Under the tutelage of its spirited governor, Lamido Sanusi, the Central Bank of Nigeria (CBN) has begun the process of transforming the country's banking sector. Mr Sanusi's reform agenda, which began last year, has already yielded dramatic results and more are expected. "What people tend not to focus on is how bad things might have been if the reforms had not been implemented," says Razia Khan, head of research for Africa at Standard Chartered.
As Ms Khan suggests, Nigeria's banking sector became afflicted by a series of problems that made reform necessary. Developments outside the sector ultimately exposed institutional failings. A number of banks engaged in margin lending, a risky practice that backfired when certain recipients of those loans, namely financial speculators, confronted a 60% collapse in the value of the Nigerian Stock Exchange. Added to a dramatic decline in the value of the country's chief export, oil, Nigeria's banking sector became exposed for its weak risk management and corporate governance failures. "The executive management teams of the failed banks did not fully understand the risks being taken, such as capital markets exposures and concentrated exposures to certain sectors," says Anthony Walker, senior director for financial institutions at Fitch Ratings.
Institutional examination
The failed banks to which Mr Walker refers are still in the process of establishing their futures following the CBN's special examination of the sector conducted late last year. Oceanic, Union, Intercontinental and Afribank were the most notable victims of the examination when the CBN reclassified many loans held as non-performing (NPLs). The resulting clarity of asset quality positions at the examined banks points to the issue of corporate governance, according to Matthew Pirnie, bank analyst at Standard & Poor's. "What the CBN's audit showed is that the banks with better corporate governance standards were the best performers. Their financial performance is generally sound, they have maintained good asset quality and made good returns," he says.
The controversy of the examination notwithstanding, it is important to note that it has helped to identify solid banking players. Standard & Poor's (S&P) recently revised its outlook for Zenith Bank from "negative" to "stable", as a result of its resilience to "tougher operating conditions in Nigeria, helping the bank stabilise its creditworthiness". Guaranty Trust (GT) has also received positive ratings coverage from S&P. Tayo Aderinokun, GT Bank's managing director, commends the governor's efforts to clean up the sector. "With the new approach, the entire industry will benefit. Banks will become more careful in credit creation and more prudent in income recognition," he says.
Ecobank, the Togo-based pan-African bank that has about 260 branches in Nigeria, has also emerged from the examination largely intact. It had an improved NPL ratio due to what Fitch notes as "its significant loan restructuring after year-end and credit growth to September 30, 2009." However, Albert Essien, Ecobank's group executive director, notes that the bank has not been immune to the Nigerian market's difficult operating conditions. "While we did not have liquidity or capital problems, Ecobank was caught up in the systemic problems in Nigeria, the stockmarket crash and oil price volatility," he says.
While the emergence of healthier institutions has been a positive outcome of the examination, it is the fate of the failed institutions that continues to be a cause for concern. For the time being, a number of them are benefiting from the interbank market, which has received exposure guarantees from the CBN until December 31 this year. "Even though I would identify the audit of the individual banks as the most important measure introduced, the guaranteeing of the interbank market has also proved important. It has helped stabilise the sector, as liquidity has been able to flow to struggling banks," says S&P's Mr Pirnie. In its most recent report on the Nigerian banking market, published in March, Fitch estimates that Oceanic has benefited to the tune of N100bn ($600m) while Union has received N120bn.
Risk appetite
In spite of this liquidity boost, Nigeria's banking sector has become increasingly risk-averse, leading to implications on lending. According to Fitch's Mr Walker, private sector credit extension is expected to fall from 42.6% of GDP in 2009 to 36% in 2010. Mr Aderinokun believes regulatory changes have had a key role to play in this development. "Banks are currently preoccupied with recovery of loans granted between 2004 and 2008. The impact of the provisions recommended by regulators on these loans has negatively affected their shareholders' funds and consequently impacted on their credit creation capacity," he says.
However, David Cowan, Citigroup's Africa economist, believes the problem runs deeper. "The basic underlying problem of Nigerian bank lending has not been resolved and that is beyond Mr Sanusi's remit. Changes need to be introduced to the legal system and the property rights system needs to be made clearer. Until they are resolved, private sector lending will remain constrained," he says.
The creation of the state-backed Asset Management Corporation (AMC), charged with purchasing non-performing assets from the country's banks, is expected to help the sector's recovery. While the proposal was first introduced last year, it only received government approval in June when Nigeria's Senate and House of Representative passed a harmonised bill for the formal establishment of the body, allowing president Goodluck Jonathan to approve the bill in July. Even better performing banks are expected to apply for AMC cover. "We are likely to dispose of some of our affected assets in Nigeria to AMC, which we believe is a very sensible initiative," says Ecobank's Mr Essien.
The purchase of non-performing assets could have a profound effect on the level of capital at the disposal of Nigeria's banks. AMC is expected to start with a minimum of about $132m. Such a sum should boost the lending prospects of banks being relieved of troubled assets. However, lending is likely to be characterised by greater caution, according to Mr Pirnie. "Banks will be looking at what sectors went wrong, how they exposed themselves, what sort of lending went wrong and how to structure loans to avoid non-performance," he says.
Broadly speaking, the outlook for the sector is expected to improve over 2010. Fitch expects that Nigerian banks' asset quality, pending the AMC coming into operation, will "continue to weaken as loan books continue to season after several years of rapid credit growth", but feels impairment charges will be "less pronounced". The sector's cause should also be aided by the country's expected economic recovery this year, driven by a recovery in oil prices. "The positive economic outlook for the country means there should be a turnaround in the level of lending. In light of the ambitious spending plans outlined by the government, momentum should return," says Standard Chartered's Ms Khan.
Consolidation process?
As Mr Sanusi ponders how the sector should operate in the future, it has been suggested that the CBN would like to see fewer but stronger banks in the country. "Further consolidation is likely, primarily because operating costs are relatively high in Nigeria. This means smaller banks lack the scale to trade more efficiently," says Mr Walker. However, Mr Aderinokun believes consolidation will take some time. "Local banks' focus this year will be to maximise loan recoveries, rebuild deposit bases and, most importantly, return to profit. It will be difficult for banks to focus on a merger or acquisition and so it is unlikely that any consolidation process will start before the year-end," he says.
Despite the changes that are taking place in Nigeria, there continues to be a great deal of optimism in the country's banking prospects over the longer term. After all, its oil wealth and demographic strength make it an attractive proposition. "The key strength of the Nigerian banking market is its growth potential, particularly considering the size of the country's population and the high percentage of unbanked citizens," says Mr Walker.
For now, the country's banks must contend with clearing their balance sheets of problematic assets as well as establishing a viable future strategy. If GT's Mr Aderinokun is correct, 2011 could be a significant year in the country's banking history. "In 2011, we expect the wave of consolidation to really kick off."
Profit after tax and provision charges
