Why CBN Annual Examination of Banks May Calm Market


As the Central Bank of Nigeria (CBN) conducts special examination on banks at a time the economy is facing serious challenges, expectations are high as to what would be the outcomes of the initiative and its impact on the economy, write Kunle Aderinokun and James Emejo

The Central Bank of Nigeria’s on-going special examination of banks has been described by all and sundry as a right step in ensuring safety of the financial system.

The apex bank had announced that in order to ascertain the actual well-being of banks owing to the nation’s macroeconomic challenges and rising non-performing loans (NPLs), it was embarking on a special investigation of the banking industry.

Contrary to initial opinion that the move could send the wrong signal to banking customers that there was trouble with the banks, experts argued that the probe was only a routine and cautionary measure by the apex bank.

Banks’ Non Performing Loans (NPLs) portfolios had increasingly become bad largely as a result of the global financial crisis occasioned by fall in oil prices as many banks had massive exposures to the oil sector.

Also, disruptions of oil production activities in the Niger Delta area had further worsened the situation. Banks’ NPL ratios are believed to be far above the prudential limit set by the CBN, raising concerns and the need for the apex bank vigilant to its core mandate of financial stability.

Noteworthy is the recent report of Nigeria Deposit Insurance Corporation (NDIC) which revealed that the NPL ratio for the industry increased to 4.87 per cent in 2015 from 2.81 per cent in 2014, though still within the regulatory threshold of 5 per cent.

The banking industry’s liquidity position was however adjudged to be strong as average liquidity ratio rose slightly from 53.65 per cent in 2014 to 58.18 per cent in 2015.

All the individual DMBs had liquidity ratios above the prudential minimum threshold of 30 per cent as at 2015.

But the recent intervention launched by the CBN in Skye Bank where it replaced its board due to lax corporate governance raised concerns in the banking public and may not be unrelated to the on-going examinations in other banks.

Besides, the CBN probe may not be unconnected with the NDIC report, which also revealed that financial fraud and forgeries cost the banking sector a total of N18.02 billion in 2015.

According to the corporation, a total of 12,279 fraud cases were reported in the period under review, representing an increase of 15.71 per cent over the 10,612 fraud cases reported in 2014.

A breakdown of industry losses to criminal activities, further showed that internet banking fraud cost banks N857 million, representing 27 per cent of total actual loss while ATM/Card-related fraud cases fleeced the industry to the tune of N504 million from N1.24 billion the previous year. This represented a share of 15.9 per cent of total industry loss to frauds and forgeries, although the loss suffered by the industry due to frauds declined significantly by 59.4 per cent in 2015.

According to the NDIC, out of the 12,279 fraud cases reported by the deposit money banks (DMBs), 425 cases were attributed to staff, while staff-related fraud cases cost the industry N979 million in 2015, representing a decrease of N70 per cent from N3.16 billion last year.

The number of fraud cases perpetrated by staff further decreased to 425 in 2015, from 465 in 2014.

It added that the highest percentage of fraud and forgery cases of 38.59 per cent was perpetrated by temporary staff.

In their opinion, economic analysts and industry watchers are anxiously waiting for the conclusion of the exercise but are positive on the outcomes and its ripple effect on the economy and foreign direct investment.

Managing Director and Chief Economist, Africa, Global Research, Standard Chartered Bank, Razia Khan, said whatever the CBN could do to reassure on the health of the banking sector will be positive.

Pointing out that, “Clearly, the macroeconomic backdrop (which has led to underperformance in the real economy, and a weaker FX rate) is a challenging situation for banks,” Khan noted that, “The sooner banks are able to deal with any potential NPLs, the faster they are re-capitalised, the sooner investor faith in the banking system is restored, the better it will be for Nigeria’s recovery prospects.”

“This means dealing in a timely and transparent manner with any NPLs that arise from the weaker FX rate, and providing concrete reassurance on the health of the banks.”

Similarly, economist and ex-banker/Managing Director, Bristol Investment Limited, Dr. Chijioke Ekechukwu, believed investigation had the potential to support the growth of the economy as well.

‎He said: “The ultimate and core function of CBN is regulatory over commercial, Merchant, Mortgage, Micro Finance Banks and other Financial Institutions. In regulating these banks, they will always examine their books. What CBN is doing therefore is not an ultra vires function. These investigations have exposed the insider abuses of the directors and executive of the banks. These investigations or examinations have helped to protect the deposits of customers and investments of Investors.

“They have forestalled fraud and malpractices and have built confidence in the prospective investors. Their Investigations have helped to grow the economy by making sure that certain sectors of the economy get appropriate percentage of funding. CBN’s function of investigation is generally aimed at supporting the growth of our economy. They are only doing their function.”

Also, Associate Professor of Finance and Head, Banking and Finance Department, Nasarawa State University, Keffi, Dr. Uche Uwaleke, described the move as a proactive measure to contain any systemic risk.

He said: “The investigation of banks by the CBN is being done in the discharge of its function as the watchdog of banks in Nigeria. This proactive measure has become necessary in order to contain any systemic risk arising from the macroeconomic headwinds, which shot up non-performing loans (NPLs) beyond the regulatory threshold of 5 per cent as well as deteriorated the Capital Adequacy Ratio of many banks due to the presence of high risk- weighted assets. Since the CBN wielded the big stick on Skye bank, the confidence in the banking sector has waned with mounting concerns over the health of banks in Nigeria.

“Without doubt, the overexposure of many banks to the oil and gas sector and the sudden implementation of the Treasury Single Account contributed to the current liquidity crisis in the industry. In some banks, this situation was compounded by outright breach of credit guidelines and abuse of insider credit. The CBN has a duty to sanitise the system and maintain financial stability.

“Part of this responsibility includes providing assurance to the public, as they have been doing recently, that the banking sector is not distressed. This assurance can only be given after a thorough assessment of the situation. Besides, there are foreign stakeholders such as international investors and rating firms like Fitch, which are equally monitoring the health of banks in Nigeria. The recent one-off forbearance granted to banks to write off their fully provided for NPLs without waiting for the mandatory one year as provided in the prudential guideline is laudable.

“To further help banks weather the storm, the CBN should consider a reduction in the cash reserve and liquidity ratios. This measure will not only boost banks’ liquidity, it will also encourage savings in the economy since the banks will be in a stronger position to increase interest on savings deposit thereby bridging the huge gap between savings and lending rates.”

Also, economist and former Managing Director, Unity Bank, Muhammed Rislanudenn, said the examination was good for the banks and the economy in general.

According to him, “I think it’s basically a risk-based special examination, more of a stress test that may seek to focus on only issues relating to capital adequacy, liquidity and corporate governance, similar to what was done in 2009.

“The aim may be targeted at testing the state of health of the banks especially given the incidence of average high non-performing loans above statutory limit of 5 per cent. It is good for the banks as well as the economy especially given the fact that economy is in recession and loan defaults might increase. It will also help in ascertaining level of regulatory support needed by any bank.”

Executive Director, Corporate Finance, BGL Capital Ltd, Femi Ademola, described the stress tests being conducted on banks by CBN as one of its regulatory responsibilities. The CBN, he explained, usually conduct these tests as the need arises. “And the need usually arise when there are concerns about the health of banks or the fear of systemic uncertainties in the financial system.”

Pointing that, “A sign of such concern or systemic risk will be the recent intervention in Skye Bank Plc and the exposure of the banking sector to the oil and gas sector which is causing a high level of non-performing loans,” Ademola said, “With these concerns, all banks are suspects despite that some appear stronger than others.”

“Because of the low confidence because investors and depositors are not able to determine the health of the banks or to differentiate between the strong and weak banks, a regulatory stress test is desirable to determine the status of the banks once and for all.”

“At the end of the tests, strong banks are given a clean bill of health while the weak banks get proper diagnosis and treatment,” he added.

On the likely outcomes of the special examination, Ademola expressed confidence that “With this done, the industry would become attractive again for investment purposes and other transactions,” adding that, “And since the financial system is a barometer for the economy, attraction of foreign investments both direct and indirect, into the banking industry, portends a good development for the economy.”

However, an analyst, who is also an investment manager, Adetola Odukoya, cautioned that “the foremost issue at this critical point in time is the proper management of information with respect to the financial system in order to avoid a loss of confidence by investors and depositors.”

To him, “the special examination and stress test will further highlight the issues that are pertinent and require prompt resolution within the system.”

Nevertheless, Odukoya believed the step by the CBN is “a positive development as it suggests that the regulatory authorities are being proactive in order to forestall any systemic challenges that may exist or arise as a result of the headwinds facing the domestic economy and the financial system.”

He therefore noted that, “a proper handling of the initiative to bring about a positive outcome will go a long way in engendering confidence in the financial system and the broad economy.”