Navigating the challenges of domestic debt restructuring: A case for Bank Asset Securitisation (BAS)
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Navigating the challenges of domestic debt restructuring: A case for Bank Asset Securitisation (BAS)

Sovereign debt restructuring refers to the process of renegotiating the terms of a country's external debt, usually with the aim of reducing the burden of the debt on the country's finances. 

This process can have significant spillover effects on the financial sector, both domestically and internationally, as well as on the broader economy. 

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In this article, I examine the ripple effect of Ghana's Domestic Debt Restructuring on the banking sector and how banks can use bank asset securitisation through exchange traded funds (ETF) to improve their balance sheet.

One of the key spillover effects of sovereign debt restructuring is the impact on the domestic financial sector. In many cases, sovereign debt restructuring can lead to a reduction in the value of the government bonds held by domestic banks, which can in turn reduce the capital of the banks and lead to a contraction of credit. 

This contraction can have significant negative effects on the broader economy, as businesses may find it harder to access credit and invest in new projects. For example, the debt crisis in Greece in 2010-2012 led to a significant contraction of credit in the Greek economy, which contributed to a deep and prolonged recession.

Domestic debt restructuring is a process by which a government restructures its outstanding debt obligations to reduce the burden of debt service and to improve the overall fiscal health of the country. 

In Ghana, the government is going through a domestic debt restructuring exercise that is having a negative impact on the financial sector, particularly on banks.

The restructuring exercise involves the conversion of short-term debt into long-term debt, which has increased the interest rate risk exposure of banks. As a result, many banks in Ghana have experienced a decline in liquidity, profitability, and capital adequacy ratio (CAR). Here are some of the ways in which domestic debt restructuring can negatively affect the financial sector and banks:

1. Liquidity: Domestic debt restructuring can lead to a decline in liquidity in the banking system. 

This is because banks that hold the short-term debt that is being restructured may face difficulty in meeting their short-term funding requirements. This can lead to a liquidity squeeze in the banking system, which can have a negative impact on banks' ability to meet the needs of their customers.

2. Profitability: Domestic debt restructuring can also have a negative impact on the profitability of banks. The conversion of short-term debt into long-term debt can lead to a rise in interest rates, which can reduce the profitability of banks. 

In addition, the reduction in liquidity can lead to an increase in the cost of funds for banks, which can further reduce profitability.

3. Growth: Domestic debt restructuring can also have a negative impact on the growth of the financial sector. Banks that are facing a liquidity squeeze may be less willing to extend credit to their customers, which can slow down economic growth. In addition, the decline in profitability may lead to a reduction in investment in the sector, which can further slow down growth.

4. Capital adequacy ratio: Domestic debt restructuring can also have a negative impact on the CAR of banks. The conversion of short-term debt into long-term debt can increase the risk-weighted assets of banks, which can reduce their CAR. This can lead to a decline in the financial stability of banks and increase the risk of bank failure.

The decline in liquidity, profitability, growth, and CAR can lead to a reduction in the overall financial stability of the sector. Though the government as part of the domestic debt restructuring, announced a regulatory forbearance for banks, it was important for the bank to take steps to mitigate the negative impact of the restructuring exercise on their balance sheet as external partners (International Banks) may not recognise our domestic forbearance and so our local banks must ensure that they have the necessary support to weather the challenges that arise from the domestic debt exchange programme.

The Basel II standards require banks to use a risk-based approach to determine the amount of capital they need to hold to cover their risk exposure. Under Basel II, banks are required to assign risk weights to their loans based on the creditworthiness of the borrower and the type of loan. The risk weights are then used to calculate the bank's capital adequacy ratio (CAR), which is the ratio of the bank's capital to its risk-weighted assets. Banks are required to maintain a minimum CAR of 8 per cent, with higher capital requirements for banks with greater risk exposure.

Basel II provides a framework for banks to manage their risks and maintain adequate capital levels, bank asset securitisation can help to improve their balance sheet and stability as a result of the new risk posed by the domestic debt restructuring programme. 

Securitisation allows banks to transfer the credit risk associated with their loans, mortgages etc to investors, which can help to reduce their risk exposure and improve their CAR. 

Securitisation is a process by which financial assets, such as loans, mortgages and other cashflow generating assets  are converted into securities that can be sold to investors. These securities are typically backed by the cash flows generated by the underlying assets and are sold to investors in the form of bonds or other debt instruments. 

However, securitisation can also take the form of exchange-traded funds (ETFs), which are securities that trade on stock exchanges and represent a diversified portfolio of financial assets. 

To create an ETF from securitised bank assets, the bank would first securitise its assets by transferring them to a special purpose vehicle (SPV), which issues securities backed by those assets. These securities are then packaged together into a portfolio and listed on a stock exchange as an ETF.

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Investors can then purchase shares of the ETF, which represent a fractional ownership in the portfolio of securitised assets. The value of the shares is determined by the performance of the underlying assets, which generate cash flows that are distributed to the investors as income.

The advantages of securitising bank assets into ETFs include increased liquidity and diversification for investors, as well as potential cost savings for the bank. By listing the securitised assets on a stock exchange as an ETF, the bank can attract a larger pool of investors who are interested in a diversified portfolio of assets. This can help to increase the liquidity of the securitised assets, making it easier for the bank to raise funds by selling the securities to investors.

Moreover, ETFs can also offer cost savings for banks, as they can reduce the need for banks to hold large amounts of capital to cover their risk exposure. By securitising their assets into ETFs, banks can transfer the credit risk associated with the assets to investors, which can help to reduce the risk profile of the bank and free up capital for other purposes.

Securitising bank assets into ETFs can be a valuable tool for banks to raise funds, diversify their portfolios, and manage their risk exposure. By listing the securitised assets on a stock exchange as an ETF, banks can attract a larger pool of investors, increase the liquidity of the assets, and potentially reduce their cost of capital. While securitisation is not without risks, it can be an effective way for banks to manage their balance sheet and improve their financial stability. However, there are also potential negative effects of securitisation on banks. One major risk is that the bank may be left with assets that are difficult to securitise or sell, which could result in a significant loss. Additionally, securitisation can lead to a misalignment of incentives between the bank and the investors in the securities. For example, if the bank is not sufficiently incentivised to monitor the performance of the assets that it has transferred to the SPV, this could lead to lower quality assets being included in the securitisation.

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Furthermore, securitisation can lead to an increase in systemic risk if it is used excessively or if the securities issued by the SPV are not properly rated or priced. This can make it difficult for investors to accurately assess the risk associated with the securities, which can lead to a mispricing of risk and an increase in overall systemic risk.

In order to mitigate these risks, it is important for banks to implement securitisation in a responsible manner. This may include ensuring that assets are properly evaluated before being included in a securitisation, aligning the incentives of the bank and the investors, and using appropriate risk management techniques to assess and manage the risks associated with securitisation.

Ghana can adopt various types of regulations to govern the securitisation of bank assets, in order to ensure that the process is conducted in a transparent, fair and responsible manner. Some of the key regulations that can be adopted include:

1. Disclosure requirements: The regulatory authorities can require banks and other entities involved in securitisation to disclose all relevant information about the assets being securitised, the terms of the securities being issued, and the risks associated with the investment.

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2. Minimum standards for credit quality: The regulatory authorities can establish minimum standards for the credit quality of the assets being securitised, in order to ensure that only high-quality assets are securitised.

3. Asset valuation standards: The regulatory authorities can establish standards for the valuation of assets being securitised, in order to ensure that the assets are accurately valued and that the securities issued are fairly priced.

4. Risk retention requirements: The regulatory authorities can require banks and other entities involved in securitisation to retain a portion of the credit risk associated with the assets being securitised, in order to align their interests with those of investors.

5. Investor protection: The regulatory authorities can establish rules to protect investors, such as requirements for disclosure, suitability standards, and restrictions on the types of investors that can invest in securitised products.

6. Supervision and enforcement: The regulatory authorities can establish a framework for the supervision and enforcement of securitisation rules, in order to ensure that banks and other entities involved in securitisation comply with the regulations.

Countries similar to Ghana that have adopted similar regulations include South Africa, Nigeria, and Kenya. For example, South Africa's National Credit Regulator has established rules for the securitisation of consumer loans, which require disclosure of all relevant information, minimum standards for credit quality, and restrictions on the types of investors that can invest in securitised products. 

Similarly, Nigeria's Securities and Exchange Commission has established rules for the securitisation of assets, which include disclosure requirements, minimum credit quality standards, and risk retention requirements. 

Kenya's Capital Markets Authority has also established regulations for securitisation, which include disclosure requirements, minimum standards for credit quality, and investor protection measures.

According to Andrew D. Stone, senior managing director in charge of mortgage and asset-backed securities at Daiwa Securities America Inc.: "You can securitise virtually everything. The imagination is our only constraint, and time, because you can't chase every deal. "

There is going to be a fundamental change in the financial sector after the domestic debt exchange programme, and banks must innovate or die!

Korsi Dzokoto
The writer is an investment advisor and a financial consultant.

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