CBN’s New Minimum LDR Requirement May Worsen NPLs

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Thursday, July 4, 2019 3:30PM / Abdulazeez Kuranga & Glory Okutue  of Proshare Research  /  Header Image Credit: BC Open Textbooks    


In a letter to all banks dated July, 03, 2019, the Central Bank of Nigeria (CBN), in its bid to improve lending to the real sector of the Nigerian economy; mandated all Deposit Money Banks (DMB) to maintain a Loan to Deposit Ratio (LDR) of 60% by September 30, 2019. The CBN further stated that failure to meet the regulatory requirement by the stated date would result in charge of an additional Cash Reserve Requirement (CRR) equal to 50% of the lending shortfall of the target LDR.

Analysts note that as a result of high Open Market Operations (OMO) and treasury bills yield rates as high as 17%, banks shifted their focus from lending to the private sector to lending to the Government through investments in treasury bills. For example, in FY 2018, ZENITHBANK invested N1 trillion on treasury bills alone, which represent 27.11% of the total customers’ deposit of N3.69tln. During this period, loans and advances were N1.82tln, which represents an LDR of 49.40%. However, the LDR of ZENITHBANK was 76.73% in FY 2016 as loans and advances during the period was N2.29tln while customers’ deposit was N2.98tln with a sum of N557.36bln invested in treasury bills.

Table 1: Q1 2019 LDR of Deposit Money Banks

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Of the 15 listed Deposit Money Banks (DMBs) reviewed, FIDELITYBK had the highest LDR of 95% in Q1 2019. Surprisingly, only one tier-1 bank has an LDR above the minimum 60% regulatory requirement as the tier-2 banks dominated with higher loans to deposit ratios. With the exception of UNITYBNK, four out of the FUGAZ banks were below the 60% LDR minimum requirement; FBNH, UBA, ZENITHBANK and GUARANTY need to increase their current loans and advances to customers by 12%, 12%, 10% and 7% respectively over the next 3 months in order to meet the new regulatory requirement of 60%.

Chart 1: Q1 2019 LDR of Deposit Money Banks

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Source: Proshare Research

Eight banks fell into the red LDR gap with UNITYBNK taking the lead with a deficit of 36%. The large LDR gap implies that at current customer deposit level, UNITYBNK needs an additional retail loan growth of N91.47bln between now and 30th September to meet up with the minimum LDR requirement. So also, seven other banks need to adjust their customers’ loan books to meet up with the LDR requirement within the given deadline.

FIDELITYBK, STERLNBANK, FCMB, WEMABANK and ACCESS are within the safe zone with ACCESS having the least surplus of 6%, which is still above the 60% minimum requirement.

Chart 2: Q1 2019 DMBs LDR Surplus/Deficit

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Source: Proshare Research


Chart 3: DMBs Below 60% Vs DMBs Above 60%

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Source: Proshare Research

In Q1 2019, FIDELITYBK had low customer deposits compared to their Tier 1 rivals, with customer deposits of N1.02trn, but it, the bank had the highest LDR at 95% of its deposit (N966.25bn). ETI, on the other hand, had a total customer deposit of N5.48trn but only gave out 56% of deposits as loans amounting to N3.09trn in Q1 2019.

Chart 4: Q1 2019 DMBs Loan Vs Deposits

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Source: Proshare Research


Economic Implication

The economic implication of the new regulatory requirement is that DMBs will have to reduce their investment in debt securities while diverting funds to higher risk loan assets. However, this is perceived to mixed consequences as it would increase risk assets and potential income but at higher levels of potential impairments, which would reduce bottom line profit. The new requirement would create a pull-push effect on profit depending on the quality of new assets created.

Chart 5: Q1 2019 DMBs Loan to Customers Vs Investment in Debt Securities

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Source: Proshare Research

NB: Investment in debt securities also include debt securities financial assets of the various banks.


What the Analysts are Saying

According to Tola Abimbola, a fixed income and currency specialist, “the regulation is probably targeted at some tier-1 banks who do not bother to lend because of the low cost of the fund as most tier-2 banks lend as they require higher yield on their assets to offset their more expensive cost of fund. But as the experiences of tier-2 banks show, retail lending comes with the risk of poorer asset quality”.

According to a recent report by SBG Securities, “By our estimates, and if the ratio of retail and SME loans of FY 18 is maintained, weighted LDR should increase to 56.5%, for GTB, 55% for Zenith Bank, 54% for UBA and 50% for FBNH. Banks can ramp up loan exposure to the CBN target sectors, increase exposure to sectors they are comfortable with or reduce their deposit book to meet the guideline.

FBNQuest notes that by ignoring the CBN’s weighting for LDR computation for its preferred sectors, a straight application of the 60% LDR ratio for the affected banks implies that Zenith and UBA both have to increase their loan books by over N350bn before the stipulated 30th September deadline. GT Bank and StanbicIBTC Bank will have to make net loan additions of around N165bn and N30bn, respectively. To put the implied loan growth into context, this would suggest absolute loan growth of 20% Q-o-Q (18% for 2019E) for Zenith using it as a read-across for the affected banks. It is unusual these days for banks to grow their loan books by more than 10% in a year not to talk of 20% in one quarter. However, given the magnitude of the 150% weightings for the targeted sectors, the net loan growth should be lower, perhaps half the 20% estimate above. Notwithstanding, given concerns around new NPLs, banks may choose to reduce their deposits to enhance their LDR ratios or rather have a higher effective CRR.

As far as CSL Stockbrokers are concerned, forcing banks to lend under the current macro-economic conditions will result in; 

  1. A buildup in NPLs given the sluggish growth in the economy and the high risk in the operating environment- this could pose a risk to financial stability. 
  1. Apart from the fact that margins of banks may suffer a squeeze if lending redirects to the real sector, high NPLs will also directly affect the profitability of banks.
  1. Capital Adequacy Ratio implication: For 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.

However, with a more favourable economic climate and improved infrastructure, the SME sector should see growth, and with less stringent CRR rules, the new guidelines may trigger a boost in the real economy.   

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