I watched the movie, The Big Short, a while ago. The movie piqued my interest in Finance particularly in how the unorthodox manoeuvers in the American financial sector brought the “Most Powerful Country” in the world to a recession.

So when Nigeria plunged into an economic recession, I was quite curious to understand the interplay between banks, financial institutions and the regulators in the financial sector leading up to the recession and after.

It was interesting to me that much of the narrative directed responsibility for recession at the Government and the CBN, and very little at the key Players in the Financial sector – the Banks.

Banks in trouble?

Our financial services sector has, for the past year, teetered on the cusp of a monumental breakdown.  Banks call in loans; borrowers don’t have the money to pay – and one by one the dominoes fall. Skye Bank fell (Financial Services), Etisalat (Telecommunications) followed, Oando (Oil and Gas) is on the brink and let’s not forget about Arik Air (Transport). As one economic mess is patched up, another one crawls out – all inexplicably tied to one Bank or many Banks at a time and entrenched within them all is a recurring factor – loans; non-performing loans (NPLs) and bad Loans. A non-performing loan is a loan either in default or close to being in default – the borrower has not made scheduled payments on the loan for at least a period of 90 days.

9mobile Saga

The Etisalat saga gives a look-in to how a lending transaction could go badly and have a devastating impact. Etisalat (now 9Mobile) at the time of the saga was indebted in a syndicated loan transaction to a syndicate of thirteen Nigerian banks (the Etisalat 13) to the tune of $1.2 billion. A syndicated loan is one in which a borrower obtains a credit facility from a group of lenders to facilitate a particular project. This occurs in a situation where the project requires a huge capital influx and the bank cannot afford to be exposed to such a large amount to a single borrower. The facility is usually made available to borrowers who require long-term and large amount loans who have a high reputation in the industry and whose financial and technical acumen are recognised by most banks.

Emphasis should be placed on “high reputation in the industry” and “financial and technical acumen”. At the time this deal was made, a huge degree of reliance would have been placed on the fact that the company is largely owned by the Middle Eastern telecommunications giant, Etisalat Group and Mubadala, another middle-eastern company –  this is where high reputation and financial acumen come into play. There would have been a degree of confidence amongst the 9Mobile 13 that should the deal fail, the Middle-Eastern investors would jump to the rescue of its Nigerian investment. A factor relied on to their detriment. They played their cards but did not expect that the Arabs would abandon the game entirely.

When Mubadala decided that they had reaped returns off their investment enough to divest their stake in the company, the banks were left holding on to the collar of a man with empty pockets. Stocks of Nigerian banks reportedly lost a whopping N106 billion naira in value as a result of the debacle.

9Mobile alone, defaulting on the loans is not – by itself – enough to bring any of the thirteen banks to its knees. However, the bigger picture is an image of a dire situation. 9Mobile is the fourth largest telecommunications operator in the country. The banks would also be exposed to larger amounts in similar deals with bigger companies.

High non-performing loan ratios

To put this into perspective, non-performing loan ratios for Nigerian banks are reported to have reached 14% as at June 2017 – that is almost three times above the 5% limit imposed by the CBN. These loans are taken out of depositors’ funds and shareholders’ funds. Skye Bank was already a victim of a major bank falling to bad debt and non-performing loans. Arik Air reportedly owes almost N40 billion to two Nigerian banks and counting.

A very important consideration in the recession is how the banks reacted to rising ratios of non-performing loans. To reduce their ratios, they have begun reducing the amount of loans granted to the private sector. Another reaction is in reduced lending to the private sector with bank lending favouring the public sector.

Thus, we are stuck in a catch-22 situation where Banks have reduced the amount of new loans granted, and the public still have to repay debts already taken out. Taking out a new loan creates money, and repayment of bank loans destroys money – that is, the money is not recycled into the economy, creating and deepening the recession.

As it affects companies, they are earning less but they still have to repay the Bank loans taken out. They are dissuaded from making investments since earnings would go into repaying debts. A greater proportion of revenues goes to servicing loans and reduces spending on investments which grow the business. This leads to a downward spiral that culminates in the economic recession.

How the CBN handles failed or endangered banks

The solution lies in the response of the regulators to the situation. There are two major responses so far. The CBN protects and bails-out companies that are deemed systematically important, that is “too big to fail” – a similar strategy was adopted by the American government in the American financial crisis of 2007. The term is currently extended to eight Nigerian commercial banks and even more unconventionally was extended to 9 Mobile in resolving the debacle.

A company is too big to fail if it is so large that the failure of such company would result in disastrous outcomes. Thus, when such companies face potential breakdown, the government finds schemes to support them to prevent an economic disaster.

The CBN had to step down from the hard-line approach it had taken in respect to Banks in the past few years and was forced to pivot from its role as a regulator and overseer of the industry to negotiate a scheme of restructuring in order to protect the interests of employees, shareholders and overall the Nigerian financial system.

The system is good but it poses several disadvantages. Corporations become more assured of a bailout by the government and become more careless in granting loans and take higher risks. This is referred to as a moral hazard. They are assured of an intervention by the Central Bank and/or AMCON should the situation worsen. The Skye Bank situation is one that particularly boggles the mind – within two years after the bank had of its own accord acquired Mainstreet Bank for N100 billion, the bank is the recipient of a N100 billion bailout from the CBN because it is “too big to fail”. This is after the bank’s books clearly revealed a portfolio of irregular loan deals.

Another response is AMCON (Asset Management Corporation of Nigeria). AMCON was set up in 2010 to take over non-performing loan assets of Nigerian banks. It could be described as a sort of cleaner in this regard. It comes in and takes over responsibility for non-performing loans on the bank’s books, taking the burden off the banks and freeing them up to conduct business.  However, AMCON is increasingly unwilling to engage in another round of non-performing loan purchases in the banking system soon or take up toxic assets. It is speculated that AMCON currently has cumulative losses of N4.5 Trillion. They are also feeling the pinch.

The regulatory authorities and the government are working hard to pull the country out of the recession and their efforts must be applauded. But even they cannot continue to posture for longer that everything is fine. The rise in the price of crude oil was enough to marginally pull the country out of the recession and if it is sustained, the country will be fine. But once we do get out, stricter and closely monitored regulatory mechanisms need to be put in place. Investing a N100 billion to save a bank is not feasible in a country with severe infrastructure problems and an alarming rate of poverty and unemployment.

What the CBN should do

The first of such regulatory mechanisms would be to diligently pursue stricter monitoring of bank loans. More specifically, measures in the form of incentives and penal sanctions should be taken to ensure that bank loans are not concentrated in a particular sector – a particular bank had 40% of its loan portfolio in the Oil and Gas sector, and this is a trend amongst several banks. A diversified loan portfolio reduces the risk should a particular sector fail. It goes without saying that when 40% of a bank’s loans are to companies in Oil and Gas, the bank is in a load of trouble should there be a downward shift in the price of crude oil.

The practice of loaning funds by Nigerian banks to Nigerian companies in foreign currency also needs to be reviewed. It is not sustainable to continue to do this as frequent upward fluctuations in the exchange rate makes it nigh on impossible for companies to meet up and repay the loans. Similarly, a downward fluctuation, would result in a loss for the bank.

With the 10 year life-span of AMCON drawing to a close, the CBN and NDIC are planning to launch a private sector controlled version of AMCON to manage non-performing loans after 2020. This eradicates the monopoly AMCON has over the field and frees up public funds for better use.

There is light at the end of tunnel. With bolder regulator mechanisms put in place and ever more creative solutions being thought up by Banks and regulators, the argument might even be made that the recession was a good thing. Too soon?

 This article was contributed by Teniola Akeju. Teniola is a legal practitioner and sends this article in from Abuja. Think you can take a stab at writing economic, business and financial articles? Send us a piece via articles@nairametrics.com 

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