Rising credit exposure, bad loans concerns for banks in 2021
Rising credit exposure and increasing non-performing loans (NPLs) should be of concern to banks and their regulators now before the policy support measures of global Central Banks end, especially where the recovery may be delayed or incomplete.
Banks gave out loans to businesses and households but the Covid-19 pandemic disrupted the repayment, as most of these businesses were shut down during the lockdown.
The global Central Banks intervened with policy measures to combat the impact of the pandemic on the industry. Some of the measures taken by Nigeria’s central bank include 1-year extension of the moratorium on principal repayments for CBN intervention facilities; Regulatory forbearance was granted to banks to restructure loans given to sectors that were severely affected by the pandemic; Reduction of interest rate on CBN intervention loans from 9 to 5 percent, and strengthening of the Loan-to-Deposit ratio policy, which has resulted in a significant rise in loans provided by financial institutions to banking customers, among others.
Banks across the globe have not been part of the Covid-19 problem so far, as they entered the pandemic with a large amount of capital and high liquidity buffers, according to the International Monetary Fund (IMF).
The IMF Global Financial Stability Report (GFSR) released last Wednesday revealed that banks had shown resilience so far, due to unprecedented policy support, which helped maintain the flow of credit to households and firms.
However, profitability challenges in the low-interest rate environment call into question banks’ ability or willingness to continue to lend in coming quarters.
Credit exposure as defined by Investopedia is a measurement of the maximum potential loss to a lender if the borrower defaults on payment. An NPL is a loan the borrower has defaulted and has not made any scheduled payments of principal or interest for some time.
In banking, commercial loans are considered non-performing if the borrower is 90 days past due.
Banks may also face challenges in generating returns above the cost of equity amid continued compression of net interest margins, a development long evident in Europe and Japan.
Underwriting standards for nonfinancial firms have tightened in some instances and bank loan growth in many countries has remained low or slowed in recent months.
But Nigeria’s aggregate domestic credit moved up by 13.40 percent in December 2020, compared with 9.48 percent in the previous month.
This was largely attributed to the Nigeria central bank’s policy on Loan-to-Deposit Ratio (LDR), complemented by its interventions in various sectors of the economy.
Consequently, the banking sector gross credit as at the end of December 2020 stood at N25.02 trillion compared with N24.25 trillion at the end of November 2020, representing an increase of N774.28 billion.
The CBN has committed substantial amount of money towards mitigating the impact of the Covid-19 pandemic. Consequently, total disbursements as at January 2021 amounted to N2 trillion.
However, the industry recorded marginal increase in the NPLs ratio, which rose to 6.01 percent at the end of December 2020 from 5.88 percent at the end of November 2020, and above the prudential maximum threshold of 5 percent.
While noting that the development was not unexpected under the prevailing circumstances, the Monetary Policy Committee (MPC), which held a two-day meeting last Monday and Tuesday to decide the direction for interest rate, urged the CBN to strengthen its macro prudential framework to bring NPLs below the prescribed benchmark.
“Though, NPLs remained slightly above the prudential benchmark, members noted that the banking system remained stable, strong and resilient. Given the success recorded under the LDR policy, it thus urged the bank to sustain its risk surveillance approach and ensure the continued soundness of the banking system,” Godwin Emefiele, governor of the CBN, said.
Nigeria’s banking industry total assets is expanding strongly and is expected to grow by 14.3 percent to N54.3 trillion at the end of 2020, from N47.5 trillion in 2019, driven by deposits growth, Ike Chioke, group managing director, Afrinvest West Africa said on December 8, 2020.
He sees the industry’s total assets growing by 6.4 percent to N57.8 trillion in 2021.
The industry’s total deposits rose sharply by 17.6 percent to N34 trillion in 2019 following significant Open Market Operation (OMO) maturities. This is expected to grow by 5.3 percent to N35.8 trillion in 2020 and 6.4 percent to N38.1 trillion in 2021.
In the first half of 2020, the Central Bank of Nigeria (CBN) issued OMO bills worth N6.38 trillion, which was 46.10 percent decrease compared with N11.851 trillion issued in the corresponding half of 2019.
Public subscription and sale amounted to N8.567 trillion and N6.453 trillion, respectively, compared with N13.054 trillion and N11.827 trillion, subscribed to, and allotted, in the corresponding half of 2019.
Stability of the banking system has been sustained throughout the year as the industry’s capital adequacy and liquidity ratios were 15.5 and 35.6 percent in October 2020, compared with the respective prudential thresholds of 15.0 and 30.0 percent.
Profitability performance also remained satisfactory buoyed by improvement in non-interest income, said Aishah Ahmad, deputy governor in charge of Financial System Stability (FSS) said in her personal statement at the last MPC meeting in November 2020
She said the financial system retained its operational and financial resilience, sustaining critical support to the economy through the crisis. Credit growth remained on an upward trajectory with robust soundness indicators and sustained decline in average lending rates.
The trend generally indicated a preservation of the sound health of the banking industry, and underscored efficacy of regulatory/supervisory measures, Folashodun Shonubi, deputy governor of CBN in charge of operations said.
Financial stability risks are in check so far, but action is needed to address financial vulnerabilities exposed by the crisis, said IMF.
The Washington based Fund said policymakers face an intertemporal policy trade-off between continuing to support the recovery until sustainable growth takes hold and addressing financial vulnerabilities that were evident before the pandemic or have emerged since it began.
These include rising corporate debt, fragilities in the nonbank financial institutions sector, increasing sovereign debt, market access challenges for some developing economies, and declining profitability in some banking systems. Employing macro prudential policies to tackle these vulnerabilities is crucial to avoid putting growth at risk in the medium term.
Announcements and rollout of vaccines the IMF said have boosted hopes of a global economic recovery in 2021 and pushed risk asset prices higher. The speed of the recovery will depend crucially on production, distribution networks, and access to vaccines.
The Fund said continued monetary and fiscal support remains vital to lessen lingering uncertainties, build a bridge to the recovery, and ensure financial stability.
A delay in the recovery would require prolonged accommodation, further fuelling financial vulnerabilities.