The Recovery of Nigeria's Financial Sector

It is well enough that the people of this nation [Americans] do not know what goes on on Wall Street, for if they did, I believe there would be a revolution before tomorrow morning
—Henry Ford, founder of Ford Motor Company

It all started with the race to consolidation. An ultimate challenge to their very survival, the N25 billion consolidation turned banking into fraud Ponzi scheme. Not even the Investment and Securities Act of 1999 (as amended in 2007) could stop banks from gambling with depositors’ funds in the capital market. Some strange marriages in the name of mergers caused conflicting corporate cultures and values, incongruent management information systems, and mismatched skills in the banking industry. And with lax in the enforcement of data quality, unsuspecting investors turned into victims of consolidation, especially given how banks churned out some inaccurate and incomplete data.

The apex bank did not provide input to SEC in planning its examinations of bank activities, nor did the apex bank receive examination reports from SEC covering bank subsidiaries. What should have stopped bank directors from getting along, especially when in return they too got billions of naira bogus loans?

Ponzi scheme
Tricked into buying because others were buying, most Nigerian investors left the safety of bank Certificate of Deposits (CDs) to join the complex financial markets. Forgetting that what they’re doing was gambling, they handed their savings to speculators. There’s no way millions wouldn’t have been swindled after being bombarded with pleasing mass misinformation. And for the banks having tasted the huge gains of gambling with depositors’ money, there’s no way, like sharks just tasted blood, they could resist circling the securities waters.

So, with consolidation turning the capital market into a casino house, everything could go wrong — including effective oversight and surveillance mechanism gone wrong. Not only that banks began returning as many times as they wished, even after getting enough and when having no need for more funds, but also dealing members having liquidity ratios of zero and negative values (in breach of Article 15(e) and Section 32 of the Investment and Securities Act) could take part in the equity market. In this Far West game, where rather than oversubscriptions being returned to the original share applicants, the banks kept the money with impunity, it couldn’t be shocking that over 30% of the share capital of Intercontinental Bank was purchased with customers’ deposits; that Afribank used depositors’ funds to purchase 80% of its initial public offering, and that the Oceanic Bank chief executive controlled over 35% of the bank, borrowing depositors via SPVs (special purpose vehicles).

But nowhere was the greatest robbery committed except in margin lending. Having colluded to artificially raise the value of their shares, they, with the lure of stockbrokers, offered irresistible margin loans. By lending them money to buy stocks, millions of illiterate Nigerian investors were dispossessed of their hard-earned savings, pensions, and properties, including their houses. For those who came out of this casino house still alive, losing N2.5 trillion (more than 18%)) of their deposits, they discovered how badly their fingers were burnt. In other words, fully aware that what they’re doing was a Ponzi scheme, the banks carefully lured millions of investors into their so overpriced stocks that could hardly be resold without massive losses.

With such growth in capital market frauds came corresponding growth in banking assets — averaging at 76% per annum. And so high grew the stock market that between 2005 and 2008 it increased by 500%. And with every high profit announcement soared and soared share prices. By the end of the day, the banks had accumulated so much liquidity that they began to run out of investment ideas. Even with the signs that the banks were running out of ideas where they invested, it seemed not to have sent the warning to the millions of obsessed “herd mentality” investors that without the banks investing their money in the productive sector, they were allowing banks to use their money in the money-doubling game.

That most bank chief executives used SPVs to launder investors’ money, or that they went on global real estate extravaganza —purchasing pricey estates all over western cities —shouldn’t be seen to cause some moral hazards to 419 bankers who, in their cleverness, dispossessed fellow citizens and their nation such vast wealth. For NDIC statistics put fraud arising from top level managerial malfeasance, supervisory level theft, as well as from lower level light-fingeredness as responsible for over 22% of bank losses in Nigeria. That, of course, was to put it mildly. (Or shouldn’t telling the truth be enough to trigger unprecedented mass riots across the country?)

High-rocketing oil prices, especially from $50 in early 2007 to $147 by mid-2008 in an absence of a productive sector meant that without overarching architecture to manage bank risks in the absence of sound macro-prudential guidelines, not only would the economy not be able to absorb such excess liquidity surge but also, without sound shock-absorber the country’s entire financial system was a ticking time-bomb. In the meantime, as the pressure on banks to deliver high returns grew with such diminishing investment returns, it became obvious that such soaring stock market without corresponding market fundamentals supporting it should have its days numbered.

Like the unprecedented massive defaulting in the US subprime lending, the financial institutions in Nigeria began to feel a big hole in their balance sheets as a result of most borrowers, particularly margin borrowers, increasingly defaulting. But it was the sudden collapse of global oil prices in late 2008, coupled with over 68% foreign portfolio investment (FPI) pursuing arbitrage opportunities outside the shores of Nigeria that quickly set the crisis in its full motion. The devastating financial tsunami was so mind-boggling that, by the time it was over, dropping from N13.5 trillion to N4.6 trillion, the stock market had lost a whopping 66% (N8.9 trillion) of its value.

Failing the CAMELS test
With all the banks failing the CAMELS (‘Capital adequacy, Asset quality, Management quality, Earnings quality, Liquidity and Sensitivity to risk), a stress test of the financial health and well-being of a financial institution, bailing the banks out became a matter of life and death. And to prevent the uncontrollable contagion about to hit the country, the newly appointed governor, Mr. Sanusi Lamido Sanusi, wisely provided N620 billion, which was only a life-support machine, while a permanent way out was hunted for. So badly exposed was the country’s capital market that the 2009 Bloomberg World Stock Market Report ranked the Nigerian Stock Exchange’s Index ‘’the worst performing equity index globally”.

While tightening of regulation and supervision framework, interest rate management and confidence building were rigorously pursued alongside pouring hundreds of billions of taxpayers’ money into the ailing banks, and determined to go after the mobster who used banks as a camouflage, the governor wasted no time in dismissing bank chairmen as well as handing many bank chief executives and executive directors to the EFCC as seasoned criminals. Recognizing the urgency to rid the banks of their life-threatening troubled assets, soon, the governor saw the urgency to refine and represent the forgotten Assets Management Bill earlier proposed by his predecessor, Prof. Chukwuma Soludo.

AMCON’s uphill task
Taking it as a personal challenge, given the serious danger t

oxic assets posed to the banking industry, soon, Mr. Sanusi set out to find that exceptionally gifted broad-based peak-performer Nigerian, a Nigerian with the kind of extraordinary wealth of knowledge, experience, integrity, as well as passion and willpower needed to lead AMCON’s daunting task of bringing the country’s financial sector out of the woods. After the long and tiring search, it was discovered that there was only one Nigerian who had it all: Mr. Mustafa Chike-Obi. Son of Africa’s foremost mathematician Professor Chike Obi, Chike-Obi’s stellar academic accomplishments and second-to-none world-class work experience — best first class in mathematics ever made at the University of Lagos, Stanford Graduate Business School’s MBA top graduate, with a second-to-none career on Wall Street (including vice president of Goldman Sachs) — was found to be the best suited for this difficult national assignment.

In accordance with the provision of the act establishing it as an efficient utility vehicle to purchase toxic assets and equity from eligible financial institutions, emerging as the provider of macro-prudential support to banking supervisors and regulators, AMCON in cleaning up the banks’ balance sheets has provided them the basis for future profitability. Having reduced credit crunch in the banking industry through bank capital ratios stabilization, AMCON has succeeded in making the banks begin to lend again.

Besides helping to restore investor confidence in the financial institutions and the markets by bringing to an end the widespread fears about the true state of health of both the banking industry and capital market, efficiently managing and disposing of eligible bank assets also meant pursuing the best available financial returns on eligible bank assets or other assets acquired by it. Rightly led by Mr. Chike-Obi since 2010, AMCON has become the best thing that has happened to Nigeria’s financial economy especially for having finally putting the real sector of the economy on its path to recovery. In other words, because doing away with credit squeeze in the economy linked to the huge toxic assets meant also stimulating a job-driven economic recovery, with AMCON the economy is not only increasingly back to business but is doing so accompanied with job creation, while making poverty reduction topping government’s agenda.

In providing an alternative recapitalization for our distressed banks as an asset management vehicle, AMCON has had no difficulty purchasing those toxic assets. Valuation of toxic assets is where the difficulty is met, especially given that most of the collateralized assets were fraudulently hyped. AMCON’s headache grows with the discovery of the difficulty disposing the recently purchased toxic debts. Disposing toxic assets by government around the world has remained a problem without which makes loss of taxpayers’ money inevitable.

Even though government guaranteeing the AMCON bond (debt instrument) was contrary to section 47 of the Fiscal Responsibility Act, it’s the best option, given the financial crisis. This arrangement was better than government bailout. To provide N4trillion bailout, government should print it; and to print it and flood the market with excess money supply would mean inflation. Because the dollar is the reserve currency of the world, the US government has had no difficulty externalizing its excess dollars to the rest of the world.

Continuously demonstrating difficulty meeting self-set deadlines for disposing, TARP has since frightened American taxpayers into believing that they it is going to be difficult for them to get off the hooks of those troubled assets. What this means is that the once rescued banks and other financial institutions will have little difficulty pursuing riskier investments since they believe government will always bail them out during a crisis. For this very same reason, it is more likely that the country will face future economic crises if the banks are encouraged to make riskier investments. Since government financing will not be provided forever, have the banks repositioned themselves with new business model that will make them survive by their own means without being exposed to risks they could not manage?

The extent to which AMCON will fully recoup its investment in these banks remains uncertain, especially given that the banks in question still face several challenges in the coming years. Even though Mr. Chike-Obi may not be expressing these concerns publicly, however, getting government out of the toxic assets quandary without heavy losses, especially from the bridge banks, remains his personal nightmare. If private investors refused touching these toxic assets for reasons pertaining to the uncertainty over their toxic asset holders and their solvency positions, why should the same private investors change their position especially now that they belong to the government?

In fact, with increase in skepticism because of the inconsistent resolution procedures government has so far implemented, it is now more difficult now for private investors to be tempted to touch those toxic debts than before. Another major drawback with recapitalisation through capital markets is that bank shares are at historical lows and a capital increase at these levels would severely dilute existing shareholders. For growth and development to occur in any modern economy, a liquid stock market will have to complement a strong banking system in providing different bundles of financial services to the economy, a trend now accepted globally. So when a market lacks liquidity, it cannot support growth and development of its underlying economy.

Exiting the bridge banks without losses is not going to be easy. If the business operations of the bridge banks are so attractive, why didn’t they raise the money themselves from the capital market? Handing the three banks to the highest bidder and the most technically competent, including foreigners, will be an irreconcilable mistake. While that might mean recovering the money poured into the distressed banks possible, for strategic reasons, on the long run it would be discovered as a mistake to allow our bank industry be dominated by foreign investors.

Allowing a nation’s banking industry to be controlled by foreigners is allowing the economy to be controlled by foreigners. One thing for sure is, foreign-controlled banks prefer promoting outward-looking investments to inward-looking investments. In other words, while they willingly extend credit facilities to importers of their home-made goods, they decline extending credit to local producers. That explains why they always have business models that hardly cater for small, low-income, informal, and rural-based economic agents. That investment follows opportunity and security, investment continues regardless of the banking industry ownership issues is enough evidence to show that the banking industry does not necessarily have to be foreign hands in order to attract foreign capital. History is evident enough to show how countries that have their banking industry in local hands have retaken the ownership of their economy, adopting inward-looking development.

Besides foreign investment flowing in when least needed and flowing out when most needed, going forward, controlling how oil prices trickle down into the economy requires effective quarantining of oil-related excess liquidity before it reaches the banking industry. Diversifying our banking industry, should be the first step because universal fractional banking operating within short-term investment horizon not only makes long-term lending difficult, it also reduces long-term investment and growth horizon that would mop up excess liquidity caused by sudden high oil prices. The one-size-fits-all model of banking has to be discontinued in this country if we want to see our bank become more real sector-investment friendly. Because niche banking is built on longer-term investmen

ts, and is more accessible to industrial and entrepreneurial businesses, it is where the future of banking is headed.

Valuating toxic assets is one of the biggest challenges facing financial institutions today. This is not just a question of the sheer complexity of the financial instruments involved. Without resolving the pricing issue or, much better, without finding a way to price these troubled assets accurately, it is going to take years before asset prices shake out. Both conventional approaches to valuing assets – mark-to-market and mark-to-model – seem not to be providing the right answer. The difficulty of creating a model to price toxic assets on the banks’ balance sheets is a problem being confronted around the world, contributing to the delay of disposing of these assets. Even warrants (call options that add to the number of shares of stock outstanding if they are exercised for a profit) and reverse auctions which could offer some reasonable solutions are not free of controversies.

Timing is a crucial component of the recovery plans, given that, even if the banks eventually recover at some point, they will not be able to remain healthy for long in a lingering recessionary environment. In short, no capital market built on thin air like ours should be expected to survive long without having in place a strong industrial sector base. If we want our capital market to begin permanent recovery, then, we should be ready to diversify this economy away from oil because, without it, all we expect to continue to have is a speculative capital market. That explains why, under our present circumstances, it remains practically impossible to sell off these assets without a value transfer from taxpayers to shareholders of these banks.

Building strong goodwill and confidence in our banking industry will require integrating policies and techniques for managing liquidity, lending profitably, and investing rationally. It also will require being able to control operating expenses, managing interest rate sensitivity, utilizing risk management techniques, and strategically planning for the future. Having played a major part in causing the crisis, it is now necessary that, going forward, we should make margin lending illegal since it makes no sense borrowing money to play jackpot. As long as questionable assets remain so opaque, investors will continue to worry about new blow-ups. It’s the high-level distrust investors now have about the asset values on bank balance sheets that make it a difficult task for AMCON to expect profitably selling off the toxic assets.

Three technocrats
Let me end this piece by saying that the three technocrats who have been doing all they can to give our financial system a world-class status, notwithstanding all obstacles on their way, should be praised rather than molested by those who, for selfish reasons, want to stop them. The CBN governor has done so well within a short time in office. Just like Rosa Park’s fearlessness that triggered a human rights revolution in the US in late 1950s, the no-nonsense capital market surgeon-general, Ms. Arunma Oteh, should be praised for rare patriotism. It’s unfair to hold her responsible simply because she was handed for repair our badly damaged car, while those who caused the damage should be free from questioning about how they caused the damage. As for Mustafa Chike-Obi, definitely, he has made his father so happy that he should be jubilating in his grave that his son is one turning Nigeria’s badly damaged financial economy around.

As is the case in the US where the Federal Reserve System and Security and Exchange chiefs enjoy long tenures in office, besides depoliticizing these very important offices, with long tenures, our own chiefs could themselves become masters of this complex and expensive game.