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How does a bank make N19 billion a month?

The strategy for banks globally is to attract deposits at a lower rate than it lends out to borrowers.

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How does a Financial Services Group make N19b a month, post a Profit After Tax figure of N230b in an environment where global commerce virtually ground to a halt in 2020?

The Zenith Bank Plc (Zenith) Year-end 2020 final results are a blockbuster, not just in the quantitative, but the qualitative as well. In all major headline numbers, Zenith posted growth on a Year-on-Year basis, specifically, Gross Earnings are up 5.2%, Net Interest Income up 12%, Customer deposits up 15.3%.

Somehow Zenith grew her loan book by 18% in a recession and reduced the volume of Non-Performing Loans in the same period. Zenith was also able to post a higher revenue number from non-interest income even as yields on fixed-income fell across Nigeria. I must stress, Zenith has posted these results by servicing her target segment of the high-end corporates in Nigeria.

READ: Union Bank Nigeria Plc posts N15.9 billion profit in 9M 2020, up by 2%

So how did Zenith achieve this? I want to do a deep dive into how to make profits in a recession. However, it is important to start with a background on how banks make money which is basically in two ways;

  • Interest income: which is income generated from the bank gathering deposits from customers and investors and “renting” out these funds to individuals and corporates for a fee called interest. Interest Income is seen as the main business of banks. It is a measure of how well the bank has fine-tuned its people, process, and systems to generate returns from a commodity called cash.
  • Non-Interest Income: This is the income the bank generates from deploying its brands and people to juice revenues from activities that do not necessitate a transfer of cash. For Example, a bank asset management business leverages the bank’s skillsets to earn fees by providing investment advice to clients. Does a business want to expand? The bank can advise on the process to make that happen.

READ: Zenith Bank spends N20 billion on IT in 2020, up 122%

The strategy for banks globally is to attract deposits at a lower rate than it lends out to borrowers. This allows the bank generate a spread between cost and revenue. The bank’s interest spread can be magnified by the number of quality loans it creates as Interest Income rests also on the quality of the loan book. Positive spread drives the funding of other banking services and is supported by the banks internal competencies to manage risk

So a bank makes profits by

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  1. Attracting cheap deposits
  2. Earning positive spread
  3. Providing value addition for a fee
  4. Effective Risk Management

All these have to happen simultaneously. A bank that sources expensive deposits by paying higher rates generates a lower spread. Lower spread exposes the bank to cost overruns and will prove fatal to long-term growth.

SSKOHN

READ: Zenith USSD banking transaction value rises by 30.8% Y-o-Y to hit N497.29 billion

With this in mind, let’s review Zenith FY 2020 Performance

  • Attracting Cheap Deposits: In 2019, Zenith’s total interest expense, which represents how much it paid to get deposits was N148b, that figure dropped in 2020 to N121b. this means the bank was able to grow deposits by 25% but at a lower cost. How? Zenith changed her deposit mix, reducing borrowed funds/leases and time deposits by 41% and 38% respectfully and increasing the share of current accounts by 155%. By swapping the deposit mix, the bank’s cost of funds ratio fell by 18mn%.
  • Earning Higher Spread: Zenith grew Net Interest Income by 12.2% in 2020. This figure represents income earned from the deposits and investments of the banking group. Again, this was achieved by asset mix reorganization. In the face of falling rates especially on shorter-dated FGN instruments, Zenith shifted allocation from Treasury bills to longer-dated FGN bonds which paid a higher yield. Zenith’s Non-interest Income also grew to N275b a 5% jump from 2019. This is driven largely by extraordinary items including foreign currency revaluation gain, which is the gain realized from the revaluation of foreign currency-denominated assets. I must highlight this. Zenith was able to post a gain of about N43b which is a 256% gain from FY 2019 based on the Naira being devalued to the US Dollar.
  • Providing Value Addition: Value addition will include all non-core banking services Zenith Group provides to the public including subsidiaries like the Zenith Penson Custodians which has N4t in assets under custody. Commission on agency and collection was a big contributor to Zenith’s non-core banking revenue.
  • Risk Management: Zenith was efficient in deploying its internal competencies to minimize and avoid risk and impairments from the ordinary and extraordinary course of business. Zenith like other financial institutions saw a pullback in commercial activities from her clients. Take the Commerce subsector, the Non-Performing Loan share in that sector grew from 9% to 24%. Zenith, booked an increase in the number of NPLs by volume to N125m in FY 2020 but the bank was able to keep the NPL ratio down to 4.29%. An extraordinary feat.

Overall, the bank was able to navigate a difficult year and post a good return and a handsome dividend of N3 to investors. Zenith was able to achieve all this while increasing the staff strength by 4.6% to 7555 employees.

However, there are red flags as well:

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  • Net Interest Margin was down in FY 2020 as yields declined. If yield continues to stay muted, can Zenith keep finding profitable avenues to invest that N5.34 deposit base?
  • Interest income positive in FY 2020 at 420b but when compared to 2017, interest income is falling.
  • If you ignore the revaluation gain, then Non-Interest income will be considerably muted, possibly negative in FY 2020
  • Fees on electronic products fell 36% in an environment where online banking has been not just sound business practice, but life-saving as well.

Overall, in an environment with months of local and international shutdowns, Zenith has posted good numbers and demonstrated it is possible to eke out gains from a hard environment. When one looks at the dividend yield, P.E. Ratio of the bank, for me, this is a Buy.

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    Analysis: Sterling Bank, foreign exchange to the rescue

    The bank’s foreign exchange trading income includes gains and losses from spot and forward contracts and other currency derivatives.

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    virtus, Sterling Bank announces an appointment
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    Sterling Bank Plc recently published its audited Annual Report, and Financial Statements for the year ended 31 December 2020. While the results indicated an underperformance based on expectations and compared to the prior year, the outcome was not totally unexpected given that the bank faced severe headwinds from the effects of the COVID-19 pandemic. Indeed, while commenting on the results, the bank’s Chief Executive Officer (CEO), Abubakar Suleiman, had explained that 2020 was an extraordinary year, defined by the global pandemic, which disrupted the society and severely impacted economic activities.

    Gross earnings fell by 7.5 percent to N138. 9 billion (compared to N150.2 billion in 2019). The bank’s Interest income also dropped by almost 12.5 percent from N127.29 billion in 2019 to N111.45 billion in 2020. This drop is mostly attributable to a drop in interest income from loans and advances to customers, which dropped to N82.88 billion in 2020 compared to N97.89 billion for the same period in 2019. The bank’s net fees, and commission also reduced to N13.1 billion in 2021 compared to N14.61 in 2020 as Other fees and commission (mostly advisory fees) fell to N2.9 billion in 2020 (2019: N5.9 billion) while the bank’s e-business commission and fees reduced to N4.98 billion (2019: N6.79).

    The bank reported that total non-performing loans (NPL) as a percentage of gross loans improved from 2.2 percent in 2019 to 1.9 percent in 2020. While this appears to be good, a closer look at the bank’s loan portfolio shows a somewhat different picture. First, loans and advances to corporate entities reduced in 2020 (corporate entities N570.88 billion and individuals N42.48 billion) compared to 2019 (corporate entities: N582.94 and individuals N48.76 billion), yet impairment allowance on loans to corporate entities and individuals increased in 2020 (N14.11 billion and N2.42 billion respectively) compared to 2019 (N11.12 billion and N1.85 billion respectively). Secondly, the bank’s credit loss expense (made up of impairment on loans and write-offs) also increased by 36 percent to N7.91 billion from N5.84 billion in 2019, thus raising the bank’s cost of risk by 10 basis points to 1 percent.

    Also, during the year, the bank sold off N19.5 billion of its loans and advances portfolio to Cambridge Springs Investment Limited, hence further explaining the significant drop in its total loans and advances portfolio from N618 billion at the end of 2019 to N596 billion by the end of 2020. It is worth noting that as at the end of 2020, the bank was yet to receive consideration for the loans and advances sold to Cambridge Springs Investments Limited worth N19.5 billion as this amount appears as a receivable in the bank’s financial statement (other assets) and explains why its accounts receivable increased from N18.62 billion as at end of 2019 to N39.33 billion by the end of 2020.

    Although well within regulatory limits of 30 percent, the bank’s liquidity ratio deteriorated from 39.2 percent at the end of 2019 to 33.87 percent by the end of 2020. The reduction in its total loans and advances portfolio while the total deposit liability improved explains the reduction in the loan-to-deposit ratio of 62.36 percent (2019: 65.29 percent).

    It was not all bad news as the bank did very well in several areas. First, as already implied, total deposits increased by 7.5 percent to N972.12 billion at the end of 2020 compared to N892.66 billion at the end of 2019. You will also recall that the Central Bank of Nigeria directed in 2020 to all banks to reduce interest rate payable on savings deposits from a previous minimum of 30 percent of MPR to a new minimum of 10 percent of MPR, effectively reducing interest rates payable on savings account deposits from 3.75 percent to 1.25 percent per annum. During the year, it appeared that one of Sterling Bank’s strategy was to significantly reduce its interest expense, as its interest expense improved by 21.3 percent from N62.59 billion in 2019 to N49. 31 billion at the end of 2020 driven by a 39.5 percent year-on-year growth in low-cost customer deposits.

    Note that the bank also increased its savings account portion of total deposit liability from 13.55 percent as at the end of 2019 to 20.5 percent by the end of 2020. The bank also significantly increased the ratio of Current and Savings Account to Total Deposit to 78.95 percent compared to 62 percent in 2019. Compared to term or fixed deposits, savings and current accounts offer the least interest to depositors. This positively and significantly impacted the bank’s cost of funds and ensured that the cost-to-income ratio declined year-on-year to 77.4 percent.

    The bank did extremely well in its trading activities as its net trading income more than doubled to N11.72 billion (2019: N5.06 billion). This performance is attributable to a more than doubling of income from trading in bonds (2020: N5.07 billion; 2019: N2.53) and income foreign exchange trading (2020: N 3 billion; 2019: N415 million). Note that the bank’s foreign exchange trading income includes gains and losses from spot and forward contracts and other currency derivatives. Despite the pandemic and the other parameters earlier described, the bank was able to post N11.24 billion profit after income tax for financial year 2020 compared to N10.6 billion recorded in 2019 a 6 percent growth in profit after taxes.

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    There was also a significant increase in the bank’s effective tax rate or Income tax expense from less than 1 percent at the end of 2019 to over 9 percent by the end of 2020. This increase impacted its Profit after income tax which would have been much higher than the N11.24 billion reported if the same effective tax rate of 2019 had been maintained for 2020.

    SSKOHN

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    Central Banks Digital Currencies (CBDCs) – a Gift or a Curse?

    Should we expect a CBN announcement on e-Naira soon?

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    China recently became the first MAJOR economy to create its Central Bank Digital Currency (CBDC).

    Specifically, China’s CBDC has gone from the testing phase to actual implementation. Such that the digital yuan is now ready for use in regular transactions. The expectations are that by the time athletes gather for the upcoming Winter Olympics, visitors to the country can pay for a wide range of goods and services using the Digital Yuan. (Think about using government digital currency to settle Hotel and Restaurant bills, Taxi rides, etc.).

    Across the world, Central Banks are racing to implement Central Bank Digital Currency (CBDC). The latest BIS 2021 survey identified that 86% of Central banks are engaged in developing a CBDC.

    In this article, we ask the question: What exactly are Central Bank Digital Currencies (CBDCs), and why are so many central banks are working towards their implementation?

    READ: Very few nations permitted to issue their Crypto – IMF

    What is a Central Bank Digital Currency (CBDC)?

    Specifically, CBDCs are legal tenders issued by a country’s central bank which will only ever be available in digital format AND will be acceptable from day one for payments of goods and services once implemented.

    Fund settlement will be facilitated by the issuing Central bank who may / may not choose to partner with an approved list of institutional counterparties. The Bank of International Settlements (BIS) has a more technical definition here.

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    READ: U.S Central Bank leader says no rush into crypto dollar

    SSKOHN

    For the avoidance of doubt, CBDCs are neither the same as Electronic Funds Transfers (EFTs) nor are they Cryptocurrencies. Despite many similarities such as contactless settlement between counterparties, key differences are that Central Bank Digital currencies are legal tender AND represent a direct claim on a central bank by end-users.

    • So, if you are one of those people who likes to “spray” very crispy notes at Owambe… better be prepared as with digital currency, you will never see any physical notes to “spray”.

    READ: Leader of world’s most powerful central bank says Crypto unreliable for wealth preservation

    Which countries have CBDCs on the horizon?

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    The latest BIS 2021 survey of 65 central banks identified that 86% of Central Banks are engaged in developing digital currencies. Out of which 60% of central banks have begun research work whilst 14% of central banks are already in the pilot and proof of concept phase.

    For a list of countries at various stages of CBDCs implementation, you can click here and here or view the image below.

    READ: U.S. dollar share of global currency reserves rose to 61.9% in Q1 2020 – IMF

    How will the CBDCs work?

    For now, each Central Bank is determining its own scope and CBDC functionality as there is no standard global framework regarding infrastructure requirements and functionality scope (e.g. some central banks simply want to focus on domestic payments whilst others want both domestic and international payments focus).

    However, having said that, the underlying workflow will likely be similar across the world, in the sense that workflow will include solutions on distribution and utilization.

    READ: Computers might steal Satoshi Nakamoto’s Bitcoin fortune

    • Distribution: Central Banks will create the digital currency and permit a list of commercial banks to access to the central payment network for onward distribution to end customers. Given that CBDCs are digital, the Central Banks will be able to track exactly who is holding how much of their currency and how exactly their currency is being spent.
    • Utilization: End-users will have a tool (e.g. digital wallets) to help them be aware of their CBDCs balances. Further, these wallets can be presented (i.e. scanned) at participating locations for transaction settlements (think QR codes on a phone app).

    In other words, as a CBDC end-user, you only need access to the internet and electricity for spending. Intermediaries such as SWIFT will be bypassed. (You can read more about how the digital yuan will work here).

    READ: Former Access Bank CEO, Aigboje Aig-Imoukhuede, launches new book, Leaving the Tarmac: Buying a Bank in Africa

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    Why are so many Central Banks rushing into CBDCs?

    Firstly, faster cross-border trade settlements / International Trade ambitions:

    The widely accepted use of CBDCs will facilitate faster cross-border settlements between participating counterparties. Regardless of your location, there will be less need to convert from local currencies into reserve currencies such as USD, GBP, EUR, and vice versa via financial intermediaries.

    Additionally, for a country such as China which has long sought to expand its global reach in international trade, the digital yuan provides mouth-watering opportunities.

    • As a simple example, for international trade facilitation, end-users of smartphones built by Chinese-owned phone companies can potentially be enabled to access the Digital-Yuan, and that digital yuan can be spent with Chinese-owned firms across the world. These payment transactions can take place on the People’s Bank of China (PBOC) controlled network and bypass any existing financial intermediary (you can read more about digital yuan opportunities here).

    Secondly, from a domestic perspective, CBDCs will be a potential game-changing macro-economic tool.

    For countries not interested in global trade dominance, digital currencies offer Central banks an exciting opportunity to transform monetary policies. Specifically with regards to financial relationships and money transmission mechanisms (too much grammar but we have all heard of stimulus and intervention funds!!)

    Under the current state, when a Central Bank wants to increase or decrease money going into the hands of consumers, it does so via a range of tools (i.e. alter interest rates, set reserve ratios, buy/sell short-term instruments, etc.). Unfortunately, this current approach has some limitations which include:

    • Transmission mechanisms: Despite all the tools available to Central Banks, they ultimately rely on financial intermediaries (i.e. banks). Existing monetary policy tools simply aim to influence commercial banks to increase or decrease the amount of money/funds available for onward lending to end consumers.
    • These tools, as well as, associated end-user responses may not often work as fast as Central Banks would like. As an example, most bank customers will tell you that loan application processes can be extremely cumbersome and sometimes subjective.
    • Also, think about folks in remote areas who truly need credit for their business expansion but are not financially included or are not able to complete the plethora of loan application forms or are missing IDs for authentication, etc.
    • All these limitations create latency challenges for Central Banks looking to influence macroeconomic indicators quickly.
    • Monitoring: Under the current approach, it is cumbersome for Central Banks to continually track existing money in circulation and utilization purposes. Think about CBN intervention funds and how difficult it is for the CBN to know exactly how its intervention funds are being spent once the funds are disbursed to applicants.

    Fortunately, with digital currencies, given that they leave digital footprints, Economic Surveillance is facilitated (i.e. Central banks can monitor exactly who owns how much and what it is being used for); arguably giving Central Banks an opportunity to better direct funds to parts of the economy requiring support.

    Thirdly, Technology advances driving the growth of the Digital Economy and lowering operating cost dynamics.

    • The unrelenting growth of the Digital Economy: The use of physical cash continues to decline driven by the exponential growth of contactless services such as e-commerce (Amazon, Alibaba, eBay), contactless interaction (Zoom, Facebook-Portal, Google-Nest), etc.
    • Global eCommerce is now projected to be over 25% of total retail sales across the world and the US estimates that Digital Economy accounted for 6.9% of 2017 GDP which made it the seventh (7th) largest component of GDP and still growing.
    • Given that no one needs physical cash for transactions in the digital economy, Central banks are warming up to the need to implement CBDCs for transactions in this emerging digital economy.
    • Changing unit cost dynamics: From a central bank perspective, there are significant costs incurred for maintaining oversight of existing payments and settlement systems. Furthermore, there are additional costs for creating cash, transporting, storing, and securing existing stock of physical cash. As existing systems become outdated and population growth continues apace, there will be an inflection point for when it will simply be cheaper to create digital currencies to drive financial inclusion. Especially as cloud computing processing capacity continues to expand at a cheaper unit cost.

    Are there risks/issues to be concerned about with Digital Currencies?

    The answer is yes, whilst there are benefits, there are also some risks and concerns such as the risk of excessive Economic Surveillance, Privacy concerns, ease of implementing, and Negative Interest (aka financial wealth tax).

    Economic Surveillance can easily be a double-edged sword especially in the hands of an authoritarian regime, as an increased level of economic oversight can easily lead to financial repression or targeting opponents. However, just like with CCTVs, the risk of misuse cannot be a unilateral reason to discredit the opportunities available with CBDCs. (You can read more about concerns here)

    So, what about Nigeria?

    The Central Bank of Nigeria (CBN) was not included in the BIS 2021 survey, additionally, the CBN has not formally outlined its position on whether it plans to implement a Central Bank Digital Currency in the future (e-Naira).

    However in February 2021, (as part of its explanation of its regulatory directive on Cryptocurrencies), the CBN acknowledged the emerging trend of Central Banks’ ability to issue legal tender digital currencies.

    Nairametrics founder, Ugodre mentioned on his Twitter Spaces show “OnTheMoney” that a senior official at the CBN informed him that the Apex bank was seriously considering digital currency and had put together a team to explore its possibilities.

    So, should Nigerians expect an e-Naira soon?

    Firstly, with regards to innovation, the Nigerian payments landscape continues to evolve rapidly as the CBN drives innovation as part of its National Financial Inclusion Strategy (NFIS). Thus far, this strategy has resulted in the deployment of new products in the Nigerian payments space such as Money Market Operators (MMOs), Payment Solutions Service Providers (PSSPs), Agent/Super Agents, Payment Service Banks (PSBs), etc.

    Furthermore, the CBN is keen to leverage its regulatory sandbox for more innovations and has very recently in 2021 issued new guidelines on open banking, as well as, QR codes.

    Consequently, having a digital Naira should not be ruled out as an additional tool to drive financial inclusion in Nigeria,

    Secondly, based on industry statistics, Nigerians are quick to adopt technology that facilitates convenience at minimal cost to end-users.

    • Specifically, CBN payments statistics reports show that the use of cash and ATMs in Nigeria continues to decline rapidly. The latest annual report shows Cash/ATM usage has declined from 18% of transactions in 2015 to 6% of transactions in 2019. In other words, 93% of activity was done electronically (across platforms NIP, REMITA, MMO, etc).
    • Furthermore, NCC reports show high penetration rates for mobile technology with over 195 million active mobile phone subscribers (95% penetration) and 150 million internet subscribers (73% penetration rate).

    These reports lend credence to the perception that Nigerians are quick adopters of new technology where the technology enhances convenience at minimal cost to end-users.

    Consequently, a digital Naira will likely have high adoption rates to the extent that end-users do not expect to incur additional onerous charges.

    Finally, from a CBN perspective, we already know that the APEX bank prefers direct interventions as part of its macroeconomic toolkit. Arguably having a digital Naira (e-Naira) allows the CBN to better facilitate direct transmission to target beneficiaries in key sectors, whilst monitoring the use of the funds disbursed, and expedite recovery when funds are due for repayment.

    So, should we expect a CBN announcement on e-Naira soon? Your guess is as good as mine.

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