huge untapped potential for banks, with approximately only 5m out of 24m inhabitants having bank accounts.

Data also points to Ghanaian banks having a preference for remaining very liquid. Measurement of the banks’ capital proportionate to their exposure, ie the average capital adequacy ratio (in February) was a somewhat elevated 18.5%: to put this into perspective, the Basel Accords have a requirement of a minimum of 10%. The loan-to-deposit average ratio was, again in February, 61%, also demonstrating excellent liquidity.

Bank of Ghana drives significant reforms

There have been important changes recently implemented by the Bank of Ghana (BoG) which have put the crunch on banks by mandating that all banks in the country recapitalise in order to meet the new minimum capital requirement of GH¢60m ($39m) before December 2012 – a huge increase from the previous GH¢7m ($4.5m) requirement. The Governor of the BoG, Kwesi Arthur-Amissah, has also signalled that he may instigate a set of reforms that could see all banks in Ghana listed on the local stock market.

The Governor remarked: “I have always wondered whether the next set of reforms should not require every bank to be listed on the stock market”, at the launch of the latest Code of Standards of the Ghana Association of Bankers (GAB) this year, further observing that such a directive would be “a definite boost for corporate governance and enterprise-wide risk management”.

The Governor noted that many of the initial attempts made by banks to raise capital locally by floating on the Ghana Stock Exchange (GSE) have been oversubscribed or successful. The BoG, however, understands that it needs to start attracting more players onto the stock exchange to start a herding effect – banks are currently put off by the limited amount of liquidity on the exchange, which comprised just $37m in the first quarter of 2011.

Critics, mainly from the GAB, have argued against the recapitalising initiative, stating that it will lead to ‘artificial’ mergers and acquisitions. A firm believer that free market forces should be the ultimate regulator in the industry, the GAB has stated that competition and maturity in the sector should be allowed to determine the adequacy and expansion ratios of individual banks and that the minimum requirement is placing pressure on banks to raise capital that they may not need.

For example, Ecobank Transnational Incorporated (ETI), in August was already in the process of finalising the acquisition of a large stake in Trust Bank Limited (TBL), due to TBL struggling to meet the required GH¢60m ($39m) before the December 2012 deadline.

Forced to change strategy

The balance sheets of banks in the country have grown rapidly in recent years, with assets increasing around 30% in 2009 and 25% last year; deposits have also been on a high, increasing at the rate of 31% in 2010.

Yet many experts are predicting that these encouraging trends will force banks to change their strategy, as lower interest rates will start cutting into lending margins. This puts the greatest pressure on the smaller banks, which will feel the crunch on their return on equity to a greater extent than their larger peers.

However, this increasingly competitive environment is also likely to provide a strong impetus for banks to become more innovative in their products and not to rely so much on current accounts, commercial vanilla loans – those with fixed interest rates and fixed terms – and letters of credit.

Victims of their own success to some extent, Ghana’s prudent lenders in a rising economic tide have proportionally many banks – 27 in a country with a GDP of an estimated $61.97bn in 2010 – and an environment yielding excellent returns that is likely to attract the interest of major foreign lenders.

With the double whammy of an escalation in capital requirements as well as competition driving down interest rates and margins, the sector is ripe for consolidation as scale becomes the order of the day. The possession of enough scale on the one hand, and diversity of lending exposure on the other, are going to be the key factors if lenders are to flourish in an environment in which currently 17% of loans fail to perform. N