Recent Developments in the Nigerian Banking Sector: A defence of Fair Value Accounting
There have been much debate and outcry over the recent statements of the new Governor of the Central Bank of Nigeria: Sanusi Lamido Sanusi regarding the health of Nigerian banks and the need for full disclosure of asset quality. This new line has prompted a number of hitherto unprecedented write downs by Nigerian Banks in their latest results: Ecobank Nigeria has written off N12 Billion; First Bank - N25 Billion and to the mother of all writedowns: Oceanic Bank - N42 Billion. These write downs have primarily been in their margin and other equity collateralised loan portfolios and are meant to reflect the steep losses witnessed in the Equity Capital Markets over the last 15-18 Months. Many analysts have sought to paint this new found penchant for fair value accounting on the part of the regulator as being ill-advised and a misguided adoption of western standards. I however beg to differ, I believe the dual and complementary emphasis on detailed disclosure and adoption of fair value accounting are two of the best initiatives in the Nigerian Banking Industry.
A bank’s – and indeed any company’s – balance sheet should be a reflection of value and its stated asset valuations should reflect the monetary value that can be obtained as consideration for the sale of such assets (there is no point listing an asset that can only fetch N40 Billion in an arms length sale as being worth N100 Billion in any balance sheet). This principle should apply to banks as well, for example I don’t think a N5 Billion loan - wholly and solely collateralised by equity securities of an equal value - advanced by a bank to a brokerage firm in 2007 is worth the same in 2009 when the basket of underlying securities serving as collateral has declined in value by over 50%. The truth is that the bank will be lucky to get N2 Billion if it recalls the loan by seizing the underlying collateral and selling it off in the market. To then account for this loan at the initial value of N5 Billion - even if a token and often reduced interest is still being paid - is unrealistic at the very best and downright fraudulent at the worst.
Fair value accounting also helps bankers and portfolio managers make the tough decisions necessary for the functioning of markets. Many bankers and portfolio managers will remain reluctant to exit losing investments under a cost or historical value accounting system, since they would not have to book the losses until they actually sell the investments. Fair value accounting helps them out by making decision making more straightforward: they would have to recognise the losses whether or not they sell the securities , so they might as well recoup whatever is left of shareholders’ or investors’ capital. Furthermore, marking down the loan books will make the Asset Management Company being proposed by the CBN more effective, without the writedowns most banks would have been seeking to sell their margin loan books to the Company at historical values.
Although I am aware that Fair Value accounting is not without its drawbacks and that it often results in volatile Balance Sheets, if given a choice between Fair Value and Voodoo accounting, I will choose Fair Value accounting over and over again!
A bank’s – and indeed any company’s – balance sheet should be a reflection of value and its stated asset valuations should reflect the monetary value that can be obtained as consideration for the sale of such assets (there is no point listing an asset that can only fetch N40 Billion in an arms length sale as being worth N100 Billion in any balance sheet). This principle should apply to banks as well, for example I don’t think a N5 Billion loan - wholly and solely collateralised by equity securities of an equal value - advanced by a bank to a brokerage firm in 2007 is worth the same in 2009 when the basket of underlying securities serving as collateral has declined in value by over 50%. The truth is that the bank will be lucky to get N2 Billion if it recalls the loan by seizing the underlying collateral and selling it off in the market. To then account for this loan at the initial value of N5 Billion - even if a token and often reduced interest is still being paid - is unrealistic at the very best and downright fraudulent at the worst.
Fair value accounting also helps bankers and portfolio managers make the tough decisions necessary for the functioning of markets. Many bankers and portfolio managers will remain reluctant to exit losing investments under a cost or historical value accounting system, since they would not have to book the losses until they actually sell the investments. Fair value accounting helps them out by making decision making more straightforward: they would have to recognise the losses whether or not they sell the securities , so they might as well recoup whatever is left of shareholders’ or investors’ capital. Furthermore, marking down the loan books will make the Asset Management Company being proposed by the CBN more effective, without the writedowns most banks would have been seeking to sell their margin loan books to the Company at historical values.
Although I am aware that Fair Value accounting is not without its drawbacks and that it often results in volatile Balance Sheets, if given a choice between Fair Value and Voodoo accounting, I will choose Fair Value accounting over and over again!
1 comment:
The new development in the banking system is very good because it will help the banking system in growing and adding new things thanks
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