Profitability of Nigerian Banks Under Threat—Fitch

By Dipo Olowookere

Earlier this month, the Central Bank of Nigeria (CBN) directed deposit money banks operating in the country to ensure 60 percent of their deposits are offered as loans to customers or risk severe punishment.

The apex bank had explained that it was taking this step in order to propel the nation’s economy through lending to small business owners as lenders were in the habit of using their deposits to mop up government securities to boost their profits.

In 2016, Nigeria slipped into recession, which affected almost every parts of the economy except the banking sector, which churned out huge profits during the economic downturn, which lasted almost a year.

Though the Africa’s largest economy is out of recession, it is still struggling to regain full recovery and in order to make this happen, the CBN said banks have till September 2019 to raise their loan to deposit ratio to 60 percent or would have to deposit extra unremunerated cash reserves, equal to 50 percent of their lending shortfall, at the central bank.

Reacting to this new development, renowned global rating agency, Fitch Ratings, said this new requirement could have an adverse effect on the profitability of Nigerian banks.

In a report obtained by Business Post, Fitch said it would be credit-negative for the banking sector, because it would push some banks to significantly increase lending to riskier borrowers, potentially with looser underwriting or underpricing of risk.

“Achieving the new LDR requirement in such a short timescale will be very difficult for some banks given their lending levels, particularly if customer deposits continue to grow at present rates. The sector’s overall LDR was 57 percent at end-May, according to CBN data. This is low relative to many markets, and reflects banks’ concern about the risk to asset quality from Nigeria’s often volatile operating environment. Nigeria’s largest banks, with the exception of Access Bank, have LDRs below or close to 60 percent and will be among the most affected by the new requirement,” the rating firm noted.

According to Fitch, “It is unlikely that there is sufficient demand from good-quality borrowers for banks to meet the target without relaxing their underwriting or pricing standards. Banks continue to struggle with high impaired and other problem loans, which is partly the cause for muted lending since 2016. The present operating conditions are not conducive to loan growth, and rapid lending during the fragile economic recovery could increase asset-quality problems in the future.

“Chasing loan growth could also weaken banks’ profitability if they cut margins to attract customers, and because of the need to set aside expected credit loss provisions under IFRS 9 when loans are originated,” it posited.

The CBN is incentivising banks to focus on SME, retail, mortgage and consumer lending in particular, by assigning a weight of 150 percent to these segments when computing banks’ LDRs for the 60 percent target. The SME and retail segments tend to be riskier for banks, and Nigeria’s mortgage market is in its infancy.

It said despite the difficulty of sourcing rapid loan growth and the risks it entails, “We expect banks to make a big effort to achieve the 60 percent target given the severity of the penalty for missing it. Depositing cash at the central bank is highly unattractive for banks as they receive no interest on it, in stark contrast to the high yields they can earn by holding Nigerian T-bills and government bonds.

“We will monitor how lending develops in 3Q19 at the sector level and at individual banks. Fast loan growth, particularly relative to the market average, or other signs that a bank’s risk profile may be deteriorating, could lead to negative ratings actions.

“Asset quality and capitalisation are key rating sensitivities for Nigerian banks, and could deteriorate as a result of fast loan growth. Most Nigerian banks’ Issuer Default Ratings are constrained by the country’s operating environment and ‘B+’/Stable sovereign rating.”

Dipo Olowookere is a journalist based in Nigeria that has passion for reporting business news stories. At his leisure time, he watches football and supports 3SC of Ibadan. Mr Olowookere can be reached via dipo.olowookere@businesspost.ng

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