How to know weak banks in Nigeria...

The Nigerian Banking system has experienced several transformations since the Failed Bank Tribunal until recent change in the Management and Board of a new generation bank. It is normal to see events like this unfolding in emerging economies like Nigeria. It is obvious that each stage makes the banking industry better and analytical investors have more confidence in the banking system. However, I have a very strong reservation about these reactionary approaches. The proactive approach is usually minimal compared to the reactionary approach. Reacting to a failed situation indicates poor regulatory supervision or inherent risks are not properly considered.

The process for risk management starts with understanding the process/product or business, to risk identification, to risk assessment, to risk mitigation or controls, to risk monitoring and risk reporting. This is a fundamental knowledge for risk managers. I will pick Monitoring as a topic of discussion here. Some of the tools for risk monitoring includes Key Risk Indicators (KRI), Key Control Self-Assessment (KCSA) and Policy Test (PT). I will, again, focus on Key Risk Indicators. Criteria must be defined when designing KRI. The criteria must be such that is data driven and carved within a defined appetite. Let me give an example. One of the KRI for Deposit Money Banks (DMBs) in Nigeria is maintenance of Capital Adequacy Ratio (CAR) of 10% for Non Systemically Important Banks (NSIBs) and 16% for Systemically Important Banks (SIBs). Any bank that falls short of this requirement has indicated that a Key Risk exists and the regulators are empowered to act. The recent event with the new generation bank was based on this and other diagnosis. However, I have a case on trend analysis which regulators do not bother about. If a bank’s CAR remains stagnant or hovers around the minimum requirements, it should give regulators a concern. On the overall, the CAR should show an upward trend. Consistent downward trend should give a concern.

Risk Based Supervision is a key factor in ascertaining the frequency of assessment of banks. Banks should be classified as high risks, medium risks and low risks. But I advise that regulators should keep these ratings confidential to avoid bad publicity for high risk banks.

How do you know a distressed bank? I will advise that the CAMEL approach should be used. CAMEL implies (Capital Adequacy, Asset Quality, Earning Potentials, Liquidity Management).

Capital Adequacy

Banks that meet and exceed the CAR appears healthy. This is a quantitative approach to assessment of the bank. As an analyst and researcher, I set a benchmark which is the industry benchmark relative to each category. For instance, if the industry average for SIBs is 18% and a particular bank rest on the border line of 16% consistently for about 2-3 quarters, it is a sign that something is wrong somewhere. I will get more worried if same bank drops a little (say 15.8% in a quarter). Though the year end figure is often taken to be more relevant since it is audited, I take it that even unaudited figures have relevance. Some banks that consistently lie below the industry average for a long time may give me worry.

Asset Quality

Components of measuring asset qualities includes the rates of Non-Performing Loans (NPL), Total earning assets to total assets, Liquid assets to non-liquid asset ratio…just to mention a few. Let me take the NPL. If the average NPL in the industry is 4% and a bank consistently gives 7% and above, then I will be worried. The standard deviation from median figure is above 50%. It indicates that the bank has more bad loans; hence more impairment charges. The impairment charges will affect the financial performance of the bank i.e. reduce its Returns on Equities (ROE). Such bank may not be able to declare dividend or give returns to the shareholders. Market sentiments may drive the share price down. My analysis of the industry reveals that the industry made impairment charge of over N400bn for FY2015. Except asset remedial actions are strengthened, more provisions are likely to occur due to exposures to various industries. Other components to consider in ascertaining asset qualities are sectorial exposures, collateral value & quality, obligor limits exposures, insider-related credits and credit risk management framework.

Management’s Quality

The quality of people that sit on the Board of a bank and the management is very key in ascertaining the healthiness of a bank. Banks with too many Politically Exposed People (PEPs) should be on a watch list (my opinion). The Central Bank of Nigeria should not give room for PEPs to sit on the Board of any bank. The problem here is that some of these PEPs can sponsor their stooges to sit on the Board and milk the bank dry. What do you look out for in Board assessment? You should look at the experience of each board member, ascertain if various board committees exist as required by code of Corporate Governance, if board members attend meetings and relevant trainings, if board members do not take more than necessary loan (unfortunately the CBN has no rule on the limit of loan for board members or their related parties…none that I am aware of). You can check further to see if there a “dominant figure” on the Board. There are banks that the Chairmen direct the affairs of the bank (irrespective of numbers of the board members). That is a very high risk. The board answer to the chairman rather than the other way. Management quality could be assessed based on experience, qualifications, appropriate post-manning etc. Other considerations for Management’s quality includes rates of internal frauds, litigations, bad press, high attrition rate at the board and management level, involvements of Board or management members with law enforcement agents etc. The business of banking comes with trust and high fiduciary responsibility, but if those who are saddled with responsibilities fail integrity test, then we are in trouble. A bank with weak management’s quality has shown high sign of distress. Investors should be careful.

Earning Potentials

Banks must have good earning potentials. This implies that the quality of assets must be such that can make the bank earn income in the future for sustenance and going concern. Weak earning potentials indicates that the bank may not be able to sustain its operations in the far or near future. In a case where half of a bank’s loan becomes toxic and the ratio of the loan to total asset is very high, then the earning potentials has dropped. For instance, if a bank’s total asset is N100bn, the Loan to Asset is 75% (N75bn); and 50% becomes toxic (N37.5bn), the bank is left with N100bn-N37.5bn (N62.5bn). The earning potential has dropped (if other factors remain same). If the earning potential falls below industry average and this is consistent for a long time and there is even further drop, then I will become sleepless if I have investment in that bank.

Liquidity Management

Banks are expected to maintain a liquidity ratio to enable the bank meet its short and medium term obligations. Banks trade in money, hence low liquidity implies that the bank cannot meet its obligations and that may lead to litigations or loss of reputation. Lehman Brothers, an investment bank that failed in the US, had over $600bn in asset, but has less than $2bn in liquid asset when it went down on Wall street in 2008. I have studied many financial statements in Nigeria and I have scarcely seen banks expressly mentioning their liquidity ratios. Basel III is about liquidity management and I think Nigerian banks should quickly implement the accord. Without computation, how do you know if a bank has liquidity crisis? A bank that cannot settle obligations at maturity may have liquidity problem. For instance, if you make a fixed deposit of N100m with a bank and they cannot settle you at maturity, that is a sign for you to wonder what is going on. If a bank owes many contractors and cannot pay. If a bank cannot pay salary on scheduled dates. If a bank keeps increasing inter-bank lending. If a bank gives “stupendous interest rates” to woo you to make placement, be careful (this is not a generic statement, it applies to a case when you sense danger. It is good to investigate).

I will like to stop here! If you need assistance on how to design a template for Internal Risk Assessment model for counter-parties or you want to design internal liquidity management (using excel), feel free to leave your email address here. If you also have vacancies for Risk Managers, please in-box me.

Thank you for reading this piece.