The performance of the Nigerian banking industry is largely dependent on the macroeconomic environment, particularly the performance of the top five banks which account for 57% of the Industry’s total assets. The last two years saw intense weakening of the macroeconomic fundamentals against the backdrop of lower crude oil prices – Nigeria’s major revenue source – and the unorthodox demand management in the foreign exchange market. The Consumer Price Index (CPI) which measures inflation peaked after almost two decades, annual Gross Domestic Product (GDP) contracted for the first time in 25 years, culminating in a recession, government revenue plummeted, and external reserves dropping to lows that increased speculative attacks on the naira.
These macro risks resulted in the banking industry’s asset quality deteriorating significantly. The top five banks, though the largest in asset size and earnings, were not spared in the asset quality issues. In the recently released Banking Industry report by Agusto & Co. states that about 47% of the Banking Industry’s impaired loans are collectively held by the top 5 banks. These impaired loans were mainly in the oil & gas and transport & communication sectors accounting for 37% and 11% respectively of the industry’s total classified loans.
In the oil & gas space, also disclosed in the banking sector report, the top five banks account for 60% of the loans disbursed to this sector which heightens concentration risks. On a segment basis, the top five banks have granted over 66% of the banking industry’s total exposure to the oil & gas (upstream), 64% of total exposure to oil & gas (midstream) and 73% of the total loans granted to the oil & gas (downstream). On an average, each of the top five banks have disbursed over 500 billion naira to the oil & gas sector. This makes them vulnerable to the financial performance of this sector which has been enfeebled
Figure 1 Breakdown of NPLs by Sector
by global circumstances. Of the impaired loans to oil & gas sector (c.37%), the top five banks account for 77% of these impaired loans. These loans largely granted in foreign currencies were further exacerbated by the volatility of the domestic currency.
There have been arguments that given the sheer size of the top 5 banks’ loan book, they will continue to account for a sizeable chunk of the banking industry’s impaired loans especially in periods of weak macroeconomic fundamentals. However we believe that these industry leaders need to strengthen risk management framework particularly in the areas of concentration risk, early warning signals and enhanced oversight governance. The undue concentration to oil and gas could become the Achilles heel for the top five banks.
Crude oil, like most other tradable commodities has boom and bust cycles which are quite difficult to predict. It’s this volatility in crude oil prices that affects other macro-economic variables in the Nigerian economy like the currency value, government spending and price stability. The militancy in the oil producing Niger Delta region – which affects production materially – also adds a new spectre of risk to the oil and gas industry. Militancy in the region and the destruction of oil and gas assets leads to force majeure, which affects cash flows and the repayment capacity of the industry.
To mitigate against these risks, Nigerian banks will need to adopt time tested values. In December 1863, Hugh Mc Cullock, then Comptroller of the currency and later Secretary of the Treasury in
the US, addressed a letter to all national banks. In the letter he said, “distribute your loans rather than concentrate them in a few hands”. Concentration risks in oil and gas (downstream) and margins trading (equities) led to the 2008/2009 banking crisis in Nigeria which resulted in the nationalisation of some of the most vulnerable institutions and the bailout of the industry. Less than a decade after, concentration risks in the Oil and Gas (upstream) is the new black sheep.
Beyond, concentration risks, Hugh Mc Cullock also offered sage advice on the basics of lending. He said in that letter that, “let no loans be made that are not secured beyond a reasonable contingency. Do nothing to foster and encourage speculation. Give facilities only to legitimate and prudent transactions”. These words are true for all time and imbibing them would help Nigerian banks avoid the next bubble just before it pops.