Business it is said is full of risks, insurance is about risk bearing, risk transfer and risk management, you are insurance expert and have just completed your PhD programme in finance with special attention on risk management in banking sector. What are the inherent risks in the banking sector? How can the sector operators mitigate against these risks?
As you said I just concluded PhD programme in finance and my thesis was on Modeling Risk Management in banks, examining why banks fail, which was a topical thesis for the university. The thesis has been published as a book and is there in the Internet. You can reach out to it. Now, talking about inherent risks in the banking sector, we have what we call credit risk, marketing risk, liquidity risk, operational risks.
For the purpose of my study, I grouped them into five risks, credit risk, solvency risk, marketing risk, operational risk and liquidity risk. So every other risks whether reputational all those Interest rate risk could be factored into these five. When you are talking about interest rate, you are talking about market risks so these are the inherent risks in the banking sector and banks are advised to device ways of managing these risks in order to avoid failure and from the research I did, I found out that one of the major causes of bank failures in Nigeria and abroad is inability of banks to manage these inherent risks properly and when you don’t manage them well like credit risks, you have a lot of debts people not being able to pay money they borrowed and when you have a large volume of debt , it will lead to illiquidity and you talk of liquidity risk and when liquidity is blown out of proportion, you talk about systemic risk because if one bank fails in a country, if a major bank fails in any country, it will bring systemic risk and there will be problem.
So these are the inherent risks among banks.
But today, we are interested to know why these banks fail and the research I carried out has shown that they fail because they don’t manage their risks properly and risk has a lot of components and factors that banks must try to manage well.
The second major reason why they fail is because of poor handling of corporate governance. Corporate governance has over 15 components. One of them is capital issue when they have inadequate capitalisation, it falls under corporate governance, when there is problem in ownership, board issue they all come under corporate governance. You move ahead from there and look at another major factor, which is regulation or supervision.
If you have banks not adhering to regulations or you have weak supervision from CBN or NDC on the banking system, there will be possibility of leakage and banks will fail. But beyond these three major components, as I said, if you take each of them, you will have over 15 to 20 factors under them, if you talk about risks you have over 20 factors on risks management so banks should manage their risks properly, have good grip of corporate governance and adhere to regulations.
What other factors contribute to the risk of failures in the banking sector?
Apart from these three major components, there are other silent factors that make banks to fail. One of them is economic factor, the second is political. Political in the sense that let me give you an example of what is happening in Nigeria today. It happened ten years ago and caused banks to fail; it happened 20 years ago and caused banks to fail. One of them is the withdrawal of government funds from the banking sector to form the treasury single account (TCA). There are many ways to kill a rat.
There is no single way of killing a rat. The government should be wise enough and should have history at the back of its mind. Not to be pulling out funds in one form because you want to fight corruption in one front you leave other fronts dead. There are many things government can do to check the fraudulent issues that the multiple accounting systems will cause. But be that as it may, the CBN has said it has appreciated the problem that will come. There will be illiquidity. Now, this single account will cause banks to close a major department, the public sector department and there will be retrenchment. And there will be illiquidity; banks won’t be able to do what they do before.
But be that as it may, banks also should at this time like my research recommended, should learn how to generate their own funds and not relying on these government funds. Easy funds you know Nigerian banks, they believe in simple procedures they want this simple cash so that they can just sit in the office and be ruling on money, they should develop products, develop strategies that will be able to generate money constantly from the system. Those who did it in the past, I will give you an example of First Bank, it did a lot of savings pool, in the past that has given it solidarity in its liquidity fund. A lot of things don’t check bank like First Bank because it has capability.
Now in practice, there are basic issues like American government has said these are the ways to judge banking industry. Banking industry using the Camel criteria for instance camel, C stands for capital, A stands for Asset. A bank must have good capital at all times. It must have good assets at all times and it must have earning strength. Earning strength is what I have just talked about not just relying on cheap funds from government. They should generate their own funds so that when this kind of policy comes up, it will not affect them. So their earning strength must be strong and their liquidity sufficiency must be adequate.
Now, because Nigerian banks don’t keep to these rules, Camel rule, you look at prudential guidelines a lot of them run into problem once there is a little heat. But government itself should also understand history and let the financial system, leave them alone so that our payment system can be guaranteed.
In the government single account policy you have just talked about, what specific risk do you see there for the banks?
The definite one is that there will be illiquidity, pulling out the funds means banks will not have much money again. The money they used to have, using it to do whatever they do in business will no longer be there. As I said earlier, this might close a whole department of a bank; the public sector department. The essence of banks employing people to face the public sector is because of public account. Now if the thing is getting back to CBN, they will only be agents.
To a large extent agents that will pull funds for CBN, but they can’t keep the funds any more so there will be illiquidity and if it grows too hard, one or two banks will fail and when they fail, the interbank system will be affected and they will be prone to what you call systemic risk. And when there is systemic risk, banks won’t be able to make inter bank payment and there will be problem in the system.
Once banks don’t have liquidity, they can’t lend funds to the public and if they are lending, it will be at a very high rate of interest. Their conditions will be tighter, everything will be tightened, for the private sector, if they don’t have funds to operate, activities will reduce there will be unemployment. Inflation will go up. So, all these are the vicious cycle that government would have envisaged before taking the decision.
How can it affect insurance industry?
For insurance, the activities that the insurance industry used to have will reduce because buildings will stop, importation will reduce, marine will fall, those who were living on government funds before, taking life policy will reduce, so insurance is affected because there will be reduced activities, people who intend to buy cars because of flows from funds from banks will no longer do that so insurance will definitely be affected once there is liquidity issue in the banking industry. Insurance will be affected all those who are building the contract will reduce ,because they will no longer be able to pay their workers. So it is a cycle that no one will want to go in and we thought the government would have waited until they appoint ministers who possibly have superior knowledge on issues like this before dabbling into it.
Insurance is in the business to bear risks, is there any way the industry will help banks in bearing this risk?
There is no way insurance can help bank in this type of risk because this is government policy and the policy is beyond insurance. There is nothing insurance can do at this time. All they can do is to flow from what the government has done to see what they can do to see whether they can guarantee the banks but the issue of guarantee should not come in because the government has come up with a policy and it must be obeyed.
As insurer and an expert in risk management in banks what do you think should be the way forward in this kind of situation?
The banking industry operators should sit down now and think. Because I thought by now, the banking industry operators, as proactive as they are, should go on and create products and go on marketing to generate savings from the public through retail banking to be able to have sufficient funds not to rely on government money so that when this situation comes up in the future, they will not be so affected. The banks should be proactive enough to generate their own funds, they should create products, they should go all out on retail banking, not the big funds now, the big funds will come but let them generate small investments funds that will give them cushion to stand this kind of situation.
As we are talking about this kind of risk from government policy against banks, let us also talk about insurance. Your colleagues in insurance are also penchant about government business to the extent that many of them rely so much on it for their survival. Assuming that government wakes up tomorrow and do exactly what it did in the banking sector on insurance by withdrawing all its businesses from insurance operators, what do you think will be the fate of insurers who rely on government business?
The government cannot do that to insurance because government cannot insure the lives of people. The mobility aspect of our lives cannot be guaranteed by government.
For instance, in aviation, they were recently talking about setting up special funds for victims of air accident and that means withdrawing this kind of policy from insurance what will be the fate of insurers in this line of business?
There is no funds they can set up that will be able to augment the risk on aviation end because the level of risk and insurance required is so high that no government can do that. They might try to say let us do that on motor aspect, say let us put up a large funds to take care of our motor vehicles but they will still fail because the statistics and level of risk they will not be able to bear it. So it is not possible for government to say we will not insure our building assets.
Because one fire incident in any of the government owned high-rising buildings will cause trouble. Because the insurance companies that insure these assets do not keep it to themselves, they reinsure it insurance companies now pay claims to the tone of N2 billion, N3billion, in this market so where will they get such money if they don’t reinsure so they are doing that so insurance companies are there to stabilise the economy they don’t keep money, they keep risks.
Can you comment on NAICOM’s latest policy of September 30th deadline for clearing of all outstanding claims by insurance firms and facing of sanctions by those who fail to meet the deadline, is it a step in the right direction?
Well, claims are continuous issue except they are talking about very old claims; claims that have been outstanding on their books. Those that are long outstanding should be paid but some of those claims that insurance companies have not adjusted, they should not be forced to pay them but where they have been adjusted and signed and sealed, insurance companies should pay. But from the reports I am getting as a consultant and broker, insurance companies are paying claims, huge claims.