Last days at Lehman
The run-up to the collapse of Lehman Brothers (“the bank”) was fraught with confusion, panic, and several last-minute attempts at saving the bank. Not just weeks before its eventual collapse, but several months prior.
As far back as August2007, it was apparent to many in the financial world that all was not well at the bank. Following the collapse of two of Bear Stearns hedge funds, Lehman’s shares fell sharply and cracks had begun to appear in the US housing market. It was no secret that Lehman was the largest underwriter of mortgage-backed securities (MBS) and, at this point, ought to have trimmed its mortgage portfolio. Rather it continued to underwrite more MBS than any other bank globally. By the end of 2007, Lehman had amassed a portfolio purported to be worth USD85billion, approximately four times its net worth. In March 2008, following the near collapse of Bear Stearns (they were eventually bought by JP Morgan), Lehman stock fell 48 percent. Fund managers, aware of the size of Lehman’s portfolio, and already questioning its valuation, began betting against the firm. This precipitated a steady and unstoppable decline in the bank’s share value. Management, in a bid to stem the decline, embarked on overtures which sometimes appeared incoherent and largely unsuccessful.
Firstly, steps were taken to sell toxic assets to a newly formed hedge fund, which was staffed by former Lehman MDs and employees, and had Lehman as its main investor. Then there was the announcement that the bank would be spinning off its asset management and commercial real estate portfolio to a ‘bad bank’ which would be then sold. This was followed by the frantic search for a buyer, including the Korean Development Bank. Unfortunately, the market had begun to realise Lehman’s plight and its valuation of the bank was less than the shareholders of Lehman were willing to accept. Eventually, the bank was allowed to fail setting off the global financial crisis, effects of which are still reverberating around the world today.
The FSB, Dodd-Frank and the Basel Committee
The contagion from the collapse of Lehman Brothers was immediate. Banks, insurance companies and hedge funds struggled to remain solvent. A few collapsed, while several had to be bailed out. The US and UK governments committed a total of USD29 trillion and GBP850 billion, respectively, of taxpayers’ money to assist the ailing institutions.
In response to this global crisis, the G20 leaders at a summit held in 2009 announced the creation of the Financial Stability Board (FSB). The FSB was made up of central bank governors and its primary purpose was to address vulnerabilities in the financial services sector.
In 2012, the FSB and Basel Committee of Banking Supervision (BCBS) put forward proposals designed to reduce the likelihood of a systemically important financial institution (SIFI) failing, and in the event of failure, the impact on the financial system will be reduced. Among other things, SIFIs were required to prepare and submit credible Recovery and Resolution Plans.
SIFIs within the EU, USA and Canada have been preparing and submitting Recovery Plans since 2011.
Nigerian banks
In 2009, Nigeria was facing a banking crisis of its own. The global economic crisis, declining oil prices, and excessive margin lending were having a negative impact on many financial institutions. Prior to this the Nigerian stock market had been one of the world’s best performing which had led to a steady increase in margin loans to customers. Margin loans are loans made by brokerage houses (many of whom were subsidiaries or affiliates to the banks) to clients which allow them to buy shares on credit – i.e., an investor could buy shares using a small portion of their own funds. The rest is provided by the brokerage with the shares held as collateral. The banks were financing about 65 percent of the Nigerian capital markets at this time through the margin facilities granted to investors and brokerage houses. Many banks shifted focus from providing credit to the real sector and instead favoured playing the capital markets for short-term speculative gain.
As the global financial crisis continued to bite, there was a large exit of foreign portfolio investors. Further to this, weak regulation allowed for unprofessional conduct by the banks and stockbrokers. Practices such as the setting up of special purpose vehicles to lend money back to themselves for stock price manipulation were rife. All these contributed to the crash in the Nigerian stock market. Several banks had a large exposure to equity-related loans which resulted in a spike in non-performing loans.
An examination of all banks in 2009 by the Central Bank of Nigeria (CBN) found that ten banks, accounting for a third of the banking assets, were either insolvent or under-capitalised. Just as in the US and UK, the Nigerian government through the CBN had to inject N620bn (of taxpayers’ funds) into the banking sector to provide liquidity and recapitalise the banks.
In September 2014, CBN and NDIC, in line with global trends and as part of reform efforts to ensure financial stability in Nigeria, issued a framework for the supervision of domestic systemically important banks (D-SIBs).
Banks are classed as systemically important if their distress or disorderly failure causes significant disruption to the wider financial system and economic activity. Systemic importance of a bank is determined by size, interconnectedness, substitutability, complexity of its business model, structure and extent of operations. In Nigeria, the largest and most complex banks, of which there are eight, account for more than 70 percent of the total industry assets.
This framework stipulates, among other things, higher loss absorbency, more stringent liquidity standards, and quarterly capital and liquidity stress testing. In addition, all DSIBs are required to submit their first set of Recovery Plans to the regulators on 1 January, 2016, and every year thereafter.
Emeka Ilomechina
