By Olatunde Vincent Adeyemi MBA, ACIB
In old Greek Mythology, Achilles was a Greek hero of the Trojan War and a central character of the Homer’s Iliad. He was born of an immortal mother named Nereid Thetis and a mortal father called Peleus. His most notable feat in the Trojan War was the killing of Hector, the Prince of Troy, outside the gates of Troy. He was such a valiant warrior that he was described as the “man who was born to kill”. However, as strong as Achilles was, he was vulnerable at the most unlikely place (his heels) and this became the gateway to his destruction, despite his mother’s prior warnings.
This analogy comes in handy in describing the delicate balance a bank must strive to keep in its pursuit of profitability. Whilst this may be applicable to all businesses, the focus of this article will be on banks.
In order to do justice to this topic, we will consider three (3) critical issues: The Need for Profit, Precipitators of Excessive Profit-drive and The Way Forward.
The Need for Profit
Banks, like any other business, must make profit since the reward for Entrepreneurship (factor of production) is profit. Below are some of the major reasons why profitability is necessary for banks:
- Huge Operating Costs: In a previous article by this author titled – These Banks Are Thieves! Really? – the major cost drivers in the operations of Nigerian banks have been well articulated. Readers are encouraged to read that article for deeper understanding of the cost profiles of banks in Nigeria. However, suffice it to say here that banks must make sufficient margins from their operations to remain a going concern.
- Growth and Expansion: Without being profitable, it is impossible for a bank to grow and expand as both physical and virtual expansions require huge capital outlays. In fact, in a highly competitive environment like the Nigerian banking industry, a bank without a deep wallet to drive innovation necessary for growth & expansion, may not survive for long. In addition, since retained earnings is considered the cheapest source of funds for capital projects, it is not surprising to see that only profitable banks are usually bullish on expansion
- Investment Appraisal: Profitability remains the ultimate proof of efficiency in the utilization of limited resources. Shareholders and other stakeholders will appraise a bank’s performance mainly on its Return on Investment (ROI) and determine whether the bank is worth dealing with or not. This is because a bank’s ability to improve shareholders’ wealth either in the form of capital appreciation or dividend payment is of paramount interest. This also explains why the Central Bank of Nigeria’s recently publicized Dividend Policy has generated many interests.
- Personal Fulfilment: As odd as it may sound, nothing probably gives banks executives more sense of fulfilment than leading a very profitable entity (truly speaking, this applies to all of us as humans). While the size of the performance bonus they will receive may also contribute to this excitement, the overall boost that leading a perennially profitable bank gives to such executives’ corporate profiles is enormous.
Precipitators of Excessive Profit-drive
From the above, the need for banks to be profitable has been firmly established. Therefore, the issue is not with banks’ profitability per se but in a bank’s ability to know (and adhere) to how much profit it can ethically realize even with the most optimal use of its current resources and capabilities. The problem usually starts when a bank intends to make much more profit than its current resources and capabilities allow for. This drive certainly predisposes such banks to over-extending themselves along dangerous borders. Some of the major factors that make banks vulnerable to excessive profit-drive are discussed below:
- Performance Pressures: Banks’ management are usually under considerable performance pressures. Such pressure is to be expected (and may even be necessary) given that shareholders want to maximize their wealth. However, care must be taken to avoid undue performance pressures that will push the bank to take on too much risk in anticipation of higher returns. Furthermore, given that this performance pressure eventually gets cascaded down to employees, same may subtly enshrine a culture of “profit at all cost” within the bank, thus making the breaching of ethical lines more plausible.
- Corporate Hubris: Hubris simply means overbearing pride or presumption. When a bank does a particular business (especially big-ticket transactions) over time, if care is not taken, the bank begins to exhibit corporate hubris towards that particular transaction or line of business premised on their supposed familiarity with that terrain. This presumption may impede on the bank’s ability to effectively appraise the current scenarios on a case-by-case basis, thus increasing the chances for oversights and errors that may be very costly if things do not go according to plan.
- Weak Corporate Governance: Corporate governance is primarily about ensuring appropriate segregation of duties in order to prevent the over-concentration of powers in one person’s or group of persons’ hands. In banks where this working definition is not adhered to, it is only a function of time before the cracks become obvious for all to see. In such environments, it is also common for the voices of objection (and reason) to be coerced into submission.
- Inadequate Specialized Skills: When banks rely on generalist skills to appraise and take decisions on highly specialized areas and transactions (e.g Telecoms, Oil & Gas, Aviation e.t.c), it is very easy for certain untested assumptions to be made. Often, these assumptions make good business sense (profit) but their implementation may be technically doubtful or beyond the abilities of the banks to enforce. When this happens, the banks are usually least protected from the headwinds that follow.
The Way Forward
The above notwithstanding, banks can continue to run profitably while keeping in check factors that predispose them to excessive profit-drive. Of a truth, this is a serious balancing act but the following suggestions can help kick-start and sustain the process:
- Institutionalized Decent Profit: This is a situation where the Boards of banks develop a Profit Policy Guide (PPG), just like the Credit Policy Guide (CPG), to define how profits will be made and more importantly, the maximum levels of profits they will always aim to make relative to capital employed. Whilst Return on Capital Employed (ROCE) ratio can give an indication of the profit levels possible, in reality, practitioners use this ratio to evaluate the minimum levels of returns realizable from an investment. Defining the maximum profit levels upfront will free banks from unnecessary pressure and temptation towards excessive profit-drive. For PPG to be effective, the expected returns must be decent given the level of capital employed. Since ideally, banks’ resources and capabilities should increase progressively, the level of returns will also increase by the same quantum and vice versa. Even though it can be argued that capping profits is contrary to the tenets of Capitalism which most banks practice, the alternative will be to have no limits on banks’ pursuit of profits. The fact that PPG will also originate from banks’ Boards will however continue to guarantee the principal element of freedom characteristic of Capitalism. PPG will also make the jobs of banks executives more straightforward – deliver a pre-defined level of returns relative to the level of resources made available to them. Although it is true that banks are well established in the annual budgeting process (which also defines expectations), the focus of annual budgets may be too immediate and whimsical to produce an institutional effect.
- Strong Corporate Governance: A strong corporate governance culture is not a nice-to-have concept for banks; it is a must-have. This is because without it, the lines of accountability and responsibilities will soon become blurry. An effective corporate governance regime is like the North Star that remains constant during the night and will always guide to the right direction in darkness (crossroads). Banks’ motivation for corporate governance should not just be to comply with the extant regulations of the land but because it remains a potent self-help concept that will guarantee their long-term profitability and survival. Where effective, a strong corporate governance structure can also help to reduce corporate hubris by ensuring that relevant stakeholders will do what is expected of them at every point in time without exception.
- Competency Framework: In November 2012, the Central Bank of Nigeria (CBN) released the final draft of the Competency Framework for the Nigerian Banking Industry to address the observed inadequacy of skills in the banking industry. It also went ahead to appoint the Chartered Institute of Bankers of Nigeria (CIBN) as the sole accreditation agency for the implementation of the Framework. However, five years after, while some progress has been made in addressing this skill shortage, there is still so much ground to be covered. Banks must do more in embracing this Framework and drive compliance to it to the latter. Although generalist skills (e.g deposit-mobilization) will still be required, this should not become the hallmark for executive definition rather breadth, judgment and competence must be considered. In addition, banks that must deal in highly specialized transactions (such as Aviation, Oil & Gas, Telecoms etc.) must ensure that their staff possess requisite and up-to- date knowledge that will help them make the right decisions as and when required
- Regulatory Effectiveness: Clearly, the Nigerian banking industry is not want for laws. If anything at all, there are probably too many laws governing our banking practice. However, the level of effectiveness of these laws is still debatable. As with all capitalists, assurance that things will always be done right cannot be left in the hands of the banks alone, there will always be a need for an independent third-party quality assurance. The regulators will need a more effective use of moral suasion, incentivizations and sanctions to enforce the healthy behaviors necessary for the long-term thriving of our banks. While regulators’ efforts in stabilizing challenged financial institutions is highly commendable, the goal should be preventing them from getting challenged in the first place.
In conclusion, according to figures from the Federal Deposit Insurance Corporation (United States’ equivalent of Nigeria Deposit Insurance Corporation), eight (8) United States banks with combined assets of over $6.53billion went under in 2017 alone. A review of the surrounding circumstances leading to their failures, amongst other things, revealed a common thread of wanting a bigger portion of the cake by over-extending themselves along dangerous borders. Nigerian banks may guide against this by aiming for decent profits with a long-term view. Unlike Achilles, they must fortify themselves against the vulnerability that this quest for much more profits predisposes them to.
About The Author:
Tunde Adeyemi is a versatile Nigerian banker with over a decade experience in the industry. He holds an MBA from the University of Lagos and is an Associate of the Chartered Institute of Bankers of Nigeria (CIBN). He is also a certified PRINCE2 Practitioner in Project Management. He can be reached via email and Twitter at email@example.com and @manovas5 respectively.