By Sonny Iroche
Nigeria’s macroeconomic environment, characterized by its dependence on oil and gas revenues, evolving fiscal policies, and a dynamic financial sector, provides a complex backdrop for evaluating the Central Bank of Nigeria’s (CBN) recent mandate to raise minimum capital requirements for banks. The CBN’s March 2024 directive increased the minimum capital base for commercial banks with international authorization to N500 billion, national authorization to N200 billion, and regional authorization to N50 billion.
This analysis justifies a further increase to N1 trillion for Tier 1 banks, exploring the macroeconomic context, the implications for banking activities, and key financial metrics such as capital adequacy ratios (CAR), loan-to-capital ratios, and stress test outcomes.
It also evaluates the positive and negative impacts of this proposed increase, considering Nigeria’s economic size and its financial sector’s role in driving growth. This call aligns with my earlier advocacy in publications across Nigerian media, where I have consistently urged for a N1 trillion capital base to enhance resilience and support economic diversification.
1. Nigeria’s Macroeconomic Context: Going by the Federal Government of Nigeria’s desire to grow the economy to a $1 trillion size by 2030, the call for bigger size banks has become imperative to drive such an ambitious goal.
GDP and Economic Size:
Nigeria’s economy is the second largest in Africa in terms of purchasing power parity (PPP) and the 53rd largest globally in nominal GDP terms, with a nominal GDP estimated at $252.7 billion in 2023 (World Bank data). Despite its size, Nigeria’s economy faces structural challenges, including heavy reliance on oil and gas, which accounts for approximately 9% of GDP but two-thirds of government revenues. The services sector, including banking, telecommunications, and fintech, contributes 55% to GDP, while manufacturing and agriculture contribute 16% and 18%, respectively.
Real GDP growth has been sluggish, averaging 1.9% annually from 2015 to 2022, driven by policy distortions, external shocks (e.g., COVID-19, global commodity price fluctuations), and domestic challenges like insecurity and exchange rate volatility.
Major Sources of Revenue:
• Oil and Gas: Nigeria produces about 2.7% of the world’s oil supply, but low production levels and global price volatility have reduced its contribution to GDP (8% in 2015). Oil revenues remain critical, constituting two-thirds of state revenues, but fiscal deficits have grown due to lower output and costly subsidies.
• Taxes and Duties: Tax revenues are low relative to GDP (approximately 6-8%), constrained by a narrow tax base and inefficiencies in collection. The government has pursued reforms to increase domestic revenue mobilization, but non-oil revenues remain insufficient to close fiscal gaps.
• Other Sources: Non-oil sectors, particularly telecommunications (12.45% of GDP in 2022) and fintech, are growing, with Nigeria leading Africa’s artificial intelligence and fintech sector (28% of continental fintech companies).
Foreign direct investment (FDI) inflows reached $6.3 billion in Q1 2018, largely in energy and banking, but high lending rates limit credit access for non-oil sectors.
Banking and Financial Services:
The banking sector is a cornerstone of Nigeria’s economy, controlling 85% of industry profits among five Tier 1 banks. Despite strong profitability (23.5% CAGR in earnings over the past decade), real growth is lower (12%) due to reliance on non-core activities like derivatives and fixed-income trading. The sector faces challenges from macroeconomic volatility, high inflation (above 30% in 2024), and foreign exchange shortages, which elevate credit and currency risks. The CBN’s monetary policy rate hikes to 27.5% in November 2024) have boosted net interest margins but strained borrowers’ repayment capacity, particularly for small and medium enterprises (SMEs).
Basel Capital Adequacy and Financial Metrics:
Nigeria’s banking sector operates under a phased implementation of the Basel III , alongside Basel II framework, since November 2021. The average capital adequacy ratio (CAR) was 13.8% in December 2022, down from 15%, reflecting rising non-performing loans (NPLs) and currency depreciation. Stage 2 loans averaged 20.4% of gross loans in 2023, while stage 3 loans were below the CBN’s 5% threshold at 4.6%. The CBN’s stress tests indicate that large banks (assets > N1 trillion) are more resilient to credit shocks than smaller banks, which had an average CAR of just 3.14% in 2016.
The loan-to-deposit ratio and risk-weighted asset ratios are critical metrics, with a negative relationship observed between banking risks and CAR.
2. Justification for Increasing Tier 1 Bank Capitalization to N1 Trillion
The CBN’s N500 billion capital requirement for internationally authorized banks is a significant step toward strengthening the sector’s resilience, but a visionary increase to N1 trillion for Tier 1 banks is justified in light of the ambitious target by the Tinubu administration to grow Nigeria’s economy to $1 trillion by 2030, and some of these following reasons.
This proposal echoes my earlier calls in Nigerian media, such as my October 2023 article in ThisDay newspaper, where I advocated for raising the capital base to at least N1 trillion to buffer against economic shocks and support lending to SMEs and infrastructure. Similarly, in an October 2023 opinion piece on Arise News, I also emphasized the need for this level to absorb losses from credit shortages and defaults, while encouraging mergers. In a November 2023 report in Blueprint newspaper, I urged the CBN to reassess capital bases to align with N1 trillion to mitigate economic vulnerabilities and strengthen tiered banking structures.
a. Strengthening Resilience Against Macroeconomic Risks
Nigeria’s economy is prone to external and domestic shocks, including oil price volatility, currency depreciation (NGN1,600/$ in 2024), and high inflation. A N1 trillion capital base would provide a larger buffer to absorb losses from rising NPLs, which increased by 200% in 2020 due to COVID-19. S&P Global Ratings estimates that the N500 billion requirement will add 400 basis points to top-tier banks’ CAR, bringing most above Basel III minimums (8% total capital, 6% Tier 1, 4.5% CET1). Doubling this to N1 trillion would further enhance loss absorption capacity, potentially raising CAR to 20-25%, aligning with international benchmarks for resilient banking systems (e.g., Norway’s optimal CET1 range of 12-19%).
b. Enhancing Global Competitiveness
Nigerian banks compete with international and pan-African banking groups, particularly in trade finance. A N1 trillion capital base would enable Tier 1 banks to scale operations, expand cross-border activities, and compete with global players like Standard Bank or Ecobank. This is critical as Nigeria aims to attract more FDI and integrate into global financial markets.
c. Supporting Non-Oil Sector Growth
The non-oil sector (services, manufacturing, fintech) is pivotal for Nigeria’s economic diversification. However, high lending rates and limited credit access hinder SME growth. A higher capital base would allow banks to increase lending to the real economy, improving credit intermediation and supporting job creation. McKinsey’s analysis suggests that bold capital raises and consolidations benefit Tier 1 banks, enabling them to capture market share and drive economic growth.
d. Preparing for Basel III Compliance
While Nigeria reports under Basel II and III, full Basel III implementation requires higher capital buffers. A N1 trillion capital base would ensure compliance with Basel III’s stricter requirements (e.g., countercyclical buffers, liquidity coverage ratios), reducing future regulatory pressure and enhancing long-term stability.
e. Addressing Capital Shortfalls
S&P Global estimates a N2.5 trillion capital shortfall for rated banks (90% of system assets) under the N500 billion requirement. Doubling the requirement to N1 trillion would address this shortfall more comprehensively, reducing reliance on mergers or license downgrades and ensuring all Tier 1 banks meet regulatory thresholds by March 2026.
3. Positive Impacts of a N1 Trillion Capital Base
1. Enhanced Financial Stability: A higher capital base strengthens banks’ ability to absorb shocks, reducing the risk of systemic crises. This is critical given Nigeria’s $15 billion in bad loans held by AMCON from the 2008 crisis.
2. Increased Lending Capacity: With stronger balance sheets, banks can scale lending to SMEs and non-oil sectors, supporting Nigeria’s diversification goals.
3. Improved Investor Confidence: A N1 trillion capital base signals robustness to international investors, potentially attracting more FDI into banking and fintech.
4. Better Stress Test Outcomes: Stress tests show large banks withstand a 100% NPL increase, but smaller banks struggle. A higher capital base would ensure all Tier 1 banks pass stress tests under severe scenarios (e.g., oil and gas loan defaults).
5. Support for Economic Growth: Increased capital enables banks to finance infrastructure and trade, integrating domestic markets and boosting productivity.
4. Negative Impacts and Challenges
1. Higher Cost of Credit: Requiring banks to finance assets with more equity could increase lending rates, as banks pass on higher capital costs to borrowers. This may exacerbate credit access issues for SMEs.
2. Capital Raising Difficulties: Raising N1 trillion per bank by March 2026 is ambitious, given the N2.5 trillion shortfall for the N500 billion requirement. Banks may need to rely on fresh equity injections or consolidations, which could strain shareholders or lead to market concentration.
3. Short-Term Profitability Pressure: Higher capital requirements may dilute return on equity (ROE) in the short term, as banks retain earnings or issue new shares. This could impact stock valuations and investor sentiment.
4. Risk of Market Consolidation: Smaller banks may struggle to meet the N1 trillion threshold, leading to mergers or license downgrades. While this strengthens Tier 1 banks, it risks reducing competition.
5. Implementation Challenges: The CBN’s prohibition on using retained earnings for capital raises complicates compliance, requiring banks to seek external funding in a high-interest-rate environment.
5. Impact on Key Financial Metrics
A N1 trillion capital increase for Tier 1 banks would have broader implications across financial ratios, influencing lending, profitability, and risk management. These are drawn from Basel frameworks and Nigerian banking data (e.g., from CBN reports and S&P analyses).
• Capital Adequacy Ratio (CAR): A N1 trillion capital base could push CAR to 20-25%, well above Basel III’s 8% total capital requirement, enhancing resilience but potentially reducing ROE due to higher equity levels.
• Loan-to-Capital Ratio: Higher capital would lower loan-to-capital ratios, reducing leverage risk but potentially limiting lending growth unless offset by increased loan demand.
• Stress Test Performance: Large banks already withstand severe NPL shocks, but a N1 trillion base would ensure all Tier 1 banks maintain buffers above regulatory minimums under extreme scenarios (e.g., 100% NPL increase or oil sector defaults).
• Non-Performing Loans (NPLs): With stage 2 loans at 20.4% and stage 3 at 4.6% in 2023, a higher capital base would provide a stronger cushion against potential NPL spikes, especially in SMEs and oil-related portfolios.
• Leverage Ratio: This measures a bank’s core capital (Tier 1) as a percentage of its total exposure (on- and off-balance-sheet assets), typically required to be at least 3-5% under Basel III. In Nigeria, the average leverage ratio for major banks was around 4-6% in 2023, reflecting moderate leverage but vulnerability to asset devaluation. A higher capital base would boost the ratio to 8-10%, providing a stronger safeguard against over-leveraging and reducing systemic risk during shocks like currency depreciation (positive), but might constrain asset growth in the short term, potentially limiting banks’ ability to leverage deposits for lending (negative).
• Return on Equity (ROE): ROE calculates net income as a percentage of shareholders’ equity, indicating how effectively capital generates profits. Nigerian Tier 1 banks averaged 20-25% ROE in 2023, driven by high interest margins but offset by economic volatility. Over the medium term, a larger capital buffer could stabilize earnings by reducing loss provisions, potentially sustaining or improving ROE through scaled operations (positive), but in the immediate aftermath, diluting equity could lower ROE by 5-10 percentage points (negative).
• Return on Assets (ROA): ROA measures net income relative to total assets, typically 1-2% for Nigerian banks in 2023, highlighting efficiency in asset utilization amid high NPLs and operational costs. Enhanced capital would allow banks to optimize asset allocation, potentially raising ROA to 2-3% by funding productive loans (positive), but higher capital costs could initially compress margins, reducing ROA if lending volumes don’t immediately rise (negative).
• Liquidity Coverage Ratio (LCR): Under Basel III, LCR requires banks to hold high-quality liquid assets to cover 30 days of net cash outflows, with Nigerian banks averaging 120-150% in 2023, above the 100% minimum but tested by FX shortages. A stronger capital base would indirectly improve LCR by freeing up resources for liquid asset holdings, enhancing resilience to short-term liquidity shocks (positive), but capital-raising efforts might temporarily strain liquidity, potentially dropping LCR below optimal levels (negative).
• Net Stable Funding Ratio (NSFR): NSFR ensures stable funding matches long-term assets over a one-year horizon, required at 100% under Basel III. In Nigeria, it’s around 110-130% for top banks, but uneven due to reliance on short-term deposits. Increased equity provides a stable funding source, pushing NSFR higher (e.g., to 140-150%), reducing maturity mismatches and supporting sustained lending (positive), but if banks issue debt to meet capital goals, it could introduce funding instability, lowering NSFR (negative).
6. Recommendations and Mitigation Strategies
To balance the benefits and challenges of a N1 trillion capital base:
• Phased Implementation: Extend the compliance deadline beyond March 2026 to allow banks to raise capital gradually, reducing market pressure.
• Incentives for Capital Raising: Offer tax breaks or regulatory relief for banks issuing new equity, easing the burden on shareholders.
• Support for SMEs: Introduce subsidized lending programs to offset higher credit costs, ensuring SMEs benefit from increased bank lending capacity.
• Regulatory Clarity: Provide clear guidelines on Basel III adoption to align capital requirements with international standards, reducing uncertainty.
• Monitoring Concentration Risks: The CBN should monitor mergers to prevent excessive market concentration while encouraging competition.
7. Conclusion
Raising the capital requirement for Tier 1 banks to N1 trillion is a visionary step that aligns with Nigeria’s macroeconomic realities and long-term growth objectives, building on prior calls by Sonny Iroche in media like ThisDay, Arise News, and Blueprint. It strengthens financial stability, enhances global competitiveness, and supports non-oil sector growth, addressing Nigeria’s structural economic challenges. While challenges like higher credit costs and capital-raising difficulties exist, strategic implementation and supportive policies can mitigate these risks. By bolstering key financial metrics like CAR, leverage ratio, ROE, ROA, LCR, NSFR, and stress test resilience, a N1 trillion capital base positions Nigeria’s banking sector to drive inclusive growth and withstand future shocks, cementing its role as a pillar of Africa’s second-largest economy.
Sources:
• S&P Global Ratings, Credit FAQ: Will Nigerian Banks’ Recapitalization Materially Strengthen Their Resilience?
• McKinsey, Nigeria’s Banking Sector: Thriving in the Face of Crisis
• World Bank, Nigeria Overview
• Fitch Ratings, Nigeria Bank Stress Test Highlights Disparity in Capital
• Wikipedia, Economy of Nigeria
• Capital Adequacy Ratio and Banking Risks in Nigerian Money Deposit Banks
• Optimal Capital Adequacy Ratios for Banks
• Investopedia, What Is the Capital Adequacy Ratio (CAR)?
• ThisDay Newspaper, October 2023: Sonny Iroche’s Article on Bank Capitalization
• Arise News, October 2023: Sonny Iroche’s Opinion Piece
• Blueprint Newspaper, November 2023: Sonny Iroche’s Quoted Advocacy
