S&P Global Ratings says banks in Nigeria could see reduced earnings, alongside weaker lending growth and asset quality, after the Central Bank of Nigeria (CBN) raised its main monetary policy rate (MPR; repo rate) by 150 basis points (bps) on September 27.
The Monetary Policy Committee’s latest move not only raises the repo rate to 15.5 per cent, but also banks’ cash reserve requirement to a minimum of 32.5 per cent (up 500 bps), amid persisting foreign exchange shortages in the country.
In its new report published on Friday about Nigerian banking, S&P Global Ratings observed that banks’ earnings would fall as non-performing loans (NPLs) increase and net interest margins decline.
“We expect the banking sector’s NPL ratio will deteriorate to 5.5 per cent on average in 2022 after improving to five per cent at year-end 2021, while the return on equity moderates to 13 per cent from 14 per cent.
“This is because of a weakening environment. Dollar-denominated oil revenue from the large oil producing companies has been under pressure amid lower oil production, due to oil thefts, pipeline leaks, and terminal shutdowns in 2022,” S$P stated.
It further noted that the increase in the MPR and intervention funds rate suggests that the CBN has not closed the taps entirely, since banks should still be able to extend credit to priority sectors such as agriculture.
That said, credit leverage in the economy remains low, with total private-sector loans representing only about 13 per cent of GDP, despite loan growth averaging close to 20 per cent over the past two years.
The Central bank has raised its MPR by a cumulative 400 bps so far this year in efforts to tame inflation, which stood at 20.5 per cent in August. At the same time, it revised the rate on its intervention facilities (special funds offered at a discount rate to priority sectors) to nine per cent in August 2022.
Banks have used the CBN’s intervention facilities to extend credit to the private sector at a preferential rate, mainly to support small and midsize enterprises amid prolonged economic setbacks.
Nevertheless, “in our view, limited financial intermediation somewhat constrains the Central Bank’s ability to curb inflation using the MPR.
“Further rate hikes are possible, given the gap between inflation and the MPR, and will put pressure on banks’ loan portfolios as they pass the full rate increase to retail customers,” the report read in part.
Although the cash reserve ratio (CRR) is now 32.5 per cent, S&P says it understands that the effective CRR has been greater than the previous statutory minimum of 27.5 per cent introduced in 2019.
According to the agency, Nigerian banks’ balance sheets have generally been very liquid. However, an additional increase of their mandatory reserves, beyond the current discretionary debits, would likely lead to a freeze in lending in the short term and squeeze net interest margins.
On a positive note, S&P said non-interest-bearing deposits account for a large share of banks’ funding sources, which should mitigate the increase in the cost of funds.
In their attempt to adapt to the CBN’s sharp liquidity tightening, banks have been purchasing government securities, but yields are low.
The 10-year yield on Nigerian government bonds has averaged about 13 per cent, well below inflation. Rising production costs for the corporate sector, due to high energy prices, and tensions in the food-producing middle belt would likely keep inflation in double digits through 2023.
In addition, although foreign exchange reserves are still holding up at around $37 billion, the agency notes that pressures on the Naira exchange rate are persisting.
The difference between the Nigerian Autonomous Foreign Exchange Fixing Mechanism
(NAFEX) rate and parallel rate has widened by about 65 per cent.
This would exacerbate foreign exchange scarcity as structural issues are yet to be addressed, undermining the performance of key sectors in the economy, it stated.
S&P Global Ratings, part of S&P Global Inc. (NYSE: SPGI), is the world’s leading provider of independent credit risk research.
It publishes more than a million credit ratings on debt issued by sovereign, municipal, corporate and financial sector entities. With over 1,400 credit analysts in 26 countries, and more than 150 years’ experience of assessing credit risk, it offers a unique combination of global coverage and local insight.
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