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Insider lending in banks needs regulatory change 15 Jun 2021

The Central Bank of Nigeria (CBN), on the 29th of April 2021, announced the removal of the board of directors of Nigeria’s oldest bank, First Bank of Nigeria (FBN), as well as that of its holding company, FBN Holdings Plc (FBNH). The dissolved Boards were chaired by Ibukun Awosika and Oba Otudeko, respectively. The CBN, in an intriguing twist, reinstated Adesola Adeduntan, who two days earlier was removed by the Board of FBN as Managing Director.
    
There were several infractions that were allegedly committed by the bank, including the removal of Dr. Adeduntan without regulatory approvals, which understandable drew the interventions of the CBN. However, non-performing loans arising from insider lending was widely reported to be the underlining cause of the upheaval at the bank. The CBN Governor, Godwin Emefiele, alluded to this when he said that the bank was in a “grave financial condition with its Capital Adequacy Ratio (CAR) and Non-Performing Loans ratio (NPL) substantially breaching acceptable prudential standards.”

Emefiele further said in a statement that “The insiders who took loans in the bank, with controlling influence on the board of directors, failed to adhere to the terms for the restructuring of their credit facilities which contributed to the poor financial state of the bank. The CBN’s recent target examination as at (sic) December 31, 2020 revealed that insider loans were materially non-compliant with restructure terms (e.g. non perfection of lien on shares/collateral arrangements) for over 3 years despite several regulatory reminders.”

The chain of events was reportedly triggered by a letter of the 26th of April, 2021, from the CBN, signed by its Director of Banking Supervision, Haruna Mustapha and addressed to the Chairman of the Board of FBN. In the letter, CBN noted that after 4 years the bank is yet to perfect its lien on the shares of Otudeko in FBNH, which collateralized the restructured credit facilities for Honeywell Flour Mills, contrary to the terms for the restructuring of the company’s credit facility. Otudeko is also Chairman of Honeywell Group, of which Honeywell Flour Mills is a subsidiary.

It is important to note that Honeywell has been in a major litigation with another bank, Ecobank, over its credit facilities. An appeal in the case has been lodged at the Supreme Court after the Court of Appeal on the 14th of December 2020, held that Honeywell was indebted to Ecobank to the tune of N3.5 billion.

Insider lending is very common in Nigerian banks. In its 2017 Nigerian Banking Sector Report, Afrinvest West Africa Limited reported that out of 14 banks profiled, only four banks had a ‘low’ level of insider lending. The other ten banks ranged from ‘moderate’ to ‘high.’ With the challenges faced by the Asset Management Corporation of Nigeria (AMCON) with respect to toxic bank loans, capital erosion and difficulty in monetizing seized assets, there are fears that the burden of bad loans in Nigeria would be borne by the taxpayers. AMCON’s current indebtedness to the CBN according to its Managing Director/CEO, Ahmed Kuru, as reported in the media in March 2021, stood at N4.7 trillion. It is only wise and prudent for the banking industry and regulators to not only try to solve the current crisis of toxic loans but go back to the root to review the laws and regulations concerning loans and borrowing. A good place to start is insider lending.

During the public hearing on the bill to amend the Banking and Other Financial Institutions Act (BOFIA) last year, the Nigerian Deposit Insurance Corporation (NDIC) submitted a memorandum to the Senate Committee on Banking, Insurance and other Financial Institutions, seeking the express prohibition of insider loans in the banking industry. In the memorandum, NDIC proposed a criminalization of insider lending by directors of a bank, making it an offence punishable with both imprisonment and fines. The proposal was obviously rejected, as BOFIA 2020 permits insider lending.

Under BOFIA 2020, the duty with respect to secured loans is simply one of disclosure. This is governed by section 17 of the Act, which stipulates that a manager or other officer of a bank who has personal interest in any advance, loan or credit facility must declare the nature of such interest to his or her bank. Where it is a director of a bank who is in anyway, directly or indirectly, interested in the grant of an advance, loan or credit facility by the bank, he or she shall declare the nature of such interest before the meeting of the board of directors of the bank at which the request for the advance, loan or credit facility is first taken into consideration. Where the interest is in respect of an advance, loan or credit facility to be granted by another bank, the director shall declare the nature of the interest to the CBN in writing prior to the grant of the advance or credit facility.

Failure to make the applicable disclosures constitutes an offence punishable with fine or imprisonment or both. A director is, however, not duty bound to disclose, where his or her interest in a company seeking the credit facility is less than 5% of the shares, or where the CBN regards the interest of the director as immaterial.

However, the provisions with respect to unsecured loans are more stringent and require approvals of the CBN. They are governed by the provisions of Section 19 of the Act, which states that a bank requires the prior approval of the CBN to give unsecured advances, loans or unsecured credit facilities of an aggregate amount in excess of N1 million to its directors, significant shareholders; or any firm, partnership or company in which it or its director(s) or significant shareholder(s) have an interest. A bank also requires the prior approval of the CBN to extend unsecured advances, loans or unsecured credit facilities to its officers and employees which in the aggregate for the officer or employer is in excess of his or her one year’s emolument.

The BOFIA Act 2020 bars a bank from lending more than 5% of its paid-up share capital to any one of its directors or significant shareholders. Furthermore, a bank’s aggregate exposure in lending to its directors and significant shareholders must not exceed 10% of its paid-up share capital. The Act also provides that credit extended by a bank to any of its directors or significant shareholders must be on the same terms and conditions as those prevailing at the time for comparable transactions by the bank with persons who are not directors or shareholders of the bank. It should not involve more than normal risk or present other unfavorable features, and it must follow the same credit appraisal procedures as transactions with persons who are not directors or shareholders of the bank. Under the CBN’s Code of Corporate Governance for Banks and Discount Houses in Nigeria, banks are to disclose their “insider-related credits” in their annual reports.

Directors are in a relationship of trust with their companies. Section 305 of the Companies and Allied Matters Act (CAMA) 2020 provides that “a director of a company stands in a fiduciary relationship towards the company and shall observe utmost good faith towards the company in any transaction with it or on its behalf.” A director is to act at all times in what he believes to be the best interests of the company as a whole, so as to preserve its assets, further its business and promote the purposes for which it was formed.

The adjectives used by CAMA for a director in relation to his company are ‘faithful’, ‘diligent’, ‘careful’, and ‘skillful’. In this wise, the CAMA in section 296 generally prohibits companies from giving loans to its directors or directors of its holding company or giving guarantees or providing any security in connection with a loan made to such director. This does not, however, apply to companies whose ordinary business includes lending of money or giving of guarantees such as banks.

One can then argue that insider lending results in a conflict of interests – the director’s personal business interests versus the interests of the bank. The loose regulations governing insider lending makes the director’s position susceptible to abuse as has been the case too many times in the Nigerian banking industry.

One cannot deny the impact of the country’s weak and inefficient legal system as well as poor enforcement of legal and regulatory provisions on toxic, non-performing loans, which are on the increase. However, there has to be tougher protocols beyond mere disclosure for insider lending. While a prohibition of insider lending as suggested by NDIC might be too stringent, or even harsh, the current regulatory regime is susceptible to abuse. More stringent measures are required, which would balance the interests of directors and/or shareholders with those of depositors and other stakeholders.

Funmilayo Odude, a Financial Nigeria columnist, is a Lagos-based legal practitioner, and a public affairs analyst.