Medium and small deposit money banks are seen to be vulnerable to credit and concentration shocks according to stress tests conducted by the Central Bank of Nigeria (CBN) as their Capital Adequacy Ratio (CAR) fell below the 10 percent regulatory standard.

The CBN in its latest financial stability report (FSR) as at December 2015, which was released yesterday said the solvency stress test captured the nature of individual bank’s balance sheet and macro-prudential concerns using the bottom-up and top-down approaches.

The exercise covered the 23 Commercial and Merchant banks using the following risk elements: credit, liquidity, interest, foreign exchange rates and foreign exchange trading risks.

For systemic and peer assessment, the banks were classified into three groups based on their asset size as follows: large banks are banks with assets greater than or equal to N1.0 trillion, medium banks have assets greater than or equal to N500 billion but less than N1.0 trillion and small banks have assets of less than N500 billion.

The stress test results indicated the banking industry and large banks’ resilience to credit risk was robust.

A simulated severe shock of a 200 per cent rise in nonperforming loans (NPLs) resulted in CARs of 12.77 and 16.52 per cent for banking industry and large banks, respectively, which were above the 10 per cent required regulatory minimum.

However, medium and small bank groups showed vulnerabilities to severe shocks of 200 per cent rise in NPLs as their CARs fell to 7.16 and 6.85 per cent respectively.

The banking industry and all peered banks also showed resilience to credit concentration risk as their CARs remained above 10 per cent under the scenario; “five biggest credit facilities shifting from pass-through to sub-standard (10% provision)”, and “five biggest credit facilities shifting from sub-standard to doubtful (50% provision)”.

However, when the CBN stresses for the scenario, “five biggest corporate facilities shifting from doubtful to lost”, CARs of the banking industry, large, medium and small banks deteriorated to 7.79, 8.73, 5.75 and 6.80 per cent, respectively, from the baseline.

“Therefore, under this scenario, none of the peered banks maintained a CAR up to 10 per cent, ”the CBN said in the report.

Tajudeen Ibrahim, Head – Equity Research at Chapel Hill Denham said the results of the stress tests will be a major shock to the banking sector.

“We have seen significantly high NPL ratios and credit losses in recent quarters that suggest that some banks need to raise capital to grow their businesses. We believe a shocking scenario such as this can be avoided if banks improve their risk management and are adequately capitalised ahead of regulatory requirements” Ibrahim said in an email response to BusinessDay questions .

However, the baseline (pre-shock) capital adequacy ratio (CAR) for the banking industry stood at 17.66 percent at the end of December 2015.

The eight large banks’ baseline pre-shock CAR was 18.48 percent, that of medium banks was 15.61 percent and the small banks numbering 10 stood at 17.61 percent over the period.

The report also showed that pre-shock return on assets (ROA) of the banking industry, large, medium and small banks were 0.11, 0.17, -0.10 and 0.11 per cent, respectively as at December 2015.

On the other hand, the return on equity (ROE) of the banking industry, large, medium and small banks were1.11, 1.53, -1.22 and 0.31 per cent in December 2015, respectively.

Non-performing loans (NPLs), rose to N649.63 billion at end-December 2015, from N628.54 billion at end-June 2015, according to the CBN.

This was equivalent to a 78.8 per cent increase from the N363.31 billion recorded at end-December 2014 taking total industry NPL ratio to 4.86 per cent from 4.65 per cent.

Although the NPL ratio remained within the prudential ceiling of 5.0 per cent, it trended closer to the upper limit.

The report revealed that a few banks had NPL ratio above the regulatory maximum limit of 5.0 percent; however this posed no significant risks to the industry.

Ayodeji, head investment research said the recent accumulation of NPLs raises questions about the risk management process of some of the Nigerian banks as well as oversight function of the Apex bank.

“We suggest more technical trainings should be provided for staff of the CBN on the dynamics of business activities in the oil & gas space which accounted for large chunk of the NPLs. This would assist in the close monitoring of the banks as well as early discovery of NPLs. Additionally, we suggest the need for the Apex bank to review the single obligor limit as well as proportion of sector loan to total loans for banks. We expect to these banks to shore up regulatory capital via Rights issue (Tier-1 capital) to remain above 16.0%, 15.0% and 10.0% regulatory CAR for Systemically Important Banks, International Banks and National & Regional banks respectively”, he said in an emailed response to BusinessDay.