What is the risk of another Nigeria banking crisis?

Is there likely to be another bail out of Nigerian banks soon? The last major bail out had happened in 2010 when AMCON acquired the non-performing loans of troubled Nigerian banks. Banks had built up an unsustainable bad loan portfolio after crude oil prices crashed in 2007 and 2008, which affected Nigerian banks that were excessively exposed to both the stock market and downstream oil sectors of the Nigerian economy.

Years down the line, Nigerian banks are once again struggling with rising non-performing loans on their books fuelled again by a sharp fall in crude oil prices. The extent of bad debts on the books of banks were exposed when Central Bank of Nigeria (CBN) on 5 April released its financial stability report showing that the non-performing loans of banks have risen sharply in the last one year.

From an average NPL ratio of 5.3 percent in December 2015, the NPL ratio of Nigerian banks closed 2016 at 14 percent. This is the highest NPL ratio level since 2012 and already twice higher than the 5 percent maximum limit set by the CBN for the banking industry. Further indicators of trouble in the banking industry include the fact that the ratio of regulatory capital to risk weighted assets at 13.9 percent is at a five year low while non-performing loans net of provisions to capital has also risen to a five year high of 38.4 percent.

But not all banks are at risk of imploding from the rising bad loans in the banking industry. The small banks, defined by the CBN as banks with assets less than N500 billion are the most affected as their average capital adequacy ratio now stands at 3.14 percent. Medium sized banks, defined as banks with total assets in the range of N500 billion to N1 trillion have average capital adequacy ratio of 12.75 percent, above the 10 percent minimum set by the CBN while large sized banks, defined as banks with assets in excess of a trillion naira, have capital adequacy ratio of 15.47 percent. This indicates that the bigger the bank is, the higher the capital adequacy position.

This basically means that only the small banks are in urgent need to boost their capital position despite the sharp rise in bad loans in the industry. The medium and large sized banks are not in immediate danger, which is good news as the CBN notes that the large sized banks actually control 88 percent of the loans in the Nigerian financial system.

A stress test that the CBN says it conducted also shows that only the small banks will go insolvent if there is a 100 percent increase in industry non-performing loans but all banks will become undercapitalised if there is a 200 percent increase in non-performing loans. This is  worst case scenario stress testing and it is most unlikely that non-performing loans will rise 100 percent and definitely not 200 percent for the whole banking industry but it can happen for individual banks, so the risk is not totally ruled out, especially if a systemically important bank sees its non-performing loans spike.

The CBN admits that there is high contagion risk “through unsecured interbank exposure as three banks including two systemically important banks failed a capital adequacy ratio test after the 100 percent default shock.”

This means that there is a risk of AMCON 2.0 being triggered if one of these “systemically important banks” sparks off a contagion risk in the financial system. But the chances of this happening will likely be determined by the direction of crude oil prices going forward because of the significant exposure of banks to the sector.

Loans to the oil and gas sector make up 29.95 percent of total banking industry credit according to the CBN. Manufacturing is the next highest with 13.41 percent of total industry credit. Cumulatively both sectors, which are quite sensitive to crude oil prices control 43.36 percent of banking industry loans.

The CBN stress tested what will happen if there is a 20 percent default in oil and gas exposures and found out that only the small banks will go insolvent if this happened. But if there is 50 percent rise in defaults in oil and gas loans, only the large banks will have enough capital to withstand the shock. Both the medium and small banks will risk going under unless they raise additional capital or the government bails them out. The CBN did not stress test what happens if there is an increase in default in both the oil and manufacturing sectors.

Stress testing both sectors simultaneously will be interesting because the buoyancy of both the oil and manufacturing sectors are closely related to the direction of crude oil prices.

Rising crude prices and increasing crude oil production have a positive impact on the oil and gas sector in form of higher earnings for firms operating in the sector. It will increase their capacity to service their debts, most of which have been restructured in the face of lower crude oil prices.

Higher crude oil prices will also be positive indirectly for the manufacturing sector. It would boost the country’s external reserves, and the CBN’s capacity to support the foreign exchange demand of manufacturers which have struggled recently to have enough foreign exchange to support their operations.

The good news is that the outlook for crude oil prices is becoming positive especially with the escalation of the crisis in the Middle East last week. Already, Brent Crude tested US$56 mark on Friday and will likely rise further if the crisis escalates.

But if crude oil prices fail to rise further from current levels, Nigerian banks, especially the small and medium sized ones will have to look for ways to boost their capital position in order not to collapse under the weight of their rising NPLs.

What is clear from the CBN financial stability report is that the health of Nigeria’s financial sector, like the Nigerian economy, continues to be closely tied to the direction of crude oil prices in the international markets. Chances of a potential crisis in the banking sector will be significantly alleviated if crude oil prices keep rising or stay at current levels of above US$50. Without rising crude oil prices, some banks will struggle.

 

Anthony Osae Brown