MONEY MATTERS: A stitch in time saves nine

The

Governor of the Central Bank of Nigeria (CBN) is auditing the loan

portfolio of all banks and asking them to make provisions, in

accordance with the Prudential Guidelines, in respect of loans deemed

as non-performing. His auditors examined ten banks during the first

wave and are looking at the rest in the second.

After the first wave of audits, he declared five

banks as technically insolvent (liabilities exceed assets), sacked the

Directors (executive and non-executive) and injected new capital of

about N420 billion into them. By the time he completes his audits,

about a dozen banks may be found to be technically insolvent and the

amount of new money required to re-capitalise all these banks could be

between one and two trillion Naira.

What are the implications of the Governor’s actions on the economy, the banking industry, depositors and investors in banks? Although losses erode capital, the effect of these losses on the capital of the industry should be neutral.

This is because the CBN is injecting new capital into the troubled banks to replace what has been eroded by losses.

The CBN has

acknowledged that it is raising the money that it is being injected

into these banks through “quantitative easing” a new euphemism for

printing money. This source of financing causes inflation and reduces

the value of the money in our pockets.

Therefore, in

substance, the CBN is taxing all of us to re-capitalise the technically

insolvent banks. This is not necessarily a bad move because it is being

done at a time when the amount of money in circulation may be falling

as the banks clean up their balance sheets.

It is therefore

safe (at least in the short run) to print money but the CBN must make

it clear that this is something it will not do again.

Banks pay a

significant portion of the companies’ income tax collected by the

Federal Inland Revenue Service (FIRS). Losses incurred by the industry

this year mean that we are likely to see a significant reduction in the

level of companies’ income tax collectible by the FIRS in 2010. VAT

collections will also be adversely affected, though to a lesser extent,

as banks cut their spending in their struggle to stay in the black.

The government should therefore expect lower non-oil tax revenue in 2010 and this may further widen her fiscal deficit.

The banking

industry should come out much stronger because its latent asset quality

problems have been brought to the fore and addressed. Confidence,

initially amongst banks and later of depositors, should be restored.

Since the CBN is

forcing the banks to take the provisions once and for all and banking

business is fundamentally profitable, the industry should return to

profitability next year.

Depositors need not

panic. This is because by re-capitalising the troubled banks, the CBN

is providing ample cushion to protect depositors’ funds. In substance,

the CBN is guaranteeing that depositors will not lose their funds. I

believe the apex bank should say this explicitly instead of the vague

statement that it will not allow any banks to fail.

In measuring the

impact on investors, the banks fall into two categories - those

adjudged solvent and those declared insolvent. The impact of all this

on the solvent banks should be a reduction in current year’s profits.

In subsequent years, profits should return to normal levels and the

wise investor should discount current year’s results in valuing these

banks.

For those that have

been declared insolvent and have received fresh capital from the

government, it is important to measure the extent to which the returns

payable on the capital provided by the government will impair future

profitability. Secondly, there is need to also measure the extent to

which capital has been impaired by losses. This is because such banks

have to make good these losses before they can resume paying dividends.

Lastly, the long-term investor must carefully assess the extent to

which these banks have improved the process they employ in booking and

managing their loans. Put simply, it will take these banks much longer

before they can return normal profits and resume paying dividends.

The principal

lesson of this whole exercise episode is that, in substance, the

depositors own banks. If banks are managed in the best interest of

depositors, shareholders and management will benefit. Otherwise

management will eventually be sacked and returns to shareholders will

be significantly disrupted. Unfortunately, the taxpayers will always be

called upon to pick up the cost of bailing the banks out.

When one recalls

the large speculative loans given by the banks in 2006 and 2007 you

remember a few paragraphs in the Advice to Bankers of 1863 one of which

says “Pursue straightforward, upright, legitimate banking business.

‘Splendid financing’ is not legitimate banking and ‘splendid financiers’ in banking are either humbugs or rascals.”