GHANA CENTRAL BANK'S NEW MONETARY POLICY

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
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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
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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
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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
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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
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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