Is Nigeria Ripe for Another Round of Banking Sector Consolidation?

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With the weakness in Nigeria’s macroeconomy and the attendant strain on the banking sector, Obinna Chima wonders if the Central Bank of Nigeria should raise the minimum capital base for Nigerian banks, 12 years after a similar exercise was carried out

A study by the International Monetary Fund (IMF) had shown that the significant and prolonged drop in oil prices since mid-2014 changed the fortunes of Nigeria and many other energy-exporting nations around the world. Finding from the report showed that budgets in oil exporting nations generally turned from surpluses to large deficits, slowdown in growth as well as increased threats to financial stability.

The report stressed that in such a challenging environment, a policy of “business as usual” will not suffice—policymakers will need to adopt significant measures to put public budgets on a sounder footing, address risks to liquidity and the quality of assets in the financial sector, and improve growth prospects.

These clearly, might have spill over effects on the banking system in Nigeria and other oil producing countries, and could be one of the reasons why the Senior Resident Representative and Mission Chief for Nigeria, African Department, IMF, Mr. Amine Mati, has suggested that the Central Bank of Nigeria (CBN) should recapitalise the banks.

Following the intense weakening of the country’s macroeconomic environment, resulting in the deterioration of asset quality and rise in non-performing loans (NPLs) in the banking industry, the IMF boss advised the CBN to consider asking the country’s lenders to recapitalise.
Banking sector’s NPLs climbed to as high as 15 per cent.
The prescribed minimum capital base of Nigerian banks was raised to N25 billion in 2005.
Mati stressed the need for the banks to remain strong so that they would be able to play their roles in the economy.

He explained: “We believe the banking sector should be strong to support the economy. So, it is important we recapitalise the banks to make sure that they are very strong.
“The regulators should try to make sure that the banks operate in line with international standards to be able to withstand any shocks.”

He, however, endorsed the CBN’s tight monetary policy stance, saying it had helped in gradually easing inflationary pressure and brought about exchange rate stability.
But he urged the central bank to continue in its pursuit of a unified exchange rate, just as he acknowledged efforts that had been made by the CBN in eliminating pressure in the forex market.
He noted that the country exited the recession in the second quarter of the year, driven by improvements in the oil and agriculture sectors.

State of the Banks
According to Afrinvest West Africa Limited’s 2017 Banking Sector Report, majority of Nigerian banks have demonstrated their resilience within the last two years amid macroeconomic challenges which weighed on credit expansion, asset quality and capital adequacy, to record largely positive performances for the year.

The report showed that the financial performance of the sector was principally affected by monetary policy decisions tied to the management of the foreign exchange (forex) market, which had a ripple effect on earnings across the industry.

This, it stated was positive for banks’ non-interest income, especially Tier-1 lenders with aggregate long Net Open Positions (i.e. higher foreign currency denominated monetary assets than liabilities) which recorded massive jumps in forex revaluation gains.
Furthermore, in a bid to attract private capital flows and shore-up the naira and external reserves, the CBN drove up policy and market interest rates, resulting in higher fixed income yields which bolstered interest income for banks.

“Consequent on the higher interest and non-interest income, industry gross earnings (for the 14 banks within our coverage) rose faster at 16.4 per cent in full year 2016 (better than 10.4% in 2015).
“However, the industry still faced significant cost pressures, particularly impairment charges which surged 91.8% within the period as a result of weaker asset quality and the one-off forbearance on writing off fully provisioned loans granted by the CBN in 2016. Nonetheless, profitability metrics improved as industryprofit before tax (PBT) expanded 9.8 per cent in 2016, an improvement from a 28.4per cent decline recorded in the prior year, while Return on Equity (ROE) strengthened to 12.3 per cent, from 9.1 per cent in 2015.

“Similar to earnings performance, the impact of prudential guidelines and monetary policy reflected on balance sheet and capital adequacy of banks,” it revealed.
According to the report, following the devaluation in June 2016, the industry’s capital adequacy level took a hit as forex-denominated risk weighted assets were revalued upwards while the CBN gave banks a soft landing by relaxing prudential rules.

It pointed out that the effect of currency depreciation was also evident in the industry gross loan book which grew nominally by 23 per cent year-on-year, given that 39.5 per cent of industry loans were foreign currency denominated.
In addition, total deposits grew 19.3 per cent in 2016, following a decline of 1.8 per cent in 2015 while total assets and total liabilities expanded 20.7 per cent and 21.8 per cent respectively.

“Given the more or less resilient earnings performance, majority of the banks maintained their dividend policy with an average pay-out ratio of about 33.0% and investors netted alpha as the banking index outperformed the market benchmark.
“Considering these factors, our outlook on the sector for the rest of the year and 2018 is broadly positive although we note that crystallisation of asset quality risk sill poses a threat to the sector, given that the economy is still recovering from a recession and banks loan book is heavily skilled to high risk sector – upstream oil & gas, manufacturing, general commerce and power sectors, “ it added.

Afrinvest believed that despite forward guidance of banks to keep credit expansion minimal in 2017, the exposure of pre-existing loans to “high risk sectors” would continue to pressure asset quality in the year.
Also, an Agusto & Co. Banking Industry report noted that the performance of the Nigerian banking industry was largely dependent on the macroeconomic environment, as well as the performance of the top five banks. The report had also shown that about 47 per cent of the banking industry’s impaired loans were collectively held by the top five banks. The top five banks in Nigeria are: Zenith Bank Plc, Guaranty Trust Bank Plc, First Bank Nigeria Limited, United Bank for Africa Plc, and Access Bank.

According to the Agusto & Co. report, the impaired loans were mainly in the oil & gas, transport & communication sectors, accounting for 37 per cent and 11 per cent respectively of the industry’s total classified loans. In the oil & gas space, also disclosed in the banking sector report, the top five banks accounted for 60 per cent of the loans disbursed to this sector, “which heightens concentration risks.”

A breakdown of the oil and gas sector loan disbursement had shown that the top five banks granted over 66 per cent of the banking industry’s total exposure to the upstream, 64 per cent of total exposure to the midstream and 73 per cent of the total loans granted to the downstream.

Should the Banks be Recapitalised?

Economists and financial market experts have expressed divergent views about whether Nigerian banks should be asked to hold a new minimum capital base.
According to an economist and the Director-General West African Institute for Economic Management (WAIFEM), Prof. Akpan Ekpo, for a country that recently exited an economic recession, raising the banking sector’s capital base would compound the situation in the country.

He explained: “How can the CBN recapitalise the banks when we are just technically out of recession and we are still walking towards economic recovery? You can’t do that! Where will the money come from?
“It will bring pressure on the banks. Even today, the banks are not financing long-term investments. So, if you ask them to recapitalise today, you create more problems.
“Normally, you encourage banks to beef up their capital base if you feel it has dropped, rather than force them to do so. So, I disagree with the IMF.”

On his part, the Chief Executive Officer, Cowry Assets Management Limited, Mr. Johnson Chukwu, argued that it may not be necessary for the CBN to stipulate a new minimum capital base for the banks.
According to Chukkwu, what the CBN needs to do is to find ways of compelling banks whose share capital are below the regulatory threshold, to either raise fresh capital or find merging partners, so that they don’t create systemic crisis in the industry.

“There may be a few banks that had been adversely affected because of the years of economic crisis and high incidence of NPLs. So, those banks, the central bank must find ways of resolving their insolvency issues.

“They are either asked to raise fresh capital or to force them to look for merger partners. So, the CBN must look for ways of resolving the issue. So, it won’t be a call for fresh capital across board. It should be specific to the affected banks,” he added.

But a former Executive Director of a bank, Abdulrahman Yinusa, welcomed the need for banks to be made to beef up their capital base, as long as it not public funds that would be used.
“Every business needs to adjust to the environment, when things improve or go bad. So, I agree that the capital base of some of the banks have been depleted, of course not all.

“All the marginal players would have had significant erosion in their capital base and therefore, their capital might have been less than the statutory minimum by now.
“I don’t subscribe to regulators mentioning banks that have capital challenges, instead, they should work on them and get them recapitalised. But I don’t think the use of public funds is recommended,” he added.

Yinusa described issuing Eurobond, as have been seen in the industry recently, as a fairly, and acceptable means of raising additional capital, if it is capital and not debt.
“If you can get capital from the Eurobond market, that is fine. We call that tier-2 capital and it is long-term and it must be subordinated,” he added.

But, it is worthy of note that the CBN has maintained that Nigerian banks are safe, sound and have strong capital buffers to withstand shocks. It had also admitted that just like in other oil and commodity-dependent economies, banks in the country also felt the headwinds in the economy.
In addition, THISDAY findings showed that the central bank conducts stress test periodically on the banks and therefore, knows the true state of their health.

Also, the Nigerian banking industry has often been described as one of the most regulated in the continent. For instance, the standard practice in several jurisdictions is that the Capital Adequacy Ratio (CAR) requirement for banks should be eight per cent, minimum. But in Nigeria, the smallest bank is expected to maintain a CAR of 10 per cent, while the large Systemically Important Banks (SIBs) are expected to maintain 15 per cent as CAR.

What this has done is that it has provided capital buffers for the banks to be able to withstand shocks. The foregoing shows that the CBN, from the array of information on the banks at its disposal, is in the right position to determine when to call for an increased capital base for the industry.