Business Cycles, Bank Risks and Spread in Ghana

Abstract

The purpose of this study was to determine the relationship between liquidity and credit risks, and bank spread. It also sought to determine the cyclicality of the effects of liquidity and credit risks. Financial institutions play an important role in the Ghana’s economy. Among other things, the intermediary role they play between entities with surplus funds and those who have a deficit. They do this by accepting surplus funds through savings and other deposits which they then give to deficit entities through loans, overdrafts and other means. Theories such as the theory of financial intermediation assign some activities, also known as qualitative assets transformation, as the fundamental functions of banks. These activities that banks undertake also have associated risks which include liquidity risks and credit risks. The risks affiliated with maturity transformation evolve partly as a result of ensuring a sustainable level of liquidity anytime short-term deposits are used to finance fixed-rate long-term loans. This results in liquidity risks. Also, as intermediaries, banks stand surety for borrowers, since they guarantee repayment to depositors (lenders). To obtain the goals of the study, data was obtained from the Ghana Stock Exchange for banks that had quarterly data from the year 2008 to 2017. Macroeconomic data was taken from the World Bank database and Ghana Statistical Service database. These were analysed using the Generalised Methods of Moments (GMM) estimation technique. The findings of the study show firstly that, business cycles have a strong positive relationship with bank spread. This relationship is statistically significant, suggesting that there is a strong relationship and correlation between business cycle phases and the interest rate spread of banks, hence bank spread among the sampled banks is procyclical. Also, the findings indicate that credit risk is significant than liquidity risk in explaining bank spreads, but their relative effects differ over the business cycle phases. Credit risk is more significant on spreads in the period of expansion in the economy, while liquidity risk is more significant on spreads in the period of recession in Ghana. It is recommended that banks should factor the cyclical feature of liquidity risk and credit risk in pricing loans. Future researchers should consider cross-country analysis in Sub Saharan Africa to determine whether our findings can be extended to include other countries in the region.