Moody’s declares 65% LDR for Nigerian banks as credit-negative – what are the implications for the economy?

Moody's Investors Service has issued a warning that meeting the Central Bank of Nigeria's minimum requirement of a 65 per cent Loan-to-Deposit ratio (LDR) could have negative consequences for the country's banks. Peter Mushangwe, a Banking Analyst at Moody’s, highlighted the challenges facing Nigerian banks as they strive to meet the LDR target by March. According to Mushangwe, the 65% LDR requirement may force banks to make riskier loans in a challenging economic environment, potentially straining asset quality and increasing funding costs. Moody's expects the Nigerian economy to grow marginally, with GDP projected at just above 2% over the next few years, further complicating the situation for banks. Mushangwe explained that increased lending to meet the LDR target could result in a substantial rise in non-performing loans (NPLs) and hinder asset quality improvements seen in 2019. Looking at the immediate impact on NPLs, Mushangwe noted that banks will need to increase their loans significantly by an estimated $690 billion, which accounts for approximately 5% of loans from October. This rapid loan expansion in a challenging economic climate may negatively affect the collectability of loan repayments in the future if economic conditions do not improve substantially. While the NPL ratio may briefly benefit from a larger denominator due to increased loans, the long-term implications could see NPLs rising over multiple quarters. The cost of deposits is also expected to be negatively affected by the 50% cash reserve requirement (CRR) penalty imposed on deposits equal to the lending shortfall. This penalty, along with increased competition for deposits, could drive up banks' funding costs in the short term and exert upward pressure on interest rates on deposits. Additionally, banks that fail to meet the prescribed LDR ratio will face penalties that further raise their cost of funding. Moody's estimates that banks could see a significant increase in deposit costs, with a bank paying a 2% deposit rate potentially facing a hike to 2.9-3.1%. Moody's negative outlook on Nigerian banks, following the sovereign rating downgrade, underlines the challenges ahead for the sector. The close ties between banks and the sovereign, with a large portion of bank capital tied up in government securities, pose risks to banks' credit profiles. Mushangwe highlighted the tough operating environment expected for Nigerian banks, with GDP growth projected at just over 2%, likely insufficient for banks to generate substantial revenues and potentially straining asset quality. In conclusion, the looming challenges for Nigerian banks underscore the need for prudent risk management and strategic decision-making. Striking a balance between meeting regulatory requirements like the LDR ratio and safeguarding asset quality will be crucial for banks navigating the turbulent economic landscape. The implications of Moody's warning extend beyond individual banks, potentially affecting the overall stability and growth prospects of the Nigerian economy.