Tier-2 banks face capital shortfall on naira depreciation –Fitch

Tier-2 banks face capital shortfall on naira depreciation –Fitch

A number of Nigeria ’s tier - 2 banks (banks with total assets less than N2 tn ) will fall below the capital adequacy ratio of the Central Bank of Nigeria should the naira depreciate to 450 / United States dollar, Fitch Ratings has said.

This was the result of a recent stress test carried out on the Deposit Money Banks in the country by the rating agency.

Fitch said its examination of Nigerian banks’ foreign currency positions as part of a peer group review showed that 40 per cent of their assets and liabilities were denominated in the US dollar.

In a statement on Thursday, Fitch said it calculated the banks’ capacity based on end-September 2017 data to withstand a hypothetical severe naira depreciation to 450/dollar without breaching their minimum regulatory total capital adequacy ratios.

The CBN sets different minimum CARs for Nigerian banks: 16 per cent for those it considers to be systemically important, 15 per cent for those with international banking licences and 10 per cent for the rest.

Fitch said, “Our stress test also included increasing the risk-weight on FC loans to 130 per cent (from 100 per cent ) to reflect extra difficulty for borrowers servicing FC loans with a weaker naira.

“We found that that the largest banks – Access Bank Plc, FBN Holdings, Guaranty Trust Bank Plc, United Bank for Africa Plc and Zenith Bank Plc – would be able to withstand this scenario without breaching their minimum CAR requirements.

However, second - tier banks had mixed results. Capitalisation is an important ratings differentiator for Nigerian banks, albeit within a narrow rating range. All the ratings are in the highly speculative ‘B’ range, constrained in most cases by Nigeria’ s sovereign rating of ‘B+’/Negative and our assessment of the operating environment.”

According to the rating agency, Nigerian banks’ move to a more market - based presentation of foreign - currency assets, liabilities and profit and loss items is likely to come into focus when they publish their 2017 results in the coming weeks.

It said financial statements with foreign currency items translated more in line with market exchange rates would give a more realistic representation of banks’ FC positions and capital at risk from potential further depreciation of the naira.

The exchange-rate risk, according to Fitch, warrants scrutiny for Nigerian banks because about 40 per cent of assets and liabilities in Nigeria’s banking sector are denominated in the dollars and not all banks operate with matched FC positions.

Fitch explained, “Our discussions with banks that we rate suggest that most will publish their 2017 financial statements based on the Nigerian Foreign Exchange Fixing rate (about 330 / dollar) instead of the official exchange rate of 305 / dollar, which they previously used.

“Some may use a blended rate . The NiFEX rate is the Central Bank of Nigeria’s reference rate for spot foreign - exchange transactions, widely used on the interbank market.”

The rating agency said that adopting the NiFEX rate was, however, only a partial step towards using market exchange rates.

According to Fitch, the IFRS guidelines say that companies operating in countries with multiple exchange rates should translate their FC assets and liabilities into local currency based on the exchange rates at which they expect to settle them.

It said, “But the guidelines leave scope for considerable judgment and flexibility, and Nigeria operates with multiple exchange rates, which adds to the confusion.

“In our view, the exchange rate used under the Nigerian Autonomous Foreign Exchange Rate Fixing mechanism is the closest to a true market rate. NAFEX was introduced last year and rates are set by market participants, giving investors and exporters a more transparent way to sell FC. NAFEX attracts greater volumes than other exchange mechanisms. The NAFEX exchange rate is about N360 / dollar.

“Switching to NiFEX or a blended rate would give a more meaningful representation of banks’ FC positions than using the official rate, in our view . But banks would still be translating the FC into naira at a rate significantly below the NAFEX rate. We do not expect banks will go further at this stage as every increase in the exchange rate used could lead to a drop in reported regulatory capital ratios , due to inflation of FC risk - weighted assets, even though the impact would be partially offset by the FC translation gains.”