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Loan-to-Deposit ratio: Evolution of marketing in banks and reprieve for borrowers

FX reserves decline by $22.01m week to date

The Central Bank of Nigeria in a bid to increase lending to the real sector of the economy set the loan to deposit ratio (LDR) in banks to 60 percent in a circular released by the apex bank on July 3, 2019 subject to a quarterly review. According to Investopedia, “The loan-to-deposit ratio (LDR) is used to assess a bank’s liquidity by comparing a bank’s total loans to its total deposits for the same period”. The LDR was soon revised upward to 65 percent in the 30th of September, 2019 circular sent to all banks with the compliance date for the new rate being 30th December, 2019. The Central Bank cited the positive result achieved in the first quarter of implementation of the policy as the reason for the increase. Gross credit was said to have increased by N829.40 billion (5.33 percent) between May and September 2019.

In order to ensure that banks actually offer loans to the real sector of the economy, the Central Bank of Nigeria adopts a weight of 150 percent to compute LDR for SMEs, Retail, Mortgage and Consumer lending which should ordinarily act as an incentive for banks especially as there is a huge penalty for non-compliance. The penalty is 50 percent of the shortfall in LDR in additional cash reserve requirement.

It remains to be seen if banks will be willing to take on additional risk by offering loans to companies which probably did not meet up with the minimum loan requirements set by these banks prior to the introduction of the 65 percent minimum LDR but that will be discussed later. The focus of this article is on how marketing in banks would have evolved since the LDR was increased as well as the benefits borrowers stand to enjoy under this new policy.

Marketing in Nigerian banks has always involved an aggressive drive for deposits as bank marketers and non-marketing staff alike are given unrealistic targets to bring in as many funds as possible. The deposits received are then invested in majorly risk-free assets to generate revenue by banks. This invariably means that the amount of deposit a bank generates is directly proportional to the bank’s revenue.

Banks are clearly wary of borrowing to sectors or individuals where repayment might be difficult. According to CEIC, a Global Economic Data Platform, Nigeria’s non-performing loan ratio stood at 11.4 percent as at December 2018 with non-performing loan defined as interest or principal that is due and unpaid for 90 days or more. This high rate of non-performing loans partly explains banks’ apathy towards granting loan requests. Banks simply prefer investment in risk-free assets rather than exposure to the obviously higher risk of lending to the real sector.

With the new LDR policy by CBN, banks are expected to lend to the real sector regardless of how risky it is. There are a few ways banks can go about this. They can simply increase the amount of loans to the SMEs and other retail and individual borrowers with the attendant higher risk or they can find a way to reduce their deposit in order to meet up with the regulatory requirement. I reckon that the latter option might be the easier of the two options for banks to adopt and this will also greatly affect the role of marketers.

Marketing in banks will now most likely involve searching for customers who will not only take loans but have the capacity to repay as well. Management of banks will most likely charge Marketers to avoid bringing in new deposits as much as possible as additional deposit will put further pressure on them to increase their loan offering in order to meet up with the new regulation. This should reduce the burden on marketers in terms of the search for new deposits but looking for creditworthy customers to offer loans to is no easier which means their burden only evolves. It however seems like the days of aggressive drive for deposits might be gone at least temporarily as banks try their best to adjust to the new policy. Does this have implication for the financial inclusion goal of the Central Bank? Maybe, but I won’t be looking at that in this article.

Borrowers will most likely be the greatest beneficiaries of the increased LDR as banks are forced to offer attractive lending rates in order to meet up with the regulatory requirement. Borrowers who previously had no chance of obtaining loans in banks have suddenly become the bride. How quickly things can change as the stone which was once rejected has now become the cornerstone. SMEs that have struggled over the years to obtain loans from financial institutions have now become necessary for banks to meet up with regulation. Individual borrowers also stand to gain a lot from this policy through mortgage offerings which should enable a lot of them become homeowners. The plethora of banks aggressively marketing and offering payday loans also confirm banks’ dire need for borrowers.  These sets of borrowers are particularly important for banks as the CBN attaches a higher weighting to the loans given to them.

Corporate borrowers also have the opportunity to obtain loans at a lower rate as banks are forced to reduce their lending rate in a bid to attract borrowers. The prime lending rate, which is the rate at which banks lend to their creditworthy customers, has continued to fall. According to the data released by the Central Bank of Nigeria, the prime lending rate was 15.40 percent in August, 15.15 percent in September and 15.07 percent in October of 2019. This development will reduce the interest financing cost for corporate institutions which would have a positive effect on their profitability.

Some corporate borrowers are also using this opportunity to refinance their existing loans. For instance, Flour Mills of Nigeria PLC which offered N12 billion naira in the 8th series of their N100 billion commercial paper at a discount of 11.94 percent in May 2019 was able to offer the 11th series of N5 billion at a discount rate of 8.88 percent in December 2019. Investopedia defines commercial paper as an “unsecured, short term debt instrument issued by a corporation, typically for the financing of accounts payable and inventories and meeting short-term liabilities”. The move by Flour Mills of Nigeria PLC should have a positive effect on their profitability in 2020. The Dangote group has also taken advantage of the receding rate to issue N45 billion commercial paper at a current yield of 7.75 percent which will also reduce their financing cost as well.

The sustenance of the LDR at 65 percent by the CBN till the end of the first quarter of 2020 means an extension on the period of the reduced pressure on marketers to bring in deposits as banks struggle to meet up with the policy in order to avoid a breach which can prove costly. At least marketers can breathe a temporary sigh of relief on seeking deposits and focus on getting creditworthy customers to give loans to. Also, borrowers can quickly take advantage of this policy to obtain the loan required to expand their business, build their own home or just reduce the cost of financing their business which should help increase their profitability.