Takeovers loom as Ghanaian banks reach inflection point

Ghanaian banks have been busy exploiting the country’s stellar economic performance. The major lenders managed to make returns on equity (ROEs) of 30% to 35% in the few years before 2009. Earnings dropped that year as the country's economy slowed, falling victim to the global downturn. But as growth revived in 2010, with the real gross domestic product (GDP) expanding 7.7%, so did banks’ profitability. With the economy expected to grow another 13% this year, they should be in for more good times.

Much of the current growth in GDP is a result of Ghana becoming an oil exporter in December, following the discovery of the huge offshore Jubilee field in 2007. This has greatly excited bankers, who say that plenty of additional business will now come their way. “We expect that banking revenues will grow significantly as a result of the oil,” says Benjamin Dabrah, managing director of Barclays Bank of Ghana.

Spin-off activities

Local banks are unlikely to finance upstream activity, given their small balance sheets and lack of expertise in providing the structured deals often required by the sector. Instead, they will seek to fund the ancillary businesses that will come with the oil. Among them are fertilisers and plastics, both of which can be made from the by-products of oil extraction. Analysts say their production is likely to increase rapidly in the coming years.

Other spin-off activities will include helicopter services ferrying workers offshore and real-estate developments in the west of the country, off the coast of which lies the Jubilee field. “The upstream sector is already dominated by external banks because they have the capital and the balance sheets to be able to do that,” says Simon Dornoo, head of Ghana Commercial Bank, the largest bank in the country. “For local banks, it’s about funding the services component of the industry. There are great opportunities.”

It is not just oil-related businesses that banks are looking to finance. Many others are expanding quickly, in line with the economy. Ken Ofori-Atta, co-founder and executive chairman of Databank, a Ghanaian investment bank, says that financial services, tourism and healthcare are all on lenders’ radars, having profited from rising wealth and a growing middle class in the past few years.

Agricultural production is also expected to increase. Despite being a largely agrarian economy, Ghana needs plenty of investment to reach its potential, say bankers. They note that less than a quarter of its arable land is cultivated and that most farming is rain-fed, not irrigated. “There’s incredible opportunity if appropriate capital and infrastructure are deployed in the area,” says Mr Ofori-Atta.

Risky retail banking

Ghanaian lenders typically make only 20% to 40% of their revenues from retail banking, deriving the bulk from corporate customers. This is mainly because of the risks of consumer lending in the country. “It’s largely a factor of the financial infrastructure,” says Mr Dabrah. “There are no reference bureaus or a national identity system. It’s very difficult to identify people properly and when they don’t pay, there really aren’t any consequences for them.

“A fully functional reference bureau will help, particularly on the retail side, because you’ll have more information about borrowers and there will be a consequence if they default. It will make future access to credit much more difficult for them.”

The government is making efforts to develop the financial system, albeit slowly. As well as plans to establish credit bureaus, it recently passed a law making it easier for banks to realise collateral from defaulted borrowers.

Other barriers remain, however. A major impediment is the expense of growing a retail operation. There is a lot of scope for expansion, given that fewer than five million Ghanaians, out of 24 million, have bank accounts. But bankers say it is often hard to justify building new branches, especially in rural areas that have little formal economic activity. Many lenders are instead focusing on making their existing networks more profitable and getting them to generate more transactions. 

Demand for consumer credit is rising, even if banks remain wary about retail banking. This is a result of not only Ghana’s burgeoning middle class, but of economic growth taking place amid falling interest rates. The central bank has reduced its policy rate from 18.5% to 13% since early 2009 – leading in turn to lower costs for borrowers – and could carry on cutting if the decrease in inflation during that period, from 20% to 9%, is not reversed.

Hunting for assets

Ghana’s lenders have the capacity to increase their exposure to corporate and retail customers. Their average capital adequacy ratio was a high 18.5% in February and their loan-to-deposit ratios just 61%. “We are very liquid,” says Mr Dornoo. “We are actively looking for assets.”

Banks’ balance sheets have grown in recent years, their assets increasing 25% last year and 30% in 2009. But deposits, by far their main source of funding, have risen even quicker – at a rate of 31% in 2010 – allowing them to maintain their strong liquidity.

Despite this, Ghana’s banks are reluctant to accelerate their lending. Most of their asset enlargement is down to them investing in government securities, rather than providing their corporate and retail customers with more credit. This caution is justified, they say, given that the banking sector’s non-performing loans ratio was 17% at the end of December.

The prevalence of bad loans is partly a result of the slowdown in 2009. The government must also shoulder some of the blame because its arrears grew to such an extent between 2007 and 2010 that many of its suppliers suffered cashflow shortages. But bankers admit that lending standards dropped amid a rush to gain market share. “It was just a question of time,” says Mr Dornoo. “Banks have paid the price for it.”

Survival of the fittest

Several analysts say that despite the opportunities provided by oil and the booming economy, Ghana’s lenders will soon struggle unless they change their strategies. This is because falling interest rates are likely to squeeze their lending margins. “We’re at a point of inflection,” says Alhassan Andani, managing director of Stanbic Bank Ghana, a subsidiary of Standard Bank. “Banks have basically survived thanks to high interest rates. As those collapse, they’ll have to think differently.”

The smallest institutions will initially be hit hardest. “ROEs will be made on scale,” says Mr Dornoo. “For smaller banks there will be a major squeeze in ROEs. You can sustain them when you’re big and you can reduce your unit costs.”

A lower interest rate environment might force greater innovation on the banking system. Most lenders offer little more than rudimentary services such as current accounts, vanilla loans and letters of credit. But as margins drop, they will have to provide more sophisticated savings and lending products.

They could also encourage more of their clients to tap the capital markets, thereby increasing their fee-based revenues. Ghanaian companies have tended to rely solely on banks, rather than institutional investors, for their debt funding. But several might be tempted to issue bonds as rates fall. Others could attempt initial public offerings, especially if banks boost their capacity to underwrite such transactions and advise firms about them.

A small investor base has hindered the growth of the capital markets. Many companies thinking about raising equity are put off by the lack of liquidity on the local stock exchange, where only 56m cedis ($37m) of shares were traded in the whole of the first quarter of 2011. But this is changing, says Databank’s Mr Ofori-Atta, as banks make bigger efforts to get Ghana’s diaspora to invest in the country and because of new legislation allowing some state pension fund contributions to be managed privately. “We’re going to see mobilised capital outside of the control of government,” he says. “It should lead to more listings because fund managers will be aggressively looking to invest in companies.”

Consolidation ahead

Several bankers believe that a long period of low interest rates will lead to consolidation. They say that the finance sector, which comprises 27 wholesale banks, is too crowded for a country with a nominal GDP of $30bn. Many dismiss the notion that having more lenders will help reduce the number of unbanked Ghanaians. “You can’t equate making banking accessible to a lot of people with having many banks,” says Mr Dornoo. “They’re not the same thing.”

Some of the smaller lenders are already struggling amid intense competition and will find it difficult to meet the central bank’s minimum capital requirement of 60m cedis – up from 7m cedis – by next year’s deadline. “Consolidation is only a matter of time,” says Mr Dornoo. “Another 500-basis-point drop in interest rates will encourage it. In a low interest rate environment, the name of the game is scale.”

Still, few rule out the possibility of more foreign banks trying to gain a foothold in the country by buying local institutions. Ghana’s banks have plenty of potential, not least because of the oil and rapid economic expansion, with or without low interest rates.