For believers in evolution, it all started with the Big Bang; for Nigerian banks, it all started with the Soludo consolidation exercise of 2005. Well, not quite. Nigerian banks had existed long before the then Central Bank of Nigeria (CBN) Governor enacted a 13-point reform program which forced industry consolidation. The oldest, First Bank of Nigeria, has existed since 1894.
Entering the new millennium, the Nigerian banking sector had shaken off the turbulence of the 90s when over thirty distressed banks had their licenses revoked, but remained a mess, consisting of a mix of strong legacy institutions and smaller struggling regional banks. Professor Soludo, freshly appointed by President Obasanjo, increased the minimum capital base for a banking license from ₦2 billion to ₦25 billion, spurring a raft of mergers and acquisitions across the industry. As the dust settled, the number of Nigerian banks had fallen from nearly 90 to 24.
A notable fallout of this was that Nigeria’s banking sector became more oligopolistic as market power concentrated among a smaller number of firms.
The logic of consolidation was to make Nigerian banks bigger and stronger, allowing them to leverage economies of scale to reduce cost, increase their risk tolerance and expand services.
Say hello to AMCON
However, as the world economy groaned under a global recession and banks in places as scattered as Iceland and the United States failed, Nigeria’s supposedly bigger and stronger banks were also on the ropes. In a speech in 2010, Lamido Sanusi, CBN Governor at the time, explained how although the global financial crisis was the straw that broke the camel’s back, the industry had been assaulted by significant failures in corporate governance (read: fraud), inadequate supervision (read: an absent CBN), amongst others.
So, four years after consolidation, Nigerian banks were struggling again; this time, in a more specific way. They had too many outstanding loans that debtors were unwilling or unable to repay—known as non-performing loans (NPL). The ratio of non-performing loans to total industry loans rose as high as 37% in 2009.
In response, the CBN set up the Asset Management Company of Nigeria (AMCON) and authorised it to purchase this bad debt from banks, thereby cleaning up the banking sector. Despite cries that this move would incentivise banks to persist in giving out bad loans (the moral hazard problem), the decision probably averted a full-blown banking crisis.
The failure of Nigerian bank lending
The consolidation of 2005 and AMCON buy-out of 2009 shaped the banking industry we see in present-day Nigeria. Although the issues these two reforms sought to address—capital adequacy and asset quality (NPLs)—exist on a smaller scale, the banking system still fails one key fit-for-purpose test: lending to the real economy, most especially SMEs and individuals.
It is no secret that Nigerian banks hardly lend to SMEs or non-wealthy individuals. According to the CBN’s H1’18 economic report, commercial banks dedicated just 3% of their total credit to agriculture, a sector that contributes a quarter of our GDP and half of all employment. Meanwhile, retail loans accounted for just 7% of the loans of one of Nigeria’s most profitable banks.
The reforms previously discussed ought to have addressed this. Larger banks can absorb more risk and extend credit to a broader range of individuals and industries. This didn’t quite happen. Instead, Nigerian banks opted to fund questionable infrastructure and energy projects. One reason for this is that CBN had permitted banks to categorise the downstream, midstream, and upstream sectors of the Oil & Gas industry as separate, allowing them to circumvent the regulatory limit of 30% loan exposure to a single industry. The 2014 oil price crash and its fallout on all parts of the oil & gas value chain have shown the folly of that decision.
Today, Nigerian banks still suffer from high NPL ratios—estimated at an average of 12.5% by CBN—mostly due to loan exposure to oil & gas and power firms. Ironically, banks have shunned lending to other parts of the economy because of their fears that they are riskier yet ended up in the same bad debt position after lending to “trusted” industries.
Moreover, had banks lent to retail individuals, they would have benefitted more from risk diversification. The law of large numbers means that the more individual loans are aggregated, the more comfortable a bank can be about the aggregate quality of its loan book (subject to assumptions about the quality of any individual loan). In short, you may default on a loan taken from a bank, but it is much less likely that everyone on your street would default on their loans—the bank hedges its risk by lending to more and more people.
In the absence of bank lending, individuals have sought alternative ways of obtaining credit. This explains the rise in peer-to-peer lending in Nigeria, with data showing that people often take out peer-to-peer loans for items that would usually be covered by traditional banks.
Banks have too much market power
The consolidation reforms of the mid-2000s have made Nigerian banks bigger, and AMCON’s intervention at the end of the 2000s helped clean up their loan books and improve governance structures. Both of these ought to encourage banks to lend more to individuals and SMEs. However, the consolidation exercise had an inadvertent effect that has hampered the attainment of this ideal: it made Nigeria’s banking sector an oligopoly.
Roughly speaking, an oligopoly is an industry dominated by a few large firms who are able to wield collective power over consumers. In 2008, Nigeria’s ten largest banks accounted for nearly 80% of all industry assets, and this has only declined slightly in the ten years since then.
Members of the Central Bank’s monetary policy committee (MPC) have often complained about how this affects the economy. Back in 2013, Chibuike Uche, at the time a member of the MPC, accused banks of only adjusting deposit rates (their costs) and not lending rates (their prices) when the CBN reduced interest rates. And even in the last 18 months, different MPC members have warned that the Central Bank cutting its base interest rate would mean nothing as banks would not pass this on to customers. In 2017, CBN Governor Godwin Emefiele explained that as “interest rates are sticky downwards, loosening [monetary policy] may not necessarily transmit into lower retail lending rates.”
What does all this mean? The current structure of Nigeria’s banking industry may be hindering it from giving out loans at lower interest rates. The academic evidence supports this conclusion, too. Both Kashyap and Stein (1997) and Cecchetti (1999) found that a more oligopolistic banking industry could restrict the effectiveness of monetary policy. While smaller banks would pass on any reduction in interest rare to their customers, larger banks were less likely to do so.
Admittedly, other factors like asymmetric information, which makes it hard for banks to tell which individuals are trustworthy, contribute to the low lending to individuals and SMEs. Nevertheless, it may be time to face up to the possibility that despite a number of landmark reforms since the turn of the 21st century, Nigeria’s banking industry is not quite fit for purpose.