In this article Freelanews Business Intelligence/Research Unit, FBI&R, points its light on the financial sector, majorly Nigerian banks, and how they are empowered and indulged by the law and government to put the entire economy and our collective future at risk.
This is an unusually lengthy piece that splits into several parts, each subsequent part focusing on case studies of one Nigerian bank after the other. It seeks to explain the motivation behind the sharp practices in banking; globally and specifically in Nigeria, and the damages it portends.
You are encouraged to invest your time in reading this unique, research-based article to gain an understanding of:
- What ‘real money’ is
- What happens to your deposit in bank and what rights do you have over them?
- Why banks do what they do
- How banks surreptitiously hold most of the assets in any economy
- How banks can just create digital money from thin air
- How 10 times the size of the global economy are being gambled with by banks and are at the risk of disappearing
- How your children will pay for the debts from the failures of banks’ gambling
- How you can help yourself
A lot to learn, a lot to marvel at and a lot to be mad at. Join us on this journey to unravel the financial industry and its Pandora box.
Nigerian banks, mostly new generation banks, have been on an expansionary train in portfolio offerings, customer acquisition/customer deposit build-up, asset building, etc. This trend has birthed mega billionaire founders, who had entered the game as youths, during the liberalization of the financial sector which was part of the Structural Adjustment Programme (SAP) introduced in 1986. Same set have continued to explore all the tricks and tweaks in marketing and branding to grow, consolidate and scale in the midst of intense competition. The competition and innovation in the industry have resulted in the emergence of financial powerhouses taking over the African financial services landscape, but not without the challenges that comes with exponential growth.
With such magnitude of scaling comes some attendant issues, which poses tremendous challenges for sustainability. The bigger problem is that the issues can lead to an implosion with the potential to totally kill the banks and even lead to economic catastrophic for the nation.
In a July, 2020 article entitled ‘We’re Dumb About Exponential Growth. That’s Proving Lethal’, author Andrew Nikiforuk notes: “Gradually, and then suddenly. That’s how exponential growth can ruin your day, undo your family, evaporate your economy, destroy your climate, crush an empire and destabilize a planet.”
Taking a look at the sporadic growth of the industry and issues arising, as echoed by customer complaints and some scandalous revelations on sharp practices, compromises and organization-wide corruption that sometimes get to the press, one can understand the call for caution and growing apprehension on the future of Nigeria’s economy as anchored on banking.
To get a fix on this, let us sketch an understanding of how money, banking, government and economy really interplay with an analysis of the current state of health of the industry.
Background: Money, banking, government and political economy
Banks are licensed to create money from ‘thin air’
There are majorly two kinds of money – physical or digital. The physical money is such that the government prints through its central or reserve bank. It forms 3-8% of the total money in circulation in any economy. It may cost about N1.20k to print one unit of N10. Therefore, the government makes a profit of N8.80k to provide printed money to banks for them to meet their cash obligations to the public. This profit is used by government to reduce its debt and lessen the tax burden on the people. But money cannot be printed arbitrarily because the more money in circulation, the lesser its value.
Money is nothing more than a measuring stick of value, just like you have ‘one lap’ of a marathon race. In terms of value, the real money are physical assets.
The other type of money is digital money, typically called debt/credit (guess you now understand why you get credit alert when money drops in your account). This is the money banks create. Printing it is as simple as just entering a figure into a computer and the sum hits the individual’s account.
The truth is that banks create the vast majority of money (97%) by just minting credit electronically. This system evolved from the British Promissory Notes Act of 1704, where buyers pay for goods and services by giving the seller a legal document that indicates ‘a promise to pay’ at a later date. This note is collateralised by the buyers’ assets, such that when they fail to pay the seller has the legal right to take over the asset. Promissory Note later got standardised and gold (the most precious material at the time) became the unit of measuring the ability to pay, hence, it became the standard material for collateralising promissory notes. Therefore, the more gold you have, the more capacity you have to buy other things without actually selling your gold!
Organisations and governments began stockpiling gold bars as a show of their ability to pay later and started extending that purchasing power, to other people with some charges, called, interests, hence, giving them the ‘ability to promise to pay later’ or credit. Here comes banking!
Modern day banks are licensed by the government to create credit that is collateralised against their reserve with the central bank, and some other measures like assets and the percentage of customer deposits into their banks. So, the cycle of money is thus that a borrower gets a loan approved by the bank, the bank input the amount into their system and the borrower’s account is credited in the bank. The borrower, say a builder, then goes on to spend the money in the economy, majorly by crediting suppliers, artisans, etc, so the money stays within the banking system and moves around. When the borrower then repays their loan to the bank, the debt and the money disappears, but the bank’s profit (from interest) remains. And the cycle begins again.
Here’s a picture – Ade owes Wale N1,000, borrows N1,000 from Banco Bank and pays Wale by crediting his account. Wale owes Femi, Tade and Nonso Stores a total of N1,000, Wale goes on to pay all three by crediting their accounts, and the N1,000 keeps circulating. Later down the line, Ade, the original borrower then gets credited some money and the bank deducts N1,000 as the principal he borrowed and N200 as interest. You can see the N1,000 that was credited just nets out within the system and only N200 remains.
Then what is the need for your cash deposit if banks can generate money from ‘thin air’?
When you deposit cash into the bank, it is no longer yours, but legally now the bank’s. What they do is keep a percentage as reserve, often determined by the central and or reserve bank and are at liberty to do whatever form of investment with the rest. In Nigeria, the deposit-reserve ratio is 27%, one of the highest in the world, which some argue inhibits max lending and reduces banks profitability. The deposit is only a record of what the bank owes you the public, which they can use as leverage to offer even more credit. For instance, when you deposit N1, 000, that can translate into N10,000 or more debt money in circulation (credit capacity for the bank). Liquid deposit are one of the bank’s outputs of production, they are called inside money and are basically the bank’s show of having earned the public’s trust.
Interests and investment profits motivate banks
That power to create money and profit from it has become the motivation for bankers to pursue profit by minting more credit money and thus earning ‘real money’ which is profits that accrues as asset. Bottom-line, the real purchasing power, or money, is asset – physical materials or a trust in a buyer’s ability to pay.
Let’s say you sell roasted corn on your street, and the richest man, who owns four houses on the street comes to you to buy 10 roasted corn worth N2,000, but promises to pay you later. You would literally accept, based on the proof of worth, which are his physical assets.
When banks lend, they face two risks; default risk and run (liquidity) risk. Default risk is the uncertainty that the borrower will repay. Run risk is the risk that the total money – physical and allowable credit, available to it may not be able to fulfil their obligations to the public. The bank cushion this risk with their own equity, which is simply the money they have in reserve with the central bank. Also, default risk is cushioned by spreading the credit to several numbers of suitable borrowers (often taken through their credit worthiness checks), smoothing out with fact that not all will fail at the same time and as such probability is netted out by the spread.
Is lower risk the reason behind bank’s preference for mortgages and long term loans?
Yes. Traditional banks found mortgage as the best places to put in their credit, because it is long-term and there is a physical asset that measures up to the value of the credit. Invariably implying that per time, the banks often hold most of the assets available to an economy. Hence, there was a massive funding of the mortgage market over the decades. The government also supported this with low interest rates and other incentives, because study have shown that it is the build-up of short-term debts that makes the economy vulnerable to a financial crisis.
But banks, in a bid to turn over their digital money, started venturing away from long-term borrowing and throwing all at derivative investments of all kinds. This is why you will notice that bank sell mortgages within themselves and to other financial houses, hedge funds, etc. Their appetite for profit has seen them take riskier turns and it is now estimated that over 10 times the global economy is placed in derivative investments, majorly banks betting on if the price of an asset will rise or fall.
The government’s indulgence and the effect on the economy
In boom, people take on debts and spend it on things they wouldn’t have been able to afford like cars, houses, tuition, etc. This catalyses economic growth and the government encourages it with monetary policies. Eventually, people cannot take on more debts because money loses value from having too much money in circulation. Hence, there is more and more defaults, banks cannot lend more, because they have to avoid, remember? Default and Run Risks! This, therefore, leads to a bust, which is when all the chain of credits collapse. A cannot pay B, B cannot pay C, C cannot pay D and everyone cannot pay everyone, sort of.
This was the case with the 2008 global financial crisis (the Great Recession) when most US banks had invested too much in Mortgage-Backed-Securities (MBS).
Let’s look at a brief summary of what happened:
- The Global Financial Crisis of 2008-2009 is widely referred to as “The Great Recession.”
- It began with the housing market bubble, created by an overwhelming load of mortgage-backed securities that bundled high-risk loans. The US mortgage market was lucrative, investors all over the world wanted a piece, banks had to meet overwhelming demands, so some relaxed the loan requirements and just everyone could access mortgages
- Default cases started piling and some companies started bundling them up as ‘subprime mortgages (mortgages that are troubled, maybe in default eventually defaulted. When they could not pay, financial institutions took major hits).
- They started selling these bundled subprime mortgages as securities that are traded, such that when they fail, the investors can just take over the mortgages and sell the houses in a worst case situation. This is called Mortgage-Backed Securities
- Reckless lending led to unprecedented numbers of loans in default; bundled together and sold as MBS, banks invested and when the bubble busted, losses led many financial institutions to fail and require a governmental bailout.
- Efforts to revive the economy were made through the American Recovering and Reinvestment Act of 2009. With the US government, in the rarest occasion in known history, creating money worth $800billion.
The Aftermath of the Global Financial Crisis of 2008-2009
Many who took out subprime mortgages and bundled as MBS were stranded, because of the supplies of houses (a lot of foreclosures from failed mortgages) was more than demand (prices were too high and people just stopped buying). The government, however, stepped in by injecting $250billion worth of credit into banks that were termed “Too Big To Fail” in form of government bonds.
The housing market was deeply impacted by the crisis. Evictions and foreclosures began within months. The stock market, in response, began to plummet and major businesses worldwide began to fail, losing millions. This, of course, resulted in widespread layoffs and extended periods of unemployment worldwide. Declining credit availability and failing confidence in financial stability led to fewer and more cautious investments, and international trade slowed to a crawl.
Government bailout (Quantitative Easing)
Central banks have no savings but cannot go bankrupt because they can create an infinite amount of money by simply buying government bonds. A bond is an exchange of money for a promise that government will pay it back with interests. Government issues bonds to influence the economy (suck up money or create it). Most often the issuance of bond is a way the government reduces the total money in circulation, often to curb inflation. To keep an economy stable and in integrity, this money eventually must be paid back by future citizens either through taxation or inflation.
Quantity Easing becoming the seemly lone option, spread across governments
This act of government intervening by creating money is called Quantitative Easing. Quantitative easing—QE for short—is a monetary policy strategy used by central banks like the Federal Reserve. With QE, a central bank increases money supply by digitally creating money to use to purchase bonds and then lower interest rates on bonds. This was first implemented by the Japanese, and then by the US in 2008/2009. Other governments of the world including Nigeria soon adopted QE, with various acts passed into law to provide legal backing. This is QE, and it is expansionary monetary policy on steroids. It has been proven to have diminishing returns.
In Nigeria, part of the implementation of the QE was the CBN’s intervention in the liquidity affairs of Nigerian banks they perceive has one of the most risk-averse. The five systemic important banks are First Bank, Zenith, UBA, GTB, Access Bank and they are covered in that in the event of a major financial crisis, the CBN is at liberty to use taxpayers’ money, according to the provision of the Bank and Other Financial Institution Act (BOFIA), to rescue the institution considered as Too Big To Fail (TBTF).
Too Big To Fail or Too Big to Fit? The Issues of Pervasive Incentive and Moral Hazard
QE has been proven to have allowed temporary reliefs and often get unintended outcomes like perverse incentive and moral hazard.
Perverse incentive is when a policy ends up having a negative effect, opposite of what is was intended. Moral hazard is at play when one person takes on more risks because another person bears the burden of it.
Let’s see how it plays out with the CBN’s bailout for Nigerian banks
Between 2008 – 2010, the Central Bank of Nigeria (CBN) committed over N3 trillion to bail out distressed banks in the country just as the sinking fund established to absorb cost of banking crises in the country has welled up to N931 billion from inception.
The bailout scheme included the N1.725 trillion spent by the Asset Management Corporation of Nigeria (AMCON) to acquire the non-performing loans of banks in the wake of the global financial crises of 2008–2010.
If you cannot picture the size of that intervention, relate it with this:
- 1 million seconds = 12 days
- 1 billion seconds = 32days
- 1 trillion seconds – 32,000 years
- 3 trillion seconds = 96,000 years
Replace the seconds with naira, and imagine that the Nigerian economy want to recoup N1million of this bailout every 12days, it will take a staggering 96,000years to achieve.
In August 2021, it was yet reported that the CBN increased its Special Intervention Reserves (SIR), its Quantitative Easing purse, to N365billion (data from its money and credit stats shows), suggesting that a commercial bank may have recently received a cash injection from the CBN.
This was later confirmed to be true, but the identity of the bank remained undisclosed (Source: Nairametrics).
No bank has been reported to have failed under Godwin Emefiele as CBN governor. This is supposed to be a good thing, right?
The CBN has adopted a more direct approach of injecting capital into distressed banks and appointing a new board and management, who are tasked to turn them around. And then they are eventually placed on sale.
The unintended consequence of this is that CBN has continued to bankroll banks’ unscrupulous pursuit of profits in riskier and riskier ventures, with the comfort that there is a fallback on the CBN bailout.
If that was the only issue, it would have been fine. But it also opens up the industry to rent-seeking and deep-seated corruption, where CBN top shots can secretly plan with industry game players to scheme a bank into the need for bailout and move to acquire such banks at far lesser market value. There are many allegations of such in the recent mergers and acquisitions.
The sum result of all these is that it sets off the dreaded diabolic loop: starting with liquidity spiral (a situation in which falling asset prices can prompt banks to reduce the supply of credit, causing further falls in asset prices), which is a systemic risk. And CBN, trying to manage it by bailout, can lead to price instability which can set off a deflationary spiral (a downward price reaction to an economic crisis leading to lower production, lower wages, decreased demand, and still lower prices). This worsens financial stability and precipitates government reaction to limit systemic risk, where monetary policy takes on a redistributive role.
In Nigeria’s case, the CBN has been trying both the money view (allegedly printing naira to fund government expenditure) and credit view (bailing out banks, other sectors).
This leads to fiscal debt sustainability issues (a fear that the government cannot honour its debt obligations), which is where the Nigeria stands today! Major, major concern.
Let’s note without any doubts that an increase in banks’ risk increases the risk of government debts. Under this circumstance, the CBN is finding it difficult to manage the inflationary and deflationary forces.
Also now rampant in the industry these days are an unchecked breach of corporate governance, fraud, abetting of money laundering, etc.
And since these information have been removed from public scrutiny about the real malpractices going on in the banks, all the banks are gunning for now is to look big and fit well into the CBN “Too Big To Fail” system as egress from the burden of their self-generated problems.
This comes in various forms like manipulation of the real size of depositor’s fund, “cross-selling”, stock manipulation (pump and dumb, Spoofing, Wash Trading, Bear Raiding, etc), money laundering, abetting mass fraud, indiscriminate charges, loan interest/charge manipulation and hijacking, etc.