Macroeconomic Challenges and Central Bank Policy to Pressure Financial Institutions in 2021

Measures put in place by the Central Bank of Nigeria (CBN) to curtail the negative impact of COVID-19 on the masses and the economy will hurt banks’ profitability in 2021, according to the latest report from McKinsey & Company.

In the report titled “Nigeria’s banking Sector: Thriving in the face of crisis“, the leading consulting firm posited that while the CBN stimulus package and other steps to mitigate the negative impact of COVID-19 on critical sectors have been reasonably effective, the banking sector faces a challenging road ahead.

The management consulting firm noted that banks’ profitability is also weighed upon by a high Cash Reserve Requirement (CRR) of 27.5 percent, one of the highest in the world.

“The CRR requires banks to park an increasing amount of local-currency deposits with the central bank, and restricts their ability to lend as these reserves are only available for intervention funds,” the report stated.

McKinsey & Company, a global management consulting firm, explained that “the CRR requires banks to park an increasing amount of local-currency deposits with the central bank, and restricts their ability to lend as these reserves are only available for intervention funds. Amidst all this, the CBN’s aspiration to achieve a financial inclusion rate of 80 percent by 2020 has led to increasing competition in payments from nonbank challengers.”

This explains why the actual growth of the sector in the last ten years has remained significantly lower at 12 percent while earnings stood at approximately 23.5 percent during the same period. Again, most of the earnings declared by these banks come from non-core banking activities like fixed income and derivative income (swaps, futures, and forwards).

“Derivative income in particular has become increasingly significant; the average Tier 1 bank carries around $1 billion worth of derivatives on its balance sheet and reports around $30 million as profit from trading in derivatives—approximately 12 percent of profitability.”

Therefore, salary cuts, layoffs and uncertainty surrounding business viability amid the worse economic recession in almost 40 years will further slow down revenues and increase loan loss provisions in 2021.

Also, margins of banks will drop due to the decline in interest rates on deposit margins while the risk costs will expand because of provisions for bad loans/write-downs from lending.

Loan volume growth is expected to remain modest in the new year, largely driven by lending to households to supplement reduced income and targeted credit facilities to corporates and some sectors such as manufacturing.

“Client-driven banking revenues could fall by as much as 18 percent by 2021, before regaining a slow recovery path,” the report noted.