Very high Nigerian Treasury Bill yields are helping banks to maintain their margins, Fitch Ratings says. Banks have been investing heavily in T-Bills since 2H16, boosting interest income and maintaining margins. Margins reported by Fitch-rated Nigerian banks averaged 7.5% in 1H17, in line with 1H16. But the boost to net interest income may be temporary, as T-Bill yields have reduced in recent weeks, falling to about 15.5% from their mid-year levels of just over 18.5%, and they may decline further.
High yields on T-Bills are part of the Nigerian authorities’ attempts to control inflation and manage demand for foreign currency. By providing a remunerative, relatively low-risk, naira-denominated investment (interest payments are tax-free), they hope to encourage naira retention and dampen demand for US dollars.
Central Bank of Nigeria (CBN) data show that volumes of naira time and savings deposits held by the banking sector fell 8.7% to NGN11.7 trillion (USD38 billion at the official exchange rate) during the 12 months to end-July 2017, as depositors switched to T-Bill investments. T-Bill yields are still considerably higher than savings deposit rates, which are capped at 30% of the monetary policy rate, currently 14%. Large, systemically important banks are holding on to their deposits, but many second-tier and smaller banks are seeing deposit outflows and almost all banks are reporting an increase in deposit funding costs.
The CBN recently raised the minimum T-Bill purchase amount to NGN50 million (USD164,000) from NGN5,000. This should stem the outflow of small retail depositors, but is unlikely to have a significant impact on overall deposit flows because most Nigerian banks are majority-funded by corporate deposits.
For now, high yields on banks’ investments in T-Bills are offsetting the rise in their funding costs and compensating for the scarcity of opportunities for profitable new lending to the private sector. Lending opportunities have been constrained by weak economic growth, continued soft oil prices and sluggish consumer demand.
High cash reserve requirements (CRRs) on naira deposits, currently set at 22.5%, are also a constraint on lending. Naira CRRs are not remunerated. In practice, some Nigerian banks are operating with an effective CRR of about 30% because the CBN is not remitting rebates due to banks when deposits are withdrawn. Our conversations with banks suggest that the CBN is targeting the sector’s more liquid banks with this restriction.
The CRR comes on top of already stringent prudential liquidity requirements that require banks to hold liquid assets equivalent to 30% of short-term naira liabilities. In addition, the portion of excess CRR retained by the CBN and owed to the banks cannot automatically be included in liquidity ratio calculations.
Earnings retention is important if banks are to continue to strengthen their capacity to absorb losses at a time of persistent fragility in the Nigerian operating environment. Banks tell us that impairments appear to have peaked, but we view this as far from certain, and the impairment metrics do not yet fully reflect the requirements to provide for expected credit losses under the incoming IFRS 9 international accounting standard.
Fitch-rated banks reported an average IFRS-calculated ratio of impaired loans to total loans of close to 8% in June 2017, but reporting classifications differ among the banks and regulatory forbearance is not uncommon in Nigeria. Oil-related lending, which represents about 30% of loans, has undergone extensive restructuring and borrowers’ ability to service the loans in line with the new terms is yet to be tested. Given these risks, we consider Nigerian banks’ capital adequacy to be weak, in general.