Making banks safer

Banks shut branches early ahead of polls

Basel III regulations are expected to allow greater financial sector stability as well as allow investors to focus more on institutional risks, writes Obinna Chima

There is a general consensus that a resilient banking sector is a necessary condition for achieving sustained economic growth.

This is because financial instability, contracting credit and falling confidence are seriously damaging for any economy.

Clearly, a stable financial system is capable of efficiently allocating resources, assessing and managing financial risks, maintaining employment levels close to the economy’s natural rate, and eliminating relative price movements of real or financial assets that will affect monetary stability or employment levels.

“If a country’s banking system is in bad shape at the outset of a recession, the downturn will likely be worse,” Ben Bernanke, former Chair of the Federal Reserve of the United States, wrote in his memoir.

According to a World Bank report, during a period of stability, the system absorbs shocks primarily via self-corrective mechanisms, preventing adverse events from having a disruptive effect on the real economy or on other financial systems.

Financial stability is paramount for economic growth, as most transactions in the real economy are made through the financial system.

It is therefore essential that Basel III, the strengthened framework of international standards for bank capital adequacy and liquidity developed by the Basel Committee on Banking Supervision (BCBS) is implemented fully and in a timely manner.

According to a report by the Bank of Canada, Basel III is a fundamental component of the G-20’s financial reform agenda.

It raises the bar relative to the prudential framework that was in effect before the global financial crisis in several important ways.

“In particular, by placing common equity at the core of the capital requirements and imposing standards to ensure that the other types of capital instruments allowed are truly loss absorbing, Basel III greatly enhances the quality of capital.

“It also introduces many innovative safeguards that were not previously part of supervisors’ tool kits,” it added.

Basel III was introduced in response to the 2008/2009 global financial crisis, given that the global financial crisis resulted in unprecedented losses and severely hurt the global financial system. Prior to the regulation, there had been Basel II and Basel II frameworks.

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While Basel I was designed to enhance understanding of key supervisory issues and improve the quality of banking supervision across countries, Basel II accord primarily focused on financial soundness as well as to enhance banks’ risk measurement and management capabilities

In Nigeria, the central bank in September 2021, issued a circular to all banks on Basel III implementation.

In the circular, the central bank had stated that the regulation was to address banks’ capital adequacy, stress testing, market liquidity risk as well as improve the regulatory framework for the banking industry.

The implementation of the regulation last year was deferred due to the outbreak of the pandemic.

“Finally, all banks are to note that capital add-on will be introduced in a phased manner as part of the overall supervisory process of Pillar II assessment to enhance better risk management practices and better align their capital with their risk profiles,” the CBN had stated in the circular.

The upcoming regulation is expected to see banks beef up their capital. In recent time, we have seen some of the commercial bank issue Eurobond to strengthen their financial position.

Analysts’ Expectations

To analysts at Renaissance Capital Limited (RenCap), an international research and financial advisory company, with Basel III policy, some of Nigeria’s tier-2 and tier-3 banks might opt for mergers and acquisitions (M&A) in order to strengthen their capital positions.

The Director, Frontier/ Sub-Saharan Africa Banks and Fintech, Renaissance Capital, Mr. Adesoji Solanke explained: “There’s room for M&A and we think it would be between tier-two and tier-three banks, because now they’re even much smaller in the grand scheme of things.”

Also, analysts at Afrinvest (West) Africa Limited noted that the adoption of Basel 111 would also strengthen Nigerian banks’ stressed capital level, improve capital quality (as risk levels are reduced with the exposure restriction) and maintain a strong liquidity position.

According to the firm, after successfully implementing Basel II, the phased implementation of Basel III commenced last month after the delay that was occasioned by the pandemic.

The phased implementation requires a parallel run of Basel II and III for six months with a possible three-month extension and a transition to full implementation if banks perform satisfactorily.

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However, it noted that the development would not be appreciated by banks with low capital requirement.

It added: “As highlighted by the CBN, adoption of Base III requires Nigerian banks to strengthen their current capital adequacy, liquidity, and leverage positions.

“Accordingly, banks are required to hold a capital conservation buffer of 1.0 per cent in addition to the minimum Capital Adequacy Ratio (CAR) of 15.0 per cent (international) and 10.0 per cent (national) with an additional one per cent of common equity capital for higher loss absorbency for Domestic Systemically Important Banks (DSIBs), in the form of common equity capital.”

According to Afrinvest, for liquidity measure, banks are to maintain liquidity coverage ratio (LCR- a stock of high-quality liquid assets (HQLA) that is at least equal to total net cash outflows) of at least 100.0 per cent on an on-going basis.

Similarly, it observed that liquidity monitoring tools were introduced and includes contractual maturity mismatch, concentration of funding, available unencumbered assets, LCR by significant currency and market-related monitoring tools.

Beyond the Basel III, one of the global rating agencies, Standard and Poor’s (S&P), predicted that private sector credit in Nigeria would range between 15 and 18 per cent of the country’s Gross Domestic Product (GDP) before 2023.

Private sector credit to GDP in Nigeria stood at 13 per cent as of the third quarter of 2020.

Also, the rating agency estimated that banking sector loan growth would average around 20 per cent through 2023, while the sector’s non-performing loan (NPL) ratio was expected to increase to seven per cent in 2021, compared with a reported 5.7 per cent in June 2021, as regulatory forbearance measures have ended for most loans.

“We forecast real loan growth to average nine per annum over the next 12-24 months, reflecting a moderate economic recovery and higher oil prices. The growth is much higher in nominal terms because of the potential naira depreciation,” it added.

In addition, it stated that banks have continued to focus on loan recoveries despite the weak operating environment and close monitoring of their restructured loans.

Due to macroeconomic shocks, it predicted that the banking sector was exposed to short credit cycles and high credit risks because of the country’s reliance on oil and its sensitivity to currency depreciation and high inflation.

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“Overall, earnings growth is likely to slow down because of higher impairments in 2021-2022 and the AMCON levy (to fund bank clean-ups in 2010),” it added.

To the Group Chief Financial Officer, Ecobank Transnational Incorporated, Mr. Ayo Adepoju, considering the present condition in the banking industry, there is need for the Central Bank of Nigeria (CBN) to review its current Cash Reserve Ratio (CRR) which is pegged at 27.5 per cent.

Adepoju explained: “The cash reserve requirement policy of the central bank is very massive, in terms of its impact on liquidity in the market.

“So, you see more of the liquidity sitting with the central bank, earning zero per cent. And when you have an industry average of cash reserve requirements over 40 per cent, that is the highest in any part of the globe as most of the markets have cash reserve either at five per cent or 10 per cent, 12 per cent or 13 per cent.

“Never would you see cash reserve going to 40 per cent threshold. I understand the perspective of the central bank trying to manage excess liquidity in the market, but at the same time, it is important to ensure that the banking industry has sufficient liquidity to power through growth in the market,” he added.

Commenting further on Basel III regulation, Deloitte, a professional services firm, noted that it may not be a panacea, and may not alone restore stability to the financial system and prevent future financial crisis.

However, it pointed out that the implications of the new regulation include systemic, operational and tactical.

In addition, because of the regulation, due to better controlled leverage and liquidity, banks would be stronger, more resilient and safer.

The returns as given by returns on equity (ROE) and other measures would be lower, but the cost of borrowing may also drop. With lower returns coupled with the loss of confidence in the banking sector, investors have to accept a new paradigm and tradeoff of returns for safety.

Lower return may impact ability to raise fresh capital required under Basel III.


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