It is no longer news that Nigeria has slid into an economic recession going by two consecutive contractions in the monetary value of all its goods and services, known as Gross Domestic Product (GDP).
In explaining recession and its impact on the banking sector, Kalu Aja, a personal finance expert, used the analogy of a bread-maker.
“Imagine a bakery making Agege bread, buys flour, sugar, yeast, pay salary, pay taxes, deposit cash in bank, banks use that deposit and create loans. An economy built by Agege bread will have loaves of bread selling at N50, at output of 1000 so GDP is N50 x 1000 =N50,000,” Aja wrote on Twitter.
“Then there is crisis, and people lose jobs. Now instead of buying one Agege bread a day, consumers buy one every two days. So the bakery sells less bread, instead of 10,000 loaves they sell 5000. So GDP is N50 x 5000 = 25000. A 50 percent fall in output of Agege bread.
“What happens? Well less Agege bread output means, less flour bought, less sugar bought, less salary paid, less cash deposited. So Agege industry stands to infect other sectors like banking,” he tweeted.
Aja said those sectors also cut down on spending, pay fewer workers, which then becomes a vicious cycle start. As banks get less deposit from Agege bread, they start posting higher interest rates, thus economy goes into peril.
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“If Agege bread output falls for 3 months it’s a contraction, for 6 months a recession. A recession is a fall in output for 6 months,” he tweeted.
Nigeria’s gross domestic product (GDP) recorded a growth rate of -3.62 percent (year-on-year) in real terms in the third quarter of 2020.
Cumulatively, the economy has contracted by -2.48 percent. While this represents an improvement of 2.48 percent points over the -6.10 percent growth rate recorded in the preceding quarter (Q2 2020), it also indicates that two consecutive quarters of negative growth have been recorded in 2020, according to the National Bureau of Statistics (NBS).
The NBS report released recently indicated that a total of 18 economic activities recorded positive growth in Q3 2020, compared to 13 activities in Q2 2020.
Nigeria’s financial institution in nominal terms recorded 9.6 percent growth in the third quarter (Q3) 2020 from 30.94 percent in the second quarter of the same year.
Although the sector is still in a positive territory, the numbers show a -21.34 percentage point decline compared to the last quarter numbers.
Impact of recession and way out – Analysts
Continuing with his bread-maker analogy, Aja recommended spending.
“The government can do the following: 1. Cut taxes so people can start buying more bread; 2. Pay Agege bread makers so they hire back workers, start buying sugar and flour; 3. Give banks deposits to replace deposits lost from Agege bread,” Aja tweeted.
“In summary, a recession is normal business cycle, but if you do bad policies (like closing border) you make Agege bread expensive to produce so the price of a loaf goes from N50 to N150. Again this makes the bread expensive and reduces sales and cycle starts again,” he said.
Uche Uwaleke, professor of capital market and president, Capital Market Academics of Nigeria, said without any doubt, recession, which represents a downturn in economic activities, poses a lot of danger to the asset quality of banks.
Given that a number of sectors are in the negative territory, it raises the risk of Non-Performing Loans (NPL) for many banks whose NPLs are already above the 5 percent CBN threshold.
The banking industry NPL stood at 5.73 percent as at October 2020, though above regulatory threshold of 5 percent.
The loan provisions required by prudential guidelines at a time when interest and principal repayments will be markedly affected will obviously erode the bottom line of many banks.
Given that the recession has been due in large part to the contraction in the oil sector, many banks with too much exposure to this sector will be worst hit.
By and large, this recession, especially if prolonged, is bound to affect the fortunes of many Deposit Money Banks since a significant part of their revenue comes from net interest income. By extension, their share prices will equally be impacted.
In order to remain afloat in this period of recession, Deposit Money Banks will be well advised to reduce their risk appetite, possibly carry out a reappraisal of their credit policies with a view of reducing over concentration and credit risk, analysts said.
“I expect any forward-looking bank to take advantage of opportunities presented by the recession. A thorough sector analysis should be carried out with a view to identifying potential sectors for purposes of deposit mobilisation and credit relationships,” Uwaleke said.
He said this is not the time to get into the black book of the CBN, so conscious effort must be made to play by the rules. It is also important they adopt cost-cutting measures and deploy technology to enhance service delivery and customer base.
Weak banks, especially some of the 2nd and 3rd tier banks, should begin to prepare for capital restructuring including through mergers and acquisitions, he said.
Olalekan Aworinde, senior lecturer, Department of Economics, Pan-Atlantic University, Lagos, said the banking industry is not operating in isolation from the economy. When a country experiences contractions, all economic agents are affected.
Recession is bad news for the banking industry, he said, because the contribution of the financial sector to growth may also reduce and at times its contribution to the GDP might increase or remain constant.
During recession, all major macroeconomic indicators will be affected. First as a result of the contraction, the level of investment will reduce and this will make employers of labour lay off workers. The major profits of bank are from interest spread and when this declines, there will also be job losses in banks.
The survival strategies for banks, he said, are to spread their risk to other areas where they can make revenue so as to stay in business.
“It is also advised that they should cut the benefits and entitlements accruable to them. There should be no frivolous spending and allowances of top bank executives should be reduced in the meantime,” Aworinde said.
Ayodele Akinwunmi, relationship manager, corporate banking at FSDH Merchant Bank Limited, said as a stimulant of economic growth through credit creation, it means the sector will have to brace up its risk management framework to ensure that it identifies sectors, projects and specific companies that it can lend to in order to lead a recovery from the recession.
He said banks will also need to be close to their clients to know what is going on with them and how they can partner with them for growth.
And finally, as a policy measure to stimulate growth, low interest rate environment may remain for an extended period of time.
Akintunde Olusegun, analyst at Polaris Bank Limited, said recession means potential growth in NPL for banks as businesses of borrowers struggle.
The strategy, he said, is to strengthen risk management and credit monitoring, identify viable industries that have the ability to weather the storm and support them.
