Dip in Banks' Profitability Underway

Dip in Banks’ Profitability Underway

Central Bank Of Nigeria

• Credit Reserve Ratio/Public Sector Fund

As banks re-strategise to fill the vacuum expected to be created by the new policy on cash reserve requirement for all public sector funds, the outlook for 2013 banking sector performance appears to favour a regime of declined profitability and scramble for deposits, reports Festus Akanbi

Two weeks after the Central Bank of Nigeria (CBN) hit money deposit banks hard with the stringent monetary policy, which raised the cash reserve requirement (CRR) for all public sector funds to 50 percent from 12 percent, the echoes of the decision of the monetary policy committee of the apex bank is still reverberating in the banking sector. This is because, most analysts that have so far reviewed the emerging scenario in the nation’s banking industry appeared to have spoken in union by raising the fear in respect of two major developments, which they say may alter the course of banking in the remaining period of the year.

Dip in Profitability

One of the fears raised is the tendency of the “financial strangulation,” which the new policy on CRR will cause in the industry. According to them, the immediate fallout of this scenario will be a dip in the profit margins of most of the banks especially those with heavy exposure to public sector funds.

Unfortunately, the policy on cash reserves rolled out by the CBN came on the heels of the fear of lower yields from fixed securities in 2012. One of the institutions that raised this fear is Afrinvest Securities Limited. The investment firm reasoned that the significant earnings growth recorded by Nigerian banks in 2012 may be challenged this year following an anticipated lower yields outlook for fixed income securities as well as increasing cost in the industry.

A fixed income security is an investment that provides a return in the form of fixed periodic payments and the eventual return of principal at maturity. Unlike a variable-income security, where payments change based on some underlying measure such as short-term interest rates, the payments of a fixed-income security are known in advance.

An example of a fixed-income security would be a 5% fixed-rate government bond where a N1, 000 investment would result in an annual N50 payment until maturity when the investor would receive the NJ1, 000 back. Generally, these types of assets offer a lower return on investment because they guarantee income.

Afrinvest Securities Limited’s position is contained in its report titled: “Nigerian Banking Sector Report –Standing on the fourth Pillar,” which focused on the 2012 financial reports on banks.

First Quarter Performance

Virtually all the banks whose first quarter results for 2013 have been made public recorded significant profits, a feat, which analysts said may be reversed by the time the final results for the year are ready.

In its first quarter results, United Bank for Africa Plc recorded a profit after tax of N27.7 billion, Fidelity Bank declared N9.1 billion, while Skye Bank’s profit before tax and profit after tax were put at N10.5billion and N84 billion respectively. The same trend is obtained in other banks, which have released their results so far.

Apart from Afrinvest, other watchers of the banking sector fear that by compelling banks to leave a bigger chunk of public sector funds in CBN, banks would be denied investible funds with a negative consequence on their profitability at the end of the financial year.

Writing on the outlook for the banking industry in 2013, Financial Derivatives Company Limited, maintain that banks are likely to raise deposit rates as they compete more intensely for other sources of funding, raising the returns on naira deposits.

Scramble for Deposits

Last week, some banks, in response to the new challenges engaged their customers through SMS messages on various offers aimed at increasing the latter’s appetite for savings. One of such messages was the one that originated from Stanbic IBTC, notifying existing and potential customers of COT free transactions and the readiness of the banks to part with higher deposit rates.

Other banks are said to have begun exploring ways to make their retail products irresistible to customers. Federal government deposits with the DMBs are estimated at N1.3trn. FDC explained that the introduction of a 50% CRR on public sector funds amounts to N650 billion quarantined or interest free. The quarantined amount is equivalent to one month and 2-3 weeks of Federal allocations. “Imagine a situation where FAAC allocations are delayed, interest rates will rise sharply due to the cash shortage,” the company said.

It added, “The DMBs’ initial reaction will be to scramble for funds to cover their positions. To do this, banks will repurchase their AMCON bonds, sell down on their Net Open positions (NOPs) or seek for more deposits from the government or private sector. The liquidity gap created at the market is expected to result

in a 3-4% spike in interest rates, which are currently at an average of 11.2%p.a. There will also be a reduction in the use of Open Market Operations auctions as a mop-up strategy, which will be unnecessary in an illiquid market.

Head Research and Intelligence, BGL Plc, Mr. Olufemi Ademola, had explained that, “There is no doubt that the hike in CRR on public sector deposits will hurt the banks. By the policy, 50% of all public sector deposits generated by the banks will be reserved with the CBN. This prevents the bank from utilising the cash for regular transactions, either trading or lending.”

He spoke on the backdrop of the fact that the increased reserve requirement would not attract any remuneration (in line with CBN circular of March 3, 2011). All these will be happening at a period of reduced income from COT and increased charges for AMCON operation.

Group Head, Ecobank Capital Nigeria, Rotimi Oyekanmi, also shared the view that banks would be denied earnings under the current arrangement. He is of the opinion that the CBN action on public sector deposit will lead to reduced earnings for the banks coupled with the reduction in charges (COT, etc) as earlier announced by the CBN.

In order to block the hole, which the new CRR regime is bound to cause, analysts predicted a renewed scramble for deposits among banks.

According to the Afrinvest report, the era of ‘real banking’ appears to be gradually re-emerging as traditional sources of high income and profitability continues to come under threat from competition and regulation.

It stated that banks were currently confronted with the need to restructure their cost bases, improve risk and pricing as well as manage customer relationships more efficiently. Therefore, it advised banks to develop and grow the depth of their core retail banking business to retain and amplify cheap deposits, expand their geographic footprint and scope as urbanisation gradually remodels cities and sub-urban areas, even as the firm urged mid-tier banks to consolidate and integrate vertically in order to compete with tier 1 banks as economies of scale and scope becomes differentiating success factors.

“We expect most bank ratios (particularly liquidity and capital adequacy) to remain in line with 2012 numbers. The outlook for treasury yields in 2013 should down play profitability for banks that have reduction and risk assets. We forecast industry earnings growth declining by more than half compared to the remarkable 128 per cent in 2012.”

THISDAY also gathered that some commercial banks have been working out modalities to revive some of their retail and treasury products to make them attractive to customers.

Furthermore, THISDAY also learnt that some of banks might also adopt a strategy that would hinge the monthly salaries and other emoluments on target.

Areola said the banks’ sources of income would have to be expanded. This, he said, is likely to be through lending to the private sector, which may require longer term and more stable deposits. “The banks would therefore be forced to encourage private savings to sustain lending to the private sector.

However, the tough risk management posture of the CBN is likely to still discourage aggressive lending and curtail creativity by the banks. The fear of regulatory punishment for non-performing loans may still restrict lending by the banks,” he stated.

He said, “Yes it will motivate banks to encourage savings but the savings don’t amount to much. To be frank public sector funds move our economy. We are not a producing nation,” he observed.