Banks in Nigeria have been given additional time to implement stricter regulations, but challenging market conditions combined with higher capital adequacy ratios are pushing lenders towards the capital markets.
While there may be a degree of uncertainty over economic policy as the new administration beds in, this is unlikely to impact the long-term need for some banks to raise further capital as Basel II regulations are implemented.
To meet the regulatory requirements set out under the Basel II framework, banks are required to have a 10 percent capital adequacy ratio, with this rising to 15 percent for those that have an international presence. The Central Bank of Nigeria (CBN) issued a note to banks in mid-March, extending the deadlines for Basel II compliance to those that had failed to meet the targets so far. Lenders have been given until June 13 to submit their plans for recapitalisation and then until June 30, 2016 to implement those plans.
Industry participants have welcomed the news, as well as the closer supervision by the CBN, broadly applauding the flexibility of the regulator. According to Omar Hafeez, CEO of Citibank Nigeria, ‘Basel II has been well-telegraphed by the Central Bank.’
‘With more banks seemingly in need of Tier 1 capital to meet minimum regulatory requirements plus a buffer, the macro environment deteriorating rapidly and significant pools of foreign capital remaining underweight in Nigeria presently, we view the CBN’s deadline extensions as a step in the right direction,’ said Adesoji Solanke, banking specialist at Renaissance Capital.
In order to meet those new ratios, banks are turning towards the capital markets. ‘There are two real strategies to meet capital adequacy: either you decrease assets or increase capital,’ Hafeez told the Oxford Business Group (OBG). ‘In a growth environment, reducing assets is not appropriate so despite temporary challenging market conditions, we expect banks in Nigeria to continue accessing the capital markets – both debt via eurobonds and pure equity.’
Increasing eurobond issuances comes about from two key motivations, said Hafeez. ‘First, banks need to fund projects in long-term dollars to avoid mismatches and, second, banks need to raise Tier II capital to support balance sheets.’
The pressure to turn to the debt markets to meet new requirements is highlighted in part by the broader headwinds the country’s financial institutions are facing. In mid-March, ratings agency Standard & Poor’s (S&P) said that Nigeria’s banking sector could face pressures during the year in terms of asset quality, profitability and potential liquidity issues. Sources of weakness include oil loans, utilities, manufacturing and US dollar exposure, but tighter regulation could help mitigate these threats, added S&P.
‘In our view, mid-tier banks are likely to be the most at risk,’ the S&P note said. ‘Nevertheless, regulation and governance over the past few years has improved, and may help limit potential downside risks.’
However, even with weakening oil prices, Nigeria is expected to achieve solid growth this year. The most recent projections from the IMF put economic expansion at 4.8 percent for 2015. While this is half the average rate over the past 15 years, growth is expected to be stronger than many other economies in the region or globally. By comparison, South Africa − the continent’s second-largest economy after Nigeria − is expected to reach 2.1 percent growth this year, according to IMF projections.
Indeed, improved confidence in the market and a reduction of security threats may help encourage lenders to advance credit at a lower cost. At the same time, the cost of repayment of loans will also ease if the local currency reverses some of its recent losses, with the naira down 17 percent against the dollar in the past six months. Citibank’s Hafeez noted, ‘in an environment of low oil prices and limited dollar supply, many currencies are taking a beating as the dollar strengthens. Attempting to prop this up at the expense of foreign reserves is a challenging proposition for any regulator.’
This comes at a time of change within the country, as businesses are waiting for a clear direction for the economy to be set by the incoming administration of Muhammadu Buhari.
One immediate impact of Buhari’s victory was on the yields of Nigeria’s N98.6bn ($500m) of eurobonds which dropped 22 basis points to 5.98 percent in the wake of the election result. The stock exchange also rallied strongly, gaining 8.3 percent on the day the results were declared. Both the retreat in bond yields and the gain in share values are seen as a reflection of the market’s positive response to the election result and a perceived improved political stability.