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Collateral Lending: The cost and the opportunities for reform

By: Emmanuel Bruce
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A recurring issue among borrowers in Ghana is concern over perceived high bank spreads in Ghana. The Governor of Bank of Ghana from a transcript of the 77 Monetary Policy Committee (MPC) new conference in Accra on July 24, 2017 indicated that the large spreads are caused by three factors :

•    A relatively large share of non-performing loans (NPLs). – As of October 2017, NPLs comprised 21.6 per cent  of total advances of banks in Ghana.
•    High Profit Margins.- Banks have relatively high profit margins on lending. A certain percentage of this can be attributed to “captive clients”, i.e. Clients who are loyal to the bank, and do not hold accounts with or take loans from other banks, and lower competition (further explained in the section related to all asset debentures). A percentage of this margin can be directly attributed to difficulties in using collateral. The absence of efficient judicial procedures to facilitate loan recovery may also increase the margins.
•    High Operating Costs. - Overhead costs are the most important component of interest rate spreads. This high overhead cost is related to low productivity and overstaffing. Banks in Ghana have more employees for a given amount of assets, loans and deposits than other banks in emerging market countries.

In disallowing collateral in the calculation of prudential loan loss provision, Bank of Ghana in its guide for reporting institution stated this “.  Property and guarantees are not currently regarded as sufficient security because of the difficulty of foreclosure and collection “

In addition, the 2017 Barclays African Group Financial Market Index stated that Ghana generally score well based on their enforcement of netting and collateral positions. However, the report noted that Ghana’s insolvency framework was the weakest in the index. Despite adhering to international standard master agreements, with the exception of Global Master Securities Lending Agreement (GMSLA), and enforcing netting and collateral positions, it fails adequately to resolve insolvency without incurring high recovery costs for creditors. On average, the payment recovery rate is 23 cents on the dollar, 12 cents below that of South Africa.

The length of foreclosure proceedings can vary from less than 1 year to up to 5 years. Creditors have less incentive to start the foreclosure proceedings if they know from the start that the proceedings may take years (with longer proceedings typically favouring degradation of collateral) and debtor discipline may be lower, as debtors may be less inclined to meet their payment obligations if loan enforcement is not a credible deterrent. IMF data tends to show that the level of NPLs is lower in countries where the foreclosure period is shorter.

Although in Ghana the Borrowers and Lender Act 2008, Act 773, allows banks and other financial institutions to takeover collateral used in securitising loans without going through the rigours of court, several loopholes have seen debtors slow banks down in taking over properties or securities. The authority from the Collateral Registry to grant a lender to take over the property presupposes two things:

1.    The quantum of debt will not be contested
2.    Can take possession of the property in a peaceable manner

The trick adopted by some borrowers is to sue the bank on some issue e.g. contest the quantum of the loan amount indicated in the demand letter. There can be no attachment or sale before the legal issues are decided by the courts.

Secondly, most mortgagors (especially if it’s a third party’s property) will go all out to make the takeover of the property difficult. Most banks, to my knowledge, take the safest route via the courts (section 33 (a) of Act 773 )

The flawed collateral process affects the demand for finance as an increasing number of borrowers have difficulties meeting the collateral requirements. The process also negatively affects lenders as they have to compete vigorously for the small crop of borrowers who do meet the stringent criteria for collateral. Lenders also have to contend with the costly realisation process. All these problems add risk to the business of lending and borrowing.

Under well-designed and well-operated collateral processes, both lenders and borrowers benefit from the pledging of collateral, resulting in limited legal claims, a reduction in informational asymmetries, limited excess borrowing, lower financing costs and increased credit in the economy. The report puts forward a number of recommendations aimed at reforming the three main components of the collateral process: creation, perfection and enforcement of security.

This article provides answers to the following questions:
a.    What is the addition in cost and time to the borrower and/or lending institution of the existing system of acquiring, controlling, foreclosing and disposing of collateral in Ghana?
b.    What is the estimate of the cost of collateral to the total lending cost in Ghana?
c.    How much do collateral requirements inhibit potential borrowers in Ghana?
d.    What are the legal and extra-legal constraints which hinder the collateral process in Ghana?
e.    What can be done to streamline the collateral process and ease the burden of costs in Ghana?
g.    Executive summary
h.    The following challenges inhibit the ease of collateralisation in Ghana:
i.    •    Weak and dispersed legal framework:There are many statutes regulating the creation and perfection of collateral. Collateral perfection in Ghana is legislated by different laws.

 First a collateral charge needs to be registered with the Registrar General in accordance with the companies’ code, then with the Lands Commission for land title/land registry and then with Collateral Registry in accordance with the borrowers and lenders’ act .

Each of these channels of collateral charges have equal priority in law. So a bank needs to register with all the channels.

The laws lack uniformity and result in a convoluted conveyance system. For example, freedom to contract has been severely curtailed by the statutes that inhibit property rights through archaic procedures and regulations. In addition, stamp duty is expensive, both in its direct cost and in the method of its collection;

j.    •    Weak and dispersed registry system:There are many registries which are manual, inefficient, uncoordinated and inconclusive;
k.    •    Weak enforcement procedures: The judicial system has been a major hindrance to lenders ability to raise security with a mix of slow judicial processes;
l.    •    Restricted scope of security instruments: Lenders have not been innovative in considering other forms of collateral. There is a tendency to rely on traditional all-asset debenture and legal mortgages at the expense of less costly and more innovative financial products.
m.    •    Injunctions: Although in Ghana, the Borrowers and Lender Act 2008, Act 773, allows banks and other financial institutions to takeover collateral used in securitising loans without going through the rigours of court, several loopholes have seen debtors slow banks down in taking over properties or securities.