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Too-big-to-fail designation to reduce banks’ ROE – RenCap

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The Central Bank of Nigeria (CBN) draft document which has designated eight banks as “too big to fail”, due to the risk their failure could pose to the entire financial system, will induce an additional cost to banks and may lead to a reduction in return on equity (ROE), according to investment bank Renaissance Capital.

“We could sum up 2013 as the year of regulatory headwinds in the Nigerian banking sector,” RenCap analysts Nothando Ndebele and Adesoji Solanke said in a note released yesterday.

“We welcome measures to increase the viability and stability of the banking sector, but we believe some are unnecessarily punitive and make it harder for banks to deliver value-creating returns.”

The banks designated as “too big to fail” or Systematically Important Banks (SIBs) in the CBN draft paper include First Bank of Nigeria, United Bank for Africa, Zenith Bank, Access Bank, Ecobank Nigeria, Guaranty Trust Bank, Skye Bank and Diamond Bank.

According to the CBN, the banks that made the list were determined by assessing four criteria: size, as defined by total assets; interconnectedness, as defined by interbank exposures and volumes of other intra-industry assets and liabilities; substitutability, as defined by ease with which the institution can be replaced as a financial services provider; and complexity, as defined by how difficult it would be to liquidate the institution.

The top eight banks currently account for over 70 percent of the industry’s total assets.

A big impact of being named as an SIB is that some banks would require additional capital. The current capital adequacy ratio (CAR) in Nigeria is 10 percent for local banks and 15 percent for banks with international operations. The proposed changes for SIBs would, however, mean a minimum CAR level of 15 percent, irrespective of whether a bank is deemed local or has international subsidiaries.

RenCap notes that all banks’ CARs are above 15 percent as of nine months (9M 2013) and half year (1H 2013), as per disclosure.

“Zenith leads the pack with 28.3 percent at 9M13, while we estimate Ecobank Nigeria has the lowest at 16.0 percent as of August 2013, followed by Skye and Diamond at c.17.0 percent, respectively, at 9M13,” the RenCap analysts said.

The draft report also mentions that SIBs would be required to provide an additional 1 percent of capital as a Higher Loss Absorbency (HLA) charge, in addition to the prescribed minimum CAR, and hold more liquid assets and meet a liquidity ratio of 5 percent above the minimum requirement currently set at 30 percent.

The aim of the HLA, according to the draft, is to ensure that a large portion of these banks’ balance sheets are funded by permanent capital, and to deal with cross-border risks. The additional 1 percent surcharge can only be funded by tier-1 capital.

Should this be implemented, RenCap says it would effectively raise the minimum CAR to about 16 percent, hence placing further strain on the banks.

Zenith Bank has the highest liquidity ratio at 63.1 percent at 9M13, followed by First Bank at 62.7 percent at 1H13 (First Bank has not yet reported 9M13 results). At the other end of the spectrum are Skye at 31.5 percent and Diamond at 36.7 percent. Rencap says if the draft were to pass, Skye – and Diamond – would need to raise liquidity.

The CBN regulations such as the hike in the CRR – the minimum cash, as a percentage of customer deposits, that each bank must set aside as a reserve – to 50 percent are seen by analysts as putting pressure on banks’ earnings going forward.

The IMF estimates that a 2-percent increase in the level of the CRR adds approximately 0.5 percent to the spread between deposit and lending rates.

“We have not changed our view that in this environment, it is best to stick with the bigger, more liquid banks with generous balance sheets,” said RenCap.

“Our top picks in Nigeria are First Bank Holdings (BUY, Target price (TP) NGN20.5/share, current price (CP) NGN16.3/share), Zenith Bank (BUY, TP NGN25.3/share, CP NGN21.3/share), and GTBank (BUY, TP NGN29.1/share, CP NG26.2/share).”

Article Credit: Business Day Newspaper

Updated 5 Years ago

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