Consumer Lending and Risk Diversification: The Potential Market for Credit Securitization and Credit Derivatives in Nigeria

Consumer Lending and Risk Diversification: The Potential Market for Credit Securitization and Credit Derivatives in Nigeria

This article was published in Financial Regulation International Volume 23 Issue 4, May 2020. © Informa UK Ltd. For more information visit www.financialregulationintl.com

1.      Introduction

Nigeria is inadvertently developing a tradeable underlying asset in credit obligations. The Central Bank of Nigeria’s (CBN) drive to push bank loans to the real sector along with the different investment initiatives by state governments and other alternative financiers to advance debt to individuals and businesses in Nigeria has expanded the portfolio of private debt and has made debt and credit of growing significance to the Nigerian formal economy. These increased lending requirements and activities will result in a consequent increase in banks’ credit exposure to different sectors of the Nigerian economy, from payday loans to small-scale retail and the MSME services industry.

It will therefore be necessary for Nigerian banks to consider ways to diversify their loan portfolios and manage their risk exposure. Toward this end, Nigerian banks may consider two available but not readily used structured finance products for mitigating credit risk exposure – credit securitization and credit derivatives. The credit obligations derived from bank loans are useful assets for developing a credit securitization and derivatives trading market in Nigeria. This article will consider this potential market, as well as the opportunities and challenges they present.

2. Structured Finance Techniques: Credit Securitization and Credit Derivatives

Nigerian banks may consider securitizing the assets within their loan portfolios and managing their risk exposure using cash flow or synthetic structures.

Cash Flow Securitization Structure

A cash flow credit securitization structure will involve the pooling of homogenous loan assets which have common payment patterns. These assets are thereafter transferred to a special purpose vehicle (SPV) which issues securities in public offerings or private placements, to investors. The payment obligations under the securities are directly funded by receivables from the portfolio of securitized assets. The legal structure for this arrangement is similar to other debt capital market issuances in Nigeria. The SPV will act as issuer of the securities and the bank will act as originator of the pooled loan assets to be securitized. The bank will also act as a service agent to manage the cashflows received under the portfolio. Placing agents will be appointed to structure the transaction and place the securities. A trustee will be appointed to represent the interests of potential investors and oversee the disbursement of payments to investors. Rating agencies will assign ratings to each loan comprising the securitized assets as well as the securitized asset as a whole and will monitor these ratings throughout the life cycle of the security issuance.

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