Why Nigerian banks have weak capital adequacy —Fitch

Due to oil-related lending, which represents about 30 per cent of banking sector loans, and the uncertainty behind borrowers’ ability to service such loans in line with  new restructured terms, Fitch Ratings has observed that Nigerian banks  have weak capital adequacy.

Capital adequacy, usually expressed as a ratio, refers to a bank’s ability to maintain equity capital sufficient to pay depositors whenever they demand their money and still have enough funds to increase the bank’s assets through additional lending. It is a requirement imposed by regulators which banks list  in their financial reports in terms of equity capital as a per cent of assets.

Fitch-rated banks, the agency revealed in a report released on Thursday, reported an average International Financial Reporting Standards (IFRS)-calculated ratio of impaired loans to total loans of close to 8 per cent in June 2017, but reporting classifications differ among the banks and regulatory forbearance is not uncommon in Nigeria.

Specifically, Fitch stated: “Oil-related lending, which represents about 30 per cent of loans, has undergone extensive restructuring and borrowers’ ability to service the loans in line with the new terms is yet to be tested. Given these risks, we consider Nigerian banks’ capital adequacy to be weak, in general.”

The agency advises lenders to embark on more earnings retention if they are to continue to strengthen their capacity to absorb losses at a time of persistent fragility in the Nigerian operating environment.

“Banks tell us that impairments appear to have peaked, but we view this as far from certain, and the impairment metrics do not yet fully reflect the requirements to provide for expected credit losses under the incoming IFRS 9 international accounting standard,” the report stated.

According to the agency, very high Nigerian Treasury Bill yields are helping banks to maintain their margins. Banks have been investing heavily in T-Bills since second half (2H) 16, boosting interest income and maintaining margins. Margins reported by Fitch-rated Nigerian banks averaged 7.5 per cent in 1 H17, in line with 1 H16.

“But the boost to net interest income may be temporary, as T-Bill yields have reduced in recent weeks, falling to about 15.5per cent from their mid-year levels of just over 18.5per cent, and they may decline further.

High yields on T-Bills are part of the Nigerian authorities’ attempts to control inflation and manage demand for foreign currency. By providing a remunerative, relatively low-risk, naira-denominated investment (interest payments are tax-free), they hope to encourage naira retention and dampen demand for US dollars.

The CBN recently raised the minimum T-Bill purchase amount to NGN50 million (USD164,000) from NGN5,000. This should stem the outflow of small retail depositors, but is unlikely to have a significant impact on overall deposit flows because most Nigerian banks are majority-funded by corporate deposits, Fitch stated.