US embassy cable - 05LAGOS536

C O N F I D E N T I A L SECTION 01 OF 02 LAGOS 000536 
 
SIPDIS 
 
DEPARTMENT PLEASE PASS TO EXIMBANK 
 
E.O. 12958: DECL: 04/08/2015 
TAGS: EFIN, ECON, ETTC, KTFN, PTER, NI 
SUBJECT: NIGERIAN BANKS IN DISTRESS? 
 
REF: ABUJA 383 
 
Classified By: Consul General Brian Browne for reasons 1.4 (b) and (d). 
 
1. (C) Summary.  With nine months remaining to meet the 
December 2005 naira 25 billion (USD 192 million) 
recapitalization deadline, banking sector noise has 
amplified.  While the banks publicly talk positive about the 
future, we have heard rumors of liquidity problems at some 
banks.  We believe that these problems are not generalized 
throughout the industry, and thus do not signify systemic 
distress.  Despite these blips and the regulatory hard time 
that weaker banks may soon face, we view the long-term 
outlook for Nigeria's banks as generally positive.  End 
summary. 
 
2. (SBU) Last July, the Central Bank of Nigeria (CBN) 
directed that Nigerian banks recapitalize to naira 25 billion 
(USD 192 million) by the end of 2005.  Halfway to the CBN 
deadline, the sector is predictably active.  More than 50 of 
the country's 89 banks have participated in merger talks or 
have engaged in public offerings on the stock exchange or 
private placements in order to raise their capital base. 
Investors and depositors have been taking second and third 
looks at various banks to determine the safest one to place 
their funds. 
 
3. (C) Credible reports suggest a few banks considered to be 
"safe", including Zenith Bank, one of the nation's largest 
banks, and City Express Bank, have been unable at times to 
immediately honor depositors' requests to withdraw money. 
Were such rumors true, some banks might be facing liquidity 
problems that could lead to panic, if publicized.  However, 
most of Nigeria's 15 largest Nigerian banks including Zenith 
and City Express Bank are considering major investments in: 
credit card services, software upgrades, and branch 
expansion.  These activities are capital and time intensive, 
and would tend to contradict reports that these banks are 
distressed. 
 
THE FATE OF BANKS: LARGE BANKS WILL LIVE AND SMALL BANKS WILL 
BE ABSORBED 
--------------------------------------------- ----------- 
 
4. (C) Whatever the state of the industry, Chris Onyemenam, 
Head of the Research and Economic Intelligence Group of 
Zenith Bank, predicts the GON will not allow Nigeria's large 
banks to fail.  He reasons the CBN recapitalization directive 
is meant to strengthen the banking sector as part of the 
GON's overall economic reforms.  Both CBN Governor Soludo and 
President Obasanjo have said that probably fewer than 20 
banks will exist after December 2005.  Most industry watchers 
expect 25 - 50 banks to remain in business, however. 
 
5. (U) Initially, the CBN had taken a hard line insisting 
banks that have not been contributing to the Nigerian economy 
through bona fide banking services would not be acceptable 
candidates for recapitalization.  The CBN was then 
encouraging mergers and acquisitions as a way for these and 
other non-viable banks to retain value.  Ideally, the 
exercise was expected to lead to a more transparent banking 
sector, with the bad banks eventually dissolved.  As the 
deadline for recapitalization nears, however, the CBN faces 
the reality that the larger banks have little or no interest 
to merge with or acquire many of the smaller banks.  Most of 
the larger banks have met the naira 25 billion requirement on 
their own, or are expected to do so by December 2005.  The 
large banks clearly prefer to avoid the pain of absorbing the 
weaker banks. 
 
6. (SBU) It is doubtful the CBN envisaged roughly 50 of 
Nigeria's small banks failing to meet the recapitalization 
deadline, because they could not consolidate with several 
other small banks or be absorbed by the larger banks.  The 
CBN wanted to rid the system of banks that existed merely 
because their board members were politically well-connected 
and assured bank access to public deposits.  However, 
widespread small bank non-compliance with the 
recapitalization directive could cause significant problems. 
To preclude this outcome, the CBN is now saying it will offer 
incentives to the larger banks to acquire the smaller ones. 
While some larger banks may do this, in the end, many smaller 
banks are likely to fail, according to Bismarck Rewane, CEO 
of Financial Derivatives. 
 
7. (C) Whether most of Nigeria's small banks will exist or 
not after December 2005 is an open question.  Widespread 
insolvency of the small banks would affect confidence in the 
entire banking sector, though the large banks would not be 
hit as hard as the small banks.  The depositors susceptible 
to panic would be the less-educated depositors who hold small 
accounts, and who would be less able to distinguish between 
the problems of the smaller banks and the opportunities of 
the larger ones.  Savvier depositors already prefer the large 
banks and believe, like some industry experts, the GON will 
not let the larger banks drown.  The larger institutions are 
the banks that will attract GON public funds, which comprised 
an estimated 40 percent of total bank deposits.  While most 
of Nigeria's elite also believe the GON will not let the 
larger banks fail, these people, who hold most of Nigeria's 
wealth, traditionally shelter a large part of their holdings 
in foreign banks. 
 
8. (SBU) For most Nigerians who do not use banks or who have 
only small deposits, the generalized collapse of the banking 
system would reinforce what they already believe:  money is 
safer under the mattress than in the bank.  But Nigeria's 
dwindling middle class would suffer most if the banking 
sector faltered.  The Nigerian Deposit Insurance Corporation 
(NDIC) guarantees deposits only up to naira 50,000 (USD 
382.00), a figure lower than the average bank deposit of the 
middle-class Nigerian.  After the recapitalization is 
implemented, the NDIC may raise the guarantee to naira 
200,000 (about USD 1525.00). 
 
9. (SBU) On balance, industry experts believe the CBN's 
reform efforts are positive.  These experts do not believe 
recapitalization will provoke the worst-case scenario; that 
is, systemic distress within the banking sector.  They expect 
ups and downs in the process, and that many banks will cease 
to exist.  By early 2006, we can expect other questions to 
arise, as sector experts now predict from 20 to 50 banks may 
meet the December 2005 recapitalization requirement.  The CBN 
may try to employ additional measures to further reduce the 
number of banks to its original target, particularly if the 
CBN still believes it has not flushed out enough of the 
banking sector's detritus.  Regardless of the number of banks 
that survive into 2006, bankers will face the challenge of 
delivering the higher returns investors, who helped their 
banks reach the naira 25 billion goal, will expect. 
 
10. (SBU)  An underlying assumption of the entire process is 
that the higher capitalized banks will embark on more 
high-end financing.  A key question that must be answered is 
whether banks will have the expertise to assess the elements 
of risk associated with large-scale projects they may have to 
finance to meet their investor expected returns?  Kola Ayeye, 
the Managing Director of National Bank, speculates more banks 
will follow the route of United Bank for Africa (UBA) and 
Standard Trust Bank (STB), both of which are undergoing a 
merger, and will retain international consultants to guide 
them through the merging process and initial risk assessment 
activities.  However, Rewane, of Financial Derivaties, 
believes many banks will continue to use in-house expertise 
and will, as a result, experience some set-backs due to less 
than optimal assessments. 
 
11. (SBU) Comment. It is a near certainty that numerous banks 
will fail due to the weight of the recapitalization 
requirement.  Nigeria's regulatory and legal institutions 
such as the CBN, the Nigerian Deposit Insurance Corporation 
(NDIC), the Nigerian Stock Exchange (NSE), the Securities 
Exchange Commission (SEC), and the court system will have to 
be ready to handle these failures.  If not, it could dent 
investor and overall confidence in the sector.  Moreover, 
should large deals go bad, some of the support structure may 
not be in place to minimize impact on the economy.  The CBN 
(reftel), the NDIC, the SEC, and the NSE have shown signs 
they are ready to take on some of the banking sector's big 
challenges; however, it is questionable whether Nigeria's 
legal system can cope with multi-billion naira default cases 
that could arise from risky projects going south.  End 
comment. 
BROWNE