Nigeria: When prudence becomes a brake, not a guardrail

Prudence is designed to make financial systems safer. Higher capital buffers, stricter underwriting, stronger compliance, and clearer rules all serve one aim: reduce the chance that shocks become crises. Prudence has a shadow cost: when imposed abruptly, uniformly, or without regard to transmission, it can shrink the economy it intends to protect.

Nigeria’s financial reset reveals this tension. The system is more conservative, compliant, and capitalised. Yet credit contracts, investment hesitates, and risk is shifted, not solved. The result: safer institutions but weaker growth.

Stronger banks, thinner economies

From a regulatory view, the logic is firm. Inflation and FX depreciation eroded real capital. Asset quality fell. Buffers needed rebuilding. Recapitalisation restores loss-absorbing power and reassures depositors. But banks don’t meet higher capital requirements by taking on more risk. They defend their ratios.

This defence is rational:

• Underwriting standards tighten
• Long-tenor and higher-risk exposures are reduced
• Capital-intensive lending gives way to safer, liquid assets
• Government securities crowd out private credit

The balance sheet solidifies. Credit flow dries.

What looks like resilience in prudential metrics often shows up as caution in economic activity. SMEs struggle to access financing. First-time borrowers are rationed out. Long-gestation projects—such as manufacturing, infrastructure, and productivity-enhancing investments—are postponed or abandoned.

Rising bank capital adequacy ratios reflect improved balance-sheet resilience, but private sector credit as a share of GDP has remained weak or declined. The divergence indicates that prudential strengthening has been achieved alongside thinner financial intermediation, with credit expansion constrained by risk aversion and balance-sheet defence rather than funding capacity.

Sources: CBN Financial Stability Reports; World Bank; Mosope Arubayi

Resilience rises. Intermediation shrinks.

Credit compression is a feature, not a bug

The composition of bank lending has shifted toward lower-risk, cash-generating sectors. Oil & gas and services have gained a larger share of loan portfolios, while manufacturing’s share has declined. This pattern reflects balance-sheet conservatism under tighter prudential conditions, with credit retreating from higher-risk, long-tenor, productivity-enhancing sectors even as overall system resilience improves.

Sources: CBN Financial Stability Reports; Mosope Arubayi

This isn’t a bank or regulatory failure. It’s a predictable feature of prudential tightening in shallow systems. In deep systems, capital markets and nonbank lenders help absorb the shock. In Nigeria, alternatives are scarce. When banks retreat, businesses stall, informalize, or self-finance at a higher cost. This is where macroprudential success can become macroeconomic drag.

The economy doesn’t contract steeply. It grows below potential, with more fragility:

• Investment becomes short-term
• Firms favour liquidity over expansion
• Households self-insure through asset sales and consumption smoothing
• Informal credit fills gaps at punitive rates

The system survives. It doesn’t compound.

FX reform comes with balance-sheet costs

Foreign exchange reform exposes the prudence paradox. Market-determined FX pricing improves transparency and credibility. It restores signalling and reduces distortions. But it also shifts volatility onto balance sheets.

Banks and corporates face:

• Sharper revaluation effects
• More volatile earnings
• Greater demands on treasury, ALM, and risk models

In response, prudence deepens. Liquidity buffers rise. Risk appetite narrows further. Credit decisions become more conservative, not less.

The system appears healthier, but the economy is tightening.

Risk avoided is growth deferred

The impact is magnified where risk transfer is weak. Insurance penetration is low. Long-term funding is scarce. Political and policy uncertainty raises returns. In this environment, prudence means avoiding overpricing. When risk cannot be transferred, it is avoided. When it is avoided broadly, growth thins. This is why prudence costs are unevenly distributed. Regulated institutions look safer. The real economy bears the strain.

When prudence meets distrust

Investors don’t just price capital; they price behaviour. Despite visible stability—operating banks, clearing FX markets, rising buffers—behaviour remains defensive:

• Dollarisation persists
• Exit risk is priced even in calm periods
• Firms delay irreversible investment
• Households favour liquidity over formal risk transfer

This is the trust gap. Prudence can be mandated. Confidence cannot be. Without trust under stress, prudence turns inward. Institutions shield themselves. Capital circulates less. Time horizons shrink. The economy doesn’t break—it stops stretching.

Prudence is necessary—but it cannot work alone

None of this argues against prudence. Nigeria needs stronger, not weaker, buffers. The challenge is sequencing and balance. Prudence shrinks the economy when it is not paired with:

• Credible, consistent policy over time
• Functional risk-transfer mechanisms (insurance, hedging, long-term finance)
• Fiscal discipline that reduces crowding-out
• Structural reforms that lower non-financial risk

Without these, prudence becomes a brake without a wheel. Prudence makes institutions safer. Growth requires confidence, risk pricing, and transmission. Nigeria’s reset reduces fragility at its core. But unless risks are transferred and trust rebuilt, the cost will surface in thinner credit, lower investment, and slower compounding. Stability buys time. How prudence is paired with reforms in this period will determine if it supports or restrains growth. The balance between prudence and broader reforms is crucial for the economy’s future. Prudence is only effective when complemented by broader reforms; otherwise, it can stifle the very economy it seeks to protect.