Access, Union Bank not Efficient as Return on Equity Lags Costs

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Nigeria banks restricted deposits CBN

A number of Nigerian banks are not economically efficient, as their returns on equity aren’t keeping pace with costs.

Specifically, Access Bank and Union Bank saw combined operating and personnel costs rise much faster than return on average equity in 2020, according to data compiled by MoneyCentral.

Access Bank’s combined operating expense (OPEX) and personnel expenses rose by 26.7 percent to N288.9 billion in 2020, compared to ROAE of 15.62 percent for the period.

In the same vein Union Bank saw its combined OPEX and personnel costs surge by 11.78 percent to N70.75 billion last year, while managing to post a ROAE of only 7.23 percent for the period.

FCMB, a mid-tier lender also saw costs rising faster than returns on equity as combined OPEX and personnel costs rose by 9.38 percent to N76.77 billion in the 2020 financial year as ROAE came in at 9.17 percent for the period.

Return on equity is an important measure of a bank or country’s banking sectors profitability.

ROE is calculated by taking the amount of net income returned as a percentage of the shareholder’s equity.

Return on Equity looks at how well a bank’s (or company’s) management is using its assets to create profits.

A majority of banks globally may not be economically viable because their returns on equity aren’t keeping pace with costs, consultancy McKinsey & Co said in its 2019 annual review of the global banking industry.

More than half of the world’s banks were already in a weak position before the coronavirus downturn, according to the report.

McKinsey urged firms to take steps such as developing technology, farming out operations and bulking up through mergers.

McKinsey, whose clients are some of the biggest corporations in the world, consults on topics ranging from strategy and technology to mergers and acquisitions, outsourcing and stock offerings.

In its report, the firm said banks risk “becoming footnotes to history” as new entrants change consumer behavior. Most recent attempts by banks to boost efficiency have been “business-as-usual,” it said.

Banks allocate just 35 percent of their information-technology budgets to innovation, while fintechs spend more than 70 percent, McKinsey said. Combined with regulatory factors lowering the barrier to entry — like open banking and looser requirements for startups — the environment is increasingly conducive for newer firms to take share from banks.

In Nigeria this is already happening with the flood of new fintechs that are attracting financial-services customers and bringing innovation to the lending space over the past 5 years, forcing the normally slow to move established banks to respond to the threat.

Fintechs like RenMoney revolutionized technology based lending which provided loans in 24 hours using mobile phones which bigger Nigerian banks are beginning to emulate.

It’s not all gloom for the established banking names in Nigeria as Guaranty Trust Bank (GTBank), United Bank for Africa (UBA), Zenith Bank, Stanbic IBTC Holdings and FBN Holdings recorded much higher returns on equity, compared to increases in costs.

GTBank which has been investing heavily in technology saw operating and personnel costs rise by 9.53 percent in 2020 to N76.77 billion, while it posted ROAE of 26.83 percent for the period.

UBA reported a 13.97 percent increase in operating costs while it posted return of equity of 17.2 percent in 2020. Zenith Bank’s operating costs increased by 9.68 percent as it was able to generate return on equity of 22.39 percent last year.

Stanbic IBTC group had operating expenses slide by -0.83 percent to N86.75 billion in 2020, as ROAE came in at 24.4 percent, while FBN Holdings operating expenses followed the same trajectory as it fell -0.65 percent, while ROAE came in at 12.6 percent.

McKinsey said lenders can cut costs and find funds for technology by outsourcing what it calls “non-differentiating activities,” including some trading and compliance functions.

Banks “need to get much more comfortable with external partnerships and being able to leverage talent externally,” Kausik Rajgopal a senior partner at McKinsey said.

Globally, banks’ valuations have fallen 15 percent to 20 percent since 2018, McKinsey said, adding that “the drop in valuation suggests that investors anticipate a sharp deceleration in earnings growth.”

Nigerian banks trade at a much sharper discount to global bank valuations and in most cases at less than half the valuations of South African Banks, reflecting the depth of investor concerns over longer term profitability.

Guaranty Trust Bank, Nigeria’s largest listed lender trades at a comparable price to book ratio of 1.10 times, compared to 1.12 times for South Africa’s Standard Bank Group, the largest on the continent.

However other major Nigerian lenders such as FBN Holdings trade at a price to book ratio of 0.34 times, Access Bank 0.42 times, Zenith Bank 0.62 times and Union Bank 0.57 times.

The price-to-book ratio, or P/B ratio, is a financial ratio used to compare a company’s book value to its current market price and is a key metric for bank investors.

Book value denotes the portion of the company held by the shareholders; in other words, the company’s assets less its total liabilities. This is calculated as the Current Price divided by the latest annual Book Value Per Share

Normally, a relatively lower P/B ratio is interpreted as a stock being underpriced and a relatively higher P/B ratio is interpreted as the stock being overpriced.

But there is a deeper significance of this to banks. For a bank, the macroeconomic conditions like inflation rate, rate of interest and liquidity are approximately the same for most of the banks.

What differentiates one bank from the other bank is a function of how efficiently the funds or the assets are utilized and how best the spreads are managed.

For banks another way to free up money is to get bigger through M&A, according to McKinsey.

“Going forward, scale will likely matter even more as banks head into an arms race on technology,” the report says.

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