By Emeka Anaeto, Economy Editor
The continuing headwinds in the economy may be defining the sustenance of the resilence banks have demonstrated in their 2014 operations. A consecutive year of severe negative operating environment may end up signposting both 2015 and 2016 as seasons of locust after signficant rises in performance indicators in the previous three years.
Much cannot be understood in the study of Nigeria’s banking industry in the last two years without the background provided by the first major regulator induced consolidation in the industry under Prof. Chukwuma Soludo led Central Bank of Nigeria, CBN, in 2004 – 2009.
lndustry analysts believe Soludo was set to build a better banking industry by share size in all respects especially capital base. By that the banks would be in better position to support economic development and less susceptible to the risks of bank failures, which had almost become the common phenomenon of Nigerian banks. Up until then banks were challenged with issues of persistent liquidity, poor asset quality and undetrcapitalisation. Banks also depended majorly on public sector deposits.
Soludo thus pursued vigorously the agenda of recapitalisation banks by increasing the minimum capital base from N2billion to N25 billion, an unprecedented 1150% jump.
Landmarks in the industry under the regime includes:
- Elimination of fringe players and establishment of relatively bigger banking institutions with solid capital base.
- Strengthening of regulation of the banking system thereby creating healthier banks
- Establishment of a strong universal banking model which transformed most merchant banks into commercial banks with healthier competition.
- Entrenchment of electronic banking including online transfers, Automated Teller Machine (ATM) and other interbank platforms.
- Increased capital bases encouraged banks to diversify into many new products and services which further drew more customers into the financial system.
But many analysts believe the banks at this time were carried away by the euphoria of their sizes and balance sheets which grew astronomically post-capatilisation. The total assets of commercial banks in December 2006 (one year after consolidation) had grown by approximately 60% to N7.2 trillion from N4.5trillion. The huge resources soon found itself into bad businesses at the same time global financial crises was seeping into Nigeria. The combined effect was a bubble burst.
The bubble burst and the Sanusi phenomenon.
The 2008/2009 global financial crisis brought new dimension into financial system regulation of the CBN following the events that played out. The year 2009 was a transition year between the administration of Soludo and the Mallam Sanusi Lamido Sanusi led CBN. The Nigerian banking system and financial market experienced a major shock arising from the contagion effect of the 2008 global financial crisis and decline in global oil prices on the international side and poor corporate governance, weak risk management framework and significant exposure to margin loans on the domestic front.
These factors led to the insolvency of eight banks which were classified as being in grave situations. The total toxic assets that were absorbed by AMCON at this time was N5.7trillion. Against the backdrop of these challenges, the monetary policy anchor of the CBN following the entry of Sanusi as governor was anchored on four pillars of banking reforms namely:
- Enhancing the quality of banks
- Establishing financial stability
- Ensuring the financial sector evolution
- Ensuring the financial sector contributes to the real economy
Though many observers believe the risk management and corporate governance focus of Sanus’s CBN was relatively commendable stability in the sector was more of a transient effect of a relatively stable economy of the time as things began to go bad with reversal of oil revenue inflow into the economy in the second half of 2014. Also despite the CBN’s attempt to ensure the banks remain responsive to activating a financially driven real sector, the impact has not been too significant.
However due to other circumstances Sanusi’s tenor at CBN ended abruptly and controversially few months to the full statutory term haven been suspended by the government. This formed the backdrop for the new CBN administration under the leadership of Godwin Emefiele which rolled out plans in 2014 geared towards running a people focused Central Bank with deliberate effort to reduce interest rate, maintain price and exchange rate stability and stimulate domestic growth.
Major highlights of the planned policies include the pursuance of gradual reduction of interest rate with its attendant impact on both deposits and lending rates comparable to the pattern in other emerging and African economies. It also seeks to maintenance of exchange rate stability and sustenance of managed float regime so as to preserve the value of the domestic currency given its import dependent nature through the conservation of external reserves.
Emefiele was set to creating financial system stability by managing factors that create liquidity shocks and zero tolerance practices that undermine the health of financial institutions. He seeks a zero tolerance policy on fraudulent borrowers and he also reinforced the cashless policy which was introduced in 2012 to help strengthen the payment system. Major policy actions of the Emefiele led CBN points towards the continuation of hawkish policy.
His CBN appeared ambitious with its plan to simultaneously pursue lower interest rate and exchange rate along steady price level given the challenges of the time when the new Governor came on board. However, the gradual winding up of the US Quantitative Easing program, slowing inflows into emerging and frontier market, the build up to 2015 elections, fiscal fragility due to falling oil prices, dwindling external reserves and fiscal policy uncertainties were some of the more daunting issues requiring a hawkish strategy than a finance agenda.
It is noteworthy that every CBN Governor in the last 3 administrations has had one form of global or national challenge to contend with. While Soludo’s CBN battled with issues of banking consolidation, the Sanusi was confronted with the fallout from global financial crisis and shaky financial system with extremely cost of risks. The major issues now confronting Emefiele’s tenure is the depletion of external reserves and simultaneous pressure on FX rates.
Subsequently, the CBN has remained actively engaged on multiple policy fronts designed to curb speculative attacks on domestic FX market while also seeking to preserve reserves. The frequency and inconsistency of such policies have contributed to weakening investors’ confidence and triggered outflows and banks are extremely uncomfortable as the books in 2015 are already in stress.
The culmination of the emergent challenges of fiscal and monetary policy environment under which the banks struggled through in 2015 could be summed up in the November Monetary Policy Meeting, MPC, decisions. In its 6th and final meeting for the year on 24th November presided over by Mr Godwin Emefiele the MPC emphasized the need to focus on financial system stability while taking proactive and administrative measures needed to support the environment in which market institutions operate.
However it noted that close coordination between the monetary and fiscal policy, was necessary for sustainable growth in the banking industry and the economy in general. At the meeting, the Committee considered the present challenges that pervade the macroeconomic space namely the expected rate hike by the USA Federal Reserve Bank, the continuously declining oil prices and the gloomy outlook on global growth.
The Committee also considered the present macroeconomic challenges in the country noting that although headline inflation has been on a persistent rise, the observed moderation in October on a month-on-month basis provided some room for monetary easing to support output in the short to medium term while keeping focus on price stability. The MPC also considered the bullish trend in the fixed income space of the bear run in the capital market.
Finally, the MPC reviewed and assessed the impact of the current policy to leave the market awash with liquidity in a bid to foster credit expansion by banks to the real sector. However, the committee noted that the expected impact was yet to be met and it was against this backdrop that the MPC made the following policy pronouncements;
- Reduction of Monetary Policy Rate (MPR) from 13.0% to 11.0%
- Cash Reserve Requirement reduction from 25.0% to 20.0%
- Asymmetric corridor of +2.0% and -7.0% around the MPR Afrinvest Group of financial analysts summarised the impact of the accommodative policy tweaks by the MPC against many analysts’ expectations as follows:
Lower rates in the credit and fixed income market. The 200bps cut in MPR and introduction of an asymmetric corridor around the MPR at +200bps and -700bps is the most significant of the policy decisions reached as this brings the Standing Lending Facility, SLF, and Standing Deposit Facility, SDF, rates to 13.0% and 4.0% from 15.0% and 11.0% respectively. Prior to the MPC decision, there has been a regulatory maximum on the remunerable SDF placement by each bank at N7.5bn. The MPC’s decision to complement this by a further 5.0% cut in CRR will add approximately N771.4 billion to liquidity level in banks based on October data from the CBN.
However, the communique issued by the CBN added a caveat that the additional liquidity would be released on a condition that the funds will be channelled to the real sector. Nevertheless, the lower SDF rate and increase in liquidity level would lower competition for deposits amongst banks and we expect to see a decline in savings and interbank rates. The more accommodative stance is also expected to drive yields downwards in the secondary Bonds market as dealers are likely to bid-down on current rates in anticipation of lower yields at the primary market auction.
We expect NIBOR rates currently at 10.1% on average to adjust to the new SLF rate to an average of 7.1% (if the same spread is maintained) whilst average yields on T-bills and Bonds market (currently at 4.7% and 10.5%) are likely to also correct to 3.7% and 9.5% respectively. Given the lower financial market rates anticipated, we expect slight reduction in prime lending rate.
Increase in credit to private sector. In the short term, we do not expect the ease in monetary policy to immediately translate to increase lending to the real sector, especially given the high risk retail/SME loans segment. Structural bottlenecks, weak quality of infrastructure and the current slowdown in economic activities constitute high risk to real sector lending, which would require more adjustments by the fiscal authorities to de-risk the sector. However, with the restriction on all cheap income lines, we expect a significant medium term expansion in Credit to the private sector (currently at N19.1tn in October 2015 and up 6.8% Y-o-Y) by DMBs.
This will necessitate banks to improve on their risk management framework to identify opportunities and earn a relatively higher margin (compared to the cheap rates in the fixed income market) and buoy assets turnover and shareholders’ return.
Lower Net Interest Margin for Banks. Interest income earned by banks on investment securities and loans are expected to reduce in the first quarter of 2016 as banks adjust to the lower primary auction rates in the bonds market and reduced interbank rates. Cost of Fund will reduce but only marginally due to: 1) 25.0% minimum mandated interest rate on savings deposits and 2) the 80.0% Loan to Deposit ratio regulation by the CBN that will continue to drive demand for deposits.
Tier-1 Banks who are net placers of funds in the Interbank Market and with higher deposit liability to fund will be impacted more in terms of net interest margin. Tier-2 banks who are net borrowers will have their cost of fund reduced although the lower interest income will still taper Net Interest Margin. Overall, we expect Net Interest Margin to decline (from 6.4% in Q3:2015) in Q1:2016. There is likelihood of a re-pricing of stocks in the stock market in the trading sessions ahead as investors are likely to go short on financial services and long on other value-sector equities.
Further FX restrictions and increase in black market rates. The CBN’s action to buoy aggregate demand side of the economy by increasing liquidity levels and reducing market rates will have a feedback effect on price and exchange stability in the short to medium term. As the CBN has remained resolute in its resolve to keep administrative measures in place to reduce depletion in the FX reserves and create a contrived stability in interbank FX rates, the effects would be felt in the parallel market for FX where rates would further depreciate.
We estimate a conservative FX rate of N255.00/US$1.00 at the parallel segment. This may create a vicious cycle of additional tightening of exchange rates rules by the CBN If accrual to external reserves does not strengthen. The strong pass-through of lower exchange rate on consumer prices in Nigeria suggests high inflationary pressure is inevitable in the short to medium term.
The relaxed monetary stance of the MPC after its last meeting for the year, though positive for stimulating short-term economic growth, may not come without negative implications for the economy in the medium term. With the reduction in interest rate, Nigeria is likely to face increased capital flight consequences in the medium to long term, more so with the Fed raising its benchmark interest rate at its last meeting in last week.
Equally, the spike in financial market liquidity resulting from the reduction in CRR to 20.0% as well as the expansionary 2016 fiscal year are expected to further trigger inflationary pressure. While the decisions by the MPC ensued from a need to grow the real sector through increased lending by banks, decision of lending will continue to be governed by risk considerations with Banks more conservative in taking risk given the macroeconomic headwinds.