Last week, the Central Bank of Nigeria (CBN) toughened its regulatory regime. Its review of risk weights on certain exposures in the computation of capital adequacy essentially did four main things. (1) It increased the risk weight on direct lending to government from 100% to 200%; (2) where a bank’s exposure to a particular sector of the economy exceeds 20% of its total lending, the bank in question is now required to apply a risk weight of 150% to its entire portfolio; (3) where banks exceed the CBN’s stipulated large exposure limits (to prevent a bank’s over-exposure to a client or group of connected clients) the central bank will henceforth treat such infractions as impairments to the respective bank’s capital; and (4) the CBN tightened the circumstances under which credit transactions may take place between “banks’ related parties within a holding company structure”.
My first reaction to these policy directives was near panic. Three considerations stood out for me. First, given the sustained clamour for the apex bank to lower its policy rate (in order it is argued to give fillip to a recovering economy, or, what is essentially the same argument, in order not to restrict the economy’s potential for growth), this represents a tightening of monetary conditions. In an economy that slowed down considerably last year, despite the gaping holes across its every nook and cranny, my question was “Do we need this new imposition?”
Second, I was bothered about the health of the banks. (I still am). True, they are likely to declare impressive financials for the twelve months to end-December 2012. However, what the numbers do not tell you is that most still bear the scars of the 2009 scare, when the CBN had to intervene to stave off the imminent collapse of the sector. Consequently, I thought it fair to ask if the banks are healthy enough to support the changes to their balance sheets that this new policy requirements demands. If the new policy adversely affects its capital adequacy ratios, the industry has any of several choices. Raise new capital. This would be difficult if not impossible in the economy’s current state. Banks could also re-price their assets (i.e. raise the rates on them). This, in all likelihood should force borrowers to pay back the loans.
Finally, there is the small matter that currently the bulk of banks’ lending to the economy is to the federal government and states (or, what is the same thing, to their ministries, departments, and agencies). If tougher conditions are imposed for lending to the public sector what might the banks do? As it were the opportunity cost of public sector lending is warehousing the loanable funds in government’s fixed income instruments. Does the new policy not thus introduce a strengthened bias in favour of banks’ purchase of treasury bills?
The responses to my questions were diverse. The most persuasive was that the CBN was right to put out the new policy as part of the design of much more relevant macro-prudential regulations for the domestic financial services space. Essentially, this is part of the shift (driven by the last financial and economic crisis) in the regulatory space from a traditional focus on the safety and soundness of individual financial institutions, to a newer focus on the negative feedback loop between the financial system as a whole and the larger economy.
To the worry over banks’ health, I received the re-assurance that only two of the tier one banks had red flags over their capital adequacy status. Therefore, the risk here is only idiosyncratic. The system can bear the new requirements quite easily. Options for these two banks? Re-pricing or outright foreclosure of the public sector loans I am told is not such a practical option. Why? The public sector might just be too broke to go through with that. Re-packaging and selling the loans off to other banks does not appear too attractive either. Given the new conditions, the haircuts that potential buyers will demand might render the transactions nugatory ab initio. So, there might be snafus in a corner of the system, which a controlled detonation might well handle.
Most industry experts that I spoke to welcomed the CBN’s efforts at restricting the space for public sector loans. Not just does this crowd out private sector borrowing, but also there is mounting evidence that the public sector increasingly sub-optimises this scarce resource. They are also sure that the banks cannot warehouse the funds thus freed up in treasury bills. That domestic fixed income space is neither broad nor deep enough for the kinds of money that will be released. Now, since the banks cannot credibly sit on the stuff, they will be forced to address the challenges of extending loans to the private sector.
This, they will probably find some short cuts round. The trouble is that the result might underwhelm all stakeholders. After 2012’s stellar financial performance, the banks will be hard pressed this year to deliver financials that good, because of the new policy change. So expect shareholders to quibble. The private sector, too, will not get as much new loans as the “captains of industry” have always argued the sector needs.
The CBN, however, may sleep better in the knowledge that the banks will be a lot stronger after they “immediately” implement the new rules than they were before.