CBN – 3 Nigerian Banks Fail Capital Adequacy Test. The Financial Stability Report released by the Central Bank of Nigeria for December 2016 revealed that three banks in the country failed a Capital Adequacy Ratio (CAR) test in the event of a default in inter-bank lending. Inter-bank lending is borrowing between two banks. Two of the banks were Systemically Important Banks (SIBs). However, none of the banks involved were mentioned in the report.
SIBs are those classified as too big to fail by the CBN. They include First Bank, Zenith Bank, GTBank, Access Bank, UBA, Skye Bank and Diamond Bank. Of the SIBs, Skye Bank, Diamond and First Bank are yet to release financial statements for the year ended December 2016.
The report also revealed that smaller banks in the country were more exposed to a risk of default in the oil and gas sector, and that the banking industry as a whole would fall below CAR requirements if there was a 200% spike in non performing loans (NPLs).
Though the CBN stated in the report that the banking industry was safe and sound, the industry had a very challenging year 2016. The economic recession, drop in crude oil prices as well as the looming power sector situation left banks in the country exposed on several fronts.
Some analysts are of the opinion that a newer version of AMCON (or AMCON 2) should be set up to take off bad loans from the banks. Similar stress tests conducted by erstwhile CBN governor Sanusi Lamido Sanusi led to the takeover of five banks by the CBN and creation of AMCON. Other banks were asked to shore up their capital base.
CAR is the ratio of a banks capital to loan exposure. It is also known as capital-to-risk weighted assets ratio (CRAR), it is used to protect depositors and promote the stability and efficiency of financial systems around the world. Two types of capital are measured: tier one capital, which can absorb losses without a bank being required to cease trading, and tier two capital, which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors.
A fall in the adequacy ratio means that the affected banks may have difficulty in meeting short term needs. The CAR for commercial banks in the country is set at 10% for national banks, 15% for banks with international subsidiaries and 16% for SIBs. The deficient banks will thus be required to raise extra capital.
The reason why minimum capital adequacy ratios are critical is to make sure that banks have enough cushion to absorb a reasonable amount of losses before they become insolvent and consequently lose depositors’ funds. Capital adequacy ratios ensure the efficiency and stability of a nation’s financial system by lowering the risk of banks becoming insolvent. If a bank is declared insolvent, this shakes the confidence in the financial system and unsettles the entire financial market system.
During the process of winding-up, funds belonging to depositors are given a higher priority than the bank’s capital, so depositors can only lose their savings if a bank registers a loss exceeding the amount of capital it possesses. Thus the higher the bank’s capital adequacy ratio, the higher the degree of protection of depositor’s monies.