When Central Bank of Nigeria governor Charles Soludo announced in July 2004 that the minimum capital requirement for banks would rise to N25 billion ($195 million) from the then minimum of N2 billion by the end of 2005, many observers thought him over-ambitious, if not foolhardy. Yet just 20 months later, his action – and the chain of recapitalisations and mergers it heralded – has transformed Nigeria’s banking sector for the better and strengthened the country’s overall economic stability.
Of course, considerable work remains to be done. While capital adequacy may have improved, efficiencies have yet to be realised from the many mergers that have occurred and corporate governance remains woefully poor at many banks. Corruption, fraud and public mistrust of the banking system remain deeply engrained. But the observers who initially dismissed Soludo’s reform plans as fanciful now concede that Nigeria’s banking sector appears to have turned a corner in its rehabilitation.
Reform agenda
Reform efforts in the financial sector have not occurred in a vacuum. Part of the reason for the success of Soludo’s policies has been the increased respect shown by many in Nigeria toward the institutions of government – despite recent attacks on oil pipelines by disenfranchised groups that are thought to have cost Nigeria $1 billion already in 2006 – since the adoption of the country’s new constitution in 1999.
The importance of the new constitution and the election of President Olusegun Obasanjo, who has been in power since its inception and is considering running for a third term in 2007, cannot be overstated. Although the 2003 elections, in which Obasanjo kept his hold on the country, were marred by some irregularities, the significance of his successive victories is not lost on a country that was a military dictatorship as recently as 1999 and which has been a byword for turmoil in the years since independence in 1960: Obasanjo’s reign is the longest period of civilian rule since Nigeria became independent.
Improving revenues
Soludo’s ability to reform the banking sector – and Obasanjo’s ability to remain in power – has been partly attributable to the boom in oil prices that increased GDP by 5.2% in 2005. The huge revenues that have flowed to the government as a result of high prices and rising exports – roughly 20% of GDP comes from oil, as does around 65% of the government’s budget – have given the government the flexibility to please both the public by, for example, making primary education free to all, and the financial markets by improving revenue collection and aiming to achieve a BBB rating investment grade from Fitch. Nevertheless, Soludo’s achievements in reshaping the banking sector are impressive.
Before Soludo launched his reform agenda in 2004, the Nigerian banking system was in a poor state. Although the country has the largest population of any black nation, at 137 million, and is the thirteenth largest oil-producing country in the world, its banking infrastructure was weak and had failed to become more sophisticated. Specifically, the banking sector was highly fragmented and had concentrated its efforts on the easy pickings of import-business related activity.
One of the chief reasons for this was the small size of most banks. When the reform programme was announced Nigeria had 89 banks, most of which were tiny, which restricted their lending ability. In Nigeria, the single borrower limit for bank lending is 35% of shareholders’ funds for commercial banks.
But before the reform, the required minimum of shareholder funds was just N2 billion. And while many banks had shareholder funds of N10 billion that meant their maximum loans could be just N3.5 billion – far too small to finance a typical project either in the oil and gas industry or in other industries vital to Nigeria’s development such as telecommunications, construction and power.
Moreover, many banks were dependent on cheap public sector funds for their own financing with, on average, 20% of funds, and in some cases 50%, coming from various government-related deposits.
The reforms began with the phased withdrawal of public funds from the banking system in July 2004 with the intention of forcing banks to find alternative deposit bases from which to find funds: an estimated 83.9% of money in circulation in Nigeria before the banking reforms was outside the banking system and the reforms aimed to encourage banks to chase these funds so that they could be used for lending.
Meeting the deadline
The 18 month timeframe – to the end of 2005 – for banks to increase their shareholder capital from N2 billion to N25 billion was seen as unachievable by many when Soludo first announced it and, for a time, there was a widespread belief that the deadline would be extended, not least because of the pressure it would create if banks were closed down and people made redundant.
But Soludo stuck to his guns – increasing confidence in the system – and rightly argued that any banks that could not sort out their finance in 18 months were unlikely to be able to do so over a longer period. The result, at the end of 2005, was a banking sector of just 25 banks compared to the 89 “fragile, small and uncompetitive banks tainted by corruption and mismanagement” before the reforms, according to Soludo – nothing short of a revolution in the banking market. Remarkably, the consolidation was achieved without the need for government sponsored bailouts of depositors – as has happened in other countries when consolidation has been attempted.
Instead, most of the banks that disappeared were merged into other entities, while there was also substantial capital markets activity such as IPOs and rights issues – with N406 billion raised from the Nigerian capital market, including notable deals such as Zenith Bank’s N20.3 billion IPO and over $650 million raised from the international markets – in order to generate sufficient shareholder funds to meet the target. The banking sector’s share of the Nigerian Stock Exchange leapt from 24% to almost 50% over the period of recapitalisation.
Most importantly, the 25 banks that have emerged from the consolidation now have 93.5% of the deposit liabilities of the banking system.
New horizons
Soludo remains ambitious for the banking sector and few doubt that further consolidation in the market is envisaged. In various speeches, Soludo has indicated that he would like to see mega banks with capital of over N70 billion so that Nigerian banks can begin to compete internationally.
Clearly, scale remains a problem for Nigerian banks. The largest bank in Africa, Standard Bank of South Africa, has total assets of about $45 billion or N5.8 trillion – more than the N5 trillion total assets of all of Nigeria's current 25 banks combined.
However, Nigeria’s banking reform is also addressing issues other than scale. At the beginning of March this year, Soludo launched a code for corporate governance for banks. Crucially, the increase of public confidence through improved corporate governance has been placed at the centre of the newly consolidated banking sector.
The Central Bank believes that the broadened ownership structure of banks – most are now listed on the Nigerian stock exchange and ‘one-man’ or family banks have almost disappeared – will improve the management of banks.
Meanwhile, a zero tolerance towards infractions of the new code by banks, an increased emphasis on transparency and the deployment of new technology infrastructure to help to ensure improved processes and procedures are other measures that should improve the business environment for banks.
The changes begun by the banking reforms are almost uniformly positive. Already the removal of state deposits from banks – forcing them to source deposits from elsewhere – and the increase in the scale of banks – giving them the scope to lend to larger projects – has had an effect on the economy.
Growth in the non-oil sector of the economy outpaced the 7.4% of the overall economy in 2005 by growing at 8.5% while lending to private sector rose by 40% in 2005. Such achievements cannot be underestimated and the positive repercussions of the banking reforms could yet herald a transformation of Nigeria’s economy.