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Moody’s: Inflation, higher interest rates heighten loan defaults, put banks at risk

By Geoff Iyatse
15 September 2022   |   2:44 am
Moody’s Investors Service, an international financial research institution, has warned of the increasing exposure of African banks to loan default as elevated inflation takes

• 59% of Nigerian banks’ incomes come from interest charges
• Local players most exposed to corporate entities among peers

Moody’s Investors Service, an international financial research institution, has warned of the increasing exposure of African banks to loan default as elevated inflation takes its toll on businesses and shrinks households’ real incomes.

Inflation expectation is, once more, uptick, following the release of America’s August consumer index (CPI) on Tuesday. The inflation decelerated to 8.3 per cent but was still higher than the 8.1 per cent general forecast.

The stock market has buckled as investors have started pricing in a possible 100 basis points (bps) increase in an interest rate at the next American Federal Reserve System meeting due next week. The August CPI halted rising confidence in cooling prices and sent jitters through the financial market.

Nigeria’s August CPI is due this morning. The headline inflation had eased from the mid-last year but spiked a few months again. Currently, on a leg up, analysts are not sure how far up the inflation rate, currently at 19.6 per cent, would go.

The Monetary Policy Committee (MPR) has responded with back-to-back interest rate hikes, bringing the monetary policy rate (MPR) to 14 per cent. Subsequently, the Central Bank of Nigeria (CBN) increased the savings rate to 30 per cent of MPR.

Across Africa like in other regions, central banks are constrained to increase interest rates in desperate attempts to rein in rising prices. Moody’s new report says African banks would respond to the rising inflation and associated higher savings rates with an upward repricing of loans.

The response, the report, foresees would weaken borrowers’ capacity to repay existing loans and increase banks’ provisioning for loan loss. It, however, notes that most of the banks “took proactive provisions following the outbreak of the pandemic” which will limit the extra provisioning required as defaults rise.

The research studies banks of the top five sub-Saharan African economies – Nigeria, South Africa and Egypt, Morocco and Kenya – highlighting their peculiar exposure to rising credit risk and how they could be affected.

“Net interest margins will widen, with banks with short-term or floating-rate loans benefiting most. Most African banks hold large volumes of loans that carry floating interest rates or are short-term. These will reprice upward as interest rates rise. We expect South African banks’ margins to benefit the most.

“The impact on Nigerian and Kenyan banks’ margins will be muted because their interest rates are already high and some of their deposit rates are index-linked to the policy rate. African banks’ sizeable holdings of government debt securities will fall in value as interest rates rise, but these unrealised losses are unlikely to crystallise,” the Moody’s Corporation’s arm states.

In Nigeria, specifically, the report notes that large volumes of the loans are short-term, hence they will be re-priced higher. This, it adds, could be constrained by already higher lending rates and stiff competition.

It also points to a weak transmission between PMR and lending as a limitation. According to the report, the extremely high cash reserve requirement has a huge negative consequence on the banks’ ability to contain rising costs.

Pairwise, the report puts the Nigerian banks’ exposure to corporate entities at over 90 per cent, which is the highest in the region while South Africa’s is the least with about 40 per cent of the total loan portfolio held by households. On interest to total income ratio, Nigerian banks are the least resilient with less 60 per cent coming from earnings from interest on loans.

“For all the largest African banking systems, net interest income is the main source of revenue and therefore any increase in margins will support their revenue growth. Egyptian banks are the most reliant on net interest income as a revenue source. The country’s banking sector had a ratio of net interest income to total revenue exceeding 80 per cent at the end of 2021. Least dependent are Nigerian banks, with a proportion of net interest to total income at 59 per cent,” Moody’s discloses.