Increased bank risk weights to add pressure on capital ratios

The higher risk weights recently introduced by the Central Bank of Nigeria (CBN) are likely to add to pressure on bank capital ratios, Fitch Ratings says in a statement.

However, if successful in reducing sector concentrations the changes could benefit asset quality and risk management.

Last month, CBN raised risk weighting on loans to the public sector from 100 percent to 200 percent – effectively discouraging states and local governments from crowding out private sector credit growth.

It also raised risk weighting of sectors which account for more than 20 percent of the loan book from 100 percent to 150 percent.

According to the rating agency, capital has been tightening at some banks as they expand their loan books following the clean-up of the sector by Asset Management Corporation of Nigeria (AMCON).

“Fitch Core Capital (FCC)

ratios at end-September 2012 were 10 percent to 30 percent”, Fitch said in the statement. “Some Nigerian banks have lower FCC than is appropriate for their growth in a difficult operating environment, reflected in their low Viability Ratings (mostly in the ‘b’ range).” Nigeria is rated ‘BB-’/Stable by Fitch.

Fitch also noted that the generous dividend policies demanded by Nigerian investors mean internal capital generation is unlikely to support sustainable growth in the medium term.

Excessive credit expansion has also been temporarily subdued by higher interest rates on government securities following the expiry of the inter-bank guarantee from the CBN in 2011.

The agency says it still expects loans to grow 18 percent to 20 percent this year, close to the rate of inflation-adjusted economic growth as banks focus on increasing lending to government-sponsored projects, especially in the power sector.

“We see little appetite for 

 fresh equity issuances in the market. Some banks may want to fund growth with long-term subordinated debt. This does not count as loss-absorbing capital in our analysis, so further growth together with higher risk weightings would put core capitalisation under pressure,” it reckons.

It added: “The Nigerian banks continue to report capital ratios based on local GAAP (generally accepted accounting principles) equity rather than the IFRS (International Financial Reporting Standards) adopted for financial reporting in 2012. This is the same approach as taken by some European regulators. We estimate the regulatory capital ratios for Nigerian banks would be 60bp-120bp lower if based on IFRS”.

FCC is Fitch’s primary capital measure and adjusts IFRS equity for assets that are not fungible.

According to Fitch FCC ratios are a key rating driver for Nigerian banks as they grow.

The higher risk weights are designed to direct lending to the real economy and to limit

portfolio concentrations that often build up during boom times in Nigerian banks. The CBN circular, issued on January 31 requires banks to increase risk weights for public sector loans to 200 percent, from 100 percent and for sectors greater than 20 percent of the loan book to 150 percent from 100 percent. Credit transactions between bank holding companies and their subsidiaries will also be regulated and risk-weighted to enhance regulation of a banking group, the agency added.

The central bank had said that the recent crisis in the Nigerian banking industry highlighted several weaknesses in the system, key of which was the excessive concentration of credit in the asset portfolios of banks.

It also said that investments in Federal Government of Nigeria bonds shall continue to attract zero percent risk weight. However, state government bonds that meet the eligibility criteria set out in the Guidelines for Granting Liquidity Status for State Government Bonds would continue to be risk weighted at 20 percent.

FEMI ASU