Nigerian Banks to Benefit from Interest Rate Hike –Fitch
Nigerian banks’ profitability will benefit from a marked increase in net interest margins (NIMs) driven by recent increases in the monetary policy rate, Fitch Ratings says. In addition, the Central Bank of Nigeria’s (CBN) rate rises and clearance of the backlog of overdue verified FX forwards have driven a modest recovery in the Nigerian naira, supporting the banking sector’s capitalisation.
However, despite the spread between the official and parallel rates narrowing, downside FX pressures persist due to negative real interest rates and low FX market confidence.
In an effort to rein in inflation and support the naira, the CBN on March 26 raised the monetary policy rate by 200 basis points to 24.75% and kept the cash reserve ratio (CRR) requirement for commercial banks at 45% of naira deposits.
Inflation accelerated to 31.7% in February from 29.9% in January. This was the second rate increase in as many months after the CRR requirement was increased by 400 basis points to 45% from 32.5% on February 27. The notable tightening of monetary policy marks progress in Nigeria’s efforts to contain inflation and support a more market-determined exchange rate.
The rate rise accompanies a sharp increase in fixed-income yields since the large naira devaluation at the end of January. A high proportion of fixed-income securities held by the banking sector is short-term, so the increased yields will quickly feed through to higher asset yields.
Asset yields will also benefit from most loans being variable-rate, enabling upward repricing in response to rising interest rates. However, analysts expect banks to exercise caution in fully passing on higher rates to certain customers in view of potentially burdensome debt servicing costs, particularly given the challenging macroeconomic conditions.
Funding costs will be less responsive to higher interest rates as a high proportion of customer deposits at most banks is in current and savings accounts. As a result, NIMs will widen markedly in 2024.
The sharp increase in the CRR requirement in February will not have a significant impact on NIMs as many banks’ CRRs were already close to 45% and low-yielding CBN-issued special bills have been repaid in the form of cash reserves. Nevertheless, the high CRR requirement is a significant constraint on NIMs, and further increases could exacerbate the impact.
Banking sector loan quality risks remain elevated due to the large devaluation of the naira (about 70% between end-May 2023 and end-February 2024; see Fitch Takes Rating Action on 12 Nigerian Banks Following Naira Devaluation) and the significant reduction in fuel subsidies.
Since net loans made up just 35% of domestic banking sector assets at the end of 3Q23, we expect pre-impairment operating profits—which will benefit from wider NIMs—to be sufficient to absorb higher loan impairment charges. Nevertheless, higher debt servicing costs will exacerbate already-existing pressures on loan quality.
As a result of tighter monetary policy and the CBN’s progress in paying off the backlog of foreign exchange forwards, the naira has somewhat recovered, rising to roughly 1,300/USD on March 27 from about 1,600/USD at the end of February.
This has led to a deflation of foreign-currency risk-weighted assets in naira terms and has partially supported the capitalization of the banking industry. Fitch expects the CBN to continue tightening policy in the near term.
But with real interest rates still negative and investor confidence in the FX market not fully restored for some time, there are still risks associated with naira depreciation and capitalization risks to the banking sector. #Nigerian Banks to Benefit from Interest Rate Hike –Fitch
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