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New loan benchmark may trigger asset bubble in banks

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Godwin Emefiele of CBN. Photo: NAIRAMETRICS

• NPL 20% above the maximum threshold, may affect dividend payout
• Experts blame the weak economy, harsh business environment
• Economists urge banks to observe due diligence in approval, strengthen risk framework

There are mounting concerns over the increase in banks’ toxic assets and the potential bubble from Loan to Deposit Ratio (LDR) as a result of the weak economy exacerbated by COVID-19-induced lockdown. The LDR represents the percentage proportion of a bank’s total money deposits that it must statutorily give out to the private sector as a loan.

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Experts believe that the Central Bank of Nigeria’s 65 per cent LDR policy has shored up Non-Performing Loans (NPLs) of Deposit Money Banks (DMBs) from 5.88 per cent at end of November 2020 to 6.01 per cent at the end of December 2020 — 20 per cent above the prudential maximum threshold of 5.0 per cent.

At the last Monetary Policy Committee (MPC) meeting, the committee had urged banks to strengthen their macro-prudential framework to bring NPLs below the prescribed benchmark.

The LDR has resulted in significant growth in credit to various sectors from N15.57 trillion to N19.33 trillion between May 2019 and August 2020, an increase of N3.77 trillion.

This growth in credit was mainly to manufacturing (N866.27 billion), consumer credit (N527.65 billion), oil & gas (N477.65 billion), agriculture (N287.11 billion) and construction (N270.97 billion).

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Recent report from the Nigeria Bureau of Statistics (NBS), in terms of credit to the private sector, showed that the total value of credit allocated by the bank stood at N19.87 trillion as of Q3 2020.

“Oil and gas and manufacturing sectors got credit allocation of N3.74 trillion and N3.03 trillion to record the highest credit allocation as at the period under review,” the NBS said.

According to analysts, Small and Medium Enterprises (SMEs) have also benefitted from the new lending culture of banks.

Experts have argued that if the government failed to provide favorable business environment that would boost performance in the real sector and sustain economic growth, there could be a build-up of toxic loans, which could eventually engender distress syndrome in the banking industry.

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Although banks were allowed to restructure most of their loans deferring principal repayments for borrowers who faced cash flow challenges due to COVID-19. Without the forbearance, the non-performance ratios of the banks could have been worse than the six per cent.

But when banks become so desperate to avoid CBN sanctions, the lending culture gets adulterated and compromised, except the banks put adequate risk management frameworks in place.

Therefore, banks were urged to implement the LDR with caution not to drive banks into accommodating non-bankable borrowing proposals that could spell doom for the economy in the nearest future, adding that aggressive lending had contributed to the banking crises of the 1950s, 1990s, and 2007/2009 in Nigeria.

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However, they argued that access to credits alone would not transform the economy, without first creating the 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. When all these are not available, the loans may go down the drain. This has been the experience in Nigeria.

Over the years, the 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.

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Segun Ajibola, Professor of Economics at Babcock University said the increase in NPL from the official figure of 5.88 per cent to 6.01 per cent between Nov 20 and Jan 21 was a reflection of the challenging times.

He said provisions for NPL are charged against bank profits and they affect banks’ profit and performance negatively.

“The issue in recent times is the debit of the shortfall in the mandatory lending of 65 per cent of deposits, imposed on deposit money banks by the apex bank. Any shortfall in the 65 per cent is debited against the bank by CBN.

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In an attempt to beat the target, banks may begin to accommodate unbankable borrowing proposals, thereby compromising credit policies, rules and regulations. The consequences, in the long run, include toxic assets, high loan loss provisions with adverse impact on shareholders funds.

This has led to desperation for lending by banks with the likely long-term adverse consequences on the quality of the loan portfolio of banks. It will also have a negative impact on banks shareholders’ funds.

“COVID-19 has affected many businesses and bank borrowers and constrained their ability to meet repayment obligations to their banks. The harsh operating environment and recent regulatory push for growth in bank loans are contributory factors.”

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Therefore, he urged banks to be more circumspect in approving the loan, strengthen their credit risk management functions, observe due diligence in loan approval processes and pay attention to internal and regulatory policy prescriptions.

“All the banks can do is to be circumspect in approving loans. In addition, “Banks should strengthen their credit risk management functions, observe due diligence in loan processing and approval process, pay attention to internal and regulatory policy prescriptions and of course work on their credit management and credit recovery strategies.”

The Head of Research, FSL Securities Limited, Victor Chiazor said business and economic activities have been very slow in the past one year and it is expected to affect repayment of most of the bank loans already disbursed.

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“However, we expect most of these loans to be restructured by the banks and project a gradual reduction in NPL’s in the current financial year as we expect economic activity to improve. For the banks that have NPL’s above 10 per cent, they will not be able to pay dividends while those above five per cent will be forced to reduce their dividend payout.

“Going by the nine months earning performance of the tier 1 banks, we expect most of them to be able to sustain the same dividend paid in the previous year, which will be positive for shareholders.”

The Chief Research Officer of Investdata Consulting Limited, Ambrose Omordion, said the increase in NPL above the regulatory benchmark of 5 per cent is likely to affect the dividend payment of some banks while others may grow their payment to maintain their dividend equalisation policy.

“The expected bank’s numbers and economic recovery will determine the next direction for the banking stocks,” he said.

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