How FX revaluation gains impacts Nigerian banks

Fitch Ratings has provided an insightful analysis on how risks to capital from further naira devaluation and loan quality pressures should not affect ratings for most banks in Nigeria. Despite the devaluation of the naira by about 40 per cent since June this year, Nigerian banks have been able to maintain compliance with minimum capital requirements. Tim Slater, Director of Banks at Fitch Ratings, outlined the impacts of FX devaluation gains from Nigerian banks. He emphasized that the devaluation has two immediate impacts on bank solvency. Firstly, it inflates the foreign currency risk-weighted assets of banks. However, Nigerian banks hold relatively small foreign currency loan portfolios, limiting the inflation of risk-weighted assets. Secondly, banks hold significant long positions in foreign currency, with their foreign currency assets surpassing liabilities. This has enabled banks to realize substantial foreign exchange revaluation gains in the first half of the year, bolstering capital and offsetting the impact of inflated risk-weighted assets. As a result, most banks in Nigeria have remained compliant with regulatory capital requirements despite the significant devaluation. Slater highlighted the importance of the central bank's directive for banks to retain FX gains rather than distribute them as dividends. This move strengthens capital buffers, supporting bank solvency and reducing credit risk. Fitch Ratings noted that while most banks have a stable outlook, three banks - Ekobank Nigeria, Coronation Merchant Bank, and First City Monument Bank - are on rating watch negative due to thinner capital buffers. The discussion also touched on the possibility of further devaluation, with uncertainties arising from foreign currency shortages. Although risks to bank loan books are expected to increase in response to the challenging macroeconomic environment, Fitch Ratings believes that banks have adjusted their underwriting standards to mitigate devaluation risks compared to previous episodes. While asset quality may face challenges, the sector's exposure to the oil and gas industry adds complexity, especially with loans denominated in foreign currencies. Despite these challenges, Nigerian banks' loan portfolios remain relatively small, reducing overall asset quality risks. Looking ahead, higher interest rates could benefit banks' profitability, driven by a rise in Treasury bill yields. However, the high cash reserve requirement in Nigeria presents a profitability challenge, as unremunerated cash reserves at the Central Bank of Nigeria weigh on earnings. The loan-to-deposit ratio is viewed negatively by Fitch Ratings, with concerns about increased credit risks in a weaker macroeconomic environment potentially impacting asset quality, profitability, and capitalization. Overall, Fitch Ratings maintains a cautious yet stable outlook for Nigerian banks, acknowledging the sector's resilience amid challenging market conditions.