CBN issues Basel III implementation guidelines for banks in Nigeria – Finance and Banking

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Nigeria: CBN issues Basel III implementation guidelines for banks in Nigeria

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Summary

On September 2, 2021, the Central Bank of Nigeria (CBN) has issued a circular to all banks in Nigeria entitled Implementation of Basel III by all depository banks (“the Circular”). The circular aims to inform all banks of the publication of guidelines for the implementation of Basel III, which is a voluntary global regulatory framework that deals with bank capital adequacy, stress testing and risk of loss. market liquidity.

Details

The Basel Accords (“Basel I, II, III”) are sets of regulations for the banking sector established by the Basel Committee on Banking Supervision (BCBS) which is a committee of banking supervisors established by governors central banks from various jurisdictions. These “Agreements” aim to improve the regulatory framework for the banking sector around the world.

Basel I was designed to improve understanding of key supervisory issues and improve the quality of banking supervision in countries. The Basel II accord is primarily focused on financial strength. It was designed to improve capital regulation by introducing risk weights, aligning banking regulation with best practices in risk management, and encouraging banks to improve their risk measurement and management capabilities.

The Basel III accord was developed by the BCBS because of the impact of the 2008-2009 global financial crisis on banks. As the global financial crisis resulted in unprecedented losses and an almost total collapse of the global financial system, there was a need to critically rethink risk management practices that had hitherto been based on the Basel II Accord. . Thus, Basel III is the answer to the shortcomings of Basel II and introduced major changes within the framework of Basel II. Some of these changes are highlighted below:

  • Introduction of a risk-free leverage ratio which requires banks to hold a leverage ratio of at least 3%;
  • Increased minimum capital requirements for banks from 2% in Basel II to 4.5% of ordinary capital, as a percentage of the bank’s risk-weighted assets. There is also an additional buffer capital requirement of 2.5% which will increase ordinary equity to 7%.
  • Introduction of two liquidity ratios – the “liquidity coverage ratio” and the “stable net funding ratio” (NSFR). The liquidity coverage ratio requires banks to hold enough highly liquid assets that can withstand a 30-day stressed funding scenario as specified by the banking supervisor. On the other hand, the “net stable funding ratio” forces banks to maintain stable funding above the required amount of stable funding during a one-year period of prolonged stress.

Although the CBN has completed the development of guidelines for the implementation of Basel III in 2020, implementation has been put on hold due to the COVID-19 outbreak to minimize the burden of regulatory compliance for the banks.

The CBN has now released the Basel III template underlisted guidelines / reports for implementation;

  • Regulatory Capital Guidelines
  • Leverage Ratio (LeR) Guidelines
  • Short-term liquidity ratio (LCR) guidelines
  • Guidelines on liquidity monitoring tools (LMT)
  • Large Exposure Guidelines (LEX)
  • Guidelines on liquidity risk management and the internal liquidity adequacy assessment process (ILAAP)

Some of the key provisions introduced by some of these guidelines are as follows:

  • Banks are required to maintain a minimum leverage ratio of 4% at all times;
  • Banks should calculate the leverage ratio in accordance with the relevant requirements specified to complement their risk-based capital requirements;
  • The LeR will be calculated both at the entity level and at the consolidated level. The consolidated levels will include the level of the banking group and the holding company;
  • The measure of leverage ratio exposure should generally be based on gross book values. Therefore, unless otherwise specified, banks should not use physical or financial collateral, guarantees or other credit risk mitigation techniques to reduce the measure of leverage ratio exposure, and nor should they use net assets and liabilities.
  • Banks are required to disclose and detail to the CBN the sources of material differences between their total on-balance sheet assets as shown in their audited financial statements (accounting assets) and their on-balance sheet exposures for their measurement of market exposure. leverage ratio.

Reporting entities are required to comply with the minimum LCR on an ongoing (daily) basis to help monitor and control their liquidity risk. However, for the purposes of prudential supervision, reporting entities must submit their respective LCR reports to the CBN in the manner prescribed below.

The CBN said in the circular that the recommendations will be implemented in parallel from November 2021 for a period of six months, which could be extended for another three months if the expectations of the supervisory authorities are met. According to the CBN, the Basel III guidelines will apply at the same time as the existing Basel II guidelines during the parallel execution, and the Basel III guidelines will come into full force once the parallel execution is completed. .

In addition, the CBN also required all banks to submit their monthly statements no later than five working days after the end of previous months, with effect from November 2021.

The CBN also added that banks should note that the addition of capital will be phased in as part of the overall monitoring process of the Pillar II assessment, which is a principled standard based on good judgment. prudential. This involves improving risk management practices and better aligning banks’ own funds with their risk profiles.

Involvement

Since these guidelines address issues such as specifying minimum liquidity coverage ratio (LCR) standards for reporting entities in the Nigerian banking system, we believe the guidelines will help control liquidity and make banks stronger. and more resistant to adverse conditions. because it will strengthen regulation, supervision and risk management within the banking sector. It is also expected that the Basel III standard will prevent banks from taking excessive risks that could have a negative impact on the economy.

Thus, greater stability of the financial sector should be achieved under Basel III, which should allow investors to focus more on the risk of financial institutions and worry less about the economic environment or the possibility of widespread financial collapse. It is important to note, however, that for banks to meet the LCR liquidity criteria introduced by the Basel III directives, they will need to hold more liquid assets and increase their proportion of long-term debt. In addition, business transactions most exposed to liquidity risks will be minimized and banks will need to be cautious of assets in high liquidation such as Special Purpose Vehicles (SPV) and Structured Investment Vehicles (SIV). .

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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