How banks outsmart the market, making profits despite bad loans

CBN-Governor-Godwin-Emefiele.jpg                                                                           Emefiele, CBN governor

BUSINESS environment in Nigeria worsened in 2016 when the economy plunged into recession. So, for most of 2017, Nigeria struggled to exit the bad economic condition. “If the economy is doing very well, some of those businesses that are defaulting on their loan obligations will also be doing well. If the economy is not doing well, then those underlying businesses would also not be doing well, thereby finding it difficult to pay back their loans,” Managing Director of the Asset Management Corporation of Nigeria (AMCON), Mr. Ahmed Kuru said while giving a clear picture of the situation.

Incidentally, lenders needs to extend new loans for greater development and provision of faster stimulants for economic recovery, but most of them  got their fingers burnt as those who borrowed money from them could not pay back.

When a borrower stops paying back money borrowed, it is regarded by the lender as a Non-performing Loan (NPL). An NPL by definition is the sum of borrowed money of which a debtor has not been able to meet up in scheduled payments for at least 90 days, and is either in default or close to being in default. Once a loan is non-performing, the odds that it will be repaid in full are considered to be substantially lower, while the NPL ratio is the amount of NPLs over total loans, usually expressed as a percentage. Such loan in effect reduces current profits because the banks will account for expected losses known as impairment charges. These are basically money that is put aside by a bank in case its customers cannot make the required loan repayments, but which will leave a huge dent in a company’s profits.

Historically, bad loan kills banking business across the world, yet banks exist to give loans. For decades, the Nigerian banking industry has suffered so much under the yoke of NPLs.

Incidentally, they cannot stop lending because the business of banking is the business of taking money from those who have, and making it available at a cost, to those who don’t have, but need it for investment and other purposes.

However, when banks go out of this intermediation role to make money from other sources, it becomes a subject of argument whether the banks are being innovative or compromising professional ethics and standards.

The central bank is aware of this when it set a rule that says lenders with “NPL ratios above 10per cent shall not be allowed to pay dividend.”

Apparently, the apex banking regulator is aware that it is a misnomer to have huge hole dug by NPLs in the books of a bank while the same lender claims to be recording jumbo profits and giving out dividends to shareholders.  This reality was captured by the Acting Chairman of the Economic and Financial Crimes Commission ( EFCC) Ibrahim Magu during a session with the Association of Chief Compliance Officers of Banks in Nigeria, May 2018.

His words:“We must work together to save this country. Most of the banks are sitting on the water. In fact, some of these banks are almost collapsing.”

So, it is interesting to have a good number of banks with huge NPLs declaring impressive profits in 2017 and first quarter of 2018.

Some stakeholders see this as innovative, arguing that thinking outside the box in this case is when a lender discovers other possible ways of delivering value to shareholders in periods when traditional methods fail. Others argue that these banks are cutting corners, and violating credit management and professional banking rules. This view is supported by Kuru when he explained that at the point when some transactions that resulted in bad loans were entered into, some of the banks did financial engineering. “They raised the interest payable and instead of the obligor paying N4billion, it becomes N7billion.  So there are some loans that are unrecoverable.”

To this end, “There must be due diligence, even in this practice of private banking. There must be accountability; there must be transparency in our transactions. You don’t have to wait until anything goes awry before you begin to find a solution to it,” Magu on his part warns.