After weeks of anticipation, the Central Bank of Nigeria last Thursday released a circular reviewing the minimum capital requirements for all commercial, merchant, and non-interest banks operating in the country. The review came exactly two decades after a former Governor of the CBN Prof Chukwuma Soludo raised the minimum capital requirements for banks from N2 billion to N25 billion, and three months after the current governor Yemi Cardoso, gave banks a heads up that they would have to raise fresh capital to serve as buffers against risk assets on their balance sheets, prevailing economic headwinds, and bolster their ability to handle big ticket transactions.

Under the current review, commercial banks with international banking licences would have to raise their minimum capital to N500 billion, national banks to N200 billion, regional and merchant banks to N50 billion, non-interest national banks to N20 billion, while non-interest banks will have to meet a new minimum threshold of N10 billion. To meet the new capital requirements in two years, the CBN directed banks to consider the injection of fresh equity capital through private placements, rights issues and/or offer for subscriptions. They could also consider mergers and acquisitions and/or upgrades or downgrades of their licences.

However, the clincher in the circular was the central bank’s definition of what it meant by minimum capital. It said minimum capital shall comprise of paid-up capital and share premium only and shall not be based on shareholders’ funds. CBN further excluded Additional Tier 1 (AT1) Capital for the purpose of meeting the new minimum capital requirements by banks. Shareholders’ funds refer to the net worth of a company after all its liabilities have been deducted from its assets. It comprises the share capital and retained profits or earnings that have been reinjected into the business by its shareholders. AT1 Capital, on other hand, are debt securities or instruments that have no fixed maturity. They usually comprise preference shares or high contingent convertible securities.

By excluding shareholders’ funds and AT1 Capital, the CBN prioritised direct cash injections into the banks over accounting entries to satisfy recapitalisation requirements. Also, though not a member of the Bank for International Settlements (BIS) in Basel, Switzerland, whose mission is to support global central banks’ monetary policies and financial system stability, the CBN by its recapitalisation guidelines deviated from the Basel III criteria for regulatory capital.

Basel III reforms were introduced in December 2010 after the global financial crisis of 2007-2009, which revealed several weaknesses in the capital bases of existing banks, as definitions of capital varied widely between jurisdictions, regulatory adjustments were generally not applied to the appropriate level of capital, and disclosures were either deficient or non-comparable. These factors contributed to the lack of public confidence in capital ratios during the global financial crisis. To address these weaknesses, the Basel Committee on Banking Supervision (BCBS) published the Basel III reforms with the aim of strengthening the quality of banks’ capital bases and increasing the required level of regulatory capital. In addition, the BCBS instituted more stringent disclosure requirements.

Under Basel III, components of regulatory capital for banks comprise Common Equity Tier 1 (CET1) Capital made up of common shares and stock surpluses, retained earnings, other comprehensive earnings, qualifying minority interest and regulatory adjustments; as well as Additional Tier 1 (AT1) Capital, which is the sum of capital instruments meeting the criteria for AT1 and related surplus, additional qualifying minority interest and regulatory adjustments. CET1 and AT1 are classified as Tier 1 Capital for banks on a going concern basis. Then there is Tier 2 Capital which is gone-concern capital and applies to banks that have failed. Tier 2 instruments must absorb losses before depositors and general creditors do so.

While it must be acknowledged that Basel III is not legally binding in any jurisdiction, and as earlier indicated, the CBN is not a member of the BIS in Switzerland, Basel III was intended to form the general basis for national or regional rulemaking for regulatory capital. Nonetheless, as with Basel I and II, even BIS members have taken different approaches to implementing Basel III. Some regulators have even gone as far as arguing that the rules apply to banks with $100 billion in assets or more. This in effect addresses any concerns raised by some market analysts at the weekend that the CBN was not complying with Basel III reforms in its latest recapitalisation programme. Besides, no Nigerian bank can boast of a balance sheet size of $100 billion in assets. Despite all their sound and fury, not one of them comes close!

Basel III aside, no Nigerians banker worth his or her salt can say that they did not see the recapitalisation programme coming. They did not need a Cardoso (or Cardi-B as he is often called in social media circles) to tell them that their banks had to initiate measures to raise fresh capital. For instance, Access Holdings Plc, in its 2023 financial accounts that was released 24 hours before the CBN circular, announced its intention to raise N365 billion through a rights issue in 2024. There was also speculation among market analysts two weeks earlier, that Guaranty Trust Holdings Plc (GTCO), which is yet to release its 2023 accounts was toeing the same path with a capital raise of N350 billion to N500 billion.   

Effectively, bankers who did not have their heads buried in the sand already knew that the naira devaluation and spiralling inflation had wreaked havoc on their risk assets, notwithstanding the supernormal profits that they declared in the second half of 2023 due to FX revaluation gains. Buttressing this, Cardoso last December revealed that due to the impact of the forex unification policy and efforts to remove the subsidy on petrol by the federal government, banks had breached some of the key metrics such as single obligor limits, resulting in the erosion their capital. It also led to a deterioration of their asset quality that could easily clog up banks’ balance sheets with non-performing loans. And as any banking system regulator knows, low asset quality affects banks’ capital and therefore their soundness.

But what the banks did not anticipated was that the CBN would not allow them to use their shareholders’ funds, which has retained earnings as a key component, as the basis for computing revised capital requirements. Unsurprisingly, since the release of the circular, there’s been disquiet in the banking sector as Nigerian lenders and their shareholders absorb the enormity of the daunting task over the next two years. Add to this a seminal WhatsApp group dedicated to all things markets that I belong to, which almost blew a gasket at the weekend as members heatedly debated the merits and demerits of the non-inclusion of retained earnings in the new capitalisation requirements for banks.

Had the CBN allowed the banks to use shareholders’ funds as a basis for the new capital base, most, if not all banks, would have carried on with business as usual because the retained earnings on their balance sheets already exceeded their paid-up capital and share premium combined by several hundreds of billions of naira. As things stand, some Tier 1 bank holding companies and banks have retained earnings in excess of N500 billion – the new capital base threshold for international banks. These are Access Holdings – N715.13 billion, FBNH Plc – N608.73 billion, UBA Plc – N750.81 billion and Zenith Bank Plc – N894 billion, while GTCO at N424.50 billion is not far off. By implication, if banks’ retained earnings are added to their current paid-up capital and share premium, they would meet and exceed the new minimum capital requirements stipulated by the CBN.

Another concern that came up was that with the exclusion of retained earnings, the options given by the CBN for fresh capital injection through either private placement, the issuance of new shares (or public offers) and/or through mergers and acquisitions was dilutive for existing shareholders of the banks. One of the first persons to throw the first salvo over the new recapitalisation guidelines released by the CBN was Mustapha Chike-Obi, Chairman of Fidelity Bank Plc and Chairman of the Bank Directors Association of Nigeria ((BDAN), who was quoted on Arise News Channel on Friday morning as stating that the non-inclusion of retained earnings would not work and called on the CBN to provide additional clarification on the issue.

Similarly, Johnson Chukwu, CEO of Cowry Assets Management Limited, faulted the exclusion of retained earnings and advised the CBN to align the new capital requirements with industry dynamics to facilitate a seamless transition. According to him, the exclusion of retained earnings will result in banks incurring recapitalisation costs, adding that this would force banks to declare cash and bonus dividends for their shareholders and undertake rights issues.

Other market analysts further posited that the exclusion of retained earnings from new capital requirements for banks would put them under pressure, given the huge amounts lenders would have to raise in an environment where capital is already constrained. According to one such analyst, “You have a situation where the CBN has adopted a contractionary monetary policy stance with high interest rates and is issuing OMO bills at 27%. This was done to curb inflation, attract foreign portfolio investors into the market and thereby improve FX liquidity. As such, capital is constrained in the country due to the tight monetary stance of the CBN. So how are banks expected to raise an estimated N3 trillion to N4 trillion to meet the new capital thresholds? This is just contradictory.”

He also wondered what the of objective of the CBN was, asking if it is to improve capital buffers of banks and strengthen their ability to fund big ticket transactions to grow the economy, how will this be achieved with the high interest rates on treasury bills that have crowded out the private sector? “In addition, with the Cash Reserve Ratio (CRR) at 45% and Liquidity Ratio at 30%, how are the banks expected to lend money to their customers. So, if the banks raise fresh equity capital, are they going to continue lending to government?” he asked.

Though it is true that the CBN’s contractionary stance is at variance with its decision to compel banks to raise fresh equity capital, it will be short-sighted for anyone to think that the current monetary tightening will be remain in place for an eternity, as the policy measures are short-term in nature. Like any central bank, once the CBN determines, say12 months from now, that inflation is beginning to recede and FX stability has been achieved, it will begin to lower interest rates and loosen its stance on CRR and the liquidity ratio, by which time the banks will be recapitalised or nearing recapitalisation and ready to create new risk assets for economic growth. Yet, for the CBN’s monetary policy to succeed, a lot of action will still be required from the fiscal side which has continued to run an expansionary budget and has failed to implement measures to address structural bottlenecks that are adding to Nigeria’s economic woes.

But even as bankers and market analysts at the weekend were losing sleep over the exclusion of retained earnings, CBN officials countered that there was either an absence of sincerity on the true position of things in the banking sector or there was pervasive ignorance. A CBN official who spoke to this writer off the record, dismissed the retained earnings of several banks, calling them mere accounting entries that are not worth the paper on which they are written. According to him, a lot the banks had been granted forbearances over the years and if the forbearances are withdrawn by the CBN, their retained earnings will be wiped out. He said total forbearances in the industry were roughly the capital the central bank is asking the banks to raise.

Providing further insight, he said almost all banks in the country have massive exposures to defaulting debtors, particularly in the energy sector (power sector and oil and gas loans), that they have scant hope of recovering. “These are loans that were given out 10 years ago to power sector investors during the privatisation exercise that have not been recovered. Then there are loans that were given to local oil and gas companies to acquire the assets of oil multinationals. All these loans are impaired, and the banks have little or no hope of recovering them. Yet, the CBN kept rolling over the forbearances to give the semblance of financial system soundness and stability. This was what Cardoso inherited from his predecessor Godwin Emefiele who was very lax with the forbearances that he gave to the banks, and they were too many of them,” the official disclosed.

The official said that save for the foreign banks – Citi Bank, Standard Chartered Bank and Stanbic IBTC – and to a lesser extent a few local banks such as GTBank, Zenith Bank and perhaps Access Bank, all the other banks have significant exposures to bank debtors whose non-performing loans (NPLs), running into trillions of naira, have not been written off against their income. He added that withdrawing the forbearances in one fell swoop would be injurious to the system, so the best route is for banks to raise fresh capital and for the CBN to allow them to bite the bullet in a phased manner.       

However, a few market analysts who sensed that the CBN has no confidence in the retained earnings of several banks, are questioning why the regulator cannot simply isolate banks that are under forbearance and allow the few without forbearance to count their retained earnings against capital. They were of the view that the blanket decision to disregard a significant portion of the book value of the banking system would amount to discrediting the financial statements of banks that external auditors and CBN examiners had approved over the last couple of years. They also felt that the CBN should tighten and monitor the calculation of risk weighted assets (RWAs) of banks so that they are not fictional, and once this is done, the CBN should focus on capitalisation of ratios. (RWAs are bank loans and other assets, weighted according to risk.) Furthermore, they recommended the exclusion of some part of retained earnings such as unrealised gains on assets and FX revaluation gains.   

Responding, the central bank official said CBN examiners had been acutely aware of the problem of rising NPLs and made recommendations to several banks to raise fresh capital in their respective examination reports, but their recommendations were ignored by both the banks and CBN executives. “Instead of being a proper regulator, the CBN became an enabler by not enforcing its own prudential guidelines,” he said. The CBN official added that the hot air being blown by banks over retained earnings was misplaced because the bulk of it was not cash and the objective of the central bank is to inject fresh cash into the balance sheets of banks.

“If they have confidence in their retained earnings, the banks should pay them out as dividends to their shareholders. But realistically, they cannot do so because a lot of these retained earnings have gone into various aspects of their balance sheets and are probably part of their risk assets which are impaired, they are also probably part of their fixed assets which you cannot immediately liquidate. So, it is difficult to include such retained earnings as part of their capital because it’s not actually cash. And since it is the CBN’s objective is to create new risk assets by way of loans, this can only be achieved through fresh cash injections,” he explained.

In addition, CBN is not unaware that the supernormal profits arising from FX revaluation gains that a lot of banks will declare for the 2023 financial year are not cash backed, so for them to pay dividends, they would have to do so from depositors’ funds. Banks can get away with it, according to Ugochukwu Obi-Chukwu, Founder/CEO of Nairametrics, “Because banks’ cashflow statements include depositors’ funds, so it is fungible and often impossible to know what funds the banks are paying out.” This interchangeability of shareholders’ funds with depositors’ funds on the financial statements of banks, renders it difficult for the public to know when a bank is distressed just by looking at its financials. It is for this reason, Obi-Chukwu noted, that central banks can only detect looming bank failure when they conduct stress tests. This, he added, reinforces Emefiele’s position when he oversaw the CBN that banks are not owned by their shareholders but by depositors because they have a significantly higher stake in banks and must be protected at all cost. In essence, without depositors, shareholders have no banks.

Well, as the banking sector recapitalisation exercise slowly but surely kicks off from today, it is expected that so many issues will be thrown up for the CBN and banks to wade through. Although it is uncertain that the central bank will back off from the non-inclusion of retained earnings to the revised capital base for banks, it will be advisable for the regulator to revisit the 30-day deadline given to banks to submit their implementation plans for recapitalisation.

For one, the Companies and Allied Matters Act (CAMA) renders the 30-day target unrealistic, as the Act stipulates that any changes to a company’s equity structure must get the approval of its shareholders. Two, a company’s shareholders can only meet by way of an annual or extraordinary general meeting after its board of directors must have met and considered the alterations to the equity structure. Three, to convene an AGM or EGM, at least 21 days notice must be given, to enable shareholders attend and approve or reject the changes to the capital structure.