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Monday, May 9, 2011


Banking Reform

    The history of banking sector reform in Nigeria did not started with Sanusi Lamido Sanusi and would certainly not end with him. His predecessor Professor Charles Soludo came with his own revolutionary 'banking sector consolidation', that in the process emphasized growth over security, creation of mega banks over increasing access to credit by the most productive sector of the economy: small businesses. His unprecedented increase in regulatory minimum bank's capital base to twenty five billion Naira, with implied intention of increasing banks' strength and making them less susceptible to capital erosion, has indeed created headline making banks who were buried in race to become number one bank in any kind of ceremonial award created by media organisations. There was the liberalization of the banking sector of the late eighties that helped the emergence of what we today called the ‘new generation banks’. The after math of that reform saw the massive collapsed of many of these newly registered banks, with thousands of depositors losing their money. The major aim of the reform program of making finance more accessible to Nigerians was not realized for reasons that included lack of links between theory and practice, politics, corruption and absence of the enabling environment for the reform. Far back before then in the seventies, there was the nationalization of foreign own banks by the federal military government to achieve the aims of local control, development of local expertise, as well as linking the sector objectives with wider government socio-economic goals.

      A particular banking reform program that take place in the course of a world wide banking reform process is historically less open to resistance compared to reforms in isolation and totally out of reality. Sanusi's reform process as it is now seem widely accepted. Some of the resistances the process is facing comes from banking stakeholders in Nigeria for different reasons of their own. On assuming office during a period of global financial crisis, a time when Nigerian banking sector was facing one of the most difficult moment of its history, Sanusi promised Nigerians to safeguard their money deposits. Many observers at that time wonder how he could achieved that looking at the rot in the banking system. His sacking of chief executives of some banks made many to think that he was waging a war he could not win. Injection of cash liquidity into about six of the most problematic banks followed the sacking of CEOs. It saw Central bank of Nigeria prompting sick banks with up to four billion Dollars of government's money. One year after, the reform cannot out rightly be said to have achieved its objective of getting the system rid off of sick and under capitalized banks. The wide spread fear that existed at the beginning of the reform is still around, only that it would be said that it have subsided to some extent.

       At the heart of Sanusi's reform was the dismantling of universal banking system and its replacement with commercial and specialize banking models. That means reverting to the earlier banking arrangement of separating commercial from investment banking. Other specialize banking arrangements in the proposal include industrial and primary mortgage banks, and non interest Islamic bank. Also as part of the reform is the new categorization of banks' capital base according to the sector a bank is operating, as well as geographical spread of its branch networks. To check the excesses of bank CEOs, chief executive officers tenure was fixed at five year tenure. In order to get the system to continue giving out loans so as to sustain economic growth, Asset Management Company (AMCON) was established to buy bank’s toxic assets. Despite these, Nigerian banks are yet to resume giving out credits to half the level it was prior to the global economic melt down. But one optimistic note is the recent IMF forecast that put Nigeria among the three highest growing nations of the world this year. Central Bank forecast has also put the contribution of non oil export during the period to be very robust.

Islamic Banking and the financial crisis
     One aspect of the reform that I intend to discuss here is the establishment of non interest banking, more popularly known as Islamic banking. The quest for non interest banking in Nigeria has been on and off for more than two decades now. But, there is yet to be any fully pledge Islamic bank in the country. Soludo past efforts at establishing non interest banks are commendable, despite the fact that they have not produced any Islamic bank. What we have today is a little window in few banks that try to provide some kind of Islamic banking services. It has been argued that since substantial segment of the country's population, especially in the Northern part, are yet to be covered by the conventional banking system, specialize banking arrangement like non interest Islamic banking will significantly help in increasing the nation banking coverage.

    But to me I am seeing this from another dimension as some one who have written on and studied the last global financial crisis, introduction of non interest banking should be viewed as one of the many measures to check the excesses of the conventional banking arrangement. Derivatives, greed, and especially exploitative interest rate are to many analysts the major causes of the last global crisis. One major feature of Islamic banking is the replacement of interest rate with profit and loss sharing (PLS) rate. This is done to remove from the system one major source of exploitation and instability that favor lender at the expense of borrower. Derivatives like the deadly credit default swaps (CDS), that Warren Buffet called 'weapons of mass destruction', is one of the many tumors affecting the health of the global financial system that can only be removed by surgery on the system. Then come greed that inspired many to put there money in highly risky activities, a kind of 'get rich or die trying'. What ever you called it, risk shifting, speculation, short, or long selling, any type of excesses no matter the form it takes is at the heart of the last global crisis including in Nigeria.
    The current banking system as it operates in Nigeria has failed to maintain any kind of balance between conflicting interests of individuals and society. Where bank managers use depositors’ money to enrich themselves, a far bigger surgery is indeed required. It is easier to deviate away from the laid down rules on credit issuing where the main requirement is on whether the borrower can pay the required amount of money loan to him, instead of his ability and skills to put the money into the most productive use. With any kind of questionable collateral, lending officials’ can lend money for what ever purpose, as it happens before the banking collapse. The Ex banks MDs sacked by Sanusi were accused of lending money to their own companies and that of their cronies. Some of these loans were given for the sole purpose of speculative investment in shares and properties. But under Islamic finance, if a borrower apply to an Islamic bank for finance, the bank will, in principle, decide whether or not to support the project on the basis of a cost benefit analysis of the scheme, not on the basis of any collateral or debenture. In addition, the high moral standard and the conservative tradition of the Islamic banking system do not tolerate speculative lending.

    In the Islamic banking arrangement, credit creation is not allowed unless it is trade credit or interest free loan. What is encouraged are ventures pursued in accordance with profit and loss sharing principle. This if practice, has the general tendency of encouraging entrepreneurship and co-operation, instead of speculative activities and cut throat competition. Islamic banking unlike conventional banking abhors injustice and exploitation and seeks to forge human relationships on the basis of justice and cooperation. Interest represents, in the Islamic value system, a prominent source of unjustified advantage. The substantial part of the non performing loans uncovered in the aftermath of the Nigerian part of the global crisis was caused by the problem of the borrowers in ability to service the debt, which can be linked to high interest rate. The high rate of interest made it difficult for use of the money in job creating enterprises like manufacturing, thus skewing the money in favor of speculative activities, thereby fueling the crisis. High rate of interest was the major caused of the third world debt crisis of the 1980s as well as the Asian financial crisis of 1997/98.
      As is always the case, if an investment methodology is working well then no one questions it until the first cracks appear, by which time it is too late. The massive margin lending for share accusation that was allowed by the central bank on the binge of the crisis was the major factor behind the booming trade in the capital market observed at that time. All you required to get money from any Nigerian bank at that time was to set aside certain percentage of the money required to purchase the shares you needed, the remaining 80 to 70 percent was provided by the bank financing the purchase. Lot of people including bank staffs and unsuspecting public were lured into buying shares of the banks granting the loans; not minding the performance of the banks stock and the profitability of doing so. This helped in boosting the performance of these banks shares on the exchange for a period of time. But when the market finally collapsed, both the banks and the unsuspecting public where left with certificate a little better than dustbin papers. The people that gained most from the episode were the managing directors of these banks who were given the opportunity to quickly sell their holdings in those stocks; in which case by the rare privilege given to them by their insider knowledge they knew the price would crashed.

    Another dimension to the crisis was the massive speculative activities in the market for importation of refine petroleum products. Banks executives together with oil importers colluded in investing a substantial amount of banks money in the importation of petroleum in order to make quick gain for themselves. This was an important source of making cool money before the crisis, but at the pick of events the strategy turned sour and banks made massive losses that two of the banks most exposed to the business were feared they would collapsed. In most occasions these oil loans were granted without any solid collateral and base on flimsy investment grounds. Greed can make the most professional of bankers to be no better than laymen with little known background in financial matters. Any ‘rational’ observer could observed at that time that the world price of crude oil had approached it climax when it near $150 per barrel; looking back at the history of global price of crude oil, it was open secret that it had never reached that height. What were the fundamentals that explained that increase in the price? The most important was the booming demand for energy that was led by China and India. Even though the global crisis did not originated from those places, it was clear a year before the crisis that Chinese economy had over heated and Chinese authorities were desperately searching for break. When they finally pushed the break pedal, and the speculative money coming to the oil sector from the global financial centers started to reduce, the world price of crude oil began to plummet.  

Islamic Finance as the solution
        Coming back to Islamic finance, the global value of Islamic financial assets is put at around $1 Trillion, and for the past three decades Islamic finance has enjoyed double digit growth that made it the fastest segment of international finance. Islamic banks have operations in all the major global financial centers, from New York, London, Frankfurt, Dubai, to Hong Kong. There are Islamic stock index in major stock exchanges like New York, Bahrain and Malaysia; while Islamic bond the ‘Sukuk’ has become the darling of corporate and government finance, being used by companies and government in far places like US, UK, Switzerland, Pakistan, and Malaysia. Nigeria is losing a lot from its reluctant to adopt Islamic finance, apart from it economic stabilizing and distributive advantages, it has the unique advantage of becoming a major source of foreign direct investment for Nigeria. For over a decade, Malaysia has been using that model to make her economy very strategic in the global financial market, and has been able to attract billions of dollars of Islamic investment from the Middle East.

     I, absolutely, don’t know what Nigeria will lose from the introduction of Islamic financial system; if not the many gains it will derive. According to an International Monetary Fund (IMF) finding, Islamic and conventional banks can co-exist in the same system without substantial “crowding out” effects. On the religious issue, some of the most important contributors to the field of Islamic finance are Westerners. You are talking of people like Professors Rodney Wilson, and Volker Nien haus who came from the European continent. Some other gains to Nigeria from the system include financial deepening, that is the increase coverage of the population by the financial system, increase economic stability because of reduction in debt to equity ratio in the Islamic system, and increase in risky capital(equity) because of replacement of Interest with profit and loss Sharing.

     Islamic micro financing model can perfectly supplement the current effort at development of micro finance bank in Nigeria. Micro finance banks were originally conceived to help poor met their financial needs that would not be attended to by bigger commercial banks. That has been the aim of Islamic banking, empowerment of the poor who doesn’t have collateral but are blessed with a viable project idea. The Islamic finance concept of Qard Hasanah (benevolent loan) is mean to help the poor that is in need of assistance without demanding to make any profit from him. One advantage of Islamic microfinance over its conventional counter part is that when it comes to interest, conventional micro banks are known for charging the poor higher rate of interest on the ground that lending to the poor is highly risky; the prohibition of interest and it replacement with profit and loss sharing and mark up modes of financing have taking care of that problem in the Islamic finance sector. Islamic micro finance model uses mode of financing that range from Mudarabah (partnership between the bank and the borrower) to Murabah (trade finance in form of working capital loan to leasing). And an IMF study has shown that smaller Islamic banks tend to be financially stronger than corresponding smaller conventional banks.

      One of the many ills of the current banking practice in Nigeria is the do or die strategy of deposit generation, where staff are send out to generate deposit or get fired. This unethical practice have derived many especially women to prostitution, another case of neglecting morality in favor of endless competition to accumulate money. Most of the money generated through these means end up been channeled into speculative activities to satisfy the hunger of the top executives for quick gain. Where is our ethical banking practice under which bankers were known as the most trust worthy people? Today bankers in contrast are vultures looking for a dead meat to feed on. Under the present arrangement banks have turned our country into a kind of spendthrift society by means of consumer credit, whereby banks finance anything from purchase of car, home appliances, holidays, to election rigging. The very moment you let banks know that you are earning big salary or they find out you are keeping a lot of money in your account, the next moment they will start sending people to sale their consumer credit facilities to you. Thus, banks instead of encouraging saving habit kill it. The trillions of Naira assets on Nigerian banks balance sheet have not translated into investable funds needed to finance Nigeria’s economic development. That is why we are where we are today.

      The system as a whole is not fit to take Nigeria to the dream land. Compare the system with what is found in other emerging economics, in China the world second largest economy, government still makes sure that finance is channel to the most strategic sector of its economy. These are building of infrastructures, construction of power generating plants including nuclear reactors, development of the manufacturing base of the economy, and micro credit. India, Brazil, Indonesia, and Turkey follow similar methods. But one cannot forget the efforts of Sanusi Lamido aim at giving more credit out to sectors like power, aviation, agriculture, and manufacturing, this is a commendable effort, but is not enough. CBN must pressure the commercial and investment banks into doing the same. Thus, there is need for a special tax in the financial sector. This is for the sole purpose of encouraging developmental finance like the ones undertaken by the development banks. By imposing tax on speculative and highly risky banks assets more money will be freed into productive activities to help the rapid industrialization of the country.

     Since the start of the civilian administrations in 1999, there has been gradual killing of development finance institutions. Institutions like Bank of industry (BOI), Nigerian agricultural cooperative rural development bank (NACRDB), Urban development bank of Nigeria, (UDBN) and National economic reconstruction fund (NERFUND) have been pushed to the periphery that you hear little about them. Both Sanusi and Soludo banking reforms have focused on commercial banks, therefore, neglecting these development finance institutions. Even though one can argue that CBN main job is to regulate deposit generating banks, but it still has some responsibilities it owe to these banks. Economic development will be difficult to be realized without these institutions, since they were initiated to assist rapid growth and development, any serious government economic development agenda must take them along. Commercial banks and other profit oriented finance institutions are short termists, while development finance institutions are long termists, and the whole process of economic development is long term oriented, hence, the need for these banks. Commercial banks can spear headed economic growth only where profit is to be realized. Lastly, CBN itself need reform, and this is not the first time this will be said. As the Ghandian saying goes, 'be the change you want to see'. CBN itself needs some over hauling and the time is now.