In a banking sector where data on non-performing loans is not a pleasant one to boost of, it is no secret that bank portfolio managers have sought to tilt their holdings in bias towards fixed income. The Bank of Ghana has in the past mentioned the obvious reason of weaknesses in the economy as a key factor contributing to the value of non-performing credit skyrocketing from GHS3.6 billion to GHS6.1 billion as at July 2016.

Although the BoG has in the past sought to caution banks not to cut down on lending to businesses as a result of toxic loans they are already shouldering which has rendered their liquidity position quite wobbly, it is only natural that Chief Executives would gravitate towards seeking safer yield options. And this has been the case, with some banks openly declaring an unusual appetitive for Treasury bill investment. Who wouldn’t do same if yield on risk free assets is attractive, as has been the case before the tail end of December 2016, and wait for a better economic fundamental to support pre-crises lending momentum.

At the time when this discussion was dominating the headlines, the government was borrowing at a little over 24% p.a in the 182-Day bill thus still presenting Treasury bill as an attractive yield option. When on average banks were lending at 29% in APR terms, the opportunity cost of about 5% being let go was something investors could stomach viz a viz the risk considerations presented by deteriorating economic performance. As prevailed, portfolio managers accelerating the percentage hold of Treasury bills in the asset basket was a no brainer in such a limited alternative scenario. Fast forward, the 182-Day bill is selling at under 17% p.a and banks have seen little improvement in the fundamentals to justify embarking on pre-2015 lending drive despite renewed consumer confidence. Should banks decide to stick to playing it safe and continue to populate their portfolio with more Treasury bills, the bottom-line implication is a whopping over 13% shave-off in yield terms assuming the current market lending rate of over 30% p.a.

To unpack, current situation of challenging business environment, muted consumer demand, and weak growth, coupled with the current unattractive yield on risk free investments (Treasury bills) pose real dilemma to bank and non-bank financial institutions in their investment decisions. Whilst the consequences of the options are clear, it is suspected that direction will be purely driven by risk appetite of banks.

For institutions whose past impressive performance has been anchored on high appetite for risk, the current low Treasury bill regime will only reinforce the motivation to pursue more loan assets despite the growing credit risk presented by the weak economy. To this group, risk is seen as a treasure-throne from where above average returns can be reaped. And recognize as an opportunity to walk the grounds where the competition is staying far away from. In as much as they are mindful of the vulnerabilities presented by the shaky economic fundamentals, they invest in risk management to seize opportunities that delivers shareholder-expected returns. Unlike earlier, the gap between 17% p.a Treasury bill rate and over 30% p.a market lending rate is simply too great to ignore in the asset allocation decision. As risk-sensitive banks are expected shy away from lending in these times, the limited investment alternative means the demand for funds slows thus driving down bank deposit rate and cost of funds. Banks with high risk appetite, and they cannot be said to be many, are thus able to mobilize cheap funds to invest in risky loans at a super normal lending rate that ensures risk is fully quantified and priced accordingly.

Risk-averse banks on the other hand are expected to sail unperturbed by the declining yield on risk-free investments. The increased lending risk is worth avoiding by significantly curtailing credit to the market. In as much as they wish for the current low Treasury bill rate regime to be a short term happening, extending to the medium term is not expected to change the tight stance on credit as long as economic fundamentals shows no sign of improving to support strong credit servicing. What will however prove challenging would be the battle with shareholders who will most likely feel they are not generating enough value on their investments. The situation becomes a concern if on the other leg risk-taking-banks are producing far better ROE under same economic roof. Also given that risk-averse banks would most probably scale-back on lending and instead concentrate on Treasury bill investments means that they will be rendered uncompetitive in the bid for funds on the market. Risk-taking banks that do not relent in the advancement of credit even in this time, given the yield opportunity, will be able to pay a bit more to attract surplus liquidity.

What is worth exploring is whether risk-sensitive banks will continue to drive-on unperturbed should the current low Treasury bill rate persist in the long term or even fall further assuming again that the economic revival promised and anticipated fail to see the light of day. A number of questions are worth asking: At what low level of Treasury bill rate will risk-sensitive banks change their risk stance and be compelled to embrace above-the-normal appetite for risk to carry more loan asset than risk free investments amidst unimproved economic performance?. Or better still, at what high level of market risk premium would these risk-averse banks consider the associated yield significant enough to drive a shift in risk stance and tilt their portfolio holdings in favour of loan asset?. It is also worth testing whether significant change in a single factor, such as Treasury bill rate or market lending rate can potentially drive a change in risk stance of banks.

What is reasonably expected is that, deciding to go light on fixed income and heavy on higher-risk/high-yielding credit is a move that will be made with considerable patience especially by risk-sensitive banks. It is believed that at a highly attractive market risk premium, and thus widened gap between risk free assets and loan investments, even the most risk-averse bank will be compelled by internal pressures to take a bullish risk approach and reorganize its asset portfolio in favour of loans.

What is not known is whether the potentiality of such a scenario persisting over an unusually long period of time can result in risk-averse banks developing permanent appetite for high risk and thus would continue to chase the high yield in loan investments even under weak economic conditions. In the end, it will be about balancing the tug of war between searching for yield and managing rising risk of loan assets in a low growth economy where subdued corporate earnings is a source of concern.

Author: Ellah Makuba
Banking Professional
CONTACT: 0277324258

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