Ghana: Selected Issues
Author: International Monetary Fund
Publication Date:
19 Jun 2007
eISBN:
9781451814972
Language:
English
Keywords:
ISCR; CR; Ghana; IMF staff estimate; asset quality; bank portfolio; investment climate; bank credit; Ghana's financial system; Stock markets; Personal income; Securities markets; Nonbank financial institutions; Sub-Saharan Africa
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This Selected Issues paper examines competitiveness and the equilibrium real exchange rate for Ghana. It estimates a behavioral equilibrium exchange rate model for Ghana to establish to what extent real effective exchange rate (REER) movements have been driven by an adjustment to its equilibrium values, consistent with changing fundamentals. The paper discusses measures of Ghana’s external competitiveness other than the gap between the actual and the estimated equilibrium REER. Achievements, challenges, and priorities in the areas of public financial management, wage policy, tax administration, and tax policy are also described in detail.

Abstract

This Selected Issues paper examines competitiveness and the equilibrium real exchange rate for Ghana. It estimates a behavioral equilibrium exchange rate model for Ghana to establish to what extent real effective exchange rate (REER) movements have been driven by an adjustment to its equilibrium values, consistent with changing fundamentals. The paper discusses measures of Ghana’s external competitiveness other than the gap between the actual and the estimated equilibrium REER. Achievements, challenges, and priorities in the areas of public financial management, wage policy, tax administration, and tax policy are also described in detail.

III. Financial System and Capital Market Development in Ghana1

A. Introduction

1. Ghana’s financial system has been undergoing a major transformation during the past few years. While the financial system is relatively small, ongoing structural reforms and gradual liberalization of the sector have paved the way for a rapid financial deepening since 2004 (see Chapter V). The banking system is profitable and reasonably sound, and competition has been increasing in recent years as more foreign banks are moving in. The nonbanking sector—the insurance, social security, and pension funds—is also growing, albeit from a very low base. The financial infrastructure, such as payment and settlements systems and automated trading, is also being strengthened. The regulatory and supervisory environment is broadly adequate, but new challenges will require continued vigilance and improvements. The authorities introduced a Financial Sector Strategic Plan (FINSSIP) in 2003, which provides for the medium-term direction of financial sector reform. The FINSSIP’s emphasis is on regulatory and judicial reform, institutional capacity building, protection of private property rights, and competition. The authorities are presently preparing a financial sector strategy note (FSSN) jointly with Fund staff that will take stock of progress thus far and provide an updated assessment of key priorities. In particular, it will consider issues related to the development of domestic capital markets (bond, equity, and money markets) and assess banking sector systemic risks.

2. In this paper, we review recent developments in the financial sector and supervision in Ghana, and identify an updated reform agenda. Section B reviews the financial sector’s structure and trends. The performance and supervision of the banking sector, capital markets and nonbank financial institutions are analyzed in Sections C, D, and E, respectively. Section F concludes.

B. Structure and Trends

3. Ghana’s financial system is dominated by the banking sector. At the end of 2005, banks’ assets amounted 37 percent of GDP and accounted for two-thirds of the financial system’s total assets (Table III.1). The largest commercial bank—Ghana Commercial Bank (GCB)—is 35 percent owned directly by the government; additional ownership by stateowned entities increase the de facto government ownership to over 50 percent. A planned increase of the capital of the GCB, in which the government will not take part, is expected to lower the government stake in the bank. The other two largest banks are majority foreignowned. Since 2005, five new regional banks have been licensed in Ghana.

Table III.1.

Ghana: Financial System Structure, end–2005

article image
Sources: Bank of Ghana and IMF staff calculations.

4. Nonbank financial institutions (NBFIs) play a limited role in Ghana’s financial system. The largest NBFI is the state pension fund (Social Security and National Insurance Trust, SSNIT), which at the end of 2005 accounted for 18 percent of financial system assets. The networks of credit unions and rural banks rival that of bank branches in terms of number of offices, but their share in financial system assets is small. Other NBFIs include insurance companies, discount houses, and mortgage finance companies.

5. The other financial markets, in order of size, are the stock market, the government bonds market, and the interbank money market. At present, there are 33 listed companies on the Ghana stock exchange with a market capitalization of 95 percent of GDP at the end of 2006. However, this measure exaggerates the importance of the stock market in the economy, as one global company with headquarters in South Africa—AngloGold Ashanti Ltd.—accounts for 70 percent of the stock market capitalization. The end-2006 capitalization of the Ghana S&P/IFC Global Frontier Market Index, which includes only locally domiciled companies that are among the most actively traded securities in the market, was just 4 percent of GDP. The end-2006 gross domestic government debt, including non-tradable obligations, was 20 percent of GDP, and the outstanding interbank borrowing at the end of 2006 was less than 2 percent of GDP.

6. The population’s access to financial services remains low. Ghana ranks low in financial access with 1.4 bank branches per 100,000 inhabitants in 2004, down from 3.2 in 1998 before the banking sector was rationalized (Aryeetey and Machiko, 1998). This compares with an average of 5.6 in middle-income Sub-Saharan Africa countries (Beck, Demirguc-Kunt, and Martinez Peria, 2005; Claesssens, 2005). Only 5 percent of Ghanaians have a formal bank account.

7. Ghana’s financial system and markets was at a broadly at a similar stage of development as other low-income countries in Sub-Saharan Africa and ranked lower than middle-income countries in SSA on a number of measures of financial deepening, such as the ratios to GDP of M2, private sector credit, and bank deposits. However, Ghana is catching up rapidly, thanks to the progress made since 2004 (Table III.2).

Table III.2.

Ghana: Average Indicators of Financial Development Relative to Peers, 2000–04

(In percent)

article image
Source: IMF, Regional Economic Outlook - Sub-Saharan Africa, 2006, and International Financial Statistics.

Includes foreign currency deposits.

C. Banking Sector

Capital adequacy

8. The banking sector as a whole appears to be well capitalized. At the end of 2006, the aggregate regulatory capital to risk-weighted assets ratio (RCAR) was around 16 percent against a minimum requirement of 10 percent (Table III.3). However, the financial soundness indicators reported by the Bank of Ghana appears to overestimate capital adequacy, as current year profits are allowed in the calculation of regulatory capital.2 But even correcting for this, the aggregate capital adequacy ratio was above the statutory minimum in recent years; in 2006, for example, it exceeded 12 percent.

Table III.3.

Ghana: Financial Soundness Indicators, 2003–06

(In percent, end-of-period, unless specified)

article image
Source: Bank of Ghana.

Average lending rate minus average (saving and demand) deposit rate.

Asset quality

9. Asset quality has markedly improved in recent years. The share of nonperforming loans (NPLs) in the aggregate bank credit portfolio has declined to 8 percent in 2006 from as high as 18 percent in 2003. Moreover, existing NPLs are almost fully covered by provisions (Table III.3).

10. The decline in the aggregate NPL ratio was due to both better loan recovery and rapid credit growth with most of the new loans remaining performing to date. Bank credit to the private sector has grown at an average rate of 36 percent over the last five years (43 percent in 2006). The gradual macroeconomic stabilization over the period has allowed the growth by over 2 percentage points of the ratio of private sector credit to GDP in 2005 and 2006 (Figure III.1). Most of the new credits are given to the services, trade, construction, commerce, and manufacturing sectors of the economy. In 2006, manufacturing accounted for 23.6 percent of lending, followed by services with 21.0 percent, commerce with 18.4 percent, and construction and quarrying with a combined share of 19.3 percent. Small businesses have not yet fully benefited from the availability of credit. A recent assessment of Ghana’s investment climate found that restrictions on access and cost of capital were more severe for local firms in Ghana than in, for instance, Kenya and Tanzania (Teal, 2005).

Figure III.1.
Figure III.1.

Ghana: Private Sector Credit by Deposit Money Banks, 2001–06

(In percent of GDP)

Citation: IMF Staff Country Reports 2007, 208; 10.5089/9781451814972.002.A003

Source: Ghanaian authorities and IMF staff estimates.

Profitability

11. Banking sector earnings are normalizing. Increased competition and declining risk-premiums in the stable macroeconomic environment have lowered banks’ return on assets and interest rate spreads. Average return on assets has declined from 6.2 percent in 2003 to 4.3 percent in 2006, bringing Ghana closer to the SSA average (Figure III.2). Banks’ returns on equity have declined faster, reflecting the build up of shareholders’ capital over the period. Interest rate spreads have been declining recently, but, at over 18 percent in 2006, they remain quite high (Table III.3). The elimination of the secondary reserve requirement in mid-2006 and increasing competitive pressures in the banking sector have contributed to some decline in interest rate spreads. But spreads are still high, relating to inefficiencies in banking operations, not fully sufficient competition, inadequate collateral sources for some firms and remaining weaknesses in the legal environment, as well lack of a credit information base on borrowers that heightens the riskiness of lending for banks. The latter will be addressed by the establishment of a credit bureau, as authorized in the recently passed Credit Reporting Law.

Figure III.2.
Figure III.2.

Banking Sector Profitability (RoA), 2005

Citation: IMF Staff Country Reports 2007, 208; 10.5089/9781451814972.002.A003

Source: BankScope.

12. Persistently high overhead costs signal inefficiency. The ratio of overhead costs to total assets in Ghana has remained in the range of 7-9 percent since 2001, compared to an average of about 6 percent in SSA countries and even lower in other middle-income countries (Table III.4). On this measure the situation does not seem to be improving; a recent Bank of Ghana (BoG) Monetary Policy Committee report stated that all measures of operational efficiency had improved except for cost to income and cost to total assets.

Table III.4.

Ghana: Bank Overhead Costs to Total Assets Relative to Peers, 2001-05

(In percent)

article image
Source: Thorsten Beck, Asli Demirgüç-Kunt and Ross Levine, 2000, “A New Database on Financial Development and Structure,”World Bank Economic Review,14, 597-605.

Liquidity

13. The banking sector appears to be liquid. The ratio of broad liquid assets to short-term liabilities has hovered above 70 percent in 2003-2005. In August 2006, the BoG eliminated the secondary reserve requirement for deposit money banks, which further freed up funds.

Risks, opportunities, and reform agenda

14. The supervision of the financial system has improved significantly in recent years. According to its self-assessment, the BoG has implemented the recommendations of the 2003 Financial Sector Assessment Program (FSAP) update. The BoG continues to upgrade the supervisory skills of its staff and the quality of the onsite and offsite supervision, and it is planning to move toward risk-based supervision and the more risk-sensitive Basel II regulatory system in the not too distant future. Since 2004, the BoG publishes a Financial Stability Report (currently on a bi-monthly schedule) that presents developments in the aggregated balance sheet and income statement of the banking system. The analysis makes use of aggregate financial soundness indicators. BoG staff is enhancing stress–testing on groups of banks and individual banks, with support by IMF staff. The BoG plans to include stress-test analysis on groups of banks in its future Financial Stability Reports and perform stress–tests on individual banks as part of its internal operations.

15. A number of measures have been taken to contain the main risks facing the Ghanaian banking sector. The 2003 FSAP Update highlighted in particular the high exposure of one systemically important bank to the Tema Oil Refinery (TOR) and the sizable share of non-performing loans in bank portfolios. Banks’ ability to withstand possible future deterioration of asset quality has been enhanced by the 2006 increase in the minimum capital requirement for banks, which was met by all banks. In addition, the risks stemming from the high exposure to the TOR have been reduced by the securitization of the loan by the government. Moreover, following the planned divestiture of TOR, high exposure by the aforementioned bank may be further reduced. Measures taken by the government to invigorate the secondary government bond market would give banks a lower–cost option than the rediscount window for accessing liquidity.

16. The passage of the Credit Reporting Law and the recent elimination of the secondary reserve requirements are expected to spur banking activity. Since the elimination of the secondary reserve requirements in August 2006, some banks have reduced their minimum deposit requirements, making financial services more affordable to the public. The new Credit Reporting Law requires all banks to submit credit details to a reporting bureau, which is now being set up and is expected to begin operations before the end of 2007. Enhanced information flow is expected to lead to better and faster credit assessment and extension of lending to other sectors, especially small and medium enterprises. In the medium term, a system for rating corporate loan applicants would further enhance transparency and lower lending risks. Further improvements to the legal system to enhance protection and enforcement of creditor rights will help to deepen confidence in the system.

17. Other financial reforms, underway or planned, to deepen the financial system and keep it stable are new prudential regulations, an upgrade of the payments system, and reinforcement of BoG supervisory capabilities. New, more risk sensitive prudential regulations will be needed in the context of the ongoing rapid financial deepening. Additional reforms of the payments system are also needed. Among reforms underway or being considered are linking rural banks through a wide area network, technologies to make all ATMs interoperable and facilitate “smart card’ use, electronic processing of bulk payments, changes in the treatment of large value payments, and legislation with respect to bankruptcy and data protection.

18. Despite the entry of new banks, competition in the banking sector can be further enhanced. Following the licensing of five new regional banks, the authorities have shifted the focus of their licensing strategy to target larger, internationally reputable banks that could enhance know-how and cost efficiency.

D. Capital Markets

Structure and trends

19. The primary government bond market is organized around a system of primary dealers and functions relatively well. Financial institutions are selected to participate in the primary auction conducted by the central bank. Auctions are held weekly on a uniform price format. The announcement to the market is comprehensive, based on the financing requirement target of the Government, including any Treasury bills the BoG has issued for monetary policy purposes. Treasury bills are now issued with 91 day, 182 day, and 1-year maturities. In December 2006, the government issued a five-year bond in domestic currency, which was met with heightened interest by investors. The issue was strongly oversubscribed with around 80 percent of the securities bought by foreign investors, following the gradual liberalization of the capital account.

20. However, the secondary government bond market is illiquid and inactive. This is due to the fact that most of the government debt, not held by the central bank, is bought by commercial banks, which hold the bonds until maturity, due to the dearth of alternative low-risk investments (Table III.5). Although the medium-term bonds are listed on the Ghana Stock Exchange, secondary trading is virtually nonexistent. Increased foreign participation in long-maturity bonds, through tighter pricing spreads and other market practices, could help stimulate the secondary market.

Table III.5.

Ghana: Ownership Structure of Outstanding Government Debt, 2001–05

(In percent)

article image
Source: IMF staff and Ghanaian authorities.

21. The development of the corporate debt market has been slow due to numerous market imperfections. The absence of a proper yield curve has negatively affected the ability of corporate issuers to borrow in the domestic market. The debt portion of the capital structure of the corporations tends to be short-term, exposing them to a funding mismatch when long–term capital expenditure is financed by short-term bonds (Yartey 2006). Progress in this area was made in December 2006, when the government issued a five–year government bond with an yield of 14.5 percent. In addition, the authorities are considering market and institutional reforms to increase secondary market trading. It may be particularly necessary to review the policy on commissions, so that the exchange can have the flexibility to charge different rates based on the issuer’s financial and business profile.

22. Although the stock market has been a source of financing for corporations, it is still small and illiquid. Trading is discontinuous with total value traded below 1 percent of GDP and a turnover below 4 percent (Table III.6). The principal limitation on the growth of the exchange is the shortage of new private issues, including from privatization. There are sizeable corporations that have chosen not to access funds through the stock exchange, because of high commissions and underdeveloped settlement and accounting processes.

Table III.6.

Ghana: Stock Market Trading Activity Relative to Peers, 2001–05

(In percent)

article image
Source: Thorsten Beck, Asli Demirgüç–Kunt and Ross Levine, 2000,"A New Database on Financial Development and Structure, "World Bank Economic Review, 14, 597-605.

Ratio of the value of total shares traded to average real market capitalization.

Opportunities and reform agenda

23. With regulatory reforms of the Ghana Stock Exchange largely in place, the challenge now is to broaden the investor base. Under the Financial Sector Strategic Plan (FINSSIP), the authorities have committed to building capacity, using outreach programs to raise public awareness, and training users of the stock market on the role it can play in economic development. Because the state pension fund will continue to be the dominant player on the exchange, much will depend on how it seeks to diversify its portfolio.

24. The authorities place high priority on upgrading debt management capacity as Ghana enters the international bond market and the domestic bond market grows. It will be necessary to use a consistent strategy to coordinate domestic and foreign bond issues, using a risk management formula that keeps debt sustainable. The proceeds of foreign bond issues are to be assigned to projects that are expected to have a high rate of social return. Among reforms planned are introduction of a predictable bond auction calendar, rationalization of bond issues and maturities to provide benchmarks for the market, reform of the system of primary dealers to make the market more efficient, and enhancement of communications with the investor community. Again, the challenge is to diversify the investor base, which can be done by issuing a variety of instruments suitable for different investors, after analyzing investor needs as part of a well–defined debt management strategy. Over the medium term, the impact of high public sector borrowing may need to be reconsidered in order to encourage the banking sector to lend more widely.

25. The development of capital markets can be further stimulated by relaxing the remaining capital controls. In 2006, the Foreign Exchange Act eased certain capital controls. Both residents and nonresidents can freely acquire capital market instruments, except that if banks wish to acquire more than 10 percent of an issue, they must have prior approval from the BoG. To issue bonds in the local market, nonresidents must also have approval from both the BoG and the Securities and Exchange Commission. At the same time, there are still many restrictions on nonresident activity in the money market. Nonresidents can only invest freely in instruments with maturity of 3-year or longer with all other money market transactions being either prohibited or requiring the BOG approval. Ghana’s gradual approach to capital account liberalization benefits from earlier experience of other countries—long-term flows, especially foreign direct investment, are liberalized first, to be followed by short-term flows.

E. Nonbank Financial Institutions

26. There is significant scope for expanding the activities of nonbank financial institutions (Table III.7). In the past, the development of the sector was to some extent held back by the lack of suitable investment opportunities in the domestic market. SNNIT and the insurance funds are the largest nonbank investors in the bond market. The lengthening of government bond maturities would benefit them immensely by allowing for a better matching of the maturity of their assets and liabilities.

Table III.7.

Structure of Nonbank Financial Institutions, 2004

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Source: IMF, Financial Sector Profiles.

27. Significant reforms at the state pension fund (SSNIT) have minimized the governance-related vulnerabilities identified in the 2003 FSAP Update. There is scope for the SSNIT to improve returns by outsourcing the investment management of some of its assets. To that end a private company has been appointed to invest certain assets, in partnership with local companies.

28. Regulation of other financial institutions has also been strengthened since 2005 by the passage of several laws, including the Insurance Act. These laws have brought the legislative basis of supervision and assessment of financial risks in line with international standards. The National Insurance Commission (NIC) has been provided with the resources to acquire the equipment it needs to fulfill its responsibilities.

F. Conclusion

29. Ghana’s recent financial deepening has supported economic growth, and the financial sector is well placed for further rapid development. Supportive laws and institutions are now in place and a stable economy offers a good foundation. The growth of long-term savings will provide assets to match with long-term investment instruments.

30. Ghana’s financial system is rapidly evolving. While the system is relatively small, continuing structural reforms and liberalization have allowed for rapid financial deepening. The banking system is profitable and sound; competition has been increasing in recent years as more foreign banks move in. The nonbanking sector, like the insurance, social security, and pension funds, is also growing, but from a low base. The financial infrastructure, such as payment and settlements systems and automated trading, is being built as part of the financial sector development plan.

31. A well-functioning capital market could diversify sources of funding for the economy and also reinforce financial stability. Currently, banks are the main source of credit, but as the economy becomes more sophisticated, it will be necessary to build up other parts of the financial sector to reduce the risk of banking sector overexposure and systemic risk during economic downturns. As pension and other institutional funds grow, they will need longer-term assets to match their liabilities. A well-developed capital market could also meet those needs, as well as providing a cheaper source of funding, which would ultimately spur economic growth.

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1

Prepared by Oduetse A. Motshidisi and Plamen Iossifov. Arnold McIntyre and DeLisle Worrell provided selected inputs.

2

The Basel I capital accord does not list current year profits among the balance sheet items that can be counted as regulatory capital.

Same Series

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Cover IMF Staff Country Reports
Ghana: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2007: Issue 208
Publisher:
International Monetary Fund
ISBN:
9781451814972
ISSN:
1934-7685
Pages:
95
DOI:
https://doi.org/10.5089/9781451814972.002

Ghana: Private Sector Credit by Deposit Money Banks, 2001–06

(In percent of GDP)

Banking Sector Profitability (RoA), 2005