A Dive into the CBN's Recapitalisation Plan: Examining Potential Benefits and Impacts
Minerva Legal
Maritime Law - Banking and Finance Law - Commercial Law - Energy and Natural Resources - Intellectual Property Law
CBN’s Rationale Behind the Circular
The global financial crisis that occurred between 2008 and 2009 sparked a widespread interest in understanding the influence of capital regulation on bank behaviour. This crisis served as a crucial indicator to nations, highlighting the implications of bank behaviour on employment, stability, national output, and economic growth and development. In response, policymakers proposed substantial changes to the regulations guiding banks, one of which sought to increase the minimum capital threshold for their operation.
In Nigeria, it has been approximately twenty (20) years since the Central Bank of Nigeria (CBN) reviewed the capital threshold for banks. Fortunately, the 2008 crisis was highly instrumental in showing the inadequacy of the former threshold which was then fixed at N25 billion and N50 billion for National Commercial Banks and International Commercial Banks respectively.
Reiterating this regulatory inadequacy, the CBN governor, Dr Olayemi Cardoso, mentioned in a speech at the 2023 Banker’s dinner that there was a need to increase the minimum capital threshold of banks to meet the needs of a projected $1 trillion economy. This position was informed by the prevailing macroeconomic challenges which emphasised the need to bolster the resilience of the Nigerian financial sector and particularly ensure the banking sector plays a pivotal role in driving economic growth.
Consequently, the Central Bank of Nigeria (CBN), via a Circular ("the Circular") signed by Mr. Haruna B. Mustafa, Director of the Financial Policy and Regulation Department, set out new minimum capital requirements for commercial, merchant, and non-interest banks.
?
A Kaleidoscopic View: Key Elements of the Circular and their Implications
Referred to as the Banking Sector Recapitalisation Programme, the revised minimum capital requirements vary depending on the bank’s authorisation:
?To meet these requirements, banks have several options available to them. They may inject fresh equity capital through private placements, rights issues, and/or offers for subscription. They can also explore mergers and acquisitions (M&As) or consider licence authorisation upgrades or downgrades.
Any of the above options will likely attract public investors interested in adding bank stocks to their portfolios, thereby stimulating the Nigerian equity capital markets. Existing shareholders have the opportunity to acquire new shares on a Right of First Refusal or Right of First Offer basis if a rights issue is implemented, allowing them to increase their ownership stake in the bank.
For banks that choose to explore mergers and acquisitions as an option, it is important to acknowledge the importance of complying with the Banks and Other Financial Institutions Act, 2020 (BOFIA) as well as regulations set forth by the Nigerian Exchange Group (NGX) and the Securities and Exchange Commission (SEC). These regulations will influence the structure of proposed transactions and timelines for their completion.?
The new minimum capital requirements took effect on April 1, 2024. Existing banks, however, have a grace period of 24 months —from April 1, 2024, to March 31, 2026 — to comply with this obligation.? During this period, banks are required to adhere to the minimum capital adequacy ratios (CAR) — a measure of how much capital a bank has available, reported as a percentage of a bank's risk-weighted credit exposures— that are relevant to their licences.
All proposed banks that submitted applications for banking licences after April 1, 2024, are also subject to the new capital threshold. In respect of pending applications for which capital deposits have been made or Approval-in-Principle (AIP) has been granted before the issuance of the circular, such application processes will continue. However, the promoters of such proposed banks are required to ensure that the difference between the capital deposited with the CBN and the new capital requirement is met by March 31, 2026.
Furthermore, all banks are required to submit an implementation plan outlining their chosen options for meeting the new capital requirement to the Director, Banking Supervision Department, Central Bank of Nigeria, no later than April 30, 2024.? It is important to note that the onus falls on the CBN to monitor and ensure compliance with the new requirements within the specified timeline.
The circular also mandates that the required minimum capital shall consist solely of paid-in share capital (i.e. paid-up capital and share premium). Essentially, this means that other components of bank capital such as (i) retained profits (ii) other reserves and (iii) Additional Tier 1 (AT1) capital will not be considered for meeting the new minimum capital threshold.
From a regulatory standpoint, the emphasis on paid-up capital and share premium exclusively ensures that banks establish a robust foundation of core capital funded directly by shareholders through initial and subsequent share issuances. This approach avoids reliance on internal capital generation methods, which could be susceptible to artificial amplification through internal bookkeeping entries.? Moreover, the exclusion of retained profits from the calculation of a bank’s minimum capital reflects the CBN's preference for fresh capital infusion from shareholders. This strategy enhances the banks' capacity to absorb losses with funds that do not require repayment and are free from obligations.
However, there are concerns regarding the exclusion of other reserves such as retained profits and accumulated profits. Retained earnings serve as a critical source of capital accumulation, allowing profits to be reinvested to support growth initiatives or buffer against unexpected losses. The ineligibility of such accumulated capital for calculating a bank’s minimum capital could hinder the ability of certain banks, particularly those heavily reliant on retained earnings, to meet the new capital requirements. This may also discourage banks from maintaining significant reserves of retained earnings.
While the Circular does not preclude the application of retained earnings towards a bank’s overall regulatory capital, relevant reserves will still be considered in determining the risk-based capital adequacy ratio (CAR) following CBN guidelines.
It is worth noting that the Circular diverges from CBN Guidelines on Regulatory Capital and Basel III standards[1] despite the acceptance of eligible capital within the Nigerian banking system. These standards typically include various capital components beyond paid-up capital and share premium.
Considering the above, there is merit in adopting a balanced approach that incorporates the nature and diversity of capital components. Many jurisdictions allow for the inclusion of retained earnings and other reserves as part of minimum capital requirements, subject to certain conditions and limitations. These conditions may include audited, unencumbered retained earnings, limits on the percentage of total minimum capital, additional regulatory approval, or risk-based adjustments based on a bank's asset risk profile.
The CBN may wish to explore such an approach in the future, once the current phase of recapitalisation is completed and the financial system stabilises. This approach could enhance the resilience and flexibility of banks while maintaining regulatory standards and promoting financial stability in the long term.
At the heart of the CBN's decision for recapitalisation lies the recognition of the evolving dynamics and challenges facing the financial industry. Like many other economies, the Nigerian financial sector has been confronted with a myriad of macroeconomic uncertainties and external shocks, ranging from exchange rate volatility to inflationary pressures. In such a fluid environment, the need for banks to maintain adequate capital levels cannot be overstated; thus, recapitalization serves as a buffer against systemic risks, ensuring that banks possess the financial strength and resilience to weather adverse economic conditions.
Ultimately, recapitalisation aligns with regulatory objectives aimed at promoting financial stability and safeguarding stakeholders' interests. By setting higher capital thresholds, the Central Bank of Nigeria reinforces prudent standards and risk management practices. Consequently, banks are incentivised to adopt more conservative lending practices, improve asset quality, and enhance corporate governance structures. This, in turn, reduces the likelihood of systemic crises and enhances the overall resilience of the financial system.
The recapitalisation programme also fosters competition and innovation within the banking industry. Banks with stronger capital bases are better positioned to invest in technology, expand their product offerings, and improve service delivery. This spurs competition among banks, driving efficiency gains and ultimately benefiting consumers through lower costs, enhanced convenience, and greater choice. Additionally, recapitalisation encourages consolidation and restructuring within the banking sector, leading to a more streamlined and resilient industry landscape.
It is also essential to assess the challenges associated with recapitalisation, particularly in meeting the new capital thresholds and accessing liquidity as well as contemplate supportive measures that will enable banks maintain stability
One such challenge arising from the revised minimum capital requirements is a potential strain on the liquidity of banks. Injecting fresh equity capital through private placements, rights issues, or offers for subscription requires significant financial resources and may not be feasible for all banks, especially smaller or regional banks.
Moreover, the economic landscape, with its susceptibility to external and domestic shocks, further complicates the liquidity challenge confronting banks. Factors such as exchange rate volatility, inflationary pressures, and subdued economic growth contribute to this challenge. Consequently, banks may encounter difficulties raising capital or attracting investors, thus jeopardising their ability to meet the new requirements within the stipulated time frame.
?
A Constructive Approach: Ensuring Maximum Effectiveness of the Circular
Given the above, it is advised that the CBN adopts a balanced approach, providing targeted support and guidance to banks facing liquidity constraints while maintaining the integrity of the recapitalisation process. It is therefore essential to consider additional schemes and support mechanisms to mitigate the impact of the recapitalisation programme on banks and maintain stability in the financial system. Some of the schemes CBN can consider include:
1. Liquidity Support Programs: The CBN can establish special liquidity support programs to assist banks in meeting the revised capital requirements. These programs will provide access to temporary funding or liquidity facilities, enabling banks to bridge short-term liquidity gaps and facilitate compliance with the new thresholds.
2. Incentives for Capital Infusion: To incentivise capital infusion, the Central Bank of Nigeria can consider implementing incentives such as tax breaks, regulatory relief, or preferential treatment for banks raising fresh capital. These incentives would encourage investors to inject capital into banks thereby bolstering their liquidity positions and strengthening their financial resilience.
3. Collaborative Initiatives: Effective management of liquidity challenges requires collaboration among banks, regulatory authorities, and industry stakeholders. The CBN can facilitate collaborative initiatives, such as industry-wide restructuring or consolidation schemes to optimise resource utilisation and collectively improve the liquidity of banks.
4. Flexible Compliance Timelines: Considering the unique circumstances faced by different banks, the CBN could adopt a flexible approach to compliance timelines. Banks experiencing severe liquidity constraints or operational challenges can be granted extensions or phased implementation timelines, thereby providing them with the time to meet the requirements without compromising financial stability.
5. Capacity Building and Technical Assistance: The CBN can offer capacity building programs and technical assistance to banks, particularly smaller or regional institutions, to enhance their financial management capabilities and facilitate compliance with the revised capital requirements. These initiatives may include training programs, advisory services, and guidance on capital-raising strategies.
?
In conclusion, It is important to note that despite any limitations or constraints banks may be confronted with, the CBN’s initiative to revise the minimum capital threshold serves to strengthen Nigeria’s banking system and position the nation as a leading economic force in the world. Through this, the banking sector becomes better equipped to navigate uncertain economic conditions, attract investments, foster competition, and promote financial stability. However, amidst the execution of this initiative, it is crucial for the CBN to also develop additional support measures that will foster collaborative efforts to ensure the sustainability of the financial systems and mitigate the adverse effects of the initiative on banks. This strategic approach will safeguard stakeholders’ interests in the industry, as well as bolster a robust and resilient financial sector in the years to come.
?
We recommend that affected stakeholders seek expert guidance from their financial legal experts regarding the dynamic impacts which the recapitalisation may have on their financial operations.
?