Examining CBN’s Directive on the Loan to Deposit Ratio of Deposit Money Banks

The Central Bank of Nigeria (CBN); regulator for Banks and other Financial Institutions in
Nigeria, in its letter dated July 3, 2019, directed all Deposit Money Banks (DMBs) to maintain a
minimum Loan to Deposit Ratio (LDR) of 60% (sixty percent) by September 30, 2019. The
reason for this directive as issued by the CBN is to ramp up the growth of the Nigerian economy
through investment in the real sector. The directive complies with section 57 of the Banks and
Other Financial Institutions Act, 1991; which empowers the CBN to make rules and regulations
for the operation and control of all institutions under its supervision.

LDR is the percentage of deposits in a Bank which is issued out as loans. Basically, it is a means
of assessing a bank’s liquidity and is usually arrived at by comparing a bank’s total loans to its
total deposits for a particular period. The LDR is an indicator in assessing the health of a bank’s
balance sheet, albeit with certain limitations. An example of such limitation is that it neither
measures the quality of loans that a bank has issued nor reflects the number of loans that are in
default or might be delinquent in their payments.

The CBN in its July 3, 2019 directive also provided a sanction for the failure of DMBs to meet
the minimum LDR by September 30, 2019; which is that a levy of additional Cash Reserve
Requirement (CRR) equals to 50% (fifty percent) of the lending shortfall of the target LDR.
CRR is the portion of the deposit in a bank which it is required to keep (either in the bank vault
or at the CBN) to provide for possible withdrawals by customers. Increasing the Cash Reserve
Requirement creates a liquidity problem for Banks.

The implication of the new regulation on banks may be both positive and negative. Positively, it
would mean increased access to funds by players in the real sector of the Country’s economy,
particularly, the SME’s, Retail, Mortgage, and Consumer Lending. Increasing access to funds for
these players will translate to the expansion of their operation, creation of jobs, increased Gross
Domestic Product, amongst others. Invariably, the foregoing is expected to encourage
accelerated growth and development for the economy.

However, increasing the minimum required LDR for DMBs also comes with its dangers. The
perspective and attitude of banks to lending money is majorly focused on mitigating the risk of
having non- performing loans. This informs the tendency of DMBs to invest more money in low-
risk enterprises such as Government lending rather than giving loans to the private sector. The
approach has indeed paid off as the Capital Adequacy Ratio (CAR) improved from the 15.14% it
was as of February 2019, to 15.69% in April 2019. In fact, Moody’s Investors Service through a
research announcement on its website published on June 18, 2019 [insert the date or event, if anywhere this was stated]predicted that Non-Performing Loans (NPLs) in Nigeria’s banking sector would decline to between 7% – 8% in 2019, from 11.7% at the end of the year 2018. This is however still above the prudential limit of 5%.

Officials of the apex Bank have expressed concerns on the attitude of DMBs in providing credit
to the private sector. The Deputy Governor, Financial System Stability, CBN, Mrs Aishah
Ahmad, at the Monetary Policy Committee meeting in May 2019 noted that the Banking

Industry must dramatically increase lending to the real sector to strengthen the economic
recovery, bolster domestic productivity and create jobs.
Against the backdrop of the above, mandating DMBs to increase lending to the real sector may
hamper the stability that the banks are trying to attain in the financial sector. This is so because
banks, in a bid to with the CBN’s directive on maintaining a minimum LDR of 60% may be less
thorough in conducting their credit checks on potential borrowers.

The importance of credit checks cannot be over-emphasised. It shows the risk associated with the overall operations of the business entities that seek access to loan facilities. Whilst banks would ordinarily be more inclined to lend money to borrowers who have good credit records, the new LDR requirement may spur them to overlook the importance of credit checks, thereby forcing them to focus more on avoiding the sanction of the apex bank. It need not be overemphasised that with minimal attention to credit checks, there will likely be an attendant increase in non- performing loans and a corresponding decrease in the CAR of many banks.

The big question is: how can the DMBs balance the need to mitigate the risk of non-performing
loans with the need to comply with the directive of the apex bank to maintain a minimum of 60%
LDR? Basically, the DMBs have to increase their risk appetite, although cautiously. In reality, an
LDR of 60% is not too burdensome. Compared to other African jurisdictions, Nigerian DMBs
have a long way to go. South Africa has an LDR that is above 90% and in Kenya about 76%.
Generally, Africa has an LDR of about 78%.

Hence, maintaining a minimum LDR of 60% is still reasonably fair, and with best practices, it
will improve the profitability of the Banks. However, if implementing the minimum LDR will
put a strain on the Banks and the economy at large, it is advisable for the Banks to communicate
such possibility to the CBN. The DMBs should also propose ways of actualising the laudable
desire of the CBN to improve the access to credit of the real sector.

In conclusion, the improvement of the Nigerian economy is much needed and all efforts to do so
must be commendable. But the fact remains that the continued economic growth goes beyond
increasing access to credit. It is important that Government should consider improving physical
infrastructure, investment in human capital and technology and essentially creating an enabling
business environment for the success of the real sector.

–Oluwatobi Fagbemi is an Associate in Kenna Partners. He works in the Dispute Resolution practice unit of the Firm on several litigation matters including cross-border cases on banking, securities and taxation. He advises start-up companies and corporations on statutory and compliance issues as well as corporate governance.