From oil price shock to banking system fragility

13 July 2016, Lagos – The prolonged decline in oil prices may have a knock-on effect on the banking industry and requires more vigilance by regulators in the industry, writes Obinna Chima

Crude-oil-declineRecent development at Skye Bank Plc has revived once again, issues around the health of Nigerian banks. This becomes more worrisome following the sustained low crude oil price, which has impacted negatively on the Nigerian economy and has seen a lot of debtors falter on their obligations.

Crude oil price has declined by about 50per cent between mid-2014 and mid-2016 to about $45 per barrel presently, thereby leading to significant losses in export earnings for Nigeria and other commodity exporters.

 Adverse commodity price shocks, according to the International Monetary Fund (IMF) can also contribute to financial fragility through various channels. Firstly, a decline in commodity prices in commodity-dependent countries results in reduced export income, which could adversely impact economic activity and agents’ (including governments) ability to meet their debt obligations, thereby potentially weakening banks’ balance sheets. Secondly, a surge in bank withdrawals following a drop in commodity prices may significantly reduce banks’ liquidity and potentially lead to a liquidity mismatch.

Financial fragility can be defined as the increased likelihood of a systemic failure in the financial system, for which the most obvious indicator would be a systemic banking crisis. Last year, the regulator gave three commercial banks until June 2016 to recapitalise after they failed to hit a minimum capital adequacy ratio of 15per cent.

Since the Central Bank of Nigeria’s (CBN) intervention at Skye Bank, which led to the removal of the bank’s chairman and chief executive officer as well as some of its directors, has continued to deepen concern over the health of Nigerian banks.

The Case of Skye Bank
The central bank had explained that it took the decision to intervene in the bank following the persistent failure of Skye Bank to meet minimum thresholds in critical prudential and adequacy ratios, which culminated in the bank’s permanent presence at the CBN lending window, its huge non-performing loans (NPLs) profile as well as its low liquidity ratio, the central bank in a proactive move effected a change in the board and management of the bank.
CBN Governor, Mr. Godwin Emefiele, said the banking sector regulator took what he described as a proactive step in order to save the health of the bank from further deteriorating.

To correct the anomalies in the bank, he said, the CBN had several meetings with the management and board of Skye bank as part of its strategy of close engagement whenever a bank’s financial or governance situation poses potential threats to the overall stability of the financial system.

However, Emefiele said despite the expectation of relevant regulators, market watchers, financial analysts and interested stakeholders that Skye Bank should be doing much better than it is right now, what they saw was the opposite. Therefore, he pointed out that given the fact that Skye bank is a domestic Systematically Important Bank (SIB) with significant interconnectedness; the CBN would be failing in its duties if it does not take immediate action to nip the steadily declining health of the bank in the bud and correct the situation.

Health of Nigerian Banks
To Emefiele, the medium-term vision of the CBN, which was unveiled in June 2014, was that the Bank would proactively manage potential threats to financial stability, maintain zero tolerance on practices that undermine the health of financial institutions, and create a strong governance regime that is conducive for financial intermediation, innovative finance and inclusiveness.

While reiterating that Skye Bank is not in distress and remains a healthy bank in the system, the CBN governor assured depositors, shareholders and all relevant stakeholders that there is no reason for concern or panic.
Emefiele further emphasised that, the three most important issues in every bank are its level of non-performing loans (NPLs), capital adequacy ratio and its liquidity.

He further stated that the strategic health of the banking industry remains strong, saying that when there is need to inform the general public about the strategic health of any bank, the central bank would not fail in its responsibility as a regulator.

“No doubt, as a result of global shocks, there are weakening of certain ratios, but those ratios have not weakened to a point where we would say the banking industry is distressed. We would like to appeal to all depositors to be calm. There is no need to leave an impression that any bank is distressed. No deposit is at risk.

“The CBN conducts its stress-testing of banks. We do not wait to be called to begin to talk about stress testing a bank. Stress testing is a process that is on-going in CBN,” he added.

Also, the Director, Corporate Communications, CBN, Mr. Isaac Okorafor, described as malicious, the news making the rounds that some banks in the country may be distressed.

To this end, Okorafor also said: “In the strongest terms that these rumours and speculations are untrue and do not reflect the actual health of the individual banks and, indeed, the entire banking industry.

“Therefore, the CBN would like to request the public to ignore speculations or rumours to the contrary as they could only be the handiwork of mischief makers who do not mean well for the Nigerian banking system and its economy. As the regulator of the industry, the CBN hereby reassures the banking and general public that their deposits remain safe in any Nigerian bank. There is therefore no need for panic withdrawals from any bank.

“Going by both the CBN’s Examination Reports as well as analysis from market watchers, International Credit Rating Agencies, and Development Finance Institutions, the Nigerian banking industry remains strong in spite of the global economic challenges emanating from the collapse of global commodity prices. We therefore urge the banking public to remain calm and go about their normal businesses without panic. It is important that we do not create problems when none exists,” he explained.

Also, the Director, Banking Supervision, CBN, Mrs. Tokunbo Martins, said “one or two” commercial banks had failed liquidity tests but they were not in the same situation as Skye Bank. But Martins said the central bank was working with the banks to restore their ratios and reassured depositors that there was no need to panic.

“We have our eyes on one or two other banks right now but they are not in a state of distress. We have our eyes on all banks,” she said. She maintained that the banking industry was healthy.
Skye’s problems worsened after it used short-term funding to acquire Mainstreet Bank in 2014 but failed to attract fresh funds, she said.

Linkage with Macroeconomic Environment
To the Chief Executive Officer of Maxifund Securities Limited, Mr. Okechukwu Unegbu, the development, is a reflection of the challenge in the economy.

Also, the Managing Director and Chief Executive of Financial Derivatives Company Limited, Mr. Bismarck Rewane, pointed out that the banking sector can only be as healthy as the economy itself.
According to Rewane, if the economy is going through turbulence, the banking sector would also feel the impact of the turbulence.

“Some banks have reported some very good numbers. But if you distill those numbers, you will find a lot of extra-ordinary items. So, if you take out the extraordinary items, you will find out that, that industry is becoming less attractive and more cannibalistic. Therefore, in the near future, we expect some further turbulence, weaker performance, head count rationalisation and restructuring to take place.

“Again, like I said, you cannot be older than your father. If the economy is in trouble, the banking system would also be in trouble. But the truth is that because the banks are adequately capitalised, they have enough buffers to withstand the shocks.

“What is happening is that the level of economic activities in Nigeria has shrunk, GDP has reduced, unemployment has gone up and that is cyclical. We don’t need to sit down and blame anybody, but to continue to seek ways to come out of these,” Rewane said.

Sub-Saharan Africa banking analyst and Head of Nigeria Research at Renaissance Capital, Mr. Adesoji Solanke, also stated recently that the situation the banks have found themselves was largely driven by the weak macroeconomic environment.
He listed other sectors in the economy also facing challenges as a result of the drop in economic activities to include the oil and gas, real estate and power.

Banks and Fresh Capital Raising
According to analysts, the development at Skye Bank is likely going to result in fresh capital raising by commercial banks, as they seek to maintain the stipulated capital ratios in the face of a weakening macroeconomic environment.
Rewane, said the solution to the challenges facing Skye Bank was for it to raise additional capital.

“There is a difference between liquidity and solvency. The bank was supposedly under-capitalised, so that was a solvency issue. So they would not have enough buffers to withstand shocks in times of stress.

“Therefore, the solution to their problem is to raise additional capital. To raise additional capital, the central bank, in its judgment felt that the board of the bank was not credible enough to overcome the crisis of confidence.

“So it is believed that the crisis of confidence has been resolved because you now have a credible board, which would allow it to raise the capital that is required,” he said.

According to Rewane, Skye Bank’s problem started when it used its shareholders’ funds to buy Mainstreet Bank, saying that if not for the “ambitious acquisition, I don’t think Skye Bank would have been in the situation it found itself.”

“So the purchase of another bank without additional capital meant that you were carrying the assets of two banks, with shareholders’ funds of one. As such, the capital inadequacy became more apparent.

“Essentially, that aggressive growth strategy was what brought about this situation,” he explained.
He, however, pointed out that during economic downturns, banks’ asset quality suffers the most and central banks the world over do everything to assist them.
He expressed optimism that the CBN would continue to support banks so as not to create a crisis of confidence in the system.

The Head of Research at SCM Capital Limited (formerly Sterling Capital), Mr. Sewa Wusu, also said banks should consider rights issues to raise additional capital so as to maintain the capital threshold.

“One of the ways to address the issues of low capital adequacy is to raise capital. What it means is that the new management has the responsibility of raising fresh capital and they should also ensure that they come up with a strategy to boost their loan recovery drive.

“Even though the economy is weak, they just have to fine-tune their strategy around recovery,” he said.

“The whole banking sector is under pressure in Nigeria given slowing growth and average loan-book exposure to oil and gas of 30 per cent,” a London-based economist at Bank of America Merrill Lynch, Oyin Anubi said.

 

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