THE GLOBAL ECONOMIC CRISIS AND THE NIGERIAN FINANCIAL SYSTEM: THE WAY FORWARD

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THE GLOBAL ECONOMIC CRISIS AND THE NIGERIAN
FINANCIAL SYSTEM THE WAY FORWARD

• BY
• CHARLES MORDI
• DIRECTOR, RESEARCH DEPARTMENT
• BEING A PAPER DELIVERED AT THE 14TH SEMINAR FOR
  FINANCE CORRESPONDENTS AND BUSINESS EDITORS, AT
  BENUE HOTELS, MAKURDI, JULY 16, 2009

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OUTLINE

• 1.0 Introduction
• 2.0 Stylized Facts about the Nigeria Economy
• 3.0 Impacts of the Financial crisis on the
  Nigerian Financial System
• 4.0 Nigerias Response to Stabilize the
  Financial Sector
• 5.0 Way Forward

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1.0 Introduction

• Conceptual Definition of Financial Crisis
• A situation where financial institutions or
  assets suddenly lose a large part of their
  value.
• Types of Financial Crisis
• Banking crises
• Bank run (one Bank)
• Systemic banking crisis (bank run on several
  banks)
• Credit crunch (insufficient funds for borrowing)
• Speculative Bubble and Crashes
• Bubble (present price has higher value than
  future income)
• Crashes (when there are many sellers and no
  buyers)

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IntroductionContd.

• International Financial Crisis
• Balance of payments or currency crisis
• Sovereign Debt default
• Sudden stop in capital flows and capital flight.
• Wider Economic Crisis. Low/Negative GDP growth
• Recession
• Depression-prolonged recession

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IntroductionContd Causes of Current Financial
Crisis

• The genesis of the current financial crisis
  could be traced to the default on sub-prime
  mortgage loans in the United States (US).
• In the pre-2007 era, the US government encouraged
  financial institutions to lend to individuals
  that would not have otherwise qualified for
  housing loans. These loans were backed by the
  federal government.
• This resulted in cheap borrowing and an
  unprecedented boom in the US housing market.

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IntroductionContd Causes of Current Financial
Crisis

• By 2005, 1 out of 5 mortgages were sub-prime
  lending in the US. The rates for the sub-prime
  were higher because they had Adjustable Rate
  Mortgages (ARMs) that were fixed for two years
  thereafter the rates were marked to the Fed
  interest rates which rose substantially.
• Home loans granted to people with questionable
  ability to pay back i.e. people with no income,
  no job and no assets (NINJA)
• Weaknesses in the application of
  originate-to-distribute model, leading to
  compromises in underwriting standards
• As interest rates on mortgage loans increased,
  the prices of houses fell, consequently the
  houses were valued less than the mortgage loans,
  thus default rate on loans increased.

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IntroductionContd Causes of Current Financial
Crisis

• The magnitude of the repossession that followed
  coupled with the mortgage companys inability to
  renegotiate loans led to the collapse of the
  government backed mortgages
• Owing to the wide spread defaults, house prices
  began to fall due to huge foreclosures.
• Banks and financial institutions repackaged these
  debts with other high risk debts and sold them to
  worldwide investors creating financial
  instruments called Collateralized Debt
  Obligations (CDO)

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IntroductionContd Causes of Current Financial
Crisis

• Financial derivatives called Mortgage-Backed
  Securities (MBS), which derive their value from
  mortgage loans spread the risk to financial
  institutions and investors around the world.
• Major Banks and financial institutions borrowed
  and invested heavily in MBS and reported losses
  of approximately US435 billion as of July 17,
  2008.

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IntroductionContd Causes of Current Financial
Crisis

• First stage - "liquidity constraints," leading to
  difficulties in raising funds
  in the US.
• Second stage -"credit contraction." this exerted
  strong downward pressure on the
  economy.
• Third stage - financial contagion arising from
  inter- linkages of the world
  financial system-Economic Recession

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IntroductionContd Effects

• The stock markets capitalization recorded
  unprecedented losses, as at end-December 2008.
• London 31.3
• New York 33.84
• Frankfurt 40.4
• Sydney 41.3
• Tokyo 42.1
• Paris 42.7
• Hong Kong 48.3
• Singapore 49.2
• Mumbai 51.9
• Shanghai 65.2
• Nigeria 45.2

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• 2.0 Stylized Facts about the Nigeria Economy

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Stylized Facts about the Nigeria Economy

• Economic growth averaged 6.3 per cent between
  2006 and 2008, projected to fall in 2009
• Inflation rate fell from 8.5 per cent in 2006 to
  6.6 per cent in 2007, it however increased to
  15.1 in 2008 due to worldwide high food and
  energy prices
• Reduced Foreign exchange inflow due to drop in
  the price and volume of crude oil sold
• Economy dependent on a crude oil as a major
  source of foreign exchange
• Crude oil accounts for
• about 90 foreign exchange earned
• 65 of government revenue

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Stylized Facts about the Nigeria Economy

• Import dependent
• A Emerging financial sector
• 2 domestic banks among the top 500 banks in the
  world
• Susceptible to oil shocks
• International crude prices
• Low non-oil exports
• Decrease in volume of oil exports mainly due to
  restiveness at the Niger Delta

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Stylized Facts about the Nigeria Economy

• Poor and dilapidating infrastructure
• Low level of financial sector integration into
  the global economy
• Central Bank of Nigeria remain the major source
  of FX in the official market
• Wide margin between lending and saving rates
• Exchange rate Depreciation

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Overview of the Nigeria Economy
Cont.Macro-Economic Indicators
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• 3.0 Impact of the Crisis on the Financial Sector
  of the Nigerian Economy

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Nigeria Financial Market Comprises

• Financial Sector Regulators
• The Central Bank of Nigeria
• The Nigerian Deposit Insurance Corporation (NDIC)
• The Security and Exchange Commission (SEC)
• The National Pension Commission (PENCOM)
• The National insurance Commission (NAICOM)
• The Federal Mortgage bank
• Deposit Money Banks
• Discount Houses
• Microfinance Banks
• Finance Companies
• Bureaux de change
• Nigeria Stock Exchange (NSE)
• Primary Mortgage Institutions
• Development Finance Institutions
• Insurance Companies

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Impact of the Crisis on the Financial Sector of
the Nigerian Economy The Capital Market

• Capital market downturn caused by foreign
  investors divestment and panic sales by local
  investors
• Stock market crash of All-Share Index (ASI) and
  Market Capitalization (MC) by 67.2 and 61.7 per
  cent, respectively, between April 2008 and March
  2009
• Reduced capitalization of companies predisposing
  them to takeovers
• Weak source of financing to listed companies

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Banking Sector

• Limited foreign trade finances for banks
  drying-up of credit lines for some banks
• Liquidity Credit crunch in the domestic economy
• Tightness in the balance sheet of banks and
  counter party risks vis-à-vis external reserves
• Higher provision for loss by banks could reduce
  profitability and lending.
• Increase unemployment rate as a result of low
  profit

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Banking Sector

• Exchange rate exposure
• Counterparty exposure
• Interest rate spread on the increase
• Prime lending
• 16.08 end 2008
• 18.95 Feb 2009

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Money Market

• Increase in Interest Rate
• As funds dry up, Liquidity squeeze sets in, the
  financial market, interest rates resets higher
  in the money market
• Higher interest on deposits as investors move
  from the stock market
• Higher lending rates to cover risk in economic
  downturn
• Increased demand pressure in the foreign exchange
  market
• Depreciation of the Foreign Exchange rate
• Exchange rate depreciated from N117 to N135 per
  US dollar as at end of Dec 2008
• Wide supply and Demand gaps
• High outflows and low inflows of foreign exchange
  into the economy

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Exchange Rate (2001-2008)
N146/
N121/
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Bond Market

• Increased preference to use bonds for fund
  raising
• Increase patronage in fixed income securities by
  investors
• Higher rates on bonds

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• 4.0 Nigerias Response to
  Stabilize the Financial Sector

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Responses by the Monetary Authority

• Reduce MPR by 50.0 basis points from 10.25 to
  9.75 per cent and later to 8.0 per cent
• Reduce CRR from 4.0 to 2.0 per cent and liquidity
  ratio from 40.0 to 30.0 per cent currently 25 per
  cent
• Expanded discount window facility from overnight
  to 360 days, interest rate not exceeding 500
  basis point above the MPR
• Buying and selling of securities through the
  two-way quote by the CBN

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Responses by the Monetary Authority

• Aggressive mop up suspended as monetary authority
  embraced relaxed monetary policy.
• Adoption of a or -3 per cent band for exchange
  rate movement
• Reduced banks foreign exchange net open position
  from 20.0 to 10.0 per and later to 1.0 per cent
  of shareholders funds
• Reintroduction of the Retail Dutch Auction System
  (RDAS)
• CBN suspended daily inter-bank foreign exchange
  market to ward off speculative attacks on the
  domestic currency

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Responses the Security and Exchange Rate
Commission.

• Five market makers to provide continuous
  liquidity and stabilize stock prices,
• Strict enforcement of listing requirements with
  zero tolerance for infractions
• Downward movement of share prices pegged at 1,
  upward movement remains at before it was restored
  to 5 either way
• Recapitalizations of security companies
• Reduction in transaction fees
• De-listed moribund companies released rules
  on share buy-back with limit of 15.0

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Responses by the Federal Government

• A Presidential Advisory Team on capital market
  was set up to reverse the declining fortunes of
  the Nigerian capital market
• 2009 Budget Review
• Oil price benchmark reduced from US59.00 to
  US45.00 per barrel
• Allocation to state governments reviewed
• Projects prioritized
• Economic Management Team mandated to come up with
  measures to curb the contagion effect of the
  global financial meltdown on the domestic economy

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• 5.0 The Way Forward

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The Way Forward

• Priority areas for domestic financial
  institutions
• Ensure access to liquidity
• Recapitalizing weak but viable institutions
• Assessment of the quality of assets and
  robustness of the funding,
• Funding may be from government and private
  sources
• Establishment of viable business plan and risk
  management process
• Help to reduce uncertainty and public skepticism
• Resolving failed institutions
• Orderly closure or mergers
• Identifying and dealing with distressed assets
• Establishment of a standardized methodology for
  the valuation of illiquid securitized credit
  instruments

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Way Forward

• Tightening of regulation and supervision
• Keep vigilance on early warning signals through
  vigorous examinations
• Encourage banks to strengthen and reduce bank
  specific contingency plans
• Greater coordination between the regulatory and
  supervisory agencies
• Appropriate corrective actions
• Collective action required to reduce overall risk
  in the banking system.
• Greater domestic cooperation between regulators
• Greater international cooperation required to
  avoid the exacerbating cross-border strains
• Need for financial institutions to embrace
  transparency on activities and products
• Full and transparent disclosure of impairment in
  banks balance sheet

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Way Forward

• Adoption of the International Financial Reporting
  Standards (IFRS)
• Review of all relevant laws relating to the
  financial sector to strengthen regulatory
  capacity
• Greater emphasis on e-FASS as a tool for banks
  returns analysis for speedy identification of
  early warning signals

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Way Forward Cont.

• Capacity Building for Financial System staff
  professionalism (Knowledge, skills)
• Greater emphasis on enforcement of Code of
  Corporate Governance
• Introduction of Asset Management Companies (bad
  banks)
• To clean out the balance sheet of financial
  institutions
• Restoring confidence based on clarity,
  consistency and reliability of policy responses

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I Thank You All For Listening!