Reasons for UT, Capital banks failure

Five key headlines I noted from the address by Dr Ernest Addison, Governor, Bank of Ghana (BoG), at the Annual Dinner of the Chartered Institute of Bankers Ghana on December 2, 2017 published on the BoG website are as follows:

Reasons for the failure of two banks

“ Let me be upfront and say that though the failure of the two banks was due to significant capital deficiencies, the underlying reason was poor corporate governance practices within these institutions. In this instance, we saw the dominant role of shareholders who exerted undue influence on management of the banks, leading to poor lending practices. This was also reinforced by weak risk management systems and poor oversight responsibility by the boards of directors. Some of the examples of recklessness that led to the failure of the two banks include:

• Co-mingling of the banks’ activities with their related holding companies. For instance, one bank was paying royalties for the brand name, even at the time that the bank’s financial performance was abysmal and could not pay dividends. Interestingly, the royalties were approved by four out of seven members of the board without the consent of the other significant minority shareholders, including an International Financial Institution. As a result, the international institution placed a notice on its website abrogating all relationships with the bank, and this led to most of the foreign lenders cutting off their credit lines to the bank and recalling their credits; thereby creating serious liquidity squeeze to the bank.

• Also, very high executive compensation schemes were being operated by the affected banks which were not commensurate with their operations. The risk and earnings profile of the banks could not support the compensation schemes.

• Non-executive directors of the banks compromised their independence and fiduciary duties to serve as checks on executive directors. This was because rewards such as business class air tickets were being granted to them annually.

• Interference by non-executive directors in the day-to-day administration of the banks weakened the management oversight function of executive directors. Some non-executive directors were also acting as consultants to the same banks with no clear mandate, which gave rise to conflict of interest situations.

• Non-adherence to credit management principles and procedures as the banks were heavily exposed to insiders and related parties. There was also no evidence of interest payments on these investments. The investments were, therefore, impaired, but some members of the board at the time accepted the responsibility to pay off the said amount through a board resolution.

• Diversion of funds to holding companies and their related parties was widespread. In the case of one bank, placements could not be traced to the bank’s records though some customers showed proof of their investments with the bank.

• Irregular board meeting also accounted for the weaknesses in the board oversight.

• In all of these cases, one thing was clear, and that is, the banks could not delineate themselves from their past practices as finance houses. They followed the same practice of borrowing from high net worth persons at very high costs, without any plans to bring themselves in line with the industry norm.

2. BoG corporate governance directives

As part of the BoG’s regulatory mandate, we are working on corporate governance directives for the banking sector. Among other things, these directives will focus on oversight responsibilities of the board of directors and bank management, prioritise risk management systems and ensure independent audit roles, among other things. In particular, the guidelines will impose the tenure of chief executive officers and non-executive directors of banks, the size of bank boards, the retiring age for directors and disclosure of attendance at board meetings by directors in annual accounts.

Another guideline which will strengthen corporate governance structures in the banking sector is that on financial publications. This has been updated to include detailed corporate governance disclosures by banks and the inclusion of provisions on corporate governance under the Banks and Specialised Deposit taking Institutions Act, 2016 (Act 930). The guide for financial publications seeks to ensure that International Financial Reporting Standards (IFRS) are adopted in the preparation and presentation of financial statements. It also seeks to clarify and provide direction, as well as bring uniformity in the financial reporting process across the industry.

3. BoG capital requirements directives

In addition, the bank has issued the Basel Capital Requirement Directive (CRD) for feedback from the banking industry as part of preparations towards the implementation of the Basel Capital Accord. All these seek to achieve fairness, transparency and accountability, which are core tenets of good corporate governance.

Madam President, in the year ahead, our banks will be Basel II/III compliant. As we speak, all banks have the Capital Requirement Directive and I implore your active participation in the implementation process. Following the passage of the BSDI Act, 2016 (Act 930), the BoG has reviewed existing directives and regulations to align with the Act.

This, together with the Internal Capital Adequacy Assessment Process (ICAAP), will strengthen the supervisory review process, which is a requirement under Pillar II of the Basel Accord. We are also driving the disclosure requirements in conformity with Pillar III of the Basel Accord to
enhance appropriate information flow to market participants.

Consequently, the bank will ensure strict adherence to the Guide for Financial Publication and the BSDI Act, particularly with regard to publication of financial statements (both audited and unaudited), and other regulatory breaches. In 2018, banks will be required to strengthen their capital base with the revision to the minimum capital requirement.

The GH¢400.00 million minimum capital requirement is in line with the broader financial sector reform plan which seeks to develop and strengthen the banking sector to support the government’s transformational agenda.

We will aggressively ensure that banks comply with this directive.

Banks are to submit plans to address Non-Performing Loans (NPL) and enforcement of loans write-offs

The key risk in the banking industry today is the increasing level of impaired assets. This has heightened banks’ risk aversion to credit delivery. Our immediate response is to reduce some of the structural bottlenecks in the credit process.

Currently, we are reviewing the governing legislations on the credit reference and collateral registry systems. These are to ensure that banks submit both positive and adverse findings on borrowers to the bureaus and also address some thorny foreclosure issues.

I have requested in my last quarterly meeting with the chief executives of banks, detailed plans on how each bank will resolve its non-performing loans on a loan-by-loan basis.

We shall enforce our directive on loan write-off going forward, and require appropriate disclosure of written-off facilities in the published financial statements of banks. It is our expectation that the national identification programme, coupled with the improved economic prospects, will support these measures and help in reducing the incidence of loan defaults in the banking sector.

Deposit protection scheme

The deposit protection scheme is expected to come on stream next year in line with the BSDI Act and the Ghana Deposit Protection Act, 2016 (Act 931) to provide a safety net for vulnerable depositors in the event of a bank failure. I entreat banks to study the Ghana Deposit Protection Act to know the requirements for enrolment on the scheme.

These proposals and initiatives are laudable and mirror some of my recommendations in my various articles, which include:

1. BoG should exercise its power under Section 105(2b) of Act 930 to direct all banks by the end of January 2018 to present a capital plan, and at the end of each quarter, starting March 2018, banks should provide BoG with status update on their capital plans. Banks should be asked to consider using guidance in the Basel Committee on Banking Supervision (BCBS) publication 277, called a sound capital planning process, in their capital planning. The guidance requires four fundamental components of a sound capital planning process: (a) Internal control and governance, (b) Capital policy and risk capture, (c) Forward-looking view, and (d) Management framework for preserving capital.

2. BoG should exercise its rights under Act 930 and prescribe guidance on corporate governance and restrictions on dividend payments tied to non-performing loans (NPLs) so as to constrain capital, restrictions on cross-border lending/risk participations and levels of lending to group-related banks. Such rights are provided under Act 930 as follows:

(i) Section 56 of Act 930 - The BoG may prescribe rules regarding any matter of corporate governance of a bank, including matters relating to (a) the scope and nature of the duties of directors of a bank,

(b) the requirements for audit and other specific committees of the board; (c) the responsibilities of key management personnel; (d) risk management; (e) internal audit; and (f) internal controls and compliance.

(ii) Section 30 of Act 930 states that the BoG may require a bank, specialised deposit-taking institution or financial holding company to maintain additional capital that the BoG considers appropriate to address concentration of risks in the bank, specialised deposit-taking institution or financial holding company, or in the financial system.

(iii) Section 77 states that the BoG may, in respect of a prudential limit prescribed under this Act, impose a stricter limit for banks, specialised deposit-taking institutions or financial holding companies or a class of specialised deposit-taking institutions or a particular bank, specialised deposit-taking institution or financial holding company for the period that the Bank of Ghana considers appropriate.

(iv) Section 66 restricts inter-institutional placements and loans if the bank has capital adequacy ratio of less than 10 per cent.

(v) Sections 105 and 106 restrict the bank from lending if the bank breaches the capital requirements.

3. Banks with NPLs above a set threshold (for example, 10 per cent) should be subject to a more intensive oversight regime to ensure that they conservatively recognise and proactively address asset quality problems.

4. BoG exercising its powers under Section 93 of the Act to require banks to submit accurate information to credit bureaus and applying the penalty for the submission of inaccurate, incomplete, delayed and non-submitted information to credit bureaus.

5. Enforcing conservative provisioning and write-off guidance under IFRS 9 - Section 78.

6. Conservative application of accounting standards should be supplemented by micro and macro prudential measures, such as time-bound targets for resolving delinquent assets and raising risk weights on impaired assets of a certain vintage (above the current 150 per cent, under the “standardised approach” adopted by all banks in Ghana).

7. Overly aggressive behaviour resulting in imprudent lending practices & excessive loan growth (especially where volatile liabilities and inadequate liquid assets exist). Focus must be to grow safely.
- However, excessively growth-minded culture, combined with well-established policies, can be a successful strategy.
- A board that sets growth or income as a prime goal to the detriment of asset quality standards or funding sources.

8. Corporate culture and internal control systems. Behaviour of top management, for example leadership style and personal lifestyle of top management of the banks. There was lot of noise around the lifestyle of ex CEO of former UT Bank and culture in Nigerian banks known to be very poor.

9. Problems involving the CEO. Capability & experience issues.
New CEO, untested, with limited executive/general management experience. Dominant CEO - Leading by fear etc.

10. A management team that is less than fully competent for the situation.

11. Target market & client selection. Weak strategy. It doesn’t have to be perfect but must be relevant and workable. Lack of experience in executing strategy.

12. Tenure of CEOs and board members. — GB