What Soludo Didn't Quite Finish

Once in a while, a combination of events occur that expose weaknesses in a system that appeared to be just fine. When such events occur, it is an opportunity for regulators and policy makers to rejig and fine-tune the system to find lasting solutions.

With the crash in oil prices, a surge in non-performing loans (NPLs) on banks' portfolios, the introduction of Treasury Single Account (TSA), exchange rate depreciation, and dollar scarcity, the Nigerian financial system has been hit by one of such combos.

Connected to this is the declining profitability of the oil sector, primarily as a result of the fall in oil prices. Nigerian banks have significant credit exposure to the oil & gas industry, especially as many indigenous firms took out loans to finance the purchase of upstream assets as International Oil Companies divested in the early part of the decade. A significant portion of industry debt is dollar-denominated, and as a result, the value of these loans has sky-rocketed following the fall in the naira. Add in dollar scarcity, and many firms have struggled to service these loans, leading to a sharp rise in NPLs.

The erosion of asset quality has squeezed the industry with many small to mid-sized banks reaching close to the mandated thresholds for capital and liquidity buffers. As a result, this may be as good a time as any to discuss whether further bank consolidations are in order.  

Soludo's Goal

The 2004 Banking Consolidation, instigated by Professor Charles Soludo, the Central Bank of Nigeria (CBN) Governor at the time, had three primary goals. These were, to position Nigerian banks to compete regionally and globally; to strengthen the banking system by pulling in the deposits of a large but cynical population; to leverage on the banking system as a vehicle for economic development in Nigeria.  

That period of consolidation is the primary reason Nigerian banks have been able to compete regionally. In his address to the Bankers' Committee in 2004, Soludo noted that pre-consolidation, the banking system was hampered by small lenders focused on low-margin activities like foreign exchange and Treasury bills trading to turn a profit. As the core banking activity of lending had become unprofitable, lending institutions were banks only in name. This was one of the issues the 2004 consolidation exercise sought to address, to turn many small players into a few healthy ones that could focus on their mandate and by so doing, help accelerate growth in Nigeria, mainly through credit facilities to the real economy. 

Unfinished Business

Nigerian banks are still not big enough, and this is relevant as the strength of the financial system is strongly correlated with economic development. Despite its status as the largest economy in Africa, no Nigerian bank features in a list of the ten largest banks on the continent. South Africa alone has five. Nigerian banks should be at least big enough to have earned a place on stock exchanges around Africa which of course increases access to capital and means even greater potential for growth.

Sturdier banks attract greater global investor attention, especially in light of the high returns attainable in many developing markets. Moreover, as some of Nigeria's larger banks have found, an international presence has its benefits: a larger and more diverse customer base, as well as stronger brand flavour. Due to their large size, banks would be able to enjoy economies of scale from savings on technical costs and innovation while enjoying cheaper finance costs, like Tier 1 banks currently do.

Moreover, bigger banks also happen to enjoy the magnanimous advantages of being seen as too-big-to-fail, which could translate into a lower risk profile for Nigerian big banks. To address the problem of moral hazard, a stronger regulatory framework would need to be created. Ideally more stringent regulation would act purely as a deterrent as both foreign and domestic investors gain confidence in these larger banks. However, regulators would need to remain on their toes to deal with these banks.

No Time To Act 

The 2004 consolidation should have tackled the problem of commercial bank dependence on government deposits. But following the implementation of the TSA and the abrupt withdrawal of public sector funds from the banking system, the industry went into a mini-meltdown. The problem is that banks primarily catered to the affluent – the top 10% – and ignored the majority of Nigerians, most of whom remain unbanked. This group should have been targeted during the consolidation exercise as banks sought to shore up their capital and asset bases.

Unfortunately, the economics of marketing to the unbanked poor remain unappealing. But larger banks will find it more profitable to engage with this group. A recent survey by EFinA in 2014 found 61% of the Nigerian population to be unbanked (74% in 2008, evidently not much has changed). 

Bigger banks would also be able to have a more diversified source of deposits, thus improving the financial inclusion mandate of the central bank and strengthening the overall banking sector's position. 

Another compulsory consolidation exercise would be extremely harsh on banks and their employees. The best option is for them to focus on expanding their asset and deposit base, either through strategic mergers or by reaching the unbanked. Modern technology and global financial integration can be leveraged on. Banks would be wise to move fast. 

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