Quest for Capital Buffers Raises Prospect of Mergers, Acquisition in Tier-II Banks

Ordinarily, the year 2022 was expected to have brought a new dawn in business and economic climate. However, the reality of economic challenges, accentuated by the ravages of the Covid-19 pandemic has put a heavy burden on banks, like any other business. As these financial institutions move to upscale their operations and beef up their cash reserves in line with the emerging realities, analysts believe the year will witness a flurry of activities including capital raising, mergers and acquisitions especially among the Tier-2 and Tier 3 banks, reports Festus Akanbi

As businesses return to their pre-December 2021 momentum tomorrow, one issue that will set the tone for discussion among business leaders and financial sector regulators is the outlook for the nation’s banking industry in 2022.

Financial sector analysts had raised the prospect of increased pressure on banks amidst a cocktail of challenges, chief among which are the unfavourable economic climate and the falling value of the naira this year, all made worse by the Covid-19 pandemic.

These two factors, it is feared, will affect the capacity of banks to perform their intermediatory role in the overall economy. Analysts, therefore, foresee banks, especially the Tier 2 and Tier 3 ones, opting for various means of improving their capital positions.

Like, in other climes, business and economic activities are just recovering from the shock of the Covid-19 pandemic. Whatever confidence that was built by the initial curtailment of the pandemic is on the verge of being eroded by the emergence of the Omicron variant of Covid and the seeming state of helplessness among members of the international community. It is therefore untrue that the economy has returned to the pre-Covid era.

Consequently, the attendant erosion in the value of the local currency and the biting shortage of foreign exchange, especially the dollars isputting more pressure on business and the economy.

Capital Adequacy

Analysts believed the scenario painted above has underscored the vulnerability of banks in one way or the other. For instance, they posited that banks are likely to see an increase in their risk-weighted asset values, and, as a result, a reduction in their capital adequacy ratios, majorly because of the projected increase in default rates as a result of the pandemic.

According to Managing Director/Chief Executive, First Bank Nigeria Limited, Mr Adesola Adeduntan, the issuance of guidelines by the Central Bank of Nigeria (CBN) to banks for the implementation of Basel III, on September 2, 2021, was aimed at making available to the Nigerian banks the global regulatory framework that addresses banks’ capital adequacy, stress testing, and market liquidity risk.

Adeduntan believed the Basel III standard will prevent banks from taking excessive risks that can negatively impact the players and the economy. He said, “the implementation of Basel III will have significant implications for capital requirement – there will be a higher minimum CAR requirement for players in the industry. However, the apex bank has engaged and defined a road map to ensure that operators in the banking industry meet and surpass the higher capital requirements.”

Capital Adequacy Ratio (CAR) sets standards for banks by weighingtheir risk against their capital. In other words, these standards analyse the capacity of a bank or financial institution to respond to credit, market, and operational risks, as well as to pay its liabilities. A bank with a good CAR has a lower risk of becoming insolvent because it has sufficient capital to mitigate potential losses.

Mergers and Acquisitions in Banks

Market watchers said the regulation is expected to see banks beef up their capital. The market has witnessed a flurry of activities by some banks in their quest to improve their liquidity positions. Already, Wema Bank has received the approval of its shareholders at a court-ordered meeting for the scheme of arrangement to reconstruct its shares. The bank has shares in issue of over 38 billion units, and the shareholders consented to a reconstruction of one share for every three held.

According to the bank’s Managing Director/Chief Executive, Mr Ademola Adebisi, with this approval of shareholders, the bank will begin the rights issuance to raise its capital base to over N100 billion. This, he said, gives the bank the room to increase its financial intermediation and further scale up its business.

Also in recent times, we have seen some of the commercial bank’s issue Eurobond to strengthen their financial position.

The First Bank MD said he wouldn’t rule out mergers and acquisitions in banks to reflect the current realities.

He said, “Despite being well-capitalised, the implementation of Basel III would reduce the capital headroom of operators and banks would have to resort to various strategies to strengthen their capital positions to drive credit and business growth. These strategies may include mergers and acquisitions (M&A) as Basel III policy implementation takes effect to strengthen their capital positions as the policy requires higher capital requirements/enhanced capital cushions. Nonetheless, I believe Nigerian banks are well-positioned to withstand regulatory headwinds whilst driving growth.”

In their estimation, analysts with Renaissance Capital Limited (RenCap), international research and the financial advisory company said with Basel III policy, some of Nigeria’s tier-2 and tier-3 banks might opt for mergers and acquisitions (M&A) 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.”

The same views were shared by analysts at Afrinvest (West) Africa Limited, who assured that the adoption of Basel III 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.

They explained that the adoption of Base III requires Nigerian banks to strengthen their current capital adequacy, liquidity, and leverage positions.

Capital Buffer

“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), inthe form of common equity capital.”

Despite these challenges, Managing Director/Chief Executive, Financial Derivatives Limited, Mr Bismarck Rewane ruled out the possibility of an increase in banks’ capital base by the CBN.

He said, while some banks may on their own volition decide to raisetheir capital base, the apex bank is unlikely going to direct banks to shore up their capital this year.

He believed what needs to be done is for the CBN to adjust banks’ capital adequacy ratio to accommodate the underlining challenges in banks.

However, in an interview with THISDAY, Group Director, Cordros Capital Limited, Mr Olufemi Ademola believed banks will place more energy on how to improve their capital adequacy position instead of concentrating on raising additional share capital.

He said, “ The argument for raising the capital base of banks due to the falling value of the Naira is a worn-out argument by analysts.

Since 2016 when the country faced its first serious exchange crisis in recent times, analysts have argued in favour of raising the minimum capital base of banks in line with the dollar exchange rate. They argued that the N25 billion minimum capital introduced in 2005 was an equivalent of about $200m at the time. Hence, if we apply the current exchange rate, banks would need a minimum capital of N70-75 billion to operate. While a number of the banks in the top tiers would meet the requirement, if imposed, several smaller banks may need to recapitalise.

“However, some analysts also argued that the general raising of banks’ capital base may not be optimal. Rather, they suggested the requirement of an increase in capital based on the level of risks being taken by each bank. They argued that asking a small bank with low-risk assets to capitalise to a minimum capital base like the other big banks may result in a waste of resources and an increase in risk-taking by the banks to make returns on the additional investment.

Whereas a big bank may require more capital than the required minimum due to a large number of risk assets in its portfolio.”

The Cordros Capital official, however, believed in the validity of the argument in favour of an adjustment to capital adequacy ratio.

According to him, “Some of the systemically important banks reported capital adequacy ratios that are lower than the required threshold.

Capital adequacy ratio (CAR) is the measure of the appropriate capital a bank should have based on the amount of risk it underwrites.

Systemically important banks are expected to have a CAR of 18% while others should have 15%. Any bank with CAR below the above threshold should be required to raise additional capital.”