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IFC Bulletin No 39
1
Development and compilation of macroprudential
indicators for financial stability and monetary policy
in Nigeria
Sunday Nyong Essien and Sani Ibrahim Doguwa1
Abstract
This paper discusses the development and compilation of quarterly macro-
prudential indicators and their relevance to financial stability and monetary policy
management in Nigeria. The indicators are analyzed on time series basis to give
insight to the level of soundness of the Nigerian financial system. The FSIs,
complemented by stress testing of the system, serve as useful tools in evaluating
the strengths and weaknesses of the financial institutions, as well as provide signals
to the Monetary Policy Committee of the Bank for possible actions to ameliorate the
vulnerabilities of the system. The results of recent macro-prudential analyses
revealed that the Nigerian financial system was stable, robust and resilient to
liquidity and funding shocks.
JEL classification: E52, E44
1 The authors are members of staff of the Statistics Department, Central Bank of Nigeria. The views
expressed in this paper are those of the authors and do not necessarily reflect the views of the
Bank.
2
IFC Bulletin No 39
1. Introduction
Although, the performance of an economy is determined to a large extent by the
level of activities in the real sector, but the critical role of the financial system in
sustaining a vibrant and stable economy cannot be over-looked. The stability,
soundness and resilience of the financial system have received considerable
attention in the recent time due to the continuous integration of the system which
leads to increased capital mobility. It brought about the gradual collapse of the
financial boundaries among nations while deepening and expanding the potentials
of the impact of external financial shocks, as evidenced from the various financial
crisis witnessed in the past, particularly the latest global financial crisis which began
from the United States as a result of crisis in the sub-prime mortgage market in
August 2007.
The beginning of a crisis in any financial system can be shocking, but there may
be glaring signals of financial vulnerabilities in the system that could be used in the
formulation and implementation of appropriate responses to prevent financial
distress or mitigate its impact on the economy. For instance, in the wake of the
global financial crisis, there was a widespread acknowledgment for the need to
strengthen links among key components of the financial system, examine carefully
how systemic risk varies over time, as well as study the robustness of the system
when hit by shocks or systemic risk.
Analysts are of the view that, excessive risk-taking coupled with lack of strict
macroprudential regulation as well as loose monetary policy was the major
contributor to the crisis. Although, it is generally believed that banks survived and
flourished on risks, but the risks must be well managed to avoid bankruptcy.
Monetary authorities and relevant regulators have a fundamental role to play in
ensuring financial stability by monitoring the performance of banks and other
related institutions, but their collective actions were clearly not enough to prevent
the crisis.
The crisis, has undoubtedly underscored the importance of a macroprudential
approach to regulation so as to assess the soundness of financial systems as well as
individual financial institutions. Regulators should not only concentrate on
identifying banks that do not manage their risks well but should also develop a
macroprudential orientation that comprises monitoring, regulation and supervision
to identify how risk systematically evolved over time and distributed across a
financial system at any given point in time. To achieve this and forestall the re-
occurrence of such catastrophe, the international financial community, spear-
headed by the International Monetary Fund (IMF) developed a new concept of
macroprudential regulation that serves as early warning signals by exposing the
vulnerability of the financial system.
This paper focuses on the development and compilation of macro prudential
indicators for Nigeria as well as examines how the indicators are used in assessing
the stability and soundness of the Nigerian financial system and for monetary policy
purposes. To achieve this, the paper is structured into six sections. Following the
introduction in this section, section two provides an overview of Nigeria’s financial
system. The development and compilation of financial soundness indicators (FSIs)
are discussed in section three. Section four reviews the dimensions of application of
macro prudential indicators for financial stability analysis and monetary policy
purposes. Section five discusses the complementary role of stress testing in
IFC Bulletin No 39
3
assessing the financial strength and vulnerabilities of the banking system, while
section six highlights the challenges and concludes the paper.
2. Overview of the Nigerian Financial System
The Nigerian financial system comprises both formal and informal sub-sectors. The
formal sub-sector is made up of the regulatory authorities, money, capital and
foreign exchange markets, insurance companies, brokerage firms, deposit money
banks, development finance and other financial institutions. The informal sub-sector
includes community-based organizations such as financial cooperatives, micro
finance institutions, rotatory savings and credit associations, self-help groups and
similar institutions. A major characteristic of the financial system is the weak
relationship and integration of the informal sub-sector with the formal sub-sector.
At end-December 2013, the regulators/supervisory institutions remained the
Federal Ministry of Finance (FMF), the Central Bank of Nigeria (CBN), the Nigeria
Deposit Insurance Corporation (NDIC), the Securities and Exchange Commission
(SEC), the National Insurance Commission (NAICOM) and the National Pension
Commission (PENCOM). The operators included 24 deposit money banks
(21 commercial banks, 2 merchant banks and 1 non-interest bank); 4 discount
houses (DHs); 6 development finance institutions (DFIs); 82 primary mortgage
institutions (PMIs); 821 microfinance banks (MFBs); 61 finance companies (FCs);
31 pension funds administrators (PFAs); 2,889 bureaux-de-change (BDCs)operators
and 59 insurance companies.
The growth of the banking system in the post-consolidation period and the
failure of the regulators/supervisors to develop commensurate supervisory
capabilities created risks to the system in the late 2000s. Other interdependent
factors such as macro-economic instability, weak corporate governance, and uneven
supervision and enforcement combined to render the financial system vulnerable,
and posed significant challenges to both regulators and other stakeholders. This
development informed the CBN intervention in August 2009 through various
initiatives aimed at enhancing the stability of the system. The high incidence of non-
performing loans in the banking industry and the consequent erosion of the capital
of some banks informed CBN’s initiative to establish the Asset Management
Corporation (AMCON) in 2010, to free such banks of the burden of toxic assets. The
CBN also took steps to expose the banking system to global best practice in
financial reporting and disclosure.
3. Development and Compilation of FSIs in Nigeria
3.1 The Origin and Relevance of FSIs
The idea of the FSI project was mooted shortly after the Asian financial crisis of the
late 1990s. The crisis exposed an enormous data gap requirement for timely
monitoring and intervention of the financial system by the monetary authorities and
effective oversight of the member countries by the IMF. In order to solve this
problem IMF launched some statistical initiatives including the compilation of FSIs,
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IFC Bulletin No 39
to improve the coverage of potential financial and external vulnerabilities. FSIs are
aggregate measures of the current financial health and soundness of the financial
institutions in a country as well as their corporate and household counterparties.
The process of compiling FSIs began with a meeting of a group of experts, officials
of member countries of the IMF, regional and international bodies and standard
setters. The meeting agreed on the urgent need for additional information and
identified some set of indicators that are required to reduce the identified data gap.
Regulatory Capit al t o Risk-Weighted Asset s
Regulatory Tier 1 Capit al to Risk-Weight ed Assets
Nonp erformin g Loans n et of prov ision t o capit al
Nonp erformin g Loans t o Tot al Gross Loans
Sectoral Dist ribution of Loans
Ret urn on Assets (ROA )
Return on Equity (ROE)
Int erest Margin t o Gross Income
Nonint erest Expense t o Gross I ncome
Liquid A sset s t o t ot al A sset s
Liquid A sset s t o Short Term Liabilit ies
Sensit iv it y t o Market Risk Net Open position in Foreign Exchange to Capital
Capit al to asset s
Large exposu re t o capit al
Geographical dist ribut ion of loans t o total loans
Gross asset posit ion in financial derivat iv es t o capit al
Gross liabilit y position in financial deriv at ives to capit al
Gross liabilit y position in financial deriv at ives to capit al
Trading income t o tot al income
Personnel expenses t o nonint erest expenses
Spread bet ween refence len ding and deposit rat es
Spread bet ween highest and lowest int erbank rat e
Cust omer deposit s to t ot al ( noninterbank) loans
Foreign-currency-denominated loans to toal loans
Foreign-currency-denominated liabilit ies to toal liabilit ies
Net open posit ion in equit ies t o capit al
Asset s to t ot al financial syst em asset s
Asset s to GDP
Total debt to equity
Ret urn on equit y
Earnings t o interest and principal expenses
Net foreign exchange exposure t o equit y
Number of applicat ions for prot ection fr om credit ors
Household debt to GDP
Household debt service and principal payment s t o income
Av erage bid-ask spread in t he securit ies market
Average t urnov er rat io in the securit ies maerket
Real E st ate Prices
Resident ial Real Estat e Loans t o Tot al Loans
Commercial Real Est at e Loans t o Total Loans
Market Liquidity
Real E st ate M arket
Source: FSIs Compilat ion Guide, 2006
Nonfinancial Corpora t ions Sect or
Encoura ged Sets
Core Sets
Deposit Takers
Other Financial Corporations
Households
Capital A dequacy
Asset Quality
Table 1: Finan cial Soundness Indica tors: Core and Encou raged Sets
Earning and Profit abilit y
Liquidit y
IFC Bulletin No 39
5
In the mid-2000, the IMF conducted a survey on the compilation and dissemination
of macro-prudential indicators with a remarkable response from over 100 countries.
This helped the IMF to identify a core set of financial soundness indicators that all
member countries are expected to compile and an encouraged set of important
indicators that countries are not compelled but encouraged to compile depending
on the national circumstances. These indicators are presented in Table 1.
The IMF published a compilation guide on FSIs in 2006. The Guide provides
guidance on the concepts and definitions, as well as sources and techniques for the
compilation and dissemination of internally consistent, cross-country comparable
sets of indicators that could provide information about the current soundness of the
aggregate financial system. The innovative Guide combines elements of
macroeconomic frameworks, including monetary statistics, banks supervisory
framework and international financial accounting standards.
3.2 Compilation of FSIs in Nigeria
The major data source for the compilation of FSIs for Nigeria is banks statutory
returns to the CBN, made up of Income and Expense Statements and Financial
Balance Sheet of commercial and merchant banks. The FSI compilers download the
bank returns from the electronic financial analysis and surveillance system (e-FASS)
of the CBN to extract relevant data for computing the FSIs. The FSI compilation is,
however, limited to those indicators whose underlying series are available in the
statutory returns as shown in Table 2.
To strengthen its surveillance and supervision activities, the CBN using the FSI
compilation guide compiled some macro-prudential indicators of the strength and
stability of the financial system. These indicators are very important in the sense that
they enable the evaluation of the system based on objective measures that include
both aggregate micro-prudential indicators of the solvency of the financial
institutions and macroeconomic variables related to the strength of the financial
system. The IMF encourages countries to compile this type of indicators in order to
start systematic monitoring of financial soundness and improve the possibilities to
execute macro prudential analysis. This comprehensive set of indicators has been
renamed financial soundness indicators (FSIs).
Available data are sufficient for compiling 11 core (out of 12) and four
encouraged (out of 28) FSIs, which is well within the range of other countries’ FSIs
reported in the IMF website. The granularity of the current framework for reporting
Income and Expense Statements and Financial Balance Sheet of banks in the eFASS
does not support the compilation of the outstanding FSIs. However, the new user
specification requirements of the Bank will ameliorate this data issue when fully
implemented and Nigeria would then be able to compile all core and at least nine
encouraged FSIs in the near future.
4. FSIs, Financial Stability and Monetary Policy in Nigeria
The Central Bank of Nigeria computes a group of macro prudential indicators for
the purpose of analyzing the effects of macroeconomic variables on the financial
system in order to pursue its goals of monetary and financial stability. When the
6
IFC Bulletin No 39
development in the key indicators are examined, it is possible to find some early
warning signals that may imply the necessity to take certain economic policy action
to avoid possible crisis in the financial system. However, the use of these indicators
for financial system stability assessments and monetary policy decisions is quite
recent.
Over the years, the CBN’s monetary policies consists of a combination of
actions aimed at ensuring monetary and price stability as well as promoting
financial system stability. It therefore becomes pertinent to have coordination
between actions taken towards each goal, as the achievement of each depends on
the other. Appropriate monetary policy is desirous of financial stability and vice
versa, and the maintenance of price stability requires a stable financial environment.
Thus, policy actions taken for both goals must be consistent and mutually
reinforcing.
The monetary policy in recent years was conducted against the background of
the lingering effects of the liquidity crunch in the domestic economy, arising from
the global financial and economic crises of 2007/2008 and internal problems in
some deposit money banks in Nigeria.
Liquidity management was, therefore, geared towards improving the liquidity
and efficiency of the financial market, without compromising the objective of
monetary and price stability. Consequently, the monetary policy measures
substantially improved liquidity conditions in the banking system and, to a large
extent, ameliorated the capital erosion witnessed in the banking system in the late
2009.
4.1 Financial Soundness Indicators
The Central Bank of Nigeria (CBN) compiles both core and encouraged FSIs for
deposit takers (DTs) in Nigeria. The compilation is limited to the indicators whose
underlying series are available in the statutory returns of deposit money banks
(DMBs) in Nigeria. The Bank has successfully computed quarterly series of FSIs for
the period spanning 2007Q1 to 2013Q4 as reported in Table 2.
Eleven out of the twelve core FSIs are currently being compiled for the banking
sector in Nigeria. These FSIs cut across four components of the indicators: capital
adequacy, asset quality, earnings and profitability, and liquidity. The definition and
methodology applied are explained hereunder.
4.1.1 Capital Adequacy Based Indicators
The three core indicators of capital adequacy are vital to the robustness of financial
sector to withstand shocks to their balance sheets. Deterioration in the ratio
signifies increased risk exposure and possible capital adequacy problems while an
increase in the ratio means the reverse. Regulatory Capital to Risk-Weighted Assets
ratio measures the capital adequacy of the banking sector in Nigeria. The numerator
represents the industry position of the regulatory capital of all DMBs in the country,
while the denominator is their Risk Weighted Assets (RWA) within the given period.
Regulatory capital is defined in line with the provisions of the Basel Committee on
IFC Bulletin No 39
7
Tier 1 and Tier 2 capitals2. The international convention is that regulatory capital
should not be less than 8.0 per cent of banks’ risk weighted assets, while the
required minimum ratio in Nigeria is 10 per cent for Regional and National banks
and 15 per cent for International banks.
Regulatory Tier 1 Capital to Risk-Weighted Assets ratio measures the capital
adequacy of the banking sector in Nigeria. The numerator represents the industry
position of the Tier 1 capital of all DMBs in the country, while the denominator is
their Risk Weighted Assets (RWA) within the given period. Tier1 capital comprises of
paid-up capital, common stock and disclosed reserves such as retained earnings,
share premiums, general reserves and legal reserves.
Nonperforming Loans net of provision to capital indicator is intended to
compare the potential impact on capital of nonperforming loans net of provision.
The numerator is treated in Nigeria as nonperforming when payments of principal
and interest are overdue by three months or more. Specific provisions are deducted
from the capital which is measured as capital and reserves reported in the sectoral
balance sheet. In the alternative, however, regulatory capital can also be used.
2 Tier1 capital is core capital, which includes equity capital and disclosed reserves.
Tier2 capital is supplementary bank capital that includes items such as revaluation reserves.
0.00
5.00
10.00
15.00
20.00
25.00
0.00
5.00
10.00
15.00
20.00
25.00
2007 Q1
2007 Q2
2007 Q3
2007 Q4
2008 Q1
2008 Q2
2008 Q3
2008 Q4
2009 Q1
2009 Q2
2009 Q3
2009 Q4
2010 Q1
2010 Q2
2010 Q3
2010 Q4
2011 Q1
2011 Q2
2011 Q3
2011 Q4
2012 Q1
2012 Q2
2012 Q3
2012 Q4
2013 Q1
2013 Q2
2013 Q3
2013 Q4
Ratio in Percentage
Ratio in Percentage
Fig 1: Trend in Capital Adequacy Based Indicators
Regulatory Tier 1 Capital to Risk-Weighted Assets Capital to Assets Regulatory Capital to Risk-Weighted Assets
8
IFC Bulletin No 39
2007 Q1 2007 Q2 2007 Q3 2007 Q4 2008 Q1 2008 Q2 2008 Q3 2008 Q4 2009 Q1 2009 Q2 2009 Q3 2009 Q4 2010 Q1 2010 Q2
1. Asset Quality and Liquidity Based Indicators
Non-performi ng Loans to Total Gross Loans 8.9 7.7 7.6 8.4 7.1 4.0 4.6 6.3 6.5 8.5 20.8 27.6 34.8 28.8
Liquid Assets to Total Asse ts 26.6 24.7 25.7 21.2 23.6 20.7 17.7 14.7 13.8 12.9 7.6 10.5 13.0 12.3
Liquid Assets to Short Term L iabilities 31.7 29.2 32.3 26.7 29.6 27.2 23.1 19.1 18.3 17.1 10.2 13.6 15.0 13.6
2.Capital Adequacy Based Indicators
Regulatory Capital to Risk-Weighted Assets 19.3 18.6 20.8 20.9 19.8 23.7 22.0 21.9 22.5 22.4 15.5 4.1 3.4 1.5
Regulatory Tier 1 Capital to Risk-Weighted Assets 18.4 17.5 19.8 20.2 19.4 23.2 21.4 21.5 22.1 21.9 15.6 4.9 4.3 2.4
Capital to Assets 12.8 12.3 14.1 15.5 14.6 17.9 16.9 17.7 18.8 19.4 12.9 4.0 3.4 1.9
Non-performi ng Loans Net of Provisions to Capital 15.0 11.9 12.4 11.1 11.4 3.5 5.5 9.1 9.5 12.5 38.9 106.8 268.0 289.8
3. Earnings and Profitability Based Indicators
Interest Margin to Gross Income 52.6 62.3 60.7 1.4 56.6 52.4 62.7 61.2 60.2 60.0 51.1 59.1 54.0 51.9
Non-interest Expense s to Gross Income 61.6 51.1 50.7 29.1 58.4 57.1 59.8 62.6 61.7 68.0 78.2 137.4 88.3 65.7
Return on Assets 6.2 7.6 7.0 9.1 5.2 4.4 3.9 3.7 4.2 3.5 (1.5) (8.8) 1.4 2.1
Return on Equity 48.5 55.0 44.2 57.2 32.0 23.0 22.0 20.7 22.7 17.7 (11.1) (19.5) 39.9 110.0
Personnel Expense s to Non-interest Expenses 40.1 41.2 43.1 47.4 43.8 43.2 43.7 41.0 43.3 41.9 39.4 47.7 41.8 40.1
2010 Q3 2010 Q4 2011 Q1 2011 Q2 2011 Q3 2011 Q4 2012 Q1 2012 Q2 2012 Q3 2012 Q4 2013 Q1 2013 Q2 2013 Q3 2013 Q4**
1. Asset Quality and Liquidity Based Indicators
Non-performi ng Loans to Total Gross Loans 35.6 15.7 12.0 10.8 9.1 5.3 4.2 4.3 4.1 3.5 3.8 3.7 3.4 3.2
Liquid Assets to Total Asse ts (Liquid Asset R atio) 10.3 12.0 18.1 17.4 20.8 25.4 24.6 22.5 20.9 24.6 27.9 20.9 18.1 22.0
Liquid Assets to Short Term L iabilities 11.3 13.3 20.1 19.4 24.8 30.1 29.2 26.5 24.6 28.4 32.3 24.3 21.0 25.2
2.Capital Adequacy Based Indicators
Regulatory Capital to Risk-Weighted Assets 0.2 1.8 6.1 4.2 7.8 17.9 18.9 17.7 17.9 18.3 19.6 18.9 18.0 17.1
Regulatory Tier 1 Capital to Risk-Weighted Assets 0.9 2.2 6.4 4.5 7.7 18.1 18.9 17.8 18.0 18.0 19.3 18.5 17.6 17.1
Capital to Assets 0.8 1.5 4.3 3.0 4.7 10.5 11.0 11.2 10.9 10.7 11.7 11.2 10.8 10.3
Non-performi ng Loans Net of Provisions to Capital 241.3 192.7 47.0 74.3 32.2 10.1 4.5 6.8 6.7 6.1 6.0 7.2 7.1 7.4
3. Earnings and Profitability Based Indicators
Interest Margin to Gross Income 54.7 53.6 56.4 49.4 66.4 31.0 63.8 67.7 66.6 62.0 62.6 65.2 65.8 63.9
Non-interest Expense s to Gross Income 70.3 50.2 74.0 70.6 47.5 24.4 68.4 59.2 68.5 64.8 63.4 62.7 69.7 68.1
Return on Assets 2.2 3.9 1.6 1.7 (1.3) 0.2 1.6 2.8 2.3 2.3 2.8 2.8 2.5 2.1
Return on Equity 285.6 266.0 35.5 55.1 (27.1) 2.2 14.5 25.0 20.0 21.1 23.2 24.8 22.4 20.1
Personnel Expense s to Non-interest Expenses 39.4 36.8 39.6 41.1 18.6 67.8 43.6 39.3 40.4 42.5 40.0 39.5 36.1 36.9
*FSIs are computed based on IMF guidelines, **Provisional.
Table2: Selected Financial Soundness Indicators of the Nigerian Banking Industry*
(All figures i n perce ntages, except otherwise indicate d)
IFC Bulletin No 39
9
Capital to Assets (CA) tends to reveal the leverage of the deposit takers by
showing the extent to which assets are funded by other funds other than those that
belong to the DTs. Both capital and assets are measured as in the core FSIs.
On the capital adequacy based indicators, it can be seen that the ratio of
regulatory capital to risk-weighted assets (commonly known as capital adequacy
ratio) fluctuated widely and peaked at 23.7 per cent in the first half of 2008. The
capital adequacy ratio showed deterioration between Q4, 2009 and Q3, 2011, but
improved considerably thereafter to 17.1 per cent at end-December 2013, which
was well above the CBN minimum CAR of 10.0 per cent and 8.0 per cent benchmark
recommended by the Basle Committee.
The ratio of Tier 1 capital to risk-weighted assets was also strong, indicating
that the Nigerian banks are resilient to shocks on their balance-sheet items. The
capital based indicators remained stable in the last three years, owing largely to
CBN’s intervention by setting up the AMCON in 2010 to absorb the prevalent toxic
assets in the banking system. Similarly, the return on equity (ROE) improved,
reflecting the competitiveness of the banking system. On the whole, the above
scenario reflected a strong capital base for Nigerian banks as indicated in Fig 1.
4.1.2 Assets Quality and Liquidity Based Indicators
There are two core indicators for asset quality; namely: nonperforming loans to total
gross loans and sectoral distribution of loans.
Nonperforming Loans to Total Gross Loans indicator shows the quality of assets
created by the banking system. The numerator is the total value of loans that are
overdue while the total value of the loan portfolio is used as the denominator. Loan
include those financial assets created through the direct lending of funds by a
creditor to a debtor through an arrangement in which the lender either receives no
security evidencing the transactions or receives a non-negotiable document or
instrument.
Sectoral Distribution of Loans reveals the level of credit concentration and/or
diversification in the loan portfolio which may be a source of vulnerability to the
financial system. The numerators are lending to each of the listed sectors while the
denominator is total gross loan.
There are two core indicators for liquidity: liquid assets to total assets and liquid
assets to short-term liabilities. Liquid Assets to Total Assets is indicator is designed to
provide an indication of the liquidity available to meet expected and unexpected
demands for cash. It is calculated by imposing the core or broad measure of liquid
assets on total assets. Core liquid assets comprise of currency and deposits and
other financial assets that are available either on demand or within three months or
less. Broad liquid asset equals the core assets plus securities that are traded in liquid
markets and can be easily converted into cash with no or minimal change in value.
Liquid Assets to Short-term Liabilities determines the liquidity mismatch of
assets and liabilities and provides an indication of the extent to which deposit takers
could meet short-term withdrawal of funds without facing liquidity problems. The
core or broad measure of liquid assets is taken as the numerator while short-term
liabilities are taken as the denominator. Short-term liabilities are the short-term
elements of debt liabilities plus the net short-term market value of the financial
derivatives.
10
IFC Bulletin No 39
The asset quality and liquidity based indicators revealed an improvement in the
asset quality of the Nigerian financial system over the years. The ratio of non-
performing loans to total loans stood at 3.7 per cent as at end-December, 2013,
reflecting a significant decline below the level of 27.6 per cent at end-December,
2009. The improved position was attributable to stricter adherence by banks to
credit risk management policies and standards. Also the level of liquidity in the
system improved steadily during the period, as the ratio of core liquid assets to total
assets increased from 16.5 per cent at end-December 2009 to 21.2 per cent at end-
December, 2013. Similarly, the ratio of liquid assets to short-term liabilities
increased from 22.3 per cent to 25.0 per cent during the same period. The trends in
these indicators are illustrated in Fig 2.
4.1.3 Earning and Profitability Based Indicators
Return on Assets measures deposit takers’ efficiency in the use of own assets. Net
income according to the amended FSI Guide is defined before extra-ordinary items
and taxes and includes gains and losses on financial instruments as per the
provision of international financial reporting standard. Return on Equity measures
deposit takers’ efficiency in the use of capital. In this case, net income is divided by
capital3.
Interest Margin to Gross Income measures the relative share of net interest
earnings – interest earned less interest expenses – within gross income. It is
calculated by using interest income as the numerator and gross income as the
denominator. Net interest income is interest income (gross interest income minus
provisions for accrued interest on NPLs) minus interest expense. Gross income
3 The definition of capital is given as above.
0.00
5.00
10.00
15.00
20.00
25.00
30.00
35.00
40.00
0.00
5.00
10.00
15.00
20.00
25.00
30.00
35.00
40.00
2007 Q1
2007 Q2
2007 Q3
2007 Q4
2008 Q1
2008 Q2
2008 Q3
2008 Q4
2009 Q1
2009 Q2
2009 Q3
2009 Q4
2010 Q1
2010 Q2
2010 Q3
2010 Q4
2011 Q1
2011 Q2
2011 Q3
2011 Q4
2012 Q1
2012 Q2
2012 Q3
2012 Q4
2013 Q1
2013 Q2
2013 Q3
2013 Q4
Ratio in Percentage
Ratio in Percentage
Fig 2: Trend in Assets Quality and Liquidity Based Indicators
Liquid Assets to Total Assets Liquid Assets to Short Term Liabilities Non-performing Loans to Total Gross Loans
IFC Bulletin No 39
11
equals net interest income plus noninterest income such as fees and commissions’
receivable, gains and losses on financial instruments, pro-rated earnings from other
deposit takers and other income.
Non-interest Expenses to Gross Income indicates the size of administrative
expenses to gross income (interest margin plus non-interest income). It is calculated
by using non-interest expenses as the numerator and gross income as the
denominator. Non-interest expenses cover all expenses other than interest
expenses, but without provisions and extra-ordinary items.
There are three encouraged set of indicators under earnings and profitability,
out of which two are currently being computed for the Nigerian banking sector.
Trading Income to Total Income is a measure of the relative share of deposit takers’
income from financial market activities in gross income. It is an indication of reliance
on market-oriented activities in gross income. It also assesses the sustainability of
the DMBs’ profitability. The indicator is calculated by using gains or losses on
financial instruments as the numerator and gross income as the denominator.
Trading income comprises of gains and losses on financial instruments valued at
market or fair value in the balance sheet. It excludes equity in associates,
subsidiaries and any reverse equity investment. Gross income is as defined under
core indicators.
Personnel Expenses to Non-interest Expenses appraises the incidence of
personnel costs in total administrative costs. It uses personnel costs as the
numerator and non-interest expenses as the denominator. Personnel costs cover
the total remuneration payable by the organization in return for services rendered
by the employers. Non-interest expenses are as defined under the core FSIs.
-10.00
0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00
-10.00
0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00
2007 Q1
2007 Q2
2007 Q3
2007 Q4
2008 Q1
2008 Q2
2008 Q3
2008 Q4
2009 Q1
2009 Q2
2009 Q3
2009 Q4
2010 Q1
2010 Q2
2010 Q3
2010 Q4
2011 Q1
2011 Q2
2011 Q3
2011 Q4
2012 Q1
2012 Q2
2012 Q3
2012 Q4
2013 Q1
2013 Q2
2013 Q3
2013 Q4
Ratio in Percentage
Ratio in Percentage
Fig 3: Trend in Earnings and Profitability Based Indicators
Return on Assets Interest Margin to Gross Income Personnel Expenses to Non-interest Expenses
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With regard to the earnings and profitability based indicators, the ratio of
interest margin (i.e. interest earned less interest expenses) to gross income
remained in the range of 31.0 per cent and 67.7 per cent, except for Q4 2007 when
it recorded 1.4 per cent. The ratio of non-interest expenses to gross income (a
measure of the size of administrative expenses for banks) average 63.98 per cent
during the period Q1, 2007 and Q4, 2013, and peaked at 137.38 per cent in Q4,
2009 with a minimum of 24.37 per cent attained in Q4, 2011. Similarly, the ratio of
personnel expenses to non-interest expenses trended down to 36.9 per cent at end-
December, 2013. Overall, the earnings and profitability based indicators revealed
that the income and cost structure of the banking sector remained stable post crisis
period, thereby confirming the sustained profitability posted by the sector in recent
years.
5. Complementary Role of Stress Testing
As a complementary approach to assessing the financial strength and vulnerabilities
of the banking system, stress testing is used to give information in addition to that
provided by the FSIs. The relationship between FSIs and stress testing derives from
the fact that FSIs are typically the output of stress tests. Specifically, an FSI provides
a quantitative measure to assess a particular vulnerability, while the stress test,
which is a shock to the relevant macroeconomic risk factor, yields an estimate of the
FSIs associated with this vulnerability.
The CBN adopts stress testing as a means of identifying the vulnerabilities, and
measuring the resilience of the Nigerian banking industry to various and varying
shocks. The stress test is conducted under four scenarios: the entire banking
industry; large; medium and small banks. The latest liquidity stress test was
conducted by the CBN at end-December 2013, using the implied cash flow analysis
(ICFA) and maturity mismatch/rollover risk approaches. The test was aimed at
assessing the ability of the banking system to withstand liquidity and funding
shocks. A solvency stress test was also conducted on the banking industry as at
December 31, 2013 to assess the stability of the sector under various hypothetically
strained macroeconomic conditions. The test results revealed that the Nigerian
banking industry, in general, was resilient to liquidity and solvency stress in the
second half of 2013.
The CBN has also, since 2010, consistently published its bi-annual Financial
Stability Report as one of the several avenues through which the Bank seeks to
contribute to the resiliency of the Nigeria financial system. The report combines the
Bank’s ongoing work in monitoring developments in the system, with a view to
identifying potential risks to the overall soundness, as well as highlighting the
efforts of the Bank and other regulatory authorities, to mitigate the risks. It is
pertinent to note that macro-prudential analyses, including financial soundness
indicators and stress test, are among the key features of the Financial Stability
Report.
IFC Bulletin No 39
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6. Challenges and Concluding Remarks
To strengthen the supervision over the financial sector, the regulatory authorities
need adequate indicators of the strength and stability of the financial system. The
macro prudential indicators are very important in this respect as they enable the
regulators make evaluations based on objective measures. Macro prudential
analysis closely complements and reinforces early warning systems and other
analytical tools to monitor inherent vulnerabilities, using macroeconomic indicators
as key explanatory variables.
The Central Bank of Nigeria uses a combination of macroeconomic and macro
prudential indicators and the associated stress testing for financial stability
assessment and monetary policy purposes. The indicators serve in measuring the
soundness and vulnerabilities of the financial system in five key areas: capital
adequacy, asset quality, liquidity, earnings and sensitivity to market risk. Currently,
the CBN compiles eleven out of the twelve core FSIs for the banking sector and only
four out of the twenty eight encouraged FSIs for deposit takers in Nigeria. The
limitation in compiling the remaining indicators arises mainly from data challenges,
which the Bank is trying to address through collaboration with other data
generating agencies in the country.
Given the expertise required in compiling the FSIs, the CBN constituted an FSI
Harmonization Committee comprising staff of Statistics, Banking Supervision, Other
Financial Institutions and Monetary Policy departments. The committee is currently
working on fine-tuning the metadata for the compiled FSI. Also, the Bank is
exploring the feasibility of expanding the coverage of FSIs compilation to include
the microfinance banks and mortgage institutions, which are major deposit takers
engaged in microfinance activities and financing of real estate in Nigeria. Similarly,
the Bank is reviewing and improving the data collection of the source data for the
capture of sectoral distribution of loans and foreign currency exposure of the DTs.
These efforts are expected to expand the number and improve the quality of
computed FSIs in Nigeria.
Recent assessments using the FSIs and stress testing revealed that the Nigerian
banking sector is stable, robust and resilient to liquidity and funding shocks. It was
found that the quality of assets of the banking industry was good as the non-
performing loans reduced drastically over time; the capital adequacy ratio of
17.2 per cent at end-December 2013 was well above the CBN minimum CAR of
10.0 per cent and 8 per cent minimum requirement of the Basle Committee; and
earnings and profitability were satisfactory. These salutary developments were
considered to be the fallout of the various initiatives and interventions by the CBN
aimed at sanitizing the financial sector.
References
CBN (2010). Financial Stability Report, Maiden Edition, December. 2010.
CBN (2010) .Annual Report, December. 2010.
CBN (2013) .Financial Stability Report, December. 2013.
Craig, R.S. (2002). “Role of financial soundness indicators in surveillance: data
sources, uses and limitations” in IFC Bulletin 12, October. 2002.
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IFC Bulletin No 39
Elfferich, K. and M. de Jong (2002). “Macro-prudential Indicators: A pilot compilation
exercise for the Netherlands” in IFC Bulletin 12, October 2002.
Hunter, L. (2008). “The relationship between monetary and financial stability” in
Reserve Bank of New Zealand Bulletin vol. 71, No.2, June 2008.
IMF (2006) Financial Soundness Indicators: Compilation Guide.
Vong, Thomas L.K. (2003). “The Financial Soundness Indicators of Macao”, Monetary
Authority of Macau.
William C.V. (2002). “The use of macro prudential indicators: the case of Costa Rica”
in IFC Bulletin 12, October. 2002.