How banks can mitigate high bad loans on jumbo rate hike

The large increase in the monetary policy rate and the cash reserve ratio in February is seen as posing challenges to banks.

Additionally, banks are under pressure to meet a 65 percent Loan to Deposit Ratio (LDR), as directed by the Central Bank of Nigeria (CBN).

High inflation rates and foreign exchange crises have profoundly impacted businesses across the nation. As businesses struggle to manage their finances amidst these challenges, their ability to borrow and repay loans has been severely hampered.

The ripple effects of this economic strain are palpable, as fears loom over the potential escalation of non-performing loans (NPLs) within banks. There is a growing apprehension that NPLs may surpass regulatory thresholds, posing a significant risk to the stability of the banking sector.

The industry NPL ratio stood at 4.15 per at the end of January 2024, according to Aku Pauline Odinkemelu, a member of the Monetary Policy Committee (MPC).

Analysts advised that banks can work closely with businesses to help them restructure their existing debt obligations. This may involve renegotiating loan terms, extending repayment periods, or offering grace periods to alleviate immediate financial burdens.

Already, lenders are repricing their assets following a hike in the benchmark interest rate by their regulator.

In terms of loan extension, some banks said they have not extended the tenor of the loans given to customers but are willing to do so if any customer requests.

Yemi Kale, chief economist at Afreximbank, said interest rates have been increased by the monetary policy authorities and rightly so to tackle money supply driven inflation as well as excess cash putting pressure on FX demand and also to encourage FX supply.

He said the sharp rise in rates may also increase cost of funds to businesses, and if they are not able to earn enough revenue to pay the extra costs from higher interest rates, they won’t be able to repay their debt.

“If they are able to restructure their costs or increase sales or both so that the extra costs from the higher interest rates are cancelled out, then it may not lead to higher NPLs. So it’s a concern at best but not a certainty and depends on various factors that are too early to tell,” Kale said.

Odinkemelu said the Nigerian financial system is resilient as the banking sector remains sound and stable. Total assets of the banking industry increased month-on-month by 24.76 percent between December 2023 and January 2024.The banking industry capital adequacy ratio remained above the minimum threshold of 10–15 percent. Similarly, the liquidity ratio remains above the regulatory threshold of 5 percent and 30 percent, respectively.

“The industry NPL ratio of 4.15 per at the end of January 2024, which is itching towards the industry regulatory threshold of 5 percent should be monitored closely,” she said.

Okiki Oladipo-Ajilore, a senior associate at Parthian Partners, said with the recent hike in MPR by the MPC from 18.75 percent to 22.75 percent, this rate hike will result in the repricing of loans previously created by deposit money banks. This repricing would trickle down to increased obligations by the borrowers, thus, the likelihood of default increases.

“To address the concerns of deposit money banks not creating enough loans for the real sector, the CBN has in the past taken measures using the Loan to Deposit Ratio (65 percent) to enforce lending to this sector. Nevertheless, there has been an observed lag in expected and actual lending, which poses the consideration of a likely minimal impact of the MPR hike on non-performing loans,” Oladipo-Ajilore said.

“Lending rates that banks charge will increase under the current market conditions as CBN continues with a tight monetary policy stance to stabilise the Naira and rein in inflation rate. And as the tight policy achieves the objective the Nigerian economy will benefit ultimately,” Ayodele Akinwunmi, relationship manager corporate banking at FSDH Merchant Bank, said.

For Olanrewaju Kazeem, group CEO of Alert Group, a pan-African microfinance bank, a high interest rate regime could lead to loan defaults and the fears are real.

He said under the current almost hyperinflation, the purchasing power of the citizens is negatively impacted, and this has implications on anticipated company turnover.

“Where consumers are not able to buy, the suppliers may suffer loss of market and inability to repay loans. That said, lenders must strengthen the risk management system, improve loan evaluation, be sectorially selective, create more protective covers, make reasonable allowance for loan losses and adhere strictly to internal rules, credit criteria and best practices,” he said.

Emmanuel Kelvin, director at Obsidian Archenar Nigeria, said the risk of continually raising MPR to reduce the flight from naira to dollar-denominated assets is that the non-performing loans in banks will increase. “That will impact their ability to absorb impaired losses from higher tendency on loan book, in the same way you are asking the banks to raise their minimum capital commitments as a means to improve their gearing ratio.”