CBN’s ‘too big to fail’ designation of 8 banks

The Central Bank of Nigeria (CBN) has released a draft document which has designated eight banks as “too big to fail”, due to the risk their failure could pose to the entire financial system.

The banks designated as “too big to fail” or Systematically Important Banks (SIBs) in the CBN draft paper include: First Bank of Nigeria, United Bank for Africa, Zenith Bank, Access Bank, Ecobank Nigeria, Guaranty Trust Bank, Skye Bank and Diamond Bank.

According to the CBN, the banks that made the list were determined by assessing four criteria: size, as defined by total assets, interconnectedness, as defined by interbank exposures and volumes of other intra-industry assets and liabilities, substitutability, as defined by ease with which the institution can be replaced as a financial services provider and complexity, as defined by how difficult it would be to liquidate the institution. The top eight banks currently account for over 70 percent of the industry’s total assets.

The CBN move seems to be following developments in the developed capital markets, where regulators have sought to name systemically important banks as too big to fail and have proposed higher capital requirements for them. As is the case abroad, a big impact of being named as a SIB by the CBN is that some of banks would require additional capital. The current capital adequacy ratio (CAR) in Nigeria is 10 percent for local banks and 15 percent for banks with international operations.

The proposed changes for SIBs would however mean a minimum CAR level of 15 percent, irrespective of whether a bank is deemed local or has international subsidiaries. All the banks named by the CBN have CARs that are above 15 percent as of nine months (9M 2013) and half year (1H 2013), as per the most recent disclosure.

The draft report also mentions that SIBs would be required to provide an additional 1 percent of capital as a Higher Loss Absorbency (HLA) charge, in addition to the prescribed minimum CAR and hold more liquid assets and meet a liquidity ratio of 5 percent above the minimum requirement currently set at 30 percent. According to the draft, the aim of the HLA is to ensure that a large portion of these banks’ balance sheets are funded by permanent capital, and to deal with cross-border risks. The additional 1 percent surcharge can only be funded by Tier 1 capital. Renaissance Capital (Rencap), an investment bank, says should this be implemented, it would effectively raise the minimum CAR to about16 percent, hence placing further strain on the banks.

Of the eight banks named by the CBN, Zenith Bank has the highest liquidity ratio at 63.1 percent at 9M13, followed by First Bank at 62.7 percent at 1H13 (First Bank has not yet reported 9M13 results). At the other end of the spectrum are Skye at 31.5 percent and Diamond at 36.7 percent. Rencap says if the draft were to pass, Skye – and Diamond – would need to raise liquidity.

The CBN regulations such as the hike in the CRR – the minimum cash, as a percentage of customer deposits that each bank must set aside as a reserve – to 50 percent is seen by analysts as putting pressure on bank earnings going forward. The IMF estimates that a 2 percent increase in the level of the CRR adds approximately 0.5 percent to the spread between deposit and lending rates.

The CBN macro prudential policies seem to suggest they are willing to be ahead of the curve to guard against any future systemic risk to the banking sector. In conclusion, we believe that the CBN move is positive for the Nigerian financial services industry, and will lead to stronger well regulated banks.