Nigerian banks are sufficiently well capitalised to absorb the impact of the 40 per cent effective devaluation of the Naira against the US dollar, Fitch Ratings stated in a release on Thursday.
The Central Bank of Nigeria (CBN) on Monday started the implementation of its new flexible foreign exchange (forex), leaving the Naira to float freely with market forces.
Fitch explained that currency devaluation affects banks’ capital ratios largely because total risk-weighted assets are inflated when foreign currency (FC) assets are translated back into naira, while capital is denominated in local currency.
The global rating agency assigned ratings to 10 Nigerian banks and its assessment was that, with a 40 per cent effective devaluation, the majority will not face an immediate breach of regulatory capital adequacy ratios (CARs).
However, if the naira continues to weaken, buffers between minimum and reported CARs may decline to a level which heightens ratings sensitivity.
Fitch-rated banks report CARs ranging from 14 per cent to 21 per cent. The devaluation will impact ratios in different ways across rated banks, depending on the level of their FC risk-weighted assets and the size of their net open FC positions.
On average, 45 per cent of net lending in the Nigerian banking sector is extended in FC, almost entirely US dollars. Balance sheets tend to be reasonably well-hedged, although CARs are primarily affected by the revaluation of their FC risk-weighted assets into Naira.
“In our view, the immediate impact of effective devaluation on CARs reported by Fitch-rated banks will be a two per cent average reduction. Any erosion of capital ratios may be short-lived because banks are profitable despite the unfavourable operating environment. Rated banks reported a 14 per cent average return on equity in first quarter of the year. Expectation is that dividend pay-outs will probably be conservative in 2016, while internal capital generation is expected to remain healthy,” Fitch stated.
The report however noted that banks’ ability to continue to generate solid performance indicators will largely depend on developments in asset quality and loan impairment trends, pointing out that impaired loans represented an average of 5.5 per cent of gross loans across our portfolio of rated banks at the end of first quarter 2016, which is reasonable considering the tough operating environment.
“Loan loss cover is adequate for most banks, but it expect impaired loan ratios to rise in the wake of the naira devaluation. This is because some Nigerian corporates are not adequately hedged by FC income streams and may find it more difficult to service their FC loans. Most major Nigerian corporates are well hedged,” Fitch stated.
According to Fitch, the success of the forex move in attracting portfolio inflows and foreign direct investment has yet to be tested but if successful, and FC supply rises, FC liquidity for banks will ease which would allow them to meet FC demand, and meet their internal and external FC obligations.