Credit –based economy: the current state of credit economy and the way forward

By Dr. Richmond Akwasi ATUAHENE

A credit-based economy is a system in which individuals, businesses, and governments use credit, or borrowed money, as a primary tool for conducting economic transactions. In such an economy, credit plays a crucial role in facilitating consumption, investment, and overall economic growth. In the developed economies like United States (216%), Germany (187%), Australia (144%), and Switzerland (108%) are the best-known credit-based economies in the world.

These economies have well-developed credit markets with a diverse range of financial products and services. These economies have well-developed credit markets with a diverse range of financial products and services. Their credit infrastructure, including credit bureaus, scoring models, and regulations, supports widespread access to credit for individuals and businesses.

These developed economies have experience stable macro-economic environment with low inflation, stable exchange rate, low minimum lending rates, manageable public debts and low fiscal deficits. Their credit infrastructure, including credit bureaus, scoring models, and regulations, supports widespread access to credit for individuals and businesses.

In such developed economies, enabling credit infrastructures of sophisticated property addressing systems and unique identification numbers like UK National Social Security Insurance Numbers, US Social Security Numbers.

These unique identification numbers are on centralized database that financial institutions could be easily accessed. In this type of environment, interest rates on loans and other credit facilities would be lower than in an environment in which the word of the borrower cannot be trusted and probability of default is high. Unique property address system is probably one of the underestimated requirements for the development of the developed economies and their financial sectors.

One can imagine what could happen if for example the addressing systems in the USA, UK. Euro-zone, and Japan disappeared overnight. These developed economies could grind to a halt because so much depends on residential or business addresses. For banks and other lenders are able to track and trace defaulter easily. For example, the UK developed its postcode system in the 15 year period between 1959 and 1974 (Bawumia, 2010).

Credit based- economies have well-developed credit markets with a diverse range of financial products and services. Their credit infrastructure, including credit bureaus, scoring models, and regulations, supports widespread access to credit for individuals and businesses.

World Bank data (2023) on domestic credit to private sector stood at 10% in 2023 one of the lowest in the Sub-Sahara Africa. World Bank data revealed on domestic credit to private sectors for the following countries; Egypt (29.3%); Burkina Faso (31.6%); Botswana (30.1%); Cote D’ivoire (22.5%); Mauritius (68.1%) and Nigeria (13.8%).

According to Dokua-Sasu data (2023) Small and Medium -sized Enterprises played a significant role in Ghana’s economy. In 2023, over 90% of business enterprises in the country were SMEs. Moreover, SMEs did not only form around 80% of the total employment in Ghana but also accounted for 60%   the country’s GDP.

The contribution of the private sector to the development and sustainable growth of an economy cannot be underestimated, as the SMEs are considered as an engine for growth. The World Bank defines small and medium enterprises as ‘any firm that has an employee size of up to 300 and an annual sales of not up to US$15 million.

In Ghana, small and medium enterprises can be defined as any enterprise or business entity that employs less than 10 employees for small enterprise and any firm with more than 10 employees is classified as medium and large according to Ghana Statistical Service. Most of credit markets  in the developing economies have fraughted with macroeconomic challenges, weak regulatory and legal infrastructures, crowding out by the government through excessive borrowing, high fiscal deficits

2.0 The current state of the credit economy in Ghana

Difficult and harsh macroeconomic environment over the past decade have affected the credit market negatively. The economy has been characterized by large budget deficits, inflation, higher interest rates, depreciation of the local currency and low economic growth. . A large proportion of the energy sector’s debt is owed to the banks.

The debt negatively affected the balance sheet of Ghana’s banks and was a primary contributor to the escalation of nonperforming loans during the period. High lending rates; high policy rates; low ratio of private sector credit to GDP; increasing levels of non-performing loans; government excessive borrowing at treasury bill market that had resulted in crowding out of the private sector. Lack of availability of credit information.

The continued lack of reliable credit information, a system of disclosing information and a database or centralized repository of borrowers’ credit histories impedes the greater flow of credit and collateral-based lending.

This has also raised the risk premium that banks require. In the myriads of macro- environment challenges, and era of non-payment of arrears to contractors, other service providers and energy companies, the recent launching of a credit scoring system is unlikely to have a meaningful impact on the availability of credit delivery as well as improving on the high non-performing loan ratio in the banking sector.

High lending rates had been a major hinderance to private sector growth. High lending rates in Ghana are among the highest in the Sub-Sahara Africa thus creating significant challenges for SMEs looking to grow and expand to contribute to the economic development Weaknesses in banks and SDIs’ risk management and in supervision have also been important factors. Universal banks and SDIs’ internal controls are generally lax and risk management practices have not kept pace with the growth of the industry and the changing risks.

Access to credit in Ghana is hindered by limited financial infrastructure, high collateral requirements, the presence of the informal economy, limited credit history, and high-interest rates. The lack of developed banking services and credit reporting systems makes it difficult for lenders to assess borrowers’ creditworthiness.

Additionally, the need for significant collateral poses a barrier for individuals and small businesses with limited assets. In Ghana, credit performance has historically been poor due to several factors, including the high level of poverty, limited financial literacy, and challenges in the regulatory and legal frameworks Ghana’s credit environment had faced general economic deterioration of macro-economic instabilities of high inflation, persistent depreciation of local currency, higher policy rates and lending rates as well high fiscal deficits. Ghana’s banking sector does not need a credit scoring system right now.

What it needs is a stable macroeconomic environment, policies that promote business growth and reforms that address the structural weaknesses in the financial system. One significant challenge that banks and SDIs faced had been partial or non-existent customer or client home and business location addressing systems; increased operational costs. Banks and SDIs may have to incur higher costs in verifying borrowers’ information and conducting due diligence which could impact on their profitability. There are nine structural issues that have impeded the credit market in Ghana over the past decade.

29. Difficult and harsh macroeconomic environment of high inflation, persistent depreciation of local currency, higher policy rates with associated higher lending rates, and low growth. A key determinant of high nominal interest rate is inflation. According to Bawumia (2010) this is why central banks through -out the world have focused more narrowly on the objective of durable macro-economic stability. Throughout the years, Ghana have been able to attain short periods of macro-economic stability, punctuated by long periods of macroeconomic instability over the past five years driven by fiscal excesses. The past five years the country has experienced has harsh and difficult macroeconomic environment for both banks and SDIs as a result of a general deterioration of economic conditions which have resulted in the rising in non-performing assets in the financial sector. Macro-economic instabilities have affected the ability of financial institutions ability to absorb and manage the risks and behavior of creditors. Stable macro-economic conditions influence the effectiveness of markets, the ability of the financial system to intermediate resources, and economic growth. Persistent macro-economic instabilities have hampered the functioning of financial markets and such conditions have also affected the ability of financial institutions to absorb and manage their risks. Over the past five years, macro-economic instabilities, market volatility had led to destabilizing creditor runs (including deposit runs). Moreover, uncertainties about future movements in relative prices including asset prices and exchange rates could make difficult to determine the medium to long term viability of the banks and SDIs. Over the past five years the macroeconomic environment deteriorated rapidly, reflecting a confluence of a food and energy crisis and an expansionary fiscal policy. As fiscal deficits widened, inflation accelerated, interest rates rose to around 30 percent, investors became skittish and began to exit the debt market, and the exchange rate began to depreciate, thereby creating conditions for asset price deterioration. Macroeconomic conditions have fundamentally changed, with a steep increase in consumer price pressures causing Bank of Ghana to tighten monetary policy that have resulted in higher policy thereby impacted on higher lending rates. For banks and SDIs, the current macroeconomic environment comes with two major challenges. First, sudden or persistently high inflation presented rationale for deposit insurer to review the appropriateness of their coverage level. Second, the tightened monetary policy necessary to reduce inflation has exacerbated economic downturns, with associated risks to deposit insurers. The Ghanaian economy was characterized by large budget deficits, inflation, higher interest rates, depreciation of the local currency and low economic growth. Ghana for the past three years has been classified as a hyperinflationary economy with three-year cumulative inflation for the country being 128%. (IMF World Economic Outlook 2023). Ghana has been on the hyperinflation watch-list for a while. Effective 31 December 2023 the International Practices Task Force (IPTF) determined that with a 3-year cumulative inflation of 133% it is now there.  When a country becomes hyperinflationary, all entities having the local currency as its functional currency must apply IAS 29. All reported balances and transactions are adjusted to compensate for the currency losing its purchasing power. This has to be achieved by adjusting the values reflected for the country’s general price index at reporting date compared to the general price index at transaction date. Macroeconomic instabilities over the past three years had impacted negatively on the financial sector. The rate of inflation remained high and volatile during much of the period 2022-2024. The rate of depreciation of the local currency, the cedi, increased over same period and the budget deficit situation has persisted. These unstable conditions impacted negatively on the operations of all financial institutions and the financial depth of the economy. The financial sector has not yielded the intended effects, primarily because of the lack of sustained improvements in the macroeconomic environment. However, weaknesses in the fundamental structure of the economy have also affected the outcome of financial sector reforms over the period 2019 -2023.
30. One of the key challenges to Bank of Ghana’s monetary policy has been the accommodation of the fiscal deficits by the central bank. The recent monetization of the government expenditures during the Covid 19 and Russia/Ukraine war affirmed the fiscal dominance which have resulted in the high inflation in the economy. High budget deficits led to increasing interest rates on government debt (Treasury Bills Market) reorienting credit away from the private sector to the government. Furthermore, since term deposits are benchmarked to treasury-bill (T-bill) rates, high fiscal deficits affect banks’ funding costs, contribute to high lending rates, and erode capacity to service debts. The underlying real economy also showed structural weaknesses which made it vulnerable to instability and poor agricultural sector and trade performance. High fiscal deficits over past five years have compounded the NPL situation, as government arrears undermined the capacity of contractors to service their obligations to banks and SDIs. In the context of these global shocks and the 2008 elections, public sector spending increased substantially, raising the fiscal deficit from 7.6% of GDP in 2006 to 14.5% of GDP in 2008 to a further record high of 15.2% of GDP in 2020 but declined to 12.2% of GDP in 2021, but declined marginally to 11.8% in 2022 and provisionally declined to 8.4% in 2023. All these high fiscal deficits have contributed to the increasing non-performing loans ratios in the banking sector over the past decade.
31. Ghana’s unsustainable debt environment over the period 2017- 2023. Ghana as a country has operated in an unsustainable debt environment which impacted negatively on their operations of the financial services sector.  Ghana’s economic and financial crisis of the last three years has been the most severe crisis that a developed economy has ever experienced in modern history, both in terms of output and employment loss as well as duration. In 2012, Ghana’s debt increased sharply from GH₵1 billion or 48.4% of GDP to GH₵122.6 billion or 73.3% of GDP in 2016, indicating an increase of GHC 87.5 million or 24.9 percentage points of GDP in four years. However, Ghana’s nominal debt has increased from GH₵122.6 billion or 73.3% of GDP to GH₵546 billion or 88.1% of GDP in 2022 and further increased to GH₵610 or 72.5% of GDP despite a comprehensive and painful domestic debt exchange program in September 2023. The situation in Ghana is a testament to the catastrophic effect that excessive borrowing has exerted on an economy and the disastrous consequences on the social fabric as well as high poverty levels. One of the core issues in this contemporary Ghana tragedy has been public debt. When the crisis started in 2022 with a debt-to-GDP ratio of around 100%, it was interpreted by most economists and policymakers as a public debt crisis. The result of these efforts will be a slowdown of the increase in debt and a boost to growth and therefore a decrease in the debt-to-GDP ratio. Ghana experienced one of the most challenging economic times in recent years worst in history of Ghana.  Like many other countries around the world, the economic challenges in Ghana have been exacerbated by external shocks including the Covid-19 pandemic and the war in Ukraine/Russia. The country experienced anemic economic growth, high unemployment, elevated inflation, severe currency depreciation, loss of external capital market access, deteriorating gross international reserves and a looming public debt crisis. The Ministry of Finance through a debt sustainability analysis (DSA) has declared public debt to be unsustainable. The present value (PV) of Public and publicly guaranteed (PPG) debt to GDP ratio as at November 2022 stood at 100.34%. The government has set a PV of PPG debt to GDP ratio of 55% by the end of 2028 to achieve debt sustainability. To restore debt sustainability and macroeconomic stability, the government requested for assistance from the IMF. As part of the condition to unlock about US $3 billion of IMF extended credit facility. The government was tasked to restructure public debt. It is obvious that the government intends to restructure both domestic and external debt.  Foreign debt accumulated rapidly with corresponding interest payments between 2019- 2023, as the country ran into economic difficulties and suspended payments on foreign debt on December 2022, private and public investment collapsed, with total investment to GDP by as much as 5 percentage points. Ghana registered the largest fiscal deficits in the past decade, which reached its peak in 2020 with an unprecedented deficit of 15.2% of GDP and 12.3% in 2021 thus sharply increasing the country’s debt stock and debt service costs, thereby creating enormous budgetary difficulties, the government of Ghana naturally aimed at achieving fiscal consolidation in the original 2022 budget. In December, 2022 the government defaulted on the external debt and also began the domestic debt restructuring which has just been completed. In 2022, Ghana faced significant challenges partly due to the Covid 19 pandemic, the Ukraine / Russia war and excessive government expenditures. These three events led to unsustainable debt levels which in turn eroded the confidence of international investors. Ghana was in debt distress and public debt is unsustainable. In response, the Government has embarked on a comprehensive debt restructuring, a significant fiscal consolidation program, and the implementation of reforms to foster economic stability and resilience. The authorities’ stabilization efforts are being supported by an Extended Credit Facility (ECF) program of the IMF for approximately $3 billion. As the time of writing, details of the external debt restructuring had been restructured with both bilateral and euro bonds. On 3^rd October 2024, Ghana achieved over 90 per cent external debt restructuring of US$13 billion and it is said to have saved nearly US$4.7 billion. The government initiated the exchange offer and consent solicitation, which marks a critical step in restoring Ghana’s debt sustainability and international financial relations. “The Eurobond exchange was designed with fairness in mind, reflecting agreements made with bondholder representatives on June 24, 2024. The process involved two main investor options: the PAR Option, which had no nominal haircut but a lower interest rate of 1.5%, and the DISCO Option, which carried a 37% nominal haircut but offered higher interest rates between 5% and 6%”. Ghana’s government has triumphantly secured over 90% approval from bondholders to restructure a staggering $13 billion in international debt, marking a pivotal moment in its quest for economic stability. This strategic restructuring aims to alleviate the nation’s debt burden and satisfy conditions established by the International Monetary Fund (IMF) as part of a $3 billion bailout package. As a result of these events, Ghana was cut off from the access to international capital markets which led to domestic debt exchange which impacted negatively on the entire financial services sector. The DDEP impacted negatively on the availability of credit and correspondent banking services declined, hampering economic recovery. BoG estimates that the ratio of private sector credit to GDP declined from 10.4 percent in December 2022 to 8.3 percent in December 2023. In addition to concerns about borrowers’ creditworthiness due to high interest rates and the adverse environment, some banks aim to cut credit to reduce their risk-weighted assets (RWAs) and improve their CARs. IMF(July,2024) noted that the nominal growth rate in private sector credit was well below inflation, at 11.0% in 2023. In addition, the nonperforming loans (NPLs) ratio further increased to 20.6% from 14.8% in December 2022. Credit to the private sector as a share of GDP is relatively low in Ghana compared to peer countries and has been declining over the past decade; and the lack of access to finance is often cited by the private sector as a key constraint to investment, particularly for small and medium-sized enterprises
32. Domestic Debt Exchange Program (DDEP) has impaired the balance sheets of banks and Sdis negatively. The DDEP severely affected both profitability and solvency of many banks that held large amounts of domestic public debt at the onset of the DDEP. Government securities accounted for about 40 percent of the banking system’s assets, represented 3.4 times regulatory capital on average, and were a key driver of many banks’ profitability. Banks’ recorded DDEP-related impairment charges of GHS 16.3 billion (US$1.5 billion) in 2022. As a result, the industry incurred an aggregate loss of GHS 8 billion (US$696 million), with only 6 banks out of 23 recording a profit in 2022. Half of the system’s regulatory capital was wiped out in December 2022 and the average CAR without regulatory reliefs fell below the minimum of 13 percent. Domestic-owned banks (state owned and private) were the most affected due to their higher exposures to Ghana of Ghana (GoG) debt and lower capital buffers. Despite the banking industry’s strong profitability in 2023, some banks are yet to meet a 13 percent CAR and require additional capital to swiftly do so. While financial stability has been preserved, the availability of credit and correspondent banking services declined, hampering economic recovery.  Bank of Ghana estimated that the ratio of private sector credit to GDP declined from 10.4 percent in December 2022 to 8.3 percent in December 2023. In addition to concerns about borrowers’ creditworthiness due to high interest rates and the adverse macro-economic environment, some banks aim to cut credit to reduce their risk-weighted assets (RWAs) and improve their CARs. Moreover, correspondent banks curtailed the services they offer to Ghanaian banks that constrained the ability of local banks to engage in trade finance, access foreign exchange, and provide related services to their customers. Banks’ off-balance sheet transactions (mainly trade finance and guarantees) contracted by 33 percent in the year ending October 2023. The restoration of sound capital buffers of the weakest banks is a precondition to restore their ability to support the economic recovery. DDEP impacted negatively on the ability of banks and SDIs in the credit market.

 

28. Government had persistently and excessively borrowed at the Short -Term end of the money- market (Treasury Bill Market) at higher rate thereby causing the Crowding out of the Private Sector. The main problem in the money market had been the continued presence of the government on the market weekly with higher market rates thus caused crowding out. The crowding out is not a new phenomenon it has been with this country ever since the government started issuing domestic bonds but the situation has gotten worst in the Post DDEP era. Domestic government debt crowds out the private sector by limiting the funds available to borrow. This has constrained the private sector’s ability to grow the economy, create jobs, and generate revenues that could be taxed. In addition, the domestic debt reduction has also created a situation known as an inverted yield curve. An inverted yield curve shows that long-term Ghana Treasury bond interest rates are less than short-term interest rates. When the yield curve is inverted, yields decrease the farther out the maturity date is. An inverted yield occurred as short-term interest rates on Treasury bills were being quoted between 24% and 28.7% per annum exceeds long- term rates on Government bonds’ coupon rate of 9.1% or 8.51% per annum. The term yield curve refers to the relationship between the short- and long-term interest rates of fixed-income securities issued by the Ghana Government Treasury. The yield curve has inverted—meaning short-term interest rates moved higher than long-term rates—and could stay inverted through 2023 and 2024. This has signaled an imminent recession or slowdown in the Ghanaian economy. An inverted yield curve is when shorter-term notes pay higher effective yields than longer-term bonds. The yield curve is considered “normal” when longer-term bonds yield more than shorter-term ones. In the post-DDEP era, the government has been borrowing at the money market at the rate between 24% and 28.7% while the government bond coupon rate is quoted at 9.1% per annum. The inverted yield curve has been viewed as an indicator of a pending economic recession in the country. When short-term interest rates exceed long-term rates, market sentiment suggests that the long-term outlook is poor and that the yields offered by long-term fixed income will continue to fall. The existing bond market was considered a major prerequisite to sustainable debt dynamics as well as improved growth prospects by the financial sector and the wider public. However, the DDEP has not managed to lower signal rates during the post-DDEP era, as the market interest rates on short-term government bills have risen to historically high levels and thus created an inverted yield curve and remained unstable
29. Government’s Dominance in economic activities had increased vulnerabilities in the Credit Market in Ghana. The government’s dominance in economic activity, against the backdrop of weaknesses in fiscal management, further increased vulnerabilities in the credit market viz- a- vis banking sector. State-owned enterprises (SOEs), MDAs and many small-and medium enterprises (SMEs) rely heavily on business from the government. Consequently, the government’s accumulation of payment arrears to contractors and other service providers has undermined their capacity to service their bank loans and created NPLs across the industry. The government was unable to make payments to contractors and other service providers, and this in turn, created NPLs across the banking system. IMF Country report 24/030 (01/2024) noted that government energy sector arrears amounting to US$ 1.6 billion (2.3 percent of GDP) and while non-energy sector arrears at about GHC 35 billion (5.8 percent of GDP) and all energy sector and non-energy sector arrears had all translated into the higher non-performing loan ratios over the past decade. Consequently, the government’s accumulation of payment arrears to contractors and other service providers has undermined their capacity to service their bank loans and created NPLs across the industry. The study had estimated that 50 percent of the NPLs, reported at end-December 2023, were directly or indirectly linked to government arrears. The NPLs in the banking sector has deteriorated from 20.6% in December, 2023 to 24.1% in June, 2024. The government was unable to make payments to contractors and other service providers, and this in turn, created NPLs across the banking system
30. Weak legal and regulatory framework for the credit market had all contributed to the up-tick of the poor credit performance in the banking sector. Challenges in debt collection and recovery. Without accurate location information, lenders struggle to locate borrowers who default on their loans and other credit facilities thus complicating debt collection and recovery processes. There are major weaknesses in the legal and regulatory framework for the credit market which translated into higher non-performing loan ratio over the past decade. The deficiencies are exacerbated by the weak environment for enforcing creditor rights. Despite the establishment of Borrowers and Lenders Act 2020 Act 1052; Credit Reporting Regulations (2020) LI 2394 and the collateral registry, banks reported experiencing prolonged delays in foreclosing on collateral. In particular, the complex and time-consuming procedures for taking possession of collateral pledged as security for loans result in low debt recovery rates. Weaknesses in the legal, regulatory and judicial systems have all contributed to the uptick in non-performing loans in the banking sector over past decade. Protracted legal disputes, persistent adjournment in credit related by courts and weaknesses in the   Borrowers and Lenders Act 2020 (Act 1052).  The establishment of the Collateral Registry at the Bank of Ghana, as mandated under the Borrowers and Lenders Act 2020 (Act 1052) was indeed a welcomed innovation to credit delivery in Ghana.The enactment of Act 1052 and the Collateral Registry Application Software (CRAS) has further enhanced the following services rendered by the Registry to its clients: the platform for registration of security interest in both movable and immovable assets ;the platform for conducting searches on assets pledged as collateral. ; assisting with the realization of security interest, upon a default, without court order; the platform for registering other post- registration activities, (i.e. discharges, ; amendments, transfer of registration, subordination of registration, appointment of receiver or manager and notices of default). However, the Collateral Registry has improved registration of immovable and movable assets, improve searches on assets and registration of securities but has no facilitated the speedy disposition and realization of collateral without the approval of courts especially in the area of legal mortgages. With passage of Credit Reporting Act 2008 Act 726 and Credit Reporting Regulations (2020) LI 2394 with the view of reducing of asymmetric information in the credit market, banks and Sdis have not been to reduce default probabilities of borrowers and not improve access to credit facilities to small and medium sized businesses. Despite the establishment of commercial courts and the collateral registry, bank reported experiencing prolonged delays in foreclosing on collateral. In particular, the complex and time- consuming procedures for taking possession of collateral pledged as security for loans result in low debt recovery rates
31. Financial inclusion (Banking the unbanked) is one of major challenges that affect the credit based- economy. The financial system cannot develop to it potential and monetary policy cannot be effective if the majority of the population continues to be excluded from access to financial service. The importance of this to the overall development of financial systems in Ghana cannot be overemphasized. Multiple factors undermine financial inclusion in Ghana and influence the prospects of increased access to financial services. An important precondition for greater financial inclusion is a sound and stable financial sector that promotes growth and development. Poverty and geography act as barriers to greater financial inclusion in Ghana, but those barriers can be overcome by a financial sector that adapts to the economic and geographic context, innovates to meet consumers’ needs, and has a diverse array of affordable financial services provided by a range of institutions. Additionally, financial sector infrastructure—particularly payments systems and credit and collateral information systems—facilitates transaction between businesses, consumers, and government and contributes to overall economic efficiency. Sustainable financial inclusion is further enhanced when consumer legal protection is enforced, when consumer rights are well understood, and when dispute resolution mechanisms are robust (NFIDS, 2018-2023).
32. Poor SMEs institutions and weak corporate governance in the SMEs space: Another important challenge to sustainable economic growth in Ghana is the lack of effective institutions and good governance. These factors have been hindering various efforts and reforms of the government to stimulate economic growth for sustainable development in Ghana. The prevalence of weak institutions and poor corporate governance as well as poor ethical standards in most public and private organizations, hinder the attainment of the goals of economic policies in the country. Poor corporate governance has adversely affected the quality of institutions to the extent that public and private institutions are used for selfish interests, thereby, making regulation and law enforcement ineffective.

I The current institutional corruption challenges to the private sector: Although corruption is a global scourge, Ghana appears to suffer particularly from it. Everyone appears to believe that the nation has a “culture of corruption”. Over the years, Ghana has earned huge sums of money from illegal export of gold from Galamsey which appears to have largely gone down the sinkhole created by corruption. Ghana was described as a rich nation floating on gold wealth “but almost none of it flows to the people.

Corruption has denied Ghanaians the value of the natural mineral resources that have accrued to the country over the years. The failure of infrastructure, political and ethical standards as well as moral and educational standards can easily be traced to corruption.

Collateral still reigns supreme: The reality in Ghana is that collateral-based lending dominates the banking sector. Even for SMEs and corporate entities, creditworthiness as measured by cash flow or credit scores does not outweigh the importance of having physical assets to secure a loan. This preference for collateral is a direct response to the broader economic instability that has made banks more risk-averse. In such a context, a credit score is unlikely to be a decisive factor for banks when it comes to approving loans (Prof Lartey.02/11/2024)

1. Furthermore, Ghana’s informal sector presents a unique challenge for the implementation of a credit scoring system. With 85 per cent of the economy operating informally, many businesses and individuals lack the financial records necessary to generate accurate credit scores.  Most transactions in the informal sector are done in cash and many participants do not have bank accounts, let alone credit histories. This limits the ability of a credit scoring system to include a large portion of the population For the informal sector to benefit from a credit scoring system, there would need to be a substantial shift toward formalizing economic activities, something that cannot be achieved overnight (Prof Lartey.02/11/2024).

Preparing the ground for a credit-based economy – what Ghana needs to do.

A Model Adapted for the Credit Based Economy by Nigerian Tunde Omilola (2023). The Ghana may have to adopt the Credit Based Economy Model based on Omilola model (2023)

3.0  With government dominance in the economic activity, it could make the path to credit-based economy very challenging and difficult because the fiscal deficits always widened, inflation accelerated, interest rates rise to around 30 percent, investors became skittish and began to exit the debt market, and the exchange rate begins to depreciate, thereby creating conditions for asset price deterioration, but however critical steps are adopted and implemented then credit-based economy could be achieved.

The informal sector further complicates credit evaluation, while the absence of comprehensive credit reporting systems hampers lenders’ ability to assess creditworthiness. Even when credit is accessible, high-interest rates make it unaffordable for many. Inflation compounds these challenges by reducing purchasing power, leading to tighter credit conditions.

With inflation currently at 21.4% and still pose to increase further, the Bank of Ghana has reduced its rate to 27% per annum, which has made borrowing more expensive and has resulted in reduced credit demand. Inflation-driven interest rate volatility discourages borrowing, and inflated asset prices make it harder for borrowers to meet collateral requirements. Inflation also introduces uncertainty and risk, making lenders more cautious and limiting access to credit.

According to Dokua-Sasu data (2023) Small and Medium -sized Enterprises played a significant role in Ghana’s economy. In 2023, over 90% of business enterprises in the country were SMEs. Moreover, SMEs did not only form around 80% of the total employment in Ghana but also accounted for 60%   the country’s GDP. The contribution of the private sector to the development and sustainable growth of an economy cannot be underestimated, as the SMEs are considered as an engine for growth.

The World Bank defines small and medium enterprises as ‘any firm that has an employee size of up to 300 and an annual sales of not up to US$15 million. In Ghana, small and medium enterprises can be defined as any enterprise or business entity that employs less than 10 employees for small enterprise and any firm with more than 10 employees is classified as medium and large according to Ghana Statistical Service.

1. The Ghana’s path to credit- based economy requires nine structural and critical transformation that must be taken:

Before an economy can be considered a credit-based economy or can consider transiting to a credit-based economy conditions such as a stable economy, stable currency, trust and confidence, transparent credit information, and an effective legal framework must be met. In Ghana, the state of the credit economy has been characterized by certain challenges, both in terms of access to credit and the impact of inflation.

First, for Ghana to transit into credit -based economy, the Government and Bank of Ghana must work hard to provide stable macro-environment in stable exchange rate, low inflation, low high deficits, and high growth. To achieve the growth aspirations, the first requirement is a stable macroeconomic environment with low inflation, stable (market reflective) exchange rates and sustainable fiscal and external balances. This requires that monetary, trade and fiscal policies are well aligned to ensure coherence and effective coordination.

A coherent and stable macroeconomic environment is a pre-requisite for sustained growth. It prevents the negative impact of uncertainty and enables businesses to plan their production, investment and consumption activities. The Bank of Ghana will continue to work towards improving the operations of the foreign exchange market to enhance its liquidity.

Non-oil revenue will be accelerated through improved tax and Customs administration, including introduction of tax on luxury items. This would ensure a more diversified fiscal revenue base away from the current dependence on crude oil and gas. Fiscal consolidation will also be pursued through cost cutting measures that include rationalization of overheads and recurrent expenditures and sub-national fiscal coordination.

Selected public enterprises/assets will be privatized to optimize their operational efficiency and reduce the fiscal burden on the government. An appropriate economic level of stability and predictable business conditions are important for credit- based economy. Stable macro-economic environment of low inflation, stable exchange rate, manageable public debt, and sustainable level of risks and certainty provide for favorable credit expansion and growth. Stable exchange rate is crucial for credit -based economy as it provides reliable medium of exchange and a unit of account reducing uncertainty for both lenders and borrowers in the credit market.

The Government of Ghana and Bank of Ghana must be committed to promoting a strong, stable, and viable banking industry to support robust macro-economic growth in terms of stable exchange rate, lower inflation, lower policy rate, lower fiscal deficits, positive terms of trade and manageable public debts that could affect positively on the entire financial sector. Macroeconomic stability is the cornerstone of any successful effort to increase private sector development and economic growth that enables the banking sector to improve on solvency because of lower inflation and stable exchange rates.

Macroeconomic stability exists when key economic relationships are in balance—for example, between domestic demand and output, the balance of payments, fiscal revenues and expenditure, and savings and investment. These relationships, however, need not necessarily be in exact balance. Imbalances such as fiscal and current account deficits or surpluses are perfectly compatible with economic stability if they can be financed in a sustainable manner.

Macroeconomic stability depends not only on the macroeconomic management of an economy, but also on the structure of key markets and sectors. To enhance macroeconomic stability, Ghana needs to support macroeconomic policy with structural reforms that strengthen and improve the functioning of these markets and sectors. Prudent macroeconomic policies can result in low and stable inflation, stabilize the local currency which could contribute to improvement on the quality of assets in the banking sector.

Inflation hurts the poor by lowering growth and by redistributing real incomes and wealth to the detriment of those in society least able to defend their economic interests. The government must ensure that macroeconomic stability is associated with prudent monetary and fiscal policies, such as low and stable levels of inflation, lower fiscal deficit, reasonable public debt levels, exchange rate volatility (nominal or real), and interest rates, among others, all of which could be quantitatively assessed on the financial sector as well as the economy.  The results have shown that improvement in macroeconomic conditions causes improvement in credit quality

Second, to ensure the safeguarding financial system stability, the government must repay all outstanding legacy debts related NPLs and resolve problem banks or re-fence the arrears. The government through Ministry of Finance have agreements with contractors, other service providers and IPPs on monthly fixed payment to clear legacy arrears must be reached with contractors, service providers and independent power producers (IPPs) to reduce the high non-performing loan ratios which have bedeviled in the banking sector over the past decade.

Third, strengthening institutional frameworks are crucial, involving the digitalizing of property addressing and the streets and roads naming systems. Building trust and consistency is key to successful credit culture in Ghana. The importance of digitalization of these two systems would go a long way to support the development of the economy as well as the financial sector.

With these development and enhancement of both residential and property address system, will enable the banks and Sdis to track, trace and locate their customers as well as borrowers. The presence of digitalized roads and street naming and address systems would reduce the risk premium attached to loans and other credit facilities granted by banks and SDIs. Another institutional reformation the universal acceptance of NIA Card as part of credit culture in Ghana.

A key ingredient underpinning financial transactions including credit facility in Ghana must be based on trust which Fukuyama (1999) referred to as Social Capital (Bawumia, 2010). Since 1801, the motto of the London Stock Exchange UK is ‘My Word is My Bond’ and deals were made with no exchange of documents and no written pledges being given. Financial transactions are based on trust and any one breaching this is ostracized with attendant consequences.

In this type of environment, default could be reduced and interest rates on loans and other credit facilities would lower than the current environment in which the borrower could not be trusted and the probability of default is high. It is important to note that in developed financial centers, financial institutions place technology to engender trustworthy behavior. Trust in financial system and institutions as well as borrowers to repay its debt are vital to the functioning of the credit markets.

Fourth, there is a need reforms to make the financial infrastructures operational and efficient including the judicial processes for with dealing foreclosures and disposal of collateralized assets. Appropriate enforcement mechanisms are needed to ensure compliance with the International Financial Reporting Standards (IFRS), Borrowers and Lenders Act 2020 Act 1052; Credit Reporting Regulations (2020) LI 2394 to improve financial reporting.

Operations of the credit registry could be improved by enforcing lender compliance with the Credit Reporting Act 2008 (726) and strengthening oversight of data quality. Further reforms are needed in the legislative and institutional framework for insolvency and creditor rights to address weaknesses in the network of registries and improve the efficiency of commercial courts. In particular, the judicial system will need to fast-track dispute resolutions and send a message of zero tolerance in order to discourage a culture of nonpayment of obligations

Fifth, empowering the private sector through the enabling business environment may assist the credit-based economy. The various government must endeavor to reduce the over dominance. Many projects properly structured will elicit private sector participation that could reduce the burden of the government expenditure on the budget. For the private sector to play its proper role however, it is important that rule of law prevails, independent judiciary systems are upheld, property rights also upheld, and contracts are respected and ‘political witch-hunting and vindictiveness are avoided.

Political democracy have literally killed all the viable private sector businesses over the past three decades. Some private sector businesses collapse when there is a change of Ghana. Uncertainty about the rule of law or the respect for property rights inform the desire of local investors Singapore provides good model of private participation.

Without the private sector being assured of this type of certainty in the business environment. The relationship between government and the private sector is also crucial for the performance of the financial sector. The situation where government has delayed to road contractor for nearly 5 years after completion impacted negatively on the ability of the private sector to service it loan obligations thus increased non-performing loans in the banking sector and reduces the incentives of banks to lend more to the private sector.

Leverage the power of the private sector. Economic recovery and transformative growth cannot be achieved by the government alone. It is essential to harness the dynamism of business and the entrepreneurial nature of Ghanaians, from the MSMEs to the large domestic and multinational corporations to achieve the objectives of this credit- based economy.

Sixth, access to reliable and credible credit information is crucial in credit- based economy. Localized Credit rating agencies and credit reference bureau are there to reduce constraint to credit markets through minimization of information asymmetry, thus enabling financial institutions to make informed decisions about the allocation of credit. Credit rating agencies expects to reduce default of borrowers as they seek to meet their payment obligations in a timely. Credit rating agencies (CRAs) play a key role in financial markets in developed economies by helping to reduce the informative asymmetry between lenders and borrower in the credit market.

Credit rating agencies (CRAs) are used to assess the risk of a borrower’s default, and its associated financial loss, in the sale financial products. Their primary function is to benchmark the likelihood of a debtor’s default by providing a credit rating. They are not to be confused with what are normally described as credit reference agencies which do a similar job but for individuals.

Credit ratings agencies have a key role in maintaining market integrity, trust and stability, and minimizing risks to consumers. To achieve this, credit ratings agencies need to consider how their activities and risk management processes could affect individuals, businesses, or the wider market.

Credit ratings – which in some countries are mandatory for banks and other financial institutions – could contribute to financial stability by acting as a monitor of transparent and relative risk‐ranking and default prospects. In a country like Ghana, where public disclosure of information is limited, objective and thorough credit rating has the potential to reduce information asymmetry between market participants, including borrowers, lenders, and regulators.

Indeed, financial sector regulators look at ratings to supplement their own risk assessments and to regulate various financial aspects – e.g., capital requirements for banks eligible assets for investment by institutional investors and collective investment schemes; etc. Credit rating Agencies (CRAs) can also play a role in the training and capacity building of financial institutions on credit‐risk assessments, especially in Ghana where a majority of banks do not have such expertise.

Nonetheless, in the absence of high standards of quality and transparency in the rating process –overreliance on ratings (as demonstrated in the years leading up to the global financial crisis) can also make markets less transparent and contribute to financial instability. Credit scoring is a critical component of financial sector system which provides for credit risk assessment and financial intermediation but it is not panacea for addressing all challenges and problems in the credit market in Ghana

Seventh, in the competitive landscape of banking and financial services, establishing and nurturing trust with customers is paramount. Trust serves as the foundation upon which long-term relationships are built and is crucial for attracting and retaining customers. In this context, effective marketing strategies play a pivotal role in enhancing trust between banks and their customers. Transparency in all communications establishes a baseline of trust. This includes clear information about fees, services, and any changes to account policies. Ensuring customers feel fully informed at every turn reinforces their confidence in your institution.

Tailoring services and communication to individual needs shows customers that their unique financial goals and challenges are understood and valued. Personalized marketing, supported by data analytics, can make customers feel seen and appreciated, fostering a deeper trust. Innovative banking solutions that offer convenience, such as mobile banking apps, online chat support, and AI-driven services, can enhance customer satisfaction and trust. Demonstrating a commitment to improving the customer experience through technology can set your bank apart. Building and maintaining trust in the banking sector requires a multifaceted approach, with marketing strategies playing a crucial role.

By focusing on transparency, personalization, security, community engagement, and leveraging technology, banks can significantly enhance customer confidence. These efforts, coupled with a commitment to understanding and meeting customer needs, pave the way for stronger, more trusting relationships. Strategies for building trust and transparency in the financial sector: provide clear and honest communication; educate your clients and customers; maintain consistent and reliable interactions; leveraging on digital technology and ensure regulatory compliance.

Eighth, Ghana’s informal sector further complicates credit evaluation, while the absence of comprehensive credit reporting systems hampers lenders’ ability to assess creditworthiness. Even when credit is accessible, high-interest rates make it unaffordable for many. There is urgent need for financial literacy education. Financial literacy education equips individuals, especially those in semi-urban and rural areas with the knowledge and skills needed to navigate the complexities of the financial sector.

It seeks to promote participation in financial markets and savvy use of financial instruments and credit systems in Ghana.  Financial literacy has earned the crucial place of being the cornerstone of inclusive financial systems that empower governments, companies, and individuals to make well-informed financial decisions, effectively manage their finances, and fully participate in the general economic system.

When financial literacy is fostered, the gap between those who have access to financial services and those who do not have such access can be bridged, thus opening up the opportunities for reduction of poverty, promotion of economic growth, and improvement in the overall well-being of the people.

Financial literacy presents enormous potential benefits to the financial market landscape in the world. For example, those who have received financial education are frequently in a better position to make prudent financial decisions than they would have done otherwise.

Individuals are usually saddled with crucial life choices and would probably have to make decisions about borrowing, investing, saving, buying insurance, and retirement planning. Participation in a formal financial system is seen as immunity against idiosyncratic risks and sudden shocks.

Lack of access to financial services is considered a moral blot, a denial of fundamental human rights imperative, and a key roadblock to entrepreneurship. Despite the benefits of having sound financial knowledge, widespread financial illiteracy is reported country-wide.

Ninth, financial inclusion (banking the unbanked) is critical component of the credit -based economy as the financial system cannot develop to its potential and monetary policy cannot be effective tool if the majority of the Ghanaian population continues to be excluded from access to financial services (Bawumia, 2010). The informal sector further complicates credit evaluation, while the absence of comprehensive credit reporting systems hampers lenders’ ability to assess creditworthiness.

Even when credit is accessible, high-interest rates make it unaffordable for many. Inflation compounds these challenges by reducing purchasing power, leading to tighter credit conditions. Promote national cohesion and social inclusion. Ghanaians are the ultimate beneficiaries of more inclusive growth and therefore, the initiatives set out in this plan are aimed at ensuring social inclusion and the strengthening of national cohesion.

4.0. Conclusion

Ghana’s banking sector does not need a credit scoring system but the government must address all myriad problems that had affected credit market by strengthen institutional and regulatory framework.

It is important to note the country is saddled with so many problems such as excessive government  dominance in economic activities, macro-economic instabilities, high financial illiteracy, time consuming, legally complex, costly, and unpredictable procedures for taking collateral and enforcing creditor rights, term deposits are benchmarked to treasury-bill (T-bill) rates, high fiscal deficits affect banks’ funding costs, contribute to high lending rates, and erode capacity to service debts, non-existence of domestic credit rating agencies, and the digitalizing of property addressing and the streets and roads naming systems be seriously addressed before Ghana can be part of the credit- based economies.

The recent exodus of professional Ghanaians to overseas had showed the weaknesses in consumer credit regime where people who were paid by the Accountant-General have all abandoned their post without paying loans and credit facilities to banks and SDIs.

Ghana is yet to develop credit markets with a diverse range of financial products and services. The credit infrastructure including domestic credit agencies, credit scoring models and legal and regulations are too porous to support widespread access to credit for individuals and SMEs. Credit scoring model alone cannot address the numerous challenges and problems in the country’s credit market.

Furthermore, in an inflationary environment like Ghana, inflation pose significant challenges, as it’s negatively impact people purchasing power, interest rates, debt burden and overhang, uncertainty and wealth distribution.

Weaknesses in banks and SDIs’ risk management and in supervision have also been important factors.  Banks and SDIs’ internal controls are generally lax and risk management practices have not kept pace with the growth of the industry and the changing risks.

In Ghana, credit performance has historically been poor due to several factors, including persistent government default to both energy and non-energy sectors over the past decade and challenges in the regulatory and legal framework.

It’s important to note that transitioning to a credit-based economy requires careful management and monitoring to prevent excessive debt accumulation, speculative bubbles, or financial instability. Balancing access to credit with prudent lending practices is crucial to ensure sustainable economic growth and stability.

According to World Bank report No: PAD00050 (2024) noted that   Ghana’s GDP growth has been projected to remain weak in 2024 (2.8 percent) because of the ongoing fiscal consolidation, macroeconomic uncertainty, elevated interest rates and inflation, and financial sector and energy sector weaknesses.

However, there are four significant risks. First, macro-economic challenges of high inflation and persistent depreciation of the local currency that could impact negatively on the entire financial sector.

Second low levels of capitalization and high nonperforming loans (NPLs) may further constrain the banking sector’s ability to provide credit to the real sector and support economic recovery. Third, the realization of contingent liabilities from the energy sector could result in additional financing needs.

Fourth, domestic policy slippages due to the political cycle, with spending pressures before the elections in December 2024, risk derailing the Government’s resolve on fiscal discipline and macroeconomic recovery

5.0 The principal recommendations are:

1. With the deteriorated macroeconomic environment of high inflation and persistent depreciation of the local currency over the past four years, reflecting a confluence of a food and energy crisis and an expansionary fiscal policy. As fiscal deficits widened, inflation accelerated, interest rates rose to around 30 percent, investors became skittish and began to exit the debt market, and the exchange rate began to depreciate, thereby creating conditions for asset price deterioration, the study recommends that the Government of Ghana and Bank of Ghana must be committed to promoting a strong, stable, and viable financial services industry to support robust macro-economic growth in terms of stable exchange rate, lower inflation, lower policy rate, lower fiscal deficits, positive terms of trade and manageable public debts. Stable macro-economic environment of low inflation, stable exchange rate, manageable public debt, and sustainable level of risks and certainty provide for favorable financial recovery and growth in the post DDEP period. In addition to a stable macroeconomic environment, a healthy financial sector is needed to ensure that financial development benefits Ghanaian firms and households.
2. The study found that stability risks had heightened considerably, with high non-performing loans (NPLs) and undercapitalized banks. The nonbanking sector also faced several constraints, including a scarcity of long-term finance, limited access to financial services, and high intermediation costs. The vulnerabilities in the banking sector largely reflect pervasive state involvement and deficiencies in risk management, supervision, and the insolvency regime.
3. Against this backdrop, the study recommended that by addressing stability risks while sustaining the momentum on broader reforms. It suggested that Government gives priority to repaying government arrears including the energy debt, resolving problem banks, closing regulatory gaps, strengthening supervisory capacity and the insolvency regime, reducing state involvement in banks, and enhancing systemic risk analysis
4. The government must strengthen the financial infrastructures the framework for insolvency by enforcing compliance with the Credit Reporting Act, Borrowers and Lenders Act and enhancing automation and coordination of all charge registries. The Chief Justice must ensure the commercial courts work on week-ends to reduce the prolonged delays in foreclosing on collateral. In particular, the complex and time -consuming procedures for taking possession of collateral pledged as security for loans result in low debt recovery rates.
5. The government through Bank of Ghana must work hard to ensure that Ghana Card and property addressing system are coherently integrated. A key ingredient underpinning financial transactions in any society is trust or what Fukuyama (1999) refers to social capital. Also, the importance of a system of property addresses is probably one probably one of the most underestimated requirements for the development of Ghana’s economy and its financial sector. Ghana National Identification Authority, Ministry of Finance, Bank of Ghana, and MMDAs work together to have an integrated systems instead the current piecemeal approach. By the integrated approach, it could significantly impact on the credit market by improving access to credit; enhance banks and SDIs confidence, conducting due diligence on borrowers will be easier, make recovery debt collection cheaper and promote responsible lending and borrowing.

Reference

Bawumia M (Dr) (2010) Monetary Policy and Financial Sector Reform in Africa- Ghana’s Experience. Oxford IBSN 978-1-60910-4I5-3

Bank of Ghana MPC reports for December,2023 and June, 2024.

Dokua Susu, D (2023) Small and Medium -sized Enterprises played a significant role in the Ghanaian economy.

Fukuyama, F (1999) Social Capital and Civil Society. Institute of Public Policy George Mason University

IMF Country report 24/030 (01/2024) government arrears due to contractors and other service providers stood at GHC35 billion or 5.8% of GDP while energy sector arrears amounting to US$ 1.6 billion (2.3 percent of GDP). IMF Washington

Lartey S. (Prof) (2024) Credit Scoring System in Graphic on Line on the November 2^nd Edition of 2024. Vice-President Regent University Accra Ghana

Ghana National Financial Inclusion and Development Strategy(NFIDS) 2018–2023

Omilola T. (2023) A Model Adapted for the Nigerian Credit Based Economy.

The writer is a Corporate Governance/Banking Consultant

(SPECIAL PAPER TO BE PRESENTED AT THE CHARTERED OFINSTITUTE OF CREDIT MANAGEMENT (GHANA) INVESTTITURE AND PRESIDENTIAL BALL CEREMONY ON 09/11/2024)