The CBN Reviews Capital Requirement for Banks: Our Perspective

The CBN Reviews Capital Requirement for Banks: Our Perspective

The Central Bank of Nigeria (CBN), on 28 March 2024 reviewed the capital requirement for commercial banks, merchant banks and non-interest banks operating in Nigeria. The CBN believe the recapitalisation exercise is necessary for banks to enhance their resilience, solvency and capacity while continuing to support the growth of the Nigerian economy amid the prevailing macroeconomic challenges. Specifically, the exercise is the apex bank’s response to the impact of the naira devaluation on the capital of banks and to ensure that the banking industry has an adequate capital buffer to support a $1 trillion Gross Domestic Product (GDP) envisioned by 2026 and promote financial stability.

The CBN also changed the composition of the regulatory capital for the banks. Hitherto, the shareholders’ funds was used as the regulatory capital and with the minimum threshold set by the apex bank. However, only the paid-up capital, comprising only the share capital and share premium, is allowed as regulatory capital under the new dispensation. Specifically, other components of the shareholders’ funds (including retained earnings) and additional tier 1 instruments will be excluded in the computation of the regulatory capital.

New banks are expected to meet the new requirement as part of the conditions to be met before a banking licence is issued. However, existing banks and those with approval-in-principle (AIP), to commence banking operations, are given 24 months to shore up their paid-up capital which will become effective on 1 April 2026 the following medium:

  • Injection of new capital through private placements, right issue and/or offer for subscription
  • Mergers and acquisitions
  • Upgrade or downgrade of license authorisation

Banks with paid-up capital below the proposed minimum are required to submit the plan to shore up the shortfall to the apex bank not later than 30 April 2024.

The last regulation-induced recapitalisation exercise in the banking industry was implemented in 2004. At the time, all banks had a homogenous banking licence (universal banking licence) with ₦25 billion ($190.8 million @₦131/$) as the minimum capital. The new directive seems to align the minimum capital with its equivalent in USD. Using the official exchange rate (₦1,303/$) on the date of the announcement, the national commercial banks are expected to have $153.5 million equivalent as the paid up capital. While the $383.7 million equivalent that the international banks are expected to maintain as paid-up capital is almost twice the minimum capital in 2004, it is expected given that they are significantly exposed to cross-border risk.

Given the information in the available financial statements, none of the banks have paid-up capital above the proposed minimum. However, when we consider the ₦10 billion raised by Jaiz Bank Plc (a non-interest bank which requires a relatively less stringent paid-up capital requirement) through a private placement in March 2024, it is the only bank with paid-up capital exceeding the proposed regulatory minimum. Thus, we anticipate an inflow of circa ₦4 trillion to meet the new capital regulation. We anticipate significant pressure on the CBN to use the total shareholders’ funds for the computation of regulatory capital or at least to include retained earnings. Should the retained earnings be used for the computation, we expect a reduction in the capital inflow to circa ₦1.5 trillion.

In our view, the proposed recapitalisation exercise has some merits given the massive naira devaluation since the last regulatory-induced recapitalisation exercise was implemented in 2004. Although some banks implemented capital raising exercises subsequently while also growing the capital base organically through retained earnings, the capital base has continued to decline in USD terms. Conversely, the persistent naira devaluation and the harsh operating environment have continued to bloat the risk-weight assets of Nigerian banks. Notwithstanding the forbearance given by the CBN, the surge in the number of banks that breached the single obligor limit (20% of shareholders’ funds) following the naira depreciation in 2023, reflects the need for an inflow of additional capital. Thus, we believe the recapitalisation exercise will strengthen the Industry’s capital base and provide additional buffers to navigate the turbulent operating climate.

In our opinion, the recapitalisation exercise is necessary to provide the funding needed to drive the $1 trillion economy the current administration is trying to achieve. Based on the experience of the last regulatory-induced recapitalisation exercise, we believe new sectors will be created while some existing industries will be expanded as the banks seeks to generate returns for the enlarged capital base. Thus, addressing the declining consumer purchasing power, strengthening the judiciary and other institutions that ensure the sanctity of contracts, de-risking some sectors of the economy, and reducing the bureaucratic bottlenecks at various government institutions and other challenges will be necessary to support the anticipated $1 trillion economy. The banks will also need to be innovative and increase de-risking activities in businesses and industries that are attractive but above the risk threshold.

The recapitalisation exercise is expected to significantly increase the size of the banking industry and the complexity of transactions supported. Thus, we believe upscaling the CBN to effectively supervise a banking industry with such size is imperative; given the events that occurred following the 2004 recapitalisation exercise.

Should the recapitalisation exercise be implemented as stated by the CBN, we anticipate a revolution in the banking industry which could exceed those witnessed during the 2004 exercise. New shareholders and institutional investors are expected to take advantage of the available opportunities. Given the low valuation of Nigeria banks (in USD terms), the relatively good performance of the banks and the appetite for banking licenses as reflected in the number of applications pending with the CBN, we believe the Industry should be able to attract the needed investments to shore up the capital base. We also anticipate some mergers and acquisitions similar 2004 when the regulation-induced recapitalisation exercise reduced the number of banks to 25 from 89.

We believe the tier one banks, will successfully raise the required capital given their strong franchise value, market share and consistent dividend payout to shareholders. However, tier 2 and 3 commercial banks might find the capital raising challenging. Thus, we anticipate mergers and acquisitions while some will scale down their scope of operations to comply with the minimum capital directive.

In our view, the recapitalisation exercise might accelerate the exit from the merchant banking segment which has contented with various challenges that moderates its profitability. As at March 2024, two merchant banks are in the process of conversion to regional banks.

However, the impact of the regulatory-induced recapitalisation will be most minimal in the non-interest banking segment. As at 31 December 2023, the paid-up capital of most non-interest banks are not significantly lower than the proposed regulatory capital.

In our opinion, the recapitalisation exercise is needed to strengthen the banking industry, support the rejuvenation of the economy and attract foreign currency inflow. Nonetheless, we believe that adequate measures must be instituted to ensure that the exercise is not used as an avenue for laundering illicit funds. The CBN must also ensure that each bank has the adequate governance structure and risk management framework to support the new financial institution.

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