Banks’ Fast-rising Bad Debts

Obinna Chima examines efforts to rein in risks in the banking system

As the level of non-performing loans (NPLs) in the banking system are on the increase as Nigeria’s macroeconomic indicators weakens, there are concerns about systemic risk in the industry.

The Central Bank of Nigeria (CBN) had in its Financial Stability Report for December 2015, disclosed that although few banks have NPLs ratio above the regulatory maximum limit of five per cent, the situation does not pose significant risks to the banking industry.

The number of NPLs in the industry has been projected to have risen higher in the first half of the year considering the headwinds in the macroeconomic environment.

In fact, banking sector NPLs have been predicted to jump to 12.5 per cent of the total loans of the banks this year, up from the central bank’s target level of five per cent at the end of last year, according to Agusto & Co, Nigeria’s main rating agency.

Nigeria’s real Gross Domestic Product (GDP) growth rate declined to -0.36 per cent in the first quarter of this year, compared to 2.11 per cent in fourth quarter of 2015, the National Bureau of Statistics (NBS) had stated.

The economy had contracted to 3.86 per cent and 2.35 per cent respectively in first quarter of 2015 and second quarter of 2015 before rebounding to 2.84 in third quarter 2015 and further shrunk to 2.11 per cent Q4 of 2015. The current decline represents the first contraction since June, 2004, a 12-year-low.

Unemployment rate in the Nigerian economy climbed to 12.1 per cent in the first quarter of this year, compared to 10.4 per cent in Q4 of 2015 and 9.9 per cent in the third quarter of 2015.

According to the NBS data release calendar, the second quarter GDP estimates are expected to be released in the next three weeks. But, there are projections that the anticipated estimates would also be negative.

The central bank ditched its 16-month old peg on the naira in June and introduced a flexible exchange rate regime to allow the currency to trade freely on the interbank market.
But dollar liquidity has remained a concern in the system with periodic intervention by the central bank. The central bank has told lenders to set aside extra provisions against their dollar loans.

Since the central bank’s recent intervention at Skye Bank, there have been increased concerns about the health of Nigerian banks.

Forbearance to Banks
In view of the current macro-economic challenges in the country, the CBN last week announced that it has granted a one-off forbearance to banks this year to write-off their fully provided for NPLs without waiting for the mandatory one year.
The CBN stated this in a two-paragraph circular by its Director, Banking Supervision, Mrs. Tokunbo Martins.

Martins stated that the central bank acknowledged the request by banks to amend the requirements of S.3.21 (a) of the Prudential Guidelines, which mandates banks to retain in their records, fully provided NPLs for a period of one year before they are written off.
“The CBN has no intention of repealing the provision of the above mentioned section of the guidelines. In view of the current macro-economic challenges, however, the CBN hereby grant a one-off forbearance this year 2016 to banks, to write-off fully provided for NPLs without waiting for the mandatory one year,” she wrote in the circular addressed to all banks.

In a related development, in view of what it described as the observed abuse of access to its Standing Lending Facility (SLF) by banks and other authorised dealers, the CBN announced measures to correct the anomaly. To this end, the central bank in another circular by its Director, Financial Markets Department, Dr. Alvan E. Ikoku, directed all authorised dealers to refrain from accessing the discount window on the settlement date for government securities’ auctions.

The securities referred to are CBN bills, Nigerian Treasury Bills and Federal Government of Nigeria bonds. It stressed that any violation of the directive would result in the denial of access to the SLF.

Reacting to this policy, the Chief Executive Officer, Financial Derivatives Company Limited, Mr. Bismarck Rewane said the central bank was being realistic.
“In writing off loans that you have already provided for is not as impacting as you think; it is the provisioning that is the problem. When you write it off, it has some tax advantage. Let me give an example. If you pick garbage from your kitchen and put it in the dustbin, that is provisioning.

“When the garbage man takes the garbage away from the front of your house, then that is write-off. So, as far as your house is concerned, you have already taken it out and put in a dust bin. So, anybody that enters your house will not know what is there.
“Now, what the central bank has done is not a big deal. The most important thing is allowing staggered provisioning. If a loan is questionable, the central bank can say instead of making a provision in one year, you can make it in five years,” the economist said.
On his part, the Head of Research, SCM Capital Limited, Mr. Sewa Wusu, told THISDAY that the central bank introduced the policy to cushion the effects of the challenges being faced by banks.

He pointed out that if banks are allowed to make full provision, the level of NPLs might further impact on their books.
“So, what the CBN did was to introduce the measure to support the banks. I also think that the CBN should begin to look at away of re-assessing the banks position again in terms of having a stress test. Banks can also raise tier 2 capital so as to shore up their capital adequacy ratio.

“So, I think there is need to carry-out that test to ensure that the banks are sound, so that they can also play their role in the economy and be able to withstand shocks. The CBN has been doing a lot. It is not easy because we are undergoing economic challenges and the financial system which is very sensitive must be protected and supported so that banks cannot fail,” he added.

Nonetheless, in order to ascertain the actual well-being of banks owing to the situation in the economy and rising non-performing loans, central bank disclosed that it is currently carrying out examination on banks. At the end of the exercise, the banking sector regulator said, it would determine how best the industry should be supported.

Martins, disclosed this in response to enquiries from THISDAY.
Responding to THISDAY’s question on the need to conduct special examination on the banks to mitigate systemic risk in the industry, Martins stated: “I totally agree. We are currently carrying out examinations in that regard and also conducting stress test. At the end of it, we will determine how best the industry should be supported.”

Effect of Adverse Commodity Price Shock
Clearly, as a country that is heavily dependent on oil, the prolonged decline in oil prices is having a knock-on effect on the banking industry.
Adverse commodity price shocks, according to the International Monetary Fund (IMF) can also contribute to financial fragility through various channels. Firstly, a decline in commodity prices in commodity-dependent countries results in reduced export income, which could adversely impact economic activity and agents’ (including governments) ability to meet their debt obligations, thereby potentially weakening banks’ balance sheets. Secondly, a surge in bank withdrawals following a drop in commodity prices may significantly reduce banks’ liquidity and potentially lead to a liquidity mismatch, the IMF stated.

Financial fragility can be defined as the increased likelihood of a systemic failure in the financial system, for which the most obvious indicator would be a systemic banking crisis. Last year, the regulator gave three commercial banks until June 2016 to recapitalise after they failed to hit a minimum capital adequacy ratio of 15per cent.

“Negative shocks to commodity prices tend to weaken the financial sector and increase the probability of banking crises, with larger shocks having more pronounced impact. More specifically, negative commodity price shocks increase non-performing loans and bank costs, reduce the provisions to non-performing loans and bank profits (return on assets and return on equity).

“Second, these detrimental effects are more common in countries with poor quality of governance, high public debt, and low financial development but are less common in countries under IMF-supported programs, holding sovereign wealth funds (SWF), implementing macro-prudential policies, and with a diversified export base.

“Third, GDP growth, fiscal performance (fiscal deficit and government revenue), savings, and debt in foreign currency are the main transmission channels of commodity price shocks to the financial sector,” the fund added.

Fresh Capital as Buffer
As a result of the situation, some banks in the country have started taking steps to increase their capital.
For instance, Diamond Bank Plc and First City Monument Bank Limited (FCMB) recently disclosed plans to raise fresh capital.

Diamond Bank is considering raising fresh capital and selling some assets in order to strengthen its capital base, its chief executive, Uzoma Dozie said.

According to him, the bank’s capital plan will ensure it meets all regulatory requirements both in the short term and in the future. Diamond Bank’s capital adequacy ratio had fallen to 15.6 per cent of assets by mid-year from 18.6 per cent a year ago.

“We are doing a capital management plan and that will determine how much capital we want to raise, tenor and size,” Dozie told an analysts’ conference call.
“We don’t have any need to grow our branch network any more. We are also looking at some assets that we can dispose of and we are a long way into that,” he said.

Diamond Bank’s non-performing loan ratio rose to 8.9 per cent in the first half, above the central bank’s target level of five per cent where it stood a year ago, Reuters had disclosed. It expects to bring down the ratio to 7.5 per cent by year end, he said.
In a related development, FCMB plans to raise N10 to N15 billion ($47 million) of tier II capital to boost its balance sheet and will target its retail investors for the offering, its chief executive officer, Ladi Balogun, said.

Balogun said its capital adequacy ratio was close to the regulatory limit of 15 per cent of assets at mid-year, and that it was undertaking the capital raising to provide an additional cushion.

He said the bank was also slowing down loan growth, adding that a rate of increase of 14.8 per cent in the first half was largely due to the 40 per cent drop in the value of the naira against the dollar since the dollar exchange rate peg was removed in June. Otherwise loans declined by 1.9 per cent, said Balogun, whose term as CEO ends next year.

“For the Tier II we would be looking at anywhere in the range of N10 to N15 billion. It’s really going to be targeted at retail because we feel that the rates from institutions will be high,” Balogun also told an analysts’ conference call.

“We have interest from some depositors who want higher yields.”
Balogun said the bank would also retain profits in addition to the bond sale to boost capital and tap into buffers at its holding company, if necessary.

Balogun said its dollar loans were fully covered as of the end of June and that the bank expects to restructure 25 per cent of loans to the oil and gas sector in the third quarter after it restructured 50 per cent of those loans last year.
In the same vein, Unity Bank Plc recently said it is planning to raise additional capital to support its growth initiative.

According to the bank, the fresh capital will also enhance its pursuit of planned growth trajectory especially in Agriculture financing, SMEs, rural economy and overall financial inclusion schemes already outlined.
Also, the Managing Director/Chief Executive Officer of Sterling Bank Plc, Mr. Yemi Adeola has said the bank would conclude its N35billion tier 2 capital raising exercise in the second half of the year.

Speaking against the background of the performance of for the bank for the first half year ended June 30, 2016, Adeola said while some of the macroeconomic challenges witnessed during the period would persist, improvements in the Nigerian economy was being expected, driven by the implementation of the budget and other fiscal palliatives introduced by the federal government. Hence, the bank is being positioned to take advantage of the improvements and create better value for all stakeholders.

In terms of policy implications, the forgoing underscores the necessity of adopting policies to increase the resilience of the banking system.
Firstly, just as outlined by the IMF, policy makers in Nigeria should promote sound economic policies and good governance that will ensure the effective use of natural resource windfalls and build fiscal buffers to help mitigate the impact of commodity price shocks and stabilise the economy.
More so, the central bank should ensure that it implements macro-prudential policies in order to limit or mitigate systemic risk.

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