Unbanked population, low savings culture  & high interest rates

BY: Alhassan Musah
Dr Ernest Addison, Governor of the Bank of Ghana
Dr Ernest Addison, Governor of the Bank of Ghana

There are a number of challenges contributing to high interest rates and cost of borrowing in developing economies such as Ghana, but this write up will focus on one of the key factors worth paying attention to.

In Ghana, governments have made varied efforts at reducing the cost of borrowing for businesses and individuals in a bid to stimulate rapid economic growth. These efforts have yielded relatively minimal  results than expected, as interest rates and borrowing costs have remained relatively high and erratic over the years.

In our efforts to bring down borrowing costs as a catalyst for the private sector to create jobs and grow the economy, one area that needs attention is the number of people operating outside the banking system and the consequent low savings culture (the significant amount of loanable but idle funds held by the unbanked population).  

Globally, available data from the World Bank Group indicate that the number of citizens worldwide with bank accounts is steadily growing. The number of people having bank accounts grew by 700 million between 2011 and 2014. The estimates put the world’s adult population having a bank account at 62 per cent; up from 51 per cent in 2011.

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The story is, however, different in developing economies, especially those in sub-Sahara Africa. In Ghana, only about 30 per cent of our citizens are estimated to have bank accounts. A significant proportion of the Bank of Ghana’s narrow money (M1) continues to remain outside the banking system.

Central bank’s report

The central bank’s report on Macroeconomic and Financial Data for May 2017 shows an increasing growth rate of currency outside the banking system from 15.20 per cent in March 2016 to 22.30 per cent in March 2017. This is a setback to the efficiency of banks in creating credit in the economy as one of their important roles. This then drives up borrowing costs for individuals and businesses.

To illustrate the point above, suppose Kofi and Esi deposit GHC500, 000.00 each at bank X. There is a cash claim of GHC1, 000,000.00 on the bank. They can write cheques to claim any amount of their money. However, bank X only needs to keep 10 per cent of the deposit (GHC100, 000.00) as cash reserving with the central bank.

Bank X can then extend credit to Musah and Afua to the tune of the remaining GHC900, 000.00. The two individuals can also claim cash to a total of GHC900, 000.00 from the bank.

This results in four different cash claims on the bank amounting to GHC1, 900,000.00 on the back of GHC1, 000,000.00 original deposits. This is possible with the principle of fractional – reserve banking, which assumes that, depositors (Kofi and Esi) will only withdraw a fraction of their deposits at a time. If the bank is hard pressed for cash to meet withdrawals, it will then fall on the central bank for short-term funding to meet the customer cash needs.

From the above, we now have GHC1, 900,000.00 cash claims on the bank (rather than nothing if the monies were kept under the pillow). This can be deployed to productive use by each of the individuals to help create more jobs. The multiplier effect is bigger if more citizens have bank accounts and their monies are in the banking system. This will result in increased availability of funds for banks to meet the demand for credit. The natural consequence (demand and supply law) would be that the price of credit (borrowing costs) will come down in a free market economy.

Limiting factor

It must be noted, however, that one limiting factor to the bank’s ability to lend all the remaining GHC900, 000 in loan is the capital adequacy requirement by the Central Bank which is currently at 10 per cent. This requires that for every GHC100.00 of loan granted by a commercial bank, a minimum of GHC10.00 must come from the shareholder’s equity. This implies the bank will only be able to lend all the GHC900, 000.00 in loans if the total qualifying capital on its balance sheet is up to GHC90, 000.00 (10 per cent of GHC900, 000.00). Otherwise the bank has to deploy the available liquidity in other risk-free assets.

With about 37 banks competing for few depositors in Ghana, the market tends to be what could be termed “depositors’ market”, where depositors (mostly large institutional depositors) demand high interests from competing banks. These interest costs then get passed on to borrowers.

Another challenge flowing from the huge unbanked population is the high liquidity risks on banks’ balance sheets. By relying on only a small number of depositors, many banks carry unquantifiable liquidity risks known as concentration risks. That is the risk of “putting their eggs in one or fewer baskets” (less diversification).
Available research shows that there is a direct relationship between the size of a country’s unbanked population and banks’ depositor concentration risk.

Rather than having a higher proportion of deposits coming from a broader retail customer base, capturing most sectors of the economy, most banks in Ghana have disproportionately higher percentage of their deposit pool skewed towards fewer (mostly institutional) depositors, or sectors of the economy. These wholesale deposits are relatively volatile, thus, compromising the principle of fractional-reserve banking as explained above.

Post financial crisis

After the 2007/2008 financial crisis, the subsequent Basel III guidelines on bank liquidity and capital management recommended that banks with high liquidity risks may deploy more of their balance sheets funding into high quality liquid asset (HQLA), such as government bonds/bills, and high quality-rated corporate debts in order to maintain safer levels of Liquidity Coverage Ratio (LCR).

With a relatively few corporates with formal ratings in Ghana, this leaves many banks with virtually no option than government bonds/bills to manage the additional risk from undiversified funding sources. This leaves less funding available for long-term lending such as mortgages etc. thus, driving costs up for borrowers.  

Efforts by the government, in collaboration with private sector, to drive more financial inclusion and increase savings culture through various channels such as E-zwich, mobile money, etc., is a step in the right direction.

Sub-Sahara Africa is the only region reported by the World Bank group to have more than 12 per cent of adults having active mobile money account compared to just two per cent globally. In many of these countries, more adults are reported as using mobile money accounts than an account with a traditional financial institution.

This is a clear avenue to get more citizens to operate active bank accounts, get more funds into the formal banking system and ultimately drive down costs of borrowing and create more jobs through increased economic activity.