Loan-Deposit Ratio Directive: Analysts Say NPL May Soar, As Banks Lend N1.4tr More

As expected, the Central Bank of Nigeria (CBN) directive that banks raise their Loan To Deposit Ratio (LDR) to 60% could immediately make between N1.3 and N1.4tr loans to real sector operators in the country by the September 2019 deadline, according to analysts on Thursday evening.
According to research notes to clients, the analysts at Lagos-based Cardinal Stone Limited and CSL Securities Limited (a member of the First City Group) say the directive is not likely to cause much of a stampede within the economy, given that the deficient banks are the major industry giants.
CSL researchers, for example, warned that the rush by banks to increase loans by 20% within such a short period, could ultimately result in a further buildup of Non-Performing Loans (NPLs). Should that happen, a bank like FBN Holdings, with Capital Adequacy Ratio (CAR) of 16.5% as at Q1 2019, it continued, would fall “below regulatory requirements if it must grow loans by 26% within 6 months.”
At the end of April, bank lending to the domestic economy, they noted, rose by 8.2% year-on-year to N20.974tr.
The CardinalStone analysts believe “the September 2019 timeline may be too short for non-compliant banks given the unfavourable macro-economic environment,” which may force the CBN to extend the current timeline.
They noted the “increasing need to encourage greater allocation to strategic segments within the private sector necessitated CBN’s recent move. In addition to this, the apex bank may have been concerned that the decline in LDR to 58.5% in 2019 (from 67.4% as at May 2018) may negatively impact credit to the real sector if not checked.”
The directive, they continued, “is unlikely to come as a surprise to banks given CBN’s previous references to the need to boost credit to the real sector. Notably, the new floor for LDR represents an attempt to move some banks closer to the relatively higher LDR levels recorded historically.
“For context, banks such as Stanbic, GTB, and FBNH experienced significant deterioration in LDR in the last five years.
“Put together, our coverage banks boasted a five-year average LDR of 72.1% relative to 62.3% in Q1’19. We also highlight that our coverage LDR ratio for Q1’19 was significantly flattered by higher ratios from a few banks within our tier 2 coverage (our coverage Tier 1 banks had average LDR of 54.4% in Q1’19).”
The researchers listed compliant banks with the new requirement as at 2019Q1 as Access Bank, FCMB and Fidelity, while non-compliant banks within its coverage include GTB, Zenith, FBN Holdings, UBA, and Stanbic IBTC Bank, who may likely need “to grow loans by a mean of 14.3% to meet the requirement. By implication, these banks may be required to create an additional approximately N1.3tr in credit assets by September 2019.
“Our analysis suggests that UBA may likely have to grow loans by 19.4%, while Zenith Bank could require the least loan growth of 6.2%.”
On the implications of the order, the CSL analysts see the directive resulting in “an additional N1.4tr in loans to the N24.16tr within the private sector as at February 2019.”
“Since many of the affected banks are the big banks, we believe the implication may not be as disastrous as would have been if smaller banks were the most affected considering many of the big banks have adequate capital and would typically have access to better quality loans.”
They further stressed that the CBN directive “does not address the fundamental question of why commercial banks have abandoned their traditional role of financial intermediation- mobilizing deposits and granting loans to individuals and corporates and have rather concentrated on investing in government instruments.
“The low-risk appetite among banks for lending to the real sector can be attributed to attractive yields on government instruments on the back of aggressive government borrowings to bridge fiscal deficits, high risk in the operating environment which has hindered the survival of SMEs, tepid demand from SMEs owing to the high cost of securing loans- brought about by the high-interest rate environment.
“Consequently, DMBs have preferred investing a huge chunk of their liquid assets in government instruments given that they do not have Capital Adequacy Ratio (CAR) implications, are tax-free and do not result in Non-Performing Loans (NPLs).”
The analysts blamed the attraction of banks to “high-yield government instruments is a fallout of the structural imbalances in the broad economy and the attractive yields on money market instruments which is aimed at ensuring Nigeria’s risk-free assets remain attractive to foreign investors to attract dollar inflows, hence ensuring stability in the exchange rate.
“If the government continues to rely heavily on borrowings to bridge its fiscal deficits and the need to keep yields on government instruments attractive to FPIs remain a priority for the CBN, yields on government instruments will remain elevated, which would mean that DMBs investments will remain skewed towards those government instruments.
Forcing banks to lend under the current macro-economic situation, CSL warned, will only result in a buildup of toxic loans “given the sluggish growth in the economy and the high risk in the operating environment- this could pose a risk to financial stability.
“Apart from the fact that margins of banks may be squeezed if lending is redirected to the real sector, high NPLs will also directly affect the profitability of banks.
In terms of capital adequacy ratio, “banks that are already close to their regulatory minimum (10% for National banks, 15% for banks with International subsidiaries and 16% for SIBs- Not being enforced currently), aggressive loan growth will impact capital.”
The new guidelines, the analysts stressed, may well be a trigger to boost growth in the real economy with a more favourable economic climate, better infrastructure that can aid the survival of SMEs, and less stringent CRR rules by the CBN.