Regulating Nigeria’s Shadow Banking in MMM Aftermath

The size and rapid growth of shadow banking has been one of the most talked-about issues since the 2007 – 2008 global financial crisis. According to the Financial Stability Board, the shadow banking sector grew from $27 trillion in 2002 to about $75 trillion in 2015. The FSB said the sector – which encompasses all loosely regulated financial intermediaries such as money market funds, private equity funds, hedge funds, securitization, mobile payment systems, online lending platforms, etc. – now accounts for up to 25 to 30 percent of the total financial system.

The FSB was established in April 2009 during the London G20 summit in response to the financial crisis. Discussions around shadow banking have centred on the risks the sector poses to the financial stability of global economies.

Unlike the traditional banking sector, most shadow banks do not take deposits and, hence, are subject to little or no regulatory requirements regarding capital, liquidity and cash reserves. Shadow banks are also not covered by government deposit insurance agencies. As a result of this regulatory exclusion, shadow banks tend to take excessive investment risks in trying to maximize profit. But some of the funds they invest come from financiers such as banks, insurance companies, and pension funds.

The modus operandi and ubiquity of shadow banking are considered to be a risk to the financial system by international finance institutions and regulators, the International Monetary Fund, the European Central Bank, and the US Federal Reserve. It is believed that when shadow banks come under selling pressures from panicky investors, akin to “bank runs” in mainstream banks, it may result in forced asset sales that rapidly erode asset value and investments. When shadow banks (in this case structured investment vehicles, securities lenders, and brokerages) began a “fire sale” of subprime mortgage-backed securities during the GFC, the ensuing depreciation in asset value was catastrophic for investors.

Shadow Banking in Nigeria

Over the last decade and a half, the Nigerian financial services sector has developed into one of the largest and most sophisticated on the African continent. Total banking sector assets, for instance, has grown from about N2.5 trillion in 2000 to over N30 trillion in 2016; the insurance sector grew from about N25 billion in 2000 to about N800 billion in 2016. As for the pension industry, assets under management grew from less than N500 billion in 2004 to over N6 trillion in 2016.

But lurking under the shadows of the robust financial infrastructure are large numbers of bank-like entities that act as financial intermediaries for both businesses and individuals. According to the Central Bank of Nigeria, shadow banking activities can be seen in the financial derivatives market in form of commercial papers, interest rate swaps, and foreign exchange forward contracts. Given that this market is still in its infancy, however, the CBN and other regulators do not consider derivatives to be a threat to the country’s financial system. In fact, the CBN said in a 2014 report that “the financial derivatives markets in Nigeria are still evolving, especially in over-the-counter (OTC). Plans are underway to introduce a derivatives exchange, where more sophisticated instruments are traded to attract foreign investors.”

Notwithstanding the CBN’s disposition towards shadow banking in Nigeria, the industry has far more coverage, given the apex bank’s regulatory deficiencies and the country’s huge population without access to formal financial services. The operations of microfinance banks in Nigeria, for instance, have largely remained in the shadows, owing to the lack of regulatory resources to effectively supervise the industry. According to CBN data, there are about 1,000 microfinance banks scattered across the 36 states and the Federal Capital Territory. With the sheer number of these banks, the CBN is practically handicapped when it comes to exercising oversight functions and demanding compliance to prudential guidelines. This regulatory constraint has allowed most microfinance banks to operate as sub-optimal financial intermediaries, unlike their commercial banking counterparts. In 2010, the CBN revoked the licenses of over 200 microfinance banks after an audit revealed that most of the banks had breached regulatory requirements with high non-performing loans and inadequate capital reserves.

Closely related with microfinance banks are pyramid schemes, popularly known as “miracle” or “wonder” banks, that spring up from time to time, promising to pay outlandish interests on periodic customer deposits. The Ponzi schemes operate until new deposits slow down and eventually dry up. In the past decade, some popular “wonder” banks include Nospecto Oil and Gas, Manpower, Pennywise, WealthBuilders, Treasure Fund, etc.

The Mavrodi Mundial Moneybox (MMM), which originated from Russia, is a more recent example of one of these “miracle” banks. There have been numerous reports from around the country about people losing their savings, school fees, investments, etc owing to the crash of MMM. A case in point is that of Osakpamwan Amieomwanghi, a grocery store owner in Edo State, who invested N4 million in MMM just one month before the Ponzi scheme crashed in December last year.

“It is painful because that was virtually all the money – capital and profit – that l had. I have become a prayer warrior for the scheme not to crash, as many had forecast. I can’t remember how many nights I couldn’t sleep because of the money. I am not a gambler and l hate gambling, but l can’t explain how l fell into this,” Amieomwanghi told The Daily Sun.

According to a 2014 Enhancing Financial Access survey, about 37 million Nigerian adults, representing 40 percent of the adult population, are financially excluded. This huge unbanked population has encouraged the proliferation of informal financial intermediaries, such as rotating savings credit associations (ROSCAs), religious organizations, cooperative societies, and community welfare schemes. These unregulated institutions provide bank-like services such as savings, loans, insurance, and even mortgages for farmers, market women, civil servants, students, artisans, traders, etc. The operations of these informal financial institutions account for a significant part of Nigeria’s informal economy – which accounts for up to 35 percent of total GDP or about N40 trillion.

Regulating Nigeria’s shadow banking industry

The activities of shadow banks in Nigeria do not currently count as one of the main threats to the country’s financial system, as noted by the CBN. This is because the industry is still largely informal (with the exception of microfinance banks and derivatives); it is also small in size compared to mainstream financial institutions such as banks, pensions funds, insurance companies, etc.

Nevertheless, shadow banks account for a significant part of Nigeria’s economy and their operations impact the lives of millions of people. For instance, many depositors have lost their savings by patronizing shoddy microfinance banks; and there are numerous cases of fraud and embezzlement in ROSCAs or cooperative societies. The Nigerian Deposit Insurance Corporation estimates that about three million Nigerians lost over N18 billion when MMM stopped making payments.

Given that some of the shadows banks still provide benefits to the economy, the government must adopt better strategies for regulating the industry in order to protect innocent Nigerians and ensure economic stability. This can be done by increasing efforts targeted at formalizing the informal financial sector, improving supervision of microfinance banks, and reducing the unbanked population.

The CBN is currently heading in this direction with efforts such as expanding mobile payments services, extending its cashless policy, and implementing simplified know-your-customer protocols, etc. But these policy actions still require substantial more coverage, suggesting that more attention should be directed at creating awareness and improving financial literacy.