July 27, 2023/Fitch Ratings
Nigerian banks face weaker capital ratios and higher impaired loans following reforms to liberalise the Nigerian naira and to remove the long-standing subsidy on fuel, Fitch Ratings says in a new report.
The official exchange rate depreciated sharply in June following the Central Bank of Nigeria’s decision to allow the naira to trade at a market-determined rate as part of the reforms under Nigeria’s new government. The official rate has depreciated by over 40% since end-2022.
The depreciation will inflate banks’ foreign-currency (FC)-denominated risk-weighted assets (RWAs), putting pressure on capital ratios. It will also inflate FC-denominated problem loans, thereby increasing the prudential provisions that banks must hold against them. The impact is mitigated by banks’ generally small FC-denominated RWAs and net long FC positions, which deliver FX revaluation gains.
Since the devaluation, Fitch has affirmed the ratings of the vast majority of Nigerian banks, with Stable Outlooks, reflecting capital headroom to absorb the negative impact of the devaluation and the second-order economic effects of the reforms on asset quality. Nevertheless, Fitch expects widespread declines in banks’ capital ratios at end-1H23, and recently placed three banks’ ratings on Rating Watch Negative, mainly reflecting thinner capital buffers and the risk of breaching minimum capital adequacy ratio requirements.
The naira devaluation, along with the fuel subsidy removal, will also lead to higher near-term inflation and tighter monetary policy, putting pressure on borrowers’ debt-servicing capacity and causing impaired loans to rise quicker than we had previously envisaged. However, the deterioration in loan quality should be less severe than that following the last major naira devaluation in 2016, partly due to FC lending standards tightening in recent years.
