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Home Markets Currencies

Fitch Issues Press Release on Naira Devaluation and How It Affects Nigerian Banks

Nairametrics by Nairametrics
November 27, 2014
in Currencies, Politics
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Fitch just issued the following Press Release regarding the devaluation of the Naira

Fitch Ratings-London-27 November 2014: The Central Bank of Nigeria’s (CBN) move on Tuesday to devalue the naira and raise interest rates will have only a limited impact on Nigerian banks at present, but FX risks are high for the sector, Fitch Ratings says. Nigerian banks’ Viability Ratings, which reflect their intrinsic credit strength, are low (in the ‘b’ range) and incorporate the challenging and volatile operating environment in Nigeria, so the policy move is unlikely to change the ratings.

Around 40% of Nigerian banks’ lending is in foreign currency, but they have small net long balance sheet positions to foreign exchange, so the impact of the weaker naira on banks’ credit risks, liquidity and solvency is likely to be manageable. The CBN devalued the mid-point of the naira’s official trading band from N155/USD to N168/USD and widened the band significantly.

The CBN also raised the benchmark interest rate to 13%, from 12%, the first change since October 2011, and the cash reserve requirement (CRR) on private sector deposits to 20% (from 15%). The interest rate hike would not necessarily lead to higher impaired loans, but higher funding costs will compress margins. For some banks, higher rates will lead to mark-to-market losses on government securities held in available-for-sale portfolios, although the impact on capital is likely be moderate. We also expect cost of funding to rise because of further tightening in inter-bank liquidity owing to the higher CRR. The CRR on public sector deposits remains unchanged at 75%.

The recent surge in banks’ US dollar debt funding and lending leaves banks more vulnerable to FX risks, especially if there is further devaluation. Nigerian banks have raised funding internationally over the last year helped by stronger investor appetite for Nigerian debt.

The CBN cut banks’ foreign-currency borrowing limits to 75% of shareholders’ funds and introduced a new 20% net open position cap on overall foreign currency assets and liabilities (the 1% net open position cap on the trading book remains unchanged) in late October. All Fitch-rated banks are below the new limits, but we believe only four have sufficient capacity to raise benchmark size amounts within the constraints, so issuance volumes are likely to fall.

The new net open position cap is also likely to curb the rise in US dollar lending, predominantly for the oil, gas and power sectors, where demand has been strong. Nigerian banks typically lend in foreign currency only to major corporates that have US dollar income. Nevertheless, as corporates extend their FX borrowings, the devaluation could impact their debt servicing ability and raise asset quality risks for banks. Inflationary pressures from the devaluation could also affect consumer disposable income and banks’ retail loans.

The FX limit could make it harder for banks to raise Tier 2 capital to meet regulatory requirements. We believe capital ratios may fall 200-300bp with Basel II implementation in 4Q14 and revised capital rules, close to or below 15% at some banks, which is low in Nigeria. The devaluation will also be a drag on capital ratios as risk-weighted assets of foreign-currency loans rise. But we expect this negative drag to be modest and largely offset by revaluation gains from long FX positions and retained earnings. Capital shortfalls may be met by raising common equity, if the FX limit constrains banks’ ability to raise subordinated Tier 2 capital internationally since there are no established local currency debt markets to tap.

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