Nigerian banks have been undergoing a structural shift in their business models since 2013 – the first full year since the end of bad debt sales to the Asset Management Corporation of Nigeria (AMCON). The new rules issued that year have significantly affected traditional sources of profit for commercial banks, including net interest margins and fee revenues, and are prompting lenders to find new ways of driving profitability over the medium term. This will likely entail a stronger focus on lending, though banks will eventually have to examine their relatively high cost base and low efficiency if they are to remain competitive in a crowded market.

Cash Reserve Ratios

The Central Bank of Nigeria (CBN), which had kept its benchmark monetary policy rate at 12% since October 2011, raised interest rates to 13% in November 2014 amidst pressure from plummeting oil prices late in the year. The same month saw a more than 8% devaluation of the naira against the dollar, from $1:N155 to $1:N168, and a widening of its trading band from 3% to 5%. A further de facto devaluation of the currency took place in late February 2015, with dollar sales effectively fixed at $1:N198, for a nearly 30% loss in value in just three months.

This move is widely expected to stop the outflow of foreign reserves from the CBN coffers, which were depleted by more than 25% year-on-year to around $31bn as of February 2015 – enough to cover roughly nine months of imports. While this is far from the three-month alert ceiling employed by country risk analysts, it has been a worrisome trend nonetheless. “This not only allows the CBN to save foreign exchange reserves, but also effectively gets rid of the distortion of two exchange rates,” Razia Khan, the head of Africa research at Standard Bank in London, told Reuters.

The CBN previously moved to tighten credit conditions using cash reserve ratios (CRRs) – the minimum share of banks’ deposits that must be held interest-free at the central bank. When this ratio was raised from 8% to 12% on all deposits in July 2012, the impact on liquidity was minimal. The CBN then raised it further on public sector deposits, to 50% in July 2013 and 75% in February 2014. These rates were far above those of African peers like Ghana (9%), Kenya (5.5%) and Rwanda (5%). Private sector deposits rates were also increased in 2014, to 15% in March and 20% in November.

The CBN justified this steep hike by pointing out that roughly half of all government funds had still not been transferred to its Treasury Single Account, which allowed commercial banks to charge a spread between cheap rates on government deposits and double-digit lending rates to government, both by lending directly and by purchasing securities such as bonds and Treasury bills. Before the initial public-sector raise in July 2013, the CBN reported, government funds made up about 10% of banks’ deposits and 25-30% of their credit book.

In an October 2013 report on Nigerian banks, Russian investment bank RenCap found that public deposits accounted for 10-16% of all banks’ deposits. According to Afrinvest, the first hike on public funds (to 50%) effectively sterilised N890bn ($5.4bn), while the second increase (to 75%) sterilised another N450bn ($2.7bn), and the initial three-point private-sector CRR hike quarantined about N165bn ($1bn).

Interest Margin Hit

While these new floors affected banks’ liquidity, and thus their ability to lend given the CBN’s 80% cap on loan-to-deposit ratios, banks also faced upward pressure on their cost of funding. Alongside the initial CRR hike in July 2013, the CBN mandated that banks remunerate savings-account deposits at a minimum of 30% of the erstwhile benchmark 12% monetary policy rate. This effective 3.6% rate was significantly higher than that paid by banks beforehand, according to a September 2013 HSBC report.

According to the report, savings rates varied from 1% (First Bank and Zenith) to 1.3% (United Bank for Africa, UBA), meaning banks’ cost of deposit funding would rise by N21.7bn ($132.4m) in 2013. With Treasury bill yields also trending downwards slightly, Fitch forecast in August 2013 that net interest margins would be down by 1-2 percentage points on average in 2014. “We expect banks to fill any funding shortfall with more expensive sources or by selling liquid assets, leading to a sharp negative impact on net interest margins,” the ratings agency said.

Mixed Bag

In parallel, the regulator has a mixed record of clamping down on fees deemed excessive. In a June 2014 circular on bank charges, the CBN set a timeframe for phasing out commissions on turnover (COT) – fees charged on debit transactions – and certain ATM fees. From its traditional rate of 0.5%, the COT is to be reduced to 0.3% in the first half of 2013, 0.2% in 2014, 0.1% in 2015 and completely removed by 2016.

Meanwhile, the N100 ($0.61) fee for third-party ATM use and the N100 ($0.61) monthly ATM card fee, which were lifted in December 2012 as part of the CBN’s “cash-lite” policy aimed at expanding the usage of payment cards to reduce the burden of cash reliance on GDP, made a partial comeback in 2014 after heavy lobbying from the banking sector. In September a N65 ($0.40) charge for extended use of third-party ATMs was reintroduced to curb frivolous out-of-network withdrawals. Customers are now charged starting with the fourth such withdrawal per month. As a result, ATM transaction volumes fell 9.6% between August and October, according to the CBN, while other payment methods picked up the slack: point-of-sale transactions and mobile money payments increased by 20.59% and 21.52%, respectively, over the period.

An HSBC report estimated that, by 2016, the top four banks would lose some N88bn ($536.8m) in combined COT revenue, roughly one-tenth of their 2012 revenues. Their fee-to-loan ratios, meanwhile, would halve from 5% in 2012 to 2.5% in 2016. Those with a higher share of retail accounts will be harder hit.

Financial Impact

 These measures – combined with the rise in the annual AMCON levy from 0.3% to 0.5% of assets in 2013 – have severely dented banks’ traditional sources of profit. As a result of the new policies, “the era of double-digit earnings growth in the Nigerian banking industry has gradually begun to thin out,” indicated Afrinvest in its November 2013 banking report. It also noted that in the first three quarters of 2013 profit before tax fell 9% for so-called tier-1 banks and 6.3% for the category of tier-2 lenders.

“The hike in the CRR and large exposure to power loans have put a dent in banks’ lending appetite,” Adebayo Adebowale, credit risk officer at UBA, told OBG. “Yet although we were expecting the higher CRR and minimum deposit rates to drive a rise in lending rates, this did not transpire given the intense competition between banks.” Average prime lending rates rose only marginally, from 16.73% in 2013 to 16.94% by February 2014 (when the final public-sector CRR hike was priced in). Meanwhile, average one-month savings deposit rates rose from 2.53% to 3.27%, according to BGL, a local investment firm.

In a bid to offset pressure on profit margins, banks – especially top-tier ones – ramped up lending in the first half of 2013. A report by Cordros Capital, another investment firm, found that lending at the top five banks grew 27.89% y-o-y in 2013, driving y-o-y rises of 9.61% in interest income and 9.79% in gross earnings. As the average interest expense at these banks rose 22.82% y-o-y, their net interest income expanded by only 3.46%, while non-interest income grew by 11.96%.

In aggregate, top-tier banks saw a 2.8% expansion in profit before tax, but a 6.42% contraction in profit after tax, according to Cordros – with GTB achieving the best results. Intriguingly however, these banks continued to grow their deposits, by 19.07% y-o-y, despite the higher CRR. This has caused concern among some bankers. “Given the CRR hike on public sector deposits and the zero-sum implications, any continued drive for public-sector funds by any bank should attract regulatory interest and perhaps investigation, as it may be indicative of gross illiquidity or insolvency,” Kehinde Lawanson, former executive director at First Bank, told OBG. “It may also call into question the correctness of the banks’ reports to the regulators.”

Although the CBN had called for eventually raising the CRR on public-sector deposits to 100%, it has shied away from this since the former governor’s departure in February 2014. Meanwhile, commentators have urged other measures to curb excess liquidity and soften the impact on domestic banks: “The increase in the CRR poses costs on banks,” the IMF noted in its April 2014 Article IV Consultation. “[There should be] more reliance, going forward, on open market operations to guide short-term interest rates to conduct monetary policy.”

Business Planning

As top-tier banks seek to weather new obstacles to profitability by increasing lending, they will also need to address their inefficient cost-to-income ratios to remain competitive. Mid-sized lenders will face even steeper challenges in adapting, especially those that have traditionally relied on public-sector deposits. The reforms of the past year will prompt banks to revise their business plans with a greater focus on creating risk assets rather than liability-driven models centred on deposits. Authorities’ attempts to expand the credit information ecosystem will provide crucial support for this new banking emphasis (see analysis).