What is the impact of the war in Ukraine on Nigerian banks?

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Nigeria’s obsession with oil is well documented. Oil and gas exports still account for 90% of the country’s foreign exchange earnings, so the economy has generally grown stronger when oil prices are high and struggled when they fall. Yet declining oil production and population growth mean that production is increasingly dispersed among the population.

At the same time, the country is spending a worrying proportion of its hard currency on fuel imports, although a new large-scale industrial project could stem the outflow, benefiting the entire financial system.

Nigerian banks have minimal exposure to Russia and Ukraine

Abuja attributes the current economic problems to the war in Ukraine and the pandemic, and these undoubtedly play a role. Still, ratings agency S&P says Nigerian banks have minimal exposure to Russia and Ukraine, so the war is unlikely to have a significant impact on their asset quality or profitability. Nigerian banks’ main exposure is to other African markets, the UK and Asia.

They are of course indirectly affected by the impact of the war on the Nigerian economy as a whole, particularly by the rising cost of basic commodities. For example, Nigeria imports about 50% of all its wheat from Russia and Ukraine, but Black Sea ports are currently struggling to ship agricultural products, so the price of imports from other suppliers increase.

In addition, it could be more difficult for Abuja, state governments and companies to issue debt, as the combination of the pandemic and the war in Ukraine has seen the appetite for bond issues in emerging markets. lessen.

The economy has benefited from higher oil prices since the lifting of most Covid-related restrictions elsewhere in the world, which has also been further fueled by the war in Ukraine.

Oil prices settled at $104 a barrel in the third week of July, down slightly from a high of $116 in March, but still very high by recent standards. As a result, rising oil revenues helped reduce the current account deficit last year. However, domestic oil production fell in the first months of 2022, with crude production falling to 1.49 mb/d in the first quarter, which weighed on economic growth.

At the same time, an upsurge in petrocrime, including illegal refining and pipeline attacks, has caused oil production in the Niger Delta to plummet. Such criminal and militant activity both affects current production and discourages investment in oil exploration and production, depressing longer-term production capacity.

As a result, Nigeria has been unable to fully exploit high oil prices. Some reports suggest crude production has been as low as 1.2mb/d, meaning Nigeria has been unable to fully utilize its OPEC quota of 1.8mb/d, and even this is far from the government’s ambitions of 4 mb/d. D.

Estimates vary wildly, but according to the Nigerian Upstream Petroleum Regulatory Commission, only 132 million barrels of the 141 million barrels of oil produced in the first quarter of 2022 were actually received by export terminals due to theft, which has cost the government about $1 billion in lost revenue. .

Various initiatives have been launched by successive governments, including military crackdowns, militant amnesties and widespread legal action, but all with limited success.

Force majeure even had to be declared at the Bonny Oil & Gas Terminal. Commission CEO Gbenga Komolafe said: “This trend poses an existential threat to the oil and gas sector and by extension the Nigerian economy if left unchecked.”

Due to low production, the rise in oil prices proved insufficient to stem the loss of foreign exchange reserves. Government foreign exchange reserves stood at $38.6 billion at the end of May 2022, down slightly from the $41.5 billion recorded in September 2021. That may not seem like a change significant, but the fact that the decline was recorded at a time of exceptional oil prices suggests that something is seriously wrong with the country’s finances.

Impact of high oil prices on banks

Fitch reported in May that “the most pronounced benefit of higher oil prices is less pressure on asset quality. Oil prices and Nigerian banks’ non-performing loan ratios have been closely inversely correlated in the past, reflecting the outsized exposure to the oil and gas sector in loan portfolios, the heavy dependence of the Nigerian economy on regard to oil revenues and spillover effects of oil to non-oil sectors.

Rising oil prices have also had a negative effect on the economy due to much higher prices for diesel, which is used as a raw material in the country’s many small electricity generators, which are used as backup by million people across the country. Intermittent but all-too-regular local power cuts gave way to blackouts across much of the country, including Lagos and Abuja, in March and April.

Fuel subsidies cost the government up to $7 billion a year, but President Muhammadu Buhari has failed to address the issue, despite promising to do so at the start of his presidency, likely fearing the public discontent if fuel prices increase.

In today’s high oil price environment, the government pays about half the cost of every liter of gasoline and diesel.

In addition, a significant portion of the subsidized fuel is then smuggled to neighboring states where fuel prices are higher. Part of the resistance to rising fuel prices in Nigeria is a cultural sentiment that it should be relatively cheap given that the country is a major oil producer.

Lack of hard currency

This would be easier to understand were it not for the fact that Nigeria imports most of the refined petroleum products it consumes due to idle domestic refining capacity.

The country’s fuel import bill varies with oil prices, but can be as high as $9 billion a year, which must be paid in hard currency. Abuja’s total budget for the current financial year is $39.4 billion.

The lack of foreign exchange in recent years has had huge implications for the economy, with the CBN forced to intervene to protect valuable reserves and leading to a 255% depreciation of the naira against the US dollar over the past decade. , including three devaluations since the outbreak. of the Covid pandemic.

The naira fell to a record low of around 600 against the US dollar on the black market in May, while the FX premium on the parallel market stands at 35-40%.

Insufficient foreign currency is affecting businesses across all sectors, while foreign currency deposits make up around 20% of total bank deposits, providing a hedge against a weaker naira, so it is vital that this buffer is protected. The CBN regulates the use of forex by banks across the country, and in addition to successfully combating fraud, it has in the past shut down banks that pursued illegal foreign exchange practices.

Still, help could be at hand with the planned completion of the massive Dangote Oil Refinery at Lekki Port this year.

It has a production capacity of 650,000 bpd, compared to the total nameplate capacity of 428,750 bpd of the country’s four existing refineries, which are generally either out of service or operating at reduced capacity.

The Dangote plant will be the largest single-train refinery in the world. In addition to providing much-needed jobs, being a key tenant in the nation’s premier deep-water port, and hopefully a reliable source of supply for refined petroleum products, it will save the economy a huge amount of foreign currency, with great benefits for the whole finance system.

Outlook

The CBN has required banks to achieve a loan-to-deposit ratio of 65% since March 2020 to increase lending levels. There is evidence to suggest that the sector is indeed becoming more efficient in corporate lending, with the level of outstanding credit to the private sector reaching N38trn in May, its highest figure on record, N6trn up from the same last month year.

Credit rating agency Fitch warned in late May that the operating environment for Nigerian banks could deteriorate in 2022-23 as adverse global economic conditions trickle down to the local economy, and it expects the CBN raises interest rates further, given the acceleration of inflation. .

However, he does not expect the Nigerian banking sector to suffer a significant shock and he calculated in July that Nigerian banks can absorb up to $6 billion in loan losses without breaching minimum debt ratio requirements. capital adequacy of 15% for internationally licensed banks, and 10% for all other banks.

Until the economy can be rebalanced to achieve much higher sustained levels of growth, the country will remain vulnerable to both internal and external shocks, and the retail and corporate client bases available to the country’s banks will remain. limited.