BoG’s Cash Reserve Ratios hampering private sector credit – Analysts warn

Credit to the private sector by banks will continue to squeeze due to the Bank of Ghana’s high Credit Reserve Ratios (CRR).

This is one of the key findings and conclusion of a research paper by banking consultant, Dr. Richmond Atuahene and data and research analyst, Isaac Kofi Agyei.

The report titled ‘Thirsty Banks: Ghana’s Dilemma with High Cash Reserve Ratios’ analysed the impact of the Bank of Ghana’s new cash reserve ratios for commercial banks.

The research paper suggests that the high CRR enforced by the Bank of Ghana appears to be constraining credit to the private sector, as banks are compelled to hold a significant portion of their deposits in reserve rather than extending loans.

The CRR has now been set at 15% for banks with a loan-to-deposit ratio above 55%, at 20% for banks with a loan-to-deposit ratio between 40% and 55%, and at 25% for banks with a loan-to-deposit ratio below 40%.

Per the report, these revised rates can be detrimental to economic growth and development, particularly in sectors reliant on bank financing for investment and expansion.

The CRR is a monetary policy tool used by central banks to regulate the amount of money that banks must hold in reserve against their deposits.

While a higher CRR is intended to stabilize the financial system and control inflation by limiting the amount of money available for lending, an excessively high ratio can stifle economic activity by reducing the funds available for investment and consumption.

If banks are required to maintain a high CRR, it means they have less money available to lend to businesses and individuals.

This can result in decreased investment, slower economic growth, and fewer opportunities for businesses to expand operations or for individuals to access credit for personal needs such as education, housing, or entrepreneurship.

“Maintaining a high Cash Reserve Ratio would have been advisable and impactful if the government retained access to both the domestic and international bond markets. However, the government’s current lack of access to these liquidity markets has forced it to rely solely on generating cash from the treasury bill space. This dependency has led to the need for very high-interest rates to entice commercial banks and private investors to participate.”

To address this issue, policymakers may need to reconsider the level of the CRR and its impact on private-sector credit.

A balance must be struck between ensuring financial stability and fostering economic growth.

This could involve gradually reducing the CRR to free up more funds for lending while closely monitoring its effects on inflation and the overall stability of the financial system.

Additionally, other monetary policy tools such as open market operations, interest rate adjustments, and targeted lending programmes could be utilized to support credit to the private sector without compromising financial stability.

Collaborative efforts between the central bank, government, and financial institutions are crucial in designing and implementing policies that promote sustainable economic growth while mitigating risks to the financial system.

Report Recommendations

While it can be beneficial for central banks to implement higher Cash/Primary Reserve ratios to control inflation and stabilize the local currency’s value, excessive ratios can lead commercial banks to hold more cash with the central bank, thereby limiting their ability to lend.

Conversely, lower cash reserve ratios allow banks to maintain less cash with the central bank, boosting their lending capacity.

Bank of Ghana should reconsider reducing the mammoth cash reserve ratios by taking into account the GHS50.6 billion of customers’ deposits used to purchase restructured government bonds with an extended maturity period until 2031.

Furthermore, the Bank of Ghana and commercial banks need to exert significant effort to reduce the current Non-Performing Loan (NPL) ratio from 24% to around 10% to fortify the banking sector’s resilience. A resilient banking sector encompasses more than just profitability; high NPLs can lead to poor capitalization among banks, liquidity challenges, and even insolvency for some institutions.

The Bank of Ghana’s MPC report in March 2024 affirmed these concerns, indicating a mixed outlook on key financial soundness indicators.

Over the past two years, the private sector has suffered due to the government’s overwhelming presence in the treasury bill market. To revitalize the private sector, authorities must focus on lowering short-term bill rates below 20 percent to foster competitiveness in the domestic market. Additionally, efforts should be made to curb the increasing diversion of credit from the private sector to the central government.

Addressing Ghana’s economic challenges requires a comprehensive approach that goes beyond relying solely on traditional monetary policy tools like increasing commercial banks’ reserve requirements or adjusting monetary policy rates.

These measures have been excessively utilized in previous years and have become less effective due to the structure of the Ghanaian economy, which has developed a level of resistance to them over time. Bawumia (2010) affirms that the high level of reserve requirements (monetary policy instrument) reflects a legacy of high fiscal deficits.

In addition to monetary policy adjustments, significant fiscal interventions are necessary to navigate the economic difficulties. This includes implementing substantial reductions in government expenditure to alleviate the current economic strain.

To combat inflationary pressures effectively, authorities must proactively reduce central government spending by an additional 30%, with a particular focus on trimming down flagship programs that have failed to deliver significant economic benefits since their inception.

In summary, the government should refrain from burdening the banks and instead concentrate on making drastic cuts to its excessively large budget. Commercial banks have incurred considerable losses as a result of the DDEP and are still in the process of recuperating; they should be allowed to fully recover without further burdens!

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