Rural Banking: The Case of Rural and Community Banks in Ghana

This case study describes the business model of the rural and community bank (RCB) network in Ghana and analyzes its performance. The study analyzes the service delivery and financial performance of the RCBs at two levels: the network of all banks and a representative sample of 12 RCBs. It finds that although the service delivery performance of the RCB network has been very good, its financial performance has been mixed.


EXECUTIVE SUMMARY
This case study describes the history and business model of the rural and community bank (RCB) network in Ghana, analyzes its performance, identifi es key issues, and makes recommendations on the way forward. The study analyzes the service delivery and fi nancial performance of the RCBs at two levels: the network of all banks and a representative sample of 12 RCBs. It fi nds that although the service delivery performance of the RCB network has been very good, its fi nancial performance has been mixed.
Before the establishment of RCBs in the late 1970s and the subsequent expansion of other service providers into rural areas, access to institutional credit for farm and nonfarm activities was scarce. The main sources of credit were moneylenders and traders that charged very high interest rates. In many rural communities, secure, safe, and convenient savings and payment facilities hardly existed. Many rural dwellers had to travel long distances to receive payments (such as salary and pension deposits), transfer funds, and cash check payments for their agricultural produce. This situation led the Government of Ghana (GoG) to take several measures to increase access to credit in rural areas. After establishing an agricultural lending requirement for commercial banks and creating a publicly owned agricultural development bank, the GoG facilitated the establishment of RCBs.
The fi rst RCB was established in a farming community in the central region of Ghana in 1976. Rural communities showed tremendous interested in the community ownership and management features of RCBs, and by 1984 the number of RCBs reached 106. The introduction of a check payment system for cocoa farmers (known as the Akuafo Check operation) also spurred the establishment of local banks in many communities. In 1981 about 30 existing RCBs formed an Association of Rural Banks (ARB) to serve as a networking forum. As a network of institutions sharing a common mission, the ARB promoted and represented the RCBs and also provided training services to member RCBs. 2 The fi nancial performance of many RCBs started to decline, however, for several reasons, including a drought that affected the country in 1983 (leading to high loan default rates), weak governing ability, confl icts within boards of directors, and ineffective management in many RCBs. Several reforms were undertaken to curb the deteriorating situation-exposure to risky sectors (mainly agriculture) was limited, distressed banks were closed, supervision by the central bank was strengthened, and RCB managers and boards of directors were offered training. Nevertheless, RCBs continued to be relevant rural fi nance service providers, and the GoG has consistently provided support to the RCBs by fi nancing capacity building (in partnership with several donors), restructuring programs, and undertaking regulatory reforms.
By the end of 2008, 127 RCBs were in operation with a total 584 service outlets. RCBs are regulated by Ghana's central bank, the Bank of Ghana, and thereby form part of the country's regulated fi nancial sector. RCBs are the largest providers of formal fi nancial services in rural areas and represent about half of the total banking outlets in Ghana (IFAD 2008).

BUSINESS MODEL
Small asset base. RCBs are relatively small fi nancial institutions with average share capital of GHc 136,526 (US$105,263), average deposits of GHc 2.3 million (US$1.77 million), and average assets of GHc 3.8 million (US$2.4 million). Values of the three indicators, however, vary signifi cantly among RCBs. Out of the total 127 RCBs, 75 percent have assets between GHc 1 million (US$771,010) and GHc 8 million (US$6.1 million), and 20 percent of RCBs have assets of less than GHc 1 million, and 5 percent of RCBs have assets exceeding GHc10 million (US$7.7 million). Similarly, 44 percent of RCBs have share capital of less than GHc 100,000 (US$77,101) and only 6 percent have share capital of more than GHc 250,000 (US$192,753).
Fully owned and governed by local communities. RCBs are fully owned by individual shareholders who are residents of communities in which they operate. Each rural or community bank has a board of directors (BoD) that is responsible for its strategic governance. BoDs are elected by owners/shareholders during annual general meetings. Election criteria are normally based on reputation in the community and professional expertise. Most board members have relevant professional experience, but experience in banking is nevertheless extremely limited. Board members can be reelected more than once.
In some of the old RCBs, board members have served as long as 32 years. The average length of service in the sample banks was 11 years. Key responsibilities of BoDs include (1) appraising and approving loan applications as well as ensuring repayment of loans; (2) monitoring the fi nancial performance of the bank; (3) providing strategic guidance to management; and (4) supervising the management.
Professionally managed and staffed. The core management staff of a typical RCB is typically composed of a chief executive offi cer who is in charge of the daily management of the bank; an internal auditor, responsible for internal control measures, who reports to the BoDs 3 ; a fi nance offi cer; and credit and project offi cers (in charge of microfi nance operations). Many of the personnel are recruited from local communities. Almost all RCBs have one or more branches, each of which is staffed with a branch manager, an accountant, credit offi cers, clerks, and cashiers.
Strategic alliance to stay competitive. The ARB Apex Bank was granted a banking license in 2001 and commenced commercial operations in 2002 with signifi cant fi nancial support from the Rural Financial Service Project, which was funded by the World Bank, the International Fund for Agricultural Development, and the African Development Bank. The Apex Bank provides specialized services essential to improving the quality and scope of products offered by RCBs and also performs important supervisory functions delegated by the BoG. Check clearing, specie supply, treasury management, loan fund mobilization, domestic and international money transfers, information and communication technology, training, and inspection and audit are among the main services offered by the Apex Bank. The Apex Bank provides most of the services on a fee basis.

PRODUCTS AND SERVICES
Savings. RCB savings products include regular savings accounts, current accounts, susu deposits, 4 and fi xed or time deposits. In the sample of 12 RCBs, regular savings deposits account for about 58 percent of the total number of clients and 57 percent of the total deposit balance. These accounts are small in size and short term. The interest rate for regular savings is low and is paid only once a balance reaches a certain amount (usually higher than the balances held by most savers). Many rural clients have access to this type of account; unlike other commercial banks, RCBs do not require a high balance to open an account. Susu is the second-largest account type, representing 21 percent of total clients, but its share of total deposits is only 11 percent because of the small size of each account. Fixed and special deposits that offer higher interest rates with a long-term deposit contract represent only about 1 percent of total number of clients.
Credit. The credit products offered by RCBs include microfi nance loans, personal loans, salary loans, susu loans, and overdraft facilities. In the sample of 12 RCBs, salary loans account for 33 percent of total advances, followed by personal loans (24 percent) and microfi nance (20 percent). In terms of the number of borrowers, microfi nance accounts for 31 percent of total borrowers followed by personal loans (26 percent) and salary loans (22 percent). RCB loans are used for agriculture, cottage industries, and trading. Microfi nance loans are categorized under trading, which accounts for 41 percent of the total sectors fi nanced. Agricultural loans are reported to account for about 9 percent of loans, but this fi gure is an underestimate given that a signifi cant portion of the loans reported as microfi nance and personal loans are actually used for agricultural production.
Money transfer and payments. RCBs offer money transfer and payment services to their clients in collaboration with the ARB Apex Bank. RCBs participate in local and international money transfers through, among others, Western Union, Money Gram, and Vigo. Government agencies use the RCB service outlets for salary and pension deposits. Clearing of checks for cocoa purchases is also an important service provided under the payment category.

PERFORMANCE
Steadily increasing outreach and service delivery. The RCB network reaches about 2.8 million depositors and 680,000 borrowers, making RCBs the largest group of licensed fi nancial service providers in rural areas. RCBs have a market share of 67 percent of depositors and 48 percent of borrowers in rural areas. Clients of RCBs consist mostly of farmers, government employees, and small and micro entrepreneurs. RCBs' increasing outreach to underserved areas has signifi cantly contributed to addressing the credit constraint in rural areas. Between 2000 and 2008, the number of depositors grew at an average annual rate of 14 percent, and the number of borrowers grew at an average annual rate of 27 percent.
Mixed fi nancial performance. The profi tability and net worth of the RCB network have steadily increased from 2000 to 2008. Networkwide capital is well above the minimum 10 percent required by the Bank of Ghana. Not all RCBs in the network are solvent, however; in 2008 seven RCBs were insolvent, and the continued operation of poorly performing RCBs is one of the key issues facing the network. The relatively high ratio of nonperforming loans is a major factor affecting fi nancial performance.
In the sample RCBs, the proportion of the loan portfolio that was in default for more than 30 days was 16 percent, compared with 3 percent for their global peer group, according to data reported in the Microbanking Bulletin. Similarly, in the RCBs, loans in default for more than a year were 3.5 percent, compared with 1.5 percent in the peer group. This indicator is a good proxy for loan losses because most loans that have been in default for more than a year are generally not paid back at all.

LESSONS AND THE WAY FORWARD
The case of rural banking in Ghana points to the following lessons: Rural communities have the capacity to create and manage their own fi nancial institutions. In Ghana, rural communities created hundreds of such institutions with very little direct fi nancial support from the government.
A fi nancial operation that aims to be profi table requires a varied ownership structure, which is lacking in the rural banking system in Ghana. The growth of the network is constrained by the RCBs' location-specifi c ownership structure, which limits the ability of the institutions' managers and owners to propose mergers and acquisitions to stay profi table and effi cient.
The initial poor performance of RCBs stems from both an unfavorable operating environment and capacity constraints. Factors causing poor operating environments include an absence of clear prudential regulations, both fi nancial and nonfi nancial, and excessive directed lending requirements, which limit fl exibility in managing risk exposure.
Although capacity constraints in rural areas limit the scope of operation of local fi nancial institutions to some extent, targeted investments in building the capacity of service providers can have positive payoffs. This fi nding suggests that initiatives to build local fi nancial institutions should have signifi cant capacity-building components.
Small local fi nancial institutions often cannot easily procure inputs such as training and specialized technical assistance for product development and setting up of operational systems from the market to be able to produce viable outputs (in terms of service and products) either because the supply of such specialized inputs is constrained or because the institutions do not have the scale to obtain these services individually at a minimum cost. Hence, initiatives to build local fi nancial institutions will also have to support the creation of strategic alliances such as the Apex Bank that can either provide such services or facilitate their cost-effective provision.
The creation of the Apex Bank also shows the challenges that such an institution faces in ensuring fi nancial sustainability while providing low-cost services. Realistic measures to ensure sustainability should be identifi ed and clarifi ed at the earliest stages to help formulate the business and revenue model for the apex institution.
Even when a good legal, policy, and regulatory environment is provided, a certain number of institutions will fail. This issue should be addressed upfront by committing the necessary capacity in terms of skills, political autonomy, and fi nancial resources to ensure effective regulation and supervision.
Donor funding for supervisory activities cannot sustain a supervisory regime in the long run, and mobilization of private funding to supervise services delivered to poor clients is not a feasible option. Government resources are thus fundamental to ensure adequate supervision of services delivered to poor clients, and donor funding should complement direct government resources allocated for supervision.
Finally, the length, breadth, and scope of the Ghanaian experience offer the potential for carrying out a rigorous impact assessment of rural fi nance and a cost-benefi t analysis of public investment in rural fi nance. Such a study is beyond the scope of this paper, but the RCB experience offers fertile ground for this research.
In going forward, the study highlights the following issues and recommendations: RCBs. The challenge for the RCBs is to become more competitive while retaining their mission of providing services to clients in rural areas. Many fi nancial institutions are expanding into the rural fi nancial market in major ways, often targeting clients of the rural banks and their personnel. In this situation, the RCBs should not try to seek protection against this competition. Rather, these competitive market conditions should stimulate the RCBs to innovate and become more effi cient in an attempt to strengthen their position in the fi nancial market. Some banks, motivated by their competitors, have undertaken measures to improve their competitiveness and improve their performance. At the network level, the ARB Apex Bank should proactively seek sustainable solutions for weak RCBs with very small capital and deposit bases. Some may have to be merged with another willing RCB or forced into liquidation.
Apex Bank. The Apex Bank was created primarily as a service provider to the RCBs, but it faces challenges in becoming fi nancially self-suffi cient and sustainable. It is considering options for generating additional revenue, such as becoming a full-service commercial bank or opening a new banking branch. Such changes should not, however, come at the expense of the mission of the RCB network, which is to increase provision of services in rural areas in a sustainable manner. The Apex Bank could raise revenues by providing additional services currently needed by RCBs, which are willing to pay for these services.
BoG. The Bank of Ghana has delegated some supervisory functions to the Apex Bank, consistent with international good practice. Direct supervision of relatively small institutions, such as RCBs, is not a feasible and fi nancially sustainable option for central banks. The arrangement is weak, however, because of resource, capacity, and structural constraints. The BoG, along with the GoG, needs to immediately address these issues to ensure RCBs' adherence to regulatory standards and thereby protect consumers.
GoG. The Government of Ghana has played a remarkable role in facilitating the creation and growth of the RCB network. In contrast to most countries-where excess regulation and political interference virtually destroyed rural fi nancial institutions, whether development banks or fi nancial cooperatives-Ghana successfully changed many of the regulations that constrained the growth of the RCB network. Some gaps, however, remain unfi lled. The GoG should ensure that adequate resources are available for supervising RCBs and compensating them when they are called upon to deliver public programs. It should also consider additional measures to protect consumers, such as deposit insurance and fi nancial literacy programs.

Chapter 1: INTRODUCTION
Rural and community banks (henceforth referred to as rural banks or RCBs) are a network of 127 independent unit banks in Ghana. They are regulated by the Bank of Ghana and thereby form part of the regulated fi nancial sector in Ghana. These banks are the largest providers of formal fi nancial services in rural areas and also represent about half of the total banking outlets in Ghana (IFAD 2008 Several challenges, however, remain. The Bank of Ghana (BoG) rated the performance of 17 of the 127 rural banks in operation as mediocre, based on capital adequacy, and it categorized 5 banks as distressed. 6 Among the banks whose performance is categorized as mediocre, 6 rural banks have negative net worth. The apex bank of the network, which was created primarily to provide services to rural banks, is not yet fully fi nancially self-suffi cient and has inadequate resources to effectively perform its functions. The BoG, which is primarily responsible for supervising RCBs, is constrained in effectively performing its supervision role because of political and civil society pressures, resource constraints, and limited delegation of supervisory functions to the Apex Bank.
This paper is based on a review of various published and unpublished documents, interviews with key respondents, and an analysis of data collected from the BoG, the ARB Apex Bank, and a sample of rural banks. The sample rural banks were selected primarily to refl ect the proportional representation of different categories of rural banks according to the BoG's performance classifi cation of all 127 banks. Other factors used to select the sample of banks were location (primarily rural or periurban, and agroclimatic zone), size, and age. Annex 2 lists the banks included in the sample. Not all data, however, were available for all the banks included in the sample. In the sample used for a specifi c analysis, the performance category of banks with missing data is mentioned wherever the results are used.
The performance analysis of the rural banks is primarily presented at the network level (consolidated data for all RCBs) using secondary data available from the ARB Apex Bank, the BoG, and other secondary sources. Whenever the necessary data are not available at the network level, data from the sample banks are used, if available. The analysis includes trends, frequencies, and composition of key indicators and their comparison with data from peer-group institutions.
This paper is organized as follows: Section 2 describes the background of RCBs, including the sociopolitical context, a narrative on the emergence and evolution of RCBs, the structure of the Ghanaian rural fi nancial market, the legal and regulatory environment, and an overview of major donor programs. Section 3 describes the business model of RCBs, including ownership, governance, staffi ng, products and services, systems, and associative structures. Section 4 analyzes the service delivery and fi nancial performance of RCBs. Section 5 identifi es some key issues and discusses options for the way forward. Finally, Section 6 draws some lessons from the RCB experience and discusses its relevance to other countries considering replicating the Ghanaian rural banking system.

AGRICULTURE AND RURAL DEVELOPMENT DISCUSSION PAPER
Chapter 2: BACKGROUND

COUNTRY CONTEXT
Ghana covers about 240,000 square kilometers of land in three major ecological zones including the rainforest zone (25 percent of total area), the transitional zone (11 percent), and the savannah zone (64 percent). 7 In 2007 Ghana's population was 23.5 million, growing at an estimated 2 percent a year, down from the 3.4 percent growth recorded in the mid-1990s. Urbanization is concentrated mainly in the southern and central regions, which contain nearly 49 percent of the country's population. Although there are densely settled pockets in the Upper East and Volta regions, more than half of the population lives in the Greater Accra, Eastern, Central, and Ashanti regions.
Real gross domestic product (GDP) growth rose gradually from 4.5 percent in 2002 to an estimated 7.2 percent in 2008, although it is still below the rate needed to achieve Ghana's ambition of becoming a middle-income country by 2015. Infl ation fell from 42 percent in 2001 to 13 percent in 2008. Agriculture contributes 40 percent of GDP; industry, 27 percent; and services, 32 percent. Agriculture also contributes about three-quarters of export earnings and provides the main source of livelihood for about 60 percent of the population. Cocoa accounts for about 16 percent of agricultural GDP; cereals and root crops, 65 percent; and forestry, livestock, and fi sheries, the remaining 19 percent.
Agricultural growth, which averaged 3.6 percent for the 10-year period from 1997 to 2007, remains the mainstay of strong overall growth performance, accounting for more than half of total growth in this period. The country has an agricultural system that is traditional, rainfed, and dominated by smallholders. Some 2.7 million farms, averaging 1.2 hectares in size, account for 80 percent of agricultural production. The 2006 Ghana Living Standards Survey (GLSS) estimates that the poverty headcount fell from 39.5 percent in 1998 to 28.5 percent in 2006.

Rural Finance Prior to RCBs
Before the establishment of the fi rst rural bank in 1976, the availability of formal credit in rural communities predominantly made up of small farmers and fi shermen was extremely limited. The main sources of credit were moneylenders and traders charging exorbitant interest rates. The Government of Ghana had taken some policy measures to improve access to fi nance in rural areas. These measures included a requirement that commercial banks lend at least 20 percent of their portfolio for agricultural uses and the establishment of the Agricultural Development Bank (ADB) in 1965 with an exclusive mandate of lending for agriculture and allied industries in rural Ghana. Subsequently, commercial banks and the ADB opened branches in rural areas, with an emphasis on cocoa-growing rural areas. Nevertheless, lending to the rural sector remained low; the commercial banks used their rural branches primarily to make payments to cocoa farmers and collect deposits for lending in urban areas. Other banking services, like credit, were not provided as initially envisioned. Commercial banks demanded higher deposit accounts and stronger collateral requirements to provide loans to rural areas. Many small farmers and fi shermen did not have deposit accounts in commercial banks, and the collateral they had available was not satisfactory for commercial lending (Andah and Steel 2003). Mensah (1993) and Ranade (1994) found that the ADB's credit provision and coverage were limited. Only 27 percent of its branches were in rural areas, and lending to smallholder farmers made up only about 15 percent of its total portfolio.
In view of this situation, the Government of Ghana (GoG) considered supporting the establishment of community banks in rural areas that would be dedicated to providing fi nancial services in those areas. It asked the BoG to send a delegation to the Philippines to study the rural banking system there and afterward decided to facilitate the opening of banks in rural farming and fi shing communities.

1976-90: Establishment and Growth
The fi rst rural bank was established in 1976 in the Central region of Ghana with paid-up capital of 60,660 old Ghana cedis (old GHc 60,660, or about US$52,000). It was established in Nyakrom, a farming community. Capital contributions were mainly drawn from farmers in the community. A second bank was opened in the following year at Biriwa, a fi shing village also in the Central region. By 1980 the number of rural banks had reached 20. Managers and directors of these rural banks founded the Association of Rural Banks (ARB) to promote the exchange of information and to improve the performance of rural banks as a whole. Over the period 1980-84 the number of rural banks rose rapidly and reached 106. This growth was driven by rising interest among rural communities in establishing their own banks and by the introduction of Akuafo Check operations 8 in cocoa-growing areas in 1982.
As the network of rural banks grew, it was essential to provide a code for establishing new rural banks. The BoG developed and issued guidelines for the establishment of rural banks in 1985. The minimum paid-up capital required by BoG was old GHc 1.5 million. Of this, shareholders were to hold 67 percent, and 43 percent was to be contributed by the BoG. The maximum share that could be purchased by an individual shareholder was limited to old GHc 10,000. This limit was intended to allow equal participation of all shareholders from the community and to mitigate the risk that a few shareholders would dominate the governance of the banks.
The rural banks provided mainly savings and credit services and products. With the increase in the number of rural banks, the number of individuals with bank accounts also increased. Salary and pension deposits for civil servants were transferred using rural bank networks. The volume of deposits increased from old GHc 148,000 in 1976 to old GHc 2.3 billion in 1988.
With the addition of credit lines, the consolidated loan portfolio grew to around US$4 million, with nearly half of the portfolio in agriculture and 30 percent in cottage industries. The repayment performance of loans worsened, however, with nonperforming loans (NPLs) rising from 5 percent in 1982 to 70 percent in 1986. The capital available in most banks was not suffi cient to cover the cost of the bad loans.
Although the 1983 drought and the 1984 bumper yield and price slump contributed to the worsening loan portfolio performance, several other factors also fi gured in this deterioration. First, the boards of directors of most banks had little experience in or understanding of the banking business. Criteria for selecting directors did not include an individual's competence to lead a banking institution. The main criterion was popularity in the community. Second, because the banks were located in rural areas and had limited resources, they could not attract well-qualifi ed and experienced personnel. Employees of the banks were in most cases selected from their own communities, regardless of qualifi cations and experience. Training opportunities were rarely available. Third, weak internal controls led to several instances of corruption by management and staff. Fourth, the sector-specifi c credit quotas and other inappropriate regulatory requirements (concessional interest rates for priority sectors including agriculture) constrained the RCBs' ability to fl exibly respond to market signals and risks unique to RCBs. Specifi cally, RCBs gave many bad loans to meet the 50 percent lending requirement for agriculture imposed by the BoG. Fifth, inadequate resources limited the BoG's capacity to supervise the rapidly rising number of rural banks and to effectively respond to their complex diffi culties.
In an attempt to respond to the worsening fi nancial performance of RCBs, the BoG introduced some fi nancial reforms. These reforms included a review of the sector-specifi c credit quotas 9 and a reduction in agricultural loans, increases in primary and secondary reserve requirements, closure of distressed banks, and a stronger role for the BoG in examination and control of the banks (Andah and Steel 2003). The World Bank-supported Rural Finance Project, approved in 1989, further advanced this attempt. The project aimed to strengthen the rural fi nance sector, particularly the RCBs, by (1) providing technical assistance for restructuring about 80 RCBs; (2) strengthening the ARB and credit unions; (3) rationalizing the roles of the Rural Banking Department of the BoG and the ARB; (4) improving the rural credit appraisal capacity of RCBs and participating fi nancial institutions; and (5) strengthening the BoG's capacity to supervise rural banks. 10

1991-2000: Restructuring and Capacity Building
The Rural Finance Project (RFP) started in 1989 and ended in 1994. Initial diagnostics showed that 98 out of 122 banks were capital defi cient. In 1992, when the BoG began rating RCBs, 23 out of 123 banks were categorized as satisfactory, and even this number was considered an overestimate. The project offered assistance to rural banks in conducting comprehensive special audits and preparing restructuring programs on the basis of the audit recommendations. Nonperforming loans were assigned to a special collection unit with collection targets, and provisions were made for bad debt. A recapitalization fund equivalent to the value of the nonperforming loans was set up to supplement the loan collection effort. Besides the restructuring program, the project provided capacity-building support to enhance the rural banks' credit administration systems, which had been one of the causes of the large nonperforming portfolio.
The restructuring activities were also accompanied by additional regulatory reforms. The absolute ceiling on shareholding limits by individuals and companies was eliminated and replaced with limits on the percentage of shareholding: individuals were limited to holding 5 percent of total capital and companies were limited to holding 10 percent. Sectorspecifi c allocation of credit was removed for sectors other than agriculture, and the allocation for agriculture was reduced from 50 percent to 20 percent. Concessional interest rates for high-priority sectors 11 were also removed.
The RFP resulted in some positive outcomes. The number of RCBs rated as satisfactory increased to 55 (out of 125); deposits increased from old GHc 4.6 billion in 1989 to old GHc 13.2 billion by 1994; and loans nearly doubled from old GHc 3.7 billion in 1991 to old GHc 6.8 billion in 1994. The recovery rate of the RCB loan portfolio improved to 60 percent. Most RCBs, however, continued to be fi nancially and operationally weak.
Of the 134 rural banks in existence at the end of 1998, 23 were classifi ed as distressed and subsequently closed by the BoG. Fifty-six of the remaining 111 RCBs were rated as mediocre (defi ned as rural banks with capital adequacy between 1 and 6 percent), and only 55 were rated as satisfactory.
At the end of the 1990s, two major policy decisions were made to strengthen supervision of the RCBs: one was to support the establishment of an apex bank, which would provide support services to the RCBs, and the second was to merge the Rural Finance and Inspection Department in the BoG with the Banking Supervision Department (BSD). The merger, accomplished in 1999, was intended to integrate supervision of the RCBs with that of other institutions over which the BoG had supervisory responsibility.
The GoG decided to borrow again from the World Bank and other donors to help establish the Apex Bank and for other activities to strengthen the rural fi nancial sector. The Rural Financial Services Project (RFSP), cofi nanced by the World Bank, the International Fund for Agricultural Development (IFAD), and the African Development Bank (AfDB), was approved by the respective boards in 2000. In contrast to the previous piecemeal attempts by these donors, this project coordinated donors in a comprehensive attempt to strengthen the rural fi nancial sector. This project will be discussed in Section 2.5.

2001-08: Toward Consolidation
The RFSP became effective in 2001, and the ARB Apex Bank created by the rural banks commenced business in 2002 with fi nancial support provided under the RFSP. The establishment of an apex structure for the rural banking system was intended to leverage economies of scale to address constraints faced by the rural banks in check clearing, specie supply, liquidity management, and training.
Several key regulatory changes were also undertaken during this period. The secondary liquidity reserve requirement was reduced from 52 to 30 percent in 2006. 12 The capital adequacy ratio was increased from 6 to 10 percent, and the paid-up capital requirement for establishing a rural bank was raised to GHc 150,000 (US$116,135). The BoG delegated part of its supervisory functions to the ARB Apex Bank and launched an electronic reporting system to ensure effi cient supervision. Moreover, some rural banks adopted a more commercial business model and introduced innovative products such as microfi nance saving and lending techniques (Andah and Steel 2003). Many RCBs started to use new techniques-namely, group savings with credit, group and individual savings with credit, individual savings with group credit, and individual savings with credit (Andah and Steel 2003).
As of 2008, there were 127 RCBs in existence. Of these, one was in the process of being liquidated and six were categorized as distressed.

REVIEW OF GHANA'S FINANCIAL SECTOR
Ghana's fi nancial sector is composed of banks and nonbank fi nancial institutions (NBFIs). The country has about 23 major banks-including 3 development banks, 4 commercial banks, and 16 universal banks-representing about 90 percent of the total assets of the banking and nonbanking sector. The NBFI subsector includes 36 institutions accounting for 5 percent of the total assets of the fi nancial sector. The NBFIs include 17 savings companies, 13 saving and loans companies, 4 leasing companies, 1 discount house, and 1 mortgage company. Many of these institutions provide services in urban and periurban areas. Their service outlets are largely concentrated around the major urban centers of the Greater Accra, Ashanti, and Eastern regions, with little outreach to rural and remote areas.
In addition to formal fi nancial institutions, informal and semiformal institutions-including 380 credit unions, 80 fi nancial nongovernmental organizations, and 4,000 susu collectors (individuals)-are important fi nancial service providers in Ghana. RCBs and their agencies represent about 5 percent of the total banking assets and account for about half of the total banking outlets in the country, and they are especially significant in rural areas. Formal fi nancial service providers such as commercial banks represent about 40 percent of the money supply in the overall fi nancial sector. The remaining amount is believed to be outside the formal system (IFAD 2008) and mainly in rural areas. Thus, institutions such as RCBs and informal and semiformal service providers play an important role in addressing the lack of access in these areas.

THE LEGAL, REGULATORY, AND SUPERVISION FRAMEWORK GOVERNING RCBs
Under the Banking Act, the BoG has overall regulatory and supervisory authority in all matters related to banking institutions in Ghana. 13 Rural and community banks are incorporated as limited liability companies 14 and licensed by the BoG within the framework of the Banking Act.
In 2008 there were 127 rural banks licensed and supervised by BoG. The statutory role of the BoG in the operation of rural banks includes the licensing of new banks, supervision, and liquidation. The regulatory framework for rural banks at the end of 2008 is presented in Box 2.1. The capital requirements for all fi nancial institutions in Ghana were increased in 2007. The other local commercial banks were given until 2012 and foreign-owned ones until 2009 to meet the new minimum level of capital (GHc 60 million, or US$46.4 million), but RCBs have not been given a specifi c date to achieve the minimum capital level of GHc 150,000 (US$116,135). RCBs whose capital falls below the stipulated minimum of GHc 150,000 will not, however, be allowed to pay dividends or open new branches or agencies until they attain the minimum level of capitalization.
RCBs must maintain primary and secondary liquidity reserve requirements to mitigate liquidity risk. As a primary liquidity reserve ratio, rural banks are required to maintain 8 percent of their deposits with the BoG and 5 percent of their deposits with the ARB Apex Bank. As a secondary liquidity reserve, rural banks are required to maintain 30 percent of their deposits as liquid investments such as BoG bonds, ARB certifi cates of deposits, and Treasury bills. Treasury bills are purchased through the ARB Apex Bank. RCBs that are fully computerized and have achieved the full capital adequacy requirements can be exempted from maintaining the secondary liquidity reserves.
New rural banks have a 10-year tax holiday. During this period, however, they are not allowed to pay dividends and are expected to use the tax savings to strengthen their capital position.

Supervision
The BoG supervises rural banks through its Banking Supervision Department (BSD). The BSD supervises operations of rural banks through on-site and off-site inspection, issuance of administrative directives, and attendance of rural bank annual general meetings. Rural banks are required to submit monthly, quarterly, and annual returns on a variety of fi nancial and nonfi nancial indicators (Box 2.2 shows the key returns fi led by rural banks). The BoG can penalize rural banks for nonsubmission, incomplete submission, delayed submission, or inaccurate submission of any of these returns.
The BoG is expected to conduct an on-site examination of rural banks at least once a year. Annual on-site supervision takes about fi ve days in each rural bank. The on-site supervision reviews various aspects of a bank's operations, including books, records, and use of fi xed assets. During these visits, BoG supervisors also check physical cash, inspect the cash storage security system, verify compliance with the liquidity reserve ratio, check insurance policies, and examine customer turnaround time. The examination is carried out without prior notice to the rural banks. In the course of the examination, inspectors may also interview staff, clients, and directors as necessary. The output of the examination is a report followed by a directive outlining actions that the bank must implement.
Based on the annual returns fi led by rural banks and on-site inspections, BoG categorizes rural banks as satisfactory or mediocre. The key performance indicators used to arrive at this classifi cation are paid-up capital, net worth, the capital adequacy ratio, loans and advances, investments, liquidity, deposits, and total assets. The BoG can revoke the license given to a rural bank if the capital base of the bank is signifi cantly eroded and liabilities exceed assets-unless the shareholders are able to inject additional capital to restore the bank to normal operation within six months of the capital erosion.
Effective supervision of rural banks by the BoG is made diffi cult by the large number of rural banks spread over a large geographical area. Because of manpower constraints, the BoG has been unable to conduct regular on-site examinations of all rural banks annually. As a result, some poorly performing banks that need these on-site examinations the most do not receive them. Until recently, RCBs were required only to submit paper-based returns, and this situation often meant poor data quality because of missing data or data errors.
To improve the quality of supervision and monitoring, the BoG recently introduced an electronic Financial Analysis and Surveillance System (e-FASS) system that requires rural banks to send their periodic returns electronically. lend to rural and community banks facing temporary 3. liquidity problems; and provide specie management and specie movement 4.

The Apex Bank's Role in Supervision
services.
Although the ARB Apex Bank currently performs all the supervisory functions envisaged for it under the 2006 regulations, the BoG continues to carry out both on-site and offsite supervision. The full delegation of powers has been constrained by structural, capacity, and resource constraints. Structurally, since the ARB Apex Bank is owned by the RCBs, its autonomy to supervise its members has been called into question. It also has limited capacity to undertake off-site and on-site supervision, partly because of resource constraints. The Apex Bank neither has access to any funds from the BoG or GoG to perform this task effectively nor can it recover the costs from RCBs because regulations do not require RCBs (or any other banks) to pay for supervision costs.

RURAL FINANCIAL SERVICES PROJECT AND OTHER MAJOR DONOR-FUNDED PROGRAMS
Several donor-funded programs have supported the rural banks for years. Section 2.1 referred to some of these programs. This section discusses some of the major recent and ongoing programs.

The Rural Financial Services Project (RFSP)
The RFSP (2000-07)-cofi nanced by the World Bank, IFAD, and AfDB-had as its overall objective the reduction of rural poverty through the broadening and deepening of fi nancial intermediation in rural areas. 16 The project had four major components: (1) institution building in the informal fi nancial sector; (2) capacity building of rural banks; (3) institution building of the ARB Apex Bank; and (4) institutional support to the BoG's Banking and Supervision Department to enhance oversight of the rural fi nancial sector.
Following a midterm restructuring of the project, the activities fi nanced under components 2 and 3 were either implemented directly or managed by the ARB Apex Bank. Component 3 provided most of the fi nancing to establish offi ce premises for the Apex Bank and for operational expenses, including training of staff in the country and overseas. Component 4 fi nanced the training of BoG staff, procurement of vehicles, and offi ce and information technology equipment to facilitate the supervision of RCB. This component also fi nanced strengthening the microfi nance oversight capacity of the Ministry of Finance and Economic Planning.
The rural banks' capacity-building program was aimed at increasing the banks' outreach through staff training and investments in technologies. This component fi nanced a large program of general banking and computer training for RCB directors, managers, and staff, as well as a special capacity-building program in microfi nance for 15 RCBs and a special training program for 8 RCBs that were categorized as mediocre at the beginning of the project. 17 Under the rural bank institution-building component, the project also fi nanced the introduction of computers and other offi ce equipment to improve the operational effectiveness of the banks.
Through the training program in general banking, more than 8,000 RCB staff members were trained in a variety of topics, such as customer care, treasury and credit management, anti-money laundering, internal controls, and check clearing. The demand for and use of training provided under RFSP is particularly remarkable because cost subsidies for training were incrementally reduced and eliminated by 2005. Until 2003 the RCBs enjoyed a 50 percent subsidy on the cost of training, and in 2004 the subsidy was reduced to 25 percent. In 2005 it was removed completely, and the RCBs also pay 20 percent of the cost to the Apex Bank as an administrative fee. The special microfi nance training program, the Microfi nance Support Initiative, trained 79 staff in RCBs that participated in this program, helped them prepare strategic plans for microfi nance, and provided handholding services as these strategic plans were implemented. Training programs on product design, internal controls, portfolio analysis, and governance were also conducted. In addition, strategic business plans and training manuals were developed. The special restructuring program helped the selected banks prepare restructured plans and upgrade the skills of their board members, managers, and staff.
The project also fi nanced full computerization of 4 rural banks and partial computerization of 13 others. Initially, the project envisioned providing all rural banks, on a full cost recovery basis, with four computers each, a photocopy machine, and wireless equipment. During implementation, however, it became clear that providing hardware alone, without additional support for networking and training, did not support the intended objective of increasing the operational effi ciency of the rural banks. Project leaders thus decided to instead support full computerization of at least one branch in a selected number of banks. Even this was found to be suboptimal, however, and it was decided that at least one RCB would be fully computerized-that is, networked computers would be installed in the head offi ce and all branches.
Currently, four banks are fully computerized. In these banks, all operations in the head offi ce and the branches are computerized, and the branches are connected to the head offi ce through a wide-area network. Two banks have local area network connections within their head offi ces and some branches, and 11 have at least one branch with a local area network.
The overall quality of service delivery and fi nancial performance of the rural banks improved signifi cantly over the period of project implementation. Key improvements in service delivery include (1) 16 percent and 28 percent average annual increases in the number of depositors and borrowers, respectively; (2) 23 percent and 32 percent average annual increases in RCB deposits and loans, respectively (in real terms after adjusting for infl ation); (3) a 61 percent average annual increase in domestic money transfers (in real terms after adjusting for infl ation); (4) a reduction in check clearing from 2-3 weeks to 3-5 days; (5) approval of advances to salaried workers from 14 days to 3 days; and (6)  The project also resulted in several activity or componentlevel benefi ts to RCBs. Initial results of an assessment of the impact of the various training programs on RCB performance, conducted in parallel to this study, fi nds that the general banking training program had a positive and signifi cant impact on both service delivery and fi nancial performance. 18 The quantitative impact of the training provided under the Microfi nance Support Initiative or special training for mediocre banks, however, could not be identifi ed because this dataset was much smaller. Nevertheless, descriptive data on the Microfi nance Support Initiative does show that the participating banks also increased the number of their microfi nance clients and microfi nance portfolios by 13 percent and 25 percent respectively, while also being profi table. Twelve out of 15 banks supported under the initiative increased their microfi nance portfolios in 2007 over 2006, and six of the banks increased their portfolios by more than 100 percent.
Too few RCBs have been fully computerized (only four), and for these banks only one to three full years of post-computerization data are available-too small a database to allow for an rigorous impact assessment of computerization. 19 Anecdotal benefi ts reported, however, include (1) enhanced effectiveness of oversight by BoG; (2) reduced staff overtime costs; (3) improved customer service (on average, turnaround time for customer services was reduced from 15 minutes to 3 minutes); (4) improved internal controls; (5) automated ledger balancing; and (6) better monitoring of loan portfolios (World Bank 2008). The computerization program is also reported to ease implementation of the electronic Financial Analysis Surveillance system (e-FASS) introduced by the BoG for reporting of prudential returns. Since 2008 all rural banks have been required to submit returns using e-FASS.
Finally, the project played a key role in the establishment of the Apex Bank, which in turn was instrumental in managing the capacity-building program for the RCBs, in introducing the MICR (magnetic ink character recognition) checks that improved the acceptance of RCB checks, developing the domestic money transfer product, and providing improved investment options for RCBs through its brokerage services.

Support Program for Enterprise Empowerment and Development (SPEED)
SPEED is an ongoing project, started in 2004, and is cofunded by the Danish government and GTZ, the German technical support agency. The project facilitates the development of the fi nancial market and business development services for micro, small, and medium enterprises of Ghana. 20 The project focuses on the northern and more rural regions of Ghana and has three major components: funding, technical assistance, and business development services.
The funding facility provides refi nancing funds to rural banks to on-lend to small and medium enterprises at their own risk. The fund is disbursed through the Apex Bank. Three types of products are provided: (1) developmental loans with technical assistance, up to a maximum of GHc 100,000; (2) a revolving fund of GHc 100, 000-300,000; and (3) terminal loans of GHc 300, 000-500,000. The technical assistance component of SPEED Ghana provides capacity-building support through training for rural fi nancial institutions, including rural banks. Rural banks are the major benefi ciaries of this component because of their proximity to rural areas. The training provided covers internal controls, risk and treasury management, and market research.
This facility has also facilitated bank-to-bank learning and experience-sharing forums. The business development services component supports business associations and nongovernmental organizations with a focus on the tourism and wood products sectors and helps build their capacity to deliver relevant services to their members on a commercially sustainable basis. SPEED has assisted about 18 rural banks through its funding facility.

Ghana Rural Banks Computerization and Interconnectivity Project (GRBCIP)
GRBCIP is fi nanced by the Millennium Challenge Corporation (MCC) and will provide support for computerizing RCBs and savings and loans institutions. 21 The program is being built on the RCB computerization program initiated by the RFSP. About 30 RCBs are expected to participate every year. Additionally, the program will establish a refinancing facility to be provided to RCBs based on specifi c eligibility criteria.

Rural and Agricultural Finance Program (RAFiP)
The focus of the RAFiP is on the rural banking sector (RCBs and the ARB Apex Bank). It is designed to strengthen institutional performance, outreach, and client orientation in all segments of the rural fi nancial system. It also seeks to integrate rural fi nancial institutions more closely with each other and with the fi nancial system as a whole and link them to support systems (particularly related to technical issues and risk management of agricultural value chains). The specifi c objective is to improve the rural and agricultural population's access to sustainable fi nancial services through enhanced outreach, sustainability, and linkages. The program has the following components and activities: 1. Strengthening the rural fi nancial system through capacity-building activities. The program improves the ability of apex organizations at the meso level to support the retail institutions and become selfsuffi cient. The primary focus will be on developing and rolling out products that make fi nancial services more accessible to clients. RAFiP will also support strategic planning, upgrading management information systems, use of data benchmarking, and rating or other measures to attract external funding.
2. Product development and innovation. Support for product development and innovation will improve the ability of rural MFIs to serve more clients in different niches and levels of agricultural value chains. This component will build product development capability in the Apex Bank.
3. Linkages and technical support. Support will be provided to technical service providers (TSPs) including training and consulting services to rural fi nancial institutions, technical assistance to agricultural producers and value chains, and business development to micro, small, and medium-sized enterprises.

Regulation, policy, supervision, and monitoring.
The program will provide support for the implementation of fi nancial, private, and agricultural sector strategies. The primary focus will be on regulation and supervision of the rural banking network. Apex organizations will also receive support to strengthen sectorwide performance monitoring and benchmarking capabilities. The program will support the engagement and training of banking inspection staff by the ARB Apex Bank.

Knowledge development and dissemination.
Knowledge development and dissemination services will be provided to apex organizations.

AGRICULTURE AND RURAL DEVELOPMENT DISCUSSION PAPER
Chapter 3: BUSINESS MODEL

OWNERSHIP AND GOVERNANCE
Rural banks are incorporated as limited companies under the Companies Code of 1963 (Act 179) of Ghana and are required to be owned by shareholders from the local community in which they operate. At fi rst, the BoG owned up to 43 percent of shares in rural banks as preference shares. This practice was stopped in the 1990s. In the early years of RCBs, the shareholding levels for an individual and a corporate body were capped at 10 percent and 30 percent, respectively. These levels have been revised to 30 percent for an individual and 50 percent for a corporate body. An identifi able group can also own 40 percent shares in a bank.
The governance structure of an RCB comprises a board of directors that represents shareholders within the bank and supervises the management of the bank. Boards of directors are elected by the shareholders from the communities where the banks are located. Election of board members takes place during annual general meetings (AGMs). Directors are elected on the basis of their reputation in the community and professional qualifi cations. The individuals nominated by the shareholders are validated by the BoG before assignment is effective. The board elects a chairperson and a vice chairperson from among the directors. In many cases, the chief executive 22 of the bank serves as the secretary of the board. A board member is elected for a three-year term but can be reelected for an unlimited number of terms by the shareholders. At every AGM, one-third of the board members need to retire but are eligible for reelection, in accordance with the Companies Code of Ghana. 23 However, a sample analysis of 10 BoDs of RCBs showed that the average number of years spent as a board member is 11; the maximum was 32 and the minimum was 1 year.
The minimum size of a BoD is fi ve, and the maximum is 11. Although the number of directors with voting rights cannot exceed the maximum allowed size, additional individuals can participate as coopted members. Based on a sample analysis of 10 RCBs, only 9 percent of the directors are women. The sample analysis also showed that a limited number of directors have experience in banking.
The board of a rural bank has three to fi ve supervisory subcommittees covering the main aspects of managing and operating the bank. Members of the supervisory subcommittees are elected from the board based on specialization and interest. The following are the main subcommittees and their respective responsibilities: Loans subcommittee: ensures that loan approvals are in accordance with the operating policy of the bank and that loans disbursed are recovered; reviews and approves loan applications; and follows up with delinquent clients and legal cases.
Finance and audit subcommittee: monitors the fi nancial performance of the bank; assesses the liquidity position of the bank and makes decisions on advances; monitors the bank's investments; reviews the operational budget; ensures that accounts are prepared for audit; ensures that prudential returns are prepared and submitted; ensures provision for bad and doubtful loans; and ensures that policies and manuals are updated and implemented.
Disciplinary subcommittee: manages confl ict among the staff and takes disciplinary action in case of misconduct.
The boards typically meet once a month. During this meeting the board approves loans above the approval threshold of the RCB management (above GHc 2,000, or US$1,542); reviews monthly reports from the internal auditor; examines portfolio quality; follows up on previous meeting actions; reviews reports from supervisory subcommittees of the board; and undertakes strategic decisions and guidance for management. The minutes of the meetings are recorded and submitted to the BoG for monitoring and information purposes.
Shareholder services-such as share registries that are essential to attract investors-are weak in rural banks. Share registries of many rural banks are not up to date despite support provided for this purpose under RFSP. Until recently many rural banks operated a system of equal voting rights for each shareholder regardless of the number of shares owned, thus creating no incentive for shareholders to increase their shareholding. This situation has been changed to voting rights based on the number of shares.
Governance of rural banks is constrained by their diffi culty in attracting and retaining qualifi ed directors, even though these positions are generally considered prestigious. The opportunity cost for professionals with the necessary knowledge and skills to serve effectively as board members of fi nancial institutions is often higher than what most rural banks can afford to pay as sitting fees or honoraria. In addition, the amount of time directors are expected to spend attending board meetings, subcommittee meetings, and other ad hoc engagements is typically higher than that in other organizations. Figure 3.1 shows the typical organizational structure of a rural bank. The management staff is headed by a chief executive offi cer (typically called a supervising manager or general manager), who reports to the Board of Directors. The core management staff of RCBs includes an internal auditor supported by assistant accountants; a fi nance offi cer; a credit head supported by credit offi cers and project offi cers in charge of the microfi nance portfolio; and a system administrator, if a bank is computerized. Some larger banks have additional departments, such as research and business development support units. At the branch level, the structure typically includes a branch manager, an accountant, credit offi cers, clerks and cashiers, and support staffs. Rural banks that provide susu products have susu supervisors and susu collectors at the branch levels.

STAFFING
The total number of staff in all RCBs reached 5,703 in 2008. The number of staff members varies, however, by the level of outreach. RCBs with a larger number of clients have larger staffs. Nearly half of the professional staffs are microfi nance credit offi cers, and of these about 26 percent are women. The client-credit offi cer ratio is 208.

SERVICES
As fi nancial intermediaries, rural banks provide primary services consisting of savings, loans, and payments. Several products are offered within each of these categories. Given the community-owned nature of these institutions, they also generally support community development services. As fi nancial institutions actively supported by the government, RCBs offer special products and services for specifi c target groups on behalf of government-and donor-fi nanced programs, such as Microfi nance and Small Loan Center (MASLOC), the Social Investment Fund, the Community -Based Rural Development Project, and the Millennium Development Authority.
The rural banks use a variety of techniques to promote their services and products, including traditional outreach by bank staff and use of electronic and print media. For example, some banks use local FM radio to promote their products (particularly microfi nance) and broadcast information about services available. This approach has been successful in reaching many clients in remote parts of the operational area. Several social occasions such as funerals have been used to disseminate important information such as repayment reminders.

Deposits
Rural banks offer all the general savings products such as the regular savings accounts, current accounts, and time deposits. Typically, the largest share of the deposit portfolio in a rural bank is held in the savings account. Interest rates offered on these accounts are typically very low, however, and often negative when infl ation is taken into account. In 2008 in the sample banks, interest rates on savings deposits varied from 5 to 16 percent, while infl ation ranged between 11 and 18 percent. Further, interest on savings accounts is often provided only when the savings balances are more than a specifi ed amount. Unlike in most commercial banks, however, rural banks do not require high minimum balances to maintain a savings account and do not charge a high ledger fee.
A unique deposit offered by rural banks is their susu deposits. These deposits are daily or weekly savings deposits that are collected by susu collectors, who are either rural bank employees or agents paid on a commission basis. This deposit and deposit collection technology builds on the traditional system of susu collectors in Ghana. Susu collectors mobilize daily deposits by visiting individuals at their houses and business premises. A susu collector has a schedule and an agreed savings plan with a client and collects the amount of deposit according to the agreed plan. One susu collector visits up to 300 clients per day (Box 3.1). Most of the susu collectors are men, whereas a majority of the participants are women. Safety is an area of concern since the women physically carry money with them. Typically, no interest is paid on susu deposits, and depositors pay a fee for the service.
Banks use different savings mobilization methodologies. Many banks use the susu approach. Some banks use deposit mobilization centers, which operate in the market on market days. Some rural banks also offer special deposit products that target specifi c target groups such as small traders and fi shmongers, or purposes such as children's education (Box 3.2).  (12), regular savings is the largest type of savings product used, both in terms of number of clients (58 percent) and balances (57 percent). 24 As expected, susu deposit accounts have a larger share of the number of accounts (21 percent) but a lower share of the total deposit balance (11 percent).
Another indicator of the primary deposit clientele of the rural banks is the percentage of deposits accounts that are below GHc 100 (US$77.1). In the sample banks, 90 percent of all accounts have balances between GHc 10 (US$7.1) and 100 (US$77.1), with only 10 percent of accounts larger than GHc 100. Not surprisingly, the top 10 percent of accounts, by size, hold 81 percent of the deposits whereas the 90 percent of smaller accounts hold only 19 percent of the deposits. Although these small accounts make up only about onefi fth of the deposit base of the rural banks, these deposits are more likely to be stable and are hence important to the banks.
In fi ve of the sample banks, more than 20 percent of clients are susu clients; in three banks this proportion is less than 20 percent, and in four banks there are no susu operations. In Nzemamale rural bank, the bank with the highest proportion of susu clients, 63 percent of its clients are susu clients, although they hold only 6 percent of the total balances. In Upper Manya Kro rural bank, however, the share of susu in

BOX 3.2: Major Rural Bank Credit Products
Microfi nance loans. These loans are provided to groups of individuals to fi nance small and micro incomegenerating activities. For some banks, the group is the borrower, whereas for others, each member of the group is a borrower. In both cases, the group is jointly liable for the loan. The size of a microfi nance loan ranges between GHc 50 and GHc 1,000; most loans are between GHc 100 and GHc 500. The term of a microfinance loan is four to six months, and the interest rate ranges between 30 and 36 percent.
Susu loans. These loans are provided to individuals following a three-month susu deposit. The size and term of susu loans are similar to those of microfi nance loans, but susu loans are provided to individuals whereas microfi nance loans are group loans.
Salary loans. These loans, provided to salaried individuals, are secured by the individual's salary, which is paid through the bank. The bank automatically deducts the loan repayment installment from the salary payments. Salary loans are used for consumption and investment, as well as social purposes. The size of the loan is determined by the salary of the borrower. The maximum term of a salary loan is 48 months, and the interest rate ranges between 30 and 33 percent.
Commercial loans. These loans are provided to companies and individual entrepreneurs for working capital or fi xed capital. The maximum loan size is GHc 100,000, the maximum term is 36 months, and the interest rate ranges between 28 and 35 percent.

Source: Various RCBs.
Rose Opoku Mensah is a susu collector who just graduated from school and joined the bank. She has been working for the bank as a susu collector for one year. She has about 599 clients in fi ve towns. She covers four towns and visits about 300 individuals in a day. Rose either walks between towns or uses public transportation to travel to towns and villages.
clientele and deposit balances is more even, at 31 percent and 28 percent, respectively.
The smaller size of deposit accounts and the concentration of a large number of deposit clients around these small-sized accounts may imply that the rural banks are increasing the depth of outreach by serving poor clients. The susu products and savings mobilization instruments are particularly well suited to the savings needs of poor clients.

Loans
The major credit products offered by the rural banks include microfi nance loans, personal loans, commercial loans, salary loans, susu loans, overdrafts, and others. Box 3.2 describes some of the major credit products provided by rural banks. Microfi nance loans and susu loans are the two special loan products that most directly benefi t the low-income population. A signifi cant portion of the salary loans, however, would also be considered microloans in the Ghanaian context. Consequently, the microcredit portfolio of rural banks is larger than the sum of the microfi nance and susu loan portfolios shown in the loan classifi cations reported by the RCBs.
Most banks are using a "credit with education" 25 approach adapted from Freedom from Hunger 26 to deliver microfinance credit products. In this approach, banks educate and sensitize members of microfi nance groups for about six weeks before disbursing the loan. First, members of microfi nance groups participate in a fi nancial education program on basic bookkeeping and preparation of business proposals for credit. Then, credit offi cers assess the readiness of the group members before releasing funds. This methodology is intended to reduce credit risk caused by clients' inability to manage and use loans in a productive way that allows for repayment. The training is provided by microfi nance offi cers, and some RCBs outsource training to NGOs. The training typically includes education on savings; the purpose of group formation; group management; good business practices; and bookkeeping. In addition to the financial education, clients also receive education on health and nutrition. The group is required to collect compulsory savings during the six-week training period to cultivate the habit of saving and managing funds. Following the satisfactory completion of the training and compulsory savings, the group is eligible to obtain formal credit from the bank. The bank requires 10-20 percent of the compulsory savings as collateral and a group guarantee of the loan. Out of the total advances, salary loans are the highest, with 33 percent of the total advances, followed by personal loans (24 percent) and microfi nance (20 percent). In terms of size of clients, microfi nance loans have the most borrowers (31 percent) followed by personal loans (26 percent) and salary loans (22 percent).
In six (out of nine) of sample banks, more than 20 percent of clients are microfi nance clients. Only one bank has no microfi nance product. In three banks-Borimanga, Upper Manya Kro, and Ahafo Ano Premier-about half of clients are microfi nance clients, and more than half of the loan portfolio is in microfi nance. The susu loan product is much less popular. Only one bank, Kintampo, has a signifi cant share of susu loans; 29 percent of its clients and 33 percent of its loan portfolio are in susu loans.
Loans can also be categorized by sector: agriculture, cottage industry, trading, transport, and other. Figure 3.4, based on data from 11 sample RCBs, shows that the two largest categories are trading and other (42 percent and 41 percent, respectively). Salary loans are typically included in the "other" category, and microfi nance in the trading category. The proportion of loans reported as being in agriculture (9 percent) is an underestimate because a signifi cant portion of microfi nance and personal loans are used for agriculture. 27

Money Transfers
Rural banks offer both domestic and international money transfer payments. Both these services are managed across the network by the ARB Apex Bank. Both the domestic and international money transfer services are provided by rural banks through a fee-sharing agreement with the Apex Bank. The Apex Bank is responsible for negotiating the fee-sharing arrangements with the external   institutions-banks within Ghana for domestic transfers and international money transfer companies.

Payment
Payment services are a key service provided by rural banks. Rural banks provide this service through the Apex Bank, which is a member of the national clearinghouse. The introduction of MICR checks in 2002 gave rural banks' checks the same legitimacy as checks issued by other fi nancial organizations. Before the introduction of MICR checks guaranteed by the Apex Bank, many institutions and commercial establishments refused to accept rural bank checks.
With the introduction of the check-clearing system in 2002, the number of checks for clearing grew by an average of 43 percent a year.
Because of their location and network of branches, rural banks are used by the central and local governments and private companies to make salary and pension payments to their employees in rural areas. The salary payment system in particular enabled the rural banks to consolidate their salary loan products that are closely tied with the salary transfers. Licensed buying companies (LBCs) also use rural banks to pay cocoa-producing farmers in their catchment areas. In 2008, rural banks facilitated GHc 68.8 million (US$56 million) in payments to cocoa farmers and earned about GHc 2.75 million (US$2.1 million) in commissions.

Social Investments
Many rural banks support social development activities in the communities where they operate as part of their social responsibility to their communities. Activities generally supported include fi nancing of infrastructure such as school buildings, community libraries, and community roads, as well as scholarships for girls and medical students. These activities also help RCBs gain acceptance in their communities as a locally owned fi nancial institution rooted in the community.

Lending Technology and Credit-Risk Management
Appropriate lending technology and credit risk management are among the most important factors in the sustainability of a lending institution. The tasks involve identifying creditworthy borrowers, appraising and approving loan applications in a timely manner, managing credit portfolios so that revenue is maximized and delinquencies minimized, and taking appropriate action in case of delinquency. This management has generally been a weak area in rural banks, with the result that the percentage of nonperforming loans has generally been higher than that in other fi nancial institutions in the rural fi nancial sector in Ghana.
As in other lending institutons, lending in rural banks is typically guided by credit manuals and credit policies approved by the boards. Some banks follow standardized credit appraisal procedures such as the one described in Box 3.3. Loans are assessed by credit offi cers and project offi cers. The assessment techniques vary by product. For individual loans, the creditworthiness of the borrower is assessed on the basis of the individual's character, the purpose of the loan, and the credit history of the individual with the bank. The level at which credit decisions are made also varies from bank to bank and has changed over time. In some banks, all credit decisions are made by credit committees in the head offi ce or by the board. In others, smaller loans are approved by branch-level credit committees. Until late 2008, loans equivalent to and greater than GHc 2000 (US$1,542) were required to be submitted for review and approval by the BoG. Loans to members of boards of directors, regardless of their size, are appraised and approved by BoG. With this exception, boards of directors can approve all loans amounts less than 25 percent of the net worth of the bank. Loan amounts The Atwima Kwanwoma Rural Bank, a large rural bank, is located close to Kumasi, the second-largest city in Ghana.
The bank uses a credit appraisal system that it calls CAMPRI, which stands for Character, Ability, Margin, Purpose, Repayment capacity, and Insurance. "Ability" stands for managerial ability and understanding of the market. "Margin" stands for profi t margin in the activity being fi nanced. "Repayment capacity" is assessed based on existing cash fl ows. "Insurance" refers to security for the loan and consists primarily of cash security of 20-33 percent and one to three guarantors. No assets are taken as collateral.
The bank requires that no more than 60 percent of the existing cash fl ow surplus is needed for loan repayment. Although interest rates on loans are fi xed, credit committees can decide to give discounts for clients considered to be highly creditworthy.

BOX 3.3: Credit Appraisal System in the Atwima Kwanwoma Rural Bank
Source: Authors' discussion with staff.
AGRICULTURE AND RURAL DEVELOPMENT DISCUSSION PAPER greater than 25 percent of the net worth of the bank must be approved by BoG.
RCBs also use group lending and guarantees by salaried individuals to reduce credit risk. The use of insurance, asset collateral, and other fi nancial risk management tools is not common in the rural banks. Microfi nance groups have monthly savings that are separate from the group loan account that will be used to repay the loan in case of default. Additionally, the banks hold a certain percentage of all loans as security.
For microfi nance loans, individual savings of group members are used as security.
Boards of RCBs are increasingly involved in cases of delinquency, and this has reportedly improved loan recovery. In cases of delinquency, the bank management usually notifi es the board. The board and the credit offi cer follow up with the client. Board members may also visit the client at his or her household or business. If a loan is delinquent for three months, a demand notice is sent to the client and the case is transferred to the bank's lawyer. In some cases, village chiefs are also involved in persuading the borrower to repay the loan. In case of lending to individuals via a group, the group chairperson, the treasurer, and other group members work together to recover the loan from the individual. In some cases, groups have paid the amount due from their group savings.

Internal Controls or Operational Risk Management
RCBs have operational manuals that stipulate managerial and administrative policies and procedures. All banks are required to have internal auditors, who are responsible for internal controls. 28 Internal auditors are expected to be autonomous from the management and report to the audit committee of the board. The internal auditor is responsible for instituting internal control measures within a bank; ensuring that transactions of the bank are undertaken according to the general regulations and operational manual of the bank; examining records to ascertain their originality and minimize fraud; ensuring that risks are identifi ed, prioritized, and reported; monitoring the credit cycle from appraisal to disbursement, ensuring the integrity of the process, and advising management on any change required; and, investigating and reporting on any irregularity in fi nancial management.
At the beginning of every year, internal auditors prepare an audit plan. The plan consists of full inspection activities; snap checks; follow-ups on previous recommendations; special investigations in case of staff problems; and other duties assigned by the board. A full inspection looks at all operations of an agency, including cash accounts, current accounts, savings accounts, cocoa purchase accounts, interagency operations, and others. Additionally, sample credit applications are reviewed. The internal auditor assesses whether the bank is properly following credit appraisal procedures and whether the quality of the assessment process meets the bank's requirements. Loan disbursement processes are also examined against the required operational procedures. The process includes checking whether the proper interest rate has been applied. A schedule is prepared for each agency, and inspection visits are made without prior notifi cation to the agency. The internal control departments of many rural banks have reportedly been strengthened following incidents of fraud such as those discussed in Box 3.4.
Case 1: In Bank N, fraud related to susu deposits was detected during inspection by the internal auditor. Susu collectors were not recording the correct amount collected, and the deposits were misappropriated by the collectors. Signifi cant mismatches between the amounts recorded in the susu passbook and the amount recorded in the bank ledger were identifi ed. Following this discovery, the bank recruited susu monitors to supervise and monitor susu collectors and daily susu transaction balances. As a result of this measure, instances of fraud related to susu deposits have declined.
Case 2: Bank NM did not have an internal control department until a major embezzlement involving the cashier took place. The bank lost about GHc 20,000. The cashier was suppressing deposits without recording the balance in the internal ledger at the time of deposit. It was noted that the cashier had served on the same schedule without any leave for more than two years. This pattern was not detected until the cashier was away from work one day and a client came to the bank to withdraw savings. Following this incident, the bank required that staff should take annual leave as stipulated in the operational manual, and other security measures were strengthened.

BOX 3.4: Examples of Fraud Detected through Internal Controls
Source: Authors based on interviews with rural bank managers.

The Association of Rural Banks (ARB)
In 1981 the 30 existing rural banks formed the ARB, with the support of the BoG, to serve as a forum for rural banks. The association has nine regional chapters. Initially, the ARB's functions were primarily to provide training to different target groups. This role has been mostly taken over by the Apex Bank since its formation, however. The ARB continues to be responsible for providing Code of Conduct training for rural bank directors. The ARB played a key role in the formation of the Apex Bank. Although it was initially proposed that the ARB should cease to exist once the Apex Bank was formed, it was later decided that the ARB should continue to function, focusing primarily on advocacy with the government and confl ict resolution among its members.

The ARB Apex Bank
The Apex Bank emerged as a result of the rural banks' felt need for an institution that could provide fi nancial, managerial, and technical support. It was fi rst recommended by a study commissioned jointly by the World Bank, the BoG, and the ARB in 1996. The study recommended setting up an institution similar to the Rabobank in the Netherlands. A subsequent feasibility study conducted in 1998 concluded that an apex bank could be fi nancially viable, and the ARB Apex Bank was incorporated in 2000 as a public limited liability company with rural banks as shareholders. It was licensed in 2001 and started operations in July 2002.
The Apex Bank currently operates from its head offi ce in Accra and through its six branch offi ces spread across Ghana. The fi rst managing director, Emmanuel K. Kwapong, came from the commercial banking sector with more than 30 years of experience in Barclays Bank and served in this role for six years. Eric Osei-Bonsu, who took over as managing director, had been president of the ARB. As of 2007, the Apex Bank had a staff of 149. The Apex Bank board, consisting of 13 members, is currently headed by Dr. Samuel Dufu. The board comprises nine representatives from the regional chapters; one each from the ARB, the BoG, and the MoFEP; and the managing director of the Apex Bank.
The Apex Bank provides the following services to the rural banks: 1. Check clearing: The Apex Bank offers check-clearing services to the rural banks through the 11 clearing centers it operates across Ghana. As discussed in Section 3.3.4, this service played a critical role in making rural banks' checks as acceptable as checks from other fi nancial institutions. The bank is currently in the process of facilitating participation of the rural banks in the automated clearinghouse with a computerized system that uses scanned check images. This system replaces the earlier system of manual check clearing.
2. Specie supply: Although the Apex Bank was initially fully responsible for the physical supply of specie to the rural banks, it has now moved to providing this service on a need basis. Most rural banks now use their own bullion vehicles to obtain cash from the Apex Bank branches. The role of the Apex Bank is now primarily to maintain adequate specie supply in collaboration with the BoG and, if necessary, to provide loans to the RCBs to purchase bullion vans.

Treasury management:
The Apex Bank provides brokerage services to the RCBs to purchase and rediscount Treasury bills and bonds, purchase Apex certifi cates of deposit, and pay interest on clearing account balances.

Loan fund mobilization:
The Apex Bank also facilitates RCBs' access to funds from donor projects such as SPEED and other government-led interventions like the Agricultural Credit and the Poverty Alleviation Loan, the Community-Based Rural Development Project (CBRDP), and the Ghana Energy Development and Access Project (GEDP).

Domestic and international money transfers:
The Apex Bank operates Apex Link, the manual domestic fund transfer platform, which allows money transfers across Ghana through the RCB network. The bank is currently planning to move Apex Link to an electronic platform. In 2008 the Apex Bank entered an agreement with Western Union to provide international money transfer services through RCBs and its own branches. Since then it has added VIGO as a partner and plans to add other remittance companies.

Information and communication technology (ICT):
The Apex bank's ICT department provides installation and support services for RCB computerization. It supported the full computerization of 4 RCBs and partial computerization of 13 RCBs and provides ongoing maintenance and troubleshooting services to these banks. The Apex Bank will also coordinate the implementation of GRBCIP, the US$20.3 million RCB computerization project being funded by the Millennium Challenge Corporation. 7. Training: As mentioned in Section 2.5.1, the Apex Bank provided or managed training that was fi nanced by the RFSP. It continues to provide training services to RCBs. 8. Inspection and audit: Given the lack of funding for this activity from either the government or the BoG, the Apex Bank currently restricts this service to "marginal" banks and to special assignments.
A key challenge facing the Apex Bank is becoming fi nancially self-sustainable. Its profi tability steadily decreased between 2003 and 2006 because of narrowing income margins, 29 but the bank reversed this trend in 2007 and 2008. In 2008, the bank made a profi t of GHc 1.2 million (US$925,212), an increase of nearly 100 percent over the profi t in 2007. The bank benefi ted from a tax holiday that expired in 2009, however, and its after-tax profi ts are thus bound to decline.

AGRICULTURE AND RURAL DEVELOPMENT DISCUSSION PAPER
Chapter 4: PERFORMANCE Table 4.1 shows the outreach of rural banks and other fi nancial service providers operating in the low-income segment. Rural banks have the largest market share in client outreach (67 percent of depositors and 48 percent of borrowers) as well as deposit and loan balances (60 percent of deposit balances and 57 percent loan balances). The cases in Box 4.1 provide profi les of a cross-section of rural bank clients.

Deposits and Loans
Rural banks cater primarily to the low-income and middleincome segments of the population. The rural banks serve primarily smaller clients because of several factors, including local ownership, regulation, and capacity. Most clients of the banks are teachers, government employees, pensioners, and small and micro entrepreneurs. Some banks, however, do have relatively large clients that obtain part of their fi nancial service needs from rural banks.
The total outreach of the rural banks has steadily increased in recent years. As shown in Figure 4.1, outreach increased from 1.1 million depositors and 139,000 borrowers in 2000 to 2.8 million depositors and 680,000 borrowers in 2008. These fi gures represent average annual growth rates of 14 percent in depositors and 27 percent in borrowers. Case 1: Asumdwe Kuw is a microfi nance group with 34 members, mostly women. A group of members contacted the RCB in their community to seek support in forming a group and in obtaining credit for their micro businesses. The bank trained the group for six weeks and formed a group eligible to obtain credit. Before joining the bank, the members explained that they had no access to formal credit. Most of them depended on family networks and moneylenders. Some had saved with savings and loans but could not get loans because of the size of their savings. Now they are able to receive loans for their businesses against small savings. Categories of businesses include small shops, snacks, and charcoal trading. The maximum loan per member is 100 GHc. Repayment is collected every Friday during a meeting organized by the group and attended by the bank's credit offi cer. The group is primarily responsible for ensuring timely repayment of loans by members. Members of the group also have susu accounts with the bank and receive susu loans.
Case 2: Tisungta Ba farming group has about 24 members. Out of these, one of them is a woman. Individuals in the group are involved in small-scale farming activities. They grow maize, groundnuts, and soybeans. The group has a treasurer, a chairman, and a secretary. Members of the Tisungta Ba started borrowing from the bank to fi nance production and marketing of their produce fi ve years ago. Before joining the bank, the group members had supported each other through free labor on each other's farms. At that time, the sale of animals was one of the sources of funds for their agriculture activities. Presently, the group has received two cycles of loans. Each member received about 50 GHc with a repayment period of six months and a 28 percent annual interest rate. The group has been repaying within the stipulated repayment schedule. The source of repayment funds is not always agriculture. During times of bad weather or lower  address the problem of credit constraint in rural areas. As Figure 4.1B shows, however, annual growth rates, though always positive, fl uctuated signifi cantly. The growth rate of borrowers shows a generally increasing trend over the period 2003-07, the period over which RFSP was implemented. In contrast, the rate of growth of depositors seemed to taper off starting in 2005.
During the same eight-year period, the total amount of deposits, adjusted for infl ation, grew from GHc 17.3 million (US$5.8 million) to GHc 100.6 million (US$77.5 million), and total advances grew from GHc 7.1 million (US$2.4 million) to GHc 72.8 million (US$56.1 million). These fi gures represent real average annual growth rates of 4 percent for deposits and 11 percent for loans. Figure 4.2 shows the growth of infl ation-adjusted deposit and loan balances in RCBs. Both deposit and loan balances show a positive growth trend, but loan balances grew at a much faster rate, showing the success of RCBs in increasing lending. Although this increase became necessary because of the falling interest rates on Treasury bills during this period, the signifi cant efforts taken under the RFSP to increase lending also likely contributed to this growth. Nevertheless, as Figure 4.3 illustrates, the yearto-year growth in both deposits and loan balances continues to fl uctuate sharply, suggesting that the RCBs go through periods of rapid increase and sharp decrease in deposit mobilization and loan disbursements.

Money Transfers and Payments
Between 2003 when Apex Link was introduced and 2008, the number of domestic transfer transactions consistently increased, rising from 10,158 to a peak of 128, 875 in 2008. The The signifi cant growth of rural bank outreach among depositors and borrowers demonstrates the ability of the rural banks to provide services to an increasing number of clients. Most important, increasing numbers of borrowers prices for agriculture produce, the farmers repay from other income-generating activities.
Case 3: Collins Parker rears grasscutters (a small animal used for meat) in a small village in Brong Ahafo. He also manages another small business operated from his household. He received a loan from his community bank to support grasscutter rearing. The loan will be repaid within two years. This schedule was drafted to match the production period of the grasscutter, a feature Collins likes. He has now started repaying the loan.
Case 4: Shaibu Muniru is an entrepreneur in Walewale district. He manages a limited liability company that includes (1) a beverage distributor, (2) a gas agency, (3) an FM radio station, (4) a construction company, and (5) an exporter of nontraditional products. One of the owners of the company is a founding member of the rural bank in that district. The company uses the bank's overdraft facility. Shaibu reports that the amount of the overdraft facility is way below the demand of the business. Additionally, the term of the bank's loans is too short for the company to use the credit products. Yet this company is one of the bank's biggest clients.
representing average annual real growth rates of 69 percent and 95 percent, respectively.

Asset Quality
The extent of nonperforming loans in a fi nancial institution's loan portfolio is often considered the best leading indicator of the institution's fi nancial performance. A low ratio of nonperforming loans to the total outstanding loan portfolio is often correlated with low fi nancial expenses and higher profi tability. A low nonperforming loan portfolio also necessitates a lower spread for the fi nancial institution between the interest it pays on its deposits and the interest it charges on its loans, thereby benefi ting its customers.
Although networkwide data are not available on this indicator, sample studies suggest that this is one of the weakest areas of RCB performance. Among the sample RCBs used in this study, the average portfolio at risk (PAR) > 30 days 30 is much higher than the average ratio for their Microbanking Bulletin (MBB) peer group (16 percent compared with 3 percent). The PAR > 365 days, which is a good proxy for the loan loss rate because loans that are delinquent for more than a year have little chance of being repaid, is more than double that of their MBB peer group (3.5 percent compared with 1.5 percent).  (2007), also shows that RCBs have higher ratios of nonperforming loans than do savings and loans and fi nancial NGOs in Ghana. The large margin between these two ratios for RCBs, in contrast to the MBB peer group ratios, also suggests that loan losses are not as large an issue as delayed payments. Nevertheless, the higher loan loss rate

FIGURE 4.4: PAR > 30 Days of All RCBs with Comparators
Source: GHAMFIN 2007. means that RCBs must recover these losses by charging higher interest rates on their loans.

Solvency
Adequacy of capital is intrinsically critical for banks because of the nature of the business they undertake. The primary business of banks is fi nancial intermediation-that is, using money provided by depositors to make loans to borrowers. Lending is inherently risky because the loans may not be paid back, resulting in fi nancial losses to the bank. Hence, banks are expected to have adequate capital to remain solvent even if some of the loans may result in signifi cant losses. The BoG requires RCBs to maintain a 10 percent capital adequacy ratio.
As Figure 4.5 shows, the infl ation-adjusted net worth (capital) of the RCB network has steadily increased in the period 2000-08 and is well above the minimum required 10 percent.
Not all RCBs in the network, however, are solvent. In 2008 seven RCBs were insolvent, fi ve of which negative net worth in excess of 10 percent. The number of RCBs with very low capital or negative net worth decreased rapidly from 26 in 2001 to 16 in 2003, but this number has remained fairly steady since then.

Profi tability
Profi tability is key to any business because it allows the business to expand and provide more and a broader range of services to a larger number of people. Figure 4. In addition, as a network, RCBs are operationally and fi nancially self-suffi cient. They have operational and fi nancial selfsuffi ciency ratios that are comparable with those of other similar institutions in Ghana (savings and loans) and exceed median values for MFIs in the mature MFI peer group of institutions reporting to the Microfi nance Information Exchange (MIX) database. The net worth of RCBs has also shown an upward trend over the past decade.
Within the network, however, the performance of a signifi cant number of RCBs continues to be weak. Although the number of such RCBs has decreased over the past decade because of turnarounds or liquidation, they still constitute about 15 percent of all RCBs in operation. The key issue though is not the weak performance of this group per se 31 ; it is the inability of the regulatory system to identify these failing institutions at an early stage and facilitate a process that leads either to a cost-effective liquidation, a turnaround, or a merger with a stronger institution.
Lessons drawn from the experiences of Ghanaian rural banks can be summarized in the following points: Rural communities have the capacity to create their own profi table fi nancial institutions. In Ghana rural communities created hundreds of such institutions with very little direct fi nancial support by the government.
Both poor operating environments and capacity constraints can adversely affect performance. Factors constituting poor operating environments include absence of clear prudential regulations, both fi nancial (such as capital adequacy) and nonfi nancial (such as qualifi cations of directors), and excessive directed lending requirements leading to concentration of lending.
Although capacity constraints in rural areas do affect the performance and limit the scope of operation of local fi nancial institutions, the Ghanaian experience also shows that targeted investments in building capacity can have positive payoffs. This fi nding suggests that initiatives to build local fi nancial institutions need to have signifi cant capacity-building components.
The requirement of location-specifi c ownership of RCBs is a key factor constraining the growth and consolidation of the network. This requirement prevents the institutions' managers and owners from merging to take advantage of economies of scale and from attracting external investors from the fi nancial markets.
Local fi nancial institutions themselves often cannot self-provide or obtain several services (such as specialized training, product development, market research) they need from the market, either because they are not available or because the institutions do not have the scale to obtain these services. Hence, initiatives to build local fi nancial institutions will have to support the creation of associations or federations that can either provide such services or facilitate their cost-effective provision.
These institutions, however, such as the ARB Apex Bank, can face capacity challenges in management and service provision. These challenges would then dictate the business and revenue model for the institution.
Even if a good legal, policy, and regulatory environment are provided, failures of a certain number of institutions should be expected. This issue should be addressed up front, however, by ensuring that the regulatory system has the necessary capacity in terms of skills, political autonomy, and fi nancial resources.
Donor funding for supervisory activities cannot sustain a supervisory regime in the long run, and mobilization of private funding to supervise services delivered to poor clients is not a feasible option. Government resources are thus fundamental to ensure adequate supervision of services delivered to poor clients. Governments can shift some of the resources used from directed and subsidized credit to subsidizing supervision of fi nancial institutions serving poor clients.
Finally, the length, breadth, and scope of the Ghanaian experience offers the potential for carrying out a rigorous impact assessment of rural fi nance and a costbenefi t analysis of public investment in rural fi nance. 32 Although such a study is beyond the scope of this paper, the RCB experience offers fertile ground for this type of study.

RCBs: BECOMING COMPETITIVE, RETAINING MISSION
The challenge for RCBs is to become more competitive while retaining their mission of providing services to a broad range of clients in rural areas. The analysis of their performance suggests that although they have succeeded to a large extent in providing deposit and payment services, they have succeeded less in providing credit services. Since 2002, however, their performance in credit services has rapidly improved. Domestic money transfer services has been an area where RCBs have been highly successful, registering a 50 percent real growth rate over the past fi ve years. The rise in international money transfers since the service was introduced network wide in 2008 has also been strong.
With increased competition from commercial banks, S&Ls, CUs, and FNGOs, it is imperative for RCBs to become more competitive. The BoG has made it clear that it will not protect RCBs from competition. Some commercial banks have entered the rural fi nancial markets in major way, often targeting clients of the rural banks and their personnel. S&Ls, CUs, and FNGOs have also expanded their outreach signifi cantly.
Interactions with managers of the sample RCBs, however, seem to show that RCBs are more concerned with competition from commercial banks rather than the other categories of institutions. This complacency appears misplaced given that the latter group of institutions is the one that primarily shares the market niche to which RCBs cater.
Several RCBs are already undertaking measures to increase their competitiveness. These measures include an increased focus on microfi nance services (primarily susu deposits and microfi nance group loans, but also susu loans and other types of small-value loans); participation in international money transfer services; and computerization of bank operations. Some of the frontrunners are trying to use technology to improve services. For example, the Kakum Rural Bank is piloting a mobile banking operation to allow clients to check their balances via mobile text message or SMS. This bank is also establishing an automated teller machine in one of its branches and planning to introduce a smart card for susu products.
A second option being considered by RCBs is the possibility of mergers and acquisitions to allow economies of scale in the face of strong competition. The Apex Bank appears to be supportive of this option, including the option of merging all RCBs under the ARB Apex Bank into one bank and transforming individual RCBs and their branches into Apex Bank branches. Another option is a regional-level consolidation. Unsurprisingly, however, the latter option does not seem to have much support among the RCBs because of their unique ownership and governance structures.
It is clear that to become more competitive, RCBs need to change at two levels. First, at the individual RCB level, RCBs need to improve their service delivery and fi nancial performance. To succeed in this endeavor, however, many RCBs would need signifi cant high-quality support from the Apex Bank, even though they may have the fi nancial capacity to pay for these services. Second, at the network level, a sustainable solution needs to be found for the RCBs categorized as distressed or weak by BoG. Some may have to be merged with another willing RCB or forced into liquidation. Others may need external support for which they do not have the capacity to pay. Support for these banks would need to be subsidized, but they may have the potential to emerge as profi table fi nancial service providers.

THE APEX BANK: TRANSFORMING INTO A SUSTAINABLE SERVICE PROVIDER
The Apex Bank was created primarily as a service provider to the RCBs. Its strategic goal has been to "achieve fi nancial sustainability based on a service model" by improving the quality and scope of the products and services it offers to RCBs and any other fi nancial institution outside the network. The Apex Bank also envisions increasing its capital base from existing shareholders-the member RCBs, the BoG, 33 and investors outside the network. The service provider model is getting another look, however, primarily because of the challenges the Apex Bank is facing in becoming fully selfsuffi cient under this model and because of the option of mergers for RCBs discussed in the previous section.
In 2008 the bank introduced full cost recovery for all its services, including banking and nonbanking services. The Apex Bank is also considering the option of converting into a fullservice commercial bank and or opening a banking branch. This option could provide the opportunity to bring in larger revenues to maintain sustainability, but it could be perceived as a threat by the RCBs.
It is clear that the Apex Bank needs to become fi nancially self-sustaining sooner rather than later. This step should not come, however, at the expense of the mission of the RCB network, which is to increase provision of services in rural areas in a sustainable manner. Discussions with the RCB managers and analysis of data reveal that there is a defi nite need, demand, and benefi t for the services provided by the Apex Bank because it is costly (and in some cases unaffordable) for individual RCBs to procure highly complex specialized services on their own.
The discussions and analysis also suggest that RCBs need other services that are not available from the market at a reasonable cost. Examples category include (1) shareholder registry management and shareholder education, (2) internal audit services-most rural banks are too small to attract good internal audit staff, (3) product development services-few organizations in Ghana can provide this much-needed service to RCBs at a reasonable cost, (4) strategic advisory services, including risk management, (5) technological upgrades besides computerization, and (6) loan syndication services. Provision of these services and others to the member RCBs can generate additional revenue for the Apex Bank, significantly contributing to the fi nancial sustainability of its service provider role.
RCBs often lose their best commercial customers to commercial banks because they are unable to provide loans of the size required by a growing commercial establishment. The Apex Bank could potentially provide loan syndication service, under which it can facilitate lending to these customers by more than one RCB. Another example of a value-added service provided by an apex institution is the automatic teller machine (ATM) network operated by Cooperative Bank in Kenya, which allows its member cooperatives to offer the service of nationwide cash withdrawal to their members. A value-added technology service that the Apex Bank could offer consists of queuing management systems that can help reduce customer wait times and improve staff productivity.
Finally, for the Apex Bank to become sustainable, its role in supervising RCBs needs to be clarifi ed and the costs involved need to be fully covered. The options for doing so are related to the future structure of the RCB network, discussed in the previous section, and the roles of the BoG and GoG, discussed in the following sections. The current system in which the Apex Bank subsidizes the costs of supervising the RCBs from the meager resources it generates from the services it provides is not sustainable.

THE BoG: TOWARD EFFECTIVE DELEGATED SUPERVISION
Weak supervision of the rural banks continues to be an issue. The BoG has been unable to take effective action on rural banks that do not meet prudential requirements. It is also not able to carry out tasks such as liquidation in a timely manner because of political pressure to allow even "distressed" RCBs to operate at the risk of causing fi nancial losses to shareholders and depositors of the affected bank.
Global experience suggests that directly supervising relatively small fi nancial institutions, such as rural community banks in Ghana, is not an effi cient option for central banks because of the high transaction cost of the function. One sustainable option is to delegate most of the supervision tasks to an external entity while retaining key tasks such as licensing and liquidation. The delegated or indirect supervision approach is practiced in many countries, including Brazil, Canada, France, Germany, Mali, Niger, and Peru. Experience from these countries suggests that an indirect supervisory regime for small fi nancial institutions such as fi nancial cooperatives and community banks ensures supervision and monitoring of fi nancial institutions according to their special needs, ownership, and governance structure, while keeping transaction costs reasonable.
Lessons from delegated supervision models, however, underscore that the independence of the delegated supervisor from control by the supervised units and a strong commitment by the ultimate supervisory authority are critical to make the delegated supervisory model work. The effectiveness of the current supervisory arrangement involving the BoG and the Apex Bank is weak because of the structural, capacity, and resource constraints discussed earlier. The Apex Bank has no sanctioning powers, and even if it had such powers, their effectiveness would likely be limited because the Apex Bank is owned by the RCBs. If the current arrangements are to be continued, the Apex Bank department that performs the supervisory role will at least have to be effectively "ring fenced" from the service provider part of the bank. This solution can also help address capacity constraints by attracting the necessary human resources, particularly if a way is found to sustainably fund the supervision activities.

THE GoG: INCENTIVIZING SERVICE DELIVERY TO THE POOR
The Government of Ghana has generally played a remarkable role in facilitating the establishment of and growth of the RCB network. In contrast to most countries, where excess regulation and political interference virtually destroyed rural fi nancial institutions-whether development banks or fi nancial cooperatives-Ghana successfully changed over time many of the regulations that constrained the growth of the RCB network. Nevertheless, the government should consider undertaking some additional measures to further strengthen the RCB network and to enhance access to fi nancial services in rural areas, particularly for low-income households and small businesses.
The major measures needed include ensuring that there are adequate resources for supervising the RCBs and fully compensating RCBs when they are called upon to deliver services for the government. Because commercial banks do not pay for being supervised, it is not reasonable to expect that RCBs should do so. Although the share of supervision costs devoted to RCBs is disproportionately higher than their share of assets in the banking system, the positive externalities that result from wider access to fi nancial services in rural areas justify devoting these resources. Rural and community banks provide essential services in many remote, underserved areas of the country that would otherwise have no formal access. Subsidizing the initial stages of the delegated supervisory regime will be necessary until the system evolves enough to be able to fi nance inspection from its own sources.
Lastly, the government can create additional mechanisms for consumer protection. An explicit deposit insurance mechanism can be useful if accompanied by stronger regulatory sanctions on poorly performing banks. A "salvage operation" mechanism suggested by Cuevas and Fischer (2006) can also be created to fi nance the reforming, closing, and merging of RCBs to prevent the loss of public deposits. Finally, the government can devote additional resources to improving fi nancial literacy in rural areas. This measure would both increase demand for fi nancial services and reduce the implicit cost RCBs incur when delivering services to a less fi nancially literate clientele.

ENDNOTES
1 At a later stage the ARB evolved into a strategic alliance between RCBs, and the ARB Apex Bank was formed in 2002. 2 Not all RCBs have internal auditors. 3 Susu deposits are small savings collected daily from clients by individual collectors going door to door. Susu collectors have long operated outside the formal system in Ghana. Recently RCBs as well as other commercial banks have started to link up with susu collectors to mobilize deposits from the public. RCBs hire susu collectors as part-time agents or employ them as regular bank staff to manage this special product. A susu option in a bank provides susu depositors a secure place for saving and access to loans using small deposits. Interest rate earnings on susu deposits, however, are insignifi cant. 4 Ghana has 10 administrative regions. 5 Banks with less than 10 percent capital (net worth as a percentage of adjusted assets) are rated as mediocre, and those with negative capital are rated as distressed. 6 This section is drawn primarily from Program Design Report, Rural and Agricultural Finance Programme, (IFAD 2008, updated with data from the World Bank's World Development Indicator database. 7 Under this system any buyer of cocoa is required to pay farmers by check instead of with cash. Farmers wanted rural community banks in their own areas to reduce the cost of traveling longer distances to cash checks. 8 RCBs were required to lend about 50 percent of their total loans and advances to agriculture, 30 percent to cottage industries, and 25 percent to other activities. 9 When the project ended, expenditures on the project were US$28.4 million. Of the US$20 million contribution from the International Development Association, US$15 million was a credit line for rural banks and $5 million went to an institution-building component. 10 High-priority sectors include agriculture, export trade, and manufacturing. 11 At the same time, the secondary reserve requirement was eliminated for commercial banks. 12 23 The number of accounts is used as a proxy for the number of clients using a particular type of product. 24 It is currently called "Credit and Savings with Education." 25 Freedom from Hunger is a registered nongovernmental, nonprofi t organization with a vision of a world without poverty. 26 Based on authors' discussion with clients and credit offi cers. 27 Some RCBs do not have internal auditors because they are unable to attract and pay for qualifi ed internal auditors. 28 The "narrowing income margins" that led to the steady decrease in profi tability were due in large part to declining Treasury bill rates, as early profi ts were based heavily on investment of initial funds in high-return Treasury bills. 29 PAR > 30 days refers to the value of all loans outstanding that are more than 30 days past due. 30 Failure of a certain percentage of fi nancial institutions is to be expected in any market economy. Even before the onset of the fi nancial crisis in 2008 leading to a wave of new bank