As the Nigerian financial sector cannot be said to be efficient, stable and significantly contributing to the economy even with the existence of the formal banking sector in Nigeria since 1892 (about 124 years) and with the many regulators (CBN, NDIC, SEC, NAICOM, AMCON), there is a pertinent need for the total overhaul of the regulatory architecture of financial sector regulation in Nigeria. While Central Bank should be restructured with a Prudential Regulatory Authority of Nigeria (PRAN) created within the Central Bank, another agency, the Financial Conduct Authority of Nigeria- FCAN) should be created to regulate and supervise the conduct of the business of all financial institutions within Nigerian financial sector.
This approach generally referred as Twin-Peaks approach will lead the scrapping of SEC, NAICOM, NDIC and AMCON with their respective two main functions- prudential regulation and conduct of business supervision allocated to the two sub-agencies (PRAN and FCAN)to be created. Published by the very reputable UK Journal of Banking Regulation, (vol 17:4: 311-331: 2016), the authors, Franklin N Ngwu (Senior Lecturer in Strategy, Finance and Risk Management, Lagos Business School) and Folarin Akinbami (Lecturer in Law, Durham University, UK) argue that adopting this approach will enhance the contribution of the financial sector to the economy.
It will lead to the achievement of the three key objectives of regulation- systemic stability (achieved through macro-prudential and micro-prudential regulation), consumer protection and the maintenance of the integrity of the financial markets. Also, it will help to refocus the CBN to its core responsibility of monetary policy and then prudential regulation of the financial sector through the sub-agency- Prudential Regulatory Authority of Nigeria (PRAN) to be created.
At present, not only in Nigeria’s financial sector marginally developed, the regulatory outcomes from the different sub-sectors are not encouraging. While the inflation rate is presently above 15%, the exchange rate remains volatile with $1 exchanging for about N360.00. Insurance penetration remains at about 1 per cent with over 70 per cent of the population excluded from the formal financial sector. Only 7 per cent of adults and 5 per cent of firms have loans from the formal banking sector even when 80 per cent of the SMEs perceive access to credit as a major problem for their growth.
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From 2008 to 2016, the average credit provided by the Nigerian banking sector as a percentage of GDP was about 28 per cent. It was 184.22 per cent in South Africa and 214.32 per cent in the United Kingdom from where Nigeria adopted her financial and other economic systems. In 2015, it was about 22% in Nigeria but 180% and 163% for South Africa and the UK respectively. Currently, while the lending interest rate in Nigeria is over 20% it is about 10% per cent in South Africa and 0.5 per cent in the United Kingdom. In 2012, only 192 companies were listed at the Nigerian Stock Exchange with the total market capitalisation of the listed companies as a percentage of GDP at 12.3 per cent. In the same year, it was 348 and 160 per cent in South Africa and 2179 and 122.7 per cent in the United Kingdom, respectively.
With these results, it can be argued that the regulation of the Nigerian financial sector has not been very effective. As achieving an adequately regulated and contributory financial sector depends, among other things, on the creation and functioning of an efficient regulatory structure, the question, therefore, is what regulatory structure should Nigeria adopt to achieve a more stable and contributory financial sector.
Key objectives and elements of regulation
Of the different objectives of financial sector regulation, the three most significant objectives are systemic stability (achieved through macro-prudential and micro-prudential regulation), consumer protection and the maintenance of the integrity of the financial markets. These objectives relate to the five elements of regulation –the first is the aim or objectives of the regulation and these will usually reflect the public interest in some way. The second element of the regulation is the framework of rules or regulatory standards (it is important to get the content and structure of the rules correct), while the third element is the institutional structure of the regulatory regime, that is, the structure and number of regulators that oversee the regime as well as the powers and responsibilities given to the regulators. The fourth element is the supervisory approach, that is, the approach the regulator takes towards delivering the regulatory objectives, for example, the intensity with which it carries out on-going monitoring of the regulated firms, while the fifth element is enforcement which refers to the sanctions imposed on the regulated for non-compliance with the rules. Getting all of these elements right is integral to the success or failure of a regulatory regime.
Which regulatory structure is best for Nigeria?
Given its importance, this article focuses on the institutional structure of regulation. Reason being that the institutional structure of regulation contributes to the achievement of the objectives of the regulatory regime and maintains a significant impact on the overall effectiveness of regulation and supervision. It also impacts on the costs of regulation and the clarity of responsibility for particular aspects or objectives of regulation. It is therefore important that policymakers put in place the appropriate institutional structure for a financial services regulatory regime.
Of the key three approaches (institutional, functional and objectives-based), the optimal structure will depend on several factors such as the particular circumstances of the country, its financial system, the personalities and abilities of the regulators and the nature of the country’s financial services markets. There is no single institutional structure that is ideal for all countries and it would be a mistake to view a particular structure as a panacea. However, it is now clear that the interconnected nature of modern-day financial systems means that insurance firms and securities firms can be so interconnected to other firms in the financial system that their failure could trigger a crisis in a national or global financial system. Also, the increase in shadow banking in recent years means that there are a large number of financial firms that are not regulated conventionally as banks but which perform similar functions to banks and therefore pose similar risks to the financial system.
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As Nigeria currently uses the institutional approach characterised by regulation of every single category of the financial operator or over every single segment of the financial market by a particular regulator, we argue that given the performance so far and the inherent challenges and development in Nigeria’s financial sector, it is imperative to adopt an objectives-based approach with a Twin-peak highly advocated. The current institutional approach has outlived its usefulness. It is a simple scheme based on, and conditional on, the uni-dimensional activity of the regulated firms. There is a focus on the type of institution being regulated rather than the range of activities the firm actually performs for example banks, insurance companies and securities firms.
Why the twin-peak approach
In the advocated objective-based approach, regulation is carried out based on the objectives that the regulator is tasked to achieve. A regulatory structure based on objectives will have one or more regulators, each tasked with a specific objective such as prudential regulation or consumer protection. It will often be asked to do this on a cross-sectoral basis, which is, without regard to the type or function of institutions being regulated. The strength of this approach is that it allows a stronger link between two of the elements of regulation discussed above – the objectives of the regulation and the institutional structure. Where appropriate, aligning these two elements in this way can contribute significantly to the success of the regulatory regime.
There are currently two types of objectives-based approaches: Single, integrated regulator and Twin Peaks. An objectives-based approach could, alternatively, have more than one regulator, each tasked with different objectives. Twin Peaks is an institutional structure where there are two regulators each of which is tasked with securing one of the two major objectives of regulation –prudential regulation and consumer protection. Twin Peaks has been described as ‘the sound’ institutional model for financial market supervision. The financial crisis serves as empirical evidence that prudential regulation and conduct of business regulation are not necessarily closely aligned, with the implication of this being that a single regulator is not necessarily able to manage those two objectives and therefore there is a stronger case for an objectives oriented approach along the lines of Twin-peaks.Twin- Peaks would also appear to be cheaper than having multiple regulators. It would lead to economies of scale as compared with having multiple regulators. Moreover, Twin Peaksallows for a clearer focus on different regulatory objectives.
Where Twin Peaks assigns the central bank with the responsibility for prudential supervision, this usefully eliminates inter-agency fault lines in the flow of macro- and micro-economic information and locates all that information within the institutional group that will have to make critical lender of last resort judgment calls. On this basis, we argue that the CBN is not an effective regulator of consumer protection. It is simply too much to ask of a regulator in this day and age to carry out this multitude of functions, and for this reason, we advocate the transfer of consumer protection of banks’ customers to a new consumer protection regulator (Financial Conduct Authority of Nigeria).
Goodhart et al (1998) have argued that ‘the ultimate criterion for devising a structure of regulatory agencies should be the effectiveness and efficiency of regulation in meeting its basic objectives’.Regulators are arguably the most effective and efficient when they have clearly defined and precisely delineated objectives with clear and precise mandates. A clear, internal management focus is more likely to be created when the objectives of the regulator are clear and precise and this can be best achieved through an objectives-based regulatory regime, based on the Twin Peaks model. As systemic (macro-prudential) regulation is different from prudential (micro-prudential)regulation, there is a question of whether both should be carried out by the same regulator. With a better understanding of the regulatory lapses that contributed to the recent financial crisis, it is appropriate for the same regulator to be in charge of both macro-prudential and micro-prudential regulation.
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As Twin Peaks allows this, it is, therefore, a desirable institutional structure for financial regulation. The objectives-based system using Twin-Peaks equips the regulators to respond to changes and developments in the financial markets. Systemic risk no longer arises with banks alone and can come from either Insurance or securities firms or both. Twin Peaks provides the opportunity to recognize (and address the fact) that systemic risk no longer arises with banks alone. This is because integrating the micro-prudential and macro-prudential regulation of banks, insurance companies and securities firms into one regulator gives that regulator the authority to supervise all firms posing either micro-prudential or macro-prudential risks. In effect, structuring the regulator based on objectives rather than institutions addresses the issue of systemic risk posed by non-banks (insurance companies and securities firms).
With the higher availability of capital since the 2004 banking consolidation, there is increasing growth and involvement of Nigerian banks in other non-banking financial services. Appropriately described as a ‘blurring of the boundaries between products and services, both the banking and non-banking activities of the financial institutions will require effective prudential regulation for capital adequacy. Allowing this fundamental aspect (capital adequacy) of regulation to be institutionally pursued by different regulators might be both time and cost-inefficient for both the regulator and the financial institutions. Furthermore, with the involvement of the banks in other non-banking activities, the assessment of risks and the calculation of capital requirement have to be done within the context of their different activities and the interconnection of the activities. Interestingly, how the involvement of banks in non-core banking activities in developed economies contributed to the global financial crisis shows that the risk assessment and capital requirement should be calculated not only based on individual institutions but the financial system as a whole. With the assumption that the banking supervision of the banks, particularly the capital adequacy issues, is retained with the central bank, it is further argued that all aspects of prudential regulation of the non-core banking insurance, securities and other firms should also be transferred to the prudential unit of the central bank (Prudential Regulatory Authority of Nigeria). This will help in the comprehensive understanding and monitoring of the capital requirements of both the banking and non-banking activities of the financial groups or holding company which is in line with the merits of combining both micro and macro-prudential regulation to ensure systemic stability. In the same vein, all consumer protection issues in both banking and non-banking activities should be transferred to a consumer protection agency (Financial Conduct Authority of Nigeria) that should be created for this purpose.
As consumer protection raises mainly micro issues while prudential (systemic stability) raises both macro and micro issues, a more stable and reliable financial sector will be achieved through the collaboration of the streamlined regulatory institutions under a Twin-Peaks approach. Moreover, there is bound to be greater accountability and transparency when it is clear precisely what regulatory agencies are responsible for. Twin Peaks will mean that where regulatory objectives conflict, the conflict will not be dealt with externally and at the political level, which according to Taylor is the best way to resolve such conflicts because it is more publicly accountable. The institutional approach towards the structure of financial regulation, which Nigeria currently uses, is characterized by duplication of duties and waste of scarce resources due to the need to hire and pay for regulators that will perform similar duties in the different regulatory agencies. For instance, effective regulation of insurance, securities and mortgages will require the hiring and payment of regulators that are conversant and competent in prudential regulation. Nigeria, like other emerging and developing countries, struggles in terms of adequacy of skills and resources, and this contributes to the weak regulation and limited development of the financial sector.
Moreover, as the central bank currently supervises the banks, what is therefore required is the strengthening of its regulatory capacity through the merging of the relevant units of the other regulatory agencies with that of the central bank (Prudential Regulatory Authority of Nigeria). This will ensure not only the application of economies of scale and scope in availability and utilization of skills but also effective regulation of the financial institutions through the sharing of ideas from their previous agencies and the enhanced tacit knowledge that will evolve. Even the financial institutions will prefer this approach due to the reduced bureaucratic and regulatory engagements that will emerge in addition to the lower regulatory fees that they will pay.
Franklin N.Ngwu (PhD) and Folarin Akinbami (PhD)
