Focus of Supervisory Activities
The CBN/NDIC during bank supervision and examination focus on the main aspects of banking operations. These include capital requirement, loan concentration, liquidity ratio, provisioning, internal control and management among others.
Adequate capital is very important for any business, and banking is not an exception. The importance of adequate capital in banking stems from the following functions being performed by capital, viz: capital provides a cushion for absorbing operational losses; it provides a measure of shareholders’ confidence and stake in the bank; it reveals the bank’s ability to finance its capital expenditure and fixed assets; and it provides protection to depositors’ funds, among others. It is therefore necessary to have enough capital so that depositors’ risks could be minimized.
Government, on the advice of the monetary authorities, prescribes the minimum paid-up capital for banks. Recently the CBN consolidated the banks by raising the Shareholders fund to ₦25 billion.
A bank’s capital adequacy is based on the capital ratio which involves the weighting of a bank’s capital base against the portfolio of risk assets carried. A minimum of 10 percent of the total risk-weighted assets of a bank is required to be maintained as capital funds. Similarly, it is required that not less than 50 percent of a bank’s capital must be Tier 1 or primary capital (that is, paid-up capital plus reserves). In addition, the ratio of adjusted capital to loan assets of the bank should be a maximum of 1:10. In other words, a Naira capital should support not more than ₦10 of loans.
Using banks’ total risk-weighted assets ratio for example, the supervisory authorities classify banks as adequately capitalized, marginally under-capitalised, significantly under-capitalised, critically under-capitalised or technically insolvent, depending on the value of their risk-weighted asset ratios. While a bank with risk-weighted asset ratio of 10 percent and above is classified as adequately capitalized, a bank with a negative risk-weighted assets ratio is classified as technically insolvent. This classification is an attempt at establishing bench-marks for prompt supervisory intervention.
Considering the fact that it is risky for a bank to concentrate its lending operations in a single sector or borrower, the regulatory authorities usually direct banks to diversify their lending activities. Also, banks are required to report large borrowings to the CBN in the statutory returns.
Banks are required to maintain a minimum liquidity requirement by ensuring that the level of cash flows is matched by expected receipts so that they can meet their obligations as they fall due. Liquidity is achieved through effective fund management. Given the critical role of liquidity in banks’ operations, it is essential for banks to provide for both the expected as well as the unexpected fluctuations in their businesses as reflected in their balance sheets and to provide funds for growth.
A bank suffers from illiquidity when its obligations to others mature faster than the obligations from others. This leads to assets/liabilities mismatch as well as gaps between its receipts and payments. When illiquidity occurs, it portends that the bank can no longer accommodate decreases in deposits or meet its obligations to its depositors. In such situations, the affected bank would not be able to grow and would be forced to acquire additional liabilities under adverse market conditions at excessively high rates. This would worsen the already illiquid position of the affected banks and may result in insolvency.
There is the need for banks to make provisions for non-performing credit facilities. The provisioning should be adequate so as not to mislead the depositors and the general public on the true state of affairs of the bank. These provisions are made on the basis of perceived risk of default on specific credit facilities. The provisioning is also applicable to performing loans because these loans also carry some elements of risk loss, no matter how small.
Good internal control is very essential in order to minimize fraud and other malpractices which can lead to loss of assets. It also helps in ensuring compliance with laid down rules and regulations on banking business by the operators. These reasons explain why bank examiners focus on the internal control systems of banks.
The CBN is responsible for approving the board and changes on the boards of banks in the country. Parameters such as competence, experience and integrity of the person or group of persons involved are considered to ensure that only qualified and responsible people are put on the boards of banks in order to safeguard depositors’ fund and enhance public confidence in the banking system. Good management in banks is a must as the quality of management has been found to be the primary determinant of success or failure of a bank the world over.
Generally, a bank’s involvement with OBS banking is to boost fee income and at the same time avoid stringent capital requirements as compared to the traditional on-balance sheet engagements. However, just as they occur in on-balance sheet transactions, OBS operations involve some risks which are, in principle, not different from those associated with on-balance sheet business.
These risks include market/position risk, credit risk and operational/control risk. In Nigeria, the total value of OBS activities has been growing both in rates and in absolute Naira value over the years. Available statistics also indicate that most banks are involved in OBS activities.
Supervisory activities have currently been extended to off-balance sheet transactions. This is because a bank that engages in off-balance sheet transactions is increasing its risk exposure. In the event that a client fails to meet up his obligations, the bank will be liable to pay the third party.