• Tuesday, July 16, 2024
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Nigerian banks’ impaired loans to surge on reform fallout – Fitch

Increase in minimum capital requirements for Nigerian banks – Part 3

A global credit rating agency has said Nigerian banks will see a jump in impaired loans as rising inflation and interest rates burden borrowers’ debt servicing capacity.

Fitch Ratings said the devaluation of the naira and the fuel subsidy removal will lead to higher near-term inflation and tighter monetary policy, which will in turn constrain economic growth.

“These developments exert downward pressure on capital ratios and will cause impaired loans ratios to rise higher than previously envisaged,” it said in a new report.

A loan is said to be impaired when it is not likely the lender will be able to collect its full value.

Read also: African banks’ credit drivers to undermine global, domestic shocks in 2023- Fitch

The rating agency said since the devaluation, it has affirmed the ‘B-’ long-term issuer default ratings of the vast majority of Nigerian banks, with stable outlooks.

“This reflects the banks’ sufficient headroom above their minimum total capital adequacy ratio requirements to absorb the negative impact of the devaluation and the second-order economic effects of the reforms on asset quality,” it added.

Fitch considers the implementation of the key reforms implemented by President Bola Tinubu to be credit positive overall for the country.

It, however, said the naira devaluation will lead to the inflation of banks’ foreign-currency (FC)-denominated risk-weighted assets (RWAs) in naira terms, exerting downward pressure on capital ratios.

It will also inflate FC-denominated problem loans, thereby increasing the prudential provisions banks are required to maintain against them, adding to pressure on regulatory capital ratios, it said.

“The impact is mitigated by banks’ generally small FC-denominated RWAs and net long FC positions, which deliver FX revaluation gains that help cushion the impact of inflated RWAs. Nevertheless, we expect widespread declines in banks’ capital ratios at end-1H23,” it added.

Fitch said the deterioration in loan quality should be less severe than that following the last major naira devaluation in 2016, which was preceded by a collapse in oil prices, resulting in oil and gas asset quality problems for banks.

“Banks’ largest loans tend to be FC-denominated, and the devaluation will therefore increase credit concentration risks, likely causing many banks to breach their regulatory single-obligor limit of 20 percent of shareholders’ funds. This would ordinarily entail a capital penalty,” it said.

It, however, noted that the regulatory forbearance with respect to this limit is still in place from the last major devaluation, and is expected to be extended by the Central Bank of Nigeria (CBN).

“Mid-sized banks will be more affected by the devaluation due to their material shares of FC-denominated assets and loans, high FC-denominated problem loans, and weaker pre-impairment operating profit buffers to absorb loan impairment charges in the event of potential asset quality weakening,” it said.

Fitch said unifying the multiple exchange rate windows and allowing the naira to trade at a market-determined rate will help alleviate FC shortages in the private sector and revive foreign investment, which has fallen to multi-year lows.

Read also: Inside details of five Nigerian banks making inroads in African market

“However, FX import restrictions remain in place and we anticipate these will be liberalised more gradually, partly aimed at managing external pressures,” it said.

It noted the uncertainty over where the exchange rate will settle, partly due to the large backlog of unmet demand for FC.

“This could result in further pressure on the exchange rate if FC supply does not normalise, although we expect some intervention from the CBN to support the currency,” it said.

The exchange rate will also depend on the extent to which the country succeeds in attracting foreign investment following the devaluation, the rating agency said.

It said foreign portfolio investors’ participation in the domestic equity market has increased since the devaluation, adding that sustained inflows will require commitment to structural and market-friendly reforms, including a more orthodox approach to monetary policy.

Fitch expects the fuel subsidy removal to reduce reliance on deficit financing from the central bank, which has been a major contributor to loose monetary policy settings, with a disinflationary impact in 2024.