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THE GLOBAL FINANCIAL CRISIS: IMPACT AND IMPLICATIONS FOR NIGERIA
Distinguished Lecture delivered by Dr. Ngozi Okonjo-Iweala
African University of Science & Technology, Abuja
March 16, 2009
I. What led to the Global Financial Crisis?
Nigeria has been hit by the global financial crisis together with developed and developing countries all over the world. We are used to crises
erupting in the developing world, with their local contagion effects, as in East Asia in 1997-98. We also have a good idea of how to manage such
crises. But this crisis originated with the subprime mortgage meltdown in the richest country in the world, the United States, and has spread like
wildfire via complex and poorly understood financial linkages. The effects of the inevitable output decline in the rich countries as credit markets
froze are now being transmitted all over the globe via trade linkages. This has led to rising inventories of unsold goods and massive job losses all
over the world. The US itself lost 2.6 million jobs last year, the worst job loss record since 1945. Commodity prices, including oil, have fallen
precipitously—although domestic food prices remain high in many poor countries, adding to their woes; and for the first time since 1982, world
trade is expected to shrink this year.
For Nigeria, the crisis is a huge challenge; but embedded in that challenge is an opportunity to reposition the economy in a way which would
reduce its overwhelming dependence on oil and create a diversified springboard for steadier long-run growth and job creation once the crisis
abates. This is the central message I want to leave with you.
I’m going to divide my speech into three parts: a quick overview of the origins of the global crisis; the channels through which the crisis is affecting
Nigeria; and a discussion of the Nigerian response to the crisis.
What led to the global crises we are now living through, which for developing countries has been manifested in the four f’s: food, fertilizer, fuel and
now financial challenges? Doubtless, hundreds of PhD dissertations will be devoted to this question in the coming years. And if we know
economists well, multiple answers will abound! Let me give you a quick tour.
The first is the idea that an insufficiency of aggregate demand has enveloped the world. Proponents of this view have pointed to the massive shift
of income and wealth towards the top quintile in the rich countries—especially in the US but also in Western Europe and Japan since 1980.#
Rich people tend to save more than the less rich, leading to a secular decline in aggregate demand. This was compounded by the fall in house
prices in the US, which began in the summer of 2006 leading eventually to the subprime crisis. The negative wealth impact led to a fall in
consumption and aggregate demand as the US ‘consumer of last resort’ was able to borrow less. For the first time since 1970, the earliest year
for which global numbers are available, real global GDP is expected to decline this year. It has become fashionable to say, “We are all
Keynesians now,” a quote attributed to President Nixon in 1971, as large fiscal stimulus packages are hastily being assembled in the US and
other rich countries. But we know that the current recession was preceded by years of large current account deficits in the US, with private
savings dropping to low levels and public savings being eroded by the Iraq war, among other factors.
This brings me to the second explanation: that of global imbalances. The idea here is that no country, not even the US, can pile on current
account deficits year-after-year financed by the rest of the world without a blow up at some point. What is the solution? One controversial
proposal is that if China allowed its currency to sharply revalue, this would solve the problem; but there is not a consensus on this. The retort is
that if the Chinese revalued the renminbi, then the US would have run current account deficits in relation to other countries because the
fundamental problem was that US households were simply spending too much! Whatever the solution, the question we have to ask is whether we
can go back to a regime of large US current account deficits once the crisis subsides. My guess is that the answer is probably no, although there
may be a strong proclivity towards this in view of the third explanation, put forward by Ricardo Caballero, an MIT economics professor: that there is
an insufficient supply of safe assets in the world.# Global savings have risen as populations age or countries like China and India ramp up savings
in pursuit of higher investment and growth. Some of this spills over into current account surpluses. Similarly, oil and other commodity exporters
need a place to park their savings. The US pretty much has a monopoly on safe, long term assets – US treasuries – and so the savings tend to
flow to the US lowering interest rates and fueling US aggregate demand. Hence, addressing global imbalances in the shape of persistent current
account deficits in the US may call for new forms of global insurance.
A fourth explanation, which I believe most would favor, combines elements of the above but centers around the financial system. This would say
that low global interest rates after 9/11 catalyzed a search for high returns. In the US, this led to a situation where risk was priced too low, leading
to a lowering of lending standards and sowing the seeds of the subprime mortgage crisis. This crisis is frightening in that it is a perfect storm
caused by everything that could possibly go wrong with the modern-day financial system: credit rating agencies which did not do their job;
executive compensation structures, including in the giant mortgage Government Sponsored Entities, Fannie Mae and Freddie Mac, which
shortened horizons and encouraged excessive risk-taking; financial innovation and globalization, which enabled originators to lay off the risk by
securitizing the subprime loans they made and selling them, leading to a proliferation of toxic assets in the shape of asset-backed securities;
outright fraud in the shape of teaser interest rates, complex loan products and imprudently high loan-to-value ratios; and a relaxation of regulatory
stringency in the mistaken belief that it was in the interest of the large financial institutions to self-regulate even as special investment vehicles
contributed to opacity in financial dealings by taking risky transactions off-balance sheet. And now, as fiscal stimulus and bailout packages are
put together in the US and rich countries, the problem of moral hazard and rising public indebtedness must also be dealt with.#
This is an opportune moment to draw three parallels for Nigeria:
First, even though we don’t know exactly when the crisis will end, we can be reasonably sure that exiting it will require a one-two punch: shoring
up the financial system to ensure credit flows even as fiscal policy is geared towards raising aggregate demand. The Chairman of the Board of
Governors of the Federal Reserve System of the US, Ben Bernanke, noted in a recent speech at the London School of Economics that he did not
believe that fiscal actions would lead to a lasting recovery without getting the financial system in order.# For Nigeria, this means ensuring that
banks and the financial system stay robust even as drawdowns are made from the ‘excess crude account’ to enable an affordable fiscal stimulus.
Second, the global question of whether we can simply return to the status quo ante after this crisis with its implications not just for global
imbalances but also soaring food and fuel prices and concerns about the impact of rapid global growth on climate change, has its echo in Nigeria:
Can we place all our trust in oil or should we take steps to diversify our economy? Fortunately, this question is easier to answer for Nigeria than
for the world! The answer is that Nigeria must take steps to diversify its economy as part of its response to the current crisis. And the good news
is that it has several important strengths which should facilitate this process, including low external and public debt, high reserves and above all, a
measure of policy credibility which must be preserved and nurtured.
Third, it means drawing lessons from the global financial crisis for better regulation and supervision of banks and the broader financial system as
we look to the future.
II. Impact of Global Crisis on Nigeria
Nigeria is being affected by the global financial crisis through the familiar channels of the labor market and remittances; FDI; and commodity
markets, the oil price in particular. Direct financial links with the rest of the world are limited and therefore likely to exact a smaller toll. Let me
take each channel in turn.
Labor market and remittances: Employment consequences of the crisis are hard to predict: formal wage employment in the private sector is only
about 2 percent of the labor force with another 8 percent in public service. Most Nigerian workers are employed as casual laborers in agriculture
or the informal urban sector. The Information and Communications Technology (ICT) and financial services sectors have continued to post strong
profits and there is no indication yet what might happen to jobs in these sectors. Remittances rose from $1.3 billion to $3.5 billion in 2005, and
have subsequently remained stable at this level, although they are expected to fall over the next two years. This will have an adverse impact on
consumption, especially in rural areas, as well as investment in SMEs. Many households in Nigeria have family members abroad and their
remittances pay for everything from school fees and health expenditure to house construction and investments in small businesses.
FDI and capital flows: Net FDI more than doubled from an annual average of around $3 billion over 2001-2004 to $7.25 billion over 2005-2007; it
dropped to $4.7 billion in 2008 and is projected to decline in 2009 and 2010. The bulk of FDI goes into oil and gas, banking and telecoms, so a
sharp slowdown should not be surprising.
Commodity markets: With negligible non-oil exports, the main external effects of the global crisis are not surprisingly going to be transmitted to
Nigeria through the oil price. Oil and gas have a stranglehold on both merchandise exports and fiscal revenues, which has remained steady over
time, as shown in the table below.
Table 1: Predominance of Oil in Nigeria’s Economy
1990 2000 2008 2009
Oil as % of total GDP 37.5 47.7 36.3 26.4
Oil/gas as % of total exports 95.5 97.2 98.8 98.2
Oil/gas as % of total revenues 82.8 82.8 82.4 72.7
Source: World Bank staff estimates; projections for 2009.
Assuming a production rate of 2.1 million barrels of oil per day, a $10 per barrel fall in the oil price would lower exports by about $7.7 billion and
fiscal revenues by approximately $6.2 billion. In contrast, the sum of FDI and remittances is expected to fall to around $6 billion in 2009 from $8.2
billion in 2008, a drop of some $2 billion.
Thus, from a balance-of-payments perspective, a $10 per barrel drop in the oil price has thrice the impact of the drop in FDI and remittances
combined! Now consider that oil prices averaged $97 per barrel in 2008 and are forecast to average $50 per barrel in 2009—a stunning drop of $47
per barrel, and it is easy to see that the oil price decline will completely dwarf all other sources of impact on Nigeria as a result of the global
crisis. This $47 drop in the oil price is the equivalent of approximately 22 percent of 2009 GDP in terms of exports and approximately 18 percent
of 2009 GDP in revenues!# If in addition oil production falls below the level of 2.2 million barrels per day assumed for the 2009 budget, the effect
will be proportionately higher. And very recently, the IMF World Economic Outlook oil price forecast itself has been lowered from $50 to $44 per
barrel.
Managing the fiscal and balance-of-payments consequences of the oil price collapse is therefore going to be an immense challenge for Nigeria.
However, it is not the sole challenge. The banking sector is also facing difficulties. And as a result of slowing credit growth and the large oil price
decline, which will place limits on public spending, non-oil GDP growth is projected to slow to 4 percent over 2009 and 2010 compared to 9.5
percent in 2007 and 7.7 percent in 2008.
Against this background, I shall start with the macroeconomic policy response to the crisis and then go on to the financial system.
III. Responding to the Oil Price Collapse
The oil price collapse is by far the biggest component of the external shock that has hit Nigeria. Policymakers face two challenges: (i) how
to respond to the down-cycle of oil prices; and (ii) how to ensure that the economy emerges stronger and more diversified after the crisis ends. In
particular, what should be done in continued pursuit of a foundation for sustained long-run growth and economic diversification? The two main
vehicles for responding are fiscal and exchange rate/monetary policy. But first let me emphasize that priority numero uno at this point is to
engender confidence, in the public as well as investors in the real and financial sectors. The message must be strongly conveyed that there is
coherence across fiscal, monetary, exchange rate and financial sector policies and that the government is wedded to transparency and good
governance. I would stress the following general principles:
Emphasize Nigeria’s macroeconomic strengths, both on fiscal fundamentals and low indebtedness as well as its high reserves cushion and ‘rainy
day’ funds in the form of the ‘excess crude account’.
Acknowledge and learn from past mistakes and avoid repeating them.
Deflect attention from the near-obsession with the spot naira/dollar rate. A healthy dose of realism would indicate that, like for other commodity
exporters, a depreciation of the currency is not so unusual given the size of the external shock; a depreciation may be desirable to avoid running
down reserves or developing an unsustainable current account position. The key issue is how the CBN gives direction on exchange rate policy
and manages the situation.
III.1 Fiscal Policy Response
A good starting point for crafting a fiscal policy response is Nigeria’s own past experience. As a result of tying government spending to current oil
revenues and running large fiscal deficits during the oil boom years of the 1970s, Nigeria became one of the most volatile countries in the world
over 1960-2000 in terms of output, real exchange rates and the terms-of-trade. To make matters worse, Nigeria had developed an external debt
overhang by the mid-1980s, which would have deterred even profitable private investment because of the resulting macroeconomic uncertainty and
the fear that the profits would be taxed away to service the debt.
It is not hard to imagine that the combination of high volatility and a debt overhang would have seriously hurt the investment climate, intensifying oil
dependence. Looked at from this lens, the adoption of the oil price-based fiscal rule (which delinks government spending from current oil prices)
and Nigeria’s 2005-06 debt agreement with the Paris Club (which resulted in an $18 billion write-off on Nigeria’s Paris Club debt of $30 billion) must
both be seen as historic accomplishments. The oil price rule helped dampen the transmission of oil price volatility to the rest of the economy
while also permitting reserves and ‘excess crude’ to be built up. The Paris Club debt agreement (facilitated by the savings related to the oil price-
based fiscal rule, as oil prices were consistently above reference prices for 2004-2008) eliminated the debt overhang. The improvement in
creditworthiness showed up in the sovereign credit ratings Nigeria subsequently received and provided a sound basis for attracting both domestic
and foreign investment into the country prior to this crisis.
Fiscal policy reform and relative stability improved the investment climate, with the reduction in volatility helping the non-oil sector. Non-oil GDP,
agriculture in particular, has been growing impressively since 2004 in sharp contrast to its dismal performance over the 1980s and 1990s and was
an important driver of growth over 2004-2007, as shown in Table 2.
Table 2: Contribution to Non-Oil Growth
(in percent)
2004 2005 2006 2007
Agriculture 46.7 45.3 42.8 40.6
Solid Mineral 0.5 0.4 0.4 0.4
Manufacturing 6.3 5.5 5.0 4.5
Telecommunication & Post 5.0 5.5 6.9 8.9
Finance & Insurance 2.0 1.8 2.8 3.1
Wholesale and Retail Trade 21.3 27.3 29.4 29.4
Building and Construction 2.5 2.7 2.8 3.0
Others 15.7 11.3 10.0 10.1
Memo: Non-oil GDP growth (%) 13.2 8.6 9.4 9.5
Source: Employment and Growth in Nigeria, World Bank Staff draft note, 2009.
Wholesale and retail trade, telecom and manufacturing have been next in line. Analysis by World Bank staff indicates that the key features of
Nigeria’s growth performance since 2001 are the following:
70 percent of growth can be explained by agriculture and wholesale and retail trade.
Relatively new sectors, such as construction, the financial sector, telecommunications and ICT have initiated a structural shift towards the
services sector.
Macroeconomic and structural reforms have spurred confidence, boosting FDI and remittances, raising aggregate demand and private investment.
Growth has largely resulted from factor accumulation. In particular, agricultural productivity has stagnated, with growth coming largely from
increased land use.
The last point is worrisome: in spite of being the ‘engine’ of non-oil growth, productivity in agriculture has stagnated; and lack of economic
diversification, including the concentrated export and tax bases, remains a serious source of macroeconomic vulnerability. Can fiscal policy
help? It has already helped during the oil boom period. But now for the first time since the adoption of the oil-price based fiscal rule in 2004,
actual oil prices could fall below the $45 per barrel budget reference price for 2009. Even at the IMF’s World Economic Outlook forecast of $50 per
barrel for 2009, the government is going to have to draw upon the ‘excess crude’ account, ECA, this year and very likely next year as well.
Three principles should guide the use of funds from the ECA:
First, this is the right time to use ECA money. The reason for setting up the ECA was precisely for a rainy day like this, when oil prices fall below
the average level one might expect will prevail over time.
Second, use ECA money wisely to spur long-run growth and diversification. Since oil revenues are the counterpart of the depletion of a non-
renewable asset, ECA funds should ideally be used in the creation of assets such as infrastructure investments, which could support long-run non-
oil growth as well as economic diversification. This is where the composition of government spending comes into play. Dipping into the excess
crude account for high rate of return public investment projects—especially those which alleviate constraints to private investment in the non-oil
sector—would be good for diversification while also providing a fiscal stimulus at this time of crisis.
An example is the $5.3 billion investment envisaged in the Nigerian Integrated Power Project, which will make a difference provided it goes into the
designated activity. Investments in human capital would also help; these will take time to yield visible returns but are an essential underpinning of
diversified long-run growth. A World Bank study is being done on employment and growth. Its strategy is to focus on sectors which are already
growing and look for ways to make them grow even faster. The sectors include ICT, construction, food processing, wholesale and retail trade.
Agriculture could also be given a boost through better rural infrastructure and more support to R&D to boost productivity while continuing market-
friendly policies. This would also help with poverty alleviation.
The effectiveness of fiscal policy in spurring non-oil growth and diversification will be greatly enhanced if combined with regulatory reform. Let me
illustrate this with an example: As you know, Nigeria is ranked 108 out of 178 countries globally by Doing Business. The National Economic
Summit Group, supported by the World Bank and IFC, did a pilot Doing Business exercise in 2008 covering eleven Nigerian states and the FCT.
Here is something astounding: if one were to take the best score on each of the ranking criteria from the surveyed states and aggregate these, the
imaginary country thus created would be ranked 51, alongside the likes of Taiwan, Italy, Kuwait and Botswana. The lesson is clear: major
progress can be made simply by learning from each other at home. A good example is that the cost of a construction permit for a warehouse is
25 percent of per capita income and takes 46 days in Sokoto, 4th best in the world!
Third, look ahead on fiscal policy and budgetary management. There is currently $20 billion in the excess crude account (ECA). According to the
rules, 1 trillion naira (about $6.7 billion at prevailing exchange rates) must remain in the account. This leaves about $13.3 billion to cushion
shocks, provide resources for public investments, etc. The 2009 budget projects a deficit of a little over 3 percent of GDP at a reference oil price of
$45 per barrel. However it is likely that the fiscal deficit of the consolidated government (the federal plus the states) will be higher, in view of the
latest, much lower oil price forecast of $44 per barrel for 2009. Thus, drawing upon the ECA as a financing source is going to be unavoidable this
year. However, one must provide for the contingency that oil prices could be low in 2010 as well. This needs to be addressed transparently and
decisively, by formulating a 2-year fiscal plan to take into account the possibility that the ECA may need to be drawn upon in 2010 as well.
III.2 Exchange rate policy
Once again, the past provides a good starting point. When oil prices collapsed in the early 1980s, Nigeria resorted to intensified import licensing
instead of letting the naira depreciate. This had two pernicious effects: (i) a high parallel market premium emerged which served as a ruinous
implicit tax on agricultural and manufacturing output and exports. Over time, this intensified oil dependence; and (ii) it gave an impetus to rent-
seeking and corruption because those who got import licenses at the official exchange rate made a lot of easy money.
The process has been managed far better this time around although some problems have appeared. This is what has happened so far:
FX reserves (which include excess crude of approx $20 bn.) fell from $62 at end-August to about $57 billion in December and then to a little under
$50 billion in February.
The naira/dollar rate was kept at about 117 (its level when oil prices were at their peak in July) until close to the end of November in spite of the
sharp fall in oil prices. As a result, CBN lost reserves defending the exchange rate – but also because portfolio investments were exiting.
The naira was allowed to depreciate at the end of November. Subsequently, CBN restricted FX sales in the interbank market, reduced the limit on
commercial banks’ net open FX positions and made a decision to discontinue interbank trading should the naira depreciate by more that 5 percent
on any one day. The naira dropped to a low of 161 per dollar around Jan 10.
Effective Jan 19th, the wholesale Dutch auction system (WDAS) was suspended with a reversion to the retail Dutch auction system which
preceded it (RDAS), effectively short-circuiting the interbank market. FX is being offered only for eligible goods and the limit on net open FX
positions for commercial banks was reduced further.
Subsequently, further restrictions have been placed on the net open positions of banks. The naira is now at about 147 per dollar but with a
significant parallel market premium. What should be done about exchange rate policy? Let me point to a key decision and a key objective.
The key decision is how much reserves to use up in defending the naira. A depreciation is inevitable given the magnitude of the fall in oil prices
and in fact the naira has depreciated by some 25 percent since August 2008. If further depreciation happens, it is better to let it occur in an
orderly manner instead of using up precious reserves, with CBN providing guidance to the market. Take the case of Russia, which had also
accumulated reserves and fiscal savings during the recent oil boom period. It has lost a little over a third of its reserves since the end of August
2008, approximately $200 billion, a significant part of which was used in defending the ruble. Eventually, the Central Bank of Russia has let the
ruble depreciate. It is now trading around 36 per dollar, a 3-year low and a depreciation of more than 45 percent since the end of August 2008.
Russia is not alone in having seen its currency depreciate rapidly as the oil price fell. The currency of another oil exporter, Kazakhstan, has
dropped by 26 percent against the dollar since last August. And over this period, other major emerging markets have also witnessed large
depreciations of their exchange rates against the dollar: Brazil, Korea and Mexico over 40 percent; Indonesia and South Africa a little over 30
percent; and India 17 percent.
The key objective should be to prevent the re-emergence of a parallel market by removing the restrictions on the interbank market. Multiple
exchange rates with a high premium on the parallel market will only serve to distort foreign exchange allocation by creating an incentive for rent-
seeking and finding ‘innovative’ ways of profiting from the premium.
The consolidation of excess crude into general foreign exchange reserves might also be worth addressing. With excess crude now included in FX
reserves, drawing upon it for fiscal reasons might give the impression that reserves are shrinking and fuel panic. Thought could be given to
separating FX reserves from ECA. This highlights the need for a joint communications strategy on both fiscal and exchange rate policy to give the
market the needed guidance.
IV. Nigerian banks
A wave of reform and consolidation reduced the number of Nigerian banks from 86 in 2005 to 25 in 2008, with greatly strengthened capital
positions. Financial soundness was bolstered by the reforms, as shown in Table 3, which compares Nigeria to other emerging market countries.
Nigeria’s capital adequacy ratio (CAR) was second only to Indonesia’s, although its share of non-performing loans (NPLs) was on the high side
with relatively low provisions.
Table 3: Financial Soundness Indicators for 2007
Country CAR
% NPL/Total Loans % Provisions/NPLs
% ROA
% ROE
%
Brazil 18.4 3.1 182.4 2.7 27.8
Ghana 15.8 7.9 n.a. 4.3 24.2
Indonesia 21.3 10.9 103.8 2.8 18.2
Malaysia 13.5 6.6 62.6 1.4 n.a.
Nigeria 18.6 7.7 59.5 1.8 13.8
South Africa 12.2 1.2 n.a. 1.4 18.4
Source: IMF GFSR. Data refers to 2007
Notes: CAR: capital adequacy ratio; NPL: non-performing loans; ROA: return on assets; ROE: return on equity.
A period of explosive growth followed the 2005 consolidation. Between June 2006 and June 2008, the number of branches grew by 54 percent, the
number of deposit accounts by 39 percent and total loans and advances by 197 percent. Bank credit to the private sector grew by 60 percent in
2007 and another 90 percent in 2008, reflected in the growing wedge between total assets and deposits in 2006 and 2007 (Figure 1). We know
from experience that such a rapid rate of credit growth could spur a rise in non-performing loans. But notwithstanding rapid credit growth, Nigerian
banks have largely avoided two problems which amplified the vulnerability to a banking crisis in other countries:
The first problem Nigeria avoided is a rapid increase in private external borrowing by banks, which then on-lend the proceeds of their external
borrowing.
The second problem Nigeria avoided is related to the first: if banks on-lend in dollars but to businesses which are not in the export sector, then a
currency mismatch would develop on the balance sheet of the borrower. And if banks on-lend in domestic currency, the mismatch would appear
on the balance sheet of the bank itself. This would make either the bank or its clients vulnerable to large depreciations in the exchange rate such
as have occurred throughout emerging market and low-income countries as the global financial crisis intensified. For example, if as in the case of
Hungary, people were given bank loans in Swiss francs to buy houses, the burden of these loans would rise with the depreciation of the forint or if
house prices fell, or both.
Source: World Bank Staff estimates.
Nigeria’s banking situation is thus relatively solid as it has managed to avoid the twin complications of burgeoning private external debt and
currency mismatches. However, its banking system is not without challenges:
External banking supervision and upgrading the commercial banks’ own internal risk management and accounting systems have not kept pace
with the rapid growth of credit.
The fastest growing sectors of bank loans has been for finance and insurance and a vaguely-defined ‘general’ category, which accounted for some
35 percent of total loans by June 2008; combined with finance and insurance, the share was 50 percent.
Credit has gone into so-called margin lending for buying stocks. The Director-General of the Securities and Exchange Commission noted recently
that the amount of such lending amounted to some N388 billion.# In principle, this is an eminently manageable number; it is the equivalent of $2.6
billion, and accounts for 5.2 percent of total credit to the private sector and approximately 1.6 percent of 2009 GDP. A more recent interview with
the Governor of the Central Bank reported in the Financial Times on March 5 notes that the exposure of Nigerian banks to the stock market is a
much higher N900 billion, approximately $6 billion; but the Governor also notes that even if all this were to be written off, capital adequacy would
still be a healthy 15 percent.# The key at this stage from an impact perspective is how this number is distributed across banks and whether
additional amounts may be at stake.
Two questions arise against the preceding background: First, what should be done immediately to help the banks? Second, what needs to
be done over the longer term to enhance the resilience of the banks and in pursuit of the goal of the Financial System Strategy FSS 2020 to
establish Nigeria as an international financial center?
Some proposals have already been floated on what should be done to help the banks weather the current storm, including creating a state-backed
Asset Management Company to buy bad loans. Any such move should be preceded by a transparent assessment of the size of the problem
Nigerian banks face; without this, funds could be misused and the Nigerian government could end up with a big increase in public debt with
minimal social benefits. If banks are seen to go scot-free in spite of making ill-advised loans, this would reinforce moral hazard and create
incentives to do the same again in the future. The lessons from East Asia and even during the early months of the Troubled Assets Relief
Program in the US—wherein some 300 billion dollars of public funds have been spent without restoring confidence—are clear: determine the size
of the problem transparently; don’t confuse insolvency with illiquidity and don’t put money into insolvent financial institutions, instead, support the
stronger institutions; don’t bailout shareholders—not especially in a poor country like Nigeria. Fortunately, the balance sheets of Nigerian banks
are unlikely to be interlinked via complex derivatives (such as credit default swaps) and it should be possible to isolate banking sector problems.
On the theme of transparency, two questions need clear answers:
What has happened to the value of capital and capital adequacy in view of the big fall in share prices over the past few months?
What is the outlook for NPLs?
The recent credit spurt has been concentrated in the corporate sector especially in oil, gas and telecom. In oil and gas, a significant amount of
loans has been extended to second- and third-tier suppliers of goods and services, who will be hit first as oil prices decline and the pace of
exploration slows.
Banks have either expanded or are planning to expand into relatively new sectors such as retail banking, SME finance and infrastructure, where
their experience is limited.
Banks are also exposed to the recent sharp decline in the Nigerian stock market via loans to their own or independent capital market
intermediaries. At the same time, loans made to corporate and retail customers for ‘general’ purposes may have been channeled into share
purchases.
Banks may have lent to state governments which may not be fully able to service their loans and this bears monitoring.
Thus, while Nigerian banks have avoided the vulnerable combination of burgeoning private external debt and currency mismatches and have
concentrated their lending to corporates rather than households, the above factors suggest that the risk of deteriorating loan quality in the near
term needs to be carefully monitored.
Looking forward, what are the priorities for maintaining the resilience of the banks? As you well know, transparency and confidence are the
cornerstones of finance, and a healthy banking system and financial sector are essential for the smooth functioning of any economy. We are now
learning from the global financial crisis that supervision and regulation even for the most sophisticated financial systems, the US being a prime
example, are in constant need of review and upgrading. Financial markets are fragile and cannot be relied upon to regulate themselves. Financial
innovation which is accompanied by opacity and inadequate regulation could lead to a disaster. The Nigerian financial system is relatively young
and considerably simpler and this is the time to lay the groundwork for sound supervision and regulation. Here are some suggestions:
Nigeria needs to adopt—rather than adapt—International Financial Reporting Standards (IFRS). This would facilitate the Financial System
Strategy FSS 2020 objective of transforming Nigeria into an international financial center. As part of this process, bank supervisors will need to
ensure that regulation conforms to IFRS and that bank inspectors are trained in the application of IFRS. This is a process that could take 3-5
years and needs to start now.
The conglomerate structure of Nigerian banks might have contributed to opacity. It is important that bank supervisors in Nigeria get a complete
picture of the consolidated balance sheets and exposures of the banks. The idea of creating a new financial supervisory authority has been
raised. This is something that needs to be pursued cautiously in the light of international experience, which my Bank colleagues can share.
Whatever decision is made in this regard, it is critical that CBN play a crucial and central role, because of the fact that Nigeria’s financial system
is likely to be bank-dominated in the years to come and the need to factor in monetary policy.
One lesson for the future inspired by margin-lending for stocks is that it might be necessary to have restrictions on the volume of loans for such
purposes as well as enhanced provisioning in view of the volatility of stock markets. Likewise, with Nigerian banks still well-capitalized, this might
be a good time to think of upper limits on leverage (i.e., debt-to-equity ratios) for banks as well as minimum liquidity requirements—as is now
being recommended for US banks—to avoid a dangerous fire-sale of assets in the event of a sharp downturn.# This may not be a hugely pressing
issue for Nigeria now, but given the inevitable boom-bust cycles associated with the oil price, this is a good time to think of such precautionary
measures.
Now that the banking system has undergone a consolidation process, it is important to identify systemically significant banks and financial
institutions and subject these to special scrutiny. This is one of the lessons emerging from the subprime crisis in the US. The Congressional
Oversight Panel set up under the “Emergency Economic Stabilization Act of 2008” to provide guidance on regulatory reform as well as monitor the
use of funds spent to shore up the financial system has recommended that systemically important institutions, namely, those deemed ‘too big to
fail’ when a crisis hits, be identified in advance and subjected to heightened regulatory requirements.
Thus, looking ahead, Nigeria’s relatively young banking system would benefit from a two-pronged approach: first, ensuring that the basic
infrastructure for accounting, financial reporting, regulation, collateral registration and credit rating is upgraded and established; and second,
preparing for the next oil boom to avoid mistakes such as those which occurred in emerging markets such as Kazakhstan or in the much more
sophisticated financial system of the US and the advanced industrial countries.
V. Concluding Thoughts
Much is riding on how Nigeria responds to the impact of the global financial crisis, given its status as a regional player, which accounts for 60
percent of West African GDP, and its aspirations of being an international player. Let me therefore end by leaving the following thoughts with you.
Nigeria has distinct economic strengths, unlike in the 1980s: public and external debt are both low, reserves are high and the budget has been
managed reasonably well since 2004. The 2003-2006 fiscal reforms paid off handsomely and the consolidation of the banks has boosted their
resilience. All this has raised credibility. This credibility is an important asset which should be protected and grown further even as this crisis is
managed, including a transparent assessment of the problems of the banks.
The crisis is not merely a challenge but also an opportunity to diversify and re-position the economy for steadier long-run growth. This can be built
into the fiscal stimulus from excess crude account withdrawals by choosing public investments which will relax infrastructure and other constraints
to non-oil growth.
Nigeria should not simply return to its pre-crisis growth path, which would hold it hostage to good luck in the shape of high oil prices. Indeed, with
all the attention being paid to greener technologies, a greater focus on energy independence in the US via new kinds of renewable energy and the
emergence of hybrids in the automotive sector, Nigeria may not be able to return to the status quo ante. A strategy which sets targets for
diversifying the export and tax bases would be highly desirable. This could include greater value-added products in agriculture and related supply-
chain management. Other sectors such as retail trade and construction also offer diversification opportunities as do solid minerals and
manufacturing. We know the constraints these sectors face and we must act to relax these in a market-friendly manner.
Nigeria has been hit by the global crisis. But Nigeria has significant strengths and must respond to the challenges it faces transparently and in a
way that engenders confidence in the private investor community while at the same time repositioning its economy onto a more diversified growth
path after the crisis subsides. This can definitely be done and I have no doubt that as a country we shall rise to the occasion.
THANK YOU.
Distinguished Lecture delivered by Dr. Ngozi Okonjo-Iweala
African University of Science & Technology, Abuja
March 16, 2009
I. What led to the Global Financial Crisis?
Nigeria has been hit by the global financial crisis together with developed and developing countries all over the world. We are used to crises
erupting in the developing world, with their local contagion effects, as in East Asia in 1997-98. We also have a good idea of how to manage such
crises. But this crisis originated with the subprime mortgage meltdown in the richest country in the world, the United States, and has spread like
wildfire via complex and poorly understood financial linkages. The effects of the inevitable output decline in the rich countries as credit markets
froze are now being transmitted all over the globe via trade linkages. This has led to rising inventories of unsold goods and massive job losses all
over the world. The US itself lost 2.6 million jobs last year, the worst job loss record since 1945. Commodity prices, including oil, have fallen
precipitously—although domestic food prices remain high in many poor countries, adding to their woes; and for the first time since 1982, world
trade is expected to shrink this year.
For Nigeria, the crisis is a huge challenge; but embedded in that challenge is an opportunity to reposition the economy in a way which would
reduce its overwhelming dependence on oil and create a diversified springboard for steadier long-run growth and job creation once the crisis
abates. This is the central message I want to leave with you.
I’m going to divide my speech into three parts: a quick overview of the origins of the global crisis; the channels through which the crisis is affecting
Nigeria; and a discussion of the Nigerian response to the crisis.
What led to the global crises we are now living through, which for developing countries has been manifested in the four f’s: food, fertilizer, fuel and
now financial challenges? Doubtless, hundreds of PhD dissertations will be devoted to this question in the coming years. And if we know
economists well, multiple answers will abound! Let me give you a quick tour.
The first is the idea that an insufficiency of aggregate demand has enveloped the world. Proponents of this view have pointed to the massive shift
of income and wealth towards the top quintile in the rich countries—especially in the US but also in Western Europe and Japan since 1980.#
Rich people tend to save more than the less rich, leading to a secular decline in aggregate demand. This was compounded by the fall in house
prices in the US, which began in the summer of 2006 leading eventually to the subprime crisis. The negative wealth impact led to a fall in
consumption and aggregate demand as the US ‘consumer of last resort’ was able to borrow less. For the first time since 1970, the earliest year
for which global numbers are available, real global GDP is expected to decline this year. It has become fashionable to say, “We are all
Keynesians now,” a quote attributed to President Nixon in 1971, as large fiscal stimulus packages are hastily being assembled in the US and
other rich countries. But we know that the current recession was preceded by years of large current account deficits in the US, with private
savings dropping to low levels and public savings being eroded by the Iraq war, among other factors.
This brings me to the second explanation: that of global imbalances. The idea here is that no country, not even the US, can pile on current
account deficits year-after-year financed by the rest of the world without a blow up at some point. What is the solution? One controversial
proposal is that if China allowed its currency to sharply revalue, this would solve the problem; but there is not a consensus on this. The retort is
that if the Chinese revalued the renminbi, then the US would have run current account deficits in relation to other countries because the
fundamental problem was that US households were simply spending too much! Whatever the solution, the question we have to ask is whether we
can go back to a regime of large US current account deficits once the crisis subsides. My guess is that the answer is probably no, although there
may be a strong proclivity towards this in view of the third explanation, put forward by Ricardo Caballero, an MIT economics professor: that there is
an insufficient supply of safe assets in the world.# Global savings have risen as populations age or countries like China and India ramp up savings
in pursuit of higher investment and growth. Some of this spills over into current account surpluses. Similarly, oil and other commodity exporters
need a place to park their savings. The US pretty much has a monopoly on safe, long term assets – US treasuries – and so the savings tend to
flow to the US lowering interest rates and fueling US aggregate demand. Hence, addressing global imbalances in the shape of persistent current
account deficits in the US may call for new forms of global insurance.
A fourth explanation, which I believe most would favor, combines elements of the above but centers around the financial system. This would say
that low global interest rates after 9/11 catalyzed a search for high returns. In the US, this led to a situation where risk was priced too low, leading
to a lowering of lending standards and sowing the seeds of the subprime mortgage crisis. This crisis is frightening in that it is a perfect storm
caused by everything that could possibly go wrong with the modern-day financial system: credit rating agencies which did not do their job;
executive compensation structures, including in the giant mortgage Government Sponsored Entities, Fannie Mae and Freddie Mac, which
shortened horizons and encouraged excessive risk-taking; financial innovation and globalization, which enabled originators to lay off the risk by
securitizing the subprime loans they made and selling them, leading to a proliferation of toxic assets in the shape of asset-backed securities;
outright fraud in the shape of teaser interest rates, complex loan products and imprudently high loan-to-value ratios; and a relaxation of regulatory
stringency in the mistaken belief that it was in the interest of the large financial institutions to self-regulate even as special investment vehicles
contributed to opacity in financial dealings by taking risky transactions off-balance sheet. And now, as fiscal stimulus and bailout packages are
put together in the US and rich countries, the problem of moral hazard and rising public indebtedness must also be dealt with.#
This is an opportune moment to draw three parallels for Nigeria:
First, even though we don’t know exactly when the crisis will end, we can be reasonably sure that exiting it will require a one-two punch: shoring
up the financial system to ensure credit flows even as fiscal policy is geared towards raising aggregate demand. The Chairman of the Board of
Governors of the Federal Reserve System of the US, Ben Bernanke, noted in a recent speech at the London School of Economics that he did not
believe that fiscal actions would lead to a lasting recovery without getting the financial system in order.# For Nigeria, this means ensuring that
banks and the financial system stay robust even as drawdowns are made from the ‘excess crude account’ to enable an affordable fiscal stimulus.
Second, the global question of whether we can simply return to the status quo ante after this crisis with its implications not just for global
imbalances but also soaring food and fuel prices and concerns about the impact of rapid global growth on climate change, has its echo in Nigeria:
Can we place all our trust in oil or should we take steps to diversify our economy? Fortunately, this question is easier to answer for Nigeria than
for the world! The answer is that Nigeria must take steps to diversify its economy as part of its response to the current crisis. And the good news
is that it has several important strengths which should facilitate this process, including low external and public debt, high reserves and above all, a
measure of policy credibility which must be preserved and nurtured.
Third, it means drawing lessons from the global financial crisis for better regulation and supervision of banks and the broader financial system as
we look to the future.
II. Impact of Global Crisis on Nigeria
Nigeria is being affected by the global financial crisis through the familiar channels of the labor market and remittances; FDI; and commodity
markets, the oil price in particular. Direct financial links with the rest of the world are limited and therefore likely to exact a smaller toll. Let me
take each channel in turn.
Labor market and remittances: Employment consequences of the crisis are hard to predict: formal wage employment in the private sector is only
about 2 percent of the labor force with another 8 percent in public service. Most Nigerian workers are employed as casual laborers in agriculture
or the informal urban sector. The Information and Communications Technology (ICT) and financial services sectors have continued to post strong
profits and there is no indication yet what might happen to jobs in these sectors. Remittances rose from $1.3 billion to $3.5 billion in 2005, and
have subsequently remained stable at this level, although they are expected to fall over the next two years. This will have an adverse impact on
consumption, especially in rural areas, as well as investment in SMEs. Many households in Nigeria have family members abroad and their
remittances pay for everything from school fees and health expenditure to house construction and investments in small businesses.
FDI and capital flows: Net FDI more than doubled from an annual average of around $3 billion over 2001-2004 to $7.25 billion over 2005-2007; it
dropped to $4.7 billion in 2008 and is projected to decline in 2009 and 2010. The bulk of FDI goes into oil and gas, banking and telecoms, so a
sharp slowdown should not be surprising.
Commodity markets: With negligible non-oil exports, the main external effects of the global crisis are not surprisingly going to be transmitted to
Nigeria through the oil price. Oil and gas have a stranglehold on both merchandise exports and fiscal revenues, which has remained steady over
time, as shown in the table below.
Table 1: Predominance of Oil in Nigeria’s Economy
1990 2000 2008 2009
Oil as % of total GDP 37.5 47.7 36.3 26.4
Oil/gas as % of total exports 95.5 97.2 98.8 98.2
Oil/gas as % of total revenues 82.8 82.8 82.4 72.7
Source: World Bank staff estimates; projections for 2009.
Assuming a production rate of 2.1 million barrels of oil per day, a $10 per barrel fall in the oil price would lower exports by about $7.7 billion and
fiscal revenues by approximately $6.2 billion. In contrast, the sum of FDI and remittances is expected to fall to around $6 billion in 2009 from $8.2
billion in 2008, a drop of some $2 billion.
Thus, from a balance-of-payments perspective, a $10 per barrel drop in the oil price has thrice the impact of the drop in FDI and remittances
combined! Now consider that oil prices averaged $97 per barrel in 2008 and are forecast to average $50 per barrel in 2009—a stunning drop of $47
per barrel, and it is easy to see that the oil price decline will completely dwarf all other sources of impact on Nigeria as a result of the global
crisis. This $47 drop in the oil price is the equivalent of approximately 22 percent of 2009 GDP in terms of exports and approximately 18 percent
of 2009 GDP in revenues!# If in addition oil production falls below the level of 2.2 million barrels per day assumed for the 2009 budget, the effect
will be proportionately higher. And very recently, the IMF World Economic Outlook oil price forecast itself has been lowered from $50 to $44 per
barrel.
Managing the fiscal and balance-of-payments consequences of the oil price collapse is therefore going to be an immense challenge for Nigeria.
However, it is not the sole challenge. The banking sector is also facing difficulties. And as a result of slowing credit growth and the large oil price
decline, which will place limits on public spending, non-oil GDP growth is projected to slow to 4 percent over 2009 and 2010 compared to 9.5
percent in 2007 and 7.7 percent in 2008.
Against this background, I shall start with the macroeconomic policy response to the crisis and then go on to the financial system.
III. Responding to the Oil Price Collapse
The oil price collapse is by far the biggest component of the external shock that has hit Nigeria. Policymakers face two challenges: (i) how
to respond to the down-cycle of oil prices; and (ii) how to ensure that the economy emerges stronger and more diversified after the crisis ends. In
particular, what should be done in continued pursuit of a foundation for sustained long-run growth and economic diversification? The two main
vehicles for responding are fiscal and exchange rate/monetary policy. But first let me emphasize that priority numero uno at this point is to
engender confidence, in the public as well as investors in the real and financial sectors. The message must be strongly conveyed that there is
coherence across fiscal, monetary, exchange rate and financial sector policies and that the government is wedded to transparency and good
governance. I would stress the following general principles:
Emphasize Nigeria’s macroeconomic strengths, both on fiscal fundamentals and low indebtedness as well as its high reserves cushion and ‘rainy
day’ funds in the form of the ‘excess crude account’.
Acknowledge and learn from past mistakes and avoid repeating them.
Deflect attention from the near-obsession with the spot naira/dollar rate. A healthy dose of realism would indicate that, like for other commodity
exporters, a depreciation of the currency is not so unusual given the size of the external shock; a depreciation may be desirable to avoid running
down reserves or developing an unsustainable current account position. The key issue is how the CBN gives direction on exchange rate policy
and manages the situation.
III.1 Fiscal Policy Response
A good starting point for crafting a fiscal policy response is Nigeria’s own past experience. As a result of tying government spending to current oil
revenues and running large fiscal deficits during the oil boom years of the 1970s, Nigeria became one of the most volatile countries in the world
over 1960-2000 in terms of output, real exchange rates and the terms-of-trade. To make matters worse, Nigeria had developed an external debt
overhang by the mid-1980s, which would have deterred even profitable private investment because of the resulting macroeconomic uncertainty and
the fear that the profits would be taxed away to service the debt.
It is not hard to imagine that the combination of high volatility and a debt overhang would have seriously hurt the investment climate, intensifying oil
dependence. Looked at from this lens, the adoption of the oil price-based fiscal rule (which delinks government spending from current oil prices)
and Nigeria’s 2005-06 debt agreement with the Paris Club (which resulted in an $18 billion write-off on Nigeria’s Paris Club debt of $30 billion) must
both be seen as historic accomplishments. The oil price rule helped dampen the transmission of oil price volatility to the rest of the economy
while also permitting reserves and ‘excess crude’ to be built up. The Paris Club debt agreement (facilitated by the savings related to the oil price-
based fiscal rule, as oil prices were consistently above reference prices for 2004-2008) eliminated the debt overhang. The improvement in
creditworthiness showed up in the sovereign credit ratings Nigeria subsequently received and provided a sound basis for attracting both domestic
and foreign investment into the country prior to this crisis.
Fiscal policy reform and relative stability improved the investment climate, with the reduction in volatility helping the non-oil sector. Non-oil GDP,
agriculture in particular, has been growing impressively since 2004 in sharp contrast to its dismal performance over the 1980s and 1990s and was
an important driver of growth over 2004-2007, as shown in Table 2.
Table 2: Contribution to Non-Oil Growth
(in percent)
2004 2005 2006 2007
Agriculture 46.7 45.3 42.8 40.6
Solid Mineral 0.5 0.4 0.4 0.4
Manufacturing 6.3 5.5 5.0 4.5
Telecommunication & Post 5.0 5.5 6.9 8.9
Finance & Insurance 2.0 1.8 2.8 3.1
Wholesale and Retail Trade 21.3 27.3 29.4 29.4
Building and Construction 2.5 2.7 2.8 3.0
Others 15.7 11.3 10.0 10.1
Memo: Non-oil GDP growth (%) 13.2 8.6 9.4 9.5
Source: Employment and Growth in Nigeria, World Bank Staff draft note, 2009.
Wholesale and retail trade, telecom and manufacturing have been next in line. Analysis by World Bank staff indicates that the key features of
Nigeria’s growth performance since 2001 are the following:
70 percent of growth can be explained by agriculture and wholesale and retail trade.
Relatively new sectors, such as construction, the financial sector, telecommunications and ICT have initiated a structural shift towards the
services sector.
Macroeconomic and structural reforms have spurred confidence, boosting FDI and remittances, raising aggregate demand and private investment.
Growth has largely resulted from factor accumulation. In particular, agricultural productivity has stagnated, with growth coming largely from
increased land use.
The last point is worrisome: in spite of being the ‘engine’ of non-oil growth, productivity in agriculture has stagnated; and lack of economic
diversification, including the concentrated export and tax bases, remains a serious source of macroeconomic vulnerability. Can fiscal policy
help? It has already helped during the oil boom period. But now for the first time since the adoption of the oil-price based fiscal rule in 2004,
actual oil prices could fall below the $45 per barrel budget reference price for 2009. Even at the IMF’s World Economic Outlook forecast of $50 per
barrel for 2009, the government is going to have to draw upon the ‘excess crude’ account, ECA, this year and very likely next year as well.
Three principles should guide the use of funds from the ECA:
First, this is the right time to use ECA money. The reason for setting up the ECA was precisely for a rainy day like this, when oil prices fall below
the average level one might expect will prevail over time.
Second, use ECA money wisely to spur long-run growth and diversification. Since oil revenues are the counterpart of the depletion of a non-
renewable asset, ECA funds should ideally be used in the creation of assets such as infrastructure investments, which could support long-run non-
oil growth as well as economic diversification. This is where the composition of government spending comes into play. Dipping into the excess
crude account for high rate of return public investment projects—especially those which alleviate constraints to private investment in the non-oil
sector—would be good for diversification while also providing a fiscal stimulus at this time of crisis.
An example is the $5.3 billion investment envisaged in the Nigerian Integrated Power Project, which will make a difference provided it goes into the
designated activity. Investments in human capital would also help; these will take time to yield visible returns but are an essential underpinning of
diversified long-run growth. A World Bank study is being done on employment and growth. Its strategy is to focus on sectors which are already
growing and look for ways to make them grow even faster. The sectors include ICT, construction, food processing, wholesale and retail trade.
Agriculture could also be given a boost through better rural infrastructure and more support to R&D to boost productivity while continuing market-
friendly policies. This would also help with poverty alleviation.
The effectiveness of fiscal policy in spurring non-oil growth and diversification will be greatly enhanced if combined with regulatory reform. Let me
illustrate this with an example: As you know, Nigeria is ranked 108 out of 178 countries globally by Doing Business. The National Economic
Summit Group, supported by the World Bank and IFC, did a pilot Doing Business exercise in 2008 covering eleven Nigerian states and the FCT.
Here is something astounding: if one were to take the best score on each of the ranking criteria from the surveyed states and aggregate these, the
imaginary country thus created would be ranked 51, alongside the likes of Taiwan, Italy, Kuwait and Botswana. The lesson is clear: major
progress can be made simply by learning from each other at home. A good example is that the cost of a construction permit for a warehouse is
25 percent of per capita income and takes 46 days in Sokoto, 4th best in the world!
Third, look ahead on fiscal policy and budgetary management. There is currently $20 billion in the excess crude account (ECA). According to the
rules, 1 trillion naira (about $6.7 billion at prevailing exchange rates) must remain in the account. This leaves about $13.3 billion to cushion
shocks, provide resources for public investments, etc. The 2009 budget projects a deficit of a little over 3 percent of GDP at a reference oil price of
$45 per barrel. However it is likely that the fiscal deficit of the consolidated government (the federal plus the states) will be higher, in view of the
latest, much lower oil price forecast of $44 per barrel for 2009. Thus, drawing upon the ECA as a financing source is going to be unavoidable this
year. However, one must provide for the contingency that oil prices could be low in 2010 as well. This needs to be addressed transparently and
decisively, by formulating a 2-year fiscal plan to take into account the possibility that the ECA may need to be drawn upon in 2010 as well.
III.2 Exchange rate policy
Once again, the past provides a good starting point. When oil prices collapsed in the early 1980s, Nigeria resorted to intensified import licensing
instead of letting the naira depreciate. This had two pernicious effects: (i) a high parallel market premium emerged which served as a ruinous
implicit tax on agricultural and manufacturing output and exports. Over time, this intensified oil dependence; and (ii) it gave an impetus to rent-
seeking and corruption because those who got import licenses at the official exchange rate made a lot of easy money.
The process has been managed far better this time around although some problems have appeared. This is what has happened so far:
FX reserves (which include excess crude of approx $20 bn.) fell from $62 at end-August to about $57 billion in December and then to a little under
$50 billion in February.
The naira/dollar rate was kept at about 117 (its level when oil prices were at their peak in July) until close to the end of November in spite of the
sharp fall in oil prices. As a result, CBN lost reserves defending the exchange rate – but also because portfolio investments were exiting.
The naira was allowed to depreciate at the end of November. Subsequently, CBN restricted FX sales in the interbank market, reduced the limit on
commercial banks’ net open FX positions and made a decision to discontinue interbank trading should the naira depreciate by more that 5 percent
on any one day. The naira dropped to a low of 161 per dollar around Jan 10.
Effective Jan 19th, the wholesale Dutch auction system (WDAS) was suspended with a reversion to the retail Dutch auction system which
preceded it (RDAS), effectively short-circuiting the interbank market. FX is being offered only for eligible goods and the limit on net open FX
positions for commercial banks was reduced further.
Subsequently, further restrictions have been placed on the net open positions of banks. The naira is now at about 147 per dollar but with a
significant parallel market premium. What should be done about exchange rate policy? Let me point to a key decision and a key objective.
The key decision is how much reserves to use up in defending the naira. A depreciation is inevitable given the magnitude of the fall in oil prices
and in fact the naira has depreciated by some 25 percent since August 2008. If further depreciation happens, it is better to let it occur in an
orderly manner instead of using up precious reserves, with CBN providing guidance to the market. Take the case of Russia, which had also
accumulated reserves and fiscal savings during the recent oil boom period. It has lost a little over a third of its reserves since the end of August
2008, approximately $200 billion, a significant part of which was used in defending the ruble. Eventually, the Central Bank of Russia has let the
ruble depreciate. It is now trading around 36 per dollar, a 3-year low and a depreciation of more than 45 percent since the end of August 2008.
Russia is not alone in having seen its currency depreciate rapidly as the oil price fell. The currency of another oil exporter, Kazakhstan, has
dropped by 26 percent against the dollar since last August. And over this period, other major emerging markets have also witnessed large
depreciations of their exchange rates against the dollar: Brazil, Korea and Mexico over 40 percent; Indonesia and South Africa a little over 30
percent; and India 17 percent.
The key objective should be to prevent the re-emergence of a parallel market by removing the restrictions on the interbank market. Multiple
exchange rates with a high premium on the parallel market will only serve to distort foreign exchange allocation by creating an incentive for rent-
seeking and finding ‘innovative’ ways of profiting from the premium.
The consolidation of excess crude into general foreign exchange reserves might also be worth addressing. With excess crude now included in FX
reserves, drawing upon it for fiscal reasons might give the impression that reserves are shrinking and fuel panic. Thought could be given to
separating FX reserves from ECA. This highlights the need for a joint communications strategy on both fiscal and exchange rate policy to give the
market the needed guidance.
IV. Nigerian banks
A wave of reform and consolidation reduced the number of Nigerian banks from 86 in 2005 to 25 in 2008, with greatly strengthened capital
positions. Financial soundness was bolstered by the reforms, as shown in Table 3, which compares Nigeria to other emerging market countries.
Nigeria’s capital adequacy ratio (CAR) was second only to Indonesia’s, although its share of non-performing loans (NPLs) was on the high side
with relatively low provisions.
Table 3: Financial Soundness Indicators for 2007
Country CAR
% NPL/Total Loans % Provisions/NPLs
% ROA
% ROE
%
Brazil 18.4 3.1 182.4 2.7 27.8
Ghana 15.8 7.9 n.a. 4.3 24.2
Indonesia 21.3 10.9 103.8 2.8 18.2
Malaysia 13.5 6.6 62.6 1.4 n.a.
Nigeria 18.6 7.7 59.5 1.8 13.8
South Africa 12.2 1.2 n.a. 1.4 18.4
Source: IMF GFSR. Data refers to 2007
Notes: CAR: capital adequacy ratio; NPL: non-performing loans; ROA: return on assets; ROE: return on equity.
A period of explosive growth followed the 2005 consolidation. Between June 2006 and June 2008, the number of branches grew by 54 percent, the
number of deposit accounts by 39 percent and total loans and advances by 197 percent. Bank credit to the private sector grew by 60 percent in
2007 and another 90 percent in 2008, reflected in the growing wedge between total assets and deposits in 2006 and 2007 (Figure 1). We know
from experience that such a rapid rate of credit growth could spur a rise in non-performing loans. But notwithstanding rapid credit growth, Nigerian
banks have largely avoided two problems which amplified the vulnerability to a banking crisis in other countries:
The first problem Nigeria avoided is a rapid increase in private external borrowing by banks, which then on-lend the proceeds of their external
borrowing.
The second problem Nigeria avoided is related to the first: if banks on-lend in dollars but to businesses which are not in the export sector, then a
currency mismatch would develop on the balance sheet of the borrower. And if banks on-lend in domestic currency, the mismatch would appear
on the balance sheet of the bank itself. This would make either the bank or its clients vulnerable to large depreciations in the exchange rate such
as have occurred throughout emerging market and low-income countries as the global financial crisis intensified. For example, if as in the case of
Hungary, people were given bank loans in Swiss francs to buy houses, the burden of these loans would rise with the depreciation of the forint or if
house prices fell, or both.
Source: World Bank Staff estimates.
Nigeria’s banking situation is thus relatively solid as it has managed to avoid the twin complications of burgeoning private external debt and
currency mismatches. However, its banking system is not without challenges:
External banking supervision and upgrading the commercial banks’ own internal risk management and accounting systems have not kept pace
with the rapid growth of credit.
The fastest growing sectors of bank loans has been for finance and insurance and a vaguely-defined ‘general’ category, which accounted for some
35 percent of total loans by June 2008; combined with finance and insurance, the share was 50 percent.
Credit has gone into so-called margin lending for buying stocks. The Director-General of the Securities and Exchange Commission noted recently
that the amount of such lending amounted to some N388 billion.# In principle, this is an eminently manageable number; it is the equivalent of $2.6
billion, and accounts for 5.2 percent of total credit to the private sector and approximately 1.6 percent of 2009 GDP. A more recent interview with
the Governor of the Central Bank reported in the Financial Times on March 5 notes that the exposure of Nigerian banks to the stock market is a
much higher N900 billion, approximately $6 billion; but the Governor also notes that even if all this were to be written off, capital adequacy would
still be a healthy 15 percent.# The key at this stage from an impact perspective is how this number is distributed across banks and whether
additional amounts may be at stake.
Two questions arise against the preceding background: First, what should be done immediately to help the banks? Second, what needs to
be done over the longer term to enhance the resilience of the banks and in pursuit of the goal of the Financial System Strategy FSS 2020 to
establish Nigeria as an international financial center?
Some proposals have already been floated on what should be done to help the banks weather the current storm, including creating a state-backed
Asset Management Company to buy bad loans. Any such move should be preceded by a transparent assessment of the size of the problem
Nigerian banks face; without this, funds could be misused and the Nigerian government could end up with a big increase in public debt with
minimal social benefits. If banks are seen to go scot-free in spite of making ill-advised loans, this would reinforce moral hazard and create
incentives to do the same again in the future. The lessons from East Asia and even during the early months of the Troubled Assets Relief
Program in the US—wherein some 300 billion dollars of public funds have been spent without restoring confidence—are clear: determine the size
of the problem transparently; don’t confuse insolvency with illiquidity and don’t put money into insolvent financial institutions, instead, support the
stronger institutions; don’t bailout shareholders—not especially in a poor country like Nigeria. Fortunately, the balance sheets of Nigerian banks
are unlikely to be interlinked via complex derivatives (such as credit default swaps) and it should be possible to isolate banking sector problems.
On the theme of transparency, two questions need clear answers:
What has happened to the value of capital and capital adequacy in view of the big fall in share prices over the past few months?
What is the outlook for NPLs?
The recent credit spurt has been concentrated in the corporate sector especially in oil, gas and telecom. In oil and gas, a significant amount of
loans has been extended to second- and third-tier suppliers of goods and services, who will be hit first as oil prices decline and the pace of
exploration slows.
Banks have either expanded or are planning to expand into relatively new sectors such as retail banking, SME finance and infrastructure, where
their experience is limited.
Banks are also exposed to the recent sharp decline in the Nigerian stock market via loans to their own or independent capital market
intermediaries. At the same time, loans made to corporate and retail customers for ‘general’ purposes may have been channeled into share
purchases.
Banks may have lent to state governments which may not be fully able to service their loans and this bears monitoring.
Thus, while Nigerian banks have avoided the vulnerable combination of burgeoning private external debt and currency mismatches and have
concentrated their lending to corporates rather than households, the above factors suggest that the risk of deteriorating loan quality in the near
term needs to be carefully monitored.
Looking forward, what are the priorities for maintaining the resilience of the banks? As you well know, transparency and confidence are the
cornerstones of finance, and a healthy banking system and financial sector are essential for the smooth functioning of any economy. We are now
learning from the global financial crisis that supervision and regulation even for the most sophisticated financial systems, the US being a prime
example, are in constant need of review and upgrading. Financial markets are fragile and cannot be relied upon to regulate themselves. Financial
innovation which is accompanied by opacity and inadequate regulation could lead to a disaster. The Nigerian financial system is relatively young
and considerably simpler and this is the time to lay the groundwork for sound supervision and regulation. Here are some suggestions:
Nigeria needs to adopt—rather than adapt—International Financial Reporting Standards (IFRS). This would facilitate the Financial System
Strategy FSS 2020 objective of transforming Nigeria into an international financial center. As part of this process, bank supervisors will need to
ensure that regulation conforms to IFRS and that bank inspectors are trained in the application of IFRS. This is a process that could take 3-5
years and needs to start now.
The conglomerate structure of Nigerian banks might have contributed to opacity. It is important that bank supervisors in Nigeria get a complete
picture of the consolidated balance sheets and exposures of the banks. The idea of creating a new financial supervisory authority has been
raised. This is something that needs to be pursued cautiously in the light of international experience, which my Bank colleagues can share.
Whatever decision is made in this regard, it is critical that CBN play a crucial and central role, because of the fact that Nigeria’s financial system
is likely to be bank-dominated in the years to come and the need to factor in monetary policy.
One lesson for the future inspired by margin-lending for stocks is that it might be necessary to have restrictions on the volume of loans for such
purposes as well as enhanced provisioning in view of the volatility of stock markets. Likewise, with Nigerian banks still well-capitalized, this might
be a good time to think of upper limits on leverage (i.e., debt-to-equity ratios) for banks as well as minimum liquidity requirements—as is now
being recommended for US banks—to avoid a dangerous fire-sale of assets in the event of a sharp downturn.# This may not be a hugely pressing
issue for Nigeria now, but given the inevitable boom-bust cycles associated with the oil price, this is a good time to think of such precautionary
measures.
Now that the banking system has undergone a consolidation process, it is important to identify systemically significant banks and financial
institutions and subject these to special scrutiny. This is one of the lessons emerging from the subprime crisis in the US. The Congressional
Oversight Panel set up under the “Emergency Economic Stabilization Act of 2008” to provide guidance on regulatory reform as well as monitor the
use of funds spent to shore up the financial system has recommended that systemically important institutions, namely, those deemed ‘too big to
fail’ when a crisis hits, be identified in advance and subjected to heightened regulatory requirements.
Thus, looking ahead, Nigeria’s relatively young banking system would benefit from a two-pronged approach: first, ensuring that the basic
infrastructure for accounting, financial reporting, regulation, collateral registration and credit rating is upgraded and established; and second,
preparing for the next oil boom to avoid mistakes such as those which occurred in emerging markets such as Kazakhstan or in the much more
sophisticated financial system of the US and the advanced industrial countries.
V. Concluding Thoughts
Much is riding on how Nigeria responds to the impact of the global financial crisis, given its status as a regional player, which accounts for 60
percent of West African GDP, and its aspirations of being an international player. Let me therefore end by leaving the following thoughts with you.
Nigeria has distinct economic strengths, unlike in the 1980s: public and external debt are both low, reserves are high and the budget has been
managed reasonably well since 2004. The 2003-2006 fiscal reforms paid off handsomely and the consolidation of the banks has boosted their
resilience. All this has raised credibility. This credibility is an important asset which should be protected and grown further even as this crisis is
managed, including a transparent assessment of the problems of the banks.
The crisis is not merely a challenge but also an opportunity to diversify and re-position the economy for steadier long-run growth. This can be built
into the fiscal stimulus from excess crude account withdrawals by choosing public investments which will relax infrastructure and other constraints
to non-oil growth.
Nigeria should not simply return to its pre-crisis growth path, which would hold it hostage to good luck in the shape of high oil prices. Indeed, with
all the attention being paid to greener technologies, a greater focus on energy independence in the US via new kinds of renewable energy and the
emergence of hybrids in the automotive sector, Nigeria may not be able to return to the status quo ante. A strategy which sets targets for
diversifying the export and tax bases would be highly desirable. This could include greater value-added products in agriculture and related supply-
chain management. Other sectors such as retail trade and construction also offer diversification opportunities as do solid minerals and
manufacturing. We know the constraints these sectors face and we must act to relax these in a market-friendly manner.
Nigeria has been hit by the global crisis. But Nigeria has significant strengths and must respond to the challenges it faces transparently and in a
way that engenders confidence in the private investor community while at the same time repositioning its economy onto a more diversified growth
path after the crisis subsides. This can definitely be done and I have no doubt that as a country we shall rise to the occasion.
THANK YOU.