Economists back economic capital for banks

Some economists have backed the Bank of Ghana’s proposal to introduce an economic capital requirement for banks as part of strategies to reform and strengthen the banking industry.

Economic capital is explained as the amount of risk capital, assessed on a realistic basis, which a firm requires to cover the risks that it is running or collecting as a going concern, such as market risk, credit risk, legal risk, and operational risk.

Typically, economic capital is calculated by determining the amount of capital that the firm needs to ensure that its realistic balance sheet stays solvent over a certain time period with a pre-specified probability.

The Bank of Ghana (BoG), as part of financial sector reforms requested by the IMF, has set up a committee to design an economic capital structure for banks in the country.

It is understood that the economic capital will not be necessarily determined by the central bank but the banks will be required to separately work it out themselves, whilst the committee validates it.

Professor Peter Quartey, Head of the Economics Department of the University of Ghana, said the economic capital is a right modern approach, and would ensure fair play in the banking sector.

"One bar cannot be set for every bank. With the economic capital, depending on your size and the economic activities you engage in, a minimum capital is determined. So, banks will be classified based on their economic activities and then capital will be set based on the categories. If you are small, your minimum capital will be small; and if you are big, your minimum capital will be big.

So, I think the economic capital [idea] will be better and it will be in line with the Basel II requirement. And this is going to be a much more modern method," Prof. Quartey said in an interview with the B&FT.

Also, commenting on the development, a Senior Economics Lecturer at the University of Ghana, Dr. Ebo Turkson, said the move by the central bank will be a sure way to check whether industry players are doing the right thing.

"Normally when the minimum capital is set up, most of the banks are able to outgrow that minimum level and they go on to involve themselves in huge risks even though they have met the minimum capital requirement.

For instance, let’s say the minimum capital requirement is $100,000 and [a bank] goes transacting businesses that are in millions of dollars and something unexpected happens, the minimum capital requirement cannot meet the loss.

So, when you set up the economic capital, it can act as a secondary measure to hold them in check, so that you can track them and find out that these firms, even though they have met the minimum capital requirement, do they have enough capital to meet all their projects?"

The BoG has announced that it is in the process of adjusting the minimum capital for banks which currently stands at GH¢120million from a previous GH¢60million in 2012.

According to the Governor of the Bank of Ghana, Dr. Abdul Nashiru Issahaku, the decision to increase the minimum capital arose from the concerns that banks are unable to undertake big-ticket transactions and as such one way to overcome the challenge is to strengthen them and make them more resilient.