Even as Ghana’s banking industry faces challenges from new minimum capital requirements, poor asset quality and insolvency, market forces and regulatory reforms have sharply increased both the number and types of financial intermediation companies in Ghana engendering fierce competition. While poor corporate governance is getting all the blame for the current high mortality rate in the financial intermediation industry, intensified competition is also playing a major role. TOMA IMIRHE examines the situation.
Until just a couple of decades ago, Ghana’s banks had a near monopoly over formal financial intermediation in Ghana. Rural banks were only introduced in the late 1980s while non bank finance houses did not begin to emerge until the mid 1990s. Micro finance institutions (MFIs) are an even moré recent genre having only been licensed by the Bank of Ghana since 2012. This allowed the banks – and there were only a handful of them – to luxuriate in armchair banking, since competition was minimal.
How the times have changed. Now there are financial institutions chartered to meet virtually every kind of financial intermediation need of investors, both foreign and local, covering deposits and financial deposit investments, as well as business financing needs.
The sheer numbers of such institutions have grown much faster than the types of genres in operation. Today there are still nearly 30 universal banks – despite the recent liquidation of seven indigenous ones and the spectre of more to come – of which there were just 12, two decades ago; about 150 rural and commercial banks, a genre that only took real hold in the early 1990s; some 70 deposit taking non-bank finance houses, another genre which only emerged in the mid 1990s; and nearly 50 savings and loans companies, a genre which is less than two decades only. But perhaps most instructively there are over 500 licensed MFIs, a genre only introduced for the first time at the beginning of this decade.
All these different genres are quite different in terms of their respective regulatory frameworks, their capital bases and their core target markets. However they have a most important shared characteristic: they are all competing for the deposits of private enterprises, public institutions and households across Ghana and are all using those deposits, along with their shareholders monies, to give loans and advances.
This means fierce competition for Ghana’s banks, indeed far beyond the competition they give each other, even though each genre engages in market differentiation and thus has different core target markets, both for depositors and borrowers.
Yet curiously, despite this intense competition, Ghana still has among the highest interest margins – the spread between what depositors are offered and what borrowers are charged – in sub Saharan Africa. This is widely seen as a failure of policy by regulators, rather than the result of market forces. Translate as the refusal of regulators to regulate interest rates despite a strong tendency for financial intermediaries to seek inordinate profits from inordinately wide interest margins.
However, the reasons for Ghana’s high interest margins, and thus until recently, the enviable profitability of nearly every bank in Ghana are deeper. Firstly, competition among the various financial intermediaries is not as fierce as the numbers indicate. Each type of institution has its own core target market and although these are increasingly beginning to overlap, the biggest factor considered in product and service pricing – risk – still varies widely for the different market segments.
Thus only the universal banks are competing for the business offered by the big corporations such as multinationals whereas only a few of those banks are in the market for the micro-sized enterprises serviced by MFIs. The non-bank finance houses and the savings and loans companies tend to target small and medium sized enterprises that the universal banks are reluctant to deal with because they are considered too risky but which the MFIs wish they could get but cannot because they themselves are considered too risky by the customers themselves. The rural and commercial banks on their part look for business from enterprises that are relatively small, but are renown in the communities where they and the banks themselves operate.
Yet this market differentiation is gradually beginning to fade away, and with it, the lines of demarcation that prevents the various genres of financial intermediaries from directly competing with each other. Users of financial products and services love this and are hoping the process accelerates. Ultimately, the expectation is that banks would then be serving micro-sized enterprises while savings and loans companies and non-bank finance houses would have some big corporations among their clientele.
There are several factors driving the reduction in niche marketing by financial intermediaries and a resultant increase in competition facing the banks across market segments.
The first and most important reason is the sheer need by various types of financial intermediary to expand their markets in the face of rising core capital requirements insisted on by regulators, which means more business volumes are required to keep shareholders happy with the returns they are getting on their investments.
This is especially the case with the universal banks who have all been struggling to win the accounts of the relatively big and well managed institutions, but who are now having to look down market, in part to diversify their loan portfolios, in part to widen their interest margins further- they can charge small firms more on their loans and negotiate lower deposit rates on small deposits such as savings accounts – and in part out of the sheer need to attract deposits from the lower market segment. As the BoG implements its impending recapitalization programme of the banks this need is intensifying and this will force the banks to go further into competition at the lower end of the market.
This has given distinct advantage to banks already focused primarily on SMEs such as Omni Bank who can use their unique expertise in this area of activity but instructively it is this category of banks that are finding it most difficult to meet the new minimum capital requirements. However several other banks have acquired the requisite expertise – and the clientele base to use it on –by buying existing savings and loans firms of MFIs (such as Fidelity Bank’s acquisition of Pro Credit S&L) or by setting up subsidiaries for this purpose such as Republic Bank’s establishment of an MFI of its own.
Conversely, the smaller institutions such as savings and loans firms and MFIs are looking up market in order to attract bigger deposits and lower the risk levels on their loan portfolios by lending to bigger, safer institutions and enterprises, both of which would be at the expense of the banks. While this is difficult because of their relatively higher cost of funds – they have to pay considerably higher deposit rates than the banks in order to attract depositors – and their relatively smaller financial capacity to provide funding, they are endevouring to include some medium sized enterprises in their respective clientele, using their relatively quick response to requests as their competitive advantage.
The second factor is the changing regulatory framework for the financial intermediation industry. Here, the Bank of Ghana which has regulatory oversight for all genres of financial intermediation companies (although it regulates the rural and community banks only indirectly, through the RCB Apex Bank), is deliberately reducing the demarcation between them. The clearest example of this has been the removal of the dichotomy between erstwhile commercial and merchant banks since the middle of the previous decade; now they are all universal banks with exactly the same operational and regulatory charter.
Importantly, the central bank has taken away the erstwhile monopoly of the banks to accept deposits. Several other genres are now allowed to accept deposits too, including non bank finance houses who, during the first decade following their introduction were only allowed to take wholesale investments from the public but not retail deposits.
This presents a veritable headache for Ghana’s banks. Non bank financial intermediaries, being involved in relatively high risk, high reward lending offer their depositors considerably higher deposit rates than the banks and despite the much higher risk to the depositors of losing their shirts (the corporate mortality rate in the MFI industry between 2013 and 2016 evidences this), many are willing to take the risk. This is forcing the banks to share part of their would be deposits with lots of competitors in other genres of financial intermediation. Importantly, the banking public now understands that banks too can collapse just like MFIs and savings and loans companies. Although government, through the BoG has ensured that no bank depositor has lost funds to bank failures, the public is also aware that this situation will not last much longer; soon depositors will only be protected to the severely limited extent of the cover provided by deposit insurance which will apply to all licensed deposits, bank and nonbank, anyway
But just as importantly, the BoG has restricted foreign exchange dealing to the banks, and even foreign exchange bureaux are only allowed to do over the counter cash transactions. Similarly, the financial intermediation genres other than the banks must still use the banks to clear cheques issued through them because the other genres are not part of the clearing house system. This is moot however, since the advent of electronic transfers enables customers of those genres to clear their monies on the same day just as the banks they use to clear their transactions do.
It is instructive that even as the banks complain about how savings and loans companies and MFIs are eating into their market share of deposits, the same banks tend to lend heavily to such enterprises for them to fund bigger business volumes than their own deposits would otherwise allow for. The banks’ strategy here is to let such specialist financial intermediation firms carry the inordinate credit risk in lending to micro and small enterprises.
The third factor is the growing mobility of skilled manpower between the various genres, which is giving the relatively smaller financial intermediaries the professional skills capacity to provide non-funded products and services that their bigger counterparts such as the banks themselves have dominated in, such as structured finance and business advisory services. Indeed, most of the smaller genres are now headed by professionals with banking experience, and whom have seen a move to the smaller genres as a quick way to move up the corporate ladder with regards to level of authority, which tends to have its own unofficial financial rewards.
This trend will be intensified by the ongoing staff lay offs resulting from bank liquidations over the past one year. For instance a significant proportion of the 1,700 employees of the erstwhile The Beige Bank will eventually find new jobs in non-bank financial institutions.
Actually though, the mobility of skilled labour between the various genres is adding to their operational costs because of the resultant competition between all the institutions involved for financial services professionals. This has resulted in a huge increase in salaries in the financial intermediation industry across board and the higher costs are effectively being passed on to customers in the form of wider interest margins and higher fees and commissions.
But easily the biggest reason why financial institutions are still able to obtain inordinate interest margins from the banking public is that the demand for loans still far outstrips supply.
Ghana’s business culture is one that requires that debt is the main source of financing even at high interest rates. Indeed gearing ratios in SMEs particularly (which measure the ratio of debt to equity in an enterprise) often tend to rise as high as 3:1.
-Actually, the much maligned banks who are blamed for their high lending rates because of inordinately wide interest margins, are the cheapest sources of loans. Currently the average base lending rate among the banks (this is the rate at which they each lend to their most favoured borrowers) is about 26% according to data released by the BoG. Base lending rates range between well over 30.0% and about 15%.
However these rates are deceptive. Only the very large corporations, which have huge cash flows, get to borrow at such rates. All the other borrowers do so at a spread above a bank’s base lending rate which can be as high as 10%, which means that some borrowers are taking bank loans currently at well over 40%.
The next cheapest are the savings and loans companies and the rural and community banks whose base lending rates generally average between 30% and 50% currently. The MFIs are the most expensive lenders and instructively they price their loans on a monthly basis rather than an annual basis, ostensibly because they rarely give loans of up to one year, because more practically because the latter would result in seemingly absurd annualized rates. MFI’s currently lend at between 5% a month and 10% a month which translates to between 60% and 120% per annum.
It is instructive that despite these high lending rates, virtually every lending institution get loan application volumes that far outstrip what they are willing to lend. This is in part because prudence persuades the banks themselves to invest at least a quarter of their interest earning assets in government treasury bills, notes and bonds, which themselves provide risk-free yields of between 16% and 22% currently. The other genres of financial intermediaries not only invest considerable parts of their loanable funds in these instruments but put some of the rest in bank fixed deposits as well.
Indeed, because of this, and their relatively small size, more than 90% of credit to the private sector originates from the banks themselves. Actually, this includes much of the credit given by the other genres, who tend to rely heavily on fund placements from the banks as a source of deposits.
Instructively, credit growth has slowed drastically since 2015 when it was revealed that many banks are suffering from poor risk asset quality and have been required by the BoG to make hefty loan loss provisions accordingly. This has made the competition to access credit more intense than ever.
With strong demand for loans by entrepreneurs and traders who traditionally prefer to rely on loans – even if inordinately expensive – than equity which would involve sharing ownership with financial partners, financial intermediaries are in a sellers market and are taking advantage of it. In effect, although the competition for customers among them is fierce, the competition among would be borrowers is even fiercer.
Another reason for high lending rates though is that the wide interest margins between lending rates and deposit rates are deceptive. While retail depositors are offered less than a third – sometimes less than a quarter – of what borrowers are charged, this category of depositors account for less than 50% of total deposits in most banks. The bulk of the deposits held by most banks are in the form of fixed deposits. These have the advantages of having fixed tenors so the banks know when their owners will come for them and also of tending to be relatively large in size.
But they do not come cheap. Most fixed deposit investors use yields on government debt securities to negotiate the interest rate they will receive, usually insisting on a premium above those yields and this means deposits that cost considerably more than the official statistics indicate.
But ultimately, the main reason why banks demand high interest rates is that they perceive most of their borrowers to be inordinately risky. Indeed this largely explains the interest rate differentials between the various genres. The banks have the relatively safest lenders, because they are relatively big, and until recently have been perceived as better managed and indeed still have relatively better track records than their nonbank counterparts.. The further down the rung a genre is – savings and loans firms, non bank financial lenders, rural banks and lastly, MFIs, the smaller, less well managed and thus more riskier they are. Since there is a direct positive correlation between risk and reward, this requires that the genres that deal with the riskiest borrowers have to demand the highest yields. Effectively the idea is to charge customers enough to ensure that those that pay can cover the losses incurred from those that default.
It is instructive that even the banks who have the relatively safest borrowers are suffering high loan defaults currently. Indeed the non-performing loans ratio (NPL) for the banking industry is at its highest level since the late 1980s when it got so high that a bailout by government and the World Bank as required to prevent the industry from collapsing.
By mid 2018 the NPL ratio was 23%, its highest level in decades. The NPL ratio for the other genres tend to be even higher because of the higher risk levels they run. The highest risks are taken by MFIs and to get around this they place the greatest emphasis on collateral and are the most willing to exercise those collaterals when defaults occur.
This risk and reward correlation works the same with deposits as well and the unusually high corporate mortality rate among financial intermediaries – including seven banks – in recent times has convinced most depositors to retreat to safe havens with little consideration for the interest rates being offered. The banks are correctly regarded by depositors as still the safest havens for their savings and investments despite their current travails and so can attract the lowest deposit rates – and now this is being accompanied by the fastest deposit growth rates again. The rates demanded by depositors rises through each genre in exactly the same way as it does with lending rates, with MFIs having to pay the highest deposit rates – currently of between 3% and 5% a month on average – since they are perceived to be the riskiest havens for depositors monies. The implications of this for the cost of funds for each genre cements the lending rate differentials between them.
This competition is a major factor – outside of sheer poor corporate governance and imprudent risk management – that has pushed some institutions over the brink. In recent years there has been a meltdown in the MFI sector led by the spectacular crash of DKM Microfinance, which took down over GHc100 million in deposits with. Several other MFIs also collapsed between 2013 and early 2016, leading to a deluge of deposit withdrawals which accelerated the meltdown. The situation has been stabilized somewhat over the past one year but depositors are now much more circumspect about the high interest rates offered by some MFIs, which are now correctly seen as pyramid finance schemes.
Several savings and loans firms have run into trouble too – the latest being First Allied – although these have been largely averted through new capital injections, takeovers and acquisitions.
Now such competition has contributed to taking the scalps of seven banks as well.
Intense competition from the various genres of non bank financial intermediaries however has come to stay even though financial industry consolidation, corporate failures and liquidations stand to reduce it somewhat. Even as they moan about it Ghana’s banks will simply have to get used to it.