Re: Ghana’s Banking Crisis: The Deposit Protection Angle, Part I

Introduction: 

After reading the succinct analysis on the above subject matter by Samuel Alesu-Dordzi, I am inclined to break my usual norm as a passive observer, to respond for the first time on this “going-places” portal (Ghana Law Hub).

A Deposit Protection Insurance as my learned friend espoused is to do inter aliathe following; 

“provide the financial resources needed for the operation of the Scheme particularly for the reimbursement of the small depositors a member of the Scheme on the occurrence of an insured event in respect of that member’^[1]

At a glance, this forebodes a noble and novel idea (at least in Ghana) where we have seen several bank failures in the past and depositors have gone home empty handed. But in jurisdictions where this type of insurance or protection has been instituted their operations are very different from that anticipated by Banks and Specialised Deposit-Taking Institutions Act, 2016, Act 930. 

This write up which comes in three parts, Parts I to III, would first address the institutional and practical challenges that the Ghana Deposit Protection Act, 2016, Act 931 (in its current form) would face when implemented and later discuss whether or not the Ghana Deposit Protection Act, 2016, Act 931 can even address the object of its creation. This is not to say the Act is dead on arrival but it looks like that anyway.

Why do we need Deposit Protection (DP)?

It is widely accepted that banks play a very important financial intermediary role in any economy. This role is heavily regulated^[2]from the commencement of the banking business, that is licensing, and regularly (monthly reports and visitations by officials of BoG) during the operations of the bank.

The regulation of banks have been supported by many in times past including Adam Smith who, generally is not a fan of government controls but advocated strongly that “banks redeem all notes in specie upon demand”.

It is needless to state the role played by banks as financial intermediaries providing transaction services with demand debt; their susceptibility to runs and panics; their role in creating and destroying money; and their custodianship of the payment system.^[3]In fact, a bank’s susceptibility to runs is the main reason why deposit protection is necessary. All customer deposits, be they current, savings or time deposit accounts are called debts to the banks. That is, the deposits are liabilities that the bank invariably owes to its customers. A bank uses the deposits received from customers to advance loans, overdrafts etc to persons that it carries out business with. In order for banks to be able to serve their customers, they need to maintain a fine balance between customers’ deposits and the ones they have given out as loans. This is called reserves.  Every business enterprise uses some form of reserves to some extent. As a matter of life, ordinary people like all of us use  reserves by keeping some cash for immediate needs and putting others into longer term uses. 

Because most firms and individuals can safely predict their cash needs, they are able to put some into illiquid projects. But banks cannot know for certain how much of their debt will become due on any given day because most of their debt takes the form of deposit payable on demand. It is easy for banks to keep all their deposits in the vault awaiting customers’ withdrawal but vault money do not earn interest. Banks would then lose their most important income, which is interest on loans and other investments. This is why centuries ago banks learned a wonderful secret of keeping just a handful of the cash at hand to pay off demand deposit.^[4]

Therefore, banks survive when one depositor is depositing cash, another is taking out cash and because these two acts are independently driven the aggregate demand and supply are predictable. But this predictability evaporates during runs. Depositors who would otherwise have left their money in the bank withdraw it at once. In view of the above, if most depositors in a single day decide to withdraw large amount of money, there would be a total chaos and the bank cannot find all the money needed for them on a single day since some of the money have been advanced to other customers as loans, overdrafts etc and have not been paid back; the bank can come to it knees within a few days. Again, if the loans and overdrafts are not paid or not paid on time, the bank may be in trouble.

It is for these reasons that a certain form of deposit insurance or protection is required to save depositors from losing their life time investment (not the peanut proposed by Ghana Deposit Protection Act, 2016, Act 931 ) which would be discussed in the second Part of this Article. 

Whilst acknowledging that the picture painted in the preceding paragraphs have not been seen in Ghana before, (at least in recent times), it also follows that deposit protection insurance is not the only medicine to cure bank failures.

The Structure of Act 931 dealing with Deposit Protection Insurance

The long title of Ghana Deposit Protection Act, 2016, Act 931 provides that it is an Act ;

“…for the establishment of a Deposit Protection Scheme, Deposit Protection Fund, Deposit Protection Corporation and for related matters”

This intention of the Act (at least from the long title) was a noble one but one wonders why the framers either by accident or intentionally decided to deviate completely from that path. If they had stayed focused during the passage of the Act, we would not be where we are now.  The following explanation would demonstrate why.

To achieve the intention of the Act espoused in the long title, the Act establishes a Deposit Protection Scheme (the “Scheme”) as a form of insurance to protect the deposits of small depositors. Section 3 of Act 931 which provides for the object of the Scheme states that it is to protect small depositors from events that are insurable under the Act, and to support the development of a safe, sound and stable financial marketplace. This is a two-prong object capable of smooth implementation.

However, the Act would not even be able to address the first and the easier part of the object, that is, the protection of small depositors (the focus of Part II of this article) because of the structure of the Act, let alone the second part of the object of the Act. 

In fact, the overall goal of the Act should have had a non-recourse burden to the taxpayer as an integral aim, although one may argue that a deposit protection and a safe and sound financial market are all targeting the protection of the taxpayer. It is needless to say the small depositors target by Ghana Deposit Protection Act, 2016, Act 931 and safe and sound market place do not target the tax-payer but are both for government benefit.

Section 4 (3) of Act 931 makes membership of the Scheme automatic upon the grant of a banking or specialised deposit-taking Institution licence by the Bank of Ghana. This in itself is problematic. What this means is that once the Bank of Ghana issues a licence to a bank or a specialised deposit-taking institution, that institution would automatically become a member of the Scheme, subject only to the Bank of Ghana informing the Ghana Deposit Protection Corporation (GDPC), established under section 22 of the Act, of the issuance of such a licence. 

However, for the deposits of depositors to be properly protected in a free market, banks and specialised deposit-taking institutions should be allowed to decide whether they want to join this GDPC or do otherwise (because of the huge financial burden associated with its membership). In some jurisdictions, the option of joining a Deposit Protection Corporation (DPC) is given to the financial institutions.  But because of the forces at the marketplace, their membership (although optional by the enabling legislation), has become compulsory because depositors are informed which of the financial institutions are member of DPC and which ones are not and therefore Financial Institutions are left with no choice than to become members of DPC and boldly advertise their membership.

Part II would continue to address the other sections of the Act that may contribute to its stillbirth.

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^[1]Section 9 of Act 931, 2016

^[2]In the case of Ghana by the Central Bank, (hereinafter referred to Bank of Ghana) by virtue of Article 183 (2) (a) of the 1992 Constitution of Ghana. Which provides that; The Bank of Ghana shall [inter alia,] promote and maintain the stability of the currency of Ghana and direct and regulate the currency system in the interest of the economic progress of Ghana. 

^[3]Carnell, et al, The Law of Financial Institutions, 5^thEdition, Wolters Kluter Law Business, 2013

^[4]Ibid