By Olukayode Akerele
Globally, the importance of banks in an economy cannot be over-emphasised. Apart from playing the intermediation role of moving funds from the surplus to the deficit sectors of the economy, they act as the barometer that measures the â€œfinancial pressureâ€ of an economy. The banking industry is the largest provider of funds to both the private and public sectors of the economy; it also provides developmental support to the key sectors of the economy. Stakeholders are thus sensitive to whatever positively or negatively affects the banking industry.
It is from this background that one views the recent publication by The African Report classifying the Nigerian banks as â€œstrongâ€ (4 Banks), â€œsatisfactoryâ€ (9 Banks), â€œShakenâ€ (7 Banks), and â€œStressedâ€ (4 Banks).
The main aims of this write-up are to:
1. Consider some criteria for the assessment of the health of banks globally
2. Comment on the qualification/integrity of the Rating Agencies.
3. Comment on the global financial crisis
4. Make an objective appraisal of the state of health of the Nigerian banks
5. Appraise the de-marketing and the rat-race phenomenon prevalent in the banking industry.
The intention of all the above is to inform and caution the unsuspecting public as to the danger inherent in absorbing sensational news hook, line and sinker.We would conclude by making some recommendations on the way forward.
Criteria for the Assessment of Banks Globally
Banks supervisory agencies are responsible for monitoring the financial conditions of commercial banks and enforcing related legislation and regulatory policy.
Although much of the information needed to do so can be gathered from regulatory reports, an on-site examination is needed to verify report accuracy and to gather further supervisory information. Much research has explored the value of this private information; both to the bank supervisors and to the public who monitor banks through the financial markets.
In Nigeria, the major supervisors of the banking industry are the Central Bank of Nigeria (CBN) and the Nigeria Deposit Insurance Corporation (NDIC) other regulators are the Securities and Exchange Commission, (SEC), the Nigeria Stock Exchange (NSE), the Federal Ministry of Finance (FMF) through adhoc circulars. By the Acts setting up the EFCC, ICPC and NDLEA, banks are required to furnish these government agencies with specific data periodically concerning their relationship with third parties.
The main regulatory authorities use CAMELS rating in assessing the condition (health) of banks.
These supervisory ratings are assigned at the end of examination and are directly disclosed only to senior bank management and to the appropriate supervisory personnel. CAMELSâ€™ ratings are commonly viewed as summary measures of the private supervisory information gathered by examiners regarding banksâ€™ overall financial conditions, although they also reflect available public information.
The general consensus in academic literature is that the private supervisory information contained in CAMELS ratings is useful in the supervisory monitoring of banks. Furthermore, to the extent that this information filters out into the financial markets, it appears to affect the prices of bank securities. Thus, private supervisory information in CAMELS ratings also appears to be useful in the public monitoring of banks.
What are CAMELS Ratings?
During an on-site bank examination, supervisors gather private information, such as details on problem loans, with which to evaluate a bankâ€™s financial condition and to monitor its compliance with laws and regulatory policies. A key product of such an examination is a supervisory rating of the bankâ€™s overall condition, commonly referred to as a CAMELS rating.
The acronym â€œCAMELâ€ refers to the five components of a bankâ€™s condition that are assessed: Capital adequacy, Asset quality, Management, Earnings, and Liquidity. A sixth component, a bankâ€™s Sensitivity to market risk was added in 1997; hence the acronym was changed to CAMELS.
The bulk of the academic literature is based on pre-1997 data and is thus based on CAMEL ratings. Ratings are assigned for each component in addition to the overall rating of a bankâ€™s financial condition. The ratings are assigned on a scale from 1 to 5. Banks with ratings of 1 or 2 are considered to present few, if any, supervisory concerns, while banks with ratings of 3,4, or 5 present moderate to extreme degrees of supervisory concern.
All examination materials are highly confidential, including the CAMELS. A bankâ€™s CAMELS rating is directly known only by the bankâ€™s senior management and the appropriate supervisory staff. CAMELSâ€™ ratings are never released by supervisory agencies, even on a lagged basis.
While examination results are confidential, the public may infer such supervisory information on bank conditions based on subsequent bank actions or specific disclosures. Overall, the private supervisory information gathered during a bank examination is not disclosed to the public by supervisors, although studies show that it does filter into the financial markets.
CAMELS Ratings in the Supervisory Monitoring of Banks
Several academic studies have examined whether and to what extent private supervisory information is useful in the supervisory monitoring of banks. With respect to predicting bank failure, Barker and Holdsworth (1993) find evidence that CAMEL ratings are useful, even after controlling for a wide range of publicly available information about the condition and performance of banks. Cole and Gunther (1998) examine a similar question and find that although CAMEL ratings contain useful information, it decays quickly.
For the period between 1988 and 1992 in the U.S they find that a statistical model using publicly available financial data is a better indicator of bank failure than CAMEL ratings that are more than two quarters old.
Hirtle and Lopez (1999) examine the usefulness of past CAMEL ratings in assessing banksâ€™ current conditions. They find that, conditional on current public information, the private supervisory information contained in past CAMEL ratings provides further insight into bank current conditions, as summarized by current CAMEL ratings. The authors find that, over the period from 1989 to 1995 in the U.S the private supervisory information gathered during the last on-site examination remains useful with respect to the current condition of a bank for up to 6 to 12 quarters (or 1.5 to 3 years).
The overall conclusion drawn from academic studies is that private supervisory information, as summarized by CAMELS ratings, is clearly useful in the supervisory monitoring of bank conditions. Flowing from the above is that it is only the major supervisory agencies that can categorically assess and judge the overall financial condition of any bank. In Nigeria, these supervisory agencies are the Central Bank of Nigeria (mainly) and the Nigeria Deposit Insurance Corporation.
The Role of Credit Rating Agencies
Generally, rating is a system of assigning letters to security issues indicating the perceived default risk associated with that class of issues.
A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. In some cases, the servicers of the underlying debt are also given ratings.
In most cases, the issuers of securities are companies, special purpose entities, state and local governments, non-profit organizations, or national governments issuing debt-like securities (i.e., bonds) that can be traded on a secondary market. A credit rating for an issuer takes into consideration the issuerâ€™s credit worthiness (i.e., its ability to pay back a loan), and affects the interest rate applied to the particular security being issued.
In contrast to CRAs, a company that issues credit scores for individual credit-worthiness is generally called a credit bureau or consumer credit reporting agency.
The value of such ratings has been widely questioned in the U.S after the 2008 financial crisis when the Securities and Exchange Commission submitted a report to Congress detailing plans to launch an investigation into the anti-competitive practices of credit rating agencies and issues including conflicts of interest.
Credit ratings are used by investors, issuers, investment banks, broker-dealers, and governments. For investors, credit rating agencies increase the range of investment alternatives and provide independent, easy-to-use measurements of relative credit risk; this generally increases the efficiency of the market, lowering costs for both borrowers and lenders. This in turn increases the total supply of risk capital in the economy, leading to stronger growth. It also opens the capital markets to categories of borrower who might otherwise be shut out altogether; e.g small governments, startup companies, hospitals, and universities.
CRA ratings are also used for other regulatory purposes as well. The US SEC, for example, permits certain bond issuers to use a shortened prospectus form when issuing bonds if the issuer is older, has issued bonds before, and has a credit rating above a certain level. SEC regulations also require that money market funds (mutual funds that mimic the safety and liquidity of a bank savings deposit, but without FDIC insurance) comprise only securities with a very high rating. Likewise, insurance regulators use credit ratings to ascertain the strength of the reserves held by insurance companies.
Under both Basel II and SEC regulations, not just any CRAâ€™s ratings can be used for regulatory purposes. If this were the case, it would present an obvious moral hazard, since an issuer, insurance company, or investment bank would have a strong incentive to seek out a CRA with the most lax standards, with potentially dire consequences for overall financial stability.
Rather, there is a vetting process of varying sorts. The Basel II guidelines for example, describe certain criteria that bank regulators should look to when permitting the ratings from a particular CRA to be used. These include â€œobjectivity,â€ â€œindependence,â€ â€œtransparency,â€ and others. Banking regulators from a number of jurisdictions have since issued their own discussion papers on this subject, to further define how these terms will be used in practice.
DefaultRisk.com, the webâ€™s biggest credit risk modeling resource list sixty seven (67) globally accepted credit rating agencies as at March 2008. These rating agencies include Agusto & Co Ltd (Nigeria); Fitch Ratings Ltd (Uk /USA), Standard and Poors (US), Global Crediting Rating Co (S/Africa), Bank Watch Ratings S.A. (Equador â€“ a Fitch Affiliate), Agence d â€˜Evaluation Financiere (ADEF) France-(already absorbed by Standard and Poors). From the long list of 67 rating agencies, the paris-based Groupe Jeune Afrique, the publisher to The African Report that recently carried the sensational classification of the Nigerian banks could not be located.
Fitch Ratings we know as a leading global rating agency committed to providing the worldâ€™s credit market with independent, timely and prospective credit opinions. Built on a foundation of organic growth and strategic acquisitions, Fitch Ratings has grown rapidly during the past decade gaining market presence throughout the world and across all fixed income markets.
The non-inclusion of the Paris-based Groupe Jeune Afrique in the list of internationally- renowned rating agencies lends credence to its (The African Report) unpopularity, hence, any pronouncement from such a rookie publisher should be discountenanced!