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The Noose gets tighter on Banks

By Babajide Komolafe
Recently the Central Bank of Nigeria suspended the treatment of Commercial Papers and Bankers Acceptances by banks as off balance sheet items. This measure according to money market operators would trigger a fresh liquidity crisis in the industry as well as occasion increase in deposit rates, Babajide Komolafe writes.

The Central Bank of Nigeria, CBN’s, determination to ensure that banks present accurate result to shareholders at all times nudge a step higher last week when the apex bank directed that henceforth, Commercial Papers (CPs)  and Bankers Acceptances (BAs)  should no longer be treated as off balance sheet items.

Commercial Papers (CPs) are debt instruments issued by companies when raising funds to finance their operations. When a company wants to raise money it approaches a bank which helps it to raise the money from investors.

The bank issues the commercial paper on behalf of the company to the investors. In doing this the bank earns commission for helping the company to raise money. Also, because the investors are the lender and not the bank, the fund raised does not appear as a loan in the books or balance sheet of the banks hence such transactions are regarded as off-balance sheet items. A Bankers Acceptance (BAs) is a variant of commercial paper. It is issued where the loan raised by the company as in above is guaranteed by a bank.

But the Nigeria Deposit Insurance Corporation (NDIC) has severally accused banks of abusing the use of CPs and BAs. According to several reports of the corporation, “Some banks continued to abuse the use of Commercial Papers and Bankers Acceptances to understate their loan portfolios and deposit liabilities as well as window dress financial statements through creative accounting in the name of balance sheet management.

“The use of BAs and CPs to window-dress accounts as well as manages non-performing loans assumed a worrisome proportion during the year and required urgent regulatory action to stem the tide especially, as some banks used them to cover their excessive lending activities”.

Explaining how banks abuse these debt instruments, a bank treasurer said that when a bank grants a loan, and the loan becomes non-performing i.e the debtor has failed to repay the loan, to avoid making provision (or deduct the value of such loan from its profit for the year) as required by the prudential guidelines, the bank would repackage the loan into a CP or BA and also move the same value from its deposit base or also repackage the deposit of a customer of the same value as a CP or BA. So the bank pretends that the deposit was to fund a CP or BA issued on behalf of a company raising money through it.

By so doing the bank removes the loan and the corresponding deposit liability from its balance sheet. In doing this the bank avoid making provision for the non-performing loan. And because its deposit base is now understated, its liquidity ratio and cash ratio i.e. proportion of deposit based banks are required to keep in liquid assets and cash improves, off course in its books. Also the amount of deposit insurance premium paid by the bank to NDIC reduces. This is based on the total deposit liability of the bank at the end of the year.

Consequently, by using CPs and BAs to hide non-performing loans, the bank hides its financial conditions from the regulatory authorities. The practice, according to a senior money market source is prevalent in the banking industry and only few banks do not engage in these so called off balance sheet transactions. He said that for some banks these off balance sheet items are more than their balance sheet items, and about 75 per cent of CPs and BAs in the system are either repackaged non-performing loans or those fictitiously created.

Against this background, and coming from a risk management background, upon resumption of office, the CBN Governor, Mr. Sanusi Lamido Sanusi’s first move to resolve the growing apprehension about the true health of Nigerian banks, especially, as relating to exposures to the capital market and the energy sector, was to ask banks to submit schedules of all the CPs and BAs.

In a circular to banks dated July 15th titled, “Submission of Schedule of Commercial Papers (CPs) and Bankers Acceptances (BAs), the apex bank stated that, “All banks are hereby requested to submit to the Ag. Director of Banking Supervision a schedule of their Commercial Papers (CPs) and Bankers Acceptances (BAs) of N20 million and above bought and sold for counter-parties. The details should include the names of the counter-parties and the amounts involved.”

An audit of the schedule submitted by banks revealed the abuse mentioned above hence two weeks ago the apex bank suspended the treatment of the instrument as off balance sheet items.

Announcing the suspension in a circular titled, “Circular to all banks and discount houses: Suspension of BA’s and CP’s as off balance-sheet items”, the apex bank stated, “The Central Bank of Nigeria has observed with concern the abuse of the use of Bankers  Acceptances (BA’s) and Commercial Papers (CP’s), by Deposit Money banks and Discount Houses.

“The abuse ranges from repackaging of troubled assets into CP’s/BAs for purported sale to other institutions, non-existence of underlying transactions for the CPs/BAs, and frequent rollovers beyond the allowable tenor. In addition, CPs and BAs are often used as the instrument of choice for raising liquidity in an attempt to conceal the extent of dependence on the Inter-bank market for banks funding needs.

“Consequently, the sell-down of BAs and CPs as off balance-sheet instruments is hereby suspended with effect from the date of this circular. All maturing CPs and BA’s are to be either fully liquidated or treated as on balance-sheet items.

“If a bank is likely to exceed its single obligor limit as a result of this circular, it is advised to seek the CBN’s approval for exemption in line with BOFIA, Section 20(1)A as amended, subject to the loans being performing and a plan for regularization by 31st March 2010.”

Money market operators told Financial Vanguard that the measure would trigger another liquidity crisis in the system. A senior operator told Financial Vanguard that most of the banks have hidden huge amount of non-performing loans as off-balance sheet items through the use of these instruments, and in the process understated their deposit liabilities. When these items are brought into their balance sheets as required by the CBN, their deposit base would swell and this could lead to a drastic fall in their liquidity ratio and cash reserve ratio.

“I can tell you that less than ten banks would meet the 25 per cent liquidity ratio required by the apex bank.”, he said.
He added that the other side is that there would be a big increase in the non-performing loans of most banks and this would increase their provision for bad debt in the current operating year. And ultimately there would be a sharp decline in the after tax profit of banks.  Already four banks have made provision for bad debts totally N95.46 billion.

A senior treasurer in one of the top five banks said that the measure could also trigger increase in deposit rates. He said that ordinarily interest rate on term deposits attract a 10 per cent withholding tax charge, but interest rate on CPs and BAs are excluded from this charge since they are off balance sheet items. Hence customers whose deposits are covered up as CPs by banks do not pay the tax charge on the maturity of the deposit.

But since banks cannot fake deposits as CPs anymore, the withholding tax charge would be applied, and this could reduce the return enjoyed by deposits. The implication is that these depositors would demand for higher deposit rates to cover the ten per cent withholding tax charge deductions.

Another money market operator said the CBN measure is going to impact severely on the market. He said though the market is yet to feel the impact, in 90 days time when all the existing CPs and BAs are expected to expire the industry could witness an unprecedented rush for deposits. Though the banks would not lose money but they would have to look for money to cover up for the fictitious transactions they created in their books through these instruments.

Since most of the 23 banks are involved in these abuses, all of them would be under intense pressure to mobilise deposits first to address the expected fall in their liquidity ratio and secondly to cover up artificially created transactions in their balance sheet.


Comments expressed here do not reflect the opinions of vanguard newspapers or any employee thereof.