The outcome of the recent stress test of commercial banks by the Central Bank of Nigeria (CBN) has revealed some weak capital signs. This may have raised some concerns, but there is no cause for alarm. According to the result of the stress test, conducted by the CBN’s Financial Stability Report (FSR), only large banks in the country have the wherewithal to stay above the regulator’s capital adequacy ratio threshold, should their nonperforming loans level rise above 50 percent.
The test, which was conducted in June 2017, covered 20 commercial banks and four merchant banks. The aim of the stress test was, among other reasons, to evaluate the resilience of the banks to credit, interest rate and contagion risks.
For the purpose of the stress test, the banks were assessed based on their size and financial power, beginning with large banks whose assets are N1trn and above, medium bank with assets of N500bn but less than N1trn, and small banks with assets of N500bn and below. One of the highlights of the test showed that none of the banks in the country can withstand the impact of the most severe shock of 200 percent increase in its nonperforming loans, as most of them have capital adequacy ratio below the 10 percent minimum prudential requirement.
Consequently, the result of the test noted that in the event of any severe shock, the solvency of the three groups of banks could be at great risk. At the time the test was conducted, the average baseline capital adequacy ratio of all categories of banks stood at 11.51 percent for the large banks, 13.13 percent for the medium ones and -6.71 percent for the small banks. These represent a decline of 3.27, 2.34 and 19.46 percentage points, respectively for the three groups of banks from their previous positions at the end of December 2016. The CBN blamed the situation on the challenges in the oil and gas sector as well as the slow recovery in the domestic economy which it said, resulted in the rise of nonperforming loans and capital deterioration of the banks.
The outcome of the stress test report was not better in the sectoral credit of the industry because the oil and gas subsector was reported to have accounted for 28.83 percent while manufacturing was 13.76 percent. These may be warning signs that call for immediate, proactive measures by the banks and the regulator’s urgent policy measures to stem the tide of these worrisome trends.
While this may not indicate a clear and present danger, the result of the stress test is a call for action. It calls for more thoughtful approach in the supervision, monitoring and strengthening of the fundamentals of the banking industry. It will be recalled that the outcome of the CBN FSS report for the month of February 2017, also raised similar concerns over the health of the banks. According to the result of the report, the total assets and liabilities of the Deposit Money Banks in the country declined to N32.1trn. The loss value of about N172.2bn, showed a difference from the N32.29trn recorded in January 2016.
The CBN stress test report should not be seen as an indictment of the banking industry in the country. But, it mirrors the state of affairs of the sector and proffer solutions.
The fact that nonperforming loans have been increasing steadily in recent years does not bode well for the banking industry. For instance, the total nonperforming loans in 2016 was N2.08tr. According to the Nigeria Deposit Insurance Corporation (NDIC) 2015 report, banks’ nonperforming loans rose to N648.8bn from N354.34bn in 2014, an increase of 82.87 percent. As a result, many banks reported losses of between, 239 percent and 449 percent.
No doubt, bad loans are dangerous to the health of banks. Last year, Fitch, a global rating agency, had cause to warn that Nigerian banks might run into stormy weather because of their overexposure to bad loans.
Nonperforming loans constitute a threat to the solvency of the banks and the economy in general. Lack of this had already affected the profitability of the banks, as their profit after tax last financial year showed. We call on the banks to strengthen their assets portfolio and revalue their loan processes.
There is need to review the capital adequacy ratio of banks and, if need be, there should be mergers and acquisitions of banks as was the case in 2009 and 2010. Capital adequacy and solid assets remain a fundamental and vital part of the modern banking industry. Maintaining constant financial stability of the banking industry through proactive measures, together with a solid framework that will set up private restructuring companies to acquire these toxic loans should engage the attention of the CBN. Above all, let our financial institutions remain stable.