Nigeria: Selected Issues


Nigeria: Selected Issues

Financial Sector Developments and Vulnerabilities1

This chapter highlights the impact of the economic downturn on banking sector vulnerabilities. The outlook points to higher NPLs and eroding capital. Results of stress test results show that a depreciating exchange rate and interest rate increases would adversely impact capital adequacy ratios (CARs), although these would remain above Basel II prudential norms. In contrast with the banking sector, non-bank financial institutions have been less impacted by the current economic downturn.

1. The size of the financial sector of Nigeria is driven by activity in the banking sector, which accounts for 80 percent of total assets. During the past year, banking sector growth was dominated by the impact of a depreciating naira, given 45 percent of the banks’ loan book is in foreign currency. In contrast, growth in non-bank financial institutions, whose assets are mainly in local currency, was driven primarily by new funding. (Figures 1 and 2).

Figure 1.
Figure 1.

Nigeria: Structure of the Financial System, 2013-16

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A003

Sources: IMF Financial Soundness Indicators; Nigeria Pension Commission; Nigeria National Insurance Commission, Securities and Exchange Commission Nigeria; and IMF staff calculations1/ Latest data available is 2014.2/ Figures as at 2016
Figure 2.
Figure 2.

Nigeria: Evolution of Banking Sector Credit

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A003

A. Banking Sector

Recent Developments

2. The banking system is oligopolistic. While the size of the five largest banks fell from 60 percent of assets in the second half of 2015 to 43 percent of assets in the first half of 2016, low competition continues to characterize Nigeria’s banking system. The Herfindhal-Hirschman index for the industry was 743 at end-June 2016 (Financial Stability Report) and market shares for the other 18 banks in Nigeria ranged from 0.3 to 6.4 percent.

3. With no clear sign of an economic recovery, the structure of the banks’ balance sheets is changing. To limit further credit loss, banks have reduced their level of lending which remained relatively flat in 2016 after taking into account the impact of foreign exchange depreciation. Nigeria remains relatively unbanked compared to other emerging markets, with a credit-to-GDP ratio of 15 percent. Moreover, current high yields on government securities present attractive options, particularly considering that they carry zero-risk weighting for regulatory capital and count towards liquidity ratio requirements.

4. Despite weaker balance sheets, banks’ funding sources remain stable with deposits continuing to be the primary source. Deposits (about 75 percent of total liabilities) have been gradually declining, reflecting mostly the implementation of the Treasury Single Account, which shifted government accounts to the central bank. Deposits below one-year maturity represent 95 percent of all deposits, of which 44 percent are unremunerated demand deposits. That said, the funding structure (loan-to-deposit ratio at 130 percent) of banks remains stable. Financing from alternative sources, such as money and capital markets, was lower in 2016, $0.6bn versus $1.47bn in 2015.


Nigeria: Yield Curves, 2015-2016

(in percent)

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A003

Sources: Bloom berg; Central Bank of Nigeria; and IMF staff calculations

Nigeria: Deposits to Total Liabilities, 2013-16

(in percent)

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A003

Sources: IMF Financial Soundness Indicators; and IMF staff calculations

Nigeriaand Peers: Deposits to Liabilities, 2015

(in percent)

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A003

Sources: IMF Financial Soundness Indicators; and IMF staff calculations

5. Banking sector vulnerabilities have increased, although capital and liquidity buffers remain adequate:

  • Asset quality deteriorated. Non-performing loans (NPLs) have doubled from a year ago, to about 13 percent of total loans by end-2016, making Nigeria the weakest performer amongst peers. Despite an increase in provisions to about 65 percent since end-2015, NPLs net of provisions relative to capital remain relatively high. The same sectors that have weighed down the economy—oil and gas, and power—continue to do so. Businesses in these sectors, coupled with sectors that depend on foreign exchange such as general commerce, have been the major contributors to the recent surge in non-performing assets (Figure 3).

  • Capital buffers have been eroded, but remain adequate. In line with worsening NPLs, capital adequacy ratios have declined from 17.7 percent in 2015 to 14.8 percent in 2016. However, the overall solvency ratios in 2016 would have averaged 16.9 percent, after excluding three undercapitalized banks–including one internationally active bank2—which have ratios below 8 percent and account for 5 percent of assets. Performance across banks is striking with solvency ratios ranging from 3.2 percent for small banks to 15.7 percent for Tier I banks.

  • Liquidity ratios decreased to 42 percent at end-June 2016, from 48 percent at end-2015, but remains comfortably above the prudential minimal limit of 30 percent.3

  • Profitability ratios have been worsening, with ROE and ROA reaching 12.6 and 1.5 percent in 2016, driven by declining net interest margins, which are still in line with peers. While audit results would need to confirm possible gains, the majority of banks long on foreign currency expect the recent depreciation to have increased “unrealized” valuation gains.

Figure 3.
Figure 3.

Nigeria: Deterioration in Asset Quality and Capital Adequacy Ratios

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A003


Nigeria: CapitalAdequacy Ratio by Types of Banks, 2016

(in percent)

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A003

Sources: Central Bank of Nigeria

Nigeria and Peers: Capital Adequacy Ratio, 2016 /1

(in percent)

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A003

Sources: IMF Financial Soundness Indicators and Central Bank of Nigeria1/ Latest data is Q2 2016, except for Turkey (Q1 2016) and Angola (end-2015).

Nigeria: Banks’ Profitability (2013 - 2016)

(in percent)

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A003

Sources: IMF Financial Soundness Indicator

Nigeria and Peers’ Profitability, 2016 /1

(in percent)

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A003

Sources: IMF Financial Soundness Ind icator1/ Angola is at end-2015

6. Reforms in the aftermath of the 2009–10 crisis and the buildup of regulatory buffers have contributed to containing risks so far. Amendments made in regulations over the past two years increased prudential ratios above international norms, and tried to contain credit and market risks arising from low economic activity and exchange rate volatility (see Box 1).

Nigeria: Major Prudential Regulations and Measures Adopted Since 2010

article image
Notes:1/ Cash Reserve Ratio (CRR), a monetary policy tool, is currently 22.5%2/ Indicate recent revisions in 2016/17Source: Central Bank of Nigeria

Outlook and Risks

7. NPLs would continue to rise before returning to normal levels. On average, it takes 5 to 6 years for NPLs to return to their normal level.4 In Nigeria, post the 2009 crisis, NPLs took three years to return to their normal levels, which was much faster than the experience of other countries. The rapid recovery was due to the swift action taken by the authorities to establish an asset management company (AMCON) that bought non-performing loans from banks. This time, the fiscal space for a similar action is limited; consequently, NPLs could persist for a while longer, although the regulatory environment is much improved. In addition to the weakened economic outlook, the increase in NPLs would depend on three critical and related factors:

  • Developments in the oil and gas sector. At 30 percent of banks’ loan books, concentration risk is high; further, 14 percent of loans are non-performing. Sabotage of oil infrastructure, along with lower oil prices than initially envisaged at loan origination, is depressing revenues and companies’ ability to repay. Hence, solving oil production problems in the Niger Delta would be key to reducing weaknesses in this area.

  • Developments in the power sector. Non-payments by electricity distribution companies of their bills to power generation companies continues to increase NPLs in the sector. Reforming the power sector, including through an introduction of cost-reflective tariffs, will be essential to improve firms’ performance in this domain.

  • Exchange rate risk. The depreciation of the naira may in some cases benefit those banks with FX assets that outweigh their FX obligations, through net valuation gain. However, FX risks either from a shortage of FX or further naira depreciation could also lead to defaults, which will increase required provisioning and reduce profits. With about 45 percent of loans and 40 percent of NPLs in foreign currency, a further depreciation of the naira by 50 percent would increase NPLs net of provisions to capital by 12 percentage point (from 28 to 40 percent) (See Chapter 2).


Nigeria: Asset Quality and Growth, 2009-16

(in percent)

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A003

Sources: IMF Financial Soundness Indicator and World Economic Outlook, October 2016.*2016 as at end-June.

8. Solvency ratios would continue to decline. The need for capital injections will depend on the banks’ vulnerability. Overall, staff (and banking industry analysts) estimates that Nigeria’s NPL would have to increase to 27 percent for CARs to fall below 10 percent. Under that scenario, the banking sector would need a capital injection of N352 billion (about 0.33 percent of GDP).

9. Concentration risk may continue to escalate, mainly as a consequence of naira depreciation. Banks’ exposure to FX loans implies the depreciating naira gave rise to a passive breach of the concentration risk threshold, which requires banks to limit single obligor exposure to 20 percent of equity and eight times equity on aggregate large exposure.5 The breach, currently the subject of regulatory forbearance, is supposed to be temporary; the regulator has demanded that banks submit proposals setting out the path to levels within the prudential thresholds.

10. To contain further exchange risk, banks may seek to reduce their FX assets and liabilities. Prudential regulations on exchange rate include foreign exchange net open position (FX NOP) and foreign currency borrowing as a percent of equity. In light of the naira depreciation, the regulator eased the limit on FX borrowing, increasing it from 95 to 125 percent of equity, but lowered the FX NOP from 20 to 10 percent of equity, to ensure that banks continue to reduce FX exposure on both sides of their balance sheets. In addition, recent measures introduced in 2014 require banks to have natural hedges for FX exposure, by matching interest rate terms of financing with lending (so that there is no mismatch of variable and fixed interest rate), and since August 2015, banks have been instructed to avoid extending FX loans to borrowers with no FX revenue.

Banking Stress Test Scenarios

11. Sensitivity stress tests performed by the Central bank indicate that banks can withstand extreme shocks. CBN sensitivity analysis on the NPL and Single Obligor Limits show that the industry as a whole remains resilient to such shocks (Figure 4).6

Figure 4.
Figure 4.

Nigeria: Banking Sector Sensitivity Stress Test Capital Adequacy Ratio


Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A003

Source: Central Bank of Nigeria

12. The performance of the banking sector is interlinked with the financial health of the corporate sector. The banking sector is heavily exposed to the corporate sector—which has come under earnings pressure, accounts for 75 percent of the loan book, and whose performance is heavily dependent on foreign exchange availability (See Chapter 2). On the other hand, corporate funding depends heavily on bank loans (including syndicated ones). Funding from capital markets (bonds and equities) accounted for only $1.75 billion—down from $2.3 billion in 2015 (Figure 5).

Figure 5.
Figure 5.

Nigeria: Corporate Sector Developments

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A003

13. Corporate Sector vulnerability stress tests complement the stress tests by looking at the potential risk to the banking sector (See Box 2 for the methodology). The level of non-performing loans is estimated by applying Moody’s estimated probability of default of 15 percent for companies with Interest Coverage Ratio less than 1.5. The extreme adverse scenario—showing an exchange rate increasing from N/$197 to N/$600 and interest rate up by an additional 400 basis points would imply (Table 1 and Figure 6):

  • NPLs rising by 26 percent, which would cause the capital adequacy ratio to fall by 8 percentage points.7 Given initial capital buffers, banks would remain resilient under this scenario. Drawing on preliminary staff analysis, which indicates that for each 1 percentage point change in capital adequacy ratio annual credit growth contracts by 4.4 percentage points, this would lead to credit to the private sector contracting by as much as 34 percentage points.

  • Corporate Sector debt at risk would in that case amount to $11.6 billion, with the number of firms with debt-at-risk doubling to 29 (Figure 6).

Nigeria: Methodology for Corporate Sector Stress Test


  • Individual corporate financial data from Orbis; in our sample there are 144 firms

  • Firms’ total outstanding liabilities amounted to $7.3 billion, about 9 percent of our estimate of outstanding debt

  • Analyze debt at risk using two definitions in the first instance a) net income as a ratio of interest expense (interest coverage ratio, ICR), and b) debt to gross income (debt income ratio, DGI). The DGI ratio was introduced to complement the analysis under ICR as the data on net income was lacking for a large number of firms in our sample. For example, of the $7.3 billion liabilities reported by firms, $0.411 billion was excluded from the ICR, compared to $0.05 billion under DGI.

  • Debt-at-risk, using both definitions has gradually declined, reaffirming the use of ICR should not underestimate the level of debt at risk for assessing impact on banks’ balance sheet.


  • Three scenarios: Baseline, Adverse and Extreme, are applied to corporate sector debt to assess the impact on banks’ balance sheet. 1/

  • Baseline scenario, incorporates 200 basis points increase in interest rates in line with increase in policy rate, and 55 percent devaluation (reflecting the exchange rate shift from USD/NGN 197 to 305). Plus, reduction in income by 5 percentage points.

  • Adverse scenario, includes a further depreciation, based on the shift from USD/NGN 197 to 400, an additional 100 bps increase (up 300 bps) in interest rates, and an income shock of 10 percent.

  • Extreme scenario, assumes a further deprecation to USD/NGN 600, a 400 bps increase (twice the level of the increase under the baseline scenario) in interest rates, and an income shock of 20 percent.

1/ Interest rate risk scenario is only applicable for the ICR measure.
Table 1.

Nigeria: Impact of Corporate Sector Stress Scenario on Banking Sector, 2015

article image
Sources: IMF Financial Soundness Indicators; and IMF staff estimates

Scenarios are as below, where baseline reflect actual changes from end of 2015 to end 2016:

Assuming banking sector holds same percentage of debt-at-risk as in corporate 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).

Assume 100 percent risk weighting.

Using multiplier of 4.4 on the change in CAR based on preliminary empirical work done by Julian Chow applying 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).

Figure 6.
Figure 6.

Nigeria: Evolution of Corporate Sector Debt-at-Risk, 2011–15

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A003

Policy Recommendations

14. The policy and operational implications of the vulnerabilities highlighted above imply the following policy recommendations for banks:

  • Addressing undercapitalized banks through the following measures is important to restore confidence

    • capital raising, though challenging under the current unfavorable market climate, should be pursued.

    • buyout and/or merger with other banks, existing shareholders will sustain losses (diluted shares and/or value of their shares), but this will have to be balanced against the broader benefit of restoring market confidence.

  • Dealing with non-performing loans is essential to kick-start bank lending

    • NPLs constrain banks’ balance sheet as they depress CAR and profitability. Options for dealing with NPL are limited, nonetheless banks should be encouraged to divest non-performing loans and restructure those that will become viable.

  • Strengthen monitoring and supervision through

    • strict enforcement of existing prudential measures on FX and concentration risks, and considering further tightening of these measures.

    • undertaking an intrusive and conservative approach to supervision.

B. Non-Banking Financial sector

15. In contrast to the banking sector, the non-bank financial sector has been less affected by the economic downturn. Pension funds, insurance companies, and managed funds remain healthy, despite a decline in asset market prices.

16. The pension sector has grown considerably in both membership and asset size over the past decade. The pension industry is on track to meet its strategic objective of capturing 30 percent of the working population under the Contributory Pension Scheme (CPS). The recent enactment of the Pension Reform Act 2014, calls on the CPS to be applicable for organizations with employees of more than three, compared to 15 under the earlier Act of 2004. Organizations with less than three employees and self-employed persons are also entitled to participate. (Figure 6).

17. A significant portion of the pension funds’ assets is held in government paper. Fixed income assets, including government bonds, provide a hedge for the funds’ obligations. Indeed, investment in government securities is approaching the upper limit of 80 percent, as fund managers rebalance their portfolio towards less risky assets.

18. In contrast, growth of the insurance sector has been modest. Mandatory requirements, for insurance coverage in motor, oil, gas and aviation sectors, plus life insurance for companies with 5 or more employees, have supported the industry’s development. Individual penetration is relatively low with corporates accounting for 80 percent of insurance coverage. Assets are currently invested mostly in short-term instruments and equities, or held as bank deposits, that is, with no exposure to government securities (Figure 7).

Figure 7.
Figure 7.

Nigeria: Developments in the Non-Banking Financial Sector

Citation: IMF Staff Country Reports 2017, 081; 10.5089/9781475591910.002.A003

19. The introduction of new insurance products is expected to further boost growth. Micro and Islamic insurance companies (for example, Takaful, a sharia compliant insurance) are in the process of being launched. It is expected that by 2020 the size of the sector will triple, and premium income will grow by 18 percent per annum.

20. Fund managers’ net market value of investments was marginally lower over the course of 2016. This trend was in line with the decline in stock and bond markets. In terms of lending to government, this is represented by “Fixed Income” of which about a third is held as investment in government bonds; exposure to government declined slightly since the beginning of the year by half a billion Naira (from 8 billion to 7.5 billion); however, most of this could be attributed to changes in market value of government bonds. (Figure 7).

Policy Recommendations

It would be important to review regulations and enhance monitoring as the sector develops.

  • As pension funds approach the upper limit on investment in government bonds, it will be important to introduce regulatory measures to limit their liquidity and interest rate risks, and consideration should be given to relax exchange rate risk.

  • With respect to the insurance sector, while the move towards risk-based regulation is welcomed, it will be important to maintain close monitoring and continue building the capacity of the regulator as the industry grows. Preparation to adopt Solvency II, an international standard for the insurance sector, should be pursued building on work done to date.


Prepared by Miriam Tamene, Mika Saito and Marwa Ibrahim.


Earlier in the year, the central bank intervened in one domestic systemically important bank (D-SIB), Skye, by replacing its management and injecting liquidity. Skye and the two small undercapitalized banks have submitted remedial plans for recapitalization.


Liquidity Ratio, where CBN applies the threshold of 30 percent, is defined slightly different to the IMF’s Financial Soundness Indicators. In CBN’s measure, both assets and short-term liabilities capture a broader set of items. For example, assets include state government bonds, whereas financial derivatives and redeemable preference shares are included in current liabilities.


See, for example, S. Aiyar, W. Bergthaler, J. Garrido, A. Ilyina, A. Jobst, K. Kang, D. Kovtun, Y. Liu, D. Monaghan, and M. Moretti, 2015, “A Strategy for Resolving Europe’s Problem Loans”, SND/15/19. Comprehensive strategy to NPL solutions take time as these include developing markets for distressed debt, tightening supervisory policies, and reforming insolvency regimes (IMF, 2015)


Such rules, for example for the oil and gas sector, which represents a huge concentration risk, have impelled banks to diversify exposure to single obligor via syndicated loans. In addition, exposures to any industry in excess of 20 percent of total credit facilities of the bank, attracts risk-weighting of 150 percent for the entire portfolio in that industry.


The authorities undertake sensitivity stress testing on a regular basis. Key risks from the Financial Stability Report, June 2016 indicate: (i) a 50% increase in NPLs will see small banks become insolvent with CARs at -9.8 percent while the industry CAR will be reduced by 1.5 percent to 13.2 percent; and (ii) a 200 percent increase in NPLs will reduce overall banking sector capital adequacy ratio to 8 percent. Based on updated information from CBN, if the provision of the five biggest obligors credit facilities were to increase to 100%, the industry’s CAR would be reduced to 6.3 percent.


Using Basel II guidance on loss given default (LGD) of 45 percent, we generate the reduction in Capital Adequacy Ratio. Although a more prudent approach would suggest applying LGD of 70 percent for Nigeria (based on World Bank’s Doing Business Assessment).

Nigeria: Selected Issues
Author: International Monetary Fund. African Dept.