Solvency and liquidity: key watchwords
Since August last year, when the Bank of Ghana (BoG) applied the stick by revoking the licences of two banks, namely UT Bank and Capital Bank, a lot of premium is now placed on issues relating to the banking sector.
As if that is not enough, the BoG has placed uniBank under a new caregiver, KPMG, to ensure that it does not go the way of the two failed banks while just last Friday an advisor was appointed for the Sovereign Bank.Follow @Graphicgh
We applaud the Governor, Dr Ernest Addison, and his team for ensuring that the rules are strictly applied without fail or let in order not to compromise the soundness and safety of the financial services sector as a whole. Sometimes the best way to get the message across is to remove the gloves and fight with the bare knuckles.
In trying to figure out how to stop banks failing, it helps to start with an understanding of why they fail. Banks exist as financial intermediaries so they are expected to be able to meet their day-to-day financial obligations to their depositors; therefore, there is a problem if they fail to honour their obligations. There are two basic risks that banks need to watch out for: solvency and liquidity.
Solvency is having meaningful positive equity on the balance sheet, that is assets exceeding liabilities. It states the relationship between borrowed funds and owner’s funds in the capital structure of a bank. Solvency is reduced by bad loans and investments, which become bad debt expenses on the profit and loss statement and write-downs in the value of assets on the balance sheet.
Liquidity is essential in all banks to meet customer withdrawals and provide funds for growth, so banks must maintain sufficient levels of cash, liquid assets and prospective borrowing lines to meet expected and contingent liquidity demands.
It can be defined as the ability to provide cash to meet day-to-day needs as they arise.Therefore, a bank must be able to generate enough money to cover short-term obligations to become a liquid organisation.
Liquidity issues arise as a result of banks undertaking maturity transformation, which is taking short-term deposits and lending them out for longer terms. Customers want to deposit funds with banks and earn a positive interest rate while being able to withdraw the funds at short notice.
Borrowers need long-term loans to purchase property and equipment for their personal or corporate uses. Banks provide a service to the economy by bridging the gap between the two. Experience has shown that maturity transformation is a dangerous business.
Rumours of a bank having solvency issues are enough to start a rush for the exits by depositors, which can snowball once pictures of people lined up outside bank branches hit the news.
And because these two major risks are very important to the financial services sector, and the economy as a whole, we are organising the Graphic Business/ Stanbic Bank on Tuesday, May 15, 2018 to discuss the solvency and liquidity management – and how they can boost the financial health of banks.
We believe that a discussion which involves Dr Addison himself; the President of the Ghana Association of Bankers, Mr Alhassan Andani, and the Senior Country Partner of PricewaterCoopers, Mr Vish Ashiagbor, will definitely bring clarity and understanding to the issues of banking and internationally acceptable best practices. — GB