CBN Stress Test Reveals Banks’ Vulnerability to Economic Headwinds

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Obinna Chima

A stress test conducted on 27 financial institutions under the regulation of the Central Bank of Nigeria (CBN) has shown that even though the banking industry solvency and liquidity position are still robust, the industry may be vulnerable under the severe scenario of sustained economic contraction.

The CBN, in its half-year economic report as of June 2020, posted on its website yesterday, stated that it conducted top-down solvency and liquidity assessment of the banking industry in the review period.
The stress test was conducted on 22 commercial and five merchant banks to assess their resilience to systemic risks.
“The stress test was conducted within the background of a sharp fall in oil prices, reduced global demand for Nigeria’s oil products, decline in government revenue, unfavourable current account position and a fall in Gross Domestic Product (GDP).

“The result showed that under the severe scenario of a sustained significant contraction in GDP of 3.5 per cent in the third quarter of 2020, negative 4.0 per cent in the fourth quarter of 2020 and negative 4.5 per cent in the first quarter of 2021, the banking industry CAR will fall to 11.19 per cent, 9.26 per cent and 8.30 per cent, respectively.
“However, the severity of the simulated GDP contraction may be contained by a combination of fiscal and monetary interventions,” the CBN stated

The CBN, however, said one of its strategic policy thrusts over the next five years (2019-2024) was to preserve financial stability through enhancement of its on-site and off-site supervision tools and processes.

“In contributing to the achievement of this strategic objective, the CBN has finalised the draft review of its framework and Dynamic Macroeconomic, and Top-down Stress Testing Tools in the review period.
“The Framework and the models aimed at complementing the existing Early Warning System Tools and enhancing the Bank’s ability to proactively identify potential risks to the financial system as well as risks to individual banks,” it added.

CBN Seeks Speedy Implementation of Economic Sustainability Plan

In a related development, the apex bank has advised the federal government to quicken the implementation of its Economic Sustainability Plan (ESP).
A speedy implementation of the policy, the CBN said, will help in addressing the structural impediments to growth and job creation as well as improving the poor state of the country’s infrastructure.

The Deputy Governor, Financial System Stability Directorate, CBN, Mrs. Aishah Ahmad, gave this advice in her personal statement at the September Monetary Policy Committee (MPC) meeting, a copy of which was obtained on the central bank’s website yesterday.
In response to the severe economic consequences of the COVID-19, the federal government had in the first half of the year launched the Nigeria Economic Sustainability Plan, a 76-page document that outlined measures to stimulate various sectors of the economy and to support the vulnerable.

To Ahmad, for optimum benefits to the economy, monetary policy instruments can only compliment policies in other sectors of the economy to deliver broad-based economic prosperity.
She stated those aspects of the plan, which seek to improve non-oil government revenue and reduce non-essential spending are vital and reinforce the importance of prioritising government expenditure to support social infrastructure, including but not limited to health, education and security, to help drive economic growth prospects.

“The bank must support these fiscal efforts by sustaining its intervention policies particularly in the agricultural sector, which will be critical to strengthening output and curtail food inflation and COVID-19 monetary stimulus measures and other initiatives designed to channel credit to critical sectors such as agriculture, manufacturing and small businesses,” she added.

She said there was a need to continue to push for the implementation of the minimum Loan to Deposit Ratio Policy (LDR); vigilance over the banking sector to preserve its strength, resilience and capacity to support the economy; and support for Small and Medium Enterprise (SMEs) to mitigate their exposure to adverse impacts of the pandemic.
In his contribution, the CBN Governor, Mr. Godwin Emefiele, reiterated the need for sustained support of the real sector to stimulate aggregate supply and enhance job creation.

According to him, given the ramifications of supply shock and food shortages for Gross Domestic Product and inflation outcomes, policy should aim to resolve structural constraints.

He said the CBN would continue to liaise with banks to restructure lending and grant forbearance to constrained economic units.
“I note the dilemma created by the rising inflationary pressure and falling output and the trade-off inherent in policy options. I acknowledge the primacy of price and exchange rate stability and underscore the need to not lose sight of output stabilisation.

“I note that both inflation and exchange rate expectations are elevated in the short-term while the growth outlook is weakened by supply shocks and the lingering effects of the COVID-19 economic lockdown.
“Given the GDP contraction in the 2020 second quarter, growth prospects remain frail for the remaining quarters of 2020. I expect that with the continued easing of restrictions, the economy will begin to recover in 2020 third quarter, though this may be incomplete even by year-end. Again, I favour measures to avert a recession or at least curtail its intensity,” Emefiele stated.

On his part, the Deputy Governor, Corporate Services Directorate, CBN, Mr. Edward Lametek Adamu, said COVID -19 had altered the way people live and conduct economic activity/business, adding that some of its consequences might remain for a while.
“There will be lasting consequences for employment, production cost and how economic agents engage resources, even under the best circumstances of early vaccine plus a cure,” Adamu added.

According to him, the surest path to early economic recovery entails, amongst others, significant financial support to the health system to enable it to cope with the pandemic.
He stated that the CBN is already leading the way with dedicated interventions in the health sector.
He, however, called for the collaboration of the private sector and government at all levels.

In his personal statement, the Deputy Governor, Economic Policy Directorate, Dr. Kingsley Isitua Obiora, noted that despite the persistence of the pandemic, the financial system has remained relatively stable and robust to withstand shocks.

He also said credit to various sectors rose from N15.57 trillion to N19.33 trillion between May 2019 and August 2020.
Obiora explained: “This outcome reflects the continued implementation of the Loan-Deposit Ratio (LDR) Policy. In particular, the growth incredit was mainly directed to manufacturing (N866.27 billion), consumer credit (N527.65 billion), oil & gas (N477.65 billion), agriculture (N287.11 billion) and construction (N270.97 billion).

“In order to support the naira, we must also continue to build a Nigeria that meets the needs of all citizens.”
Also, the Deputy Governor, Operations Directorate, CBN, Mr. Folashodun Shonubi, said: “Overall, the state of the economy requires that we must keep as many as possible economic agents active and promote the expansion of economic activities to create more employment and guarantee income.

“On the back of an inflationary pressure that is induced, largely, by temporary disruption to supply chain, one-off shocks and structural rigidity, I am certain that as we keep the engine of economic activities grinding, the cost reducing the effect of increased productivity and economies of scale will eventually, drive prices down.”