A sound and stable financial systems underpin economic growth and development. Financial systems have made possible the expansion of credit.

That is; flow of capital from those who have more (lenders) to those who need (borrowers). Payments from buyers to sellers in distant locations are made possible by the financial systems. So, you would concur that a country’s financial system plays a crucial part in its development. Just as a stable financial sector can propel growth, any hitch within the system can generate a whole economic crisis.

The effects of the global financial crises of 2008 are known to many and I need not reiterate. As with Madina to Accra ‘trotro’, don’t worry if you missed the impact of the global financial crisis; another may be along shortly.

The need for effective and pro-active Prudential Regulations

The emergence of microfinance in the economy was touted as a unique local financial intermediary as it serves the large informal economy. It was all right until its boom created stiffer competition which led to sham financial engineering’s to woo clients. The recent DKM scandal may have reawakened the supervision role of the Bank of Ghana (BoG). After the DKM scandal, the BoG passed the microfinance industry through the furnace. The Bank published names of microfinance institutions that are in good standing, those that were not even licensed, while it revoked the licenses of others. Another rude awakening within the financial sector was the insolvency of UT and Capital Banks. The incidence could have triggered a bank run with dire consequences on the whole financial sector. Let me pause for a moment to congratulate the BoG on how it effectively managed the situation.

So, we are on a road to developing a stable and resilient financial sector. The BoG in September this year announced a three-fold increment in the minimum paid up capital required of individual banks. With less objection, commercial banks have taken the new directive in good fate and working towards meeting this requirement. It is obvious that, with this increment, the BoG is bent on safeguarding public deposit while increasing confidence in the banking sector.

Equally important on this road, are effective macroprudential regulations. Foreseeing and preventing any systemic risk within the system is key. It is not enough to provide solutions to incidence that emerge, it must be nipped in the bud. The foremost task in preventing any risk from building-up is monitoring. The Banking and supervision department of the BoG, must ensure that it identifies and monitors any systemic risk that may develop within the macroeconomy. It could be risk that stem from the interconnectedness of financial institutions or the interaction of the financial system with the real economy. To this end, timely and accurate data, information on key financial indicators are needed. Again, it is imperative that macro stress test be carried out at regular intervals to ascertain the financial sectors reaction to any macroeconomic shock.

Is excessive competition a threat?

Prior to the take-over of UT and Capital Bank by GCB Bank, Ghana had thirty-seven licensed banks providing financial services to about a quarter of the twenty-five million people (formal sector). In pure economics terms, there is an excess supply of financial services. And as with any excess supply, “prices” would have to drop. Evidently, we have moved from the days you would need about 100 cedi and detailed documents to open a bank account. Competition has made it possible for one to open an account even without an initial deposit. In fact, increased competition has driven banks to accelerate their efforts in the provision of their services. So, how then is competition a threat?

Unlike in the goods market where consumers enjoy lower prices due to competition, the effects of competition in the financial sector is fairly different. You would expect, commercial interest rates to be dropping due to competition. Don’t be carried away! Until recent, commercial rates have been on ascendancy. A widely held view is that excessive competition in the financial sector erodes market power and profit margin of banks. The fear in losing market share and profit margins drive banks to engage in high risk services that can trigger a financial crisis. As theoretically true as this may be, there is a converse situation in Ghana. Banks in Ghana do not concern themselves with market share. Their goal has always been on their profit margin. An analysis into the audited financial statements of commercial banks, shows that banks report high profits. That is to say, competition has not necessarily eroded their profit margin. Banks reap abnormal profits amid the high competition.

The real effects of increased competition in the financial sector remains a puzzle. But one thing is crystal clear. In search of higher profits, banks are recording higher non-performing loans (NPL). And this is a time bomb. Growth in NPL due to competition will force banks to reduce credit. Should this happen, there will be a breakdown in the role banks play in private sector development, halting the engine of economic growth. Hence, any worry about the intense competition in the banking sector should be directed at policies to reduce the growth in banks NPL’s. Perhaps, it’s time for a national credit Bureau.

Is bigger really better?

As a country, we have banks that serve the various “classes” within the population. Whether you despise this or not, reality is that certain segment of the population feels more welcome in some banks than others. There is a bank for everyone.

Following the announcement of the increase in the minimum capital requirement, news from the grapevine has it that, there will be some mergers and acquisition within the banking sector. Banks without rich foreign parents are the most affected. The Bank of Ghana has prescribed some recommendations as to how banks can raise the needed capital. Nonetheless, the task is huge for relatively smaller and domestically owned banks.

Merging and acquisitions will definitely reduce the number of players within the industry. It will sanitize the industry and ensure only resilient banks are in operation. Consolidation may help reduce wasteful competition and inefficiencies that some of the poorer performing banks have. What’s more, the managerial talent and the competitive edge of the stronger banks will be transferred to a wider scale. That said, the dynamics within the banking industry will change. We are likely to have a foreign dominated banking industry. If you care less about nationalism, then you may brush off this point.

I am tempted to delve into the oligopolistic competition that may emerge due to mergers. Well, the argument may be premature, but to be aware is a step in curbing it. The risks of merging do not appear to be much given that the regulation and supervision over banks will be heavy. The newly created bigger banks should not be given too much leg room to engage in risky ventures. The seeming comfort of ‘too big to fail’ should be dealt with by regular monitoring and tests.

The recent impairment, may be signs of deep cracks within our financial system. We have set on a path to build a more resilient system. As the post-financial crises show, the key to a stable financial system is an ever-watchful regulatory watch-dog.