The Appreciating Ghana Cedi Value: Impact on banks’ credit portfolios and strategies for sustainability and profitability

The Appreciating Ghana Cedi Value: Impact on banks’ credit portfolios and strategies for sustainability and profitability

The Ghanaian economy has in recent times witnessed quite a significant appreciation of the Ghana Cedi (GHS) against major foreign currencies; a development that has far-reaching implications for various sectors of the Ghanaian economy, including the banking industry.

The appreciating Ghana Cedi can impact the credit portfolios of Bank’s operating in Ghana in several ways, affecting their profitability and sustainability.

The appreciation of the Ghana Cedi creates both opportunities and challenges for banks. At the outset, an appreciating domestic currency engenders optimism regarding the overall health of the economy.

However, for banks’ credit portfolios, the implications are far from straightforward. Credit portfolios, which comprise various types of loans—including corporate, consumer, and foreign currency denominated loans—must be re-evaluated in the new context.

The appreciating Ghana Cedi can have both positive and negative effects on the Bank’s credit portfolios. On one hand, a stronger Ghana Cedi can lead to reduced Credit Risk for Banks, as Borrowers with foreign currency-denominated credit facilities may experience a decrease in their debt burden.

This reduction in credit risk can lead to lower provisioning requirements, resulting in cost savings for Banks. On the other hand, the appreciating Ghana Cedi can lead to currency mismatch, potentially resulting in losses for Banks with significant foreign currency-denominated assets.

A bank’s credit portfolio is typically made up of facilities from various sectors/segments of the economy. Not all sectors are affected equally by the currency’s appreciation. For instance, the manufacturing and export sectors may face challenges as a stronger domestic currency reduces their competitive edge in global markets.

Conversely, sectors that rely heavily on imports, such as technology and consumer goods, may benefit from lower local costs of imported components. As a result, banks need to segment their credit portfolios to differentiate sector-specific risk profiles.

Let us explore some sectors that could be adversely impacted by an appreciating Ghana Cedi:

Export-Oriented Sectors

• Agriculture: An appreciating cedi could make Ghanaian agricultural products more expensive for foreign buyers, potentially reducing demand and exports.
• Manufacturing: Similar to agriculture, manufactured goods could become pricier for international buyers, impacting export revenue.
• Tourism: An appreciating cedi might make Ghana a more expensive destination for tourists, potentially affecting the tourism industry.

Local Industries Competing with Imports

• Manufacturing: If imports become cheaper due to the appreciating cedi, local manufacturers might struggle to compete, potentially leading to reduced sales and revenue.
• Agriculture: Imported agricultural products could become more affordable, potentially affecting demand for locally produced goods.

Some sectors of the Ghanaian economy, however, might benefit from an appreciating Ghana Cedi include:

• Importers: Importers might benefit from cheaper imports, potentially leading to increased demand and sales.
• Consumers: Cheaper imports could lead to lower prices for consumers, increasing their purchasing power.
• Sectors reliant on imported goods: Industries that heavily rely on imported goods, such as manufacturing, can benefit from reduced costs and increased competitiveness.
• Financial Sector: A stable and appreciating cedi can boost confidence in the financial sector, attracting investors and potentially leading to increased investment and economic growth.
• Stock Market: The Ghana Stock Exchange has seen strong performance, with market capitalization increasing significantly due to renewed investor confidence, particularly in the mining, IT, and finance sectors.

With all that said, the actual impact would depend on various factors, including the specific industries, market conditions, and government policies.

This article aims at exploring the impact of the appreciating Ghana Cedi on the credit portfolios of Bank’s operating in Ghana and discuss potential strategies to manage credit portfolios, ensuring sustainable profitability.

Impact of the GHS Value appreciation on Banks’ Credit Portfolios

As indicated above, the appreciation of the Ghana Cedi can have both positive and negative effects on banks’ credit portfolios:

1. Credit Risk Reduction: A stronger Ghana Cedi can lead to reduced credit risk for banks, as borrowers with foreign currency-denominated loans may experience a decrease in their debt burden. The increased ability to repay debt significantly improves the Risk Assets’ Portfolio health.
2. Risk Profile Distortion: If Lenders have structured their financing based on an expectation of a stable or devaluing currency, unexpected appreciation may distort the risk profiles of these assets, potentially increasing the likelihood of loan write-offs or impairments in future periods if not managed properly.
3. Collateral Valuation: The domestic valuation of collateral assets may be affected, and adjustments in loan-to-value ratios may be necessary.
4. Reduced Provisioning Requirements:
   1. An improvement in asset quality normally leads to a reduction in the need for banks to provision for bad debts, resulting in improved profitability.
   2. As the cedi appreciates, the value of USD-denominated loans decreases in cedi terms. This reduction in loan value might lead to lower provisioning requirements, as the expected loss on these loans decreases.
   3. If provisions were previously made for potential losses on USD-denominated loans, an appreciating cedi might lead to a reversal of these provisions, positively impacting banks’ profitability.
5. Repayment Dynamics: Borrowers might opt to repay USD-denominated loans earlier to take advantage of the appreciating cedi, which could lead to changes in banks’ loan portfolios and cash flows.
6. Currency Mismatch: Banks with significant foreign currency-denominated assets may face challenges due to currency mismatch, potentially leading to losses. When the Ghana Cedi appreciates, the value of these assets may decrease, resulting in losses for banks.
7. Increased Lending Capacity: With a more stable currency, banks may be more willing to lend, potentially increasing their lending capacity and revenue. This increased lending capacity can enable banks to support economic growth and development in Ghana.
8. Interest Income Impact: Banks might face pressure to adjust interest rates on USD-denominated loans to reflect the changed economic conditions, potentially impacting their interest income. This is a decision that has to be made in the face of increased competition in the Banking industry for creditworthy customers.
9. Decreased Capital at Risk: With the appreciating cedi, the capital at risk for USD-denominated loans might decrease, as the reduced loan value in cedi terms would require less capital to be set aside.
10. Impact on Capital Adequacy Ratio: The reduction in capital at risk and potential reversal of provisions could lead to an improvement in banks’ capital adequacy ratios, making them more resilient to potential shocks.
11. Reduced Demand for Credit: A stronger Ghana Cedi can lead to reduced demand for credit, particularly for importers and businesses that benefit from a weaker currency. This reduced demand can negatively impact banks’ revenue and profitability.
12. Increased Competition: A stronger Ghana Cedi can lead to increased competition in the banking industry, as foreign banks may be more likely to enter the Ghanaian market. This increased competition can put pressure on banks to improve their services and reduce costs.

Recommended Strategies to Manage Credit Portfolios

There is little point discussing the impact of the appreciating GHS without providing suggestions on strategies to manage credit portfolios in this situation. To remain profitable and sustainable, banks in Ghana can adopt the following strategies:

Risk Management

• Credit Risk Assessment: Banks should conduct thorough credit risk assessments to identify potential vulnerabilities in their loan portfolios. This assessment should include evaluating the potential impact of currency fluctuations on their borrowers’ ability to service their loans.

Banks must also initiate a reassessment of credit risk models. Traditional indicators, such as debt service coverage ratios and collateral valuations, become more volatile in the light of currency appreciation.

Banks will be faced with the dual task of recalibrating exposures while also maintaining profitability margins in a context where the cost of funds might also shift as the central bank’s monetary policy might experience changes, in response to the new currency dynamics.

• Stress Testing: Banks should conduct regular stress tests to evaluate the potential impact of currency fluctuations on their credit portfolios. These stress tests can help banks identify potential vulnerabilities and develop strategies to mitigate potential losses.
• Hedging Strategies: Banks can employ hedging strategies, such as forward contracts or options, to mitigate potential losses due to currency fluctuations. These hedging strategies can help banks manage their currency risk and reduce potential losses.

Diversification

• Diversify Loan Portfolios: Banks can diversify their loan portfolios to reduce exposure to specific sectors or industries that may be negatively impacted by the appreciating Ghana Cedi. This is a regular practice in the industry and an adherence to this principal could be a key management tool. This diversification can include lending to different sectors, such as agriculture, manufacturing, or services, who may experience varied levels of impact.
• Currency Diversification: Banks can consider diversifying their assets and liabilities across different currencies to mitigate potential losses due to currency fluctuations. Financial Institutions will normally hold different levels of assets and liabilities in different currencies in an effort to mitigate exchange rate risk.
• Geographic Diversification: Where possible and practicable, Banks may consider expanding their operations to different geographic regions to reduce exposure to specific markets. This geographic diversification can include opening new branches or subsidiaries in different countries.

Regulatory Compliance

As the appreciating Ghana Cedi shifts the risk profile of banks’ credit portfolios, regulatory frameworks are bound to evolve. Banks must work closely with regulatory authorities to ensure that their internal capital buffers and risk management practices are aligned with updated guidelines.

• Monitor Regulatory Requirements: Banks should closely monitor regulatory requirements and guidelines related to foreign exchange transactions and credit risk management. This monitoring can help banks ensure compliance with regulatory requirements and avoid potential penalties.
• Maintain Adequate Capital: Banks should maintain adequate capital buffers to absorb potential losses due to currency fluctuations. This capital adequacy can help banks maintain stability and avoid potential insolvency.

Robust capital planning and alignment with regulatory frameworks are not only essential for compliance but also critical to maintaining market confidence in a bank’s long-term stability.

Conclusion

In Ghana’s current situation, the appreciating value of the Ghana Cedi presents both opportunities and challenges for banks in Ghana. Banks in Ghana can effectively manage their credit portfolios and remain competitive in a rapidly changing economic environment by choosing to adopt some of the recommendations made.

By adopting effective strategies to manage credit portfolios, banks can mitigate potential risks and remain profitable and sustainable. This article highlights the importance of diversification, hedging, etc in managing credit portfolios in a changing currency environment.

Banks are increasingly incorporating forward-looking measures into their credit risk models. This means that, rather than relying solely on historical performance, contemporary risk assessment leverages macroeconomic forecasts, sectoral trends, and currency fluctuation projections.

Banks must also remain vigilant about the possibility (though unlikely) of sudden reversals in currency trends. Even as the Cedi appreciates under current conditions, reversals or periods of heightened volatility could expose a significant unhedged portion of their credit portfolios. Hence, a dual approach—taking advantage of current conditions and preparing for potential future volatility—is the most sustainable route to managing these currency fluctuations.

RICHARD BOAFO

rboafogh@gmail.com

(The Author is an Associate Member of the Chartered Institute of Bankers, Ghana and a Certified Credit Administrator)

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