By Richmond ATUAHENE (Dr)
Central banks are national authorities with specific mandates on price stability or price stability and employment (Mishkin, 2019).
Under their mandate they typically perform a number of tasks such as issuing fiat money, organizing a safe and secure payment infrastructure, designing and implementing monetary policy and acting as a lender of last resort by offering loans to commercial banks that otherwise have no means of borrowing, and whose failure would adversely affect the economy.
Often central banks also manage part of the national reserves and hold significant amounts of securities denominated in foreign currency for the purpose of monetary policy interventions.
For the commercial banking sector, the central bank acts as a bank, i.e. commercial banks hold deposits at the central bank to facilitate interbank transactions. Commercial banks can also obtain financing from the central bank, which typically ranges from regular credit operations at near-market competitive rates to special credit windows with more onerous terms, such as those defined under the lender of last resort function.
In fulfilling their mandates, central banks make profits on the services that they provide to society and to commercial banks. A central bank is the monopoly supplier of banknotes that the general public uses as legal tender in day-to-day life.
By acting as the bank for commercial banks, the central bank performs economic transformations and takes over risks from the banking sector. As the central bank can set the terms and conditions, both these functions contribute in general to the central bank’s profitability.
The benefit of profitability is that it increases a central bank’s independence from government and contributes to a positive perception on the part of the general public that the central bank is a “revenue centre”.
The flipside of this is that unexpected central bank losses may attract public attention with suspicions of inefficiency and may lead to scrutiny regarding the measures that caused it. Seigniorage is a form of taxation by a non-elected national authority. Therefore, from a public’s perspective, a central bank’s profits should be in proportion to the services it provides to the economy and the risks it takes on its balance sheet.
Literature Review
Central banks may operate perfectly well without adequate capital as conventionally defined. A large negative worth, however, is likely to compromise central bank independence and interfere with its ability to attain policy objectives. If society values an independent central bank capable of effectively implementing monetary policy, recapitalization may become essential (IMF, WP/97/83).
The study found that central bank capital as conventionally defined is not strictly necessary, a weak central bank balance sheets invariably lead to chronic losses, an abandonment of price stability as a primary goal, a decline in central bank operational independence, and the imposition of inefficient restrictions on the financial system in an attempt to suppress inflation.
Because central banks are diverse and not regulated, literature on the topic of central bank capital adequacy is only available to a limited extent. However, as central bank profits can be sizeable and constitute a non-negligible part of the government budget, the topic of central bank capitalization is relevant.
A paper by Stella (1997) triggered a series of papers from the IMF staff and others, in particular Blejer and Schumacher (1998), Stella (2002), Ize (2005), Stella and Lonnberg (2008), Klüh and Stella (2008) and Adler, Castro and Tovar (2012).
The main conclusion from these papers is that financial strength is key for a central bank to be independent from governments and to be credible in achieving its policy objectives. Stella (1997) finds that though central bank capital as conventionally defined is not strictly necessary, a weak central bank balance sheet leads to chronic losses, an abandonment of price stability as the primary policy goal, a decline in central bank independence, and the imposition of inefficient restrictions on the financial system.
He concludes that if society values an operationally independent central bank, the transfer of real resources to recapitalize the central bank becomes necessary when the losses are sizeable. According to Stella (1997) and later papers, the notion of financial strength focusses on the net worth of the central bank, including the franchise value (or seigniorage) as well as its off-balance sheet rights and obligations. The monopoly in the provision of the domestic currency gives the central bank a significant franchise value. Furthermore, central banks can create demand for their own liabilities by imposing reserve requirements on banks.
The target level of capital according to Stella (1997) should be dependent on the precise policy objectives. Furthermore, Stella (1997) lists four ways to express a target level of capital: (1) an absolute level, (2) a target ratio relative to another balance sheet item, (3) a target level relative to a macroeconomic variable, and(4) in relation to the central bank’s perceived risks.
The ultimate risk for a central bank is “policy insolvency”, i.e. that it is not able to meet its policy commitments. The ultimate risk for a central bank is not the more common technical insolvency, or the inability to meet its financial liabilities. An important contribution to the topic of central bank capital adequacy is the BIS Paper by Archer and Moser-Boehm (2013). It gives a rich overview of the theoretical and empirical literature as well as the practices in the central banking community.
The authors take a broad perspective on a central bank’s financial strength, including balance sheet composition, income generation and accounting rules, as well as the capital buffers on the balance sheet. They conclude that the central banking community is so heterogeneous that the question of capital adequacy is highly idiosyncratic. The framework they present for assessing the appropriate amount of financial strength is therefore also broad.
The capital that is ultimately needed depends on the specific policy. Furthermore, Stella (2002) concludes that the central bank is financially strong if it possesses resources sufficient to attain its fundamental policy objectives. A strong, clean balance sheet heightens the chance that an independent central bank will be able to successfully implement policy, but also that variations in its financial results will broadly affect the direct costs and benefits of the policy it undertakes.
If credibility is important for the success of the policy, the central bank must be financially strong. A weak central bank will make losses, which, if they reach sufficient magnitude, will necessitate financing through current or future money creation, thereby undermining monetary and exchange rate policies The ultimate risk for a central bank is not the more common technical insolvency, or the inability to meet its financial liabilities responsibilities of the central bank, the amount of risk that cannot be transferred to the government and the accounting policies and the profit distribution scheme in place. A profit distribution scheme specifies which part of the profits is retained and which part is transferred to the State in the form of dividend.
Capital adequacy is key to being a credible, independent monetary authority. The topic of central bank independence has received quite a lot of attention over the years. Good overviews are provided, for instance, by Berger, de Haan and Eijffinger (2001) and de Haan and Eijffinger (2019). Today, central bank independence is mostly accepted as a necessary requirement for an effective central bank responsible for monetary policy (Blinder, 1998), although some criticism also exists (Draghi, 2018).
In the Euro-system, the concept of central bank independence is operationalized in the ECB convergence reports. (2020). These convergence reports describe four dimensions of independence: functional, institutional, personal and financial. According to these reports, financial independence includes sufficient capitalization. Cukierman (2011) sets out a number of considerations with regard to the level of central bank capital needed to safeguard independence in scenarios where risks and losses accumulate.
Key determinants of central bank capital according to the author are: the size of potential shocks, the breadth of responsibilities, the tendency of governments to create deficits, the institutional arrangement between the central bank and the government, the structure of the central bank’s balance sheet and the central bank’s credibility.
Central bank policies, particularly monetary policy, can significantly impact the technical solvency of financial institutions and the overall financial system. Central banks, through tools like interest rate adjustments and liquidity provision, aim to maintain financial stability and price stability, which indirectly affects the solvency of institutions.
Policy solvency refers to the central bank’s ongoing ability to fund and implement its operations in line with its policy objectives, which are typically related to monetary policy and financial stability. a. it ensures the central bank can carry out its duties, such as setting interest rates, managing inflation, and providing liquidity to the financial system.
b. Policy solvency requires sufficient revenues to cover costs and build capital reserves, allowing for independent and appropriate policy decisions while technical solvency refers to the central bank’s ability to meet its financial obligations and cover potential losses, ensuring its long-term financial stability. a. It involves having sufficient assets to cover liabilities and maintaining a healthy balance sheet. b. Technical solvency is crucial for maintaining public confidence in the central bank and its ability to fulfill its mandate.
In the context of central banks, technical insolvency refers to a situation where liabilities exceed assets, while policy insolvency (or “bankruptcy”) is a more nuanced concept that considers the broader implications of a central bank’s financial situation and its ability to fulfill its policy mandates, even if technically solvent.
A central bank may be policy insolvent if it departs from its objectives to satisfy its financial obligations, e.g. by allowing inflation to increase above its target. In extreme cases, this may result in a loss of confidence in the currency, leading to hyperinflation and strong depreciation. In central banking, technical insolvency refers to a situation where a central bank’s liabilities exceed its assets, while policy insolvency relates to the central bank’s inability to fund and implement its monetary policy objectives independently without government intervention.
Technical insolvency, in the context of a central bank, means that the total value of its liabilities (what it owes) is greater than the total value of its assets (what it owns). This can occur due to various factors, including accumulated losses from past operations, large-scale currency interventions, or losses from holding foreign currency reserves.
While not necessarily a direct threat to monetary policy, it could erode public confidence in the central bank and potentially require government intervention, undermining its independence. Policy insolvency, on the other hand, refers to the central bank’s inability to maintain its independence and effectively pursue its policy objectives due to a lack of sufficient financial resource.
This could arise from insufficient revenues to cover operational costs, a lack of capital reserves to withstand economic shocks, or a need for government funding to implement policies, potentially leading to fiscal dominance. Policy insolvency can undermine the credibility of monetary policy, potentially leading to inflation or economic instability, and could erode public trust in the central bank.
The main arguments in favour of a strong balance sheet of Bank of Ghana
A financially independent central bank is generally recognized as one that has sufficient resources to carry out its functions without over-reliance on the government (Haldane, 2020).
In contrast, a financially dependent central bank may find that its policy choices are constrained, explicitly or implicitly, or even directed by the finance ministry and hence by political considerations. When a central bank has insufficient financial resources, market participants may perceive it as losing its political independence and its policy effectiveness; politicians may perceive its governors as having made bad decisions; and taxpayers may perceive it as being at risk of needing a bailout with public money. Having sound financial resources is not just about the money, it is about central bank credibility and independence
The central bank’s balance sheet plays a key role in the implementation of monetary policy. In normal times, the central bank may only be exposed to some credit risk and the market risk of gold and reserves in foreign currencies. In turbulent economic times, financial market participants expect the central bank to step in, defend the currency, support commercial bank funding and take any other necessary measure to restore trust in financial markets.
These activities result in financial risks on the central bank’s balance sheet that can turn into losses. The central bank should therefore be able to absorb such losses with adequate capital – up to a reasonable level – in a stand-alone capacity for the following two reasons (Archer and Moser-Boehm, 2013).
A strong balance sheet with adequate capital, on the other hand, supports public confidence as it implies that fiat money as a central bank liability is covered by the central bank’s assets. In a way, adequate capital is therefore the successor to the gold standard, ensuring sufficient assets to cover the monetary base. Trust in money is the precondition for the legitimacy of the central bank, which in turn is the foundation for central bank independence, as argued by for instance Braun (2016).
Adequate capital supports central banks’ independence. A key principle in modern central banking is that monetary policy should be conducted independently of politics. A government’s interests are diverse and sometimes conflicting. Monetary policy aimed at price stability and financial stability are deemed too important to be part of trade-offs that concern short-term financial interests of the government.
A stand-alone central bank that is independent of the government can fulfil this role in a time consistent manner but needs sufficient resources to do so effectively. Financial independence implies that the central bank generates its own income to pay the necessary costs and holds buffers to be able to absorb the losses it may incur. Adequate capital supports central banks in being credible as a monetary authority. Credibility is essential for a central bank which issues fiat currency as consumers need to trust banknotes.
Under normal economic circumstances, monetary policy can be conducted in a straightforward way with the extension of credit to commercial banks, deposit-taking and the use of policy rates as the main parameters. In exceptional economic circumstances, additional measures with more risk may be needed, such as quantitative easing, acting as a lender of last resort to commercial banks or exchange rate interventions. A central bank that is independent of the government needs to be perceived as being able to deploy the necessary strength in these operations. Together, independence and credibility of the central bank are important preconditions for central bank effectiveness (Blinder, 1998).
A country that is committed to an independent central bank can demonstrate that commitment by giving the central bank adequate resources to perform its task independently. The strength of a central bank balance sheet depends on various components such as credit and collateral quality and the amount of gold (as an anchor in times of stress). In this study we focus on the amount of capital as a key driver of a central bank’s financial strength. Capital provides the ultimate loss-absorbing cushion. If the amount of capital is adequate relative to the financial risks on the balance sheet and the latent risks, the balance sheet will be strong.
A strong balance sheet with adequate capital is important for an independent and credible central bank, but it is not a sufficient requirement on its own. In order for a central bank to be effective, other conditions need to be fulfilled as well, such as a good central bank law providing a strong legal basis and sufficiently high institutional quality of the public sector in a country. A central bank without a proper legal mandate and statutes is less effective. The government’s financial position is also relevant. If the government’s financial situation has been weak over many years, but the central bank balance sheet remains strong, the central bank may be perceived as less effective by market participants who assess the consolidated public finances. For instance, in emerging market economies, financial conditions may be determined by the government’s credit quality and the nation’s institutional quality. In such a case, a strong central bank balance sheet is helpful but not sufficient to ensure policy effectiveness. On the other hand, if the deterioration of government finances is temporary and takes only a few years, a well-capitalized central bank may remain effective and bridge this period. One more perspective in favour of adequate capital comes from the public’s perception that the central bank performs banking services for the commercial banks and often manages part of the national reserves in the form of gold and other investments. The public will perceive the central bank as a “bank” that needs to be adequately capitalized. Therefore, from a communication perspective it makes sense to adequately capitalize a central bank, even if the central bank is considered to be a financial subsidiary of the government. The central bank being a mother of regulatory governance requires sufficient capital is needed having regard to the risks that the banking sector. Even if the parent has given the banking institutions explicit guarantee, supervisory authorities will still require the subsidiary to hold sufficient capital. Dalton and Dziobek (2005) warn that failure to address ongoing losses, or any ensuing negative net worth, will interfere with monetary management and may jeopardize a central bank’s independence and credibility. Where central bank losses give rise to negative net worth, IMF recommended practice is for the government to recapitalize the bank by an injection of either cash or government securities bearing interest at market-related rates
The Critics of the negative capital of Bank of Ghana
Critics can argue that a central bank does not need adequate capital. The critics cited multiple reasons for that: (a) a central bank can always meet its liabilities by printing money, (b) the government offers (implicit) support to the central bank, and (c) seigniorage acts as a buffer for the central bank. (a) A central bank can always meet its liabilities by printing money. Although it is true that a central bank technically cannot go bankrupt in its domestic currency, the practice of printing money to cover costs or losses is unsustainable. It will jeopardize public confidence in the central bank and drive up inflation as a result, in an extreme case leading to hyperinflation. (b) The government offers (implicit) support to the central bank. Some central banks with negative capital seemingly operate without problems. This primarily works, however, because stakeholders such as financial markets and the public have trust in the government and the strength of the national economy. From a public finance perspective, the central bank’s balance sheet can be considered part of the consolidated government’s balance sheet. If the consolidated balance sheet is strong, but a weak central bank balance sheet may appear to be non- problematic for the role and effectiveness of the central bank. This is because the central bank implicitly relies on the strength of the government. With both weak central bank with negative capital and weak consolidated government balance sheet like Ghana could be considered as significant problem as a result of huge debt overhang, macro-economic challenges of high inflation, persistent depreciation of local currency as well as high fiscal deficit etc. Without the support from the government, stakeholders would perceive a central bank with negative capital as one whose main tool (the balance sheet) is weak and whose liabilities (fiat money) are only partly covered by the central bank’s asset values. In a crisis, financial markets will factor in the financial strength of the government, which may be deteriorating at that point as well. In such a situation, there may be limits to what the central bank can achieve on its own in pursuing its objectives. Therefore, a central bank with a negative capital position may not be independent enough and may experience lower credibility.
- c) Seigniorage acts as a buffer for the central bank. Central banks earn income through their conduct of monetary policy because the policy rate for lending is somewhat higher than the policy rate for deposits, generating an interest margin. More importantly, a central bank has a monopoly of the issuance of banknotes, which are liabilities that bear no interest rate. Against these liabilities the central bank invests in assets with positive expected returns. We refer to this collectively as the central bank seigniorage income and this explains why central banks generally make profits. Various efforts have been made to estimate the present discounted value of future seigniorage income, assuming it is significant and extends far into the future (Buiter, 2008)
However, the amount of seigniorage income is uncertain and depends on the applicable monetary policy in place. In adverse scenarios – and if monetary policy demands it – seigniorage may be low for a long time or even negative for a number of years. Therefore, seigniorage does not help to ensure independence and credibility over the medium term. Even in a normal economic environment seigniorage is notoriously hard to estimate because it requires assumptions about the interest rate margin. It is therefore prudent not to take future seigniorage income into account as a loss-absorbing buffer. This is in line with commercial banks, which likewise do not include their future net income as a buffer. If financial risks were covered by seigniorage only, this would place an additional constraint on monetary policy. The central bank in this case would effectively have to restrict its monetary policy options to those that are profitable over the short to medium term. As a result, such a central bank would have lower credibility as a monetary authority to deploy whatever needs to be done.
To summarize, the general message of the above listed literature is that a central bank may work well even with negative capital because that country has a strong consolidated government balance sheet. Due to its position in the financial system, even a central bank with negative capital could function without any liquidity problems. Moreover, as the issuer of the currency, the central bank has substantial non-interest- bearing liabilities (primarily currency) that enable it to generate profits and have a positive economic value even with negative capital. To sum up, negative capital on its own is neither a signal of potential illiquidity, nor a signal of insolvency. Nevertheless, positive capital is highly recommended due to the risks implied. For a central bank that is perceived by markets financially weak can be rather difficult to backstop the financial system if adversely affected by a major shock. Weak balance sheet could also reduce financial independence due to the doubts about ability of a central bank to withstand further shocks without recourse to public finances. Low degree of financial strength may then reduce credibility of a central bank as to meeting its policy objectives. Some authors therefore claim that the central bank should always have positive capital and seek government assistance soon enough if some losses occur.
Overview of Bank of Ghana’s Negative Capital.
The Bank of Ghana reported a loss of GHC 60.8 billion in 2022. The main reason for this huge loss is the impairment of the holding of marketable Government stocks and non-marketable instruments of Government all being held in the books of the Bank of Ghana. This stock of Government instruments has been built over the years. In addition, the Bank of Ghana’s (BoG’s) exposure to COCOBOD, which has been built over the years, was also impaired. As we all know, the Government of Ghana embarked on both domestic and external debt restructuring. The holdings of Government instruments and COCOBOD exposures were all part of the perimeter of the debt exchange. Whereas all other stakeholders that participated in the Domestic Debt Exchange (DDEP) did not have principal haircuts, but rather had new instruments with new tenors and coupon structure, the BoG, served as the loss absorber to the entire debt exchange program, a key requirement that allowed the Government of Ghana to meet the threshold for the approval of the IMF program. As a result, the BoG had to take on a 50 percent principal haircut on the total principal (which stood at GHC 64.5 billion at the time of the exchange). Consequently, BoG had new instruments with extended tenor and significantly reduced coupon. By applying the full requirements of IFRS 9, this means that from the principal alone, a 50 percent haircut on the non-marketable amounted to a loss of GHC32.3 billion. Restructuring of marketable instruments amounted to a loss of GHC16.1 billion. The impairment from exposure to COCOBOD also amounted to GHC 4.7 billion. These three DDEP items (marketable, non-marketable and COCOBOD) accounted for GHC53.1 billion out of the total loss of GHC 60.8 billion for 2022. In addition to these three items, price and exchange rate valuation effects accounted for GHC 5.2 billion of the total loss, whereas interest expense on cost of monetary policy operation accounted for GH3.3 billion in 2022, the BoG reported a staggering GHC60.9 billion losses due to impairments during the domestic debt exchange program, and in 2023 the losses continued with a GHC10.5 billion deficit, primarily attributed to high expenditures related to monetary interventions aimed at controlling inflation. It is also expected that in 2024 financial statement yet to be published may record significant losses that would long way to compound the already worst negative equity. The Bank of Ghana’s (BoG) negative equity, primarily stemmed from losses incurred due to the domestic debt exchange program, has undermined its credibility and impacted negatively on the Ghanaian economy’s stability. The inability to cover costs and build sufficient buffers over the short to medium term require that capital injection from the government which has undermined its independence and credibility of monetary policy and also affect public confidence in the central bank’s operations. Bank of Ghana’s policy solvency is being questioned as it has not been able to raise needed realized revenues to cover costs and to build longer-term capital reserves allowing for independent and appropriate policy decisions. The Bank of Ghana’s monetary interventions involved open market operations, repos, and discounting facilities which are crucial for mopping out excess liquidity in the economy to maintain demand for forex for goods and services at a stable level. Bank of Ghana’s equity capital, however, exceptional situation where misperceptions and political economy dynamics interacted with losses to compromise the central bank’s standing. There was macroeconomic mismanagement and the state lacks credibility, losses eroded the central bank’s standing, which has jeopardized its independence and that led to the huge losses in the domestic debt exchange program in 2022/2023. The central bank’s credibility could also be at risk if it lacks sufficient resources to fund its operating needs, such as future earning capacity or government recapitalization without conditional political influence. Adequate capital not only supports the central bank’s independence and credibility, but also instils confidence in the public and financial markets. Sufficient capital enables the central bank to focus on most-appropriate monetary policy without being constrained by the strength of its balance sheet or government’s short-term financial interests. The Bank of Ghana’s losses should not be too breezily dismissed, given their impact on the public finances and the fact that, in extreme cases, such losses could even weaken the independence of a central bank. Fry (1990, p.8) defines a central bank to be insolvent “when it can continue to service its liabilities only through accelerating inflation.” This implies that as long as the central bank can service its debt through accumulation of additional debt, thereby avoiding an acceleration of inflation, it cannot be considered insolvent. However, the public will only be willing to hold a growing volume of central bank debt at increasingly higher interest rates, entailing adverse implications for economic growth.
A central bank should therefore be considered insolvent if it can only continue to service its debt through accelerating inflation or decelerating growth. Stella (2002) posited that loss-making central banks should be recapitalized with equity transfusions from the government. The equity infusion should take the form of interest-bearing marketable government debt that eventually could be exchanged for loss-generating central bank liabilities or otherwise used to cover the losses. According to the Minister of Finance, Hon. Dr. Ato Forson the government will require to recapitalize of Bank of Ghana to the tune of GHC53 billion or equivalent of US$ 3.4 billion. Recapitalization often involves the government injecting capital into the central bank. This can be done through various means: a. direct cash injection: The government can provide a direct infusion of funds to the central bank. b. issuance of Government Securities: The central bank may receive government bonds or securities, which can be held on its balance sheet to bolster its capital. c. equity investment: In some cases, the government may increase its equity stake in the central bank. d. internal measures: The central bank can also take internal measures to improve its capital position, such as retaining earnings, selling non-core assets, or adjusting its portfolio of foreign reserves, sales- lease back of their new head office block, sale of their 12% stake in ADB and their other properties. However, with the country’s current debt overhang, limited fiscal space, access to both international and domestic markets blocked there is an urgent need for government to have innovative options by leveraging on huge natural resources as well as up tapping into inward remittance space like Diaspora bonds to finance the Bank of Ghana’s recapitalization.
Case Studies of Recapitalization
- European Central Bank (ECB): During the European sovereign debt crisis, several euro-zone central banks faced significant losses. The ECB and national governments had to undertake measures to recapitalize these banks to stabilize the financial system. The economies of Euro-zone were strong and robust so weak central bank was of no important.
- Bank of Japan (BoJ): In the late 1990s, the BoJ underwent recapitalization to manage the aftermath of the Japanese asset price bubble. The government provided substantial financial support to ensure the central bank could maintain monetary stability. The robust and resilient of the Japanese economy supported the weak central bank. The two central banks had negative equity yet fully met their objectives
Discussions and Findings
Critics including previous Governor and some economists in the country have argued that Bank of Ghana as central bank does not need adequate capital and also argued that despites the negative capital of Bank of Ghana, they professed that Bank of Ghana was policy solvent, but theoretical literature by Wessels and Broeders (2022) affirmed that countries with weak government consolidated balance sheet saddled with huge debt overhang and macroeconomic challenges could not operate with central bank which is technically bankrupt. If recapitalization of the Bank of Ghana was not any strategic important why did IMF signed a Memorandum of Understanding (MOU) for recapitalization with Bank of Ghana and the Government of Ghana. This move comes as a strategic effort to bolster the central bank’s financial health and improve its equity position after experiencing substantial losses in the past three years. The Bank of Ghana’s recapitalization plan aims to strengthen the financial sector by ensuring banks meet minimum capital requirements, potentially through fresh capital injections, and is crucial for maintaining a positive Capital Adequacy Ratio (CAR). Recapitalization often involves the government injecting capital into the central bank. This can be done through various means: a. direct cash injection: The government can provide a direct infusion of funds to the central bank. b. issuance of Government Securities: The central bank may receive government bonds or securities, which can be held on its balance sheet to bolster its capital. c. equity investment: In some cases, the government may increase its equity stake in the central bank. Any of the above funding approaches could add up to the already worst fiscal pressures which Minister of Finance has vowed not do it now or in the near future. The Government is currently running a significant fiscal deficit are likely to be reluctant sources of external funds, particularly in a scenario where the losses were caused by a wider economic stress that would also have had a negative fiscal impact. Recapitalizations are often a last resort and require careful political and economic handling. In the case of a government constrained by a high debt burden, a central bank recapitalization could theoretically be undertaken by a foreign agency, such as the IMF, the World Bank or a development bank
This recapitalization is anticipated to enhance the BoG’s operations both domestically and internationally, reinforcing its role in the economic stability of Ghana and this affirmed and confirmed in theoretical literature by Wessels and Broeders (2022). However, those critics have cited multiple reasons for that: (a) a central bank can always meet its liabilities by printing money, (b) the government offers (implicit) support to the central bank, and (c) seigniorage acts as a buffer for the central bank. From the under-listed review (a) The Bank of Ghana can always meet its liabilities by printing money. Although it is true that a central bank technically cannot go bankrupt in its domestic currency, the practice of printing money to cover costs or losses is unsustainable. The past policy of printing more money had jeopardized public confidence in the central bank and as inflation rose as a result, that gradually led to hyperinflation during 2023-2024. In the recent times through the printing of monies and monetization of government fiscal deficits had driven the country into hyperinflation and also jeopardized public confidence in the central bank. (b) The government offers (implicit) support to the central bank. Some central banks with negative capital seemingly operate without problems. This primarily works, however, because stakeholders such as financial markets and the public have trust in the government and the strength of the national economy (Wessels and Broeders, 2022). From a public finance perspective, the central bank’s balance sheet can be considered part of any country’s government consolidated balance sheet. Governments with strong consolidated balance sheet like Canada USA, Japan and UK, with a weak central banks’ balance sheet may appear to be non-problematic for the role and effectiveness of the central bank but that has not been case of Ghana where the country defaulted to both domestic and international bond holders’ payments in 2022, with huge debt overhang, macro-economic instabilities as well as dwindling foreign exchange reserves all in the face of technically bankrupt central bank. Ghana. This is because Bank of Ghana could not implicitly relied on the strength of the government because the economy is broke and in shambles. Without the support from the government, stakeholders like Bank of England, US Federal Reserve Bank, European Central Bank (ECB) Bank of Japan and others would perceive a central bank with negative capital as one whose main tool (the balance sheet) is weak and whose liabilities (fiat money) are only partly covered by the central bank’s asset values. In a crisis, financial markets will factor in the financial strength of the government, which may be deteriorating at that point as well. In such a situation, there may be limits to what the central bank can achieve on its own in pursuing its objective
With the persistent Bank of Ghana’s negative capital this could jeopardize on both independence and credibility of key components of a central banks’ balance sheet. From the Ghanaian perspective, where country’s consolidated balance sheet had been very weak as a result of the huge debt overhang and macroeconomic challenges over the past three years which have impacted negatively on Bank of Ghana’s balance sheet which appeared to be more problematic for the role and effectiveness of the central bank. This was because the central bank implicitly relied on the strength of the government. Without any significant support from the central government, Bank of Ghana’s correspondent bankers like Bank of England, USA Federal Reserve Bank, European Central Banks and other stakeholders would perceive Bank of Ghana with negative capital as one whose main tool (the balance sheet) is weak and whose liabilities (fiat money) are only partly covered by the central bank’s asset values. However, with the country’s weak and huge debt overhang on consolidated government balance sheet and also a weak Bank of Ghana’s balance sheet thus appeared to be problematic for effective implementation of its monetary policy. In the current economic crisis, financial markets will factor in the financial strength of the government, which may be deteriorating at that point as well. In such a situation, there may be limits to what the central bank can achieve on its own in pursuing its objectives. Therefore, Bank of Ghana with a negative capital position may not be independent enough and may experience lower credibility. (c) Seigniorage acts as a buffer for Bank of Ghana. Bank of Ghana earns income through their conduct of monetary policy because the policy rate for lending is somewhat higher than the policy rate for deposits, generating an interest margin. More importantly, Bank of Ghana has a monopoly of the issuance of banknotes, which are liabilities that bear no interest rate. Against these liabilities the central bank invests in assets with positive expected returns. We refer to this collectively as the central bank seigniorage income and this explains why central banks generally make profits. Various efforts have been made to estimate the present discounted value of future seigniorage income, assuming it is significant and extends far into the future (Buiter, 2008). However, the amount of seigniorage income is uncertain and depends on the applicable monetary policy in place. In adverse scenarios – and if monetary policy demands it – seigniorage may be low for a long time or even negative for a number of years. Therefore, seigniorage does not help to ensure independence and credibility over the medium term. Even in a normal economic environment seigniorage is notoriously hard to estimate because it requires assumptions about the interest rate margin. It is therefore prudent not to take future seigniorage income into account as a loss-absorbing buffer. This is in line with commercial banks, which likewise do not include their future net income as a buffer. If financial risks were covered by seigniorage only, this would place an additional constraint on monetary policy. The Bank of Ghana in this case would effectively have to restrict its monetary policy options to those that are profitable over the short to medium term. As a result, such Bank of Ghana would have lower credibility as a monetary authority to deploy whatever needs to be done. One more perspective in favour of adequate capital comes from the public’s perception that the Bank of Ghana performs banking services for the commercial banks and often manages part of the national reserves in the form of gold and other investments. The public will perceive the central bank as a “bank” that needs to be adequately capitalized. Therefore, from a communication perspective it dose not make sense to have poorly capitalized Bank of Ghana, when the central bank is considered to be a financial subsidiary of the government. Bank of Ghana being a mother of regulatory governance requires sufficient capital is needed having regard to the risks that the banking sector. Even if the parent Bank of Ghana has given the banking institutions explicit guarantee, supervisory authorities will be require the banking institutions to hold sufficient capital. Prolonged losses and negative equity could directly affect the ability of central banks to operate effectively.
Bank of Ghana’s Negative Capital implications on the wider economy.
From the theoretical literature, Bank of Ghana could be considered as both technical and policy insolvent. Technical insolvency, in the context of Bank of Ghana meant that the total value of its liabilities (what it owes) is greater than the total value of its assets (what it owns). From the policy insolvency as Bank of Ghana is unable to raise insufficient revenues to cover operational costs, a lack of capital reserves to withstand economic shocks, or a need for government funding to implement policies, potentially leading to fiscal dominance. The huge technical losses is leading to policy insolvency which could undermine the credibility of monetary policy, potentially leading to inflation or economic instability, and could erode public trust in the central bank.
The government through the Ministry of Finance should recapitalize the Bank of Ghana often involves the government injecting capital into the central bank, (a) direct cash injection, (b) issuance of government securities, (c) equity investment: all these funding approaches could have serious implications on the Government fiscal pressures. Any government funding approach to Bank of Ghana’s losses may add to the already worst Government fiscal pressures. The persistent losses of the Bank of Ghana had impacted negatively on its prestige and authority and may also influence macroeconomic developments. The perception that it may not be financially sound, however simplistic the view, could erode its authority to supervise the financial system and limit its ability to use moral suasion as an instrument of policy. Its independence in managing its internal affairs may be diluted by, for example, pressures to make the central bank’s administrative budget subject to approval by the government or the legislature, as a way to limit its losses. Consequently, the accumulated loss could undermine the credibility of BoG’s monetary policy. The persistent Bank of Ghana’s losses had been relatively large to the monetary base could erode the ability of the central bank to conduct monetary management efficiently, further compounding the current adverse macroeconomic conditions of higher monetary policy rate of 27%, annual inflation of 23.1%, and persistent depreciation of the local currency. A second will be that Bank of Ghana resort to financial repression with negative repercussions on financial system efficiency and soundness.
Seriously deteriorated balance sheet of Bank of Ghana could cause chronic losses that will eventually with price stability. Facing such a situation several possibilities exist; one will be abandoning price stability as a goal, by financing losses by money creation with obvious consequences of higher inflation. Losses of the Bank of Ghana had been relatively large to the monetary base, that could possibly erode the ability of the central bank to conduct monetary management efficiently, further compounding the adverse macroeconomic effects mentioned above. From the experience of countries such as Jamaica indicates that persistent losses of the central bank could lead to inconsistent use of monetary policy instruments. Growing losses create an environment in which the central bank would face the continuous task of sterilizing the monetary impact of its losses by absorbing liquidity from the financial institutions in the country. If the recent Bank of Ghana losses are not managed well there is the that possibility of have negative implication on the monetary management whether the central bank relies on market-oriented indirect instruments of monetary control or on direct instruments, such as bank specific credit ceilings and administratively fixed interest rates. Under the indirect approach, as the losses could lead to progressively higher interest rates and increase their volatility, interest rate management and financial programming become more complex. Interest rate volatility will also impede the development of the money market. These problems may eventually force the Bank of Ghana to depart from its indirect approach, at the cost of distorting interest rates and impeding efficient resource allocation.
With Ghana’s default status and the Bank of Ghana’s negative equity are in conflict with the international financial sector regulation, as Basle Core Principle recommended on specific risk weights to various asset categories, including restructured bonds under the DDEP against which proportionate capital is required to be held. Prior to the domestic debt exchange, Bank of Ghana applied a zero weight (implying zero risk) to Government of Ghana’s domestic debt on the basis of the Government’s strong track record and commitment to debt repayment and the supporting constitutional provisions in this regard with the defaulted country status and the Bank of Ghana’s negative capital status could not reissue the zero risk -rated bonds. Ghana government defaulted debt and the Bank of Ghana negative equity would automatically place the reissued domestic bonds in the category of impaired and poorly rated assets, thus immediately triggering higher risk weighting and provisioning requirements applicable to such categories of assets. The risk weight normally applicable would be at least 100.0 per cent and would thus require very significant increases in capital of the entire financial system
Bank of Ghana’s negative equity has already posed communication challenges. For instance, some policy decisions, such as retaining rather than selling government bonds, could be misinterpreted as being motivated by a desire to contain losses rather than as actions to pursue specific policy mandates. This would reduce central bank credibility. Likewise, financial flows from government, including actions to strengthen central bank capital positions, could be misperceived as being inconsistent with central bank independence. This underscores the importance of clear communication about the reasons for losses and of a transparent framework for financial flows between the Bank of Ghana and the government. One more perspective in favour of adequate capital comes from the public’s perception that the central bank performs banking services for the commercial banks and often manages part of the national reserves in the form of gold, foreign currency reserves with Bank of England UK, Fed Reserve Bank of USA, etc. and other investments.
The public will perceive the central bank as a “bank” that needs to be adequately capitalized. • The Reserve Bank of Australia (RBA) recorded a 2022 book loss of 37 billion Australian dollars, which more than wiped out the central bank’s equity• The UK Government faces £150 billion bill to cover Bank of England’s losses (According to the Financial Times of July 25, 2023).• The Swiss National Bank (SNB) in early January reported a record preliminary loss of 132 billion francs for 2022• In September 2022, the central bank of the Netherlands notified the country’s government in a letter that it projects net interest losses amounting to a potential EUR 9 billion for the years 2023 through 2026• The US Federal Reserve has no longer been able to remit weekly billion-dollar transfers to the US Treasury since autumn 2022. Instead, a debt obligation to the US Treasury (a liability that the Fed recognizes as a deferred asset) has been growing on the Fed’s balance sheet since then. The Fed eventually will have to pay this liability sometime in the future (when it resumes generating profits). From a public finance perspective, the central bank’s balance sheet said to be considered part of strong consolidated government’s balance sheet. If this consolidated balance sheet is strong, a weak central bank balance sheet may appear to be non- problematic for the role and effectiveness of the central bank. This is because the central bank implicitly relies on the strength of the government. Weak Bank of Ghana’s balance sheet and weak consolidated Ghana’s government balance sheet do not allow Ghanaians to compare with weak central banks from USA, UK, Swiss National Bank and Reserve Bank of Australia, all these countries have strong and robust consolidated government’s balance sheets. We in Ghana cannot compare apples with oranges. Historically, some central banks have operated with negative equity yet fully met their objectives but because of strong consolidated governments’ balance sheets they are able function properly. Ignorance or neglect of Bank of Ghana’s negative capital over a sustained period could lead to deterioration of the balance sheet to a point where further losses become virtually inevitable. These losses could erode Bank of Ghana’s independence and make the effective conduct monetary policy difficult or impossible.
Conclusion.
In this paper, we argue that central banks need adequate capital in order to be effective as a monetary authority, independently of their governments. A strong balance sheet gives the Bank of Ghana sufficient fire power to implement its monetary policy in an effective way.
Given the importance of the Bank of Ghana’s objective for the economy and the role played by its capital in supporting credibility as well as operational capacity, it is important that central bank is adequately resourced financially, without reliance on government decisions which may be driven by political rather than economic considerations.
Adequate capital is an important ingredient of a strong central bank balance sheet. It also supports the public and financial markets’ confidence in the independence and credibility of the central bank. With sufficient capital, Bank of Ghana can focus on the most appropriate monetary policy without having to consider the strength of its balance sheet or the short-term financial interests of the government.
Finally, the public expects adequate capitalization would enhance the credibility and legitimacy of Bank of Ghana. Central bank just as any other bank is supposed to make profits because of the seignorage involved in currency issue. However, many central banks make losses because the costs involved in trying to preserve the value of the currency, and in supporting government policy through quasi-fiscal activities, outweigh seignorage.
According to literature by Wessels and Broeders, (2022) any central bank like Bank of Ghana with negative capital could jeopardize on both independence and credibility of key components of a strong central banks’ balance sheet.
To conclude, a central bank’s credibility depends on its ability to achieve its mandates of price stability. The basic prerequisites are a strong degree of Bank of Ghana’s independence with strong and robust balance sheet and the absence of fiscal dominance and clearly defined objective of achieving price stability together with absence of other nominal objectives. Persistent losses could jeopardize that ability and are sometimes the price to pay for achieving those aims.
To maintain the public’s trust and to preserve central bank legitimacy now and in the long run, stakeholders should appreciate that central banks’ policy mandates come before profits From the Ghanaian perspective, where country’s consolidated balance sheet with huge debt overhang and macroeconomic challenges over the past three years that have impacted negatively on Bank of Ghana’s balance sheet that appeared to be problematic for the role and effectiveness of the central bank.
This was because the central bank implicitly relied on the strength of the government. Without the support from the central government, Bank of Ghana’s correspondent bankers like Bank of England, USA Federal Reserve Bank, European Central Banks and other stakeholders would perceive Bank of Ghana with negative capital as one whose main tool (the balance sheet) is weak and whose liabilities (fiat money) are only partly covered by the central bank’s asset values.
However, with the country’s weak and huge debt overhang on consolidated government balance sheet and also a weak Bank of Ghana’s balance sheet thus appeared to be problematic for effective implementation of its monetary policy. In the current economic crisis, financial markets had factored in the financial strength of the government, which may be deteriorating at that point as well.
In such a situation, there may be limits to what the central bank can achieve on its own in pursuing its objectives. Therefore, Bank of Ghana with a negative capital position may not be independent enough and may experience lower credibility. (c) Seigniorage acts as a buffer for Bank of Ghana. Bank of Ghana earns income through their conduct of monetary policy because the policy rate for lending is somewhat higher than the policy rate for deposits, generating an interest margin.
More importantly, Bank of Ghana has a monopoly of the issuance of banknotes, which are liabilities that bear no interest rate. Against these liabilities the central bank invests in assets with positive expected returns. We refer to this collectively as the central bank seigniorage income and this explains why central banks generally make profits. Various efforts have been made to estimate the present discounted value of future seigniorage income, assuming it is significant and extends far into the future (Buiter, 2008).
However, the amount of seigniorage income is uncertain and depends on the applicable monetary policy in place. In adverse scenarios – and if monetary policy demands it – seigniorage may be low for a long time or even negative for a number of years.
Therefore, seigniorage does not help to ensure independence and credibility over the medium term. Even in a normal economic environment seigniorage is notoriously hard to estimate because it requires assumptions about the interest rate margin. It is therefore prudent not to take future seigniorage income into account as a loss-absorbing buffer.
This is in line with commercial banks, which likewise do not include their future net income as a buffer. If financial risks were covered by seigniorage only, this would place an additional constraint on monetary policy. The Bank of Ghana in this case would effectively have to restrict its monetary policy options to those that are profitable over the short to medium term.
As a result, such Bank of Ghana would have lower credibility as a monetary authority to deploy whatever needs to be done. A strong balance sheet could give Bank of Ghana sufficient fire power to implement its primary objective widely known as price stability in an effective way. Adequate capital is an important ingredient of a strong central bank balance sheet.
It also supports the public’s and financial markets’ confidence in the independence and credibility of the central bank. With sufficient capital, the central bank can focus on the most appropriate monetary policy without having to consider the strength of its balance sheet or the short-term financial interests of the government. Finally, the public expects adequate capitalization for a central bank just as for any other bank.
Policy Recommendations.
First, the government through Ministry of Finance must urgently recapitalize Bank of Ghana after the domestic debt exchange in 2022/2023. IMF, 24/334/2024 recently announced options to ensure consistency with the Fund-supported program parameters include recapitalization via budgetary or asset transfers, suspension of profit transfers, and/or use of any buffers that could be generated in program implementation.
- To strengthen the recovery of its net equity over time. In the crucial times like in the country’s history the government could leverage the country’s huge natural resources and inward remittance space to recapitalize the Bank of Ghana to tune of GHC53 billion (US$3.4 billion) without put much stress on the national budget in the next few years. (a) Reviewing Natural Resource Fiscal Regimes: The paper recommends the urgent need to change the fiscal regimes to allow Ghana to increase its ownership of, and benefits from, its natural resource wealth. This will require reviewing the natural resource laws, including the Petroleum (Exploration and Production) Act, 2016 (Act 919) and the Mining and Minerals Act, 2019 (Act 995). The new fiscal regimes should be based on production-sharing or service-contract agreements. The initial capital constraint for exploration and development of the natural resources can be overcome through pledging or collateralization of the natural resource deposits especially gold against capital raised for the purpose. In the interim, the need to have a moral conversation with the stakeholders in the natural resources sector particularly hydrocarbon and gold to have closed door discussion on supporting current debt profile through sale and purchase agreement, debt equity swaps and ownership structure for Ghana to fully benefit from our natural resources (b)Exchange Rate Management through beefing up Inward Remittances through the following: i. Urgent review of regulatory framework covering inward remittances to ensure that the Payment Service and Systems Act, 2019 (Act 987) and part of the Bank of Guidelines on inward remittance settlement processes ensure total compliance with the Foreign Exchange Act, 2006 (Act 723) by all Money Transfer Companies and the Fintech companies licensed by the Bank of Ghana. The full compliance of the Act and BOG’s guidelines will stop the externalization of remittance inflows in order to bolster FX receipts and raise national savings thereby curtailing any Balance of Payment crises. Setting up Inward Remittances Department at the BOG to trace, track and capture all FX accumulated from inward remittances from the new Money Transfer Companies and other 11 Fintech Companies in the foreign remittance space to be in compliance with the Foreign Exchange Act 2006 (Act 723). The Inward Remittances Department at the BOG will be strengthen to collaborate with the Central Bank of Bangladesh to learn how 90%-95% of remittances are captured through the banking system.
Traditional recapitalization of Bank of Ghana including budgetary or asset transfers, suspension of profit transfers and use of any buffers would have the mainstay of the recapitalization program.
The most practical route for a capital infusion would thus be for the government to provide the central bank with interest-bearing marketable government securities. This is tantamount to internalizing the fiscal impact of Bank of Ghana’s financial condition in the country’s national budget.
However, with the country’s current debt overhang, limited fiscal space, access to both international and domestic markets blocked there is an urgent need to have innovative options by leveraging on huge natural resources as well as up tapping into inward remittance space like Diaspora bonds to finance the Bank of Ghana’s recapitalization.
Second, recommendation is that strong balance sheet gives Bank of Ghana sufficient fire power to implement its monetary policy in an effective way. Adequate capital is an important ingredient of a strong central bank balance sheet.
It also supports the public’s and financial markets’ confidence in the independence and credibility of the central bank. With sufficient capital, the central bank can focus on the most appropriate monetary policy without having to consider the strength of its balance sheet or the short-term financial interests of the government
Third, recommendation is that Bank of Ghana’s target level of capital should be proportional to (nominal) GDP as a proxy for the latent risks. The target level of capital should grow gradually and steadily over time. As a minimum, the capital target should grow with inflation to maintain its real value.
To achieve this, the capital target could be linked to one or more macroeconomic variables. In particular the capital target could be linked to GDP growth. In this way, the capital target will grow steadily in line with the underlying latent risks (which broadly follow GDP) and its growth rate will be within reasonable limits (typically two to five percent per year) even when times are benign or adverse. If over time it is concluded that the latent risks are growing faster than GDP, a recalibration could take place.
For instance, this would be justified with a booming financial sector in a country. Two additional reasons for Bank of Ghana to strive for a gradual and steady growth of the target level of capital are public perception and model risk. First, steady growth of the capital target, when agreed and communicated upfront, creates the perception of being in control of effectively implementing the central bank’s mandate.
Conversely, large changes in the target level of capital create the perception of reactive, short-term management by the central bank and are potentially detrimental to its effectiveness. Second, financial risk calculations hinge on quantitative analyses, models and parameter estimates.
The risk of inaccurate modelling supports an approach that is more prudent with respect to the calculated financial risks and uses a target calibrated against robust parameters with a long-term view. This prudent approach avoids short-term adjustments to the risk calculations and changes in the resulting capital target (Wessels and Broeders,2022).
Fourth, Central banks like Bank of Ghana can mitigate the risk of misperception through effective communication to their stakeholders. They can clarify the context for potential losses, noting how the measures were undertaken to ensure price and economic stability over the medium and long-term for the benefit of households and businesses, which incidentally boosted economy-wide income and hence the overall tax base.
In their public communications, Bank of Ghana can prepare stakeholders for losses at the outset of policy interventions, explaining that APPs or other programs carry financial risk. And they can reiterate these messages when losses are imminent, explaining how central bank finances work and that losses are not relevant for policy. Several central banks have already done so when publishing their recent financial statements or through other public communications (Bell et-al, 2023)
Lastly, beyond immediate capital needs, the central bank and government must implement measures to ensure long-term financial sustainability. This might involve policy adjustments, improved risk management practices, and strategies to prevent future capital shortfalls.
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