The Banking Industry May Face Liquidity Crisis Should This Happen…

Hold on, relax and catch a breath. This by no means is not a cause for alarm but still important for investors like me to take note of. The CBN regularly conducts stress test on banks in Nigeria to appraise their risk and viability and ensure that they conform to regulatory policies put in place to checkmate distress. As such a stress test was conducted by the FBN in a report it calls Financial Stability Report back in June 2013. It only just released the report and this was one of the findings;

The Implied Cash Flow Analysis assessed the impact of sudden withdrawals of deposits, short-term wholesale and long- term funding, with specific assumptions on asset fire sales. The test assumed a gradual average outflow of 3.8, 5.0 and 1.5 per cent of total deposits, short-term wholesale and long-term funding respectively, over a 5-day period (Test 1.1) and 22.0, 11.0 and 1.5 per cent of total deposits, short-term wholesale and long-term funding, respectively, applied one-off on a 30-day balance (Test 1.2).

The results showed that the industry liquidity ratio declined to 16.7 and 13.3 per cent after the respective 5-day and cumulative 30-day shocks were applied, from the pre-shock position of 67.8 per cent (Table 3.3).  The liquidity ratios of most banks were below the regulatory threshold of 30.0 per cent for the 5-day and cumulative 30-day scenarios. Similarly, three (3) banks recorded negative liquidity ratios, following the application of a cumulative 30-day shock.

Interpretation

Permit me if I am wrong but that they are basically saying is that should Nigerian banks be faced with sudden withdrawals of deposit based on some of the (see link for more assumptions) assumptions stated above most banks the industry liquidity ratio will fall below the 30% cap. In fact three banks (which they did not mention for obvious reasons) will have negative liquidity ratios. And from experience liquidity is the biggest indicator of a soon to be failed bank.

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Now these are worst case scenarios and may not play out as tested except maybe under extreme conditions. Some of which can be wars, industrial action/crisis, revolutions etc. Does this mean I dump my investment in banks? No! Does it means banks are risky investments? Yes! Which is why we must constantly monitor news about them.