Banks earnings rose sharply in 2023 as Nigerian lenders earned higher interest income from loan book repricing.

In the latest earnings release by banking sector dominating lenders, their individual report showed interest income skyrocketed using effective pricing method.

Many borrowers are paying higher interest on existing loans from lenders following an adjustment to monetary policy rate. Since May 2023, the Central Bank of Nigeria policy committee has deployed rate hikes as inflation fighting strategy to stabilize price level.

The contractionary stance is currently having negative impacts on private sector expansion as Nigeria’s gross domestic product receded in the four quarter.

GDP growth slowed down below 2.8% in 2023 versus annual growth rate of 3.1% in the comparable year in 2022.

Analysts had told MarketForces Africa that the economy cannot accommodate higher interest rate environment as growth underperformed expectations.

Low growth rate amidst surging population surge has plunged per capita income downward over the past decade.

Private sector operators are facing multiple pressures from changing market dynamics—interest, inflation conditions has increased significantly post pandemic.

Addressing the issue of loan repricing with MarketForces Africa, Jibril Aku, Chairman and Chief Executive Officer of Marathon Group said there are two types of pricing available to Nigerian lenders: – Fixed rate and floating rate.

He said when rate is fixed, interest payments on existing loans will not change until maturity.

However, Aku said that to allow the banks to comply with the monetary policy committee directive, most banks grant fixed rates loans for tenors not exceeding 3 months and, in some cases, 6 months.

“This will allow the banks to reprice. In the case of floating rate which is often used more in loan syndications, they are indexed to the money policy rate (MPR) or Nigerian interbank borrowing rate (NIBOR). The interest payment would change when the pricing index changes."

“In some cases of fixed rate loans, some banks insert in the documentation that the banks’ reserve the right to re-price the loans based on “market conditions,” Aku explained.

He said small customers without leverage accept this “poison pill” and therefore empower the banks to make immediate changes to fixed-rate loans before maturity.

Aku said loan interest is calculated daily but debited at the end of the month. This means the amount debited at the end of the month is the effective interest rate. It has accounted for the time value of money.

Also, Peter Amangbo, Chairman, Globus Bank Limited, said most loans granted are based on variable interest rates. “When the interest rate is anchored or benchmarked using MPR, etc, the implication is that when the MPR changes, the interest rate will change accordingly.

“This is similar to the practice in the global financial markets, where the benchmark used to be LIBOR, which was later changed to Secured Overnight Financing Rate (SOFR). It’s important to note that deposit rates also respond to changes in the benchmark rates. Hence, both deposits and loans are affected depending on the terms of the contract,” Globus Bank chief told MarketForces Africa. .

Praise Ihansekhien, Head of Investment Research at Meristem Securities Limited, said most times, rates are not usually fixed because the banks understand that MPR can move. He said loan repricing means there could be an increase in the interest rate of existing loans, considering the adjustment made to the benchmark interest rate.

According to him, an increase in MPR affects the interest rate that banks will pay on customers’ deposits, thus the need to also reprice loan rates. Meristem Securities research head said the new rate would be based on the new benchmark rate plus the original spread – the difference between the benchmark and banks loan rate.

“The effective interest rate method for computing interest income is an accounting method used to compute and report interest income and expense.

“The objective of determining an effective interest rate is to identify the economic rate of return of a financial asset based on the concepts of accrual accounting. It’s mostly applied to the other financial instruments they hold (bonds, Tbills, etc). Though, there’s also an accounting provision on how it can be applied on loans.

“Using the effective interest rate considers all loan payments and the time value of money, giving a more accurate picture of profitability than just the stated rate. For income reporting, it smooths out fluctuations in interest rates. This smoothing could potentially overstate the bank’s income in reports”, Ihansekhien told MarketForces Africa.

He added that reporting interest income using the effective interest rate on existing loans can sometimes result in inflated income figures, especially if there are significant discrepancies between the effective interest rate and the nominal interest rate charged on loans.

Michael Oyebola, Morgan Stanley Alumni and Founder, Money Counsellor said, almost 100% of customer loans in Nigeria are variable rate loans which means when interest rates rise, or fall, their loan will be repriced. So in the case the customers’ loan to a bank will be increased too.

“A loan may be given at say 30%, but more likely the interest accrues daily. So whilst a layperson may calculate 30% of a N1m loan to be N300,000 over 1 year (say with end of year bullet payment), what they will likely pay to the bank is N349,363 as interest is accrued daily and compounded by the bank”.

In a response sent to MarketForces Africa, Victor Ndukauba, Deputy Managing Director at Afrinvest Limited, said the questions asked are valid and, more often than not, they stem from general sorts of public interest questions.

He stated that a lot of people wonder about banking and why things seem to be the way they are. Your question spoke, for example, about the re-pricing that banks have done to old loans based on the adjustments to the MPR, and essentially what that means.

“So, for example, if a customer borrows at 20%, which was above policy rates at the time, and later there was an adjustment to that rate, does it mean the customer will be asked to increase”? Afrinvest DMD said in this case, the customer will not be asked. “The customer will simply be informed that the interest has been adjusted, and it’s simple.

“In the contracts, the loan agreements, there’s usually a clause provided by banks that talks about the fact that the banks have the leeway or the right to review rates, both upward or downward, in line with market realities.

“That is the reality of the market, and it’s one of the things that is actually typically very clearly spelled out in a bank contract, in the form of a loan contract.”. He explained.

Responding to a request for expert views on rate adjustments and impacts on borrowers, Damilare Asimiyu, Afrinvest’s Head of Research, said other conditions stated in the terms of the loan would be key.

According to him, if in the terms of the loan it is stated that interest is MPR plus 20% markup, the customer would be called to take up a new letter stating the higher repayment condition any time MPR increases to maintain the 20% markup cap.

“if the terms of the loan state that “MPR plus a markup with a total below a certain threshold, say 35%,” the customer would not get a full adjustment to the level of the interest rate hike. So, there is no straight answer to the question.”.

He stressed that an effective interest rate works like a compound interest rate. It grows rapidly as the interest rate environment changes. So if a loan of #100 is given at a repayment rate of say 7% every month. As the client repays the 7% (#7), banks would put the #7 in an interest bearing investment of say 2% per month.

When the client pays another #7 the next month, the bank will add the new #7 to the previous #7 and the Internet on it and re-invest. By the time they do this for a year, the result you see is a compounding effect on a bank’s balance sheet, not a linear effect.

Dr. Joe Mekiliuwa, non-executive director at FMDQ Group and principal consultant at Joe Mekiliuwa consulting firm, said, “If you have an existing loan facility with a bank at an interest rate of say 20%, that transaction has been locked in until maturity before a review can be made to reflect the new MPR.

“Just like if you fixed money with a bank at 10% to mature in September, which transaction has been locked in, even if the MPR rate has increased now, the bank will not allow upward review.

“It is only when the investment has matured and the customer wants to rollover that the bank will allow the customer to negotiate upward at the new rate.”.

Mekiliuwa then said that if the banks will not allow the customer to enjoy a new rate when money is fixed with them until maturity, why must the bank increase the loan rate before the maturity of an existing loan?.