US embassy cable - 04ABUJA1405

UNCLAS SECTION 01 OF 03 ABUJA 001405 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN, NI 
SUBJECT: Nigerian Banking Reform - CBN Encourages 
Acquisition of Nigerian Banks 
 
 
1.  Summary. On July 6 the governor of the Central Bank of 
Nigeria (CBN), Charles Soludo, proposed several reforms to 
the banking sector, the most important of which is raising 
the capital requirement of banks from naira 2 billion (USD 
15 million) to naira 25 billion (USD 189 million) effective 
December 31, 2005. While his proposal has generated mixed 
reactions in financial circles and among the public, the CBN 
is seeking support from the banking community and 
multilateral financial and donor agencies. The CBN is also 
encouraging the foreign banks operating in the country to 
acquire banks that are up for acquisition. It is not clear 
which, if any, banks will take up this challenge. End 
summary. 
 
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CBN Meets With Diplomatic Community 
----------------------------------- 
 
2. On August 11 the CBN, led by its governor, Professor 
Charles Soludo, briefed heads of diplomatic missions, and 
representatives of multilateral financial and donor agencies 
on proposed reforms in the Nigerian banking sector. Soludo 
asserted that the overall health of the Nigerian banking 
system is generally satisfactory, but the state of some 
banks is cause for concern. Specifically, as of April 2004, 
the CBN's ratings of Nigeria's 89 banks classified sixty-two 
as sound, fourteen as marginal, eleven as unsound (and two 
as dormant). He affirmed that the CBN is pursuing the 
reforms to prevent the boom and bust cycle of the banking 
sector characteristic of Nigeria's banking history. 
 
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Background to the Reforms 
------------------------- 
 
3. Ignatius Imala, Director of Banking Supervision, 
confirmed that the Nigerian banking sector needs reform. He 
said that while the top ten banks account for 50 percent of 
the industry's assets and liabilities, the end of March 2004 
review had revealed that 17.6 percent of total bank deposits 
were at risk and 19.6 percent of total bank assets were 
equally so.  CBN's total exposure to the banks was naira 
71.366 billion (USD 537 million) as of July 2004. 
 
4. The Nigeria Deposit Insurance Corporation (NDIC) 2003 
review of the banking industry also revealed a deteriorating 
trend in the quality of risk assets of insured banks. Non- 
performing loans and advances had totaled naira 135.7 
billion in 2001 and naira 199.6 billion in 2002, but the 
volume rose to naira 260.2 billion by the end of 2003. The 
ratio of non-performing loans to total loans had been 16.9 
percent in 2001, 21.3 percent in 2002, and further increased 
to 21.6 percent in 2003.  The ratio of non-performing loans 
to shareholders' funds had been 77.1 percent in 2001, 85.9 
percent in 2002, and further deteriorated to 89.7 percent in 
2003. 
 
5. Imala had noted that most of Nigeria's banks are small, 
their capital base averaging naira 1.3 billion (USD 10 
million).  Insolvency,  poor credit policies and 
administration including excessive risk taking, weak 
corporate governance and ethical misconduct, and closed 
ownership structure characterize the unsound banks. 
 
6. Imala also confirmed that the CBN hopes that its proposed 
reform measures will help create a sound banking system that 
depositors can trust, create banks that are investor 
friendly and can finance capital intensive projects, enhance 
corporate governance and accountability, drive down the cost 
structure of banks, and help banks meet the challenges of 
globalization, all of which could prevent a systemic crisis. 
 
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The Reform Agenda 
----------------- 
 
7. Imala confirmed that the reform program is anchored on 
thirteen points, among which are: 
 
     -    a minimum capital base requirement of naira 25 billion 
       to be met by December 31, 2005. The capital base is defined 
       as paid-up capital and reserves unimpaired by losses. The 
       reserves must exclude asset revaluation surpluses resulting 
       from revaluation in the course of consolidation, while paid- 
       up capital is defined as ordinary shares plus non-redeemable 
       preference shares; 
 
     -    consolidation of banks through mergers and 
       acquisitions; 
 
     -    adoption of a risk-focused and rules-based regulatory 
       framework; 
 
     -    zero tolerance for weak corporate governance, 
       misconduct and lack of transparency; 
 
     -    establishment of an asset management company to manage 
       the CBN's exposure to the banking sector; 
 
     -    accelerated completion of the electronic Financial 
       Analysis and Surveillance System (e-FASS), to ease the 
       submission of returns by banks and enhance CBN's 
       surveillance capacity; 
 
     -    strict enforcement of contingency planning for systemic 
       bank distress; 
 
     -    revision and update of relevant laws and drafting of 
       new ones; 
 
     -    closer collaboration with the Economic and Financial 
       Crimes Commission's (EFCC) Fraud Investigation Unit and 
       enforcement of the anti-money laundering and other economic 
       crimes measures; 
 
     -    enforcement of dormant laws, such as the Dud Checks 
       Act; 
 
     -    review of monetary policy; and 
 
     -    reorganization of the Nigerian Security Minting and 
       Printing Company (the Mint), to meet the nation's security 
       printing needs as well as those of the west-African sub- 
       region. 
 
--------------------------------------------- -------- 
Guidelines, Incentives & Modalities For Consolidation 
--------------------------------------------- -------- 
 
8. The guidelines announced by the CBN indicate that: 
 
     -    only mergers and outright acquisitions or takeovers are 
       acceptable. Mere interlinking group arrangements are not 
       allowed. Banks coming together as a group cannot retain 
       their individual brand names, but have to merge under a 
       single brand name. 
 
     -    All monies toward re-capitalization must be denominated 
       in naira, but can include both ordinary and preferred 
       shares. 
 
     -    Consideration must be by exchange of shares and not 
       monetary payments, except by dissenting shareholders and 
       provided that payments do not impair the financial condition 
       of the new entity. 
 
9. The modalities for consolidation approved by the CBN 
further stipulate that: 
 
     -    each party must have a different advisor except where 
       the acquired bank is a wholly-owned subsidiary; 
 
     -    the board of directors must not exceed 20 members for 
       the consolidated entity; and 
 
     -    co-chairmen or co-chief executive positions will not be 
       allowed. 
 
10. The incentives for mergers announced by the CBN include: 
 
     -    CBN to provide technical assistance to consolidating 
       banks at no cost; 
 
     -    possible write-down of CBN's exposure to the acquired 
       unsound bank to make it more attractive; 
 
     -    tax incentives like capital allowances, companies 
       income tax, stamp duties, etc; 
 
     -    reduced transaction fees payable to the Securities and 
       Exchange Commission, the  Corporate Affairs Commission, the 
       Nigerian Stock Exchange (NSE), and other similar 
       institutions; and 
 
     -    amnesty for previous misreporting detected in the 
       course of consolidation. 
 
 
 
11. Banks that attain the new minimum capital base within 
the stipulated period will be authorized to deal in foreign 
exchange, granted permission to take public sector deposits 
and recommended to the fiscal authorities for the collection 
of public sector revenue, and allowed to manage part of 
Nigeria's external reserves, subject to prevailing 
guidelines. 
 
------------------------- 
Foreign Banks Should Come 
------------------------- 
 
12. Soludo invited foreign banks to avail themselves of the 
opportunities of the reforms by acquiring Nigerian banks. He 
said the time is right and the startup costs are minimal, 
because the banks to be acquired already have a countrywide 
network of branches. 
 
--------------------------------------------- --------- 
What Happens To Banks That Do Not Meet the New Capital 
Requirement? 
--------------------------------------------- --------- 
13. Soludo said the CBN will publish the names of healthy 
banks on December 31, 2005. Those that do not make the list, 
because they cannot meet the new recapitalization 
requirement and are not suitable for mergers or 
acquisitions, will cease to exist as a result of the 
public's shunning them. Soludo asserted that he small banks 
unable to meet the capitalization directive may apply for 
community bank licenses to serve clients in a limited 
geographic area. 
 
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Is The Reform Sustainable? 
-------------------------- 
 
14. Soludo said the sustainability of the proposed reforms 
will depend on the level of success achieved. If they s 
succeed, the public will support them irrespective of the 
government in power. Soludo is convinced that the reforms 
will stand the test of time. 
 
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Comment 
------- 
 
15. The CBN's incentives for consolidating the banking 
sector show that it took some of the earlier criticism of 
the reform measures into consideration. But the Senate 
Committee on Finance has expressed reservation and intends 
to hold hearings, after which it may propose a bill to amend 
the act of 1991 that governs the Central Bank.  Meanwhile, 
it remains to be seen whether its proposed incentives will 
induce foreign banks to invest in Nigeria, a country 
characterized by macroeconomic instability and frequent 
policy reversals, though opportunities for high returns 
abound. End comment. 
 
CAMPBELL