The Credit Crunch is Here!

It is now clear that the sequence of events that led to the global financial crisis is unfolding in the domestic economy after a one year delay. The strategy and advisory firm, Resources and Trust Company (RTC) where I work as CEO has since the last quarter of 2008 identified some striking similarities between the fundamental causes of the US (and later Global) financial crisis and the underlying realities of our financial system and economy. As we have pointed out to multiple audiences since then, with the exception of our (relatively) better macroeconomic conditions, virtually every other factor present in the US scenario was manifest in ours.
We had an asset price bubble, even though ours was in stocks while the US had a property bubble. The jury remains out regarding our property prices as well! The same way US bankers aggressively booked mortgages against over-valued properties, our financial system also booked margin loans against over-valued stocks. The underlying market conditions in both economies were the same-an over-exuberant capital market and a financial system loaded with excess capital. In the US and Nigeria, every (or at least almost every) participant in the financial system believed “nothing could go wrong”. The last piece of the disastrous jig-saw puzzle was regulation-weak in both environments though for different reasons.
In the US, the motivation was ideological-the Republicans believed in the market sorting itself out. Everyone celebrated financial innovation and regulators believed they had finally tamed the economic cycle. Alan Greenspan believed asset prices were infinitely sustainable! In Nigeria, our CBN was in an over-celebratory mood after a very successful banking consolidation exercise, our SEC probably lacked the capacity to regulate the evolving market and our Stock Exchange did not have the detachment and independence required. The real substantive differences between our markets were the macroeconomic conditions, the absence of securitisation in our market and our limited integration into global financial markets.
Even concerning macroeconomics, the difference was nuanced. Even though our static macroeconomic condition going into the global financial crisis was strong (large foreign currency reserves, low external debt, recapitalised banks etc), the trends to all knowledgeable people were weaker (falling oil price, stalled economic reforms, declining capital flows, a domestic capital market crisis that preceded the global slump and inherent vulnerabilities in the financial sector). The only factor that delayed the domestic manifestation of the global financial crisis in effect then was transparency and disclosure about what was going on-while the US and global banks had no choice but to write down their capital to reflect their toxic assets and publish resultant losses, the Nigerian CBN agreed with the banks to defer recognition of bad loans till December 2009. With Sanusi Lamido revoking this policy, conducting stress tests, requiring immediate loan write-offs and publication of the resultant Profit and Loss Accounts, the last difference in our scenarios have been removed.
Now let’s go back to the global financial crisis. After the US and global banks took the massive loan write-offs their next response was not surprising-they stopped lending and an economy-wide credit crunch developed. That credit crunch led directly to recession and unemployment in the US and other western economies as firms were forced to lay off workers and cut output and as families and firms reduced consumption. You do not have to be a rocket scientist or Nobel Prize winning economist to recognise the similarities with Nigeria as a domestic credit crunch develops in the wake of the huge loans write-offs by the local banking system. We are at risk of a collapse of trade, services, manufacturing and jobs if the local banking system is not encouraged to resume lending and/or if as in the US the government does not respond with an appropriate policy package to mitigate the developing credit crunch. The CBN decisions arising out of the Monetary Policy Committee Meeting of November 3, 2009 are a fair start-introducing an asymmetric MPR structure (plus 2, minus 4) to discourage banks dumping all their deposits at the CBN; removing the ban on BAs and CPs; waiver of the 1 percent general loan loss provision; fast-tracking efforts to set up the asset management company; and “quantitative easing” (i.e. printing money!) to boost money supply. Concerning quantitative easing, we hope the capacity to properly calibrate and time the measures and the will to reverse the easing at the right time are present.
Of course our situation is better than the US equivalent. Virtually all major US banks were in danger of collapse as the situation unfolded. Citibank, Goldman Sachs, AIG etc all required some form of rescue or the other from the US government or the Federal Reserve. Here only eight or ten banks are mortally threatened according to the CBN. The other banks have by and large absorbed the loan write-offs against capital or earnings and may resume normal activities after the shock wears off, probably late in Q1 2010. Perhaps the CBN over-dramatised its actions in relation to the sector and could have minimised disruptive emotions? Perhaps the systemic implications could have been better anticipated and counter-cyclical measures adopted in advance rather than as a reaction? Whatever it takes, we must get the banking sector to resume lending or else a sharp drop in private sector output is imminent in 2010.