As part of efforts to boost credit lending and stimulate economic growth, the Central Bank of Nigeria (CBN), last week, increased the minimum Loan Deposit Ratio (LDR) of commercial banks to 65 per cent, up from 60 per cent that it announced in July. LDR is a portion of customers’ deposit that is given out as loans. The banks were given September 30 to comply with the directive. Although most banks were reported to have failed to meet the 60 per cent LDR, the apex bank explained that the upward review became necessary to stimulate growth in the economy through adequate funding and investment in the real sector.
It is also part of regulations aimed at compelling banks to increase lending to farmers, small and medium-size businesses and consumers. Arising from this development, the banks now have until December 31, 2019 to comply with the directive or risk an additional Cash Reserve Requirement (CRR) equal to the 50 per cent of lending shortfall implied by the ratio.
The CBN Director of Banking Supervision, Mr. Ahmad Abdullahi, pointed out that the upward review of the LDR to 65 per cent was to “sustain the momentum” of compliance in lending. According to the CBN, the new directive is to be reviewed quarterly. It enjoins commercial banks to strengthen their risk management practices in their lending operations.
We believe the measure will reignite growth in key sectors of the economy and improve access to credit for operators of micro, small and medium enterprises. So far, the total credit extended to the real sector by the banks is not encouraging. For instance, in 2018, the total lending by the banking industry to the real sector was N15trillion. Also, as at July 2019, when CBN directed the banks to attain a minimum 60 per cent LDR, the total industry LDR stood at 57.64 per cent.
This is less than three per cent below the target. But the banks explained that the below target performance in credit lending was largely due to surge in bad loans in the wake of crash in crude oil prices. The economy is still vulnerable to both local and external shocks because of the deterioration in debt sustainability and rising bad loans, low capital adequacy and weak capital assets.
With the increase in LDR, it is expected that the impact on asset quality of the banks will improve significantly when the economy begins to improve. We believe that the measure will lead to increased lending. But our worry is that the new measure is coming at a time when many banks’ net interest margins have come under intense pressure because of lower yields on government securities. The problem now is how the banks will meet the new threshold when most of them could not meet the earlier minimum threshold of 60 per cent ratio. If the recent report that only two of the nation’s top six banks met the requirement as at September 30, what is the guarantee that all the banks will meet the new LDR at the end of December deadline? The CBN should ponder over this and do what is necessary to achieve the target without arm-twisting the banks.
There is no doubt that the 57 per cent LDR is too low to make appreciable impact in the real sector of the economy. The CBN should ensure that a viable scoring system similar to what is obtainable in developed economies is put in place before the December deadline to avoid putting the banks at great credit risk.
Though the LDR in South Africa is 91 per cent; Kenya, 76 per cent; India, 75 per cent and Japan 70 per cent, their banking industry is on firmer ground with sound asset quality, low non-performing loans and adequate capital ratio. These indices might have made bank failures in these economies a rare occurrence. Undoubtedly, bad loans and weak capital assets are dangerous to the health of the banking industry.
All the same, if the banks must play their traditional role as financial intermediation, it is appropriate that they comply with directives that will make credit accessible to borrowers at affordable interest rates. The current slow growth in the nation’s Gross Domestic Product (GDP) is likely to continue unless the real sector, which holds the engine of economic development with projected 60 per cent contribution to the nation’s GDP, is given priority in credit lending.
Therefore, we urge the banks to use the three months window to increase their loan to deposit ratio to the new requirement of 65 per cent. They should see the new lending policy as a timely intervention to normalise the credit markets and spur economic growth.