Numerous hiccups dotted the traditional financing model of Nigeria’s upstream oil sector and invariably made way for alternative options. Domestic bank funding was one of those financing options. Before that, joint venture, production sharing contracts, and service contracts were the dominant vehicles for financing upstream oil sector projects. However, persistent delays and defaults by the government in meeting its contractual obligations, as well as the cumbersome nature of the contracting process, necessitated the search for alternatives. Encouragingly, the alternative financing option incentivized the private investor leadership of the process. Among the class of the alternative financing sources (public bond, equity investments, reserve-based lending, the United States Private placement), the commercial bank option provided convenient short-term complementarity. It was a very flexible short-term option for working capital financing in the sector, considering its heavy funding pressure partially ascribable to the comparatively high cost of production of crude oil in Nigeria’s deep waters.

It was nevertheless a sweetener for the banking sector, which increasingly concentrated about 25% of its balance sheet in the oil and gas sector. Consequently, between 2000 and 2010, total banking sector credits to the oil and gas sector grew fourfold from about 6% to approximately 24%. But this was a precariously rewarding relationship that prospered the banks in booms and hurt them at inauspicious times. Much scholarly research has shown a strong inverse relationship between banking industry concentration in the oil sector and its profitability. Based on the Nigerian banking industry data between 2007 and 2019, banks’ liquidity position on average appears to improve by 45% for every 1% increase in the crude oil export price. On the flip side, a 1% increase in crude oil price leads to about a 67% drop in the banking industry non-performing loans on average. Understandably, this means that the oil sector substantially meets its loan obligations during gainful periods.

The reverse is the case when the price drops close to or lower than the cost of production. That raises much concern at this time when the export price of crude oil has been descending precariously. The profitability of First Bank, a Tier 1 bank leader, Unity and FCMB banks appear to swing in the same direction with the movement in oil prices. But it has a virtually unconnected effect on First Bank’s Asset quality. It shares this characteristic with Ecobank, and Stanbic-IBTC that that do not have much exposure to the sector.

The effect of oil price shocks on banks generally manifests through direct and indirect channels.  There are at least four ways in which banks receive the impact. The first is through the reduction in interest income as well as overall profitability. Only Tier 1 banks’ (led by Access Bank and Eco bank) net interest margin showed direct albeit weak relationship with changes in crude oil export prices based on their annual performances on this indicator since 2007.  Other effect transmission channels include the possible negative impacts on bank balance sheets as well as potential increases in their operational costs.  Again, it is also possible that if this very-low crude oil price regime lasts for more than six months without significantly sustained interventions in the banking sector, that confidence issues may crop-up. An initial reduced confidence trigger may take roots among the not-too-strong banks that are also severely exposed. If not properly managed, this may worsen depending on the degree of withdrawals and liquidity mismatch experienced by such banks. It is needless to state that the indirect transmission channels can be as devastating as the direct impact pointsThe income-depressing effects on government and corporate earnings are perhaps the first level of indirect transmission. The negative impact on governments income and many corporates with their economic activities embedded in the upstream oil sector’s value chain will, albeit at varying degrees, affect their capacity to repay their obligation to banks. In the same vein, the dilemma of our dangerous dependency on crude oil export for foreign exchange and our huge import dependency and appetite will naturally put pressure on both the exchange rate as well as the supply of foreign exchange. The adjustments that will ensue will result in spikes on the cost of doing business. Many businesses will close shop as a consequence. These effects will aggravate the size of non-performing loans of the banking sectors. The severity of all of these potential consequences will depend on the extent to which the government’s fiscal interventions facilitate the revamp in these other non-oil sectors. All things being equal, the effect may be tempered slightly in the manufacturing, pharmaceuticals, and transport sectors due to the central bank’s palliative measures. There is also the interaction of all these with the attendant aggregate demand decline. The banking sector will, without doubt, receive a hit. Again, much will also depend on how long the lockdown lasts.

Which banks will be worst hit? In the past two years, GT Bank appears to have exhibited the highest appetite for granting oil sector credits. In 2018 and 2019, 37% and 40% of its loan exposures respectively were to the oil and gas sector. Although GT Bank is not alone in this, it has nevertheless recorded fantastic average improvements in its asset quality since 2009. In 2019, the credit exposures of Zenith Bank, FCMB, First Bank, Union Bank, Sterling Bank and Access Bank to the oil and gas sector all exceeded 25% of their total loan portfolio. On the other side of the divide are banks that have consistently reduced their exposures to the oil sector. Since 2016, Union Bank and Sterling Bank have steadily dropped the relative shares of their exposures to the oil and gas sector. In 2016, about 50% of Sterling bank’s loan exposures were in that sector. The bank dropped it to 42% in 2017 and 35% in 2019. Likewise, Union Bank dropped the percentage share of its oil and gas sector loans from 47% in 2016 to 26% in 2019. In general, it appears as if most of the banks successfully anticipated the current reality and are adequately prepared for it courtesy of experiences from the previous oil price shocks.

That noted average asset quality of Tier-2 banks strongly and inversely correlate with crude oil prices. Union Bank and Wema bank strongly exhibit this pattern regardless of the efforts of the former to whittle down its exposures to the oil sector. A similar but moderate relationship exists with Tier-3 banks. Tier-1 banks do not seem to share that relationship. Similarly, Tier-3 banks profitability appears to share a relatively strong positive correlation with oil price movement. Tier-3 and Tier-1 banks liquidity positions appear to share a pattern of swaying in the same direction with oil price changes. Despite all these patterns, it does seem as if the current profitability threats to the upstream sector will not deal as much a devastating blow on the Nigerian banking industry as many would expect. There appears to be adequate readiness for it as well as a few impacts reducing possibilities that may blunt the ferocity of the effect. It is even more real if the current low-price crude oil regime lasts for less than 8-months. The nature of the relationship between Nigerian bank performance indicators and changes in crude oil prices do not seem to be strong enough to cause that. The experiences of the similar crisis in 2007 – 8 and 2014 – 15 might have informed possibly higher levels of cover against such probable devastations.

That noted many of the players in the industry have started defaulting since the end of February. The credit default heat is already transmitting to the banks. Banks, on the other hand, are out with their daggers drawn to recover their funds. This cross-pressure is not going to stop very soon. And since we do not expect global economic activity to resume in the short term substantially, there is no improvement on site. That also calls to question on the aloofness of the central bank in extending palliatives to the oil and gas sector crisis time. In the 2015 – 17 crisis, local players in the upstream segment of the oil and gas sector were left to auto recuperate even though they were the first on the line to receive the bash. Unfortunately for the sector, they are yet to get healthy when this current crisis prevailed upon them. Perhaps, the banks may survive the district much better if there is some relief for the upstream oil and gas sector. However, even without that, though, it is unlikely that the crisis might bring down any of the banks.

In any case, relief to the banking sector will nevertheless come fastest to those banks that understand the dynamics of SME, agriculture and manufacturing industry financing and play well in them as the economy reboots. Much of the success that is achievable in this respect will depend on a banks ability to creatively resurrect dying industries and nurture large numbers of SMEs to sustained profitability. They are unarguably the new opportunity frontiers at least for now and which is in symphony with the intervention focus of the CBN.