By The Editor
Developments in the economy are transmitting bad signals to the banking sector. The connection between crude oil price and bank earnings is big and the link has already begun to trigger another wave of credit losses in banks.
The banking sector’s exposure to oil and gas remains as large as 30 percent of aggregate credit volume and the assets were built largely at significantly higher oil prices than what the market presently offers. The big jerk down in asset values is set to distribute losses to both lenders and borrowers.
A resurgence of credit losses seems to be the handwriting on the wall for banks this year. They have experienced two-three years of sharp reductions in loan loss expenses, as crude oil prices recovered from the 2015 plunge. The coronavirus pandemic has driven oil prices already lower than any time in decades and the bottom is yet to be reached.
Last year, the two-year declining credit loss expenses and write backs of banks bottomed out, as the Central Bank’s increased loan-deposit ratio forced banks to re-enter the lending field at a heightened risk. This year, the biggest credit loss expenses in many years are to be expected in the banking sector, as banks try to comply with regulation by building loans at a bad season.
The puncture in asset values in bank balance sheets will hit income statements harder than experienced in many years. Interest income, the main revenue line of banks, has stagnated for some years now. This year, major drops in interest earnings will most likely be the general operating story for banks. This means loss of asset values in the balance sheet will transmit loss of revenues to income statements.
Bank managements have always applied cost cutting approaches to try to defend the bottom line against stagnant or declining revenues. Such cost cutting ‘innovations’ can be expected to run rampant this year. How to defend profit from skyrocketing credit losses and failing revenues will expectedly be the focus of bank strategists in all of 2020.
Profit defensive strategies will no doubt focus on cost saving initiatives once revenue is failing. Banks have three major cost lines – interest expenses, loan impairment expenses and operating cost. With the anticipated rise in loan impairment expenses, managements’ cost saving strategies would concentrate on cutting interest and operating expenses.
Interest cost is an equivalent of cost of sales and so there is a limit that banks can go in the direction of reducing cost of funds. The drop in money market rates comes handy for banks in this direction. However the discouraging interest rates place a check on how much customer deposits they could get. Loss of deposits could reinforce loss of asset values and lead to significant drops in the size of bank balance sheets in 2020.
Operating cost is bound to be the centre of massive cost cutting that banks are likely to embark upon this year. Managements’ pruning saws can be expected to be applied deep enough to try to compensate for revenue constraints and rising loan loss expenses.
Personnel costs are a key component of operating expenses and the implication is that job losses are again impending in the banking sector. Most banks are very likely to close the year with a significantly lower number of personnel than they have begun it.
The other aspect of operating expenses is running cost –the cost of goods and services consumed in the course of business. Cutting down costs in this area have been on for years now and could head for yet a new level this year.
The implication is that banks generally are going to consume much less of usual supplies of goods and services in the cost cutting drive. Suppliers of banks will therefore face some closed doors to their businesses and the negative multiplier chain would go down the line of whatever banks consume in the normal course of operations.
These adverse trends will call for a rethink of the business at bank board levels, as the operating difficulties spell gloom on the horizon. A new round of consolidation in the banking industry would be triggered. The worst to be hit will be banks with limited market focus and others with small market shares. They cannot stand the financial aridity that is presently brewing with rising credit losses. Marginal operators that fail to seek protective shelters early enough through business combinations might be out of business.
The Central Bank of Nigeria indicated its intension last year to raise the capitalization benchmark for banks. It can cause panic in the industry this year if it applies this as a desperation expedient measure to deal with the challenges ahead. The banks need measures to strengthen liquidity this year, prevent credit losses from rising at least and boost earnings more than anything else. If a bank is liquid and profitable, it can, with time heal itself of capital deficiency even in the worst case of technical insolvency.
The CBN is expected to take steps early to strengthen bank liquidity and help them minimize the impact of oil price-induced credit losses on revenue and profit. With stable growth in revenue, banks would be able to absorb loan losses easily and with reasonable improvements in profit, they will steadily shore up the equity base. Such measures will limit individual survival effort with their downside multiplier effects on the banking sector and the economy.
Regulatory policies that are restrictive to bank liquidity such as the recently increased cash reserve ratio will need to be relaxed for now. Foreign portfolio traders are on the reverse side of the flow irrespective of the high interest rates here. The CBN may seize the opportunity to cut interest rates as a stimulatory move to economic activities. This will enable existing borrowers to repay bank loans and stem the tide of oil price-induced credit losses.
These regulatory initiatives can be expected to ensure stability of the banking sector and rev up economic activities. They ought to be applied proactively and as swiftly as the US’ Federal Reserve has cut interest rates.
The forces for another economic tempest have been set in motion. How each nation fares in the global economic wind down depends on what it does or fails to do and how swiftly it does it. As in the 2008 global financial crisis, the Fed has again set the pace, showing that the way forward is in the direction of stimulatory measures of which monetary policy has a lot to offer.
The strategy is to set the counter cyclical forces in motion as soon as the adverse functions begin to take hold. If the counter cyclical actions are delayed and the downward forces are allowed to gain momentum, the corrective policies would be insufficient to stem the tide.
Nigeria still lacks the fiscal space it has never had and so a lot depends on the monetary authority – which it seems not to be aware of. The monetary policy committee [MPC] of the Central Bank is still sitting back waiting for the next scheduled meeting to review the sudden, sweeping downturn in the global economic outlook and draw up responsive policies. Before then the economy would probably be in the negative territory.
The stock market has lost over a trillion naira in weeks and yet no emergency session has been summoned by the MPC so far. The indication is that the regulatory misconduct seen in handling the 2008 financial crisis is already being repeated.
It is all silence from the bodies that have responsibility for decisive actions – finance ministry, the CBN’s MPC and the economic advisory group. With neither actions nor strategic direction from them, the President may well be excused for turning himself into a commentator in the economic management game in which he is supposed to be the chief player. Coronavirus is “affecting what we very much depend on, the petroleum industry and therefore revenue”, the President ‘reported’ last week.
The policy-making organs in government should rise up to their job of leading the President towards macro-economic governance.
