Monday, July 08, 2019 / 03:57PM / By
The requirement for Nigerian banks to have a loan-to-deposit ratio (LDR) of at least 60% at end-September is credit-negative for the sector, Fitch Ratings says. We believe it will push some banks to significantly increase lending to riskier borrowers, potentially with looser underwriting or underpricing of risk.
The Central Bank of Nigeria (CBN) announced the measure on 3 July to stimulate lending and boost economic growth. Banks failing to meet the requirement will be penalised by having to deposit extra unremunerated cash reserves, equal to 50% of their lending shortfall, at the central bank. Due to the new LDR requirement, we have raised our 2019 loan growth forecast to an average of 10% for Fitch-rated banks, compared with 1% growth in 2018.
Achieving the new LDR requirement in such a short timescale will be very difficult for some banks given their lending levels, particularly if customer deposits continue to grow at present rates. The sector's overall LDR was 57% at end-May, according to CBN data. This is low relative to many markets, and reflects banks' concern about the risk to asset quality from Nigeria's often volatile operating environment. Nigeria's largest banks, with the exception of Access Bank, have LDRs below or close to 60% and will be among the most affected by the new requirement.
It is unlikely that there is sufficient demand from good-quality borrowers for banks to meet the target without relaxing their underwriting or pricing standards. Banks continue to struggle with high impaired and other problem loans, which is partly the cause for muted lending since 2016. The present operating conditions are not conducive to loan growth, and rapid lending during the fragile economic recovery could increase asset-quality problems in the future. Chasing loan growth could also weaken banks' profitability if they cut margins to attract customers, and because of the need to set aside expected credit loss provisions under IFRS 9 when loans are originated.
The CBN is incentivising banks to focus on SME, retail, mortgage and consumer lending in particular, by assigning a weight of 150% to these segments when computing banks' LDRs for the 60% target. The SME and retail segments tend to be riskier for banks, and Nigeria's mortgage market is in its infancy.
Despite the difficulty of sourcing rapid loan growth and the risks it entails, we expect banks to make a big effort to achieve the 60% target given the severity of the penalty for missing it. Depositing cash at the central bank is highly unattractive for banks as they receive no interest on it, in stark contrast to the high yields they can earn by holding Nigerian T-bills and government bonds.
We will monitor how lending develops in 3Q19 at the sector level and at individual banks. Fast loan growth, particularly relative to the market average, or other signs that a bank's risk profile may be deteriorating, could lead to negative ratings actions. Asset quality and capitalisation are key rating sensitivities for Nigerian banks, and could deteriorate as a result of fast loan growth. Most Nigerian banks' Issuer Default Ratings are constrained by the country's operating environment and 'B+'/Stable sovereign rating.