PRESENTATION OUTLINE

1. “IMPORTANCE OF LIQUIDITY AND CAPITAL ADEQUACY TO COMMERCIAL BANKS”Induction ceremony of ACCEVenue: UCC CampusMr. EdemCudjoeAmengor,MBA,ChEHead, Corporate Treasury,Senior Manager (Amalgamated Bank)

2. PRESENTATION OUTLINE • Introduction • Reasons for banks requiring liquidity • Capital Adequacy • Financial Institutions that Failed in Recent Times • Conclusion

3. INTRODUCTIONA bank in Ghana is a corporate body incorporated in Ghana and issued with a license by the Bank of Ghana to carry on the business of Banking.The liquidity of a commercial bank is the oil that keeps the bank moving smoothly and capital adequacy is the shock absorber that keeps the bank steady on the road when it falls into a pot hole or even a manhole

4. General Banking business involves the mobilization of funds/deposits from excess or surplus units of the economy and given out to deficit units as loans and advances. This is called financial intermediation. The performance of these functions by banks opens them to several risks; prominent among these is liquidity and credit risks.

5. The requirements of the surplus units (lenders) and the deficit units (borrowers) are diverse and conflicting. When widespread, such conflicts cause a great deal of problems, hence demand and supply of funds become unmatched. This is why the liquidity and capital adequacy of funds become a prudential issue for commercial banks. As a result, the prudent management of liquidity and adequate capital is necessary for the smooth operations of commercial banks.

6. The liquidity of a commercial bank relates to its ability to meet its obligation as they fall due.Banks require adequate liquidity, relative to their commitment in order to maintain the confidence of their customers (particularly their depositors) and their shareholders.

7. Specific reasons for banks requiring liquidity: • The need to be able to cover withdrawal of funds by customers. • To meet inter-bank indebtedness, which may arise on day-to-day basis following the payment clearing process; • To be able to meet unforeseen borrowing requests from customers. • To be able to cope with interruptions to their normal cash flow.

8. In addition to these commercial factors, commercial banks are required by law (Banking Act, 2004, Act 673, Section 31) to keep 9% of their deposits as primary reserves in an account with Bank of Ghana, which is used primarily to settle inter-bank indebtedness, and also as insurance for depositors.Banks are required to adhere religiously to this requirement. The Regulatory Authorities monitors this through the submission of weekly prudential returns and banks are penalised when they default.

9. CAPITAL ADEQUACY • The capital of a commercial bank may be defined as the value of its net assets. (That is total assets less total liabilities). The capital base normally comprises the bank’s share capital, various forms of accumulated capital reserves and certain types of sub-ordinated loan stock. • The capital base of a bank is vital for the protection of its creditors (its depositors) and hence for the maintenance of general confidence in its operations and the under-pinning of its long-term stability and growth.

10. The capital that a bank has is an important consideration since it is a measure of the banks ability to absorb losses which can arise from bad debts and trading losses (as with Barings in London). It is also a source for investments in technology and acquisition of other financial institutions.The adequacy of any given capital base depends not only upon the absolute volume of liabilities to be covered, but is also affected by the quality of the bank’s assets.

11. Thus, the more risky the assets, the greater must be the cushion of capital funds, other things being equal, to maintain a given level of capital adequacy. The importance of capital to a commercial bank is also given strong recognition by Bank of Ghana supervisory control which requires that banks maintain a minimum capital adequacy ratio of 10% at all times while in operation. (Banking Act, 2004 Act 673, section 23(1).Hence, in order to obtain and keep Bank of Ghana’s authorization to operate, capital adequacy is necessary.

12. Regulators use LR and CAR requirement to protect the customers and the financial system. When a crisis strikes, the Government is often the saviour of last resort. During the financial crisis, many major economies of the world guaranteed the savings of their citizens. Eg. The UK Government guaranteed up to the first GBP 50,000 each customer’s net savings.While capital is the seed upon which banking grows, liquidity (simply put, deposits) is the lifeblood of banking.

13. Liquidity is the lifeblood of a bank as well as the financial system as a whole. In commercial banking setting, achieving strong liquidity takes a long time because deposit have to be gathered primarily from retail sources. But these are often more stable and pose less liquidity risks. On the other hand, investment banks raise their funds from the wholesale market and so achieve liquidity pretty quickly. At the same time however, their liquidity can evaporate much more quickly.

14. Some Examples of Financial Institutions that Failed in Recent Times • Bank for Housing and Construction • Ghana Cooperative Bank Lehman Brothers, a 158-year old investment bank collapsed because it had assumed risks several multiple times over its capital base, and had run out of liquidity. Lehman was the biggest corporate bankruptcy in history in terms of assets (it held $639 billion of assets).

15. CON’T • Lehman’s high degree of leverage made it precariously vulnerable to market conditions. For example, in 2007 the ratio of its total assets to shareholders equity was 31. • Another US investment bank Merrill Lynch, had to be bailed out by Bank of America in a $50 billion rescue bid. • American Insurance Group (AIG) had to be rescued with an $85 billion loan because it had destroyed its capital.

16. CON’T • The Bank of Ghana measures the capital adequacy of a bank, as a percentage of the adjusted capital base to its adjusted asset base, and this should be 10% as already indicated. • The importance of capital to a bank is again given a global impetus by the Basel II Agreement on capital standards and relevant EU Directives.

17. CON’T • For example, in order to maintain authorisation to operate in the UK, and other EU countries, a bank must hold capital equal in value to at least 8% of its risk-weighted assets. • As already indicated, due to the high importance that regulatory authorities attach to capital adequacy of a bank, control is more stringent and banks are statutorily required to submit prudential returns on a monthly basis, and when they fall short of the required level, have 90 days to make up for the deficit or face sanctions in the form of penalty payments.

18. It must be mentioned that, currently, for a bank to be licensed to operate the business of Banking in Ghana, a minimum capital of GH¢60 million is required up from the previous level of GH¢7 million.This is again an indication of the need for a bank to have adequate capital to be able to absorb losses from operations and also to be able undertake bigger transactions, especially at this time of oil discovery and big multinational corporations will be engaged in the oil business in Ghana.

19. Bank of Ghana Monetary Policy Committee’s press release on the economy on February 19, 2010 which says that; The banking system has remained strong with improved liquidity, a large capital base and an expanding asset base. ‘The Banking Systems’ capital adequacy ratio (which measures the banking system’s ability to withstand shocks) increased significantly to 18.2% in December 2009, from 13.8% in 2008 as a result of the recapitalization of the banks.

20. This strengthens the fact that the banking sector in Ghana is adequately capitalised and liquid or oiled enough and remains strong with improved liquidity to absorb any shocks that may arise.

21. Thanks for your Audience