Friday, August 21, 2009

Tasks before the new CBN Deputy Governor

THE Central Bank of Nigeria (CBN) has completed an audit of 10 out of 24 banks, of which only five banks scaled through. Consequently, the Managing Directors (MDs) and Chief Executive Officers (CEOs) of the affected five banks were fired, followed by an injection of about $2.6 billion in convertible loan to stabilize the affected banks and preserve public confidence.

As at now, the government has injected funds and guarantee loans of the 'Five'. However, this should be seen as a temporary rather than an ultimate solution. Account cooking might actually increase as other banks may risk insolvency in the future, believing that the government can always bail them out when in distress. Injection of funds should be considered a temporary measure pending determination of an exit plan, either through merger and acquisition or failure.

That the CBN governor has acted swiftly and decisively in restoring confidence in the banking sector does not automatically imply that the issues facing the banking sector are now fully resolved. Rather the CBN response provided an avenue to more appreciate the degree of regulatory failure and inadequate corporate governance in the Nigerian banking industry.

The CBN response is a vindication of the positions that have been long expressed by local commentators and public policy analysts calling to question whether all is well with the Nigerian banking sector. For example, questions have been raised as to the actual state of health of the banks, which hitherto had been shrouded in secrecy with guesswork being completely at work.

Even as questions were being raised, both the banks and the CBN have had to debunk the visible indications that accounts of many of the bank might actually be in the red. But one would hesitate discountenance their defense given the billions of Naira in profit that these banks often declare quarterly or half yearly. One wonders whether these banks compete on the basis of such declarations, albeit falsehoods. Many of the banks have won awards within and outside the country, while their ratings had soared higher. The public now knows better. What can be inferred from the CBN governor's sacking the 5 bank CEOs is an admittance that Nigerian banks tend to be reckless. A great deal of banks' problems has been traced to unsafe exposure to margin loan. Banks gave out loans in excess of their single obligor limit. Often most of these loans are either backed by inadequate collaterals or dubious collaterals. Although who a particular bank grants its loans to is its business, but it is a core banking practice that must meet some regulatory procedures. In this case, strengthening the quality of credit risk analysis and moderate the size of exposure of individual bank is equally important.

More specifically, the signal that the affected banks were indeed distressed relates to their transactions at the CBN's Expanded Discount Window (EDW). The EDW enables banks borrow funds for a longer period (e.g. as long as 360 days) as against the overnight arrangement that was in place previously, which ultimately allowed banks easy access to funds anytime they are in need. According to the CBN governor, the affected five banks accounted for 90% of the whole of EDW transactions, whereas their non-performing loans stand at about 40% of the total for the whole industry. Thus, if five of 10 banks that have undergone comprehensive audit failed, that the remaining 14 banks will scale through is less obvious.

The argument that the signs of distress in the affected banks started only a few months earlier is misplaced. Rather, the crisis reveals severe shortcomings in corporate governance of the Nigerian financial institutions generally and the banks in particular. There seems to have been a systematic cover-up and failure of the regulatory bodies to perform their required functions. Potential bank failures have not been acknowledged.

Credibility has always been an issue in the banking sector. Defective supervision of the banks has brought the crisis of confidence into the banking industry. Also, the apparent unethical and unprofessional camaraderie that characterised the regulators and industry operators has compromised regulators and made effective supervision weak.

The ownership and management structure of Nigeria Banks appears to be structurally defective. This ought to be addressed. Some banks are built around certain individuals (e.g. MDs/CEOs). This provides incentives for such individuals to exercise excessive power in those banks. In theory, shareholders own those banks but it is oligarchy in practice. In Nigeria, such individuals have been seen to be very powerful to the extent of manipulating shareholders. Not a few thought the CEOs actually owned their banks because they were seen competing for political relevance with politicians at the expense of their banks. The role of the regulator has been less obvious in this regard.

The above suggest that the existing regulatory framework have failed to provide the checks and balances that banks need in order to cultivate sound finance and banking practices. Thus the crisis can be seen as a crisis of corporate governance. The appointment of Dr. Kingsley Moghalu as a Deputy Governor (pending Senate confirmation) is expected to put improved corporate governance at the centre of banking practices in Nigeria. In this regard, he will have to rise over and beyond mere slogans and be a problem solver as his profile shows.

Good and improved corporate governance is a key element to the integrity of Nigerian financial institutions and markets, and central to their health and stability. A key task before the deputy CBN governor is to institute a reform of regulatory framework emphasising greater corporate governance in the finance and banking sector. This will involve a set of processes, policies, laws, and institutions to affect the way the banks are directed, administered and/or controlled.

Also, the principal stakeholders will include the shareholders,

management, the board of directors, and the public. An important public

policy element here is to recognise a set of interrelationships among

these stakeholders and the goals for which they are governed. For example,

the corporate governance system should ensure the accountability of

certain individuals (E.g. MDs/CEOs) in individual banks through mechanisms that reduce or eliminate agency problems. Agency problems in the banking industry arises when the banks act on behalf of the shareholders/customers under conditions of incomplete and asymmetric information such that MDs/CEOs pursue own self-interests rather than the interests of those they represent. Independent reports, public disclosure procedures, and public information about the state of health of banks can potentially eliminate agency problems and positively impact on the efficiency and competition of the banks. The ultimate effect is a regulatory framework that enhances public welfare.

Obviously, regulation and supervision alone might not completely make the business of finance and banking less risky. However, through effective corporate governance, it is expected that Moghalu's office will ensure that taking excessive risks becomes less frequent, less costly, and not a drain on public purse.