Winning Back Public Confidence in the Banking System

By Julius Opuni Asamoah (BSc, MBA, CA)

An efficient financial sector provides the rudiments for income-growth and job creation. This means that the financial sector plays a significant role in economic development. Any financial system that is not effectively regulated runs the risk of creating weak financial institutions. Indeed, if we so wish to ensure the stability of the banking sector, then the supervisory framework of Bank of Ghana (BoG) including ensuring well capitalised institutions, reliable and adequate information, a good legal framework with adequate enforcement provisions, transparency and disclosure requirements, needs to be enforced. Additionally, BoG should ensure effective risk management systems in banks, adoption of a risk based approach to supervision, good corporate governance practices, strict anti-money laundering regulations, and the adherence to sound ethical principles.

Many economic crises in history have been the result of financial crises, and many of these financial crises in turn originated as failures of financial intermediaries. In every instance the reference has been to banks, in their essential role as deposit-taking institutions involved primarily in the business of lending. We have witnessed many instances of bank failures and many of them, indeed, were left with impaired operations. The outcome has certainly exacerbated the scale and scope of the crisis and public confidence in the country’s banking sector has shrunk. Consequently, there has been a blatant public loss of confidence in the banking sector. Loss of confidence is when people who matter to an entity, feel they are no longer safe. When the very foundation upon which a relationship is built is threatened and when people believe they can no longer hold you to your words and may want to terminate any form of association, it is deemed that there is a total shrink in trust. Public confidence and trust are topical issues in banking. On the basis of evidence of declining trust in the banking sector certain schools of thought have concluded that we are now living in an ‘age of banking distrust’. They spoke of an apparent ‘banking crisis of trust’ to the extent that the loss of trust has become a cliché of our time. This identified powerful erosion of public confidence and credibility in the banking sector is quite worrisome. Invoking confidence and trust within the banking sector should be a matter of great concern to all players in the financial sector.

Public confidence is important in all areas of life. Public confidence is the belief that the public can have faith in or rely on ‘something or someone.’ In this case that ‘something or someone’ is the banking sector as well as its stakeholders. It is fanciful to appreciate that public confidence is a significant factor, and a big number of transactions would not be implemented without it in a market where the information is not equally available to participants. In a certain time period, confidence is necessary for concluding and implementing a transaction. In a difficult financial situation, smooth operation of banks is directly related to the customers’ public confidence and considered to be the basis of a long-term relationship. Public confidence decreases the social complexity, which is unavoidable and further increases in modern societies.

Public confidence in the banking sector is about the feeling of self-assurance arising from an appreciation of their bank's own abilities to deliver when required. Practitioners believe that public confidence in the banking sector is the belief or trust the public have in their banks or the banking sector as well as in the ability of the institutions and systems in the sector to act in a proper, trustworthy, or reliable manner. All these happen when there is stability in the banking system and this stability is assured when there is a well-balanced likelihood and not likely to fail, liable to collapse, overturn, and deteriorate in performance. In summation, stability in the banking sector is a situation when banks are recording favourable performances and there are no controversial bank closures, collapses or scandals in the sector. The smooth operation of the financial sector is strengthened through building stability and public confidence in the financial system. Instability and lack of confidence in the financial sector has resulted in the public failing or under-utilising the services of the banking sector, in recent times.

The two components essential for confidence are trust and certainty. Trust creates an obligation on both the bank and the customer while certainty means that the nature of the beneficiaries must be clear. Three certainties must be satisfied to create a valid trust and these are certainties of intention, subject and objects of the matter. The three types of trust that matter if financial markets are to operate smoothly, include, between customers and their agents, between customers and intermediaries, and between customers and the market, regulated to protect their interests. First, the customer needs the agent’s trust, that is, trust that the provider will guard and increase the value of savings or provide the financial services when needed in the future, consistent with the terms the consumer agreed to when signing up. Second, customers need trustworthy information to make choices, where product quality is not objectively verifiable. Third, they need market trust. They need to trust the marketplace to offer them a choice of agents who will act in customers’ interests or else they will not seek out financial products. There is a range of reasons why customers might distrust banks, but a necessary condition for trust more broadly is that customers believe that banks will fulfill their primary role of looking after their money. The role of trust and confidence in economic life, and their relevance to the banking financial crisis outline the relationship between social trust and economic prosperity and further differentiates the informal and social bases of trust from three significant formal mechanisms of economic confidence. The loss of public confidence in the banking system occurs when a bank or some banks in the system experience illiquidity or insolvency resulting in a situation where depositors fear the loss of their deposits and a consequent break down of contractual obligations that results in runs on the bank. Confidence is regained when banks are perceived to be well capitalised, customers can withdraw their funds without restrictions and bank charges are not too high.

Public trust in the banking system is a pertinent issue. In the past three years, this sector has established itself as an unstable sector, loosing clients’ trust on a daily basis. Therefore it is very important to rebuild customers’ trust in banks. High trust levels may not only reduce contractual costs, but also legal costs by reducing litigiousness. Trust reduces agency costs and transaction costs in banking relationships, which means that trust is one of the most important elements that determines the development of future business relationships, therefore it is necessary to define the concept of confidence precisely and to identify the factors that condition it. Regarding the conceptions of trust, the number of different concepts of confidence need to be analysed and taken into action, all to ensure public confidence in the banking sector. Talking about trust in banks, it would be valuable to analyse it from the economic-psychological aspect, because the customer has the key role in this relationship between the financial institution and the customer itself, and his decisions are influenced not only by economic factors, but also by psychological aspects. Due to this, majority of interpretations of trust are an interaction between psychological and economic expressions of human behaviour. Some people see trust as a prediction of other individual future behaviour. They conclude that trust is based on a customers’ certainty that the managers assisting their clients will take any actions necessary for the client’s benefit. Trust aids the possibility to control risks and diminish them. This conception can be applied defining the business trust establishment in financial institutions. All operations of companies are associated with a certain degree of risk, therefore it is very important for a company to manage and control the possible risks appropriately. Analysing the interaction between the risk and trust, one can make a conclusion that they are two factors that cannot exist without one another. This state can be applied to the operations implemented electronically as well as all other activities of financial institutions, while all of them are related to a certain degree of risk.

There is a direct relationship between trust and confidence. Trust is the conviction of clients in the creation of secured relations with the bank. Potential clients will not choose a company that cannot guarantee security of their provided services, for example in financial institution business they may treat the insecurity as a possible loss of money. Therefore, trust in banks is the existence of quality relations between the employees of a financial institution and their clients, which ensures security. Trust is acknowledged as one of the main factors, on the basis of which relations between individuals and businesses are formed. Hence trust is one of the most important factors in the business environment and is essential to ensure the successful activities of a bank. Consequently, understanding that trust is one of the main factors in choosing a commercial bank, it is necessary to identify factors conditioning such trust.

The banking sector has been blighted by poor corporate governance practices as well as delayed reactions by BoG in addressing these challenges, contributed to the entire nation experiencing a chain of bank collapses since the past three years. Since public confidence in the banking sector has waned, the majority of the public has preferred to keep their cash at home, creating the short-term transitory nature of bank deposits and low savings. Public confidence is a multiple social phenomenon, consisting of expectations of participants and the pursuit of gain. Trust is a value that influences the formation of cooperation between a customer and a bank. Trust is a part of an intangible property of organisations, which transforms itself to real value upon effective management. The issue of trust will always be with humanity, as long as we build, maintain and manage relationships.

The factors affecting public confidence in the banking sector identified are excessive risk-taking by banks, higher capital requirements, insolvency arising from contagion and counterparty risk, laxity in supervision and examination of banks, lack of regulatory and supervisory integration, quality, ethics and skills of bankers, implicit government guarantees, regulatory policies that do not encourage adequate risk management and the lack of efficient resolution regimes. Innovation in financial services, products and mobile banking have the potential to improve the relationships between banks and consumers by reaching remote corners of the world where the majority of the under banked and the unbanked population reside. Banks are highly leveraged institutions, with most of their funds coming from depositors and creditors and the management of a banking institution must exhibit impeccable integrity and professionalism in their conduct so as to engender public confidence in the safety of their deposits. Challenges faced by the banks could be attributed to deficient or ineffective supervision by the central bank, weaknesses in legal compliancy, operational pressure, and opportunities to commit fraud arising from weak internal controls, all these require effective regulations and monitoring and supervision.

Ghana has made great progress in its drive towards financial inclusion. However, this progress is being threatened with the recent happenings in the banking sector. The challenge is that the illiquid nature of bank assets (loans) which were financed by liquid liabilities (deposits) threatened the stability of banks by exposing them to runs by depositors who were unable to assess the financial health of banks, based on the existence of asymmetric information between depositors and banks. It needs to be notified that the financial system stability is the resilience of a financial system to internal and external shocks. Financial stability is evidenced by and reflected through an effective regulatory infrastructure, effective and well developed financial markets, and sound financial institutions. When there is a breakdown in trust, systems are threatened with turbulence. As many Ghanaians have lost confidence in the financial sector, since banks were not managed well. This lack of confidence has counted out prospective bank customers of financial inclusion. Considering the effect of the dominance of cash in any economy, the last we may want to do is inadvertently increasing the amount of cash outside the banking sector, therefore, the public confidence in the banking system needs to be restored.

In fact, it is the responsibility of the government to earn back public confidence in the banking system by providing a countercyclical policy instrument to provide support for the financial system and this requires that government remains creditworthy at times of stress through building buffers in good times. According to Ghana’s Business News, dated 3rd March of Year 2020, Mr. Eric Nana Nipah, the receiver for the 347 Micro Finance Companies as well as 23 Savings and Loans and Finance House Companies whose licenses were revoked on 31st March 2019 and 16 August 2019 respectively announced the commencement of full and final payments of depositor funds on 24th February 2020. The receiver explained that full and final payments are ongoing in line with government’s commitment to protect depositors’ funds and to shore up public confidence in the financial system. The financial system, in many ways just like any other industry, is more important, as money forms the foundation for any industry's operations. This means that the financial markets must function for any other industry to operate, therefore, the government must ensure that the financial markets are operating in order for the economy to function.

The common reasons for banks’ failure are bad loans due to lowered or compromised credit standards and funding issues caused by general market conditions, but more often occur because depositors lose faith in a particular bank. Sight should not be taken off assets and liabilities mismatch arising from re-pricing risk exposures, when a bank’s assets are severely unmatched to the liabilities supporting them. In much the same way, bad risk management decisions that can result in large losses, inappropriate loans to bank insiders, rogue employees who bypass internal controls, runs on banks where depositors lose confidence and demand their money all at once, are equally classified as the causes of banks’ failure.

To salvage the current situation, BoG and its partners in the financial sector need to exercise their overall supervisory and regulatory authority in all matters relating to banking and non-banking financial business with the purpose to achieve a sound, efficient banking system in the interest of depositors and other customers of these institutions and the economy as a whole. The development and expansion of the financial sector of every nation largely depends on the regulatory and supervisory framework underlying the sector. As a people, we need to create a vibrant banking sector and this requires an enabling environment for it to thrive. BoG should continue playing active role as a regulator. The authorities should implement acceptable reforms to strengthen the regulatory and supervisory framework and financial infrastructures, in order to bring back public confidence in the banking sector.

To conclude, banking crises are costly occurrences in terms of economic dislocation as the financial distress that arise usually take longer to dissipate. There is an urgent need to formulate a well-articulated strategy to deal with current and future potential financial imbalances. The strategies include a consistent macroeconomic policy framework, the use of monitoring tools, including macro-prudential analysis, market infrastructure, safety buffers, high-quality standards and practices, the development of markets and financial instruments, quality and availability of cross-border information, risk evaluation and pricing of financial instruments, development of prudent and efficient internal risk management systems, market discipline through prudential regulation and supervision, market forces to exert discipline, international cooperation of supervisory authorities and multilateral institutions, and the deposit insurance institution. Cooperation and coordination are critical in dealing with systemic crises. The unstable financial situation has caused a decrease in customers trust in banks. Therefore it is important to strengthen customers’ confidence in banks at the moment. The banking system has experienced significant changes since the onset of the financial sector reforms. However, the regulatory environment should be tougher with BoG reinforcing its supervision and monitoring activities, to prevent future recurrence of any newer financial crises.