Economic Confidential, November, 2009

FEATURES

The Other Side of Recapitalisation

By Abubakar Jimoh

The aim of any economic policy always geared towards the reformation of an existing state of economy sector or establishment and development of a new one, all towards the effective growth and development of the nation concerned. However, if tact is not exercised in policy formulation and implementation, an economy system tends to spell doom for the citizenry. This situation would define the economy system to be at regressive position instead of progressive.

Considering this in view of Nigeria recapitalization policy introduced in the year 2005, aimed at restructure the Nigeria banking sector. The performance of such a policy could be majorly perceived from negative side as many banks that were previously believed to be capitally sound and buoyant were found to be in bad condition due largely to mismanagement.

The ineffectiveness of these banks could be traced to non-performing loans being exercised by the top hierarchies of the troubled banks consequently of being overcapitalized.

While deliberating on the effect of overcapitalization, Igben(2007) has it that the excess capital  for the banks level of operation would induce the bank to be unable to put the whole of the long term fund into profitable use. This described the effect of the so-called N25billion capital base accelerated from N2billion could pose to our banking sector.

What level efficiency should be expected from a bank forced to upgrade its capital base from N2billion to N25billion within a short period? If not with a strong future projection, effectiveness in these banks would be hardly achieved. That is, the bank often looks forward at exhausting the capital in non-profitable investments such as giving out loans in absence of collaterals and grossly overtrading.

Overtrading in most cases is when a bank operates in excess of its mandated operational capacity. At this stage, a bank tends to operate outside its defined level of operation by the regulatory authority (Central Bank).

The general and often primary requirement in every banking sector is that, if a bank gave out loans and the borrowers are not viable, then efficient allocation of capital requires that the borrowers’ collateral be liquidated and redeployed to bridge the fund obtained from the bank.

Collaterals seem not to be the primary consideration in the ongoing Nigeria banking system anymore as now lend out billions of naira in absence of collaterals. This aggravated and increased the rates of non- performing loans.  With non-performing loan, a bank suffers from major losses that if immediate actions are not taken the financial institution may be in total distress.

Distress according to Ologun(1994) is the inability of a bank to meet its obligations to customers, owners and the economy, which render it either liquated or insolvent. The situation will eventually resulted to selling off the bank assets with a view to settle its creditors and owners as it occurred in the past in the case of Financial Merchant banks, United Merchant Bank, Society General Bank, Savannah Bank among others insolvent banks in Nigeria.

According to Diamond(2001) when a bank keep operating at losses, three major concerned parties—depositors, creditors and the regulator (Central Bank) tend to instantly take actions. The depositors rush to withdraw their fund from the bank as the level of confidence cannot longer be trusted. The market responds unfavourably by making it more difficult for such a bank to raise fund since the investors would not like to lend their funds to a dying bank. The regulator would respond and finally close-down or recapitalizing the troubled bank.   

Recapitalization often poses other problems to both depositor ( long term deposit especially) as the bank capital structure becomes the major determinant of its ability to raise fund for its relationship loans. Rajan(2000) opined that the higher capital structure implies high rent to the bankers, a higher level of required capital reduces the sum of the value of deposits alongside investors capital.

The recapitalized banks will tend to operate with the capital accelerated and often devalued the interest of depositors and investors as the new capital has overshadowed their funds. In this case, the interest-accrued-capitals would be borrowed from the owners at lower and non-profitable interest.  This will lead to deposit and investment discouragements and hence, worsen further, the economic situation of a nation.

Therefore, accelerating capital structure than its necessary poses strained circumstances not only to the bank’s operational capacity but also to fund raising for its relationship loans. To achieve effectiveness in reformation program, it would be logical and reasonable enough to look into other qualitative means such as incentive and efficiency of management.     

Abubakar Jimoh.

University of Abuja

abujimoh01@yahoo.com