Increase in LDR and worry over toxic loans

There has been a renewed call for the diversification of the productive base of the economy from crude oil. This has brought agriculture and manufacturing into focus.

While there have been attempts to stimulate activities in these areas, getting the banks to increase credit to the sectors has been a major challenge. Hence, players in the sectors have identified access to credit as a major set back

But recent figures have shown that this narrative could change soon. A recent National Bureau of Statistics (NBS) report on bank credits shows that year-on-year (y/y) deposit money banks’ credit to the economy recorded an improvement in 2019, hitting N17.18 trillion compared to N15.1 trillion in 2018, N15.7 trillion in 2017 and N16.1 trillion in 2016.

The increase in lending has both positive and negative implications for the economy. While credit is a catalyst for growth, it also increases risk pressure on lenders. Hence, experts are also worried the increase in LDR could cause an increase in toxic loans, except the banks put adequate risk management frameworks in place.

Over the years, government depends heavily on the oil sector for both foreign exchange and revenue. Hence, the performance of the oil sector is a major determinant of the health of the economy. The 2016 recession was triggered by the crash in oil prices.

Efforts have been made to provide funds for the manufacturing and agricultural sub-sectors through various banking agents other than the deposit money banks, creating a missing link between the financial services and the real sector of the economy.

However, research has shown that a number of small and medium scale manufacturing firms and agriculturist in developing countries including Nigeria are faced with the challenge of accessibility to bank credits, which can be attributed to the underdeveloped structure of the financial system,

To grow the economy by making credit available to the real sector, the Loan-to-Deposit Ratio (LDR) of banks was raised to 65 per cent in October 2019. That was a month after a similar increase. This is because the survival or otherwise of the real sector is largely dependent on access to finance. The increase in LDR boosted credit access.

Chief Investment Officer at Afrinvest Asset Management Limited, Robert Omotunde, said aggregate credit to the private sector rose 10.7 per cent to ₦270.3 trillion in 2019, compared to a 1.9 per cent increase in 2018.

According to him, the major theme in the first half-year (H1) of 2019, was the compulsory increase in banks’ LDR, and how banks were expected to navigate the tide.

“The loan book of banks under our coverage expanded by 14.2 per cent y/y in 2019, faster than the 2.3 per cent growth achieved in 2018. Albeit, slower than the 17.6 per cent y/y growth in the deposit base. The jump in risk asset creation was driven by the increase in the LDR initially from 58.5 per cent to 60 per cent (July 2019), and later to 65 per cent (October 2019).

“In terms of compliance, industry LDR stood at 68.1 per cent up from 67.1 per cent in 2018 and slightly above the CBN’s threshold. Loan growth for H1, 2020 has been slower at 7.4 per cent relative to the 2019 level, as banks exercised caution in risk asset creation due to the slowdown in economic activities.

“In terms of aggregate credit to the private sector (CPS), it rose by 10.7 per cent to ₦270.3 trillion in 2019 compared to a 1.9% increase in 2018 and grew 16.0 per cent y/y to ₦169.0trillion in H1:2020.

“While the impact of the increase in credit may have been masked by the lockdown of activities which affected most sectors of the economy in H1:2020, we note that economic growth improved significantly in the last two quarters of 2019 (Q3: 2.3% and Q4: 2.6%) bringing the full-year growth to 2.3 per cent.”

A Professor of Economics, at the Babcock University, Segun Ajibola, said the policy on loan to deposit ratio of 65 per cent has shored up total loans by Deposit Money Banks (DMBs) from about N15 trillion in April 2019 to over N18 trillion.

He insisted that many sectors of the economy including the Small and Medium Enterprises (SMEs), have benefitted from the new lending culture of banks.

However, he argued that improvements alone cannot transform Nigeria’s economy without the creation of an enabling environment for business and investment.

“Loan on its own is an enabler, but must be completed by a healthy operating environment, ease of doing business, infrastructural facilities for the lending banks, the borrowing entities and individuals and the economy as a whole to harness the benefits.

“If and when all these ones are not available, the loans may go down the drain. This has been the experience in Nigeria. In compelling banks to lend, the Central Bank ought to go a step further to influence the provision of other complementary facilities to help business promoters to generate positive results from such bank loans.

“My fear is that when banks become so desperate to avoid CBN sanctions, the lending culture gets adulterated and compromised. The result is a build-up of toxic loans, which can eventually engender a distress syndrome in the banking industry.”

He advised that LDR be implemented with caution not to drive banks into accommodating non-bankable borrowing proposals that can spell doom for the economy in the nearest future, adding that aggressive lending contributed to the banking crises of the 1950s, 1990s, and 2007/2009 in Nigeria.

A stockbroker and Chief Executive Officer of Sofunix Investment Limited, Sola Oni, admitted that on the back of the push LDR, personal loans to the retail sector have increased significantly.

According to him, domestic credit from banks to the private sector amounted to N37.31 trillion as at June this year, an indication that the CBN’s policies really worked.

However, he argued that many companies are still in dire need of cash to remain afloat because some banks are reluctant to lend to the real sector. “Banks are reluctant to lend to the real sector because of fear of the companies’ creditworthiness as many of them lack authentic credit ratings.

“Government should evolve financial reforms as well as policies that can narrow the spread between savings and lending rates. It is high time the government stops crowding out the private sector by reducing excessive borrowing from the financial system,” he said.

Director, Centre for Economic Policy Analysis and Research (CEPAR), University of Lagos, Professor Ndubisi Nwokoma, said the CBN policies trying to direct banks to lend to the real sector have been effective, but expressed worry on the likelihood of growth in non-performing loans (NPLs) considering the harsh operating environment.

“There has been an effort made by the deposit money banks (DMBs) to comply; official CBN data indicates so. More credit is good for the economy particularly in a situation of instability and stagnation.

“The critical question however is the likelihood of growth in non-performing credit or bad loans since the operating environment is not very conducive for businesses particularly SMEs.

“While growing the volume of credit to the economy is desirable, the consequence of creating problems for the banking sector through an increase in bad loans should also be factored in,” he said.

Indeed, the Nigerian banking sector recorded the most credit growth to the real sector of the economy in almost five years, hitting N17.1 trillion in the fourth quarter of 2019.

The breakdown of the sectoral credit shows that oil and gas, and manufacturing sectors got credit allocation of N3.42 trillion and N2.62 trillion, respectively, to record the highest credit allocation during the period under review.