Category Archives: Financial Services in Nigeria

Africa Banking Industry Retail Customer Satisfaction Survey

To succeed in today’s banking environment, bank executives need to understand their customers: their preferences, their channel usage, their needs and their satisfaction.

Much has changed across Africa’s banking industry in the past three years. In 2013, when we published our first edition of the Africa Banking Industry Customer Satisfaction Survey, our report found that retail customers were most concerned about the financial stability of their banks. Fast forward to 2016 and the rules of the game have changed.

Customers are still concerned about financial stability; but what they primarily want from their banks is enhanced high-quality service, more innovation and greater convenience.

Some of the reasons for this shift are obvious. Regu-lators across the continent have been highly focused on building up the stability of their banks with higher capital ratio requirements, tighter lending requirements and more stringent regulatory requirements. In some cases, this has led to consolidation as smaller, less capital efficient banks are squeezed out of the market.

In many other cases, it has raised customer and investor confidence as the banking sector regains strength. At the same time, other regulatory and policy reforms – this time focused on improving financial inclusion as a way to drive economic growth and development – have driven higher levels of competition across many markets.

Regional players have continued to expand their footprints across Africa, emboldened by more liberalized market

regulation and the growing maturity of regional trade and economic blocs.

New entrants and non-traditional players are gaining a foothold in many markets, further intensifying

competition and creating disruption. At the same time, however, these new players have also widened financial

literacy amongst Africans and – in many cases – heightened expectations of how traditional banks

should operate.

With more competition and fewer concerns about the stability of their banks, Africa’s banking customers have naturally started to differentiate their banks based on their experience when interacting with their banks.

The problem is that ‘customer satisfaction’ is not a single lever or discreet project that banking executives

can simply invest into, activate or install. Rather it is a complex web of facets and perceptions, all of which

combine to create the customer experience. There are dozens of potential levers and thousands of combinations

that can be pulled, and no two banks will pull them in the same way.

Our survey demonstrates that branches continue to be most preferred channel for Africa’s banking customers. But our data also suggests that use of alternative delivery channels is on the rise in most African markets. As more options become avai lable, our survey shows that customers are increasingly shifting their preferences towards these channels. This report also suggests that efforts by Africa’s banks to improve customer service have started to pay off with the majority of customers now saying service has improved. Half are happy enough to recommend their bank to others. However, the data also shines a spotlight on some key areas for improvement for Africa’s banks, particularly given the rising levels of competition in most markets. Based on our data, this report provides a number of clear suggestions for Africa’s banking executives:

• Improve the quality of interactions between employees and customers Ninety-one percent say that staff’s attitude and their knowledge of products is important and almost 83 percent say they are satisfi ed with these measures. However, while customers believe that prompt responses to their complaints are equally important, just 77 percent are satisfi ed with their banks in this regard. • Increase the focus on delivering fast, accurate and timely transactions Eighty-nine percent say that the timeliness of transaction processing is important to their satisfaction, but just 33 percent are currently satisfi ed with this measure. Similarly, 90 percent say that receiving accurate and complete information from banks is important but just 34 percent are satisfi ed with the information they receive.

Ecobank unveils more banking lounges

Ecobank unveils more banking lounges

The services include a bouquet of lifestyle enriching products to address their day-to-day banking needs with dedicated relationship managers, whose main function is to give specialised services and on board the customers to all our service points.

Ecobank Nigeria has unveiled three additional lounges in Uyo, Port Harcourt, and Abuja, meant for its “Advantage Customers.”The innovation was scripted to offer dedicated banking services targeted at the upwardly mobile customers and generally, professionals in various fields.

The services include a bouquet of lifestyle enriching products to address their day-to-day banking needs with dedicated relationship managers, whose main function is to give specialised services and on board the customers to all our service points.

Speaking at the opening of the Lounge in Abuja, the Group Head, Personal Banking, Mrs. Olukorede Demola-Adeniyi, said the decision to establish lounges in various parts of the country was conceived to promote excellent banking services to its customers. She noted that customers in the Advantage Banking segment would have opportunity for personalised services in the various lounges.

According to her, the lounge, which is fully kitted with state of the art digital touch screen computers, will further create a conducive and comfortable ambience for Advantage customers to do their transactions with ease.

“It is our effort to raise the bar in service delivery for our customers. As a Bank, we cherish and hold our customers in high esteem and would want to hear them speak to us, while we listen and make deliberate efforts to provide the best service delivery channels and outlets available to them. Our plan is to open more of such outlets in most parts of the country,” she said.

In addition, the Gold debit and credit Mastercard is available to these customers in local and foreign currencies, which enable customers’ access loyalty benefits/discounts from the bank’s partners – hotels, boutiques, and fragrance shops amongst others.

At the commissioning of the Abuja Lounge, the Managing Director, Tom Hawksworth Limited, Adekola Isaiah Ogundayo, commended Ecobank for promoting the interest of its customers and expressed optimism that the lounges would attract more customers.

How to Maximize Financial Stability and Inclusion: A Framework

Achieving greater financial inclusion and maintaining financial stability are mutually reinforcing policy compulsions and the challenge is how to ensure both while exploiting the synergies between the two objectives. A possible answer arguably lies in a facilitative regulatory environment which ensures that the formal financial system delivers affordable financial services to those excluded from the financial system with greater efficiency without compromising on the acceptable levels of safety and soundness.

First, for financial inclusion to be expanded through financial regulation, market uptake is critical. Passing enabling regulation does not guarantee increased access. Current research on the financial behavior of the poor shows that they already employ informal financial tools in a sophisticated way (Collins et al, 2009). An understanding of the needs and incentives of 133 Box IX.1: Reconciling Financial Inclusion and Stability: Insights from the South African Experience The South African financial sector policy includes 4 priority objectives namely, financial stability, consumer protection and market conduct, financial inclusion and financial integrity. A recent CGAP report assessed the effect on stability of 5 decisions made by the South African government to support financial inclusion. These are: • Permitting payroll deduction for repayment of small loans (1993-2006) • Banks’ commitment to provide affordable housing loans (2003) • Alleviation of the Know Your Customer (KYC) requirements to allow banks to offer simplified “Mzansi” accounts to the unbanked (2004) • Enactment of the law on cooperative banks to allow formalization of informal providers and creation of new financial cooperatives (2007) • New regulatory framework for micro-insurance (2011). It is estimated that these decisions lead to the following outcomes in terms of financial inclusion and stability:

the users of financial services is therefore a critical step in the design of a proper regulatory strategy. An essential attribute to the kinds of financial services that people may want is the nature of employment in a country. This is important to identify sectoral-specific opportunities to improve productivity. If, for example, the bulk of the workforce is self-employed like in Mali this implies the need for a reliable and low-cost source of working capital, which would allow them to optimize on their inventories. Discovering such opportunities and converting them into viable lending models is something the financial sector may benefit from, and regulators can provide the right set of incentives.

Equally important is how the poor spend their money. This is important to provide incentives for the development of products that can help the poor meet these expenditures without bearing a crushing burden. For example, in some countries such as Guinea or Sierra Leone, one of the most significant unusual expenditures is on medical treatments. This indicates the need for a low-cost health insurance scheme. It is also essential to analyze investment and savings motivations. Typically, the primary channels for deploying financial savings are bank deposits and the mattress. A key question is why people prefer to keep their savings in a certain proportion that may not optimize their risk-return profiles. One possible explanation is that investment options are subject to a minimum threshold which may not be accessible to the poor. From a financial inclusion perspective, the challenge is to lower this threshold in a way that does not compromise the commercial viability of the service providers. The same logic applies to the motivations driving savings behavior. These are typically old age, children’s education, ceremonies, and emergencies. For all these requirements products and services are generally available yet threshold requirements apply. The possibility to lower these thresholds in a viable manner should be explored.

Challenges to the Development of Technology-Based Financial Services

While technology emerges as a short cut to financial inclusion in Africa, various obstacles have been preventing the development of technology-based financial services at a large scale. These include:

Stringent regulation: Several African countries are still missing regulatory frameworks that govern the activities of technology-based financial services, including mobile financial services. For instance, M-payments require the accepted use of electronic signatures, such as a PIN number to authorize transactions. If the e-signature is not legally valid, the transaction could be challenged. There is therefore a need to provide status to electronic transactions equivalent to that achieved by physical signature. Moreover, international Anti Money Laundering/Combating the Financing of Terrorism (AML-CFT) standards require that adequate customer due diligence (CDD) be undertaken on all new accounts and on single payment cash operations to identify suspicious transactions. National laws and regulations in Africa typically require verification of: (i) client identity using an official document and (ii) client’s physical address. This constraints the outreach of technology-based solutions as only 22% of African households receive mail at home and a large share of them does not have identity documents.4 This calls for clear regulatory frameworks for technology-based solutions and flexibility in the application of CDD requirements.

Limited interoperability: Reaching an optimal scale for a provider of technologybased financial services requires interoperability at many levels. The ideal situation is to have a widespread access to a point of sale to allow customers to perform a large spectrum of operations. According to the outcomes of the Global Payment Systems Survey conducted in 2010 by the World Bank, less than 20% of the products were reported to be fully and partially interoperable. This limits the attractiveness of technology-based solutions to customers and leads to a low level of usage.

Scarcity of qualified Agents: The ability of agents to drive transaction volumes, educate customers on how the service works and deliver error-free transactions have major bearing on the success of a technology-based financial solution. The 2011 GSMA Global Mobile Money Adoption Survey shows that agents of the eight fastest growing mobile financial services deployments had significantly more activity (up to 64.8 transactions per active agent outlet per day) relative to agents of other services (average of 3.8 transactions per active agent outlet per day). Well qualified agents are not always easy to find in Africa. It is only through well trained agents that success of technology-based solutions can be ensured.

Low levels of financial literacy and income: Africa holds one of the lowest literacy rates in the world. In this context, the population’s ability to understand technology-based financial services is not optimal. Hence, financial literacy programs are needed to inform 114 customers and show them how these services work and the risks involved. In addition, adoption of solutions tailored for smartphones will eventually become widespread in Africa but so far smartphones are unaffordable to a large share of the population.

Growth in mobile phone penetration has revolutionized the delivery of financial services in Africa. Specifically, the emergence of mobile money transfers and mobile banking put Africa firmly at the forefront of the global mobile money industry. However, regulators have the difficult task of striking the right balance between supporting growth-enhancing innovation and implementing prudent regulation and effective risk-based supervision. This partly explains why new electronic or technology-based financial services have so-far gained momentum only in a handful of African countries, and in some of these with regulation thus far kept to a minimum. In Africa where financial services are a distant dream to millions of people there should be considerable lead from the government and other financial institutions to foster the financial inclusion agenda. Nevertheless, successful experiences implemented in Kenya, Tanzania and South Africa have shown that mobile financial services have the potential to significantly reduce the number of unbanked in Africa. This could boost domestic savings, incoming money transfer from diaspora and lower the cost of doing business by SMEs and the overall private sector, all of which should help Africa achieve greater development and move out of poverty. This requires among others: · Provision of conducive regulatory frameworks: This would allow operators to pursue innovative approaches to reach the bottom of the pyramid. Governments should also design policies that enforce regulation set by central banks regarding financial inclusion strategies. This could entail for example the implementation of a ceiling for acceptable cash payments. For example, in WAEMU, all payments due by or owed to the government, in the reference amount or above, must be paid by a check, wire or any other scriptural payment method at a post office or a bank. The reference amount is set by a ministerial decree to 100,000 CFA francs in the Union.

Data collection to underpin strategies: There is a strong need to gather sufficient and reliable data in order to better understand the baseline and starting point of access and usage of financial services. Country level data and diagnostic assessment can inform the design and sequencing of a strategy and can be useful to the private sector to adapt the design and delivery of financial services.

Promotion of Mobile Government-to-person payments (G2P): According to a CGAP/DFID note, only eight African countries have been involved in technology- based G2P transactions in 2009. Governments are important payers and all payments such as salaries, social benefits, pensions, and student scholarships could be processed using technology-based solutions such as mobile financial services. This would reduce delays, errors or fraud, and 115 other risks related to G2P transactions. However, the sustainability of such payments is as crucial as their implementation mechanisms. This relates to the fact that a lack of a paired infrastructure for continuous use (merchant network) and awareness campaigns can provoke G2P failures as it has been the case in some Latin American countries and in India.

 

Going Beyond Mobile Financial Services

As most African economies remain cash-based, cash in/ cash out points, in the form of ATMs or Point of Sale (POS) terminals are essential elements for financial service delivery provided efficient payment and settlement systems are in place (Box VII.3). In Sub-Saharan Africa, the number of ATMs and POS remains limited. For example, in 2010, Botswana counted 21 ATMs and 288 POS terminals per 100,000 people while in South Africa the number of ATMs and POS stood at 52 and 700, respectively. However, the number of ATMs and POS has been growing at a high pace, the second highest in the world after South Asia.3 This growth has been fostered by reduced prices of hardware and supporting infrastructure. Debit and credit card readers now cost as little as USD 125 and operate wirelessly. Debit and credit cards are likely to help banks cater for the poor because they reduce delivery time and costs. This was supported by the findings of a 2010 CGAP survey which shows that 62 financial institutions from 32 countries use technology channels, such as ATMs and POS card readers and mobile phones, to handle transactions for poor customers. The advent of the internet has also revolutionized financial service delivery, empowering organizations with new business models and new ways to offer 24 hour accessibility to their customers.

Technology and Banking in the WAEMU The West African Economic and Monetary Union (WAEMU) achieved significant improvements in the union’s payment and settlement systems. The Real Time Gross Settlement System (RTGS) and the Automated Clearing House were implemented in 2004 and 2006 respectively while the card-based interbank system (GIM-UEMOA) was put in place in 2007. This system, which counts 105 banks, three microfinance institutions and one Electronic Money Issuer as members, has recorded over 1.5 million transactions in 2012. ICTs have played a major role in these achievements. Today, members have centralized operations in one platform and many banks in the Union are moving towards network-based computing, networked ATMs, internet banking, smart card based products. ICTs have also been used for customer relationship management, customer transaction pattern analysis, credit profiling and risk management. Yet, physical outreach in the union remains low compared to other African regions. At end 2011, the global retail network consisted of 1,560 branches, 1,500 POS and 3,200 ATMs for a total population of approximately 94 million.

Linking financial development and economic growth in Africa: existing evidence

Linking financial development and economic growth in Africa: existing evidence Examining the linkages between financial development and economic growth requires addressing two separate but related empirical questions. The first is whether the overall development of the financial system leads to higher economic growth. The second question is to identify the channels through which financial intermediation affects economic growth.

The empirical economic growth literature has addressed the first question by relating indicators of financial development to the growth rate of real per capita income in growth models including conventional determinants of economic growth (especially investment, human capital, and initial income). While there are only a handful of studies that focus explicitly on Africa, the existing evidence suggests that financial development has a positive effect on economic growth. Odedokun (1996) and Spears (1992) find that aggregate measures of financial intermediation have positive and statistically significant effects on the growth rate of real per capita GDP. Allen and Ndikumana (2000) find similar results in the case of the Southern African Development Community. Gelbard and Leite (1999) also find results that suggest a positive and statistically significant link between real per capita GDP growth and their indices of financial development. They find that both the level of initial financial development and the change in the overall financial development index between 1987 and 1997 are positively and significantly 19 related to economic growth. 17 Their results confirm the findings from earlier studies that concluded that the initial level of financial development is an important determinant of future economic growth (King and Levine 1993a). Gelbard and Leite (1999) also find that the changes in the indexes of financial liberalization, the institutional environment, and the array of financial products enter the growth equation positively and significantly.

To address the second empirical question, researchers seek to examine how financial development affects the factors that are believed to cause economic growth. These include capital accumulation, factor productivity growth, and saving. Crosscountry studies have made significant advances on this front,18 but evidence on African countries remains limited. However the existing evidence suggests that research in this area is promising. Ndikumana (2000) finds that financial development positively affects domestic investment. At this point, we are not aware of empirical studies that have linked financial development to factor productivity growth or saving in Africa.

The Fintech Challenge and the New Face of Banking By Austin Okere (Part 1)

Should Banks be changing?

After centuries of conservatism in receiving deposits and making loans, should banks be changing? There are two main issues stirring the yearning for change: The first being that it is a very difficult Club to join, and hence the large population of unbanked adults. Secondly, even for the members of this elite club, the relationship is acutely skewed in favour of the banks; naturally so, as they have carried on as protected monopolies with no serious challenge or competition, resulting in no significant innovation over the decades.

The biggest threat to the banks has been precisely their seeming success. Centuries of relatively significant higher returns, even in the midst of economic downturns that adversely affect the real sectors, has engendered an attitude of invincibility and pomposity, characterized by a loss of touch with their customers. Considered too big to fail, they take it for granted that they will be bailed out with taxpayers’ money in the event of any missteps – a perfect prey for disruption.

Fintech – the new kid on the block

Today, there has emerged a powerful force of challenge from Financial Technology companies or FINTECHs, as they are more popularly referred to. The promise of Fintech is great. It is shaking up a stodgy banking system and helping to build a more efficient one, especially for consumers and small businesses.

Emerging Markets showing the way in Fintech

For years, emerging economies have looked up to developed countries for ideas about how to manage their financial systems. When it comes to Fintech though, the rest of the world will be studying the experience of the emerging markets, embodied by the widely successful MPESA mobile money system, championed by Safaricom in Kenya. MPESA has made it possible for a large swathe of the population to gain financial inclusion by providing the opportunity to transact financial services vide your mobile phone, on a continent where typically 70% of the population is unbanked. MPESA today has more than 60% of Kenya’s 33 million mobile users; not bad for a service which was only launched in 2007. Similar applications have metamorphosed across Africa.

In Nigeria the Yello Mobile Account, jointly offered by ICT giant CWG Plc and GSM major MTN, added over 6m accounts to an early adopter, Diamond bank, within the first year of launch. Mobile Money services are today generating 6.7% of Africa’s GDP.

China is the undisputed World leader in Fintech

By just about any measure of size, China is the world’s leader in Fintech. It is by far the biggest market for digital payments, accounting for half of the global market, according to the Economist Magazine. A ranking of the world’s most innovative Fintech firms gave Chinese companies four of the five top slots in 2016. The largest Chinese Fintech company, Ant Financial, has been valued at about $60b, on par with UBS which is Switzerland’s biggest bank. Today, digital payments account for nearly two-thirds of non-cash payments in China, far surpassing debit and credit cards.

Peer-to-Peer (P2P) lenders in China grew from 214 to over 3,000 in 2015, and P2P loans increased 28 fold from 30b yuan in 2014 to 850b yuan in 2016.

Austin’s Five Forces Model and the future of Banking

There are indeed five major forces at play here:

The banks – traditional and established, best with cash and ancillary instruments

Fintechs – the new kid on the block, disrupter, mostly telecom roots, best with digital currencies and mobile services

Regulators – Central Banks, regulating traditional banks; and Communication Commissions, responsible for telecoms regulation (and thus Fintechs)

Currencies – traditional, such as cash and cheques; or Digital, such as bitcoin or other cryptocurrencies

Customers, and the weight of their new found voice. Typically, they clamour for whatever will give them convenience and lower costs.

These forces and their interplay are represented in the schematic below:

A schematic representation of Austin’s five forces analysis of the future of banking. Image by Omimi Okere

Customers are the most significant force, and represented by the outermost sector of the concentric circles. As they tend more towards a preference for digital currencies, the Fintechs will tend to assume a more prominent role in the new face of banking, and the Regulatory regime will inadvertently tend towards the Communication Commissions under whose purview the Fintechs fall.

This will introduce a regulatory imbroglio, as future ‘Huge Banks’ may fall outside the regulatory ambit of Central Banks (as seems to be the case with the MPESA mobile money platform, through which Kenyans transacted $28billion in 2015, representing about 44% of the country’s GDP. Safaricom, the telecoms promoter of MPESA ironically falls under the regulation of the Communications Authority of Kenya rather than the Kenyan Central Bank).

If the customers however, maintain a strong appetite for traditional instruments of financial transactions such as notes & coins, cheques etc. then the current status quo will remain. The face of banking will thus be more of the same, and the regulatory authority will continue to be Central Banks. Between these two positions may be many variants, depending on the appetite and preferences of customers, and the pace at which they are willing to embrace change.

Retailers are jumping into Financial Services

Fintechs are not the only ones challenging traditional banks for turf. Retailers are also jumping into the financial services fray. For instance Amazon has launched Amazon Cash, a way to shop its site without a bank card. The service allows consumers to add cash to their Amazon.com balance by showing a barcode at a participating retailer, then having the cash applied immediately to their online Amazon account. This product is meant to appeal to the those who get paid in cash, don’t have a bank account or debit card, and who don’t use credit cards.

Google is also rolling out a new integration on mobile. Users of the Gmail app on Android will be able to send or request money with anyone, including those who don’t have a Gmail address, with just a tap.

 

Key components of a Recovery Plan

Key components of a Recovery Plan

Recovery Plans should be realistic, challenging and should force financial institutions to consider taking bold, and potentially unpalatable actions in advance of a stress, to avoid failure. A Recovery Plan should describe the actions to be taken when severe stress is indicated. The stress indicators need to be clearly established to provide the board and management with knowledge of the urgency of implementing a plan should it become necessary. The timing of implementing the plan is critical as once the market gets wind of the state of distress, stopping the slide as with Lehman’s, becomes almost impossible.

A credible Recovery Plan should include: Strategic Analysis A background on the bank, its legal structure, and existing strategy. Its risk profile and framework already in place to address the various risks. The strategic analysis identifies the bank’s core business, critical economic functions and material entities. Recovery Indicators and Triggers These are selected and developed along the bank’s framework for qualitative and quantitative indicators. This section of the plan details how indicators will be monitored regularly. Robust Scenario and Stress testing Scenario definition including market wide, idiosyncratic, and combined scenarios; identifying the impact of events on capital, liquidity, profitability and operations. Recovery Plans should include the definition, analysis and quantification of specific scenarios in order to determine and test the efficacy of the recovery options. The plans establish the metrics that will trigger the consideration of the implementation thereof. Unlike standard stress tests, scenario testing under Recovery Planning should be approached more robustly, and should cover the entire stress spectrum. It should analyse the firm’s ability to respond to a wide range of internal and external stresses.

Recovery Options Selected options are broken down to granular details with a rationale provided for each. There should be a quantitative and qualitative evaluation of these options under business as usual and stress scenarios. D-SIBs have to ensure the credibility of their plan through analysis of the impact of each recovery option on counterparties, creditors, clients, depositors, and market confidence. Governance and Communication A plan for decision making during a crisis is important. Identification of responsible persons and description of the escalation and decision-making process, as well as of the indicators which would trigger this process is necessary. Document Release This is where sign-off and approval requirements by senior executives and the board is documented.

From our experience in other jurisdiction, regulators typically expect to see well thought out robust plans which demonstrates the below attributes: • ownership of a plan, • full integration into the risk management and crisis management framework, • early warning indicators which are not set too late to risk execution, • a broad mix of relevant quantitative and qualitative indicators, • indicators on group financial position, • ready to be used operationally, • any barriers to implementation removed, and • operational interconnectedness fully understood by banks.

Conclusion Recovery Planning could have prevented the desperate panic at Lehman’s that engulfed the board, management and staff, and would quite possibly have helped to avert the firm’s demise. The cracks that were appearing in the US housing market as far back as early 2007, should have been an indicator. The sharp fall in share price following the collapse of two Bear Stearns hedge funds that were heavily exposed to MBS (just as Lehman were), was another indicator. By the time Bear Stearns was sold, the market was aware of Lehman’s plight so all recovery actions subsequently, proved futile.

In Nigeria, the global financial crisis that was taking shape internationally should have served as an indicator for the banks. Liquidity was drying up fast in the traditional markets. Several banks in Nigeria that had offshore credit lines and hedge funds that had exposure in the Nigerian Stock Exchange began withdrawing funds. All these were potential indicators and trigger points which with a robust plan, could have resulted in action to avert the crisis that unfolded. The Nigerian economy is currently fragile, with the fall in oil prices, ever depreciating currency and recent political changes. Many businesses are struggling to remain profitable, service their debt, and even stay afloat. Financial institutions would do well to sit up and treat Recovery Planning as a critical and indispensable tool for survival irrespective of whether they are a D-SIB.

 

The effects of the global economic crisis, declining oil prices, and excessive margin lending for Nigeria.

The effects of the global economic crisis, declining oil prices, and excessive margin lending for Nigeria.

In 2009, Nigeria was facing a banking crisis of its own. The effects of the global economic crisis, declining oil prices, and excessive margin lending, were having a negative impact on many financial institutions. Prior to this the Nigeria stock market had been one of the world’s best performing stock markets 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 allows 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% 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 shortterm 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 was 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 nonperforming 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 Central Bank, had to inject N620b (of tax payer’s 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 (8), account for more than 70% 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 D-SIBs are required to submit their first set of Recovery Plans to the regulators on 1 January 2016, and every year thereafter.

Recovery and Resolution Plans :Although often used interchangeably, Recovery and Resolution Plans are two distinct plans, designed to be invoked at different stages of a SIFIs distress. Recovery Plans These are detailed strategies for rapid, orderly and least cost recovery of a financial institution in the event of severe distress.

An effective plan sets out the menu of actions a bank can use to recover from both idiosyncratic, and systemic financial stress or both. Resolution Plans These are designed to facilitate the effective wind-down of financial institutions without severe systemic disruption and without exposing tax payers to any loss.

As the illustration below depicts, an event may trigger a liquidity or capital crisis, which takes an institution below a ‘crisis threshold’. Below this threshold, and if reacted to on time, is the ‘recovery zone’, where predetermined actions can be employed to recover from the negative shock. If allowed to continue, the institution crosses the ‘failure threshold’, at which point, efficient resolution activities will have to be used to facilitate its effective wind-down.

The Financial Stability Board, 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 USD29trillion and GBP850billion respectively of tax payer’s 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, SIFI’s 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.

 

Recovery and Resolution Planning Not just another piece of Regulation.

Recovery and Resolution Planning Not just another piece of Regulation.

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 August 2007, 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%.

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 then be 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.

Loans – Intercompany loans are a common source of funding within financial services groups

Loans – Intercompany loans are a common source of funding within financial services groups

Intercompany loans are a common source of funding within financial services groups. Related parties would be expected to satisfy the FIRS that the remuneration being received or charged for the intercompany loans are appropriate. Common risks with intercompany loans include the risk that the interest rate is not appropriate and the risk that the interest could be re-characterised as dividends.

Risk of re-characterisation:  Groups in the financial services industry must investigate if the transaction meets the definition of a loan based on the law and accounting standards of the country of the borrowing company. Where the tax authority successfully argues that the loan does not meet the definition of debt, it can re-characterise the loan as equity and deem the interests paid as dividends. Ordinarily, interests paid on loans are tax deductible. However, if such loans are re-characterised as equity, the dividends will usually not be tax deductible.

Even where there are no express definitions of debt and equity in the tax law, tax authorities are still able to challenge the substance of the loans based on the nature of the transaction and the conduct of the parties. This is the case in Nigeria where the FIRS can rely on transfer pricing principles to challenge the substance of a related party loan and the resulting interest. In general, the risk of re-characterisation is relatively lower with banking groups compared to other businesses in the financial services industry. Some of the factors which could lead the tax authorities to challenge the substance of a related party loan include where: the borrower is very thinly capitalised, there is no specified tenure or repayment date in the agreement, the tenure of the loan is unusually long, repayments are not made when due and are outstanding for a long period of time, the loans come with voting rights, the loans are tied to profitability, the loan in not secure in spite of significant transaction risks etc. These conditions suggest that the lender is taking on significant risks which it is not likely to take if it were dealing with an independent party. The risks associated with the lending are therefore considered to be similar to the risks taken by an equity investor, hence the re-characterisation of the loan to equity.

Level of interest charged : The interest charged on a loan must reflect the risk associated with the borrowing. Transaction terms such as loan currency, tenor, interest type (floating vs. fixed), presence of collateral and security, restrictive covenants, seniority of the loan etc. are relevant for assessing the risk and consequently determining the arm’s length interest rate. Other factors such as the country of borrower, business of borrower, economic circumstances at the time of the borrowing etc. also play a role in establishing the arm’s length interest rate. Since the provision of loans is in the ordinary course of their business, banking groups have relatively more access to information that can be used to determine the appropriate interest rate for intercompany loans. This information includes information on internal comparables i.e. independent companies who they have similar transactions with. The interest charged on comparable transactions with independent companies can be used as a benchmark for setting the interest rate on the related party loans.

It will however be important to ensure that there are no material differences (between the third party and related party transactions) which could impact the interest rate. Where any material differences exist, appropriate adjustments should be made. Where internal comparables do not exist it will be necessary to search for similar loan transactions involving two independent parties (i.e. external comparables).

The first step will usually involve estimating the credit rating of the connected borrower and also identifying the material terms of the related party loan transaction (these steps are also applicable when internal comparables exist). The next step is to search for loan transactions between third parties where the borrower has a similar credit rating as that of the connected borrower. It is important to ensure that terms and conditions of the related party loan are similar to those of the third party loans. Where the transactions are considered similar enough, the interest rate applied on similar third party loans can be compared with or used as a basis to price the related party loan. Where there are material differences in transaction terms, adjustments will need to be made. Country risk, tenor risk and currency risk adjustments are some of the adjustments that are sometimes necessary to achieve comparability.

Conclusion

It is expected that groups in the financial services sector will be one of the targets of future TP audits. They must therefore be prepared and ensure that all intragroup transactions are priced appropriately and in line with the arm’s length principle. Group CFOs must be prepared for the future audits and should carry out reviews of their current TP practices and defence documentation to ensure that they are not exposed.

 

Head office/ Management/Shared services (Intra-group services).

Head office/ Management/Shared services (Intra-group services).

It is common within groups to give an entity the responsibility for providing services to other group entities. Typically, the service provider would be the holding company. In other instances, it may be one of the operating companies within the group. The services include strategic functions and centralised management services such as executive administration (e.g. HR and legal), financial control, treasury management, internal audit, IT etc.

Other functions which are usually performed by holding companies include financing, procurement and holding of intellectual property such as the brand and trademark. Commercial reasons for these intra-group services include greater economies of scale, standardisation of processes and increased efficiency.

As with other connected party transactions, the pricing for these services must be at arm’s length. For Nigerian headquartered groups, the FIRS will be looking to ensure that the Nigerian head office receives an appropriate remuneration for the head office and other services provided to group companies outside Nigeria.

Where the Nigerian company is a subsidiary of a foreign company, the emphasis will be on ensuring that payments made for the head office and other services are not excessive.

Although different groups may have similar “service transactions”, the structure and manner of providing the services including the allocation of functions, risks and assets between the service provider and service recipient may be different.

This will mean that the pricing approach and methods for the services could be different for different groups even though the services could appear to be similar on the surface. This creates a risk when dealing with tax authorities.

Often, the expectations which the authorities form as a result of reviewing the transfer pricing affairs of one financial services group can influence their thinking on the pricing of these services in another group as they could expect the pricing arrangements to be the same or similar. Industry players would therefore need to provide robust analysis supporting their transfer pricing practices.

This analysis should include all factors relevant to the pricing of the transactions including industry factors, business specific factors etc.

A key consideration in determining whether it is appropriate to charge for a service is to determine whether an independent party would be willing to pay for the particular service.

Duplication of services : The FIRS (and other tax authorities) may not allow a management fee deduction if it believes the services are duplicated. This risk is high where a service recipient has staff that appear to be performing activities which are similar to those being provided by the service provider. The tax authority may argue that there is a duplication of services and there is no additional benefit which the service recipient obtains from the service provider. For example, if a management service fee is being charged for financial accounting services and the company receiving the service has a well staffed financial accounting function, the tax authorities could argue that the management services are not necessary To prevent the risk of duplication, companies should clearly delineate the activities performed centrally from those performed locally. This information should be recorded in their TP documentation reports. Companies should also record evidence of the direct benefit derived from the provision of these services. Sometimes, demonstrating the benefit derived from the services can be challenging.

Shareholder services : These are activities which a holding company or head office undertakes for its own benefit and which do not provide any clear commercial benefit to the subsidiary. Tax authorities will not allow holding companies to recharge costs relating to shareholder activities to their subsidiaries. A common example of a shareholder cost will be costs incurred by the holding company while raising funds for the acquisition of its interests in subsidiaries. Another example is costs relating to the reporting requirements of the holding company such as consolidation of reports. The line between what is for the benefit of the holding company and what is for the benefit of the subsidiary / operating company may not always be clear.

Pricing and allocation :

Compensation to the service provider should be commensurate with the services and benefit. A common practice is for the provider to receive a fee which covers the costs incurred in providing the services together with an arm’s length mark-up. Where there are multiple recipients, the costs should be apportioned based on an allocation key that reflects the relative benefit received. Some common allocation keys include time spent by staff in providing services to each entity, headcount, number of IT users etc. The mark-up to be charged will depend on the nature, complexity and risks associated with providing the service.

 

Transfer Pricing issues within the Financial Services Industry

Transfer Pricing issues within the Financial Services Industry

The Income Tax (Transfer Pricing) Regulations No 1, 2012 (“TP Regulations”) came into force in August 2012.

The Regulations provide a clear set of rules for the application of the general anti-avoidance provisions in the Companies Income Tax, Petroleum Profits Tax and Personal Income Tax Acts with respect to transactions between related parties.

The Regulations are to be interpreted in a manner consistent with the United Nations and Organisation for Economic Cooperation and Development (“OECD”) Model Tax Conventions and the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines).

The Regulations require related parties (referred to as connected taxable persons) to observe the arm’s length principle. Under the Regulations, persons are related if one of them participates (directly or indirectly) in the management, control or capital of the other or if a third person participates (directly or indirectly) in the management, control or capital of both persons.

Related parties are required to transact at prices and terms that would normally be agreed between independent parties transacting under similar conditions. If this is not done, the tax authorities can adjust the transfer prices and tax any additional profits that arise as a result.

To comply with the Regulations, connected parties are required to prepare, and update annually, a TP documentation report.

This report is to contain information and analysis which demonstrate that the transfer prices and other commercial terms of their related party transactions are in accord with the arm’s length principle.

Other compliance requirements include maintaining a TP Policy and filing TP declaration and disclosure forms. The Federal Inland Revenue Service will typically use this information to perform a risk assessment and subsequently select taxpayers for TP audits.

Banking and financial services groups often have transactions involving one or more group members. Some of the more common transactions include provision of loans (and other forms of financial support) and intragroup services. Intergroup services include management services, head office services and various other services (e.g. IT services, treasury services, risk management services etc.).

The intergroup services within a financial services group will depend on the specific industry sub sector within which the group operates and could include generic management services and more specialised services. For example, an insurance group could have intragroup services such as risk management and reinsurance, contract and claims management, investment and asset management etc.

Some of the intercompany transactions that cut across the various industry subsectors as well as the key TP issues arising from those transactions are discussed below.

 

Money laundering and regulation

Money laundering and regulation

For the past few years, regulators in more developed markets have begun to turn their focus to anti-money laundering (AML) regulations, more specifically the enforcement of those regulations. This has particularly affected banks with operations in the USA and Europe. At the same time, fines have grown ever larger as regulators lose their patience and banks are often forced into settlement agreements for criminal and civil liability in addition to paying fines.

What these statistics clearly show is that non-compliance is no longer commercially viable. The largest fines are so large that they affect profitability and the value of shares. Executives that willfully flouted requirements and circumvented controls earned their banks the largest fines, though even simple negligence has resulted in large fines being levied. One bank was fined for inadequate sanctions screening. Its defence? The system it had installed was too complicated and staff did not know how to operate it effectively. The current state across Africa Africa has thus far escaped relatively unscathed: the UK subsidiary of a South African bank received a £7.6 million fine for failings relating to its AML policies and procedures regarding corporate customers and their links to politically exposed persons. The UK subsidiary of a Nigerian bank was fined £525 000 for failings in its AML controls for high-risk customers. Additionally, the South African Reserve Bank (SARB) has recently fined the four top South African banks for AML failings, and conducted inspections at a number of other banks including foreign banks that operate locally. Indications are that AML is going to be a Central Bank of Nigeria (CBN) priority in the coming months. While African banks, by and large, might not have much cause to fear that local regulators will be imposing fines worth billions of dollars’ on them any time soon, they are not in a position to be complacent.

Key drivers of change

Foreign operations

This is probably the most obvious concern for all banks, including those in Africa. A number of so-called African banks have operations in Europe or the USA making them subject to the requirements of foreign-based regulators. Foreign regulators have not shied away from imposing fines on local branches of foreign banks. Operating in their country makes the foreign bank just as accountable as any local bank, possibly even more so due to the potentially heightened risk associated with foreign customers from less stringent jurisdictions. Failing to meet the necessary standards will put banks at risk of being fined by the relevant enforcement authorities. In addition to this the regulator may feel that it is necessary to take control of the operations of the bank. The worst case scenario for any bank would be that their transgressions are so severe that it is felt that the best course of action would be to suspend their banking license.

Correspondent banking

In order to enter into a correspondent banking relationship with a foreign bank, thereby accessing a foreign market, banks need to meet higher requirements to satisfy the foreign bank that they are sufficiently risk averse so as not to introduce unnecessary risk to their operations. Part of this is the requirement that AML systems should be sufficiently robust to meet the requirements of the foreign regulator. By allowing a foreign bank’s customers access to your accounts, your organisation is duty bound to ensure that they are not being abused to launder money or move funds for sanctioned individuals or entities.

A foreign regulator will hold the bank responsible for any failings taking place on its accounts – regardless of the fact that they were the result of a lax correspondent bank. African banks will need to ensure that they take AML seriously in order to maintain their correspondent banking relationships.

Reputation

Adverse reputation should be a major concern for any bank. A negative reputation can frighten off customers and bring the regulator calling. A key example of just how damning a negative reputation can be is seen in the case of FBME. The Federal Bank of the Middle East (FBME) is headquartered in Tanzania and is the country’s largest bank with assets in the region of $2 billion. Over 90% of its assets and global banking business are, however, located in Cyprus. FBME is facing serious challenges following the US Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) naming it as a foreign financial institution of primary money laundering concern and proposing steps that will effectively shut FBME out of the US financial system. Following this pronouncement, the Central Bank of Cyprus (CBC) took over the management of operations in Cyprus.

The CBC feared the FinCEN pronouncement would deal a serious blow to FBME’s operations, endangering the stability of the Cypriot financial system and risking depositors’ funds. The CBC intends to sell off operations to protect depositors. Following the CBC’s pronouncement, the central bank of Tanzania, Bank of Tanzania (BoT), took control of FBME’s Tanzanian operations, protecting the stability of the Tanzanian banking system and the safety of customer deposits. The actions of the CBC and BoT have resulted in their taking control of FBME. The bank is unlikely to survive in its present form. Central to this, however, is the fact that it was a bad reputation that set the chain of events into motion. Banks should pay heed to the fact that actions by unrelated foreign regulators can have disastrous consequences on their global operations.

What the future holds

In the past regulators focussed on a prescriptive approach. They dictated what banks needed to do in order to be compliant. Usually this took the form of providing lists of documentation that should be collected before a bank could take on a customer. The approach of regulators in this regard is changing.

Regulators are shifting to a collaborative risk-based approach, as advocated by the global inter-governmental Financial Action Task Force. In this approach, banks must evaluate the risk posed by each customer and treat them accordingly. Banks will no longer be able to claim compliance because they collected the correct documentation, they will need to show that they had a comprehensive view of their client and took appropriate steps to mitigate the risk posed by that client. This has the benefit of giving banks the freedom to design their own controls, but equally exposes them to far greater risk for non-compliance as regulators will take a dim view in cases where a bank does not apply sound rationale when assessing the risk posed by a client. What clients should be thinking about Compliance with AML regulations is no longer optional, and must be embedded into a bank’s operations to create a culture of compliance for bank employees at all levels. The cost of implementing a sound AML regime pales in comparison to the fines being issued to banks. Even worse is the fact that having imposed a fine, the regulator will still expect the banks to take steps to rectify their shortcomings; so banks end up having to bear the implementation cost regardless.

 

Banks should proactively take steps to bring their AML regimes into line with local regulation and leading international practice – particularly if they have operations in other jurisdictions – while they can still do so on their own terms.

 

The new auditor reporting standard Towards a more transparent and relevant auditors’ reporting

The new auditor reporting standard Towards a more transparent and relevant auditors’ reporting

 

The revised, new Auditor Reporting Standard was released in January 2015 in response to a need for enhanced transparency and readability of the auditors’ report. It is aimed at addressing some of the concerns raised by investors around auditors’ reporting as it relates to going concern and matters identified as involving significant auditor attention during the audit. The International Auditing and Assurance Standards Board (IAASB) believe that the new auditors’ report will:

  • increase confidence in the audit and the financial statements,
  • enhance communication between the auditor and the board of directors/audit committee, ]
  • increase attention by management to the disclosures in the financial statements to which reference is made in the auditor’s report, and
  • renew focus of the auditor on matters to be communicated in the auditor’s report hence increasing the auditor’s professional skepticism. The Standard will be effective for audits of financial statements for periods ending on or after 15 December 2016 with early application permitted.

So what’s new? Insight The new auditor’s report is aimed at providing insight on Key Audit Matters which are those matters that the auditor considers are of most significance in the audit of the financial statements. Transparency An introduction of an affirmative statement regarding the auditor’s independence is aimed at achieving improved transparency. Readability The restructuring of the auditor’s report, in particular, putting the audit opinion first, is aimed at improved readability. Standardised wording in the auditor’s report such as description of the auditor’s responsibilities and what is involved in an audit can be placed at the end of the report or in an appendix or can be referred to in a common website. The key changes to the auditors’ report are as presented in the table below: