Banking sector regulation is over complex and disproportionate — Ravi Takhar, CEO of UK’s LSE listed Orchard Funding Group PLC

• High minimum capital good for incumbent banks, creates oligopoly, stifles competition

• Capital, liquidity important, but must be in context of banks’ business plan 

  
  

RAVI TAKHAR, with 35 years plus’ experience in the creation, acquisition, financing, disposal and growth of financial businesses, is the chief executive officer of the London Stock Exchange listed Orchard Funding Group PLC, which he co-founded in 2002 and has led the growth of the UK business to its current size. His first involvement in financial services was as an investment banker and head of financial services investment at Nikko, the Japanese investment bank, from 1998 to 2002; as well as chairman of Mortgages PLC, the mortgage lender. Takhar was also head of Mortgage Principal Finance at Investec Bank PLC from 2005 to 2008 and chairman and chief risk officer of Urban Exposure PLC, the development finance lender from 2009 to 2020. He qualified as a banking solicitor at Clifford Chance, a leading international law firm, and has an MA from the University of Oxford. He recently published a book, “How to Build a Bank, a Guide to Key Bank Regulations, the Licence Application Process and Bank Risk Management,” published by De Gruyter, which captures the intricacies and challenges of taking such a bold step in the  UK. In the light of the Central Bank of Nigeria (CBN) new directive on bank recapitalisation in Nigeria, TAKHAR fielded questions in London with Business a.m.’s PHILLIP ISAKPA, where he shared his thoughts about issues raised in his book and about Nigeria’s new minimum capital requirement of N500 billion ($359 million) for an international banking licence.

Your book, “How to Build a Bank”, attempts to take the reader through a guide on key bank regulations, the process of licensing application and bank risk management. Tell us about this and then share your thoughts on the process of setting up a bank from a global landscape point of view.

RT – Banking is a very simple business. In short you take money from one party, a depositor and pay the depositor an interest rate for it and then lend the money to another party, the borrower and charge the borrower an interest rate for it. Hopefully your lending to your borrower will be paid back and is at a higher rate than the rate you have to pay the depositor. 

As depositors are in the main protected by the government, the regulatory process in effect protects the government from banks behaving in a manner which risks the repayment back to the depositors. My book is a simple explanation of how the government tries to protect itself, through a raft of documentation and operational requirements from bad banks. The book is unprecedented as it actually takes the reader through the core documentation that is required to be completed to the satisfaction of the government. 

Globally, do you consider the regulatory process of setting up a bank the same? What do you see as differentiating factors? 

RT – The process is not the same. The principles I believe should be the same. For a business to operate as a bank in any jurisdiction, it should have a clear and transparent shareholder structure, a strong senior executive team, consisting of at least a CEO [chief executive officer], CFO [chief financial officer] and CRO [chief risk officer] and a completely independent chairman, independent head of audit and independent head of risk. The bank should have a viable business plan, adequate capital and liquidity, and a full plan to show how it can recover from shocks to its business plan and in the worst case wind down its business and repay all depositors.

Can you share your thoughts on global banking regulations  in relation to emerging economies, the African landscape and what you know about Nigeria in that respect? 

RT – I think banking sector regulation is over complex and disproportionate. Large banks and small banks must follow the same capital and liquidity rules, same governance requirements and same oversight.

This is the way of the world after the global financial crisis of 2008. It has dramatically impacted bank returns and the provision of liquidity in the market. For example, there are less home mortgage loans in the UK today than there was in 2007. 

There has been no real test of all the new rules and regulations as we have thankfully not yet suffered another financial crisis. If history is an indicator, this is just a matter of time. This will be the acid test for the current regulatory regime. No doubt it will be found wanting in some respect that no one expected. That is the nature of financial crises. I have lived through two, 1990 and 2008 and both were not expected, all thought that all banks were regulated and properly supervised before both those crises. Yet we still suffered a financial crisis.

I think having a very high minimum capital requirement for banks as I understand is the case in Nigeria, is only good for incumbent banks, creates oligopoly, stifles any competition and ultimately creates banks that are “too big to fail”. It was not the small banks that caused the global financial crisis, just some of the very big ones.

How does the book help a desiring bank owner in a non-UK financial regulatory environment? 

RT – The book fully explains the documentation requirements for anyone wishing to set up a bank and provides a template of the documentation that can be adapted to any one applying for a bank application.

You have yourself applied for a banking licence, unsuccessfully in the UK. Can you share your experience and what would you attribute to your lack of success?

RT – I have in-fact been instrumental in helping a number of banks obtain a bank licence. With Orchard we decided to withdraw our bank licence application due to Covid-19 and a re-focus on our core business. The book sets out the documentation requirements based on those used by successful and operating banks in the UK market.

Your book outlines the documentation process and suggests how huge this could be. In the UK and elsewhere, how do you think an investor wanting to set up a bank should treat this matter of documentation?

RT – Documentation is the starting point for any business, bank or otherwise. The book provides templates for anyone wishing to start up a banking business. If these are completed correctly any business will be able to demonstrate it can operate as a bank.

You appear to suggest that there is a lot of frustration with regulators in the process of setting up a bank. Can you share the state of this frustration and how widespread is it across different climates?

RT – The frustrations arise due to the fact that regulators work to different timelines than business. They also have no incentive to approve a bank licence application. 

In some jurisdictions, in particular emerging and developing markets like Nigeria, minimum capital requirement is often seen as the key to setting up or acquiring a bank. What does your experience and understanding tell you about how this should be treated by investors? 

RT – Minimum capital requirements actually protect investors from a bank failure. The problem is that an increase in capital leads to a corresponding reduction in return on capital. Investors should be realistic in their return expectations from investing in a bank. In the main a bank can only ever earn from lending safely. This in turn limits the amount of interest they can charge and ultimately limits the amount of return an investor can achieve from investing in a bank.

The technical commentary in your book is particularly strong on capital and liquidity. How do these help our understanding of the workings of banks, the banking industry and best practice?

RT – A thorough understanding of capital and liquidity requirements is fundamental to the understanding of how a bank works. A bank’s whole business, the amount and type of lending it can do is all determined by its capital. Liquidity is fundamental to any business, especially a bank, whose business is money. 

How do potential investors intending to set up  a bank approach the twin issues of capital and liquidity?

RT – Investors must start with a business plan, as this will determine the basic amount of capital and liquidity they will require. The book then identifies how the business plan will be stressed through the ICAAP (Internal Capital Adequacy Assessment Process) and ILAAP (internal liquidity adequacy assessment process)  to determine the minimum levels of capital that the bank will require in extraordinary situations. 

You also focus on the internal capital adequacy assessment process, the internal liquidity adequacy assessment plan, among others. For those who don’t know, what do these look like in reality and how daunting are these to go through in trying to build a bank? 

RT – Without my book they are extremely daunting – they shouldn’t be. That is why I wrote the book. My book will help anyone who wants to understand how these complex and detailed plans actually work in practice. I hope in simple and plain English, so that anyone with an interest in learning can quickly understand the topic.

Let us try to zero your thoughts on Nigeria where the central bank has issued new minimum capital requirements. For an international banking licence, for instance, the minimum capital is now N500 billion, which at the time of announcement in March, was between $353.32 million and $359 million. What do you make of this need to raise bank minimum capital?

RT – The minimum capital requirement of $359 million for any bank in Nigeria appears to be a complete roadblock to new banks being set up in the country and will effectively only enable banks who are “too big to fail” to exist. If you compare that to Europe and the US where the minimum capital requirement can be as low as $5 million, the $359 million appears to be completely uncompetitive and restrictive.

Two schools have emerged, for and against this capital raise. For instance, one commentator argues that “to sustain financial system stability banks require a strong capital base, and adequate liquidity to build depositor trust. Banks may have adequate statutory capital, but inadequate operating capital based on recent foreign exchange shifts.” What is your take on this division on bank capital levels?

RT – The commentator is no doubt correct. He appears to be looking at banks which have foreign currency exposure. The largest and simplest lending for simple banks is domestic and secured on property in its jurisdiction. Capital and liquidity is important no doubt, but it must be put in the context of the business plan of the bank. For example if the bank is only going to create a $1 billion dollar book of loans secured on first charges on residential properties a $359 million capital [requirement] is excessive. Further, the $359 million capital requirement does not help small business and consumers in the Nigerian market as it limits the amount of banks who can supply this much needed and fundamental liquidity requirement in a growing and dynamic economy.

Another area of contention in the decision to raise bank minimum equity capital in Nigeria is the one where the CBN says the banks would not be allowed to use retained earnings as part of their new equity. The central bank is therefore suggesting that banks bring new capital to support their future operations by growing their loan books but de-risking their statements of financial position by building stronger equity buffers. How do you see this and what would be your position giving your experience and knowledge?

RT – I am just a simple lawyer, not an accountant. However, even I know that retained earnings interact with a balance sheet by increasing reserves and therefore equity. Again the Nigerian stance appears to be completely at odds with Europe and the US and also completely against international accounting standards.

Some banks are already looking to float rights issues and other options of capital injections. How do you think banks in Nigeria can approach raising capital, especially if they have to seek investors from the global markets? What are the opportunities out there?

RT – Banks should deliver stable, long term and sustainable returns to their investors. In the main they simply have to ensure they lend at higher rates than they borrow from depositors. The problem for banks is that they cannot offer super off market returns. They are not tech stocks or in the latest fashionable business sector. It is a problem faced internationally by all banks. You only need to look at how share prices are generally trading at a discount to the NAV (net asset value).

What other capital raising methods would you advise Nigerian banks, especially those with international banking licence which allows them to operate beyond Nigerian borders?

RT – The future is technology. Banks cannot pay much less to depositors or charge much more to borrowers. In the EU and US, the regulator is very active in ensuring that both these matters are strictly controlled. Banks are also now constrained by regulations on how much they can leverage their businesses to increase returns to investors. The only thing that banks can do is try to conduct their business in a regulated, low risk and legal manner with less operational costs. Only technology can do this. For example in the EU, open banking enables borrowers to be fully underwritten in a matter of seconds, with little human intervention. 

Taking a note from your book, “How to Build a Bank”, your experiences in the financial services industry, and the banking recapitalisation exercise currently on in Nigeria, what do you make of the role of corporate governance? In the book you point out that no regulatory process can fully protect us from bad actors. And one reviewer said: “However, I am sure we would rather have a system that puts great weight on good governance, rather than just relying on numerical tables and ratios. There are many other options for those who find this governance irksome.”

RT – Corporate governance or its failure became a hot topic after the financial crisis of 2008. Views differ on the improvement in corporate governance after the many new rules that have been implemented under this topic.

The regulatory view and requirements put emphasis on different and skilled people for different roles so there are separate and independent checks on everything the business does. This involves the interaction of lots of people and lots of board and committee meetings. One could argue that such an approach is good for preventing things being done and therefore safe. I will leave it to wiser people than me and the market to make the final judgement.