By Muhammad A. Akanji and Adenike Alao
Prologue
Two decades after the last banking recapitalisation exercise in Nigeria, the CBN, through a circular memo in March 2024, issued a directive intended to reshape the financial landscape and boost the risk profiles of the nation’s deposit money banks (DMBs) against external and domestic shocks. In the direct memo, the regulator revised the capitalisation requirement for existing and proposed banks, setting new benchmarks for “commercial,” “merchant,” and “non-interest” banks. Everyone agrees that healthier, stronger, and more resilient banks are crucial for sustainable economic growth. Thus, the revised requirement is intended to support Nigeria’s government’s plan to reflate the economy to US$1 trillion by 2030.
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If the 2008/2009 global financial crisis taught us anything, it is that sufficient regulatory capital and banks with a larger capital base can underwrite larger levels of credit, which is crucial to lubricating and catalysing the growth of the economy. Adequate capitalisation is an indicator of the efficiency and stability of the financial system. It is also a measure of a bank’s financial soundness, ensures the safety of depositor’s funds, improves confidence in the banking system, deepens financial intermediation, and enhances its capability to buffer economic growth through investment funding. So, this directive, a crucial step towards economy-wide reform, proposed a time-sensitive two-year journey, indicating that banks have limited windows to prop up their base.
New minimum capital gaps and recapitalisation options
With the new directive, it is estimated that the Nigerian banking industry will require an additional N4 trillion in fresh capital inflow to meet the minimum requirement, and this is by no means an easy feat.
Nigerian Banks Capital Gap
The CBN’s circular recognises three options for banks seeking to comply with the new order: fresh equity, mergers and acquisitions (M&A), and change of licence operations. So as the shareholders, directors, management teams, and those charged with the governance of the banks begin to engage on how to meet the new minimum, it is crucial to explore strategies that can be deployed on how the new minimum can be met.
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(i) Injection of fresh capital through private placement, right issue, and/or offer for subscription
It seems clear that this option will open up a path for public investors who want to add bank equities to their portfolios, subject to the unique capital-raising strategies used by the banks. More importantly, though, it will likely boost the Nigerian equity capital markets. If a rights issue is approved, current shareholders will also have the opportunity to receive new shares as a matter of priority, allowing them to enhance their equity interests.
(ii) M&A
Over the past 20 years, the banking sector has seen several significant mergers and acquisitions. Although some of them have recently been spurred by a few banks’ development plans, the initial wave of bank M&As was brought about by the 2004 recapitalization laws.
Even though Nigerian banks are generally stronger this time around, M&A activity aimed at complying with the new minimum capital requirements regulations is still anticipated to occur, most notably in the national, regional, and merchant bank categories.
In this regard, the CBN has reassured the public that depositor accounts and monies will remain safe in the case of a merger or acquisition (M&A) since the acquiring institution will take on all liabilities and obligations related to depositor protection. This complies with current legislation.
(iii) Upgrade or downgrade of licence authorisation
It is recommended that banks consider the possibility of reducing the authorisation of their licence to comply with the recently implemented minimum capital standards. Although banks have always had the option to upgrade, which gives banks in lower licensing tiers the chance to increase their authorisation, banks that would otherwise find it difficult to meet capital requirements have a lifeline in the form of the ability to downgrade, for which M&A transactions may not be the best course of action. Under a revamped operating platform, these banks can now lower their authorization level and create long-term plans for a stable capital basis.
A key concern regarding the new requirement, which notably introduces a 900 percent increase for each of the international and national commercial bank categories, is whether the affected banks are properly positioned to attract the required capital within the 24-month timeframe set by the authority.
With the CBN insisting on fresh capital, the sector would see a large inflow of new equity-debt portfolios, a tendency towards mergers and acquisitions (tier 3 and fewer tier 2 banks will likely be morphed into larger entities), and possibly the setting up of new banks with the revised minimum paid-up capital. Tier 3 banks or those with negative shareholders’ funds will likely be absorbed rather than merged, as seen during the 2005 exercise.
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Much ado about retained earnings
Based on the capital eligibility criteria set by CBN, the capitalisation circular mandates that only paid-in share capital (i.e., share premium and paid-up capital) are to be included and that other components of bank capital, such as (i) retained profits and (ii) other reserves and additional Tier-1 (AT-1) capital, shall not be included to meet the new minimum.
It must be noted that this approach to capital recognition is a deviation from the previous CBN’s policy of setting minimum capital by reference to shareholders’ funds, which comprises not just the paid-up capital and share premium but also the retained profits and other reserves. The regulator’s decision, therefore, may make it harder for banks to meet their new requirement. Nevertheless, this decision is in line with BDI’s observation of the books of many commercial banks in that while the banks have shareholders’ funds and other tier-1 capital in multiples of N25bn as prescribed by extant laws, none of them had a share capital of N25bn. Thus, prior, banks were allowed to continue their operations without regulatory penalties despite their shortfalls. But it appears that this is about to end.
The exclusion of retained earnings and AT-1 capital has split opinions amongst industry experts and analysts. The protagonist of retained earnings argued that the proportion of retained earnings used to finance bonus or scrip issues for shareholders should be taken as part of the bank’s share or common equity capital (CET1), likening it to expecting a diver to dive fifty feet under without his diving gear—an unconscionable suggestion! Others argue that the CBN is justified because share premiums and paid-up capital represent the true current status of the banks. More so, insisting that banks bring up new capital means that they have more financial muscle to support future operations by growing their loan books while de-risking their statement of financial positions by building a strong equity buffer.
Over the next few years, we anticipate banks to pay out dividends aggressively as retained earnings will no longer be used as a source of capital. The goal of this is to improve the financial standing of shareholders so they may benefit from options that the banks may choose to pursue to raise additional capital, such as placement or right issues. However, the payment of such dividends must comply with all applicable CBN regulatory standards and/or be approved by the CBN.
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This new regulatory game, we observed, is not without its risk; the increase in the bank’s capital, while a positive thing, could potentially be misapplied and exacerbate the lenders’ non-performing loan position. The real challenge, therefore, should shift to the bank’s management quality and not just the money. We submit that while the CBN intends to grow local banks with the potential to support big-ticket transactions to support the economy—a noble intention—the outcome is still uncertain momentarily.
Muhammed is a research and data analyst at BusinessDay Intelligence. He has years of experience in analysing the economy, finance, and human capital development.
Nike is the Chief Research Officer at BusinessDay Intelligence. She is a market research expert with a dynamic blend of innovation and strategic prowess across diverse industries.
For enquiries: Nike Alao-Chief Research Officer
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