MON 18 JAN, 2021-theGBJournal- On 13 January, the Central Bank of Nigeria (CBN) sold treasury bills (TBs) at ultra-low yields, with a 0.5% coupon rate for 91-day, a 1.0% for the 182-day TB and 1.5% for 364-day TB. This is in line with the CBN policy to ease interest rates, with a cut of 250 basis points starting May 2020 in response to the coronavirus-related economic fallout. The decline in yields also pushed down the banks’ average prime lending rate to 11.6% as of November 2020 from 14.9% a year earlier.
These ultra-low rates amid high inflation rate are credit negative for Nigeria’s banks’1 because they will compress banks’ net interest income as banks will be unable to reduce their cost of funding at the same pace. Net interest income contributed about 68% of Nigerian banks total core income as of September 2020.
Given that Nigerian banks (Nigerian banks in this report refer to Moody’s-rated banks in Nigeria) hold a significant portion of their total assets in investment securities (mainly treasury bill and bonds), at about 30% as of September 2020, they are highly exposed to this decline in yields, particularly given the short maturities of these securities (just below 70% of these holdings mature within one year).
The lower government securities yields, together with the decline in average lending rate, will negatively impact banks’ net interest margins (NIMs). The average NIM for Nigerian banks reduced by 42 basis points from a year earlier to September 2020 Looking at a longer time horizon, Nigerian banks’ NIMs declined by an average of 170 basis points between year-end 2016 and September 2020. The decline affected most of the banks, with the exception of Guaranty Trust Bank Plc (B2 negative, b22) and Sterling Bank Plc (B2 negative, b3), whose NIMs remained relatively high. Conversely, Union Bank of Nigeria Plc (B2 negative, b3) and FBN Holdings, parent of First Bank of Nigeria Limited (B2 negative, b3), declined the most at 274-438 basis points between year-end 2016 and September 2020. We expect NIMs to continue to decline in 2021, especially for midsize banks that have limited room to reduce their cost of deposits.
Lower NIMs will strain banks’ pre-provision income and diminish their capacity to cover their credit losses. Loan loss provisions, which increased 1.2x at the end of September 2020 from a year earlier, will remain high as some of the policies put in place to mitigate the pandemic are unwound while asset risks remain high because of weak economic activity and foreign currency shortages.
However, the banks are trying to mitigate the negative NIM effect on profitability by containing their cost bases. In September 2020, bank operating costs grew less than inflation, and banks have room to enhance efficiency further given the still high cost-to-income ratio at over 60%. The high cost-to-income ratio partly reflects banks’ high technology investment amid slow take-up of digital products, although the pandemic is increasing the usage of digital platforms, which will increase transaction volumes and support fee income.-Moody’s analysis