By Chinwendu Obienyi
With the investments concerns and displeasures shown by bankers and investors owing to omission of retained earnings from capital requirements set by the Central Bank of Nigeria (CBN), Haruna Mustafa, Director, Financial Policy and Regulation Department at the apex bank, insists that shareholders’ funds and other reserves will continue to be recognized in calculating banks’ Capital Adequacy Ratio (CAR).
In a recent podcast monitored by Daily Sun, Mustafa sheds more light on the overview of the ongoing recapitalization exercise, its impact on interest, loans and GDP as well as what the CBN expects from the exercise.
Excerpts:
Overview of the ongoing recapitalization exercise
The banking sector recapitalisation programme, as the name suggests, is an initiative or policy of the Central Bank of Nigeria (CBN) that requires commercial, merchant and non-interest banks to raise their capital relative to the frequent classes or organization. The overarching objective here is to strengthen the Nigerian banking system especially against the background of prevailing macroeconomic challenges that is currently being witnessed.
Under the policy, we set out two broad objectives. Firstly, we want to enhance the solvency and the resilience of banks to enable them absorb current and unexpected shocks, and this is speaking to the traditional function of capital, which is to absorb unexpected losses which is very important because capital is very core and one of the key metrics that regulators, supervisors use in assessing the soundness of banks.
The second objective is to reposition the banks to continue to support the growth and development of the Nigerian economy and this is in the context of the current aspiration to achieve a $1 trillion economy by 2030. Banks play a very critical and pivotal role in this regard.
So, these are the two broad objectives and under the policy, banks are expected to achieve the minimum requirements through multiple pathways. They may opt to inject fresh funds through rights issues, private placements or capital markets through public offerings.
Banks may also opt to go through mergers and acquisitions, and downgrades their current license authorization or upgrade. The different capital requirements reflect the different risk profile, size and license category of the banks. For International banks, the current capital requirement is N50 billion and under the new requirements, international banks are expected to hold N500 billion in capital.
For National banks, the requirements are currently at N25 billion, but under the new policy, they are expected to hold N200 billion. Merchant banks currently are expected to hold N50 billion. So the list goes on and on all the way to the least, that is the non-interest bank, which is a regional bank, holding N10 billion, up from N5 billion initially. Hence, the overarching objective is to strengthen the banks and put them in a position to be able to support the growth of the economy. Now, banks are expected to meet these requirements and in terms of definition of these capital requirements, it comprises paid-up capital and share premium.
Stronger banks and deadline for recapitalization exercise
What we are doing is in the ordinary discharge of our routine responsibilities. The central bank from time to time prescribes capital. This mirrors regulatory practices all over the world. You will recall a similar experience in 2004/2005 when we moved from N2 billion to N25 billion. So, you also recall what happened back then, the central bank was very proactive and little did we know that the global financial crisis was going to hit economies in 2008 and we all can relate to the deleterious consequences of that episode. The whole idea is to prepare our banks, especially in the context of the prevailing macro-economic shocks, which are both exogenous and also domestic. As a risk based regulator, we will be remiss in our regulatory duties and responsibilities if we do not take some proactive steps and that is precisely what this is all about. This exercise is supposed to span a period of two years, commencing from the first of April 2024 and terminating on the 31st of March 2026. This is a sufficient time for banks to be able to meet requirements which were stated in the circular we issued.
Optimism level of the exercise
We are quite optimistic that at the end of the program, we are going to have stronger banks, a healthier banking system, and a more resilient banking system that can withstand future shocks.
Impact of the exercise on interest rates and loans
In terms of direct impact on customers, the programme will not in any way negatively affect customers’ ability to conduct daily transactions in banks. But in terms of whether it will affect interest rates or the cost of borrowing, now, when banks have stronger capital, they are in a position to be able to deliver a variety of products and services that can lead to better customer experience but in terms of whether the new policy will affect cost of funding, price of money in the interest rates, not at all. What it is meant to have a positive impact in terms of banks’ ability to be able to operate more efficiently and also be able to sustain their operations.
Reasons for excluding shareholders’ retained earnings
To address that question, let me just highlight two important points. Number one, Section 9 and section 63 sub section 2a of the banks and other financial institutions Act 2020, empowers the central bank to determine paid capital from banks and also the timeline in which banks should comply with these requirements. It also enables the central bank to set the level of quality of capital that banks will have and this is without prejudice to what should constitute the shareholders’ funds of banks. What the central bank has done is to ensure that banks inject fresh equity or capital. Don’t forget, banks are in the business of financial intermediation and this comes with risks and the capital is there to absorb some of these risks or losses that may arise from their operations. Going back to 2004/2005, when the Central Bank raised the minimum capital requirement from N2 billion to N25 billion, this elicited similar reactions. There was so much hoopla as to why we should go that drastic. Looking back at it, did we see tomorrow? No but 2-3 years down the line, the global financial crisis hit and back then we had a motley crowd of 89 mostly big banks. Banks that could not fund big ticket transactions unless they came under a club of syndicate arrangement and that did not bode well for the sustainability of the banks, and indeed the banking system.
So, what did the central bank do? It raised capital requirements to strengthen the banks and position them to play on the global stage and also to support the growth of the economy. Now as regards that singular action that we took when the global financial crisis came, especially the second round effects, the banking system would have been badly hit with deleterious consequences for the economy. But that act saved the day and that is what ushered in or heralded the banking sector consolidation that led to the emergence of strong banks and right now we are all beneficiaries of the positive fallout of that policy.
Nigerian banks could then play on the global stage. Today you have Nigerian banks with footprints across continental Africa, even Europe and the Americas. This is partly the foresight of the central bank in introducing the banking sector conservation program.
So back to the exclusion of retained earnings, what we have simply done is to nudge the banks to inject fresh capital and this is without prejudice, like I mentioned, to what the different components of shareholders’ funds will be, and like we have stated in our circular, shareholders’ funds and other reserves will continue to be recognized in the competition and determination of banks’ Capital Adequacy Ratio (CAR) which is an important metric in our assessment of the soundness of banks, so it doesn’t detract from what the capital adequacy of banks should be and we are not changing the definition of capital. What we have done again, is akin to a vaccine shot. You will recall our experience during the COVID 19 situation where almost everyone took a vaccine shot. Some people even went for a booster shot and so this is like a booster shot. Yes, the banking system is safe, sound and resilient, but we can do with more capital to enhance and further strengthen the banking system.
Effect of the exercise on stabilizing the FX market
We at the CBN expect to see massive inflow of foreign direct investments and these are patient forms that any economy will need for long term sustainable growth because one fundamental challenge or development story is the absence of long term patient capital.
This is going to lead to an inflow of FDIs. We are looking to see investors coming in to take position in our banking system, if to the extent that we have more FX inflows to that extent, this is going to have a salutary impact on liquidity in the capital market and in the FX market, and which will also have a concomitant positive impact on the exchange rates.
This is just a simple demand and supply and this will be complementary to ongoing reforms by the central bank to ensure that we achieve stability and credibility in the FX market. So this policy, to my mind, is like a silver bullet that will help in achieving multiple objectives and so that is the end goal and at the end of the day, we see banks being able to support the growth of the economy.
To put these in bold relief, and I am very sure the banks will also relate to this. Capital is critical. Not only like I mentioned, in terms of their ability to be able to absorb shocks, or even in terms of the ability to be able to operate. In supervisory parlance, we have some metrics that we use in restricting or limiting banks risk exposures. So I will give you one example. There is what we call a single obligor limit, which is a function of capital to banks which cannot lend to a single borrower in excess of 20 per cent of their shareholders funds on impairment losses. Now what that means is that if I wanted to lend to the promising customer, for instance, a major individual in the economy, I am hamstrung if my capital is not sufficient to meet his needs and that does not bode well for the sustainability of the banking system. So that is what we are trying to trying to achieve. So if banks can not lend, especially profitable, you know, take advantage of profitable opportunities, then it becomes an issue in terms of their long term sustainability and that could have a knock on effect on their bottom line, which also have a knock on effect on their capital.
So there is a sense in which these dots connect and so this is very important.
Will the recapitalization exercise slow down GDP growth in the short-to-medium term?
Talking about contribution to GDP, I mentioned the pivotal role that banks play in an economy. For them to be able to effectively play that role, they need to be robustly capitalized to be able to support the growth of the economy to the extent that banks are able to effectively perform their intended intermediation function. Currently, are they able to contribute economically?
Let us think about the different economic players that access credit, for instance, and think about the multiplier benefits that will accrue. Manufacturers, other economic players and also the job opportunities that will be created up and down the value chain. Big infrastructure projects require bigger capital, so things are changing in very fundamental ways and we need to really keep pace with some of these developments. This is part of a suite of reforms that the apex bank is currently powering to ensure that we have a strong banking system, a resilient banking system can support an equal good old economy and can also work for Nigerians with these and complemented by other reforms. It is just a matter of time and I am sure we will begin to see the benefits manifest to the glory of our country and to the benefit of all.
Engagement with banks on the creation of the exercise
If you recall, the Governor announced plans by the Central Bank back in December and this was like a heads-up to the banks, that is one point of engagement. At the recent bankers committee meeting, the governor also raised the issue, the issue was discussed and the banks were fully aligned with the discussion. There were even a number of banks who started making plans to raise capital given the announcement by the Central Bank. In terms of consultation, there is this regular engagement with banks either through reports or our day to day interactions with them and so I think there was sufficient engagement with the banks in that regard. But in terms of the numbers we rolled out, that was a closely guarded secret.