Rescue of Nigerian banks complicates plot for industry

As markets digest the news of Nigeria’s banking-sector bailout, attention is turning rapidly to how the $2.6 billion capital injection into the five rescued banks will be funded.

Standard &Poor’s has lowered Nigeria’s BB- foreign-currency and BB local-currency long-term sovereign ratings to B+ with a stable outlook, saying the bailout costs will constrain the authorities’ fiscal flexibility.

According to S&P, this is especially true given the depletion of oil revenues by output shortfalls related to the Niger Delta crisis.

However, in our view, the rating action is difficult to justify, as the risks associated with the relatively modest capital injection by the authorities are limited, and the outlook for Nigeria’s economic fundamentals is gradually improving. In this report, we consider the likely costs of the banking-sector cleanup, the funding options available to the authorities, and the overall macroeconomic effect of the bailout.

In contrast to the S&P statement, rather than involving considerable fiscal costs, the immediate capital injection of NGN 400bn ($2.6 billion) into Nigeria’s five rescued banks appears to have been funded – in the short term, at least – through the creation of money.

According to press interviews given by the Central Bank of Nigeria (CBN) governor, cited by both Reuters and Bloomberg, the CBN expanded its balance sheet to inject the capital into the banks.

This is borne by trends in Nigeria’s money market, where the injection of additional liquidity into the market saw overnight interbank rates collapse – from levels close to 20 per cent just before the bank bailout to six per cent by the end of the week in which the capital injection was announced.

The release of monthly statutory allocations (oil earnings distributed to the three tiers of government) during the same week and expectations of a one-off US$2bn disbursement from Nigeria’s excess crude account no doubt also reinforced this trend.

Nigerian oil revenue – one of the key drivers of base money growth – has been severely constrained. The resulting reduction in Federal Accounts Allocation Committee (FAAC) disbursements has led to a substantial tightening of monetary conditions, with currency in circulation having fallen for some time now.

Although the oil sector is thought to contribute only 20 per cent of the country’s overall GDP, there is little doubt that disbursements of oil revenue remain a key driver of money supply growth.

According to the CBN’s May 2009 Monthly Economic report (the most recent), narrow money supply, contracted by 5.4 per cent month on month between May and April 2009. Broad money, fell by 3.1 per cent m/m.

Given the stresses seen in the banking sector since then, broad money may have contracted even further. Oil output has only started to recover recently with the announcement of an amnesty for Niger Delta militants.

Whether this will be sufficient to offset banking-sector influences is doubtful, at least in the near term. CBN directive on commercial paper (CP) and bankers acceptances (BAs) has likely impacted already-subdued velocity of money.

We also expect a decline in the velocity of money, deepening the potential contractionary impact on nominal output.

Many of the reforms put in place to accelerate the banking-sector cleanup have been aimed at reducing the high cost of bank funding, which had been a key constraint on private-sector credit growth.