Nigeria: Selected Issues
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International Monetary Fund. African Dept.
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Publication Date:
08 Apr 2016
eISBN:
9781475550559
Language:
English
Keywords:
ISCR; CR; price; firm; Nigeria; monetary policy; firms' use; medium-size firm; firms in a number of state; firms' performance; firm size; Capital formation; Commercial banks
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Nigeria: Selected Issues

Abstract

Nigeria: Selected Issues

Financial Deepening and the Non-Oil Sector Growth in Nigeria1

1. Nigeria’s recent growth has been supported by the strong growth in the non-oil sector. It is important to investigate how much of the non-oil growth was associated with the oil price boom. In particular, it is important to understand how the growth in the oil sector was transmitted to the non-oil sector growth, both by raising aggregate demand in the economy but also by raising aggregate supply and potential output of the non-oil sector. The channel of transmission through the aggregate demand channel was analyzed in the 2014 Article IV using the input-output table. The transmission through the aggregate supply channel, in particular by financing investment (both fixed capital formation and working capital) in the non-oil sector is less understood. Better understanding of the magnitudes of spillovers through the aggregate supply side of the economy is important at this juncture as the reversal of oil price boom observed since summer 2014 could result in not only a decline in the aggregate demand but also in the aggregate supply and potential output which could have a lasting effect on the long-run growth.

A. Impact of the Oil Price Shock on the Corporate Sector

2. The collapse in oil prices reduces the aggregate demand. A decline in oil prices and a decline in terms of trade more generally can reduce consumption demand by reducing real income and wealth. The 2014 Article IV estimated, using the input-output table, the effect of a unit decline in oil price on consumption demand. Given that the majority of consumption goods and services are produced in the non-oil sector, the impact of a decline of oil prices on the non-oil sector growth was nontrivial: non-oil growth was projected at 5.5 percent in 2015, down from 7.2 percent for 2014.

3. How much could the collapse in oil prices reduce aggregate supply by reducing financing available for working capital and fixed capital formation for the non-oil sector? The more important channel of spillover from the oil sector for the country’s long-term sustainable growth is the channel through investment. How much has the oil price boom been fueling investment and in turn raising potential output or long-run aggregate supply? To answer this question a number of questions need to be investigated. How much of the growth in investment (both fixed capital formation and working capital) in the corporate sector in recent years financed by retained earnings as opposed to other sources of financing such as credit from suppliers, bank credit, equity and bond financing?

4. Sources of financing have a critical importance in assessing inter-linkages across sectors from the supply-side of the economy. If fixed capital formation and working capital investment rely solely on retained earnings, then a decline in demand for goods and services in one sector and thus a decline in retained earnings in that sector will impact availability of funding for fixed capital formation and working capital for that sector. On the other hand, if other sources of financing become available through financial deepening, then firms in one sector can mitigate some of adverse demand shocks in that sector by borrowing from resources available from other sectors. This change makes the economy more robust to shocks. But this change also implies that an adverse shock in one sector (e.g., the oil sector) can be transmitted more easily to other sectors of the economy (e.g., non-oil sector) through reducing investment and growth in other sectors.

5. Enterprise surveys conducted in the eve of the 2008-09 financial crisis and in the midst of 2014 oil price shock suggest that means of financing investment changed in Nigeria. Enterprise surveys show that growth real sales in the corporate sector was on average 13.6 percent before the 2008-09 crisis but was down to 3.5 percent in 2014. Empirical investigation suggests that the transmission of the slowdown in the oil sector (which began in 2012) was more prominently observed in firms in non-oil sector that have benefited from financial deepening partly due to changes in means of financing their fixed capital formation and working capital.

Survey coverage

6. This section uses the World Bank’s Enterprise Survey to get a snap shot of the corporate sector activities in two periods, (i) the eve of the 2008-09 global financial crisis and (ii) the midst of the 2014 oil price shock. Enterprise surveys were conducted in 2007, 2009 and 2014. In 2007, 2,387 firms in 25 states were surveyed. Subsequently, in 2009, 3,157 firms in remaining 11 states were surveyed. As these two sampling periods, 2007 and 2009, covered the entire country, in this section of the paper, the first survey period is referred to as the 2008 survey or the survey conducted at the eve of the 2008-09 global financial crisis. In 2014, 2,676 firms in 19 states were surveyed. This survey is also referred to as the survey conducted the midst of the 2014 oil price shock as it was conducted during April 2014 and February 2015. The panel dataset for this study was constructed to include only firms that had an observation in 2008 (either 2007 or 2009) and 2014, which comprised 1,354 firms in 18 states.

7. The panel data constructed for this study cover a wide range of enterprises across states, sectors, and size. The total number of firms observed both in 2008 and 2014 are 1,354 firms (Table 1). It is important to note that 1,354 firms is a small set of firms as the enterprise population for the entire country is estimated in the range of 73,000 firms.2

Table 1.

Nigeria: Enterprise Survey Coverage, 2007/09 and 2014

article image
Sources: Enterprise Survey; and IMF staff calculations.

Growth

8. Real annual sales growth at the eve of the 2008-09 global financial crisis was much higher than in the midst of oil price shock in 2014.

  • Annual sales growth reported in the current fiscal year from a previous period was on average 13.6 percent in the 2008 survey while only 3.5 percent in the 2014 survey (Table 2 and Figure 1).

  • Firms in a number of states in the north west region (e.g., Zamfara, Sokoto, Kebbi, and Katsina) experienced a sharp decline in annual sales growth, though there were some exceptions (Kaduna).

  • Real annual sales growth declined the sharpest in the chemical and pharmaceuticals industry, while the construction industry showed a robust growth in the 2014 survey.

  • The real annual sales growth observed in the 2014 survey portrays similar patters observed in the national income accounts data (e.g., strong growth in IT services and construction) but not all for all sectors (e.g., textile, chemical and pharmaceutical products, basic metals, machinery and equipment, and accommodation and food services all showed strong growth in the national income accounts data).

  • It is important to note that the evidence of slowdown in the real annual sales growth was observed for firms with all sizes but a large variation was observed among large firm, some continue to do well with others (e.g., retail and whole sale trade and hotel and restaurant) facing a much sharper decline in real annual sales.3

Table 2.

Nigeria Growth in Real Sales, 2007/09 and 2014

(Percent)

article image
Sources: Enterprise Survey; and IMF staff calculations.
Figure 1.
Figure 1.

Nigeria Growth in Real Sales: By Firm Size, 2007/09 and 2014

(Percent)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A004

Sources: Enterprise Survey; and IMF staff calculations. The point and the line indicate the mean and the confidence interval.

Labor input

9. The sources of slower growth in the 2014 survey are examined in turn. More specifically, the rest of this section explores differences in labor, capital, and productivity between the 2008 and 20014 surveys.

10. Annual employment growth declined in the 2014 survey relative to 2008 survey. It declined from the average growth of 8.3 percent in the 2008 survey to 5.3 percent in the 2014 survey (Table 3).

  • There were notable differences among firms with different sizes. While small- and medium-size firms were contracting the employment size, large-firms (with some variations) were expanding on average.

  • Employment continued to grow in some states (e.g., Cross River, Enugu, Gombe, Niger, and Oyo states) in 2014, but a sharp decline in others (e.g., Katsina), but there is no regional pattern. Employment continued to grow in chemical and pharmaceuticals despite a decline in real sales growth. This in terms implies that there was a significant decline in labor productivity in this sector.

  • Growth in the use of temporary workers did not change much between the two periods.

  • The female ownership seems to have declined sharply between the two periods (Table 4). The question was as “among the owners of the firm, are there any females?” and the statistics in the table is the average of yes = 1 and no = 2. That is, the average of 1.16 for 2008 implies that there were 16 percent of the firms in the sample that answered no to this question in 2008. However, 74 percent of the firms indicated no females in the ownership.

Table 3.

Nigeria: Growth in Employment, 2007/09 and 2014

(Percent)

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Sources: Enterprise Survey; and IMF staff calculations.
Table 4.

Nigeria: Female Ownership, 2007/09 and 2014

(Percent)

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Sources: Enterprise Survey; and IMF staff calculations.

Fixed capital

11. The fraction of firms that purchased fixed assets also declined in the 2014 survey (Table 5).

  • The question asked was “Did This Establishment Purchase Any Fixed Assets In Last Fiscal Year?” The table is the average of yes = 1 and no = 2. That is, 53 percent of the firm did not invest between 2007-08, while 61 percent did not investment between 2013-14.

  • There is a large difference between the two periods among large firms (Figure 2). In 2008, only 16 percent of large firms indicated “no investment in the past year,” while in 2014, 49 percent of large firms as such. This evidence is consistent with what is presented in the later part of this paper that the larger firms were more expansionary in the earlier period.

Table 5.

Nigeria: Fixed Capital Investment, 2007/09 and 2014

(Index: Yes = 1; No = 2)

article image
Sources: Enterprise Survey; and IMF staff calculations.
Figure 2.
Figure 2.

Nigeria: Fixed Capital Investment: By Firm Size, 2007/09 and 2014

(Index: Yes = 1; No = 2)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A004

Sources: Enterprise Survey; and IMF staff calculations.The point and the line indicate the mean and the confidence interval.

Factors affecting productivity

12. Firms differed between the two periods in other aspects affecting productivity. Total factor productivity cannot be measured using the enterprise survey, as capital stock data are not available. This section looks at both labor productivity (which can be measured) and other factors affecting productivity (e.g., power outage (duration), whether they own a generator or share a generator, whether transportation is a major obstacle or not (costs of delivery of goods and services), use of email or having website (efficiency and delivery of goods and services), whether tax admin, tax rate, or licensing as a major constraint, number of bribery incidence, and security costs).

13. Labor productivity declined on average between the two periods (Table 6).

  • In particular, chemicals and pharmaceuticals decline and construction improved.

  • Larger firms were worse hit than small- and medium-sized firms, as despite the decline in the growth of real sales, employment continued to grow in large firms (Figure 3). There were however large variations among large firms, some improved productivity significantly while others had a major set-back.

  • There were no particular regional patterns.

Table 6.

Nigeria: Labor Productivity, 2007/09 and 2014

(Percent)

article image
Sources: Enterprise Survey; and IMF staff calculations
Figure 3.
Figure 3.

Nigeria: Labor Productivity: By Firm Size, 2007/09 and 2014

(Percent)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A004

Sources: Enterprise Survey; and IMF staff calculations.The point and the line indicate the mean and the confidence interval.

14. Other factors affecting productivities suggest some positive and negative pictures.

  • The annualized losses due to power outages as a percent of total annual sales have gone up on average 8.2 percent in 2008 to 20.3 percent in 2014. Here the distinction between small- and medium-sized firms and large firms are large. In fact large firms on average reduced the losses due to power outage. In contract, small- and medium-sized firms were largely hit by power outages.

  • Large firms were hit by less by power outages (Figure 4). The percent of electricity from generator owned or shared, however, increased for large firms.

  • On the other hand, the percent of contract value paid in informal gifts to secure contracts have gone down from on average 7.4 percent in 2008 to 3.8 percent in 2014. The decline is evident for both large- and small- and medium-sized firms.

  • The perception that tax administration as an obstacle to firm operation seems to have eased somewhat. The multiple choice ranged from no obstacle = 0 to very severe obstacle = 4 and the average statistics decline from 1.7 in 2008 to 1.4 in 2014. However the decline was more evident among large firms (the average score went down from 2.5 to 1.0) but not for small firms (the score remained unchanged at around 1.5).

  • The contrast between large firms and small- and medium-sized firms is noticeable in terms of the use of technology (Figure 5). In 2014, on average only 70 percent of large firms used email communications with clients and suppliers while 80 percent of firms on average across all sizes did not use email communications. The change over time was not however evident.

Figure 4.
Figure 4.

Nigeria: Loss Due to Power Outage: By Firm Size, 2007/09 and 2014

(Percent of Total Sales)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A004

Sources: Enterprise Survey; and IMF staff calculations.The point and the line indicate the mean and the confidence interval.
Figure 5.
Figure 5.

Nigeria: Use of Technology: By Firm Size, 2007/09 and 2014

(Index: Yes = 1; No = 2)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A004

Sources: Enterprise Survey; and IMF staff calculations.The point and the line indicate the mean and the confidence interval.
Table 7.

Nigeria: Other Factors Affecting Productivity, 2007/09 and 2014

(Percent)

article image
Sources: Enterprise Survey; and IMF staff calculations.

Financing investment

15. There is a noticeable difference in the form of financing in Nigeria between the two periods (Table 8). First, the financing of fixed capital formation has changed between the two periods.

  • On average, 90 percent of fixed capital formation was funded by retained earnings or internal funds. This dependence on internal funds declined sharply in the 2014 survey, down to about 25 percent in 2014. This pattern is observed in all states, sectors, and size, except for textile industry.

  • Credit from suppliers, advances from customers, equity issuances (most likely private equity), and borrowing from non-bank financial institutions and others (which includes debt issuance) have become alternative financing options in 2014.

16. Financing of working capital has also changed (Table 9).

  • On average, two thirds of working capital were funded by retained earnings or internal funds. The share of retained earnings that are financing working capital goes down to 55 percent by 2014. This pattern is all across states, sectors, and size, except for textile industry.

  • As in the case of fixed capital formation, alternative funding sources are credit from suppliers, advances from customers, equity issuances (most likely private equity), and borrowing from non-bank financial institutions, debt issuance, and others.

  • The share of retained earnings declined (and the share of alternative funding increased) especially in the manufacturing sector.

Table 8.

Nigeria: Financing of Fixed Capital, 2007/09 and 2014

(Percent)

article image
Sources: Enterprise Survey; and IMF staff calculations.
Table 9.

Nigeria: Financing of Working Capital, 2007/09 and 2014

(Percent)

article image
Sources: Enterprise Survey; and IMF staff calculations

17. This change in sources of financing, or larger use of external financing (e.g., loans, debt and equity finance) rather than internal financing (e.g., retained earnings) has important implications on the inter-linkages between sectors within a country. On the one hand, options to have internal financing can cushion the impact of a negative shock in its own sector as it will allow firms to obtain financing from other sectors that are not affected by a negative shock. On the other hand, this may put firms more exposed to and linked to fluctuations in other sectors.

Panel data analysis

18. From the descriptive statistics above, it is important to notice that larger firms’ performance declined by more than small firms in the second survey period. Further analysis is warranted given the importance of those large firms in terms of macroeconomic impact. In particular, the panel data analysis considers the following three types of factors that could explain why large firms were affected by more:

  • Factors capturing factors of production: employment growth, whether they had invested on fixed capital, age of the firm, fraction of full-time workers, whether lack of education level considered major obstacle (skill constraint; skilled labor cannot absorb shocks),

  • Factors that affect the shock absorption capacity: share of imported inputs (this would capture vulnerability to depreciation), whether access finance is a major constraint (facing credit constraint; borrowing can absorb shocks), share of retained earning used for working capital investment (this captures either credit constraint or more profitability), share of retained earning used for fixed investment (size of buffer).

  • Other factors that affect productivity: efficiency and delivery of goods and services, whether tax admin, tax rate, or licensing as a major constraint, number of bribery incidence, and security costs; use of technology.

19. The focus of the analysis is which firm characteristics can explain the slowdown in the decline in the performance of the oil sector (which began in 2012). The empirical model is therefore specified as follows: “change” in performance is the left-hand side (LHS) variable and the characteristics of firms at the pre-crisis level (in 2008) and the “change” in these firm-characteristics as the right-hand side (RHS) variables between the two survey periods.

20. As heteroscedasticity was observed the weighted ordinary least square (OLS) estimator was preferred. Moreover, to control for the endogeneity between share of retained earnings used to finance investment (one of the RHS variable) and performance (the LHS variable), the real growth of sales in 2008 was used as an instrument, as this will affect how much individual firms had access to external finance while it cannot explain what will happen to firms’ performance following 2008. The null of weak instrument was not rejected at 5 percent level. The result of the instrumental variable (IV) estimator is presented in the last column.

21. Main findings from the regression analysis are as follows (Table 10):

  • The level of or the change in employment do not seem to explain the difference in the change in real sales between the two periods, but the composition of labor (permanent vs. temporary) and the change in this composition both seem to matter.

  • Expanding fixed capital in the late 2000s seems to have had a negative impact on the change in real sales, but not with a statistical significance, once controlled for the endogeneity.

  • Improvements in financial access over the two periods did seem to have contributed to firms’ performance (measured in terms of real sales).

  • Starting to own a generator seems to have contributed to firms’ performance.

  • Other characteristics that matter in distinguishing firms’ performance are the use of IT technology and the requests for informal gift for administrative process.

Table 10.

Nigeria: Factors Affecting Firm Performance, 2007/09 and 2014

(Variables in difference are changes between 2008 and 2014, while levels are for 2008)

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Source: IMF staff estimates. Standard errors in parentheses. Astrisks indicate: *** p<0.01, ** p<0.05, * p<0.1.

B. Corporate and Banking Sector Vulnerabilities

22. How much would the decline in oil prices affect the bank’s balance sheet by raising the corporate sector vulnerabilities? The April 2015 GFSR highlighted two features regarding Nigeria’s banking sector relative to other emerging market economies: (i) Nigerian banks have relatively high exposure to the corporate sector; (ii) the corporate sector performance was more negatively affected by the oil price decline than those in the other countries. This section of this paper traces the same story at a more granular level using firm-level data with the breakdown of banks into large versus other banks and examine the differences in the exposure to the corporate sector and possible impact on their balance sheet.

Debt stock outstanding of the non-financial sector

23. As noted above, firms’ access to external sources of financing has increased. This increases the integration of the corporate and financial sector increasing the scope for shocks in one element of the corporate sector to be transmitted to the financial sector and, through that channel, spillover to other elements in the corporate sector. One specific aspect of this development that is Nigerian firms’ use of market based financing through either bond issuance or syndicated loan issuance.

24. Data from Dealogic provides insight into the evolution of how Nigerian corporates have used market-based sources of financing. We track issuances by Nigerian non-financial corporates on a subsidiary basis (i.e., all debt issued by Nigerian resident entities, even those with multinational parents). This is more relevant for balance of payments purposes and represents the full scale of the liabilities of Nigerian entities.

25. There was a significant surge in the scale at which Nigerian corporates tapped market based sources of financing in 2013 (Figure 6). This has not only increased corporate sector vulnerabilities but also external vulnerabilities. It is noteworthy that syndicated loans account for the largest part of this issuance. Issuance dropped off significantly in 2014; this suggests credit conditions may have tightened and would also explain the increased reliance of large firms on internally generated resources to finance working capital in the 2014 Enterprise Survey.

Figure 6.
Figure 6.

Nigeria: Non-Financial Corporate Sector, 2009-14

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A004

Sources: CBN; and Dealogic.

26. To estimate total debt outstanding of the non-financial corporate, we also incorporate the banking sector’s claims on the private sector. Given that local banks are likely to be involved in some part of syndications, we assume that all syndicated loans in local currency are held by domestic banks. Similarly, we assume that domestic banks hold all bonds issued in local currency; while this likely overstates the full extent of their holdings, this may offset the likelihood that domestic banks may take a small proportion of syndicated loans in foreign currency. In addition, we do not have any information on lending to the household sector so we allocate all lending to the private sector as lending to the non-financial corporate sector.

27. Overall, we estimate that total debt outstanding of the non-financial corporate sector is of the order of $100 billion as of end-2014 (Figure 6). Of this, about 25 percent is market-based financing, and the remainder financing from the domestic banking sector. In terms of specific risk exposures, about 40 percent of this debt is exposed to exchange rate risk, while almost all of the debt is in the form of loans and so exposed to significant re-fixing risk (i.e., the risk that interest rates rise significantly). Consequently, it is critical to assess the potential impact on the banking sector of rising vulnerabilities in the corporate sector.

The corporate vulnerability stress test4

28. The corporate vulnerability stress test is conducted using the same approach adopted in recent GFSRs. The key points are as follows:

  • We use detailed firm level data for about 100 firms for 2014 from Orbis; the total debt captured in this sample is about $8.8 billion (or a little under 10 percent of our estimate of total corporate debt outstanding).

  • Of this, $2.5 billion (or 30 percent) is what we would call “debt-at-risk”, i.e., the total debt of firms where their interest coverage ratio (ICR) is less than 1.5 times.

  • This debt-at-risk is concentrated in large firms; they represent 72 percent of the “debt-at-risk” (although they account for 89 percent of total debt outstanding).

  • Overall, there was a sharp increase in debt-at-risk from 2012 to 2013—from $1.1 billion to $2.1 billion (and from 16 percent of total debt outstanding to 27 percent of current total debt outstanding) (Figure 6).

  • More notable is the fact that there is a significant deterioration in interest coverage between 2013 and 2014. Over this period, debt where ICR is less than one increased from $0.9 billion to $2.2 billion. This suggests a significant increase in vulnerabilities in 2014, which would explain the apparent tightening of credit conditions mentioned above.

29. The potential evolution of this debt is assessed under a baseline, adverse and extreme scenario:

  • For the baseline scenario, we incorporate the actual exchange rate depreciation of 18 percent in 2015 plus assume a 100 basis point increase in borrowing costs (in line with the observed widening of the Nigerian EMBI spread). Under this scenario total debt increases to $9.4 billion and debt-at-risk increases by 11 percent in 2015 to $2.8 billion. Note that the increase in total debt captures the stock effect (or solvency effect) of the depreciation, while the change in debt-at-risk also captures the impact of increased interest rates (or liquidity effect).

  • For the adverse scenario, we assume there is a further depreciation of 15 percent (consistent with the estimated overvaluation in the exchange rate assessment), a further 100 basis point increase in borrowing costs, and a decrease of net operating income by 10 percent reflecting the unfavorable prospects for increase in profitability under the current economic climate.5 Under this scenario, total debt would increase to $10 billion, while debt-at-risk would increase by 19 percent to $3 billion.

  • Finally, under the extreme scenario, we assume the exchange rate depreciates by a further 30 percent, borrowing costs increase by 350 basis points relative to the baseline (in line with an extreme scenario explored as part of the Vulnerability Exercise), and a further decrease in net operating income by 20 percent. Under this scenario, total debt would increase to $10.5 billion and debt-at-risk increase by 110 percent to $5.3 billion.

  • Importantly, the scale of debt at firms with less than 1 ICR increases from $2.3 billion to $3.5 billion; i.e. the proportion of highly vulnerable corporate debt increases markedly (Figure 7).

Figure 7.
Figure 7.

Nigeria: Corporate Sector Vulnerabilities, 2010-14

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A004

Sources: Orbis; and IMF staff calculations.

Potential impact on the banking sector

30. What is the potential impact of these scenarios on the banking sector? We assume that the banking sector holds the same proportion of debt-at-risk as is reflected in our corporate sector sample. Taking Moody’s estimated probability of default of 15 percent for companies with ICR<1.5, this generates non-performing loans of between N560 billion to N1,291 billion; this would take the NPL ratio from 2.4 percent as of end-2014 to between 4.5 to 10.4 percent (Table 11).6

Table 11.

Nigeria: Impact of Corporate Sector Stress Scenario on Banking Sector, 2014

article image
Sources: Financial Soundness Indicators; and IMF Staff estimates.

Assuming banking sector holds same percentage of debt-at-risk as in corparate sector sample, with a 15 percent probability of default.

Assuming a 45 percent loss given default (note, this is an optimistic assumption, based on WB Doing Business, Resolving Insolvency should be 70 percent).

Using assumed multiplier of 4.4 on the change in CAR based on preliminary empirical work by Julian Chow estimating the Bernanke and Lown (1991) approach on a sample of 2,317 banks across emerging market countries for the period 2001 to 2014. Note as a reference, various empirical studies with U.S. data suggest the multiplier for the U.S. to lie within the range 0.7 - 2.8 depending on the specification; emerging markets are likely to have a higher multiple (given they are more dependent on the banking system for credit).

31. To assess the potential impact on capital, we use the Basel II guidance on loss given default of 45 percent. This indicates that the system’s CAR could decrease by between 1.3 to 2.5 percentage points.

32. While the banking system would remain resilient to this shock, the impact on credit growth could be very significant. To determine the potential impact on credit growth of such a loss of capital we draw on preliminary staff analysis which indicates that for each 1 percentage point change in the capital/asset ratio translates into a 4.4 percentage point reduction in annual credit growth.7

Appendix. Corporate Sector Vulnerability Analysis

1. Nigerian banks’ exposure to the corporate sector is exceptionally high. The April 2015 Global Financial Stability Report highlighted more than half of bank loan books in 11 or 21 emerging markets consists of loans to firms, rendering them more exposed to corporate weakness. In Nigeria, banks’ exposure to the non-financial corporate sector is particularly high, accounting for over 75 percent of loans (chart).

2. Consequently a deterioration of corporate sector financial health would have significant risks to the banking sector. The broader impact to the economy would depend on the banks’ capacity to absorb losses and continue provide liquidity and credit, since banks continue to be the primary source of financing. While Nigerian banks are well capitalized, non-performing loans (NPLs) have been rising which could lead to reduction in credit growth. Indeed according to some market participants NPLs are close to 10 percent of total assets as of end-December 2015, that is, double of the amount reported in Central Bank of Nigeria’s June 2015 Financial Stability Report.1

A04app01ufig1

Nigeria banks’ distribution of credit by sector, 2015

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A004

Sources: CBN; IMF staff estimates.

3. The authorities have taken measures, but more can still be done. The authorities have taken action by increasing the level of provisions required for performing loans, which is one of way of building buffer. However, a systemic approach that differentiates between businesses might be warranted, so as to avoid stifling credit to the entire corporate sector which may do more harm by further slowing down the economy. For example, requiring banks to increase their provisions or allocate higher capital for loans extended to creditors that are highly indebted (with high debt to equity, or interest cover ratio).

4. The methodology used to analyze the corporate sector liability

Database: As noted in the main text of this paper, the financial statements of 100 firms were analyzed.

Indicator: The indicator used to assess risk was interest cover ratio (ICR), more specifically interest payments as a percentage of operating surplus. Generally firms with debt service ratio of less than 2 are considered to be risky. The credit rating agency Moody’s maps debt indicators to its credit rating where debt service ratio of 1.7 is mapped to have a credit rating of “B”, one notch above the lowest credit rating. On this basis, the threshold 1.5 was selected to indicate debt-at-risk.

Implied loss rate: by applying the definition of 1.5 interest cover ratio we determine the level of debt at risk (and its ratio as proportion of total debt). We then multiply this ratio with probability of default (PoD) and loss given default (LGD) to determine the loss rate. S&P and Moody’s put the probability of default of corporate entities with credit rating of “B” at around 15 percent. For LGD, we apply Bank of International’s standard rate of 45 percent for corporate sector. A more prudent approach would suggest applying LGD pertinent to Nigeria which is 70 percent, according to World Bank’s Doing Business Assessment. If one assumes 70 percent instead of 45, the loss rate increases significantly.

Nigeria: Implied Loss Rate

article image

Capital adequacy ratio: assuming the risk weighting of such loans was 100 percent (a reasonable assumption given their riskiness) if loss was to materialize it would lead to a corresponding fall in regulatory capital (and hence capital adequacy ratio).

5. Impact on credit growth: based on the approach of Bernanke and Lown (1991), that examined the link between banks’ capital and credit growth, various empirical studies with U.S. data suggest the multiplier for the U.S. to lie within the range 0.7–2.8 depending on the specification. That is for 1 percentage point reduction in capital adequacy ratio, the corresponding reduction in credit growth could be 0.7 to 2.8 percent. For emerging markets, given their higher dependency on the banking sector, the multiplier is likely to be higher. Based on preliminary internal IMF work the multiplier is estimated to be around 4.4. The implication is, as can be seen from the chart, the credit growth would decline significantly should the extreme scenario materialize.

A04app01ufig2

Nigeria: Implied Credit Growth, 2014

(Percent)

Citation: IMF Staff Country Reports 2016, 102; 10.5089/9781475550559.002.A004

Sources: Financial Soundness Indicators; Staff estimates.
1

Prepared by Allison Holland, Mika Saito, and Miriam Tamene, with research assistance from Sebastian Corrales and Marwa Ibrahim.

2

The World Bank survey was conducted in collaboration with Nigeria’s National Bureau of Statistics (NBS). Based on the information available on NBS’s website, there were 68,168 small size enterprises and 4,670 medium size in 2013.

3

Firm size is defined as follows: small for 5-19 workers; medium for 20-99 workers; and large for more than 100 workers.

4

Please see the Appendix for a depiction of corporate sector vulnerability analysis.

5

Net operating income, here is defined as earnings before interest, depreciation and amortization.

6

Assuming a 45 percent loss given default could arguably be considered an optimistic assumption. Based on World Bank’s Doing Business assessment, the number is higher, at 70 percent (see Appendix).

7

This is based on preliminary empirical work by Julian Chow (MCM) estimating the Bernanke and Lown (1991) approach on a sample of 2,317 banks across emerging market countries for the period 2001 to 2014. Note as a reference, various empirical studies with U.S. data suggest the multiplier for the U.S. to lie within the range 0.7-2.8 depending on the specification; emerging markets are likely to have a higher multiple (given they are more dependent on the banking system for credit).

1

SBG Securities Nigerian Banks 2016 Looks Tough too (January 15, 2016).

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Cover IMF Staff Country Reports
Nigeria: Selected Issues
Author:
International Monetary Fund. African Dept.
Volume/Issue:
Volume 2016: Issue 102
Publisher:
International Monetary Fund
ISBN:
9781475550559
ISSN:
1934-7685
Pages:
59
DOI:
https://doi.org/10.5089/9781475550559.002
  • Figure 1.
    View in gallery
    Figure 1.

    Nigeria Growth in Real Sales: By Firm Size, 2007/09 and 2014

    (Percent)

  • Figure 2.
    View in gallery
    Figure 2.

    Nigeria: Fixed Capital Investment: By Firm Size, 2007/09 and 2014

    (Index: Yes = 1; No = 2)

  • Figure 3.
    View in gallery
    Figure 3.

    Nigeria: Labor Productivity: By Firm Size, 2007/09 and 2014

    (Percent)

  • Figure 4.
    View in gallery
    Figure 4.

    Nigeria: Loss Due to Power Outage: By Firm Size, 2007/09 and 2014

    (Percent of Total Sales)

  • Figure 5.
    View in gallery
    Figure 5.

    Nigeria: Use of Technology: By Firm Size, 2007/09 and 2014

    (Index: Yes = 1; No = 2)

  • Figure 6.
    View in gallery
    Figure 6.

    Nigeria: Non-Financial Corporate Sector, 2009-14

  • Figure 7.
    View in gallery
    Figure 7.

    Nigeria: Corporate Sector Vulnerabilities, 2010-14

  • View in gallery

    Nigeria banks’ distribution of credit by sector, 2015

  • View in gallery

    Nigeria: Implied Credit Growth, 2014

    (Percent)

Figure 1.

Nigeria Growth in Real Sales: By Firm Size, 2007/09 and 2014

(Percent)
Figure 2.

Nigeria: Fixed Capital Investment: By Firm Size, 2007/09 and 2014

(Index: Yes = 1; No = 2)
Figure 3.

Nigeria: Labor Productivity: By Firm Size, 2007/09 and 2014

(Percent)
Figure 4.

Nigeria: Loss Due to Power Outage: By Firm Size, 2007/09 and 2014

(Percent of Total Sales)
Figure 5.

Nigeria: Use of Technology: By Firm Size, 2007/09 and 2014

(Index: Yes = 1; No = 2)
Figure 6.

Nigeria: Non-Financial Corporate Sector, 2009-14
Figure 7.

Nigeria: Corporate Sector Vulnerabilities, 2010-14

Nigeria banks’ distribution of credit by sector, 2015

Nigeria: Implied Credit Growth, 2014

(Percent)