What have they done now?This week the Central Bank of Nigeria locked out nine banks from participating in the interbank foreign exchange market for failing to remit US$ government deposits worth US$2.3bn to the Central Bank as part of the Treasury Single Account directive, first implemented in September 2015.

It was our understanding that back in 2015, when the TSA was first implemented, that the CBN, cognisant of the tight US$ liquidity position of the banking sector, had granted a moratorium on the repayment of the same. We are therefore surprised by the sudden reversal in policy, especially since the US$ liquidity position of the banks, in our view, has progressively gotten worse.

Why the sudden change in heart?

Although we do not dispute the underlying logic of TSA implementation – the CBN should be the sole banker to the sovereign – Tuesday’s directive has the feel of a summary order from the Presidency rather than a practical working solution.

For one, the sums being mentioned in the media do not even tally with the industry-wide data published by the CBN: according to the former, banks are on the hook for US$2.3bn while according to the latter, total public sector FX deposits were just US$1.4-1.5bn at the end of July. But more importantly, any institution with a working knowledge of banks operations and balance sheets – as the CBN undoubtedly has – would know that overnight implementation of the TSA was not a realistic possibility. So beyond the immediate liquidity risk to the banks (which we discuss later in this note), this news will only add to perceptions that the CBN is not in full control of its regulatory functions.

How does this affect the Naira?

To the extent that the banks named in the directive will need to come up with USD liquidity immediately, we think TSA implementation will only pile more (downward) pressure on the exchange rate, which had already weakened from NGN328.25/US$ to NGN342.00/US$ as of this writing. However, as we argue throughout this note, we do not think that full and immediate implementation is possible. The affected banks do not have the required US$ liquidity to refund the TSA deposits, and the FX market is not deep enough for them to purchase those sums over any short-term horizon.

One possible work-around is that the CBN sells them US$ to cover existing (past due) trade obligations, on the agreement that the resulting liquidity would then be used to re-fund TSA deposits. This would enable (at least part) compliance with a directive that we assume is driven by the Presidency, with no net impact on reserves for CBN, and minimal impact on the exchange rate.

Is this a big deal for the banks?

Yes. At a headline level, the US$2.3bn of deposits represents 4.0% of total sector deposits, a shock the banks should easily be able to absorb. However the TSA deposits contribute a significantly higher proportion of banks US$ deposits; as highlighted in the table below, we estimate the TSA deposits account for almost 25.1% of bank’s total US$ deposits. With an average US$ loan-to-deposit ratio of 121.9%, we believe bank’s US$ liquidity positions are already quite stretched.

The TSA repayments combined with the repayment of outstanding debt maturities will, in our view, significantly stretch banks’ dollar liquidity, especially since banks have little scope for liquidating their US$ assets (most of their US$ assets are in the form of loans to the oil & gas and power sectors, whose durations have been increased significantly in the past eighteen months as part of efforts by banks to mitigate credit risk).

How bad can it be?

We have argued in the past, that a banking crisis in Nigeria will not be crystallised by significant asset quality deterioration or capital inadequacy; these are issues which the banks can defer by either restructuring their balance sheets or getting a temporary moratorium from the CBN. However, as we have seen for the Western banks during the global financial crisis, a liquidity crisis cannot be “kicked into the long grass” and gradually resolved over time.

Given the magnitude of the figures being quoted, we think enforcement of the policy could potentially cause significant liquidity problems for some of the banks involved and that in turn could become a systemic problem for the entire sector.

Can’t they just bail them out i.e. AMCON 2?

No, unlike the 2009 crisis, the issues that the Nigerian Banks face is on their US$ balance sheet. Thus, unlike 2009, the CBN cannot bail out the sector by issuing and then monetising promissory notes (AMCON bonds). In case of a full scale crisis, the banking sector will need a “hard currency” bailout which the CBN or Nigeria cannot afford. To put things in context, the aggregate TSA deposits of US$2.3 is almost 10% of the countries FX reserves.

Are we likely to see a policy reversal (again)? Given the current fundamentals of the country, we think the negative impact of a full scale banking crisis far outweighs any positive benefits that the government will accrue from additional US$ liquidity on its own balance sheet (especially when the amount in consideration of US$2.3bn is not that significant). We therefore think the CBN might re-consider its policy decision.

One man’s poison is another man’s cure.

We think this development could have positive consequences for the banks not directly impacted by this policy directive. Specifically, within our universe, we think Guaranty Trust Bank, Zenith, Access and Stanbic IBTC profitability ratios could benefit from: a) an increase in trading revenue due to potential volatility of the Naira and increased market share in the interbank market (as most of their competitors are locked out); and b) like in H2, we think the banks could record significant revaluation gains due to a depreciation of the Naira. Of course, the tail risk of contagion from a full scale liquidity crisis would outweigh any of these benefits.

CBN Graph Exotix

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Ronak Gadhia, CFA; Alan Cameron

Website: www.exotix.com