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How do we get the
banks to resume lending to key sectors of the economy? And how do we
reverse market sentiments (capital and funding markets to be precise)
in favour of the financial services industry? These questions have
furtively moved to the top of the list of the average Nigerian’s
worries over how to move this economy away from its addiction to oil,
and into rehab. Apparently, in respect of financial sector worries, not
much will be achieved before something is done about the banks’ loan
books.

At the height of
the last economic bubble, banks were lending as if the funds they were
holding would burn a hole in their vaults otherwise. With the massive
increase in access to retail credit, consumer spending jumped as a
proportion of domestic output. Domestic output growth in turn drove
increases in banks’ deposits, allowing the banks to lend more over the
next cycle, and so on. When the floor came off the home mortgage market
in the United States, this virtuous cycle turned vicious very quickly.
The bottom fell off the local stock market, and with stock prices
plummeting, most bets on the trajectory of the equities market came
unstuck. Since a goodly number of retail investors had piled into the
market with nothing but the prospects of the virtuous cycle supporting
their punts, the nation’s nest egg ended up trapped in the equities
market.

Loans default

With borrowers
unable to meet their obligations, the downturn has meant that banks
have a portfolio of loans on which they haven’t earned anything in a
long while. Even when most banks in the country have taken losses on
the unprecedented levels of provisioning they have had to make to clean
their balance sheets, they cannot create new assets until they have
sorted this mess out. And the markets, investors largely, will not take
this group of businesses seriously, as long as their balance sheets
still contain so much dross.

Enter the Central
Bank of Nigeria. If the central bank governor is to be believed, the
bank’s intervention in the market thus far is anchored on four pillars:
enhancing the quality of banking in the country; ensuring financial
stability; ensuring healthy financial sector evolution; and making sure
that the financial sector contributes to the development of the
economy. Its proposal to clean up the banks’ balance sheets with the
Asset Management Company (AMC) must thus be interrogated within this
context. The plan is for banks with large non-performing loan burdens,
to move these assets off their balance sheets and onto the books of the
Asset Management Company. The company then bears all the risks of the
assets transferred, and arranges to deconsolidate the bad loans through
sale to external investors. Meanwhile, the banks obtain a fresh lease
on life from the ability to use their newly clean balance sheets to
restore their profit and loss accounts.

Commentaries on the asset company

Most commentators
on this proposal have focused on the cost of this process. For
instance, given the trillion naira estimates of the size of the
non-performing section of the banking sub-sector’s loan book, how
adequate would the N10 billion proposed as initial capital for the
asset company be? There are other costs: legal, tax, regulatory, and
accounting. How much forbearance would government and the regulatory
authorities have to offer banks to ease the proposed asset transfers?
Then, there are governance matters. Would the process be better served
by establishing an independent valuation process/agency? What other
incentives would the banks have to sell these assets, after providing
fully for them? The eventual look of the banks will depend on how the
final structure of the company combines these variables.

Important, though
all these are, one point is sorely missed: Transparency. It is the lack
of transparency on the books of the severely burdened banks arising
from their bad loans portfolios that interferes with the capital and
funding markets’ interest in these institutions. The value of the
banks’ loan books, the risk transfer process, and the rationale for the
forbearances that the regulators offer to sweeten the transfer process
must be as plain as a pikestaff if the process is to result in a
re-opening of the banks’ access to new funding sources. This
requirement is even more crucial in the context of the CBN’s barely
concealed desire to have new capital come into the industry.