Nigeria’s drive to increase bank lending in a weak economy is very risky

Following the recent meeting of the Central Bank of Nigeria (CBN)’s  Monetary Policy Committee (MPC), the bank revealed that it would begin a monthly review of Deposit Money Banks’ loan-to-deposit ratios from September 30 as part of efforts to increase lending and stimulate economic growth.

“The need to boost output growth through a sustained increase in consumer credit and mortgage loans and granting loans to our Small and Medium Enterprises,” Godwin  Emefiele, Governor of CBN said in a Communique.

However rating agency, Moody’s is of the opinion that if Nigeria’s operating environment, which is still recovering from a 2016 recession, remains weak, increased private-sector lending will be credit negative for banks because their new loans are likely to be riskier. Increased lending – in particular to SMEs, whose balance sheets are vulnerable and whose financial records are poor, and to consumers and household borrowers, who have weak or limited credit histories – will likely create nonperforming loans (NPLs) down the road and slow banks’ ongoing reduction of NPLs. An economic slowdown, a depreciation of the Nigerian naira, the local currency, or a downturn in oil prices, would exacerbate the asset risks.

The policy statement follows the CBN’s recent requirements that banks should maintain a minimum loan-to-deposit ratio by September, the reduction of remunerable daily placements by banks at the CBN’s Standing Deposit Facility to NGN2.0 billion from NGN7.5billion and, more recently, banning banks from buying treasury bills at an auction for their own accounts. 

“The individual directives would not force an average Nigerian bank to create large amounts of new loans, but taken together we believe they risk resulting in higher lending volumes and increased asset risks,” Moody’s said.

A combination of few lending opportunities following Nigeria’s recession in 2016, and a still high stock of NPLs tying up banks’ capital is reflected in banks’ low loan origination volume. Muted economic activity has reduced demand for loans, and some borrowers have repaid their loans. Bank lending volumes contracted 6.7 percent in 2018 to NGN12.8 trillion and have recovered slightly to NGN12.9 trillion in April 2019, according to Moody’s.

It is worthy to note that more lending will increase banks’ asset risks because borrowers will likely struggle to service their debt amid Nigeria’s weak economic growth, which is off its lows, but which remains weak and has not materially boosted household earnings and cash flows. 

Moody’s expects real GDP to increase by 2.3 percent this year and 2.8 percent in 2020, from 1.9 percent in 2018. Despite the increase in GDP growth, it will be insufficient to catalyse strong economic activity in the country.

Although Nigerian banks reduced the volume of NPLs by 24 percent in 2018, increased lending will likely slow this progress as the banks are still burdened by high asset risks, with NPLs at 9.4 percent of all loans as of the end of June.  The banks’ high exposure to the cyclical oil and gas sector, at about 30 percent of total loans, and high exposure to foreign currency loans, at about 40 percent of total loans, will continue to create vulnerabilities if oil prices collapse or the naira depreciates. 

The rating agency further said that Nigeria’s operating environment is also pressured by corporates’ high leverage and a limited number of lending opportunities. The Nigerian Stock Exchange All Share Index’s debt/EBITDA ratio, a good proxy for corporate leverage in Nigeria, was high at 5.6x in May 2019, versus an average of 3.9x before the 2016 recession. The debt/equity ratio in May was 109 percent, deteriorating from 76 percent before the 2016 recession and indicating a limited capacity for corporates to assume more debt. Banks’ limited lending opportunities are reflected by the fact that 47 percent of loans were extended to the 100 largest clients in the banking system in the first quarter of 2019.