Wednesday, 01 June 2011 00:00 By Duncan Alford
Since his appointment in the summer of 2009, the new Governor of the Central Bank of Nigeria (CBN), Lamido Sanusi, has introduced a spate of reforms in response to the global financial crisis and the mismanagement of certain Nigerian banks.
Major changes to the financial industry are under way in Nigeria, the most populous nation in sub-Saharan Africa, the eighth most populous nation in the world, and the seventh largest exporter of oil. The CBN under Sanusi intends to raise the quality of bank supervision and bank operations to a world standard and has signaled its more interventionist role in the Nigerian economy.
This article briefly reviews the history of Nigerian banking, places this latest reform effort within the context of that history, analyzes this reform effort, and then suggests some implications of these reforms for Nigeria and for potential investors in Nigerian banks and the Nigerian economy generally.
The current reform effort by Governor Sanusi follows a significant reform effort begun by his predecessor, Charles Soludo in 2004 that resulted in the consolidation of the banking industry in Nigeria.
Soludo took office as governor of the Central Bank of Nigeria in June 2004. The following month, he announced a new policy to increase the minimum paid in capital of banks to N25 billion (US$ 173 million) from N2 billion (US$ 14 million).
Banks were required to obtain this capital by the end of December 2005, roughly 18 months from the policy announcement. The clear intent of the policy was to consolidate the existing banks into fewer, larger, and financially stronger banks.
In 2004, the banking industry of Nigeria consisted of 89 banks. The industry was fragmented into relatively small, weakly capitalised banks with most banks having paid in capital of $10 million or less. The best capitalised bank had capital of $240 million as compared to Malaysia where the least capitalised bank had capital of $526 million at the time.
Most of the smaller banks were family-owned and privately held. However, the industry was heavily concentrated, with the 10 largest banks controlling 50 per cent of the assets and deposits in the Nigerian banking system.
The result of this new, much larger capital requirement was the consolidation of banks into larger entities. During this 18-month period, there were a number of mergers and acquisitions among Nigerian banks in order to meet this new capital requirement. In the end, the 89 banks that existed in 2004 decreased to 25 larger, better-capitalised banks.
Thirteen banks did not meet the deadline for increasing their capital and their banking licenses were revoked.
On June 4, 2009, Lamido Sanusi, former managing director of First Bank, took office as Governor of the Central Bank of Nigeria. Early in his term, he empanelled a special joint committee of the Central Bank of Nigeria and the Nigerian Deposit Insurance Corporation to conduct a special examination of all 24 universal banks in Nigeria.
On August 14, 2009, the CBN announced the results of the examination of 10 banks and determined that five banks were insolvent – Oceanic Bank, Union Bank, Afribank, Finbank, and Intercontinental Bank. The aggregate percentage of non-performing loans of these five banks was 40.81 per cent. In addition, these banks were chronic borrowers at the Expanded Discount Window (EDW) of the CBN, indicating that they had little cash on hand. To improve the banks’ liquidity, CBN, as the lender of last resort, injected N420 billion (roughly $2.8 billion) into these banks in the form of a subordinated loan. These banks in aggregate represented significant systemic risk as they held approximately 30 per cent of the deposits in the Nigerian banking system.
Other senior executives of the insolvent banks have also been charged with crimes. In an unprecedented move, Sanusi published a list of the names of debtors of non-performing loans held by Nigerian banks.
Subsequently, the CBN completed its special examination of the remaining 14 universal banks in Nigeria to determine their solvency. As a result of this audit, on October 3, 2009, the CBN dismissed the CEOs of three additional insolvent banks – Bank PHB, Spring Bank, and Equatorial Trust Bank – and injected an additional N200 billion into these banks.
A fourth bank, Unity Bank, was determined to be insolvent but had sufficient liquidity to meet its current obligations. Similar to the banks receiving capital injections after the August 2009 audit, these three banks received funds through the Expanded Discount Window of the Central Bank of Nigeria in the following amounts: Bank PHB (N64 billion), Spring (N80 billion), and Equatorial Trust Bank (N56 billion of which N30 billion has been repaid).
The CBN appointed new managing directors for each of these eight banks. Sanusi has stated clearly that these actions were not intended as a nationalisation of these banks, rather they were intended to prevent serious disruption of the banking system.
Thus far, eight banks have received N620 billion or approximately $4.1 billion from the CBN, representing 2.5 per cent of Nigeria’s entire 2010 GDP of $167 billion. Following the special examination and during the period from December 2008 to December 2009, Nigerian banks wrote off loans equivalent to 66 per cent of their total capital; most of these write offs occurred in the eight banks receiving loans from the CBN.
By year end 2009 all banks must change their accounting years to the calendar year, and all subsidiaries of the parent bank must follow the same accounting year. Different reporting years for Nigerian banks made financial comparison difficult among banks and limited transparency of bank financial results. The CBN’s stated purpose for this policy change was “to further enhance the level playing field in the banking sector post-consolidation.” The CBN is also seeking banks to adopt International Financial Reporting Standards (IFRS) by the end of 2012. Currently, most banks follow Nigerian GAAP while some Nigerian banks with international operations have issued their 2009 financial statements using IFRS.
On January 18, 2010, CBN issued a circular detailing the type and format of financial information that must be disclosed by banks in their yearly financial statements. As illustrated by these actions, CBN is aggressively pursuing accounting reforms to improve disclosure to regulators, investors, and depositors regarding the financial health of Nigerian banks.
In January 2010, the CBN issued regulations limiting the terms of CEOs of banks to a maximum of 10 years, which will require some sitting CEO’s to resign by July 31, 2010.
The intent of the regulation is to improve corporate governance of Nigerian banks by avoiding the “sit-tight syndrome” where bank executives manage the bank as a personal business as opposed to a publicly held corporation accountable to shareholders, depositors, and government regulators.
CEOs are limited to two renewable five year terms and are disqualified from serving as a director for three years after their second term as CEO expires.
This new policy resulted from the special examination discussed earlier that revealed serious corporate governance deficiencies among the insolvent banks. While some commentators have commented that life directorship is not consistent with company law, others have criticised this policy, arguing that its retroactive application is counter to Nigerian law, it usurps the rights of shareholders in electing management, and that there is no evidence linking the length of executive service to fraud committed by corporate executives.
Likewise, in March 2010, the Central Bank of Nigeria announced its plans to dismantle central tenet of banking regulation in Nigeria – the exclusivity of universal banks as the vehicle for conducting banking in Nigeria.
The CBN plans to categorise banks by function and allow variety of banks to operate in Nigeria with varying levels of capital depending on the bank’s function, as opposed to the single current minimum capital of N25 billion (approximately $173 million).
The intent is to allow the creation of banks that would serve different market segments, such as small and medium-sized enterprises, and to phase out the “one size fits all” requirement by September 2011. Each type of bank would apply for a different licence.
This policy is a fundamental reversal of the consolidation policy of 2005 and is likely to encourage the development of an increased number of financial institutions in Nigeria. Critics of the proposed policy argue that the CBN does not have sufficient regulatory staff, in either number or professional skill, to supervise various types of banks.
A key component of the second phase of banking reform in Nigeria is the removal of toxic assets or non-performing loans from the books of the banks receiving government support. To that end, the Ministry of Finance and the CBN have introduced a bill in the National Assembly that will create an asset management company, which will purchase toxic assets from the banks. The legislation is currently under consideration by the Nigerian National Assembly.
In early March 2010, the legislation received its second reading and will likely become law. While the bill only provides N10 billion as the corporation’s initial capital, the CBN expected that the Asset Management Company (AMCON) will require capital of N700 billion and that it will be operational by September 2010. AMCON will focus its purchases of non-performing loans from the eight banks that have received government support. There are an estimated N1.06 trillion of non-performing loans in the Nigerian banking system.
The concept behind the AMCON bill is a good bank – bad bank approach where AMCON will purchase the toxic assets from the banks and the banks after this purchase will have “clean” balance sheets. The bill grants broad powers to AMCON to purchase, maximise the value of, and eventually sell these non-performing loans.
After these transfers, the banks will be relieved of funding pressures from these non-performing loans because investors and depositors will have more confidence in the bank and its future stability.
Very important tasks will be to determine what entity will fund AMCON – the public or private sector – and what price will be paid for the toxic assets. The CBN states that AMCON’s purchase of non-performing loans will be “based on terms aimed at strengthening the balance sheets (of the banks) with a focus on asset quality, improving liquidity and capital adequacy as well as on reducing debt overhang relating to the stock market in order to stimulate activity in the capital market.
Critics of the bill note that it focuses on banks only and does not deal with the distress in the capital markets, particularly securities firms that lent on margin with bank stock as collateral. AMCON will require personnel with specialised skills to deal with the non-performing loans and related collateral that it will purchase in the near future and such qualified personnel are in short supply in Nigeria.
In a forceful and uncharacteristically frank speech by a central bank governor, Sanusi analyzed the reasons for the financial crisis and then described the four pillars upon which financial reform in Nigeria will rest. Sanusi argues that eight factors caused the financial crisis: “ macroeconomic instability caused by large and sudden capital inflows, major failures in corporate governance at banks, lack of investor and consumer sophistication, inadequate disclosure and transparency about the financial position of banks, critical gaps in regulatory frameworks and regulations, uneven supervision and enforcement, unstructured governance and management processes at the CBN/weaknesses within the CBN, and weaknesses in the business environment.”
The reform programme advocated by Sanusi rests on four pillars: enhancing the quality of banks, establishing financial stability, enabling healthy financial sector evolution, and ensuring the financial section contributes to the real economy.
According to Sanusi, consolidation of the banking system into a smaller number of financial institutions is not an end in itself,108 a statement contradicting his predecessor Soludo’s policy.
Considering other developing nations such as Brazil, Turkey, Malaysia and Indonesia, several different banking industry structures could serve Nigeria well. The CBN does play a major role in deciding on the structure of the Nigerian financial system. Sanusi notes that “foreign ownership played an essential role in raising standards in the industry” in Turkey, Brazil and Malaysia.1 0 9 Similarly, foreign banks in Nigeria could also raise standards.
The CBN is reviewing the one-size-fits-all banking model and will attempt to introduce more diversity into the Nigerian banking industry. One conclusion from the recent special examination of Nigerian banks was that the recent consolidation of the banks in 2005 placed “pressure on banks to deliver high returns to their shareholders after the rapid expansion in their capital base post-consolidation” resulting in “the highly risky behavior that led to the collapse of some of the banks.”
Sanusi’s rapid regulatory reforms since July 2009 will result in significant changes in the structure of the Nigerian banking industry and will likely create opportunities for banks and investors already operating in Nigeria and those new to the Nigerian market.
Further consolidation of Nigerian banks is very likely. The eight banks supported by the CBN will become attractive targets once their toxic assets have been transferred to AMCON.
Likely purchasers include the better-capitalized Nigerian banks that have not received government support; foreign banks already operating in Nigeria – Stanbic-IBTC, Standard Chartered, and Citibank; and certain foreign banks, particularly those from South Africa.
Sanusi’s stated intention is to encourage foreign ownership of banks in order to transfer management expertise and skills lacking in Nigeria.
A variety of institutions will provide financial services in Nigeria in the future. The” one size fits all” universal banking model will weaken and the CBN will license institutions to provide different services (corporate banking, small and medium sized business lending, Islamic banking) to different markets. This change in licensing requirements will create opportunities for financial service providers, other than commercial banks, to enter the Nigerian market.
(The CBN will play a more interventionist role in the Nigerian economy. Under Sanusi, the CBN will expand its role in promoting economic development and may even ease its inflation target in order to grow the economy and alleviate poverty.
However, in order for all of these reforms to succeed, the pervasive corruption in the Nigerian economy and the weak rule of law must also be addressed. The rapid pace of reform under Sanusi does not appear to be slowing. A key development to watch is the progress of the AMCON bill and the subsequent operation of AMCON – its success (or failure) will be a harbinger of the long-term effectiveness of Sanusi’s reforms to the Nigerian banking system.
Alford writes from university of South Carolina, Columbus, USA