Ghana’s financial system has facilitated the smooth flow of funds between several economic units (i.e. individuals, businesses, and agencies) at the community, regional and national levels since the 1950’s when Bank of Ghana was set up to regulate banking transactions in the country. However, historically and in present times, the provision of credits by commercial banks has been marked by significantly high cost, which has in most cases, resulted in borrowers’ inability to service debts. Rates offered by the Savings and Loans, Microfinance and Money Lending Institutions are even higher.
In this article, we focus on the high lending rates in Ghana, analyze the causes, examine efforts being made to confront this phenomenon, and suggest additional measures to address this financial and economic challenge. We also compare Ghana’s case with other African peers including Botswana, Kenya, Mauritius, Nigeria, Rwanda, South Africa and Tanzania. In making the cross-country comparison, we apply the following macroeconomic and financial variables; lending rate, policy rate, corporate tax rate and inflation rate. We also calculated the Operating Expenses to Interest Income Ratio (OPIIR) of listed banks in Ghana to ascertain the extent to which banks’ operating expenses deplete their revenue.
Capital Accumulation- A key Driver of Growth
Capital accumulation is a key driver of economic growth, therefore sustained rate of growth and development can be realized if businesses are provided with the needed funds by commercial banks at affordable rates to be channeled into productive and profitable ventures of the economy. Over the years, businesses in sectors including construction, communication, manufacturing, services, real estate, mining, industry, and transportation amongst others have undoubtedly benefited from financial intermediation supports in the form of loans provided by commercial banks.
Critical Challenge to Capital Accumulation in Ghana- High Lending Rates
However, economic units have battled with high interest rates on loans provided by commercial banks resulting in high financing costs, high business operating expenses, projects disruptions, eroding of acquired capital, high non-performing loans, amongst others. As indicated in the Bank of Ghana June 2018 Banking Sector Report, credit risk in the banking sector remains elevated with about a fifth of all loans in the industry being classified as non-performing. The report also indicates that, total non-performing loans in the sector at the end of the second quarter of 2018 stood at GHS8.74 billion.
Cross-Country Analysis of Lending Rates
From Chart 1, amongst the eight countries, Ghana has the highest average commercial bank lending rate; i.e. 26.98% per annum. However, it can be seen that rates have eased consistently, albeit marginally since the beginning of the year; thus, from 29.25% in January to 26.98% in August.
Botswana has the most stable and lowest lending rate amongst the countries, remaining flat at 6.5% from the beginning of 2018.This is followed by Mauritius and South Africa with stable average lending rates of 8.5% and 10% respectively from the beginning of the year.
Also, Kenya’s average lending rate of 12.78%, Tanzania’s 15.5%, Nigeria’s 16.53% and Rwanda’s 17.23% are all better than the case of Ghana.
Determinants of Lending Rate in Ghana
The lending rate of commercial banks is determined in consideration of the following: cash reserve requirement; regulatory capital adequacy ratio; general provisions; corporate tax rate; policy rate; interbank lending rate; Inflation rate; 91 Day treasury bill rate; operating expenses; total assets; and expected return on equity.
Out of these 11 parameters, only four are controlled by the banks; namely operating expenses, total assets, interbank lending rate and expected return on equity. This therefore leaves the banks with little room for significant downward review of credits cost.
Causes of High Lending Rates in Ghana
- High Operational Costs of Banks
The expenses and obligations of banks are a function of variables including impairment losses/provision of loan loss, personnel expenses, rent, utilities, taxation, national fiscal stabilization levy, amongst others. The combination of these cost drivers significantly deplete the bank’s topline items i.e. interest income and revenue.
The Operating Expenses to Interest Income (OPII) Ratios of the listed banks in Chart 2 below indicate the extent to which expenses drain banks revenue.
Analysis of Operating Expenses to Interest Income Ratio
Within the 4-year period, ADB Bank recorded the highest average OPII Ratio i.e. 91%, followed by Ecobank Ghana and Societe Generale (80% respectively); Republic Bank followed with 73% and GCB Bank recorded an average of 65%. Access Bank and CAL Bank recorded the lowest ratios of 47% and 43% respectively.
Banks have always argued that, operational expenditure and cost of providing banking services are expensive, necessitating the need to recover these costs to remain in business. On account of their high operating expenses, banks have mostly hiked their lending rates to increase interest income in order to compensate for the impact of these expenses on their earnings and profitability.
- Relatively High Policy Rate Compared to Peers
The policy rate is the benchmark interest rate which the Central Bank lends to commercial banks. Ghana’s policy rate currently stands at 17%, the highest amongst the eight countries. Mauritius has the lowest rate of 3.5%, followed by Botswana (5%), Rwanda (5.5%), South Africa (6.75%), Tanzania (9%), Kenya (9%) and Nigeria (14%) respectively.
The Bank of Ghana has historically maintained a tight policy stance owing to inflationary risks, but has in recent times lowered the rate especially from 2016-2018 (a reduction by 900 basis points from 26% to 17%). Unfortunately, the recent reductions of the policy rate has not yielded a corresponding reduction in the banks’ lending rates.
In determining their base rates, banks consider the policy rate of the Central Bank amongst other variables; therefore, the current rate of 17% implies that banks can only provide credits at a premium.
III. Reserve Requirements (Statutory Reserves, Cash Reserves, Cash in Vault Reserves, Credit Risk Reserves)
The main purpose of statutory reserve requirements set by the Bank of Ghana is to protect depositors’ funds. Statutory reserves represent the cumulative amounts set aside from banks’ annual net profit after tax, as required by Section 34 of the Banks and Specialized Deposit-Taking Institutions Act, 2016 (Act 930).
In addition to the statutory reserves, banks are required to comply with cash reserve requirements which is set at 10% and cash in vaults requirement which is set at 2%. Banks therefore charge high lending rates on the available funds in order to make up for the reserved funds which are deemed to be “idle” and yielding no income.
- Macroeconomic Factors/Variables (inflation and exchange rate fluctuations)
Macroeconomic factors such as high inflation over the years has partly contributed to the high lending rate regime. From Chart 4, Ghana recorded the sixth highest average inflation rate for 2018 (i.e. 9.9%). However, there has been a mostly downward trend since 2016.
Rwanda has the lowest average inflation rate of 0.16%, and even witnessed deflation in June, July, September and October respectively. This is followed by Botswana (3.15%), Tanzania (3.6%), South Africa (4.57%), Kenya (4.60%), and Nigeria (12.30%) respectively.
In the case of Ghana, anticipated fluctuations and increases in inflation has seen banks charge high lending rates in order to compensate for the “time value of money” and the loss in the future value of a loan. Further, the fluctuations in exchange rate, which has seen the Cedi depreciate consistently against major trading currencies has led to exchange rate losses of some banks. As a result, banks that fund projects which have implications on exchange rate income charge high rates in order to make up for anticipated exchange rate losses.
- Default risk and Term Risk of Interest Rates
Banks price loans at premiums due to perceived and anticipated risk of default. Thus, the higher the risk associated with a loan, the higher the lending rate charged by banks. Also, banks borrow from depositors and lend to borrowers on medium to long term basis. Therefore, even if the prime rate and deposit rates fall in the short term, banks are mostly reluctant to lower lending rates since they rely on repayment from borrowers in order to meet obligations to their lenders.
Effects of High Lending Rates
- Affect borrowers’ ability to service debt.
- Leads to situations where borrowers use borrowed funds to service already contracted loans.
- High operating cost of businesses, which must be passed on to final consumers in the form of increased and high output prices, posing upside risks to inflation.
- Further, according to Stightz (1980) and Basely (1994), it leads to wrong selection of loan applicants as risk appetite borrowers have mostly recorded the high risk of default.
- Poses a major challenge for startups and already existing businesses who wish to scale up operations.
- High non-performing loans on the books of the banks
- High impairment losses
The Way Forward for Lending Rate Reduction in Ghana
- Establishment of a robust and efficient credit reporting system – The Experience of Botswana
Banks face credit risks in the form of defaults by borrowers. The lack of adequate information and credit history of borrowers deepen the likelihood of default that expose banks to credit risk; therefore, the higher the credit risk faced by banks, the higher the lending rate charged on loans.
It can be seen from Chart 1 that Botswana has the lowest lending rate amongst the eight countries. One of the measures that was adopted by Botswana to achieve the lower levels is the establishment of a transparent and efficient credit monitoring and reporting system. This facilitates access to credit information on borrowers, and hence reduce credit/default risk. This was made possible by the Credit Information Sharing Project Funded by FinMark Trust and the German Corporation for International Cooperation (GIZ). The objective of the project was to reduce constraints to doing business in the financial services industry and increase access to finance in the Southern African Development Community (SADC) Region, both at the national and regional levels.
In addition to the private credit bureaus, the Botswana Bankers Association upon consultation with the commercial banks and the Central Bank of Botswana launched the Credit Reference Bureau (Africa) Ltd in 2015 to facilitate credit information sharing in order to reduce banks’ credit risk.
The primary purpose of Credit Reference Bureau (Africa) Ltd is to ensure that creditors have the information they need to make lending decisions. Unlike private credit bureaus that may be limited by the amount of credit information, CRB (Africa) Ltd by its nature, and backed by appropriate regulations is constantly being furnished with credit information by commercial banks in Botswana.
In addition to adopting Botswana’s measures, we recommend that the Bank of Ghana should set up a Credit Registry Department, backed by regulatory powers to ensure commercial banks submit credit information to the Registry on customers periodically. This can facilitate easy access to credit data and help ease credit risks.
II. The Reference Rate: The Cap introduced by the Kenya Central Bank (KCB) on the Reference Rate is yielding counterproductive results
In its bid to address the menace of high lending rate, the BoG came up with a new policy directing all banks to publish their base rates in the dailies on a monthly basis for customers to know what rate they should expect when applying for loans; this led to the base rate computation concept. However, this failed to achieve the intended results of reducing interest rates.
In April 2018, the BoG set the maiden Ghana Reference Rate at 16.82%. The Bank of Ghana in consultation with the Ghana Association of Bankers reconstituted a Working Group to review the existing Base Rate model and develop a new framework for base rate determination. Banks were directed to price loans by adding or subtracting their risk premiums to the Reference Rate, with the expectation that this will ensure a reduction in lending rate.
The experience of Kenya indicates that, the reference rate by itself will not guarantee a decline in lending rates. Kenya introduced the Bank’s Reference Rate (KBRR) in July 2014 as a benchmark rate set by the Central Bank of Kenya for pricing all floating credit facilities with the objective of reducing rates. However, lending rates remained high despite the introduction of the reference rate. Therefore, the Kenya Central Bank decided to cap interest rates in 2016, in response to calls from the public for banks to reduce rates.
- Whereas demand for credit increased following the capping of lending rates, credit to the private sector has continued to decline, leading to reduced access to credit;
- The structure of revenue to banks has started to shift away from interest income. Also, some banks have exploited the existing approval limits to increase fees on loans in a bid to offset loss in interest income;
- Banks have shifted lending to Government and the large corporates. Some have begun withdrawing credit to MSMEs which have implications on Kenya’s economic growth prospects;
- Kenya’s banking sector remains resilient. However, small banks have experienced significant decline in profitability in recent months, which may complicate their viability;
In addition to these findings, there are other evidence that interest caps have generally resulted in debilitating effects in a number of economies which introduced these caps
- Nicaragua, South Africa, Armenia and Zambia:
Reduced transparency – increase in the total cost of loans through additional fees and commissions
- France and Germany:
Decreased diversity of products for low-income households
Increase in illegal lending
- Zambia, Poland, Bolivia:
Withdrawal of banking services from the poor and specific segment of the society
The findings of the report give an indication that ongoing discussions on possible capping of interest rates in Ghana must be approached with significant caution, backed by extensive research with broader consultations with all stakeholders.
III. Reduce Corporate Tax Rate
One argument that banks have made in favor of the cost of credit is the corporate tax rate of 25% which erodes a significant portion of their revenue. Even though Ghana’s corporate tax rate remains better than five of the countries under review as shown in chart 6, we recommend a reduction in the rate from 25% to 20% as promised by the government in the round up to the 2016 general elections. Following a reduction, the moral calls on banks to cut lending rates will be justified.
- Cap Operating Expenses
One of the reasons that have been advanced by banks for charging high lending rate is high operating expenses. From chart 2, the Operating Expenses to Interest Income Ratios of the eight listed banks have been undoubtedly high in historical and current periods. Going forward, the Bank of Ghana may have to explore and consider introducing regulations to cap banks operating expenses, subject to extensive and broader consultations. This will lead to a lowering of banks operating expenses and hence partly contribute to reduction in lending rates.
It can be inferred from the preceding paragraphs that commercial banks, the Central Bank and the government have specific roles to play in order to ensure interest rate reduction in Ghana.
We believe that if the above recommendations are well implemented, the lending rate of banks will see a downward trend and would result in lower borrowing cost, increased real investments, economic growth and overall improved economic development.
Author: Wilfred Agyei,
Senior Analyst- Corporate Finance and Research , UMB Investment Holdings Limited. [email protected]