Banking Regulation and Supervision Module 1

Introduction to Banking Regulation

• Banking regulation refers to laws made by Nigeria's federal legislature, subsidiary legislations made by regulatory authorities, and guidelines issued by the Central Bank of Nigeria (CBN) and Nigeria Deposit Insurance Corporation (NDIC)

History of Banking Regulation in Nigeria

• Era of Free Banking (1894-1952): No regulation, free entry and exit, many banks failed, and depositors lost money
• Era of Regulation (1952-present): Started with the Banking Ordinance of 1952, introduced licensing and minimum paid-up capital requirements for banks
• 1958: Central Bank of Nigeria Act was enacted, vesting considerable institutional powers on the CBN
• 1968: Banking Act codified rules and regulations guiding the business of banking in Nigeria
• Era of Indigenisation and Nationalisation (1972-1976): Compelled participation of Nigerians and the Federal Government in the acquisition of controlling equities of foreign banks
• Era of Liberalisation (1984-1992): Removed stringent rules, led to the establishment of the deposit protection scheme in 1988
• Era of Bank Consolidation (2004-2009): Increased minimum capitalization requirements for banks, reduced number of banks from 89 to 25

Why Banks are Heavily Regulated

• Prevent systemic financial crises and ensure stability of the banking system
• Safeguard deposits of individual customers and sustain public trust and confidence in banks
• Prevent money laundering and other financial crimes
• Ensure banks maintain sufficient liquidity and capital to meet their obligations
• Protect consumers from fraudulent activities, unfair practices, and mismanagement of funds

Regulators of the Nigerian Banking Industry

• Direct Regulators:
  • Central Bank of Nigeria (CBN): supervises banks and manages the financial system
  • Nigeria Deposit Insurance Corporation (NDIC): insures deposit liabilities of banks and other financial institutions
• Indirect Regulators:
  • Federal Ministry of Finance (FMF): handles fiscal policy and supervises the NDIC
  • Securities and Exchange Commission (SEC): regulates the capital market and registers eligible securities
  • Economic and Financial Crimes Commission (EFCC): investigates and prosecutes economic and financial crimes
  • National Drug Law Enforcement Agency (NDLEA): identifies and prosecutes money laundering arising from illicit drug dealings

International Regulators

• Basel Committee on Banking Supervision: established in 1974 to improve the quality of banking supervision worldwide
• Basel Accords: sets minimum capital requirements for banks
  • Basel I (1988): focused on credit risk
  • Basel II (2004): expanded to include market risk, operational risk, and liquidity risk
  • Basel III (2010): emphasizes liquidity standards and macroprudential regulation
• International Monetary Fund (IMF) and the World Bank: promote public interest in the financial services sector

Core Principles for Effective Banking Supervision

• 29 core principles for effective banking supervision, including legal and institutional structure, regulatory structure, supervisory structure, and safety net arrangements### International Monetary Fund (IMF) and World Bank
• Created at Bretton Woods conference in New Hampshire, USA in 1944
• Goal: establish a framework for economic cooperation and development to lead to a more stable and prosperous global economy
• IMF focuses on macroeconomic issues
• World Bank focuses on long-term economic development and poverty reduction

Regulation and Supervision

• Regulation: setting standards, rules, or laws that govern the banking industry
• Supervision: ensuring that banks comply with regulations and operate safely and soundly
• Importance of regulation: protects consumers, promotes financial stability, and prevents financial crime
• Reasons for adapting to regulatory change:
  • Comply with the law
  • Reduce risk
  • Improve efficiency
  • Remain competitive

General Principles of Regulation

• Licensing and supervision: banks require a license to operate and are supervised to ensure compliance
• Market discipline: banks must publicly disclose financial information to inform depositors and creditors
• Prudential requirements: regulations imposed on banks to promote safe and sound operations
• Failure resolution processes: arrangements for handling distressed banks and minimizing impact on depositors and the economy

Banks and Other Financial Institutions Act (BOFIA)

• Primary legislation for regulating banks in Nigeria
• Gives Central Bank of Nigeria (CBN) powers to supervise and regulate banks
• Covers licensing, capital requirements, liquidity, risk management, corporate governance, consumer protection, and anti-money laundering

BOFIA 2020 Highlights

• Functions, powers, and duties of the CBN
• Banking business: only licensed companies can engage in banking activities
• Opening and closing of branches: requires CBN approval
• Restructuring, mergers, and disposal of banks: requires CBN approval
• Minimum paid-up share capital: CBN determines capital requirements
• Revocation of license: CBN can revoke license for non-compliance with regulations
• Minimum capital adequacy ratio (CAR): banks must maintain a minimum CAR
• Minimum holding of cash reserves: banks must maintain cash reserves with the CBN
• Disclosure of interest: directors, managers, and officers must disclose interests in credit facilities
• Prohibition of interlocking directorship: restrictions on holding directorships in multiple banks
• Restriction on certain banking activities: limits on lending and credit facilities
• Special examination: CBN can investigate banks and specialized banks
• Intervention powers in failing banks: CBN can take control of failing banks
• Resolving systemic banking crisis: CBN can provide assistance to resolve crises

Other Provisions of BOFIA

• Asset separation tool: CBN can transfer assets of a failing bank to a private asset management vehicle
• General restriction on advertisement: unauthorized persons cannot advertise to take deposits
• Prohibition of receipt of commissions: bank staff and directors cannot receive commissions for banking services
• Disqualification and exclusion of certain individuals: restrictions on employment of certain individuals in banks
• Offences by directors and managers: penalties for non-compliance with regulations
• Penalties for offences not otherwise provided for: fine and imprisonment for non-compliance
• Protection against adverse claims: Federal Government, CBN, and officers cannot be liable for actions taken in good faith
• Jurisdiction of the Federal High Court: exclusive jurisdiction to try offences under BOFIA
• Supremacy of BOFIA: prevails over other applicable laws
• Priority of deposit liabilities: deposit liabilities have priority over other liabilities in liquidation
• Power to make regulations: CBN can make rules and regulations for banks
• Consolidated supervision: CBN can examine books and records of banks and affiliated entities
• Corporate governance and ethics: CBN can make regulations and guidelines
• Designation of systemically important banks: CBN can designate banks as systemically important
• Restrictions on operations of agents of banks: CBN can regulate agents
• Unclaimed funds or abandoned property: regulations for dormant accounts
• Establishment of Banking Sector Resolution Fund: fund to resolve banking crises### Resolution Fund
• The Resolution Fund is utilized exclusively for:
  • Paying operating costs of a bridge bank
  • Paying costs of transferring whole or part of a bank's business
  • Providing loans or credit facilities to banks or financial institutions
  • Supporting resolution measures as prescribed by the Governor

CBN Powers

• The CBN has the power to:
  • Manage and regulate the Resolution Fund
  • Freeze a customer's account if suspected of criminal activity
  • Impose and review penalties for contravention of provisions
  • Grant exemptions to financial institutions from certain provisions
  • Charge fees for its services

Special Tribunal

• A Special Tribunal for the Enforcement and Recovery of Eligible Loans is established
• The Tribunal exercises jurisdiction, powers, and authority as conferred by the Act

Other Relevant Legislation

• Companies and Allied Matters Act 2020
• Nigerian Deposit Insurance Corporation Act 2006
• Securities and Exchange Commission Act 2007
• Economic and Financial Crimes Commission (Establishment, Etc.) Act 2004
• Money Laundering (Prohibition) Act 2011 (as amended)

CBN Initiatives

• Introduced a new regulation in April 2023 requiring banks to have a minimum capital adequacy ratio of 12.8%
• Introduced several regulations for various purposes, including financial stability and consumer protection

Prudential Guidelines

• Introduced in 1990 to guide asset classification and loan loss provisioning
• Revised in 2010 to address various aspects of banks' operations, including risk management, corporate governance, and loan loss provisioning

Highlights of Prudential Guidelines

• Risk Management:
  • Credit policy to be approved by the Board of Directors
  • Limit on exposure to a single obligor or connected lending
  • Credit concentration policies to identify, measure, and monitor credit risk concentrations
• Exposures to Directors and Related Interests:
  • Definition of significant shareholding and insiders
  • Disclosure requirements for director and related interests credit exposure
• Loan Loss Provisioning:
  • Classification of credit facilities as performing or non-performing
  • Criteria for sub-standard, doubtful, and lost credit facilities
  • Provisioning rates for each category

Capital Adequacy Ratio

• The minimum ratio of capital to total risk-weighted assets is 10%
• Banks are encouraged to maintain a higher level of capital commensurate with their risk profile
• Classification of banks based on capital adequacy ratio, with corresponding supervisory actions

Other Select CBN Initiatives

• Rendition of False Returns to Regulatory Authorities
• Foreign Exchange Management
• Prohibition of borrowing from within the banking system to re-capitalize banks
• Currency Substitution and Dollarization of the Nigerian Economy
• Reporting Unethical Conduct/Whistle-blowing
• Prudential Regulation for the Management of Foreign Exchange Risks of Banks
• Measures to Dissuade Issuance of Dud Cheques in Nigeria
• Know Your Customer (KYC) and Bank Verification Number (BVN) regulations
• Consumer Protection and Financial Inclusion initiatives
• Adoption of Basel Accords for banking regulation

Banking Regulation and Supervision

• Supervision is either on-site or off-site
• On-site examination is carried out on the premises of the bank
• Off-site supervision is done on the premises of the Regulator
• Reasons for supervision include:
  • Banks' role as financial intermediaries is risky
  • To ensure solvency and prevent collapse
  • To ensure compliance with laws and regulations