A sound financial system is critical to economic growth for any country, and a healthy banking system is a key component of this. Economic research shows that a well-functioning banking system helps accelerate economic growth and poverty alleviation, while poorly-functioning banks can impede economic progress.
During the last global recession in 2008, the banking system was the central protagonist and arguably suffered the most. As many as 465 banks closed in the United States between 2008 and 2012. Likewise, Nigerian banks suffered following the 2016 recession, ultimately leading to the creation of Polaris Bank to takeover Skye Bank’s operations and assets.
Without a doubt, recent challenges with Nigeria’s banking system have affected the wider economy. The Central Bank of Nigeria (CBN) has been swift in strengthening the sector, from the 2009 intervention that created the Asset Management Corporation of Nigeria (AMCON), to the aforementioned rescue of Skye Bank. Despite these efforts, the Nigerian banking system is yet to reach true stability. A big part of this is tied to the failure to address three lurking challenges: Non-Performing Loans (NPLs), Capital Adequacy, and Corporate Governance.
First: the Bad Loans Problem
A loan is considered non-performing when the borrower fails to make any scheduled (interest) payments for a specified period, usually ninety days.
Nigerian banks have a lot of these: ₦1.4 trillion, according to the last National Bureau of Statistics (NBS) report in June 2019, and as much as 9% of all loans in the economy. Meanwhile, the CBN prescribed a 5% threshold for NPLs in the economy, and the last time the banking sector met that was in the last quarter of 2015. Since then, the figure has only dipped below 10% this year.
Given that a bank’s core business activity is giving out loans and earning interest on them, Nigerian banks’ failure to do so is a worry, and has impacted profitability. As much as 40% (₦577 billion) of these NPLs can be traced to the oil & gas sector, which Nigerian banks have historically favoured, but has suffered since the 2014 oil price crash.
But high NPLs don’t just hurt banks, the whole economy suffers. Borrowers struggle to get additional funding because banks become risk averse and conscious of their poor asset quality, leading them to focus more on debt recovery. Many individuals and small businesses in Nigeria struggle to get decently priced loans and their plight is not helped when a bank is risk-averse because it already has lots of bad loans on its books.
Nigeria faced the high NPL problem in 2009 (NPLs got as high as 37%) and created AMCON to take over those loans and try and recover them. At the time AMCON was established, a number of Nigerian banks were on the brink of financial distress largely as a result of the huge portfolio of non-performing loans these banks had on their book. But the reality is that one asset management company cannot effectively manage all the outstanding bad debts and non-performing assets in the Nigerian banking system. The portfolio is simply too large. A better solution would be to create a framework to establish and empower multiple private asset management companies for this purpose, like in China.
Two decades ago, the Asian giant addressed its struggle with high NPLs by setting up four asset management companies (AMCs) and pairing them with four State Banks to clean up their loan portfolios. The framework was designed in a unique manner that, among other things allowed the AMCs act as security brokers and empowered them with extensive powers to procure sale of equity in a company through stock listing. This approach contributed to the success of the framework and today those AMCs have now evolved into alternative lenders.
If Nigeria pursued a similar strategy, it would do well to learn from the mistakes with the first AMCON experiment. While 6000 NPLs constitute about 20% of the current unresolved assets portfolio purchased by AMCON, about 350 NPLs account for approximately 80%. AMCON’s failure to differentiate its enforcement and recovery strategy for the mammoth sized NPLs from the smaller ones has therefore significantly hampered its recovery efforts.
Of course, this strategy only addresses existing bad loans and does nothing to ensure that Nigerian banks are more prudent in the future. That would require regulation focused on beefing up banks’ risk assessment frameworks, better identifying loans that may go bad, and so on.
Second: Not Enough Capital
Capital Adequacy Ratio (CAR) is a metric that compares a banks’ equity to its risk exposure; it is essentially a metric of how much of its outstanding risk a bank is able to cover with its existing capital (like its shares). It’s the internationally-recognised measure of a bank’s capacity to absorb a reasonable amount of loss.
CAR rules vary in Nigeria, from a 10% equity to risk asset ratio for local banks to a 15% minimum for Nigerian banks with an international footprint.
Earlier this year, the CBN announced that industry CAR had risen from 10.8% in August 2018 to 15.3% at the end of the year. Even with that progress, though, the numbers have been unstable. Put simply, it is doubtful that enough Nigerian banks have the capital buffers to withstand unexpected economic shocks. For example, the CBN also revealed that seven banks failed a stress test on adequate funding at the end of 2018.
Weak capital buffers in the banking sector can be traced to banks’ failure to put aside enough money to guard against the financial and operational risks they face, despite the volatilities of the Nigerian economy and sector’s close relationship with the oil & gas industry. Failure to stay above the regulatory thresholds weakens banks’ ability to safeguard deposits when things go wrong.
One reason this trend has occurred is that Nigerian banks have consistently paid dividends irrespective of their risk profile, rather than retaining earnings as extra capital buffers. The CBN has at last clamped down on this by introducing stricter rules that limit dividend pay-out in banks that fall below CAR thresholds. More generally though, as we have seen abroad, cultural change—manifested in how banks are set up—is key to ensuring that banks commit to having enough resources to survive inevitable lean times.
Third: Robbers and Crooks
The final issue plaguing Nigeria’s banking sector may be the trickiest: corporate governance. Corporate governance refers to the rules, processes or laws by which businesses are operated, regulated or controlled. Good corporate governance practices ensures that a company’s board and management always act in the best interest of the company and remain accountable to the company’s shareholders. Crucially, poor corporate governance is often identified as a major factor in virtually all instances of financial sector distress, making it more important for banks to be held to the highest standards of corporate governance.
Like many things in Nigeria, corruption has found a home in the banking sector, with poor corporate governance systems and unethical leadership at the center. Financial mismanagement or misconduct by the executive management of Nigerian banks has hampered their performance and sustainability. Back in 2009, eight executive directors and eight chief executives of Nigerian banks were removed by the CBN due to corporate governance infractions. In some instances, the management of banks give out unsecuritised or bogus loans to friends and families, putting their financial interest ahead of the bank.
As an added measure, it will be useful to set up a special committee of the CBN responsible for carrying out periodic monitoring of banks’ activities to ensure that they remain in check at all times. In the event that they fail to comply with the required standards, this committee will also be responsible for kick starting enforcement action and ensuring compliance with the law. Perhaps it will also be helpful to also establish a Dispute Resolution Tribunal (the Tribunal) for the Nigerian banking sector, similar to the Tax Appeal Tribunal (TAT). The Tribunal must ensure that all complaints of failure to comply with set rules are dealt with in a timely and expeditious manner. If the TAT’s success story is anything to go by then indeed a specialized tribunal will ensure that sanctions for poor corporate governance practices by banks are effectively and appropriately imposed.
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