The least any business owner will do is to deliberately undertake transactions to undermine the future of his or her company that he or she has labored to build. The most basic financial impulse in to invest for the future, because the future is so unpredictable. But the bare fact is, not many of us get through life without having a little bad luck. Sometimes huge losses: Like results of the financial crises from 2013 to date. Risk teaches us that there are always unforeseeable events in the future, which will never lose their capacity to take us by surprise. Like the great depression in the 1930s 40s and the 2008 financial meltdown in the US.
A recent review by the International Monetary Fund (IMF) revealed that over 133 member countries had experienced significant banking sector problems from the 1980s and Africa had its fair share. Banking crises are not a new economic phenomenon, and similarly are not the only source of financial crises. Over the course of the past two centuries there have been a surprisingly large number of financial crises, as demonstrated in the attached figure. In understanding banking crises over time, it is useful to identify the causes in context with historic examples of banking collapses.
Figure 1. Banking crises in Africa From 1980 – 2010
Source: Laeven and Valencia, 2008
InJune 2016,I gave a contrarian, comprehensive account of the banking crisis, both its origin and extent but I also explained how the deeper problem was a type of public policy-making failure.
I’ve offered my own assessments, and obviously, I consider them valid. Decide for yourself.
“The failure in the microfinance sector is just a microcosm of greater challenges facing the overall financial sector. It is also believed that a number Non-Bank Financial Institutions (NBFI) are facing similar challenges and it is only time will tell when the authorities will have another set of challenges on their hands. Banks are quickly approaching their “automation tipping point,” and they are downsizing in the past three years, some on the quiet and others are in public domain. A case point is Standard Bank Ghana.”
The above is a quote from an article published in B&FT newspaper in June 2016. Fast forward 2019, so far, the central bank has revoked the license of 420 financial institutions on the grounds of insolvency.
- 347 microfinance institutions license has been revoked.
- Licenses of 9 insolvent banks were revoked. Others were merged to reduce the number from 33 to 23.
- 15 savings and loans companies, eight (8) finance house companies, and two (2) non-bank financial institutions that had already ceased operations.
- Security and Exchange Commission (SEC) has revoked the license of 5 Investment Banks and voluntary cessation of operation by 6.
- SEC is investigating 21 Fund Managers whose depositors’ funds of about 5 billion cedis are tied up.
Banking crises can be caused by inadequate regulatory oversight, government policy failure, macroeconomic instability, bank runs, positive feedback loops in the market and contagion.
Conditions Leading up to the Banking Sector Crisis from 2012 – 2016
Growth Trends After 2012
On a macroeconomic level, generally, Ghana had a steady growth up 2012 when growth started slowing to the lowest since the fourth republic.One major indicator of a country’s macroeconomic performance is real GDP growth. Ghana’s growth record was quite erratic prior to the mid-1980s when the country embarked on economic reforms.
From a reasonably high GDP growth of 11% in 2011, the economy of Ghana began to record a consistent year on year slowdown in GDP growth reaching the lowest of 3% in 2016. The performance of the financial sector of our country depends on the performance of the larger economy and the sluggish growth of the economy has made many businesses unprofitable rendering borrowers unable to repay their loans. Lower rate of non-performing loans indicates the improvement in the real economy of the country and the opposite is also true.(see Figure 2).
Fig. 2. GDP Growth Trends from 1960 – 2017
Source: World Bank data
2012 Election Year Economic Shock
For the past 30 years Ghana records an average 6.5% budget deficit but in 2012 Ghana recorded 12% budget deficit, which is the highest ever recorded in the fourth republic. Despite the huge budget deficit, shortfall in Government’s revenue performance, culminated in Government’s decision to go the IMF in 2014 for balance of payment support. Coupled with 4 years of ‘DUMSOR’, the country never really recovered from 2012 economic shocks.
Fig. 3. Budget Deficit/Surplus from 1992 – 2017
Source: IMANI Ghana website
Three Years of ‘Dumsor’
It is clear that the power crisis affects the production and overall operations of companies expensively. Three years of ‘dumsor’ had lead most companies to resort to alternative electricity supplies such as generators to as the number coping strategy to deal with the blackouts.In the 2013 World Bank Enterprise Survey on African countries, including Nigeria and Ghana, it named poor electricity power supply as one of the biggest barriers to growth of the countries’ economy, and hindrance to many multinational investors. Banks and financial institutions in Ghana were not spared about the disastrous effect of ‘dumsor’,they resorted to running on generators 24hrs. Increasing their cost of operation astronomically to the extent that most banks started recording losses which further culminated into impairment of their capitals.
In the U.S. recession is defined as a period of general economic decline and specifically as a decline in GDP for two consecutive quarters. The roots of a recession and its true starting point actually rest in the several quarters of positive but slowing growth before the recession cycle actually begins. . On this measure, one could say that the Ghana’s economy was in depression somewhere between 2012 -2016.
Non-Performing Loans (NPL)
Ghana’s banking sector faces several obstacles such as bad loan culture as well as underdeveloped capital market which mostly depend on the mobilization of the savings and granting credit facilities to businesses by the commercial banks non-bank financial institutions (NBFIs). It is known to all that entire non-performing loans shrink the profitability of banks. Non-performing loans decrease the loanable fund of the banks and it stops the recycling banking business. Bank needs to create high percentage of provision to cover high percentage of non-performing loans. All kinds of non-performing loans reduce the profitability of the banks and banks face capital impairment problem which has impacted on our banking sector badly.
Fig. 4. Interdepency of NPL, Bank Performance and the Economy
Source: European Commission
A high volume of non-performing loans cannot be a boon for the economy. If the invested funds in an economy are not recovered, it limits the recycling of the funds is reduced by the amount of classified loans which may lead to economic stagnation. NPL affects banks’ profitability adversely because of the provision of classified loans and consequent write-off as bad debts, reduces return on investment (ROI), and disturbs the capital adequacy ratio (CAR). It also increases the cost of capital, widens assets and liability imbalance and upsets the economic value additions (EVA) by banks. EVA is equal to the net operating profit minus cost of capital. Banks may face liquidity problem due to high rate of NPL amount.
“The stock of NPLs increased from GH¢7.15billion as at end-April 2017 to GH¢8.63billion in April 2018 – a new record high, according to the Bank of Ghana’s report published in May 2018. It was reported that about a fifth of the banking industry’s loan portfolio was impaired or went bad between the period with the capital adequacy ratio exceeding the 10% statutory limit.” B&FT.
This is more than enough time to gain perspective, collect the evidence, apply some logic, and achieve a valid conclusion, so such crises won’t recur in the future.
Domestic Consequencesof the Banking Crisis
Within a given system, banking failures create a range of negative repercussions from an economic perspective. Banks coordinate and economy’s savings and investment: the act of pooling money to capture higher returns for everyone while simultaneously funding business dependent upon leveraging debt and equity. With this in mind, a banking crises can have a variety of averse individual and economic consequences within the system.
First and foremost, investment suffers. When banks lack liquidity to invest, businesses that depend upon loans struggle to raise the capital required to execute upon their operations. When these businesses cannot produce the capital required to operate optimally, sales decline and prices rise. The overall economic performance of any debt-dependent industries becomes less dependable, driving down consumer and investor confidence while reduce overall economic output. Banks also perform more poorly, due to the fact that they have less capital to invest and returns to acquire.
This drives down the overall economic system, both in the short term and the long term, as companies struggle to succeed. The fall in liquidity and investment drives up unemployment, drives down governmental tax revenues and reduces investor and consumer confidence (damaging equity markets, which in turn limits businesses access to capital). There is a distinctive cyclical nature to these adverse effects, as each are interconnected in a way that creates a domino effect across the domestic economic system.
Which Way Out of the Crisis?
- Economic remedies to save the system from collapse are bound to fail so long as they remain within the framework of the existing capitalist system. Closing down financial institutions is not going help the already precarious economic conditions with high unemployment.
- Changes that are required to revitalize the economy and turn things around point to a redistribution of wealth and income to increase mass consumption
- This would increase demand for consumer goods, hence increase production, and create jobs for the unemployed, as well as raising revenue for the state through corporate and individual income taxes
- All these would require a restructuring of the economy away from failed taxation driven policies and toward a new set of priorities that promote production and employment of working people.
- And this would, in turn, benefit society greatly and set us on a prosperous course that would vastly improve living standards and pull us out of the economic crisis.
From the above observations, it is overly clear that there is have significant dependency between macroeconomic factors and the loan portfolio profitability in banks. The banks’ ability to earn interest income depends on credit risk management quality in different stages of business cycle that is highly related to the non-performing loans problem. The necessity to assess the not only debtor’s specific but also external factors is evident.
The performance of Ghana’s economy has shown that the banks’ loan portfolio profitability was negatively affected by the downturn of the country’s economy in 2012 –2016. The main problem in banks was the sudden growth of non-performing loans that reduced the further lending decreasing the loan portfolio quality and amount. The demand for money in banks became low and the interbank interest rates started to fall. All these factors reduced the banks’ interest income and relatively the loan portfolio profitability declined. Finally, no bank or financial institution has ever survived bank-run, the uneasiness in the financial sector is only making the financial sector more vulnerable.
Drawing from the above, the deep macroeconomic unbalances, low economic growth, ‘dumsor’, non-performing loans, lack of customer deposit, high cost of operation resulting from ‘dumsor’, low liquidity had left their mark on financial sector. The consequence is the crisis in the financial system we are witnessing now. Though few pockets of financial institutions were involved in unapproved activities, the large majority were doing genuine business and creating hundreds of thousands of employment and supporting growth in the economy.
The next write paper will attempt to look at the processes adopted by Bank of Ghana in resolving the challenges facing the banking sector and the general economy as a whole.