US embassy cable - 05ACCRA1517

UNCLAS SECTION 01 OF 02 ACCRA 001517 
 
SIPDIS 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: EFIN, ECON, GH 
SUBJECT: GHANA CENTRAL BANK'S NEW MONETARY POLICY 
FRAMEWORK: IMPACT ON THE FINANCIAL SECTOR 
 
 
Summary 
------- 
1. (SBU) The Bank of Ghana (BoG) instituted a new monetary 
policy framework on July 1 -- including reduced reserve 
requirements -- to move towards an inflation targeting 
regime, increase transparency, and make the financial sector 
more competitive.  Despite the potential expansionary effect 
of the new policy, the BoG is confident it is controlling 
inflation and is positioned to handle any external shocks. 
Private banks applauded the policy shift and say it should 
spur lending.  However, they complain of constraints such as 
labor costs and an inadequate legal system that increase 
risks and lead to high lending rates.  End Summary 
 
Bank of Ghana's New Monetary Policy Framework 
--------------------------------------------- 
2. (SBU) On July 1, the BoG unveiled its new monetary policy 
framework, which aims to create a more transparent, efficient 
and competitive financial sector, develop a secondary market 
in government securities, and encourage banks to expand the 
inter-bank lending market.  The BoG will lessen its focus on 
controlling the money supply and will focus more on using the 
Prime Rate and other BoG lending instruments to control 
inflation and signal the direction of short-term interest 
rates. 
 
3. (SBU) The key element of the new framework is the 
reduction of the secondary reserve requirement (RR) on 
deposits from the current level of 35% -- high compared to 
Ghana's peers -- to 15%.  (Note:  banks' primary RR of 9% is 
deposited in non-interest bearing accounts at the BoG, while 
the secondary RR must be held in a mix of long and short term 
government securities.  End Note).  Another key aspect is 
that the BoG will separate Open Market Operations (OMO) from 
Public Sector Borrowing Requirement (PSBR) operations, which 
should make for more transparent BoG signaling to the 
financial markets. 
 
4. (SBU) BoG Governor Paul Acquah's top policy advisor, Dr. 
Mahamudu Bawumia, commented to econoffs that the high 
secondary RR contributed to disintermediation and high rate 
spreads (between deposits and loans) in the banking system. 
Conversely, lowering the RR should increase available funds 
banks have to lend to the private sector, which should result 
in greater competition and lower lending rates. 
 
5. (SBU) The framework also includes the introduction of 
overnight REPO and reverse-REPO facilities, designed to 
deepen and improve the transparency of inter-bank markets, 
and give banks incentive to use the inter-bank market to 
solve their liquidity problems.  The BoG also intends to 
increase transparency by providing continuously updated 
information on inter-bank market transactions through 
Reuters.  Finally, the BoG will facilitate development of the 
non-cash payments system by requiring all banks to use the 
Visa Payments (ATM) Platform. 
 
Private Banks' Views 
-------------------- 
6. (SBU) Ghana's banks have been among the most profitable in 
sub-Saharan Africa, largely as a result of earnings on their 
holdings of high-interest government T-Bills and large 
spreads between deposit and loan rates.  According to a 2005 
BoG survey, interest rate spreads in Ghana were among the 
highest in Africa in 2004, with average deposit rates of 7.5% 
and average lending rates of 28.8%.  The spread has narrowed 
over the last year as T-Bill rates fell, but is still 
significantly larger than in any of Ghana's peer countries. 
 
7. (SBU) The high lending rates are a main reason for 
relatively limited lending to the private sector.  However, 
banks point out that the GoG traditionally absorbed much of 
the available credit through the high reserve requirements, 
which acted as an implicit financial tax.  Furthermore, the 
BoG capped bank fees, which encouraged banks to boost returns 
through higher lending rates.  (Note: The BoG study also 
reports evidence of oligopolistic behavior among Ghanaian 
banks, with five banks controlling 70% of total assets and 
little evidence of competition in fee pricing or interest 
rates.  End Note) 
 
8. (SBU) Bankers agree that the lower RR will increase their 
liquidity and should result in more lending to the private 
sector.  However, they point to other factors that raise both 
costs and risks for banking in Ghana. Banks' labor costs 
average over 55% of overhead costs and are a major 
contributor to the large loan-deposit rate spread.  Banks 
also point to the lack of an effective land titling system, 
high costs of foreclosure, and inadequate legal and 
regulatory structure as main components of high risk premiums 
-- resulting in higher rates and fees.  They also have a 
legitimate claim that the difficult macroeconomic environment 
from 2000-2004 discouraged lending.  Finally, banks have 
tapped out blue chip customers so most new lending will go to 
SMEs.  Given inherent risks in SME lending, as loans to this 
sector increase over the next few years many in the industry 
expect the non-performing loan ratio to increase. 
 
BoG Comments on Inflation Concerns 
---------------------------------- 
9. (SBU) Some observers have commented critically on the 
timing of this initiative, given pressures from high fuel 
costs on inflation and following on the heels of the BoG's 
expansionary policy decision in May to lower the Prime Rate 
from 18.5% to 16.5%.  Dr. Bawumia admits that the lower RR 
will increase the money supply over the medium term, which 
may create an excess liquidity problem for the BoG to deal 
with.  Nevertheless, he notes that BoG officials are 
confident the economy has absorbed February's 50% fuel price 
hike and inflation is on a downward trend. 
 
10. (SBU) Dr. Bawumia also argues that the BoG is better 
equipped to handle the impact of future shocks, such as 
further fuel price increases, with its separate Open Market 
Operations, and with the BoG's two new OMO tools:  28 and 56 
day T-bills.  Bawumia even comments that the BoG's medium 
term goal is to relax BoG oversight even further by 
eliminating the secondary reserve requirement altogether. 
The BoG is also drafting a new foreign exchange law that will 
liberalize the entire financial sector, eliminating capital 
controls and opening up opportunities for foreign currency 
and off-shore lending. 
 
Comment 
------- 
11. (SBU) Banks have been vocal for years with their 
complaints about the high reserve requirements on deposits, 
and have used it as the main justification for their high 
lending rates and relatively limited lending to the private 
sector.  Now that they have their wish, it is put up or shut 
up time.  However, if an upward trend in private sector 
lending does not develop over the second half of 2005, we can 
expect calls from the private sector and even government 
ministries for the BoG to increase pressure on the banking 
system.  End Comment. 
YATES