Moody’s Ghana’s Latest Rate Cut Will Support Banks’ Asset Quality
Last Monday, Bank of Ghana (BOG), the central bank, reduced its monetary policy rate by 150 basis points to 21%. The cut, which exceeded market expectations of a 100-basis-point reduction, is credit positive for Ghana's banks because it will reduce their asset risks, which will outweigh the loss in profitability from lower interest income. Also, the rate cut signals abating inflationary pressures, indicating a gradually improving operating environment.
Since November 2016, BOG has cut the monetary policy rate by five percentage points from a peak of 26% (see Exhibit 1 in attached). This most recent rate cut is BOG's fourth consecutive reduction since November, and is in response to the central bank's expectation that Ghana's inflation rate will fall to its 6%-10% target range from 12.1% in June.
This latest monetary policy rate reduction will reduce banks lending rates and asset risks, which increased substantially in 2016 and caused banks nonperforming loans to rise to 21.7% of gross loans as of May 2017 from 14.6% at the beginning of 2016. We expect borrowers debt repayment burden to fall further as the average lending rate decreases.
The system average lending rate declined to 30.5% in April 2017 from 32.03% in November 2016, when BOG first began lowering the monetary policy rate, and we expect additional reductions in the system's average lending rate to follow. Lower lending rates, together with declining inflation, will provide cash flow relief to borrowers, improving their repayment capacity and improving banks asset quality, although the system"s nonperforming loan ratio will remain high.
The rate cut and falling inflation also will support Ghana's operating environment, boosting demand for new loans and benefiting banks revenue. Real private-sector credit contracted by 0.8% in 2016 because of Ghana economic slowdown, during which real GDP growth decelerated to 3.5% from an average of 7.7% in 2010-15. We expect GDP growth to recover to 6.1% this year and 7.5% in 2018.
The rate cut will reduce banks interest income earned from treasury bills, whose yields have already declined by an average of about 600 basis points since November 2016 (see Exhibit 2 in attached). Banks investment in government bills and bonds was high at 21% of total assets as of April, and BOG classifies 72% of these as short term, which creates reinvestment risks for banks.
However, banks will partly offset the effect of lower interest income by reducing their deposit rates, thus lowering funding costs that constrained interest margins and profitability in 2016, albeit from a high base. As an example, the 90-day deposit cost increased to 15.25% in April 2017 from 13% in April 2016.
The increased cost of deposits reduced banks interest spread to 4.1% from 5.1% over the same period, lowering profitability as reflected by an average return on assets that fell to 4.0% from 4.7% over the same period. For GCB Bank Limited (B3 stable, b31), the only Ghana-based bank we rate, the rate reduction will benefit its asset quality.
However, the lower rate will likely harm GCB's interest income because of its large sovereign debt portfolio (about 43% of total assets as of the end of 2016).