Bank Reforms, Competition, and Stability in the Ghana

BANK REFORMS, COMPETITION, AND STABILITY IN THE GHANA

BANKING INDUSTRY

James Antwi

A dissertation submitted to the Faculty of the University of Delaware in partial fulfillment of the requirements for the degree of Doctor of Philosophy in Economics

Spring 2020

BANK REFORMS, COMPETITION, AND STABILITY IN THE GHANA

BANKING INDUSTRY

James Antwi

Approved: ______Michael A. Arnold, Ph.D. Chair of the Department of Economics

Approved: ______Bruce W. Weber, Ph.D. Dean of Alfred Lerner College of Business & Economics

Approved: ______Douglas J. Doren, Ph.D. Interim Vice Provost for Graduate and Professional Education and Dean of the Graduate College

I certify that I have read this dissertation and that in my opinion it meets the academic and professional standard required by the University as a dissertation for the degree of Doctor of Philosophy.

Signed: ______James L. Butkiewicz, Ph.D. Chair of dissertation committee

Signed: ______Evangelos M. Falaris, Ph.D. Member of dissertation committee

Signed: ______Kenneth A. Lewis, Ph.D. Member of dissertation committee

Signed: ______Breck Robinson, Ph.D. Member of dissertation committee

ACKNOWLEDGMENTS

I am very grateful to Professor James L. Butkiewicz, who chaired my

dissertation committee, for his constant guidance and support. My research has

benefited greatly from the inspiration and the immense knowledge he provided.

To my committee members Professor Evangelos M. Falaris, Professor Kenneth

A. Lewis, and Professor Breck Robinson, I express my profound appreciation for your

valuable contribution in reading and providing critical comments and corrections. I

thank Deborah Sharpley and the professors in the Economics department for their

support throughout my studies in this program.

This doctoral project is dedicated to my wife, Gloria, my children Mame, Ama,

Rachel, and Joel, for their support. I give thanks to my Lord and Master, Jesus Christ, who gives me life, knowledge, wisdom, strength, and courage to reach this highpoint in

my academic pursuit.

iv TABLE OF CONTENTS

LIST OF TABLES ...... vii LIST OF FIGURES ...... viii ABSTRACT ...... ix

Chapter

1 INTRODUCTION ...... 1

1.1 Background ...... 1 1.2 Purpose of the Study ...... 4 1.3 Research Questions ...... 10 1.4 Problem Statement and Background ...... 11 1.5 Economic Growth in Ghana...... 16 1.6 Ghana Cocoa Sector Financing ...... 18 1.7 Method and Organization of the study...... 19

2 REVIEW OF LITERATURE ...... 20

2.1 Bank Competition and Financial Stability ...... 20 2.2 Bank Competition, Bank Stability, and Economic Growth ...... 25 2.3 Bank Recapitalization and Financial Stability ...... 27 2.4 Universal Banking and Financial Stability ...... 30

3 THE BANKING INDUSTRY AND MACROECONOMIC DEVELOPMENT IN GHANA ...... 32

3.1 Historical Perspective of Banking Policies in Ghana ...... 32 3.2 Structure of Ghana’s Banking System ...... 35 3.3 Administrative Structure of the Bank of Ghana ...... 40 3.4 Ghana Banking Sector Regulations ...... 41 3.5 Banking Sector Performance in Ghana ...... 48 3.6 Macro-Financial Stress Tests ...... 52 3.7 Macroeconomic Development in Ghana ...... 55

3.7.1 Real Sector Performance and Economic Activity ...... 56

v 3.7.2 Inflation and Interest Rates ...... 58 3.7.3 Bank Credit to Private Sector Development ...... 61

4 METHODOLOGY ...... 62

4.1 Data Consideration and Sources ...... 62 4.2 Description and Explanation of Variables ...... 63 4.3 Measure of Bank Competition ...... 66

4.3.1 Estimating the Lerner Index ...... 67

4.4 Measure of Bank Stability ...... 68

4.4.1 Estimating the Z-score ...... 68

4.5 The Degree and Evolution of Bank Competition ...... 69 4.6 Model for Bank Competition and Financial Stability ...... 69 4.7 Model for Bank Recapitalization and Financial Stability ...... 72 4.8 Model for Bank Competition, Bank Stability, and Economic Growth .... 72

5 EMPIRICAL RESULTS ...... 75

6 CONCLUSION AND POLICY RECOMMENDATION ...... 93

REFERENCES ………………………………………………………………...……. 96

vi LIST OF TABLES

Table 1-1: Real Interest Rates and Inflation Rates in Selected Sub-Saharan African Countries ...... 6

Table 1-2: Non-Performing Loans Value (in Percent) for Selected SSA Countries .... 13

Table 2-1: Summary of Literature Review on Bank Competition and Stability ...... 24

Table 3-1: The Structure of Ghana Banking Sector...... 36

Table 3-2: Evolution of Banks in Ghana ...... 39

Table 3-3: A List of Regulations in the Ghana Financial Industry From 1998 to 2017 ...... 47

Table 3-4: Bank Performance and Financial Indicators (in Percent) ...... 51

Table 3-5: Selected Macroeconomic and Financial Indicators (in Percent) ...... 56

Table 4-1: Overview of Variables Names and Definitions ...... 65

Table 5-1: The Lerner Index for Ghana (1998 – 2018) ...... 77

Table 5-2: Summary Statistics for Bank Stability, Competition, Bank Specific and Macro Variables ...... 78

Table 5-3: Parameter Estimates for the Effect of Competition on Bank Stability ...... 82

Table 5-4: Parameter Estimates for the Effect of Bank Recapitalization on Bank Stability ...... 86

Table 5-5: Summary Statistics for the Effect of Bank Stability and Competition on Economic Growth ...... 91

Table 5-6: Panel Unit Root Test Results for Sub-Sahara Africa Countries 1996-2014 ...... 91

Table 5-7: Parameter Estimates for the Long- and Short-Run Effects of Competition and Stability on Economic Growth ...... 92

vii LIST OF FIGURES

Figure 1-1: Non-Performing Loans in Ghana ...... 10

Figure 1-2: Real GDP Growth (in percent) for Selected SSA countries ...... 17

Figure 1-3: Ghana’s Real GDP Growth (annual %) ...... 17

Figure 1-4: Ghana’s GDP Per Capita (constant 2010 US$) ...... 18

Figure 2-1: ROA, NIS, and NIM for The Ghana Banking Industry ...... 21

Figure 2-2: Ghana’s Private Credit by Banks to GDP (%) ...... 31

Figure 3-1: Inflation, Nominal Bank Lending Rate, and Nominal Bank Deposit Rate ...... 52

Figure 3-2: Macro-Financial Stress Tests ...... 54

Figure 3-3: Inflation, Real GDP Growth, and External Debt to GDP ...... 55

Figure 3-4: Inflation, Real Lending Rate, and Real Deposit Rate ...... 60

Figure 3-5: Inflation, Nominal Lending Rate, and Nominal Deposit Rate ...... 60

Figure 3-6: Domestic Credit to the Private Sector by Banks (% of GDP) and NPL .... 61

viii ABSTRACT

The central theme of my study is to assess the link between bank reforms, competition, and financial stability in the Ghana banking industry. Competition and stability are important for economic growth, but there may be trade-offs between competition and stability, so it is also important to determine which is more beneficial for growth. The research uses a panel data set of twenty-six banks in Ghana from 1998 to

2018. The Lerner index measures bank competition and the Z-score measures individual bank stability. I find that a rise in banks' market power promotes financial stability, and the recapitalization policies by the Central Bank of Ghana have not contributed to financial stability in Ghana. Moreover, over the last two decades, Ghana's banking industry has become moderately competitive. I assess the link between competition, bank stability, and economic growth of twenty Sub-Saharan African countries from 1996 to

2014. The empirical evidence shows that competition and stability positively affect economic growth in the long run, and competition is more beneficial for growth.

However, banks' market power improves growth in the short-run.

Keywords: Bank Reforms, Competition, Stability, Recapitalization, Economic Growth

JEL Classification: G21, G28, G33, G38

ix Chapter 1

INTRODUCTION

1.1 Background

During the 1980s, as part of structural adjustment programs, most developing countries, including Ghana, implemented financial sector reforms policies to eliminate the remnants of financial market repression (Ziorklui & Barbee, 2003). The objective of the reforms was to restructure troubled banks and remove nonperforming loans from banks' balance sheets to promote competition, efficiency, the stability of the banking industry, and to mobilize savings (Ziorklui & Barbee, 2003). The most recent two decades provide important lessons on the reforms-competition-stability link by assessing the connection between bank reforms, bank competition, and banking sector stability in

Ghana that have previously not been explored. Over the years, the Ghanaian banking sector has evolved in response to changes in the domestic and global macroeconomic environments (Ackah & Asiamah, 2014).

Most sub-Saharan African nations have opportunities to grow mobile banking services and to form regional banking groups (Mlachila et al., 2013). Data from the World

Bank indicates that 34.6 percent of people (15 years and above) in Ghana have access to financial services, signifying opportunities for banks to expand banking services. Ghana has a diversified financial system, including universal banks, savings and loans

1 companies, rural banks, microfinance institutions (MFI), and fund management companies. However, the financial system is still bank-based. Banks control over 85 percent of the total assets of the financial industry.1The number of both domestic and foreign banks operating in Ghana increased from 18 in 1998 to 34 in 2017. The number of foreign banks was 17 in 2017, a rose from seven in 1998 (see Table 3.1). Despite the financial reforms and robust economic growth, a 2013 study by Mlachila and others find that for many SSA countries, including Ghana, the banking industry is underdeveloped, with inadequate competition. They note that small domestic markets and weak contract enforcement hinder the development of the SSA countries’ banking industry.

Bank competition promotes innovation and efficiency of financial services

(Laeven & Claessens, 2004). The authors explain that bank competition increases access to financial services for firms and households and results in economic growth. Weill,

Schobert, & Pruteanu-Podpiera (2008) report that competition reduces the monopoly power of banks, and hence reduces banking product prices, which increase in investment and economic growth.

The global financial crisis of 2008-2009 prompted public awareness for the supervision and regulation of banks (Ackah & Asiamah, 2014). Subsequent to the financial crisis, several countries are starting to highlight financial stability and looking

1 Bank of Ghana annual report 2017.

2 to balance bank regulation with the expansion of inclusive growth, particularly in developing countries (Ackah & Asiamah, 2014).

Financial sector reform stimulates innovation and increases efficiency, thereby improving growth (Beck & Maimbo, 2013). On the other hand, the banking industry deregulation can cause unintended consequences, such as disrupting the industry and slowing retarding economic growth (Beck & Maimbo, 2013). The authors explain that structural reforms increase bank competition with the associated stability-fragility trade- off. Banks account for a more significant percentage of Sub-Saharan Africa (SSA) financial industry assets, and the banks are inadequately contestable; hence, systemic bank failures have severe spreadable effects in the economies (Beck & Maimbo, 2013).

A contestable market is a market with a few companies that behave competitively because of the threat of new entrants.2

This study examines policies and reforms that have been implemented for the most recent two decades to determine if such policies and reforms have caused any significant changes to Ghana’s banking sector using comprehensive data over the period

1998 and 2018.

2 https://www.investopedia.com/terms/c/contestablemarket.asp. Retrieved on May 25, 2019.

3 1.2 Purpose of the Study

An important policy objective of Ghana is to develop an efficient financial system to promote savings and to offer efficient payment and credit services (Ackah & Asiamah,

2014). The percentage of bad loans (NPL)3 of the Ghanaian banks has worsened over the last five years (see Figure 1.1). Also, banks’ return on assets (ROA) and net interest spread (NIS) dropped in the previous four years (see Figure 2.2). The growth rate of business loans from domestic sources as a percentage of GDP also deteriorated over the last decade (2008-2017), averaging 1.4 percent from an average of 6.9 percent a decade

(1998-2007) earlier. The reduced credit growth is partly due to a switch by banks to invest in government securities. The rise in NPL and the decline in profitability may be the result of excessive risk-taking behavior to remain in business. The banks are providing more loans to the government to reduce bad loans. The deteriorated domestic loans to businesses show that banks are investing more in risk-free government securities instead of funding loans and advances with associated credit risk. Non-bank financial institutions provide about 12 percent of the credit to the business community. The banks in Ghana are not required to buy government bonds.

The portion of loans by the universal banks to businesses was 88.0 percent in 2018 compared to 89.8 percent in 2017.4 The rise in Ghana’s NPL is not due to financial crises,

3 The ratio of non-performing loans to gross loans.

4 Bank of Ghana Annual Report, 2018.

4 but the result of high real lending interest rate (see Table 1.1). The real lending interest rate in Ghana is the highest compared to peer countries, and when faced with a higher cost of capital, borrowers optimally choose higher-risk projects (Boyd & De Nicoló,

2005). The market determines the real lending interest rate. The banks are reluctant to give loans to businesses because of the high loan default rate.

5 Table 1-1: Real Interest Rates and Inflation Rates in Selected Sub-Saharan African Countries Panel A: Real Interest Rates in Selected Sub-Saharan Africa Countries 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Average Ghana 10.73 13.50 17.89 17.97 18.57 13.93 13.51 10.35 13.75 16.93 14.71 Kenya -12.22 5.57 10.41 1.02 10.35 11.60 9.64 9.50 10.26 5.66 6.18 Nigeria 3.56 7.45 3.86 5.18 4.57 8.25 8.49 7.84 1.19 1.03 5.14 Rwanda 0.81 3.83 17.25 13.59 6.43 11.39 14.90 14.80 10.12 8.89 10.20 South Africa 5.07 4.44 5.77 3.98 3.03 2.72 2.99 4.91 3.86 5.19 4.20 Uganda 8.40 7.94 16.20 5.27 13.47 18.38 18.51 17.01 18.18 16.07 13.94 Mauritania 12.99 17.28 10.72 11.31 12.10 12.87 13.47 13.75 15.53 14.75 13.47 Benin -2.96 2.82 2.81 2.54 -1.71 4.40 6.34 4.88 6.14 5.06 3.03 Burkina Faso -5.68 2.37 5.88 2.50 1.22 4.75 5.60 4.20 5.54 4.78 3.12 Cote d'Ivoire -1.32 3.96 3.89 0.34 3.73 2.71 4.89 3.90 4.57 4.45 3.11 Togo -3.71 1.26 3.67 1.69 2.46 3.46 5.15 2.57 4.01 6.12 2.67 Panel B: Inflation Rates in Selected Sub-Saharan Africa Countries 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Average Ghana 16.52 19.25 10.71 8.73 7.13 11.67 15.49 17.15 17.45 12.37 13.65 Kenya 26.24 9.23 3.96 14.02 9.38 5.72 6.88 6.58 6.30 8.01 9.63 Nigeria 11.58 11.54 13.72 10.84 12.22 8.48 8.06 9.01 15.68 16.52 11.76 Rwanda 15.44 12.89 -0.25 3.08 10.27 5.92 2.35 2.53 7.17 8.28 6.77 South Africa 10.06 7.26 4.06 5.02 5.72 5.78 6.14 4.51 6.59 5.18 6.03 Uganda 12.05 13.02 3.98 16.56 12.68 4.91 3.08 5.59 5.71 5.21 8.28 Mauritania 7.35 2.22 6.28 5.69 4.90 4.13 3.53 3.25 1.47 2.25 4.11 Benin 7.95 2.16 2.31 2.72 6.74 0.89 -1.01 0.27 -0.85 0.08 2.13 Burkina Faso 10.66 2.61 -0.76 2.76 3.82 0.53 -0.26 0.95 -0.24 0.36 2.04 Cote d'Ivoire 6.31 1.02 1.23 4.91 1.30 2.58 0.45 1.25 0.72 0.69 2.05 Togo 8.69 3.71 1.45 3.56 2.58 1.83 0.19 2.59 1.29 -0.98 2.49 Source: The World Bank, the Bank of Ghana, and averages are calculated by the author.

6 Ghana does not have large banks to provide long-term financing (loans with a repayment period of over ten years), and the security market is less developed to fill this gap. The government wants large banks and a stable financial system to support economic development. Consequently, the government has moved to create big banks, by consolidating the banks that do not meet the minimum capital adequacy ratio (CAR)5 requirement of at least 10 percent. The Bank of Ghana (BOG) regulates the financial system. The Bank of Ghana encourages banks with low capital to merge. For instance, two banks with low capital may merge upon approval of BOG, or a larger bank may acquire the smaller bank. The Bank of Ghana permits banks to use retained earnings and new shares to meet capital6 requirements.

Canada has a concentrated banking system, and it is regarded as the most stable financial system in the world, which provides a significant benefit to the Canadian economy. However, the Canadian concentrated banking system may provide financial stability which is suitable for economic development, but such a system may be less efficient (Bordo, Redish, & Rockoff, 2015). Canada is a developed country with a well- developed capital market and stable macroeconomic fundamentals.

On the other hand, Ghana is a developing country with a less-developed capital market and relatively unstable macroeconomic fundamentals. If the government of

5 CAR is the ratio of bank capital and reserves to risk-weighted assets.

6 Capital includes paid-up shares and common stock.

7 Ghana’s quest to create large banks by consolidation is successful, then what will be the level of banks’ market power and the implication for banking industry stability?

My research examines the link between banking regulations, bank competition, and financial system stability to determine if bank competition and bank recapitalization policies affect bank stability. I further investigate the relative contribution of competition and stability to growth. Lerner (1934) index is the proxy for competition. Studies that have used the Lerner (1934) index includes Anginer, Demirguc-Kunt, & Zhu (2014);

Beck & Cull (2013); and Demirguc-Kunt & Peria (2010). Prior research on Ghana have examine competition and efficiency (Alhassan & Ohene-Asare (2016); Biekpe (2011);

Mathisen & Buchs (2005) and the link between financial reforms and competition

(Akomea & Adusei (2013); Brownbridge & Fritz Gockel (1996); Owusu-Antwi (2009).

Other similar studies on Ghana analyze financial reforms, efficiency, and bank profitability (Antwi-Asare & Addison (2000).

Banya & Biekpe (2017) use data from 2005 – 2012 to examine the impact of competition on growth for selected African countries, including Ghana. The results show that bank competition promotes economic growth. They note that over the study period,

Ghana recorded a decrease in a banking concentration ratio from 99 percent in 2005 to

55.7 percent in 2011 and conclude that Ghana banking competition has increased over the sample period.

Alhassan & Ohene-Asare (2016) assess bank competition and efficiency in Ghana from 2004 to 2011. They report that competition improves the cost efficiency of banks.

8 Using data from 2003-2010, Akomea & Adusei (2013) investigate the link between bank recapitalization and concentration and conclude that a consolidation of five or more banks triggered by bank recapitalization policy culminate in high concentration. Bank recapitalization policy requires banks to increase their minimum paid-up capital. Banks that are not able to raise their capital may merge or be acquired by a larger bank upon approval from the Bank of Ghana.

Biekpe (2011) uses data from 2000 to 2007 to investigate competition and intermediation efficiency. The author finds banks in Ghana to be non-competitive, which hinders financial intermediation, and high investment requirements and related costs deter potential new entrants. A 2005 study by Mathisen and Buchs notes that financial reforms have not adequately fostered banking competition in Ghana. The authors observe that

Ghana’s macroeconomic instability hurts the size and the quality of financial services.

Financial sector reforms have enhanced financial development and improved banks’ performance (Antwi-Asare & Addison, 2000).

This research builds on prior studies in four important ways. First, this study is the first to use a comprehensive data set from 1998 to 2018 to examine the degree and evolution of bank competition in Ghana. A data set with an extended sample period is necessary to determine the Ghana banking industry market structure (Biekpe, 2011). The full impact of reforms may take time to materialize. Second, the study addresses the complex interaction between the financial reforms-competition-stability relationships for

Ghana’s banking industry using a comprehensive data set. Third, this study examines the

9 relative contribution of competition and stability to economic growth. Fourth, my aim is to add more evidence to the competition-fragility link for Ghana’s banking industry.

Figure 1-1: Non-Performing Loans in Ghana

NPL to Gross Loans (%) Loans to GrossNPL 5 NPL Ratio Gross

1.3 Research Questions

The research answers these questions:

1. What is the degree and evolution of bank competition in Ghana from 1998 to

2018?

2. How has bank competition impacted the stability of the Ghana banking industry?

3. What is the impact of bank recapitalization on bank stability in Ghana?

4. What is the relative contribution of stability and competition to economic growth?

10 1.4 Problem Statement and Background

The banking sector is significant for economic development. Banks provide a market for loanable funds where savers and borrowers are brought together in well- organized structures. Major challenges facing the Sub-Saharan Africa banking systems include high non-performing loans (NPL)7, weak internal control mechanisms, poor governance, and weak institutional capacity (Mlachila et al., 2013). Ghana has relatively high value of NPLs relative to peer countries (see Table 1.2). NPL in Ghana have increased from 7.7 percent in 2008 to 21.6 percent in 2017, partly due to low-income levels, and weak contract enforcement. Also, the lending rate in Ghana is high, and, when faced with a higher cost of capital, borrowers optimally choose higher-risk projects (Boyd

& De Nicoló, 2005). The Bank of Ghana (the Central Bank) is encouraging banks to write-off protracted bad loans (Ackah & Asiamah, 2014).

Effective supervision and regulation of individual banks are needed; however, structural regulation tends to discourage entry into banking markets, thereby allowing incumbent banks to increase market power (Ackah & Asiamah, 2014). According to the authors, bank regulation includes structural, conduct, and prudential regulations.

Structural regulation restricts banks’ activities or entry into banking markets. Structural regulation includes the functional separation of banks into a commercial bank, an investment bank, and a development bank. Conduct regulation attempts to control the

7 NPL is the ratio of non-performing loans to gross loans.

11 strategic or operational policies of banks such as interest rates control, the volume of loans granted, and branch networks expansion policies. Prudential regulation seeks to maintain the stability of banks and protect consumer interests. Prudential regulation includes recapitalization and deposit insurance policies. Later sections of this study discuss the evolution of the state of supervision and regulation in Ghana.

A significant challenge to banks in Ghana is the lack of a well-developed credit bureaus to screen potential borrowers (Mlachila et al., 2013). A contributing factor to the lack of mature credit bureaus is the absence of a national identity card, such as the USA’s social security card. The adoption of the Credit Reporting Act 2007 in 2008 provided a framework for the operation of a system of credit reference bureaus.8 The usage of credit bureau services among banks and non-bank financial institutions (NBFIs) improved from

13,490 searches in 2010 to 2,060,049 searches in 2017. Thus, an increase of 15171 percent over eight years.

Another challenge facing the banking industry is the high lending interest rates.

The inflation rate and the prime rate decreased from 17 percent and 21 percent in 2014 to

11.8 percent and 20 percent in 2017, respectively. Most banks are unwilling to cut the nominal lending rates due to the existence of low-quality loans on their books. The nominal interest rates are high to compensate for high loan default risk and to increase profitability. The real lending interest rate in Ghana is the highest compared to peer

8 Bank of Ghana.

12 countries, and when faced with a higher cost of capital, borrowers optimally choose higher-risk projects (Boyd & De Nicoló, 2005).

Table 1-2: Non-Performing Loans Value (in Percent) for Selected SSA Countries Year Ghana Kenya Madagascar Nigeria Rwanda South Africa Uganda 2008 7.7 9.0 6.4 7.2 10.3 3.9 2.1 2009 16.2 8.0 8.1 37.3 8.6 5.9 4.0 2010 18.1 6.3 9.6 20.1 7.3 5.8 1.9 2011 14.1 4.4 10.7 5.8 5.6 4.7 2.0 2012 13.2 4.6 11.1 3.7 5.1 4.0 4.1 2013 12.0 5.0 11.6 3.4 5.9 3.6 5.8 2014 11.3 5.5 10.1 3.0 5.2 3.2 6.2 2015 14.7 6.0 9.0 4.9 5.9 3.1 5.1 2016 17.3 8.7 8.4 12.8 7.1 2.9 10.4 2017 21.6 10.1 7.3 14.8 7.2 2.8 5.5 Source: Author’s compilation using the World Bank data. Note: SSA stands for Sub-Sahara Africa

Demirguc-Kunt & Detragiache (1997) show that at least one of the following four situations should hold for an incident of banking distress to turn into a full-fledged crisis: i) The NPL ratio in the banking industry exceeds 10%. ii) The cost of the rescue operation is at least 2% of GDP. iii) Extensive bank runs occur, or the government decrees emergency measures such as deposit freezes, extended bank holidays, or generalized deposit guarantees in response to the crisis. iv) Banking sector problems result in large-scale nationalization of banks.

Ghana experienced the first three of the above conditions from 2016 to 2018. The non-performing loans (NPL) remain high on banks’ financial statements averaging a little over fourteen percent (14.59%) over the last two decades (see Table 1.2). The NPL rose

13 from 11.3 percent in 2014 to 21.6 percent in 2017. Asset quality remains a source of concern because banks’ stock of non-performing loans (NPLs) rose between April 2017 and April 2018.9

The Bank of Ghana enacted for the first time the Ghana Deposit Protection Act,

2016 (Act 931) in July 2016. The Act protects for up to GH¢6,250 ($1,500) for depositors with banks and GH¢1,250 ($300) for depositors with non-bank financial institution such as microfinance institutions (MFI) and savings and loans companies (S&L). Between

2017 and 2018, rescue operations for seven domestic banks at the cost of about 3.5 percent of Ghana’s GDP were in place, as well as several cases of bank runs and deposit freezes from 2016 to 2018. The Bank of Ghana and the Ministry of Finance initiated discussions to rescue the non-bank financial institutions at the cost of 2.9 percent of GDP.

Ghana’s real GDP growth fell from 15 percent in 2011 to 3.7 percent in 2016, and inflation climbed from 8.6 percent in 2011 to 15.4 percent in 2016 (see Table 3.5). The rise in non-performing loans from 14.1 percent in 2011 to 21.6 percent in 2017 is evidence of poor debt collection (weak law and order and weak contract enforcement) by banks.

A bank collapse creates serious negative externalities that ultimately lead to a loss of confidence in the financial system (Kupiec & Ramirez, 2013). Between August 2017 and August 2018, 20 percent of the banks in Ghana (seven out of thirty-four) lost their operating license. The Bank of Ghana revoked the licenses of seven banks. The banks

9 Banking Sector Report, Bank of Ghana, May 2018.

14 had a capital adequacy ratio (CAR) of less than 5 percent. The required minimum CAR is at least 10 percent, and there is no maximum CAR limit.

In 2017, the Bank of Ghana mandated the GCB Bank to acquire the UT Bank and the Capital Bank due to liquidity and solvency challenges to prevent the two banks from collapsing. Liquidity is the ease to convert assets to cash to settle obligations. Solvency

(measured by the CAR) is the ability to meet short and long-term obligations of a bank.

In 2018, the Bank of Ghana merged the five banks to form the CBG bank. According to the Bank of Ghana, the Royal Bank was insolvent, while the Sovereign Bank acquired its licenses through suspicious means. The Bank of Ghana on-site examination of the bank in December 2017, revealed that bank directors and shareholders lent depositors’ money to themselves without due process. Also, the Sovereign Bank owners showed money as evidence to set up the bank and turned around to withdraw the same money leaving the bank with little or no working capital. The rescue of the seven domestic banks come at the cost of GH¢9.9 billion (about $2.2 billion) to the taxpayer. The cost is about 3.5 percent of Ghana’s GDP. Asset quality remains a source of concern because banks’ stock of non- performing loans (NPLs) rose between April 2017 and April 2018.10 The non-performing loans remain high on banks’ financial statements averaging a little over fourteen percent

(14.59%) over the last two decades (see Table 1.1 and Figure 1.2). Concerns about financial sector stability in Ghana have grown.

10 Banking Sector Report, Bank of Ghana, May 2018.

15 1.5 Economic Growth in Ghana

Ghana's average real GDP growth over the last two decades is 6.1 percent, which is among the highest compared to peer countries (see Figure 1.2). Figure 1.3 shows a steady growth of real GDP from 3.7 percent in 2000 to 8.4 percent in 2008 despite the global financial crisis of 2007-2008. The stable growth was the result of improved performance in the agricultural and the industrial sectors. Ghana's largest sector is the agricultural sector, and it contributes about 34 percent of GDP. The industry sector’s share of GDP is about 24 percent. From 2012 to 2016, Ghana experienced persistent, irregular, and unpredictable electric power outages caused by a power supply shortage that negatively affected domestic growth conditions.

On April 3, 2015, Ghana received the IMF Extended Credit Facility (ECF) of

US$918 Million. The four-year ECF program ended on April 2, 2019. The objective of the ECF is to boost growth, jobs, and macroeconomic stability. The GSGDA program aims to promote manufacturing, to modernize agriculture, and to exploit Ghana’s natural resources sustainably. In 2017, the Ghana government rolled out policies including the

Free-Senior-High-School. The initiative offers free high school education to improve the human capital base for development. The Planting-for-Food-and-Jobs policy provides improved seeds and fertilizers to farmers at subsidized prices to boost agriculture productivity. The One-District-One-Factory program seeks to establish, at least, one factory in each district in Ghana to boost manufacturing.

16 Figure 1-2: Real GDP Growth (in percent) for Selected SSA countries Average Real GDP Growth: 1998 - 2018

Uganda South Africa Rwanda Nigeria Madagascar Kenya Ghana

0123456789

According to the World Bank, Ghana experienced a banking crisis in 1982-1983.

Ghana's real GDP growth decreased from 0.47 percent in 1980 to -6.92 percent in 1982 before rising to -4.56 percent in 1983 (see Figure 1.3). The 1982-1983 banking crisis has a similar pattern as in Reinhart & Rogoff (2014). The authors suggest that it takes approximately eight years for a country’s real per capita GDP to reach the level before to the crisis.

Figure 1-3: Ghana’s Real GDP Growth (annual %) 20

-5

-10

Real GDP growth (annual %)

17 The pre-crisis real per capita GDP in 1981 is US$827.82. Eight years after the banking crisis, the real per capita GDP rose to US$834.07, as shown in Figure 1.4. Ghana experienced a recent banking crisis in 2017-2018. A modern banking crisis is characterized by bank runs, poor asset quality, and bank closures (Reinhart & Rogoff,

2014). Ghana’s 2017-2018 banking crisis does not have a similar pattern as in Reinhart

& Rogoff (2014). Ghana’ real per capita GDP did not fall during the 2017-2018 financial crisis.

Figure 1-4: Ghana’s GDP Per Capita (constant 2010 US$) 2000 1800 1600 1400 1200 1000 800 600 400 200 0

1.6 Ghana Cocoa Sector Financing

Ghana's cocoa sector contributes to employment, government revenue, foreign exchange earnings, and infrastructural expansion (Kumi, A. S., 2016). Cocoa exports over the last decade contributed about $2.4 billion yearly, which is about 23% of Ghana’s total merchandise exports. A major challenge facing the sector is inadequate financing to license buying companies (LBCs). Ghana Cocoa Board (COCOBOD) rely on pre-export

18 syndicated loans from external sources for cocoa purchase through LBCs. In the 2016 and 2017 cocoa seasons, the COCOBOD raised a US$ 2 billion pre-export syndicated loan externally (Kumi, A. S., 2016). The government of Ghana wants the COCOBOD to raise pre-export syndicated loans from the local banks. Presently, Ghana does not have big banks capable of raising the needed funds for the COCOBOD to pre-finance the cocoa purchasing activities of LBCs.

1.7 Method and Organization of the study

Section 2 is the literature review. Section 3 describes the banking industry and macroeconomic development in Ghana. Section 4 explains the methodology, and Section

5 is the results. Section 6 is conclusions.

19 Chapter 2

REVIEW OF LITERATURE

This section reviews the studies on financial reforms, the link between bank competition, stability, and economic growth.

2.1 Bank Competition and Financial Stability

Banking industry competition has attracted empirical studies in the previous three decades. The Ghana banking industry has experienced dramatic changes due to deregulation and regulation of financial systems, developments in banking technology, innovations, and policy and economic changes (Owusu-Antwi, 2009). Before 1987, the government of Ghana owned majority of the banks. The government directed the banks to extend credit to the government priority areas such as indigenous business and farmers that would ordinarily not get a loan from the foreign banks (Brownbridge & Gockel,

1996). The Bank of Ghana (the Central Bank) controlled the interest rates. The Central

Bank abolished the interest rate controls in 1987. The Banking Law 1989 introduced a minimum capital adequacy (CAR) requirement of at least six percent (6%) with no maximum limit.11 In 2005 a higher minimum CAR requirement of at least 10 percent, an

11 Ghana Banking Law 1989 (PNDCL 225).

20 increase from six percent (6%) was in place.12 There is no maximum limit for the CAR requirement. These developments have implications for the industry.

Ghana’s banking sector remained profitable despite declining trends of return on assets (ROA) over the last four years (see Figure 2.1). The trend is due to increased provision for bad and doubtful debt, branch expansion and increased administrative expenses, and a slowdown in economic activity that have contributed to higher costs and reduced profitability.13

Figure 2-1: ROA, NIS, and NIM for The Ghana Banking Industry 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 2014 2015 2016 2017

ROA NIS NIM

Note: NIS is net interest rate and NIM is net interest margin.

12 Ghana banking and financial laws 1998-2006.

13 Bank of Ghana Annual reports.

21 According to Berger & Hannan (1998), banks are less efficient in concentrated markets. The authors used US banking data from 1980 to 1989 to show that reduced competition in a concentrated market leads to efficiency costs in addition to the deadweight loss to society. The main finding posits that higher concentration decreases operating efficiency. The authors argued that the efficiency cost far outweighs that of social loss associated with market power due to mispricing. According to the authors, the efficiency cost results in a less competitive market because managers are less motivated to maximize operating efficiency. The results imply that the social cost of anti- competitive mergers is higher than what the deadweight triangle might suggest (Berger

& Hannan, 1998). Also, using data for 26 Ghana banks from 2004 to 2011, Alhassan &

Ohene-Asare (2016) found that bank competition improves cost efficiency.

According to Stucke (2013), competition harms society when businesses compete to exploit buyers' bounded rationality.14 The author argues that competition motivates firms to devise clever means to exploit consumers by suggesting high retail prices from which bounded rational buyers negotiate.

Theoretical and empirical studies have not reached a consensus on the impact of bank competition on stability. Most of the research focused on the developed nations and mainly in a cross-country setting (Fosu, 2013). Studies of banking competition and

14Bounded rationality is the idea that individuals make rational decisions based on the limits of the information available to them and their mental capabilities. Retrieved on November 27, 2018. https://www.ecnmy.org/learn/you/choices-behavior/what-is- bounded-rationality/

22 stability in Sub-Sahara Africa are scanty. Leroy & Lucotte (2017) studied the competition-stability link for European banks. The authors conclude that competition causes banks to be unstable. Also, there is a robust competition-fragility link in countries with effective credit information sharing, stricter activity restrictions, mature stock exchange markets, and generous deposit insurance (Beck et al., 2013). Empirical evidence for 61 countries in 1980–1997 shows the quality of supervision impacts deposit insurance (Demirgüç-Kunt & Detragiache, 2002). The authors explain that deposit insurance causes moral hazard, which can lead to banking crises. The risk can be minimized by better bank regulation and supervision, thus reducing the negative effect of deposit insurance. Ariss (2010) investigates the market power and stability link for developing countries and concludes that market power results in bank stability. Based on data from 14 Asian Pacific countries from 2003 to 2010, Fu et al. (2014) show that competition increases banks’ risk exposure.

Financial market liberalization promotes competition, which ultimately erodes franchise values and motivates a bank to make bad loans causing the moral-hazard problem (Hellmann et al., 2000). Thus, increased competition drives banks to gamble, which make banks vulnerable to failure (Hellmann et al., 2000).

Contrary to the competition-fragility link, evidence from emerging economies shows that competition promotes diversification and consequently leads to stability

(Wolfe & Amidu, 2013). According to Boyd & De Nicoló (2005), competition lowers bank risk. According to the authors, banks with market power charge higher rates, and, when faced with a higher cost of capital, borrowers select higher risk projects. Schaeck,

23 Cihak, & Wolfe (2009) observe that competition decreases risk. Efficiency is the channel by which competition increases to stability (Schaeck & Cihák, 2014).

A meta-analysis of the competition-stability link shows different views of the relationship (Zigraiova & Havranek, 2016). The authors used 31 studies from 2003 to

2014 in the meta-analysis. They record that the definitions of competition and stability do systematically influence the results. The authors observed that differences in the characteristics of the banking industry for countries might impact the results.

Table 2.1 shows a list of literature reviews on bank competition and stability.

Table 2-1: Summary of Literature Review on Bank Competition and Stability Competition-Stability Competition-Fragility Non-Linear relationship View View Boyd & De Nicoló Ariss (2010) for Brei, Jacolin, & Noah (2005). developing countries. (2018) on Sub-Sahara Africa. Schaeck & Cihák (2014) Leroy & Lucotte (2017) Zigraiova & Havranek on the United States and for European listed banks. (2016). Europe. Wolfe & Amidu (2013) Beck, De Jonghe, & Berger, Allen, Klapper, & for emerging economies. Schepens (2013) using a Turk-Ariss (2009) on 23 sample of 79 countries. industrialized countries.

Schaeck, Cihak, & Wolfe Fu, Lin, & Molyneux (2009) (2014) on Asia-Pacific.

Salas & Saurina (2003) on Spain. Source: Author’s compilation

24 2.2 Bank Competition, Bank Stability, and Economic Growth

Many economists seek to assess the proposition that competition and bank stability contribute to economic growth. Economic theory suggests that competition is good for a country. A competitive banking industry promotes economic growth through efficient financial intermediation (Mathisen & Buchs, 2005). According to Claessens

(2009), competition affects bank efficiency. The author argues that competition impacts access to banking services and hence promotes economic growth. The structure and market characteristics discourage entry into Ghana’s banking industry, and consequently, shelter the large profit of the banks (Biekpe, 2011; Mathisen & Buchs, 2005). Evidence from 1998 to 2003 suggests that the non-competitive nature of the Ghana banking sector negatively affected the efficiency of financial intermediation (Mathisen & Buchs, 2005).

A study by Biekpe (2011) finds that Ghana’s banking industry is monopolistically competitive.

Bank competition promotes innovation and efficiency of financial services

(Laeven & Claessens, 2004). The authors explain that bank competition increases access to financial services for firms and households and results in economic growth. Weill,

Schobert, & Pruteanu-Podpiera (2008) show bank competition leads to lower monopoly power of banks, and hence reduces banking product prices, which results in a rise in investment and economic growth. Fernandez, Gonzalez, & Suarez (2016) report that bank competition improves the efficiency of financial services delivery and economic growth.

The authors also explain that bank stability lowers economic volatility through credit supply, particularly in industries that rely on external finance and in developed financial

25 systems. Economic instability encourages residents to hold more foreign assets (Fogli &

Perri, 2015).

Coccorese (2008) finds that bank consolidation positively impacts short-run economic growth. The author explains that higher market power promotes quicker growth in businesses and economic growth overall. Based on this evidence, the Bank of Ghana's policy of promoting some level of bank consolidation is an apt choice, at least in the short- run.

Claessens & Laeven (2005) find that bank competition promotes faster development of financially dependent industries. They explain that competitive banking systems are better able to provide credit to financially dependent firms. Using data from

1992 to 2009, Adam (2011) concludes that competition positively affects the long run

GDP growth in Ghana.

Creel, Hubert, & Labondance (2015) explain that bank stability enables better risk management resulting in better use of resources, thereby promoting GDP growth in the

European Union. Claessens & Laeven (2005) report that financial stability promotes industrial growth in the long-run. Using a panel vector autoregressive (VAR) model for

18 OECD countries, Jokipii & Monnin (2013) observe a banking stability promotes economic growth. The authors report that GDP growth usually follows episodes of banking stability (Jokipii & Monnin, 2013).

Jayakumar et al. (2018) use data of 32 European countries from 1996 to 2014 and report that bank competition and bank stability positively impact long-term economic growth.

26 2.3 Bank Recapitalization and Financial Stability

Bank recapitalization means adding new equity to improve the balance sheet of banks. Policymakers and economists agree that a combination of minimum capital requirements and effective supervision provide a sufficient prudential regulation

(Hellmann et al., 2000). If banks have their paid-up capital at risk, they invest in the prudent asset in equilibrium (Hellmann et al., 2000). Prudential regulation addresses the concern of moral hazard in the free-market competitive equilibrium (Hellmann et al.,

2000). The authors opine that financial liberalization can increase bank competition that provides incentives for banks to increase gambling behavior. Prudential regulation, such as recapitalization, seeks to protect banks’ failure. Over the past decade, the Bank of

Ghana (BOG) has placed greater emphasis on bank capital requirements.

I ask whether recapitalization can promote the Ghana banking sector’s stability.

If banks have sufficient paid-up capital at stake, they are careful to invest in risky assets and elect to pursue prudent investment (Hellmann et al., 2000). The authors observe that moral hazard causes bank failures, and competition promotes risk-taking. Banks invest in a risky asset with a high expected return if the gamble succeeds; however, depositors lose if the gamble fails (Hellmann et al., 2000). Competition can increase risk-taking behavior, whereas capital regulation encourages carefulness because banks’ equity is at risk

(Hellmann et al., 2000).

An increase in the minimum paid-up capital of banks can prevent bank failure. In

France, the central bank may require owners of a distressed bank to increase paid-up

27 capital, which saved Al Saudi Banque, S.A.165 in 1988 (Garten, 1993). In contrast, bank failures in the United States from 1930 to 1937 show that the double liability principle to protect depositors is insufficient (Marquis & Smith, 1937). The double liability principle requires that shareholders of bank stocks should be liable to twice the amount of their shares in the event of bank failure. According to Marquis and Smith (1937), the Bank

Acts of 1933 and 1935 ended the double liability in the United States national banking system. The Act of 1933 brought the Federal Deposit Insurance Corporation and approved the issuance of shares without double liability (Marquis & Smith, 1937). On

July 1, 1937, the Bank Act of 1935 ended double liability on all national banks (Marquis

& Smith, 1937).

The current trend to protect depositors includes the use of deposit insurance policy and the accumulation of surplus income. However, the stable Canadian banking system before the introduction of deposit insurance in 1967 was due to the absence of deposit insurance and the lack of regulatory barriers to competition (Carr, 1995). The author explains that the absence of deposit insurance provides incentives for carefulness on the part of bank management. It also encourages monitoring by depositors and bank regulators. The lack of regulatory barriers to competition contributes to the small number of large efficient banks of the Canadian banking industry (Allen & Engert, 2007).

Canada’s banking industry is monopolistically competitive, and the small number of

Canadian banks do not form collusive oligopoly power (Allen & Engert, 2007). Canada has a concentrated banking system, and it is also the most stable financial system and provides significant benefit to the Canadian economy (Bordo et al., 2015). The Canadian

28 concentrated banking system may provide financial stability which is suitable for economic development, but such a system may be less efficient (Bordo et al., 2015).

According to Kane & Demirguc-Kunt (2002), deposit insurance is not always good or permanently bad. It is an essential part of bank regulation in an effective prudential regulation and supervision environment (Kane & Demirguc-Kunt, 2002).

Effective bank supervision encourages banks to recapitalize or close down before considerable losses occur (Kane & Demirguc-Kunt, 2002). The authors report that deposit insurance promotes bank instability in a poor institutional environment; however, this effect is minimized in countries with effective prudential regulation and supervision.

In 2016, the Bank of Ghana introduced the Ghana Deposit Protection Act, 2016

(Act 931). The Acts provide a legal framework to deal with emerging risks in the financial system, nurture innovation and financial inclusion and help resolve challenges of failing financial institutions proactively.15 To complement the Acts, the Bank of Ghana issued the recapitalization directive in 2017 to make banks stable. The directive took effect on

December 31, 2018. The number of bank failures in 2018 occurred before the adoption of the recapitalization policy. Any bank that does not meet the requirement by the effective date loses its operating license.

15 Bank of Ghana annual report 2016.

29 2.4 Universal Banking and Financial Stability

Universal banking is a system where banks provide an extensive diversity of financial services such as retail banking, wholesale banking, and investment services under one roof.16 Portfolio theory explains that the firm-specific risk can be reduced by combing assets of negatively correlated returns. This supporting the proposition that universal banks are better able to withstand financial failure. Thus, universal banks reduce risk exposure to commercial lending services by diversifying their product mix (Garten,

1993). Also, diversification permits universal banks to find other revenue sources

(Casalin & Dia, 2011).

Regulators in some European countries opine that universal banking is the reason for the minimum incidence of bank distress in those countries (Garten, 1993). According to the author, a universal banking system's source of strength is not the offering of product mix under one roof, but instead providing different services to customers that establish long-term bank-client relationships. Banks can examine credit risk and to recognize problems when they know their customers well (Garten, 1993).

Ghana has less developed capital markets, such as stock exchanges and fixed income markets. Banks in Ghana can satisfy the private sector's demand for credit facilities. Banks’ credit to businesses is increasing in the last 20 years (see Figure 2.2).

Bank stability is vital for business.

16 https://marketbusinessnews.com/financial-glossary/universal-bank/. Retrieved on April 23, 2020.

30 Figure 2-2: Ghana’s Private Credit by Banks to GDP (%)

20 Private credit to GDP (%) 18

6 Private Credit to GDP (%)to GDP Credit Private 4

In Ghana, banks are the leading players in the loanable fund market because most business firms do not resort to less developed securities markets for financing. Therefore, the Ghana business community should have an interest in the stability of the banking sector. The apparent link between universal banking systems and financial stability is the result of capital market structures and regulations, instead of the financial products that the universal banking offers (Garten, 1993).

31 Chapter 3

THE BANKING INDUSTRY AND MACROECONOMIC DEVELOPMENT IN

GHANA

This section provides an analysis of the banking industry and macroeconomic development in Ghana.

3.1 Historical Perspective of Banking Policies in Ghana

In the colonial period, the provision of banking services was governed by the laws of Company Ordinances and the Bank of the Gold Coast (Antwi-Asare & Addison, 2000).

After 1957, the Bank of Ghana had the power to prescribe the amount of banks' liquid assets, request information from banks, restrict investments, and fix the minimum capital of banks (Antwi-Asare & Addison, 2000). According to the authors, the Bank of Ghana’s objective after independence was to ensure that banks support the government industrialization policy by implementing sectoral credit guidelines issued by the Bank of

Ghana.

Before 1987, most banks in Ghana suffered from poor prudential regulation, poor corporate governance, and inadequate banking supervision. The government directed the banks to give loans to indigenous businesses and farmers that would ordinarily not get a

32 loan from the foreign banks (Brownbridge & Gockel, 1996). The Bank of Ghana (the

Central Bank) controlled the interest rates.

The Banking Act of 1970 was enacted in 1970 to regulate banks in Ghana. The

Act set the minimum capital requirement with no limit on the maximum. A local bank maintains at all times a paid-up capital of not less than ¢750,000 ($735,401) or an amount which is not less than 5% of the deposit liabilities of the bank (Ellimah, 1975). Foreign banks were to maintain a capital of not less than ¢2,000,000 ($1,961,070) or an amount which is not less than 5% of the deposit liabilities of the bank (Ellimah, 1975). According to Brownbridge & Gockel (1996), the capital adequacy requirements were pointless since there were no clear accounting rules on how to recognize loan losses, to account for non- performing loans, and to accrue unpaid interest.

To fund the development agenda after independence, the government of Ghana established the national banks with mandates to strengthen industrialization, agriculture, commerce, and construction sectors (Akomea & Adusei, 2013). During this period, government interference, interest rate controls, credit controls, lack of innovations, and poor regulations caused the banks to pile up high levels of non-performing assets in their books (Akomea & Adusei, 2013). Corruption and fraud worsened the banks’ losses because some borrowers were not qualified for loans on merit (Akomea & Adusei, 2013).

The foreign banks resisted government interference and would not extend credit to non- qualified borrowers, and as a result, foreign banks did not suffer loan losses relative to the local banks (Akomea & Adusei, 2013).

33 The Bank of Ghana administratively controlled interest rates to lower the cost of credit to promote investment and to support preferred borrowers (Daumont, 2004). The riskier sectors, like agriculture, received a preferential lending rate because the government considered the agriculture sector as the engine of growth. The government abolished the interest rates controls in 1987 (Brownbridge & Gockel, 1996).

Before 1987, BOG policies significantly impacted the banking markets in Ghana.

The country experienced significant banking crises in 1981-1982.17 The roots of the banking crisis can be linked to government policies from the 1960s to the early 1980s

(Brownbridge & Gockel, 1996). BOG’s policies caused distortions in the banking sector, and during the period, real interest rates became negative due to high inflation

(Brownbridge & Gockel, 1996).

The economy was unstable; per capita GDP growth averaged a negative 1.2 percent per annum between 1969 and 1986. In 1975, per capita GDP growth was negative

14.45 percent per annum. Inflation climbed from 7.32 percent in 1969 to 24.57 percent in 1986. Between 1969 and 1986, the average rate of inflation was 43 percent and peaked at 123 percent in 1983. High inflation and negative real interest rates caused holding of foreign exchange and physical assets (Brownbridge & Gockel, 1996).

Ghana’s financial industry suffered significant financial disruptions that led to the collapse of some banks, while others were in and out of insolvency (Brownbridge &

17 The World Bank.

34 Gockel, 1996). Non-performing loans, weak internal control mechanisms, and poor corporate governance also contributed to the bank distress, and it became necessary to reform the banking sector to encourage competition, improve efficiency, and promote banking sector stability (Brownbridge & Gockel, 1996).

3.2 Ghana’s Banking Industry Structure

The banking industry is made up of universal banks and rural banks (RCB). There are other non-bank financial institutions (NBFI). The asset size of the RCB and the NBFI represented 13.3 percent of the industry’s total assets, and universal banks controls the remaining 86 percent. At the end of 2018, 23 universal banks, 144 RCB, 566 MFIs, and

68 S&L were operating in Ghana. The number of universal banks decreased from 34 in

2017. In December 2018, the universal banks comprised of 14 foreign banks and nine domestic banks. The share of credit by the universal banks to the private sector was 88.0 percent in 2018 compared to 89.8 percent in 2017. In 2018, the universal banks’ credit to the government was 12 percent.18

In 2017, the banks operated 1,491 branches spread across the ten regions of

Ghana, an increase from 1,341 in 2016.19. During 2017 The Construction Bank, The

Beige Bank, and GHL Bank were licensed. The number of banks has increased over the

18 Bank of Ghana.

19 Ibid.

35 last two decades, from 18 in 2003 to 34 in 2017. The ratio of foreign banks has reduced from 56 percent in 2011 to 50 percent in 2017 due to the entry of more domestic banks

(see Table 3.1). Following the completion of the recapitalization exercise in December

2018, the banking industry is presently comprised of fourteen foreign banks and nine domestic banks.20

Table 3-1: The Structure of Ghana Banking Sector Bank No. of Local Foreign Asset (% Bank Year Banks Banks Banks of GDP) CAR (%) Branches* (%) (%) 1998 18 61 39 9.9 11.1 1999 19 58 42 13.1 11.5 2000 16 56 44 15.0 11.6 2001 17 59 41 15.5 14.7 2002 17 69 41 14.7 13.4 2003 18 61 39 14.0 9.3 2004 19 58 42 14.1 13.9 3.1 2005 20 55 45 15.2 16.2 3.2 2006 23 52 48 17.0 15.8 3.6 2007 23 52 48 19.4 15.7 4.6 2008 25 48 52 21.3 13.8 4.8 2009 26 50 50 23.8 18.2 5.1 2010 26 50 50 23.9 19.13 5.4 2011 27 44 56 22.9 17.41 5.4 2012 26 42 58 22.7 18.56 5.7 2013 27 44 56 24.1 18.45 5.8 2014 28 46 54 26.4 17.93 6.0 2015 29 41 59 27.7 17.81 7.1 2016 33 48 52 27.3 18 7.1 2017 34 50 50 15.6 8.4 Source: Author’s calculation21; Bank of Ghana Annual Reports; The World Bank. * Bank Branches is number per 100,000 adult population.

20 Bank of Ghana.

21 Author calculated local and foreign bank percentages.

36 Table 3.2 shows the changes in the banking industry in Ghana over the years. It summarizes the existing, failed, acquired, and merged banks.

There have been several bank failures, mergers, and acquisitions over the last two decades. In 2003, Societe Generale (SG) from France acquired SSB to become SG-SSB

Bank.22 In 2000, the Bank of Housing and Construction, the Co-operative Bank, and the

Bank for Credit and Commerce closed down because of the deterioration of their loan portfolio that affected their ability to satisfy the capital adequacy under the banking law.23

All three banks failed because of persistent capital ratio deficiency.

The Republic Bank of Trinidad and Tobago purchased majority shares of the HFC

Bank Ghana Limited in 2015.24 In August 2017, the Capital Bank Limited and the UT

Bank Limited became insolvent, and the GCB Bank acquired them.25 The GCB Bank assumed some selected assets and liabilities of the Capital Bank Limited and the UT Bank

Limited in a Purchase and Assumption (P&A) arrangement, with

PricewaterhouseCoopers acting as the Receiver.26 The Bank of Ghana froze the accounts

22 https://societegenerale.com.gh/en/your-bank/corporate-profile/history-the-bank/. Retrieved on May 28, 2019.

23 https://www.ghanaweb.com/GhanaHomePage/NewsArchive/Government-Closes- Down-Two-State-Owned- Banks-9376. Retrieved on May 28, 2019.

24 Bank of Ghana.

25 Ibid.

26 Ibid.

37 of all directors and senior management members of the two banks to aid with investigations into the collapse.27 The developments led to the total number of universal banks increasing to 34 from 33 in 2016.

In August 2018, the Beige Bank, the UniBank, the Construction Bank, the

Sovereign Bank, and the Royal Bank were insolvent and on the verge of collapse, so BOG merged them to form the CBG Bank. The UniBank had liquidity challenges and regularly breached its cash reserve requirement. It persistently had a negative (negative 24 percent in 2018) capital adequacy ratio (CAR). The UniBank depended extensively on liquidity support (over $450 million) from the central Bank from 2016 to 2017 to meet its recurring liabilities.28

27 https://www.myjoyonline.com/politics/2017/august-18th/bog-lack-of-foresight- collapsing-financial-market-ndc-mp-fumes.php. Retrieved on May 28, 2019.

28 Ibid.

38 Table 3-2: Evolution of Banks in Ghana29 Bank Name Acronym Year Origin 1 Standard Chartered Bank SCB 1896 The U.K. 2 Barclays Bank BBG 1917 The U.K. GCB Bank (formally Ghana + 3 Commercial Bank) GCB 1953 Ghana 4 National Investment Bank NIB 1963 Ghana 5 ADB Bank (formally Agricultural Development Bank)+ ADB 1965 Ghana 6 Universal Merchant Bank Ltd. (formally Merchant Bank)+ MBG 1972 Ghana 7 Bank for Housing and Construction* BHC 1972 Ghana 8 National Savings and Credit Bank* NSB 1977 Ghana 9 SG-SSB Bank SSB 1977 France 10 Co-operative Bank* CO-OP 1977 Ghana Bank for Credit and Commerce 11 Ghana Ltd.* BCC 1978 Pakistan 12 ECOBANK EBG 1990 Togo 13 CAL BANK CAL 1990 Ghana 14 First Atlantic Merchant Bank FAMBL 1995 Ghana 15 UT Bank* UTB 1995 Ghana 16 International Commercial Bank* ICB 1996 Malaysia 17 Prudential Bank PBL 1996 Ghana 18 The Trust Bank* TTB 1996 Ghana 19 Amalgamated Bank* ABL 1997 Mali 20 Stanbic Bank SBG 1999 South Africa 21 Metropolitan & Allied Bank* MAB 2000 Foreign 22 UniBank Ghana UGL 2001 Ghana Republic Bank (formally HFC Trinidad and 23 Bank)+ HFC 2003 Tobago 24 United Bank for Africa (formally Standard Trust bank)+ UBA 2005 Nigeria 25 Zenith Bank ZBL 2005 Nigeria 26 Guaranty Trust Bank GTB 2006 Nigeria 27 Intercontinental Bank* IBG 2006 Nigeria 28 Fidelity Bank FBL 2006 Ghana

29 There were 34 banks as of December 31, 2017.

39 Table 3-2: Evolution of Banks in Ghana (Continued)

Bank Name Acronym Year Origin 29 Bank of Baroda BBL 2008 India 30 Sahel Sahara Bank BSIC 2008 Libya 31 Access Bank ABG 2009 Nigeria 32 Energy Commercial Bank EBL 2011 Nigeria 33 Bank for Africa BOA 2011 Nigeria 34 The Royal Bank TRB 2012 Ghana 35 FBN Bank Ghana Ltd FBN 2013 Nigeria 36 Capital Bank Limited* CBL 2013 Ghana 37 First National Bank Ghana Ltd FNB 2014 South Africa 38 GN Bank Limited GNB 2014 Ghana 39 Sovereign Bank Ltd. SBL 2015 Ghana 40 Premium Bank Ltd. PBL 2016 Ghana 41 Omni Bank Ltd. OML 2016 Ghana 42 Heritage Bank Ltd. HBL 2016 Ghana 43 The Construction Bank TCB 2017 Ghana 44 The Beige Bank TBB 2017 Ghana 45 GHL Bank GHL 2017 Ghana 46 Consolidated Bank of Ghana CBG 2018 Ghana Source: Author’s compilation; Bank of Ghana Annual Report; Akomea and Adusei (2013) * No longer operational + Name change

3.3 Administrative Structure of the Bank of Ghana

The Board of Directors governs BOG. It comprises of the Governor, who is the

Chairman, the First and Second Deputy Governors, and ten other members.30 The Board has four committees to assist the Bank of Ghana to perform its functions: The Audit

30 Bank of Ghana annual report 2017.

40 Committee; the Human Resource, Corporate Governance and Legal Committee; the

Economy and Research Committee; and the Strategic Planning and Budget Committee.

The Audit Committee oversees and ensures that the BOG complies with statutory requirements; it examines the Bank of Ghana’s audit reports and makes recommendations to the Board.31 The Human Resource, Corporate Governance, and Legal Committee recommends to the Board matters concerning bank regulations, supervision, operations, and processes to ensure that banks observe statutory requirements and international standards.32 The Economy and Research Committee assesses and makes policy recommendations on economic, banking and financial issues, and the Strategic Planning and Budget Committee helps to formulate strategy in the fulfillment of the BOG’s mandate and oversees BOG’s budget.33

3.4 Ghana Banking Sector Regulations

The Bank of Ghana has supervisory and regulatory authority over banking industry. As a regulator, the Bank of Ghana ensures that banks maintain solvency, good quality assets, adequate liquidity, and profitability. The Bank of Ghana ensures fair

31 Bank of Ghana annual report 2017.

32 Ibid.

33 Bank of Ghana reports.

41 competition among banks.34 The Ghana banking sector has experienced three periods of financial reforms: 1987 to 1991, 1992 to 1995, and from 1996 to date.

The objective of the 1987-1991 reform was to review and strengthen the legal and regulatory environment of the banking sector (Biekpe, 2011). Banking Law 1989 introduced a minimum capital adequacy requirement of not less than 6 percent.35 In 1987, the Bank of Ghana removed the interest rate controls, and abolished the minimum savings deposit rates in 1990 (Brownbridge & Gockel, 1996). The law set a new minimum paid- up capital of ¢200 million ($740,700) for a domestic bank, a foreign-owned bank ¢500 million ($1,851,850), and ¢1billion ($3,703,500) for a development bank (Antwi-Asare &

Addison, 2000). According to the authors, the secured and unsecured loans were not to exceed 25 percent for any borrower. Also, the authors state that lending to subsidiaries was not to exceed 25 percent of a bank's value for a subsidiary and not to exceed 35 percent for more than one subsidiary.

The second phase of the reform focused on strengthening the supervisory role of the central Bank (Biekpe, 2011). The Banking Laws P.N.D.C.L 291 and P.N.D.C.L 225 gave BOG more supervisory (Leith & Söderling, 2003). Banks freely priced deposits and allocated loans in the early 1990s (Owusu-Antwi, 2010).

34 Bank of Ghana reports.

35 Ghana banking Law 1989.

42 The third stage of the reform led to the divestiture of state-owned banks and the creation of several banks (Biekpe, 2011). The Bank of Ghana Act 2002 sets up a department with the responsibility to supervise and examine all banking institutions in

Ghana. Act 2002 authorizes the BOG Bank of Ghana to maintain price level stability. Act

2002 promotes economic growth; improves the effective and efficient operation of the banking and credit system; ensures the smooth operation of banks; promotes, licenses, regulates, and supervises non-banking financial institutions.

In 2003, Universal Banking Business license was instituted to make the banking industry more competitive.36 The universal banks were to meet a minimum paid-up capital of not less than GH¢7,000,000 (nominal and real values based on consumer price index (2010=100) are $8,076,013 and $19,782,802 respectively) irrespective of a bank’s total assets. There was no maximum limit on the paid-up capital. It has smoothed the playing field and unlocked the banking industry to competition, innovation, and new entry.37

The Banking Act 2004 was enacted in 2005 with a higher CAR ratio requirement of at least 10 percent, an increase from 6 percent. Act 2004 required all banks at all times to maintain a minimum CAR of not less than 10 percent. The Banking Act 2004 permits

36 https://www.pwc.com/gh/en/industries/financial-services.html. Retrieved on May 28, 2019.

37 BOG November 12, 2015, Licensing Policy and Guidelines. Retrieved on September 22, 2018: https://www.bog.gov.gh/supervision-a-regulation/licensing-policy-a- guidelines/overview.

43 banks in Ghana to provide financial leasing, money transmission services, investment products, and the Internet banking products. Also, the Act allows banks to engage in commercial, agricultural, or industrial businesses through a subsidiary company. Equity in the subsidiary company shall be up to fifteen percent of the bank’s value and not more than thirty-five percent if more than one subsidiary. Banking Amendment Act 2007 amends the Act 2004 to ensure bank stability. On April 5, 2007, the Credit Reporting Act

2007 was enacted to provide a framework for the operation of a credit referencing bureaus system.

In 2016, the Bank of Ghana introduced Ghana Deposit Protection Act, 2016. The

Acts provide a legal framework to deal with emerging risks in the financial system, nurture innovation and financial inclusion and help resolve challenges of failing financial institutions proactively.38 The Ghana Deposit Protection Act 2016 (Act 931) requires all institutions licensed by BOG to be members of the Deposit Protection Scheme. The Act protects for up to GH¢6,250 ($1,500) for depositors with banks and GH¢1,250 ($300) for depositors with a non-bank financial institution.

In the last twenty years, the banking industry has experienced four periods of recapitalization policy. In 2003, the central bank of Ghana issued a directive to commercial banks for upward capital review to not less than GH¢7,000,000 ($8,076,013 and real $19,782,802; CPI (2010=100)).

38 Bank of Ghana annual report 2016.

44 In 2008, the Bank of Ghana again announced an upward capital review from

GH¢7,000,000 ($8,076,013 and real $19,782,802) to not less than GH¢60,000,000

($33,410,983 and real $28,685,088; CPI (2010=100)) by December 2012 irrespective of a bank’s total asset. There was no maximum limit on the paid-up capital requirement. The purpose of the upward review was to make banks more resilient against failure. In 2013 there was a revision of the minimum paid-up capital from GH¢60,000,000 ($33,410,983 and real $28,685,088) to not less than GH¢120,000,000 ($61,410,916 and real

$47,216,175; CPI (2010=100)). This round of recapitalization led to the consolidation of three banks. The Ecobank acquired the Trust Bank, the Access Bank acquired the

Intercontinental Bank, and the Bank of Africa acquired the Amalgamated Bank.

In 2017 as part of the reforms to develop and improve the banking industry stability, BOG further raised the capital requirement of universal banks from

GH¢120,000,000 ($61,410,916 and real $47,216,175) to not less than GH¢400,000,000

($91,940,637 and real $39,585,820; CPI (2010=100)). All banks maintain at all times a

CAR ratio of at least 10 percent. The deadline for the new minimum capital requirement was December 2018.39 At the end of the recapitalization exercise in December 2018, the banking industry comprises fourteen foreign banks and nine domestic banks. The government of Ghana sees a modernized and stable banking sector as an effective vehicle

39 Bank of Ghana annual report, 2017.

45 for economic transformation. The overall goal of the reforms is to create a competitive banking environment and to ensure a stable banking sector.

Table 3.3 is a summary of the list of regulations in the Ghana financial industry from 1998 to 2018.

46 Table 3-3: A List of Regulations in the Ghana Financial Industry From 1998 to 2017 Year Regulation Explanation 2002 Bank of Ghana Act The Act 2002 appoints the Head of the 2002 ( Act 612) Banking Supervision Department with the responsibility to supervise and examine all banking institutions in Ghana. The Act also licenses and promotes non-banking financial institutions. 2003 Universal Banking The Universal Banking license allows banks Business license to operate all banking businesses. 2003 Bank recapitalization In 2003, BOG issued a directive requiring all policy banks to increase stated capital to GH¢7million ($8,076,013). 2004 Banking Act 2004 (Act The Act 2004 establishes the Banking 673). Supervision Department with the responsibility to supervise and examine all banking institutions in Ghana. It introduces a higher CAR ratio requirement of at least 10 percent an increase from 6 percent. 2007 Credit Reporting Act The Act provides a framework for the 2007 (Act 726) operation of a credit referencing bureaus system. 2007 Banking Amendment The Act seeks to attract foreign direct Act 2007 (Act 738) investment and creates three types of licenses to expand banking services. 2008 Bank recapitalization In 2008, the Bank of Ghana raises the policy minimum paid-up capital from GH¢7,000,000 ($8,076,013 and real $19,782,802) to not less than GH¢60,000,000 ($33,410,983) 2013 Bank recapitalization The Bank of Ghana revises of the minimum policy paid-up capital from GH¢60,000,000 ($33,410,983) to not less than GH¢120,000,000 ($61,410,916).

47 Table 3-3: A List of Regulations in the Ghana Financial Industry From 1998 to 2017 (Continued) Year Regulation Explanation 2016 Ghana Deposit Ghana Deposit Protection Act, 2016 (Act Protection Act, 2016 931), protects for up to GH¢6,250 ($1,500) (Act 931) for depositors with banks and GH¢1,250 ($300) for depositors with a non-bank financial institution. 2017 Bank recapitalization The Bank of Ghana raises the minimum paid- policy up capital of universal banks from GH¢120,000,000 ($61,410,916) to not less than GH¢400,000,000 ($91,940,637). Source: Author’s compilation from the Bank of Ghana reports.

3.5 Banking Sector Performance in Ghana

Table 3.4 presents the profitability and efficiency indices of the Ghana banks. The fall in profitability ratios from 2003 to 2008 was due to increases in total assets without a corresponding increase in profit levels.40 Also, the continuous fall of profitability from

2007 to 2009 may be the result of increased provision for bad and doubtful debt and unexpected inflation. The Bank of Ghana had a single digit inflation target for the years

2005 to 2009. Rising inflation and interest rates contributed to the increased rate of loan delinquency, which negatively affected banks’ profit. The universal banks real lending rates rose from 7.5 percent in 2005 to 13.5 percent in 2009, which is relatively low given the high level of credit risk in Ghana. The annual average inflation was 19.3 percent in

2009 exceeding, the single digit inflation targets for the period. The unexpected inflation

40Bank of Ghana annual reports.

48 benefits debtors and harms creditors as interest rates (if fixed) do not include a large enough inflation premium. Moreover, branch expansion and increasing administrative expenses contributed to reduced profitability.41 The number of bank branches increased from 3.1 per 100,000 of the adult population to 5.1 per adult population between 2004 and 2009 (see Table 3.1).

Between 2009 and 2014 the profitability improved mainly due to a reduction in the cost of funds as against a marginal decrease of interest on loans and advances. The real lending rates also decreased from 13.5 percent from 2009 to 2014. These events led to a reduction of provision for bad and doubtful debt in the banks' income statement. The provision for bad and doubtful debts is negatively related to banks’ income. During the period, the NPL ratio decreased from 16.2 percent in 2009 to 11.3 percent in 2014. Banks’ net interest spread rose from 9.1 percent in 2009 to 12.6 percent in 2014. Also, net interest margins rose from 10.8 percent in 2009 to 13.4 in 2014. The decline in interest rates partly reflected a downward trend in inflation from 2009 to 2013. Bank of Ghana prime rate

(BOG policy rate) shrank from 18 percent in 2009 to 16 percent in 2013 partly due to falling inflation from 19.3 percent in 2009 to 13.5 percent in 2013. The sustained disinflation process during the period provided scope for monetary policy easing and transfer of the gains in macroeconomic stability to the broader economy. The Monetary

41 Bank of Ghana annual reports.

49 Policy Committee of the Bank of Ghana, consequently, lowered the Monetary Policy Rate

(prime rate). The policy rate cuts transmitted to lower interest rates.

From 2015 to 2016 profitability declined due to high-interest costs, a general slowdown in economic activity and electricity supply shortfalls. These factors led to high operating costs for businesses, which contributed to increasing non-performing loans

(NPL).42 Non-performing loans ratios of banks increased to 14.7 percent in 2015 from

11.0 percent in 2014. Real GDP growth decreased from 7.1 percent in 2013 to 3.7 percent in 2016 (see Table 3.4) due partly to the worsening energy crisis.43Ghana’s primary source of energy is hydroelectric power generated by the Kpong Dam, the Bui Dam, and the Akosombo Dam. The water levels decreased due to adverse rainfall shocks during

2015 and 2016 resulting in a shortage of power. Also, the Ghana government could not buy enough fuel for the few installed generation facilities, which led to the energy crisis.

The energy crisis ended in 2017 due to favorable rainfall and sufficient supply of fuel for the installed generation facilities. Return on equity of the banks in 2017 improved marginally over the previous year’s position. The Ghana banking industry remained solvent and generally fulfilled the CAR of 10 percent. The average CAR as of December

2017 was 15.6 percent, compared with 18 percent in 2016.

42 Bank of Ghana annual report 2015.

43 Ibid.

50 The high net interest spread can in part be attributed to the lack of an alternative source of funding for a business. Banks can charge high lending rates because banks are the primary source of loans. Ghana has a less developed capital market, and the Bank of

Ghana does not control the banks' interest rates.

Table 3-4: Bank Performance and Financial Indicators (in Percent) Year ROA ROEA ROE NIS CTI NIM CAR Inflation Lending Deposit 2001 8.7 9.4 49.7 12.4 40.2 14.4 14.7 21.3 30.9 28.9 2002 7.3 9.3 37.6 11.9 44.8 10.1 13.4 15.2 16.2 26.6 2003 6.3 8 33.4 12.3 63.9 10.6 9.3 23.6 14.3 18.7 2004 4.6 5.9 22.9 8.9 63.5 9.6 13.9 11.8 13.6 17.1 2005 3.3 6.3 24.1 10.8 68.7 6.5 16.2 14.8 10.2 11.5 2006 4.8 6 27.4 9.9 59.3 11.2 15.8 10.5 8.9 10.2 2007 3.7 4.8 25.8 8.4 62.5 9.7 14.8 12.8 8.9 10.6 2008 3.2 4.3 23.7 8.6 64.7 10.1 13.8 16.5 11.3 24.7 2009 2.8 3.8 17.5 9.1 62.8 10.8 18.2 19.3 17.1 23.7 2010 3.8 5.1 20.4 11.1 58.5 12.4 19.1 10.8 12.9 12.3 2011 3.9 5.3 19.7 9.7 59.8 10.2 17.4 8.6 8.9 10.3 2012 4.9 6.5 25.8 10.3 53.8 10.9 18.6 8.8 10.1 22.9 2013 6.2 8.1 30.9 11.5 48.2 12.6 18.5 13.5 12.4 18.8 2014 6.6 8.7 33.1 12.6 48.3 13.4 17.9 17.0 12.9 25.8 2015 4.6 6.2 22.2 12.5 53.2 13.8 17.8 17.7 13.3 23.1 2016 3.8 5.1 17.3 11.4 57.4 13 18 15.4 18.2 16.4 2017 3.6 4.7 18.7 10.2 59 11 15.6 11.8 16.3 13.3 Source: Author’s compilation; Bank of Ghana Annual Reports. ROA is Return on Assets; ROEA is Return on Earning Assets; ROE is Return on Equity; NIS is Net Interest Spread; CTI is Cost to Income; NIM is Net Interest Margin; CAR is Capital Adequacy Ratio; CPI is Inflation; Lending is average banks’ nominal lending interest rate, and Deposit is average banks’ nominal deposit Interest rate.

Figure 3.1 shows that time series of inflation and interest rates over the last twenty years.

51 Figure 3-1: Inflation, Nominal Bank Lending Rate, and Nominal Bank Deposit Rate

70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0%

Inflation Lending rate Deposit rate

3.6 Macro-Financial Stress Tests

A macro-financial stress test is a framework to assess the resilience of the banking industry to adverse macroeconomic events. The Bank of Ghana has performs macro- financial stress tests to examine the resilience of the banking sector to withstand systemic shocks from macroeconomic challenges and macro-financial developments. The exercise stresses universal banks financial statements to extreme but reasonable shocks. Four conceivable situations of possible threats to financial stability are identified and categorized as either the single largest borrower credit, interest rate, liquidity, and exchange rate risks to the banking sector. The risks are rated and ranked according to the likelihood of incidence and the expected effect on the financial system.

Figure 3.2 presents the macro-financial stress test in a risk assessment map. It is constructed such that a move away from the origin indicates deterioration in the ability

52 of Ghana financial system to withstand shocks. A reasonable level of risk would be level

20. Figure 3.2 suggests that the financial system is prone to credit and single largest borrower risks. The Bank of Ghana does not disclose if the loans to single borrowers are long-term loans. However, given that it persists over the years suggest that the loans are long term-loans. The banking law of 1989 (PNDCL 225) requires that secured and unsecured loans should not to exceed 25 percent of a bank’s net worth for any particular borrower.

Unlike the USA Supervisory Stress Test model which looks at the supervisory scenarios with a broader range of shocks to project the regulatory capital ratios and net income, Ghana’s macro-financial stress test focuses on only the solvency (CAR) stress test. Moreover, the USA supervisory scenarios use several domestic and international variables including but not limited to real and nominal GDP, inflation, unemployment rate, and exchange rates. Ghana’s stress test does not cover a wider range of shocks.

Threats to the stability of Ghana’s financial system heightened in 2014 and 2016 due to domestic macroeconomic instability and global macro-financial developments such as falling commodity prices, an economic slowdown, and weak global demand.44

The result of the 2014 stress test shows that exchange rate risk is reasonably controlled.

The ability to resist interest rate shocks continued to deteriorate from 2013 to 2014. There was a general improvement in 2015. The single largest borrower risk was moderate, and

44 Bank of Ghana Annual Reports.

53 the exchange rate risk remained tame. The result of the 2016 stress test displays that the banking industry was vulnerable to the single largest borrower and credit risk in general.

However, exchange rate risk and liquidity risk were well-contained. Overall, banks invested more into less risky assets such as Treasury Bills and Government bonds to lessen the increasing vulnerabilities.

Figure 3-2: Macro-Financial Stress Tests

Source: Bank of Ghana Annual report.

In 2017, there was enhanced resilience of the banking industry to exchange rate, interest rate, credit, and concentration risks due to the relative macroeconomic stability experienced. As shown in Figure 3.3, inflation fell from 15.4 percent in 2016 to 11.8

54 percent in 2017, and external debt to GDP was 36 percent in 2017 as against 40.8 percent in 2016.

Figure 3-3: Inflation, Real GDP Growth, and External Debt to GDP

45.0% 42.4% 40.0% 39.7% 35.0% 35.6% 36.3% 30.0%

25.0% 24.6% 20.0% 17.0% 17.7% 15.0% 15.4% 13.5% 11.8% 10.0% 7.3% 8.5% 5.0% 4.0% 3.8% 3.7% 0.0% 2013 2014 2015 2016 2017

Inflation Real GDP Growth External Debt to GDP

3.7 Macroeconomic Development in Ghana

In this section, I assess how macroeconomic factors have impacted financial stability. Macroeconomic problems usually precede financial crisis (Demirguc-Kunt &

Detragiache, 1997), but countries that experience macroeconomic problems can implement financial reforms to achieve financial stability (Dziobek and Pazarbasioglu,

1997). A review of macroeconomic performance and key financial indicators helps to evaluate the effectiveness of Ghana financial reforms.

55 3.7.1 Real Sector Performance and Economic Activity

Ghana’s economy was stable from 2000 to 2008. Table 3.5 shows a steady growth of real GDP from 3.7 percent in 2000 to 8.4 percent in 2008 despite the global financial crisis.

Table 3-5: Selected Macroeconomic and Financial Indicators (in Percent) Cedi / Credit to US$ the Real Real Real Inflation ( % private lending Prime deposit Year GDP (CPI) change) sector (% rate Rate rate growth of GDP) NPL 1998 4.7 14.6 12.9 9.20 51.3 17.2 37 17.5 1999 4.4 13.8 52.9 12.41 42.3 12.8 27 9.8 2000 3.7 40.5 99.4 13.82 18.6 11.9 27 -11.9 2001 4.2 21.3 3.9 11.75 40.1 19.6 27 9.6 2002 4.5 15.2 15.3 12.00 31.5 22.7 24.5 1.0 2003 5.2 23.6 4.9 12.39 9.2 18.3 21.5 -9.3 2004 5.8 11.8 2.2 13.06 17.0 16.3 18.5 1.8 2005 5.8 14.8 0.9 15.43 7.5 13.0 15.5 -4.6 2006 6.2 10.5 1.1 11.02 10.8 7.9 12.5 -1.6 2007 6.5 12.8 5.1 14.42 11.5 6.4 13.5 -3.9 2008 8.4 16.5 25.1 15.83 10.8 7.7 17 -5.2 2009 4 19.3 17.6 15.54 13.5 16.2 18 -2.2 2010 8 10.8 3.2 14.58 17.8 18.1 13.5 2.1 2011 15 8.6 5.2 14.38 18.1 14.1 12.5 0.3 2012 8.8 8.8 21.3 14.74 16.9 13.2 15 1.3 2013 7.3 13.5 17.0 16.07 12.1 12.0 16 -1.1 2014 4 17 45.5 18.84 12.0 11.3 21 -4.1 2015 3.8 17.7 18.6 19.62 9.8 14.7 26 -4.4 2016 3.7 15.4 10.7 18.56 15.8 17.3 25.5 2.8 2017 8.5 11.8 5.2 16.04 17.5 21.6 20 4.5 Source: Author’s calculation45, The World Bank, and Bank of Ghana annual reports.

45 Author calculated real lending and deposit interest rates.

56 The financial crisis started in August 2007 after the breakdown of the US mortgage market. In September 2008, the crisis intensified solvency concerns and triggered bankruptcies, mergers and public interventions in the United States and Western

Europe.46 In 2008, crude oil prices increased by 33.3 percent from an average of 16.5 percent in 2000-2007. High crude prices result in high operating costs that caused a fall in production in Ghana. The 2006-2007 energy crisis in Ghana resulted in a protracted period of power outages causing production time losses in the mining and manufacturing sectors. Ghana relies on hydroelectric power so when the water levels fall due to adverse rainfall shocks, then there is a shortage of power supply. The stable growth was the result of improved performance in the agricultural and industrial sectors: Ghana’s largest sector

– the agricultural sector contributing about 34 percent of GDP. The industry sector share of GDP is about 24 percent. The agriculture and industrial sectors recorded growth rates of 4.9 percent and 8.3 percent in 2008 from 2.1 percent and 3.8 percent in 2000, respectively.

The year 2011 was the beginning of oil production in commercial quantities. The real GDP growth in 2009 was significantly lower than the 8.4 percent achieved in 2008.

The fall was due to the low performance of the industrial sector of the economy, which recorded growth rates of 4.5 percent in 2009 from 8.3 percent in 2008. The economy expanded by 3.7 percent in 2016 a decline from 15 percent in 2011 due to a persistent

46 Bank of Ghana annual report 2008.

57 energy crisis, a rising cost of utilities, sharp depreciation of the local currency, lower than expected international commodity prices that adversely affected the country’s export earnings, and oil production bottlenecks. From 2012 to 2016 Ghana experienced a persistent, irregular, and unpredictable electric power outage and blackouts caused by power supply shortage that adversely affected domestic growth conditions. Ghana is a primary commodity exporter. Cocoa price per ton declined 23.1 percent from 2011 to

2016, and crude oil price per barrel fell by 50.7 percent from 2011 to 2016. The total effect was a fiscal slippage resulting from low revenues from oil, cocoa, and gold posing challenges to the economy.

The industry sector share of GDP is about 23 percent. The growth in the industry sector decreased from 41.6 percent in 2011 to -1.4 percent in 2016. The slowdown in the industry sector was attributable to the fall in the growth rate of crude oil production after the start of production in 2011. In 2016, the contribution to GDP of the Services, Industry, and Agriculture sectors was 53.2 percent (45.8% in 2011), 22.7 percent (23.9% in 2015), and 17.7 percent (23.7% in 2011) respectively. Ghana recorded a GDP growth rate of 8.5 percent in 2017.

3.7.2 Inflation and Interest Rates

From 2000 to 2006, interest rates declined due to the fall in inflation. The Bank of Ghana prime rate plummeted from 27 percent in 2000 to 12.5 percent in 2006. The average lending rate fell from 59.1 percent in 2000 to 21.3 percent in 2006. Also, the

58 exchange rate (GH¢/US$) depreciated 31 percent from 2000 to 2006. The domestic primary balance (% of GDP) averaged 2.47 percent from 2000 to 2005. The inflationary pressure that built up in 2003 was due to the upward adjustment in petroleum prices.

The inflation rate was 16.5 percent in 2008, an increase from 10.5 percent in 2006.

The rise was partly the result of the domestic pass-through effects of high crude oil and food prices. The crude oil price rose 50.5 percent from 2006 to 2008. In response to upward adjustments in the policy rate from 12.5 percent in 2006 to 17 percent in 2008, average lending rates rose from 21.3 percent in 2006 to 27.3 percent in 2008. The policy rate dropped from 18 percent in 2009 to 12.5 percent in 2011, reflecting diminishing inflation and policy rate easing. Inflation fell from 19.3 percent in 2009 to 8.6 percent in

2011. Inflationary pressures softened in 2009 on the back of good food harvests, and declining food prices. The steady rise in inflation from 2011 to 2015 reflected the pass- through effects of domestic currency depreciation on imported items causing upward adjustments in the prices of petroleum products, utility tariffs, and transport cost. The cedi depreciated due to demand for imports, loan settlements, and contractual payments for infrastructural developments. Inflation increased from 8.6 percent in 2011 to 17.7 in 2015. The average bank lending rates increased marginally from 26.7 percent in 2011 to 27.5 percent in 2015. Figure 3.3 shows graph of inflation and nominal interest rates from 1998 to 2017.

The inflation rate was 11.8 percent in 2017, a decrease from 15.4 percent in 2016.

The average lending rates decreased at a much slower rate, suggesting an insensitivity of the bank's lending rates to the Bank of Ghana monetary policy rates. Over the sample

59 (1998-2017) period, the correlation between inflation and exchange rate growth rates is about 70 percent, which shows an exchange rate pass-through effect on inflation. Table

3.5 and Figure 3.4 show time series of inflation and real interest rates.

Figure 3-4: Inflation, Real Lending Rate, and Real Deposit Rate 60.0%

50.0%

40.0%

30.0%

20.0%

10.0%

0.0%

-10.0%

-20.0%

Inflation Real lending rate Real deposit rate

Figure 3-5: Inflation, Nominal Lending Rate, and Nominal Deposit Rate 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0%

Inflation Lending rate Deposit rate

60 3.7.3 Bank Credit to Private Sector Development

Figure 3.6 shows the link between NPL and banks credit to the private sector.

The non-performing loans shrunk from 17.2 percent in 1998 to 13 percent in 2005. Also, in response to monetary tightening, bank loans to the private sector moderated from

2006 to 2009. Between 2010 to 2014, loans to businesses as a percent of GDP rose from

14.6 percent to 18.8 percent partly due to a gradual decline of NPL from 18.1 percent to 11.3 percent. The loans to businesses fell from 19.6 percent in 2015 to 16 percent in

2017 due to concerns about rising NPLs from 14.7 percent in 2015 to 21.6 percent in

2017.

Figure 3-6: Domestic Credit to the Private Sector by Banks (% of GDP) and NPL 25.0%

20.0%

15.0%

10.0%

5.0%

0.0%

CPS/GDP (% of GDP) NPL

61 Chapter 4

METHODOLOGY

The objective of this section is to design an econometric model and an estimation strategy to determine the bank reforms-competition-stability link. It describes the data source, description, and explanation of the variables as well as the measurement of the variables.

4.1 Data Consideration and Sources

The research questions 1 to 3 uses a panel data set from 1998 to 2018. Several studies have used panel data sets to assess the nexus of bank competition and stability

(Ariss, 2010; Brei et al., 2018; Schaeck & Cihák, 2014). I obtain bank level data from banks’ financial statements and banks’ annual reports. The macroeconomic variables data are from the World Bank, the United Nations, and the Bank of Ghana annual reports. The data set of 26 universal banks out of 31 banks was due to the availability of adequate and appropriate data. The total assets of the 26 banks are more than seventy percent of the industry’s total assets. The period under study is chosen for three reasons. First, I do not have bank level data before 1998. Second, this is a period in which the banking sector has suffered substantial losses from non-performing loans in their portfolios and record number of bank failures. Third, major regulatory changes were made in this period.

62 I use a panel of 20 Sub-Saharan African countries from 1996-2014 to answer the research question 4. I obtain the data from the World Bank.

4.2 Description and Explanation of Variables

Table 4.1 shows the variable definitions. I use the Z-score as a direct measure of bank stability. Other empirical studies explore the influence of bank characteristics, the regulation, and the macroeconomic environment on bank risk (Brei et al., 2018).

Therefore, the variables I control for in the study include bank characteristics and the macroeconomic environment.

The Lerner index: I proxy bank competition using the Lerner index. Studies that used the Lerner index includes (Anginer, Demirguc-Kunt, & Zhu, 2014; Beck & Cull,

2013; Demirguc-Kunt & Peria, 2010).

Income diversification is the ratio of non-interest income to total assets, as used in Ghosh (2015). I control for income diversification because a better-diversified bank is less risky according to portfolio theory.

Interest rate: Louzis et al. (2012) report a positive link between non-performing loans and real lending interest rates for Greek banks. Also, investigation of the issue of rising NPLs in Sub-Saharan Africa during the 1990s shows that high real lending interest rates contribute to high nonperforming loans (Fofack, 2005). The author explains that the persistence of exorbitant real lending interest rates can cause a financial crisis. Using data

63 from 23 developed nations, Berger et al. (2009) explain that banks with market power charge higher interest rate and may cause loans repayment problems.

Inflation: Inflation increases NPLs (Ghosh, 2015). According to Klein (2013), inflation contributes to higher NPLs.

Human development index and physical capital: Modern growth theory literature shows that human capital and physical capital promote economic growth.

I use real variables based on the availability of data and whenever possible. The real values remove the effect of inflation to obtain a more accurate picture of the trends in the variables. Inflation in Ghana is volatile and consistently higher than target.

64 Table 4-1: Overview of Variables Names and Definitions Variable Symbol Description Calculation Dependent Variables 퐸 Z-score An inverse measure of overall + 푅푂퐴 푇퐴 bank distress. A larger value indicates higher bank stability 휎 and less overall bank risk. Real per capita Log GDP per capita (constant GDP 2010 US$). Variables of Interest Lerner Index A measure of a bank's 푃 − 푀퐶 competition. A measure of a 푃 bank's competition. Higher values mean a higher degree of market power. Recapitalization Re-capitalization policy is an A dummy upward revision of the minimum variable. regulatory capital of banks. Bank specific variables Income Non-interest income divided by Non-interest diversification total assets. income divided by total assets. Macroeconomic variables Inflation Consumer price index. Human capital Human development index. Physical Capital Log Gross fixed capital formation (constant 2010 US$). Real lending Bank lending rate adjusted for Lending rate - interest rate inflation. inflation Source: World Bank databases, The United Nations and Author’s calculation.47

47 Author computed z-score, Lerner index, income diversification, real lending interest rate, and recapitalization.

65 4.3 Measure of Bank Competition

Bank competition can be measured by structural or non-structural methods. The structural method link market power to market concentration. It assumes that concentrated markets are less competitive. An example of a structural approach is the

Herfindahl–Hirschman concentration index (HHI), a proxy for bank concentration. The proponents of HHI say that a concentrated market enables less competitive behavior and permits banks to charge higher interest rates for their products and services (Lapteacru,

2014). A concentrated market may be competitive if it is contestable (Baumol, 1982). A contestable market is a market with a few companies, but it behaves competitively because of the threat of new entrants. Laeven & Claessens (2004) report that contestability determines competition, and therefore concentration is not a good measure for competition.

The non-structural approach infers product market competition from market behavior. Examples of non-structural methods is the Lerner index (Lerner, 1934), an individual proxy of market power. Lapteacru (2014) says that the bank's product price equals its marginal cost under perfect competition. The Lerner index has the advantage of measuring bank behavior directly instead of inferring it from indirect measures such as market shares. Studies that have used the Lerner index include Anginer, Demirguc-

Kunt, & Zhu (2014); Beck & Cull (2013); Demirguc-Kunt & Peria (2010).

66 4.3.1 Estimating the Lerner Index

The Lerner index takes values of zero under perfect competition, and one under pure monopoly. The index may be negative in a competitive case (Spierdijk & Zaouras,

2017). A negative value of the Lerner index suggests a non-optimizing behavior of banks

(Agoraki, Delis, & Pasiouras, 2011). The Lerner index provides a bank-level proxy for competition.

Formally, the index is calculated as price minus marginal cost divided by price:

퐿푒푟푛푒푟 = (1)

where i stands for bank i and t stands for year t. 푃 is the price of bank assets and 푀퐶 is the marginal cost. The price of bank assets is the ratio of total revenue to total assets.

The marginal cost is computed from a translog cost function. Following Berger, Klapper,

& Turk-Ariss (2009), the study estimates the translog cost function as follows:

푙푛푇퐶 = 훽 + 훽 푙푛푇퐴 + 푙푛푇퐴 + ∑ 훾 푙푛푊 + ∑ ∅ 푙푛푇퐴 푙푛푊 + , ,

∑ ∑ 푙푛 푊 푙푛푊 + 휖 (2) , ,

TCit is the total costs. It is the total bank expenses. TAit is the total assets (Fernández &

González, 2005). W1,it is the ratio of personnel expenses to total assets. W2,it is the ratio of interest expenses to total deposits. W3,it is the ratio of administrative expenses to total

67 assets. The translog cost function is estimated by ordinary least squares. The marginal cost for each bank is estimated as follows:

푀퐶 = [훽 + 훽푙푛푇퐴 + ∑ ∅푙푛푊,] (3)

4.4 Measure of Bank Stability

The Z-score is a bank level proxy for stability. The Z-score is inversely linked to the likelihood of a bank’s failure and is useful as a proxy of bank stability (Berger et al.,

2009; Fu, Lin, & Molyneux, 2014; Lepetit & Strobel, 2013). A higher Z-score suggests a lower likelihood of failure. A bank is insolvent if its asset value is less than its debt (Boyd

& Runkle, 1993). The Z-score is a widely used proxy of bank stability (Demirguc-Kunt

& Peria, 2010; Laeven & Levine, 2009).

4.4.1 Estimating the Z-score

Following Berger, Klapper, & Turk-Ariss (2009); Fu, Lin, & Molyneux (2014) and Lepetit & Strobel (2013), the Z-score is computed as follows:

푍 = (4) where i stands for bank i and t stands for year t. 푍(Z-score) is a proxy of stability for

,푅푂퐴 is the rate of return on assets, is the ratio of bank equity to total assets, and

휎 is the standard deviation of return on assets. I use a three-year rolling window for

휎 to permit for change in the standard deviation of return on assets; this method

68 prevents that the Z-scores are solely influenced by a change in the ratio of bank equity to total assets and profitability (Schaeck & Cihák, 2014).

A 2011 study by Marfo-Yiadom and Agyei suggests that for banks in Ghana the dividend paid out ratio is 24.65 percent. Their research covers 1999-2003 with a sample size of 16 banks. I will account for dividend in the calculation of the Z-score.

4.5 The Degree and Evolution of Bank Competition

Research question 1: What is the degree and evolution of bank competition in Ghana from 1998 to 2018?

I calculate the average annual Lerner index for the banking industry from 1998 to

2018 using the banks’ level of market power. Then, following Weill (2013), the evolution of bank competition in Ghana is calculated as the mean Lerner index in 2018 minus the mean Lerner index in 1998.

4.6 Model for Bank Competition and Financial Stability

Research question 2: What is the impact of bank competition on the stability of the

Ghana banking sector?

I use the Arellano and Bond (1991) and the Blundell & Bond (1998) System

Generalized Method of Moments (System GMM) estimator. According to Sanya &

Wolfe (2011), the System GMM estimator addresses econometric issues induced by unobserved bank fixed effects as well as explanatory variables that are not exogenous.

69 System GMM is also suitable for a dataset with a relatively short period (20 years for this study) and larger group (26 banks). The System GMM estimator controls for the endogeneity concerns of market power, the diversification index, and the real lending interest rate. Endogeneity can arise when bank risk affects market power. If a bank increases its risk, the higher expected return may allow the bank to gain market power.

Also, banks' decision to diversify revenue sources and the lending interest rate may be influenced by past and current performance. Sanya & Wolfe (2011) explain that banks may diversify to take advantage of business opportunities. Adeleye et al. (2017) explain that the consistency of the system-GMM estimator is evaluated by the Hansen test of over-identifying restriction and Arellano-Bond test for second-order autocorrelation

(AR(2)) in the residuals (Arellano & Bond (1991) and Blundell & Bond (1998)).

The System GMM estimator uses two sets of equations as in equations (5) and

(6). Equation (5) is specified in differences and instrumented with lags of bank stability

(zscore) and explanatory variables (the Lerner index and 푋). The variables in equation

(6) are in levels and are instrumented with their differences to increase the efficiency of estimation.

∆푧푠푐표푟푒 = 훽∆푧푠푐표푟푒 + 훽∆퐿푒푟푛푒푟 + 훽∆푋 +∆휀 (5)

푧푠푐표푟푒 = 훼푧푠푐표푟푒 + 휙퐿푒푟푛푒푟 + 훼푋 + 퐹퐸 + 휇 (6)

In these equations, i is for bank i and t for year t, 푋 is a set of controls, including the diversification index, the real lending interest rate, and inflation. The 퐿푒푟푛푒푟is the bank competition indicator for bank i at year t,푍푠푐표푟푒is overall bank risk, and 퐹퐸 is the

70 unobserved bank-specific effect. I use regulatory dummies as additional instruments. The regulatory dummies are zero up to the year prior to the regulation is enacted and one from the year that the law is passed, and휀and 휇are random errors.

The coefficient of interest is 휙; a positive 휙 implies that market power (higher values of Lerner) increases financial stability and a negative 휙 coefficient implies that market power ( higher values of Lerner) decreases financial stability. The changes in the regulatory environment that are used as external instruments are listed in Table 3.3.

Keeley (1990) provides both a theoretical framework and empirical evidence that regulatory changes of the US banking sector led to a decrease in banks’ market power and consequently affects their stability. The author explains that although regulation is not necessarily the essential factor increasing the degree of bank competition, it is an easily observed exogenous factor concerning bank risk-taking. Keeley (1990) shows that changes in regulations over time provide the opportunity to investigate their effect on market power in banks and whether exogenous variations in market power impact banks’ risk-taking. Salas & Saurina (2003) provide empirical evidence of a link between regulatory changes, market power, bank risk. The authors use changes in regulation, bank-specific, and macro variables as instruments for market power.

71 4.7 Model for Bank Recapitalization and Financial Stability

Research question 3: What is the effect of bank recapitalization on the stability of the

Ghana banking industry?

I extend the model for research question 2 to include recapitalization dummies, as stated in equations 7 and 8.

∆푧푠푐표푟푒 = 훽∆푧푠푐표푟푒 + 훽∆퐿푒푟푛푒푟+ 휃∆푅푒푐푎푝 + 훽∆푋 +∆휀 (7)

푧푠푐표푟푒 = 훼푧푠푐표푟푒 + 휙퐿푒푟푛푒푟 + 훼푋 + 휃푅푒푐푎푝 + 퐹퐸 + 휇 (8)

In these equations, i is for bank i and t for year t, 푋 includes the diversification index, the real lending interest rate, and inflation. The 퐿푒푟푛푒푟 is the bank competition indicator for bank i at year t, 푍푠푐표푟푒is overall bank risk, and 퐹퐸 is the unobserved bank-specific effect. 푅푒푐푎푝 captures recapitalization policies (in 2008, 2013, and 2017), 휀, and 휇 random errors.

4.8 Model for Bank Competition, Bank Stability, and Economic Growth

Research question 4: What is the relative contribution of competition and stability to economic growth?

This paper uses a panel autoregressive dynamic lag (ARDL) model and the Pooled

Group Mean (PMG) estimator proposed by Pesaran, Shin, & Smith (1999). The data is a panel of twenty-three Sub-Saharan African countries over 1996–2014. Pesaran et al.

72 (1999) use the ARDL (p, q, …., q) model as the empirical structure. The PGM estimator permits the short-run coefficients to vary across countries while restricting the homogeneity of long-term coefficients across countries (Pesaran et al., 1999). The base model for economic growth, bank competition, bank stability, and other determinants of economic growth is as in equation (9). The base ARDL (1, 1, 1, 1, 1) model is shown in equation (10). I used the Akaike Information Criterion (AIC) to determine the lag order of the ARDL.

푙푛퐺퐷푃 = ∑ 훽 푙푛퐺퐷푃 + ∑ 훿 퐿푒푟푛푒푟 + ∑ 휙 푍푠푐표푟푒 + ∑ 훾 퐻퐶퐴 + ∑ 훼 푙푛퐺퐹퐶퐹 + 퐹퐸 + 휀 (9) 푙푛퐺퐷푃 = 훽푙푛퐺퐷푃 + 훿퐿푒푟푛푒푟 + 훿퐿푒푟푛푒푟 + 휙푍푠푐표푟푒 + 휙푍푠푐표푟푒 + 훾퐻퐶퐴 + 훾퐻퐶퐴 + 훼푙푛퐺퐹퐶퐹 + 훼푙푛퐺퐹퐶퐹 + 퐹퐸 + 휀 (10) where i stands for country i and t stands for year t. 푙푛퐺퐷푃 is per capita real GDP,

푙푛퐺퐷푃 is per capita real GDP in year t-j, 퐿푒푟푛푒푟 is bank market power, 퐿푒푟푛푒푟 is country i bank market power in year t-j. The 푍푠푐표푟푒 is country i banking stability in year t, and 푍푠푐표푟푒 is country i bank stability in year t-j. The 퐻퐶퐴 is a human capital index, 푙푛퐺퐹퐶퐹 gross fixed capital formation (investment) for country i in year t, 퐹퐸is the unobserved country fixed effects, and 휀 is an error.

The re-parametrized ARDL (1, 1, 1, 1, 1) error correction model is specified in equation (12), which is derived by adding equations (10) and (11) and rearranging it.

− 푙푛퐺퐷푃 = −푙푛퐺퐷푃 + 훿퐿푒푟푛푒푟 − 훿퐿푒푟푛푒푟 + 휙푍푠푐표푟푒 − 휙푍푠푐표푟푒 + 퐻퐶퐴 − 훾퐻퐶퐴 + 훼푙푛퐺퐹퐶퐹 − 훼푙푛퐺퐹퐶퐹 (11)

∆푙푛퐺퐷푃 = 휃푙푛퐺퐷푃, − 휆푋 +Γ Δ푋 (12)

73 Notes:

 휃 = −(1− 훽) is group specific speed of adjustment coefficient (expected−2 <

휃 <0).

 휆 = is a vector of long run relationships.

 푋 = [퐿푒푟푛푒푟푍푠푐표푟푒퐻퐶퐴 푙푛퐺퐹퐶퐹].

 푙푛퐺퐷푃, − 휆푋 is the error correction term.

 Γ =−[훿 휙 훾 훼 ] is a vector of the short-run dynamic coefficients.

 Δ 푖푠 푡ℎ푒 푓푖푟푠푡 푑푖푓푓푒푟푒푛푐푒 표푝푒푟푎푡표푟.

Another estimator, the mean group (MG), is consistent when the slope and intercepts vary across countries (Pesaran et al., 1999). I use the Hausman test to select between the PMG and the MG estimators (Pesaran et al., 1999). The PMG estimates are consistent and efficient in a long-run link between stationary (i.e., I(0)) and integrated

(i.e., I(1)) variables (Pesaran et al., 1999). For the PMG estimates to be consistent and efficient, the coefficient on the error-correction term should be between -2 and 0 (Loayza and Rancière, 2004).

74 Chapter 5

EMPIRICAL RESULTS

I present the findings of the link between bank reforms, bank competition, bank stability, and economic growth. I analyze the impact of competition, income diversification, real interest rate, inflation, and capital regulation on bank stability. I also assess the effect of competition and stability on growth while controlling for human capital and investment.

Research question 1: What is the degree and evolution of bank competition in Ghana from 1998 to 2018?

I examine the degree and evolution of competition in Ghana from 1998 to 2018.

Table 5.1 reports the yearly average Lerner indices and that of the entire study period.

Four findings stand out.

First, Ghana’s average Lerner index over the study period is 43.4 percent, which can be considered moderately competitive. This number is comparable to what Nagore &

Maudos (2005) report. The authors report an average Lerner index of 38.53 percent for

Ghana from 1995 to 1999 in a cross-country study. Adjei-Frimpong, Gan, & Hu (2016) show an average Lerner index of 34.9 percent for Ghana between 2001 and 2010. Second, the mean Lerner index for the study period is between 34.60 percent and 56.80 percent.

Thus, on average, price is more than marginal cost by 34.60 percent to 56.80 percent

75 compared to price. Third, the evolution of the Lerner index is -7.9 percent over the study period, which implies a 7.9 percent improvement in bank competition. Thus, bank competition has marginally improved over the last two decades.

The result is consistent with other studies. Alhassan & Ohene-Asare (2016) find that Ghana banking competition improved by nine percent between 2004 and 2011. The authors sampled 26 banks and use the Boone (2001) indicator measure of competition to estimate the evolution of competition. Banya & Biekpe (2017) use data from 2005 to

2012 to examine the impact of competition on growth for selected African countries including, Ghana. They note that over the study period Ghana recorded a fall in its banking concentration ratio from 99 percent in 2005 to 55.7 percent in 2011 and conclude that Ghana banking competition has increased over the sample period. According to

Bokpin (2016), Bank of Ghana regulations contribute to an increased level of bank competition.

Fourth, between 1998 and 2008, the evolution index is -17.2 percent, but the evolution index is 9.4 percent from 2008 to 2018. It means that competition increases through 2008 and then declined. Figure 1.1 above shows that non-performing loans started to rise in 2007. The findings seem to suggest that the increase in competition resulted in many risky loans and caused banks to behave less competitively. According to Agoraki, Delis, & Pasiouras (2011), banks engage in lower credit risk when they have market power. Based on data from 14 Asian Pacific countries from 2003 to 2010, Fu et al. (2014) report that lower pricing power (competitive firms) increases banks' risk exposure.

76 The main result is that banking competition has increased in Ghana over the study period, and the finding is supported by other studies. The current consolidation process has decreased the number of banks in Ghana; however, banking competition may likely increase because of Internet banking. The study has important economic consequence because improvement in banking competition may lead to lower interest rates and increase demand loanable funds and investment (Weill, 2013).

Table 5-1: The Lerner Index for Ghana (1998 – 2018) Panel A. Panel B. Graph of the Lerner Index Lerner Years index 1998 0.518 1999 0.538 2000 0.568 2001 0.550 Lerner index 2002 0.496 0.6 2003 0.502 2004 0.460 0.5 2005 0.394 2006 0.425 0.4 2007 0.365 0.3 2008 0.346 2009 0.355 0.2 2010 0.388 2011 0.376 0.1 2012 0.451 2013 0.472 0 2014 0.426 2015 0.419 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2016 0.422 2017 0.413 2018 0.440 Mean 0.434 Evolution -0.079

77 Research question 2: What is the impact of bank competition on the stability of the

Ghana banking sector?

Table 5.2 shows summary statistics and Table 5.3 shows the effect of banks’ market power on stability.

Table 5-2: Summary Statistics for Bank Stability, Competition, Bank Specific and Macro Variables Variable Obs Mean Std. Dev. Minimum Maximum Dependent Variables Z-score 302 6.051 6.270 -1.747 39.073 Explanatory Variables Lerner index 302 0.434 0.172 -0.161 0.871 Bank Specific Variables Diversification index 302 0.700 0.192 0.145 0.992 Macro Variables Inflation, consumer prices 302 14.841 5.864 8.600 40.50 Real lending interest rate 302 17.06 9.40 7.500 51.30

Table 5.3 reports the F-test for joint significance of regressors. Arellano-Bond test for first and second-order serial autocorrelation in the residuals, and Hansen test of over- identifying restrictions. The Hansen test shows a statistically insignificant result suggesting that the model does not suffer over-identification problem. Many instruments may reduce the reliability of the Hansen test (Sanya & Wolfe, 2011). According to Sanya

& Wolfe (2011), the rule of thumb is that the number of groups should not be less than instruments in the model (Roodman, 2006). Table 5.3 shows that AR(1) is significant at

5% level, while AR(2) is insignificant at 5% level. The result of the AR(2) test suggests that the models do not suffer from second-order serial correlation. Finally, the F-test is significant at the 1% level.

78 I use as dependent variable the Z-index to measure overall bank risk. The regression includes the Lerner index to proxy bank competition. I also include inflation, real lending interest rate, and diversification index to control for changes in the macroeconomic development and business environment. Table 5.3 exhibits the findings of estimating equation (6) for the effect of competition on bank stability. The Lerner index is positive and significant at the 5 percent level. It means that market power improves banks' stability. The finding is corroborated by Salas & Saurina (2003), Ariss (2010),

Agoraki, Delis, & Pasiouras (2011), Fu, Lin, & Molyneux (2014), and Leroy & Lucotte

(2017).

Using a sample of 21 Spanish banks from 1968 to 1998, Salas & Saurina (2003) observe that competition decreases market power and profits, which ultimately reduces banks’ incentives to refrain from taking risks. Ariss (2010) reports that market power results in bank stability. The author explains that banks with market power are better able to improve profit efficiency, which leads to bank stability. Agoraki, Delis, & Pasiouras

(2011) report that banks engage in lower credit risk when they have market power. Based on data from 14 Asian Pacific countries from 2003 to 2010, Fu et al. (2014) show that lower pricing power (competitive firms) increases banks risk exposure. Leroy & Lucotte

(2017) studied the competition-stability link for European banks. The authors conclude that competition motivates banks to take risk that eventually causes the individual banks to be unstable.

79 My finding does not agree with the studies by Boyd & De Nicoló (2005), Schaeck et al. (2009), and Wolfe & Amidu (2013). Boyd & De Nicoló (2005) show that competition increase stability. They demonstrate that less competitive markets are less stable. According to the authors, banks with market power charge higher loan rates and, when faced with a higher cost of capital, borrowers optimally choose higher risk projects.

According to Schaeck, Cihak, & Wolfe (2009), more competition reduces risk-taking.

Their findings show that competition contributes to stability. Contrary to the competition- fragility link, evidence from emerging economies shows that competition promotes diversification and consequently leads to stability (Wolfe & Amidu, 2013).

I do not interpret my finding as a contradiction to the competition-stability view.

Banks with market power may charge higher loan rates that may increase credit risk.

However, the positive link between market power and stability suggests that banks use other risk management practices to shield their value from the credit risk (Berger et al.,

2009).

Table 5.3 shows that the coefficient of the lagged Z-score is significant and positive, suggesting persistence in bank risk. The diversification index is not significant.

So, diversification does not impact banks stability. Inflation is negative and significant.

The real lending interest rate is negative and significant. The findings imply that a high real lending interest rate and a high inflation negatively affect bank stability. High interest rates encourage customers to engage in high risk projects that could negatively affect their ability to pay back the bank the loans. Louzis et al. (2012) provide evidence from Greek

80 banks to show a positive link between non-performing loans and real lending interest rates. Also, investigation of the issue of rising NPLs in Sub-Saharan Africa during the

1990s shows that high real lending interest rates contribute to high nonperforming loans

(Fofack, 2005). The author explains that the persistence of exorbitant real lending interest rates can cause a weak banking industry into a crisis, through the buildup of NPLs.

Inflation negatively impacts bank stability. Inflation increases NPLs (Ghosh, 2015).

According to Klein (2013), inflation contributes to higher NPLs. The coefficient of the diversification index is positive as expected because a better-diversified bank is less risky according to portfolio theory, but it is statistically not significant.

My findings support merger and consolidation activities in Ghana and add evidence to the Competition-Fragility view. The results mean that higher market power that results from consolidation may result in banks being more likely to practice other risk management processes to protect the banking system. The implication is that bank mergers and consolidation might result in a stable banking system (Berger et al., 2009).

81 Table 5-3: Parameter Estimates for the Effect of Competition on Bank Stability Estimator System GMM Dependent variable Z-score Constant 2.107 (4.538) Lagged Z-score 0.367*** (0.063) Competition Indicator Lerner index 7.834** (3.431) Bank-Specific Variables Diversification index 0.602 (5.606) Macro Variables Inflation, consumer prices -0.069* (0.036) Real lending interest rate -0.061** (0.028) Observations 273 Number of groups (banks) 26 Number of instruments 16 Hansen test of over-identifying restrictions 13.57 p-value = 0.193 Arellano-Bond test for AR(1) -2.11 p-value = 0.035 Arellano-Bond test for AR(2) -1.67 p-value = 0.095 F-test for joint significance of regressors 12.10*** p-value = 0.000 ***, **, * significant at 1%, 5% or 10%, respectively. Robust standard errors in parentheses.

Research question 3: What is the effect of bank recapitalization on the stability of the

Ghana banking industry?

Table 5.4 shows the results of estimating equation (8) for bank recapitalization and bank stability. I estimate four models that include model 1, which combines all three recapitalization dummies. Also, I estimate equation (8) using only one of the

82 recapitalization dummies at a time to find if one policy is better than the others. Model 2, model 3, and model 4 include 2008, 2013, and 2017 recapitalization dummy, respectively.

The results reported in Table 5.3 are unchanged after including dummies for bank recapitalization policies. For all the four models, the Lerner index is significant and positive, which implies that banks with market power are more stable. This result is corroborated by the works of Agoraki et al. (2011), (Barth, Caprio, & Levine, 2004),

(Kim & Santomero, 1988), and (Koehn & Santomero, 1980). Also, the estimated coefficient of the lagged z-score is significant and positive, which suggests that the last period risk increases the next period risk. The diversification index is not significant.

Inflation is significant and positive for all the four models. The real lending interest rate is significant and negative for all the four models. The results indicate that a high real lending interest rate and a high inflation rate negatively affect bank stability. High interest rates encourage customers to engage in high risk projects that could negatively affect their ability to pay back the bank the loans.

Evidence from Table 5.4 indicates that 2008 and 2013 recapitalization policies negatively affect banks stability, but the results are insignificant. Overall, the impact of the recapitalization policies are insignificant, indicating that there is no direct effect of recapitalization policies on banks stability. Several studies have not established a clear link between bank capital and bank failure (Koehn & Santomero, 1980).

Agoraki et al. (2011) examine if capital regulations directly impact bank risk- taking or if they indirectly impact bank risk-taking via the banks’ market power. The authors use a sample of the Central and Eastern European banks from 1998 to 2005. They

83 report that capital regulations do not affect banks’ overall risk-taking. Capital requirements seem to decrease credit risk; however, they raise the insolvency risk of banks with market power (Agoraki et al., 2011).

Barth, Caprio, & Levine (2004) find a weak link between capital requirements and banking failure after controlling for other factors. Kim & Santomero (1988) uses a single-period mean-variance approach to study the usefulness of bank capital regulation to reduce risk. The author finds that uniform capital ratio regulation is not sufficient to reduce banks’ insolvency risk. The author explains that it overlooks differences in the preference structures of the individual banks and permits "risky" banks to get around the restrictions using financial leverage. Koehn & Santomero (1980) investigate the impact of capital ratio regulation and the activities of banks. They conclude that the relationship between a higher capital requirement and the likelihood of banking sector instability are ambiguous.

My result is contrary to the findings of Mansour & Zouari (2018), Lee & Hsieh

(2013), and Salas & Saurina (2003). Mansour & Zouari (2018) report that a specific level of capital provides a margin of safety for the banks. They find that sufficient bank capital serves a buffer against operational losses and lowers bank risk.

Lee & Hsieh (2013) use the GMM model to assess the effects of bank capital on bank risk from 1994 to 2008 for forty-two Asian countries. The authors find a negative link between capital and risk in lower-middle income nations. Also, commercial banks show the highest negative capital impact on risk, and the risk variable is persistent (Lee

& Hsieh,2013). They conclude that a country's income levels influence the capital effects

84 on bank risk. Regulators implement minimum capital policies to reduce overall bank risk, but credit risk is hard to control because banks' internal policies influence credit risk

(Salas & Saurina, 2003).

In summary, the relationship between capital regulation and stability is ambiguous. It does not imply that capital requirements are unnecessarily. The negative link between recapitalization and overall bank risk though insignificant, suggests that the central Bank of Ghana should go beyond recapitalization and use effective supervision to reduce excessive credit risk-taking. The central Bank of Ghana should also monitor closely banks’ risk management practices. The modern approach to the risk-related capital regulation may be more useful if the weights are chosen optimally (Kim &

Santomero, 1988).

85 Table 5-4: Parameter Estimates for the Effect of Bank Recapitalization on Bank Stability Estimator System GMM Model 1 Model 2 Model 3 Model 4 Dependent variable Z-score Z-score Z-score Z-score Constant 3.463 3.650 2.030 0.729 (2.203) (2.143) (1.357) (1.255) Lagged Z-score 0.350*** 0.349*** 0.382*** 0.389*** (0.078) (0.079) (0.070) (0.068) Competition Indicator Lerner index 7.678** 7.167** 8.003** 7.930** (3.552) (3.192) (3.674) (3.469) Bank-Specific Variables Diversification index 2.546 2.653 2.067 2.632 (2.085) (1.714) (1.901) (1.901) Macro Variables Inflation, consumer prices -0.107** -0.118** -0.078** -0.077** (0.048) (0.051) (0.037) (0.035) Real lending interest rate -0.113* -0.105* -0.093* -0.068* (0.059) (0.055) (0.052) (0.039) Recapitalization Dummies 2008 Recapitalization -1.417 -1.703 (0.928) (1.049) 2013 Recapitalization -0.570 -1.077 (1.021) (1.066) 2017 Recapitalization 0.512 -0.219 (0.954) (1.172) Observations 273 273 273 273 Number of groups (banks) 26 26 26 26 Number of instruments 16 16 16 16 Hansen test of over-identifying 9.54 14.25 8.45 11.16 restrictions p-value 0.299 0.114 0.489 0.265 Arellano-Bond test for AR(1) -2.24 -2.24 -2.20 -2.16 p-value 0.025 0.025 0.028 0.031 Arellano-Bond test for AR(2) -1.68 -1.68 -1.66 -1.59 p-value 0.094 0.092 0.097 0.112 F-test for joint significance of 38.34*** 41.58*** 43.40*** 51.35*** regressors p-value 0.000 0.000 0.000 0.000 ***, **, * significant at 1%, 5% or 10%, respectively. Robust standard errors in parentheses.

86 Research question 4: What is the relative contribution of competition and stability to economic growth?

The results of estimating equation (12) for the contribution of competition and stability to growth are presented in Table 5.7. Table 5.5 shows descriptive statistics, and

Table 5.6 shows a stationary test of the time series. Table 5.6 reports that the variables are either I(1) and I(0). The ARDL model does not require pre-testing of the order of integration of the variables (Lee & Wang, 2015). Table 5.7 shows the Hausman test and the coefficients estimates between real growth, bank market power, bank stability, human capital, and physical capital. The PGM estimation is selected based on the Hausman test.

The error correction term (−0.173) is negative and significant at the 10 percent level, suggesting the model’s correction toward the long run is at the speed of 17.3 percent.

Table 5.7 shows bank stability, human capital, and gross fixed capital formation positively impact GDP growth in the long-run. As expected, the coefficient of the physical capital is significant and positive, confirming the theoretical prediction that physical capital is a key driver of real economic growth (Romer 1986, 1990). The result implies that investment in physical capital is vital for long run GDP growth in sub-

Saharan Africa. Banya & Biekpe (2017) report that gross fixed capital formation positively impacts real GDP growth in Africa.

The human capital variable is positive and significant for the long run GDP growth of sub-Saharan African countries. The result is supported by Romer (1990) and

Mankiw, Romer, & Weil (1992). According to Romer (1990), larger human capital accumulation leads to faster economic growth. Škare (2011) examines the effect of

87 human capital on output and reports that human capital is an essential driver of GDP growth in Croatia between 1950 and 2009. The author concludes that educational investments are necessary to improve human capital accumulation. Using unbalanced panel data for 73 countries from 1960 to 1990, Kubík (2010) shows that human capital positively impacts growth. Prados de la Escosura & Rosés (2010) report that human capital promotes labor productivity growth and facilitates technological advancement.

Table 5.7 reports that bank stability and human capital are not relevant in explaining short run economic growth. However, physical capital is positively related to short run GDP growth.

The coefficient of bank stability is significant and positive at a 1 percent significance level, indicating that a one percentage point rise in bank stability may increase per capita real GDP by .009 percentage point over the study period. Jokipii &

Monnin (2013) report a positive link between bank stability and growth for a sample of

18 OECD countries. The authors note that economic growth typically follows episodes of banking stability.

The Lerner index is negative and significant in the long run. The result implies that higher market power negatively affects the long run GDP growth. A percentage point increase in bank market power decreases per capita real GDP growth by 0.303 in the long run. However, bank market power has a positive and significant link with growth in the short run. The findings show that bank stability benefits long-run growth, but market power reduces growth. The net effect is -0.294, which implies that the negative effect of market power exceeds the benefit of bank stability for long-run growth. Table 5.7 results

88 imply that bank market power is good for short run economic growth but bad for long run

GDP growth. The results seem to be coherent with the theoretical proposition by Petersen

& Rajan (1995) and the empirical studies of Cetorelli & Gambera (2001); Coccorese

(2008); Idun & Aboagye (2014); and Jayakumar et al. (2018).

The model developed by Petersen & Rajan (1995) shows that market power banks develop leads to lending relationships with young and unknown firms with the hope to share in their future profits. This implied equity stake in the firms allows banks with market power to set a lower interest rate (relative to the competitive market) in the short run. The lower interest rate encourages more firms to borrow for investment and hence short run growth. However, in the long run, banks with market power set a high-interest rate (relative to the competitive market) to compensate for the initial low rate. The high- interest charge discourages borrowing and investment, resulting in lower GDP growth.

Also, in the long run, as the interest rate increases, the likelihood of moral hazard compels the banks with market power to reduce lending, which negatively affects investment and

GDP growth.

Using a sample of 41 countries, Cetorelli & Gambera (2001) report that in the short run, banking market power positively impact economic growth. The authors explain that market power banks have incentives to build a lending relationship with younger firms in the hope of sharing in their future profits. Cetorelli & Gambera (2001) observe that younger firms tend to introduce novel technologies. Technological progress increases labor productivity and hence positively impact growth (Romer 1986, 1990). But, in the

89 long run, market power results in higher loan rates, which reduce the quantity of loanable funds and economic growth (Cetorelli & Gambera, 2001).

A 2008 study by Coccorese finds that bank consolidation positively impacts short run GDP economic. The author explains that higher market power promotes quicker growth in businesses and economic growth overall. Idun & Aboagye (2014) provide evidence from Ghana to show that bank competition positively impacts long run growth, but in the short run, bank competition is negatively related to growth. Jayakumar et al.

(2018) use a vector autoregressive (VAR) model and panel data from European Union countries to show that bank competition and bank stability positively impact long run economic growth.

Banking competition improves the efficiency of financial services delivery and positively affects long run economic growth (Fernandez, Gonzalez, & Suarez ,2016).

According to Claessens & Laeven (2005), bank competition promotes industrial growth by extending credit to newer businesses resulting in GDP growth. Adam (2011) concludes that bank competition positively affects long run growth.

The results of my study are generally consistent with other studies on the link between competition, bank stability, and growth. The findings reveal that bank competition and bank stability are important for long run growth. Also, higher market power positively impacts short run growth. These findings are essential for policymakers; because, a stable and competitive banking industry allocates resources efficiently to promote economic growth (Banya & Biekpe, 2017).

90 Table 5-5: Summary Statistics for the Effect of Bank Stability and Competition on Economic Growth Variable Obs. Mean Std. Dev. Minimum Maximum Dependent Variables Log Real GDP per Capita 323 6.799 0.933 5.364 9.123 Explanatory Variables Lerner Index 323 0.289 0.121 -0.386 0.640 Z-score 323 12.183 6.470 2.616 42.899 Human Capital Index 323 0.368 0.124 0.109 0.729 Log Gross fixed capital 323 20.993 1.399 15.139 24.977 formation (Physical capital, constant 2010 USD)

Table 5-6: Panel Unit Root Test Results for Sub-Sahara Africa Countries 1996- 2014 Variables Level Order of ADF PP IPS Integration Log Real GDP per Capita 25.2858 47.1897 3.1755 I(1) Lerner Index 77.0197*** 111.257*** -3.2808** I(0) Z-score 87.6793*** 76.7831*** -4.4181*** I(0) Human Capital Index 57.5479** 36.1966 -1.3157* I(1) Log Gross fixed capital 56.6315** 50.251 -1.6132* I(1) formation (Physical capital, constant 2010 USD) Note 1: ADF stands for the ADF-Fischer test, PP stands for PP-Fischer test, IPS stands for Im, Pesaran, and Shin test. Note 2: ***, **, * significant at 1%, 5%, and 10% respectively.

91 Table 5-7: Parameter Estimates for the Long- and Short-Run Effects of Competition and Stability on Economic Growth Dependent Variable: Log Real GDP per Capita Dynamic specification: ARDL (1 1 1 1 1 ) Estimator Pooled Mean Mean Hausman Group Group test Long-Run Coefficients Lerner Index -0.303*** -0.101 H0: PMG (0.045) (0.242) Ha: MG Z-score 0.009*** 0.036 Chi-square (0.001) (0.029) statistic = Human Capital Index 2.894*** 2.765** 1.85 (0.218) (0.857) [0.764] Log Gross fixed capital formation 0.076*** 0.302 (Physical capital, constant 2010 (0.006) (0.319) USD) Error Correction Coefficients: Phi -0.173* -0.724*** (0.093) (0.118) Short-Run Coefficients Δ Lerner Index 0.053* 0.107 (0.031) (0.101) Δ Z-score 0.000 -0.003 (0.002) (0.002) Δ Human Capital Index -0.195 -0.609 (0.251) (0.541) Δ Log Gross fixed capital formation 0.028* -0.006 (Physical capital, constant 2010 (0.015) (0.019) USD) Constant 0.679** 4.614** (0.347) (1.447) Number of Countries 20 20 Number of Observations 301 301 Note: ***, **, * significant at 1%, 5% or 10%, respectively. Standard errors in parentheses.

92 Chapter 6

CONCLUSION AND POLICY RECOMMENDATION

Ghana's banking sector has done poorly in the past, and there were crises from

1981 to 1982, and from 2016 to 2018. From the late 1980s, various reforms, including the universal license and recapitalization policies, have been introduced. The reforms aim to create a competitive and efficient banking environment and to ensure a stable banking sector. Between August 2017 and August 2018, 20 percent of the banks have failed. The collapse of the banks has come at the cost of GH¢9.9 billion (about $2.2 billion), which is about 3.5% of Ghana’s GDP. There were episodes of bank runs from 2015 to 2018.

Ghana continues to record high NPL, high real interest rates, and high inflation. Concerns about financial sector stability in Ghana have grown.

Prior studies on the Ghana banking system have mainly focused on the efficiency effects of bank competition (Alhassan & Ohene-Asare, 2016; Biekpe, 2011; Mathisen &

Buchs, 2005) and the link between financial reforms and competition (Akomea & Adusei,

2013; Brownbridge & Fritz Gockel, 1996; Owusu-Antwi, 2009). Other similar studies on

Ghana assess the effect of financial reforms on the efficiency of intermediation and bank profitability (Antwi-Asare & Addison, 2000).

This research builds on previous studies in four ways. First, this study is the first to use a comprehensive data set from 1998 to 2018 to examine the degree and evolution of competition in the Ghana banking industry. According to Biekpe (2011), a data set

93 with an extended sample period is necessary to determine the Ghana banking industry market structure. The full impact of reforms may take time to materialize. Second, the study addresses the complex interaction between the financial reforms-competition- stability relationships for Ghana’s banking industry using a comprehensive data set.

Third, this study examines the relative contribution of competition and stability to economic growth. Fourth, my aim is to add more evidence to competition-fragility link for the Ghana banking industry.

Ghana’s average Lerner index is 0.434 over the study period, suggesting a moderately competitive banking industry. The findings show that higher market power

(lower competition) improves banks' stability. It also shows that a high real lending interest rate and high inflation negatively affect bank stability. High-interest rates encourage customers to engage in high-risk projects that could negatively affect their ability to pay back the bank the loans.

The findings in this study show that financial stability positively impacts long run growth in Sub-Saharan African countries. Additionally, higher market power

(concentration) slows long run growth. However, in the short-run, higher market power improves growth. My findings show that the Bank of Ghana's policy of promoting some level of bank mergers and consolidation is a good policy. Such a policy would strengthen the banking system, and at the same time would make the banks well capitalized to support the development agenda of the country. A contestable market is a market with few companies but which behaves competitively because of the threat of new entrants.

The negative effect of banking concentration in Ghana can be minimized if policymakers

94 implement policies to make the banks contestable. Policies such as strengthening non- bank financial institutions and markets including savings and loan companies, microfinance institutions, fund management companies, and the Ghana Stock Exchange to serve as external competitors to the banking industry. BOG should improve its supervisory roles. Effective monitoring prevents unethical banking practices. Also, effective bank supervision and regulation encourage banks to recapitalize or close down before considerable losses occur (Kane & Demirguc-Kunt, 2002). Moreover, it prevents banks from exercising collusive oligopoly power. Canada has a concentrated banking system, and it is also the most stable financial system and provides significant benefits to the Canadian economy (Bordo et al., 2015). The small number of Canadian banks do not exercise collusive oligopoly power because they are effectively regulated. It can be considered a monopolistically competitive industry (Allen & Engert, 2007).

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