In just over a decade, between 1994 and 2000, 35 Nigerian banks folded up. After 2000, 10 more banks followed, among which were the popular Savannah and Fortune Banks. By 2004, the Central Bank of Nigeria (CBN) made efforts towards strengthening the country’s financial system, what the experts term as ‘macroprudential regulation.’
These regulations seek to reduce the risk to the financial system as a whole. What that meant for Nigeria was the CBN mandating commercial banks operating across the country to increase their minimum capital base from ₦2 billion to ₦25 billion.
This was to ensure that the financial system can withstand economic shocks and absorb losses. Another reason for increasing the capital base was to increase loans; as a more secure banking system translates to increased confidence in the sector, and more loan origination with banks raising more deposits. Real sectors such as manufacturing, technology and entertainment sectors that produce goods and services, and employ Nigerians were to benefit from this.
New Capital Requirements
Recently in June 2019, the Governor of CBN stated that Nigerian banks will be required to maintain higher levels of capital in the coming years. This new increase is driven by two main factors – a significant change in the exchange rate and an increase in non-performing loans. Since 2004 when the last regulation was put in place, there has been a significant devaluation of the naira as the exchange rate has depreciated from ₦100:$1 to ₦360:$1. This has reduced the dollar value of the ₦25 billion minimum capital base.
In addition, banks made loans to sectors, such as power and oil sectors, that have been unable to pay back. The implication is that banks are currently more vulnerable to economic shocks or losses. According to the 2018 Financial Stability Report, in a situation where the current level of non-performing loans double, banks will no longer be secure - the Capital Adequacy Ratio (CAR) of the banking industry will fall below the 10% threshold specified by the CBN.
Although no figure has been officially put forward, there are indications that the new minimum capital base requirements will range between ₦35 billion to ₦230 billion - depending on if banks require regional, national or international licenses. While increasing the minimum capital base requirement of banks has the potential to strengthen the country’s financial system, Your Nigerian Economist discusses its shortcomings and why it should be implemented alongside other macroprudential policies.
Cracks in the system
International financial policies place a lot of emphasis on Tier 1 capital. This is the most "perfect" form of capital - it is the bank's own funds which comprises of money obtained from capital investors by selling bank’s shares as well as the retained earnings of the bank. As such, money that the bank borrows is not classified as a bank’s Tier 1 capital.
However, some Nigerian banks have raised ‘fake capital’ in the past in an attempt to meet CBN requirements. They have been found to exchange capital between themselves to show the regulators as their ‘own funds’. Additionally, in a few cases, some of the bank’s shares were bought with customer’s deposits.
As such, each bank may not be fully compliant with capital requirements as they move capital between themselves during inspection season or finance their capital with debt from the banks’ books. If this is still happening today then the idea that the banking sector is secure is merely an optical illusion!
Also, an increase in the minimum capital base has not been able to protect banks from sectors that are particularly prone to shocks or losses. For instance, even when banks had met the capital base requirement, the downturn in the oil and gas sector indirectly led to the closure of some banks. This is because, with the oil price crash in 2014, many oil and gas businesses were forced to default on their loans. The fall of Diamond bank in 2018 is a case in point as non-performing loans accruing to the oil and gas sector was influential in the bank’s failure. Up until recently, the data shows that Nigeria’s oil and gas sector accounts for over 66.5% of the total non-performing loans: ₦738 billion out of ₦1.108 trillion as at April 2019.
As a result of these loopholes, the CBN will have to be more innovative in its macroprudential regulation role. The CBN classifies seven banks as Domestic Systemically Important Banks (DSIB) as they account for 64% of the industry's total assets and 66% of its loans. Given that a few banks hold the majority of the assets in the banking sector and the sector is highly interconnected, the CBN could mandate higher capital requirements for these banks relative to others. By imposing stricter rules, including in the quality of capital that is required, the system is better able to absorb losses.
This is in line with recent global regulations that target systemically important financial institutions. As a matter of fact, the Basel Committee - an international committee of banking supervisory authorities - stipulates that global systemically important banks should be subject to higher capital requirements to reduce the probability and impact of their collapse on the entire financial system.
To protect the financial system from risk-prone sectors, an additional capital buffer should be required for risky sectors. For instance, considering that oil prices are internationally determined, volatile and unpredictable, sectoral capital requirements for the oil and gas sector would do well to protect the banks from oil price shocks. Belgium is a case in point where the National Bank of Belgium introduced sectoral capital requirements in 2013 to protect Belgian banks from adverse developments in the real estate sector.
As we mandate banks to provide more loans to Nigerian businesses, it is critical to build a more resilient financial system. A system that is better able to withstand shocks whether its from oil price or the rapid devaluation of the naira; and absorb losses whether as a result of debtors unable to pay their loans or a run on banks. Although the CBN is in talks to increase the minimum capital requirement of banks, Your Nigerian Economist opines that more weight should be placed on risk-prone sectors as well as our top banks, which some refer to as FUGAZ (First Bank, UBA, GT Bank, Access Bank, and Zenith Bank). Getting this right is key. As Hendrith Smith puts it, “Banks are to the economy what the heart is to the human body.”