Reflections on Nigeria’s Banking Reforms (2)
As of December 2008, some banks were exposed to the oil industry to the tune of 754 billion naira, representing over 10 per cent of total industry lending and over 27 per cent of shareholders’ funds. These exposures created liquidity stresses for Nigerian banks. As part of liquidity support to the banking system, the central bank expanded its Discount Window to accommodate money market instruments such as Bankers Acceptances and Commercial Paper. As of June 2009 the total commitment under the EDW was 2.6 trillion naira, while outstanding commitments were 256 billion naira, most of which was owed by half of the existing banks. When the CBN later shut the window and in its place guaranteed interbank placements, the same numbers of banks were the main net-takers under the guarantee arrangements. Clearly, there were deep-rooted liquidity problems.
The situation of the banks was aggravated, perhaps even more fundamentally, by weak corporate governance. In many banks, the boards of directors were beholden to the CEO and management instead of exercising supervisory governance, insider-lending was rife, and many of these loans went bad. Indeed, in several examples the intent was not to repay the loans at all, making it a case of the saying that “the best way to rob a bank is to own one”.
A Decisive Intervention
The appointment of Lamido Sanusi, a banking risk management expert, as Governor of the CBN was a game-changer. This was the first time a CBN Governor would have a strong risk management background in an industry in which lip service was payed to the concept but few banks were truly serious about managing risks effectively. Sanusi decided to ascertain the true state of the banks through a joint special examination led by CBN bank examiners, working with others from the Nigerian Deposit Insurance Corporation (NDIC). The examination’s purpose was to review, evaluate and determine the quality of the banks’ loan portfolios. The examination found substantial amounts of non-performing loans, poor corporate governance, weak risk management, and weak capital adequacy and liquidity. Nine banks were found to be in a “grave condition” and a tenth was found to have insufficient capital. The stage was set for a decisive intervention in the threats to Nigeria’s banking system.
With the banks thus initially stabilized, the CBN proceeded to unveil a reform agenda with four main pillars: (a) enhancing the quality of banks; (b) establishing financial stability; (c) enabling healthy financial sector evolution; and (d) ensuring that the financial sector contributes to the real economy.
The Reforms
• Enhancing the quality of banks. This leg of the reform was aimed at making Nigerian banks more solid entities in terms of quality and not just quantity. This meant steps to improve the quality of the capital held by banks, and improving their risk management, corporate governance and transparency. The CBN introduced the Risk-Based Supervision of the banking system. This approach seeks to establish the present and likely future health of banks by focusing on the risk factors in their business activities and the quantum and direction (escalation or deceleration) of those risks and their possible systemic impact. This forward looking approach is different from the previous technical approach in bank examination that was focused exclusively on what is known as the CAMELS (capital adequacy, asset quality, management quality, earnings, and liquidity, with sensitivity to market risk added later as a rating issue).
As noted above, the boards of directors of several banks were mere window-dressings dominated by the CEO, which was a fundamental corruption of the principles of governance by supervisory boards. This situation arose largely as a result of the fact that many CEOs of the banks were significant or even dominant shareholders on their institutions and thus “owned” the banks. Amongst several steps to improve corporate governance and manage “key-man risk” in Nigerian banks, the CBN imposed a maximum tenure of 10 years for bank CEOs and a three year hiatus before such executives could return to the boards of their banks. The Bank imposed a mandatory uniform reporting annual reporting timelines in the industry in order to improve transparency.
•Establishing Financial Stability. After stabilizing the distressed
banks with liquidity injections, removing and replacing their executive management with temporary managements, the CBN initiated the establishment of the Asset Management Corporation of Nigeria (AMCON), a “bad bank” whose main task was to buy up toxic assets from the banking system and thus clean up the banks’ balance sheets with bonds it issued, recover and restructure these bad debts over a longer period, and contribute in recapitalizing some distressed banks. Despite several issues regarding the work of AMCON, including the matter of possible moral hazard, without the establishment of AMCON, an approach that has been utilized in other jurisdictions including Malaysia, South Korea and Ireland, it would clearly have been difficult if not impossible to stabilize Nigeria’s banks in 2010. This is simply because unlike in many jurisdictions in advanced industrial economies where the fiscal authorities bailed out their banking systems with taxpayers’ funds, Nigeria’s fiscal balance sheet was in no position to carry this burden at the time.
• Enabling Healthy Financial Sector Evolution. This leg of the
reforms focused on restructuring the banking system in a manner that would facilitate its healthy growth. To achieve this, the central bank enacted a new banking model under its regulatory powers. The new model abolished the universal banking system in which banks could operate as financial supermarkets owning non-banking subsidiaries but which operators had abused through regulatory
arbitrage that utilized those same subsidiaries.
•Financing the Real Economy. The CBN took steps to mobilise
and encourage banks to increase lending to the real economy, in particular agriculture and agribusiness, in a manner that would develop the agricultural value chain to create a more developed and industrialised agricultural sector. The main instrument utilized for this reform has been the Nigerian Incentive-based Risk Sharing Agriculture Lending (NIRSAL) program in which the central bank and the commercial banks combine through risk-sharing schemes and incentives to lend to agriculture at market-based interest rates. This has led many banks to overcome previous fears of lending to the agriculture sector as a result of exaggerated perceptions of the risks therein.
Unique Reforms
Nigeria’s banking reforms under both Governors Lamido Sanusi and Soludo were unique in several ways. No African country has carried out such radical and far-reaching banking sector reforms, let
alone in a relatively short span of 10 years. First of all, the reforms
were bold and decisive, benefiting from a combination of factors such as strong leadership, the independence of the CBN (enacted in the CBN Act of 2007 by the National Assembly through the efforts and advocacy of Governor Soludo) which enabled the Bank to do what was necessary for Nigeria’s economy despite powerful vested interests in what has predominantly been a crony capitalist system. Very importantly as well, the CBN Governors enjoyed complete political backing by Presidents Olusegun Obasanjo for the Soludo-led consolidation and Umaru Yar’Adua in the era of Lamido Sanusi.
Second, the reforms were driven by clarity of vision. Both CBN heads were clear about what they wanted to achieve in the face of the tasks before them, and followed through with single-mindedness. Soludo, unimpressed with two-thirds of Nigeria’s banks being marginal players, wanted big banks that could expand the economy and be reckoned with globally. Sanusi was determined to save the Nigerian financial system from distress and wanted sound banks that could operate in discrete niches of the economy whether large, medium or small. In my considered view, despite whatever shortcomings that could be ascribed to both reforms (there are no perfect reforms!), both visions and reforms were necessary and, in fact, complementary. Without consolidation, most of Nigeria’s banks would not have had a hope and a prayer of surviving the global financial crisis, and Sanusi could therefore not have been able to save the too many banks that would have had to fail. And without the Sanusi-led reforms, Nigeria’s banking system might have remained a vainglorious den of corporate iniquities that would have passed for ‘banking”.
Third, Sanusi-led reforms imposed accountability on bank executives at a time and in a manner that no other jurisdiction did. Professor Ben Bernanke, the recently retired Chairman of the board of governors of the U.S. Federal Reserve Bank, has published his memoir titled The Courage to Act. He regretted the absence of
accountability for the bankers who threw the global financial system into a near-collapse and the world economy into a recession, and noted that some bankers should have gone to jail. In Nigeria, the
Economic and Financial Crimes Commission (EFCC) commenced
the prosecution of a number of bankers at the request of Governor Sanusi, and has secured a conviction in one case.
Fourth, the stabilisation of the banking system under Governor
Sanusi was accomplished without the direct injection of fiscal resources, which was different from the experience of many other jurisdictions after the global financial crisis. Moreover, Nigeria became the only banking jurisdiction in which banks, including those that were not stressed, have had to (grudgingly but gallantly!) contribute their
own resources to ensure financial stability. A Sinking Fund was
established for AMCON to ensure that, beyond the asset management corporation’s recovery of bad debts, additional support from the CBN and the commercial banks is contributed annually to ensure an orderly exit from the financial implications of the banking crisis.
Risks nevertheless remain because the bonds issued by AMCON
were guaranteed by the Federal Government of Nigeria and thus
remain a contingent liability. It is important to ensure that AMCON makes as much recoveries as possible of bad debts, and that a moral hazard problem be avoided for the future. That problem could be instigated by an impression that AMCON, or an AMCON-like structure would always be around to bail badly-run and failed banks. Just who will bear such costs in the difficult economic environment that exists and may do dwell with us for a while? The cost of doing this again may be too high. The alternative is for the CBN to proceed to develop a clear framework of financial stability that draws on the concept of “living wills” developed by banks for their possible death and orderly funeral in order to avoid the painful phenomenon of inflicting financial losses on either public institutions or depositors when banks fail.
Policy Choices
The Sanusi-led banking reform faced three important policy choices. The first choice was that of what approach to adopt in communicating the deep distress within the Nigerian banking system in 2008/2009. Although it was apparent to many in the Nigerian financial sector, and increasingly to the public (no thanks to bank executives “demarketing” competitor banks by highlighting their weaknesses to potential and actual clients), Soludo repeatedly sought to reassure the Nigerian public that the financial system was not under threat of collapse and that things were under control. Doubtless, the central bank wanted to avoid bank runs and almost certainly had plans up its sleeve to deal with the situation at hand (I had not joined the Bank by this time and so cannot speak authoritatively about this specific issue). But, while its effectiveness in this instance can be questioned, this approach was not unusual in central banking.
As Ben Bernanke revealed in his memoirs, when he and Hank
Paulson, the US Secretary of the Treasury went to brief the US Congress on the financial crisis, they did not reveal the full scale of what they knew of the situation lest the political establishment panic and take knee-jerk actions.
Sanusi, on the other hand, made a policy choice to disclose that several banks were in a grave situation, but simultaneously announced policy decisions such as guarantees of the interbank system and creditors’ funds which was aimed at calming the nerves of several stakeholders, prior to embarking on reforms. Even Sanusi, however, still not disclose all he knew, for, had he done so, the confidence he sought to restore might have evaporated even before he started his reform program!
The second policy choice was between market discipline and financial stability. If a banking business is badly run, should it not suffer the market discipline of being allowed to fail? The answer may appear straightforward but when, as was the case at the time in question, the failure of one bank may trigger systemic failures of several other banks that were also weak, the cost to national economies and societies may be considered too much and a larger scale bailout may become necessary. This was the argument for systemic financial stability versus individual bank failures. The globalization and financial interconnectedness of financial systems that was already prevalent by 2008 introduced this new dynamic into central banking and banking regulation as a reality of our time. The point is that, having experienced the huge costs of maintaining financial stability in the aftermath of that crisis, public policy in many mature jurisdictions has been looking at how to accomplish the aim of financial stability and still have the banks, which are ultimately
private businesses, bear the costs of their own failure. Hence the
policy approaches of increasing equity and reducing leverage in the banking sector, and of “bail-in” in which bondholders and other creditors of banks bear the costs of bank failures by losing part of their investments, as opposed to bailouts with public funds.
The third policy choice that confronted the CBN in late 2009 and in 2010 was the tension between the anxieties of shareholders in distressed banks as the recapitalization with new equity and mergers and acquisitions by new investors approached, and the worries of depositors. Some category was bound to lose their shirt in the banking sector bailout. Whose shirt would it be? Sanusi was clear that, in the view of the Bank, the depositor was king, and shareholders who made a business bet that went awry would have to be prepared to take losses. This policy choice was informed by vivid recollections of the harrowing consequences for most depositors in the failed Nigerian banks in the 1990s, and the unique nature of banking business which relies far more on depositors’ funds and leverage than on shareholders’ funds.
Conclusion
The banking reforms have attempted to do all these things, with varying degrees of success. I would argue that they have been most successful in their structural and financial stability dimensions, but we still have a long way to go to an economy in which finance operates at its fullest potential for economic development. This is largely owing to factors such as structural deficiencies in the wider economy that are outside the control of the central bank, although many do not understand this and thus the tendency to focus on the central bank in assessing economic leadership and performance.
But we can have some satisfaction, at least, that in these reforms the CBN has certainly moved the needle in Nigeria’s development trajectory, demonstrated what African institutions can achieve when empowered and allowed the independence to do so while held accountable for their actions, and acted in ways and with concepts that were often well ahead of even more mature jurisdictions. Other African countries have good and valuable lessons to learn from these reforms as they navigate their own path to economic development and the role of finance in that context.
–Being the concluding part of a keynote address by Moghalu at the at the Commerzbank Investment Banking Conference for African Banks Frankfurt, Germany.