Even as we struggle to make meaning of the country’s dire economic straits, it was without doubt a high watermark in the evolution of the financial services industry.
Two discount houses, Consolidated Discount House Limited, and Express Discount House Limited, imploded in chorus, and there was barely a murmur heard anywhere. Banks remained open. And there was no run on the industry — not even on the remaining discount houses.
How much of this remarkable resilience is due to the better risk management practices of operators in the sector — the interbank market where these discount houses had leveraged their positions did not miss a step — is open to debate. But no one can deny that the Central Bank of Nigeria’s (CBN) prompt response to the problem helped put a lid on it. The CBN’s investor refund programme guaranteed all investors in the failed discount houses a return of their principal.
It could be argued whether the yields these investors forfeit is adequate enough punishment for not paying attention to the fortunes of these companies. Similarly, there is space for interrogating by how much a blanket insurance of this nature aids the process of strengthening the market in its oversight of the industry. The regulatory challenge is to structure compensation for losses to investors and depositors in a way that the final pay off hurts them enough to interest them in the governance of those financial institutions into which they put their funds.
Investors in both discount houses should have known that they were treading water. Or should they? The industry’s regulators apparently had no inkling, either. Which is strange! Because the CBN’s claim to have moved to a risk-based supervisory regime in response to the 2007/2008 global financial and economic crisis means that it ought not to have missed serious build up of distress in one discount house. Not to mention two, almost at the same time. Then, again, both these institutions were evidently not systemically important.
Nevertheless, over the weeks since the CBN intervened to keep the floor beneath the markets, after the recent discount houses failure, it has emerged that this might not be the only supervisory failure. A far more disturbing (because of its long-term implications for efforts at raising the economy’s savings rate) problem has emerged in connection with the CBN’s decision to similarly treat two classes of investors (treasury bills holders and time depositors) in the failed discount houses.
Investors in treasury bills instruct their bankers (or discount house, in this case) to buy treasury bills on their behalf. Issued by the CBN to manage domestic liquidity, treasury bills are re-discountable through licensed money market dealers, and (because they have a sovereign guarantee) carry no risk — both initial sum invested and the return on it will always be paid. Consequently, they are the risk-averse investor’s haven of choice. Time deposits, on the other hand, are deposits placed with banks (or discount houses) by investors who negotiate a favourable rate of return and tenor. These form part of the working capital of the financial services industry. Hopefully, deposit taking financial institutions are able to lend these funds out for far more than they pay on them — the net interest margin. Accordingly, these deposit categories run all the risks that the deposit taking institutions face.
In the resolution of a failed financial institution, to treat both these instruments as if they were the same is to threaten retail investors’ belief in treasury bills as a risk-free instrument. It is, to put the same point differently, to heighten the risk profile of domestic savers.
To argue that the discount houses may have encumbered their treasury bills holdings (discount houses are custodians of their retail investors’ treasury bills holdings) by using these instruments as collateral in the interbank market, is to miss a point, and raise a regulatory challenge.
The point missed in this argument is a simple one. The discount houses can only alienate instruments that they have title to. Indeed, the counter-parties who lent to these discount houses against instruments properly belonging to the formers’ clients run a great risk. The regulatory challenge is no less simple. It is posed by the need to ring-fence proprietary treasury bills (owned by banks and discount houses) from the ones they hold in custody for their clients.
I hear that this may not be as easy as it sounds. Indeed, I would be loth to add another layer of regulation to the industry. Why not instead compel the counter-parties to the two failed discount houses (those which hold the retail investors’ treasury bills) to pay the coupon on the instruments? After all, they have no real title to the instruments.
Support PREMIUM TIMES' journalism of integrity and credibility
Good journalism costs a lot of money. Yet only good journalism can ensure the possibility of a good society, an accountable democracy, and a transparent government.
For continued free access to the best investigative journalism in the country we ask you to consider making a modest support to this noble endeavour.
By contributing to PREMIUM TIMES, you are helping to sustain a journalism of relevance and ensuring it remains free and available to all.
TEXT AD: To advertise here . Call Willie +2347088095401...