These are challenging times for Nigeria’s banks. As the country’s oil-dependent economy stalls and government spending and private sector investment begin to wane, opportunities for growth in this competitive market are diminishing. These difficulties have been compounded by lack of firm economic policy from the new government of Muhammadu Buhari, who was not expected to appoint a cabinet until the end of September, close to four months after his election. Meanwhile, regulatory headwinds from the central bank, including increased cash reserve requirements and the introduction of various foreign exchange controls, have hit the banking sector’s liquidity hard.
Cumulatively, these events have drained any near-term optimism from most of the country’s largest lenders. “This is going to be a very difficult year for Nigeria’s banks. I don’t see any way around it,” says Abubakar Suleiman, executive director of Sterling Bank. Though much will depend on the movement of oil prices, as well as the policy decisions of the federal government in the coming months, there is some way to go to achieve any material change in the growth prospects for the sector.
Nevertheless, most of the country’s largest banks are in a good position to weather the storm. Zenith Bank, Nigeria’s largest lender by Tier 1 capital, has a capital adequacy ratio (CAR) of 20% with non-performing loans (NPLs) of 1.44%. Similarly, United Bank for Africa, the third largest lender by total assets, has a CAR of 20% and an NPL ratio of 1.8%. Indeed, these numbers are broadly indicative of the strength of Nigeria’s top banks.
Oil at the bottom
“Capital adequacy ratios are very high, averaging more than 15% in the industry and arguably the highest in the continent,” says Ladi Balogun, chief executive of First City Monument Bank, Nigeria’s 10th largest lender by total assets. “Loan books are largely secured, and more than 50% of industry deposits are in either treasury bills or cash reserve with the central bank.”
Accordingly, most lenders are looking at the bigger picture and the opportunities offered by a fundamentally dynamic economy. “With all of the challenges we face as an economy, there’s still a lot of belief in the country,” says Zenith Bank chief executive Peter Amangbo.
Immediate difficulties are expected to multiply, however. For one thing, there is little the banks can do to address the most pressing cause of their woes; namely, oil prices that are sitting below $50. Since the Nigerian government derives about 70% of its revenues from oil production, as well almost all of its export revenue, the impact on economic growth has been significant. Gross domestic product growth in the second quarter of 2015 slumped by almost half compared with the same period in 2014, to 2.35% from 6.54%.
This represents the slowest quarterly growth rate in Nigeria for more than 10 years, according to data from Fitch Ratings. Moreover, this is expected to hit the banks’ earnings growth and asset quality in the coming months. In an August report issued by Fitch, the agency forecast that the Tier 1 capital ratios for a number of Nigerian banks will dip below 15%, while the sector as a whole will face challenges in raising additional capital.
“Lower oil prices [will] mean that over the next few months, lower government spending, reduced consumer spending, a slowdown in business investment and a worsening net export position should cause domestic growth to soften,” says Bisi Onasanya, group managing director and chief executive of First Bank of Nigeria, the country’s largest lender by total assets.
Highly exposed
Similarly, the exposure of Nigeria’s banks to the oil and gas sector is large, even by the standards of other oil-producing countries. First Bank, Guaranty Trust Bank and Zenith Bank, the country’s three largest lenders by total assets, have about 40%, 36% and 20% of their respective total loan books geared towards hydrocarbons.
As a result of this exposure, the banking sector’s NPLs are expected to increase by the end of the year: Fitch Ratings predicts the sector’s total NPL ratio will exceed the central bank’s unofficial 5% limit by the end of 2015. However, the impact of this increase is expected to be manageable.
“The implications are somewhat negative, but not as dramatic as one might think,” says Mr Balogun. “Borrowers in the government value chain, especially contractors, and in the oil production value chain, will experience higher rates of default. However, we do not expect industry NPLs to rise by more than 50%, which is insufficient to cause any capital erosion for banks.”
Falling oil prices have also weighed heavily on the country’s 36 constituent states. With more than $3.3bn of total debt on the states’ books, the impact of dwindling oil receipts has left many in a precarious position. A large number have been unable to pay public sector employees or meet other basic financial obligations. In August, the government intervened by restructuring this debt into long-term sovereign bonds, a move which has so far applied to 11 out of 36 states in the federation.
“[With this intervention] the state balance sheets have been repaired. I believe that the federal government balance sheet will begin to improve by mid-2016,” says Mr Suleiman. “What needs to happen now is a commitment to fiscal discipline to prevent any future deterioration.”
Desperate measures
Meanwhile, more serious challenges have emerged as a consequence of the lower oil prices. As the value of the naira began its extended decline in 2014, falling by about 20% against the dollar year on year by February, the central bank staged a series of hotly debated interventions in its defence. Beginning in December 2014, these include curbs on currency trading and dollar deposits, as well as restrictions on the provision of foreign exchange for the purchase of 41 listed imports. These efforts to prop up the currency and restrict dollars from leaving the economy – while stabilising the naira but arguably leaving it overvalued – have severely hampered private sector activity.
“Most players in the market are of the view that the naira will depreciate further because the fundamentals supporting the currency such as the crude oil price and our reserves remain weak,” says Mr Onasanya. “The central bank has adopted a number of administrative measures to defend the currency. But in our view, these measures are temporary.”
Opposition to the central bank’s approach has been growing. Large swathes of the international and local media, as well as private sector analysts and observers, have called into question the efficacy of its strategy, and many expect devaluation to be inevitable. Indeed, pressure grew on the governor of the central bank, Godwin Emefiele, as JPMorgan Chase & Co delisted Nigeria from its local currency emerging market bond indices in September, citing a lack of transparency in the determination of the exchange rate, a lack of liquidity for transactions and the absence of a fully functioning two-way foreign exchange market.
For its part, the central bank has argued that its measures are justified in order to prevent speculation in the market. It has also argued that it has a role to play in stimulating local manufacturing and production capacity. It also disputes the claims advanced by JPMorgan, arguing that high levels of transparency do prevail in the country’s foreign exchange market, while it presides over a functioning “order-based two-way” foreign exchange market that enables participants to meet import obligations and other transactions.
Rate harmonisation
“One consequence of [the Central Bank of Nigeria's] defence is a degree of illiquidity, which has led to Nigerian sovereign local debt being gradually exited from the JPMorgan Global Bond Index for Emerging Markets. This will have the effect of a rise in local currency interest rates and the monetary authority will need to accompany this with some loosening measures such as a reduction in cash reserve requirements,” says Mr Balogun.
Here, some of Nigeria’s lenders have been presented with a further problem. In May the central bank harmonised the banking sector’s cash reserve requirement (CRR), the portion of a bank’s deposits held with the regulator at 0% interest. Under the previous rules, Nigerian lenders faced a CRR of 20% for private sector deposits and 75% for those from the public sector. Yet the new directive issued by the CBN saw this rate harmonised to 31%.
The response to these changes has been mixed. First, for lenders with greater exposure to the private sector, they will represent a challenge to their liquidity position and cost of funds. Second, for Nigerian banks with larger exposure to the public sector, particularly the country’s Tier 1 banks, it may unlock significant additional liquidity. Beyond these outcomes, the harmonisation essentially offers lenders a more simplified means to handle CRR requirements under a unified rate.
“The First Bank of Nigeria’s mandatory reserve deposit of N642bn [$3.23bn] – representing 14.5% growth since December 2014 – was a consequence of the CRR harmonisation that took place in May 2015,” says Mr Onasanya. “Projecting into the future, the Treasury Single Account [TSA] window introduced by the government should reduce the bank’s public sector deposits and consequently cause a reduction in the CRR in the near term.”
In tandem with changes to CRR requirements, the government has also forged ahead with the introduction of the TSA. Essentially operating as a single account for all government revenues, the TSA is a product of Mr Buhari’s drive to eliminate corruption from government ministries and agencies. Before its introduction in September, public institutions operated a fragmented system of bank accounts held with local lenders. Effectively, this allowed for extensive abuse of public funds, encouraged corruption and helped to contribute to large gaps in government finances.
In response, the president ordered the creation of the TSA, a single account held by the central bank, to accommodate the funds of all ministries, agencies and para-statal organisations. While this system promises huge benefits for standards of governance in Nigeria, it is also expected to starve the country’s banks of about N1200bn. As such, it is heaping further pressure on an already challenging liquidity situation for the banking sector.
In the three days following the enforcement of the TSA on September 15, Nigeria’s interbank market had frozen as a result of low liquidity levels. At press time, the situation had not ameliorated despite indications from Mr Emefiele that the paralysis was a symptom of a sentiment-driven market spike. In an interview with Reuters, the governor also indicated his willingness to inject liquidity into the interbank market if necessary.
Optimism prevails
While the difficulties facing Nigeria’s banks are expected to multiply in the coming months, particularly for smaller lenders, on the ground most senior bankers remain optimistic. “We should not be fixated on oil prices. If the economy is well diversified the impact will be minimised,” says Zenith Bank’s Mr Amangbo. “This is what Nigeria is aiming for. Look at the demographics of Nigeria. We have a lot of young people and a vibrant workforce. The middle class is growing too. It’s a winning formula.”
Nevertheless, until the new government unveils a credible set of economic policies and addresses questions around the value of the naira, the remainder of 2015 will be tough. As long as growth continues to dip and foreign investors become increasingly wary, the country’s banks will be facing an uphill struggle.
