Banking: Challenges Facing Regulatory Authorities
By O.I Imala
As stakeholders in the banking industry, an appreciation of the challenges faced by the regulatory authorities in the supervision of the banking industry will no doubt go a long way in improving the reporters' skills.
I consider the topic of my presentation "Challenges Facing the Regulatory Authorities in the Supervision of the Banking Industry". very apt and could not have come at a better time than now, when the banking industry is undergoing major structural reforms. 1, therefore, thank the organizers of this workshop, the Nigeria Deposit Insurance Corporation (NDIC), itself a major stakeholder in the banking sector, for providing this platform
Banks play an important role in the development of any nation. Through the process of financial intermediation, they help to promote efficient allocation of financial resources. Banks help to promote the operation of an efficient payment system, while the effects of government policies are usually transmitted, through the banking system, to the rest of the economy.
In executing its responsibility of promoting price stability and a sound financial system, the Central Bank of Nigeria (CBN) regulates and supervises the conduct of banks and the banking system in the country. This is necessary to minimize the risks that banks are exposed to and also sustain public confidence in the system. It is the responsibility of business editors and finance correspondents to interface with bank operators, the supervisory authorities and the banking public to ensure that information is correctly and promptly disseminated. Therefore, collectively as stakeholders, we all have our roles to play in ensuring that our financial system is safe, stable and sound.
This presentation has been structured into six sections: section one is the introduction above; section two is on overview of the Nigerian banking system and the regulatory framework; section three highlights the challenges of banking supervision in Nigeria while section four reviews some of the regulatory efforts at meeting them. Section five is an outline of the current supervisory initiatives to reform the Nigerian banking system. The conclusion is in section six.
2.0 The Nigerian Banking System And The Regulatory Framework.
2.1 The Banking System
The Nigerian Banking Industry is characterized by a retinue of small players. Currently, there are 89 banks operating in the country with 3,300 branches. Generally, the level of capitalization of the banks is quite low and they exhibit various forms of weaknesses. This has informed the CBN's periodic directives to increase the paid up capital for each bank from N500 million to N1 billion and N2 billion in 2001 and 2002 respectively. The small sizes of these banks make them vulnerable to market shocks and render them ill-equipped to perform any meaningful developmental roles like their counterparts in other countries. For instance, the average capitalization of a typical Nigerian bank is under $10 million (N1.3 billion) while the largest bank has a capital base of about $297 million (N38.62 billion), compared to the smallest bank in Malaysia with a capital base of $526 million (N68.38 billion).
The banking sector is dominated by the top 10 banks which account for as much as 50% of sector's assets/liabilities.
Corporate Governance practice in the industry is generally weak. Furthermore, the lack of transparency in the system has aided the accumulation of large amounts of non performing loans, particularly insider related facilities in banks. For instance, the ratio of non performing loans to total credit was about 23.19% as at June 2004, while CBN's exposure to banks in absolute terms was about N71.366 billion as at July 2004. These make a major restructuring of the banking system inevitable.
2.2 The Regulatory Framework
The Central Bank of Nigeria (CBN) is the apex regulatory authority in the Nigerian financial services industry. The Bank derives legal authority from the CBN Act 1991 as amended and the Banks and Other Financial Institutions Act (BOFIA) 1991 as amended. Both instruments replaced the CBN Act of 1958 and the Banking Act of 1969.
The BOFIA 1991 as amended brought the activities of a myriad of financial Institutions, covering deposit money banks (DMBs), finance companies, discount houses, primary mortgage institutions, bureaux de changes, community banks as well as the specialized non-deposit taking banks (development finance institutions- DFls) under the regulatory and supervisory purview of the CBN. The Act confers licensing powers on the Bank as well as the power to regulate and supervise the activities of banks and other financial institutions operating in the country. Indeed, the CBN is empowered by the Act to exercise prudential supervision over banks and non bank financial institutions. This is carried out through periodic on-site examination and off site supervision to ensure sound banking practices. The on-site function is carried out by the Bank Examination Department, while the Banking Supervision Department performs off-site surveillance. I must quickly emphasize that these functions are complementary. The Other Financial Institutions Department - established in 2001 - carries out the surveillance of financial institutions other than deposit money banks. The BOFIA stipulates a regime of monetary penalties and/or other sanctions for offences and contraventions of the Act by banks and other financial institutions and empowers the CBN to remove erring directors and principal officers of the banks. The Act also vests the CBN with the power to revoke the operating licence of any bank.
The Nigeria Deposit Insurance Corporation (NDIC), the organizers of this workshop was established by Act No. 22 of 1988 to undertake deposit insurance and related services for deposit-taking institutions in order to promote confidence in the banking system. In this regard, the Corporation is authorized to examine the books and affairs of insured banks and other deposit taking financial institutions. In fact, the NDIC has the responsibility to monitor the safety of depositors' money by ensuring that banks adequately insure their deposit liabilities in line with established standards, by not only paying the insurance premium but also undertaking safe banking practices. Additionally, the NDIC, jointly with the CBN, carries out the routine as well as special examination (where necessary) of deposit money banks, particularly banks that are experiencing some difficulties.
3.0 The Challenges Facing Banking Supervision
While the regulators have successfully managed to prevent a systemic crisis in the banking industry, the supervisory authorities' efforts have, however, been hindered by a number of issues. Some of the major challenges which require mention include:
i. Weak Corporate Governance practices.
The issue of corporate governance has taken the center stage in international discourse in recent times. Sound code of ethics and professionalism are necessary for effective and transparent leadership of any institution. In Nigeria, certain weaknesses have been identified as causing distortions to the smooth intermediatory role of banks and capable of triggering financial instability in the system. Some of these weaknesses include:
Falsification of bank returns/call reports. This makes it very difficult and extremely expensive for the regulators to ascertain the true financial condition of the banks. Often, returns are deliberately falsified to hide management inefficiency by presenting a robust picture of the banks, contrary to the true position. In the past, this has also been used to hide frauds and insider abuses.
High volume of delinquent insider related credits, arising largely from poor financial disclosure and auditing requirements.
Inadequate representations of non-executive directors on the Board. This usually arises from the lack of in-depth knowledge of, and ability to interpret, financial statements and corporate strategies. The Financial Institutions Training Center (FITC) in collaboration with the regulators recently organized a workshop for banks' non-executive directors with a view to equipping them with the relevant knowledge to enable them function better on the Board of banks.
Formulation of self seeking policies. This is possible in situations of tight insider control of banks by majority shareholders.
ii. Weak capital base of banks. As stated above, the capital base of Nigerian banks is quite low, compared to banks in other countries. This hinders the performance of key developmental roles expected of them, and exposes them to the vagaries of illiquidity and market shocks. In the past, this had adverse consequences for depositors and bank owners alike. With poor capital base, ability to expand both structurally in terms physical size and in volume/scale of operations is limited. Consequently, the banks' interface with the other sectors of the economy is narrow, concentrating rather on FX trading and treasury bills speculation.
iii. Poor credit administration resulting in predatory borrowers' abuse of the system by taking multiple credits from different banks and allowing such credits to go bad. The increasing prevalence of credit delinquency in the banking sector has dire consequences on the health of not only the institutions themselves, but the entire economy, bearing in mind the experience of the banking industry crisis of the early 1990s. Poor understanding of clients' business, inadequate credit appraisal and poorly structured loan contracts are some of the factors responsible for the deteriorating risk asset quality in the banking industry. This, in the past, occasioned huge provisioning requirements, thereby negatively affecting the industry's profitability and the going-concern assumption of some of the banks. This disturbing picture of the banking sector calls for a concerted effort to arrest the situation and engender the confidence of depositors to grow and sustain a virile financial system.
iv. The paucity of executive capacity in the industry caused by the inability of banks to adequately train their staff and culture of staff poaching in the banking sector has led to inexperienced officers manning sensitive portfolios and positions beyond their capabilities/competencies. It is precisely to arrest this ugly development that the CBN issued the Circular on Staff Poaching in the Nigerian Banking Industry of 2001.
v. The prolonged judicial process which causes delays in, and hinders the effectiveness of, supervisory processes. As at date, the liquidation of Savannah Bank Plc, whose licence was revoked by the CBN in 2002, is yet to commence because of protracted legal processes. The consequence is the erosion of public confidence in the supervisory process;
vi. Difficulties in the reviewing of supervisory legal framework. Amendments to the CBN Act, the BOFIA and the NDIC Acts have been submitted to the National Assembly. The ability of the regulatory authorities to effectively carry out the supervisory functions is impaired by the inadequacies in the existing legal framework.
4.0 Regulatory Efforts At Meeting The Challenges
Formidable as the above challenges are, the CBN has continued to formulate policies, issue guidelines/circulars and adopt strategies and measures to ensure the stability and soundness of the banking system in Nigeria.
Some of such measures that have been adopted to mitigate the challenges facing the regulatory authorities in the supervision of the banking industry in Nigeria include:
i Banks' Reporting Software
The CBN in collaboration with the NDIC introduced the Bank Analysis System (BAS) that enables the operators (banks) to render statutory returns to the regulatory authorities in soft copies. This made it easier to review the banks' returns, enable faster, more accurate and swifter retrieval of information about the individual banks as well as the whole industry on a consolidated level. The software is currently being upgraded such that banks would render such returns on-line and the regulatory authorities would be directly linked in order to have unimpeded daily access to the database of the reporting institutions. The upgraded software would be more robust, and would help in minimizing false reporting since a daily appraisal of a bank's financials would enable the regulatory authorities to have an updated knowledge of the financial condition of a bank. The software has also been expanded to cover other non-bank financial institutions.
When deployed, the application would improve the quality and integrity of information available to the regulators. The timeliness of information generation and the absence of the incentives to manipulate data would significantly improve the effectiveness of the supervisory process.
ii. The Credit Risk Management System (CRMS)
This is a database established by the CBN to monitor the credit status of borrowers in the banking system. Banks are compulsorily required within this framework to access the database and update same with all loans in excess of N1 million they grant to any borrower. The essence of the CRMS is to forestall credit abuse whereby some predatory borrowers obtain facilities from various banks, which eventually get sticky as a result of their inability to service such credit facilities.
iii Code of Conduct for Directors
In order to address the challenges of weak corporate governance, the CBN enforces a code of conduct for banks' directors. This code stipulates the minimum ethical standard expected from bank directors in relation to their position of trust. Specifically, the guidelines restrict the quantum of credits to be granted to banks' directors or majority shareholders in banks. In addition, such credits and their performance status are now required to be disclosed in banks' published annual accounts.
iv Know Your Customer Manual
In its efforts to guard against financial and economic crimes and money laundering, the CBN in November 2001 issued a circular on Customer-dueDiligence, otherwise, known as Know-Your- Customer (KYC). This circular was aimed at reminding banks of the need to ensure that appropriate procedures and documentation are followed in accepting new customers while closely monitoring the activities of existing customers to avoid their banks being used as havens for financiai crimes.
v Appointment to Top Management/Board of Directors in Banks
The supervisory challenges created by the spate of insider abuses and the dearth of executive capacity as a result of which inexperienced personnel occupied very sensitive positions in banks, compelled the CBN in January 2001 to issue guidelines on pre-qualifications for top management appointments in banks. This was aimed at strengthening management capacity and staff stability within the industry. The guideline has, to a large extent, moderated the appointment of unqualified persons to boards and top management positions in banks.
vi Collaboration With Other Regulators of the Financial System
Apart from the subsisting collaboration between the CBN and the NDIC in the supervision of the banking system, the establishment of the Financial Services Regulation Co-coordinating Committee (FSRCC) in 2000 has provided a forum for the financial system regulators to collaborate and eliminate regulatory arbitrage, and consequently enhance the effective supervision of the financial system.
vii Adoption of International Best Practices
Globalization and liberalization would require Nigerian banks to operate in the global arena. This, on its own, would create supervisory challenges for the harmonization of local and international standards. It was therefore imperative that the CBN should adopt international best practices in the regulation and supervision of the banking system.
a. Accordingly, the "Core Principles for Effective Banking Supervision" issued by the Basel Committee on Supervision has been adopted as a sine qua non for banking supervision. We are currently at an advanced stage of compliance with the 25 Core Principles.
b. We have also fully adopted the 1988 Basel Capital Accord, which relates the total capital of a bank to its level of risk assets. The Capital Accord requirements are currently under review to broaden the requirements for determination of the minimum capital of banks in relation to their level of operations. The industry is also currently being sensitized in preparation for the implementation of Basle 11 Capital Accord, which will come into operation by January 2007. Essentially, the new Basle 11 Capital Accord seeks to relate the capital requirement of a bank to its risk profile in a more risk- sensitive format.
viii Contingency Planning for Systemic Distress and Crises
The CBN over the years adopted a policy of preventing distress contagion in the banking system by easing out terminally distressed banks. However, it introduced the Contingency Planning for Systemic Distress and Crises in August 2002 as a proactive distress resolution measure.
The contingency framework stipulates trigger points for regulatory intervention in the resolution of observed problems.
ix Recapitalization of Weak Banks
Over the years, the CBN has been challenged by the relatively weak capital base of the banks. This problem has contributed significantly to the causes of bank failure in Nigeria, right from the pre- independence era. Section 9 of Banks and Other Financial Institutions Act (BOFIA) 1991 as amended, however, requires the CBN to determine from time to time the minimum paid up share capital of barks. In line with this requirement, the CBN has continued to review the minimum capital requirements of banks.
However, the challenge of weak capital base of banks has remained with us.
From the adoption of international best practices in banking supervision and the prescriptions of the Basel Capital Accord, it is evident that the shareholders' fund, rather than the paid up share capital determines the level of capitalization required to support banks' operations.
On this premise, the need to strengthen the capacity of Nigerian banks to play in the international arena, and also to support developmental activities within the economy, compelled the CBN in July 2004 to raise the minimum shareholders' funds of Nigerian banks to N25 billion with effect from December 2005.
5.0 The Current Banking Sector Reforms.
5.1 Reform Agenda
The structural weakness of the banking system, which has hindered the performance of its developmental role in the economy and seriously curtailed the achievement of Government's objectives of ensuring price stability, economic growth and high employment level prompted the CBN to embark on the current reform of the banking sector.
The reform package which was announced by the CBN on 6th July 2004 is anchored on a 13-point program, salient among which are:
I. Minimum capital base requirement of N25 billion which must be met on or before 315t December 2005
II. Consolidation of banking institutions through mergers and acquisitions.
111. Adoption of a risk focused and rule-based regulatory framework.
IV. Zero-tolerance for weak corporate governance, misconduct and lack of transparency.
V. Accelefated completion of the electronic Financial Analysis and Surveillance System (e-FASS) to enhance the process of rendering returns by banks and other financial institutions to the supervisory authorities.
Vl. Strict enforcement of the contingency planning framework for systemic banking distress.
Vll. The establishment of an Asset Management Company as an important vehicle for banking system distress resolution.
Vlll. Promotion of the enforcement of dormant laws, especially those relating to the issuance of dud cheques
IX. Revision and updating of relevant laws, and drafting of new ones relating to the effective operations of the banking system.
X. Closer collaboration with the Economic and Financial Crimes Commission (EFCC) in the establishment of the Financial Intelligence Unit (FIU), and the enforcement of
5.2 The Case for Consolidation
It is expected that banks that may not individually meet the new N25 billion capital base requirements would consolidate and maximize the benefits of economy of scale and low transaction costs. After the exercise, banks would be more robust, bigger and better suited to fund developmental activities at low interest rate. They would also meet challenges of globalization by being a major player in the integration of the ECOWAS financial system and beyond.
Adequate capitalization is indispensable for a safe banking system that would play its expected developmental role in the economy. Strong capital base would enable banks to gain competitive edge, acquire relevant technology, absorb losses and above all, withstand market shocks. Consolidation through mergers and acquisitions is aimed at eliminating small, shaky and weak institutions that are gradually eroding the public confidence in and the smooth operation of the banking system. This will afford the consolidated banks the benefits of cost savings attributable to economies of scale, achieve revenue enhancement, risk reduction as well as meet challenges of globalization.
5.3 Incentives To Consolidating Banks
To stimulate the process of consolidation through mergers and acquisitions, which is the cornerstone of the reform agenda, the CBN offered several incentives to the banks that are willing to consolidate, among which are:
Provision of technical assistance at no cost to the banks.
Where a distressed bank is involved, the Bank would consider possible write-down of its exposure to the acquired bank to make it more attractive.
To reduce the burden of merger, the CBN in consultation with other relevant bodies is working out additional incentives including:
Tax incentives in the area of capital allowances, companies' income tax, stamp duties, etc.
Reduction in transaction costs payable to SEC, NSE, etc.
6.0 Conclusion
The challenges of banking supervision and the need to evolve a comprehensive supervisory approach that will enhance safety and soundness of the banking system require the cooperation and good faith of all stakeholders.
The regulatory authorities are constantly retooling their approach to the supervision of the banks in order to focus and channel more supervisory resources to the critical areas of banks' operations, their risk assets. It is in realization of this necessity that the CBN/NDIC Executive Committee is working towards the adoption of "Risk-Based-Supervision"
The CBN and other stakeholders are also working towards the establishment of an Asset Management Com-pany (AMC). This is expected to be an interventionist agency, as in the other parts of the globe, to acquire the risk assets of distressed banks in order to free such banks from provisioning requirements inherent in the impairment of such assets.
Good faith from the operators in the area of the on-going recapitalization and consolidation, integrity in their operations, financial reporting and the institution of an effective corporate governance structure would put the banking system on a high pedestal to accomplish more effectively its goal of financial intermediation and economic development in the country.
To the Business Editors and members of the FICAN, your support would be immeasurable in the on- going banking system restructuring.
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