Nigeria
Financial Sector Stability Assessment
Author: International Monetary Fund. African Dept.
Publication Date:
28 May 2013
eISBN:
9781484304440
Language:
English
Keywords:
ISCR; CR; bank liquidation regime; bank supervisor; credit line; AMCON bond; intervened bank; bank capital; CBN circular; oversight role; CBN discretion
Download PDF (1.7 MB)

This Financial Sector Stability Assessment on Nigeria discusses the macroeconomic performance and structure of the financial system. Although Nigerian economy experienced both domestic and external shocks in recent years, the economy continued to grow rapidly, achieving more than 7 percent growth each year since 2009. The performance of financial institutions has begun to improve, though some of the emergency anti-crisis measures continue to be in place. However, the regulatory and supervisory framework has gaps and weaknesses. In sum, the Nigerian economy has emerged from the banking crisis, and has the potential to enjoy an extended period of strong economic growth.

Abstract

This Financial Sector Stability Assessment on Nigeria discusses the macroeconomic performance and structure of the financial system. Although Nigerian economy experienced both domestic and external shocks in recent years, the economy continued to grow rapidly, achieving more than 7 percent growth each year since 2009. The performance of financial institutions has begun to improve, though some of the emergency anti-crisis measures continue to be in place. However, the regulatory and supervisory framework has gaps and weaknesses. In sum, the Nigerian economy has emerged from the banking crisis, and has the potential to enjoy an extended period of strong economic growth.

I. Macroeconomic Performance and Structure of the Financial System

11. The Nigerian economy experienced domestic and external shocks in recent years, but the economic outlook remains positive. Large buffers, built before the crisis, and low public debt, helped mitigate the impact of the 2008-09 shocks by providing room for expansionary fiscal policy. Only moderate deceleration in growth, to around 6.3 percent, is expected in 2012. High oil prices in 2012, and efforts to dampen abuses of the fuel subsidies, contributed to a strengthening of the external current account surplus and, together with a tighter monetary policy stance and strong portfolio inflows, increased international reserves to five and a half months of import cover by end–November 2012.

Figure 1.
Figure 1.

Recent Macroeconomic and Stock Market Price Developments

Citation: IMF Staff Country Reports 2013, 140; 10.5089/9781484304440.002.A001

12. The continued economic stabilization helped improve market sentiment. In response to stronger fiscal and external buffers, as well as ongoing economic reforms, Standard and Poor’s (S&P) raised its long-term foreign and local currency sovereign credit ratings on Nigeria from B+ to BB-, putting them in line with those of Fitch and Moody’s.1 Barclays announced the addition of Nigeria to its emerging market local currency bond index from end-March 2013. JPMorgan added Nigeria’s local currency bonds to its GBI-EM indices in October 2012.

13. However, failure to implement Nigeria’s fiscal consolidation strategy could pose risks to financial stability. In particular, overly ambitious infrastructure spending, continued fuel subsidies and directed credit schemes, and large contingent liabilities in the form of AMCON bonds, could require sustained high interest rates to contain inflation and fight pressures on the currency.2

14. The Nigerian financial system is growing fast and becoming increasingly integrated into the regional and global financial systems (Table 2). As of end–2011, gross financial system assets accounted for 61 percent of GDP. At the core of the system are banks, followed by pension funds. Banks are the main players in the money markets; act as settlement banks in capital markets, and account for 36 percent of total equity market capitalization.3 Non-banking financial institutions (NBFIs), other than pension funds, stand at 7 percent of total financial market assets. The insurance sector has the equivalent of less than 2 percent of GDP in assets. Life business is underdeveloped, with assets constituting only about half of non-life sector assets.

Table 2.

Nigeria: Structure of the Financial System, 2011

(₦billion, unless specified otherwise)

article image
Source: CBN.

15. Capital markets remain relatively small, with low investor confidence since the crisis, and large sectors of the economy underrepresented. The only securities exchange operating in Nigeria is the Nigerian Stock Exchange (NSE). Its market capitalization dropped from US$80.6 billion (30 percent of GDP) at end-2008 to a low point of US$27.7 billion, before recovering to US$52 billion (12 percent of GDP) at the end of September 2012. At end September 2012, there were 202 listed companies, of which only six new companies have listed since end–2009. The top five companies account for about 60 percent and the largest company over 25 percent, of market capitalization. Equity trading is dominated by foreign investors.

16. Despite a large number of broker-dealers in the Nigerian securities market, the sector is concentrated. The 10 largest dealing members had over 75 percent market share during the first half of 2012. The collective investment scheme sector remains small. As at September 7, 2012, the Net Asset Value of the funds under management remained at approximately US$600 million, managed in only 43 collective investment schemes that were primarily open-ended unit trusts.

Table 3.

Nigeria: Comparative Size of Capital Markets

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17. The insurance sector is underdeveloped. Penetration of insurance is less than 1 percent of GDP; there has been minimal growth in written premium over the last decade in real terms, and more than 90 percent of premium written is for commercial risks. There is potential for micro-insurance and takaful insurance (Appendix 3).

II. Financial Sector Risks and Resilience

A. Banking System Structure and Performance

18. The Nigerian banking system has undergone significant reforms. After the 2005 bank consolidation and capitalization, Nigeria experienced rapid credit expansion, as banks broadened their activities and moved to the untapped retail sector, and borrowers speculated in the equity market (margin lending collateralized by shares). The oil price drop and currency devaluation in 2008 stressed particularly those banks with heavy concentration in the energy sector, while the stock exchange downturn affected banks exposed to margin lending. By 2009, the banking sector was in crisis. Widespread insider abuse and inappropriate related-party lending were identified. In response, the CBN undertook a comprehensive set of measures (Box 1). Further reforms are under way: the full adoption of IFRS; the end of universal banking; and differentiating bank licenses by activity profile.

19. The banking system is dominated by six banks out of 20 in total. At end–2011, the six dominant banks (one pan-African and five domestic banks) accounted for about 60 percent of total banking sector assets. Unlike in many other sub-Saharan African countries, European banks in Nigeria held only 4 percent of total assets.

20. The Nigerian banking system appears well capitalized, liquid, and profitable (Appendix Table 6.2 and Figure 2). The capital adequacy ratio (CAR) grew from under 2 percent in 2010 to an average of 18 percent in June 2012.4 Tier 1 is almost 100 percent of total qualifying capital, while the leverage ratio is about 11 percent of net assets. The NPL ratio fell to about 5 percent of gross loans by end–June 2012, mainly due to the transfer of bad assets to the Asset Management Company of Nigeria (AMCON).

Figure 2.
Figure 2.

Nigeria: Selected Financial Soundness Indicators, 2008–129

Citation: IMF Staff Country Reports 2013, 140; 10.5089/9781484304440.002.A001

Source: CBN.

21. Banks’ true positions may be less positive because current classification rules delay the recognition of problem loans.5 Eight banks had negative profitability in 2011, but most of these were profitable in the first half of 2012. By end–June 2012, return on assets (ROA) for the industry had risen to 1.2 percent, and return on equity (ROE) to 8.9 percent. Longer prospects are unclear, given that the improvement in 2012 derived at least in part from the one-off effect of the disposal of assets to AMCON.

22. Three small banks demonstrated even more severe weakness. One bank (under 2 percent of banking assets) has been insolvent since at least June 2012. The CBN intends to resolve it by end–2012 through merger. Two others are former bridge banks, with AMCON being the main owner (Figure 3).6 All three weak banks reported negative profitability as of end–August 2012.

Figure 3.
Figure 3.

Nigeria: Bank-Wide Financial Soundness Indicators, June 2012

Citation: IMF Staff Country Reports 2013, 140; 10.5089/9781484304440.002.A001

Source: CBN.

Measures Adopted in Response to the 2008 Banking Crisis

Below are some of the measures taken by the CBN:

  • Ten banks were intervened and eight had their management replaced.

  • The CBN provided liquidity and capital support of ₦620 billion (US$4.1 billion) in the form of unsecured, unsubordinated debt.

  • A guarantee of interbank and foreign credit lines of banks was introduced, and extended for six- monthly periods until end–2011.

  • The CBN publicly committed to protect all depositors and foreign creditors against loss.

  • The authorities established the AMCON to support the troubled bank resolutions and the banking industry more broadly.

  • The universal banking model was abolished in favor of a “back-to-basics” model, and a new bank license regime was introduced.

  • A new supervisory framework was adopted combining risk based and consolidated supervision.

  • A number of regulatory guidelines were issued, including capital adequacy, related parties and large exposures, risk and risk management, and internal control and auditing.

  • The CBN issued a Corporate Governance Code to the banks.

  • The CBN issued a directive on accounting and disclosure practices.

  • The placing of resident examiners in banks was instituted.

  • The CBN signed Memoranda of Understanding (MOU) with foreign supervisors geared toward receiving information on the financial condition, and adequacy of risk management and controls, of the various entities of the banking groups that have foreign operations.

  • Cooperation and coordination between the two agencies involved in banking supervision, the CBN and the Nigeria Deposit Insurance Corporation (NDIC), were strengthened.

  • Coordination was also enhanced through bi-monthly meetings of the Financial Services Regulation Coordinating Committee (FSRCC), on which the CBN, SEC, NAICOM, and NDIC participate.

23. In 2011, 20 percent of banks’ assets were held in short-term investments (treasury bills and the stabilization securities).7 However, weaker banks had a higher stock of AMCON zero-coupon bonds, while the rest had a higher proportion of treasury bills. In the first half of 2012, weaker banks started increasing their stock of T-bills, to about 10 percent of assets, although there seems to have been some reversal since.8

B. Risks to Banking Sector Stability

24. Although the financial system has recovered since the peak of the recent crisis, it is still vulnerable to global and domestic shocks. The likelihood and potential impact of key risks is assessed below and summarized in the Risk Assessment Matrix (Appendix I). While oil prices have recovered recently, a further deterioration in the global environment could result in a sharp drop in oil prices. Such a shock, or disruptions in oil supplies (including from theft), would impact Nigeria’s current account and fiscal positions, thereby limiting the buildup of international reserves and increasing public debt. A more immediate risk stems from the recent upswing in terrorist activity in northern Nigeria, that is harming the non-oil sector (particularly agriculture and commerce) there. A further deterioration in the security situation would raise business costs in an already high-cost environment, and dampen activity.

C. Stress Tests

25. Stress tests suggest that most Nigerian banks could withstand extreme shocks. The tests, which were carried out in close cooperation with the CBN (Box 2), included three macroeconomic scenarios, which were translated into single and multi-factor shocks: i) a slowdown in the global economy and a sharp drop in oil prices; ii) continuing terrorist attacks in the North; iii) economic deterioration elsewhere in Africa; and (iv) a decline in value of the AMCON bonds and increased contingent fiscal liabilities of the government. These tests suggest that a severe increase in overall NPLs would result in undercapitalization of just a few banks. The general resilience reflects banks’ high capitalization and currently low NPLs,10 which in turn reflects the banking system restructuring and recapitalization after the 2009 banking crisis. However, some individual banking institutions appear vulnerable, and one is insolvent even before any stress test. The credit risks analysis suggests that the highest risk comes from credit concentration to single names and group borrowers.

26. Stress tests were not derived from econometric time series analysis (so called macro stress tests) because of lack of structural breaks. The banking sector time series (including that for the NPLs) have recent and fundamental structural breaks due to the major consolidation since 2005–06, and the significant changes in the structures of the banks’ balance sheets following their surrender of bad assets. Among these effects was the reduction of NPLs from about 35 to about 5 percent in 2011.

Stress Test Scenarios and Shock

To approximate the impact of several macroeconomic shocks materializing at the same time, the stress tests translated a set of macroeconomic scenarios into a series of single and multi-factor shocks.11 Due to data constraints, the scenarios are based on expert judgment and historical qualitative and quantitative information where applicable. The following scenarios have been analyzed:12

  • A slowdown in the global economy is expected to result in a sharp oil price drop (about US$50 per barrel). This scenario would result in (i) aggregate NPLs increasing by 200 percent; and (ii) a further increase of NPLs of the same magnitude in the major sectors financed by the banks: oil and gas, general commerce, real estate and construction, and general loans.13 In addition, the rate of the Naira vis-à-vis the U.S. dollar would depreciate by 30 percent and the stock market index decline by 30 percent.

  • Continuing terrorist attacks would result in an overall shock to the economy (by at least three standard deviations of GDP). This scenario is expected to increase aggregate NPLs by 100 percent, depreciate the Naira vis-à-vis the U.S. dollar (and other major foreign currencies) by 30 percent; and depress the stock market index by 50 percent.

  • Economic deterioration in other African countries with Nigerian banks’ subsidiaries and branches would result in a structural deterioration of the Nigerian banking sector. This scenario is put as resulting in an increase of NPLs by 200 percent and a sharp decline of the local stock market index by 30 percent.

  • Decline in value of the AMCON bonds and increased contingent fiscal liabilities of the government. This scenario would result in the decline of bank capital, and in banks’ liquid assets, and thus in their liquidity ratios.

27. Single factor market risk tests confirm that most risks appear manageable. Banks are resilient to severe interest rate shocks, and the impact of the exchange rate risk is minimal, given the stringent net open position limits14 and the limited foreign currency lending to unhedged borrowers. Severe combined shocks would however cause at least two banks to become insolvent (see also Appendix II).

28. Liquidity stress tests suggest that the system could withstand liquidity pressure and absorb moderate potential losses, although some banks appear more vulnerable.15 All large banks pass the liquidity stress test, though some only by a narrow margin. However, some smaller banks appear vulnerable. Overall, the banking system could withstand relatively large liquidity pressures from the funding and market side, mainly as a result of current excess liquidity. A complete transfer of federal government deposits within 30-day period would result in an illiquid banking system.

29. The analysis demonstrates that in the event of a default of one bank, there would be only one small systemically unimportant bank defaulting through interbank linkages. The interbank market appears clustered with most banks being either lenders or borrowers, and contagion risk through interbank exposures is generally small (Figure 4). In general, the interbank market is capable of withstanding significant adverse liquidity and funding shocks.

Figure 4.
Figure 4.

Nigeria: Tiered Structure of the Banking System

Citation: IMF Staff Country Reports 2013, 140; 10.5089/9781484304440.002.A001

Note: The green nodes represent banks with CARs above 15 percent; yellow – banks with CARs between 10 and 15 percent; and black – banks with CARs under 10 percent. The thickness of the edges represents approximate amount of the obligations between the banks connected by these edges. The size of the nodes (vertices) approximately reflects the share of the bank’s assets in the total assets of the banking system.Source: CBN data and IMF staff calculations.

D. Systemic Liquidity Management

30. The CBN has struggled to contain the upsurge in systemic liquidity created largely by government spending of oil receipts. Over the past few years, the CBN has undertaken a number of reforms toward meeting its monetary policy operating target, including implementing an interest rate corridor, resolving problems with accounting and payment systems, and enhancing the effectiveness of its monetary policy instruments. Nonetheless, it still faces challenges:

  • Structural liquidity in the financial system continues to fluctuate, because oil revenues accumulate in banks for a month and are then disbursed to all tiers of government simultaneously. Combined with volatile oil prices, this makes monitoring and sterilization of liquidity difficult. Monetary policy implementation has been further challenged by the weakening of the oil price fiscal rule and the ECA.

  • At times, the CBN’s pursuit of multiple objectives has confused the markets, particularly after the 2009 crisis.16

  • Short-term markets are segmented. Some banks seem not to be able to participate.

  • Frequent changes to the operating procedures of monetary policy have undermined credibility. Over the past two years, the monetary policy rate (MPR) corridor has varied between 400 and 700 bps. The use of the cash reserve ratio (CRR), which was progressively raised from 1 percent in 2010 to 12 percent in 2012, drives an increasing wedge between banks’ costs and their revenues, and contributes to high interest rate spreads.

III. Macroprudential and Cross Sectoral Issues

A. Macroprudential Policy

31. Nigeria has taken important steps toward the identification and adoption of a framework for macroprudential policies. Nigeria has placed responsibility for macroprudential responsibility with a dedicated sub-committee of the inter-agency Financial Services Regulation Coordinating Committee (FSRCC).17

32. The FSRCC coordinates the supervision of financial institutions (Box 3). It does not however have an explicit mandate for financial stability, nor for financial crisis management. Nevertheless, it could be the natural forum for coordinating financial stability issues. So far, however, it is not evident how much impact the FSRCC has had. It should meet regularly on a more frequent basis, have a permanent secretariat, prepare detailed work programs, and ensure that it is fully abreast of cutting edge work on macroprudential policies and instruments.

B. Cross-Border Issues

33. Nigeria’s financial system is dominated by domestic institutions, but international linkages are increasing. The consolidation of the banking sector in 2005–06 generated capacity for several Nigerian banks to expand internationally, establishing subsidiaries particularly in Africa. A major regional bank headquartered outside Nigeria, and active in 32 African countries, has its largest subsidiary in Nigeria. One of the largest reinsurance companies is a regional entity, with headquarters in Nigeria and offices in much of Africa.18

34. The CBN has been gradually implementing initiatives to enhance its cross-border oversight. It has established a unit for cross-border supervision and put in place a Framework for the Supervision of Cross-Border Institutions, and has initiated and executed bilateral MoUs on cross-border supervision and cooperation,19 with three in 2012.20 Recently, the establishment of MoUs with host regulatory authorities has become a prerequisite for the initiation of Nigerian banking operations in foreign jurisdictions. The CBN has commenced joint examinations of Nigerian banks with host central banks in West African countries,21 and initiated a process for establishing specific Colleges of Supervisors for foreign subsidiaries of Nigerian banks. The CBN also participates in the core college established by the Financial Services Authority (FSA) for Standard Chartered Bank.

35. While its steps in this regard are welcome, the CBN faces challenges in further strengthening cross-border supervision. Among the obstacles are language barriers, differences in quality of supervision, reporting requirements, data reliability in some weaker jurisdictions, and off-site monitoring systems. The CBN has opened its supervisory training program to foreign inspectors to strengthen capacity in other jurisdictions. It is also actively promoting the harmonization of reporting requirements and off-site monitoring tools through the adoption of Electronic Financial Analysis and Surveillance System (eFASS).

The Financial Services Regulation Coordinating Committee

Membership: The FSRCC is chaired by the Governor of the CBN and comprises the Managing Director of the NIDC, the Director-General of the SEC, the Commissioner for Insurance, the Registrar-General of the Corporate Affairs Commission (the body that administers the provisions of the Companies and Allied Matters Act) (CAC); and a representative of the FMoF. The Director-General of PENCOM has also been admitted as a member, but the CBN Act needs to be amended to formalize this. The NSE, Abuja Securities and Commodities Exchange, and Federal Inland Revenue Service send observers to the FSRCC, and the CBN serves as the Secretariat.

Objectives: Its objectives include: (i) to coordinate the supervision of financial institutions especially conglomerates; (ii) to reduce arbitrage opportunities; (iii) to deliberate on problems experienced by members with any financial institution; (iv) to eliminate any information gaps; and (v) to articulate strategies for the promotion of safe, sound and efficient practices by financial intermediaries.22 Under Article 4 of the Charter of the FSRCC, the functions include:

  1. Identify the causes of distress in the financial system, examine resolution options adopted so far and recommend any other solutions and measures to avert future distress.

  2. Examine the regulatory and supervisory standards of each member and recommend areas that require joint supervision and enforcement.

Sub-Committees: The FSRCC has five standing sub-committees:

  1. Financial Sector Soundness (Chair: CBN) that conducts surveillance over potential risks and recommends measures to avoid systemic crisis.

  2. Harmonization and Coordinating (Chair: NDIC) that examines regulatory and supervisory standards, recommends joint supervision and enforcement and capacity building.

  3. Information sharing (Chair: SEC) that identifies processes for information sharing.

  4. Legal and enforcement (Chair: CAC) that identifies overlaps, gaps, conflicts, inconsistencies and enforcement cooperation.

  5. Financial Market Development (Chair: NAICOM) that indentifies and recommends areas to improve the financial system.

Information sharing: There is a multilateral MOU for information sharing between members of FSRCC and a website through which information is shared among member agencies.

Decision making: FSRCC decisions are taken on a consensual basis.

36. Ecobank,23 a pan-African financial conglomerate, presents particular cross-border supervisory challenges. Headquartered in Lomé, Togo, the Banking Commission of the West Africa Economic and Monetary Union (WAEMU) in Abidjan is responsible for exercising consolidated supervision, despite the limited presence of the group in the home country.24 In light of the supervisory weaknesses observed in some of its countries, this is challenging. The CBN supervises the Nigerian operations on a stand-alone basis, but may not observe losses elsewhere in the group, or for instance the build-up of intra-group exposures or double gearing of capital. Discussions with CBN staff suggested that there was little awareness of the bank’s overall condition.25 The CBN should ascertain that the home country exercises adequate consolidated supervision with respect to Ecobank.

37. The CBN should enhance its supervisory oversight over banks with a regional or international presence. Joint inspections should enhance international supervisory cooperation, both where Nigeria is host and where it is the home authority. Ex ante arrangements on what to do in the event of difficulties would be helpful. Crisis Management Groups can be set up to ensure that relevant information is shared and recovery and resolution plans prepared on a group wide basis. Infusions of capital from overseas should be subject to precise verification as to their sources to prevent recurrence governance issues that arose before the 2009 banking crisis. Finally, the headquartering of a bank in a country where domestic supervision may not be the strongest should lead the CBN to be particularly careful that it knows the bank’s full condition.

38. A recent CBN circular issued in May, restricting Nigerian banks’ capacity to capitalize their foreign subsidiaries, is not in the spirit of enhancing cross-border cooperation. Although the CBN claims that it would allow for exemptions for well-capitalized parent banks, the Circular does not seem to provide for any exemptions. Such measures risk undermining the goodwill and trust of host authorities necessary to strengthen home-host cooperation and coordination. Existing prudential requirements already grant the CBN discretion to refuse outflows of capital. It is recommended therefore that the circular be withdrawn.

C. Other Cross-Sectoral Issues

39. While, as indicated in the following chapter, each supervisory agency is confronted with distinct legal, regulatory and operational issues, there are a number of challenges that cut across them. These may be divided into macroprudential policy development and implementation; cross-border supervision; legal certainty; data issues; and capacity constraints.

40. All supervisory agencies seem to suffer from a lack of capacity. Maintaining financial soundness is challenging in any case, but all agencies are faced with major enhancements in their work in the coming period, for instance implementation of IFRS and relevant aspects of Basel III. There will be dangers to financial stability if sufficient staff with the necessary skills cannot be recruited.

41. Data deficiencies are also an issue. Data requirements for effective supervision have been rising recently, but infrastructure and capacity constraints have led to difficulties.

42. Legal certainty is a prerequisite for effective action in any area. During the crisis, policy was necessarily on occasion ad hoc, with measures implemented on the basis of narrowly-focused laws, regulations or guidelines, or even just official statements. As the crisis period recedes, there is uncertainty in a number of areas as to what the actual situation now is, for instance as regards the status of the blanket guarantee on deposits.

IV. Financial System Oversight

A. Banking Sector

43. In light of the potential risks and vulnerabilities to the banking sector, the CBN has taken decisive action over the last few years to strengthen its oversight. Though the banking crisis inflicted extreme and severe damage, there may be a silver lining. A sense of urgency was engendered, minds became focused and prompt action was taken.

44. Although these reforms are highly commendable, much still needs to be done, including:

  • Bank supervisors need the capacity to challenge banks effectively. They need to apply zero tolerance to non-compliance and corporate governance violations.

  • The HR proposal for separate career paths for employees in areas such as risk management, information technology, accounting and auditing, and project management, should be implemented expeditiously.

  • The BOFIA needs to be reviewed and updated. It was last amended in 1999, but since then there have been many changes to the internationally generally accepted framework for bank regulation and supervision.

  • The draft consolidated supervision framework, the draft code of corporate governance, and the framework for financial and bank holding company structures need to be finalized, issued, and implemented.

  • Blockages in the legislative process need to be addressed so that the legal and regulatory frameworks can remain current.

  • Gaps in the regulatory framework need to addressed, for instance in relation to market, operational, and interest rate risk.

  • The authorities need to enhance communication, cooperation, and information exchange, including through the FSRCC.

  • The authorities need to pursue contingency planning for crisis management, that simulation exercises are undertaken periodically with clarity of roles for each agency, stress testing is performed regularly, and (financial) buffers are built and maintained. The FSRCC should be given an explicit financial stability mandate.

  • A robust insider trading framework and regime needs to be developed and implemented.

  • More regular disclosure of aggregate data on the banking system would improve market discipline and facilitate public understanding.

B. Securities Markets

45. The Nigerian Securities and Exchange Commission (SEC) has made marked progress since the 2002 FSAP, and has a number of significant achievements. Under the Investment and Securities Act 2007 (ISA), the SEC is the sole regulator of the securities markets. Since the adoption of the ISA, it has continued to strengthen and expand its rules and regulations. There are comprehensive legal provisions to ensure its robust governance structure. However, the SEC has been without a Board since June 2012. The authorities need to expeditiously finalize Board appointments. Further, corruption continues to be a significant problem in the Nigerian court system, although the government’s efforts to combat it are gaining international recognition. SEC management is pursuing a zero tolerance policy against corruption, although internal and external reports suggest that the issue is not yet fully resolved.

46. Additional reforms are needed. The SEC’s independence needs to be further enhanced. Its mandate to issue rules and regulations is subject to the final approval of the minister of finance, who can also exempt a person from the application of the ISA. Even though the Senate does not have any formal role vis-à-vis the day-to-day operations of the SEC, in practice its views seem to have an impact on the SEC’s decisions. This compromises the SEC’s independence. The SEC should formalize its procedures. The regulatory framework is weak in prudential and organizational requirements, including internal control, risk management, and capital requirements. Broker-dealers have been rarely inspected, and the few inspections conducted have been reactive, triggered by major deficiencies in capital. The limited supervision of broker-dealers can potentially introduce systemic risk through the securities settlement system. In addition, the SEC should exercise its comprehensive enforcement powers in a timely, effective, and consistent manner.

C. Insurance and Pension Sectors

47. NAICOM has worked hard to improve the regulatory environment. Following the recapitalization of insurers and reinsurers in 2007, the National Insurance Commission (NAICOM) issued a voluntary code on corporate governance; issued operational guidelines; upgraded regulatory requirements including the risk management framework, KYC and antimoney laundering and combating the financing of terrorism (AML/CFT) requirements; and prepared for the adoption of IFRS. It has begun work on the transition to risk based supervision, although it needs significant capacity enhancement.

48. With the rapid expansion of insurance sector, more reforms are needed. NAICOM should collaborate with the FRC to improve the timeliness and reliability of audited financial statements, and be able to sanction non-complying insurers more effectively. NAICOM should improve disclosure standards for the industry. Intermediaries should be required to disclose their capacity to act (whether as agent or broker), their financial interest in the policy, and any conflict of interest that might affect their recommendation of products. NAICOM should promulgate standards for micro-insurance and takaful insurance. The enforcement of compulsory insurance must be enhanced. The authorities should focus on the development of long-term financial instruments in anticipation of growth in the life and annuities markets, and establish a level playing field in agricultural insurance. Finally, the government should reconsider its position on mandatory reinsurance cessions to local insurers.

49. Despite the reforms of the Pension Reform Act of 2004, challenges remain. Redemption bonds’ funding needs should be actuarially determined and the formula for funding reviewed. The six legacy civil service schemes should be aggregated under the minister of finance and supervised by the National Pension Commission (PENCOM). To ensure compliance, a database of employers needs to be developed. PENCOM should reconsider the timing of the introduction of multi-funds (investment alternatives). PENCOM and NAICOM need to jointly develop and enforce disclosure standards for annuity products and programmed withdrawals. Country specific mortality tables are needed to calculate final benefits to retirees.

V. Financial Safety Nets and Crisis Management

50. The CBN took decisive measures to avert a systemic banking crisis (Box 1), but should now more fully develop its crisis management and safety net arrangements. The authorities have introduced a framework that sets out general and specific triggers for a range of corrective actions as well as a prompt corrective action (PCA) regime. However, the post-crisis Supervisory Intervention Framework (SIF) needs to be aligned with the early intervention powers in the BOFIA, to ensure that the powers have a sound statutory footing. Proposed amendments to the BOFIA that provide for the CBN to acquire shares in a failing bank should be deleted. The CBN should also implement recovery and resolution planning for banks that are systemically important financial institutions (SIFIs) in Nigeria.

A. Crisis Management Tools

Official Financial Support

Emergency Liquidity Assistance (ELA)

51. The CBN should develop a comprehensive framework for a longer term liquidity facility.26 An expanded discount window facility was provided during the crisis, from September 2008 to August 2009. Under this facility, the CBN provided loans up to 360 days, and the range of eligible collateral was increased to include non-federal government securities, such as commercial paper and bank acceptances. To enhance systemic liquidity, the CBN granted a blanket guarantee on interbank claims27 and provided ₦620 billion in liquidity. It should develop a longer term ELA facility and include clear policies, guidelines, and procedures, including a solvency test, eligibility requirements, applicable interest rates (typically penal) and acceptable collateral. Banks that access such a facility should be subject to enhanced supervision.

52. The NDIC’s statutory role in providing ELA and guarantees should be removed. Although this facility has not been used in the last two decades and an operational framework is lacking, such a role potentially exposes the NDIC to losses and would reduce funds available for a payout. Financial support from the NDIC to banks should be limited to assisting resolution measures, and should be capped at the amount of insured depositors’ funds that would have been paid out by the NDIC if the bank had instead been liquidated.

Solvency Support

53. During the banking crisis, the CBN’s support extended well beyond the provision of liquidity to solvent banks. The CBN provided solvency support to the banking sector through AMCON, guaranteed inter-bank claims, and provided a blanket guarantee on deposits. It also contributed capital for AMCON and will from 2011 to 2020 contribute ₦50 billion annually to the Banking Sector Resolution Cost Fund (established for the purposes of paying the AMCON bonds). The FMoF contributed by providing part of the initial capital for AMCON and guaranteeing its bonds.

54. With the financial system stabilized after the crisis, the CBN should move toward unwinding crisis measures for solvency support:

  • The provision of support beyond liquidity assistance for illiquid but solvent banks is the role of the FMoF, which should take all necessary steps (e.g., standing approvals or standing legislation) to ensure that such support can be made available on an expedient basis. If the CBN were to provide such support, it should be indemnified by the FMoF.

  • There should be proper public communication that the deposit blanket guarantee announced by the CBN during the 2008–09 crisis is no longer in place and that reliance would henceforth be placed on the existing conventional DIS operated by the NDIC.

55. Proposed amendments to BOFIA to provide a statutory blanket guarantee should be deleted. These amendments envisage that the CBN shall, upon revocation of license, pay all private deposits liabilities not covered by deposit insurance and thereafter seek to recover in liquidation. Instead, payment of private deposit liabilities should be limited to the criteria and levels stipulated under the NDIC Act.

Orderly and Effective Resolution

Going Concern Resolution

56. The CBN and NDIC have a broad resolution toolkit which was put to use during the crisis to resolve the intervened banks. The authorities arranged mergers and acquisitions, set-up bridge banks to take over assets and liabilities of problem banks, and established an asset management company to deal with NPLs and recapitalization of banks. However, these powers were not invoked without challenges, both legal and procedural.

57. The resolution authorities should have express statutory power to override shareholders’ rights. The measures taken during the crisis had to abide by company law requirements relating to shareholders’ rights to vote and a requirement for court sanction, which added to the duration of the resolution proceedings. Such shareholder rights requirements and court approval should be disapplied.

58. Steps should be taken to minimize the disruption to the resolution process caused by legal challenges. The authorities faced numerous challenges to the exercise of their resolution powers. The law should be amended to provide that (i) in the event that there is any challenge to resolution actions, there should be no suspension of resolution proceedings; and (ii) redress for wrongful measures should take the form of monetary compensation.

59. The resolution toolkit could be expanded. It could include mandatory recapitalization of banks without the pre-emptive rights of existing shareholders; the power to write-down capital without shareholders’ approval;28 and the power to carry out a bail-in.29

60. The statutory triggers for invoking resolution measures could be expanded and harmonized. The triggers should be harmonized under the BOFIA and the NDIC Act to include both quantitative triggers (tied to CAR, liquidity ratios, etc) and qualitative triggers (e.g., breaches of laws and regulations, carrying on business detrimental to depositors).

Gone Concern Resolution - Orderly Liquidation

61. The NDIC carries out, and the CBN monitors liquidation proceedings.30 The NDIC as a liquidator also facilitates the implementation of the Failed Banks Act, which provides for the recovery of debts owed to failed banks and for the trial of offences relating to financial malpractices in banks and other financial institutions.

62. The bank liquidation regime needs to be amended to address legal challenges and protracted delays. Past experience with bank liquidation has been fraught with delays and uncertainty for bank depositors and creditors, eroding confidence in the banking system and raising the costs of bank failures. The law should be amended to prevent suspension or reversal of resolution proceedings (subject to payment of monetary compensation for wrongful revocations or liquidations). To speed up liquidation, the CBN should regain legal authority to appoint the NDIC as liquidator immediately upon revocation of the license and requirements for advertisement of the petition before appointment dispensed with.

B. AMCON

63. The creation of AMCON in 2010 has been pivotal in restoring the financial health of Nigeria’s banking sector. AMCON injected capital into five banks to bring them to zero net asset value, leaving the remainder of the recapitalization to private investors. AMCON also purchased equity and topped up the capital of the three former bridge banks, it has acquired more than 12,000 problem bank loans, generally on the basis of valuation that follows best available market prices,31 which for some distressed assets presents challenges.32 While the initial round of acquisitions focused on the absorption of margin loans backed by shares, subsequent rounds focused on a broader set of assets. In return for the transferred assets, banks receive AMCON bonds, guaranteed by the federal government.33

64. AMCON has concentrated on the largest corporate loans and provided generous debt relief, yet delinquencies are high. Restructuring arrangements with some large corporations (460 loans represent 80 percent of the portfolio) frequently involved partial conversion of debt into equity and an initial down payment of 10–20 percent of the outstanding debt. Despite generous debt relief in NPV terms and that the restructurings were conducted only recently, delinquencies on the newly restructured loans are, according to AMCON, already in the order of 10 percent.

65. The authorities should ensure that AMCON follows the legal framework and is treated as a temporary arrangement created as a response to the crisis:

  • AMCON has yet to produce its first audited financial statements.34 The first deadline was missed, and the CBN has provided a waiver; AMCON expects to release its final statements soon.

  • The increasing use of debt-for-equity swaps can create misalignment of incentives. In its capacity as a (co-)owner of distressed companies, a bank is unlikely to enforce its creditor rights aimed at maximizing repayment on its claims. Ensuring a successful company restructuring is also challenging, including because political pressures can stand in the way of a drastic restructuring and liquidation may not be a credible threat.35

  • AMCON’s cash flows should be earmarked for buying back bonds. It may be politically expedient to use AMCON as a vehicle for keeping ailing industries and financially challenged public utilities afloat, but such bailouts are the subject of industrial policy and clearly outside AMCON’s mandate.

  • A credible exit strategy for AMCON needs to be devised, in line with the one-off character of its operations. It should be considered a temporary arrangement, to be dismantled as soon as circumstances permit. This calls for the setting of a firm and ambitious closing date for AMCON’s operations, recommended as 2017, and embedded in the law.36

  • A sunset clause should be established, disposal targets set (with an emphasis on frontloading) and the regulation capping the proportion of NPLs in banks withdrawn. The most recent purchases were made in June 2012, enabling banks to comply with the 5 percent prudential cap on NPLs. The acquisition of problem loans should be discontinued, relevant prudential requirements withdrawn and responsibility for maintaining a sound loan portfolio shifted back to the banks. The moral hazard associated with encouraging banks to pass NPLs on to AMCON damages banks’ incentives.

66. Steep redemptions in 2014 will likely exceed the funds accumulated.37 Consequently, a detailed plan for handling the bond roll over must be developed, including clarifying whether AMCON will access the government guarantee. Contributions to the Resolution Cost Fund (RCF) are projected to be the main income source, accounting for about 60 percent of total cash flows. Recoveries on acquired assets are expected to contribute another 20 percent, with the remainder consisting of disposals. AMCON is currently investigating financing options. It is in the process of setting up an investment policy.

67. The RCF MoUs signed by the banks and the CBN to contribute to the costs to redeem AMCON bonds should be formalized in legislation.38 All banks contribute, regardless of their financial state and use of AMCON. Although draft legislation creating a statutory basis has been prepared, it has not yet been submitted to the National Assembly.

C. Systemic Crisis Management

68. The CBN has set out its systemic crisis management framework in Part 4 of the SIF. In the event of a systemic banking distress, the CBN and NDIC would jointly establish a crisis management unit (CMU) to determine the condition of all banks in the system and take immediate remedial actions, ranging from CBN loans, NDIC liquidity support, blanket guarantees, inter-bank guarantees, to the use of AMCON to purchase NPLs. The public nature of the SIF generates expectations that banks will be bailed-out and AMCON always around, raising serious moral hazard issues. Bank liquidation is effectively ruled out in the framework, even for non-viable banks.

69. Part 4 of the SIF should be withdrawn immediately. An effective resolution regime should not create an expectation that public solvency support will always be available and that AMCON has an indefinite lifespan. Private sector solutions should be favored and the industry should bear the costs. If public solvency support is needed, there needs to be a stringent systemic risk test39 with a decision to be taken at the highest level of government and the CBN, accompanied by strict conditions imposed on the bank.

D. Deposit Insurance

70. The NDIC has broad functions extending well beyond the provision of deposit insurance. It shares supervisory responsibilities with the CBN and is the resolution authority. Depositor preference is provided under the BOFIA, and the NDIC is entitled to such preference by way of subrogation. Coverage seems adequate, but it is suggested to eliminate the practice of netting, and legal clarity needs to be established regarding the status of claims upon liquidation of banks. NDIC membership is mandatory for all deposit-taking institutions.

71. The NDIC should be exempted from the Fiscal Responsibility Act, and the CBN credit line should be replaced by one from the FMoF. The FRA impedes the accumulation of funds as it requires 80 percent of the NDIC’s operational surplus to be channeled to the government. Supplementary funding should come from the FMoF as it is a fiscal responsibility.

72. The 90-day payout term for the mainstream banking system should be shortened significantly. The NDIC plans to reduce the payout term to 30 days, which is still comparatively long as banks worldwide are aiming for 15 days or even less.40 Besides the labor intensive process of netting claims, it faces multiple challenges in making rapid payouts.

E. Legal Protection

73. Legal protection could be enhanced, as numerous challenges are made to regulatory and resolution actions. The judicial process has been exploited with frivolous cases being filed, and numerous interim and interlocutory injunctions and stays sought to delay proceedings. The burden of proof should be reversed such that it is the party alleging wrongdoing that has to show bad faith. The threshold for commencing legal action could be raised to that of gross negligence or willful misconduct. Legal protection should be extended to all staff of AMCON, and there should be express indemnity provisions for all staff of the agencies.

VI. Developmental Issues in Finance

74. Access to bank credit for SMEs is very low. Nigeria lags significantly behind comparator countries, with access to finance described as the biggest obstacle to development after the lack of a reliable supply of electricity.41 Banks and SMEs lack capacity and suffer institutional deficiencies, holding back higher credit growth in the sector

75. The microfinance sector has undergone significant changes and continues to be in a state of transition. The 2005 Microfinance Policy Framework, revised in 2011, provided the basis for the emergence of the microfinance sector. The government is pursuing a financial inclusion agenda with highly ambitious targets, but at the moment lacks an implementation strategy. Licensing requirements could usefully be reviewed.

76. There are five active Development Finance Institutions (DFIs), but their financial state is precarious, preventing them from meeting their mandates. The DFIs specialize in agriculture, housing, the SME sector, export-imports, and infrastructure. However, the financing gaps that they are established to address are not well defined, and often their mandate deviates from the targeted market failure.

77. The CBN administers nine Development Finance Schemes (DFSs) aimed at addressing diverse agendas in development finance. These schemes combine lines of credits and guarantees. The majority are aimed toward a developmental objective, although some have been used to bail out or restructure troubled sectors (as in the case of the recently-constituted airline scheme). All represent a contingent liability to the FMoF. Given their mixed performance and the contingent liability they represent, the FMoF should review their appropriateness, design and performance.42 Bailout related activities should not be financed by the CBN.

78. Housing finance remains underdeveloped. Mortgage loans outstanding represent just 0.36 percent of Nigeria’s 2011 GDP, while the estimated housing shortfall is thought to be as much as 16 million units. The gap between production and demand is growing as Nigeria urbanizes and the population increases. Primary Mortgage Institutions (PMIs) have been unable to deliver the finance necessary to allow for the required investment into the housing sector. The CBN’s new regulatory framework for PMIs, raising minimum capital to ₦5 billion, should help rationalize the sector. Standardization of the mortgage underwriting process and documentation would create a more efficient system and prepare lenders for a secondary mortgage market.

VII. Payment Systems

79. Nigeria continues reforms with regards to payment systems. These include the real time gross settlement (RTGS) system, the Nigeria Interbank Settlement System (NIBSS), and the Mobile Payment Services (MPS). The CBN established the RTGS User Technical Committee to determine whether the new RTGS system meets user requirements, as well as to obtain feedback and gauge user satisfaction with regard to its effectiveness and efficiency. The NIBSS’ switching capability, service quality and governance need to be significantly augmented. Given the CBN’s oversight role, it should divest its shareholding in NIBSS and no longer play an active role in its management. The 2009 Regulatory Framework for Mobile Payment Services needs to be revised to level the playing field and intensify competition. The Payments System Management Bill needs to be enacted and RTGS related operational rules updated.

VIII. Anti-Money Laundering and Combating of Financing Terrorism (AML/CFT)

80. Despite Nigeria’s high-level political commitment to work with the Financial Action Task Force (FATF) and the Inter Governmental Action Group Against Money Laundering in West Africa (GIABA) to address its strategic AML/CFT deficiencies, it has not made sufficient progress in implementing its action plan, and certain strategic AML/CFT deficiencies remain. Nigeria should continue to work on addressing these deficiencies, including remaining issues regarding criminalization of money laundering and terrorist financing. The FATF encourages Nigeria to continue implementing its action plan.

81. Nigeria is due to undergo a comprehensive assessment of its AML/CFT framework for the purposes of its FSAP Update.43 Nigeria was last assessed against the AML/CFT standard in 2008, by GIABA. The evaluation report highlighted a number of significant AML/CFT deficiencies and, consequently, a relatively low level of compliance with the FATF standard. As a result, Nigeria was placed under monitoring by the FATF International Cooperation Review Group. While the Nigerian authorities have agreed to an action plan to address the deficiencies and taken steps to enhance the AML/CFT framework, these measures were not considered sufficient by the FATF, and Nigeria—alongside other jurisdictions—was included in the FATF’s June 2012 Public Statement. In line with FSAP policies, the FSAP mission pressed the authorities for their commitment to undergo an AML/CFT against the FATF 2012 Recommendations by March 2014. In preparation for such assessment, Nigeria should address its principal AML/CFT deficiencies and challenges including but not limited to: (i) the criminalization of terrorism financing; (ii) the revision of the AML/CFT laws and regulations consistent with the new FATF Recommendations; (iii) enhancing the legislation establishing the Nigerian Financial Intelligence Unit as an autonomous operational agency; (iv) enhancing the role and capacity of the supervisory agencies in AML/CFT supervision, particularly that of the central bank; and (v) strengthening AML/CFT supervision of designated non-financial institutions including through a restructuring and retooling of the Special Control Unit Against Money Laundering.

Appendix I. Nigeria: Risk Assessment Matrix

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Appendix II. Stress Testing Matrix (STeM)

Appendix Table 1.

Nigeria: Solvency Risk Stress Tests

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Appendix Table 2.

Nigeria: Liquidity Risk Stress Tests

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Appendix Table 3.

Nigeria: Interest and Exchange Rate Risk Stress Tests

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Appendix III. Status of Implementation of 2002 FSAP Recommendations

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Appendix IV. Profit and Loss Sharing Banking in Nigeria

82. Islamic banking, which is also referred to as Profit/Loss Sharing (PLS) Banking in Nigeria, refers to a system of banking that complies with Islamic law or Shariah law. Nigerian PLS banking is at early infant stage. There are two banks, which were given the special licenses to conduct PLS banking early 2012, namely Jaiz Bank Plc (Jaiz) and Stanbic IBTC Bank (Stanbic). In Nigeria, PLS banking is in two distinctive modes, that is stand-alone license (Jaiz) and window license of the conventional outfit (Stanbic). Both modes of operations are subject to meeting applicable standards and guidelines to ensure that the PLS banking operations are fully Shariah compliant.

83. In a dual banking system in which conventional and PLS banking products are offered in parallel, a critical aspect of the regulatory and supervisory frameworks is the consistency of rules and regulations across sectors to eliminate possibilities for regulatory arbitrage. At the same time, there is a need to reflect the differences in the nature of risk inherent in PLS banking products and services. In view of being in the infancy stage, the existing regulatory and supervisory frameworks for conventional banks are also applicable for PLS banks, and the CBN has yet to carry out detailed studies on the need (if any) to modify the existing frameworks to cater for risks specific to PLS banking business. However, there is a specific regulation (Framework for the Regulation and Supervision of Institutions Offering Non-interest Financial Services in Nigeria) which focuses mainly on Shariah compliant guidelines. All PLS banks are required to set-up Advisory Committee Experts (ACEs), to oversee the Shariah compliant aspects of the operations, while a requirement to have internal Shariah advisors within the bank helps to operationalize the Shariah ruling by these committees. The set-ups at individual bank level are complemented by the CBN Advisory Council of Experts (CACE) at CBN level. In any instance of conflicting Shariah views between the individual banks’ ACEs and CACE, the ruling of CACE will prevail.

84. The CBN’s risk-based supervisory (RBS) approach is the universal approach and hence should be, and has been, appropriately applied to the two PLS banks. Since the two banks commenced operations in 2012, there has yet to be a completed supervisory assessment on them. Currently, the CBN supervisors, via a specific supervisory division that supervises PLS banks, are in the midst of completing the first round of supervisory assessment on these banks’ operations, and expect to complete the whole process by end–2012.

85. From a legal perspective, the PLS banking operation is governed by the same banking act applicable to conventional banks namely, Banks and Other Financial Institutions Act (BOFIA). To ensure that the PLS banking operation can be carried out appropriately and not be subjected to the restriction of conventional banking activities in the BOFIA, the CBN via Section 52 of the Act (exemption for community banks or PLS banks from the provision of the Act) has provided the relevant exemption to PLS banks, namely to carry out asset trading activities to assist the PLS banking activity, which are mostly asset-based. Nevertheless, there was no specific circular issued to the current PLS banks on the exemption given.

86. Being very new and still at the infant stage of development of PLS banking, there are several areas that need the CBN’s serious attention. It is critical for these gaps to be addressed at the early stage to ensure that PLS banking starts on the right and robust ground.

87. Explicit legal support is required to promote the PLS banking operations. Although Section 52 of the BOFIA is in place to support the setting-up of PLS banking operations, the CBN needs to be explicit in its licensing on the applicability of the section, to clearly indicate that PLS banking operations are allowed to carry out asset-based transactions. This is critical to avoid future legal complication that can expose the PLS banks to soundness issues e.g., nonperforming customers who may use legal loopholes.

88. As far as the tax implication is concerned, Federal Inland Revenue Services (FILS) via its Board Technical Committee, has set-up a sub-committee on non-interest banking whose task is to address the issue of tax neutrality for PLS banking, which includes exemption from capital gains tax and multiple stamp duties on the transfer of assets for the purpose of PLS banking transactions. The Islamic Finance Council of the U.K. was also consulted as Islamic banking in the U.K. has addressed the issue effectively. However, the proposal has yet to be finalized, and since the two banks are heading toward the end of their first year of operation, the issue needs to be finalized soonest.

89. Another area that requires serious attention is the legal implication of the Shariah rulings by the CACE. All legal issues for commercial transactions are addressed via civil courts, and these include the PLS banking transactions. Currently, there is no legal provision that requires a court of law to consult CACE on a PLS banking transaction. It is critical for the court of law to understand a Shariah ruling by CACE, which may be taken on the basis of financial stability. Therefore, the CBN should consider making a platform for consultation available to judges that preside on PLS banking transactions. The CBN may also consider having representatives from the legal community as members of CACE, to advice on legal related matters.

Liquidity and Supervisory Infrastructure to Support PLS Banking Operations

90. Currently, the PLS banks are allowed to enter into interbank transactions with the conventional banks via conventional interbank products, to help these banks in liquidity management. Moving forward however, such exemption from Shariah rulings may expose these banks to reputational risk.44 On this note, the CBN has taken the initiative to introduce interbank instruments that are Shariah compliant. The Committee of Governors has recently approved three interbank instruments namely Wadiáh (safe-keeping) interbank placement, non-interest CBN notes, and the use of U.S. dollar ABS Sukuks (with strong international ratings). The other proposal for CBN to issue Ijarah (lease-based) Sukuks was put on hold for further study. It is recommended that the initiatives be implemented as soon as possible, to avoid the reputational risk of not having Shariah systems, and to ensure efficient use of appropriate interbank instruments for liquidity management purposes. The CBN may also consider reviewing the CBN Act which prohibits it from entering into asset trading transactions, so that it can issue asset-based Sukuks to assist the liquidity management of PLS banks.

91. The RBS framework is sufficiently universal to enable it to be applied to PLS banking operations. However, there may be a need to introduce Shariah non-compliant risk elements into the framework to ensure PLS banks are not exposed to unnecessary reputational risk arising from Shariah noncompliant activities. Capacity building of the CBN supervisors is expected in the area of PLS banking. Similar to the recommendations on the ROSC/BCP assessment, the CBN may consider having Shariah specialists as part of the proposed Specialist Risk Unit.

Prudent Implementation of International Capital and Accounting Standards

92. The Islamic Financial Services Board (IFSB), which is the counterpart of the BCBS for Islamic finance, had issued Capital Adequacy Standard (CAS-2005) as guidance for supervisory authorities across the globe. The standard is similar to Basel II (Pillar I) Accord for the standardized approach. The most distinctive difference is the risk absorbent feature of profit sharing funding. The standard basically allow for risks on assets funded by profit-sharing investment accounts (PSIA) to be deducted from capital adequacy calculations so as to reflect the true nature of the Islamic banking funding structure. The CBN is currently in the midst of implementing Basel II Accord for the conventional banks, and it is just a matter of time before the CAS-2005 of IFSB is applied to the PLS banks. However, any jurisdiction including Nigeria should be very diligent in considering the implementation of this specific element in CAS-2005. Understanding the different players/characters in the PLS banking system is critical to the success of this element. Otherwise, it may lead to an under-capitalised PLS banking system, which will expose the system to financial instability.

93. In terms of accounting and disclosure requirements, the PLS banks are guided by the Framework for the Regulation and Supervision of Institutions Offering Non-Interest Financial Services (paragraph 12.0). The guidance expects PLS banks to adhere to the accounting and disclosure standards of Nigerian Accounting Standards Board (NASB), IFSB, Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) and International Financial Reporting Standards (IFRS). Similarly in this situation, CBN also needs to be mindful of the differences between these various standard-setting bodies. Specifically there are two areas that need to be carefully analysed before implementing the relevant accounting and disclosure standards:

  • Treatment of PSIA. AAOIFI standards treat PSIA as off-balance sheet items since the loss from the investment is technically fully borne by the investors. However, based on IFRS principals, the volatility of PSIA’s return still affects the return to the banks, and hence the exposures must be treated as on-balance sheet items.

  • Treatment of Profit Equalization Reserves (PER)/Investment Risk Reserves (IRR). AAOIFI allows the use of PER/IRR as income smoothing mechanism but IFRS is very strict in allowing for any generic nature of reserves to be provided without any support of empirical studies.

94. The above differences may lead to different disclosure objectives and the CBN needs to fully internalize which objective it expects to achieve. In any case, the financial stability objective must be a top priority for any regulatory and supervisory stance that the CBN plans to take.

Appendix V. Key Tables

Appendix Table 4.

Nigeria: Selected Economic and Financial Indicators, 2009–14

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Large errors and omissions in the balance of payments suggest that the current account surplus is overestimated by a significant but unknown amount.

For 2013 and 2014–15, the budget oil price is assumed to be US$78 and US$75 a barrel, respectively.

For 2012, includes one-off payment of about 1 percent of GDP to settle arrears accrued in 2011.

Source: Nigerian authorities and IMF staff estimates and projections.
Appendix Table 5.

Nigeria: Financial Soundness Indicators

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Source: Nigerian authorities and IMF staff calculations.
Appendix Table 6.

Nigeria: Credit Risk Sensitivity Analysis

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Excluding the bank that is insolvent even before the stress tests.

Including the bank that is insolvent before tests. Other banks that become insolvent are included in the other outlier banks.

Source: Top Down: CBN and IMF staff calculations.
Appendix Table 7.

Nigeria: Interest Rate Risk Sensitivity Analysis (Banking Book)

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Source: Top Down: CBN and IMF staff calculations.
Appendix Table 8.

Nigeria: Foreign Exchange Risk Sensitivity Analysis

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Source: Top Down: CBN and IMF staff calculations.
Appendix Table 9.

Nigeria: Equity Price Risk Sensitivity Analysis

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Source: Top Down: CBN and IMF staff calculations.
Appendix Table 10.

Nigeria: Sensitivity Analysis: Multi-Factor Shocks

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Source: Top Down: CBN and IMF staff calculations.

Annexes. Observance of Financial Sector Standards and Codes Summary Assessments

This Annex contains the summary assessments of Nigeria’s observance of financial standards and codes. These assessments help identify the main strengths of the supervisory, regulatory and market infrastructure framework in managing potential risks and vulnerabilities in the financial system. They also point to areas that need strengthening and further reform.

These summaries are based on detailed assessments of the following international standards:

Basel Core Principles (BCP) for Effective Banking Supervision – by Khairul Ibrahim (external expert) and Carel Oosthuizen (IMF).

IAIS Insurance Core Principles (ICP) – by Mimi Ho (external expert) and Rodolfo Wehrhahn (IMF)

IOSCO Principles and Objectives of Securities Regulation – by Carlos Barsallo (external expert) and Eija Holttinen (IMF).

Annex I. Compliance with the Basel Core Principles for Effective Banking Supervision

A. Introduction

95. The assessment of the current state of the implementation of the Basel Core Principles for Effective Banking Supervision (BCP) in Nigeria, against the BCP methodology issued by the Basel Committee on Banking Supervision (BCBS) in October 200645, was completed between August 27 and September 19, 2012, as part of a FSAP update, undertaken jointly by the IMF and the World Bank, and reflects the regulatory and supervisory framework in place as of the date of the completion of the assessment. The previous BCP assessment was conducted in 2002, in terms of the 1998 BCP methodology, which is not directly comparable to this assessment.

B. Information and Methodology Used for Assessment

96. The assessment team46 reviewed the legal framework for banking supervision and held extensive discussions with the staff of the CBN and the NDIC, which both perform supervision of banks, though the former is the lead supervisor. The assessors also met with officials of the FMOF, several commercial banks, audit firms and the Chartered Institute of Bankers of Nigeria. The team examined the current practice of on-site and off-site supervision of the CBN and the NDIC.

C. Institutional and Macroeconomic Setting, and Market Structure - Overview

97. Nigeria has a diverse financial sector. The number of financial institutions as at December 31, 2011 included the following: 21 commercial banks (CBs) (six banks, including five domestic banks and one pan-African bank, dominate the banking sector) five discount houses (DHs), 876 microfinance banks (MFBs), 107 finance companies (FCs), 101 primary mortgage institutions (PMIs), 31 pension fund administrators (PFAs), five pension fund custodians (PFCs), 1,946 bureaux de change (BDCs), 690 securities brokerage firms, five DFIs, three private credit bureaux, 61 insurance companies, two reinsurance companies, 50 loss adjusters, and the AMCON.

Annex Table 1.

Nigeria: Structure of the Financial System, 2011

(₦billion, unless specified otherwise)

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Source: CBN.

98. The CBN, as part of its statutory mandate of promoting a sound financial system in Nigeria, licenses and carries out the prudential regulation and supervision of CBs, other financial institutions (OFIs), DHs, non-interest Banks (NIBs), MFBs, PMIs, FCs, BDCs, and AMCON. NDIC, on the other hand, administers the deposit insurance scheme and also collaborates with the CBN in the on-site and off-site supervision of commercial banks, merchant banks, and insured MFBs and PMIs. The supervisory departments of the CBN and NDIC had 847 supervisors as at end–December 2011. Each of the CBN and NDIC, respectively, separately maintain off-site supervision function in Abuja and on-site examination function in Lagos. Other sector regulators include the SEC, the NAICOM and the PENCOM for the securities, insurance and pensions sector respectively.

99. The co-ordination of the activities of the Nigerian banking sector supervisory authorities is conducted under the aegis of the CBN/NDIC Executive Committee on Supervision which should ensure that operations of the two supervisory authorities are coordinated to remove overlaps, avoid gaps and ensure adequate information sharing on issues of supervisory concern. The Financial Services Regulation Coordinating Committee (FSRCC) provides the platform for the co-ordination among and information sharing with regulatory authorities, inter alia with reference to financial sector stability, and supervision of financial conglomerates, financial holding companies and bank holding companies.

100. The CBN and NDIC derive their supervisory powers principally from the CBN Act, NDIC Act, and the BOFIA. Other legislative instruments that impact on banking supervision include the Failed Banks (Recovery of Debts) and Other Malpractices in Banks Act, 2004, the Companies and Allied Matters Act (CAM Act), 2004, the Economic and Financial Crimes Commission Act 2004 and the Money Laundering Prohibition Act 2011. The CBN and NDIC also issue rules and regulations pursuant to their powers under the above-mentioned legislation.

101. Total banking sector assets stood at ₦18.21 trillion as at end–December 2011, which represented 53.6 percent of GDP. Of the 21 banks, four are owned by foreign banking organisations while seventeen are domestically controlled. The domestic banks controlled 86.4 percent of industry assets as at end–December 2011 compared with 13.6 percent controlled by foreign institutions. The three domestic banks that were acquired by the AMCON in 2011 controlled 5.0 percent of industry assets.

102. The banking sector appears relatively sound as at end-December 2011, as shown by soundness indicators, many of which displayed an improving trend. The ratio of regulatory capital to risk weighted assets increased to 17.8 percent at end–December 2011, representing a 13.6 percentage point increase over the ratio of 4.2 percent recorded at the peak of the banking crisis (end-June 2011). Similarly, the ratio of Tier 1 capital to risk weighted assets of 18.1 percent at end–December 2011 was 13.6 percentage points higher than the level of 4.5 percent achieved at end-June 2011. Asset quality indicators also showed a substantial improvement. The ratio of NPLs to total loans of 4.9 percent showed a decline of 22.5 percentage points from its peak of 28.8 percent at end–June 2010. The level of liquidity in the system also displayed an increasing trend––the ratio of core liquid assets to total assets increased to 25.7 percent at end–December 2011 from 17.2 percent at end–June 2010. Similarly, the ratio of liquid assets to short-term liabilities increased by 11.8 percentage points to 31.2 percent between June 2010 and end–December 2011.

103. The banking sector has undergone significant change and reform. After the bank recapitalizations following the 2005–06 banking sector consolidation, Nigeria experienced rapid credit expansion as banks broadened their activities and moved to the untapped retail sector, to borrowers involved in equity market speculation (margin lending collateralized by shares) and acquiring nonbank subsidiaries. The 2005–06 banking sector consolidation generated capacity for several Nigerian banks to expand internationally, establishing subsidiaries particularly in Africa.

104. The Nigerian economy has experienced a number of domestic and external shocks in recent years, which impacted the banking sector. The oil price drop and currency devaluation accompanying the 2008 global financial crisis stressed those banks with heavy concentration in the oil and gas sector, while the NSE downturn adversely affected banks exposed to margin lending. In 2008, the Nigerian stock market lost about two-thirds of its value, following a sharp decline in world oil prices and currency devaluation. Banks with heavy concentration in the oil and gas sector were stressed, while the stock exchange downturn adversely affected banks exposures to margin lending. By 2009, the banking sector was in crisis.

105. But large buffers, built before the global crisis, and low debt, helped mitigate the impact of the shocks by providing room for expansionary fiscal policy. Fortunately, the economy continued to grow rapidly at over 7 percent during each year since 2009. Monetary policy was tightened in 2011 after an increase in inflation and a decline in international reserves in 2010. Although the macroeconomic outlook remains positive, substantial risks remain, in view of the fact that oil constitute more than 90 percent of exports and oil receipts generate 75 percent of government revenue, and the recent spate of social unrest in the north of the country continues.

106. A banking crisis, which involved more than 40 percent of the banking sector assets, came to a head in the second half of 2009. The authorities identified the following as the main contributing factors:

  • Macro-economic instability caused by large and sudden capital inflows.

  • Major failures in corporate governance at banks.

  • Lack of investor and consumer sophistication.

  • Inadequate disclosure and transparency about the financial position of banks.

  • Critical gaps in regulatory framework and regulations.

  • Uneven supervision and enforcement.

  • Unstructured governance and management processes at the CBN/weaknesses within the CBN.

  • Weaknesses in the business environment.

107. A comprehensive set of measures were taken by the authorities to counteract the 2009 banking crisis and, as a result, Nigeria avoided a major economic meltdown, and the economy was stabilized. The measures adopted in response to the 2009 banking crisis included:

  • Special examinations were commissioned in respect of all banks and executed by the CBN and NDIC.

  • Ten banks were found to be in a “grave situation” and were intervened.

  • The CBN removed eight banks’ senior management and replaced them with CBN appointees.

  • The CBN provided liquidity support in the amount of ₦620 billion (US$4.1 billion) in the form of unsecured, subordinated debt. (In essence, this constituted solvency support as well.)

  • A blanket guarantee of interbank and foreign credit lines of banks was introduced, and extended (for six–monthly periods) until end–2011.

  • The CBN made a public commitment to protect all depositors and foreign creditors against loss and not to permit any bank to fail.

  • At the peak of the crisis, the CBN created an expanded discount window which admitted non-federal government securities as eligible securities, while extending the tenure of the facilities to 360 days.

  • The FMoF and the CBN established AMCON to support troubled bank resolution, and the banking sector more broadly. AMCON purchased banks’ NPLs in exchange for AMCON three-year zero coupon bonds (which are guaranteed by the federal government.) AMCON facilitated mergers and acquisitions of the intervened banks and the creation of bridge banks, which were re-capitalized by AMCON.

  • NDIC coverage of insured deposits was recently increased to ₦500,000 for CBs and ₦200,000 for insured community banks.

108. Important reforms, broadly in line with BCBS pronouncements, were instituted. These reforms included the following:

  • The universal banking model was abolished in favour of a “back-to-basics” banking model, and a new bank license regime was introduced.

  • Risk-based supervision was embedded.

  • The Corporate Governance Code was implemented.

  • A number of regulatory prescriptions were issued covering a range of issues, inter alia by way of circular, code, guideline, prudential guideline, framework and regulation, including capital adequacy, risk and risk management and risk-based supervision, credit risk management, large exposures and related parties, margin lending, cross-border supervision, consolidated supervision (only in draft form), fitness and propriety, internal control, disclosure and AML/CFT.

  • Adoption of IFRS in 2012.

109. The financial sector is large, remains dominated by the banking sector, and has significant international linkages. The Nigerian banking system has undergone significant change in the recent period, and this process is still ongoing. Although the sector remains dominated by domestic institutions, a few international banks have a presence in Nigeria, with a major regional bank headquartered outside Nigeria and active in 32 countries in Africa, having its largest subsidiary in Nigeria. Overall the number of banks has fallen from 89 in 2005 to 21 in 2012. Six of the banks, of which one is the above-mentioned subsidiary, dominate the banking system, with a market share of around 60 percent of total banking sector assets. Three small banks are distressed, the smallest of which is insolvent and the other two being former bridge banks with AMCON being the main owner.

110. The macroeconomic outlook remains positive, but substantial risks remain. Like the rest of the Nigerian economy, the financial sector is exposed to the effects of volatility in international markets for commodities and capital. Fortunately, large buffers built before the global crisis, and low debt, helped mitigate the impact of the shocks, by providing room for expansionary fiscal policy.

111. The Nigerian economy emerged from the banking crisis, and has the potential to enjoy an extended period of strong economic growth. This could be facilitated by a comprehensive strategy to conclude and exit from the crisis management period; to enhance protection against existing and emerging vulnerabilities; and foster financial deepening that can underpin sustainable growth on an enduring path for the periods ahead.

112. Although systemic risk has declined since the peak of the recent crisis, the financial system is still exposed to risks from both global and domestic factors. Though oil prices recovered, a further deterioration in the global environment could result in a sharp drop in oil prices. Also, oil exports could be disrupted. This could impact negatively the current account and fiscal positions, thereby dampening the build-up of international reserves and/or increasing public debt, in the absence of fiscal consolidation. The security situation is concerning, arising from terrorist activity in the north of the country.

113. The bank regulators and supervisors have an extensive reform agenda. In addition to IFRS, the authorities intend to implement Basel II and III. New instruments, such as macroprudential, and new techniques, such as stress testing and scenario analysis and analysing financial stability are also important.

D. Preconditions for Effective Banking Supervision

114. Macroeconomic policies have the potential to pose risk to financial stability. Sound macroeconomic policies are a precondition to and a foundation of a stable financial system. Failure to implement politically difficult fiscal adjustment measures or curb overly ambitious infrastructure spending could pose a risk to the financial system. Fiscal dominance (arising from the imperative to keep monetary policy tight, in order to counteract the deleterious effects of weak fiscal discipline, consequential pressures or the currency, all of which fuels inflation, notwithstanding private credit growth sputtering) is a major contributor to an unfavorable trade-off between inflation and growth. This could also put an undue burden on monetary policy to contain inflation and also fight pressures on the currency and international reserves. At times the markets appear confused, perceiving that the CBN is pursuing multiple objectives. Following the crisis, significant efforts are being made to harmonize the structure for the implementation of monetary policy and prudential regulation. Accordingly, a framework has been developed in Nigeria to align financial system stability goals with broad macroeconomic policy. The key areas that are being addressed progressively by the authorities include: policy harmonization and the resolution of the conflict of objectives between the Economic Policy Directorate and the Financial System Stability Directorate of the CBN, the development of a macroprudential toolkit, enhancing the quality of data, and consideration of fiscal and monetary policy instruments that have the potential to impact financial stability.

115. The key elements of required public infrastructure are present, though the qualitative dimensions show weaknesses and vulnerabilities. These key elements include: a system of business laws, including corporate, bankruptcy, contract, consumer protection and private property laws; comprehensive and well-defined accounting principles and rules that command wide international acceptance, in the form of IFRS, which banks are required to adopted with effect from 2012; a system of independent audits for listed companies, as well as for banks, independent assurance for users of financial statements that the accounts provide a true and fair view of the financial position of the company; an independent judiciary and self-regulated accounting, auditing and legal professions; supervision of other financial markets and, where appropriate, their participants; and a payment and clearing system for the settlement of financial transactions. Concerns regarding the qualitative dimensions of public infrastructure arise, inter alia, from weaknesses in policy making and legislative processes, legal uncertainty on key issues, inability to resolve banks promptly, inability to achieve prompt collection of outstanding debts through legal avenues, inability to execute promptly on collateral, unpredictability of legal outcomes, weak ability to prosecute financial crimes, seeming absence of accountability of external auditors, weaknesses in supervision of other financial institutions and markets, and weaknesses in the payments and clearing system (though the Payment System Vision 2020 aims at significant improvements.)

116. Gaps and weaknesses in market discipline was a material contributor to the 2009 banking crisis. Effective market discipline depends substantially on adequate flows of information to market participants, to enable informed decisions, appropriate financial incentives to reward well-managed institutions, and arrangements that ensure investors are not insulated from the consequences of their decisions. In 2010, the CBN issued a circular on minimum disclosure in the financial statements of banks. The implementation of international standards like IFRS and the relevant part/s of Basel II/III should enhance transparency. Since 2010, the CBN has published a Financial Stability Report (FSR) on a biannual basis, to focus stakeholders’ attention on those factors that predispose the financial system to shock as well as the policies to address these concerns. More attention has focused on the data quality of regulatory information submissions by banks. Since 2008, the CBN has not issued an annual bank supervision report. With effect from 2011, a semi-annual FSR, which strives to cover also what previously was covered by the annual bank supervision report, has been issued.

117. The Nigerian framework for crisis management and the financial sector safety net was effective in containing (the contagion from) the crisis, though much needs to be done to benefit from the lessons learnt. The CBN took decisive measures to avert a potential systemic crisis by intervening in troubled banks, injecting liquidity into these banks and providing broad guarantees. These quick measures stabilized the banking system and allowed the authorities time to design a strategy to resolve the intervened banks. The resolution strategy ultimately employed consisted of many elements, including: replacing management in a number of banks; recapitalization subject to shareholders’ approval; setting up an asset management company, AMCON, to purchase NPLs of banks in exchange for tradable three-year zero coupon bonds issued by AMCON and guaranteed by the federal government; entering into M&A arrangements; and setting up bridge banks that were capitalized by AMCON. All these measures helped the authorities stabilize a banking system that was on the verge of a systemic crisis. The NDIC constitutes an important component of the safety net. Despite the success, the CBN should more fully develop its crisis management and safety net arrangements. Nigeria has taken important steps to facilitate the identification and adoption of a framework for macroprudential policies, with the FSRCC coordinating the supervision of financial institutions and a dedicated department, the Financial Policy and Regulation Department (FPRD), in the CBN having been set up to perform the function of macroprudential supervision. It is necessary to improve bank resolution, inter alia, by specifying preference for depositors and creating a non-judicial/administrative special resolution regime.

E. Main Findings of the BCP Assessment

118. Nigeria has recorded significant improvement in its level of compliance with the BCPs since the last independent assessment by the IMF and the World Bank in 2002. The 2002 independent assessment concluded that Nigeria was compliant with three, largely compliant with 11, materially noncompliant with nine, and noncompliant with two core principles. Considered against the essential criteria, Nigeria is now compliant with one, largely compliant with 17, and materially non-compliant with seven CPs.

119. The improvement in the assessment ratings is attributed to the enhancements of the supervisory capacity of Nigerian banking system supervisors through: (i) the enactment of new laws and amendment of laws; (ii) issuance of various regulations, circulars, and guidelines to address the weaknesses observed during the 2002 assessment; and (iii) reform initiatives embarked upon in the aftermath of the 2009 banking crisis.

Objectives, independence, powers, transparency and co-operation (CP1)

120. A principal objective of the CBN is to promote financial stability. The CBN is charged with the primary responsibility of bank supervision and has clear related objectives. The NDIC cooperates with the CBN in discharging the bank supervision responsibility. Though bank supervision is not explicitly clearly stated as an objective of the NDIC, it is implicit. An effective and efficient legislative process through the National Assembly is a necessary precondition to enable congruence and to keep pace with the internationally generally accepted legal and regulatory framework for banking, which is not being achieved currently. It is important to maintain the currency of the legal and regulatory framework, by way of prompt responses (to international policy developments and local needs), through sound policy development and a responsible legislative and regulatory process. (BCP1(1))

121. The CBN possesses operational independence, transparent processes, sound governance, and adequate resources, and is accountable for the discharge of its duties. The position of the NDIC in relation to independence and to whom it is accountable is less clear. (BCP1(2))

122. A legal framework for banking supervision, including provisions relating to authorization of banking establishments and their ongoing supervision is in place. A thorough review and comprehensive updating of the legal and regulatory framework is necessary. (BCP1(3))

123. The legal framework for banking supervision empowers the supervisor to address compliance with laws. The law and regulations appear, implicitly, though not necessarily explicitly, to permit the supervisor to apply qualitative judgment in safeguarding the safety and soundness of the banks within its jurisdiction––this should be made explicit. (BCP1(4))

124. The legal framework for banking supervision makes provision for legal protection for supervisors––however, it does not make provision for their concomitant legal costs. (BCP1(5))

125. Arrangements for sharing information between supervisors and protecting the confidentiality of such information are in place, though the coordination between the CBN and the NDIC may require attention. (BCP1(6))

Licensing and structure (CPs 2-5)

126. The permissible activities of institutions that are licensed and subject to supervision as banks are clearly defined, and the use of the word “bank” in names is controlled as far as possible. (BCP2)

127. The licensing authority has the power to set criteria and reject applications for establishments that do not meet the standards set. The licensing process, at a minimum, consists of an assessment of the ownership structure and governance of the bank and its wider group, including the fitness and propriety of Board members and senior management, its strategic and operating plan, internal controls and risk management, and its projected financial condition, including its capital base. Where the proposed owner or parent organization is a foreign bank, the prior consent of its home country supervisor is obtained. Important elements of licensing, including important criteria, and other requirements and process, are implicit and informal––these should be explicitly specified and formalized. The list of prescribed criteria contained in the legal and regulatory framework is incomplete, and the criteria should be focused on outcomes, as opposed to inputs. In addition, the CBN should be required to create a formal audit trail, by the CBN formally and in writing assessing a new bank license application against each and every one of the prescribed criteria. (BCP3)

128. The supervisor is empowered to review and, if deemed appropriate, to reject any proposals to transfer significant ownership or controlling interest, whether held directly or indirectly in a bank, to other parties. The supervisor’s flawed powers to review and the supervisor’s weak and inadequate