Regulatory Capital, Banking Efficiency and Macroeconomic Stability: Evidence from Ghana

In the last decade, there have been massive regulatory capital adjustments within the banking sector of Ghana. Yet, concerns of excessive risk-taking activities and the threat of instability of the sector remain. This study therefore seeks to investigate the actual influence of regulatory capital on banking efficiency and stability as measured by specific bank level outcomes – interest rate spread, non-performing loans and credit allocation – and the interrelationships among these variables. Further, we will investigate how responsive banks are to banking regulatory policy changes. Using bank and industry level characteristics and macroeconomic indicators, this proposed study seeks to employ a simultaneous equations framework in a panel data analysis. We argue that as many countries in Africa are making preparations to fully implement the Basel II Accord, a move which could put enormous pressure on banks to keep huge capital buffer against risks, it is important the experience in Ghana is highlighted to guide future policy choices. Even though the banking sector in Ghana has experienced a phenomenal growth and cutthroat competition as a result of the proliferation of banks and a massive injection of capital over the last decade or so, interest rate remains exorbitantly high, amidst a relatively stable macroeconomic environment.

Research Questions

  • How do regulatory capital requirements affect banks’ specific level outcomes? In other words, to what extent do net minimum capital requirements or capital adequacy link with mainstream banks’ risk-taking incentives, efficiency and supply of credit?
  • Do higher capital adequacy requirements affect the sectoral distribution of credit?
  • How responsive are banks to regulatory capital changes?
  • How does capital compliance cost impact on banks’ outcomes; and
  • What is the nature of interrelations among banks’ performance outcomes and regulatory capital variables?

Objectives

The broad objective of this study is to investigate how regulatory capital compliance affects bank stability and efficiency and the interrelationships among these outcomes in Ghana. More specifically, the study will seek to:

  • investigate the effect of regulatory capital, namely, net minimum capital requirement, CAR and reserve requirements on banking efficiency, NPL, and credit supply;
  • investigate the sectoral credit distributional effect of changes in regulatory capital adequacy requirement;
  • investigate the sensitivity of banks’ lending rates or interest rate spread to changes in the central bank’s policy rates;
  • investigate how the cost of compliance to minimum capital requirements affects loan allocation, interest rate spread, NPL and the supply of credit; and
  • examine the nature of interrelationships among bank specific level outcomes and the regulatory capital variables.

Policy Relevance and Significance of the Study

The significance of this study hinges on the belief that a major drive towards financial stability and the growth of the banking industry in developing countries depends on appropriate regulatory policy responses from government, monetary authorities, banking industry and development partners that create an optimal set of incentives and desired outcomes. This study therefore is significant in many respects. First, from the perspective of broad policy directions from all stakeholders, this study touches on all the four possible effects of regulatory changes and reforms namely, the quantity effect, price effect, risk effect and distributional effect for a holistic approach in addressing stability concerns. For example, the study will be significant for the monetary authorities in that it provides information as to the likely effects of any future regulatory capital changes on credit supply, interest rates and distribution among the various sectors of the economy.

Second, the findings will also help regulators to possibly gauge how banks will respond to any future changes in regulations to bring about the desired results. Third, the banking industry itself will be guided by the findings of this study as it seeks to inform of the appropriate/optimal capital structure banks should maintain to bring about efficiency, profitability and stability in their intermediation efforts. Fourth, as many countries in Africa are making preparations to fully implement the Basel II Accord, a move which could put enormous pressure on banks to keep a huge capital buffer against risks, it is important the Ghanaian experience is highlighted to guide future policy choices both within and across Africa.

Last but not least, this study will fill the void in the banking and finance literature since there is a huge evidence gap regarding the distinct role regulatory capital adjustments in Ghana have played in the varying banking level outcomes, particularly in the African context. This study therefore seeks to provide a better understanding of the actual influence of regulatory capital on specific bank level outcomes – interest rate spread, credit allocation and risk-taking – and the interrelationships among these variables, as well as the extent to which banks respond to regulatory changes.

Target Institutions

  • Bank of Ghana
  • Ministry of Finance and Economic Planning
  • Development Partners: World Bank and IMF
  • Ghana Banking College/Banking Association
  • Academia: University of Ghana: Business School, Economic Department and ISSER etc.

Outputs

  • Research in progress.

    Project last updated on: 4 Sep 2014.