My column this week presents an article I wrote for African Banker magazine in the first quarter of 2020 about the lending boost policies of Nigeria’s central bank. At the time, African countries had not started to implement COVID-instigated lockdowns. With extraordinary measures now in place by most of the continent’s central banks to break the fall of their respective economies owing to the pandemic, the following allows an objective reflection on the state of Nigerian banks without any COVID-related bias.
In early January, the Central Bank of Nigeria (CBN) announced its decision to retain its minimum 65 percent loan deposit ratio (LDR) “in the interim.” It also maintained the “incentive which assigns a weight of 150 percent in respect of lending to SMEs, retail, mortgage and consumer lending”. If a bank fails to meet the minimum LDR on or before March 31, 2020, the CBN would levy an “additional cash reserve requirement of 50 percent of the lending shortfall of the target LDR”.
The CBN has left no one in doubt about its seriousness. In October 2019, it deducted about 500 billion naira from the accounts of 12 banks for failing to meet the then minimum 60 percent LDR requirement (set in July) by end-September 2019. Despite the shortfall by these banks, private credit sector extension increased by about 5 percent over about four months to 16 trillion naira in late September. Having increased the minimum LDR to 65 percent in September with an end-December 2019 deadline for compliance, the central bank deducted another N650 billion from the accounts of non-compliant banks three months later.
The CBN has left no one in doubt about its seriousness. In October 2019, it deducted about 500 billion naira from the accounts of 12 banks for failing to meet the then minimum 60 percent LDR requirement (set in July) by end-September 2019
So, what are the implications of these policies for the Nigerian banking sector and economy at large?
Minimum LDR requirement is credit negative
Moody’s reckons economic growth would remain subdued, forecasting 2.5 percent for 2020; which its reasons is “insufficient to markedly improve living standards.” And while Moody’s highlights the decline of problem loans in Nigeria, it believes they will remain high. One reason why is that a “high proportion of restructured loans mask true levels of problem loans”.
Regardless, Moody’s believes “capital will remain moderate, with most banks taking advantage of a three-year transition for IFRS 9 adoption”; albeit capital would be “stronger at the top-tier banks”, by its reckoning. Furthermore, Moody’s believes “banks’ earnings will be constrained by subdued loan growth and rising costs (IT, investments, AMCON levy, higher staff costs).
On its part, Fitch Ratings has revised its Nigerian banking sector outlook to negative (from stable in 2019), which it asserts “reflects increasing regulatory risks and unorthodox monetary policy.” More pointedly, Fitch sees the CBN’s minimum LDR of 65 percent weighing on banks’ asset quality and profitability, eroding capitalisation, and reducing liquidity.
Fitch actually sees large banks being the “most affected by the LDR rule because of their smaller loan books relative to assets.” Fitch reckons “forcing banks to lend into priority sectors and within a short timeframe will inevitably increase asset quality vulnerability” and sees a modest rise in the sector’s average impaired loan ratio, albeit it would probably remain below 10 percent in 2020.
Furthermore, Fitch sees risks in the oil & gas and power sectors persisting. Still, it expects large Nigerian banks to “continue to outperform smaller peers due to franchise strengths and overall good asset-quality metrics.” Besides, Fitch expects all banks to benefit from what are still high lending rates and high yields on government securities, albeit by its reckoning, smaller banks would “be affected by higher funding costs and weaker asset quality.”
When asked about his assessment of the impact thus far of the lending boost policies of the CBN, Mahin Dissanayake, senior director, Europe, the Middle East & Africa (EMEA) banks at Fitch Ratings says that “while we don’t agree with the LDR, it is clear that the CBN’s measures to stimulate bank lending are working.”
“Banks have reluctantly resumed lending, initially increasing exposure to their existing prime customers but given the need to meet the higher LDR hurdle (in a relatively short-time frame) they have started to increase lending in new segments, particularly in retail banking (which most banks avoided in the past)”, adds Fitch’s Dissanayake.
But the loan growth comes with risks. The minimum LDR requirement “effectively forces banks to lend at a time when operating conditions are not conducive to growth”, Fitch’s Dissanayake says. Consequently, Dissanayake expects “a further, albeit a modest, increase in impaired loans over the next two years as these new loans season”.
“Furthermore, risks in the oil and gas sector and the power sector persist, giving rise to continuing asset quality concerns despite sector impaired loans reducing since 2018”, Fitch’s Dissanayake asserts. That said, Dissanayake does not expect “a faster deterioration in asset quality as banks have (over the last two/three years) written off, restructured or recovered large amounts of legacy bad loans.”
On his part, Peter Mushangwe, a banking analyst at Moody’s says “although gross loans and advances increased 4 percent by October 2019 from July, when the regulation took effect, loans will need to grow by around N690 billion (about 5 percent of gross loans as of 31 October) to meet the minimum requirement by March 2020.”
“Given Nigeria’s challenging operating environment, meeting the minimum requirement will be credit negative for banks because we expect them to make potentially riskier loans, which will outweigh potential benefits from diversification as they lend to more granular borrowers and reduce their high single-name concentration risk”, Moody’s Mushangwe adds.
An edited version was published in the Q1 2020 issue of African Banker magazine
