Olubunmi: Effective Credit Risk Management Key to Impaired Loans’ Reduction

Head, Financial Institutions Ratings, Agusto & Co, Ayokunle Olubunmi

The Head, Financial Institutions Ratings, Agusto & Co, Ayokunle Olubunmi, spoke to Goddy Egene on the state of the Nigerian banking industry following the release of the rating agency’s Banking Report 2020. Excerpts:

Agusto and Co have recently published its 2020 report on the banking landscape in Nigeria. How will you compare the current banking scene (in this pandemic period) with what was obtainable during the 2016 recession?

Nigerian banks were not prepared for the 2016 recession, particularly in terms of foreign currency asset-liability management, exposure to vulnerable obligors and other risk management practices. As a result, foreign currency credit exposure to obligors without foreign currency receivables formed a high proportion of the foreign currency loan portfolio of most banks as at 31 December 2016. Based on the lessons learnt during the 2016 recession, the quality of the loan book is relatively better.

Currently, most banks only extend foreign currency loans to customers with foreign currency receivables, appetite for oil and gas loans (excluding exposure to the IOCs) has waned and loan applications are scrutinised more rigorously. The Central Bank of Nigeria (CBN) has been proactive to an extent in managing this pandemic. This was reflected in the forbearance granted to banks which encouraged the restructuring of loans extended to businesses that were adversely impacted by the COVID-19 pandemic.

Approximately N7.8 trillion loans, representing 47.1 per cent of the industry’s loan book, were restructured in the first half of 2020, largely based on the forbearance.

Most of these loans would have been impaired, in the absence of the loan restructuring exercise. The 2016 recession was largely restricted to businesses that rely (either directly or indirectly) on imported inputs. However, the COVID-19 pandemic is more pervasive with the disruption of the global supply chain, crash in the price of crude oil, and the downturn in the global economy. Thus, most businesses, are negatively impacted by the pandemic. The uncertainties associated with the pandemic have also constrained the ability of banks to adequately address the challenges emanating from the current crisis.

Nigeria’s banking sector is the second-largest in sub-Saharan Africa behind South Africa with total assets worth N39.6-trillion as at August 2019. Currently, what is the size of the Nigerian banking industry when compared to its counterparts?

As at 31 December 2019, the Nigerian banking industry’s total assets and contingents stood at N46.6 trillion ($127.6 billion at N365/$) and represented a 21.9 per cent year-on-year growth. At this level, the Industry remained the second-largest in sub-Saharan Africa with the South African banking industry’s total assets at $422.8 billion as at 31 December 2019. The total asset base of the Angolan banking industry is estimated at $110 billion as at the same date. We do not anticipate any significant change in the near term as the pandemic has moderated the growth plans of most banks.

One key insight from the Agusto report is that in the last four years, following the 2015/2016 recession, the Nigerian banking industry has written off a minimum of N1.9 trillion of impaired loans from its loan portfolio. As a consultant, what solutions would you proffer to mitigate this huge loss?

Maintaining an effective credit risk management framework is sacrosanct to keeping impaired loans and the associated write-offs low. A good understanding of industries and businesses before extending credits is also important. Banks also need to adopt a worst-case scenario analysis while reviewing loan requests. Given the volatile operating terrain, loan monitoring needs to be prioritised. An increase in the frequency of reviewing the realities of businesses relative to the assumptions that underpin loan approvals is also important. While most banks have an effective credit risk management policy, full adherence to the policy has been a major challenge in the Industry.

Unfortunately, the quest for higher profit and regulatory pressure have resulted in an increased focus on risk asset creation at the expense of loan monitoring.

How has regulatory policies impacted the Industry’s performance in the last six months and what are the implications for banks going forward?

The aggressive implementation of the cash reserve requirement (CRR) policy as part of measures to moderate the volume of liquidity in the financial system has been a strain to the Nigerian banking industry’s performance in the first half of 2020. This was compounded by the additional CRR debits associated with non-compliance with the 65 per cent minimum loan-to-deposit ratio (LDR) by some banks given the prevailing headwinds and the waned appetite for loan growth. As at 30 June 2020, 18 per cent of the banking industry’s total assets were held sterile with the CBN, up from 12.6 per cent recorded as at 31 December 2019 and the 10 per cent historical average. Thus, the effective CRR (restricted funds/local currency deposits) of most banks exceeded 50 per cent as at 30 June 2020. The impact of the elevated sterile restricted funds, which are not available for daily banking operations, is most prominent in the merchant bank segment where operators depend primarily on purchased funds. However, the lingering low interest rate environment has moderated the impact of this regulation on the Nigerian banking industry. An increase in the prevailing interest rate in the near term will exacerbate the impact of the CRR implementation on the Industry’s performance.

The downward review of bank charges which became effective on 1 January 2020 has also been a constrain on the performance of Nigerian banks. The tariff on electronic banking transactions (the second-largest component of non-interest income) coupled with card issuance and card maintenance costs were the most affected by the downward review. However, the increase in the volume of electronic banking transactions as a result of the pandemic moderated the effect of the reduction in bank charges on the Industry’s performance in the first half of 2020.

Across key parameters such as asset quality, profitability, capitalisation and liquidity, how will you compare Nigerian banks to their counterparts in other African markets?

As at 31 December 2019, impaired loans in the Nigerian banking industry represented 7.6 per cent of gross loans, lower than 10.8 per cent recorded in the prior year on the back of write-offs. The 17.8 per cent loan growth recorded in 2019, largely induced by the introduction of the minimum LDR policy in July 2019, and also supported the reduction in the Industry’s impaired loan ratio. At this level, the impaired loan ratio was lower than the 20 per cent estimated for the Angolan banking industry, albeit higher than four per cent posted by South African banks as at 31 December 2019. The Nigerian banking industry with a capital adequacy ratio (CAR) of 20 per cent is better capitalised, compared to its sub-Saharan African counterparts as at 31 December 2019.As at the same date, the CAR of the Angolan (18.8 per cent) and the South African (16.5 per cent) banking industries were also high. The prevailing turmoil in the global economy is expected to adversely impact the capitalisation of banks.

Given the unfavourable valuation of equities at the stock market, some Nigerian banks are leveraging the prevailing low interest rate environment to raise long term funds that qualify as tier II capital. Most African banking industries recorded improved profitability in the financial year ended 31 December 2019. Relative to its counterparts, the Nigerian banking industry recorded the second-highest return on average equity (ROE) of 24.3 per cent in 2019. The Angolan banking industry had the highest ROE (26.6 per cent)while South African banks together recorded ROE of 14.5 per cent during the year under review. We anticipate lower profitability in the near term based on the prevailing headwinds.

The Nigerian banking industry fared better in terms of liquidity during the year under review. As at 31 December 2019, the liquid assets of Nigerian banks represented 53.5 per cent of total deposit liabilities, higher than 21.1 per cent recorded by the South African banking industry. In the near term, we anticipate an increase in liquid assets as most banks de-emphasise loan growth due to elevated credit risk induced by the prevailing pandemic.

In the wake of the pandemic and its effects on the industry, what opportunities are available for banks to increase market share?

The physical distancing and the economic lockdown policies implemented to contain the COVID-19 pandemic have forced most Nigerians to the digital platforms of banks. As a result, banks now have the opportunity to acquire and serve customers beyond their vicinities of their branches. While the digital platforms of banks were hitherto available, Nigerians are constrained to further embrace the electronic banking channels due to the pandemic. In the short to medium term, we believe the electronic banking channels will be the primary medium for initiating and processing transactions in the Industry, thus enabling an increase in market share without necessarily expanding the branch network. Given the disruptions to the global supply chains and the currency crisis emanating from the COVID-19 pandemic, some import-dependent companies have initiated backward integration programmes. Thus, there are opportunities for banks to fund local manufacturing of essential inputs that were hitherto imported. Similarly, the intervention fund established by the CBN to support the healthcare and pharmaceutical industries provides an opportunity to increase market share and diversify the loan book to these industries that have not been prioritised by most banks over the years.

According to news reports, the Nigeria Deposit Insurance Corporation (NDIC), has requested to be involved in the process of licensing new banks in the country. How do you assess this appeal and will this positively impact the banking sector?

The NDIC is primarily responsible for protecting depositors in the event of a bank becoming insolvent. The NDIC has been involved in the resolution of most failed banks in the country since its inception in 1988. Thus, we believe the experience garnered by the corporation over the last 32 years in resolving failed banks could be useful in assessing the eligibility of promoters of new banks. In our view, the input of the NDIC could be valuable in the formative years of new banks. However, we believe that care must be taken to ensure that the duties of the CBN and the NDIC are clearly delineated to prevent inter-agency rivalry which could ultimately reduce the effectiveness of both regulators.