S&P Global Ratings believes banks in Nigeria could see reduced earnings, alongside weaker lending growth and asset quality, after the Central Bank of Nigeria (CBN) raised its main monetary policy rate (MPR; repo rate) by 150 basis points (bps) on Sept. 27.
The monetary policy committee’s latest move not only raises the repo rate to 15. 5%, but also banks’ cash reserve requirement to a minimum of 32. 5% (up 500 bps), amid persisting foreign exchange shortages in the country.
The central bank has raised its MPR by a cumulative 400 bps so far this year in efforts to tame inflation, which stood at 20. 5% in August.
At the same time, it revised the rate on its intervention facilities (special funds offered at a discount rate to priority sectors) to 9% in August 2022. Banks have used the CBN’s intervention facilities to extend credit to the private sector at a preferential rate, mainly to support small and midsize enterprises amid prolonged economic setbacks.
“In our view, the increase in the MPR and intervention funds rate suggests that the CBN has not closed the taps entirely, since banks should still be able to extend credit to priority sectors such as agriculture.
That said, credit leverage in the economy remains low, with total private-sector loans representing only about 13% of GDP, despite loan growth averaging close to 20% over the past two years.
Nevertheless limited financial intermediation somewhat constrains the central bank’s ability to curb inflation using the MPR. Further rate hikes are possible, given the gap between inflation and the MPR, and will put pressure on banks’ loan portfolios as they pass the full rate increase to retail customers,” S&P said.
Although the cash reserve ratio (CRR) is now 32. 5%, the effective CRR has been greater than the previous statutory minimum of 27. 5% introduced in 2019.
Nigerian banks’ balance sheets have generally been very liquid. However, an additional increase of their mandatory reserves, beyond the current discretionary debits, will likely lead to a freeze in lending in the short term and squeeze net interest margins.
On a positive note S&P said, non-interest-bearing deposits account for a large share of banks’ funding sources, which should mitigate the increase in the cost of funds.
In their attempt to adapt to the CBN’s sharp liquidity tightening, banks have been purchasing government securities, but yields are low. The 10-year yield on Nigerian government bonds has averaged about 13%, well below inflation.
Rising production costs for the corporate sector, due to high energy prices, and tensions in the food-producing middle belt will likely keep inflation in double digits through 2023.
What’s more, S&P expects banks’ earnings will fall as nonperforming loans (NPLs) increase and net interest margins decline. We expect the banking sector’s NPL ratio will deteriorate to 5. 5% on average in 2022 after improving to 5% at year-end 2021, while the return on equity moderates to 13% from 14%.
This is because of a weakening environment. Dollar-denominated oil revenue from the large oil producing companies has been under pressure amid lower oil production, due to oil thefts, pipeline leaks, and terminal shutdowns in 2022.
In addition, although foreign exchange reserves are still holding up at around $37 billion, pressures on the naira exchange rate are persisting.
“The difference between the Nigerian Autonomous Foreign Exchange Fixing Mechanism (NAFEX) rate and parallel rate has widened by about 65%. This will exacerbate foreign exchange scarcity as structural issues are yet to be addressed, undermining the performance of key sectors in the economy,” S&P said.