At the regulatory front, 2018 is poised to be the busiest year in the banking history

A number of things will happen in 2018: Russia will be hosting the football/soccer world cup.  It will be a century since the end of World War I.   For banks in Ghana, in my lifetime, it will be the busiest year due to the following ten (10) key things going to happen at the regulatory front in 2018:

  1. Banks are required to enhance their business practices and risk management framework

 

The passage of the Banks and Specialized Deposit-taking Institutions Act 2016 (Act 930) and other Bank of Ghana (BoG) directives require banks to enhance their business practices and risk management systems.

This means the existing guidelines for the following will have to be updated:

  • Credit policy
  • Stress testing Framework
  • Enterprise risk framework
  • Risk appetite framework
  • Credit risk management framework
  • Non-Performing loans management framework
  • Write off practices
  • Loan provision practices
  • Internal Capital Adequacy Assessment Process (ICAAP)

The Bank of Ghana’s Capital requirement directive will require the following new documents:

  • Risk Management Framework
  • Internal Capital Adequacy Assessment Program (ICAAP)
  • Capital Management Framework (CMP)
  • Credit Risk Management Framework (CRMF)
  • Operational Risk Management Framework (ORMF)
  • market risk framework (MRF)

The adoption of IFRS will also require an update to the following documents: IFRS 9 Modelling Manual, IFRS 9 Impairment process manual, Credit policy Manual, Credit Committee Manual, watch-list process, credit risk modelling process, pricing of loans, Credit risk strategy document, General ledger chart of accounts, Data quality controls, Credit risk gaps mitigation, Treasury Manual for IFRS 9 classification and measurement and Enterprise risk manual

 

  1. Banks required to meet minimum capital requirement of GHS 400 million by end of 2018

 

All banks in Ghana are required to meet the minimum capital requirement of GHS 400 by end of 2018. Based on the transcript of the Monetary Policy Committee (MPC) Press conference which was held on Monday, November 27, 2017[1], below is a list of questions and responses from the Governor on the status of how banks are meeting the GHS 400 million by the end of 2018.

 

 

Question Governor’s Response
You mentioned briefly the government’s transformation agenda. With the recent increase in minimum capital requirement for all the commercial banks, can we know how many of these banks have satisfied the requirement? I cannot tell you off-hand, but I know that given the rules that are being used, including the fact that they [the commercial banks] can capitalise their income surplus accounts, at least four or five banks are said to have met it already, even before the process starts. So we expect that more banks would meet it. In any case, the banks are supposed to be submitting their plans to capitalise up to 400 million cedis, and the deadline is the end of November. We are meeting with them this week and would get an update on where each bank is.

 

We were told that one of the reasons for the recapitalization of the banking sector is to consolidate the banks. Now, over the years, anytime there is a request for recapitalisation we see banks going outside to raise money to meet the BoG requirements. This time, the 400 million cedis [that the banks are expected to raise by December 2018], what, if the banks go outside to raise that money to meet your requirement? Would you have achieved your objective?

 

[With reference to your question is it about] whether we would see the consolidation that we are looking for if the money is raised from outside? Well, if all the 32 banks are able to raise money from outside then maybe we would not see the consolidation that we want to see. But it is highly unlikely that 32 banks would be able to raise that type of money externally within the period that has been given so we expect that there would be consolidation in the sector.

 

 

Based on my understanding of  sections 28 -34 of Act 930, a Bank that does not have capital of at least ¢400 million as at December 31, 2018 will be considered as an undercapitalized Bank .An undercapitalized Bank may lose its license to operate as a Bank in the following sequence of events:

  1. Section 105(2b) of Act 930 – The undercapitalized Bank will be required to submit capital restoration plans within 45 days to BoG’s requesting it.
  2. The Bank has 180 days from submission to conclude the capital and liquidity restoration process.
  3. BoG will further impose restrictions on growth of assets or liabilities, in other words the Bank may not be able to lend or accept deposits from the public ( Section 105 (5a)(5b)(5c) of Act 930
  4. Section 106 (1a) (1b)- If the problem persists after the first attempt, BoG will provide a 90 day window for a new plan and a further 180 days to remedy the situation
  5. Sections 107-122 of Act 930- Third, where the initial 2 attempts fail, BoG will place the institution into official administration
  6. Lastly, section 123 of Act 930 provides the BoG the right to revoke the license of the Bank if the BoG believes the Bank will be insolvent within 60 days

 

 

  1. Implementation of Bank of Ghana Capital Requirement directive (Basel II & III)

On November 14, 2017 Bank of Ghana (BoG) sent a letter to all Managing Directors that they should expect an email on draft capital directive requirement (CRD or the Directive) and reporting forms. Banks are required to perform an impact assessment of the draft directive by January 31, 2018. In the draft capital directive sent to banks, Bank of Ghana requires Banks to comply with the capital directive on July 1, 2018. The BoG letter dated November 14, 2017 addressed to Managing Directors (MD) of banks stated that BoG is giving immediate priority to Basel II pillar 1 risk (i.e. credit, operational and market) and the Basel III capital framework. The letter went on to state that when the Basel regulatory framework is in place, BoG will look to introduce other parts of the Basel framework, namely Basel II pillar 2  and Pillar 3 and or  Basel III liquidity requirements. The CRD consists of four parts:

  • Part 1 – Definition of Regulatory Capital;
  • Part 2 – Management and Measurement of Credit Risk with three sub-sections;
  • Part 3 – Management and Measurement of Operational Risk; and
  • Part 4 – Management and Measurement of Market Risk.

 

The key impact of this new capital directive includes the following

 

  1. Systems and data

Most banks will need to change their systems – or indeed to build new systems – to ensure that they are collecting the necessary data on their borrowers and other counterparties, and can calculate the new risk weights using the Directive

  1. Capital ratio:

 

  • Capital ratio increased from 10% to 13% due to inclusion of 3% for Capital Conservation Buffer (CCB1) means some banks may need additional capital.
  • Earning retentions if Capital Conservation Buffer (CCB1) of 3% is not achieved by January 1, 2018
  • Leverage ratio of 6% means some banks may need additional capital to finance its  assets
  • Regulatory capital: some Banks tier 1 and 2 capital may not qualify as tier 1 and 2 capital under the Directive leading to the need for some Banks to introduce fresh capital
  • The full complement of capital ratio requirements across the components of capital are summarized in the Table:

 

  Regulatory Capital % RWAs
1 Minimum CET1 6.5
2 Capital Conservation Buffer (CCB1) – CET1 only 3.0
3 CET1 Ratio plus CCB1 (1+2) 9.5
4 Maximum AT1 1.5
5 Minimum Tier 1 Capital Ratio (1+4) 8.0
6 Maximum T2 2.0
7 Minimum Capital Adequacy Ratio (CAR) (5+6) 10.0
8 Minimum CAR plus CCB1 (7+2) 13.0
9 Countercyclical Buffer (CCB2) 0
10 DSIB Buffer 0
11 Minimum CAR plus CCB1 plus CCB2 plus DSIB (2+7+9+10) 13.0

 

  1. Numerator of the capital ratio :

The definition and constituents of regulatory capital consists of ‘tiers’ as follows:

  • Tier 1 Capital or ‘going-concern capital’ – capital that supports the bank’s operations and can absorb losses as required: Common Equity Tier 1 (‘CET1’) and Additional Tier 1 (‘AT1’)
  • Tier 2 Capital or ‘going-concern capital’ – capital to absorb losses or convert to equity if a bank is wound up.
  • Bank will need to assess eligibility of their ordinary shares as regulatory capital under the new Directive. Banks may have to obtain legal opinions to review documentation and terms and conditions of their existing share capital documents.
  • Bank will need to assess eligibility of their debt instrument as tier 2 capital under the new Directive. Banks may have to obtain legal opinions to review documentation and terms and conditions of their existing debt instruments.
  • Only audited profit will be accepted as part of CET1. This means interim unaudited profit will not count towards CET1 (Paragraph 35 of the Bank of Ghana Capital Requirement Directive specifies that income surplus of common equity tier 1 capital refers to profit and loss accounts at the end of the previous financial year. Banks may reckon the profits in the current financial year only after appropriate audit, verification or review procedures prescribed by BOG have been undertaken by a third party. Dividends should be deducted from CET1 in accordance with applicable accounting standards)
  • Bank of Ghana should consider to allow the interim profit and loss account in the retained earnings and other comprehensive income
  • Certain items such as deferred tax assets , Cash flow Hedge Reserves, Intra-group transactions for capital or funding purposes and Defined benefit pension fund assets and liabilities will be deducted from CET since they are considered to have the ability to supports the bank’s operations and can absorb losses as required

 

  1. Denominator of the capital ratio
  2. Credit risk :
  • Banks will manage and measure credit risk by the Standardized Approach (SA) and the measurement of credit risks consists of three parts: on-balance sheet exposures , off-balance sheet exposures and credit risk mitigation
  • Credit risk weighting will be done at a more granular level than it is currently done.
  • Credit risk-on-balance sheet exposure – Risk weightings for some exposures have increased .This means some Banks may face higher or lower capital requirements as a result of the Directive, depending on the risk profile of their exposures
  • The approach for credit risk will improve the robustness and risk sensitivity of the existing approach
  • Depending on the Bank’s portfolio, additional capital may be required
  • Credit risk systems and processes will have to be modified to accommodate the granular data requirements
  • Differences in risk weighted assets (RWA) to total assets (also called RWA Density) will be minimized
  • Risk weighting for past due and non-performance loans increased by additional 50% risk weighting
  • A risk weight add-on of 50% will apply to a credit exposure to a counterparty, except the Government of Ghana, BOG, public sector entities (PSE) or banks that has a currency mismatch and is “unhedged”. A currency mismatch arises where the loan is denominated in a foreign currency that is not the currency of the borrower’s primary income. An “unhedged exposure” is defined as an exposure to a borrower that has no natural or financial hedge against the foreign exchange risk arising from the currency mismatch.
  • Credit risk-off-balance sheet exposure – credit conversion factors for some off –balance sheet exposures have increased. This means some Banks may face higher or lower capital requirements as a result of the Directive, depending on the risk profile of their off-balance exposures
  1. Operational risk
  • The current approach of Basic Indicator Approach of 100% of 3yrs Average Annual Gross Income  going to be changed Standardized Approach which may lead to higher capital requirements for some banks
  • The standardized approach is much more complex and risk based and will require additional capital than the basic indicator approach
  1. Market risk;
  • The current approach is 50% of Net Open Position (NOP). This approach capture only foreign exchange risk element of market risk and ignores other market risk such as interest rate related instruments, equities position risk and commodity position that a Bank may be currently exposed. The Directive proposes that Bank uses a standardized approach for market risk. The Standardized Approach is a building block approach where the capital charge for each risk category is determined separately. Within the interest rate and equity position risk categories, separate capital charges for specific risk and the general market risk arising from debt and equity positions are calculated.  For Banks currently having interest rate related instruments, equities position risk and commodity position may require additional capital requirements.

 

 

  1. Banks are to submit plans addressing Non-Performing Loans to Bank of Ghana

The key risk in the banking industry today, is the increasing level of impaired assets.  Based on Bank of Ghana November 2017 banking sector report, the non-performing loans for the banking sector stands at 21.6 percent at the end October 2017. This has heightened banks’ risk aversion to credit delivery. Bank of Ghana’s immediate response is to reduce some of the structural bottlenecks in the credit process. Bank of Ghana is said to be reviewing the governing legislations on the credit reference and collateral registry systems. These are to ensure that banks submit both positive and adverse findings on borrowers to the bureaus and also address some thorny foreclosure issues.

Based on the increasing trends of non-performing loans, Bank of Ghana  have requested banks to provide  detailed plans on how each bank will resolve its non-performing loans – on a loan by loan basis.

 

  1. Enforcement of loan write-off

Bank of Ghana has indicated that they are going to enforce their directive on loan write-off going forward, and require appropriate disclosure of written-off facilities in the published financial statements of banks.

 

  1. Bank of Ghana corporate governance directives

Based on an address made by Dr. Ernest Addison, Governor, Bank of Ghana (BoG) at the Annual Dinner of the Chartered Institute of Bankers Ghana on Dec. 2, 2017 (https://www.bog.gov.gh/privatecontent/Speeches/Speech_Annual%20Bankers%20Dinner_Final%20Dec%202017.pdf), Bank of Ghana soon will release directives on corporate governance for the banking sector. Among others, these directives will focus on oversight responsibilities of the Board of Directors and bank management, prioritize risk management systems, and ensure independent audit roles, among others. In particular, the guidelines will impose the tenure of Chief Executive Officers and Non-Executive Directors of banks, the size of bank Boards, the retiring age for Directors and disclosure of attendance at Board meetings by Directors in annual reports.

 

  1. Enforcement of Guide for financial publication

An area that Bank of Ghana will sought to strengthen corporate governance structures in the banking sector is through financial publications.  Bank of Ghana guide on financial publications was updated June 28, 2017.  Please see the link:

 

https://www.bog.gov.gh/privatecontent/Public_Notices/Guide%20for%20financial%20publication%202017V1.1.pdf

 

The updated guidance  include detailed corporate governance disclosures by banks and the inclusion of provisions on corporate governance under the Banks and Specialized Deposit taking Institutions Act, 2016 (Act 930). The guide for financial publications seeks to ensure that International Financial Reporting Standards (IFRS) are adopted in the preparation and presentation of financial statements. It also seeks to clarify and provide direction as well as bring uniformity in the financial reporting process across the industry.

 

  1. Deposit protection scheme:

Based on an address made by Dr. Ernest Addison, Governor, Bank of Ghana (BoG)  at the Annual Dinner of the Chartered Institute of Bankers Ghana on Dec. 2, 2017 (https://www.bog.gov.gh/privatecontent/Speeches/Speech_Annual%20Bankers%20Dinner_Final%20Dec%202017.pdf) , the deposit protection scheme is expected to come on board next year in line with the BSDI Act and the Ghana Deposit Protection Act, 2016 (Act 931) to provide a safety net for vulnerable depositors in the event of a bank failure. The Governor entreats all banks to study the Ghana Deposit Protection Act to know the requirements for enrollment on the scheme.

 

  1. Whistle blower policy:

Based on an address made by Dr. Ernest Addison, Governor, Bank of Ghana (BoG)  at the Annual Dinner of the Chartered Institute of Bankers Ghana on Dec. 2, 2017 (https://www.bog.gov.gh/privatecontent/Speeches/Speech_Annual%20Bankers%20Dinner_Final%20Dec%202017.pdf) ,  it was noted that  Bank of Ghana (BoG) is fine-tuning a whistleblowing policy that will encourage the general public to pass on confidential information on malpractices in banks for thorough investigations to be undertaken and appropriate sanctions applied.
The policy, which will be the first of its kind by the central bank, will also prescribe protections for whistleblowers as part of a grand strategy by the bank to help encourage whistleblowing on banks in the country.
The Governor of the BoG, Dr Ernest Addison, said that the move was part of a range of measures due to be introduced into the banking sector.

The initiatives are meant to promote transparency and accountability in the entire financial sector and the Governor noted that “We will advocate for a whistleblower provision to protect individuals who raise alerts to the BoG on malpractices by the banks,”

 

  1. Implementation of IFRS 9 on January 1, 2018

IFRS 9 is a new accounting standard which includes guidance on loan loss provisioning. The new accounting standard will require faster level of loan loss reserve starting January 1, 2018 and is called IFRS 9 Financial Instruments. IFRS 9 will require banks to show their losses earlier than in the past. Overall, the losses themselves do not change in total over the life of the loans; only the timing of their recording by the bank will be different. The new approach is seen as more timely and it reflects the underlying economics more closely since expected future losses are already priced in the interest rate charged on the loans.

Before IFRS 9, accounting rules forced banks to “wait” for a loss event before recording a loss against a loan asset. This was the case even when banks expected that a percentage of their loans would not be paid back in full. When the downturn came they had to catch up by recording significantly larger losses all at once. The result was the heavy criticism of banks during the financial crisis for providing “too little too late”.

The international accounting standards board (IASB) field work on the impact assessment of the new accounting standard indicates that allowances could increase as follows:

  • Between 30% and 250% for mortgage portfolios
  • Between 25% and 60% for non-mortgage portfolios

The European Banking Authority (EBA) Impact assessment is a 30% increase in current loan loss reserves.  Also, A Deloitte survey shows approximately 50 percent more allowance as compared to the current levels of provisioning

Bank of Ghana encourages Banks to follow Basel Guidance on credit risk and accounting for expected credit losses (https://www.bis.org/bcbs/publ/d350.htm). In addition to the Basel guidance, Bank of Ghana specified its IFRS 9 expectation in its Bank of Ghana issued June 28, 2017.  Please see the link: https://www.bog.gov.gh/privatecontent/Public_Notices/Guide%20for%20financial%20publication%202017V1.1.pdf.

Application of IFRS 9 impairment requirements adherence to Basel guidance and Bank of Ghana financial publication guide and additional clarification guide requires the following:

  1. A bank should adopt a robust process that is designed to equip the bank with the ability to know the level, nature and drivers of credit risk
  2. A bank’s board of directors (or equivalent) and senior management should ensure that the bank has appropriate credit risk practices, including an effective system of internal control, to consistently determine adequate allowances in accordance with the bank’s stated policies and procedures, the applicable accounting framework and relevant supervisory guidance
  3. A bank should have a credit risk rating process in place to appropriately group lending exposures on the basis of shared credit risk characteristics
  4. A bank should adopt a robust approach in segmentation of their policy
  5. A bank should have policies and procedures in place to appropriately validate models used to assess and measure expected credit losses
  6. A bank should use experienced credit judgment, especially in the robust consideration of reasonable and supportable forward-looking information, including macroeconomic factors, is essential to the assessment and measurement of expected credit losses
  7. A bank should have a sound credit risk assessment and measurement process that provides it with a strong basis for common systems, tools and data to assess credit risk and to account for expected credit losses.
  8. Bank’s public disclosures should promote transparency and comparability by providing timely, relevant and decision-useful information.
  9. A Bank should adopt a forward looking approach to assess significant increases in credit risk and its measurement of expected credit losses
  10. A bank should adopt, document and adhere to sound methodologies that address policies, procedures and controls for assessing and measuring credit risk on all lending exposures. The measurement of allowances should build upon those robust methodologies and result in the appropriate and timely recognition of expected credit losses in accordance with the applicable accounting framework.
  11. A Bank is required to have documentation around IFRS 9  models specifically the following
  • Credit risk factors : How the Bank identifies  factors that affect repayment of each type of portfolio, whether related to borrower incentives, willingness or ability to perform on the contractual obligations, lending exposure terms, conditions or  Economic factors considered (such as unemployment rates or occupancy rates) and  internal and external factors such as the underwriting standards applied to a lending exposure at origination and changes in industry, geographical, economic and political factors
  • Loan portfolio segmentation- the different type of loan portfolio segmentation used for staging and ECL measurement
  • Segmentation criteria- description of the basis for creating groups of portfolios of exposures with shared credit risk characteristics
  • Outline the bank’s policies on defaults for the different portfolios
  • Staging unit of account : Whether the evaluation of credit risk  will be  conducted on a collective or individual basis,
  • Staging criteria- quantitative, qualitative and other criteria for classifying financial assets into stages 1, 2 and 3
  • what are the factors used to classify a loan under stage 3
  • Staging probation period : Policy for upgrading/downgrading financial assets in the various stages
  • The approach and process to incorporate forward looking into  staging
  • Staging validation approach –
  • How the life of an exposure or portfolio is determined (including how expected prepayments and defaults have been considered)
  • Outline the bank’s policies and procedures on write-offs and recoveries
  • The time period over which historical loss experience is presented
  • The factors that are considered when establishing appropriate historical time periods over which to evaluate historical loss experience
  • The ECL assessment and measurement methods (such as a loss rate method, probability of default (PD)/loss-given-default (LGD) method, or another method) to be applied to each exposure or portfolio
  • The reasons why the selected ECL method is appropriate
  • Limitations associated with the selected ECL method and how such limitations are going to be mitigated
  • Inputs, data and assumptions used in the allowance estimation process (such as historical loss rates, PD/LGD estimates and economic forecasts)
  • Process for evaluating the appropriateness of significant inputs and assumptions in the ECL assessment and measurement method chosen.
  • If PD, LGD method is used, documentation of the PD approach (Regression Modelling, Transition matrices, Cohort Analysis, Pooled PD, Survival method, etc.)
  • If PD, LGD method is used, documentation of the LGD method (market LGD, the implied LGD, implied historical LGD and workout LGD)
  • If PD, LGD method is used, documentation of EAD approach for amortizing and revolving products
  • Criteria to duly consider the impact of forward-looking information, including macroeconomic factors
  • The approach to adjust historical experience with current conditions
  • The approach and process to incorporate forward looking …. into ECL measurement
  • The forward looking factors chosen and their relevance
  • How   scenarios or consideration of other possible outcomes are required by IFRS 9.5.5.17  considered in ECL measured
  • How  are scenario weights determined
  • The methods used to validate models for ECL measurement
  • Policies for modification and renegotiation of financial assets
  • ECL approach and assumptions for off-balance sheet items (LC, guarantees, undrawn balances)
  • ECL approach and assumptions for placements with other banks
  • ECL approach and assumptions for ECL measurement of government securities

 

[1] https://www.bog.gov.gh/privatecontent/MPC_Press_Releases/Transcript%20of%20MPC%20Press%20Briefing%20-%20November%20%202017.pdf