Expansion of financial inclusion to reach more unbanked customers in Nigeria

Nigeria’s banking sector is a diversified one, in which the largest banks follow the universal banking model and a range of specialised actors tap specific niches within Africa’s largest economy. New trends include merchant banks, sector-specific lending vehicles, and from policymakers, increased focus on financial inclusion. These include microfinance, mobile tools, and the establishment of a network of mobile money agents to service this developing financial infrastructure.

For now, however, the banking sector features a slate of risks that leaves banks reluctant to lend to the private sector, and economic actors of most types suffer from inadequate access to finance. Many of the banks that had extended credit to the oil, gas and power sectors earlier in the decade have lost money on those loans, and are now cautious. This credit was extended before oil prices dropped in mid-2014, and at a time when plans for privatising and enhancing the utilities sector were expected to boost power supply and capacity and create a new group of credit-worthy electricity businesses. Visual evidence of that period of easier credit availability for energy entrepreneurs is still apparent at Lagos’ central business district, where the total of repossessed offshore oil rigs moored has grown from two to four as of the spring of 2018. Concerns over asset quality are not gone, but are diminishing thanks to an early-stage economic recovery in Nigeria as a result of a rise in oil prices in 2017 and early 2018.

Credit Demand

For financial institutions the least-risky course of action in Nigeria has traditionally been to lend to actors outside the private sector. Options pursued in recent times include servicing government clients, investing in public sector securities, and, in the mid- to late-2000s, margin lending to equities investors, often so they could buy shares of bank stocks. The latter practice led to a solvency crisis and bailouts, and since then the government and the Central Bank of Nigeria (CBN), the country’s banking regulator, have been working towards the right mix of law and regulation to protect the banking sector from instability and prevent the public sector from crowding out private sector credit demand. The goal is to make financial institutions more enthusiastic about lending to real economy actors, in hopes of driving long-term development and sector growth.

Size & Scope

As of October 2018 there were 21 commercial banks licensed by the CBN, a 75% drop from July 2004 when there were 89 – with the marked decrease being in part due to a consolidation programme. Licensees also include five merchant banks, six development finance institutions, five discount houses, 64 finance companies, 36 mortgage institutions and 1106 microfinance companies. “Nigeria now has more than 1000 microfinance institutions, many of which do not have the capacity to function adequately. The issue of consolidation should be the primary focus of the industry, along with ways to optimise the benefits of the ongoing digital revolution,” Godwin Nwabunka, CEO of the Grooming Centre, told OBG. The country also has 3048 bureaux de change and one Islamic bank, which follows a sharia-compliant approach to banking in which interest payments are neither charged, nor collected. Islamic banks instead charge fees for services, often calculated to be competitive with interest rates.

The sector is led by eight large banks, which are considered systemically important. These are referred to as Tier-1 banks and include sector players such as First Bank of Nigeria, Zenith Bank, Access Bank and United Bank for Africa (UBA). Together, these firms account for 70% of market share by assets. “Tier-1 banks lend to the choice customers and have the best retail platforms,” Chinedu Onyia, founder of Parsifal Partners, a Lagos-based management consultancy, told OBG. “They are looking to do current and savings accounts, and payments services, but not much retail lending.” The central bank introduced a regulatory framework that applies specifically to this group in 2014, including boosting both the capital adequacy ratio (CAR) as well as the liquidity ratio, but implementing those moves has now been deferred indefinitely. There are further divisions amongst the 21 main commercial banks that limit their geographical scope – 10 have authorisation from their central bank licence for international operations, whereas nine are domestic banks and two are limited to specific regions.

Foreign investment in Nigeria’s banking sector has been limited to a few early entrants, but the trend is positive. South Africa’s Standard Bank has established a presence in the form of Stanbic IBTC Bank, and the UK multinational Standard Chartered Bank has as well. South Africa’s FirstRand, Africa’s largest financial services provider, is present in the market with Rand Merchant Bank Nigeria. As of 2018 others interested in increasing their exposure included Atlas Mara, the London-based and Africa-focused investment vehicle owned by former Barclays CEO Robert Diamond. The company announced in June 2018 that it was increasing its stake in Union Bank of Nigeria from 48% to 49%. In addition, Barclays Africa CEO Maria Ramos said in March 2018 that the bank was eyeing the Nigerian market as part of an effort to boost its share of the African banking market from 6% to 12%.

Within the group of Tier-1 and mid-sized lenders, business models are tailored to Nigeria or have a regional strategy. In some cases, banks have been conceived with this focus in mind – Ecobank, for example, was founded in 1985 in Lomé, Togo, with the purpose of following a continental strategy and providing an African banking option at a time when the sector was dominated by foreign investment and profits repatriated elsewhere. The challenge for now is profitability: regional banks tend to generate lower returns and grow more slowly than those limited to one country, according to an October 2017 report “Remaking the bank for an ecosystem world” from the management consultancy McKinsey & Company.

Sector Organisation

The CBN, as regulator, plays a large role in shaping the banking sector, with several of the major changes and evolutions in recent years originating from the regulatory agenda. The first big change came in July 2004, when a capitalisation exercise was driven by then-governor Chukwuma Charles Soludo. The average capital base for a bank at the time was N2bn ($6.5m). Soludo’s reform programme mandated raising minimum capital requirements to N25bn ($80.8m), and that helped drive consolidation of the licensees. However, the move also helped shift banks’ attention to capital markets, as a way to raise funds and boost share prices, which in turn set the scene for a domestic banking crisis that manifested itself in 2009, independent of the global financial crisis at the time.

In subsequent years, following the crisis, banks realised that they could boost their capital through repeated share issuances. Even though adding to the existing volume of outstanding shares in an equity venture would upset existing shareholders, because profits were to now be split between a greater number of shares, the market move worked as long as share prices rose. Some banks were helped by investment managers and investment firms encouraging clients to buy bank shares and helping them arrange for margin loans in with which to do so.

The crisis was also a unique opportunity for Nigeria to rethink its economic priorities and the targets of its bank loans. “Banks have to play a greater role in the development of the economy by lending more outside the oil and power sectors,” Charles Kie, former managing director of Ecobank Nigeria, told OBG.

New Leadership

Soludo was replaced in May 2009 by Sanusi Lamido Sanusi. By this time a banking crisis was seen as possible, with investment managers concerned about inflated stock prices and a mismatch between them and actual assets and profits. Sanusi led the drive to end margin lending, drove corrupt CEOs out of jobs, and helped to establish the Asset Management Corporation of Nigeria to purchase bad debts from banks. Several lenders were nationalised and recapitalised, and the non-performing loan (NPL) ratio fell from 32.8% at the end of 2009 to less than 3% in 2014.

Sanusi was followed in June 2014 by Godwin Emefiele, a former CEO of Zenith Bank, as the new CBN governor. Emefiele was appointed at a difficult time: oil prices were about to plunge, triggering a currency crisis and the CBN and federal government were working on monetary, fiscal and trade policy moves to prevent a collapse in the naira’s value and preserve investor confidence. This policy package was tweaked several times without success until April 2017. At the time, a combination of currency futures became available through the FMDQ Over the Counter Securities Exchange, enhancing the availability of foreign exchange (forex) for importers and exporters through the CBN.

Currency Test

The central bank remains an intervening force willing to use both foreign reserves and monetary policy to keep the naira from falling out of a desired range, but the changes it has allowed have introduced a greater degree of market-based price discovery for the currency than any other time in the past.

However, the issue of transparency at the central bank is becoming a greater concern as outlined in the 2017 draft annual report, published in August 2018. The delay in reporting can be pinned to an extent on the banks, as the CBN relies on prompt disclosures by licensees in order to generate the statistics used in its own publications. In April 2018 the CBN published a directive announcing that banks are to file their required annual reports within 12 months of the end of a financial reporting period. Fiscal years end on December 31 for the Nigerian banking sector, with violators facing the possibility that in the future, they would be made to fire their CEOs, as per the directive.

Solvency

With the Nigerian economy emerging from recession in 2017, and with domestic owners of power sector assets still struggling through a reform and privatisation process that has yet to work out as planned, there were some residual concerns about asset quality in the banking sector as of spring 2018.

In March 2018 the IMF called for a review of banking assets with its annual Article IV evaluation of the economy. The IMF had some concerns that some banks may require capital injections and also encouraged enhancing risk-based supervision and “strict enforcement of prudential requirements”.

Resiliency in the market is more likely among the Tier-1 banks, according to a report from Fitch Ratings, which cites currency stability as an important ingredient for banks, some of which have as much as 40% of assets and liabilities denominated in dollars. A depreciation from the current level, in which official rates range from about N305 ($0.99) to N365 ($1.18), could send CARs below regulated thresholds. The minimum is 16% for Tier-1 banks and 15% for those with licences that allow international operations. For the rest, it is 10%. Fitch analysed the sector based on a scenario in which the naira depreciates to N450 against the dollar.

Solvency concerns may also be heightened by the adaptation of a new global financial standard for how assets are accounted for on balance sheets. The International Financial Reporting Standard 9, published by the International Accounting Standards Board, moves provisioning from a reactive approach to a proactive one, in which banks must set aside provisions in advance based on loss expectations. The result is likely to be that some loans are re-categorised as in default, and key banks see higher cost-of-risk ratios. Expectations for impairment charges will rise with the ratio, though likely at a rate well below 1%, according to market research from Renaissance Capital. CARs could also fall.

In a June 2018 speech to banking sector compliance officers, Ibrahim Magu, acting chairman of the Economic and Financial Crimes Commission (EFCC), highlighted the risk of insolvency for banking customers who may have gained funds through corrupt means, and said that some banks could collapse as a result. The EFCC wants banks to balance privacy concerns with transparency and accountability, while offering lenders assistance in getting defaulters to repay their loans.

Corruption Battle

Banks have had to adjust in recent years to the anti-corruption efforts that President Muhammadu Buhari made a central pillar of his 2015 election campaign, and these are also a variable that could impact earnings in the short-term. For example, anti-corruption measures led some people in the country to close down their accounts and remove assets from the formal system. Banks lost an estimated 2m customers in 2016 and 2017, and the number of active accounts has dropped by 1.5m, according to data from the Nigeria Inter-Bank Settlement System, to 63.5m. In some cases, money was returned to the federal government, through its Voluntary Assets and Income Declaration Scheme. Customers must now provide a Bank Verification Number (BVN) as an identifier linked to their accounts, possibly another factor that is discouraging customers. The hope is that corruption is reduced, and figures show that BVN-linked accounts rose from 26m in 2016 to 41.3m a year later.

Emefiele said in February 2018 that the CBN will implement new money laundering regulations to curtail the activities of unlicensed shell banks. The new regulations would be in accordance with the latest recommendations of the Paris-based Financial Action Task Force. Previous moves to reduce corruption in the banking system include the closure of most accounts held by ministries and most other bodies which receive budget allocations. Those accounts have been consolidated into the Treasury Single Account system at the CBN to help the Federal Ministry of Finance gain a clearer picture of cash flows across federal bodies and remove opportunities for leakages. A by-product of the change however has been the loss of a reliable source of deposits for the banking sector.

Commercial Lending

Nigerian banks have typically looked to limit their private sector exposure to the biggest and most financially secure customers, preferring safer and shorter-term loans than extending credit to riskier borrowers at higher rates. Access to credit is widely seen as an obstacle amongst potential borrowers, and the government has responded with lending schemes for areas identified as suitable for policy support, such as the food and agriculture sector. Nigeria wants to increase domestic food production to end the increasing need for imports, and therefore has created several lending schemes over the years to both help reduce risk for financial institutions as well as increase private sector lending, such as the Nigeria Incentive-Based Risk Sharing System for Agricultural Lending that was launched in 2011 and aims to build capacities of both banks and value chain actors. There are also specialist banks created by the state to aid with financing, such as the Bank of Agriculture, the Bank of Industry, the Federal Mortgage Bank of Nigeria, the National Economic Reconstruction Fund, the Nigerian Export-Import Bank and the Infrastructure Bank.

The transport sector has also benefitted from lending schemes. In May 2018 the government’s plan to create its own aircraft leasing company won support from the African Development Bank (AfDB) and African Export-Import Bank. The two institutions agreed to raise $20bn as seed capital for Abuja’s proposed leasing company. The plans dovetail with Nigeria’s efforts to re-establish a flagship air carrier, as well as multilateral ones to boost intra-African air travel. It is expected that $4bn of the funding will be spent on 50 medium-sized short-haul aeroplanes for regional flights.

Equity in Energy

Once major lenders to the oil, gas and power sectors in Nigeria, banks have reversed course in the latter half of the 2010s. Banks provided most of the financial backing to conglomerates who bought majority stakes in most of the state’s power plants and regional distribution companies in a 2013 privatisation exercise. The federal government had hoped that shifting ownership of these assets to the private sector would trigger new investment in the sector and end a history of undersupply and dysfunction.

At the same time, banks were financing another set of local energy entrepreneurs who were purchasing equity stakes in oil and gas fields, some of them in production and others in the development stages. These transactions were the result of multinational oil companies including Shell and Chevron seeking to divest some of their assets. Shell and others aimed to restructure their portfolios to increase offshore projects, whereas for US multinational energy firm ConocoPhillips a $1.79bn asset sale in 2014 to Oando facilitated an exit from the Nigerian market. Deals took place in a period of high oil prices, with pricing tied to the current value of oil and size of the deposits; however, with the collapse of international oil prices in mid-2014, new buyers were no longer able to generate revenue at the levels expected when they had agreed to loan terms, leaving both themselves and their bankers with exposure.

One of the biggest bets was made by First Bank of Nigeria, the largest lender by total assets, which stood at N5.3trn ($17.1bn) at the end of June. It had an NPL ratio of 20.8%, of which more than half came from various energy sector activities.

System-wide bank credit to the oil, gas and power sectors accounted for 26% of the total extended to the private sector as of 2017, a figure that fell to 22.5% as of the second quarter of 2018, according to the National Bureau of Statistics. That was followed by manufacturing at 13.2% of total credit. Lending to government accounted for 9.6%. An indication of increased interest in commercial banking, however, is the addition of several merchant banks to the market since 2013, including a division of First Bank called FBNQ uest, and Rand Merchant Bank Nigeria. The CBN website lists three other merchant banks: Altitude Microfinance Bank, Coronation Merchant Bank and FSDH Merchant Bank.

Retail Banking

Given that banking the government and blue-chip corporations is seen as significantly less risky in Nigeria, the retail banking market is much less developed. Getting banks to focus on the real economy is a main policy goal in the country.

The effort to make retail banking more attractive was helped by the Treasury Single Account, which removed from the market an easy source of large-scale current and savings accounts deposits. The government has also decided that its approach to sovereign borrowing should focus on international markets rather than domestic ones, where treasury bills fetch a yield near 20%. A market with a large supply of bonds with that kind of return is seen as a far better bet than lending to the private sector, either at a premium of a few percentage points for blue-chip corporates or at even fatter margins in the retail market. For Abuja, the decision to sell fewer of these bonds and more international ones means both a lower cost of debt servicing, because eurobonds have lower yields, as well as the removal of an incentive for banks to avoid lending to the economy.

The CBN’s continued effort to create regulatory incentives for banks to service the real economy has been years in the making, and a source of policy continuity from the previous Sanusi years to those of Emefiele now. One of the most-recent moves to help boost private sector credit access came in 2017 with the CBN’s licensing of the Development Bank of Nigeria (DBN). Its stated role is to fill the funding gap for micro-, small and medium-sized enterprises (MSMEs). Banks often consider MSMEs in the same category as retail consumers, often because these small businesses lack the detailed financial accounts, sometimes audited by outsiders, that help de-risk larger corporates. The estimated 37m entrepreneurs and small businesses in Nigeria contribute about 50% of GDP, but just 5% can access credit, according to the DBN’s figures. The European Investment Bank has contributed a $20m equity stake, and the AfDB $50m.

While efforts have yet to pay off – rather, Nigeria is in the midst of a sector-wide debate about how to bring more people into the banking system – technology could emerge as an additional driver of the process.

Banks are either boosting spending on their own technology-acquisition process or hiring financial technology (fintech) companies to help them, according to research from Exotix Partners, a developing countries-focused investment research firm. “Key goals are to lower customer acquisition and product distribution costs, improve the customer service experience and improve understanding of customer behaviour,” according to Exotix research. Diamond Bank, for example, which has a retail base of about 15m customers, has developed a new banking app it hopes will add 1m more customers from the youth segment.

Banks are also pairing with other corporations where synergies are available, such as with bancassurance relationships. For example, in May 2018 Access Bank announced a partnership with Kia Motors Nigeria for automotive financing. Kia customers who qualify would be offered financing and entitlement options, with loans of up to 90% the value of the vehicle.

Inclusion Debate

At the core of this debate over technology and reaching the unbanked is the role of telecoms companies. In developing countries, it is often mobile telephony providers that have the greatest ability to reach customers, given they have built country-wide networks of airtime sellers and service points, as well as agents who go to small places far from banks to provide services. However, in Nigeria, as in many other countries, the banking regulator has been reluctant to licence telecoms providers as financial services providers. Despite this, parameters for fintech are now enhanced and 2018 has seen the continued maturation of fintech start-ups, particularly in the payments segment. Of the $117m raised by start-ups in the first nine months of 2018, the lion’s share has gone to fintech firms such as Flutterwave, Paga and Paystack, all of which have seen increasing attention and funding from major global players including Mastercard, Visa and Stripe. This financial inclusion story is poised for its next steps, including the development of a nationwide agent network that can be used by all of its citizens, as well as steps in how to mitigate exposure to unbanked customers with unproven creditworthiness.

Outlook

With economic recovery in Nigeria deemed at both a fragile and early stage within the business cycle in mid-2018, forecasts indicate a range of outcomes. Rising oil prices and a stable naira are a boon to lenders’ operating environment, and liquidity risks are falling as a result, according to a May 2018 report from the global ratings service Moody’s. However, the ratings agency also highlighted that asset quality remains weak, indicating outstanding loans on the books to companies that are seen as having risks. Moody’s expects that for loans that are underwritten in the near future, 15.5-18% could end up in the default category.

Overall, performance is not expected to slide due to the counteracting improvements in the economy. As well, loan growth should climb to reach 7-10%, according to Exotix research. Regulatory moves leave banks with fewer high-yield options that do not help the real economy, which could hamper earnings growth. Activity over the course of the year may be lighter than it otherwise would be however because of the February 2019 presidential election, when President Buhari will seek re-election for a second term. Thus, for investors in a young democracy like Nigeria’s, a national election is often seen as reason to reduce holdings and delay new capital deployment or borrowing until after the vote.