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

1
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

2
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

3
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)

4
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

5
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.

6
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.

7
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)

8
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.

9
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

10
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

11

• 2.0 Stylized Facts about the Nigeria Economy

12
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

13
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

14
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

15
Overview of the Nigeria Economy
Cont.Macro-Economic Indicators
Indicator 2006 2007 2008
GDP Growth Rate () 6.0 6.5 6.4
Inflation Rate () 8.5 6.6 15.1
M2 Growth Rate () 30.6 44.2 58.0
Current Account Balance 18.5 11.8 17.5
FDI 13.9 5.6 5.8
External Reserves (US billion) 42.3 51.3 53.0
Exchange Rate End-Period 128.2 117.9 132.5
External Debt (US billion) 3.5 3.6 3.7
16

• 3.0 Impact of the Crisis on the Financial Sector
  of the Nigerian Economy

17
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

18
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

19
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

20
Banking Sector

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

21
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

22
(No Transcript)
23
Exchange Rate (2001-2008)
N146/
N121/
24
Bond Market

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

25

• 4.0 Nigerias Response to
  Stabilize the Financial Sector

26
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

27
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

28
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

29
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

30

• 5.0 The Way Forward

31
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

32
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

33
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

34
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

35
I Thank You All For Listening!