Concerns Mount, Investors Jittery over Banking Stress Test

01 Apr 2012

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Minister of Finance, Ngozi Okonjo Iweala

Banks are putting their books in order, preparatory to a stress test by the Central Bank of Nigeria this quarter. However, there is growing concern that the test could roll back the recovery in the financial system, reports Festus Akanbi

As Central Bank of Nigeria examiners start to scrutinise the books of banks this month, the overall consensus is that the exercise may not unearth the can of worms that the 2009 banking industry audit brought to the surface. Unlike 2009, industry stakeholders comprising regulators, operators and independent analysts who spoke with THISDAY last week all agreed that the Nigerian banking public has no reason to panic over the planned test because things are being done differently this time around.

Irrespective, concerns linger over the timing of the stress test, which a few industry analysts warned could slow down or stamp out the green shoots that have started to appear in the financial system after the whirlwind of interventions, banking takeovers and reform measures introduced by the CBN.

According to one analyst, who questioned the rationale for the stress test at this time, he said that with the country yet to fully recover from the intervention in eight banks in 2009 that cost tax payers several billions of naira, and the nationalisation of three out of the eight banks, which cost several billions more, the stress test is bound to cause uncertainty among investors and the banking public.

“From now till the outcome of the stress test is made public, an air of uncertainty will prevail in the market whether we like it or not over the outcome of the test. Banking stocks, which are already depressed, will remain depressed and could tank further on the likelihood of a negative outcome from the test.

“This will deter investors from buying banking stocks and encourage them to offload them. It could also affect a bank like United Bank for Africa Plc which is planning a Euro bond issue. Given that the CBN has already put in place a risk-based assessment regime, there is no reason for the regulator to cause further jitters in the financial system. My take is that the CBN could have waited at least one more year to undertake another industry-wide stress test like the one in 2009,” said the analyst who did not want to be named.
In spite of the concern, CBN’s deputy governor, Operations Directorate, Mr. Tunde Lemo confirmed the readiness of the industry regulator to examine the books of the banks. He told THISDAY last week that there was no going back on the proposed exercise, explaining that the same yardstick would be used to measure the performance of all the banks.

Pointing out that there won't be any sacred cow in the exercise, Lemo said: “The test will be conducted by CBN examiners with technical assistance from the International Monetary Fund, where required, and may last for about three months.
“There is no special consideration as all the banks are now strong. The stress test is just to test how strong and resilient they are how they will cope in the unlikely event of a more hostile macroeconomic environment.”

Explaining the justification for the exercise, chief executive, Proshare Nigeria Limited, Mr. Femi Awoyemi added that the exercise was in the interest of the nation's economy.

Basel III Compliance
“I have confirmed from sources in the CBN that indeed such a stress test is not only imminent but that modalities for conducting such was being worked on to reflect both the need to conduct a risk review as a continuous assessment tool and a Basel III requirement. Indeed, most jurisdictions are conducting same globally and the most recent being that was conducted for 18 banks in the USA,” Ayoyemi explained.

He said, “Stress tests are unlike audits or routine supervision tasks. Indeed, stress testing is a process, usually computerised, that evaluates an institution's reaction to different situations.” He pointed out that stress testing measures whether the institution has adequate capital and/or assets to respond effectively to various, adverse scenarios presented by the computer programme, adding that stress testing became particularly important in the United States in the spring of 2009 when Treasury Secretary, Timothy Geithner, conducted a series on troubled American financial institutions to determine which were able to raise private capital and could therefore begin repaying TARP funds extended the previous year.

“On December 16, 2010, the Basel Committee issued the Basel III rules, which presents the details of global regulatory standards on bank capital adequacy and liquidity agreed by the governors and heads of supervision, and endorsed by the G20 Leaders at their November 2010 Seoul summit.

“The rules text presents the details of the Basel III framework, which covers both micro prudential and macro prudential elements. The framework sets out higher and better quality capital, better risk coverage, the introduction of a leverage ratio as a backstop to the risk-based requirement, measures to promote the build-up of capital that can be drawn down in periods of stress, and the introduction of two global liquidity standards.

“For Nigeria, we may construct a stress test to determine how the emerging banking landscape can meet a reasonable level of capital, even following possible losses associated with a major economic downturn or changes in business conditions,” he explained.
The Proshare chief was, however, of the opinion that at this time, all the banks appear to be in sufficient good health and are within or above the expected capital adequacy targets. “In effect, the stress test envisaged by CBN does not reflect any concern as to the health of Nigerian banks but perhaps in compliance with the Basel III requirement for which the methodology is being worked on and hopefully, the CBN would disclose its assumptions if not the methodology,” he explained.

The American Example
Commenting on the recent experience in the USA, Awoyemi said under the US test, banks were required to show they could maintain a five per cent tier one common capital ratio during a stressed scenario. This was based on a five per cent decline in real gross domestic product, an unemployment rate of 13.1 per cent, a 52 per cent drop in stock prices and a 21 per cent drop in home prices.
Four of the 19 US banks tested, including Citigroup, SunTrust, Ally Financial and MetLife, failed to show they had enough capital to survive another serious downturn. Citigroup is the third-largest US bank. The majority of the 19 tested passed.

All those tested, according to the US Fed, were in a much stronger position than they were after the 2008 financial crisis. The Fed tested the banks' ability to withstand a similar crisis that triggered a rise in unemployment to 13 per cent, a 50 per cent fall in share prices and a 21 per cent drop in house prices. Their strength was assessed by its Tier 1 capital ratio - assets held in reserve as a buffer against financial troubles.

The European Example
In the case of Europe, only eight of a total of 91 lenders failed a European test last July. But in October, the European Banking Authority (EBA) identified a 114.7 billion euros ($151.3 billion) capital shortfall after testing 71 European banks. Awoyemi explained that the European capital shortfall test in October 2011 was tougher because it demanded that lenders increase the minimum core tier I capital ratio to nine per cent while applying market prices to sovereign bonds.

Asked to comment on the readiness of Nigerian banks for the test, he said the question of readiness does not arise. “We have an improved corporate governance regime that means that banks comply with their reporting and disclosure requirements as at when due and the CBN undertakes its supervisory and compliance functions as intended.

“If and when a stress test is to be conducted, there is sufficient data to conduct that at the CBN. Unlike an audit, these tests are simulations whose outcomes will be discussed with the banks and further information, plans and projections considered based on the methodology used by the Central Bank,” he said.

But unlike Lemo who argued that nationalised banks do not deserve to be treated with kid gloves, Awoyemi said: “The nationalised banks are quarantined institutions at this time and I believe AMCON is preparing them for sale at a future date. The CBN will clarify its approach to this at some point, as this is a new territory for the market. The good thing is that they would equally be included, if only to ensure compliance with the Basel III requirements.

Routine Exercise
Is there any cause for alarm over the stress test? He said, “This exercise does not present any need for fears. If anything at all, it should be seen from a positive outlook and a practice which other institutions should embrace. In most purpose run non-bank organisations, the strategy and research teams have always conducted scenario planning exercises that consider different economic assumptions in both their budget planning and five year strategic plans which produces best, worst and most likely scenarios. For the banks, this is now a risk imperative and a compliance issue that they have fully embraced. The public needs to be better enlightened on this best practice initiative from our regulator by the media - just as you are doing now,” he said.

Another industry operator who expressed confidence that the stress test was not likely show up anything of major concern, was the president, Financial Market Dealers Association of Nigeria, Mr., Akinsowon Dauda. Speaking with THISDAY last week, Dauda said, “Given the assignment carried out by the AMCON in the banking industry so far, I am convinced that the result of the proposed stress test will be much less negative. I am sure that the result of the test will show that the industry is more robust, unlike what happened in the previous exercise.”

The FMDAN chief believes that the apex bank had over the time institutionalised corporate governance in such a way that has enabled most of the banks to clean up their balance sheets. He recalled that the apex bank has also put in place prudential guidelines and other policies to safeguard against the likely recurrence of a systemic crisis. He, however, said that only time will tell the efficacy or otherwise of the reform measures put in place so far.

In his response to enquiries on the planned test for banks, managing director/chief executive, First Bank of Nigeria Plc, Mr. Bisi Onasanya also said there was no cause for alarm over the proposed exercise. When THISDAY asked if there was any cause for the banking public to fret over the exercise given the shock that followed bank audit in 2009, Onasanya said the CBN was merely discharging its supervisory duty and that there was no need to panic.

“Perhaps a good way to answer this question is to examine the findings of the 2009 audit. The CBN is mandated by law to promote a sound financial system in Nigeria through effective supervision and regulation of financial institutions including Deposit Money Banks (DMBs).

“Audit exercises are routine examination of banks, other financial institutions, and specialised banks, to ascertain the true financial health of Nigerian banks in the public interest. The 2009 exercise essentially identified the factors that led to the crisis witnessed by the sector. Some of these included macroeconomic instability arising from large and sudden capital inflows, corporate governance failures in banks, inadequate disclosure and transparency about the financial position of banks, critical gaps in the regulatory framework and regulations, and lack of structures to ensure investor and consumer protection, among others”

The bank chief said a critical look at the sector today will show that these issues have been largely been addressed, leading to the emergence of a new paradigm shift in the sector where best practices and good corporate governance have been embraced. According to him, “Confidence has been restored to the financial system and this is a giant leap for the sector as trust remains pivotal to achieving a sound banking sector. Consequently, I believe there is no reason for the banking public to fret over the impending audit as it would only serve to consolidate the gains of the ongoing reforms and reposition Nigerian financial institutions for more robust regional and global competitiveness.”

When reminded that some big names among American banks failed a similar test conducted recently, Onasanya said, “I don't think it would be proper to pre-empt the outcome of the audit as the essence of the exercise is not to throw up upsets. Audits and reforms are globally considered as tools of ensuring that financial systems continue to perform efficiently and optimally. We all know that a sound financial system is crucial for the survival of any economy regardless of how sophisticated it is.

“The beauty of audits is that they provide a platform for identifying threats and facilitate the adoption of effective steps to mitigate the risks accompanying the threats. I believe that a notable outcome of the audit is that it will further strengthen Nigerian financial institutions and make the financial system contribute more to the development and growth of the economy.”

Beating his chest that the Nigerian banking industry has put the issue of 2009 behind it, Onasanya said: “Going by the success so far recorded by the reforms, one can say that Nigerian banks are in a much better position to navigate through unforeseen shocks or threats to the nation's economy.

“We are witnessing an unprecedented regime of best practices in the areas of corporate governance and risk management, transparency, and public disclosure of transactions. Banks are also recording profits and improvements in their balance sheets with a rising trend in lending by the sector. The additional liquidity of over N1.7 trillion injected into the banking system through bonds issued by AMCOM is also a welcome development. These are unique achievements that can only make our banks stronger.

“In addition, Nigerian banks are taking their place as key players in the global financial market with a good number of our banks ranked within the Top 20 banks in Africa and among Top 1,000 banks in the world. The level of intra sector cooperation among operators and the regulatory body through peer reviews and regular meetings has improved considerably, paving the way for a joint ownership approach to sustaining the overall progress we have witnessed in the last two years. I believe the future is bright for the Nigerian financial sector.”

Another operator who bore his mind on the proposed stress test for banks was the managing director/chief executive, Keystone Bank Limited, Mr. Oti Ikomi. Ikomi said there was nothing strange about the planned exercise. “Banking is a regulated industry and these kinds of tests are required to ensure no systemic issues and to provide early warning indicators.

“With enhanced governance and risk management in Nigerian banks, we project no significant issues. This also applies to a bank like Keystone Bank where we have an independent risk management function and focused on growing quality assets. We meet and exceed all regulatory ratios of the CBN, are well capitalised and poised to return to profit in 2012.” Ikomi said Keystone Bank awaits guidance on implementation and does not expect any anxiety from the process.

Managing director, Financial Derivatives Company, Mr. Bismarck Rewane added that such tests should be forward looking and not historical like what happened in 2009. “What the CBN is doing is to determine the capability of banks to maintain their ground in case the economy deteriorates. A stress test is different from an audit. Today, I believe Nigerian banks are adequately capitalised.

“What the regulators are saying is that if the oil price is to drop and some of your customers default then the bank may not have enough capital. If this happens, the most sensible thing is to add to your capital or reduce your dividend payment,” he said.

Tags: Business, Nigeria, Featured, BANKING, Stress Test

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