Chibuike Oguh, Frontier Markets Analyst, Financial Nigeria International Limited

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Subjects of Interest

  • Capital Market
  • Finance and Investment
  • Frontier and Emerging Markets

How will Nigerian banks fare in 2016? 19 Jan 2016

During her recent visit to Nigeria, Christine Lagarde, the Managing Director of the International Monetary Fund, talked about the difficulties faced by Nigerian banks last year, stating that “the weakening oil sector is stressing [government and corporate] balance sheets and putting pressure on the banking system.”

Indeed, the Nigerian banking system had a challenging year in 2015. Banks were faced with sustained uncertainty before the general elections, which President Muhammadu Buhari later won. Banks were also impacted by other factors including the implementation of the Treasury Single Account (TSA), which withdrew cheap government deposits in excess of N1 trillion from the banks; higher levels of non-performing loans as a result of decline in economic growth caused by fallen oil prices; and limited foreign exchange from the Central Bank of Nigeria to prosecute lucrative foreign currency transactions.

As Nigerian banks move into 2016, these headwinds, which negatively impacted on their financial results last year, look set to grow stronger. The first place to begin is oil. Global oil prices have fallen by nearly 70 percent in the past 18 months resulting in lower government revenues in Nigeria and weak economic growth in 2015. Given that the current oil glut shows no sign of abating – especially with the lifting of sanctions against Iran by Western nations and the removal of the ban on American oil exports – oil prices look set to remain low in 2016.

It’s no secret that Nigerian banks are heavily exposed to the oil and gas sector, which constitutes 70 percent of government revenues and 90 percent of all exports. According to Oxford Analytica, a London-based consulting firm, Nigerian banks allocated 23.8 percent of their loans to the oil and gas sector in the first half of 2015, up from 10 percent in the previous year. The three largest banks in asset terms – Zenith Bank, Guaranty Trust Bank and First Bank of Nigeria – grew their oil and gas portfolios by 101 percent, 47 percent, and 37 percent, respectively in 2014, Oxford Analytica stated.

With this level of exposure to the oil and gas sector, which is facing a sustained period of low oil prices, non-performing loans in Nigerian banks may reach alarming proportions this year. This may significantly lower banks’ revenues and profits in 2016. However, there is the issue of whether Nigerian banks will be honest enough to disclose the full extent of their loan losses. In 2015, banking stocks were the worst performing stocks on the Nigerian Stock Exchange, demonstrating that investors had little confidence in the rosy financial results reported by most banks last year.

Aside from the threat of lower oil prices, Nigerian banks will face significant pressure this year from the abolishment of commissions on turnover (COT), which came into force on January 1st. According to Richard Obire, a former executive director of Platinum Bank (now Keystone Bank), Nigerian banking revenues consists of mainly interests on loans, which constitute about 70 percent of total revenues, and fees and commissions, which make up the rest. COT alone contributes over 60 percent to the fees and commissions income segment. Thus, Nigerian banks stand to loose about N100 billion (out of N550 billion) in annual revenues as a result of the implementation of the zero COT policy, Obire reportedly said.

Although Nigerian banks have had ample time to prepare for the removal of COT since the CBN gave a three-year notice, they are now faced with the herculean task of trying to diversify revenue streams in a period of weak economic growth. More so, the decision by the U.S. Federal Reserve to raise interest rates and the weakening of the naira in the parallel market have raised the cost of foreign borrowing, and would compound lost COT revenues. All these mean that Nigerian banks are under significant pressure with very little wriggle room this year as they attempt to plug potentially massive holes that might be created in their balance sheets.

The implementation of the TSA presents additional challenges for banks in 2016. Over the years, Nigerian banks have reaped massive profits by using cheap federal government deposits to buy treasury bills or lend to high-grade borrowers at exorbitant interest rates. With the TSA, however, banks are faced with much lower liquidity to fund such operations. Although the CBN has boosted liquidity by lowering the cash reserve ratio (CRR) from 25 percent to 20 percent, this measure cannot replace the easy profits that banks earned by leveraging on federal government deposits.

To offset the loss of federal government deposits, banks must allocate additional resources this year to source for deposits from the Nigerian real economy. This may result in higher staff and overhead costs, which would impact on revenues and profits this year. However, sourcing for new deposits could yield positive results given Nigeria’s massive unbanked population – about 70 percent of the adult population, according to a survey conducted by the Enhancing Financial Innovation and Access in 2012.

While announcing the reduction of the CRR, which is estimated to inject about N900 billion into the banking system, the CBN Governor, Godwin Emefiele, warned banks to channel the additional funds to small and medium enterprises (SME) or risk losing the CRR funds boost. This directive raises fresh risks for banks this year because they have hitherto developed miniscule capabilities to create loans for the SME sector.

According to the National Bureau of Statistics, at least nine out of ten businesses in Nigeria are SMEs, accounting for an estimated half of Nigeria’s GDP. Yet, the SME sector attracts less than 10 percent of all bank loans in Nigeria. Thus, this lack of know-how in dealing with SMEs raises the risk that non-performing loans may spike this year as banks lower their risk acceptance levels to provide for the SME sector.

Despite these threats facing Nigerian banks this year, it is widely expected that banks will weather the storms and grow much stronger. Even Lagarde admitted that the Nigerian banks are “generally well-capitalized and more resilient” compared with the period of the global financial crisis in 2008/2009 that resulted in several bank failures around the world.

The optimism derives from the growth outlook of the Nigerian economy. From 3.8 per cent GDP growth of 2015, Nigeria is expected to grow by 4.2 per cent this year. This growth outlook is expected to improve business confidence in Nigeria and boost the performance of the banking sector. Additional source of optimism for the banks is the active role they would play in financing the deficit of the federal budget. President Muhammadu Buhari plans to finance half of the N2.2 trillion budget deficit through domestic bonds.

While the growth outlook for the Nigerian economy and that of the banks are predicated on the non-oil sectors activities, a dramatic improvement in the outlooks could come about if oil prices make unexpected, strong rebound in the course of the year. This would help strengthen the naira and support the exchange rate, which has partly made foreign portfolio investors to remain on the sidelines of investing in Nigeria.