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The value of transparency and disclosure

August 25, 2009

Do people bank with GT Bank because of its catch phrase “Wouldn’t you rather bank with us?” Or is it because the bank is externally regulated to keep deposits safe, report regularly and held accountable for its fiduciary responsibilities? Why should an investor prefer to buy or hold GT Bank shares – despite the present challenges facing the banking sector?

Could it be GT Bank’s high regard for its reputation? Do advertising blitzes communicate more than cheap talk? Advertisements, a reflection of the premium an organisation places on reputation, reinforce the trust of stakeholders. But beyond elaborate ad campaigns, a company’s reputation can be gleaned from the people who run it and the people it deals with.

Similarly, and increasingly in Nigeria’s financial sector, disclosure and transparency are highly valued. It’s been regarded as one means to stand out from the crowd, earning and boosting confidence, other than advertisements. This is why Mr Lamido Sanusi, the new CBN governor, has set the restoration of confidence, through greater disclosure in the banking sector, as one of his goals.

Diffidence or disclosure

For some time, analysts have contended that the level of disclosure, which banks are statutorily compelled to disclose, fails to meet minimum international standards. During the race for size and profit, rapid growth, easy access to domestic and international credit fuelled expansive creation of risk assets. Times are now testy: risk management and corporate governance – fallout of an expansionary period unmatched by accounting and financial disclosure levels – are at present the bane of Nigerian banks.

In its 2009 Nigeria Banking Report, Afrinvest Research says that “current statutory disclosure levels and other deficiencies with industry information structure make it difficult for that strong position [the gains of the sector’s consolidation] to be credibly communicated to key stakeholders: in particular, investors, creditors and depositors.”

Banks pursued different operational strategies and as a consequence arrived at unique levels of gross risk exposure, liquidity and capital adequacy. Afrinvest also noted that some significant risk exposures, of some banks, are not captured in traditional loan book assessments. In short, there are risks that the current reporting requirements render incomprehensible. Add to this the incompleteness and irrelevance of information provided, the level of trust in the market slumps.

Afrinvest further remarked that the margin loan exposure of banks mirrors, albeit barely, a larger problem: “structural weaknesses that allow short-term funds flow from banks to other financial institutions for trading purposes.” The recent CBN directive that banks disclose their exposure to Bankers Acceptances (BA), Commercial Papers (CP) and the energy sector are a pointer. To restore confidence, the air about the health of banks has to be cleared. Can greater (and more frequent) disclosure achieve this?

The incentive effect

Much of the clamour for transparency has been external.  However, externally compelling banks – or brokers, as the Security and Exchange Commission (SEC) recently did – to provide more information must contend with the issue of incentives. Is it in the best interest of the banks to bare all? Probably yes, for now, – Nigerian banks are learning the hard lesson that transparency and liquidity are close relatives. Thus, some are trimming dividend payouts and writing off margin loans.

But going forward, regulatory bodies (CBN, SEC, NSE, NASB etc) must note that they are disadvantaged when it comes to requesting information. The information requested belongs to the organisations. To reveal it or not depends on the incentive. Because the benefits of transparency are widely dispersed and the cost of disclosure is borne by a few eg, banks, disclosers are less eager about transparency. Therefore vested interests, more likely to loose from greater disclosure, can politicize and scuttle the process toward providing better and useful information.

Besides, the incentive – for banks and the regulatory bodies – are incompatible. The regulators are expected to take regulation seriously. During the stock market boom, few Nigerian banks were willing to reveal accounting and financial information beyond the required minimum.

That was before the problem of insufficient information began to smear the reputation of the industry eg, unguarded statements and de-marketing strategies. The consequences of ignoring these were huge. For instance, the ability to attract deposits – necessary for berthing at the common-year end without mishaps, was at stake.

As a result, a couple of banks made public the stress tests of their balance sheet – to separate themselves from the maddening crowd. As a group, they decided to adopt IFRS; a welcome but insufficient signal to the market.

Investors and customers have cast their vote of no confidence, with their wallets and feet respectively. The risks they perceive, real or imagined are priced into their bank shares. Unless confidence is restored, it will limit the capacity of banks to raise fresh funds.

Possible gains from being acquired or merged with a local or foreign bank eg, skills, capital and systems, will be hampered. The informal sector will continue to dominate the economy; the default option being to save in a mattress rather than a bank.

Trust me, I’m transparent

Some banks clearly understand this. These, according to Afrinvest, are the “major winners that are able to provide the frequency and depth of information on operating performance and position that counter-parties seek for decision making.”

Confidence suggests a relationship of trust. Trust, a valuable economic asset, is hard to create but easy to destroy. When there’s no trust there’s no business. Presently, Nigerian banks are pitched against some of their stakeholders because of the asymmetry of information. That is, the banks know something that those who they regularly transact with don’t. A situation that can’t last for long; but if it persists, business transactions will become pricey.

And few bank counter-parties can foot the bill of monitoring a bank’s every action.  Therefore, banks that provide clarity and transparency will be first in the pecking order for corporate and large-ticket business. And disclosure does pay dividends. For one, transparency increases liquidity.

A balance sheet cluttered with illiquid and risky asset does no good. Uncertainty or lack of transparency, about the makeup of a particular bank’s balance sheet will in turn affect liquidity of its shares ie, buying and selling of a bank’s shares without affecting its price. Hence in Afrinvest’s view “liquidity and its impact on the ability to take opportunities as they emerge will further direct business towards a select group of banks”.

Particularly since opportunities for corporate and large-ticket businesses are now fewer. Erstwhile long-term market opportunities eg, fuel importation and (the now shrinking) public sector deposits are wilting.

Fast changing business dynamics altered by macroeconomic fundamentals (barring a positive oil price shock) mean that banks have to back-out from a me-too competitive strategy and conserve the losses made from risks that accompanied those business areas.

Therefore banks that hitherto devoted less time to risk management (safety and effectiveness are the new buzzwords) will miss out on emerging opportunities. For instance, such banks will find it difficult get credit lines from foreign banks – a balance sheet with more impaired loans relative to capital adequacy, cuts no mustard.

If they extended credit at all, it will be with caution and at a premium. Meanwhile, chances of a second wave of consolidation, via foreign ownership of Nigerian banks, mean that only banks with healthy balance sheets will have bargaining power. Those that do not will be easy game.

Corporate governance: a fad or fact?

Corporate governance matters, after all is said and done. The charge, to developing industry-wide standards on disclosure and risk management, has to be the led from the Board level. The Board is the one that makes buzzwords like effectiveness and safety matter of fact. Advanced degrees of corporate governance, in this regards, has become a differentiating strategy. Corporate governance’s role, in an organisation’s long-term sustainability, is profound.

According to Afrinvest, “GTBank is one of few Nigerian banks to place emphasis on international recognition and world standards in corporate governance as a deliberate corporate strategy.” Irrespective of external pressures.

Banks that insist on such principles from the onset, instead of waiting for such pressures to arise, are better positioned to thrive in the new environment. They are better equipped, from a corporate perspective, to sustain the course amid the storm.

Rather than being hurled hither thither, banks with stronger corporate governance had in place the mechanisms and structures to manage post-consolidation risks. Invariably, properly constituted Boards dictate the pace and risk threshold.

Gird your loins

But this doesn’t take away the role of regulators. To insist on principles of corporate governance isn’t to spell out the rules and punish offenders. People must trust that such laws will be enforced – fairly and without favour.

So, will the provision of more information perk up the confidence level in Nigerian banks? Not exactly. Two problems: information and incentives can’t be ignored. Banks with no incentive to disclose information will try to slow down or prevent regulatory reforms. (The common year-end for banks was supposed to have begun last year).

Then there’s the issue of the integrity of information provided. In extensive interview with the Financial Times (FT), the CBN governor was asked if IFRS would be made mandatory. He replied that “it’s extremely important to understand that if the problem is the integrity of data being presented, then IFRS does not address the problem”. He also added “there’s nothing that stops them [banks] from presenting false numbers under IFRS.”

However, regulators can get the best of both worlds. External supervision can stimulate self-regulation by making public the erring banks and their true situation. Banks concerned about their reputation will then take compliance seriously.

John Kay, an economist and FT columnist, in his book The Truth about Markets, doubts if insistence on information and disclosure work. According to him, “Reputation is a powerful mechanism, but only external supervision can ensure that reputations are only earned when deserved.”

This article originally appeared in BusinessDay on July 3rd 2009

One Comment leave one →
  1. August 26, 2009 9:21 am

    This post is spot on. It is even more timely now with the on going shake-up in the banks.
    GT Bank has to a large extent created a good impression with their “emphasis on world standards in corporate governance as a deliberate corporate strategy.”
    In a rough sampling of 5 friends, all of them gave GT Bank as one place where they didn’t suspect any boardroom hanky panky and felt thier money was safe in.

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