As the global economy is inter-related, there is no doubt that the Nigerian banking system is susceptible to vulnerabilities like its peers in emerging market economies.
Significantly, the risk of global economic crises has heightened and global aggregate demand has fallen while commodity prices have collapsed, analysts said.
They claimed that if the situation is not tamed, it would snowball into a worse scenario for the Nigeria banking system and the entire economy.
Financial sector vulnerabilities in emerging markets and developing economies (EMDEs) are largely divided along income lines.
While vulnerabilities are low to moderate in higher-income EMDEs, half of lower-income countries face much higher risks.
In addition, progress on financial development goals such as local capital market deepening has stalled in many countries.
Advances, however, have been made on financial inclusion for individuals and in efforts to green the financial sector.
Meanwhile, EMDE banks substantially increased their holdings of government debt. These exposures currently stand at a decade high and subject the financial sector to additional risks, particularly in countries with weaker macroeconomic policies and public debt sustainability challenges.
In addition, climate change is particularly challenging for EMDEs because they face higher risks from it than advanced economies as well as larger climate financing gaps.
Despite being the largest source of finance, the banking sector in EMDEs supplies only limited climate finance.
EMDE banking authorities are beginning to adopt tools and innovate in their approaches to address climate-related financial sector vulnerabilities and climate finance gaps, though they will need to avoid compromising on important objectives of financial stability and inclusion.
The financial sector risk outlook for EMDEs is largely divided along income lines. Over the next 12 months, vulnerabilities appear low to moderate in higher-income EMDEs, while several lower-income countries are significantly more vulnerable. In many of these countries, domestic vulnerabilities are exacerbated by global risks related to the monetary policy and growth outlook in advanced economies, as well as by geopolitical conflicts.
The country risk assessment is based on World Bank expert judgment, informed by the state of the financial sector policy framework and macro-economic and financial data.
A majority of the countries facing high financial sector risks are currently not well prepared to handle financial sector stress.
They face important weaknesses in regulatory and supervisory frameworks and essential components of crisis management frameworks and financial sector safety nets are often missing or inadequate.
These vulnerable countries should take urgent steps to remedy critical policy and institutional gaps in order to improve the resilience of their financial sectors.
EMDE banks substantially increased their holdings of government debt in recent years, a situation known as the sovereign-bank nexus.
The exposure of banks to government debt in EMDEs rose by more than 35 percent from 2012 to 2023 as governments borrowed more, partly to deal with the COVID-19 pandemic.
The exposure rose even more—by over 50 percent—in debt-distessed countries.
Excessive government debt exposures among EMDE banks mean government debt distress could be contagious and trigger banking crises. Such combined crises have been particularly damaging in the past, leaving GDP per capita significantly lower than it otherwise would be.
New analysis finds that countries with a high sovereign-bank nexus tend to be less prepared to deal with financial stress.
While broader policies that preserve public debt sustainability and macroeconomic stability are necessary, EMDE banking authorities should shore up their financial crisis management and safety net frameworks and consider introducing disclosure requirements for banks’ exposures to the government to encourage more prudent risk taking by banks and foster market discipline.
In addition to elevated climate risks, EMDEs face a substantial shortage of financing for low-carbon and climate-resilient growth— with more limited domestic and private sector financing for climate goals.
Most climate finance is channeled toward China and advanced economies, predominantly for mitigation purposes. Adaptation accounts for only 16 percent of domestic and international climate finance in developing economies (excluding China) is channeled for adaptation. Out of this small share, 98 percent is either public resources or official financing.
Banks dominate the financial sector landscape in these countries. With more than 80 per cent of financial sector assets, they have the potential to play an important role to finance climate adaptation and mitigation.
Yet according to a World Bank survey, climate financing is 5 percent or less of the lending portfolio for nearly 60 percent of EMDE banks – with 28 percent providing no climate financing at all.
Significantly, central banks and prudential authorities are starting to implement approaches to address climate-related financial sector risks and mobilise climate finance – though guidance for applying them is lacking and their potential effectiveness is both mixed and unproven in some cases.
Banking authorities must therefore, take care to prioritise financial stability and continue to promote financial inclusion and efficiency.
Based on experience to date, tools can broadly be divided into three categories: win-win, jury’s still out, and not recommended. The sheer size of the climate financing gap will require support from beyond the banking sector—from central governments (through fiscal policies like carbon pricing) as well as deeper capital markets and national development financial institutions.
BII Intervention
British International Investment, the UK’s development finance institution and impact investor, is to launch a new facility to boost the flow of private capital to meet the twin challenges of development and the climate emergency.
The new facility aims to unlock hundreds of millions of pounds of private investment into climate and sustainability-focused investments in emerging economies that are currently deemed to be too risky by global investors.
It will address the gap between the risk appetite and return thresholds of commercial investors who are currently inclined to place capital in more developed markets.
Nick O’Donohoe, Chief Executive of BII, said: “With the launch of this facility, BII and the UK Government are demonstrating global leadership in unlocking the private capital that is so desperately needed to accelerate the green transition in emerging economies.
“The role for BII, and the development finance community, is to judiciously deploy concessionary finance to give global investors the confidence to put their capital where it is most needed.”
These investments are expected to include utility-scale climate infrastructure, such as renewable energy generation and transmission; other climate infrastructure, such as water, waste-to-energy, and battery storage; green finance, through banks and specialist finance companies that lend to climate-focused businesses; and investments that deepen capital markets for gender finance.
The facility will target deep and long-term pools of capital, such as pension savings and life insurance policies; as well as focus on asset managers in the City of London and beyond, to design investment products that increase investment allocations to emerging markets.
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