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The looming credit drought

September 21, 2009

Contrary to previous assurances, that Nigeria’s economy was insulated from the global crisis, a rude awakening has dawned. A credit drought is looming; the after effect of Nigeria’s homemade credit boom gone bust. An Ibadan-based bank manager contends that the credit squeeze may have started much earlier.

He noted, in an interview with Business Day last Friday, that new lending to fund new and old businesses, contracts etc, was already constricting; the aftermath of CBN’s actions may just have heightened the level of illiquidity. Thus, after CBN’s audit opened Pandora’s Box, Nigeria is realising the economy wasn’t insulated after all – at least not from a local crisis.

The sack of five bank chiefs and injection of fresh capital was because these banks had embarked on a slew of reckless lending. Most of these uncollaterised loans have gone sour, so also have those that were securitised with share certificates. The stock market is in the doldrums.

As a result, the bank manager foresees slow growth, reduction in money supply and fewer business expansions. In addition, he believes there’s a flight to safety – a dash for cash – by banks, and a flight to quality by depositors. On a positive note however, banks perceived as stable will be recipients on new deposits. While banks that are experiencing withdrawals will have to up their deposit drive.

Afrinvest Research, in its just released banking sector update: The Value of Disclosure opines that “We anticipate further constriction in private sector lending as banks intensify debt recovery efforts and embark on a more frantic migration of balance sheets to more liquid assets. The drive for deposit growth will become even more aggressive with deposit rates expected to climb into the high teens as the December 2009 common year-end deadline draws closer.”

What is clear is that the banking crisis may have brought people: bankers and their creditors, to their senses. Speculators: briefcase fuel-importers, investors and brokers, trying to make a fast naira are indeed having a rethink. Planned deregulation of the downstream sector, discontinuation of fuel subsidy and pump price equalisation, revamp of the capital market by the Nigeria Security and Exchange Commission (SEC), are inadmissible signals for changing direction.

Reckless lending practices, hitherto the disorder of the day, will be abandoned. Ultra-cautious lending will do for now. Thus, banks, for sure, will steer clear of high risk businesses eg, fuel importation. Unfortunately, genuine fuel marketing businesses will feel the crunch. So will the diesel-dependent real sector.

Furthermore, following CBN’s request for the list non-performing loans (100 million and above) from all banks, it isn’t implausible that debt recovery and debt workouts, rather than new lending, will preoccupy the banks. Expectedly, only companies with strong balance sheets: little debt, high cash flow and stable earnings, will be the least affected. However, their creditors and suppliers who aren’t in similar shape will find it difficult to do business without credit.

Job losses are thus in the offing. This is turn will shrink the purchasing power of consumers (just when consumer finance by banks was taking root in the economy). The race is to the frugal. That is, those who prudently invested during the boom and conserved cash.

With hindsight, a credit drought isn’t unexpected. At the height of the credit crunch in western economies, the money market bunged up. A credit drought was happening in Nigeria; albeit invisible. A run on Nigerian banks by other local banks may have been underway in the interbank market. The interbank money market is where investment institutions, companies and banks lend and borrow billions of naira for up to year at a time.

Banks are better positioned to tell which among them is illiquid or insolvent. By withholding money from the market or charging a premium (higher interest rates) to counterparties perceived as illiquid. Money markets matter because their lending rates act as references for rates on loans to consumers and companies. High interbank market rates signal trouble.

Interbank rates respond to the Monetary Policy Rate (MPR) – CBN’s tool for controlling money supply. High interbank rates reflect an expected rise in MPR – abnormal given CBN’s liquidity stance – or increasing counterparty risks or illiquidity within the banking system.

Lamido Sanusi, the CBN governor, recently noted that “we guaranteed interbank placements [and] immediately saw the affected banks taking money from the interbank market to repay their exposure to the discount window. This was clear evidence that they do not have cash at all. Their balance sheet had shrunk. The cash had gone.”

No wonder the interbank rates plummeted the week after CBN infused 420 billion naira into the five banks. But Afrinvest doubts if the low rates are sustainable. Deposit growth and debt recovery “will expectedly exert an upward pressure on interbank rates, presently at a 6-month low of 4.5%, thus putting further strain on liquidity, despite the recent cash infusion by the CBN.”

The higher the interbank rate the higher for borrowers. If rates are too high or loans are unavailable, at any price, bankruptcies and job losses are likely consequences. For instance, viable businesses face the risk of folding up either due to high interest rates or lack of credit.

Steep interest rates will erode profits. Those without credit – necessary to bridge the time between they sell and collect cash – may be hard pressed to shed weight. That is, sack some workers in order to stay as going concerns. The bank manager, who asked to remain anonymous, sees no light at the tunnel until early 2010.

All the same, the CBN is intent, by cutting its lending rate, lifting foreign exchange controls, and guaranteeing interbank transactions for the next nine months, on lowering lending rates which, hopefully, will be passed onto consumers. A decisive solution to bank’ debt overhang was crucial to ensure a synch of monetary policy with the banking systems’ financial intermediation role.

Six indicators will be watched closely to measure the improvement of the financial intermediation capacity of the banking system. The ratio of the growth of credit to the private sector to GDP growth; the ratio of broad money to GDP; changes in interest spreads; central bank credit to banks as a percentage of GDP; changes in the real interest rate; and experiences with recurrent banking problems.

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