Implications of the CBN’s Reduction of the Loan-To-Deposit Ratio to 50% on Nigerian Banking Operations and Credit Availability

CONTRIBUTOR: IFEDIORA OBIORA CHISOM

Introduction

The recent decision by the Central Bank of Nigeria to lower the Loan-to-Deposit Ratio from 65% to 50% marks a turning point in the regulatory environment of the Nigerian banking sector. This policy adjustment is poised to have profound implications for the operational strategies of banks, the availability of credit in the economy, and broader economic development. The recalibrated LDR reflects the CBN’s proactive stance on steering the financial system towards heightened prudence amidst macroeconomic headwinds.

This article aims to dissect the potential impacts of this significant policy change, exploring its influence on banks’ lending behaviours, risk management approaches, and the resulting credit accessibility for various sectors, particularly for Small and Medium Enterprises which form the backbone of the Nigerian economy. By scrutinizing the intended and unintended consequences of the adjusted LDR, the essay will offer insights into the evolving financial landscape and the delicate balancing act faced by the CBN in its objective to ensure economic stability and growth.

Understanding Loan-to-Deposit Ratio

The Loan-to-Deposit Ratio (LDR) is a financial measure that assesses the liquidity position of a bank. It is calculated as a percentage by dividing the total amount of loans by the total deposits during a specified period.^[1] Put differently, the LDR is a banking operations mechanism that gives an insight into the proportion of assets a bank can create from its liabilities. It also indicates the amount of income/profit a bank can generate.^[2] For instance, if a bank has N100 million in deposits and issues N80 million in loans, its LDR would be 80% (80 million / 100 million).

The LDR serves as an indicator of a bank’s risk exposure and its ability to meet liquidity needs, such as paying depositors, during adverse market conditions. A high LDR may suggest that a bank could face challenges in fulfilling its obligations, while a low LDR might indicate that the institution is not utilizing its deposits efficiently.^[3]

In essence, the LDR is a useful instrument for assessing a bank’s financial status. It principally measures a bank’s liquidity and provides insights into its associated risk level. The justification for the LDR policy can be deduced from its definition: to encourage banks to enhance credit delivery to the real sector of the economy.

The Loan-to-Deposit Ratio (LDR) Policy in Nigeria

The Loan-to-Deposit Ratio (LDR) policy has long been a tool employed by the Central Bank of Nigeria (CBN) for several years to manage liquidity and achieve various economic objectives. Initially, the deposit lending ratio (LDR) in the Nigerian banking industry before the minimum LDR directive in 2019 was 57%.^[4] In 2013, the CBN set a prudential requirement of a maximum LDR of 80% for Nigerian banks.^[5] Later, In order to have a more risk management practice by MDBs and grow the economy, On July 3, 2019, the CBN instructed banks to maintain an LDR of 60%, which was later increased to 65% on September 30, 2019, to stimulate consumer, mortgage, and corporate credits, thereby boosting aggregate demand, output growth, and employment.^[6]

Most recently, on April 18, 2024, the CBN issued a circular^[7] reducing the LDR to 50%. The CBN emphasized that this decision aims to promote an effective strong risk management practice with regard to bank lending operations in Nigeria. This significant reduction from previous LDR levels may suggest a more restrictive economic policy. Should any Money Deposit Bank (MDB) fail to adhere to this new policy, it may attract penalties, such as an additional cash reserve requirement of 50% of the lending shortfall of the target LDR.^[8] This penalty structure was previously enforced when the LDR was set at 65% in 2022. The absence of a new sanction in the recent circular implies that the previous penalty likely still applies.

Implications of the Recent Reduction of the Loan-to-Deposit Ratio (LDR) by the Central Bank of Nigeria (CBN)

The recent reduction of the Loan-to-Deposit Ratio (LDR) by the Central Bank of Nigeria (CBN) to 50% has the potential to significantly impact various aspects of banking operations. It is pertinent to note that the actual effects will depend on how banks adapt their strategies and how the broader Nigerian economy responds to the policy change. Banks have been obliged to shape their lending principles according to the recent announcements made by the CBN as well as the new LDR. This will particularly cause large and medium-sized businesses to be threatened as they rely on bank credit facilities.^[9] This unprecedented move will definitely affect the ability of banks to issue loans, impacting companies that depend bank financing.

This measure may act as a double-edged sword. On one side, it could create challenges in obtaining loans for companies, potentially increasing loan interest rates. The credit crunch could benefit the credit market as lenders become more cautious, leading to better financial practices and reduced excessive risk-taking. Banks might retain more money to deal with short-term contingencies, improving liquidity.^[10]

On the other side, with reduced pressure on MDBs to expand their loan books, banks may focus more on credit quality, potentially decreasing the level of non-performing loans (NPLs). However, the reduced LDR could result in a scarcity of credit for SMEs, discouraging businesses from seeking bank leverage for investments^[11], which could slow economic momentum.

The new LDR could also reduce the amount of loans to the SMEs and other retail and individual borrowers.^[12] SMEs that have struggled over the years to obtain loans from financial institutions will still struggle to get loans with this reduced rate and individual borrowers may also find it difficult to gain from this policy through mortgage offerings.

Furthermore, the premises over which the CBN’s liquidity ratio could restrict inflation are based on the growth of deposits. If the deposits continue to grow as fast as they have done recently, following that growth trajectory, the banks will retain enough liquid assets to be able to loan money progressively without harming their liquidity ratios.

The ultimate impact is that the central bank’s LDR policy aims to balance inflation control and bank liquidity, but it might also restrict the credit pipeline, potentially slowing down economic activities.

Conclusion

The Central Bank of Nigeria decision to limit the Loan-to-Deposit Ratio to 50% is a sharp prong that is aimed at not only managing the risk profiles of risk in Nigerian banks but also protecting Nigeria’s currency value. It may help in some of the sector’s most concerning ways, like creating flexibility in liquidity and strengthening a solvent supervisory environment. However, in their quest of reinforcing Nigeria’s financial sector, they will have to do so at a substantial premium, at the expense of the reduction in new credit, that is, adorning self-employed individuals, Small and Medium Enterprises, and individual borrowers already facing credit indiscipline at the same time. In this regard, the expected outcomes of the policy include banking adaptation to the proposed regulations, deposit growth, and interactions with other aspects of the economy which interact with the important institutions of the financial sector. Sometimes it might take due changes in the regulatory environment as the way to reach balance between smoothing liquidity and financing credit so as to motorize expeditious recovery.

1. Murphy, C.B, ‘Loan-to-Deposit Ration Definition’ (Investopedia, 24 May 2024) < https://www.investopedia.com/terms/l/loan-to-deposit-ratio.asp> 17^th May, 2024 ↑
2. Adenuga A.O, et.al, ‘ Measuring the Impact of Loan-to-Deposit Ration on Banks’ Liquidity in Nigeria’, EFR (2021) (59) (2), p 43 ↑
3. Murphy, C.B, ‘Loan-to-Deposit Ration Definition’ (Investopedia, 24 May 2023) < https://www.investopedia.com/terms/l/loan-to-deposit-ratio.asp> 17^th May, 2024 ↑
4. CBN, ‘LDR Bridging Credit Gap’ CBNUPDATE (2021) (3) (4) < https://www.cbn.gov.ng/out/2021/ccd/cbn%20update%202021%20(april).pdf> accessed 19 May 2024 ↑
5. BusinessDay, ‘Banks’ Loan to Deposit Ratio Drops low in 2012’ (BusinessDay, 6 May 2013)< https://businessday.ng/banking/article/banks-loan-to-deposit-ratio-drops-in-2012-lowest-in-four-years/> accessed 19 May 2024 ↑
6. Adenuga A.O, et.al, ‘ Measuring the Impact of Loan-to-Deposit Ration on Banks’ Liquidity in Nigeria’, EFR (2021) (59) (2), p 44 ↑
7. Central Bank of Nigeria (CBN), ‘Regulatory Measures to Improve Lending to the Real Sector of the Nigerian Economy’ ([BSD/DIR/PUB/LAB/017/005], 17 April 2024) < https://www.cbn.gov.ng/Out/2024/CCD/RE-REGULATORY%20MEASURES%20TO%20IMPROVE%20LENDING%20TO%20THE%20REAL%20SECTOR%20APRIL%202024.PDF> accessed 17 May 2024. ↑
8. Kayode Tokede, ‘9 MDBs Fail to meet CBN 65% LDR Requirement in 2022’ (This Day News, 19^th may 2023) < https://www.thisdaylive.com/index.php/2023/05/17/nine-dmbs-failed-to-meet-cbns-65-ldr-requirement-in-2022/> 17 May 2024 ↑
9. Ibid ↑
10. Ibid ↑
11. CBN, ‘LDR Bridging Credit Gap’ CBNUPDATE (2021) (3) (4) < https://www.cbn.gov.ng/out/2021/ccd/cbn%20update%202021%20(april).pdf> accessed 19 May 2024 ↑
12. Ibid ↑