Loan Defaults Could Cause Stress For Nigerian Banks, World Bank Warns

With some 6.3 percent Non-Performing Loans (NPLs) sitting in the balance sheets of Nigerian banks, the system is already showing signs of stress, the World Bank warned on Tuesday as it raised doubts on the country’s 1.8 percent economic growth projection for 2021.

“Despite the harsh operating environment, the banking system has proven generally resilient, but signs of stress are beginning to appear,” the World Bank stated in its Nigeria Development Update (NDU) launched both virtually and physically in Abuja.

According to the World Bank, Nigeria’s financial system has escaped a credit crunch, but must continue to deal with the impacts of COVID-19 crisis, rising inflation, collapse of crude oil prices seen since the first half of 2020, a surge in unemployment, and a protracted disruption in the supply of foreign exchange.

“ In comparable countries, this combination of shocks has caused bank balance sheets to rapidly deteriorate, yet in Nigeria in February 2021 the nonperforming loan (NPL) ratio was still 6.3 percent, largely unchanged from a year earlier.”

Nigeria’s banking system is still well-capitalized, with a capital adequacy ratio (CAR) of 15.2 percent in February 2021, up about 30 basis points (bps) from a year earlier.

Despite abrupt dollar funding tightening in 2020, the system’s overall liquidity position appears comfortable; in February the 40.5 percent liquidity ratio was well above the prudential minimum.

Access to international capital market has equally opened up alternative funding for Nigerian banks, with two of them placing 5-year Eurobonds raising US$650 million in recent months which would help ease FX liquidity strains and extend funding maturities.

Expectations are also rife that more financial intermediaries in Nigeria will tap international markets to issue foreign currency denominated securities or syndicated foreign currency denominated financing in order to partially meet the growing foreign currency needs as well as upcoming foreign currency denominated maturities.

The World Bank is of the opinion that, the CBN’s policy initiatives and development-finance interventions so far have helped prevent a severe credit crunch in the private sector.

The CBN cut its monetary policy rate by 100 bps in May 2020 and by another 100 bps in September and has for several months, left benchmark rates steady.

Regulatory forbearance for the restructuring of pandemic-affected exposures is now in effect until March 2022.

The CBN has also softened the terms of its development-finance interventions, and the new terms have been extended through March 2022. It has also launched a range of new development-finance initiatives at subsidized interest rates in an attempt to ease the impact of COVID-19 on households and SMEs.

The apex bank is also helping pharmaceutical companies, health practitioners, and SMEs respond to the pandemic by injecting up to N400 billion in loanable funds. The new funding is equivalent to about 2 percent of private sector bank credit.

“The regulatory forbearance granted by the CBN for restructuring loans impacted by COVID-19 was crucial to keep the banking system sound, but in the next few quarters NPLs are expected to rise,” the World Bank notes in the latest update.

While the average NPL ratio may be slow to respond to recent disruptions, sectors with higher loan dollarization and those directly exposed to crude-oil prices, such as oil and gas and construction, have started to see a decline in loan quality.

The World Bank is further concerned that in some other sectors, the impact of the crude- oil price shock on loan quality will take several quarters to fully register.

A bigger concern is that as the forbearance on the loans are withdrawn, “some corporate business models will cease to be financially viable, and with growth prospects for 2021 more muted, the repayment capacity of borrowers would be under pressure, which is also likely to affect loan quality.”

Profitability is also falling due to, among other factors, compression of net interest margins, a dramatic slowdown in credit origination, and rising impairment charges.

“Several banks, both large and small, now have capital cushions that are only slightly above the minimum requirements. Corporate lending exposures account for most of the credit portfolio and are concentrated among the largest borrowers; as their leverage increases, so does the risk associated with corporate lending exposures.

“In this context, latent material credit-risk vulnerabilities could emerge in the next few quarters,” the World bank stated in report.

The IMF Article IV Consultation report of December 2020 had noted that recent CBN stress tests simulating the migration of 25 percent of the unrestructured loan portfolio to NPL status could cause the system’s CAR to drop below 10 percent.

Meanwhile, the continuing surge in inflation has been accompanied by a contraction in real credit to the private sector.

Although in the first three months of 2021 demand deposits continued to expand at an average real rate of 35 percent, real quasi-money deposits started to fall as negative real interest rates persisted, illuminating the risk of financial disintermediation.

More positively, since March 2021 the prime lending rate of commercial banks has fallen by some 360 bps, with the maximum rate lower by 274 bps as deposit funding costs dropped by 200–400 bps across different maturities.

The Bretton Woods institution recommended that as Nigeria lays the groundwork for a sustained post-pandemic recovery, if resilient, broad-based growth and job creation are to be ensured, broadening access to credit should be a priority.

It anticipates credit segments to recover at different speeds, and the authorities must take special care in managing the process of withdrawing forbearance and other pandemic-related support measures.

But reversing the bank-debt repayment moratorium and forbearance measures present distinct risks to CBN as supervisor of banks and of other financial institutions.

The World Bank is asking policymakers to also balance continued support for businesses and households against the risk that low-quality (impaired) assets will become entrenched in the system, intensifying liquidity risks and eroding the culture of loan repayment.

It is also expected that rolling back pandemic-related support measures will reveal previously hidden deterioration in asset quality, raising solvency risks for more thinly capitalized banking institutions.

“Managing the consequences of this process will test the adequacy of the processes for dealing with banks in distress and resolving bank insolvency.

“If inflation continues to accelerate, pressures in the FX market fail to subside, or both, the CBN will likely need to raise policy rates.

“Accelerating inflation tends to be associated with higher inflation volatility, which in turn makes credit risk assessments less reliable and banks more cautious about lending,” the further indicated.

Source: BusinessDay

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