Nigerian Banking Crisis: From irrational market exuberance to regulatory exuberance

Since Friday August 14, the Nigerian banking system has not been the same. What started as a rumour that some bank chiefs were about to be sacked became real. The CEOs of Intercontinental Bank, Oceanic Bank, Finbank, Union Bank and Afribank went to the office as CEOs in the morning and returned home early and jobless and with the real prospect that they were also on the verge of losing their stakes in the banks they have sat on as owner managers for close to two decades.

The Central Bank of Nigeria (CBN), the apex regulatory organ for Nigerian banks had taken the decision to wield the biggest stick in the Nigerian banking industry. Sacking five CEO's, three of whom before the sack, were considered among the top five banks in the country, have been described as the Nigerian banking tsunami.

Justifying its action, the CBN facts are convincing. The five banks according to CBN had given out loans of close to N2.8 trillion of which close to 50 percent were classified as none performing. The five banks, said the CBN, had become virtually illiquid accounting for 90 percent of inter bank borrowing over a seven month period, first through the CBN expanded discount window and then when the window was closed and the interbank market opened, they borrowed from the interbank window to pay down their debts at the EDW. This, no doubt was a clear sign that these banks had run out of money to meet their day to day operations and will collapse like a pack of cards if they are not able to borrow short term funds from the interbank market.

Besides, their desperation at the interbank market was also distorting rates at that window where the CBN was doing all it can to reduce the lending rates. As long as these big banks engaged in desperate borrowing from this window, the CBN efforts to bring down interbank lending would be fruitless. It was obvious that these banks could only survive their critical liquidity challenges with a fresh injection of equity or debt capital.

But considering the state of both local and international capital markets, it was obvious that any attempt by these banks to raise fresh capital may be like a camel going through the eye of the needle.

So the CBN was left with the option of injecting its own capital, arranging a bail out of the banks like it happened in America. In its wisdom however, the CBN felt that, it would not pump in capital and allow the same managers, which by their action and inaction allowed their banks to run into this state of illiquidity to continue to sit at the top of management. Most importantly, it is obvious that the CBN felt that it was time, that it sent a strong message out there that poor banking practices in the industry will no longer be allowed.

But in the process of sending out this message to the industry has the CBN "over killed." It is obvious that Sanusi Lamido Sanusi, riding on his strong reputation as a risk manager, may have unduly focused on curtailing poor credit risk practices in the industry without taking into consideration reputational risk. So in an attempt to pluck the loop holes created by poor credit risk practices, the Sanusi may have left the banks exposed to reputation risk damage that the concerned banks may never recover from and the banking industry at large may take a long time to overcome.

Was there a better way to effect the significant changes required in the practice of banking in Nigeria without creating all the drama that is currently prevalent in the Nigerian banking industry? Many have argued that the CBN could have forced all the banks to make the required provisions, declared their losses and take the hit on their capital that would have invariably resulted and demanded the recapitalization plans from the board of the banks. Where they were not in a position to recapitalize, the CBN will move in with its new capital and as the new majority owner, sack the board and effect the necessary changes.

This may have taken a longer time but no doubt the process would have been more tidy and transparent. The haste with which CBN has sacked the MD's has been overtly populist. Surprisingly, the CBN sacked only the MD's leaving the board, whose responsibility it is to ensure proper banking is enshrined in their institutions, intact. It is not clear why the CBN sacked the MD's and left the boards intact. If there has been a failure in these institutions, it was a failure of the board rather than executive management. Leaving the board intact is an endorsement of poor corporate governance and the continuation of board negligence and inactivity which has primarily been the course of recurrent bank failures. If the CBN really wanted to change the way banking is done in the country, sacking the board would have be the best action as it would sent the strongest signal that sitting on the board of a bank comes with its privileges but it also comes with huge responsibilities which must not be taken for granted.

Regulatory exuberance is further displayed in the CBN action with its hasty publication of the list of bank debtors without even allowing the new management it had put in place in the banks it had taken over to settle in. Basically, the CBN action has removed the greatest tool the new management has in collecting these loans, that is the threat of "Name and Shame" the debtors. Having lost this tool, they have now resorted to the lame tool of threat of arrest.

This is a lame threat considering that lending is not a crime neither is borrowing. Lending without collateral is an offence under BOFIA but there is no definition what collateral is and besides no bank lends without a form of collateral. And still in the spirit of regulatory exuberance the EFCC goes ahead to ask debtors to pay within seven days by issuing a draft in favour of the Federal Government. The first question is, did the Federal government lend money to these so called debtors? So why should they pay money to the Federal Government?

Then where will the alleged N774 billion owed by the debtors come from? Is it from the supposedly healthy banks in the system? How many of the supposedly healthy banks survive the removal of N774 billion from their vaults in seven days? This order does not only smack of regulatory exuberance but also strong ignorance of how the financial system works. And the truth is that if  the banking system had N774 billion lying around in its vaults, there will not be liquidity crisis, neither will interbank and lending rates be hitting new highs.

The most dangerous aspect of the current regulatory exuberance however is the current attempt to criminalize lending and borrowing. Since 2005, the Nigerian economy has been able to sustain a growth rate of six percent and above and this period also marked the unprecedented growth in bank lending to the private sector. The link between economic growth and bank lending is not coincidental as many economists will tell you. This is where the danger lies in the current CBN/EFCC joint efforts to criminalize the act of lending and borrowing.

There is a real possibility that this may result in a credit freeze to the economy. First banks may become averse to take the risk of lending to the vulnerable sectors of the economy that usually have a higher risk of default why entrepreneurs will also become averse to borrowing. If this happens, the impact will be disastrous to the economy. The already high unemployment rate will get worse and poverty will be intensified.

There is no doubt that following years of carefree growth; the banking industry needed an urgent dose of sanity. But sadly, the way the CBN has gone about it will harm the Nigerian economy in the long run. The CBN under Sanusi has effectively replaced irrational market exuberance with its own regulatory exuberance.