IMPACT OF CRR HIKE ON NIGERIAN BANKS: Emergence of a new trend in Profitability index?


Monday, December 02, 2013 1538hrs / MorganCapital Research 

When the Monetary Policy Committee met on July 22nd and 23rd 2013 to review the economic conditions and challenges that confronted the Domestic Economy in the first half of the year, particularly since the last MPC meeting in May 2013 and to determine whether or not the benchmark rate (MPR) and other key Monetary policy decisions should be retained at the then current levels, not many analysts, economic watchers and other stakeholders saw the introduction of a 50% (from 12%) Cash Reserve Ratio (CRR) on public sector deposits coming.

As a result of this Singular Policy Pronouncement, which was largely unexpected, analysts saw all their robust earnings expectation from Banks thin out considerably, as Banks found themselves at the receiving end of a seemingly unfavorable Monetary Policy because a lot of the Banks relied heavily on public sector deposits rather than develop an aggressive retail strategy, which would have been a major buffer for them at times like this.

The big challenge for every investor/ market watcher then became how to determine the exposure of each of the Banks to Public Sector Deposits, so as to assess the impact of the new policy on their lending capacity, which consequently leads right into their Interest Income generating capacity. Unfortunately, this information is not currently available in the financial statements of Banks, which meant that investors had to depend on the Management of these Banks to furnish them with their respective exposures to public sector funds. We do hope that the Central Bank of Nigeria and other regulators will encourage Banks to disclose this important piece of information in their financial statement going forward.

The situation was further made worse by Banks favorable disposition to fixed income instruments rather than the higher margin credit extension to the real sector, which incidentally is the major responsibility of Banks.

The Q3 -2013 became a test run to assess the impact of the new policy on the earnings of Banks and despite the best efforts of the Management of these Banks to assuage the fears of investors, the third quarter earnings report clearly showed that the CRR hike was more of a problem than they cared to admit.

CRR hike, a Clog or a Catalyst?
In our review of the H1 2013 report of Zenith Bank, we came to the conclusion that there were two ways to look at the impact of the hike in CRR on the earnings of these Banks. 

The CRR hike as a Clog
There is no gainsaying that virtually all Nigerian Banks have exposure to public sector funds, which is very attractive because of the very low cost of fund and its potential for generating sustainable interest income. However, the level of exposure varies from Bank to Bank. For all Banks with exposure (worse on those with High Exposure), the new policy is a potential earnings clog as it can stifle the interest generating capacity of the Bank and lead to a short –medium term consequences on their Asset-Liability management strategy.

The CRR hike as a Catalyst
Having established the fact that most Nigerian Banks have exposure to public sector funds, the new policy was clearly a problem that needed to be resolved, just like the N25billion recapitalization policy of the former Central Bank Governor Prof. Chukwuma Soludo which saw Banks responding by flooding the Capital Market with repeated IPO’s in other to meet the new Capital base. We expect that the new CRR policy will spur the Management of these Banks to develop an aggressive retail strategy so as to cushion the biting effect of the policy on interest generating capacity, thereby making the new policy a catalyst. The table below shows how the various Banks bore the brunt of the CRR hike and which of the Banks managed the situation better in the Q3 2013 earnings releases.

Looking at the respective Banks performances in Q3 -2013, one thing that clearly stands out among the majority of them is the slowdown in revenue growth between Q2 -2013 and Q3 -2013. CLEARLY the slower growth in interest income on account of the introduction of 50% cash reserve ratio and the comparatively slower reduction in interest expenses because of the desperation of some of the Banks (especially the mid-tier Banks) to raise deposit was a major factor in the slow revenue growths.

The Monetary Policy Committee
The Monetary Policy Committee held its last meeting for the year on Monday 18th and Tuesday 19th of November 2013 and voted to retain the MPR and public sector CRR at 12% and 50% respectively. This clearly leaves the Banks with no choice than to dig deep and develop a strategy that will mitigate the downside risks of the new policy and ensure sustainable growth going forward.

Our Verdict
It is MorganCapital’s verdict that the negative sentiment currently surrounding the Banking sector is as a result of the introduction of the 50% cash reserve ratio for public sector deposits by the Monetary Policy Committee in July 2013. The unhealthy exposure of some of the Banks to public sector deposit has made them vulnerable to the effect of the new policy (as shown in the table above) and as such investor confidence with respect to their earnings capacity in the short run is low, resulting in a negative run on the prices of some Banks. That said, we think that some of the Banks have the capacity to minimize the effect of the new policy on their earnings growth and have already proven this even in their third quarter releases. For some of them, their exposure to public sector deposits are minimal, while to some others a fluid proactive movement in the balance sheet particularly with respect to loan book growth will put them out of harm’s way.

Management must as a matter of urgency develop and implement a strong retail strategy (especially for the more exposed Banks) in other to remain competitive in the short term while there should be a strategic rebalancing of their portfolios and reassessment of their Asset-Liability strategy. We acknowledge that the Banking sector is a closely regulated sector and as such Banks are exposed to the effect of policy changes from time to time. However, with the depth of liquidity in the economy and the strategic economic responsibility of Banks which is financial intermediation, the fundamentals of the sector remain positive and we still expect the historic moderate dividend payout tradition to continue even in the short term. 

Going Forward
The role of Banks as financial intermediaries in the economy puts them in pole position to capitalize on the opportunities inherent in the economy. GDP growth rate has averaged around 6.5% and inflation has been maintained around a single digit band (7.5%). All of these provide the right incentive for the sector to thrive. 

The eventual privatization of the power sector which is the most recent initiative of the Federal Government opens up a new world of opportunities for the economy at large and the Banking sector in particular. It is our opinion that the sector is strategically positioned and the recent positive news out of the economy will ensure the long term sustainability of the sector.



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