“BANKING SECTOR CONSOLIDATION IN NIGERIA AND THE NEED TO GENERATE SUPERIOR RETURNS”

On Tuesday, 6^th of July 2004, Central Bank of Nigeria governor, Professor Charles C. Soludo made pronouncements on banking sector reforms. This was designed to ensure a diversified, strong and reliable banking sector, which will ensure the safety of depositors money, play active development roles in the Nigerian economy and becoming competent and competitive players both in the African and global financial systems. Others are encouraging the emergence of regional and specialized banks.

However, Nigeria might be the 13^th largest oil-producing nation in the world with an estimated population of 137 million – the most populous Black nation in the world – but the state of its economy and infrastructure is yet to reflect the benefits of this position.

The banking sector has continuously been labeled as the major culprit for this situation. It is believed to have completely reneged on its role of financing sustainable economic development by rather supporting the import-dependence nature of te economy. Most of the revenue generated by banks is import business-related. This is largely due to the highly fragmented nature and the weak capital base of Nigerian banks.

But how the sector revitalizes itself and stands to the challenges of 21^st century banking, towards ensuring that stand-alone banks can boast of superior returns at the end of the financial year and partake in the reconstruction of the nation’s economy.

It is already widely recognized that one of the limitations of the banking sector in Nigeria is that most daily payments for commercial and other transactions, involving the overwhelming majority of the population, are being carried out outside the banking sector. This limitation constricts and stunts the development of the country’s economy, with far-reaching consequences to domestic savings and domestic investments, and for the modernization of agriculture and of small and medium scale manufacturing, which are essential requirements for self-sustained economic development. This limitation of the economy with regards to payments also discourages many forms of foreign investments, which find very attractive, the country’s substantial home market for consumer goods.

These limitations of the banking sector have various causes. But a major one among these is that this sector has not yet adapted its orientation, methods of operation and whole ethos, to the systems of commercial and other payments actually operated by the majority of the people of Nigeria in both the rural and urban areas.

In many parts of Nigeria, for some transactions, payments in public with, or without formal witnesses, are normal. But payments for other transactions are normally in private. The banks as they are now, have not adapted to this. Neither have they adapted to the fact that, almost all over Nigeria, people with substantial sums of money to pay, or to receive, can not just make these payments, or collect these sums of money, from any Tom-Dick-and-Harry, just because he, or she happens to be the cashier, or, the manager of the bank. They will only make these payments to persons they have built some relations of recognition, respect and trust with. As a result, the banking system is avoided for large volumes of transactions, which if the banks had adapted to the moral economy of this country would normally be done through them.

Infact, the banks in Nigeria have not yet adapted their operations to the economic behavior of ordinary Nigerians, to enable many small shareholders, even their own shareholders, to get their dividends paid to them. The operations of these banks largely excludes these shareholders, even for something as basic as cashing a dividend certificate.

There are, besides these, many other limitations of Nigerian banks, which cripple their capacity to provide adequate banking services, which can propel the economy forward. One of the major areas of their shortcomings is in the limited reach of their saving services. The extensive networks of savings and credit schemes found all over the country, known as adashi, esusu and by other names, have up to now not linked up in a sustained, productive way with Nigerian banks. All the rhetoric about micro – credit from the highest levels of the Nigerian Government, have evaded facing up to this woeful failure of Nigerian banks and of the governments in creatively adapting to, and developing these vital systems of savings and credit.

It is widely recognized that savings, by individuals, families, clans, public institutions, municipalities, local, regional and central governments, are key to the rapid and sustained economic progress of China, Korea, and most of South East Asia, over the last 40 years. Domestic savings and not foreign direct investment, has been the crucial factor, crucial in earlier cases of successful investment in to the modernization of agriculture and industrialization in Europe, the Americas and Japan. Nigeria cannot take-off economically in to the 21ist century unless and until, its banks are capable of raising the rate of its domestic savings and investments to a much higher level.

It has been seen as a paradox that despite the state of the economy, the country’s reserves are still deposited in foreign vaults due to the low capacity of the local banks. This has rendered the system very marginal relative to its potentials and in comparison to other countries. There has therefore been the need to be proactive and to strategically place Nigerian banks to be active players and not spectators in the emerging world economy.

In as much as the minimum capital base requirement for banks was N 2 billion (before the recent requirement of N 25 billion), a lot of banks still depended on deposits from the public sector. Many banks appeared to have abandoned their essential intermediation role of mobilizing savings and inculcating banking habit at the household and micro enterprise levels. Although the distribution among banks of public funds was not uniform, there were some banks whose dependency ratios were in excess of 50%. The implications were that the resource base of such banks became weak and volatile, rendering their operations highly vulnerable to the savings in government revenue, arising from the uncertainties of the international oil market.

To effectively provide banking services to customers and mobilize funds from the public, banks will need to deploy various capital-intensive service delivery channels. The over-dependence on cheap public sector funds has negatively affected the drive of Nigerian banks to provide these alternative service delivery channels and therefore undermined the need for banks to increase their capitalization. With the new reforms, banks should, finally begin to look beyond the minimum N 25 billion and regard these policy changes as an opportunity to emerge as mega banks with capitalization of probably over N 70 billion to effectively migrate into and participate in the global financial marketplace.

As the banks undergo reformation, a new look sector should emerge functioning as an effective enabler of development in other sectors of the economy. In the Nigerian situation, the banking sector is experiencing phenomenal growth at about 24% while the real sectors of the economy have been experiencing slow growth, stagnation or even negative growth. The reasons behind this abnormality in sector growth trends cannot be too far from the fact that the core income – generating line for the Nigerian banking industry has been import finance. The impetus for the Nigerian banking sector to support the relatively more painstaking riskier real sectors of the economy ha thus been eroded since the import business with shorter turn-around time and reduced risk can deliver the required profitability for the banks. This situation has lingered on for years and unfortunately, the impact has been a falling Naira and dwindling foreign reserves.

With the reforms and specifically the removal of public sector funds from the banks, banks should be forced to shift their focus to the real sectors and target the cash flows of these businesses. Essentially, banks will thereby support economic growth in a sustainable way. The resultant effect will be a banking industry that effectively meets the financial needs of the Nigerian economy at all levels.

Superior returns, shall not only be in monetary forms because the reform will have a positive impact on the labour force in the long term. The banking industry is a significant employer of labour, employing over 470,003 of the skilled workforce in Nigeria. A potential fall-out of the proposed industry transformation will possibly be staff redundancy in a bid by banks to maximize efficiency. However, the number of the economically active population of the country, which is to be about 71 million individuals, makes the overall impact of potentially layoffs minimal. While this maybe disruptive in the short-term, the benefits to the economy over the long-term are more extensive. A stronger banking industry will be able to adequately support rejuvenating the real sector and ultimately creating more jobs within the economy in the long-term.

With the recent consolidation of banks due to inability to meet up with the minimum capital base stipulated by the Central Bank of Nigeria, new, strong and reliable mega banks shall emerge with the capability, to drive the nation’s economy in to the global marketplace. The banking panorama is expected to change after the consolidation programme currently in progress. Mega banks with a large capital base shall dot the landscape with corresponding large assets, deposits, customers and shareholders base and funds. This change though will no doubt create challenges for both the operators and regulators of the industry. To curb this, the Central Bank, has embarked on the establishment of an Asset Management Company (AMC) to purchase non-performing loans in emerging banks that cannot face the challenges.

As the banking sector faces reformations, there are great needs, to turn in superior returns. But how the banks ensure the realization of this goal;, remains the unanswered question. One major obstacle to realizing this would be poor corporate governance. Post consolidation banks should design, install and implement transparent and accountable corporate governance structures, processes and strategies. Corporate governance should provide for zero tolerance of insider abuse and non-performing insider credit which is the major reason for financial and management crisis in some banks.

Design, installation and implementation of effective risk management and internal control systems to ensure that risks they take on in their operations are properly assessed, priced and managed. Consequently, persons to head the risk management and internal control portfolios must be of top management grade with the requisite skills, power and authority to execute their mandate. The corporate governance codes must provide for the monitoring of compliance with anti-money laundering laws and regulations.

The Central Bank stands in a very key position, in revitalizing the banking sector and generate superior returns after all. What is necessary, is an atmosphere where the Asset Management Company (AMC) and a technical committee set up by the apex bank, would screen intending banks on money handling, working experience, size, strength et al as the Central Bank wishes, so that our monies stored up in foreign vaults which continually generate huge interest for such banks abroad, would be “deported” and lodged in our own now mega banks. With this happening, the interests that once were accrued for foreign banks would now be accrued for our local banks, and at the end, invested in the real sector of the economy.

However, one realization today is that investors are seeking above market (superior) returns on investment without subjecting their capital to undue risks. Accomplishing these often, contradictory goal require a discriminating investment strategy, an approach affordable by private equity investment partnerships. A private equity investment can be defined as a stock ownership stake in a company with equity securities that are publicly traded. Superior returns are developing corporate programs for management and employees, and identifying appropriate add-on acquisitions. Private equity investments represent an attractive form of diversification for banks and other large investors. Allocating assets to private equity investments can generate a significant long-term impact on the value of portfolio.

For example, assume that a $100 million fund generates a consistent return of 10% a year. Over a 10-year period, the fund will grow to $259.4 million. What would happen if the fund decided to switch a small portion of its assets - $5 million – into a private equity investment that yielded a 25% annual return, leaving the remaining $95 million to accumulate at 10%? The first year’s increase in overall return would be $750,000, yielding the investor 10.75% instead of 10%, a modest but worthwhile gain. But over a 10-year period, the results would be truly dramatic: the fund’s assets would grow to a total of $293 million, an increase of $33.6 million. That works out to an average annual return of just over 11.3 percent, a 130 basis point improvement.

There is every need for greater superior returns by Nigerian banks due to some distresses like high costs of IT, inflation and interest rate. But there is every need for greater profits, to have enough so that the real sector growth can be encouraged. The import finance dependence has to be abolished. But it is only when the industry is getting enough from the real sector that it is going to shy away from import business relations, and settle down for homegrown industrialization.

The value of the Naira has continued to drop and this is no good omen for the economy. The better the profit turnover, the more cash flow and then a stable Naira. The apex bank must also play a part in realizing this need. It must stand disciplined, and stick to its agenda for improving the industry. As such, the internal machinery for effective supervision of the industry must be put in place. The judicial system should also begin to prepare first, for post-consolidation altercations that may arise because of some incompatible “marriages” and then necessary e-laws to guide the new face of banking. Thus even as the portfolios increase a new haven would appear to have been created for criminals and debtors. This is why the judicial and security systems in the country must provide protection against both armed and unarmed criminals.

The living condition of the masses should also be looked into, as they are the depositors of major funds. Community projects and environmentally conscious developments should be planned as they also stand as a type of investment.

The banking regulations towards ensuring greater superior returns must also walk the same path with the Federal Government’s reform policies. These policies though long-term, should be made lenient enough, to yield short-term benefits. The Nigerian State is heading towards holding the controls of world economics and only when its economy is vibrant and the banking sector strong, shall it be able to withstand any storm at sea.