The capital requirement is the minimum amount of capital a bank or other financial institution has to hold as required by its financial regulator.
A bank’s capital adequacy ratio on the other hand is expressed as a ratio of equity as a percentage of risk-weighted assets. These requirements are put into place to ensure that these institutions do not take on excess leverage and become insolvent.
There is a strong consensus among policymakers in favour of higher bank capital requirements, especially Tier I capital. The benefit of increased requirements is clear:
• Having more capital helps banks better absorb adverse shocks and thus, reduces the probability of financial distress.
• More capital would also reduce bank risk-taking incentives and, therefore, improve investment efficiency and overall welfare.
• A strong banking sector boost economic growth, attracts foreign direct investment and increases business confidence.
The importance of adequate capital in banking in the Ghanaian economy cannot be over-emphasised.
Banks play an important intermediation role in the economy. In fundamental terms, banks take on deposits (incur liabilities) and provide loans and advances (create assets).
From undertaking these activities, banks would make a profit and retain some of its profits to boost its capital strength, distribute (some) to providers of capital, or make a loss.
For the conduct of both activities, banks require adequate capital to provide comfort and satisfaction to both customers and the regulator of the industry and also to achieve confidence in the financial services system.
The importance of the adequacy of bank capital cannot be over-emphasised.???
Various media networks in Ghana reported on September 8, 2017 that Bank of Ghana (BoG) will (earliest as September 11, 2017) formally direct banks in the country to recapitalise to GH¢400 million, equivalent to about US$100 million.
This would represent an increase of 233 per cent over the old capital level and would be the biggest capital increase witnessed over the banking landscape.
The first time in the last decade where banks in Ghana were required to raise their minimum regulatory capital was in 2008. The regulator increased the minimum regulatory capital from GH¢7 million to GH¢60 million.
The industry was put on a two-track race to compliance: banks with majority foreign ownership had two years, and banks with majority local ownership were given a more lax time frame of five years.
Banks in Ghana were last recapitalised in 2012, when the BoG asked them to raise their stated capital from GH¢60 million at the time to the current GH¢120 million.
According to the media sources, banks would be given up to December 2018 to meet the new capital requirements of GH¢400 million.
Based on my estimate, the industry would potentially need to raise GH¢8.6 billion (in absence of financial statements available for National Investment Bank Ltd, OmniBank Ghana Limited, The Beige Bank Limited, The Construction Bank (Gh.) Limited, GHL Bank Limited and ARB Apex Bank Ltd, I assumed each of them will need GH¢ 400 million) by December 31, 2018 (ignoring IFRS 9 impacts, any expected worsening of credit and economic impacts, profits for 2017, and potential consolidations).
This is estimated to be about 78 per cent of June 2017 total shareholder’s funds of GH¢11 billion per the July 2017 Banking sector report (see question 13).
At the end of 2015, the statutory credit risk as a percentage of the IFRS reserve was 42 per cent.
Let’s assume this ratio was the same as the end of 2016 and June 2017 and we apply ratio on the 2016 and 2017 statutory credit risk, we can derive both the IFRS reserve and BoG reserve.
If we further assume that IFRS 9 will lead to an increase of loan reserves by 50 per cent, the impact is that the industry will need additional capital of GH¢ 238 million to remain at the same level, or capital reduces by 1% per cent.
Hence, taking a potential IFRS 9 impact into consideration, the industry will have to raise GH¢9 billion (in absence of financial statements available for National Investment Bank Ltd, OmniBank Ghana Limited, The Beige Bank Limited, The Construction Bank (Gh.) Limited, GHL Bank Limited and ARB Apex Bank Ltd, I assumed each of them will need GH¢ 400 million) by December 31, 2018 (ignoring any expected worsening of credit and economic impacts not factored into the IFRS nine estimate, profits for 2017, and potential consolidations).
In view of the above analysis, I recommend the following actions to be adopted by BoG and the banking industry from now until December 2018 and thereafter:
1. BoG should exercise its power under Section 105 (2b) of Act 930 to direct all banks by the end of January 2018 to present a capital plan and at the end of each quarter end, starting March 2018, banks should provide BoG with status update on their capital plans.
Banks should be asked to consider using guidance in the Basel Committee on Banking Supervision (BCBS) publication 277 called A Sound Capital Planning Process in their capital planning. The guidance requires four fundamental components of a sound capital planning process: (a) Internal control and governance (b) Capital policy and risk capture (c) Forward-looking view (d) Management framework for preserving capital.
2. Bank of Ghana should exercise its rights under Act 930 and prescribe guidance on corporate governance and restrictions on dividend payments tied to non-performing loans (NPLs) so as to constrain capital, restrictions on cross-border lending/risk participations and levels of lending to Group related banks. Such rights are provided under Act 930 as follows:
(i) Section 56 of Act 930- The Bank of Ghana may prescribe rules regarding any matter of corporate governance of a bank, including matters relating to (a) the scope and nature of the duties of directors of a bank, (b) the requirements for audit and other specific committees of the board; (c) the responsibilities of key management personnel; (d) risk management; (e) internal audit; and (f) internal controls and compliance.
(ii) Section 30 of Act 930 states that the Bank of Ghana may require a bank, specialised deposit taking institution or financial holding company to maintain additional capital that the Bank of Ghana considers appropriate to address concentration of risks in the bank, specialised deposit-taking institution or financial holding company, or in the financial system.
(iii) Section 77 states that The Bank of Ghana may, in respect of a prudential limit prescribed under this Act, impose a stricter limit for banks, specialised deposit-taking institutions or financial holding companies or a class of specialised deposit-taking institutions or a particular bank, specialised deposit-taking institution or financial holding company for the period that the Bank of Ghana considers appropriate.
(iv) Section 66 restricts inter-institutional placements and loans if the bank has capital adequacy ratio
of less than 10%
(v) Section 105 and 106 restricts the bank from lending if the bank breaches the capital requirements.
3 Section 78 of Act 930 requires banks to prepare accounts and financial statements in the form and provide details in accordance with a) internationally-accepted accounting standards; and b) rules or standards based on the Basel Core Principles as prescribed by the Bank of Ghana. In view of the requirements of section 78 of Act 930, BoG should require all banks to follow the following Basel principles
(i) Basel Committee on Banking Supervision (BCBS) publication 75 called “Principles for the Management of Credit Risk”.
(ii) BCBS 239 : Principles for effective risk data aggregation and risk reporting. BCBS 350 : Guidance on credit risk and accounting for expected credit losses
(ii) the Bank of Ghana applying the Basel Committee on Banking Supervision publication 155- Principles for sound stress testing practices and supervision to require all banks to perform stress testing as part of Internal Capital Adequacy Assessment Process (ICAAP) at least on a quarterly basis and for those banks that fail the stress testing, the Bank of Ghana will then exercise its rights under Section 30, Section 29 (6) and Section 29 (7)
(iii) Basel 2 and 3 requirements relating to leverage and liquidity ratios.
4. Banks with NPLs above a set threshold (for example, 10 per cent) should be subject to a more intensive oversight regime to ensure that they conservatively recognise and proactively address asset quality problems.
5. Bank of Ghana exercising its powers under Section 93 of the Act to require banks to submit accurate information to credit bureaus and applying the penalty for the submission of inaccurate, incomplete, delayed and non-submitted information to credit bureaus.
6. Enforcing conservative provisioning and write-off guidance under International Financial Reporting Standards (IFRS) 9- Section 78
7. Conservative application of accounting standards should be supplemented by micro- and macro prudential measures, such as time-bound targets for resolving delinquent assets and raising risk weights on impaired assets of a certain vintage (above the current 150 per cent, under the “standardised approach” adopted by all banks in Ghana).