Journal Issue

Country focus: Why do Ghanaian banks behave uncompetitively?

International Monetary Fund. External Relations Dept.
Published Date:
June 2005
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Acompetitive banking system is important for effective financial intermediation—channeling savings into productive investment—and this, in turn, is a key to economic growth. A new study finds that an uncompetitive market structure as well as certain other characteristics of the banking system and economy are hampering financial intermediation in Ghana. Thierry Buchs, who recently transferred from the World Bank’s International Finance Corporation to Switzerland’s State Secretariat for Economic Affairs, and Johan Mathisen of the IMF’s Policy Development and Review Department, spoke with Jacqueline Irving of the IMF Survey.

IMF Survey:Why are banks in Ghana behaving uncompetitively?

Mathisen: The main reason is the government’s continuing financing needs; banks have been able to rely on interest earnings on their large holdings of treasury bills, with little need to compete for lending business in the private sector. A second reason is that large banks have advantages, including economies of scale, and the small savings base prevents smaller banks from emerging quickly. A third reason is that Ghana lacks an enabling business environment for the private sector. High investment costs might also deter new entrants—particularly costs of telecommunications, which are largely dysfunctional outside the main cities.

IMF Survey:Why did you do this research now?

Buchs: We were struck by the Ghanaian banking sector’s relatively high profitability indicators—significantly higher than those not only in many developed countries but also in other African countries and emerging markets. We thought these “super profits” were likely to be related to the market’s uncompetitive nature. To estimate competition in the market, we looked at banks’ financial statements, applying a model that had been derived and used for other markets worldwide since the 1980s but never before for an African country. We ran regressions using bank level data, allowing for bank-specific differences in the production function and differences in bank size and ownership. We then looked at the prices of factor inputs.

Mathisen: Our study, which relied largely but not solely on the model, grew out of an IMF Financial Sector Stability Assessment (FSSA) Update for Ghana in 2003. We also incorporated local bankers’ perspectives in our findings. The model’s framework is simple, testing whether marginal revenues equal marginal costs and the extent of any differential. This enabled us to come up with an overall score to determine the level of competition in the banking sector.

IMF Survey:Did you find that when interest rates—treasury bill yields—fell, as has happened to some extent in recent years, banks’ revenues and profitability declined in tandem?

Mathisen: We looked at the banking system’s dependency in terms of its interest earnings. This was very significant for the banks in both nominal and real terms and that indicated that banks are heavily dependent on this source of income.

IMF Survey:You see sustained fiscal adjustment—to further reduce interest rates and avert the crowding out of private investment—as necessary to deepen, and increase the efficiency of, the Ghanaian banking system. But fiscal lapses during election years have caused problems that have proved difficult to resolve in subsequent years. What is the way around this?

Mathisen: That’s a tough question. Continued fiscal adjustment is one prerequisite to achieving a higher level of competition and further developing all financial services in the economy. Reverting to the stop-and-go fiscal policies of the past would only prolong banks’ dependence on income from treasury bills. The government’s financing needs have had a key role in fostering inefficiency in the banking system. If banks were no longer able to rely on this huge source of revenue, they would have to start operating as banks again and look for business opportunities. A big question is whether the banking system’s ability to find and develop new, profitable opportunities has eroded because of its long-standing dependence on this easy income.

Buchs: Improvements in the business environment are essential to enabling banks to appraise investment projects, develop the proper credit culture, and start investing in private sector projects. Better protection of creditor rights, including the ability to seize collateral where necessary, is fundamental to banks’ willingness and ability to take risks.

IMF Survey:The risk-averse nature of banks in Ghana means small to medium-sized enterprises continue to face restricted access to bank financing. Could credit reference bureaus improve the sector’s efficiency, assuming macroeconomic conditions are conducive to the provision of bank credit to the private sector?

Buchs: Such bureaus can definitely provide part of the information banks need to be well informed about potential customers—including small and medium-sized enterprises that are not well known to the banks but that may be reasonable credit risks. It also will be increasingly necessary for banks to improve the quality of their loan portfolios. Ghanaian banks generally have high levels of nonperforming loans (NPLs)—around 25 percent of total loans on average. Moreover, until very recently, the definition of an NPL in Ghana and the associated provisioning modalities were rather lax compared with other countries. This means that NPLs have been underestimated. Some cleanup of banks’ portfolios is needed first, to enable them to take additional risks and move to a less traditional customer base.

Mathisen: A credit reference bureau is, in fact, now being set up in Ghana. This is clearly part of what is needed so that when the banks become banks again, they are not saddled with huge amounts of NPLs.

IMF Survey:A new banking law under discussion would align capital adequacy requirements with international standards prescribed in Basel II. What effect would this have on competitiveness and efficiency?

Buchs: Moving toward international standards would increase the transparency of banks’ finances and hopefully prompt a simultaneous move away from heavy reliance on treasury bills. This would likely increase competitive pressure and produce consolidation within the system.

IMF Survey:How has the presence of foreign banks affected competitiveness and efficiency? Could future mergers and acquisitions help address high investment costs?

Mathisen: Our results show foreign-owned banks are better at generating revenues than wholly Ghanaian ones. One can hypothesize that this is because they’ve been better able to access revenues from fee-based services such as foreign exchange transactions. Our research did not indicate directly, however, that a larger share of foreign ownership in the banking system would automatically increase competition.

Buchs: This was puzzling. It is striking that foreign banks appear more profitable than domestic banks. The crucial difference is that they have better-quality portfolios. Foreign banks have not really been affected by political lending, and loans extended to state enterprises that have subsequently gone into default comprise a large part of the poorest-quality bank portfolios.

Mathisen: Our research does not indicate that foreign banks are actually better at scrutinizing customers. Foreign banks tend to have access to more creditworthy international clients. So while they are more profitable, the reasons are not necessarily straightforward.

IMF Survey:Foreign banks seem to operate alongside and quite separately from the domestic banks.

Buchs: Yes. Because there is a lack of competition, there is significant market segmentation. This is related to the fact that the banking sector is skewed in favor of larger players.

Mathisen: This also points to our finding that state-owned banks tend to be less able to generate revenues from interest paid by borrowers, the traditional core banking business. But there is no significant difference in the total revenues of state-owned and other banks. That indicates that state-owned banks have somehow been able to recoup these revenue losses, perhaps by servicing larger public enterprises that are late on their payments or have debt workouts.

IMF Survey:Could further development of the nonbank financial sector help spur competition in the banking sector?

Mathisen: We had insufficient data to develop recommendations for further development of the nonbank financial sector. Since our results show that size brings significant advantages in Ghana, it would be difficult to argue that further development of, for example, microfinance would have a major effect—at least until these institutions form a large network or become substantial players in the financial system. With only 5 percent of the population serviced by banks, one could nevertheless argue that certain non-bank financial institutions might provide specialized services to increase outreach.

Buchs: I agree that it’s difficult to see nonbank financial institutions creating additional competition at this stage. But they may serve a very important role for certain clients, particularly since there is significant demand for certain financial services not currently being provided by the commercial banks. For example, some nonbanks are providing leasing services to fill the gap in credit available to small to medium-sized enterprises. In the future, this could have a strong signaling effect, encouraging banks to start providing this financial service.

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