Guarding against Credit Risk

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There is need for increased vigilance by the banking sector regulator to guard against credit risk in the industry, writes Obinna Chima

There have been concerns that the prolonged drop in oil prices may have a knock-on effect on the banking industry and requires more vigilance by regulators.
The increase in banking sector non performing loans (NPLs) to 11 per cent, far above the five per cent threshold that was set by the regulator has also been the focus of industry analysts in recent times.

Crude oil price has declined by about 50per cent between mid-2014 and mid-2016 to about $50 per barrel presently, thereby leading to significant losses in export earnings for Nigeria and other commodity exporters. This has seriously affected purchasing power in the country as individuals and firms find it difficult to honour their obligations with banks.

However, with forecasts of uncertainties and risks in the global economy, the recent results from the three world’s biggest banks which showed decline in earnings in their third quarter results raises fresh concerns of spill over effects on Nigerian banks.

Citigroup last week reported that its net income fell by 9.5 per cent to $3.8 billion, from $4.2 billion the same quarter a year ago. Its revenues were also down 3.8 per cent to $17.8 billion during the July-September period, from $18.5 billion the same period last year. After the release of the results, shares of Citigroup fell 2.4 percent to $48.39 after opening Friday at $48.60 on the U.S. stock market.

Similarly, JP Morgan Chase’s net income fell 7.3 percent to $6.3 billion. That’s was down from $6.8 billion. Its revenues, however, rose 8.5 percent to $25.5 billion after posting $23.5 billion in the third quarter of 2015. Shares of the bank fell 2.2 percent to $67.30 after they began the day at $68.80. Stirred with illegal banking activities, Wells Fargo’s earnings were highly anticipated.

The bank said last Friday that its net income fell 3.4 percent to $5.6 billion in third quarter of 2016, from $5.8 billion during the same period a year ago. Revenues were up 1.8 percent to $22.3 billion from $21.9 billion. After opening at $45.17, shares of Wells Fargo fell 1.8 percent to $44.33.
But the Chief Executive Officer of the Financial Derivatives Company Limited, Mr. Bismarck Rewane, pointed out that the afformetioned three global banks are strong decline the reduction in their earnings.

“The banks are solid. They all passed the stress test. They did stress test in Europe and the United States and they all passed. So, both on a credit rating basis and capital adequacy basis, the banks are sound and solid,” he explained.
He dismissed the insinuation of a likely contagion effect, saying they total size of Nigerian banking system is insignificant

Nonetheless, 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.

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.

CBN’s Assurance
But the Central Bank of Nigeria (CBN) Governor, Mr. Godwin Emefiele pointed out that a recent reports of the World Economic Outlook showed weakness in the global economy
“When you have situation where there is a weak global outlook as we have now, practically all financial market suffer same kind of issues such as weakening of balance sheets and the rest of them.

“But I must say that for the Nigerian banking environment, it is not as bad as people may think, given that we have strong prudential guidelines and ratios in place. I think we can only continue to strengthen the banks by putting in place strong prudential regulations that would continue to shield the banks and protect depositors,” the CBN governor said.

The CBN also allayed concerns over the soundness of Nigerian banks, assuring the public that they are sound and have strong capital buffers.
However, the Director, Banking Supervision, CBN, Mrs. Tokunbo Martins, admitted that just like in other oil and commodity-dependent economies, banks in the country were also feeling the headwinds in the economy.

She added: “That is not to say that the banking sector is not feeling the economic headwinds, they are. Just like every other jurisdiction. It is not strange. NPLs at 11 per cent is not what we need to focus on. What we need to focus on is if the banks have the capacity to absorb losses that may arise from those NPLs? And the answer is yes. They have very strong capital buffers.

“Another thing that is important is that Nigerian banks have very huge capacity to generate income to also absorb those losses, if they do arise. And then the loans that are non-performing, can they re-perform? Yes they will because the underlying assets are still there and they are good.
“The fact that the country has NPLs at a period like this should be expected and is not a thing that any jurisdiction should be demonised about.

“Other jurisdictions going through what we are also going through are experiencing the same thing. There are countries that have NPLs as high as 15 per cent, some 30 per cent, and some countries in Europe have NPLs as high as 80 per cent.”

Risk of Downgrade
Despite the assurance from the central bank, Fitch, an international ratings agency, acknowledged that banks in the country had experienced a sharp rise in NPLs, adding that other key concerns in the banking industry include forex scarcity, weakening capital adequacy ratios, and the sovereign’s ability to support banks, given its weaker financial flexibility.

“If current challenges do not ease, the banks could face further downgrades,” Fitch said.
Fitch Ratings also warned of downgrades if NPLs continued to deteriorate.
Worsening NPL trends in the sector have accelerated since the end of 2015. Fitch expects this to continue because operating conditions remain difficult.

The CBN’s latest financial stability report released this week showed that the sector’s NPLs rose to 11.7 per cent of gross loans as of June ending 2016 from 5.3 per cent at the end of 2015. This exceeded Fitch’s start-of-year expectations of a 10 per cent NPL ratio by the end of 2016.

But NPLs are not evenly spread among banks and sector NPL ratios are distorted by some exceptionally high concentrations. For example, First Bank of Nigeria, the country’s largest bank, reported a 23 per cent NPL ratio at end-June 2016.

“If current challenges do not ease, the banks could face further downgrades. Our discussions with banks indicate that most impairment is concentrated in the private sector, which is affected by foreign currency shortages and the depreciation of the naira.
“Borrowers are struggling to access scarce FC and those dependent on naira income are finding it hard to meet escalating repayment costs triggered by the depreciation.

“Sector NPLs would have been higher if banks had not undertaken widespread restructuring of loans to the oil and gas sector, which accounts for 30 per cent of total sector loans,” Fitch added.

On his part, a former CBN Governor, Prof. Charles Chukwuma Soludo has called on the CBN as well as other central bankers across the globe to start taking preemptive, proactive contingency planning, in anticipation of the next global crisis, which according to him might happen in few years’ time. According to him, there is a whole lot of uncertainty and risks everywhere, saying that it would take one major crisis in one country and it will snowball into another global crisis.

He argued that there was an uptick in the level of uncertainties in the global economy, saying that the world was yet to get over the 2008-2009 global financial crisis.
He pointed out that there was still tepid growth in Europe and America, as well as concerns over China.
Soludo stressed that the key thing for central banks and policy makers over the world to be concerned about ought to be the state of affairs of the global economy and the financial system.