Large amounts of forex lent to the central bank pose further risk to the banking sector – Moody

Moody’s, a global credit rating agency, has warned that Nigerian banks face significant risk due to foreign-currency shortages at local companies.

The rating agency also pointed out that the forex lent by Nigerian banks to the central bank could create further risks to the banking sector.

The country’s constrained domestic oil production, higher prices for imports of refined petroleum products, and capital outflows are causing acute shortages of foreign currency in Nigeria.

The country’s crude oil production materially declined in 2022, and the production outlook for 2023 remains uncertain, despite a mild uptick in the last quarter of 2022.

On CRR debits

According to Moody, it estimates that rated Nigerian commercial banks had lent an aggregate of $10.4 billion in FX to the central bank as of June last year.

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Large amounts of forex lent to the central bank pose further risk to the banking sector – Moody
Foreign-currency Shortages at Local Companies Pose a Risk for Nigerian Banks - Moody's
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CBN Gov, Godwin Emefiele addressing reporters.
CBN Gov, Godwin Emefiele addressing reporters.


Moody’s, a global credit rating agency, has warned that Nigerian banks face significant risk due to foreign-currency shortages at local companies.

The rating agency also pointed out that the forex lent by Nigerian banks to the central bank could create further risks to the banking sector.

The country’s constrained domestic oil production, higher prices for imports of refined petroleum products, and capital outflows are causing acute shortages of foreign currency in Nigeria.

The country’s crude oil production materially declined in 2022, and the production outlook for 2023 remains uncertain, despite a mild uptick in the last quarter of 2022.

On CRR debits
According to Moody, it estimates that rated Nigerian commercial banks had lent an aggregate of $10.4 billion in FX to the central bank as of June last year.

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“Nigerian banks have placed significant foreign currency with the central bank in the form of derivative transactions (including swaps and forwards).
At a time when the central bank is rationing its foreign-currency allocations to the economy, there is a risk that the central bank may decide to temporarily prolong those contracts beyond their original maturity date.
“A material delay in repayment could well lead to the banks facing their own foreign-currency shortages and could constrain their ability to repay their own foreign currency liabilities.”
“However, despite the central bank’s strong track record of repaying the FX it owes to the banks, at a time of acute FX shortages, there is an increased risk that it would extend the life of some contracts, postponing repayment.”
Moody also suggests most of the bank’s foreign currency deposits held by the CBN are included in the country’s $37 billion reserves.

“Nonetheless, we estimate that, as of June 2022, Nigerian financial institutions (including commercial and national development banks) had placed at least $14.2 billion with the central bank through various foreign-currency derivative contracts, including around $10.4 billion placed by rated Nigerian commercial banks.”
“We understand that these foreign-currency derivatives instruments are included in the country’s $37 billion foreign-currency reserves as of December 2022.”
On the impact of devaluation
According to Moody, it expects that a “rapid convergence of official and unofficial foreign-exchange rates” will not happen anytime soon as it opines the CBN will allow the exchange rate to continue to adjust at a gradual pace.

Moody also indicates that in the event of devaluation, Nigerian banks’ benefit from the long net open positions will be outweighed by an increase in risk-weighted assets due to the higher value of the loans denominated in foreign currency, which would weigh on capital ratios by increasing the denominator.

In simpler terms, if the value of Nigeria’s currency drops significantly, it could be bad news for banks in the country.

Although they may have some protection from holding assets in foreign currencies, they could still suffer from higher debt burdens, which would make it harder for them to keep enough money on hand to keep operating.

Essentially, the banks could find themselves in a position where they owe more than they’re worth.

In response to the foreign-currency shortages, Moody explains that the central bank has scaled down its foreign-currency allocations to local companies, leading to a material gap between official and unofficial exchange rates in the country.

These commitments are typically covered by trade-related instruments (e.g. letters of credit) issued by the banks.

Off-balance Sheet Trade Finance-related Exposure
Moody estimates that the aggregate off-balance sheet trade finance-related exposure of rated Nigerian commercial banks amounted to around $9.8 billion as of June 2022, representing over 54% of their FX liquid assets.

This off-balance sheet exposure includes trade-related contingent liabilities (in the form of letters of credit) that may partially or fully crystallize should corporate clients be unable to meet their payment obligations.

Specifically, for rated Nigerian banks, as of June 2022, Moody estimates that 36% of outstanding credit letters were expiring within the following three months, and an estimated 93% of outstanding credit letters were expiring within the following twelve months.

Nigerian banks have a healthy foreign currency position
According to Moody, Rated Nigerian banks, viewed as a group, carry sound levels of liquid resources in foreign currency. Moody states that as of June 2022, the banks had $18.2 billion in foreign-currency liquid assets, which covered 45% of the bank’s total foreign-currency liabilities of $40.7 billion.

This ratio increases to 115% when excluding foreign-currency customer deposits from the total foreign-currency liabilities.
The sound foreign-currency liquidity positions of Nigerian banks help partly moderate the risk from their trade finance exposure and foreign-currency lending to the central bank.

Moody also points out that banks’ foreign-currency deposits have remained stable, and that their correspondent banking lines have remained in place.

The stability of the foreign currency deposits reflects the fact a significant portion of corporate deposits are operational and transactional deposits, along with the fact that retail depositors have limited alternatives to place their foreign currency.

Following on Nigerian banks’ sound forex liquidity, Moody also indicates that the portion of banks’ FX liabilities due over the next 12 months is limited, “but they do not have outstanding Eurobonds due in 2023-24.”