A recession is usually defined as a period of economic contraction. Recession is considered to have occurred if there is negative economic growth for two (2) consecutive quarters. This will suggest a fall in real national output and real national income. As confirmed by the National Bureau of Statistics (NBS) Nigeria has reported 3 consecutive quarters of negative economic growth. The country was further confirmed to be in its worst recession in 29years. The impacts are visible across the economy, manifesting in different forms, with diverse and far reaching implications.
The recession period is characterized with very slow economic activity, high inflation and high unemployment, fall in real estate prices and industrial output, cashflow challenges, reduced capital investments, fall in disposable income leading to weak aggregate demand, business uncertainties and associated vulnerabilities. The case is even worse in a mono economy with little depth and highly dependent on imports and the related currency shocks, and that is likely to be affected by policy inconsistencies and coordination challenges. Situations like this usually protracts recession leading to slow and painful recovery.
LENDING IN A RECESSION
The financial sector like other sectors of the economy is also affected by economic recession. Fall in disposable income and business cashflow as well as high leverage will usually affect demand for credits. Similarly, banks are more likely to be protective of their balance sheets, liquidity and capital requirements to remain resilience to withstand shocks. The combination of demand and supply factors are responsible for intricate challenges of lending in a recession.
Loan growth usually stay negative in a recession and likely to remain muted within 18-24 months from commencement of recovery as growth and recovery could be slow depending on the transmission mechanism.
ISSUES AND CHALLENGES
It is always perceived that tightening of lending standards tends to prolong recession. Due consideration should however be given to the fact that banks can only lend when they are confident they will be able to get repayment (cashflow) which is usually uncertain in recession.
Banks lend against cash flow. Profitability and cashflow tend to shrink in recession while fragility, insolvencies and uncertainties are usually elevated. In such situation, it would be difficult for banks to lend. Besides, loan portfolio is likely to be affected by features described above, with implications for higher than expected loan delinquencies and prudential breaches. The natural reaction of banks would be to minimize damage to their balance sheet, concentrate on loan workout and recovery to maintain healthy portfolio, as well as protect capital and liquidity.
Regulators would also require banks to maintain prudential ratios to safeguard the financial
system, and be able to cope with challenges of the recession.
The high inflationary and high interest rate environment is an important factor to consider. They tend to reduce disposable income of borrowers and cashflow of businesses. Weak aggregate demand could lead to huge inventory of unsold goods, high holding costs that drives up financing cost, thin margins if not losses. All these have implications for cashflow, lending decisions and loan repayment.
It is important to appreciate the structure of the economy as highly import dependent and highly susceptible to external shocks and imported inflation. Foreign Exchange challenge has acted as a binding constraint to lending and economic growth. Most Credit lines for importation of raw materials, plants, equipment and spares witnessed about 20% utilization due to FX challenges, forcing many companies to either operate sub-optimally or close down.
Considering the realities of our economy, it would be important to stimulate demand for goods and services through improved disposable income. That may suggest government being the largest employer of labour would have to be current with workers’ salaries to clear the backlog of personal loans and improve livelihood (Most state governments are in arrears of between 28months, some on half salary for almost a year). There will also be need to increase salaries that have been eroded by currency devaluation and associated imported inflation. With about 70% increase in the price of petroleum products and domino effect of that on consumer goods and services, it is highly unlikely that consumer demand will be strong without corresponding wage increase. This is necessary to maintain living wage and avoid deprivation as well as tame desperation. That will make it also possible to deleverage household balance sheets, increase disposable income and consequently aggregate demand. This is the first level of creating the lever for growth and opportunity for banks to jump start lending.
Government policies may also be designed to target real sector of the economy in such a way
that it does not penalize banks, but offer incentives for participation. It may also be in the form of regulatory support by way of reduction in Cash Reserve Requirement from the current 22.5% to about 6%. This singular reform is capable of reducing interest rate significantly and provide extra liquidity to banks to jump start lending. As a form of financial support, the Federal Government may attempt to back stop state governments to clear salary arrears and restore purchasing power of households. With restored consumer spending power and aggregate demand, businesses would be able to sell their products, holding cost of inventories would reduce and free up cashflow for debt service and investments. This will make it possible for banks to lend while the economy recovers.
In conclusion, the challenge is for the government, regulators, lenders and borrowers to work
together to stimulate the economy, enact laws that supports efficient bankruptcy regime and
penalizes adverse credit behavior. This should be in addition to incentives that alleviate fragilityand vulnerabilities in the real sector of the economy to support lending through economic cycles.
Olusegun Alebiosu, Chief Risk Officer, First Bank of Nigeria