Banking sector: Dividends paradox needs a second look

By Prof. Samuel Lartey

Introduction

THE banking sector in Ghana has long been an essential driver of the country’s economic development, with shareholders playing a critical role by providing capital to these institutions.

In return, they expect to share in the profits through dividends, which serve as a reward for their investments and a key incentive for continued financial participation.

However, in recent years, the Bank of Ghana (BoG) has imposed a freeze on profit-sharing for shareholders, citing the need to shore up the financial sector in the wake of the 2017-2018 banking crisis.

This move, however, has raised concerns about the fairness of penalising shareholders for the mismanagement of bank administrators, boards, and staff.

This feature explores the history and motivations behind this freeze, the impact on rural and community banks, and why shareholders should not bear the brunt of management failures.

We will examine the evolution of share issuance in Ghana, the historical returns on investments, and the effects of the freeze on the sustainability of banks, particularly rural and community banks, as well as their investors.

The Evolution of Share Issuance in Ghana’s Banking Sector

The tradition of shareholding in Ghana’s banking sector can be traced back to the colonial period when foreign-owned banks such as the Bank of British West Africa (now Standard Chartered Bank) and Barclays Bank were established to serve the colonial administration.

Following independence, Ghana’s banking sector gradually opened to private investors, with financial reforms in the 1980s and 1990s spurring the establishment of the Ghana Stock Exchange (GSE) in 1990. This provided a platform for banks to issue shares, allowing citizens and institutional investors to acquire ownership stakes in banks.

During the 2000s and early 2010s, Ghana’s banking sector witnessed significant growth, driven by increased lending, the expansion of banking services, and the introduction of innovative financial products.

This growth was reflected in the profitability of banks, with institutions like GCB Bank and CAL Bank consistently offering substantial returns to shareholders. For instance, in 2013, GCB Bank paid GHS 0.23 per share in dividends, and CAL Bank paid GHS 0.05 per share in 2014.

Shareholders benefited from these returns, which were supported by a strong financial sector with high average returns on equity (ROE) of around 20% during that period.

The 2017-2018 Banking Crisis and the Freeze on Shareholder Returns

In the mid-2010s, however, Ghana’s financial system began showing signs of distress, culminating in the 2017-2018 banking crisis. A combination of poor corporate governance, risky lending practices, inadequate capital, and non-performing loans led to the collapse or consolidation of several banks.

The Bank of Ghana responded by revoking the licenses of seven banks, including UT Bank and Capital Bank, and merging them into the newly created Consolidated Bank Ghana (CBG).

To prevent further destabilisation of the sector, the BoG introduced stringent reforms, including raising the minimum capital requirement from GHS 120 million to GHS 400 million in 2018.

As part of these reforms, the BoG imposed a freeze on the distribution of profits to shareholders, mandating that banks use their profits to strengthen their capital reserves and stabilise their balance sheets.

While this decision was necessary to restore confidence in the banking system, it has left shareholders frustrated, particularly as bank boards, management, and staff continue to receive benefits like sitting allowances, clothing allowances, and rent loans.

Impact on Investors in Rural and Community Banks

The impact of the BoG’s profit-sharing freeze has been particularly harsh on shareholders of rural and community banks (RCBs). These banks play a critical role in providing financial services to underserved populations in rural areas, including farmers, traders, and small businesses.

The capital that these shareholders provide helps RCBs expand their services, offering loans and credit facilities that are crucial for local economic development.

Rural and community banks rely heavily on the loyalty and investment of local shareholders, many of whom are individual investors who use their dividend earnings as a source of income.

The freeze on profit-sharing has hit these investors hard, especially in communities where banking stocks serve as a significant means of wealth accumulation. Without the prospect of dividend payments, investors in rural and community banks have seen their expected returns vanish, leaving many disillusioned.

Moreover, the suspension of profit-sharing has created a disincentive for further investment in rural banks. Shareholders, seeing no immediate returns on their capital, have become reluctant to reinvest, leading to a potential capital shortfall for RCBs.

This poses a serious threat to the sustainability of these banks, which already operate in a challenging environment characterised by limited access to financial markets and dependence on local capital.

The Paradox: Management and Staff Benefit, Shareholders Lose

While shareholders in both commercial and rural banks have been denied their returns, the benefits extended to boards and management have continued uninterrupted. Bank boards and executives have continued to receive allowances and bonuses, further widening the gap between those managing the banks and those who invest in them.

In 2021, for example, GCB Bank reported a profit of GHS 593 million but could not distribute dividends due to the BoG’s directive. Meanwhile, management and staff continued to enjoy perks such as clothing allowances and rent loans, which are seen by many as excessive in the current context.

This disparity has raised significant concerns among shareholders, particularly those in rural and community banks who rely on dividend payments as a source of livelihood.

These investors question why they are being penalized for the poor management decisions that led to the banking crisis when those responsible for those decisions continue to benefit from the system.

Why Should Shareholders Suffer for Management Missteps?

The most pressing question raised by the freeze on profit-sharing is why shareholders, who provide the capital that banks need to function, are being made to suffer for the mismanagement of administrators, boards, and staff.

Shareholders are not involved in the day-to-day management of banks, nor do they make decisions regarding lending or corporate governance. Instead, they trust the boards and executives to act in their best interests and to maintain sound corporate governance practices.

However, the 2017-2018 banking crisis revealed widespread governance failures, including risky lending practices, inadequate oversight, and in some cases, outright fraud.

These actions were not the fault of the shareholders, yet they have been the ones to bear the financial burden through the suspension of profit-sharing. This has created a deep sense of injustice among investors, particularly given the continued benefits enjoyed by management.

The Suspension’s Impact on the Sustainability of Banks in Ghana

The suspension of shareholder returns has had profound implications for the sustainability of banks in Ghana, particularly rural and community banks. RCBs, which rely heavily on local investment, have seen their ability to raise capital severely hampered by the freeze on profit-sharing.

Shareholders who once viewed RCB stocks as a reliable source of income are now reconsidering their investments, leading to a reduction in the capital available to these institutions.

This situation is particularly concerning given the vital role that rural and community banks play in providing financial services to underserved populations. RCBs are often the only banks operating in rural areas, and their ability to offer loans and credit facilities is critical to the economic development of these regions.

The reduction in available capital resulting from the freeze on profit-sharing threatens to undermine the sustainability of these banks, potentially leading to closures or consolidations.

In addition to the impact on rural banks, the suspension has also affected the overall banking sector in Ghana. With shareholders receiving no returns on their investments, investor confidence in banking stocks has plummeted.

The financial sector index on the GSE, which includes banking stocks, declined by 7.92% in 2022, reflecting reduced investor appetite for bank shares. This has weakened the financial sector’s ability to raise capital and undermined its overall growth prospects.

Historical Suspension of Shareholder Returns and Financial Repercussions

Before the 2017-2018 banking crisis, shareholders in Ghana’s banking sector enjoyed steady and reliable returns. For instance, GCB Bank’s dividend payout of GHS 0.23 per share in 2013 reflected the profitability of the banking sector during that time.

However, the suspension of profit-sharing following the crisis marked a turning point, with banks forced to retain profits to meet new regulatory requirements.

Since the suspension, banking stocks have become less attractive to investors, leading to stagnation in the stock market and a reduction in capital flows into the banking sector. The long-term effects of this freeze could be devastating for the sector, particularly if investor confidence is not restored.

Conclusion

The freeze on profit-sharing for shareholders in Ghana’s banking sector raises serious questions about fairness and the long-term sustainability of the sector.

While the Bank of Ghana’s motivations for imposing the freeze are rooted in ensuring the stability of the financial system, shareholders should not be made to suffer for the mismanagement of administrators, boards, and staff.

The continued payment of benefits to these individuals, while shareholders are denied returns, only serves to deepen the sense of injustice felt by investors.

Particularly concerning is the impact of the freeze on rural and community banks, which play a vital role in supporting economic development in underserved areas. The suspension of profit-sharing has weakened these institutions’ ability to raise capital, threatening their sustainability and the livelihoods of the communities they serve.

As Ghana’s banking sector continues to recover, the Bank of Ghana must consider lifting the freeze on profit-sharing to restore investor confidence and ensure the long-term sustainability of the sector.

A phased approach, allowing banks to distribute a portion of their profits to shareholders while retaining sufficient capital to meet regulatory requirements, could be a viable solution. This would provide a fairer outcome for shareholders while maintaining the stability of the financial system. The future of Ghana’s banking sector depends on a balanced approach that protects the interests of all stakeholders, shareholders, banks, and the broader economy alike.