Naira devaluation, oil sector crisis threaten banks

25 June 2016, Abuja – The capital adequacy ratios of a number of Nigerian banks will come under increasing pressure should the weakness in the naira and crisis in the nation’s oil sector persist, Fitch Ratings has said.

Naira-notes

Naira

CAR, which is a measure of a bank’s capital, is used to protect depositors and promote the stability and efficiency of financial systems around the world, according to Investopedia.

“Nigerian banks are sufficiently well capitalised to absorb the impact of the 40 per cent effective devaluation of the naira against the United States dollar seen as of Wednesday, the third day of trading under the nation’s new market-driven exchange-rate policy regime,” Fitch said in a statement on Thursday.

According to the global credit rating agency, the currency devaluation affects banks’ capital ratios largely because total risk-weighted assets are inflated when foreign currency assets are translated back into naira, while capital is denominated in local currency.

“We assign ratings to 10 Nigerian banks and our assessment is that, with a 40 per cent effective devaluation, the majority will not face an immediate breach of regulatory capital adequacy ratios.

“However, if the naira continues to weaken, buffers between minimum and reported CARs may decline to a level which heightens ratings sensitivity.”

Fitch-rated banks report CARs ranging from 14 per cent to 21 per cent, according to the statement.

It said the devaluation would impact ratios in different ways across rated banks, depending on the level of their foreign currency risk-weighted assets and the size of their net open FC positions.

The agency noted that the oil sector was responsible for an inflow of impairments into some rated banks.

It said, “We believe that the oil sector’s fundamental problems pose a threat to asset quality across the banking sector because of disruptions to production and because oil prices remain low.

“Around 25 per cent of Nigerian banks’ lending is to the oil sector. If problems in the sector persist, impaired loan ratios could accelerate, further pressurising CARs.”

The standalone viability ratings of the Nigerian banks were all in the ‘b’ range, indicating highly speculative fundamental credit quality, Fitch said.

According to the agency, on the average, 45 per cent of net lending in the Nigerian banking sector is extended in FC (almost entirely the US dollars). Balance sheets tend to be reasonably well-hedged, although CARs are primarily affected by the revaluation of their FC risk-weighted assets into naira.

It said the immediate impact of effective devaluation on CARs reported by Fitch-rated banks would be a two per cent average reduction.

“Any erosion of capital ratios may be short-lived because banks are profitable despite the unfavourable operating environment. Rated banks reported a 14 per cent average return on equity in the first half of 2016, we think dividend payouts will probably be conservative in 2016 and internal capital generation is expected to remain healthy.

“Banks’ ability to continue to generate solid performance indicators largely depends on developments in asset quality and loan impairment trends. Impaired loans represented an average of 5.5 per cent gross loans across our portfolio of rated banks at end-1Q16, which is reasonable considering the tough operating environment.

“Loan loss cover is adequate for most banks, but we expect impaired loan ratios to rise in the wake of the naira devaluation. This is because some Nigerian corporates are not adequately hedged by the FC income streams and may find it more difficult to service their FC loans. Most major Nigerian corporates are well hedged.”

It said the success of the FX move in attracting portfolio inflows and foreign direct investment had yet to be tested, adding, “If successful, and the FC supply rises, we expect the FC liquidity for banks to ease which will allow them to meet the FC demand, and meet their internal and external FC obligations.

According to the report, new impaired loans emerging in 2015 and early 2016 are often linked to the trading and manufacturing sectors where the scarcity of the FC liquidity forced a reliance on the parallel currency market where the FC rates were far higher.

It said the new FX regime could bring some relief if the supply of the FC improved substantially.

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