Babajide Komolafe
22 September 2008
Banking experts have said that the fall of United States banking giants, Lehman Brothers and Merril Lynch last week is a powerful signal to Nigerian banks on the limitation of size (capital base) and age in determining the future of a bank.
Last week, September 14 and 15 to be precise, the raging fire of financial crises in the United States of America for some time now took an unexpected dimension when it consumed two banking giants - Merryl Lynch and Lehman Brothers.
Following a string of loses arising from exposure to the troubled U.S sub-prime market, on Monday September 15, Lehman Brothers filed for bankruptcy, while on Sunday September 14 Merrill Lynch was acquired by Bank of America in a $50 billion all stock transaction. The demise of the two venerable banking institutions shook the world financial markets with the New York Stock Exchange going down by 504 points. In addition to been among the biggest and largest investment banks, the two companies were also among the oldest.
Merrill Lynch was founded in 1914. It had a capital base of $34 billion and total assets of $1.6 trillion. Reputed to be the largest securities firm in the world, with offices in over 98 cities and membership on 28 exchanges, the company has about 60,000 staff around the world.
Lehman Brothers was founded in 1850 as a commodity (cotton) trader and broker, from where it veered into investment banking in 1899. It had a capital base of $26.3 billion and assets of $639.4 billion, with 26,189 employees. The company specialized in investment banking, equity and fixed income sales, research and trading, investment management, private equity, and private banking. It was a primary dealer in the U.S. Treasury securities market. Combined together, in terms of capital base and assets, the two banks are bigger than all the 24 Nigerian banks put together.
Reacting to the demise of the two institutions and the implications for Nigerian banks, executive director, Risk Asset Management, and Managing Director/chief executive designate, First Bank, Mr. Sanusi Lamido remarked that the fall of the two banks confirms what he had always said that, Abanks are sustained by the quality of assets and management prudence not amount of capital. No matter how much capital a bank has poor asset quality will bring it down one day.
In the same vein, assistant general manager, Associated Discount House, Mr. Kayode Ojo, stated that Aage and size is not an insulator from failure. Management must remain focused and professional. Liquidity and cash management is very important. Early recognition of losses and Asset and liability management is the key."
Former, Director, Special Insured Institutions Department (SIID), Nigeria Deposit Insurance Corporation (NDIC), Mr. Joe Ahimie noted that ANigerian banks need not panic about the failure of Lehman Brothers. It will have no effect on our economy or any impact on Nigerian banks except where there is direct financial dealing with Lehman. Are there any lessons for us? Yes. Banks should be cautious about lending at the inter-bank market. They should also be cautious with consumer credits particularly now that liquidity is poor.
However, Former President, Association of Bureaux de Change Operators of Nigeria (ABCON) and managing director/chief executive, Macro BDC, Mr. James Tifase, warned that, Aour regulatory bodies should not be over confident and depend on only the conventional tools of supervision. They should employ more non-conventional methods of obtaining insider information. Our current crops of bankers are sophisticated in records manipulation as could be seen from the consolidation exercise.
Speaking in the same regard, a former top staff of one of the financial sector regulatory bodies, who spoke on condition of anonymity, noted that, Athe global financial crisis initially seem not to have crossed the border to Nigeria. But in the last few weeks, we have experienced rubbles because of the stock market. When the prices in the stock market were buoyant, no one looked at the underlying transaction and the balance sheets vis-a-vis fixed income flows from abroad. These flows are moving out albeit slowly while the domestic market had tight liquidity.
"Painfully enough, we created confidence crisis in the market with policy reversals and institutional harassment. A vivid example is the challenges faced by the CBN. CBN should have full autonomy to run the market efficiently - that is lacking. The lessons for us from the failure of the two banks are one; No bank is too big to fail. Secondly, the supervisory role of the CBN should role up their sleeves to do effective risk management. Finally, the market will penalise policy reversal and so the government should allow CBN to have the air of confidence.
The demise of Lehman Brothers and Merril Lynch has further confirmed the historical fact that no bank or financial institution is too big or too old to fail. History is replete with banks that were so big that nobody believed could fail or would be allowed to fail. Bank of Credit and Commerce International (BCCI), which collapsed in 1991 and Barings Bank which failed in 1995 are classical examples in this regard.
In fact, few believed the ranging financial crises could consume Lehman Brothers and Merrill Lynch as both have survived earlier crises especially the great Wall Street crash of the 1920s. However, the message for Nigerian banks is the fact that both failed due to undue credit exposure to the mortgage sector/subprime market through mortgage backed securities.
The crises that consumed the two banks, popularly known as the subprime mortage crises, started with the bursting of the US housing bubble and high default rates on "subprime" and other adjustable rate mortgages (ARM) made to higher risk borrowers with lower income or lesser credit history than "prime" borrowers in 2006. The term subprime lending refers to the practice of making loans to borrowers who do not qualify for market interest rates owing to various risk factors, such as income level, size of the down payment made, credit history, and employment status.
The crisis can be attributed to a number of factors, such as the inability of homeowners to make their mortgage payments; poor judgment by the borrower and/or the lender; and mortgage incentives such as "teaser" interest rates that later rise significantly. Further, declining home prices have made re financing more difficult. As a result of innovations in securitization, risks related to the inability of homeowners to meet mortgage payments have been distributed broadly, with a series of consequential impacts.
Loan incentives and a long term trend of rising housing prices encouraged borrowers to assume mortgages, believing they would be able to refinance at more favorable terms later. However, once housing prices started to drop moderately in 2006B2007 in many parts of the U.S., refinancing became more difficult. Defaults and foreclosure activity increased dramatically as ARM interest rates reset higher. During 2007, nearly 1.3 million U.S. housing properties were subject to foreclosure activity, up 79 per cent from 2006.
The mortgage lenders that retained credit risk (the risk of payment default) were the first to be affected, as borrowers became unable or unwilling to make payments. Major banks and other financial institutions around the world have reported losses of approximately $435 billion as of July 17, 2008.
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