Ghana has experienced challenges within the banking system in the past but nothing close to what happened between 2017 and this year.
During this period, nine banks have been liquidated at a cost to the public purse in excess of GH¢9 billion.
The ripple effects have been felt throughout the economy and are yet to be fully addressed.
The debate continues about the remote and proximate causes of the crisis and regulatory failure is frequently cited as the culprit.
In this paper, we discuss the financial regulation architecture in Ghana, how it might have contributed to the bank failures and the options for reform.
Types of regulation
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Financial regulation is the establishment of specific rules of behaviour for financial institutions and the monitoring of compliance through ongoing supervision and surveillance.
There are three dimensions of financial regulation: prudential regulation is the regulation of the safety and soundness of the financial institutions; market conduct regulation is the regulation of how financial institutions conduct their business with their customers and the protection of the consumers of financial services and macroprudential regulation relates to the soundness and stability of the financial system as a whole and the management of systemic risk.
Economists generally agree that there are economic justifications for financial regulation.
The justifications include the correction of market failures and imperfections, the need for consumer protection and confidence and the need to maintain systemic stability.
Globally, there is a wide variety of financial regulation architectures of which we can identify the following prototypes:
1. The traditional model
2. Fully integrated financial regulation
3. Partial integration
4. Twin Peaks regulation
Traditionally, the regulatory system has been built by creating regulatory agencies for categories of financial services.
In this system, there are separate regulators for insurance, banking, securities and pensions.
It is obvious that unless a special effort is made to coordinate the regulatory activities of the agencies, the system has in-built fragmentation.
For this reason, it has been called the ‘silo’ system.
By far, the vast majority of countries operate under this traditional model.
In recent times, many silo systems have attempted to improve regulatory coordination by augmenting the regulatory system with Financial Stability Councils, whose membership usually includes all the regulatory agencies.
At the opposite end of the continuum, there are regulatory systems that are fully integrated under one supervisor that is either the central bank or an independent agency.
In Singapore, the Monetary Authority of Singapore, which is the central bank, regulates the entire financial system.
Until 2013, the UK had the Financial Services Authority, a single regulator outside the central bank.
Fully integrated regulatory systems are designed to achieve a high level of regulatory coordination.
Under partial integration, the central bank is usually in charge of banking regulation with all other financial services regulated by a single agency outside the central bank.
Until 2018, the Reserve Bank of South Africa regulated banks while the Financial Services Board regulated all other financial services.
Mauritius also operates a similar system
The partial integration model is an attempt to improve regulatory coordination while preserving the primacy of the central bank in banking regulation and financial stability.
Some jurisdictions have opted for unified regulation but with a separation of prudential regulation and market conduct regulation into separate agencies.
This latter approach has been established by countries desiring a balance between prudential and market conduct regulation.
It has also been observed that prudential supervisors may face a conflict of interest if they also supervise market conduct.
This occurs because the prudential supervisor is primarily interested in strengthening the balance sheet of financial institutions and supervisory actions taken in this regard may not be in the interest of the consumer.
For these reasons, many countries have established independent consumer protection agencies (as in Canada) or a financial ombudsman (as in the UK).
The model resulting from the separation of prudential regulation and market conduct regulation is called the “Twin Peaks” model.
Australia and the UK are currently operating twin peaks models.
South Africa converted to a twin peaks model in 2018.
Many of the regulatory models have emerged from the peculiar circumstances of a country based on country experience, the political system, constitutional provisions and tradition.
Since the Global Financial Crisis of 2007-2008, many countries have taken a second look at their regulatory architecture.
Many have concluded that the architecture before the crisis did not allow for effective coordination.
In addition, the importance of the stability of the financial system and management of systemic risk had not been adequately recognised in pre-crisis regulatory systems.
Consequently, there has been a notable increase in the number of countries establishing Financial Stability Councils and moving towards better coordinated regulation.
The financial regulatory system in Ghana is a ‘silo’ system.
BoG regulates banks and special deposit-taking institutions (savings and loan, finance houses, microfinance companies); the Securities and Exchange Commission (SEC) regulates the securities industry and its market operators; the National Insurance Commission (NIC) regulates insurance companies and brokers and the National Pensions Regulatory Authority (NPRA) regulates pensions.
The system was not deliberately designed. Indeed, the current regulatory architecture may be considered a historical accident.
As each subsector developed, a regulatory agency was established to regulate the sector.
Relatively, little attention was paid to the linkages in the financial sector, thus leaving the regulators to operate relatively independent of each other.
However, Ghana’s financial system has become much larger with an increasingly wide variety of institutions and financial products and interlinkages between subsectors.
The following developments are instructive:
1. Regulatory arbitrage: This occurs when market operators look for loopholes in the system in order to escape regulation.
A common type of regulatory arbitrage in Ghana is that because of higher stated capital requirements, promoters find it easier to obtain an SEC licence as a fund manager with a stated capital requirement of GH¢100,000 compared to GH¢15 million for a savings and loan/finance house licence issued by BoG.
The discrepancy between the licensing and regulatory requirements has led to the phenomenal growth of asset management companies (from 34 in 2007 to 155 in 2017).
Many of them operate as disguised deposit-takers (to the chagrin of the SEC), issuing deposit liabilities without the need to comply with the capital, liquidity and solvency rules for formal deposit-taking institutions regulated by BoG.
2. Financial conglomeritisation: Today, there are groups of related financial institutions with the same beneficiary ownership with interests in securities, banking, non-bank financial institutions, asset management and insurance.
The BEIGE Group, for example, has interests in insurance, asset management, banking (the erstwhile BEIGE Bank) and pension management.
Conglomeritisation creates a severe asymmetric information gap between the regulator and the conglomerate.
Capital can be moved around the related companies undetected by the regulator whose supervision is limited to a subsector such as insurance or securities.
The writer is a financial economist and CEO, SEM Capital Advisors Limited