In the wake of the ongoing reforms in the Nigerian banking industry, there have been several posts on how to get out of the myriad of challenges facing the industry. I vividly remember that in an article published sometime last year, I tried to draw attention to the likely financial and economic implications of the bailout funds injected by the Central Bank of Nigeria. My position was that it could lead to a situation of excess liquidity within the banking industry and the economy in general.
My argument was based on the fact that the injection of the bailout funds was not backed by any real economic activity, so in economic terms it has no real value. The net effect of intervention funds is basically an increase in the amount of money in circulation coupled with a significant increase in depositor confidence. Beyond that, much more effort is required for the reform to have a holistic effect. My opinion was that it was necessary to develop strategies and mechanisms to ensure that intervention funds had a positive impact on the industry and the economy.
With the recent information leaked about the banking system, it appears that we have a scenario where most banks are overly liquid, and yet the borrowing community continues to experience a severe credit crunch. The main objective of financial intermediation for which banks exist is almost defeated. It is argued that most bank managers have become risk averse and would prefer to invest in short-term secured financial instruments rather than lend money to borrowers.
The lending conditions for borrowers are so strict that it is almost impossible to obtain a loan from a bank. The net effect is that banks end up with too much liquidity at the close of daily, weekly and monthly operations.
But the downside of the above scenario is that since too much attention has been focused on the liquidity side of banking, there will be a negative effect on the profitability side. Over time, most Nigerian banks are likely to experience declining profitability. All of this will be evident at the branch, zonal and regional level of banking operations. General metrics used to measure performance can reveal poor results despite the hard work put in by staff members in a branch or unit.
The recent drop in interest rates also means that bank managers must look for more creative and innovative ways to break even. Banks will need to avoid funds that are considered expensive and therefore unattractive in the current dispensation. However, the Central Bank of Nigeria has a responsibility to promote bank lending to the real sectors of the economy. While the reforms initiated by the CBN succeeded in maintaining depositors’ confidence in the financial system, they also succeeded in eroding bankers’ confidence in granting loans. Most bank managers feel safer keeping the funds they have rather than lending them to businesses.
This is where the challenge for the regulator lies. Some type of loan guarantee scheme for priority sectors may be required, among other measures.
Bank managers must keep in mind that liquidity and profitability work at cross purposes. The more liquidity you maintain, the less profitability you will obtain. Hence, good financial management always seeks a balance between liquidity and profitability. The dilemma facing all business managers is that both high liquidity and high profitability are desirable. However, the more you seek from one, the less you will get from the other.
As for the managers of financial institutions in the Nigerian banking industry, it is time to pay close attention to profitability as the long-term survival of any business venture rests on this. Business models must be carefully evaluated in light of the prevailing circumstances and, when corrective action is necessary, decisions must be made accordingly.