Banks to Raise Tier-1 Capital Over New Divided Rule

  • Banks to Raise Tier-1 Capital Over New Divided Rule

Deposit Money Banks (DMBs) are expected to raise Tier-1 capital in compliance with the Central Bank of Nigeria’s (CBN’s) new dividend payout policy.

Tier-1 capital is the core measure of a bank’s financial strength from a regulator’s view. It is composed of core capital, which consists primarily of common stock and disclosed reserves (or retained earnings), but may also include non-redeemable non-cumulative preferred stock.

Raising Tier-1 capital becomes necessary, if the lenders intend to pay dividend or distribute capital as directed by the apex bank, the Financial Derivative Company (FDC) Economic Monthly Update released last week advised.

The report explained that since the issuance of the directive, the banking sub-sector index, on the Nigerian Stock Exchange (NSE) lost about 4.03 per cent.

“This is partly as a result of negative investor sentiment towards banking stocks, as investors’ expectations point towards reflecting the true value of these stocks. Hence, banks will have to boost their tier 1 capital, if they intend to embark on distribution of capital ( that is, issue dividend) as a way to signal financial strength, as well as comply with this new directive,” it said. This, it said, affirmed that the banking system remains fragile.

The report said the adoption of International Financial Reporting Standards (IFRS 9) from last month would further exacerbate the financial woes of most banks.

The implementation of IFRS 9 changes the measurement of financial assets as well as provisions for loan losses (impairments). This will have an immediate impact on profitability and ultimately worsen most banks’ CAR, it said.

It added that banks’asset quality might improve considerably, while the cost of regulatory capital to cover risk weighted assets will remain high.

“This will further erode banks’ economic profit, preventing banks from taking on more risk assets with-out raising additional capital. This becomes a vicious cycle – in a bid to protect depositors from growing NPLs, the CBN imposes strict regulations to serve as buffers, which reduces the risk appetite of banks. As a result, banks charge borrowers exorbitant rates to cover the cost of regulatory compliance. But sky high rates increase the risk of default, adversely affecting NPLs,” it said.

It said prior to this guideline, most banks adopted an aggressive dividend policy, partly to shore up their share price and to splash cash to shareholders.

Consequently, banks resorted to external funding sources to support their balance sheet, as against internal capital consolidation in the form of retained earnings.

According to the report, to further comply with the Basel accords, the CBN in October 2014 issued a directive aimed at preventing a systemic failure and effectively pushing banks to enhance their capital buffers.

This was in form of restricting deposit money banks (DMBs) and discount houses (DHs) with low capital base and high non-performing loans (NPLs) from paying out dividend.

This order ensured banks provided adequate capital buffers and prevented them from paying out cash dividend out of their reserves.

The CBN on January 31 directed banks, which maintained Capital Adequacy Ratio (CAR) of at least three per cent above minimum requirement, low composite risk rating (CRR) and Non-Performing Loans (NPLs) between five and 10 per cent, to retain a dividend pay-out ceiling of 75 per cent. Banks with worse indexes were banned from paying dividends.

Before this new guideline, the CBN did not make adequate provision for banks with low CRR, but NPLs between five per cent and 10 per cent.

About the Author

Samed Olukoya
CEO/Founder Investors King Ltd, a foreign exchange research analyst, contributing author on New York-based Talk Markets and, with over a decade long experience in the global financial market. Contact Samed on Twitter: @sameolukoya

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