• Wednesday, May 29, 2024
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The exclusion of retained earnings from Nigerian bank’s recapitalisation components

The exclusion of retained earnings from Nigerian bank’s recapitalisation components

I came across an article on BusinessDay online dated March 29, 2024, which discussed the reasons behind the Central Bank of Nigeria’s decision to exclude retained earnings from the capitalization terms for banks.

According to the CBN, when defining share capital, retained earnings were omitted from the calculation, with only the bank’s ordinary share capital and share premium being considered.

However, a compelling argument exists that the current framework, which excludes retained earnings from the components considered for a bank’s capitalisation, needs a fresh look. This is especially critical in light of the apex bank’s endorsement of International Financial Reporting Standards (IFRS) for entities, following approval by the Financial Reporting Council of Nigeria (FRC).

Under IFRS, share premium, representing the profit generated when shares are issued above their nominal value minus issuance costs, is classified as a reserve—remarkably similar to undistributed profits, now known as retained earnings, which have been accumulating over the years.

This inconsistency raises questions about the rationale behind excluding retained earnings from the bank’s capital base. Shouldn’t these accumulated profits, a testament to the bank’s strong financial performance, be acknowledged as a source of strength when assessing its overall capital adequacy?

The apex bank should seriously reconsider its position and adopt a more flexible approach, allowing retained earnings to be factored into banks’ capitalization calculations. However, to ensure precision and transparency in financial reporting, it’s imperative to exclude certain unrealized gains that contribute to retained earnings. These include foreign exchange gains resulting from transaction conversions and adjustments of receivables and payables denominated in foreign currencies at the end of each reporting period.

Moreover, gains arising from the fair value adjustment of financial assets categorised as having fair value through profit or loss should be omitted from consideration unless these assets have been liquidated, thereby actualising the gains.

By implementing these refinements, the regulatory framework will not only ensure accuracy but also encourage banks to maintain sustainable profitability while upholding accountability and transparency standards. Such measures will undoubtedly foster greater trust and confidence in the banking sector, ultimately fortifying Nigeria’s financial landscape for sustainable growth and development.

Reasons why retained earnings should be considered for capitalisation:

Stability and solvency: Retained earnings represent a bank’s accumulated profits that have not been distributed to shareholders but retained for reinvestment. Utilising these earnings can strengthen a bank’s capital base, enhancing its stability and solvency.

Enhanced market confidence: Using retained earnings for recapitalisation signals to investors that the bank has generated enough profits to support growth plans, bolstering market confidence in its ability to operate profitably.

Reduced external funding dependency: Recapitalising retained earnings reduces reliance on external funding sources like debt or equity financing, lowering financial risk and reducing interest payments or diluting existing shareholders’ stakes.

Preservation of shareholder value: Utilising retained earnings for recapitalisation preserves existing shareholders’ ownership stakes, maintaining confidence and protecting their interests during the process.

Overall, including retained earnings in Nigerian banks’ recapitalisation efforts is deemed justified, providing a stable source of internally generated capital that enhances financial strength, market confidence, and shareholder value preservation.

In conclusion, the Central Bank of Nigeria’s (CBN) exclusion of retained earnings in bank capitalization warrants careful reconsideration, as it is a crucial aspect of assessing a bank’s financial health.

A more nuanced approach could involve conducting a comprehensive analysis of each bank’s profit composition, taking into account both realised and unrealised gains. By excluding all forms of unrealized gains from retained earnings, the CBN could gain a clearer understanding of a bank’s true financial strength and stability.

This would enable the identification of institutions with a sustainable track record of profitability, fostering greater confidence among stakeholders and investors in the banking sector. Ultimately, such measures would contribute to promoting a more robust and resilient banking sector in Nigeria, better equipped to withstand economic challenges and ensure long-term financial stability.

Deji Awobotu (Dr), FCTI, FCA, F.IoD, mni, Chief Executive, MBA, Financial Consulting, Training and Management Consultant.