WHY WE SHOULD RESTRUCTURE THE FINANCIAL SYSTEM, BY SANUSI

Sanusi
Central Bank of Nigeria (CBN) Governor, Mallam Sanusi Lamido Sanusi, recently spoke on the current reform and the blueprint mechanism targeted at providing the key strategies that would propel the economy in 2011, after the banking sector intervention of the August 14, 2009. Sanusi provided full details on the workings of the bank's reform blueprint which is built upon four pillars namely - enhancing the quality of banks, establishing financial stability, enabling healthy financial sector evolution, and ensuring that financial sector contributes to the real economy.

The governor, who addressed a distinguished gathering of top bankers in the Nigerian banking industry in Lagos, on the occasion of the 2010 Bankers' Dinner, hosted by the Chartered Institute of Bankers of Nigeria (CIBN) spoke extensively on the reforms in the banking industry.

Excerpts:
Influence of the recent global financial crises and mismanagement of some Nigerian Banks

As you are aware, one of the factors which cost the global economy a great fortune by way of losses in the recent financial crisis was the sub-prime mortgage lending in the United States. In addition to this undeniable fact, some people have blamed the crises on the greed of bankers, yet, others blame it on lax regulation and supervision. Let me say that each of these perspectives of arguments may have their strong points.

What is not in doubt, however, is the fact that the recent global financial crisis came with serious consequences, which reverberated across all economies, banking sectors and financial markets in particular. Since then, global recovery has been slow and the recent sovereign debt crisis in Greece has further threatened even the fragile recovery. Let me say that at least in the next couple of years, the post-crisis global environment will be characterized by many economic challenges that are likely to engender uncertainty, volatility and instability in the global financial markets.

The recent global financial crisis reduced the gains of the previous economic and banking sector reforms in Nigeria. Generally, the crisis impacted the economy through various channels, including significant decline in revenue to all tiers of government from oil export, reduction in capital inflows; depletion of external/foreign reserves, demand pressure in the foreign exchange market, substantial decline in stock market capitalization and share prices. Also, some banks in particular, which had huge exposures to the capital market and the oil and gas sector were worse hit by the crisis and thus accumulated large non-performing loans (NPLs) from margin loans, share-backed facilities, as well as oil and gas related exposures, which deteriorated, following the commodity price slump of 2008-2009, among others.

The current reform process
In the light of the grave situation in the banking sector, it became clear that the CBN had to take specific and urgent actions in order to avoid a systemic distress in the banking industry. The activities at the Central Bank since then have and are being guided by the bank's reform blueprint, which is built upon four pillars namely - enhancing the quality of banks, establishing financial stability, enabling healthy financial sector evolution, and ensuring that financial sector contributes to the real economy. The implementation of the blue-print involved the following: industry remedial actions, regulatory reforms, strengthening the implementation of the risk based supervision approach, consumer protection and internal transformation of the CBN.

Indeed, as an additional measure to strengthen the reform process, the Assets Management Corporation of Nigeria (AMCON), the enabling Act of which has already been signed into law by the President, is expected to serve as a resolution vehicle to soak the toxic assets of banks and provide liquidity to them as well as assist in needed recapitalization. Only this week, the appointment of the Board of AMCON was confirmed by the Senate and they are expected to hit the ground running.

The CBN has equally focused attention on the issue of the soundness and stability of the banking system in the aftermath of the crisis that was largely mitigated by the actions taken in 2009. The measures taken to ensure the stability of the  banking system include: establishment of a Consumer and Financial Protection Division to provide a platform through which consumers can seek redress, review of the Guide to Bank Charges, which is on-going, with a view to making the charges realistic and consumer friendly, collaborating with the Consumer Protection Council on the review of the Consumer Protection Council Act No. 66 of 1992 to enable regulators to enforce discipline in the market and, the issuance of guidelines on mandatory additional disclosure by banks preparatory to the adoption of the International Financial Reporting Standards (IFRS) 2012 for transparency and global competitiveness.

Others were the strengthening of the inter-agency coordination framework through the Financial Services Regulation Coordinating Committee (FSRCC); conducting own-risk assessments and relying less on classifications by rating agencies; limiting the tenor of chief executives of banks to two terms of 5 years each; sound and timely regulation and supervision of the financial sector; stringent demand for transparency in the financial sector; and, transparency in structured credit instruments to be improved upon for easy assessment of associated risk. Furthermore, the CBN in conjunction with the Securities and Exchange Commission (SEC) developed the harmonized rule on margin lending to cover the type of securities that qualify as marginable securities as well as the rules governing margin trading. Moreover, the CBN announced the adoption of common accounting year end to enhance transparency and comparability of developments for policy analysis.

Development functions of CBN
As part of the efforts by the CBN to show the way towards enhanced financing of the real sector and infrastructure projects, and improve credit flow to the sector, a N500 billion fund was established out of which N300 billion is for Power/Infrastructure and Aviation projects, and N200 billion for the Refinancing/Restructuring of banks' existing loan portfolios to manufacturers/ Small and Medium Enterprises (SMEs). Also, a N200 billion SME Credit Guarantee Scheme was created, to catalyze adequate flow of finance to the SMEs from the DMBs.

In Nigeria, agriculture accounts for 42 per cent of the GDP, however the sector attracts only one per cent of bank lending. Also the SMEs, while responsible for 70 per cent of total employment, attract only three per cent of bank lending. A banking system which relies on short-term current and savings deposits accounts which constrains long-term funding. Development requires long-term financing for critical infrastructure such as power, energy, telecoms and transport infrastructure. Even where there is a seeming market for the development of long-term funding through the capital market, a significant part of both Financial Institution and Equity issues in Nigeria come from the balance sheet of banks, either from proprietary positions or using depositors' funds.

There is a general failure to recognize the limitations of the banking system when it comes to delivering economic development. The banking system as a whole is only useful in the context of good economic policies that promote the production of real goods and services especially in agriculture and manufacturing. Emphasis on Financial sector reform and Financial stability while important, can only make sense in the context of structural transformation that unlocks the potential in sectors such as agriculture from a present state of being dominated by primary production, into one that develops a value chain that is commercially viable and capable of absorbing finance on a commercial scale and also industrial policy that improves the competitiveness of manufacturing and its ability to take advantage of the market.

It is important that the industrialisation of the Nigerian economy be accorded high priority. This is because there is no nation that can attain greatness without a solid industrial base. Hence, there is the need to intensify diversification of our economy both within the commodity sector into the production of non-traditional items with growing markets, or into further processing of commodities and in manufacturing  and service activities. Emphasis should therefore be placed on promoting value-chain agricultural, industrial and information and communication technology activities.

In light of the above fundamental challenges faced by the Nigerian economy, the Central Bank of Nigeria (CBN) has undertaken some initiatives to drive activities that would spur the growth process of the economy. These initiatives which focus on those sectors identified to be the major drivers of growth in the near-to-long-term include:

• The review of the Universal Banking guidelines to refocus banks on their core mandate;

• Another initiative is the recent amendment to the Prudential Guidelines, the first time in the last 20 years. The purpose of which is facilitate the channelling of bank resources towards the real sector;

• CBN is also playing a more activist role in its engagement with policy makers to create a proper policy environment in the power sector, downstream petroleum sector and the agricultural sector; and

• We have recently, together with the banking industry, commenced the designing of a new agricultural financing framework, the Nigerian Incentive-based Risk Sharing System for Agricultural Lending (NIRSAL), in collaboration with the Alliance for a Green Revolution in Africa (AGRA) and the United Nations Industrial Development Organization (UNIDO). NIRSAL is expected to: (i) stimulate innovations in agricultural lending, (ii) encourage banks that are lending to the sector; (iii) eliminate state dependency by banks for deploying loanable funds to agriculture; (iv) leverage banks' balance sheets for lending to agriculture; and (v) ensure risk sharing approach that will build a business approach where banks share in the risk of lending to the sector.

In order to unlock these value-chain activities, efforts must be directed at tackling structural rigidities, infrastructural deficiency, building human capacity and improving business environment through good governance, transparency and accountability. The CBN sees its role as being a value chain manager, but also as an institution that should take calculated risks with its balance sheet in order to reposition the Nigerian economy.

The Commercial Agricultural Credit Guarantee Scheme (CACS) was established in 2009 by the CBN in collaboration with the Federal Ministry of Agriculture and Water Resources. It is being funded through the issuance of FGN Bond worth N200 billion by the Debt Management Office. The first tranche of N100 billion has been raised and passed on to participating banks for on-lending to farmers.  As at end October 2010, the CBN has released the sum of N90.361 billion for disbursement to 94 projects/promoters (inclusive of 15 state governments). For the manufacturing/SME fund, the CBN has released N150.0 billion credit facilities to the manufacturers at a fixed rate of 7% through the Bank of Industry (BOI) and deposit money banks.

Restructuring CBN for efficiency
The CBN mindful of the challenges posed by the governance and management processes in-house, on its ability to deliver on its core mandate, also embarked on the transformation of its internal structure and processes. It reorganized/streamlined its structure to ensure an enhanced capacity to better supervise the industry and enhance its service delivery process by creating the following new departments; the Financial Markets, Risk Management, Reserve Management and Banking and Payment System Departments. The CBN also established an internal risk management specialist function to develop the Nigerian Capital Adequacy and Enterprise Risk Assessment Process Guidelines, in order to ensure that the industry adapts to the highest standards of risk management.

In particular, the Bank established a separate department, the Financial Policy and Regulations Department, within its supervisory directorate to focus mainly on financial system stability and macro-prudential issues. A Consumer Protection Division to enlighten consumers on financial services/products, respond to major issues and ensure that consumers are fairly treated was also created. The Bank also has strengthened the Financial System Stability Committee (FSSC), to stem the incidence of regulatory arbitrage and enhance inter-agency co-operation in the regulation of the financial services industry.

Wither the banks?
We are not oblivious of the comments, both negative and positive, that the reforms have attracted from commentators, analysts and stakeholders. These were no less than we expected when we embarked on the reforms. We have benefited immensely from constructive comments and good suggestions as we all have a common interest in the well-being of the financial system and by extension the soundness and stability of the banking system. The system has benefited tremendously from the reforms including the restoration of customer confidence in the financial system, improved transparency following the adoption of additional disclosure requirements and the common accounting year end from December, 2009 and substantial recovery of delinquent loans.

I dare say there has been considerable improvement in corporate governance as well as banks' balance sheets. Indeed, most banks have returned to the path of profitability including the CBN-intervened banks as shown by their recently published results. However, the same cannot be said in respect of channeling credit to the real sector, which has been contracting since the beginning of the year. Over the level at end-December 2009, credit to the core private sector has maintained a declining trend since January 2010 and only rose marginally by 1.0 per cent at end-September 2010. This trend is consistent with the fact that as banks' capital shrank (by about 60%) due to the high levels of Non-Performing Loans (NPLs), a converse shrinkage in credit outflow is occasioned by the lack of available capital for on-lending.

Despite this, it remains, however, desirable for banks to play an active role in our developmental efforts through effective real sector financing. Let me say that it is not possible to talk about long-run stability of the banking sector without a strong and prosperous real economy. Income stream to banks from interest payments is the major source of funds that keep banks going. Indeed, a weak private sector is a serious threat to financial stability. If economic agents are not paying interest on loans or credit flow to the private sector dries up, where and how will the banks survive? This is the big issue in Nigeria 's financial landscape today and it remains a threat to the stability of the banking system.