The Nigerian banking system experienced a decrease in liquidity during April 2024, a trend largely attributed to the sustained tight monetary policy by the Central Bank of Nigeria (CBN), according to the latest monthly economic report by the apex bank.
Data from the CBN indicates that average liquidity within the banking system stood at N146.59 billion in April 2024, a notable 43.34 percent decline from N258.71 billion recorded in March. The decrease can be traced back to two main factors: the impact of the Cash Reserve Ratio (CRR) hike and the regular Open Market Operations (OMO) conducted by the CBN.
Read also: A creative transaction, to stabilise the banking system, protect depositors and save jobs
The sharp decline in liquidity highlights the continued efforts by the monetary authorities to curb inflationary pressures and stabilise the economy. Interestingly, Nigeria’s tight monetary policy stance appears to be yielding results in the fight against inflation.
The country has recorded a drop in inflation for two consecutive periods, with the inflation rate standing at 32.15 percent as of August 2024 from 33.40 percent in July 2024, data from the National Bureau of statistics (NBS) showed. This marks a significant improvement in the central bank’s efforts to control rising prices, but it also underscores the balancing act between containing inflation and supporting economic growth.
While the reduction in inflation is a welcome development, it comes at a cost, as tighter liquidity in the banking system can slow down credit growth and economic activity. The CBN’s policies, particularly the combination of higher CRR and frequent OMO auctions, are aimed at maintaining this positive inflation trajectory.
The CRR, a regulatory tool used to control the amount of funds banks must hold in reserves, plays a pivotal role in the liquidity dynamics. By increasing the CRR, the CBN effectively reduces the amount of money available for banks to lend or invest, forcing a tightening of liquidity across the system. This reduction is further compounded by the CBN’s aggressive OMO auctions, through which it mopped up N676.65 billion during the review period, further squeezing liquidity.
Open market operations have become a key instrument in the CBN’s liquidity management strategy. Through these operations, the CBN sells short-term securities to commercial banks in order to absorb excess liquidity and keep inflation under control. This reduces the amount of funds circulating in the banking system, but it also directly impacts the liquidity available for lending and investment, creating a tighter financial environment.
In April 2024, the impact of these operations was significant, with OMO-related debits reaching N676.65 billion. While this approach has been instrumental in combating inflation, it also tightens liquidity conditions for banks, creating a more cautious lending environment and increasing borrowing costs for businesses and consumers.
Read also: Banks, NDPC’s partnership seen enhancing data security
Despite the tight liquidity, activities at the Central Bank’s standing deposit facility (SDF) increased. Total transactions at the SDF window reached N456.11 billion during the month, reflecting banks’ preference for parking excess funds safely with the CBN instead of lending to the broader market. The SDF provides an avenue for banks to deposit surplus funds overnight, earning nominal interest on these reserves.
On the other hand, activity at the standing lending facility (SLF) window, where banks borrow from the CBN to meet short-term liquidity needs, decreased during the same period. This decline in SLF transactions suggests that banks were either managing liquidity more conservatively or found it challenging to access funds given the tighter market conditions.
The drop in banking system liquidity could have far-reaching consequences for the Nigerian economy. Tighter liquidity typically translates to higher interest rates, making borrowing more expensive for businesses and individuals. This can slow down investment and consumer spending, both of which are critical drivers of economic growth.
Furthermore, the CBN’s continued use of OMO and CRR adjustments as a means of liquidity control may create more volatility in the banking sector, as institutions adjust to fluctuating liquidity levels.
April 2024 saw a considerable contraction in banking system liquidity, driven by the Central Bank’s tight monetary policy measures. While these actions are necessary to maintain price stability, evidenced by the drop in inflation to 32.15 percent in August 2024, they also create a challenging environment for banks and borrowers alike.
