From August 2017, Ghanaians have had a rude awakening to bank collapses. The axe has been laid to the roots of seven banks, and at this stage we are still not sure whether more will go. The reasons are varying and numerous. The immediate potential losses considered are depositors’ money. Of course, that is most crucial for public confidence. However, it is not the only factor; there are others like creditors, investors, employees and contractors who are significant.
The financial sector is susceptible to contagion factors, where a negative occurrence in one institution affects other industry players and possibly the entire industry depending on the influence the source institution wields over the industry. For instance, when Lehman Brothers collapsed it shook economies and came down with other institutions including Merrill Lynch.
Specific Ghanaian cases cannot be cited due to their unconfirmed nature – however, it is speculated that one of the seven collapsed banks was much-exposed to a finance house which itself had collapsed a couple of years ago. Exposure to the finance house may not have been the only factor, but it was significant. Again, following the collapse of Lehman Brothers, pension funds were wiped out and AIG – the world’s largest insurance company – also wobbled badly and had to be rescued by government.
The reason the US government saved AIG was that the company was going to take down too much of the US economy, as well as other smaller economies directly linked to the US financial industry. Had the Bank of Ghana not saved those seven banks, the effect would have been devastating on the entire financial industry. The point here is that collapse of the banks could affect the pensions industry.
How will the current bank collapse and reforms affect pension funds in Ghana and therefore people’s benefits? It is worth noting that the 1st tier scheme run by SSNIT may not be affected much due to its defined-benefit structure, which applies a pre-determined formula to derive members’ benefits. Those benefits are somehow guaranteed. However, if SSNIT is heavily invested in equities of collapsed banks, it is likely those would be lost due to the prioritisation of capital and financing during liquidations. Where contributors could lose out is in the indexation (annual upward adjustments), due to the loss of investment income.
The 2nd and 3rd tiers which are defined-contribution (DC) are private pensions with unguaranteed benefits. The level of benefit for the DC scheme, among other things, depends on how well funds have been invested and performance of the investment. Therefore, any factor that militates against good investment performance diminishes the fortunes of the fund.
As part of the pension investment guidelines, trustees are permitted to invest in both core assets and alternative assets of banks and other financial institutions. The core investment instrument from banks are mainly fixed deposits and equities. The alternative assets are investment trusts and mutual funds. Though the alternative asset category may be set up as separate entities, they are still connected to the mother-banks. The good thing is that investment guidelines from the pensions regulator set limitations on how much can be invested in every asset class and in any one institution (or issuer).
Trustees are permitted to invest a maximum of 35% of their total funds in banks’ fixed deposits (FDs), but a maximum of 5% into any one individual bank. Therefore, assuming a scheme invests in a bank’s FD to the 5% limit, that investment would be lost should the bank go down without any remedy. Additionally, if the scheme invested in the equity of a collapsed bank, that part of pension would be lost if the collapsed bank is not remedied or if the bank is remedied but it is not solvent enough to pay up equity investors. This is due to the low ranking of equities in liability payout during liquidations.
And for a collapsed bank, it is most likely that pension funds invested into its equity would be lost. In the case of the rescued banks, the new bank takes on their liabilities, especially with those of fixed deposits – so that is a breather for the contributor. However, they may not be able to pay up pension funds which were invested in equities of the collapsed banks if there were any. Again, on the fixed deposits an investment risk will be realised when the new bank re-negotiates terms like return rates and other redemption terms.
The pensions law also places pension funds high in the ranking of payable liabilities during liquidation situations. For instance, section 108 of the Act 766, stipulates thus: ‘unpaid contributions of the employer and payroll deductions made from the contributor’s salary which have not been remitted to a trustee at the time of liquidation shall have priority over any other debt’. The investment guidelines also forbid pension funds from investments into the relatively risky non-bank financial institutions (NBFIs), and so pension funds are directly insulated from risks inherent in that sector. There may however be indirect exposures owing to placements the banks or collective investment schemes may have done with the NBFIs.
Contributors should be assured that due to the mandatory diversification guidelines, there exists a good level of protection for pension funds. It is not likely that their entire funds (or a larger part) would be wiped out as happened in other jurisdictions where there are no such investment restrictions. Of course, every loss is a loss, but its better to salvage say 80%-90% of your fund than lose it all.
Contributors should also know that such risk of losses cannot be completely eliminated in the management of pension funds during its lifetime. Best pension management practices only work to minimise the inherent risks. This is what is expected of trustees, to act as fiduciaries by taking good care of the funds to the highest standards. They are expected to manage such risks of loss. In the specific case of Ghana, fixed deposits with the failed banks will be assumed by the Consolidated Bank as well as any other entity who takes over. Equities however may not be redeemed and could be lost, but so far as is known only UT had listed equities among the group.
The author is a Pensions and Management Consultant with M-DoZ Consulting. He provides retirement planning and pension advisory services to pension schemes, organisations and groups.