Nigeria: Fortifying financial stability oversight
Weak banks are a worldwide phenomenon. The COVID-19 pandemic has contributed to weakening credit conditions and certain asset valuations in the financial system. More often than not, excessive risk exposures, excessive leverage, lack of profitability, liquidity concerns, poor asset quality, capital erosion, and reputation problems stem from weaknesses in corporate governance, erroneous risk-reward compensation policies, and internal control systems.
While shocks to the financial system usually emanate from a combination of factors, they can be traced to credit-related problems in the majority of cases. This is not surprising given that credit advancement has been, and still is the foundation of banking. Banks’ lending is critical to the fabric of any economy, and necessary to finance investment as economies progress in recovery. Thus, strong capital requirements are a necessary but not sufficient condition for banking sector stability i.e. a strong liquidity base is as important as having robust regulatory oversight.
Unfortunately, some Nigerian banks may have been left behind as they have seen severe capital erosion since the last recapitalization exercise that was implemented nearly two decades ago. High delinquency rates on facilities provided to some people and companies have had detrimental implications for the asset quality of loan portfolios of affected banks, forcing them to increase their loan loss provisions (LLPs).
As non-performing loans (NPLs) are a recurrent feature of financial crises and financial stress episodes, the common equity Tier 1 (CET1) capital of some banks has deteriorated significantly – falling short of the regulatory capital adequacy requirement of 15% as well as the dollar value of the minimum recapitalization requirement implemented in 2005. The continued deterioration in the asset quality and earning performance of these banks could limit their capacities to absorb higher loan losses over time. This would undermine their ability to intermediate credit and support the budding post-pandemic economic recovery. Therefore, the affected banks should be on red alert on the radar of Nigeria’s financial system regulators.
Weak banks have common problems and experience has shown that bank problems can worsen rapidly if not promptly addressed. As banks do not suddenly become weak, a high frequency of problems is often a sign of financial or managerial weaknesses that have been allowed to persist for some time. These problems can very quickly become major concerns for a regulator if minimum prudential requirements are not met and the bank’s viability is threatened. Therefore, all forms of weakness – needless of their magnitude and character – must be addressed by the affected bank and the regulators.
Early intervention – which may include a recapitalization plan for weak banks – is critical to prevent an escalation of the problem as the economic recovery remains shaky. Building buffers and raising capital will be crucial not only to ensuring credit flow but also to building resilience in the financial system. Therefore, it is imperative for monetary and fiscal authorities to never lose sight of bank asset performance – even as political bells chime – as shocks to the financial system seem to be becoming more frequent and previous minimum capital requirements – that were set based on historical loss events – have become less sufficient to absorb lenders’ losses in the prevailing economic climate.