A memo from Habibu Adam, a Senior Economist at the Office of the Senior Minister, in August 2017 sheds light on critical issues in the banking sector following the collapse of UT Bank and Capital Bank.
The memo, published in full below was addressed to the Governor of the Bank of Ghana and provides a sound analysis of culpability of each of the stakeholders for the challenges of the financial sector.
The document presents detailed insights into how the Government, Regulator, financial institutions and their customers were culpable in the banking sector challenges at the time, and makes recommendations for the way forward.
Many of the issues raised are applicable to recent events in the sector -- events that have led to the closure of five banks by the Regulator.
Read the full, unedited memo below.
TO: The Governor, Bank of Ghana
FROM: Senior Economist, Office of the Senior Minister
THROUGH: The Senior Minister, Office of the President
SUBJECT: Developments in the Financial Services Sector. Who is culpable?
DATE: 24th August 2017
As a former worker of the financial services industry for nearly ten years, I wish to share some few perspectives of the Sector with you to help your decisions in the future. It is actually an article I wish to publish but will want to share with you for your thought. It is written devoid of any quotation of Banking Laws or financial jargons for the understanding of the ordinary and less educated Ghanaian.
Ghana's financial services sector has come under scrutiny after the takeover of UT Bank and the Capital Bank by the GCB Bank Ltd. This is coming nearly two years after Bank of Ghana suspended the operations of DKM and God's Love Microfinance. These crises, in my opinion, exposed the frailties in the financial system and why the perceived lax regulatory regime could jeopardise the entire system.
The problem is multi-dimensional blamable on the key stakeholders-the Government (as in its policies), the Regulator (Bank of Ghana), the financial institutions and the customers of the financial institutions. Even though, the financial institutions and the customers are to take some of the blame for being smartly rationale in their dealings, the chunk of the blame is to be put on the door steps of the Regulator and government policies.
I would like to take each of the stakeholders in the ensuing paragraphs and discuss the reasons they are culpable for the challenges in the financial services sector.
Government policies can affect financial institutions positively or negatively. If government cannot control its macroeconomic indices and allow interests rates to rise or allow the cedi to depreciate speedily, then, there will be problem for the financial institutions.
For instance, in 2007/2008, the minimum capital requirement for banks was raised to sixty (60) million Ghana cedis at the time the dollar to cedi was 1:1. Today, that GHS60 million is less than $15 million dollars. It means that for no fault of the banks but government, the banks have lost 75% of the initial minimum capital requirement originally held.
Again, when government is borrowing in the domestic market at around 25% or more, at what rate should the private sector borrow? And what kind of businesses if not the riskier ones will attract interest rates of over 30%.
In the early 2000s when interest rate was above 40%, government came out with a policy of converting short-term instruments to long term instruments. Also by taking advantage of the HIPC Initiative, monies were made available which went into paying domestic debts, contractors and for development. Banks had surplus funds and were virtually chasing people to give loans. Today the story is the opposite.
In addition, government is the biggest spender in any economy. Therefore, how government awards contracts and pays contractors will have a significant impact on the financial services sector. To illustrate this, we look at the period between 2003-2008 just before the global financial crises, Ghana's economy grew consistently because of the positive developments in the financial services sector.
Government honoured its domestic debts payments, payments to contractors and suppliers of MDAs and MMDAs on time or within reasonable time.
Banks made supernormal profits and led to the influx of the foreign banks especially from Nigeria and the proliferation of the Savings and Loans and microfinance companies.
Unfortunately, government and Bank of Ghana have so far not done enough to protect or support the local banks from unfair competition from the foreign banks who either could not meet minimum capital requirement from their home Central Banks or have the advantage of cheap funds from their mother banks.
Also, when your economy begins to capitulate under four (4) years of Dumsor' with GHS2.4 billion energy sector debt and its crippling effect on the financial systems, government not able to pay contractors, suppliers to government agencies on time and a national debt of GHS132 billion for which nearly GHS10 billion will be required to service interest at the expense of development. How will the banks survive under these conditions as compared to the 2003-2008 period illustrated above?
According to BOG reports, growth in the financial sector's income before tax declined sharply from 54.4% in September, 2014 to 5.9% in September, 2015. Cost to income ratio for the same period rose from 75.4% in Sept, 2014 to 80.8% in Sept, 2015. Total assets growth declined from 41% in 2014 to 19.7% in 2015. Credit growth to the private sector declined from 26.6% in 2014 to 3.6% in 2015. (B&FT, February 2, 2016). The Non-Performing Loans (NPL) as reported earlier in January, 2017 was about 18% and majority of these debts are owed by government and its agencies as well as contractors who executed GOG projects.
REGULATOR, BANK OF GHANA (BOG)
The BOG has a mandate to undertake overall supervisory and regulatory authority in all matters relating to banking and non-banking financial business with the purpose to achieve a sound, efficient banking system in the interest of depositors and other customers of these institutions and the economy as a whole.
Licencing of the Financial Institutions
How are these financial institutions licensed? As at the last count in August, 2017, there were about thirty one (31) Universal Banks, twenty nine (29) Savings & Loans, twenty three (23) Finance Houses, One hundred and forty (140) Rural/Community Banks and about four hundred and twenty nine (429) Microfinance companies. There are also unlimited number of the finance institutions operating without licence.
It is reported that Nigeria with a population of 180+ million has only twenty two (22) banks with an unbanked population of 46%. Why will Ghana with a population of about 27 million have over 30 banks when they cannot cover more than 30% of the population?
Are the criteria for licencing these institutions strict enough? How can we have such huge numbers especially at the Microfinance level which are highly volatile?
Auditing of the Institutions
How are these finance institutions audited? The auditing of these finance institutions are done both remotely through prudential reports by the institutions and on-site audits.
What kind of reports are submitted to the Regulator? Does BOG investigate those reports? What kind of rates are quoted by the financial institutions for both the liabilities (deposits) and assets (loans)? Don't that send signals to the Regulator? If some financial institutions are quoting wrong rates which is widely perceived to be so, what is the Regulator doing about it? What sanctions are applied?
For the on-site audits, there is the need to take a relook at how it is done. It is widely perceived that the same audit team can audit the same institution for several years. Also sometimes, the excuses given by the financial institutions for breaches of the law are not tenable. Yet, no sanctions are applied.
There are no system audits in terms of going into the institution's core banking software and spooling list of depositors and loan clients. If the BOG Banking Supervision division does not have enough staff or expertise in some of the banking software, then they should outsource some of those jobs to the private sector.
Monitoring should not only involve on-site audits or perusal of prudential reports, but should include intelligent reports gathering. Often times, we hear a lot of worrying issues coming out of these financial institutions either as rumours or through leaked memos. How do the BOG treat those rumours or leakages? The sanctions regime for breaches of the various laws are not punitive enough. Some financial institutions in the country get licence to operate and within a short time they open branches everywhere. And these are branches that are visible and staff of BOG see and transact businesses in those branches without question. It should not be out of place for the BOG to plant officers in such institutions to monitor what is happening in those institutions.
Even though the BOG provides various risk management frameworks, regulations and prudential guidelines, such as Prudential Guidelines on Loan Classification and Provisioning, Single Obligor Provisions, Related Party Provisions, Investments in subsidiaries. These guidelines are flagrantly flouted with impunity. There is the need to overhaul the entire risk management framework and make it more robust and difficult for the institutions to take advantage of the weak systems.
The Collateral Registry which was established to help financial institutions confiscate properties used to secure loans is not effective. This is because even when the 'Certificate of No Objection' is issued for the confiscation of an asset, a court order will still be required to confiscate the asset. And the lawyers always have their way of stalling the process which ends up defeating the very essence of the Collateral Registry.
Transitioning Financial Institutions
The BOG must watch out for transitioning financial institutions. Especially those transitioning from Micro finance to Savings & Loans and to Universal Banks. These are one-man businesses that transform into bigger institutions. The owners have absolute control over the entire business and micro manage every action by management. They also intimidate and abuse staff of their rights and cow them into submission; that they cannot reveal the rots within the system they operate.
These businesses have ceremonial shareholders and board members who are only there to rubber stamp the decisions of these owners. Sometimes decisions are taken and implemented before the Board gets to know and at the blind side of the regulator. Even when the regulator gets to know, no action is taken or if taken, are not punitive enough?
THE FINANCIAL INSTITUTIONS
Most of the Ghanaian owned financial institutions are either owned by one individual or few individual partners with wide differences in shareholding giving one or two persons the controlling interest.
As a result, board members are selected to do the bidding of the controlling shareholders and only served as ceremonial board members. In some cases friends and family are brought in to hold shares in trust of the owners to give impression of broad-based ownership. Hence, these people have no say in major decisions of the company.
Management & Capacity Building
In some of these financial institutions especially for the Tier 1 (Universal banks) and Tier 2 (Savings & Loans) categories, there is adequate management expertise as most of them are poached from other universal banks. In some of them too, there is lack of capacity in some of the management members in handling some of the job roles and are occupying those positions by virtue of connection of social and family relations.
In addition, there is lack of training or refresher courses for management and staff of these institutions and they see training as additional cost to their operations. In some institutions, people can work for more than two years without going through any training in a dynamic industry like banking.
But the most dangerous aspect of these financial institutions is the lack of corporate governance structures. Even where the management personnel have the required capacity and expertise, they are often railroaded into taking sub-optimal decisions as those decisions are taken according to the whims and caprices of owners which often have serious repercussions on staff motivation, risk management and profitability among others.
This has been very appalling in most of the financial institutions. Either there is lack of expertise to handle some of the transactions or where the expertise exist, they are not allowed to work freely but under duress by either the owner or the Board.
In some institutions too, there is perceived staff connivance with some clients to defraud the institution in reaction for being mistreated or not being paid well. Also they perceived top management as cutting deals with top customers of the institutions. Other risk issues worth mentioning include:
- Poor structuring of facilities: Most of the institutions do not have good credit risk managers to structure facilities properly. Some operate with a straight jacket type of template for analysis for all types of loans whether project financing or salary loans. Poor analysis of cash flows and sometimes often relying on value of collateral instead of proper cash flow analysis to determine the ability to pay.
Often the owners or board members impose a lot of policy loans on the Credit Committees of those institutions to approve. Majority of these loans often go bad and are usually the major source of NPL of most of these institutions.
- Inadequate Monitoring: one of the important defects of lending among the financial institutions is lack of regular follow up on loans disbursed to customers. The financial institutions also do not enforce adherence to facility covenants. These encourage widespread diversion of loan proceeds among customers which results in loan defaults. Bank of Ghana should insist on thoroughly reviewing the credit files of all 100 largest exposures for evidence of facility monitoring in all inspections and examination.
- No or inadequate Due Diligence: It may sound strange to note that the level of due diligence carried out by financial institutions has been appalling. Name lending has been growing in significance recently more worrying among the big ticket credit requests since these transactions are likely to be somewhat sponsored by senior executives. Financial institutions do not submit the required information on borrowers as they choose which information to submit to the Bureau. This reduces the usefulness of information generated from the Credit Reference Bureaus as is often incomplete and out-dated
- Liquidity Mismatch: In some institutions, short term deposits are put into long term investments or assets. In addition, some of the depositor's funds go into opening branches and acquiring lots of non-income generating fixed assets. No proper analyses are done on maturing investments and often lead to liquidity crises. They are others who venture into areas they have no expertise or financial strength to operate and lead to huge losses.
- Over burdening expenses: The institutions especially the Savings & Loans and Microfinance do not match their income to their expenses. They often match their income on paper to their spending patterns. In addition, they poach staff from other financial institutions and often give them luxurious vehicles and twice or three times the salaries they were earning from their previous employers compounding their operational costs.
They open too many branches at a time resulting in huge operating cost on staff compensation, utilities which were very biting during the Dumsor periods, basic consumables and general overheads.
- Holding Company Concept: A recent phenomenon in the Ghanaian business environment is the Holding Company Concept. This is dangerous for deposit taken institutions as there is the tendency for the holding company to use a subsidiary (financial institution) as the cash-cow to finance activities of the other subsidiaries in unrelated industries which are often not properly managed and thus not profitable. This further deepens the woes of these institutions. Unless something is done about this phenomenon, these institutions can wreck a serious havoc on the financial system.
CUSTOMERS OF THE FINANCIAL INSTITUTIONS
The customers of the financial institutions are as guilty as the financial institutions themselves. They are motivated by greed to taking advantage of the poor loan governance regime of lending without monitoring to engage in unconventional banking practices. As a result, the wilful defaulters take advantage and defraud or cheat them.
Others behave irrationally by diverting funds (loans) meant for projects for other things like cars or other assets. Even when the banks are ready to finance all the projects of their customers as far as monies are coming in as and when certificates raised and payments made through the accounts of the financing institutions, the customers often go behind the banks to connive with the accountants of the contract awarding institutions mostly MDAs and MMDAs to pay the money through other channels, thereby denying the banks of their funds.
In addition, there is greed on the part of deposit customers who shop round for high and unreasonable deposit rates. These customers throw caution to the wind by falling for the tricks of some of these financial institutions who pay the highest deposit rates and then charge unrealistic rates on loans they grant their loan customers. Loan customers are unable to turn these loans over and are therefore unable to repay them resulting in growing Non-Performing Loans.
THE WAY FORWARD
- Ensure macroeconomic stability of the economy
- Ensure prudent financial management by ensuring proper and strict implementation of the GIFMIX programme so that payments for executed contracts can be made in good time.
- There should be incentives to protect the local financial institutions by ensuring that majority of the government MDAs and MMDAs route a minimum percentage of their business through the local financial institutions. The local financial institutions should have lower minimum capital requirement just as foreign traders are asked to show proof of certain amount of money before they can trade in Ghana.
- Government should do well to pay contractors and suppliers of MDAs and MMDAs in time to honour their obligations to the banks to reduce the Non-Performing Loans.
The Regulator, Bank of Ghana (BOG)
- The BOG must set limits for ownership/shareholding structure before transitioning one financial institution from one Tier to another. An elevated due diligence should be done on the majority shareholder especially for transiting financial institutions. This should conclusively deal with, aside the statement of networth usually required, all businesses the shareholder has interest in.
- Majority shareholders should be required to inform BOG before they venture into any business. No one person or institution related to the financial institution should own more than 50% of the total shares of the company.
- BOG must insists on institutional representations in the shareholding structure or on the boards of these transitioning financial institutions before being licensed to operate or transitioned from one Tier to another.
- BOG should set out different categories of banks with different capital adequacy ratio depending on their focus. The capital adequacy ratio of banks in the SME sector should be different from those in the energy or infrastructure sector.
- Outsource the on-site audits to private audit firms to be licensed according to a criteria to be determined by BOG. The criteria should include the following:
o There must have expertise in accounting, audit and banking system software common in the Ghanaian financial industry
o The Audit Firms should be in Tiers with different performance criteria. The higher the Tier, the higher the acceptability of the reports. This way, firms could be demoted for stated misbehaviour
oStandard ranges of audit fees for the various Tiers so that there is no incentive for any financial institutions to keep one Audit firm for several years to do their bidding.
o Under no circumstances should any one audit firm be allowed to audit any financial institution for more than two years. After which there will be a cycle of five years before a firm can audit same financial institution
-Although BOG approval is required for Executive approval, Bank of Ghana should set a minimum criteria required for people to occupy certain key positions especially in the Tier 1 and Tier 2 categories. The BOG must approve before such appointments can be made.
-BOG must set limits within a range for both deposit rates and interest rates for the various Tiers. The deposit rate should not be too wide from government's Treasury bill rate. Likewise the interest rate should also not be too wide from the policy rate of the BOG. This may not be a popular action for a free market economy like Ghana but is worth discussing with key stakeholders to bring down the rates.
-The BOG must put in place stringent and prohibitive measures to ensure that financial institutions do not just open branches unnecessarily and as and when they like. They should be punished severely including closing down those branches when flouted.
-The BOG should empower the Collateral Registry through a legislation to work with the courts to ensure that the 'Letter of No objection' issued out for confiscation of assets of defaulting clients are not subjected to undue delays.
- The BOG must find a way of enforcing the submission of credit reports on time to the Credit Reference Bureaus. Same should apply for the registration or submission of collateral reports to the Collateral Registry.
-There should be an enhanced scrutiny for the 100 largest exposures submitted by the financial institutions to the Bank of Ghana.
- BOG together with the Credit Reference Bureaus should find a way of blacklisting all serial wilful defaulters of the financial institutions.
- Institute proper corporate governance structures
- Recruit qualified personnel for the critical roles
- Improve the risk management practices
- Control expenditure especially those related branch expansions
- Abide by laws of Ghana and the Regulator
The customers who willfully defraud on the repayment will have difficulty transacting with any bank in the future and that could collapse their businesses as well.
I do hope this information will be helpful in better decisions to sanitize the financial system.
Mr. Habibu Adam
Office of the Senior Minister
Office of the President Annex