Banks’ Recapitalisation: Retained Earnings As Banana Peels
To most banks in the country, the decision of the Central Bank of Nigeria (CBN) to omit retained earnings of banks in the proposed capitalization process is seen as banana peel which upon stepping on it may cause a fall, but according to health and nutrition experts, banana peels have their benefits to the human body. BAMIDELE OGUNWUSI examines several opinions about retained earnings.
The decision of the Central Bank (CBN) that banks in the country should recapitalize to be able to play actively in the new $1 trillion economy being planned by the Tinubu’s administration has continued to elicit several comments and opinions, especially on the exclusion of retained earnings of banks in the proposed capitalization process.
The CBN on April 28, 2024 released a circular reviewing the minimum capital requirements for all commercial, merchant, and non-interest banks operating in the country.
The review came exactly two decades after a former Governor of the CBN Prof Chukwuma Soludo raised the minimum capital requirements for banks from N2 billion to N25 billion, and three months after the current governor Yemi Cardoso, gave banks a heads up that they would have to raise fresh capital to serve as buffers against risk assets on their balance sheets, prevailing economic headwinds, and bolster their ability to handle big ticket transactions.
Under the current review, commercial banks with international banking licences would have to raise their minimum capital to N500 billion, national banks to N200 billion, regional and merchant banks to N50 billion, non-interest national banks to N20 billion, while non-interest banks will have to meet a new minimum threshold of N10 billion.
To meet the new capital requirements in two years, the CBN directed banks to consider the injection of fresh equity capital through private placements, rights issues and/or offer for subscriptions.
They could also consider mergers and acquisitions and/or upgrades or downgrades of their licences.
However, in the circular was the central bank’s definition of what it meant by minimum capital.
It said minimum capital shall comprise of paid-up capital and share premium only and shall not be based on shareholders’ funds.
CBN further excluded Additional Tier 1 (AT1) Capital for the purpose of meeting the new minimum capital requirements by banks.
Shareholders’ funds refer to the net worth of a company after all its liabilities have been deducted from its assets.
It comprises the share capital and retained profits or earnings that have been reinjected into the business by its shareholders.
AT1 Capital, on other hand, are debt securities or instruments that have no fixed maturity. They usually comprise preference shares or high contingent convertible securities.
By excluding shareholders’ funds and AT1 Capital, the CBN prioritised direct cash injections into the banks over accounting entries to satisfy recapitalisation requirements.
Also, though not a member of the Bank for International Settlements (BIS) in Basel, Switzerland, whose mission is to support global central banks’ monetary policies and financial system stability, the CBN by its recapitalisation guidelines deviated from the Basel III criteria for regulatory capital.
Basel III reforms were introduced in December 2010 after the global financial crisis of 2007-2009, which revealed several weaknesses in the capital bases of existing banks, as definitions of capital varied widely between jurisdictions, regulatory adjustments were generally not applied to the appropriate level of capital, and disclosures were either deficient or non-comparable.
These factors contributed to the lack of public confidence in capital ratios during the global financial crisis.
To address these weaknesses, the Basel Committee on Banking Supervision (BCBS) published the Basel III reforms with the aim of strengthening the quality of banks’ capital bases and increasing the required level of regulatory capital.
In addition, the BCBS instituted more stringent disclosure requirements.
Experts kick
The decision of the CBN to omit retained earnings from the share capital calculation has been queried by financial experts.
Retained earnings are the amount of profit a company has left over after paying all its direct costs, indirect costs, income taxes and its dividends to shareholders.
This represents the portion of the company’s equity that can be used, for instance, to invest in new equipment and marketing
The apex bank excluded retained earnings from the calculation. Instead, it specified that share capital comprises only the banks’ ordinary share capital and share premium.
According to the circular, the move, initially disclosed by the CBN Governor, Olayemi Cardoso, in his address to the Annual Bankers’ Dinner in November 2023, was to enhance banks’ resilience, solvency, and capacity to continue supporting the growth of the Nigerian economy.
Olusoji Agbana, a university lecturer, argues that ,”This approach fails to acknowledge the actual value that these earnings represent which goes against the conventional and legal treatment of a company’s capital structure”.
Olu Abiri, a financial analyst, is of the opinion that, “Since banks made the money in retained earnings, they should be able to use it as a buffer during recapitalisation exercises like this”.
Stephen Iloba, another analyst, sai the decision of the CBN is not encouraging to banks.
“I think the CBN has to make a rethink in this regard and that omitting retained earnings from the share capital calculation in its recent recapitalization guidelines is totally discouraging “.
Others also expressed the opinion that while the CBN prefers banks to retain most of their earnings to reinforce their capital base, it should not concurrently prevent them from counting these undistributed earnings as part of their capital.
At the last check, the retained earnings of the ten largest banks in the country cumulatively stood at at N4.2 trillion.
With the exception of Sterling Bank, none would require additional capital raising if retained earnings were recognized as part of share capital.
This may explain the widespread dissatisfaction among bankers with the Central Bank of Nigeria’s (CBN) directive.
It seems that the Central Bank is prioritizing direct capital injections into banks rather than relying on accounting entries to satisfy recapitalization requirements.
Although the CBN has permitted mergers and acquisitions, this suggests it anticipates that some banks might struggle to meet the new capital requirements.
The CBN has stated that the purpose of raising capital is to “engender the emergence of stronger, healthier and more resilient banks to support the achievement of a $1 trillion economy by the year 2030” in line with the Renewed Hope agenda of the Tinubu administration.
The apex contends that larger banks with substantial capital bases are essential, as they can offer more significant levels of credit in the economy the current government intends to build.
Fitch speaks
To ratings agency, Fitch Ratings, increased paid-in capital requirements for Nigerian banks will spur equity issuance over the next two years, supporting a recovery in the banking sector’s capitalization.
It added that the sharp devaluation of the Nigerian naira since May 2023 has depressed capital ratios via the inflation of foreign-currency-denominated risk-weighted assets, adding that some small and medium-sized banks may struggle to raise the necessary capital, leading to increased mergers and acquisitions (M&A).
“This would result in a more concentrated banking sector, with higher barriers to entry, greater economies of scale and stronger long-term profitability.
“However, such developments would be unlikely to have significant rating implications, as the Long-Term Issuer Default Ratings (IDRs) of the vast majority of Nigerian banks are constrained by Nigeria’s ‘B-’ Long-Term IDR”, Fitch added.
It added that, “No Fitch-rated banks currently meet the new requirements. Several would do so if they could transfer their retained earnings and other equity reserves to paid-in capital. However, the CBN has prohibited the use of these items to meet the new requirements, in contrast to the other markets that have increased paid-in capital requirements in recent years, such as Egypt and Ghana. We do not expect banks to pay out large dividends for shareholders to reinject as paid-in capital, as we doubt the CBN would grant approval, and, in any case, the dividends would be subject to tax”.
As a result, banks will, therefore, have to meet the new requirements through fresh equity capital injections or M&A, or by downgrading their licence authorisation, and they must submit their implementation plans to the CBN by the end of this month. The combined paid-in capital shortfall for Fitch-rated banks is about NGN2.6 trillion (USD2.1 billion).
“We expect a marked increase in equity issuance over the next two years. Access Holdings and FBN Holdings recently announced plans to raise up to NGN365 billion and NGN300 billion of capital, respectively. These amounts, if downstreamed as paid-in capital, would be sufficient for their banking subsidiaries to meet their new requirement of NGN500 billion.
Some other banks have recently raised, or are in the process of raising, large amounts of capital relative to their balance sheets, but not enough to meet the new requirements.
“Some small and medium-sized banks may struggle to raise the necessary capital, and could be acquired by larger banks. Certain domestic systemically important banks have particularly high capital ratios but are significantly below the new paid-in capital requirements, and may prefer to consider acquisitions over seeking fresh capital injections. We do not expect licence authorisation downgrades to play a major role in meeting the new requirements as they would necessitate divesting foreign subsidiaries or disentangling regional branch networks”, it added.