Tuesday, 12 June 2012

Does a falling crude oil price threaten Nigerian banks?


The Nigerian naira has come under heavy pressure in the last few weeks as crude oil prices head northwards. Brent Crude prices which closely mirror Nigeria’s Bonny Light dropped to a year low of $97 on Tuesday afternoon reflecting worries over the continuing economic uncertainty in the Eurozone. The fear, rightly expressed, is that if the Eurozone crisis is not resolved, global demand will weaken and consequently demand for crude oil.
Sanusi Lamido Sanusi, Governor, Central Bank of Nigeria
Reuters reported on Tuesday that a lack of U.S. buying interest led to the price of Nigeria’s Brent Crude falling to a six week low due to a significant overhang for July cargoes with three or four Qua Iboe cargoes unsold for July. "Demand is not great. There are probably only one or two cargoes that have traded this week," Reuters quotes a West African oil trader.
Fareed Zakaria on why crude oil prices will remain high
Nigeria, West Africa’s largest economy is already feeling the impact of the global panic. The Nigerian naira slipped to a 22 week low on Tuesday exchanging for N163.68 to the dollar at the Nigerian interbank market. Reuters report that dealers claim that the Central Bank could not meet the demand for dollars in the interbank market. The apex bank sale of $300 million in the market was not enough to meet the demand of foreign investors selling down the naira to get out of Nigerian held positions in securities.

Reuters quotes a dealer in Nigeria’s interbank market as saying that "The demand for the U.S. dollar is not being met at the central bank window. So we have all the oil importers as well as foreign investors exiting short term government securities exerting pressure (on the naira)"

Foreign investors’ hitting the panic button is understandable. Nigeria regularly auction dollars in the interbank market to stabilize the naira at a preferred rate. The dollars sold in the interbank market comes mainly from crude oil sales which brings more than 90% of Nigerian foreign exchange earnings. A steep drop in crude oil prices translates into less crude oil revenues and weakens the capacity of the CBN to defend the naira at its preferred rate. If the CBN cannot defend the naira, the naira will depreciate and depreciation of the naira mean whatever gains foreign investors have been made in currently held positions in government securities will be wiped out by the depreciation in the exchange rate.

The implication is that as long as crude oil prices continue to depreciate, the naira will come under pressure as foreign investors who are the dominant players in Nigeria’s equity and bond markets will want to get out of their positions as fast as possible to cut their losses or hold to their profits. Nigeria was in a similar position in 2008, when the sharp fall in crude oil prices from over $120 per barrel to about $40 per barrel led to a sharp fall in the value of the naira as foreign investors hit the exit button from Nigerian capital and money markets. This led to the eventual collapse of the Nigerian capital market, a rapid buildup of toxic assets on banking books and the eventual failure of some banks.

This time around, Nigerian banks are not heavily exposed to margin loans in the equity markets. However, most banks are heavily exposed to supposedly risk free government bonds on their books. The high yields on these bonds means most banks have exhibited a healthy appetite for federal government bonds. The Nigerian government is not expected to default on these bonds however banks may still incur losses if the prices of the bonds fall as demand for them drops. The liquidity of FGN bonds may also deteriorate if the revenue outlook for the government weakens. It is not however; very clear the extent of the negative impact a drop in liquidity and prices will harm Nigerian bank balance sheets. Nonetheless it is a risk worth watching.

The real risk may be in bank’s exposure to the oil and gas sector of the Nigerian economy. As at the close of 2010, an average of 20% of bank lending were to companies operating in the oil and gas sector of the Nigerian economy. Deterioration in the outlook for the sector is likely to have a significant impact on the balance sheets of most banks depending on the exposure of each bank to the sector.  Though, many Nigerian banks have capital adequacy ratios in the 10% to 20% range, there will always be a challenge if there is a simultaneous deterioration in risks in the sector which impacts on liquidity of held positions.  

Another point of transmission risk for Nigerian banks will for banks exposed through their Eurobond issues. A rapid depreciation in the dollar could mean rise in the naira value and servicing cost of these debts. It is not clear how well most Nigerian banks have been able to hedge this foreign exchange risk in their Eurobond debts.  

Nigeria banks risk to the global crisis will however largely depend on how low crude oil price fall. The lower it falls, the higher the risk. Unlike 2008 however, the sanctions against Iran and the crisis in Syria and even Boko Haram activities in Nigeria may mean that crude oil prices may not fall to 2008 low levels. 
Analyst speak on the impact of Euro crisis on Nigeria