IMF warns Nigeria on rising bad loans despite stronger banks

The International Monetary Fund (IMF) has warned Nigerian regulators to remain vigilant over rising non-performing loans (NPLs) despite acknowledging that the country’s banking system has become more resilient following the ongoing recapitalisation exercise.

In its latest Article IV consultation on Nigeria, the IMF said the financial sector remains stable but cautioned that growing credit risks and banks’ exposure to government debt require close monitoring.

“Directors welcomed that the financial system remains resilient, helped by the recent recapitalisation of banks, while encouraging continued vigilance of rising NPLs and the sovereign-bank nexus,” the Fund said.

The warning comes as Nigeria’s banking sector undergoes one of its most significant regulatory overhauls in years, driven by the Central Bank of Nigeria’s recapitalisation programme and a series of stress tests aimed at strengthening lenders’ balance sheets.

The IMF’s assessment suggests that while banks have improved their capacity to absorb shocks, concerns remain about the quality of loan portfolios and the risks posed by banks’ increasing holdings of government securities.

Adding to concerns about the banking sector, the IMF said Nigerian banks tend to pass higher interest rates to borrowers quickly when monetary policy is tightened but are slower to lower lending rates or improve returns to depositors when policy conditions ease.

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“Interest rate transmission displays a clear ‘rockets-and-feathers’ pattern, with borrowing rates adjusting upward rapidly during tightening cycles but declining only gradually when policy is eased,” the IMF said.

According to the Fund, the pattern is statistically significant and suggests that banks transmit monetary tightening rapidly and, in some cases, even amplify its effects, while responding much more slowly during easing cycles.

 

The finding comes after the Central Bank of Nigeria raised interest rates aggressively over the past two years to combat inflation and stabilise the foreign exchange market, leading to a sharp increase in borrowing costs across the economy.

 

The sovereign-bank nexus, which the IMF also highlighted, refers to the close financial links between governments and banks, particularly where lenders hold significant amounts of sovereign debt. Such exposure can amplify risks during periods of fiscal stress.

The Fund’s comments align with concerns raised by Bismarck Rewane, managing director and chief executive officer of Financial Derivatives Company (FDC), who recently highlighted growing divergence within the banking industry following the CBN’s stress-testing exercise.

Speaking at the Lagos Business School Breakfast Session, Rewane said the regulatory exercise had effectively created two categories of banks, separating institutions with strong balance sheets from those facing higher capital and provisioning pressures.

“Nigeria’s banking sector is increasingly divided between lenders with strong enough balance sheets to reward shareholders and those struggling with heavy provisioning requirements following the Central Bank of Nigeria’s stress-testing exercise,” Rewane said.

“The banking sector has seen moderate corrections since the start of the stress test,” he added.

According to Rewane, some banks have emerged from the exercise with sufficient capital buffers and earnings strength to continue paying dividends, while others remain constrained by the need to make additional provisions and strengthen their capital positions.

The IMF nevertheless expressed confidence in the overall health of the banking sector, noting that recent reforms have improved resilience amid broader macroeconomic adjustments.

The Fund also encouraged Nigerian authorities to accelerate the implementation of Basel III banking standards, including the countercyclical capital buffer and liquidity coverage ratio, to further strengthen the sector against future shocks.

In addition, the IMF urged regulators to enhance supervisory oversight and bring stablecoin and other crypto-asset activities within the regulatory framework.

The Washington-based institution welcomed Nigeria’s removal from the Financial Action Task Force (FATF) grey list, noting that sustained implementation of anti-money laundering and counter-terrorism financing measures would be essential to preserving gains in financial integrity.

The banking sector has remained one of the key beneficiaries of Nigeria’s broader economic reform programme, which has included foreign exchange liberalisation, tighter monetary policy and efforts to strengthen fiscal sustainability.

While acknowledging the progress made, the IMF stressed that continued regulatory vigilance would be necessary to ensure that rising bad loans, credit risks and vulnerabilities within the banking system do not undermine the stability achieved through recapitalisation and other reforms.

The Fund said maintaining a sound and well-capitalised banking system would be critical to supporting economic growth, financial stability and investor confidence as Nigeria continues its reform agenda.