#MoneyReport2023: Impact of DDEP impairment losses on banking sector and role of the Financial Stability Fund

… the case of local/ indigenous banks

A research paper by Dr. Richmond Akwasi ATUAHENE and K.B. FRIMPONG

The Ghanaian financial sector has been in severe distress, characterised by an insolvent banking system as result of the domestic debt exchange in 2022. Using the 16 percent discount rate for the NPV calculation for government bonds, the DDEP losses of 22 banks stood at GH¢37.7billion, with the private domestic banks and state-owned banks accounting for losses of GH¢19.9billion while foreign-owned banks accounted for GH¢17.8billion. The DDEP impairment losses have technically rendered some Ghanaian locally-owned banks insolvent, which would require additional capital support from shareholders or to participate fully in the Ghana Financial Stability Fund.

According to IMF Country report (23/168), the World Bank, other donors and the Government of Ghana were expected to provide GFSF of US$1.5 equivalent in cedis to facilitate the build-up of capital buffers for qualifying banks. The local or indigenous banks have already submitted their credible time bound plans to rebuild capital buffers on a phased basis in line with timelines set in the country’s financial sector strategy.

These recapitalise plans would have to be reviewed by Bank of Ghana and finalised by banks for approval by Bank of Ghana by the end of September, 2023. For capital restoration for local banks through Ghana Financial Stability Fund, the preference or priority must be given to those local banks that are not quoted and listed on the Ghana Stock Exchange Market as those listed banks are expected to raise additional capital on market.  The operationalisation of the Ghana Financial Stability Fund to support the insolvent banking system could go a long way to support the economic recovery of the country in the post-pandemic era.

Furthermore, operationalisation of the fund and planned recapitalisation would ward away the potential takeover of domestic banking sector by foreign-owned banks as we have already done harm to mining and telecom sectors. One of the major problems plaguing the banking sector was the domination of the sector by foreign banks and the attendant effect of illegal capital transfers as well as, so the government must make conscious effort to develop and support the indigenous banking institutions.

The capital restoration of the local/indigenous banks must take into consideration the entire losses for their participation in the DDEP and the deletion of all the regulatory reserves in the balance sheets of those banks. There has been a heightened need for the recapitalisation of banks operating in Ghana after the domestic debt exchange programme in December, 2022, and it has been spearheaded by the foreign-owned banks operating in the country.

A couple of months ago, Standard Bank.SA (Standard Bank) and First Rand SA – both based in South Africa, revealed their plans to recapitalise their operations in Ghana even before the submission to recapitalisation plans to Bank of Ghana. Standard Bank (Stanbic) has reportedly reserved South Africa Rand (ZAR) 1.5 billion approximately US$81million for impairment losses from the DDEP. Also, Nigerian-owned bank Zenith has revealed that it has set aside US$265million to ring fence its impairment losses as a result of the participation of DDEP.

Domestic bonds were widely distributed across thefinancial sector in Ghana, representing the most important asset class held by 22 universal banks, specialised deposit-taking institutions, pension funds, asset management companies, and insurance companies. Banks held 30 to50 percent of their total assets in government securities before the DDE—with especially highexposures in the state-owned banks—and relied significantly on income from these securities.

The coupon reductions and maturity extensions in the recently completed DDE mean that the value of these assets had declined to about 70 percent of the par value (IMF Country report, 23/168). From the IMF report (2021), domestic debt restructuring have a direct impact on the balance sheet and earning potential of financial institutions holding sovereign debt. The impact on bank balance sheets could be significant where sovereign securities comprise a large share of bank asset as Ghanaian banks held about 30 percent to 50 percent of the government bonds.

Any loss in value of government debt exposures have led to serious capital losses in banking institutions as most banks never absorbed by provisioning and mark-to-market (MTM) accounting. These losses were due to a combination of coupon or interest rate reduction (16 percent), and maturity extension with below-market coupon rates of 19.3 percent as a result of the domestic debt exchange implementation.

According to IMF country report (23/168) the government offered most bondholders a set of new bonds at fixed exchange proportions with a combined average maturity of 8.2 years and coupons of up to 10 percent (with part of the coupons capitalised rather than paid in cash in 2023 and 2024). The capacity of the banking sector to absorb losses were lower as some of the banks were not properly capitalised. When banks are able to absorb losses without having to resort to a recapitalisation from the government, the fiscal consolidation and/or burden-sharing by other creditors required to restore debt sustainability would be smaller.

According to IMF country report (23/168), the completed DDEP has produced very large cash debt relief for the government of almost of GH¢50billion in 2023 and the baseline fiscal cost of DDEP to the financial sector is up to 2.6 percent of GDP.

The recent domestic debt exchange programme of unprecedented size and dire consequences is a major concern throughout today’s society, from the popular press to policy-makers, regulators and academics around the country. The near collapse of prestigious local banking institutions could be followed by the near paralysis of the banking sector with negative consequences for the real economy, making the past crisis a singular point in the series of modern crises and unquestionably qualifies it as the most severe one since the independence of the country in 1957.

The uniqueness of the crisis has prompted efforts to identify its determinants and the solutions to cope with. The crisis is frequently attributed to the bursting of the Ghana’s bond market bubble bust. But such a complex event presents a multi-dimensional profile as well as poor and lax risk management and regulatory capture and failure on the part of the banking fraternity.

Negative impact of DDEP impairment losses on the banking sector

The 22 universal banks and their external auditors, Bank of Ghana and the Ministry of Finance agreed a 16 percent-18 percent discount rate as the final terms of the DDEP, implying an average NPV reduction of about 30 percent for government bond holders (IMF Country report, 23/168). Using the 16 percent discount rate for the NPV for government bonds calculation resulted in DDEP losses of 22 banks at GH¢37.7billion, with the private domestic banks and state-owned banks accounting for losses of GH¢19.9billion while foreign-owned banks accounted for GH¢17.8billion. The 8 local /indigenous banks captured GH¢8.6billion in the 2022 audited financial statements while the foreign-owned banks also captured GH¢10.8billion in their 2022 audited financial statements.

Most of the foreign-owned banks like Standard Bank S.A, First National Bank, Zenith Bank, ABSA, Standard Chartered Bank and others have all indicated that they will provide capital support and funding to ring fence the impairments.

However, the IMF country report (23/168) requires the Ministry of Finance and Bank of Ghana to develop a strategy by end-June 2023 for strengthening the financial sector and for rebuilding financial sector buffers to be accomplished by the end of the programme. Individual banks have submitted their credible time-bound plans to rebuild capital buffers on a phased basis in line with timelines set out in this financial sector strategy; those plans have been reviewed by Bank of Ghana and finalised by banks for Bank of Ghana approval by end-September 2023. As part of this process, regulatory forbearance – including on capital requirements – will be lifted as soon as possible.

The Bank of Ghana has continued to monitor the expected capital shortfalls stemming from the ongoing recognition of debt restructuring losses in Capital Adequate Ratios calculations and, thus, ensure that the plans on rebuilding capital buffers are implemented based on periodic milestones. With further incentives from Bank of Ghana, individual banks are to expedite the process to include the prohibition of distributing dividends, restrictions in risk exposures, and enhanced monitoring for those that do not meet minimum CAR, and support for early recapitalisation from the Ghana Financial Stability Fund. Any government support for recapitalisation will be designed to incentivise private capital injection and will be conditional on reforms to improve long-term profitability

According to financial statements published in April and March 2023 by the 22 banks, DDEP impairment losses stood at GH¢19.4billion which affected the Capital ADEQUACY RATIO of 8 banks that are operating below 13 percent, as well as profitability indicators (Return on Equity & Return on Assets). The CAR refers to the measurement of a universal banks’ accessible capital, which is expressed as a percentage of a bank’s risk weighted assets and liabilities. Out of the 22 banks, only six banks managed to capture the entire DDEP impairment losses in 2022 while the rest of the losses would have to be captured before the banks could submit their recapitalisation as requested by the IMF country report (23/168).

The DDEP impairment losses have presented substantial challenged for the health of the financial sector, especially the banking industry. The DDEP has resulted in restructuring losses in CAR calculation, so the Bank of Ghana must monitor the expected capital shortfalls and ensure the plans on rebuilding capital buffers are implemented based on periodic milestones. Earlier research by Atuahene and Frimpong (2022) predicted what has been stated in the IMF document (2023/168). The DDEP impairment losses that have affected capital adequacy ratios of some banks could adversely affect their capacity to lend, and dampen credit to private sector and economic activity (IMF, 23/168).

The 2022 audited financial statements of 22 banks reflected only partial impact of the Domestic Debt Exchange Programme (DDEP) losses and the challenging operating environment that prevailed in the year. Most banks reported significant losses on the back of the mark-to-market valuation losses on their respective holdings in Government of Ghana bonds following the implementation of the DDEP. Other losses were due to higher impairments on loans and rising operating costs.

The industry posted a before-tax loss of GH¢8.billion in 2022, compared with a profit of GH¢7.4billion recorded in 2021. After-tax loss was GH¢6.6billion in 2022, relative to profit-after-tax of GH¢4.8billion in 2021. These unprecedented losses of GH¢8billion could be attributed to DDEP implementation in December 2022.The uncaptured losses of nearly GH¢17.1billion could impact negatively on 2022 audited financial statements of 16 banks that did not capture the entire losses in 2022 audited financial statements and this would in turn impact negatively on main profitability indicators (ROE and ROA) as well as CAR.

The main profitability indicators, namely return-on-assets and return-on-equity, all turned negative in 2022 because of the industry’s DDEP loss position. The 2022 audited financial statements of 22 banks also pointed to some impairments in capital levels, although most banks posted Capital Adequacy Ratios (CARs) above the 10 percent regulatory minimum at end-December 2022. This was attributed to the effect of the roll-out of the temporary regulatory reliefs extended to the banks to cushion them against the impact of the DDEP as was done at the onset of the pandemic.

The DDEP impairment losses have technically rendered some of Ghanaian locally-owned banks insolvent that would require additional capital support from shareholders or participate fully in the Financial Stability Fund. According to Bank of Ghana Monetary Policy Report May 2023, the industry’s average CAR adjusted for the regulatory reliefs was 16.2 percent in December 2022, compared with the CAR of 19.6 percent in December 2021. The adjusted CAR reflected valuation losses on GoG bonds, elevated credit risk, and revaluation losses on foreign-currency-denominated loans.

Asset quality also weakened, with the industry’s Non-Performing Loans (NPL) ratio at 18.4 percent in December 2022, from 15.9 percent in December 2021, reflecting higher loan impairments relative to the growth in the stock of loans. From the Bank of Ghana Monetary Policy Report (May 2023) and IMF Country report on Ghana (23/168), the DDEP have had a considerable negative impact on CAR, profitability indicators, and Non-performing loans ratios; and if not managed carefully, the country could experience systemic banking crisis.

Systemic banking crisis occurs when many banks in Ghana have serious solvency or liquidity problems at the same time because they were hit by the domestic debt exchange programme. Banking problems could be traced to decrease in the value of the banks’ assets. The deterioration in asset values occurred because of reduction in average coupon rate from 19.3 percent p.a. to 9 percent with maturity extension from 5 years to 15 years.

According to IMF Country Report (23/168/d/d 05/2023), the government offered most bondholders a set of new bonds at fixed exchange proportions with a combined average maturity of 8.2 years and coupons of up to 10 percent, with part of the coupons capitalised rather than paid in cash in 2023 and 2024. At a 16-18 percent discount rate, the final terms of the DDE imply an average NPV reduction of about 30 percent for these bondholders.

The domestic debt exchange could have a negative impact on the liquidity as a result of credit losses incurred during the DDEP. Further analysis by Atuahene and Frimpong (2022) on the Domestic Debt Restructuring indicated that the 22 banks operating in the country lost additional GH¢6.1billion due to reduced coupon rate and the extension of the maturity period from 5 to 15 years.

In addition, DDEP losses had the potential to reduce the banks’ liquidity, which could lead to higher cost of funds for banks, which could further reduce their future ability to lend to private sector as the engine of growth. The data analysis clearly shows the domestic debt exchange could lead to serious decline in liquidity in the banking system.

The central event of the domestic debt exchange could be liquidity squeeze at some of the banking institutions operating in Ghana as banks that hold the short-term debt have restructured into long-term debt with reduced coupon rate that may face difficulty in meeting their short-term funding requirements. These banks could lose the confidence of customers and counterparties, leading to losses of cash through withdrawals of deposits, cut-off of short-term lending, and other channels.

Domestic debt restructuring can lead to a decline in liquidity in the banking system. This is because banks that hold the short-term debt that is being restructured may face difficulty in meeting their short-term funding requirements. This can lead to a liquidity squeeze in the banking system, which can have a negative impact on banks’ ability to meet the needs of their customers. Domestic debt restructuring could also have a negative impact on the growth of the banking sector in the medium to long term. Banks that could face a liquidity squeeze may be less willing to extend credit to their customers, which can slow down economic growth.

In addition, the decline in liquidity could lead to a reduction in private sector credit, which can further slow down growth. The domestic debt exchange brought about significant strains on liquidity for banks and their customers. To the extent that (i) the domestic debt restructuring and resulting strains were not anticipated by banks and (ii) the shocks to liquidity (drawdowns, withdrawal of wholesale funding) were primarily determined by the actions of actors outside the bank; we can assume these shocks to be exogenous to the bank’s endogenous liquidity management operation.

The onset of domestic debt exchange could be described as a liquidity crunch but could also be easily described as a sudden spike in risk aversion, expressed in part as aversion to some types of privately created liquidity. It is often marked by a run or run-like behaviour, in which short-term lenders suddenly converge on a borrower. Inadequate liquidity may not be the best way to describe the phenomena we currently see. The anomalies and conflicts we’ve described indicate a larger underlying disfunction. Each anomaly is hard to trace back to a specific regulatory change.

Not only have there been major regulatory changes, but the monetary policy response to the crisis, the crisis itself, the continuation of pre-crisis trends, and the banking industry’s adaptation to these also influence market functioning. But taken as a whole, they indicate a general decline in market responsiveness. Liquidity currently seems ample, but perhaps only because market participants don’t urgently need it right now. The market appears persistently less able to withstand large shocks. Disruptive shocks are likely in the years to come, especially sudden changes in the original coupon rates of 19.3 percent to weighted rate of 9 percent and extension maturity period extended from 5 years to 15 years.

From the data analysis from the government bonds and notes under the IFRS 13, a move to Market to Matrix has to be applied to assess the Fair Value of the instrument to be valued (i.e., Mark to Matrix); and finally, Level 3 applies valuation model. The restructured government bonds under the Market to Matrix model will become untradeable as a result of its illiquidity. IMF Country report (23/168) opined that Bank of Ghana has continued with its liquidity facilities, including the repo window and Emergency Liquidity Assistance (ELA), which will be available to banks during the post DDEP period to mitigate the liquidity crunch in the banking industry.

From the afore-mentioned analysis, the domestic debt exchange had lowered the wealth and income of individual households directly through retail holdings or indirectly through shares in mutual funds and pension entitlements. In addition, a domestic debt exchange could have affected availability of bank credit and cost of borrowing for corporations and households, with potential indirect distributional effects. This calls for a thorough assessment and mitigation of the distributional implications of the restructuring on case-by-case basis.

It is due to these distribution considerations that—in contrast to wholesale government securities—retail debt instruments have generally been left out of the scope of domestic debt restructuring. The consequences of domestic debt exchange, if not properly managed, could render banks unable to support private businesses and negatively impact economic growth, with small and medium-sized enterprises being the worst victims.

This has the tendency of hindering the economic growth of the private sector, which is said to be engine of growth; thereby negatively impacting job creation needed in the economic recovery process. The indirect effects of a domestic debt restructuring on the financial system could be more damaging, but it may be harder to assess.

Banks directly affected by the restructuring could face deposit runs, with potential spillovers to other banks possibly due to a loss of confidence in the government’s inability to backstop the deposit insurance scheme. With a hit to its capital base and/or profitability, banks could pull back from lending to the private sector; thus, affecting the real economy. Other indirect effects that could put pressure on financial institutions’ balance sheets include:

• Capital flight and the attendant effects on the net international reserves position;
• Margin calls or withdrawal of foreign credit lines by local banks’ corresponding banks that have been triggered by a sovereign rating downgrade,requiring topping up of the collateral or repayment;
• Exchange rate depreciation pressures driven by a run to safety or increased demand for foreigncurrency to meet margin calls;
• Loss of ability to access the central bank’s normal liquidity facilities due to limited eligibility ofrestructured assets as collateral;
• Rapid decline in asset values driven by fire sale of assets and deleveraging by banks; and
• Spillovers due to ownership and financial interlinkages with affected financial institutions (i.e. banks, insurance companies, investment funds, etc.)

There are various channels through which debt restructuring affects the economy as was highlighted by IMF (2002) and Darvis (2011, p.5). These channels include:

• Direct wealth effect on holders of the bonds who see the value of the government instruments’ cut, especially pensioners. Eventually, the negative wealth effect on corporations and households can lead to a decrease of consumption and investment.
• Loss of confidence that exacerbates the fall in output manifested by capital outflows, falling money demand, and sharp hikes of interest rates on sovereign bonds.
• Disruption of the domestic financial system as the banks receive the hit, through direct effect on the asset side of balance sheets of the banks.
• Bank runs and deposit withdrawals because of loss in confidence.
• Interbank market freezes due to the increase of overall lending risk, credit crunch.
• Interest rate hikes, typical to crises, increasing the cost of funding as a result repricing of new deposits into banking system.
• Flight to quality – deposits shifted to other saving in foreign currencies, often foreign-owned, banks. Because of the costs to the economy, the decision to restructure is not an easy one, but even more importantly the success of the restructuring (regaining debt sustainability) is under threat.
• Market exclusion and interest rate spreads.
• Costs on domestic economy (direct wealth effect, loss of confidence, disruption of domestic financial system).
• Contagion and reputational spillovers.

It is obvious that a reduction in the value of securities of financial institutions (banks, mutual funds, insurance companies, pension funds, etc.) have reduced their asset value, coupon reduction and maturity extensions in the recently completed DDEP meant that the value of these assets have declined to about 70 percent of the par value; thus, reduced their equity and increase their vulnerability and increase the implicit government financial guarantee which can create a dangerous feedback loop.

That is, a debt restructuring can increase the vulnerability of the financial sector and increase the probability that the government may have to bail out the financial sector in the future, which can then worsen the government’s financial position, and which can then flow back to the financial sector in a never-ending cycle. Indeed, it is instructive to note that the current fiscal challenges have, in part, been attributed by the government to the recent financial sector clean-up exercise (bail-out).

• The domestic debt exchange had created weaker local banks; thus, creating potential for possible takeovers, acquisitions and mergers by the existing strong foreign banks operating banking space (IMF Country report on Ghana, 23/168).

Another negative impact of Government of Ghana domestic debt exchange was that the international credit rating companies clearly indicated prior to exchange that any form of distressed debt exchange would be considered as a default, a trigger for further downgrades for Ghana. The international capital market would, therefore be, effectively closed to Ghana as in the cases and Jamaica or Ecuador which took five years to re-access the international capital markets following its debt exchange. Seminal research Cruces and Trebesch (2011), covering all sovereign debt restructurings with foreign banks and bondholders between 1970 and 2010, put significant and credible doubt on claims that higher spreads and exclusion from the capital markets following sovereign default is short‐lived.

This represented the first study that explicitly accounted for the size of the haircut when determining the historical consequences of default. The main conclusions were that deeper haircuts are associated with higher post‐restructuring global bond spreads and longer duration of exclusion from capital markets. Further, if there were a debt restructuring, the perception of increased risk of government debt was expected to significantly blunt confidence in the Ghanaian economy in general, thereby affecting the creditworthiness of private institutions as well.

This has translated into a further cut in credit lines to domestic banking institutions, which would have grave implications for external trade and the stability of the foreign exchange market. Ghanaian domestic banks had already suffered the effects of cuts in credit lines and margin calls by corresponding banks as a result of the international credit crunch in the post pandemic period. Further, withdrawal of credit lines and margin calls have had devastated effects on the international trade system, financial markets and in the Ghanaian economy in general.

As most corresponding banks have withdrawn their credit lines, especially with the local banks, thus making it difficult for international trading system. One major negative effect of DDE has been real risk of capital flight as well as decline in foreign direct investment as Ghana experiences financial market instability associated with these types of liability management programmes. In the case of Uruguay, which undertook similar market-friendly debt rescheduling to Jamaica, within six months of the announcement of the restructuring programme in April 2003, capital outflows surged by over 700 percent. The outflows continued into the following year.

Although not as severe, Ukraine had a similar experience. Ghana would not be able to withstand even a mild form of capital flight in the recessionary periods surrounding the recent domestic debt exchange. These have precipitated massive exchange rate depreciation and general macroeconomic instability and have thus led to higher inflation resulting in the increase on the Bank of Ghana’s policy rate to 30 percent recently.

The tightening of monetary policy that would be required to restore stability would lead to higher debt service costs to the government and defeat the main objective of the debt swaps. By the same token, the further weakening of the Ghanaian economy would work against any improvement in the country’s fiscal and debt profiles.

Ghana debt exchange, like other debt restructuring episodes, have also triggered interest rate hikes, thereby increasing the cost of banks’ funding and affecting their comprehensive income statement. Altogether, these factors could impair the financial position of domestic institutions to a degree that it threatens financial stability and raises pressures for bank recapitalisation and official sector bail-outs which have been confirmed in the recently completed Ghana’s domestic debt exchange programme.

Recent history has confirmed that domestic debt restructurings have adversely affected domestic financial sectors. Two main examples are the defaults of Russia and Ecuador, which contributed to the effective collapse of the domestic banking systems in these countries and from past literature, there could be collapse of the Ghanaian banking sector.

Ghana’s domestic debt exchange programme have negatively affected the foreign banks from Nigeria, South Africa, Togo, Trinidad and Tobago, United Kingdom, Morocco, France and all the financial institutions that are operating in the country. These institutions have been exposed to the risks in associated with undergoing domestic debt restructuring that could transmit the shock across borders, be it directly via loss of value of government securities or indirectly via their exposure to the Ghanaian banking sector, resulting in huge DDEP losses for which most them have started recapitalisation process.

This downward spiral could also shut down domestic banks’ lending to businesses and companies, as they all lose liquidity (cash on hand) needed to keep companies or businesses to continue with operations which can affect production and could negatively impact the already low domestic tax generation. The estimated losses from debt exchange could impact negatively on domestic tax generation. The government would not be able to generate domestic revenue as the various local banks incur huge losses as result of economic downturn on their comprehensive income statement and as a result, may not be able to pay any corporate taxes, national fiscal stabilisation levy and financial sector recovery levy in the next few years.

This will negatively impact the low tax to GDP of 15.7 percent in 2023 to the projected tax to GDP of 18.5 percent in 2026. It is on record that the banks paid little corporate taxes as a result of losses incurred because of domestic debt exchange programme. Ghana’s restructuring episode can have an adverse impact on the financial sector of the country for several reasons.

First, the asset side of banks’ balance sheets have taken a direct hit from the loss of value of the restructured assets, such as government bonds, and in turn affected the interest income. Second, on the liability side, banks have experienced little deposit withdrawals and the interruption of interbank credit lines. This can negatively affect their ability to mobilise resources at a time of stress.

Further, a weakened financial sector could impair financial intermediation leading to a hesitance of financial institutions to provide funds to individuals and businesses. This would then threaten future economic growth and development. Indeed, the present economic challenges compromised the ability of individuals and businesses to pay their loans, which impacted negatively non- performing loan ratio which stood at 18 percent at the end of December 2022 and thus has potential to rise further in the months ahead. This has consequential effects on banks liquidity as the liabilities of these agents form assets of financial institutions.

A potential default from the household and corporate sector on its debt, given the current economic challenges, impaired the balance sheets of financial institutions which can then lead to a weakening of the sovereign balance sheet given that the value of the implicit guarantee increases as the value of bank assets drop. That is, it became more likely that the government would have to bail out the banking sector as the value of the financial sector’s assets drop through financial stability support fund. A debt restructuring must therefore be carefully thought through in the current economic circumstances, given that the value of domestic debt has already been reduced in value due to inflation. Debt exchange could hurt domestic banks holding other public bonds, thereby hampering credit, investment and output in the economy; that is, a government default will disrupt more real activity and generate a larger social cost in countries.

Operationalisation of Ghana Financial Stability Support Fund to recapitalise 8 local insolvent banks after DDEP impairment losses

Most of the foreign-owned banks like Standard Bank, SA (Stanbic), First National Bank, Zenith Bank, ABSA, Standard Chartered Bank and others have all indicated that they will provide capital support and also provide funding to ring fence the impairments; and for this reasons (Fitch, 2023; Bloomberg 2023), the Ministry of Finance and Bank of Ghana must ensure all the eight domestic bank are adequately capitalised.

The Ghana’s Financial Stability Support Fund could be modelled on the 1988-1991 Non-Performing Asset Trust (NPART), where Ghana, with World Bank support, implemented a Financial Sector Adjustment Program (FINSAP) supported by a Financial Sector Adjustment Credit I between 1988-1991 and a Financial Sector Adjustment Credit II between 1991-1997.

As part of FINSAP, the government established the Non-Performing Assets Recovery Trust (NPART) as a temporary public asset management company under Provisional National Defense Council Law 242 on February 28, 1990, with an initial 6-year statutory life for the purpose of 1) Facilitating the restructure and recapitalisation of major state-owned banks; 2) Expediting the restructuring of public-private enterprises; and 3) Maximising recovery value of non-performing assets (NPAs) to reduce the government’s fiscal burden (IMF, 99/3/ 1999).

The Ministry of Finance and Bank of Ghana must urgently collaborate and operationalise the Ghana Financial Stability Support Fund of GH¢15billion as soon as possible to mitigate and address the actual solvency challenges facing the 8 local banks, including CBG Ltd., UMB Ltd., ADB, CAL Bank Ltd., Prudential Bank Ltd., Fidelity Bank Ltd., Omni BSIC and GCB that signed on the Domestic Debt Exchange Programme. The total impairment losses of the 8 local banks, including the three public listed banks, stood at GH¢8.6billion captured in the 2022 audited financial statements, and the impairment losses for the five private domestic banks stood at GH¢4.8billion while the 3 public listed banks accounted for DDEP impairment losses of GH¢3.8billion. The fund was expected to provide capital support for the 8 local banks, including the state-owned banks that participated fully in the Domestic Debt Exchange Programme.

The Financial Stability Fund should be shared to the local banks in proportion to their DDEP losses they incurred in 2022. The Ghanaian banking sector has been in severe distress in terms of solvency and liquidity since the implementation of DDEP amid high and variable rates of inflation, persistent depreciation of the cedi, expected low economic growth, and financial policies ill-suited to the country’s goals. Ghana, with World Bank’s support and other donors, could implement a Financial Sector Stability Fund Programme (FSSFP) for 2023-2026. The Bank of Ghana could be required to issue GFSSF bonds to offset transferred DDEP losses as needed while the government offsets DDEP losses made to local banks.

The General Framework of Ghana Financial Stability Support Fund must include a ‘one-time’ financial package of measures tailored to specific requirements for each local distressed bank to restore solvency, and to provide sufficient capital. For working modalities, DDEP losses in the books of the local banks would have to be transferred to Ghana Financial Stability Support Fund on behalf of the State to take any necessary action to recover all DDEP losses outstanding from the shareholders of the local banks that participate in the fund; to administer and manage the DDEP losses Recovery Fund to ensure full recovery at the of 5-year statutory life.

The fund could have an initial 5-year statutory life. Initially, GFSF could recapitalise all the eight indigenous banks, including private domestic banks that participated in the domestic debt exchange programme, by transferring from the banks’ capital losses at book value to Bank of Ghana’s FSSF office based on the approved recapitalisation plan to Bank of Ghana.

The DDEP losses will be replaced with Bank of Ghana-issued GFSF bonds on behalf of Government of Ghana, which could yield 7 percent – 9 percent per annum, with maturities of between two and five years, where local banks will be required to repay for the bonds yearly from their business operations in respect of capital support received from GFSF. Furthermore, the GFSF bonds issued to the banks provided “for these bonds to be discounted at the Bank of Ghana on behalf of GFSF, as solvency has become a problem after the implementation of domestic debt exchange programme”.

Thus, this additional usage of indirect monetary instruments “addressed both the solvency and short-term liquidity needs of affected banks, while also avoiding the risks of high-cost borrowing of funds in this distressed economy”.  Furthermore, the operationalisation of the US$1.5billion under the Ghana Financial Fund and the planned recapitalisation of banks would ensure financial stability as well as strengthen financial intermediation to the private sector to facilitate the engine of growth.

GFSF bonds will be issued by the GOG, set to mature between 2 to 5 years and yielding 7 – 9 percent p.a. – in many instances, the bonds were rolled over for bonds with interest rates of about 15 percent. DDEP losses should be transferred from banks’ capital at book price to Ghana Financial Stability Fund Secretariat Office at Bank of Ghana, and the capital shortfalls of the banks be replaced with interest-bearing Government of Ghana-issued FSSF bonds, yielding 7 percent – 9 percent p.a. with an initial 5-year statutory life for the purpose of facilitating the restructuring and recapitalisation of 8 local banks and also to reduce the government’s fiscal burden while shareholders of banks undertake to repay the Ghana Financial  Stability Fund with the bonds with requisite interest within a five-year period.

This could further create incentives for banks to expedite the process. This will include the prohibition of distributing dividends, restrictions in risk exposures and enhanced monitoring for those that do not meet minimum CAR, and support for early recapitalisation from the GFSF. The operationalisation of the Financial Stability Fund would enhance capital base of local banks to support SMEs as well as big-ticket businesses that could have the potential to propel the country beyond the current economic challenges. Second, strong capital base serves as a buffer that absorbs losses and reduces the probability of bank failure. This protects bank creditors and, in systems with explicit or implicit public guarantees, taxpayers.

Third, adequate capital has a preventative role by improving incentives for better risk management. When asymmetric information prevents creditors from pricing bank risk taking at the margin, banks operating under the protection of limited liability will tend to take excessive risks. The local banks with higher capital help banks attract funds, maintain long-term customer relationships, and carry risks essential to lending and international trade finance businesses (Dagher et al 2016).

The local banks with higher capitalisation could reduce the probability of banking distress and help to avoid the associated systemic spillovers. An individual local bank’s distress may propagate to other banks through direct interbank exposures, fire sale and contagious panics (Allen & Gale, 2000).

Conclusion

The government, Ministry of Finance and Bank of Ghana must ensure that the insolvency of domestic banking institutions are adequately re-capitalised through the operationalisation of Financial Stability Support Fund which could support the private sector recovery. The local banks with strong capital base could attract low-cost deposits, maintain long-term customer relationships and conduct robust risk assessment in their lending businesses, and carry on their international trade businesses with correspondent banks effectively.

The impact of large domestic debt haircut to bank holdings of sovereign claims on banks, especially local banks’ capital adequacy, can adversely affected their capacity to lend and dampen credit to the private sector and economic activity. Without adequate recapitalisation strategy, the indigenous or local banks would be candidates for takeover and acquisition by the well-recapitalised foreign-owned banks operating in the country. Well-capitalised local banks could be followed by higher credit, GDP growth, improved investor confidence in the domestic market and high job security if GFSF is operationalised quickly.

This is because domestic debt restructuring will be taking place during economic and social downturns because of higher inflation and persistent depreciation of the local currency since the beginning of 2022. With domestic debt restructuring in addition to the downgrading of credit rating and the depreciation of cedi against all major trading currencies, and inflation reaching a record high over 43.1 percent over the last 25 years, businesses’ survival and people’s livelihood are at risk.

The domestic debt restructuring could affect not only domestic banks and other companies, but also impact negatively on the economic and financial livelihood of Ghanaians, especially the poor and vulnerable in the society whose incomes have whittled away by the higher inflation. Any debt restructuring, including maturity extension and coupon rate reduction, could trigger a decline of domestic investors’ confidence in governments’ creditworthiness and raise doubts about the sustainability of government finances. Credit losses from domestic debt exchange and mark to market valuation on the debt domestic restructuring have affected the confidence in the domestic market.

These losses were due to a combination of face value haircut, coupon or interest rate reduction, and maturity extension with below-market coupon rates. Accepting a restructuring agreement implies that the creditors will suffer a reduction in payments from the Government of Ghana. Furthermore, the weakened financial sector could impair financial intermediation and lead to a hesitance of financial institutions to provide funds to individuals and businesses as well as poor low savings culture.

This would then threaten future economic growth and development. Indeed, the present economic challenges may compromise the ability of individuals and businesses to pay their loans; and that would heighten the impairment levels. This has consequential effects on banks, for example, as the liabilities of these agents form assets of financial institutions. A default from the household and corporate sector on its debt given the current economic challenges could impair the balance sheets of financial institutions, which can then lead to a weakening of the country’s balance sheet given that the value of the implicit guarantee increases as the value of bank assets drop.

Footnotes*

*From our calculation using the discount rate of NPV, the 8 local/indigenous banks have already captured GH¢8.6billion in their 2022 audited financial statement with remaining balance of GH¢11.3billion yet to be captured in the 2023 while the foreign-owned bank captured GH¢10,8billion in 2022 audited financial statements, with a balance of GH¢7billion in the 2023 audited financial statements.

All things be equal, the banks that did not capture the entire DDEP impairment losses will be forced to the remaining outstanding losses in the 2023 audited financial statements and it is our believe that in the course submitting their capital plans, those banks captured all the DDEP impairment. Furthermore, banks that participated in the GH¢7.9billion Cocoa bills and in US$-denominated bonds of US$809million would experience negative impact on their solvency in 2023 Audited Financial Statements*

Reference

• Allen, F. and Gale, D. (2000) Financial Contagion Journal of Political Economy 108 (1) 1-33.
• Bank of Ghana Monetary Policy Committee (MPC) Reports ( April, May and June) 2023
• Cruces, J.J and Trebesch, C. (2011) Sovereign Defaults: The Price of Haircut. American Economic Journal: Macroeconomics. Vol.5 No3 July 2011 pp85-117
• Dagher, J; Dell’Ariccia, G;  Laeven, L;  Ratnovski, L and  Tong, H (2016) Benefits and Costs of Bank Capital; IMF DISCUSSION NOTES SDN/16/14
• Darvis, Z. (2011): Debt restructuring in the euro area: a necessary but manageable evil? Breugel Policy Contribution 2011/07
• Ghanaian Banks Audited Financial Statements of for the year 2022 for 22 banks operating in Ghana
• IMF Country report no 99/3 (1999) Ghana Selected Issues
• IMF (2002): Sovereign Debt Restructuring and the Domestic Economy: Experience in Four Recent Cases. Policy Development and Review Department, 21 February 2002
• IMF Country report on Ghana no 23/168 (2023) Request for arrangement under the Extended Credit Facility