MON, MARCH 11 2019-theG&BJournal-Fitch Ratings– Nigerian banks’ rising local-currency (LC) issuance is credit positive as it diversifies their funding and reduces their foreign-exchange risk, Fitch Ratings says in a new report. However, most ratings remain constrained by Nigeria’s operating environment and ‘B+’ sovereign rating.
The increase in LC issuance reflects banks’ reduced appetite for foreign-currency (FC) lending, their desire to diversify funding given the high cash reserve requirements (CRR) on LC customer deposits and their need to issue capital securities to meet forthcoming Basel III capital requirements. Investor demand for LC bonds is mainly domestic, but higher real yields and greater exchange-rate stability could attract foreign interest.
Banks are increasingly shifting focus to LC lending given the challenges in FC lending, particularly to the troubled oil sector. They are likely to grant more lending to existing LC borrowers that benefit from the economic recovery, and target new sectors that have been underbanked, particularly retail and SMEs.
Nigerian banks are predominantly funded by customer deposits (77% in LC and 23% in FC at end-1H18). There are drawbacks to this, as FC deposits can be volatile, exposing banks to significant liquidity risks, and LC deposits are subject to a punitive CRR of 22.5%, one of the highest in the region. The CRR forces banks to park significant reserves at the central bank. These reserves are unremunerated, and the central bank does not return excess reserves immediately. The CRR significantly constrains banks’ ability to fund LC loan growth with LC deposits, and is a major incentive for them to diversify their funding.
Another reason to issue bonds is to build capital buffers. Nigeria is moving towards Basel III, which may get under way this year and is likely to weigh on banks’ regulatory capital ratios. We expect banks to bolster their capital by issuing subordinated debt eligible as Tier 2 capital rather than by raising equity. Raising equity could be difficult given the equity market decline in the past year.
Banks’ LC issuance in 2014-2015 was mostly subordinated debt, driven by the need to rebuild regulatory capital positions that had been weakened by deteriorating asset quality. Issuance plummeted in 2016-2017 following the oil price crash, which led to economic deterioration, weaker credit demand and rapidly worsening asset quality, particularly for oil-related loans. Issuance recovered in 2018, when operating conditions started to improve and four banks tapped the market to bolster capital ratios or fund growth. Nigerian banks’ LC bonds totalled NGN233 billion (USD640 million) at end-January 2019.
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