CBN’s aggressive CRR policy stunts banks’ ROE growth, says Agusto & Co

NIGERIA’S BANKING IN DUSTRY’S POS SIBLE 31.6 percent return on equity (ROE) achievement was stunted in 2020 by an aggressive Central Bank of Nigeria (CBN) implementation of its cash reserve ratio (CRR) policy, foremost Nigerian rating agency, Agusto & Co, has stated in an industry report just released.

ROE is a significant measure of how the management of a company utilizes the company’s assets to create wealth for shareholders. Thus, it is the amount of net income returned as a percentage of the shareholders’ equity.

More than ten years after the 2008 financial crisis, Nigeria’s banking sector has continued to wrestle with macroeconomic pressures, including wobbly real gross domestic product (GDP) growth rates, rising inflation and unemployment rates, and fluctuating naira-to-dollar exchange rates caused by unstable oil prices and increasing pressure emanating from higher demand for the greenback. Moreover, the negative effect fueled by the COVID-19 pandemic has also impacted the industry’s preexisting vulnerabilities with profitability being dampened by the Cash Reserve Requirement (CRR), which, at 27.5 percent, is among the highest in the world.

According to the comprehensive report on the banking industry in Nigeria based on the review of the financial statements of twenty commercial banks and five merchant banks, there was generally a cautious approach to lending in the industry, given difficulties in the operating environment. Furthermore, it is noteworthy that Nigeria has the highest reserve requirement in sub-Saharan Africa. South Africa, Kenya and Ghana all have CRR’s of below 10 percent.

Although, from the 2020 full-year estimate, Agusto highlighted the banking industry’s restricted cash reserves to exceed N9.5 trillion and translated to an effective CRR of 37 percent with the industry heavyweights of Zenith (N1.37 trillion), Access (N1.27 trillion), First Bank (N1.23 trillion) UBA (N1.07 trillion) and GTCO (N1.01trillion) leading the chart in that respective order.

But the rating agency believes the elevated CRR level moderated the industry’s performance and liquidity position during the year under review.

Supposing the sterile CRR was invested in treasury securities at 5 percent, the report claimed that

N482 billion would have been added to the industry’s profit before taxation (PAT) and this would have increased the industry’s return on average equity (ROE) by 11 percent to 31.6 percent in the financial year ended 31 December 2020.

Although gross loans and advances grew by 12 percent, loan growth was negative when the 19.3 percent on the naira devaluation is considered.

Underpinned by the forbearance and proactive measures adopted by banks, the NPL ratio improved to 6.6 percent from 2019 estimates of 7.6 percent, while banks have been enabled to provide temporary and time-limited restructuring of facilities granted to households and businesses severely affected by COVID-19.

However, the reliability measure for business continuity was put to a test in 2020 on the back of government lockdown rules resulting from surging cases of the pandemic for some months as most banking institutions showed resilience through innovative measures, including remote work arrangements and upgrade of network infrastructure to accommodate higher traffic on digital channels. These arrangements also provided support during the mandatory curfew elicited by the civic unrest that followed the #EndSARS protests in October 2020, the report revealed.

Without shifting out from the crux of the matter, policy targets by the apex bank which are aimed at lowering interest rates have persisted especially given the dire need to stimulate the economy following adversities created by the pandemic. However, the aspirations of the apex bank to attain a financial inclusion rate of 80 percent have led to rising competitions from non-bank challengers.

Nevertheless, with particularity on the rate of inflation which needs to be moderate in the face of efforts to maintain a stable exchange rate, the cash reserve requirement (CRR) was increased and standardised to 27.5 percent for both merchant and commercial banks.

The report reviewed the industry structure, financial condition, the regulatory environment in addition to the macroeconomic environment and its impact on the Nigerian banking industry while leveraging lessons from the 2016/2017 recession.