The effect of Nigeria’s new Central Bank lending policy

The Central Bank of Nigeria (CBN) on July 4, 2019, sent a letter to all the banks in Nigeria directing them that to maintain a minimum Loan Deposit Ratio (LDR) of 60 percent by the end of September 2019.

According to the CBN, this is in order to ramp up the growth of the Nigerian economy through investment in the real sector which will help to encourage SMEs, Retail, Mortgage, Consumer lending. The bank also warned that failure to meet the above LDR would lead to a levy of additional cash reserve requirement equal to 50 percent of the lending shortfall of the target LDR.

Before we continue it is best we understand what some of the words used above means. The LDR is the portion of customers’ deposit that is given out as loans while the cash reserve ratio (CRR) is the share of customers’ deposit that is kept with the central bank. The banks do not earn interest on this money kept unlike loans.

Some people have reacted to this news positively while others don’t think it would really have a positive impact.

On the positive note, this could mean good news for small businesses like manufacturers who have always complained about access to finance as one of the major issue affecting the growth of their businesses. But one has to be very cautious about being excited as the banks are yet to state the interest rates at which these loans will be given looking at the fact Nigeria’s interest rates are still double digits. However, it is worthy to note that in 2018, the Bankers Committee of the CBN agreed that banks could give loans to the real sector at 9 percent interest rate.

On the other hand, most Nigerian banks already have LDR of over 50 percent except for the likes of UBA. This could mean that the new requirement may not boost lending in any way but instead what we would see is bank being forced to give loans to subprime creditors.

Peter Mushangwe, a banking analyst at Credit rating agency Moody’s in a statement sent to TheNerve Africa said that “the Central Bank of Nigeria’s directive requiring banks to maintain a minimum LDR of 60 percent by the end of September 2019 is credit negative as although it doesn’t tighten their funding positions, it will force some banks to take out potentially riskier loans to meet the minimum LDR.”

According to the rating agency, greater lending to the SMEs and consumers, borrowers that some banks judge as too small and too risky, will likely increase banks’ asset risk. Consumer lending in Nigeria is hampered by lack of good household credit records and weak recovery enforcement. Midsize banks that tend to have higher exposure to consumer and SME loans also tend to report higher nonperforming loan (NPL) ratios than large banks.

Diamond Bank Plc had above-average exposure to consumer and SME loans and its NPL ratio increased to 42 percent of gross loans in 2017 before it merged with Access, a stronger and larger entity. Nigerian banks were still laden with bad debts at 10.8  percent of gross loans as of March 2019.

“However, higher LDRs will support loan growth recovery in Nigeria and support banks’ revenue,” says Moody’s.

According to the agency, Nigerian banks loans contracted 6.7 percent in 2018 and they expect loan volumes to grow by about 5 percent this year. However, they do not expect the new directive to prompt banks to lend excessively over the next 12-18 months because most banks already meet the requirement, notwithstanding our expectation of relatively strong deposit growth.

“The directive will also encourage banks to diversify their exposure to more granular borrowers, reducing their concentration risks,” Moody’s said further.

Nigerian banks have a high concentration risk, with 47 percent of total system loans having been extended to 100 large customers. The volume of small loans (up to NGN100 million or about $277,000) contracted by 31 percent during 2015-17 (the latest available data), while large loans increased by 26 percent over the same period. The contribution of small loans has fallen to 6 percent from 11 percent, according to Moody’s.

Moody’s is of the opinion that the minimum LDR will not tighten banks’ funding positions because it is fairly low, and will still enable banks to continue to fund their loans with deposits rather than market funds. Nigerian banks are largely deposit funded, with customer deposits contributing about 60 percent of banks’ liabilities.