Shedding over N4 trillion of toxic debt to the state-run AMCON starting in 2010 was the first step in a cycle for Nigerian banks which has now come full circle in that still subdued impairment charges have neatly correlated with rising ROEs and improved capital adequacy ratios (CAR)–now up sector-wide to over 17 percent from sub-10 percent levels two years ago–that reflect, in part, lower risk weighted assets–once a headwind but now collateral for high yield paper that[alongside sticky money market rates] pads net-interest margins as well as overall net interest income in the face of suddenly sluggish credit growth (a phenomenon the central bank (CBN) labeled this spring as “indicative of a disturbing trend of growth in lending to States and Local governments at the expense of the core private sector”, though as RenCap analysts point out roughly 80 percent of Nigeria’s private credit goes to sectors of the economy that account for ~23 percent of real GDP growth).
Banks’ role in developing the real economy (read providing credit) comes concurrent, however, with a continued drive to (arguably) over-provision, seen for example in Diamond Bank’s 1H12 results wherein provisioning rose 18.3 percent q/q against an annual impairment decline of roughly 10 percent–an example of the differences stemming from the newly adopted International Financial Reporting Standards (IFRS), which replaced Generally Accepted Accounting Principles (GAAP) and has had a direct impact on lowering the aforementioned impairments at certain banks while actually raising required provisions at others: analysts stated that First Bank , Zenith and UBA all saw impairment charges decline between 20-38%, for instance (in essence the method of provisioning is based upon an informed rather than prescribed rate assessment process). Yet to what extent banks build out and/or adopt the capacity to leverage the new standard standard and moreover apply it effectively to future asset buildout is just the sort of “sustainable change” alluded to by the CBN that will define and ultimately differentiate Nigerian banks once general impairment drivers disappear from earnings and funding profiles become more competitive. Moreover, some pundits also fret about how the IFRS mark-to-market ethos will impact various [hitherto opaque] credit portfolios, especially given how counter-party credit risk will imediately be passed onto balance sheets and require offsetting flexibility in reserving.
Alongside overall asset and non-interest income growth, Fitch wrote last fall that “cost management [can be] expected to take on increased focus” within the Nigerian banking sector; indeed, most explictly this sort of “efficiency” (often proxied by non-interest expenses as compared with revenue or in some cases total assets) may be magnified given the fine line between containing risk and capturing its returns inherent to a business model that post-Lehman and under Basel III looks to discourage rather than encourage it in the first place. Touting falling NPLs and higher capital levels as a sign of “strength” is thus somewhat misguided. A recent paper in fact (“Effect of Capital Adequacy on the Profitability of the Nigerian Banking Sector”) reiterates the “non-significance between CAR and selected bank profitability and performance metrics” while suggesting regulators focus rather on “intrinsic elements of bank operational activates” in terms of cultivating stability. For Nigeria’s banks, the work has just begun.