Babajide Komolafe and Peter Egwuatu
5 January 2009
The year 2008 will always be remembered by the banking industry as one of those years of turmoil and crisis. Whilst there were a lot of positive development in the industry during the year, the magnitude of the crisis which gripped the industry towards the end of the year, a fall- out of the global financial crisis, overshadows the effect of the positive development.
The crisis arose from three development which occurred separately in the course of the year.These are the common financial year policy, the stock exchange market decline, and the global financial crisis.
In January the Central Bank of Nigeria (CBN) announced that all the banks in the country will now have a common financial year end and directed in February that the policy will take effect from December 31st and also extended the policy to subsidiaries of banks within the country.
The major objective of the policy is to facilitate the rating of banks in the country. Despite caution from several quarters, the apex bank insisted there is no going back on the policy. Hence, some banks sought and got the approval of shareholders to change their year end as directed by the monetary authority.
This, however, sparked-off an aggressive drive for deposit mobilisation by banks in apparent bid to shore up their deposit base ahead of the December 31st common year end. To achieve their deposit mobilisation drive banks jerked up their interest rate with deposit rate reaching 18 per cent in some banks and lending rates touching 30 per cent. The hike in interest rate forced the CBN to acknowledge the unsavoury consequences of the policy, and as a result it initially postponed the implementation of the policy and later suspended it in August.
Decline of the stock market The share offers by banks during the consolidation exercise in 2004 increased public awareness in capital market investment hence an many more Nigerians and institutional investors were attracted to the market between 2004 and 2007.
This occasioned steady demand for shares and with quoted companies especially banks declaring huge and sometimes unbelievable profit share prices rose rapidly thus further enhancing the attractiveness of the market to millions of Nigeria. Consequently, banks started offering share purchase loans also called margin loans both to individual inventors and to stock broking firms. However, the market owing to a number of factors began to decline steadily with share process falling by alarming rate. Consequently, it becomes increasingly difficult for investors to recoup their investment in the market. By extension banks too could not realize the money they gave out as margin loan.
Though the CBN said that total expose of banks to the stock exchange is about N700 billion, investigations reveal that it is more than that. This exposure prompted liquidity difficulties in the industry. Consequently, in the course of the year banks stop granting margin loans and also stop accepting share certificates as collateral for loans. However to moderate the effect of the exposure on banks profit and loss account as well as give investors breathing space, the apex bank granted banks the permission to restructure all margin loans by one year.
The global financial crisis
The global financial crisis started in the United States of America in 2007. However, it assumed a crisis status in September following the collapse of two of the world oldest and biggest investment bank namely Lehman Brothers and Merrill Lynch. Like wildfire the crisis spread to other parts of the world prompting major stock markets to tumble and fumble, while central banks and world leaders announced bailout measures to improve liquidity and forestall further collapse of banks. All together about $3 trillion dollars have been expended in this regard.
Initially, it seems the Nigerian banking industry was totally insulated from the crisis. The year 2008 will always be remembered by the banking industry as one of those years of turmoil and crisis.
There were apprehensions in many quarters that the crisis might also cripple the Nigerian banking system, with some experts calling for bailout measures for the banks.
Despite its assurance that the impact of the crisis would be limited, the CBN nevertheless took preemptive steps to minimize whatever impact the crisis will have the banks and on the economy. Among other things the apex bank reduce the Monetary Policy Rate (MPR) from 10.25 per cent to 9.75 per cent; Reduced cash reserve ratio of banks from four per cent to two per cent ; Reduced the liquidity ratio from 40 per cent to 30 per cent.
It also allowed repo transactions against eligible securities for 90 days, 180 days and 360 days; while offering to buy and sell securities through the two way quotes. These measures which were intended to buoy liquidity in the industry, translated to injection of about N1 trillion liquidity into the economy.
Notwithstanding these measures, Nigerian banks started feeling the hit of the crisis when the foreign correspondent banks began to recall or reduce credit lines extended to them. Also foreign Fund management firms began to pull out of the country.
These resulted into capital flight which triggered huge demand for foreign exchange between October and November. From $1.27 billion sold in September, foreign exchange sales shot up to $3.4 billion in October and $3.1 billion in November. This prompted a sharp depreciation of the naira as the exchange rate rose rapidly from N117 per dollar to N135 per dollar between November and December.
But besides the above, the impact of the global financial crisis on Nigerian banks has been relatively minimal. Unlike banks in the developed countries which suffered credit crunch, severe illiquidity and recorded losses as well as takeover by government through bailout measures, Nigerian banks have continued to grant credit, enjoy robust liquidity and one of the best capital adequacy ratio of about 20 per cent. They have also continued to post eye popping profits and declare generous dividend payment.
Speculations, profit taking, inconsistent policies mars stock market growth in 2008 The downturn in the stock market experienced in year 2008 will remain indelible in the minds of many investors and other stakeholders in the Nigerian economy as the bubble which was built several years ago suddenly burst, leaving investors with bitter experience.
Apparently, the stock market recorded an unprecedented growth hitting N12.6 trillion market capitalisation and 66,371.20 points All Share Index in the first week of March 2008 before the bears set in .In absolute terms, the market lost N3 trillion from March to October 2008 before the intervention by regulators to stem the pathetic situation.
After some weeks of losses, the market witnessed a rebound in the second week of May 2008. However, that recovery did not last as the bears set in again towards the close of May and sent panic signals to investors and regulators. But after the market recorded its first real dip of 3.03 per cent for the week ended May 6, 2008, regulators had to step in freezing further downward the movement of prices. The intervention paid off as the index closed with record appreciation of 7.04 per cent to close at 60,191.83 base points while the market capitalisation stood at N11.72 trillion.
But as at end of trading a day before the yuletide, the market capitalisation closed at N6.797 trillion and index 30728.91 base points. This indicates that investors had lost N5.9 trillion between March and December 24, 2008, while index dropped by 35,642.29 base points.
Genesis of Bear Run The continual slide in prices of equities at the Nigerian Stock Exchange (NSE) began March 5, 2008. Ordinarily, stock markets go in two directions-up and down. But a bear run in March was considered worrisome as that period was supposed to be bullish. The market was supposed to be bullish in March due to the high expectation on the part of investors that companies with December as year end would begin to declare their various returns.
While most of the companies actually announced improved performances and rewarded investors with higher dividends, prices continued to move downwards. Market operators attributed four factors for that decline in prices of stocks.
The first reason was profit-taking.Many investors who realised that their investments had witnessed significant appreciation in the first two months of the year decided to sell in order to enjoy capital appreciation.
The second reason was a shift in investors' focus to private placements following the potential of rapid capital gain. Many investors, who made mouth-watering returns from private placements, began to comb the market for more. They flooded the secondary market with offers so that they can use the proceeds to buy more private placements.
Also delay in the passage of the budget was attributed to the depression in the market. But the last straw that was said to have broken the camel's back was the withdrawal of margin loans by banks.
The Managing Director of Goldman Assets Management Limited, Mr. Olu Abayomi Sanya, said, since the Central Bank of Nigeria (CBN) gave the directive, some of the banks that gave out margin loan facilities recalled their loans. This he said is affecting the liquidity in the market. On his part, the Managing Director of Partnership Investments Company Limited, Mr.Victor Ogiemwonying, said, that the late passage of the budget affected investors' enthusiasm. This slowed down decisions, he asserted.
Before the NSE intervened, regulators and operators had, some months back, expressed confidence that the market cannot crash given the fundamentals of quoted companies. The Head of Media, Securities and Exchange Commission, Mr. Lanre Oloyi, had then said: "We at SEC are not disturbed by what is going on in the market.
"That is the nature of the stock market all over the world. Price making is a function of demand and supply based on companies performance, hearsay and others. The fall in price could be due to low demand by investors. Once demand for shares improves, everything will normalise. We are confident that the market will not crash.
"The market fundamentals are very strong. You can see that from the impressive performances of the quoted companies. Many of the companies continue to report improved results and are also delivering good returns to investors. The decline is temporary and is normal in every market situation."
Similarly, the Director-General of NSE, Prof. Ndi Okereke-Onyiuke had said: "Our capital market cannot crash because the fundamentals in terms of price, capacity for growth of listed companies potential and the economic horizons are all in favour of the market."
A broker, Ogiemwonyi had said the market would soon bounce back and that the fundamentals are strong. SEC gave the first indication of a likely intervention when Oloyi said rules on margin loans would be rolled out in the market. "A committee comprising the NSE, the Central Bank of Nigeria (CBN) and Chartered Institute of Stockbrokers (CIS) was involved in process of evolving the rules. SEC will soon issue new rules on margin accounts. As you know the capital market is rule-based. So there is nothing new in SEC issuing rules in this regard," he said.
Two days after Oloyi made this disclosure, price losers disappeared from the Exchange on a Monday. Investors who usually thronged the Exchange for a copy of the stock market daily trading summary were confused and began to ask questions. Unfortunately, nobody was there to provide answers. The telephones of key officials suddenly went dead. The only clarification a few journalists got was that the disappearance of the bears resulted from the implementation of new rule on price movement.
The new rule stipulates that before any stock can move upwards or downwards, there must a minimum 100,000 units. The NSE followed this rule with the introduction of margin account in the form of Custody account. The Custody account allows stockbrokers to borrow money from banks and trade in stocks.
The only difference between margin loan and custody account is that before a stockbroker trade any shares in a custody account, the banks must be informed. Just as speculations were rife that NSE may have deliberately stopped downward pricing of stocks, Okereke-Onyiuke confirmed the intervention. She said there was nowhere in the world that markets would continue to go down without intervention by the regulators.
She said NSE did not interfere in the market activities but was forced to come in when some operators were discovered not to be playing their roles properly. She said: "It is the role of stockbrokers who are dealing members to explain to members of the Nigerian investing public the dynamics of the market in order to prevent panic. Where in the world that anything goes up and never comes down.
"There is no Stock Exchange in the world that allows a free fall in share prices and would not intervene. We would be lagging in our regulatory role if we allow a free fall in the market with no reason. There is no longer going to be downward movement in the prices of stock without explanation. There are always regulatory intervention and not interference," she said.
Apart from the direct intervention, the NSE also rolled out measures to discourage the patronage of private placements that was said to have contributed to low demand for equities of listed companies. Okereke-Onyiuke said any private placement would be listed at its offer price, thereby removing the incentive that attracted demand for private placements. Investors always embrace private placements due to the fact that such companies are always listed on the NSE at a price higher than their offer prices.
This used to guarantee instant capital gain. It is believed that without instant capital appreciation, investors would be discouraged from buying private placements and channel the funds to the secondary market of the NSE.
However, the strongest death knell came with the speedy loss of confidence and money in the equities market. The stock market decline exerted systemic influences on other markets. It had positive effects on the real estate market as well as on the banks whose products the investors shifted to as alternative investments. But the impact on the real sector appears different. Firstly, it frustrated the plans of many manufacturing firms to raise money from the equities market. Furthermore, as already explained, it led to the direct and indirect frustration of the private placement market.
With minimal capacity to attract more funds for scale operations, many firms which hitherto battled with worsening environment of business were not be able to maximize scale or scope economies in order to be competitive. Many firms which had tied their survival to their successes at the market for more funds could no longer do so.
The situation then was really grave although one may not correctly surmise whether the situation in the market has got to a point where there can be a long-stretched depression as was the case in the stock market crash of 1929. Even though the market has not crashed eventually, there is however a serious gravitation towards that end save the various levels of appropriate (and otherwise) interventions by the government and the market regulators. Yet these levels of intervention exhibit both desperation and confusion which have helped in prolonging the crisis to date.
The performance of the equities market reflects to some extent the performance of the economy particularly in a free market where there are minimal entry restrictions. As such there would be much wider representation of the various sectors of the economy. Since the strength of the economy depends on the relative proportion of firms that are generating positive economic value-added to those that are not, strong growth of the market signals the perception of economic agents about the ability of various firms to generate positive economic value added. Oftentimes this perception is right. But inflationary bubbles can obscure the truth and send a signal that the market is doing well. The decline in the market therefore was a pointer to the state of the economy: an indication of loss of confidence in the underlying values of the stocks or the general performance of the firms.
Although in reality some equities would have declined much lower than their true values as a result of a generally infectious low market confidence, on average the underlying fundamentals of many of the firms in the market reflect that situation. Many businesses in the country operate far less profitably than many investors really imagine because of a harsh environment in which business is conducted.
The crises faced by the Nigerian equities market in the year under review can be summarized to be traceable to two primary causes: one is primary and derives from domestic monetary and financial policies such as the untimely reversal of the margin trading policy which halted the fuelling of the bull market as well as the consequent increased pressure on banks a few months from the halt of the policy to start recalling their funds; the increase in Monetary Policy Rate (MPR) rom 9.50 per cent and the increase in Cash Reserve Ratio (CRR) from 2 per cent to 4 per cent all in a bid to curb the seeming excess liquidity which was also part of the underlying reason for halting the margin facility; the rumours of a CBN policy on the harmonization of banks' year end which triggered a desperation in the industry for fund mobilization which equally bid up the interest rates and made the money market even more attractive. The CBN had denied issuing any order halting margin trading. The second primary cause of the problem has two variants. The first variant is the response of the international investment community to the developments within the domestic financial market environment while the second is their reaction to developments in their own financial landscape.
When the global economy started to operate at the borderline of recession, investors and entrepreneurs generally scouted in desperate panic for alternative investment outlets and opportunities for better returns and minimization of losses. The Nigerian market which at the time was being driven by excessive bank credits following heavily engineered recapitalization became the coveted bride.
For many of the banks with heavily skewed ownership structure the battle for maintenance of the existing ownership structure resulted in shades of financial engineering through the use of re-labelled customer funds and credits from colluding banks to finance the acquisition of trillions of shares. And through a second level of share price engineering at the stock market, ballooned and manipulated prices created enough funds to repay creditors. And to further cover the trail, there was need for second and third rounds of capital raising exercises.
Prices of equities continued to soar as if it would never recede. The capital world hailed the Nigerian market as one with the highest returns in the world; and one which equally offers huge opportunities for portfolio diversification in the face of the imminent depression in their markets. As a result, there were massive inflows of portfolio investments into the Nigerian stock market. Many foreign investment banks promptly set up offices in Nigeria in order to closely monitor and take advantage of the opportunities which the market offered.
Earlier in 2006, following the central bank's appointment of 14 local banks to manage the country's foreign reserve, robust relationships developed between the foreign asset managers with which local banks were then mandatorily expected to work with. This relationship further created opportunities for entry into the Nigerian financial market.
The futility of attempted remedies
The Securities and Exchange Commission, the Nigerian Stock Exchange, the Central Bank and even the federal government have all come up with varying measures aimed at stemming the tide in the market place. The earliest reactions came from the Nigerian Stock Exchange who imposed a one-week fixed floor on price drop such that while it was possible for the prices of stocks to go up, it was not possible for them to come down. Despite numerous calls for the immediate change of such anti-market decisions which many analysts considered as ill-conceived, the Exchange went ahead with the plan. Share prices stood still and awaited the removal of the ban. This decision practically resulted in less than expected upward pressure on the market prices. Consequently, as soon as the wedge on price fall was removed, prices once again resumed its downward tumble.
Not satisfied with the market performance in response to the intervention of the Nigerian Stock Exchange, the federal government set up a presidential advisory committee B made up of 16 persons - partly composed of key market regulators such as the Central Bank of Nigeria, the Securities and Exchange Commission, the Nigerian Stock Exchange and the ministry of Finance, to find a solution to the persistent fall of equity prices and make the capital market once more attractive to foreign investors. The committee once again was lured into adopting one of the earlier failed anti-market fixed floor for equity prices, namely that share prices should not drop below 1% of its market price for each day whereas it can rise to as high as 5%.
Other measures within the emergency solutions basket include: longer loan repayment period for investors. Banks were equally persuaded to inject funds into the stock market through the extension of margin facilities as well as the restructuring of equity related credits. There was also the issue of setting up of a capital market stabilization fund, allowing quoted companies to buy back up to 20 per cent of their shares as well as zero tolerance for infractions in listing process. The NSE and the Securities and Exchange Commission were equally asked to reduce their transaction costs by 50 per cent.. The attorney general on his part was to commence the process of reviewing capital market laws which are unfriendly particularly to give effect to the 20 per cent share repurchase arrangement for quoted companies. All these announcements produced flashes of positive growth but on a longer stretch did not positively alter the direction of the market.
Later on the proposed stabilisation fund was suspended. Its suspension was predicated on the government's conviction that the other measures put in place were adequate and as such, there was little need for such a fund. The suspension was a wise decision. It is important to note that such a fund - following historical experience - would have simply created graft and self enrichment opportunities for many of the bureaucrats that may have direct responsibility for its management.
Irrespective of how beautiful the rules and intervention or investment strategies upon which it is operated are, it will more than present ample opportunities for corruption. In the long-run, it may just be the source of instability for the market. Since it was also going to be a government fund, it would have also been an indirect way of introducing government interventions in the market which would probably have lasted even much after the resolution of the current situation. It could also have been used to subtly nationalize some companies by acquiring substantial holdings of such company's equities As much as is possible, it is important that the market is clear of many external regulatory (and now intervention) claws. Private participants should make the market and not the government.
On the other hand, much more specific rules on share buy-back has been put in place: the limit for the total number of shares is now 15 per cent of its existing issued and paid up capital in a given financial year.
In addition to the provisions in the Companies and Allied Matters Act (CAMA) is a special resolution of the company which authorizes the share repurchase in addition to the requirement of publishing the buy-back in at least two national newspapers. Notwithstanding how the buyback is executed, that is, whether through the open market or through Self Tender Offer, it would not be permitted in situations where the firm is deemed illiquid. Some analysts have condemned the idea of share buy back on the grounds that it amounted to investor fraud since it will entail the cancellation of shares and result in subtle company share restructuring. This is not necessarily true in as much as the repurchase actions are conducted voluntarily based on board and general agreement.
Moreover, the argument that companies (institutions) gain at the expense of retail investors under the share repurchases arrangement is equally shallow as the profits of the companies are automatically that of those investors. Be that as it may, it is believed that the modalities for the activities should make it as transparent as possible. The CBN on its own part responded in late September by reducing the monetary policy rate by 0.5 per cent from 10.25 per cent to 9.75 per cent.
Similarly, the cash reserve ratio dropped from 4.0 per cent to 2.0 per cent; the liquidity ratio was slashed from 40 per cent to 30 per cent. Repos transactions against eligible securities were to be allowed for 90 days, 180 days and 360 days. All these policy mix were aimed at attracting about N1 trillion into the economy out of which a substantial part is expected to flow into the stock market. The effect was felt very temporarily, even much less as most quick fix effect would. Afterwards, prices returned to their normal downward movement albeit restricted from a free flow.
In sum therefore, the various panacea did fail in achieving even some fairly lasting positive effects on the market. What this means in effect is that the fire brigade approach so far adopted do not constitute the appropriate solution set for the problem in the market place. Some commentators have also noted that the views of shareholders and some other relevant stakeholders in the capital market were not carried along in the design of the ultimate solution.
Furthermore, the inability of the direct market interventions applied at different times only go a long way to prove how ineffective they can be in this circumstance and in most other circumstances, will always produce unhealthy consequences for the market over a longer period. The crucial question now
is: what more options should we try?Where do we go from here?
It appears that the market has bottomed out and prices of stocks may not continue to fall perpetually as the real value of stocks set in. Also, the reversion to 5 per cent condition for daily price movement is also in the right direction since our market operates on the vagaries of demand and supply.
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