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Falling oil prices may push banks’ cost of risk to 4.4% in 2015

By BusinessNews Staff on December 25, 2014

Banks’ exposure to the oil and gas sector in the face of tumbling oil prices may raise the industry’s cost of risk (COR) to an aggregate of 4.4 per cent in 2015, a report has shown.
According to the report, the additional three per cent COR would reduce 2015 estimates of banks’ profit before tax on aggregate by 36.8 per cent.

CSL Stockbrokers which stated this in a report titled: “Devaluation Scenario,” created a scenario whereby the naira would be devalued further to N185.00/$1 in 2015 in view of the falling oil price and part of the findings was that this would pose additional risks from an open forex positions to banks.

On 25 November the Central Bank of Nigeria (CBN) changed the midpoint of its target exchange rate band from N155/$1 to N168/$1 and widened the band from +/-3.00% to +/-5.00%, establishing a new target range of N159.60/$1 to N176.40/$1.

In the interbank market the naira has been trading around N180/$1.

Lending in US dollars to customers amounted to 29.6 per cent of gross loans to customers at the end of 2013.

The report stated: “Assuming 10 per cent of these US dollar loans become loss loans in 2015, and would therefore require 100 per cent provisions (disregarding collateral), we estimate this would add an additional three per cent points to banks’ aggregate cost of risk (COR).

“This additional three per cent COR would reduce our current 2015 estimates of profit before tax on aggregate by 36.8 per cent.

“Currently our base case for banks in 2015 assumes an aggregate 1.1 per cent cost of risk. We believe that currency dislocation could raise that COR to 4.1- 4.4 per cent in aggregate.

“Why pick 10 per cent as a potential default rate for US dollar loans in 2015? We have little guide as to how hard this currency crisis is going to hit. Nigeria’s 2009 banking crisis was preceded by a devaluation of the naira, between December 2008 (N117.70/US$) and January 2009 (N147.90/US$) of 25.8 per cent, a bigger fall than the 13.8% we consider here. And 2009’s banking crisis was partly associated with margin lending and related-party lending, abuses which the CBN has done much to prevent since then.”

THISDAY exclusively reported on Monday that owing to banks’ exposure to the oil and gas sector in the face of tumbling oil prices as well as the risk management deficiencies revealed by a recent risk-based supervision exercise conducted by the Central Bank of Nigeria (CBN), the CBN has directed deposit money banks (DMBs) to ensure that they have sufficient capital buffers to mitigate the escalating risk-taking activities.

The central bank gave the directive in a letter addressed to all banks titled, “Oil and Gas Industry Credit Risk” signed by the Director, Banking Supervision, Mrs. Tokunbo Martins.

Consequently, the central bank stated that where exposure to the oil and gas sector (as defined by the International Standard Industrial Classification of Economic Sectors as Issued by the CBN), is in excess of 20 per cent of total credit facilities of a bank, the risk weight of the entire portfolio in such facilities would attract a risk weight of 125 per cent for the purpose of capital adequacy computation.

In addition, banks were directed to prepare and forward to the central bank their computation and results of their single-factor sensitivity stress test as at December 8, 2014.

The single-factor sensitivity testing is a form of stress test that usually involves an incremental change in a risk factor, holding other factors constant.

The price points to be used by the banks for the test are $50 per barrel, $55 per barrel, $60 per barrel and $65 per barrel.

The price of a barrel of crude oil has almost halved from $115 in June to around $60 last week. Most analysts have forecast that oil prices would remain low for most of next year and this may be the challenge banks in the country that have financed oil and gas deals would face.

[ThisDay]

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