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Why CBN excluded retained earnings in its recapitalization terms

The Central  Bank of Nigeria (CBN) omitted retained earnings from the share capital calculation in its recent recapitalisation terms released on Thursday.

The apex Bank announced a new set of capital thresholds for Nigerian banks, requiring international, national, and regional banks to maintain minimum share capital of ₦500 billion, ₦200 billion, and ₦50 billion, respectively.

In a calculation check by BusinessDay, the recapitalisation of these banks will bring in ₦3.3 trillion into the system.

This effort will enhance the resilience of an industry faced with high inflation, naira devaluation and weak economy.

In defining share capital, the CBN excluded retained earnings from the calculation. Instead, it specified that share capital comprises only the banks’ ordinary share capital and share premium.

“For existing banks, the capital requirements specified above shall be paid-in capital (Paid-up plus Share Premium) only. Bonus issues, other reserves and Additional Tier 1 (AT1 Capital shall not be allowed or recognized for the purpose of meeting the new minimum capital requirements.” the CBN noted.

Retained earnings is the profit of banks that are not distributed as dividends. It’s the same as any other earnings. It represents the cumulative total of all earnings retained since the company’s inception, including profits and losses.

There have been dissenting voices by bankers on the exclusion of retained earnings from the recapitalisation guidelines given by the CBN which they argue that it fails to acknowledge the actual value that these earnings represent, going against the conventional and legal treatment of a company’s capital structure.

“What the CBN should do is to conduct a stress test of all the banks and determine the capital required by each Institution based on the quality of their risk assets,” a source familiar with the matter said.

“That’s how it is done in Europe and the US. The CBN is taking a lazy and easy way out of what would have been an opportunity to reset the Banking industry after years of neglect and regulatory lax,” the source added.

The CBN excluded retained earnings from the computation of the new minimum capital base for international banks for the following reasons:

Risk Assessment: The CBN aims to ensure that banks have a robust capital base to absorb potential losses and avoid systemic shocks. By excluding retained earnings, which can be volatile due to business cycles and other factors, the focus remains on more stable capital components.

Quality of Capital: Retained earnings represent accumulated profits over time. However, their quality may vary. Some retained earnings might be tied to risky assets or speculative ventures. By excluding them, the CBN emphasizes higher-quality capital components and ensures a level playing field for banks.

Transparency and Comparability: Excluding retained earnings simplifies capital calculations and enhances transparency. It ensures consistency across banks and facilitates meaningful comparisons.

Alignment with Basel III Standards: The CBN’s guidelines align with international standards (Basel III). These standards emphasize core capital elements (such as paid-up capital and share premium) to enhance financial stability.

“The CBN had also made it clear that additional Tier 1 capital shall not be eligible for this new computation of minicsputsl base,” another source said.

“Though banks have been given 24 months to meet up. It is a tough call that may lead to further banking consolidation and M&As,” the source noted.

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