In the wake of the coronavirus pandemic, financial institutions and regulators in Nigeria, like their counterparts worldwide, are steering through unchartered waters. Financial analysts project that banks are likely to see an increase in their risk-weighted asset values, and, as a result, a reduction in their capital adequacy ratios, majorly because of the projected increase in default rates as a result of the pandemic. Capital Adequacy Ratio (CAR) sets standards for banks by weighing their risk against their capital. In other words, these standards analyse the capacity of a bank or financial institution to respond to credit, market, and operational risks, as well as to pay its liabilities. A bank with a good CAR has a lower risk of becoming insolvent because it has sufficient capital to mitigate potential losses.
Capital Adequacy Ratio is shown as a percentage of a bank's risk-weighted credit exposures. The higher the ratio, the more efficient and stable the bank will be.
The Central Bank of Nigeria (CBN) set a deadline of end of April 2021 for the submission of Internal Capital Adequacy Assessment Process by Nigerian banks. In order for banks to meet the minimum regulatory requirement and the deadline set by CBN, banks in Nigeria will have to get creative about maintaining liquidity and cash as well as navigating complex regulatory measures to demonstrate solvency.
This article will discuss the evolution of the Basel Accords that guide CAR submissions and the CBN's approach to their implementation. This article will also assess the impact of COVID-19 on Capital Adequacy Ratio and suggested measures to mitigate its effect.
What is the Central Bank of Nigeria's Regulations Regarding Capital Adequacy Ratio?
The Central Bank of Nigeria (CBN) on 10th December 2013, announced the implementation of the Basel II and III recommendations of the Basel Committee on Banking Supervision (BCBS).
Consequently, all commercial banks licensed by the CBN are therefore required to comply with Basel II and some parts of the Basel III Accord. Following this announcement, the capital adequacy ratio (CAR) requirement for banks in Nigeria is set at 10% and 15% for regional/national banks and banks with international banking licenses, respectively.
It is important to note, however, that the CBN's implementation of the Basel II and III complies significantly with the Basel II/III accords; certain sections were adjusted to reflect the peculiarities of the Nigerian banking industry. It should also be noted that CBN has issued an exposure draft relating to the adoption of Basel III.
The Evolution of the Basel Accords and How They Influence CAR
What are the Basel Accords?
The Basel Accords (Basel I, II, III, and IV) are sets of regulations for the Banking sector established by the Basel Committee on Banking Supervision (BCBS). The purpose of these accords is to improve the regulatory framework for the banking industry worldwide. The Basel II agreement is currently implemented in Nigeria.
The Basel II structure is based on Basel I as a foundation. It has three pillars; market discipline, minimum capital requirements, and supervisory review.
Market Discipline: banks are required to disclose their overall risk assessment process, capital adequacy, and risk exposures.
Supervisor Review: provides guidelines on how regulatory authorities should handle risks such as liquidity risk, legal risk, and systemic risk.
Minimum Capital Requirements: under this accord, the description of risk-weighted assets is refined. Furthermore, guidelines for calculating minimum regulatory capital ratios by dividing the eligible regulatory capital of a bank into tiers is introduced under this pillar.
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