After successfully implementing Basel II, the Nigerian banking sector is expected to commence the adoption of Basel III from November 2021 after a year-long delay due to the COVID-19 pandemic. CHIMA NWOKOJI in this report examines inherent benefits and the preparedness of Nigerian lenders for the adoption of Basel III.
THE Basel Accords (“Basel I, II, III”) are sets of regulations for the Banking sector established by the Basel Committee on Banking Supervision (BCBS) which is a committee of banking supervisory authorities established by the central bank governors of various jurisdictions.
The Bank for International Settlement has identified the overall aim of Basel III, which is to strengthen the regulation, supervision, and risk management measures of banks.
Basel III is already operational in some countries, although the transition window is open till 2028.
In Nigeria, implementation (initially planned for 2020), was delayed due to the outbreak of COVID-19. According to Nigeria’s central bank however, the adoption of Basel III commences in November 2021 and will run concurrently with the preexisting (Basel II) regulatory framework for a period of six months, extendable by three months if banks perform satisfactorily.
The implementation of Basel III started globally in January 2013 and places importance on strong liquidity and capital for financial stability.
In its latest banking sector report, an investment banking group, Afrinvest (West) Africa Limited observed that this adoption would strengthen banks’ stressed capital level, improve capital quality (as risk levels are reduced with the exposure restriction) and maintain a strong liquidity position.
However, this is no good news for banks below par as capital is rising to meet up could cause a weakening and affect dividend payout.
Also, maintaining the revised liquidity position could hurt Net Interest Margin (NIM) as banks have to pay down long-term assets with higher yield, Afrinvest said.
On the current strength of Nigerian banks, the Monetary Policy Committee (MPC) noted that the Capital Adequacy Ratio (CAR) and Liquidity Ratio (LR) of banks remained above their prudential limits at 15.2 and 41.2 per cent, respectively.
It also revealed that the Non-Performing Loan ratio (NPL) at 5.3 per cent in October
2021, reflected progressive improvement, compared with 5.7 per cent in October 2020. The Committee, however, urged the CBN to sustain its tight prudential regime to bring the NPL ratio below the 5.0 per cent prudential benchmark.
Even at that, the Basel III requirement will make this even tighter for the lenders.
Core requirements of basel I, II and III
As highlighted by the CBN, banks are required to hold a capital conservation buffer of 1.0 per cent in addition to the minimum Capital Adequacy Ratio (CAR) of 15.0 per cent (international) and 10.0 per cent (national) with an additional one per cent of common equity capital for higher loss absorbency for Domestic Systemically Important Banks (DSIBs), in the form of common equity capital.
Notably, additional tier 1 capital which is typically a hybrid instrument was introduced in the computation of total Tier 1 capital. Also, ceiling for banks’ dividend payment would be based on Common Equity Tier 1 (CET1) capital adequacy, NPL ratio, leverage ratio and composite risk rating (determined by the CBN) as against previously using NPL and CAR ratios.
On September 2, 2021, the Central Bank of Nigeria (CBN) issued a Circular to all banks in Nigeria titled Basel III Implementation by all Deposit Money Banks.
The Circular aims to inform all banks of the issuance of Guidelines for the implementation of the Basel III standard which is a voluntary global regulatory framework that addresses bank capital adequacy, stress testing, and market liquidity risk.
The purpose of these ‘accords’ is to improve the regulatory framework for the banking industry worldwide.
Basel I was designed to enhance understanding of key supervisory issues and improve the quality of banking supervision across countries.
Basel II accord is primarily focused on financial soundness. It was designed to enhance capital regulation by introducing risk weights, aligning bank regulation with best practices in risk management, and providing banks with incentives to enhance risk measurement and management capabilities.
The Basel III accord was developed by the BCBS due to the impact of the global financial crisis of 2008 – 2009 on banks. Given that the global financial crisis resulted in unprecedented losses and almost total collapse of the world financial system, there was a need for a critical rethink of risk management practices which were hitherto based on the Basel II Accord. Thus, Basel III is the response to the deficiencies of Basel II and introduced major changes to the Basel II framework. Some of these changes are highlighted below:
Introduction of a non-risk based leverage ratio which requires banks to hold at least a three per cent leverage ratio; increased minimum capital requirements for banks from two per cent in Basel II to 4.5 per cent of common equity, as a percentage of the bank’s risk weighted assets. There is also an additional 2.5 per cent buffer capital requirement that will bring the common equity to 7per cent in Basel III.
Introduction of the Liquidity Coverage Ratio and the Net Stable Funding Ratio (NSFR);
The liquidity coverage ratio requires banks to hold sufficient high-liquid assets that can withstand a 30-day stressed funding scenario as specified by the bank supervisor.
On the other hand, the ‘net stable funding ratio’ requires banks to maintain stable funding above the required amount of stable funding for a period of one year of extended stress.
According to research analysts at Meristem Research under the preexisting (Basel II) regulatory framework, Nigerian banks were required to maintain minimum total capital equal to 10per cent (15 per cent for banks with international licence) of total risk-weighted assets.
This has been retained under the new (Basel III) framework; however, the definition of total capital has changed. While total capital was defined as the sum of Tier 1 and Tier 2 capital, the new definition splits Tier 1 capital into Common Equity Tier 1 (CET1) and Additional Tier 1 (AT1) capital with required minimum ratios for each class of Tier 1 capital. Generally, the capital requirements under Basel III are more stringent.
In addition to raising the minimum CET1 capital ratio from 2.50 per cent (under Basel II) to 4.50 per cent, Basel III requires banks to maintain AT1 capital of 2.50 per cent. This brings the minimum required total Tier 1 capital ratio to 7.00 per cent. AT1 capital however, need not exist. In which case, Tier 1 capital must be at least 7.50 per cent of total risk-weighted assets for banks with nation al license, and 11.25 per cent for banks with international authorization.
Although the CBN had completed the development of the Guidelines for Basel III implementation in 2020, the implementation was suspended due to the COVID-19 pandemic outbreak to minimise the regulatory compliance burden on the banks.
The CBN has now issued the updated Basel III Guideline/Reporting Templates for implementation.
“Finally, all banks are to note that capital add-on will be introduced in a phased manner as part of the overall supervisory process of Pillar II assessment to enhance better risk management practices and better align their capital with their risk profiles,” the CBN emphasised.
Some Analysts believe that there are trade-offs in the guidelines. For instance, when banks strive for higher liquidity it impacts on higher margins, and raising solid capital has a way of affecting dividend payout and risk asset growth.
Meanwhile, ahead of time, Access Bank has raised additional tier 1 capital. Given its success, it is hoped that other banks could follow suit.
Furthermore, the CBN also instructed all banks to submit their monthly returns no later than five working days after the end of the preceding months, with effect from November 2021.
Banks are to note that capital add-on will be introduced in a phased manner as part of the overall supervisory process of Pillar II assessment, which is a principles-based standard premised on sound supervisory judgment. This is to enhance better risk management practices and better align the capital of banks with their risk profiles.
Non-interest banks
Non-interest banks in Nigeria need more instruments to improve liquidity under the Basel III requirements of the global banking system. Mr Abdulwaheed Shitta, a banking and finance expert said while speaking on “Opportunities and Challenges of Islamic Banking and Treasury Management in Nigeria.”
He said the Basel III Accord was initiated by the Basel Committee on banking supervision to address the global financial crisis of 2007-2008 to strengthen the banking sector across the globe and emphasized capital, liquidity management of banks, and other segments in the financial market.
Describing Liquidity as the ability of financial inflation to balance inflows and outflows for the institution to be liquid, Shitta said liquidity risk can occur when there is a mismatch between liabilities and assets.
The Basel committee therefore developed two minimum standards to ensure the liquidity of banks within the short-term and NSFR (Net stable funding ratio) to ensure liquidity at the medium to long-term.
Global financial analysts have concluded that the impact of Basel III on Islamic banks is relatively smaller compared to the conventional financial institutions, considering the model of non-interest banking that does not support non-Shariah-compliant securities or derivative products.
Shitta said in Nigeria, one common short-term money market instrument is the treasury bills which are not shariah-compliant. This is a reason for limited liquidity for non-interest banks under Basel III.
Benefits of basel III
Stakeholders believe that the implementation of the new CBN guideline is sure to make Nigerian commercial banks pay greater attention to risk management, internal controls and underwriting standards, as the limit of the banks’ balance sheet exposures will now determine their capital adequacy requirements.
Explaining the implications, the Research arm of Afrinvest Investment advisory firm noted that since these Guidelines address issues such as specifying the minimum Liquidity Coverage Ratio (LCR) standards for reporting entities in the Nigerian banking system, the Guidelines are capable of helping controlling liquidity, and making banks stronger and more resilient to unfavorable conditions because it will strengthen regulation, supervision, and risk management within the banking industry.
“It is also expected that the Basel III standard will prevent banks from taking excessive risks that can negatively impact the economy,” it stated.
Thus, greater financial industry stability should be achieved under Basel III Standard which should allow investors to focus more on financial institution risk and worry less about the economic backdrop or the possibility of broad-based financial collapse.
According to analysts at Afrinvest, it is however important to note that for banks to satisfy LCR liquid-asset criteria introduced by the Basel III Guidelines, they will need to hold more liquid assets and increase their proportion of long-term debts.
In addition, business operations that are more liable to liquidity risks will be minimised and banks will need to exercise caution with respect to high run-off assets such as Special Purpose Vehicles (SPVs) and Structured Investment Vehicles (SIVs).
Forward-Looking FSB
Information obtained from the FSB website indicates that due to a one-year deferral to increase the operational capacity of banks and supervisors to respond to COVID-19, these reforms will take effect from 1 January 2023 and will be phased in over five years.
The FSB promotes global financial stability by coordinating the development of regulatory, supervisory and other financial sector policies and conducts outreach to non-member countries.
It achieves cooperation and consistency through a three-stage process.
According to the board, full, timely and consistent implementation of Basel III is fundamental to a sound and properly functioning banking system that is able to support economic recovery and growth on a sustainable basis.
It adds that consistent implementation of Basel standards will also foster a level playing field for internationally-active banks. In December 2017, the Group of Central Bank Governors and Heads of Supervision, which is the Basel Committee’s oversight body, endorsed the finalisation of Basel III reforms.
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