A new lending directive in Nigeria holds the promise of boosting commercial bank credit to cash-strapped businesses but puts the loan book quality of the lenders at risk.
The Central Bank of Nigeria (CBN) on Wednesday said it was mandating deposit money banks to have a Loan to Deposit Ratio (LDR) of 60 percent by the end of September 2019 in an effort to force banks to lend in an economy still reeling from a contraction in 2016 that caused bad loans to surge.
The new directive means banks must use at least 60 percent of their deposits for loans, 150 basis points higher than the industry average of 58.5 percent as at May.
According to the apex bank, a failure to meet the minimum LDR of 60 percent by the specified date will result in a levy of additional Cash Reserve Requirement (a specified minimum fraction of the total deposits of customers, which commercial banks have to hold as reserves with the central bank) equal to 50 percent of the lending shortfall of the target LDR.
The LDR is a ratio between a bank’s total loans and total deposits, and is generally expressed in percentage terms. A high loan to deposit ratio means that the bank is issuing out more of its deposits in loans and vice-versa.
“On one hand, this is a good development that should encourage banks to increase their lending, especially to the private sector,” said Taiwo Oyedele, an economist and head of tax and regulatory services at PricewaterhouseCoopers (PwC).
“On the other hand, the risk is that the quality of banks’ loan portfolio may deteriorate in an attempt to meet the target at all cost thereby resulting in relatively high non-performing loan ratio,” Oyedele said. “The CBN therefore needs to ensure a balance between the potential benefits and inherent risks of the new guideline.”
The spate of bad loans in 2016 has left a lingering taste in the mouth of banks and they have been reluctant to lend to businesses in an economy laden with risks of inflation and weak consumer demand.
Instead, the banks have piled cash into risk-free government securities for a healthy return of around 14 percent, 300 basis points above inflation.
Although bank lending to the domestic economy rose by 8.2 percent YoY to N20.974 trillion (as at April 2019), an increasing need to encourage greater allocation to strategic segments within the private sector necessitated the CBN’s new order.
Before now, Central Bank Governor Godwin Emefiele repeatedly urged banks to boost lending or have access to risk-free assets restricted.
He said at the last Monetary Policy Committee meeting that he would create “a mechanism” to limit banks’ purchases of government securities.
“The new lending measures could be slightly positive from a loan growth standpoint,” said Aderonke Akinsola, an investment analyst at Chapel Hill Denham.
“However, we expect these measures to negatively impact banks’ asset quality as loans to the target sectors will likely be of lower asset quality relative to traditional higher quality corporate loans,” Akinsola added.
Non-performing loans as a percentage of total credit in the Nigerian banking industry declined to 11 percent in the first quarter of 2019, from 14 percent a year ago, according to the National Bureau of Statistics.
Five commercial banks currently fall short of the CBN’s new lending guidelines.
Based on first quarter numbers published by the commercial banks, five banks have a loan to deposit ratio lower than 60 percent.
These banks include Guaranty Trust Bank (54 percent), Zenith Bank (56 percent), First Bank of Nigeria Holdings (49 percent), Stanbic IBTC (49 percent) and United Bank for Africa (48 percent).
Assuming deposits are unchanged from Q1’19 levels, these five banks would likely have to grow loans by a mean of 14.3 percent to meet the requirement, according to estimates by the research arm of investment bank, Cardinal Stone.
By implication, these banks may be required to create an additional N1.3 trillion in credit assets by September 2019.
“Our analysis suggests that UBA may likely have to grow loans by 19.4 percent, while Zenith Bank could require the least loan growth of 6.2 percent,” Phillip Anegbe and Jerry Nnebue of Cardinal Stone said in a July 4 report to clients.
The estimated loan growth that may be required by GTB and Zenith to meet the regulatory requirement already falls within their FY’19 guidance.
Anegbe and Nnebue were of the opinion that the September timeline may be too short for non-compliant banks given the unfavourable macro-economic environment and that may “force the CBN to extend the current timeline”.
Shares of GTB and UBA closed lower on Thursday, while Zenith, First Bank and Stanbic were unchanged from the previous trading day.
Uche Olowu, president/chairman of council, Chartered Institute of Bankers of Nigeria (CIBN) said banks will comply but they are expecting a detailed framework to the directive.
He said the reason for the new guideline is that the CBN wants to jump-start exposure to the real sector.
“Bank lending to the real sector has not been sufficient,” Olowu said. He added that the reason for insufficient lending is due to the fact that the risk environment has not been mitigated.
“There should be a win-win situation,” he said.
Nigeria’s banks are some of the most reluctant lenders in major emerging markets, with an average loan-to-deposit ratio below 60 percent, according to Bloomberg.
In Africa, average loan-to-deposit is at around 78 percent, according to data compiled by Bloomberg. It’s above 90 percent in South Africa and about 76 percent in Kenya.
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