Over the past few months, despite government’s dramatically increased fiscal deficit needs – forced on it by the dramatically increased public expenditure demands and significant revenue shortfalls brought about by the coronavirus pandemic – interest rates offered on public debt securities have hardly risen. This is the result of prudent, deliberate strategy by the Ministry of Finance towards financing the increased fiscal deficit whereby it has resorted to unconventional means of raising its needs, such as direct Bank of Ghana financing.
This means that the 200 basis points reduction in the interest rates applicable on both new on ongoing loans, during the period that the COVID 19 pandemic is afflicting Ghana, as agreed between government and the Ghana Association of Bankers, would not wipe away the risk premium demanded by banks for the loans they give to their customers. At the time that agreement was reached there were worries that lower interest rates on bank loans and higher coupon rates on risk free government debt securities would narrow that risk premium to the extent that banks would no longer see it as worth the risks that go with such loans to their customers.
But despite the preservation of a reasonable risk premium, banks are still reluctant to lend to their customers. This is because of the uncertainties in the economy and the fortunes of their customers going forward as a result of the COVID 19 outbreak. Simply put, banks can no longer evaluate their credit risks properly.
Their stance is understandable; after all over the past couple of years they have had to write off huge amounts from their respective loan books due to a peak in the incidence of non-performing loans. Banks first responsibility is to their depositors not to borrowers so it would be imprudent of them to use depositors monies to grant inordinately risky loans.
However, in an economy where enterprises clearly prefer debt to equity as a financing mode, less bank credit means inadequate working capital for business and none at all for expansion.
This is why there is the pressing need for Ghana’s financial markets to spread credit risk beyond financial intermediation companies. The way to do this is for business enterprises to issue commercial paper for short term business financing and bonds for longer tenured credit, but in both cases, leaving investors with the credit risk in exchange for higher interest rates than what they could obtain from fixed deposits which are guaranteed by the financial intermediary where the deposit is placed.
Using this financing mode, the financial intermediation companies earn issuing house fees rather than a much bigger interest margin since they are not taking on the credit risks themselves. But most importantly, it ensures that investors with an appetite for calculated risk make financing available for deserving borrowing enterprises.
To be sure there are considerable risks involved. Investments in commercial paper and bonds are not guaranteed their principal nor the accruable interest. But as long as potential investors are provided the requisite information to calculate their risks, there will always be both institutional investors and high networth individuals ready to invest in credit to companies with solid financials in exchange for higher returns than they can get from guaranteed deposits.
Ultimately, this would mean more readily available debt finance for deserving enterprises, even when the banks are understandably reticent about lending to them directly.