Banks operating below capital base: Matters Arising


By Ayobami Adedinni

Following the revelation by members of the Monetary Policy Committee (MPC) of the Central Bank of Nigeria, (CBN), last week over the gross undercapitalization of Nigerian banks, fears have emerged that Nigerian banks might be heading for systemic distress.

Members had much to say on the pressures on the banking sector. Several commented on the growth in Non Performing Loans, (NPL) with one noting that they are factored into banks’ pricing models and therefore limit the banks’ capacity to support economic recovery.

Another member railed against the excessive concentration in their assets, which he illustrated with some choice figures. Big players borrowing more than N1 billion accounted for more than 81 per cent of aggregate loan portfolios, and small enterprises borrowing N1 million or less for just 1.3 per cent. Firms best placed to ratchet up output and create jobs receive very low allocations of credit, and at high cost, they had said.

Although, they did not name the lenders, they however said the four banks together were equivalent to at least one Systemically Important Bank (SIB).

Financial sector stress tests showed capital adequacy ratios for the industry in Nigeria worsened to 11.51 percent in June, from 12.81 percent in April, as against a regulatory minimum of 15 percent for lenders with international licences.

Capital Adequacy Ratio (CAR) is basically the proportion of the bank’s tier 1& tier 2 equity (Qualifying capital or Equity) as a proportion of its risk weighted assets (loans). It is the proportion of a bank’s own equity in relation to its risk exposure.

If a bank for instance, has N200billion risk weighted assets and has a qualifying capital of N60billion then its CAR is N60 billion/N200 billion which is equal to 30 per cent.

CAR for banks in Nigeria currently stands at 10 per cent and 15 per cent for national/regional banks and banks with international banking licence, respectively.

CAR helps regulators protect depositors from banks which lend aggressively and in doing so do not get back most of the money lent.  This is because when a bank makes large loan losses that wipe out its total equity, it may lead to an immediate bankruptcy thus making depositors lose their money.

The Central Bank of Nigeria (CBN) had in July, 2014 directed each of the then 89 banks in the country to raise their capital base from N2 billion to N25 billion by 31 December 2005 or merge their operations with those of other banks.

The directive, issued by former CBN Governor Charles Soludo  was one of the measures aimed at repositioning the country’s banking system to face global challenges.

In addition, the apex bank warned that directors and management of banks would henceforth be held liable for the failure or distress of their banks.

A Dubai-based international investment bank, Arqaam Capital had raised the alarm and doubted the soundness of Nigeria’s banking industry after a stress test it conducted last year. The investment bank stated that some banks were jointly undercapitalised to the tune of N1 trillion.

It also reported that two other banks were close to insolvency. The investment bank argued that Nigeria’s banking industry, “is experiencing a full-blown financial crisis” as failed fiscal and monetary policies had led to a major credit crunch.

Arqaam had said two Nigerian banks were close to being insolvent, adding that some lenders would require dilutive capital increases.

Financial analysts have explained that undercapitalization occurs when a bank does not have sufficient capital to conduct normal business operations and pay depositors.  They add that this can occur when a bank is not generating enough cash flow or is unable to access forms of financing such as long term debt or equity.

Some of the analysts reckon that under-capitalisation may be caused by acquisition of Assets during recession at low costs. Also, there may be under-estimation of capital requirements of the bank by its Board. This may lead to capitalisation which is insufficient to conduct its operations.

According to them, the management of a bank may be highly efficient if they are able to run the business with minimal equity invested.  But as lending business expands, the paucity of equity could lead to challenges with the creation of income earning assets and result in a rush for costly local deposits or raising of equally risky foreign bonds.

Quite a few analysts have heaped the blame of the current capital adequacy debacle on rising non-performing loans which has crawled to twice the regulatory threshold of 5 per cent.

However, as part of its efforts at enhancing the quality of banks and ensuring financial system stability, the Central Bank of Nigeria (CBN) is proposing a maximum capital base of N100 billion for banks operating in the country.

Under the new regime that replaces universal banking expected to begin next year, three tiers of banks are to come into effect with the lowest capital base – N15 billion – set aside for those classified as regional banks. According to the classification, banks with the maximum capital base could operate internationally while national banks whose operations are confined to the country will be required to have N25 billion.

On the other hand, regional banks which are allowed to operate in a minimum of five and a maximum of 10 contiguous states are required to have N15 billion.

Also, banks’ present structure is expected to evolve into a holding company model, with the parent company holding investments in banks and non-core banking independent subsidiaries.

The implication, according to analysts, is that the present configuration whereby banks have subsidiaries in non-related banking institutions with group assets and functioning as a consolidated group with marginal distinction between the bank and the subsidiaries in terms of management and operations will no longer exist. The present arrangement is thought to have created a platform for the misallocation of depositors’ funds.

Earlier this year, the International Monetary Fund (IMF) said three Nigerian banks were undercapitlised with their capital adequacy ratio (CAR) far below the regulatory threshold.

Although, IMF did not mentioned the names of the banks but said in its final copy of the Article IV Consultation with Nigeria, that as of December 2016, three banks (about 5 percent of assets)-including one internationally active one- were undercapitalized (with CARs below 8 percent).

The IMF said some weak banks in the country have been frequent users of the CBN’s liquidity window.

The consultation which is aimed at identifying the progress and limitations of Countries Monetary policies said to be under the adverse balance sheet effects 45 percent of bank loans are in foreign exchange and the corporates represent 75 percent of banks’ loan book.

The CBN had introduced the implementation of higher capital adequacy ratio requirements for systemically important banks (SIBs),

The policy, which was to take effect from July 1, 2016 stipulates the implementation of 16 per cent minimum CAR for SIBs.

The SIBs are First Bank of Nigeria Limited, Guaranty Trust Bank Plc (GTBank), Zenith Bank Plc, United Bank for Africa Plc (UBA), Access Bank Plc, Skye Bank Plc, Ecobank Nigeria and Diamond Bank Plc.

The eight financial institutions designated as SIBs by the central bank were required to hold more liquid assets and a liquidity ratio of 35 per cent. This meant the affected banks were expected to have a minimum liquidity ratio, which is five per cent above the 30 per cent requirement in the industry.

As the MPC meets tomorrow, industry watchers believe the way to tackle NPLs is not to further sterilise bank deposits by increasing liquidity ratio or cash reserve, but to be firm with supervision and ensure that insider-related loans are outlawed.

“Most of the bad loans we understand, are sitting with powerful directors of the banks. It may be a good time to seek presidential approval and ensure that they bear personal liability like was done in 2009. There should be consequences for ruining a bank and jeopardising depositors’ funds,” they said.

 The jury still remains out on the financial status of local banks and their resilience will be determined more by the passage of time than by debates between anxious investment analysts and prickly financial regulators.


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