An extract from The Banking Regulation Review, 12th Edition
Prudential regulationi Relationship with the prudential regulator
While some countries have separated their financial regulators along the lines of licensing, prudential regulation and consumer protection, in Nigeria all roles are primarily performed by the CBN. In February 2011, the CBN released its Supervisory Intervention Framework for the Nigerian Banking Sector (the Supervisory Framework 2011), which was designed to complement the CBN's Prudential Guidelines for Deposit Money Banks in Nigeria 2010 (the DMB Prudential Guidelines).22 It reflects the fact that the CBN has adopted a risk-based supervisory approach.
The risk-based supervisory approach is a continuous process of updating risk assessments through on-site and off-site examinations of financial institutions to create an early warning system so the CBN can anticipate and deal with emerging issues. This approach results in the CBN producing a composite risk rating for financial institutions. Under the Supervisory Framework 2011, financial institutions will be awarded one of the following risk scores:
- 1: for institutions with low risk profiles;
- 2: for institutions with moderate risk profiles;
- 3: for institutions with above-average risk profiles; and
- 4: for institutions with high-risk profiles.
Pursuant to Section 13 of BOFIA 2020, the CBN has the power to establish and enforce capital ratios and prudential standards over all deposit-taking financial institutions operating in Nigeria. The CBN's website sets out all the prudential guidance notes currently in force.23 The DMB Prudential Guidelines comply significantly with the Basel II framework, but adjust certain sections of the framework to better reflect the distinctive features of the Nigerian economy.
The CBN mandates all banks licensed to carry out banking business24 in Nigeria to perform an annual internal capital adequacy assessment process and forward copies of their reports to the CBN no later than four months after the end of the year.25 Failure to comply with this obligation puts a bank at risk of having its banking licence revoked.26
Furthermore, the CBN's Framework for the Regulation and Supervision of Domestic Systemically Important Banks 2014 (the D-SIB Framework) mandates that banks classified as systemically important banks maintain a minimum capital ratio of 15 per cent and set aside an additional surcharge of 1 per cent of their respective minimum required capital adequacy ratio (CAR).27 Any DMB designated as a systemically important bank that fails to comply with the D-SIB Framework or any other CBN-specified standards and requirements applicable to systemically important banks will be liable for a fine of not less than 5 million naira, and an additional penalty of 200,000 naira for each day the failure persists.28 Failure by any bank to maintain the CAR stipulated by the CBN constitutes a ground for the revocation of the bank's banking licence.29NDIC
The NDIC also supports the CBN by implementing the CBN's banking policy. The NDIC, through its off-site surveillance, ensures compliance with the CBN's prudential standards and guidelines.30 Off-site surveillance is carried out by the NDIC's insurance and surveillance department. This consists of analysing the returns from licensed banks and other deposit-taking financial institutions on a periodic basis to ascertain their compliance with prudential regulations. The analysis culminates with a report on the condition and performance of the bank in question, with recommendations for corrective action in weak areas.Consequences of a licensed deposit-taking financial institution's failure
Where the financial position of a DMB becomes precarious, the NDIC may, after consulting with the CBN, take over management of the bank to salvage the bank's operations by the creation of a bridge bank.31 In this regard, the NDIC is empowered to, inter alia, take over the management of the failing bank until its financial position is substantially improved; acquire, manage and dispose of the failing bank's impaired assets either directly or through an asset management company; and incorporate a bridge bank32 to assume the deposits, assets and liabilities of the failing bank, as the NDIC may determine.
Where the restructuring of the bank proves unsuccessful, the Nigeria Deposit Insurance Corporation Act establishes a legal regime for the winding up of a failed bank. Further details are set out in subsection iv.ii Management of banksCorporate governance requirements for banks
The corporate governance requirements for banks in Nigeria are laid out in the 2014 CBN Code of Corporate Governance for Banks and Discount Houses (the Code).33 The Code is designed to update and align corporate governance in the Nigerian banking industry with international best practices. Compliance with the Code is mandatory for all banks in Nigeria, and they are required to render returns on the status of compliance to the CBN at the end of every quarter.
In this regard, the Code provides that the size of the board of directors (board) of any bank shall be a minimum of five members and a maximum of 20 members, and the board of a bank is required to be composed of more non-executive directors than executive directors. Further to this and to ensure the continuous injection of fresh ideas, the Code stipulates that non-executive directors of banks shall serve for a maximum of three terms of four years each, while the tenure of the MD or CEO shall be subject to a maximum period of 10 years, which may be broken down into periods not exceeding five years at a time.
The Code emphasises the importance of risk governance as part of a bank's general corporate governance framework, and promotes the value of the board and several board committees with effective control functions. Specifically, the Code:
- regulates equity holding in banks by investors;
- discourages a government majority stake in banks by limiting the maximum holding of any government to 10 per cent;
- encourages a whistle-blowing framework and the protection of stakeholders' rights; and
- strengthens disclosure requirements and transparency in banks' annual reports.
In addition to compliance with the Code (which is banking sector-specific), the Financial Reporting Council of Nigeria (FRCN) extended the requirement of compliance with, and the application of, the Nigerian Code of Corporate Governance 2018 (NCCG) to Nigerian banks on 1 January 2020.34 Similar to the Code, the NCCG contains broad principles and international best practices on corporate governance applicable to each level of management (i.e., the board, the MD and CEO, independent directors, the chairperson, the company secretary and external auditors). The FRCN requires the relevant entities (including banks) to report compliance with the NCCG in their annual reports for each financial year.
The new Companies and Allied Matters Act, 2020 (CAMA 2020) also introduces certain corporate governance principles that are generally applicable to public companies including banks. Some of these principles are in tandem with hitherto existing corporate governance codes but it includes some additional requirements. For instance, CAMA 2020 now requires that every public company shall have at least three independent directors. Accordingly, all Nigerian banks that are public companies are required to have at least three independent directors appointed to their respective boards.Legal and regulatory duties of management of banks
In accordance with the Code, the management of banks in Nigeria is generally responsible for policy implementation and the development of a sound system of risk management and internal control policies that must clearly define the roles and responsibilities of the board and its risk management committee, as well as the roles and responsibilities of management and the internal audit function.Bank holding company structure: decision-making over subsidiaries
The Nigerian bank holding company (HoldCo) subsidiary structure is based on the principle of corporate personality such that the subsidiary banks are different and distinct from their HoldCos. Accordingly, pursuant to the CBN Guidelines for Licensing and Regulation of Financial Holding Companies in Nigeria, 2014 (the HoldCo Guidelines), no financial HoldCo shall arrogate for itself any of the powers or functions of the board of directors, or internal management responsibilities and obligations of any of its subsidiaries or associates of any such subsidiaries. In addition, no financial HoldCo shall interfere with the day-to-day activities of the subsidiaries; nor shall it be involved in the credit administration and approval process of its subsidiaries.Restrictions on bonus payments
There are no regulations currently in place in Nigeria that restrict bonus payments to the management and employees of banking groups. However, it is noteworthy that the Code requires every bank to have a remuneration policy established by its board, and to disclose the policy to the shareholders in the bank's annual report. Under the Code, it is also expected that a committee of non-executive directors would be responsible for determining the remuneration of executive directors.iii Regulatory capital and liquidity
The prudential standards relating to regulatory capital for Nigerian banks are found in the DMB Prudential Guidelines, which are based on the standards of Basel II, and the CBN's Guidance Note on Regulatory Capital 2018 (the Regulatory Capital Guidelines), modelled on Basel III.Risk-weighted capital
Under the DMB Prudential Guidelines, a DMB with a national banking licence must maintain a minimum of 10 per cent of the total risk-weighted assets as capital funds on an ongoing basis.35 DMBs that have been authorised by the CBN to carry out banking activities outside Nigeria must maintain a higher CAR of 15 per cent.36Tier 1 capital
The capital a DMB must maintain to achieve its CAR must be made up of Tier 1 and Tier 2 capital. Under Section 2 of the Regulatory Capital Guidelines, Tier 1 capital includes disclosed reserves and shareholder equity, which constitute issued and fully paid up ordinary shares or perpetual non-cumulative preference shares.Tier 2 capital
Under Section 3 of the Regulatory Capital Guidelines, Tier 2 capital is made up of two components: hybrid debt instruments and subordinated debt. Hybrid debt instruments feature characteristics of equity and debt.
The CBN has determined that hybrid instruments may be included in Tier 2 capital where they are able to support losses on an ongoing basis without triggering liquidation. To qualify as Tier 2 capital, hybrid instruments, inter alia:
- must be unsecured, subordinated and fully paid up;
- must be available to participate in losses without the bank being obliged to cease trading;
- must not be redeemable at the initiative of the holder or without the prior consent of the CBN;
- may carry an obligation to pay interest, but that obligation cannot permanently be reduced or waived;
- should allow the obligation to pay interest to be deferred where the profitability of the bank would not support payment; and
- where redeemable, must have an original maturity of at least 10 years, and must clearly specify that repayment is subject to authorisation by the CBN.37
In calculating the amount of Tier 1 and Tier 2 capital that comprise a bank's capital base, net of all permitted deductions, the calculation is subject to certain limits. Fundamental Tier 2 capital can constitute, at most, 33.33 per cent of net Tier 1 capital. There is no limit on the inclusion of Tier 1 capital for the purpose of calculating regulatory capital.Consolidated supervision
Neither the DMB Prudential Guidelines nor the Regulatory Capital Guidelines impose specific requirements for DMBs in Nigeria that form part of a group. The HoldCo Guidelines stipulate that a financial HoldCo must have at least two subsidiaries, and the conglomerate's focus must be in the financial services sector.38 The consolidated supervision approach for Nigerian banks is the solo-plus approach,39 complemented by a quantitative and qualitative assessment of the banking group to assess the potential impact of other members of the group on the operations of the supervised bank.Liquidity
The CBN requires all banks operating in Nigeria to ensure that their level of cash flow is matched by expected receipts, so that banks always have enough cash to meet the requests of their depositors. This is to ensure that each bank's cash balance plus assets, when compared to the total liabilities owed by each bank, is high enough for the bank to meet its obligations as they fall due. The CBN sets out the minimum liquidity ratio benchmarks for the banking sector in its Monetary, Credit, Foreign Trade and Exchange Policy Guidelines (the MCFT Policy Guidelines).
The MCFT Policy Guidelines are a periodic publication of the CBN designed to provide guidance to financial institutions for the medium-term fiscal period, and to demonstrate the CBN's direction and policy objectives. The latest version of the MCFT Policy Guidelines covers the period from January 2020 to December 2021. Under the current guidelines, the CBN requires that banks maintain minimum liquidity ratios as follows: DMBs: 30 per cent; merchant banks: 20 per cent; and non-interest banks: 10 per cent.Local regime divergence from Basel III
The Basel frameworks have been progressively implemented in Nigeria since January 2013. The Basel II and III Framework Guidelines list all areas of national discretion set out under the International Convergence of Capital Measurements and Capital Standards, although these mainly deal with the International Convergence of Capital Measurement and Capital Standards, June 2006 (Basel II framework).
Key areas of divergence include the fact that under the Basel II and III Framework Guidelines, the CBN departs from Paragraph 49(xii) of the Basel II framework by not permitting banks in Nigeria to employ short-term subordinated debt as a third tier of capital.iv Recovery and resolutionResolution of failed banks in Nigeria
The NDIC is the main body responsible for the resolution of failed banks in Nigeria. BOFIA 2020 also mandates the CBN to step in when a bank is in crisis, to turn over management and control of such bank to the NDIC. The NDIC is empowered to provide financial and technical assistance to failing or distressed banks in the interest of depositors. Financial assistance can take the form of loans, guarantees for loans taken on by the bank or the acceptance of accommodation bills. Similarly, technical assistance may include taking over the management and control of the bank, changes in management or assistance in a merger with another viable institution.40
In 2002, in collaboration with the CBN, the NDIC introduced the Contingency Planning Framework for Banking Systemic Crises to facilitate the prompt resolution of failing banks. The aim of the Framework is to reduce the incidence of systemic distress by improving the supervisory processes, providing transparent and objective thresholds for regulatory intervention, and promoting self-regulation among banks. Some of the mechanisms that the NDIC (in collaboration with the CBN) has adopted for the resolution of failed banks are open bank assistance (OBA), purchase and assumption (P&A) transactions and bridge banks.41 One of the key innovations introduced by BOFIA 2020 is the establishment of the Banking Sector Resolution Fund, which is to be funded with specified contributions from the CBN, the NDIC and all banks, specialised banks and other financial institutions in Nigeria.42 The Fund will be utilised exclusively to provide financial assistance to failing banks and bridge banks, as well as generally support any banking resolution process.OBA
The NDIC may decide to offer a failing bank financial assistance if it meets certain requirements. Financial assistance in the form of OBA is made available to a failing bank without interrupting its operation as a going concern. The NDIC does this by offering a loan to the failing bank, guaranteeing a loan that the bank has taken on or accepting an accommodation bill. In addition to the conditions that may be stipulated by the NDIC, the bank must also meet the liquidity threshold prescribed by the NDIC.P&A transactions
This is a resolution transaction in which a healthy bank purchases some or all the assets of a failed bank and assumes some or all its liabilities. If the whole bank is purchased, the acquirer may receive a government payment covering the difference between the market value of assets and liabilities. If only some deposits are assumed, the acquirer may be given the option of assuming any of the others, and take their pick of the failed bank's assets.Bridge bank
A bridge bank is a temporary bank established and operated by the NDIC to acquire the assets and assume the liabilities of a failed bank until a final resolution can be accomplished. In some instances, the bridge bank will retain the failed bank's licence, but it will operate under a different name in the same premises used by the failed bank. In other instances, the CBN may revoke the failed bank's licence and issue a new licence to the bridge bank. The bridge bank would permit continuity of banking services to all customers and fully protect the depositors and creditors of the failed bank.
Another form of bank resolution for failed banks is the acquisition of non-performing loans of failed banks by the Asset Management Corporation of Nigeria.43
In accordance with BOFIA 2020, in the event that a failed bank over which NDIC has assumed control cannot be rehabilitated, the NDIC may recommend other resolution measures to the CBN, which may include revocation of the failed bank's licence. Where the licence of a failed bank has been revoked, the NDIC may apply to the relevant court for a winding-up order in respect of the failed bank. Upon the court's order for the winding up of the failed bank, the NDIC shall give notice by advertising in national newspapers or other news media for all depositors with the failed bank to forward their claims to the NDIC. The NDIC, acting as liquidator of the failed bank, shall have power to realise the assets of the failed bank.Bail-in powers
Under Sections 37 to 39 of BOFIA 2020, the CBN is empowered (for the purpose of rescuing a failing bank, a specialised bank or any other financial institution) to cancel, modify, convert or change the form of an eligible instrument44 (issued by a bank or to which a bank is subject or a party), or determine that such eligible instrument has effect as if a right of modification, conversion or change of form had been exercised.45 The CBN may take action where it is of the opinion that the eligible instrument ought to be bailed-in to facilitate the rescue of the bank or the bank's available assets do not, or are unlikely to, support the bank's payment of its liabilities as they become due and payable.46 Before taking such action, the CBN may appoint one or more persons to conduct an independent assessment, to determine the extent to which the exercise of the CBN's bail-in powers are necessary. Under Section 38 of BOFIA 2020, following the delivery of the assessment report, the CBN governor issues a bail-in certificate that must specify the name of the bank it applies to and the details of any eligible instrument to be cancelled, modified, changed or converted (as applicable). The provisions in the bail-in certificate shall have effect notwithstanding any restrictions set out in the provisions of any written contract or any law in force prior to the date the bail-in certificate comes into effect.47 Furthermore, any claims or judgment debt enforcement in respect of an eligible instrument (to which a bail-in certificate relates) existing or being pursued as of the date of the bail-in certificate shall be automatically suspended and unenforceable against the failing bank for the duration period specified in the bail-in certificate or any period as may be determined by the CBN governor.48