MPC harmonises CRR on public, private sector deposits to 31.0%

The Monetary Policy Committee (The Committee) at its May 18 -19 meeting took key monetary decisions expected to shape the financial markets in the months to come.

The Committee reviewed key developments in the global and domestic economies during the period and assessed the short-to-medium term risks to price and financial stability, as well as the outlook for the rest of the year.

The Committee took the following key decisions:

Retain the MPR at 13 percent with a corridor of +/- 200 basis points around the midpoint; Retain the Liquidity Ratio at 30 percent, and harmonise the CRR on public and private sector deposits at 31.0 percent.

Ahead of the start to a new administration, the Committee has decided to monitor future fiscal direction of the incoming government before taking any major policy decision, therefore additional tightening measures may not be appropriate now to avoid overheating the economy, in our view.

Key considerations: the need for harmonisation of CRR

The successful conduct of the 2015 general election will bode well for the macroeconomic environment. It is expected to stem the spate of capital reversal, reduce pres sure in the FX market and stabilise the financial markets in the short to medium term.

A combination of the renewed confidence and recent administrative measures around the foreign exchange market have eased pressure on the naira, resulting in relative stability in all segments of the foreign exchange market.

The Committee was concerned about the creeping headline inflation since January 2015, but noted that the causal factors were largely transient and outside the purview of monetary policy.

Furthermore, the significant rising trend in credit to government was regarded as potential headwinds to growth with negative spillovers to the already elevated lending rates, credit to the private sector and aggregate domestic investment including inflationary pressures

The Committee expressed deep concern over the lacklustre performance of the external sector arising from a number of significant global shocks.

It therefore stressed the need for proactive measures to protect the reserve buffer to safeguard the value of the domestic currency and engender overall stability of the banking system.

It was, however, noted that monetary policy was gradually approaching the limits of tightening and would, therefore, require complementary fiscal and structural policies.

Furthermore, the Committee considered that the current discriminatory CRR on public and private sector deposits has not only constrained the policy space but could inspire moral hazard by private market participants.

Consequently, it was recognised that while additional tightening measures may not be appropriate now to avoid overheating the economy, a harmonisation of the CRR was imperative in order to curb abuses and improve the efficacy of monetary policy.

Harmonising CRR: More, less or the same?

The harmonisation of the MPR was the only monetary policy change at last MPC meeting as other rates were left unchanged. We note that this action portends little or no change in aggregate banking system liquidity. Given the recent decline in government revenue, the proportion of public sector funds to total banking sector deposits has declined significantly. With the new harmonised CRR of 31 percent, we think the MPC envisages a new proportion of public sector funds in the system at c.20 percent, down from our earlier estimate of 27.2 percent, which had yielded a blended CRR of 34.8 percent given 20 percent private sector CRR and 75 percent public sector CRR.

More importantly, we think a single CRR regime is consistent with the imminent enforcement of the Treasury Single Account (TSA), which is expected to have effects similar to the use of public sector CRR.

Implication for banks and yields

Although the aggregate impact of the CRR harmonisation remains muted for the sector, we believe banks that are relatively more exposed to public sector funds are set to benefit, albeit marginally pending the implementation of the TSA. The downward adjustment of the public sector CRR to 31 percent from 75 percent creates additional liquidity for banks to play in the fixed income space in the short term while lenders with relatively higher private sector funds may see a contraction in margins unless they can significantly re-price deposits. We expect a muted impact on yields as we estimate that the CBN would sterilise at least 58 percent more in private sector deposits which would be effectively offset by a 55 percent increase in the sterilisation of private sector deposits.

The bigger picture: Setting the agenda for more counter-cyclical actions

In our view, the harmonissation of the CRR was motivated by the need to have a tighter control of banking system liquidity in the short to medium term. The MPC stressed that it is nearing the limits of tightening. A blended MPR of 31 percent lends more credence to this. In light of this, we have penciled in a downward review of the CRR in the medium term as banks’ lending is expected to be spurred with greater clarity on the policy agenda of the incoming government.