Are some banks on liquidity life support?

In my recent article titled: “Is the Energy Sector Levies considered as a bailout of Banks in Ghana?” I examined the financial health and soundness of 12 Banks that are creditors to the Energy Sector State-owned enterprises (SOEs) and the Bulk Oil Distribution Companies (BDCs). These 12 Banks are looking forward to the proceeds of the Energy Bonds issued by E.S.L.A Plc for the repayments of the energy sector SOEs and BDCs debts. In that article, I used the Financial Soundness Indicators (FSIs) abbreviated as CAMELS[1] (C: capital adequacy; A: asset quality; M: management quality; E: earnings ability; L: liquidity; S: Sensitivity to market) to measure the financial health and soundness of the 12 Banks.  Based on that analysis, I noted each of the 12 Banks faces one or more of these three listed below key risks:

1. Liquidity risk (the ability of a bank to fund increases in assets and meet obligations as they come due, without incurring unacceptable losses)
2. Worsening asset quality (this includes the adequacy of underwriting standards, soundness of credit administration practices, and appropriateness of risk identification practices, quality of the loan portfolio, the adequacy of the allowance for loan losses, the existence of asset concentrations, the ability of management to properly administer its assets, including the timely identification and collection of problem assets, etc.)
3. Capital risk (ability of a Bank’s capital to absorb unexpected losses)

In this article and subsequent two articles, I want to expand on my analysis of the above three key risk to cover all Banks in Ghana.  In this article, I will cover the liquidity risk faced by Banks in Ghana. My next articles will touch on the other two risks:  Asset quality (Are Banks in Ghana facing non-performing loans crisis) and Capital (Are Banks in Ghana well capitalized).

 

1. Key Soundbytes/Executive summary:

Key soundbytes of this article include:

1. High leverage ratio posing high liquidity risk for some Banks: Some Banks are highly leverage as their ratio of tier 1 capital to total off and on balance sheet exposure is below the 3%-5% global threshold for leverage ratio. From various studies and from the experience of the recent credit crisis, high leverage ratio of some banks raises the possibility of liquidity crisis for those banks. The leverage ratio shown in the analysis section of this article could be worse or higher for some Banks after adjusting for these three things:  1) deferred tax assets (DTA)  that rely on future profitability of the bank to be released are deducted in the calculation of common equity tier 1 (CET1) capital as required by Basel III and DTA for temporary differences  such as allowance for credit losses are subject to threshold deductions of 10% of adjusted CET1  2) defined pension fund net assets are deducted from CET1 3) excess of IFRS 9 expected credit loss over prudential loan loss reserve are deducted from CET1.

Though leverage ratio is mentioned in section 29 (7) of Act 930, the minimum requirement is currently not defined by Bank of Ghana.  I therefore recommend that Bank of Ghana should set a minimum leverage ratio of 5% in normal times and 3% during crisis, and make it a mandatory measure from 2018.

Banking is all about leverage.  Beyond a certain point, however, we know that too much leverage can be perilous. This is because, in times of stress, the fixed servicing obligations that debt imposes on a firm may not be able to be covered by the cash flow generated by a firm’s assets. Fluctuations in revenue, or the need to write down the value of assets, may create a shortfall in servicing ability, which has to be met by writing off some of the interests of equity holders. In an extreme case, all of the interests of equity holders are wiped out and the firm fails. So there is a point beyond which adding more debt, relative to the riskiness of the cash flow generated by the firm’s assets, is no longer efficient, and potentially dangerous. In the academic literature, this particular trade-off is often referred to as the trade-off between the tax advantages of debt and bankruptcy costs. To compensate for this risk, almost all governments have set up regulatory regimes with minimum requirements for bank capital, leverage, liquidity, funding and large exposures – as well as behavioral standards on governance, fitness and propriety, risk management, internal controls and audit. These requirements aim to ensure that the high leverage inherent in bank business models is carefully and prudently managed.

Some hold the view that leverage ratio is inconsistent with liquidity ratio such as the Liquidity Coverage Ratio (or LCR). This is because LCR or liquid ratio is deemed to encourage banks to hold a portfolio of highly liquid, lower-risk assets, a non-risk-based leverage ratio provides incentives to switch from lower-risk to higher-risk assets. I see such viewpoint as somewhat naive. First, regulators are well aware of the adverse incentives that leverage ratios – if used in isolation – can create. But that is why regulators do not use the leverage ratio in isolation. One need to look at Basel III as a package of constraints that mutually reinforce prudent behavior. So, a leverage ratio provides an absolute cap on leverage but, by itself, may also create an incentive to take on high-risk assets. The LCR compensates for this by preventing banks from imprudently running down their liquidity. And, of course, the risk-based framework would quickly constrain any bank that materially increased its risk profile without additional capital to support it.

2. High ratio of short-term borrowings to tier 1 capital: Related to soundbyte 1 is that some Banks ratio of short-term borrowings to Tier 1 capital is more than 100% raising the possibility of liquidity crisis among some banks.
3. Contractual maturity mismatch: Some Banks faces negative liquidity gaps within the less than 1 month and between 1 to 3 months maturity buckets. Under stress scenarios, those banks may be liquidity bankrupt. Banks and regulators should be focusing on mismatches in liquidity flows and on the ability of banks to fund such mismatches on an ongoing basis, rather than on statutory liquid assets and traditional access to the central bank.
4. High deposit concentration risk: Some banks in Ghana have their twenty largest depositors exceeding more than 30% of their total deposits. If a Bank has a few large depositors and one or more withdrawal their funds, enormous problems will occur if alternative funding cannot be quickly be found. Deposits concentration can pose problem in unforeseen circumstances. In normal times, the deposit concentration may not pose a problem and instead prove to be profitable, but in unforeseen circumstances, sudden withdrawal of funds by the category of deposits can pose a serious challenge to those Banks. The sensitivity of banks to large withdrawals in an uncertain environment cannot be overemphasized.
5. High corporate depositors concentration: Most Banks have high percentage of deposit from Private and public enterprises than deposit from Retail (individual) customers.  Corporate depositors normally demand high rates than retail customers and most corporate depositors shop for higher rates compared to retail customers. In countries with deposit insurance, retail deposits tend to be “sticky” and not to move, especially when they fall within the deposit guarantee limits, and therefore little run-off is assumed from retail depositors in computing the Basel III liquidity coverage ratio. Corporate deposits are assumed to be less sticky and are assumed to run off in greater volume.  This assumption may not currently be applicable to Ghana since Ghana is yet to operationalize the Ghana Depository Protection Act, 2016 (Act 931). After Act 931 become operationalize, the tide may change for more sticky retail customers in Ghana as such, Banks are encouraged to deepen their share of wallet among retail banking customers. As a Banker with the primer direct Bank in Canada, I have experienced a strong relationship between overall satisfaction and share of wallet and  that retail banking customers with higher levels of overall satisfaction also have greater share of their deposits and investable assets with their primary bank.
6. High concentration of term deposit instruments: From the liquidity maturity table of the analysis section of this article, it is evident that some Banks have high concentration of term deposits.  High concentration of fixed deposits (i.e. investment accounts) over transaction deposits (current and saving account CASA) poses a serious problem when the former reaches maturity, leaving a funding gap which the bank must fill up at a higher cost. Also, bank’s earning will be adversely affected from this high dependence on term deposits as against CASA.
7. No prudential limit on liquid ratio – Though Banks are required to disclose liquid ratio, there is no set limit of liquid ratio. Bank of Ghana should consider setting prudential benchmarks for the disclosures of liquid ration and the ratio of net liquid assets to deposits from customers.
8. IFRS and regulator disclosure requirements not adhered to by some Banks: IFRS required disclosure on concentration risk and regulator requires disclosure of liquid ratio, top 20 depositors to total deposits and breakdown of deposits into retail and corporate. I noted that some Banks did not complied with by those requirements by IFRS and the regulator. In addition, most Banks do not break down their corporate depositors into private and public enterprise. This inhibits the ability to know Banks that are overreliance on the government for deposits. Auditors and Bank of Ghana should ensure that liquidity risk calculations and disclosures are made by Banks in accordance with IFRS and Bank of Ghana guide for financial institutions.
9. Liquidity risk disclosure should be enhanced – Banks should enhance their publicly disclosed information on liquidity risk that will enable market participants to make an informed judgement about the soundness of its liquidity risk management framework and liquidity position.
10. Liquidity risk not addressed as key audit matters of Auditors Opinion of Banks facing liquidity challenges – International Standards on Auditing (ISA) issued by the International Federation of Accountants (IFAC) through the International Auditing and Assurance Standards Board (IAASB) requires auditors to include in their opinion a section called “Key Audit Matters”. The Key Audit Matters is a multi-step judgment which is expected to take into account areas identified as significant risks, areas in which the auditor encountered significant difficulty during the audit, including with respect to obtaining sufficient appropriate audit evidence and the effect on the audit of significant events or transactions that occurred during that year. Certainly, I am not an auditor and not an authority on auditing standards so speaking as a layman I have 2 concerns about the audit opinions of Banks in Ghana 1) I noted the Key Audit Matters were specified for only listed Banks in Ghana. Some non-listed Banks are far bigger and public exposed than the listed Banks. This is an area I will recommend regulators to take a second look at it. Some countries have passed regulation to make it mandatory for public interest entities which in most cases includes all Banks to have their audit opinion include the Key Audit Matters section 2) almost all auditors were singing the same song for Key Audit Matters, which is impairment of loans. Clearly in my view some Banks are facing Capital and Liquidity risk should have their Key Audit Matters addressing Liquidity and Capital.
11. Banks need a robust liquidity management framework: Banks should put in place a robust liquidity risk management framework that is well integrated into the bank-wide risk management process. Banks and the Bank of Ghana should employ liquidity monitoring tools such as Contractual maturity mismatch; Concentration of funding; Available unencumbered assets; liquid coverage ratio by significant currency; and Market-related monitoring tools.
12. Bank of Ghana and Banks should adopt Basel III liquidity measurement ratios: The central Bank must establish formal, quantitative requirements for the liquidity levels that banks must attain. This can be achieved by adopting Basel III, the two liquidity ratios measures of Liquidity Coverage Ratio ( LCR) and Net Stable Funding ration (NSFR)
13. Some Banks are not complying with the BoG directive to publish their full financial statement on their website

Subsection 2 of section 90 of Act 930 and page 129 of the BOG guide for financial institution published requires Banks to publish both audited and unaudited (unaudited financial statements reference is not in Act 930 but it is in BoG directive) financial statements in at least two daily newspapers of national circulation in Ghana and the website of the Bank. Some Banks have not published their full 2016 financial statements on their website. For such Banks, the analysis in this report is inconclusive for their liquidity positions. Bank of Ghana should enforce its guidance and ensure that all Banks publish their full financial statements on their website so that the public is well aware of the financial performance and position of all Banks.

 

1. Setting the stage for liquidity analysis of Banks in Ghana

Banks in Ghana play a key role in the economy of Ghana. For Banks to perform their role effectively, banks must be safe and be perceived as such. The single most important assurance is for the economic value of a bank’s assets to be worth significantly more than the liabilities that it owes. The difference represents a cushion of “capital” that is available to cover losses of any kind. However, the recent financial crisis underlined the importance of a second type of buffer, the “liquidity” that banks have to cover unexpected cash outflows. A bank can be solvent, holding assets exceeding its liabilities on an economic and accounting basis, and still die a sudden death if its depositors and other funders lose confidence in the institution. For example, Lehman Brothers boasted a Tier 1 capital ratio of 11 per cent just five days before the firm’s collapse[2]. Eight days before it was nationalised, Northern Rock had a total capital adequacy ratio of 14.4 percent, nearly double the eight percent required by the Financial Services Authority, in line with Basel II guidelines. Capital adequacy ratios cannot and will not assist a financial institution in a liquidity crisis simply because the amount of capital held has no relevance to an organisation’s cash position and strengths. It is therefore time for the regulatory regime in Ghana to take a long, hard look at its cashflow policies, and embark on a healing journey.

Liquidity, up until 2007, was rarely mentioned in regulatory circles: it was accorded step-motherly treatment by almost all regulatory regimes, it was the ‘forgotten risk,’ an ‘Asian problem,’ a ‘Russian problem,’ or not an issue at all since it is guaranteed by the central banks.

Prior to 2007, liquidity risk was regarded by many as inconsequential, since liquidity of banks was always guaranteed by the central bank. However, recent events have clearly demonstrated that most central banks did not step into the role of ‘lender of last resort,’ as evidenced by the spectacular collapses of Northern Rock and Lehman Brothers. In the years preceding the banking crises of 2008, some banks pushed the liquidity and maturity transformation to an extreme, borrowing sometimes over a week to purchase long-term illiquid assets, which significantly increased the risk. As a result several banks found themselves facing a liquidity crisis in 2008 and after.

In order to curb the liquidity risk faced by Banks, the Basel committee decided to introduce two ratios on bank liquidity to ensure that banks keep a minimum cushion of liquidity.

The first, called Liquidity Coverage Requirement, aims at ensuring that banks have enough funding resources available over the next 30 days: it requires banks to have enough liquid assets to cover 30 days of expected net liquidity outflows (cash withdrawals from customers).

The second liquidity ratio, called Net Stable Funding Ratio, aims to ensure that banks have enough funding resources over the next 12 months to cover for the expected funding needs over the same period.

 

1. Why some Banks in Ghana may be in danger of  facing liquidity crisis

Recently, the following developments have raised the possibility of liquidity crisis among some Banks in Ghana:

1. The failure of two Banks in Ghana (UT and Capital Bank) raising questions about solvency of the rest of the Banks
2. Raising non-performing loans (NPL) among Banks in Ghana
3. Some Banks capital adequacy ratio and minimum capital requirements falling below the prudential limits
4. Energy sector of State Owned Enterprises (SOE) debt. The Energy Sector Debt consists of bank loans and payables due suppliers and power producers of GHS 9.4 billion as at end of August 2017. About a third of the total energy sector debt (GHS 2.71 billion) is owed to financial institutions in Ghana and about GHS 2.86 billion is also due to fuel suppliers in respect of feedstock supplied for power generation (natural gas, light crude oil and diesel).

One of the strategies that the Government of Ghana adopted was to pay the debt of the energy sector SOEs was the passage of Energy Sector Levies Act (ESLA) in December 2015 which took effect from January 4, 2016. It was amended on 28 March 2017 by the Energy Sector Levies (Amendment) Act, 2017 (Act 899) (the ESLA Amendment).

In July 2016, the domestic banks (led by representatives of the Ghana Association of Bankers and the chief executives of each bank) agreed on a framework with the Ministry of Finance in relation to the restructuring and repayment (over 3 to 5 years) of approximately GHS 2.2 billion of debts owed by VRA and TOR to domestic banks. At the time, this amount represented legacy debt consisting of approximately USD 358 million and GHS 776.6 million.

 

The above factors leading to a possibility of liquidity risk of some Banks, recently picked up energy/momentum by these two news:

5. E.S.L.A. Plc failed to raise the entire GHS 6 billion (GHS 4.6 billion was raised) that was aimed to pay off some of the energy sector debt. Some of the creditors including Banks may not receive their entire amount unless the S.L.A. Plc decides to issue additional bonds. (Page 21 of the prospectus defines the bond the GHS 10,000,000,000 bond issuance programme established by the Issuer (and as amended from time to time), under which the Issuer may, from time to time, issue Bonds denominated in the Currency and having such maturity as may be set forth in the Applicable Pricing Supplement and page 36 of the prospectus also stipulates that the program of GHS 10 billion have 5 years from the date of the Prospectus[3] to expire. The prospectus is dated October 12, 2017). This development raises the question of whether some banks have baked this development into their liquidity projections.
6. Peace FM on November 11, 2017[4] reported that “New Patriotic Party (NPP) government is pushing local banks to write-off 40 per cent of debt it owes them as part of measures to address the 2.5 billion dollar energy sector debt. This follows a recent floating of energy bonds to offset the debt which failed to yield the intended targets”. What is not clear about the Peace FM news is whether the GHS 2.7 billion stipulated on page 207 of the Bond Prospectus as the amount owed to Banks at the end of August 2017 is going to be further reduced by 40% or the amount stated is after the 40% haircut. Banks and the regulator need to seek clarity on these ongoing discussions by the ministry of Finance and the Banks and if such discussions are more likely than not (greater than 50% probability) to reflect a haircut to existing debts, then Banks should reflect this haircut accordingly in both liquidity projections and loan write-offs.

In view of the above developments, I seek to analyze the liquidity situation among Banks in Ghana and specifically address these questions:

• What is the liquid ratio and maturity mismatch among Banks?
• To what extent are Banks leveraged and dependent on borrowings from the central bank to stay alive? Hence Are some Banks on liquidity life support
• What are some of the liquidity monitoring tools that the Banks and the central banks can use to manage liquidity?

 

1. Liquidity risk analysis of Banks in Ghana

The analysis performed in this section of the article is based on each Bank’s December 31, 2016 financial statements (Bank’s website or the PwC Banking survey report) and Bank of Ghana Banking sector reports. This section of the article is organized as follows:

1. Is the Banking Industry liquidity on life support from the central Bank?
2. Are Banks in Ghana on liquidity life support- What is the liquidity conditions of individual Banks in Ghana

 

1. Is the Banking Industry liquidity on life support from the central Bank?

On page 11 of the July Banking sector report, the central bank (Bank of Ghana or BoG) asserted that the banking industry remained adequately liquid as indicated by the improvement in the industry’s core and broad liquidity indicators during the review period, on account of the industry’s improved ability to meet its short term obligations. In the same report, BoG provided the table 1 to support its conclusion. Unlike the capital adequacy ratio of 10 %, these liquidity indicators below have no benchmark or prudential limits. Except for a trend analysis of these ratios, it is difficult to tell if the industry have adequate liquidity or not.

In addition, what is not clear from the Bank of Ghana report is how the liquidity ratios are impacted by Bank of Ghana own lending activities to the Banks.  One of the indicators of liquidity life support from BoG is the proportion of liquid assets that are from other financial institutions including BoG to a Bank.

1. Are Banks in Ghana on liquidity life support- What is the liquidity conditions of individual Banks in Ghana

• Liquidity concentration risk of Banks (amounts in table are in thousands of GHS)

Explanation of concentration risk disclosure:

Paragraph 34 © of International Financial Reporting Standard -7 – financial instruments-disclosures (IFRS 7) requires an entity to disclose of concentration risk. This is includes concentration risk disclosure of Deposits from Customers and Deposits from Banks and Other Financial Institutions. Implementation guide to IFRS 7 requires concentration risk into industry sectors, geographical distribution and a limited number of individual counterparties or groups of closely related counterparties and credit rating or other measure of credit quality. The implementation also stated that similar principles apply to identifying concentrations of other risks, including liquidity risk and market risk. For example, concentrations of liquidity risk may arise from the repayment terms of financial liabilities, sources of borrowing facilities or reliance on a particular market in which to realise liquid assets. Concentrations of foreign exchange risk may arise if an entity has a significant net open position in a single foreign currency, or aggregate net open positions in several currencies that tend to move together In addition, page 116 of Bank of Ghana guide for financial institutions requires deposit from customers to be broken down into retail customers and corporate customers.

 

• Regulatory and IFRS liquidity disclosures in the financial statements (amounts in table are in thousands of GHS)

Explanation of ratios

 

• Regulator Liquid ratio disclosure in the financial statements

 

• Page 18 of the Bank of Ghana guide for financial institutions[5] requires that financial institutions on their quarterly and annual financial statement should disclose liquid ratio. The guide further defines liquid ratio as Liquid assets divided by Volatile funds. The guide does not specify any limit for the liquid ratio.
• Page 19 and 45 of the Bank of Ghana guide for financial institutions states that Banks should disclose defaults in prudential requirements including statutory liquidity. The guide does not define statutory liquidity but widely interpreted as the primary reserve ratio of 10%.
• Page 83 of the guide requires year end, average, minimum and maximum of the ratio of net liquid assets to deposits from customers. For this purpose net liquid assets are considered as including cash and cash equivalents and investment grade debt securities for which there is an active and liquid market less any deposits from banks, debt securities issued, other borrowings and commitments maturing within the next month.
• IFRS 7 contractual maturity mismatch disclosure

Further paragraph 39 of International Financial Reporting Standard (IFRS) 7 – financial instruments-disclosures requires an entity to disclose quantitative data about an entity liquidity risk primarily focusing on maturity analysis of both non-derivative financial liabilities and derivative financial liabilities. The disclosure is based on the earliest contractual maturity date because this disclosure shows a worst case scenario.

IFRS 7. B11 D requires that the contractual amounts disclosed in the maturity analyses as required by paragraph 39(a) and (b) are the contractual undiscounted cash flows

Hence the disclosure of the liquidity table requires by IFRS 7 will differ from the balances in the balance sheet because the liquidity table is based on undiscounted cash while the  amount included in the statement of financial position because the amounts in that financial statements are based on discounted cash flows.

Further IFRS 7. B11E requires that a n entity shall disclose a maturity analysis of financial assets it holds for managing liquidity risk (e.g. financial assets that are readily saleable or expected to generate cash inflows to meet cash outflows on financial liabilities), if that information is necessary to enable users of its financial statements to evaluate the nature and extent of liquidity risk.

Though I have highlighted liquidity gaps in red, one need to be careful on how to interpret those gaps. Those gaps have these two main limitations:

1. The asset side of the liquidity table includes loans and advances to customers which may include long term investment and not liquid, some loans are liquid since they are short term. There are so divergent in practice on how the loans and advances are presented in the liquidity table. Some entities presents impaired loans as payable on demand rather than the collateral expected cash flow date which averages between 2 to 5 years. In addition, in reality a performing loan that is due to mature within three months may be more than three months due to revolving nature of some loans and also some loans may turn out to be non-performing after the reporting date. To mitigate this limitation, one have to exclude loans and advances from the liquidity table for the purpose of assessing the liquidity risk of the entity.
2. The IFRS 7 disclosure for the financial liabilities section is based on a worst case scenario. This is more than stress case scenario as required by Basel III for liquidity coverage ratio.   Basel III specifies what percentage of liabilities with an indefinite maturity, such as demand deposits, will be assumed to run off. In countries with deposit insurance, retail deposits tend to be “sticky” and not to move, especially when they fall within the deposit guarantee limits, and therefore little run-off is assumed from them. Corporate deposits are less sticky and are assumed to run off in greater volume.  This assumption may not be applicable to Ghana since we do not operationalize the Ghana Depository Protection Act, 2016 (Act 931)[6] and due to the level of poverty and savings rate, it may well be that corporate deposits are sticky than retail deposits in Ghana

Hence, total expected cash outflows are calculated by multiplying the outstanding balances of various categories or types of liabilities and off-balance sheet commitments by the rates at which they are expected to run off or be drawn down. Retail deposits are divided into “stable” and “less stable” portions of funds as, with minimum run-off rates listed for each category recommended by Basel. The run-off rates for retail deposits are minimum floors, with higher run-off rates established by individual jurisdictions as appropriate to capture depositor behavior in a period of stress in each jurisdiction.

• Leverage among Banks (amounts in table are in thousands of GHS)

Note: Tier 1 capital of Banks in blue were not disclosed so it was computed as stated capital plus income surplus plus statutory credit risk reserve less intangible asset ( where not disclosed the entire property and equipment balance was used)

Regarding off-balance sheet items, Banks with brown color means  full  financial statement of such banks were not available on their website for me to identify their off-balance sheet items.

 

Explanation of ratios

 

1. Leverage ratio

In technical terms the leverage ratio is defined as the capital measure (the numerator) divided by the exposure measure (the denominator), with this ratio expressed as a percentage: Leverage ratio = Capital measure / exposure measure.

 

Banks in Ghana are theoretically constrained on the amount of assets they can have relative to their capital by the 10% capital requirement, meaning they should fund themselves with GHS 10 in capital for every GHS 100 they lend. For example, assuming a 10% capital requirement, if the risk weight of government bonds is 0% and the risk weight of corporate loans is 100%, how much of each asset could a bank hold for 100 GHS of capital? a) 100 GHS / 0% / 10% = indefinite government bonds b) 100 GHS / 100% / 10% = 1,000 GHS in corporate loans

There is no limit on how much less risky asset you can generate , there is infinite amount of government bonds you can hold because it attracts 0% risk rating, so u are encourage to be leveraged. In the example above, a bank seeking to maximize its return on capital would hold only government bonds; government bonds may pay less interest but that doesn’t matter if you can hold 100x more of them for the same capital. In order to address this issue, Basel III plans introduced a leverage cap that limits the total quantity of assets that a bank can hold relative to its capital. The leverage cap does not take into account risk weights and is therefore simpler to understand and harder to manipulate.

Currently, there is a 3% leverage ratio under Basel III, but Ghana is yet to apply Basel III.

 

1. Liquidity risk Findings of Banks in Ghana

Based on the above analysis of the liquidity positions and disclosure of liquidity management of Banks in Ghana financial statements for December 31, 2016 and the monthly Bank of Ghana Banking sector report, I arrived at the following findings:

1. Page 116 of Bank of Ghana guide for financial institutions requires deposit from customers to be broken down into retail customers and corporate customers. Corporate customers to be further disclosed separately for private enterprises and public enterprise. Adequate disclosure was not made by most Banks to distinguish deposit from individuals, deposit from public enterprise and deposit from private enterprise. Most Banks disclosed 2 line items either 1) Individual and other private enterprise 2) public enterprises or 1) retail 2) corporate.
2. IFRS 7 requires disclosure by industry, geography for concentration risk, customer type, etc. Most Banks did not disclose customer deposit into industry sectors and geographical location such as Ghana, outside Ghana etc.
3. Regulator requires disclosure of ratio of twenty largest deposits to total deposits, some Banks did not disclose that.
4. It is reported by some that the prudential limit for ratio of twenty largest deposits to total deposits is 15%. Most Banks have a ratio greater than 15%.
5. Leverage is the ratio of debt or assets to equity; at 33-to-1 leverage, a mere 3 percent drop in the value of a firm’s assets can wipe out its equity. Some Banks are highly leverage fall below the Basel III threshold of 3% or exceeding the 33 times of Basel III leverage ratio. This raised the question whether such Banks are on liquidity life support.
6. Though leverage ratio is mentioned in section 29 (7) of Act 930, the minimum requirement is currently not defined by Bank of Ghana, leading to high leverage among some Banks. Leverage is the ratio of debt or assets to equity; at 33-to-1 leverage, a mere 3 percent drop in the value of a firm’s assets can wipe out its equity.
7. Some Banks have no balance for Deposits from other banks and financial institutions. This raises the question of whether other banks have lost confidence in them and not placing their excess liquidity with them
8. The total Borrowings and Borrowings from Banks and other institutions or short term borrowings exceeds their Tier 1 capital, raising the question whether such Banks are on liquidity life support from other Banks.
9. Bank of Ghana on a monthly basis through its   Banking sector report publishes  the following liquidity indicators ; Liquid Assets to total deposits (Core)-%, Liquid Assets to total deposits (Broad)- %, Liquid assets to total assets (Core)- % and Liquid assets to total assets (Broad)- % . Unlike the capital adequacy ratio of 10 %, these liquidity indicators have no benchmark or prudential limits. Except for a trend  analysis of these ratios,  it  is difficult to tell if the industry have  adequate  liquidity or not
10. The Bank of Ghana guide for financial institutions requires disclosure of liquid ratio in the Annual, half yearly and quarterly financial publications of Bank. This ratio has no prudential limit and may not mean anything to a user of financial statements
11. Some Banks do not disclose the liquid ratio as required by the Bank of Ghana guide for financial institutions to disclose liquid ratio in the Annual, half yearly and quarterly publication of financial statements of Banks.
12. The Bank of Ghana guide requires the year end, average for the period, maximum for the period and minimum for the period of the ratio of net liquid assets to deposits from customers. This ratio has no prudential limit and may not mean anything to a user of financial statements
13. Some Banks did not make the disclosure of the ratio of net liquid assets to deposits from customers.
14. The Bank of Ghana guide for financial institutions defines liquid ratio as the ratio of Liquid assets to volatile Liabilities. The guide also provided the definitions of liquid assets and volatile liabilities. From the ratios disclosed by some Banks, it appears that some Banks did not compute the liquid ratio according to the guide. I have observed that Banks presents this ratio as a percentage. One Bank for instance disclose its liquidity ratio as 1.29% and another as 11.23%.
15. The Bank of Ghana guide for financial institutions requires disclosure of Defaults in prudential requirements including statutory liquidity and the accompanying sanctions, if any. The statutory liquidity is interpreted as the primary reserve ratio of 10%. Some Banks did not disclose this requirement.
16. Though IFRS provides flexibility in the disclosure of liquidity risk table maturity buckets, the Bank of Ghana guide for financial institution requires the following buckets; less than 1 month, 1- 3 months, 3-6 months, 6 months to 1 year, 1 -3 years and more than 3 years. Some Banks did not follow this guideline to the extent that some did not disclose the less than 1 month bucket which is critical to assessment of liquidity risk under stress scenario.
17. The disclosure requirement of IFRS 7 .39 (c) on how an entity manages liquidity risk is based on boilerplate text and not being specific to the Bank and does not provide sufficient detail to understand how the company manages its liquid risk. In addition, some Banks did not disclose the lending arrangements they have for liquidity purposes and methods used for measuring the institution’s current and projected future liquidity.
18. As highlighted in red, some Banks may be facing liquidity risk, but there is not enough disclosure around how they are managing those liquidity risk. Specifically, some Banks did not include a description of its policies and performance with respect to: controlling the cash flow mismatch between on- and off-balance sheet assets and liabilities; maintaining stable and diversified sources of funding; accessing alternative sources of funding, if required; and ensuring it has sufficient liquid assets on hand in relation to its daily cash flows.
19. Financial statements disclosure deficiencies noted included a) full disclosure of the calculation of regulatory capital including tier 1 capital and various adjustment b) lack of disclosure of intangible assets on the face of the balance sheet as required by IAS 1. 54 ( c)

 

1. Recommendation to avert liquidity crisis in Ghana

On the basis of the above findings, I recommend the following

1. Regulators and auditors should ensure that Banks complies with IFRS and BoG guide by disclosing deposit to customers by customer type such as From Government and parastatals, retail (individuals), corporate (private sector) and into industry sectors and geographical location such as Ghana, outside Ghana etc.
2. Bank of Ghana should set a minimum leverage ratio of 5% in normal times and 3% during crisis, and make it a mandatory measure from 2018
3. The central Bank must establish formal, quantitative requirements for the liquidity levels that banks must attain. This can be achieved by adopting Basel III, the two liquidity ratios measures of Liquidity Coverage Ratio ( LCR) and Net Stable Funding ration (NSFR)
4. Auditors and Bank of Ghana should ensure that Banks follow the Bank of Ghana guide for the publication of financial statements by Banks. Especially the aspect of the guide that requires Banks to disclose liquidity risk table along the following maturity buckets: less than 1 month, 1- 3 months, 3-6 months, 6 months to 1 year, 1 -3 years and more than 3 years.
5. Auditors and Bank of Ghana should ensure Banks disclose the year end, average for the period, maximum for the period and minimum for the period of the ratio of net liquid assets to deposits from customers.
6. Bank of Ghana should consider setting prudential benchmarks for the disclosure of the ratio of net liquid assets to deposits from customers
7. Though liquid ratio is required by Bank of Ghana to be disclosed, it does not mean anything to a user of financial statements because the ratio cannot be benchmark to anything. Hence to make the ratio meaningful to users of financial statements, Bank of Ghana should set prudential limit for the liquid ratio similar to the Basel Liquidity Coverage Ratio (LCR) and establish penalty for breaches. The Basel LCR ratio year-by-year minimum ratio requirements for 2016, 2017, 2018 and 2019 are 70%, 80%, 90% and 100%, respectively.
8. Banks should enhance their publicly disclosed information on liquidity risk that will enable market participants to make an informed judgement about the soundness of its liquidity risk management framework and liquidity position. As part of its periodic financial reporting, a bank should provide quantitative information about its liquidity position that enables market participants to form a view of its liquidity risk. Examples of quantitative disclosures currently disclosed by some banks include information regarding the size and composition of the bank’s liquidity cushion, additional collateral requirements as the result of a credit rating downgrade, the values of internal ratios and other key metrics that management monitors (including regulatory metrics that may exist in the bank’s jurisdiction), the limits placed on the values of those metrics, and balance sheet and off-balance sheet items broken down into a number of short-term maturity bands and the resultant cumulative liquidity gaps. A bank should provide sufficient qualitative discussion around its metrics to enable market participants to understand them, e.g. the time span covered, whether computed under normal or stressed conditions, the organizational level to which the metric applies (group, bank or non-bank subsidiary), and other assumptions utilised in measuring the bank’s liquidity position, liquidity risk and liquidity cushion
9. Bank of Ghana should consider setting limit for the liquid ratio that it requires Banks to disclose
10. Banks should put in place a robust liquidity risk management framework that is well integrated into the bank-wide risk management process. As a starting point, Banks should adopt Basel Committee on Banking Supervision (BCBS) publication 144 called Principles for Sound Liquidity Risk Management and Supervision[7] .

 

[1] The Camels rating is a supervisory rating system originally developed in the U.S. to classify a bank’s overall condition. CAMELS was developed under the Uniform Financial Institutions Rating System (UFIRS) implemented in U.S. banking institutions in 1979.  Following a recommendation by the U.S. Federal Reserve, the CAMELS rating is now used globally.

[2] http://www.finance-watch.org/hot-topics/understanding-finance/1229-bank-capital

[3] https://www.eslaplc.com/pages/download/E_S_L_A_PLC_GHS_10_billion_Bond_Programme_Prospectus_Revised.pdf

[4] http://www.peacefmonline.com/pages/business/economy/201711/334591.php

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

[6] The Act is essentially an insurance scheme where depositors may receive up to GHS6,250 in compensation for deposits with banks and GHS1,250 for depositors with other specialised deposit taking institutions

[7] https://www.bis.org/publ/bcbs144.pdf