Servicing Engine of Growth

The new economy will thrive on proper regulation of the banking sector, writes Godson Ikoro.

In the theory and practice of international monetary arrangement, there is neither a world central bank nor world currency for international transactions.  The trading nations develop systems whereby national monies can be used to conduct international transactions, such as import and export of goods and services. This is the function of economic and financial regulation.  And this basic fact places a heavy burden on the regulatory organs that control the economy.

Thus, the singular and collegiate public polices of the Central Bank of Nigeria (CBN), Securities and Exchange Commission (Sec), Nigerian Stock Exchange (NSE), Pension Commission (Pencomm) and Nigerian Insurance Commission (Naicom), as well as various ministries and parastatals, through their various committees, will modulate the new economy of the Buhari administration.

But, specifically, the role of the banking sector in the emerging new economy of Nigeria will therefore depend on regulations, adherence to corporate governance and global best practices, and other factors that sustain resilience of the economy. It will also depend on exchange rate stability and predictability, as well as purchasing power parity conditions that will attract or repel foreign investors in Africa’s biggest economy.

Ordinarily, the primary aim of this regulation is to promote beneficial externalities and reduce negative externalities that may accompany an unfettered and unregulated market structure. The regulatory reforms in the sector have gone almost 360. From Professor Chukwuma Soludo’s consolidation, which increased capitalization of banks from one billion naira (two billion naira for new banks) to N25 billion, down to the reforms of Sanusi Lamido Sanusi that followed the global financial crisis, regulation of the sector has been pervasive and continues to be proactive.  The ultimate aim of these reforms is to consolidate and strengthen Nigerian banks, so as to ensure a diversified, strong and reliable banking sector; ensure safety of depositors’ money, make them play active developmental roles in the Nigerian economy, and be competent and competitive players in the African regional and global financial system.

This is more so, given that CBN launched the FSS2020 in August, 2006, to fast track achievement of the country’s Vision 2020 propelled by Goldman and Sachs research. The regulator has tried to create a level playing field for all players.  The findings of 2005 predicted Nigeria as one of two possible African countries that have the potential to join the league of the next 11 of world powers on or before 2025. FSS 2020 is based on the recognition of the linkage between financial deepening/ growth and economic developments.

Background of regulation of banking for the new economy

But the global financial crisis exposed the innards of the consolidation. Although banks had passed through different kinds of reforms and restructuring policies, the reforms gave them a lot of challenging issues. The global economic meltdown led to actions and reactions within the Nigerian banking sector. It created problems of system integration, human capital integration, corporate governance, return on investment and recapitalization.

Specifically, after the merger and acquisition exercise, integration posed a lot of challenges to banking institutions, as most of the consolidated banks lacked the flexibility to respond to global banking challenges that require technical risk management skills for good judgments on asset management.

Indeed, the integration of human capital in consolidated banks became a burden, which a lot of the big banks contended with before the economic meltdown. This was in addition to a survey of the Nigerian economy by Sec, which showed that about 40 per cent of quoted companies in the stock market, including banks, had no recognized code of corporate governance in place.

According to Dr. Yerima Lawan Ngama, given the precarious state of Nigerian banks, the CBN, in June 2009, took a three-pronged approach to assess the financial conditions of the 24 banks. The first was the special examination exercise jointly conducted by the CBN and the Nigerian Deposit Insurance Corporation (NDIC). This exercise pin-pointed inadequacies in capital asset ratios and liquidity ratios, as well as weaknesses in corporate governance and risk management practices in nine banks.

These banks were found to be in a grave situation as a result of capital, liquidity and corporate governance concerns. They failed to meet the minimum 10 per cent capital adequacy ratio and 25 per cent minimum liquidity ratio. Apart from accumulating high non-performing loans, the banks were seriously exposed to the oil and gas sector, as well as the capital markets.

“Poor risk management practices in the form of absence of necessary control measures were prevalent, as the board and management of the banks had failed to observe established controls”, Ngama said. “The remaining14 banks were found to be in a sound financial state and did not require CBN to take any action”.

The second approach was to carry out diagnostic audit through independent consultants. The report of the audit exercise revealed greater magnitude of weak financial condition of the nine banks. All of them were “technically” insolvent, with significant negative asset value. It also exposed several illegal activities that had been taking place in five of the affected banks.

 It was against this background that CBN moved decisively to strengthen the industry, protect depositors and creditors, restore public confidence and safeguard the integrity of the Nigerian banking industry. This happened during the governorship period of Sanusi, whose tenure saw the cleaning of the Aegean’s stable.

The initial measures and initiative taken by CBN, in conjunction with NDIC and the Federal Ministry of Finance (MOF), included injection of N620 billion into the nine banks; replacement of the chief executives and executive directors of eight of the nine banks with competent managers with experience and integrity; reaffirmation of the guarantee of the local interbank market to ensure continued liquidity for all banks and guarantee of foreign creditors’ and correspondent banks’ credit lines to restore confidence and maintain important correspondent banking relationships.

Today, the sector can aptly be described as safe and sound, supported by a solid regulation frame work. The numerous actions taken under CBN guidance were to ensure that banks operated effectively, with particular emphasis on improving transparency and operations.

The apex bank repositioned operations by mandating banks to improve reporting infrastructure, internal governance and risk management procedures; increase transparency and disclosure; ensure effective and continuous communication with all stakeholders and ensure weekly reporting between the managing director and the CBN on financial performance, loan recoveries, and immediate report of any material developments to the CBN. Other measures taken to improve operations include continued focus on loan recovery, to improve non performing loans (NPL) ratios, especially with the creation of Asset Management Corporation (Amcon); reducing cost to income ratio; avoiding unnecessary costs; focusing on de-risking and de-leveraging the balance sheet and liquidity management.

Since 2013, these initiatives enabled some of the banks to continue normal business operations and prevented a total collapse of the banking sector. The introduction of the CBN cashless policy and its digitization of the sector is a watershed in the annals of banking.

Impact of regulation

Today, CBN is obsessed with financial sector stability and how the financial system will assist in growing the real sector of the economy. With strategic medium to long term measures, recent CBN reforms include enhancing the quality of banks; establishing financial stability; enabling healthy financial sector evolution and ensuring that the financial sector contributes to the real economy. This is by making sure that crisis is forestalled through implementation of risk based supervision (RBS), reforming the regulatory framework; enhancing provisions for consumer protection and internal transformation of the CBN itself. Its regulatory framework reform programme revolves round systematic review of regulations and guidelines around the key causes of the crisis by industry regulators; harmonization and raising to world-class standards of the supervision processes, technology and people within the various financial regulators and establishment of a centre of competence for International Financial Reporting Standard (IFRS) and N-GAAP+ implementation. The sector is also attuned to the global requirements of Basel ll and has a favourable reputation in the comity of nations.

Expectations

It is important to note that any economy that cannot create jobs on a continuous basis, reduce poverty and guarantee its citizens functional and qualitative education as well as world class infrastructural facilities is not only unsustainable, but would remain globally uncompetitive. Attainment of this height goes beyond short term palliative measures.

Having been through painstaking rigours of reforms, the banking sector in the new economy is expected to fund the development of other sectors. Beyond the sector’s bail-outs for agriculture, power, aviation and mining, Nigerians expect the sector to fund new refineries, new manufacturing outfits and construction of national strategic monumental structure for national pride. Having been sufficiently made strong, safe and sound, the sector, through syndication, should demonstrate its capability to exponentially create development and ability to swim against the tide.

In the area of consumer protection, the aim is to ensure that consumers receive appropriate protection, with CBN acting as advocate, setting standards of customer service for the industry and ensuring that customers are treated fairly in all their dealings through its complaints resolution model.

The sector is expected to create jobs on a continuous basis. The continuous renewal of human resources is expected to create employment to more people, to decimate the galloping unemployment ravaging the country.

The determination of CBN to buoy the naira, despite external pressure, is one area where policy should demonstrate the courage to stand by the nation to resist demands that will ridicule the nation. But it has to be done in a manner that does not make the citizens suffer. If the price of oil falls to $20, what will the CBN response be? Is the level of exchange rate set as a reflection of economic fundamentals? Or will the exchange rate variability be excessive? And how will prospective policy changes affect the level and variability of exchange rates?

Thus, CBN will begin to answer these questions with selection of a suitable benchmark. The price of exchange rate is largely determined by asset market considerations. This has been the useful paradigm for organizing the theory of exchange rate determination. When this happens, the apex bank has to demonstrate whether it will have plan B to foreign investors’ expectation, given that in the real world, the supply of money and bonds is stochastic.

The apex bank has continued to apply administrative and capital control measures in containing the pressure on the naira. On June 23, 2015, CBN released a circular that expanded the list of imported goods and services that are excluded from accessing foreign exchange (forex) at the Nigerian Interbank Foreign Exchange Market (IFEM).

On November 6, 2014, it had excluded six items: electronics, finished products, information technology, generators, telecommunication equipment and invisible transactions from the retail Dutch Auction System (RDAS). The funding of the six items was transferred to the interbank forex market.

These and other measures are to ensure stability of the forex market and efficient utilisation of forex, and in the process, conserve foreign reserves, encourage local production of items and enhance employment generation in the long run. But the knee jerk manner by which it was done spread panic to foreign investors.

Policy makers at CBN are concerned about irrational or excessive speculative behavior, but they should be able anticipate the extent of swing in nominal and real exchange rate.

The present arbitrage opportunities and speculative attacks on the nation’s currency, the naira, may be addressed through timely adjustment of the currency, reasons Mr. Bismarck Rewane, managing director and chief executive officer of Financial Derivatives Company (FDC).

He also forecasts the likelihood of further devaluation of naira by CBN in a bid to adjust to the fair value of the naira. The fair value of a currency is the price or rate that equates its supply and demand.

Writing on “Ensuring the Naira Trades Close to its Fair Value”, in FDC’s bi-weekly bulletin, Rewane argued that delays in currency adjustment presents profit making opportunities for market watchers. Worse still, he further contends that the mere anticipation of adjustment, whether real or not, is often accompanied by speculative demand and capital outflows which, in turn, make the impact of such adjustments more severe.

Rewane said economic agents were averse to being taken by surprise, as they are likely to over react and display some unintended behaviour.  He argued that it was the duty of CBN to control this, by making adjustments in the currency less ad-hoc, urging lenders’ watchdog to adopt a more transparent and scientific approach.

Again, as a destination for foreign investments, issuers of securities that trade public markets in Nigeria are required to meet information disclosure requirements. Such rules are intended to redress the asymmetry between issuers of securities and investors, and promote investor protection.  The rules that require common accounting policies are expected to provide a positive externality by making accounting statements comparable across firms – in fact, with the introduction of the Internal Financial Reporting Standards (IFRS). This shows the extent to which Nigeria’s financial system creates room for international investors and its capacity to support regulation, such as capital requirements for new banks in the new economy.

In this regard, banks’ reserve requirement, capital adequacy requirements, information disclosures on interest paid to depositors, control on banking and under writing activities, among others, are on the full watch of CBN.

Also, markets or exchange listing requirements, margin requirements permitted securities, price movements, etc, by Sec, should be explicit by the capital market regulator. Firms’ accounting principles for calculation on income exposure to risks and accounting rules of disclosure of geographic activity and business segment activity should be well known. Rules of taxation:  On ordinary income, capital gains, withholding taxes, taxes on payments to foreigners, transaction taxes and stamp duties on exchange securities should be such as to enable foreign investors to transfer their legitimate profits without let or hindrance.

Conclusion

From the fore going, one can conclude that for the banking sector to play its expected roles in the new dispensation, CBN, in conjunction with other regulators, should strive to actualize the Financial Systems Strategy 2020. This is the blueprint that will be used in achieving the goals of developing and transforming Nigeria’s financial sector into a catalyst that will engineer Nigeria’s evolution into an international financial centre.

This will deepen the financial system and keep pace with developments that will lead to Nigeria’s emergence as a world economic power by 2020.This presupposes that the country’s policies are investor friendly in other sectors such as transport, aviation, telecommunications, manufacturing and even distributive trade.

The policies will be such as to attract foreign banks into the investment and merchant banking subsector, as well as mortgage banks that that can take up the challenge of mitigating the housing challenge and creating world-class infrastructure for power, agriculture and mining.

The knowledge, cognate experience and administration savvy and courage of policy makers will positively boost investment in the new economy.