CBN caps on Lending and Deposit Interest Rates: An exercise in futility?

Yesterday the Governor of the Central Bank of Nigeria (CBN): Professor Charles Soludo announced that interest rates on deposit and loans in Nigerian Banks are now subject to a maximum of 15% and 22% respectively.

While I am not unmindful of the destabilizing effects of rising interest rates and I fully appreciate the need to put in place measures to stem the trend, I am convinced that this particular measure is an exercise in futility. I believe that one of the lessons the current market crisis has thought us is that bankers can hardly be forced into doing anything, America's Congress has not been able to get banks to increase lending despite the fact that the American Taxpayers are basically responsible for the continued existence.

Nigerian Bankers, and bankers everywhere, are quite famous for acting in their perceived self-interest and for being able to creatively work around regulations that have potentials to reduce their profits. I am sure that by now, each bank will have worked out its strategy of beating the 22% maximum lending rate restriction. What we are likely to see is that each bank will obey the restriction in theory, but will resort to filling their credit offer letters with all sorts of hidden and open charges that will ensure that their lending rates inch up to the rates they will like to lend at (and not what the CBN wants them to lend at!).

Furthermore, the maximum deposit rates of 15% can also be easily breached in practice as banks desperate to attract sizable deposits from their competitors will devise new products that will ensure that they can offer depositors interest rates in excess of 15% and still not breach the letter of the law. For example, instead of offering 180-day fixed deposit products, a bank may simply issue a 180-Day Commercial paper yielding say 18% to a potential depositor. This commercial paper, though technically not a deposit, has the same effect liquidity-wise on a bank. It may even be more attractive to a potential investor since they are discount instruments which do not attract interest payments (which are subject to withholding tax), the implied interest is capitalised and is realised through the capital gains at redemption. Since capital gains are not taxable in Nigeria, the depositor (because that's what he effectively is) will have received tax-free "interest" from the bank and the bank will also have "stolen" depositors from other banks (maintaining 15% deposit rate limits).

In addition to this, the cap will also limit credit creation in the industry, which is a situation we really cannot afford in a slowing economy. For instance, there are quite a number of companies who can still access financing from banks, but they can only do that at high interest rates such as 25-26% in view of the risks perceived by the banks. Setting an interest rate cap (of 22%) may result in banks cutting off credit to these categories of borrowers who may then reduce operations or lay off workers.

In conclusion, I believe reactionary measures such as the one currently being proposed by the CBN will not solve the crisis in the banking sector but only create avenues for "black markets" and rule dodging. Since market forces have pushed up interest rates in our banking system, we need to also find a market-based approach to solving the interest rate crisis not just wish them to stay at a rate through fiat!!.

Book Review : Outliers- The Story of Success

I just finished reading (over the extended weekend) Outliers: The Story of Success, written by the writer - and the world's favourite "drugstore sociologist" - Malcolm Gladwell, author of bestselling works: Tipping point and Blink. The core essence of the book is the idea that men of great abilities and achievements did not get there by only their own efforts but that many of the ingredients and determinants of success are often beyond the control of most people and highly dependent on the opportunities presented by society and cultural legacies.

The author weaves together anecdotes and case-studies of various successful businessmen, academics, scientists and lawyers to support his assertion that successful people are not necessarily outliers with indecipherable secret formulas, but products of a complex interplay of personal effort (e.g. the 10,000 hour rule), unique opportunities (a 13 year Old Bill Gates was fortunate to attend a private school with a more powerful computer than many universities at that time) and enduring cultural legacies (Asians are generally smarter than most other people due to their increadible work ethics, which is in turn necessitated by the demanding nature of the primary occupation of their ancestors: rice cultivation).

The first part of the book: Opportunity describes the unique advantages enjoyed by many successful people, which ensured that they had a deeper and more meaningful preparation - than most of their competitors - for the careers and/or goals that they later embarked upon. He stated that Bill Gates probably had logged in over 10,000 hours of programming time before he was 19 at a time when most people his age had never even being within a 10 meter radius of a computer in their entire lives. To illustrate the importance of opportunity in developing successful people, he mentions a case of a man with an IQ of 190 (Albert Einstein's was a mere 150!) who spends his time on a horse farm, lacks a college degree and has spent his entire adult life doing a string of low-income jobs such as ranch hand, bouncer etc. The answer is simple: Einstein had access to people, systems and institutions that provided him with a platform to develop and display his talents, while the 190 IQ man had nothing in his life or background to help him develop and display his abilities. As the author wrote about the man: "He had to make his way alone, and no one — not rock stars, not professional athletes, not software billionaires, and not even geniuses — ever makes it alone."

The second part deals with the effect of history or cultural legacies on our abilities to achieve great things and he asks a simple question: why do Asians (particularly Chinese) seem to beat almost everyone else at Mathematics and Science?. Is it because they are smarter than everyone else?, the author's simple answer is simple: Cultural Legacy. The Chinese were primarily rice farmers for much of their history and rice cultivation is an infinitely more demanding activity (which requires a mastery of various sophisticated value-addng tasks) than wheat cultivation which was the norm in Europe (or yam, Cocoa and cassava cultivation in West Africa!!). This has resulted in Chinese and Japanese people being more comfortable with having highly demanding work schedules and School Calendars that last more days in the year than most people in the world!

Overall, it was a very enjoyable book as it makes a good attempt at explaining the sources and characteristics of success and successful people. According to the author: Success "is not exceptional or mysterious. It is grounded in a web of advantages and inheritances, some deserved, some not, some earned, some just plain lucky"

Beyond the ICRC - Infrastructure Concessions and Investing in Nigeria

It is longer news that the Federal Government has appointed a high powered board (under the chairmanship of former Head of State: Chief Ernest Shonekan) to oversee the Infrastructure Concession Regulatory Commission (ICRC). The ICRC, established in 2005, is charged with creating and managing a framework for regulation of Public Private Partnerships (PPP) in Infrastructure Development in Nigeria. While the fact that we must - as a country - make significant investments to improve our dilapidated infrastructure is not in doubt, what remains to be substantiated is the level of our preparedness to embrace Infrastructure Concessions and investing in this country.Infrastructure concessions have become an increasingly important activity the world over, with infrastructure rapidly attaining the status of an asset class in which specialised firms such as Macquarie and Babcock & Brown (both Australian companies) have built time-tested profitable business models. Infrastructure concessions cut across a wide cross-section, ranging from: Toll roads, to airports & seaports to electricity projects and even waste management. Despite this broad spectrum of activities which may be classified as infrastructure investing, most successful infrastructure regimes share similar characteristics (which I attempt to describe below).

Infrastructure concessions are highly dependent on strong contractual, and stable political, frameworks, this is due to their capital intensive nature and standard lengths of concession (not usually less than 30 years, often extending to 90 years or more). Concessionaires not only need to enter into binding contractual agreements with the relevant authorities, they must also be confident in the ability of the concessions they have received to withstand changes in governments and political alignments. Nigeria's recent history of reversed privatisations and concessions (the Abuja Airport transaction is a good case study!) is very discouraging and doesnt signify the willingness and/or enthusiasm with honouring agreements (contractual or gentlemanly) which may have been entered into between investors and previous governments. Therefore, for us to begin to contemplate raising serious money for our PPP initiatives , the government has to display a greater willingness to honour and abide with convenants already agreed to and prove its commitment to a stable polity.

An equally important "ingredient" for successful Infrastructure Concessions is the depth and sophistication of domestic financial markets. Infrastructure projects (such as Toll roads, power plants and rail lines) are capital intensive projects with long gestation periods and as such they depend on access to long-dated financing arrangements. Most of the infrastructure projects originated by Macquarie Bank (probabaly the biggest firm in the infrastructure asset class) are sold and passed on to dedicated infrastructure funds (both listed and unlisted) that it manages. Furthermore, the firm routinely has access to long term bank financing with various lenders advancing loans with tenors up to 30 years to augment its equity contribution. In the case of Nigeria, two (2) quick questions come to mind: 1. Do we have investors with the competence, capacity and appetite to invest equity in infrastructure projects?; and 2. where are the sources of long term debt financing which will enable project sponsors complete their deals. The longest-dated bank financing in Nigeria - at least that I have heard of - is the 12-Year term loan given to the Lekki Concession Company - developer and operator of the Lekki Toll Road, the first toll road in Nigeria - by First Bank and UBA. A 12-Year term loan is a significant development in Nigeria (at least given where we are coming from) but it will be barely scratching the surface if bigger projects such as the Port Harcourt-Maiduguri rail line and the Lagos-Ibadan expressway are to be developed by the Private Sector. It is clear that for Infrastructure Concessions to take off and become serious business in Nigeria, we must begin to put structures in place to mobilise private capital (in the form of debt and equity) for executing various infrastructure projects.

Despite the obvious limitations cited above, I am of the opinion that - once proper structures are put in place - infrastructure investing has a bright future in Nigeria. The opportunities are so great (to the point of being limitless) due to our very low development base. The electricity situation in Nigeria is so bad and demand so far outstrips supply that almost any business model
for generating and/or distributing electric has a high chance of returning a profit to its sponsors. The same idea applies to investing in urban transportation, the proposed Red and Blue lines up for concession by the Lagos State Government will serve such an obvious need that I wonder how concessionaires operating these railway lines will lose money. If the Government backs up its talk with action and the proper incentives, infrastructure concessioning may turn out to be the "silver bullet" (if any exists!) which we have been seeking to our currently dreadful infrastructure situation.

Proposed Deregulation of the Downstream Petroleum Industry - Good riddiance to an unsustainable system

The Federal Government of Nigeria announced its intentions to deregulate the downstream petroleum industry by discontinuing the current government subsidy on petroleum product pump prices and privatising the Country's refineries. I believe this announcement has potentially beneficial implications for the growth of the sector and for the encouragement of private sector participation in building refining and distribution capacity in the Country.

Although, a cross-section of Nigerians and organised labour are up in arms against the proposed discontinuance of the subsidy and have described it as being insensitive I believe the policy has the potential of modernising the industry, encouraging private sector investments and strongly mitigating the cronyism and patronage for which the sector has achieved notoriety (even in corruption riddled Nigeria!). I cannot help but wonder how much of the 1.6 Trillion Naira (about USD 11 Billion) in Government subsidies was spent in supporting the inefficiencies and corruption in the system and not on actually alleviating the burden of high Crude Oil prices on Nigerians. For example, what warped logic dictates that imported petroleum products which are offloaded in Lagos should sell for the same price in Maiduguri which is hundereds of kilometres in the hinterland, despite the considerable costs involved in trucking these product over hundreds of kilometres from Lagos to the far north.

The current industry structure and the monopoly enjoyed by the PPMC (downstream arm of the NNPC) reminds me of the pre-2001 regulatory regime in the Nigerian telecommunications industry when NITEL was "lord and master" over all. A not so distant era during which NITEL officials had to begged, bribed and paid homage to before we could get overly expensive telephone lines which broke down for more days than they worked. The liberalisation of the telecoms industry and the advent of the various Mobile and Fixed Wireless Access (FWA) operators filled the deep void created by NITEL, rendering it practically irrevelant in the scheme of things with the Nigerian subscriber being the better for it. I am sure that a liberalised downstream petroleum sector will be ultimately beneficial to Nigerians, as it will lead to increased transparency engendered by competitive tension, reduced inefficiencies and greater mobilisation of private resources in building capacity.

Furthermore, the deregulation will help mobilise private investments in developing and improving the Country's refining capacities. All the refineries in Nigeria (which are currently under government ownership and control) are either moribund, grossly underutilised or both, this is in spite of the hundreds of millions of US Dollars which have been spent on various Turn Around Maintenance (TAM) contracts. The best option is for us to privatise the nation's entire refining capacity, so they can quit constituting a drain on the public treasury and a conduit for lining politicians' pockets.

An often cited reason for the inability of private refineries to kick off in Nigeria is the difficulty in securing financing for the projects. This lack of investor appetite is directly attributable to the current pricing regime, as we will be hard pressed to find a rationale investor who will be willing to spend hundreds of millions of US Dollars in developing an immovable asset (i.e. a refinery) to produce goods (petroleum products) over which he will not have pricing control. As someone else (the all knowing Federal Government of Nigeria of course!) will dictate their pump price all over the country and will almost certainly prevent him from exporting to other markets if he is uncomfortable with the prices the Government dictates in the domestic markets. Even if such an investor can be found, I am sure that he/she will not be able to get a bank that will be willing to provide financing for such a venture.

On the whole, I believe the deregulation of the downstream petroleum sector is one of President Yar'Adua's better decisions since taking office. Although the effects may sometimes be difficult for Nigerians to bear, we will all eventually be the better for it.