The Battle of the Fittest

IFN Monthly Article on Nigeria

The Battle of the Fittest


The COVID-19 pandemic has undoubtedly brought immense healthcare and economic challenges. The Nigerian Federal Government now expects GDP to contract by 3.5% in 2020 largely due to a sharp decline in projected oil earnings and business output. The Government has already made sharp cuts to its projected revenues for 2020 and approached multilateral finance institutions to seek budget support. The government has also announced some stimulus measures estimated at N4 trillion (($10 billion) or 2.75% of GDP. However, many argue that the stimulus is not nearly enough compared to South Africa’s 10% and average global stimuli ranging from 5%-15% of GDP.

This is the backdrop against which the country’s nascent Islamic finance companies will operate in for the near future. Nigeria has only two full-fledged Islamic banks, one of which has operated for less than a year. The other is the pioneer Islamic bank, which has operated for eight years but only obtained a national license four years ago. However, out of the 24 banks in country, Islamic banks account for less than 1% of the total assets of the banking industry – a key metric for weathering a strong storm such as this one. Two key challenges likely to face the banking industry are deposit mobilization and asset quality. Other risks arise from some of the unique features of some Islamic banking products which could present a challenge to Islamic banks in particular. In the face of an unprecedented event and downturn occasioned by the COVID-19 pandemic, all banks, conventional and Islamic, must be concerned with the potential deterioration of their credit portfolios. The difference is that while a conventional bank can easily restructure a loan and continue collecting interest for the extended period, the most prevalent contract used in Islamic banks to advance credit, Murabaha (or cost plus mark-up contract), does not allow for a higher mark up even if the tenure is extended due to a restructuring of the facility. Not only does this reduce the income expectation on that facility, it also introduces a moral hazard or arbitrage opportunity for a customer with facilities at both a conventional and Islamic bank. Islamic banks will have to ensure that their penalty clauses act as enough of a deterrent to avoid this.

Due to the country’s demographics, the existing Islamic banks have a strong footprint in Northern Nigeria which incidentally also has a large percentage of the Muslim population. The predominant occupations among the financially affluent in this area include public administration and trade. Deposit growth from customers engaged in public administration could be impacted as the Federal Government, which now has a smaller purse, has already announced plans for rationalization in the public sector including the merger of multiple agencies to improve efficiency. Some state governments have also proposed steep pay cuts. On the other hand, the country’s second largest commercial city, Kano is now the epicenter of the outbreak in the Northern region and the government-imposed travel restrictions will adversely impact the livelihoods of traders – another key customer base. The upside is that the northern half of the country is also the food belt, the only sector that is thriving in this pandemic.

With these challenges, all financial institutions will face a test of fitness. With social distancing and remote work likely to become commonplace, the banks with the best technology platform and digital channels will clearly have an advantage. Those who had previously made the investment will enjoy stronger patronage. However, the proliferation of artificial intelligence-based lending will likely slow as algorithms must be adjusted for this huge structural dislocation.

The government has set up an Economic Sustainability Committee to assess systemic vulnerabilities and develop programs that would limit the duration of the looming recession and quicken the recovery thereafter. Perhaps, the Nigerian authorities may consider approaching the Islamic Development Bank Group (IsDB), which has promised to spend an aggregate of $2billion in financing the health and socioeconomic challenges of the pandemic. The IsDB is active in Nigeria and has sponsored numerous projects in the education, health, social services, agriculture, trade and energy sectors. It has previously aided the country in financing social programmes in insurgency-prone pockets of the North-East. The IsDB has already pledged $50million in financial support to Nigeria’s neighbours, Benin and Chad.

Nigeria’s Islamic finance industry holds a lot of promise and has strong long-term fundamentals. Given the small size of the industry, the days ahead may be tough, but they are used to that. One advantage they have is that Islamic bank have always operated in the real economy, assessing real businesses and following the money. That leaves them well placed to carefully navigate the somewhat treacherous waters ahead.