S&P Global Ratings estimates that the Central Bank of Nigeria's (CBN) capital increase requirement will add an average of 400 basis points (bps) to top-tier banks' regulatory capital ratios. The sharp increase in banks' paid-up capital will improve their loss absorption capacity in a context of high operating, credit, and currency risks in Nigeria. It will also help top Nigerian banks better compete against international and other pan-African banking groups, particularly in trade finance. By strengthening their balance sheets, some mid-tier banks will be able to scale their lending to the real economy and improve credit intermediation.

The previous recapitalization of the banking sector in Nigeria was completed in 2005, when the Nigerian naira (NGN) was about 130 against 1 U.S. dollar (USD). Multiple episodes of naira depreciation over the past decade have curbed banks' USD-denominated capital. At the same time, Nigerian banks' balance sheets increased by 3.5x in USD terms as banks deepened their reach in Nigeria and across Africa. Nigerian banks' balance sheets have material foreign currency exposures, which underpins the need to strengthen capital.

We do not expect any rating changes related to the recapitalization exercise as our bank ratings are constrained by Nigeria's sovereign creditworthiness (B-/Stable/B). Below, we discuss frequently asked questions from investors about the effects of the recapitalization exercise on banks' performance and creditworthiness and the key risks ahead.

Frequently Asked Questions

What are the new regulatory capital requirements for Nigerian banks?

In March 2024, the CBN mandated all licensed banks to raise their minimum paid-up capital to NGN500 billion ($313 million at NGN1600/$) from NGN50 billion ($31 million) if they had an international license, NGN200 billion ($125 million) from NGN25 billion ($16 million) in the case of a national license, and NGN50 billion ($31 million) from NGN10 billion ($6 million) if they had a regional license. We rate 10 banking groups in Nigeria that represent about 90% of the system assets. According to data from full-year 2023, we estimate that our rated banks' capital shortfall is approximately NGN2.5 trillion ($1.6 billion). Banks have until March 31, 2026, to raise capital by injecting fresh equity, consolidating, or downgrading their banking license to meet the new requirements. Banks are not permitted to meet the new capital requirement through retained earnings.

What is the likelihood of rated banks being able to raise the required capital by March 2026?

We anticipate that our rated banks will manage to comply with the new capital requirements before March 31, 2026. Banks have a diversified investor base that includes Nigerian pension funds, as well as retail and foreign investors. We expect top-tier banks (top five banks in Nigeria by total assets) will be able to raise their announced capital targets with relative ease as their strong performance and dividend distribution could appeal to institutional and retail domestic investors alike. Additionally, they will likely attract foreign capital flows, thanks to their foreign investor base and considering the banks' valuation in USD terms. Most top-tier banks have already gone to the market for their proposed equity raise with a mix of rights and new share issuance.

We understand that most mid-tier and small banks will take up to end of March 2026 to raise their capital shortfall. Foreign-owned banks will rely on their parents to shore up their capital, while some smaller banks could opt to lower their licenses or merge with other banks. We therefore expect the current number of 26 commercial banks will decline. This will not affect the stability of the banking sector, which exhibits some degree of concentration since top-tier banks account for 70% of system assets.

Why is foreign currency risk elevated?

Nigerian banks' total USD-denominated equity deteriorated in recent years because of their balance sheet structure. While they carry material foreign currency exposures of 55% on average, their capital is largely NGN-denominated. Banks have a material exposure to the oil and gas sector. That said, their long USD-denominated asset position enabled them to record exceptional trading gains at the back of the naira depreciation in 2023. Although the CBN reduced banks' net long foreign currency position to 0% (from 10%) of shareholders' equity in February 2024, banks have recorded additional revaluation gains of their USD-denominated assets, following the depreciation of the naira in first-quarter 2024. Although the naira volatility contributes to banks' stronger earnings and capital accretion, it tends to erode capitalization in USD terms.

How do you assess capital?

In line with our global approach to assessing bank capitalization, we use our risk-adjusted capital ratio (RAC), which is materially different to the regulatory capital adequacy ratio because of the difference in applied risk weights (see chart 1). Risk charges in our RAC model are derived from our view of economic risks and sovereign ratings in each country, among other factors. Extremely high economic risks in Nigeria result in higher risk charges and affect our RAC ratios. Therefore, our rated banks' RAC ratios--which are at 3%-5% for most banks--are significantly lower than banks' regulatory capital adequacy ratios, which mostly range between 16%-30%. We also look at banks' earnings to assess their internal capital generation capacity. Although improvements in our RAC ratios due to the recapitalization will not in themselves result in upgrades (given the level of the sovereign rating), we could see in some cases a strengthening of banks' stand-alone credit profiles (SACPs), that is, our view of intrinsic creditworthiness, excluding any sovereign constraints.

Chart 1

Are banks' earnings strong enough to absorb higher credit losses and support capital?

Due to Nigerian banks' strong profitability and earnings retention through the cycle, average credit losses do not adversely affect their capitalization. We expect earnings will remain strong in 2024, supported by robust net interest margins because of high interest rates. The CBN has increased the monetary policy rate by a cumulative 850 bps to 27.25% this year. Higher yields on government securities and loans will underpin banks' earnings. Banks' digital capabilities also support increases in their non-funded revenues during economic downturns. Non-interest income accounted for an average of 50% of rated banks' total income in 2023.

What are the structural risks to capital?

Higher credit losses or volatility in the foreign exchange (FX) market could impair capitalization. The Nigerian banking industry's credit losses largely result from banks' exposures to the oil and gas sector and foreign currency risk. The oil and gas sector accounts for about one-third of the Nigerian banking sector's gross loans. Although the CBN has made efforts to stabilize the FX market by clearing the foreign currency backlog and providing some liquidity to the market, we believe U.S dollar supply is still somewhat constrained by the underperformance of the oil and gas sector, which is one of the major sources of foreign currency inflows in Nigeria. As a result of the naira weakness, foreign currency exposures exceeded 50% of total loans in 2023, from about 40% in 2022. That said, most of these loans are backed by receivables in the same currency. Although most banks tried to deleverage their balance sheets and convert some of these loans into local currency, successive episodes of naira depreciation over the past decade curbed their efforts (see chart 2).

Chart 2

We expect tight supply of foreign currency will continue to weigh on key sectors of the economy through 2024, which could lead to higher impairment charges. In addition, the sector operates with a structurally high level of problem loans. Rated banks' stage 2 loans averaged 20.4% of gross loans on Dec. 31, 2023--which largely resulted from foreign currency shortages that delayed payments--while the average for stage 3 loans stood below the CBN's 5% threshold at 4.6%. Although small and midsize enterprises account for less than 5% of domestic sector loans, high inflation and interest rates will also constrain borrowers' repayment capacity.

Will the capital raise accelerate the Basel III reform?

The new capital requirements will result in an increase in banks' capital adequacy ratios and leave most rated banks with significant buffers above their regulatory minimum requirements under the Basel II framework. Once they are implemented, the stronger buffers will ease future compliance with Basel III capital requirements (see chart 3). Nigerian banks have reported their capital adequacy under both frameworks to the regulator since November 2021. Under Basel III, the regulatory minimum capital requirement increases by 2 percentage points to 17% for domestic systemically important banks. The minimum capital requirement includes a 1% high loss absorbency requirement and a 1% capital conservation buffer. All other banks must comply with the latter.

Chart 3

How does the recapitalization affect bank ratings?

As banks complete their planned capital increase, we expect some rated banks' capital and earnings will improve, which will strengthen their SACPs. We consider Nigerian top-tier banks' intrinsic creditworthiness is stronger than that of the sovereign because of their ability to grow their revenues and maintain strong profitability through the cycle. Top-tier banks' SACPs exceed the sovereign rating by two notches. Yet we do not rate financial institutions in Nigeria above our 'B-/B' global foreign currency and 'ngBBB+/ngA-2' national scale sovereign ratings, due to the direct and indirect effects that sovereign stress would have on banks' operations and creditworthiness. Our outlook on most ratings on Nigerian banks is stable, except for Ecobank Nigeria Ltd. and First City Monument Bank. Our stable outlook largely reflects the outlook on the long-term sovereign rating as our bank ratings will move in tandem with the sovereign ratings. Therefore, the recapitalization exercise will be neutral to our bank ratings, unless our view of the sovereign's creditworthiness improves.

Table 1

Related Research

• Nigerian Banks Are Confronted With The Lingering Naira Depreciation, April 2, 2024
• Nigeria Ratings Affirmed At 'B-/B'; Outlook Remains Stable, Feb. 2, 2024
• Nigerian Banking Outlook 2024: Banks Stand Firm Amid Macroeconomic Pressures, Jan. 18, 2024
• Tech Disruption In Retail Banking: Regulation And Infrastructure Development Can Help Nigeria's Retail Banks Fend Off Fintechs, Jan. 15, 2024
• Banking Industry Country Risk Assessment: Nigeria, Nov. 30, 2023