The Banking Sector in Ghana: Issues in relation to Current Reforms

Text Sample: Chapter 2.4, The Need for Capitalizing Banks: According to Field (2008) 'when a nation's bank experience major losses, depositors, the markets, and regulators respond' The market responds by making it difficult for the bank to raise funds. Depositors may rush to withdraw funds from the banks. The regulators, according to Levine (1998) respond by closing banks, guaranteeing their liabilities, or recapitalizing them. The most obvious decision that regulators have to make is whether to let banks fail. Do their inabilities to raise sufficient private capital indicate that they are not viable or produce future services that are worth less than their cost, and thus should be closed? Only if the government, depositors, and borrowers were first allowed to jointly renegotiate first, would the inability to restructure indicate that the banks are not viable. According to Hogarth and Thomas (1999) in many countries, there is a very deep government safety net and substantial regulations that influences discussions on bank capital structure. So one approach in the view of Sufian and Chong (2008) would be to ignore the markets and analyze bank recapitalization as a bargaining situation between banks and regulators. Even with total deposit insurance, Hassan and Bashir (2003) are of the opinion that the banks will need to consider the effects of their credit rating on the other lines of business they can provide. If the level of capital is below the minimum necessary to stay in business (and this minimum will actually be enforced), then, Flannery (2009) thinks banks will need to do whatever it takes to increase their capital to the minimum. This 'whatever it takes' type of bank behavior, Nakaso (1999) argues could have undesired effects on the economy. It focuses on the effect of bank recapitalization on banks and their existing borrowers. According to Banks (2004) the effect on future borrowers (new business development) is ignored on the basis that new banks, other recapitalized banks, or even foreign banks could provide such new relationship-based funding without a subsidized recapitalization of the majority of existing banks. Recapitalizing a large number of banks, according to Goddrad et al (2004), is desirable only if it protects the value of existing relationship lending and human capital in banks and firms. If the reason to have a well-capitalized banking system is to ensure that new relationships can be established, then it can be achieved by recapitalizing a few of the best banks. The analysis here points out that the recapitalization, and ist extent, can result in transfers between banks and borrowing firms that can go in either direction. This result is because according to Rivard and Thomas (1997) bank capital influences the bargaining between a bank and ist borrowers. In addition, recapitalization can have efficiency effects by influencing a bank's decision whether to foreclose on ist defaulted loans. According to Cooper et al (2003) the amount of current bank capital, affects the behavior of a bank when it is required to have a minimum amount of capital in order to remain in business. The same effect occurs when the threat of closure due to low capital comes from market participants who, according to Brissimis et al (2008) may not provide capital or from potentially uninsured depositors who may withdraw deposits.