NIGERIA: An Introduction to Banking & Finance
DETAIL Commercial Solicitors
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SECTOR OVERVIEW AND GENERAL ECONOMIC CONDITIONS
The Nigerian banking and finance sector is primarily regulated by the Central Bank of Nigeria (CBN), which is in charge of licensing and regulating banks and other financial institutions pursuant to the CBN Act 2007, and the Securities and Exchange Commission, which is responsible for regulating investments in the capital markets, including the conduct of participants therein, pursuant to the Investment and Securities Act 2007 and its subsidiary legislation.
In the past 18 months, the sector has witnessed various threats to its stability and road map for growth. Firstly, several proposed investments and contracts were stalled in the moments leading up to the general elections conducted in Q1 of 2019, due to uncertainty regarding the general economic climate following the elections in the event of a change in government. However, the re-election of the incumbent president ensured continuity of government policies and, consequently, a stability in financing activities which filtered through to Foreign Direct Investments (FDI), as the country’s reported FDI of USD247.37 million in Q1 of 2019 slightly increased to USD257.25 million in Q4 of 2019. In addition, there was a general increase in total lending to the private sector by banks, as credit facilities reported in Q4 2018 to be about NGN61 trillion grew to about NGN63 trillion in 2019.
The economic stability has, however, been disrupted, as there has been a recent 40% drop in the global crude oil price from a benchmark of USD57 per barrel to USD35 per barrel. Considering the dominant role of oil and gas operations in development of the Nigerian economy, the drop in prices will likely impact the economy severely. Accordingly, the repayment of loans will be negatively impacted, particularly in the case of obligors with an oil and gas-based revenue. In turn, access to loans by players in other sectors will be impeded.
Furthermore, the outbreak of the COVID-19 pandemic has negatively impacted business activities/operations due to measures imposed by governments across the world, including travel bans, isolation of citizens and quarantine of infected persons, in order to curb the spread of the pandemic. Organisations have reported substantial business disruptions, including closure of offices and factories, disruptions to supply and distribution channels, shortage of labour and decline in demand.
The economic downturn occasioned by the pandemic poses heightened risk in the following areas:
(a) Economic retraction.
(b) Reduction in fee and trading income, as well as pressure on net-interest income.
(c) Higher credit losses and its attendant impact on overall asset quality, capital and liquidity, among others.
KEY TRENDS AND DEVELOPMENTS
Despite the current threats to the development and sustainability of the sector highlighted above, it is noteworthy that the sector witnessed several milestone achievements in recent years, some of which are highlighted below:
CBN Loan-to-Debt Policy
In a circular issued by the CBN, all Deposit Money Banks (DMBs) were mandated to maintain a minimum loan-to-debt ratio of 60% by 30 September 2019. The requirement was subsequently revised to 65% in October 2019, with an attainment date of 31 December 2019. This policy is aimed at compelling banks to create new loans in order to increase financing activity. Based on the lending statistics above, the CBN policy is arguably fostering growth of the credit portfolio of DMBs, in addition to facilitating the receipt of deposits.
Recapitalisation of Financial Institutions (Microfinance Banks and Insurance Companies)
In order to strengthen the microfinance banking subsector, which consists largely of small, poorly capitalised institutions with low lending capacity, the CBN increased the minimum capital requirement for microfinance banks (MFBs) operating in Nigeria. They were were required to comply in two instalments: by April 2020 and April 2021, respectively. However, in a recent circular dated 29 April 2020, the CBN extended the deadlines for compliance by one year, such that:
(i) MFBs in the Tier 1 Unit are required to maintain a minimum capital of NGN100 million by April 2021 and NGN200 million by April 2022;
(ii) MFBs in the Tier 2 Unit are required to maintain a minimum capital of NGN35 million by April 2021 and NGN50 million by April 2022; and
(iii) State MFBs and National MFBs are required to maintain a minimum capital of NGN500 million and NGN3.5 billion, respectively, by April 2021, and NGN1 billion and NGN5 billion, respectively, by April 2022.
In the same vein, the National Insurance Commission has, by a circular issued in May 2019, required all insurance and reinsurance companies to increase their capital base. The deadline for compliance with the new minimum paid-up share capital requirement is 31 December 2020. This has led to a spike in financing activities in the insurance sector as insurance companies look to meet the regulatory requirements.
Issuance of Banking Licences by the CBN
In addition, banking licences were granted to three new finance institutions (two commercial banks and one non-interest finance institution), in order to further strengthen financing activities.
Development of the FinTech Industry
Nigeria has not been left out of the shift to technological solutions in the global financial services industry. Although the Nigerian economy is predominantly cash-based, the banking and finance sector has been receptive to this change and has deployed several technological solutions, including platforms such as Quickteller and Remita (a platform primarily used for payments to ministries, departments and agencies of the Nigerian government). The Nigerian FinTech landscape consists of about 250 companies, key stakeholders (banks, telecommunication companies and the government), and enablers and funding partners (such as research institutions, investors and technology incubators). Nigeria’s FinTech revenue is expected to reach USD543.3 million in 2022, from USD153.1 million in 2017. Currently, there is no general regulatory framework for this industry and no specific FinTech licensing regime. Thus, participants in this industry typically rely on and comply with various licensing and regulatory requirements in the current banking and finance legislation. For instance, most FinTech companies obtain MFB licences to carry out any lending operations. That said, due to the unique nature of FinTech operations, it is expected that an industry-specific regulatory framework will be established soon.
Bonds and Other Fixed Income Securities
Another notable trend is the increase in the issuance of fixed-income securities by large corporations in Nigeria as a source of financing. There has been an increase in capital market financing within the last year, in which the market witnessed an increase of 20.42% in fixed income raised in Q3 2019. We are of the view that the increase was caused by a combination of factors, such as the need for longer-term financing (which is not available from banks) and the activities of the Infrastructure Credit Guarantee Company, which supported the establishment of a NGN50 billion Debt Issuance Programme in 2019. Also, securitisation is now a recognised tool for raising finance. In 2019, the SEC approved a NGN16.5 billion Series 1 note issuance under the NGN100 billion Medium Term Bond Programme issued in May 2019.
In 2019, the SEC licensed and approved the establishment of the FMDQ as an additional securities exchange in the Nigerian capital market. The FMDQ is expected to expand the financial market and complement the services being provided by the Nigerian Stock Exchange. In addition, the SEC registered the FMDQ's wholly-owned central securities depository subsidiary, FMDQ Depository Limited. This is noteworthy for secured lending transactions involving securities lodged in the depository, as this may potentially impact the taking and perfection of security on such assets.
THE IMPACT OF NEW LEGISLATION AND POLICIES
African Continental Free Trade Area Agreement (“AfCFTA”)
In July 2019, Nigeria became a signatory to AfCFTA, which is expected to foster a more balanced and sustainable export base by reducing dependence on extractive commodities such as oil and minerals, which traditionally have accounted for most of Nigeria’s exports. AfCFTA is also generally aimed at improving cross-border trading activities and the establishment of business relations between African countries. Consequently, there is a projected growth in export commodities financing, issuance of letters of credit and other trade financing activities by banks.
Fiscal Policies Affecting Cross-Border Lending
In February 2020, Nigeria enacted the Finance Act, 2019, which is a compilation of fiscal-related laws for individuals and entities doing business in Nigeria. The Act introduces the thin capitalisation concept to Nigeria using the 'earnings-stripping' approach, thereby denying deductibility of interest expenses on foreign related party loans which are above 30% of a company’s EBITDA. This new law is aimed at discouraging structures that are typically adopted by multinational companies to fund local subsidiaries in Nigeria in a manner which allows these companies to repatriate maximum non-taxable profits through interest payments. In addition, the act also amends the law on withholding tax payments for interest on cross-border loans. Going forward, interest on foreign loans can no longer be structured to qualify for 100% tax exemption, as the maximum exemption under the law is now 70% of the applicable withholding tax.
The CAMA Bill and Financial Assistance in Acquisition Financing
The Nigerian Senate recently passed the Companies and Allied Matters Act (Repeal and Re-enactment) Bill, 2020. The Bill, which – subject to presidential assent – will become a law, includes provisions permitting a private company to provide financial assistance for acquisition of its own shares upon fulfilment of certain conditions. This provision will significantly impact the acquisition financing landscape in Nigeria, as the position for a long time has been that financial assistance is prohibited in raising finance for such acquisition transactions. For instance, in the case of the privatisation of the power sector, financiers were unable to take security on certain assets of the target entity being acquired due to this restriction.
CBN COVID-19 Policy Response
In response to the pandemic, the CBN maintained the current monetary policy rate, as of March 2020. However, it introduced additional measures, including:
(a) reducing interest rates on all applicable CBN interventions from 9% to 5% and introducing a one-year moratorium on CBN intervention facilities;
(b) creating a NGN50 billion targeted credit facility;
(c) liquidity injection via a NGN3.6 trillion stimulus package in the form of loans (which is 2.4% of GDP) into the banking system, pledging NGN100 billion to support the health sector, NGN2 trillion to support the manufacturing sector, and NGN1.5 trillion to impacted industries; and
(d) a NGN50 billion targeted credit facility through NIRSAL Microfinance Bank for households and MSMEs.
Regulatory forbearance was also introduced to restructure loans in impacted sectors.
In addition, the CBN has disclosed plans to establish an infrastructure development vehicle with a NGN15 trillion equity base (InfraCo Plc) for the purpose of stimulating infrastructure development, particularly in the transport sector. It is expected that over the next twelve months to three years the CBN will commence implementing these policies.
Emergency Economic Stimulus Bill 2020 (EESB)
The Nigerian House of Representatives introduced and passed for third reading a bill that seeks to provide a stimulus for the Nigerian economy. Some of the provisions in the EESB are aimed at fostering job security and alleviating the financial burden on citizens due to the economic downturn occasioned by the pandemic. Some key provisions in the EESB are as follows:
(1) All payment of mortgage obligations on residential properties acquired by individuals should be deferred for a period of 180 days from 1 March 2020.
(2) A waiver of import duty on medical equipment, personal protective equipment and other medical necessities will be implemented from 1 March 2020 to 31 December 2020.
In March 2020, the SEC published its exposure draft of rules for the regulation of the currently unregulated crowdfunding activities in Nigeria. The proposed rules detail the regulatory framework for companies to raise debt or equity capital from the public to finance a project or business via crowdfunding platforms. It is noteworthy that, in 2018, crowdfunding platforms in Africa saw an estimated growth of 101.5%. Therefore, it is expected that regulatory certainty would facilitate the sector's growth.
The CBN has taken a sector-wide approach in relation to debt recovery. Through a circular issued on 26 August 2019, banks are now required to include in financing documents a clause which stipulates that, where a loan is in default, the lender may, through the CBN, exercise a right of set-off from any monies of the obligor, which is in any account in any other bank or other financial institution under the CBN's regulatory purview. Consequently, such clauses are now negotiated as part of financing transactions. However, it is unclear how this will be implemented in practice and what the potential challenges for affected obligors and financial institutions will be.
There has been an increase in the rate of stamp duty payable on unsecured loan agreements from a nominal rate of NGN500 to 0.125% of the loan amount, by the Federal Inland Revenue Service. This has had a significant impact on the lending market due to the consequential significant increase in lending cost. This challenge is not entirely present in the case of security documents, for which company law permits upstamping, that is, stamping of such documents for a lower amount. It is noteworthy that, in relation to unsecured facility agreements, there is no similar provision in any legislation.
THE FUTURE OF BANKING AND FINANCE IN NIGERIA
With the unexpected fall in international oil prices, the impact of the pandemic on the world economy, and fluctuations of the foreign exchange rate of the naira against the US dollar, it is expected that lenders will be keen on ensuring that obligors adopt various hedging arrangements in order to cushion the effect of foreign currency volatility on credit exposures. Similarly, there is a propensity for discussions on mass restructuring of existing financings (particularly in the oil and gas sector due to the drop in oil prices).
While the efforts of the CBN to encourage discussions for restructuring of credit facilities by granting regulatory forbearance is laudable, it is beyond the CBN's regulatory power to mandate such restructurings. Therefore, banks will need to consider whether to utilise the regulatory forbearance permitted by the CBN or to review contractual obligations and undertakings as part of their financing arrangements. Some key discussions likely to arise include a determination of the implications of the pandemic and oil price, and whether this will result in a material adverse effect on the ability of obligors to service their debt obligations, as well as a review of existing security, level of stamp duties paid, and also any commercial and legal reasons for an upstamping on existing security documents.