Banks’ Soaring Impairment Charges: A Reflection of Nigeria's Economic Vulnerabilities

Nigerian banks are facing growing risk from deteriorating credit portfolios, as reflected in the N648 billion in impairment charges recorded by six major banks in H1 2024—a staggering 69% increase from the N382.5 billion provisioned during the same period in 2023. This spike in impairments highlights the deepening impact of Nigeria’s broader macroeconomic challenges, including persistent currency devaluation, rising inflation, and a high interest rate environment. These factors are making it increasingly difficult for borrowers to meet their loan obligations.

The Deepening Crisis

The Central Bank of Nigeria’s (CBN) recent benchmark rate hikes to 26.25% have further exacerbated the situation, increasing borrowing costs and pushing more loans into the risk category.

This situation bears striking similarities to the U.S. subprime mortgage crisis of 2008, which led to a collapse of the American banking system. In the U.S., banks aggressively extended subprime loans to borrowers with weak credit profiles, leading to widespread defaults and the eventual breakdown of the financial system. While the context in Nigeria differs, both crises share a common thread: the expansion of lending portfolios into sectors that are particularly vulnerable to currency volatility and macroeconomic instability—such as oil and gas and infrastructure. As a result, the rising number of defaults and growing impairment charges are placing significant strain on both banks and borrowers, much like the cascading defaults that fuelled the subprime crisis in the U.S.

As these economic headwinds intensify, straining both borrowers and financial institutions, banks are being forced to set aside larger provisions for bad loans in an effort to shield themselves from the increasing credit risks. The higher impairment charges not only erode their profitability but also signal the growing difficulty in managing loan performance amidst such uncertainty. The trend is likely to continue, as inflationary pressures and currency devaluation remain key destabilising forces in Nigeria’s economic landscape, much like the prolonged aftermath of the U.S. housing market collapse that shook global economies.

Key Economic Drivers

Currency Volatility

The continuous devaluation of the Naira has created a significant burden for businesses with dollar-denominated loans. Borrowers in sectors like energy and infrastructure, which earn revenues in Naira but have foreign currency obligations, are particularly vulnerable. As the Naira weakens, their ability to service foreign loans diminishes, pushing up non-performing loans (NPLs).?

According to industry reports, 40% to 50% of loans in Nigerian banks are typically tied to sectors vulnerable to foreign exchange volatility. As banks have extended these loans in foreign currency, the currency depreciation has made it much harder for borrowers to meet repayment obligations.

Potential Strategy: Companies should consider implementing robust hedging strategies to manage currency risk effectively.

High Inflation

With inflation on the rise, the cost of goods, services, and borrowing has increased significantly. This has not only affected consumers but also businesses, many of which are struggling to manage their debt obligations amidst escalating prices.

Data Insight: Recent Consumer Price Index (CPI) data shows significant month-on-month increases, reflecting the growing cost of living and operational expenses for businesses.

Rising Interest Rates

The CBN's interest rate hikes, while necessary to curb inflation and stabilise the economy, have made borrowing more expensive. This has further constrained businesses' ability to repay loans and pushed up impairment charges for banks.

Alternative Policies: The CBN could explore mixed monetary policies that balance interest rate hikes with measures to support growth, such as targeted lending programs to support critical sectors or initiatives to enhance financial inclusion.

Regulatory Pressures on Lending

The CBN’s loan-to-deposit ratio policy, mandating banks to maintain a 65% lending ratio, encouraged aggressive lending in recent years. However, this has also increased the exposure of banks to riskier assets, exacerbating the impact of economic headwinds on their balance sheets.

Implications for Banks

Eroding Profit Margins

The rising impairment charges mean banks are setting aside more capital to cover potential losses from non-performing loans. This directly reduces their profitability. While some banks like Stanbic IBTC and Zenith Bank have seen charges increase by over 300%, others, such as Guaranty Trust Holding Company and UBA, have managed to reduce their impairment charges, demonstrating the uneven impact across the sector.

Interestingly, the impact on banks may be more attributable to their loan portfolio composition, than the quality of their risk practices. Banks with higher exposure to vulnerable sectors such as oil and gas, real estate, or import-dependent industries are likely to experience higher impairment charges. While those with more diversified portfolios or greater exposure to more resilient sectors may fare better.

Interest income remains a major component of revenue for Nigerian banks, often constituting between 60% to 80% of their total revenue. The reliance on interest income underscores the critical role that lending activities play in the overall profitability of the sector. For instance:

• Access Bank reports that approximately 75% of its revenue comes from interest on loans.
• Zenith Bank attributes around 70% of its revenue to interest income.

For example, Stanbic IBTC's impairment charges increased from N5.98 billion in H1 2023 to N26.5 billion in H1 2024. This translates to a significant portion of interest income being consumed by provisions for bad loans, affecting overall profitability.

The rise in bad loans not only diminishes the interest income from non-performing loans but also forces banks to divert more resources towards provisioning, thereby reducing available capital for further lending. This situation can create a cycle where banks become more risk-averse, tightening lending standards and stifling economic activity.

Impact on Banks' Balance Sheets

Using impairment charges as a proxy for the portion of assets affected by bad loans provides insight into how banks’ balance sheets are being impacted. For example:

• Zenith Bank, with total assets of approximately N12.3 trillion in 2024 and impairment charges of N415.29 billion, has about 3.38% of its total assets impacted by bad loans.
• Access Bank, with assets totalling N18.6 trillion and impairment charges of N122.74 billion, has 0.66% of its assets affected.

Adaptation Strategies: Banks should adopt robust risk management frameworks, such as stress testing and scenario analysis, to better prepare for potential NPLs and mitigate their impact on balance sheets.

Credit Crunch

As banks respond to these risks by tightening their lending standards, businesses and consumers may find it increasingly difficult to access credit. This could slow economic activity further, compounding the challenges for an already strained economy.

Long-term Impact: SMEs, which are often the backbone of economic growth, may face significant challenges in securing financing during this period of tightened credit conditions, potentially leading to slower job creation and economic expansion.

Implications for the Broader Economy

Sector-Specific Risks

The energy, infrastructure, and manufacturing sectors, which are more dependent on foreign exchange and external funding, are likely to face the most significant challenges. Rising debt service costs could lead to more defaults, further impacting banks’ balance sheets and raising systemic risks.

Government Intervention: The government could introduce targeted support mechanisms for these sectors to mitigate risks and maintain their contribution to economic growth.

Inflationary Pressures and Purchasing Power

With rising interest rates and inflation, consumers' purchasing power is eroding. This will likely lead to reduced spending, affecting retail businesses and service providers and potentially resulting in job losses in the long term.

Historical Context: Previous economic downturns have shown that consumer spending typically decreases during periods of high inflation and rising interest rates, leading to a contraction in economic activity.

Strategic Actions

For Banks

• Strengthen Risk Management: Adopt comprehensive risk assessment frameworks that include stress testing and diversification strategies away from sectors most vulnerable to currency fluctuations.
• Focus on Digital Transformation: Leverage fintech innovations such as automated loan processing systems or AI-driven risk assessment tools to streamline operations, reduce costs, and improve decision-making in loan approvals.
• Explore Alternative Revenue Streams: Banks should consider diversifying their income sources beyond traditional lending, such as expanding into wealth management, advisory services, or digital banking solutions.

For Government

• Monetary and Fiscal Coordination: Implement policies aimed at stabilising the Naira by boosting foreign exchange reserves through strategic partnerships or trade agreements. A more stable currency will ease pressure on businesses with foreign currency debt and reduce the likelihood of widespread defaults.
• Inflation Management: The CBN must continue to adopt measures to curb inflation. While higher interest rates have their drawbacks, a careful balancing act is required to ensure that inflation is controlled without stifling economic growth. This could include targeted fiscal policies alongside monetary measures.
• Structural Reforms: Implement long-term structural reforms to diversify the economy, reduce dependence on oil exports, and create a more resilient economic foundation.

For Borrowers

• Debt Restructuring and Risk Mitigation: Companies exposed to foreign exchange risks should consider restructuring their debt obligations to align more closely with their revenue flows. This might include negotiating longer repayment terms or exploring local currency financing options.
• Diversification Strategies: Businesses should explore diversifying revenue streams and cutting non-essential expenses to navigate the turbulent economic environment. This could involve expanding into new markets or developing products less sensitive to economic volatility.
• Embrace Technology: Adopt cost-effective technologies to improve operational efficiency and maintain competitiveness in a challenging economic landscape.

Conclusion

The increase in banks' impairment charges is a clear signal of the economic strains facing Nigeria. While this presents challenges, it also offers opportunities for reform and innovation in how banks, borrowers, and the government navigate these risks. By implementing proactive measures—such as enhancing risk management practices in banks, coordinating monetary policies effectively by the government, and restructuring debts among borrowers—stakeholders can work collaboratively and proactively towards ensuring long-term financial stability in Nigeria's economy.

The increase in banks' impairment charges is a clear signal of the economic strains facing Nigeria. While this presents significant challenges, it also offers opportunities for reform and innovation in how banks, borrowers, and the government navigate these risks. By implementing proactive measures—such as enhancing risk management practices in banks, diversifying loan portfolios, coordinating monetary and fiscal policies effectively, and restructuring debts among borrowers—stakeholders can work collaboratively towards ensuring long-term financial stability in Nigeria's economy.

The path forward requires a delicate balance between managing short-term risks and fostering long-term economic resilience. As Nigeria navigates these turbulent waters, the actions taken today will shape the country's economic landscape for years to come. By learning from past crises and adapting to the unique challenges of the present, Nigeria has the potential to emerge stronger, with a more robust and diversified financial sector capable of supporting sustainable economic growth.