Recapitalisation and Financial Inclusion in Nigeria: Legal Implications for SMEs and Access to Banking Services

Background:

Recapitalization is a process often mandated by regulatory authorities to ensure the financial stability of banks. It refers to the process of increasing a bank’s financial strength by raising additional capital.

In Nigeria, the Central Bank of Nigeria (CBN) plays a crucial role in ensuring the stability and soundness of the financial system. To achieve this, the CBN periodically introduces recapitalization policies to enhance the resilience of Nigerian banks. While the primary aim of recapitalization is to bolster the capital base of financial institutions, its ripple effects extend beyond mere fiscal health, impacting financial inclusion and the accessibility of banking services.

The legal implications of recapitalization are profound for small and medium-sized enterprises (SMEs), which are crucial drivers of Nigeria’s economy. This article explores how recapitalization has influenced financial inclusion and access to banking services in Nigeria, with a particular focus on its impact on SMEs.

Legal Framework Governing Recapitalization in Nigeria:

The Central Bank of Nigeria (CBN) is the principal regulatory body overseeing the banking sector, and its policies on recapitalization are grounded in several legal instruments. The Banks and Other Financial Institutions Act (BOFIA) 2020 provides the legal foundation for the CBN’s authority to mandate recapitalization. Under Section 9 of BOFIA, the CBN is empowered to prescribe the minimum capital requirements for banks[1], which has led to various rounds of recapitalization, notably in 2005, and more recently, March 2024.

The legal framework aims to ensure that banks maintain sufficient capital to absorb losses and protect depositors. However, these mandates also create a legal obligation for banks to comply, often leading to mergers, acquisitions, and the consolidation of smaller banks that struggle to meet the new capital requirements.

The 2024 Recapitalization Policy:

In March 2024, the CBN announced a recapitalization policy that increased the minimum capital requirements for “commercial,” “merchant,” and “non-interest banks” in Nigeria, effective from April 1st, 2026. This means that banks in Nigeria have now been given 24 months (April 1, 2024, to March 31, 2026) to raise the required funds.

The circular announced[2]:

• Upward review of the minimum capital requirements.
• Options available to banks to meet the new minimum capital requirements.
• Time limit to comply with the new requirements.
• Submission of implementation plan.
• Eligible capital for proposed banks.

The main objectives of this policy include[3]:

• Strengthening Resilience: To improve the resilience of Nigerian banks against both local and global shocks and promote the stability of the financial system.
• Supporting Economic Growth: By ensuring that banks have the capacity to take bigger risks, support various sectors of the economy, and enhance confidence in the banking system.
• Aiming for a $1 Trillion Economy: The CBN aims to contribute to the Nigerian Federal Government’s goal of achieving a $1 trillion economy in Gross Domestic Product by 2030.

Recapitalization and Impact on Financial Inclusion:

Financial inclusion refers to efforts to make financial products and services accessible and affordable to all individuals and businesses, regardless of their personal net worth or company size[4]. Financial inclusion is a critical goal for Nigeria economic development as a significant portion of the population remains unbanked or underbanked. Recapitalization, while intended to strengthen the banking sector, has had mixed effects on financial inclusion.

Positive Impacts:

1. Expansion of Banking Services:

• Broader Reach: Recapitalization strengthens banks’ financial capacity, allowing them to expand their services to previously underserved areas, including rural regions. This expansion increases the accessibility of banking services to a larger portion of the population, contributing to financial inclusion[5].
• Investment in Technology: With a stronger capital base, banks are better positioned to invest and improve on their digital infrastructure, such as mobile banking and online services. This technology enables people in remote areas to access financial services without the need to visit physical branches, significantly improving financial inclusion.
• Stability: Recapitalization increase the valuation of Banks and ensure banks are stable, stronger and insusceptible to hostile takeovers.

2. Innovation in Financial Products:

• Tailored Services: Recapitalized banks have the resources to develop and offer innovative financial products that cater to the needs of various customer segments, including low-income individuals and small businesses. These products can include microloans, savings accounts with lower fees, and insurance products, all of which help bring more people into the formal financial system​.
• Support for Financial Literacy: Banks with increased capital can also fund financial literacy programs, which are crucial for helping individuals understand and use financial services effectively. These programs can empower more people to engage with the banking system, thus enhancing financial inclusion​

Challenges of Recapitalization on Financial Inclusion:

1. Increased Risk Aversion:

• Stricter Lending Conditions: As banks focus on meeting recapitalization requirements, they may adopt more conservative lending practices, particularly towards SMEs. This increased risk aversion can make it harder for SMEs to access credit, limiting their ability to grow and contribute to the economy​.
• Potential Neglect of High-Risk Areas[6]: Banks might prioritize safer investments and more profitable urban markets over rural or high-risk areas, where financial inclusion is most needed. This can lead to a widening gap in financial access between different regions, exacerbating financial exclusion in underserved areas​.

2. Consolidation and Reduction of Bank Presence:

• Fewer Local Banks: Recapitalization often leads to mergers and acquisitions, which can reduce the number of small, community-focused banks. While larger banks may emerge stronger, the reduction in the number of local banks can decrease access to banking services in rural areas where these small banks previously operated, potentially hindering financial inclusion​[7].
• Disruption in Service Continuity: Mergers and acquisitions can also disrupt existing customer relationships and services, as the new entities may restructure their offerings. This can cause temporary setbacks in service availability, particularly affecting low-income customers who rely heavily on consistent access to banking services[8].​

Effect on Small and Medium-Sized Enterprises (SMEs)[9]:

SMEs are particularly vulnerable to the legal and economic consequences of bank recapitalization. As the backbone of Nigeria’s economy, SMEs rely heavily on access to affordable credit and financial services, which can be disrupted by the recapitalization process.

• Tighter Credit Conditions: Following recapitalization, banks often adopt more conservative lending practices to comply with stricter regulatory requirements. This is particularly true for SMEs, which are considered higher-risk borrowers. The legal obligation for banks to maintain higher capital reserves can lead to reduced credit availability for SMEs or more stringent borrowing terms. As a result, many SMEs may find it difficult to secure the financing they need for expansion or operational continuity, thereby stifling their growth potential. However, as postulated by KPMG, this challenge presents an opportunity for insurance company to expand their participation in financial services and significantly increase Nigeria’s historically low insurance penetration in the sector[10].
• Interest Rates and Costs: Recapitalization can have a significant indirect impact on interest rates. When banks raise additional capital through debt issuance or other costly means, they may pass on these increased costs to borrowers. This is particularly relevant for small and medium-sized enterprises (SMEs), which often face higher borrowing costs as a result. The higher interest rates can reduce SMEs’ profitability and limit their ability to invest in growth and innovation. This can pose a challenge to financial inclusion, as SMEs play a critical role in economic development and job creation.
• Operational Disruptions: During recapitalization, banks may undergo restructuring, mergers, or even close branches, which can disrupt existing banking relationships for SMEs. These changes can lead to a temporary loss of access to familiar services, forcing SMEs to adapt to new banking channels or seek alternative financial institutions. Such disruptions may hinder SMEs’ operational efficiency and financial stability, potentially affecting their day-to-day activities and long-term growth prospects​.
• Legal and Regulatory Compliance: Recapitalization often leads to new regulatory requirements that SMEs must comply with, such as updated documentation, enhanced reporting standards, or stricter collateral obligations. These changes can impose additional administrative burdens on SMEs. Legal professionals play a crucial role in guiding SMEs through these new regulations, helping them navigate compliance challenges, and mitigating potential legal risks, ensuring that they continue to operate smoothly within the evolving regulatory landscape​.
• Collateral and Loan Recovery: Recapitalization may lead banks to impose stricter collateral requirements, requiring SMEs to provide additional security for loans. This can increase the financial burden on SMEs, potentially limiting their access to credit. Additionally, banks may strengthen their loan recovery mechanisms, which could reduce SMEs’ flexibility in negotiating loan terms during financial distress, potentially leading to quicker asset seizures or other legal actions​.
• Capacity Building and Financial Literacy: Recapitalization offers banks the opportunity to invest in advanced technology and financial literacy programs. These initiatives can significantly benefit SMEs by providing them with the tools and knowledge needed to manage their finances more effectively. Capacity-building programs can enhance SMEs’ financial management skills, improve their access to banking services, and ultimately support their growth and sustainability in a competitive market​.

Conclusion:

Recapitalization in Nigeria’s banking sector, driven by legal mandates, has had significant implications for financial inclusion and the access of SMEs to banking services. While the process has strengthened the capital base of banks, ensuring greater financial stability, it has also presented challenges, particularly for underserved communities and SMEs.

On this premise, Policymakers must strike a delicate balance, ensuring financial stability while promoting greater access through supportive regulations and lending policies. Also, the insurance industry can leverage on Bank’s risk aversion, in counterbalancing SMEs need financial liquidity and the Banks need to be guaranteed repayment on their loans.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

[1] Section 9 BOFIA 2020

[2] Harlem Solicitors (24th May, 2024) “CBN Recapitalisation Policy 2024: Meaning, Purposes And Implications” CBN Recapitalisation Policy 2024: Meaning, Purposes And Implications – Financial Services – Finance and Banking – Nigeria (mondaq.com) Accessed 12/08/2024

[3] Hope Moses-Ashike (2nd April, 2024) “What CBN recapitalization means for banks, economy” BUSINESS DAY https://businessday.ng/news/article/what-cbn-recapitalisation-means-for-banks-economy/ Accessed 12/08/2024

[4] Mitchell Grant (March 12, 2024) “Financial Inclusion: Definition, Examples, and Why It’s Important” INVETOPEDIA https://www.investopedia.com/terms/f/financial-inclusion. Accessed 15/08/2024

[5] KPMG (July 2024) “Nigeria’s Banking Recapitalization: What Lies Ahead” Nigeria’s Banking Recapitalization: What Lies Ahead (kpmg.com) Accessed 12/08/2024

[6] Hope Moses-Ashike (2nd April, 2024) “What CBN recapitalization means for banks, economy” BUSINESS DAY https://businessday.ng/news/article/what-cbn-recapitalisation-means-for-banks-economy/ Accessed 12/08/2024

[7] Research Department CBN “Financial Inclusion in Nigeria: Issues and Challenges”  https://dc.cbn.gov.ng/cgi/viewcontent.cgi?article=1037&context=cbn_occasional_papers Accessed 12/08/2024

[8] David Ijaseun (7th August, 2024) “Path to recapitalization: Seven Nigerian banks strive to restore customer confidence post-currency crisis” BUSINESS DAY https://businessday.ng/backpage/article/path-to-recapitalisation-seven-nigerian-banks-strive-to-restore-customer-confidence-post-currency-crisis/#google_vignette Accessed 12/08/2024

[9] Small Business Insights “Banks’ Recapitalization and Its Implications for SMEs in Nigeria” Banks’ Recapitalization and Its Implications for SMEs in Nigeria – SMALL BUSINESS INSIGHTS Accessed 12/08/2024

[10] KPMG: Nigeria’s Banking Recapitalisation: What Lies Ahead https://assets.kpmg.com/content/dam/kpmg/ng/pdf/2024/06/Nigeria%27s%20Banking%20Recapitalisation%20What%20Lies%20Ahead%20(1).pdf Accessed 15/08/2024