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The IMF got it wrong on AMCON

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The IMF Article IV Consultation and review is a very important and extremely useful tool for IMF member countries and market analysts. It is a tool used to evaluate the effectiveness and context of a country’s economic policies and management in dealing with macro-economic stability and fostering growth.

The review not only provides an early warning signal but is also useful for pre-emptive moves to prevent economies from derailing and suffering from the consequences of exogenous and internal shocks.

Therefore, most monetary and development economists take the staff reports that accompany the consultation very seriously. One has to take the review in conjunction with the outlook and sovereign credit ratings of global rating agencies like S&P’s, Moodys and Fitch before drawing conclusions on the economic direction of these countries.

The Article IV Consultations are respected not only for their depth, professionalism and intellectual input but more than anything else their objectivity. The process of the consultation involves discussions with the Economic Management Team of the governments as well as inputs from private sectors subject matter experts, across the critical sectors and industries of the economy.

In our view, the process is objective and dispassionate, thus almost ensuring that the outcome is consistent with the process.

In the public information notice No. 13/36 of March 28, 2013 the executive board assessment addressed a number of issues which we are mostly in agreement. However, in the 7th paragraph we disagree with the recommendation and thus the conclusion as it relates to Asset Management Corporation of Nigeria (AMCON). “Directors commended the authority’s success in restoring financial stability after the 2009 banking crisis. In light of this achievement, they recommended winding down the operations of the asset management company to curb moral hazard and fiscal risks.”

The cost of a banking sector collapse in Nigeria

Bank failures and financial crises are economic hazards. These crises are accompanied by worsening macroeconom

mar

ic performance. A distressed banking sector will be a serious obstacle to economic activity and aggravate the effect of adverse shocks, e.g., tightening of monetary policy, the end of a credit boom, or a reversal in foreign capital inflows. A distressed banking sector will mean firms may be unable to obtain credit to deal with a period of low internal cash flow. In fact, lack of credit may force viable firms into bankruptcy. Similarly, lack of consumer credit may worsen declines in consumption and aggregate demand, aggravating unemployment.

AMCON – the bad bank

Asset Management Corporation of Nigeria (AMCON) – Nigeria’s bad bank – was set up to revive and stabilise Nigeria’s banking industry through the purchase of non-performing loans (NPLs) of the nation’s banking industry.

AMCON has so far acquired over 10,000 NPLs worth N3.5 trillion ($20 billion). Before its formation, NPLs ratio in the Nigerian banking industry was in excess of 35 percent. As of December 31, 2011 the NPL ratio had fallen to 5 percent, enabling the banks to focus on lending. In addition, AMCON

long injected fresh capital into eight Nigerian banks, five of which have entered into successful mergers. As a result of the recapitalisation of banks, it currently owns Mainstreet Bank, Enterprise Bank and Keystone Bank. The establishment of AMCON has also averted a potential financial disaster.

AMCON, the bad bank, was initially conceptualised to be a bank to resolve the serious and grave situation of the banking industry and insulate the system from those risks. Apart from the resolution of manifested risks and toxic assets roughly estimated at N4trn, it was also considered an essential part of the institutional framework for preventing and developing early response to isolated pockets of risks that could easily become contagious or viral.

The Nigerian position is not any different from other bad banks in emerging, advanced and frontier economies. For example, in 1992, the government of Sweden’s attempt at curbing its banking crisis led to the creation of several asset management companies. The two most important were Securum and Retriva. Some 3,000 non-per

 

forming loans that had been extended to 1,274 troubled companies were transferred from Nordbanken (which had been completely taken over by the government) to Securum, and Retriva took over 45 percent of Gota Bank’s assets shortly after the bank was nationalised. In 2007, the revenues from several sources, dividends, selling of stock and a rising value of the government’s remaining equity stake, finally offset the cost of the bailout. The success of the bailout eventually paying for itself is attributable to the success of Sweden’s bad bank plan in minimising losses on troubled assets.

We will address the two issues raised by the IMF separately. Firstly, the question of a moral hazard arises when the

cost of an alternative resolution option is less expensive to the system and taxpayer. It also becomes a problem if the defaulting operators pay a less than punitive price which encourages deviant behaviour in the future. The price at

which AMCON is purchasing toxic assets is so punitive that no rational banker or operator will sell assets to it except as a last resort. In addition the stigma of being an AMCON client in the domestic and international business community is both a fiscal and social burden. Empirical evidence shows that the NPLs of the banking system were as high as 35 percent in 2009/10 and have now declined to 5 percent. The Loan Deposit Ratios (LDRs) are also in a much better state together with the Capital Adequacy Ratios (CAR). The IMF review attested to these facts.

AMCON had actually discontinued the purchase of toxic assets since December 2012. In fact, there are instances of banks trying to repurchase the assets and collateral back from AMCON.

The second issue raised is that of the fiscal costs. Empirical evidence shows that almost all bad banks have become profitable over a period of time. This is because the toxic assets are purchased at steep discounts and are sold back into the market after a recovery, e.g., AIG and the TARP. Moreover, Nigerian banks are bearing the funding costs of the exercise. Nigerian banks are paying 0.5 percent of their total assets as a levy. The financial burden of the treasury and taxpayer is minimised by the banks agreeing to pay a levy for 10 years.

The main fiscal burden there

fore is the opportunity cost of the government revenue deployed for distress resolution or avoidance which could have otherwise been used for infrastructure, welfare projects or investments.

After addressing the two major concerns raised by the IMF staff – fiscal risks and moral hazard – one should address an issue which is not peculiar to Nigeria but is critical at this point in its economic transition from a national wealth to a produced wealth economy. The orthodox approach to economic development is unlikely to allow for a leapfrogging of the country from a frontier status to an emerged or BRIC nation. This means that the current level of national leverage of 18 percent, well below that of South Africa, Malaysia or South Korea, will need to be increased. This will happen almost simultaneously with the national savings ratio and also capital formation now 4.9 percent of GDP. All of these variables will lead to possibly an increase in the rate of financial and credit intermediation at the government, corporate, and retail and mortgage levels. Therefore, one can assume that the quantum of risk asset creation by banks and other financial intermediaries will increase sharply over time. If that assumption is true, then it is only natural for us to look at the history of financial crisis and distress in Nigeria. It is also important to see the frequency and magnitude of banking crisis and

its impact on the macro economy in the last 60 years.

History of financial distress in Nigeria

The first round of bank failures was under the colonial government in the 1950s. The casualties included the Farmers Bank, Agbomagbe, etc. The major reason for the failure was weak credit processes and diversion from the original loan purposes to other uses. The banking crisis was easily isolated and was confined to indigenous banks with less than 3 percent of total banking assets. The three international banks controlled more than 90 percent of deposit liabilities and assets. Therefore, the system and macro-economy was insulated, with the only real effect being loss of confidence at the retail level.

The next round of distress was in the 1970s and early 1980s which saw National Bank, African Continental Bank and Bank of the North stutter and fail. The failure of these government-owned banks affected less than 10 percent of total banking assets. Again, similar to the past, the collapse of these institutions was attributable to government meddling, governance failures and insider lending.

There were three subsequent crises, one in the 1980s after the government withdrew its deposits from banks leading to an asset/liability mismatch. This led to a rush by merchant banks into commercial banking, for the purpose of accessing current account

as

deposits. This was to be followed by the NERFUND crisis, in which Nigerian and foreign banks were drowned by cross-border risks after the naira was devalued from N22/$ to N80/$. In all of these crises leading to the failed bank decree, the systematic fallout was much longer than anticipated. But the aggregate banking assets affected were still less than 20 percent of total banking assets; a major financial earthquake.

The final and big one was the 2009 crisis, which coincided with the global asset bubble. The crisis of solvency liquidity and confidence affected approximately 40 percent of the total banking system. The financial cost of the intervention is now in excess of N5trn, not to talk of shareholder values destroyed.

The importance of this chronological review is to show that over time the casualties of banking crisis has grown at a more astronomical rate than the growth of the economy and industry. This is in spite of the establishment of the Central Bank of Nigeria (CBN) and the Nigerian Deposit Insurance Corporation (NDIC). Also from an anthropological perspective, it would appear that the lessons of a poor credit culture and process have not been learnt or internalised by the operators. Every time there is a new financial crisis, it is always bigger than the past ones.

Therefore, whilst the fear of a moral hazard may be real and must not be ignored, it is important to also note that toxic assets are not only a function of dysfunctional credit officers and abuse but cyclical downturns, exogenous shocks and technological changes. Even at times as a result of policy changes, i.e., import prohibition, increased levies, etc.

Therefore, to dismantle or demobilise significantly the institutional framework or the architecture needed to deal preemptively, containing or resolving crises is not advisable. To dismantle mothball or render impotent AMCON, the fact remains that the next systemic crisis which is inevitable may be a big and huge macroeconomic miscalculation.

In conclusion, it is only fair to say that the broad macro-economic objectives of Nigeria are better served if policymakers understand the context and time in which we operate. Also to understand the strategic intent to grow rapidly, build a solid development base whilst simultaneously ensuring macro-economic stability. To this extent, we need to accept those recommendations of the IMF that are consistent with our national economic objectives and discuss or realign the others that are at variance with our long-term goals. Failure to do this may prove to be expensive if recommendations are accepted without any modifications.

 

BISMARCK REWANE

Rewane is MD/CEO Financial Derivatives Company Ltd

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