(a.) Financial Intermediation as a Form of Business Activity

Financial intermediation is a core business activity in the monetary and financial system, where institutions act as intermediaries between surplus units (savers/depositors) and deficit units (borrowers/investors) to facilitate the efficient allocation of funds. In essence, it involves transforming savings into productive investments, managing risks, and providing liquidity services, all while generating profits through spreads and fees.

As a business activity, it can be described as:

• Risk Transformation and Management: Intermediaries like banks pool funds from many small depositors to lend to larger borrowers, diversifying risks. For example, in Ghana, commercial banks such as GCB Bank mobilize deposits from retail customers and extend loans to SMEs, bearing credit risk but mitigating it through collateral and due diligence under the Banks and Specialised Deposit-Taking Institutions Act, 2016 (Act 930).
• Maturity and Liquidity Transformation: They borrow short-term (e.g., demand deposits) and lend long-term (e.g., mortgages), profiting from interest rate differentials while ensuring liquidity via reserves mandated by BoG’s Liquidity Risk Management Guidelines.
• Information Asymmetry Resolution: By screening borrowers and monitoring loans, intermediaries reduce adverse selection and moral hazard, acting as delegated monitors. This is evident in Ghana’s banking sector, where institutions like Ecobank Ghana use credit scoring systems compliant with BoG’s Capital Requirements Directive to assess loan viability.
• Payment and Settlement Services: Facilitating transactions, such as through Ghana’s GhIPSS (Ghana Interbank Payment and Settlement Systems), which enhances operational efficiency.
• Profit-Oriented with Regulatory Oversight: While profit-driven, it operates under prudential regulation to ensure stability, as seen in the 2017-2019 banking cleanup where poor intermediation led to collapses like UT Bank due to liquidity mismatches.

In practice, this activity boosts economic growth by channeling funds to productive sectors but requires strong governance per BoG’s Corporate Governance Directive 2018 to avoid systemic risks.

b. Enhancing Profitability of a Financial Intermediary with Reference to Revenue Streams and Cost Components, Within the Ambit of Caution (15 Marks)

Profitability in financial intermediation is measured by metrics like Return on Assets (ROA) and Return on Equity (ROE), derived from net income after costs. It involves optimizing revenue streams while controlling costs, but always within cautious bounds to comply with regulations, maintain capital adequacy, and mitigate risks like those exposed in Ghana’s 2022-2024 Domestic Debt Exchange Programmed (DDEP), which eroded bank profits through haircuts on government securities.

Key Revenue Streams

Financial intermediaries generate revenue primarily through:

• Interest Income: From loans, advances, and investments (e.g., Treasury bills). This forms the bulk, often 70-80% of revenue in Ghanaian banks.
• Non-Interest Income: Fees and commissions from services like wire transfers, trade finance, and advisory (e.g., Stanbic Bank Ghana’s forex services).
• Investment Gains: Returns from securities and equities, though volatile.
• Other Income: From fintech partnerships or insurance cross-selling, regulated under the Payment Systems and Services Act, 2019 (Act 987).

Key Cost Components

Costs include:

• Interest Expenses: Paid on deposits and borrowings.
• Operating Expenses: Staff salaries, IT infrastructure, and compliance costs (e.g., anti-money laundering under BoG directives).
• Provision for Loan Losses: Reserves for non-performing loans (NPLs), heightened post-DDEP.
• Capital and Regulatory Costs: Maintaining minimum capital per BoG’s recapitalization guidelines (e.g., Notice No. BG/GOV/SEC/2023/05).

Strategies to Enhance Profitability Within Caution

To boost profitability (e.g., improving net interest margin from 5-7% typical in Ghana to higher via efficiency), strategies must balance growth with prudence, aligning with Basel II/III principles adapted for Ghana and BoG’s sustainable banking focus as of 2025.

• Optimizing Revenue Streams:
  • Diversify Loan Portfolio: Shift from high-risk sectors (e.g., real estate, post-2019 cleanup) to resilient ones like agribusiness under Ghana’s Planting for Food and Jobs. For instance, Access Bank Ghana enhanced ROE by 15% post-recapitalization through SME lending, but cautiously with NPL ratios below 5% as per BoG thresholds.
  • Boost Non-Interest Income: Expand digital services like mobile banking apps, generating fees without proportional cost increases. Ecobank Ghana’s Ecobank Mobile app, compliant with BoG’s Cyber and Information Security Directive 2020, increased fee income by 20% in 2024, but with caution against cyber risks via regular audits.
  • Strategic Investments: Invest in government bonds post-DDEP recovery, but limit exposure to 20-30% of assets to avoid concentration risk, as learned from the 2022 crisis where banks like Fidelity lost billions in impairments.
  • Hedging Instruments: Use forex forwards and interest rate swaps (per topics on corporate finance & risk management) to protect against cedi volatility, enhancing treasury income. Global comparisons like Barclays’ use of derivatives show profitability gains, but in Ghana, BoG approval ensures no speculative excess.
• Controlling Cost Components:
  • Efficiency in Operations: Adopt fintech for automation, reducing staff costs (e.g., AI-driven credit assessments cutting processing time by 50%). However, outsource cautiously under Act 987 to vetted providers, avoiding risks like data breaches seen in global cases.
  • Manage Funding Costs: Attract low-cost deposits via competitive savings products but maintain liquidity coverage ratios (LCR) above 100% per BoG guidelines to prevent runs, as in the 2018 panic withdrawals.
  • Proactive Risk Provisioning: Use forward-looking models for loan loss provisions, aligned with IFRS 9, to minimize surprises. Post-2019 cleanup, banks like Stanbic improved by stress-testing portfolios quarterly, enhancing ROA while staying prudent.
  • Capital Optimization: Raise tier-1 capital through retained earnings rather than dilution, as in GCB Bank’s post-DDEP strategy, ensuring CAR >13% for BoG compliance and dividend payouts.
• Balancing with Caution (Prudential Measures):
  • Regulatory Compliance: All enhancements must seek BoG feasibility, e.g., new products require approval to avoid fines under Act 930.
  • Risk-Adjusted Returns: Use RAROC (Risk-Adjusted Return on Capital) metrics to ensure profitability doesn’t compromise solvency, drawing from Basel adaptations.
  • Ethical Practices: Incorporate ESG under BoG’s sustainable principles, like green lending, which boosts long-term revenue (e.g., 10% premium on eco-loans) without ethical lapses.
  • Monitoring and Governance: Strong boards per 2018 Directive oversee strategies, with internal audits preventing overreach, as UT Bank’s collapse highlighted governance failures.

In summary, profitability can rise 10-20% through diversification and efficiency, but caution via regulation ensures resilience, as evidenced by Ghana’s banking sector’s recovery to average ROE of 18% by mid-2025 post-DDEP.