As Nigeria’s Banking Stocks Crash, Central Bank of Nigeria Must Review Recapitalization Policies

I agree – I am a village boy. But I have it on record that I am not a fan of the Central Bank of Nigeria (CBN) recent  policy where banks’ retained earnings are excluded from the recapitalization process. My position was that it would make capital utilization inefficient: “Bank Recapitalization In Nigeria Could Make Capital Inefficient Through Exclusion Of Retained Earnings”.

I have noted that markets become inefficient where capital is designed to have “tiers” based on many factors. Adam Smith in his invisible hands theory cautioned against that. So, if you structure your recapitalization to prefer people in New York, London, etc to invest in Nigerian banks (they export USD to Nigeria, but have to convert to Naira, to buy the equities which are sold in Naira), you are creating a tiered system.  That is bad.

The zenith of any efficient market is when Naira from New York, London, Umuahia, Kano, Ife, Jos, Nairobi, Moscow, etc all have equal weights.  But when fudge factors are introduced to rank capital based on source, you destroy a market. Diamond Bank which funded my doctoral program in banking and finance helped me to understand the dimensions of global finance, international market and currencies.

CBN’s policy which is geared to attract USD to our equity market is causing real problems because it has made the market inefficient. FirstBank of Nigeria* is down 44% in April 2024, and 39% in the  last 30 days of trading. Remember, you cannot afford to annoy those currently investing in the Nigerian stock exchange (NGX), even as you hope for the Londoners, New Yorkers, etc to come. I have spoken as a village boy; I yield to the wiser people!

Comment on Feed

Comment 1: Every asset on a banks balance sheet is funded by two broad means:

1. Debt Capital (depositors and lenders)
2. Equity Capital (shareholders)

Most bank regulators around world are primarily saddled with two broad responsibilities:

1. Stability of the financial system
2. Protect capital providers (depositors, lenders and shareholders)

Let’s focus on number #2:

Without capital providers, there’s no financial system, there’s no bank, there’s economy.

However, there’s often a divergence of interest between debt capital providers and equity capital providers.

Hence, the bank regulators needs to use a hierarchy – and in that hierarchy – Debt capital providers rank higher than Equity capital providers. What this means is that a bank regulator will first and foremost protect Debt capital providers before Equity capital providers.

Now, even amongst Debt capital providers there’s also a hierarchy and generally: Depositors rank higher than lenders. Hence, a bank regulator will protect depositors first before lenders.

Amongst lenders, there’s also a hierarchy: secured lenders ranking higher than unsecured lenders.

What is my point?

Capital is tiered in the financial system – all capital are equal but some are more equal than others (animal farm).

Case in point:

Early last year, Credit Suisse collapsed and the Coco bond holders (a capital provider tier within the debt capital tier) was wiped out; their capital was used to absorb the losses the bank had incurred. The decision to do that was taken by the Swiss bank regulator – and they did it to protect other debt capital providers and ensure financial stability.

Now to Nigeria.

Who amongst the different tiers of capital providers stand to benefit the most from the recapitalization of the banks excluding retained earnings and also benefit from the withholding of dividend payments?

The answer is the debt capital provider: raising more equity capital ensures that the banks have adequate equity capital to absorb losses and protect their debt capital providers.

And the losers are the existing Equity capital providers: dividend withheld, dilution coming, stock price tanking.

So, in doing this, the bank regulator, in this case, CBN, is simply following it’s hierarchy of capital providers and at the same time ensuring the stability of the financial system.

Banks are highly leveraged – roughly for every 1 naira of asset you see on a banks balance sheet, more than 80kobo was funded by debt capital providers. If you successfully protect Debt capital providers, you have successfully protected the bank from collapsing.

So, while Equity capital providers are bleeding at the moment (it will be short term), I strongly believe that CBN’s decision will ensure a long term stability of the banks and protect the most important source of capital for the banks.

My Response: The scenario you created is self-evident but is different from my focus. We do know that we preferred shares, ordinary shares, etc. Depositors, debtors, equity holders, etc are not within the issues being debated on bank recapitalization; so, that is totally irrelevant in the debate. Read my piece and my piece is solely focused on the funds used to buy shares, and the need for fairness.  

If I am in Kano and have N10,000 to buy GTCO Plc shares, I must be in the same tier as someone living in New York who wired N10,000 to buy the shares. And if you make policies to entice that person against me, I will not like it. That does not bring classes of shares which we know are never the same, and are tiered. In liquidation, for example, debtors go first before ordinary shareholders, etc.

Here, I am saying N10k from Kano should be respected as N10k from London! If both are not weighted at the same level, you are unfair to one person. I wrote “rank capital based on source”, making it clear where I was focusing on.

Comment 2: Ordinarily, using retained earnings for recapitalization should have been a welcome idea but looking at the banks that have released their financial statements, I see their profits coming from unusual activities which they might not be able to repeat next financial year. If about 90% of your total profit is made from foreign exchange gain, then there is need for caution. Historically, what has been the level of profit of these banks in the last 3 years? Can they sustain same feat next year and beyond?

The recent run on the shares of Nigeria banks, I can say is more as a result of existing shareholders’ perception of dilution. If the existing shareholders perceive that the bank might issue new shares and it will affect the value of their shares, it might lead to sell-off. In First bank, there has been contention about who has the controlling share at the bank so if a large shareholder decides to minimize his risk due to the fact that he is not willing to increase his/her investment in the bank, it will definitely have a huge impact on the market. Access bank just changed its leadership; I think this will likely affect its ownership and share structure and even many of these banks have been dropping shares for the past 3 months.

… the regulator, CBN, has come out to say that retained earnings of banks are not allowed to be part of the capitalization. If it was allowed then the banks can talk about scrip or bonus shares in place of dividend.

For the banks, it means more work and increased capacity to handle big ticket business. For shareholders, it’s an opportunity to scheme and for the economy, it means increased opportunity for the real sector and stronger financial industry.

My Response:  The recapitalization is a good policy. It is necessary. But consider this scenario. A bank makes N20 billion for 100 shareholders (think of units)  and the bank cannot pay dividends. The bank goes to the capital market, raises more funds, and now has 120 shareholders. Later, it pays dividends across 120 shareholders. How would you feel if you are among the 100 shareholders?

Strategically, since there would be dilution, the best thing is to sell high, and rejoin later, post recap. I think that is what is happening because there is no bottom on how far the banks could dilute!

Investors are not charities, and even though they think this is done for the economy, they do not want to carry the “cross”

I agree – I am a village boy. But I have it on record that I am not a fan of the Central Bank of Nigeria (CBN) recent  policy where banks' retained earnings are excluded from the recapitalization process. My position was that it would make capital utilization inefficient: “Bank… pic.twitter.com/qNWK14kOaW

— Ndubuisi Ekekwe (@ndekekwe) April 24, 2024

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