• Thursday, December 07, 2023
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Banks re-price funding costs on back of high liquidity


Banks are currently re-pricing their cost of funds following declining interest income. Cost of funds is the amount banks pay for deposits and other liabilities. Analysts say this re-appraisal is being fuelled by a banking system that is awash with cash.

In the past months, yields on fixed income instruments have been experiencing a downward trend. This is ditto for rates at the Nigeria Interbank Offered Rate (NIBOR), which have fallen from 12 percent to slightly above 10 percent in the last few weeks, leaving the banks with no option but to consider re-pricing the cost of their liability bearing instruments – deposits, commercial papers, bankers’ acceptances, etc.

Some analysts told BusinessDay at the weekend that the likely renewed pressure on the exchange rate and external reserves, following vandalisation of pipelines and consequent reduced oil output, have created market sentiments of a declining interest rate environment.

Bismarck Rewane, chief executive, Financial Derivatives Company (FDC) limited, said at the recent report on Global Economy and Nigeria, that “cost of funds are being re-priced by banks, due to declining interest rate occasioned by high liquidity, with average NIBOR at below 12 percent and the ensuing market sentiments in favour of lower interest rate.”

Consequently, Rewane said, the development is making investors and portfolio managers take positions based on expectations of monetary easing.

According to a senior banker, “It does not make business sense to pay high interest rate on fixed deposits and other instruments like commercial papers (CPs) and bank acceptances (BAs) when the system

is awash with liquidity.

In fact, some banks are said to be involved in the repackaging of customers’ deposit as CPs to evade payment of the mandatory insurance premium to the Nigeria Deposit Insurance Corporation (NDIC), thereby reducing the yearly insurance premium which is usually based on the total deposits liabilities of the financial institutions.

Specifically, the Central Bank of Nigeria (CBN) requires banks and discount houses to treat all transactions in BAs and CPs, in which the bank merely adds its name, as guarantee to enhance marketability without investing in the instrument, as a contingent liability. In effect ,all financial entries for each bank guarantee shall be passed as off-balance sheet items.

“Where a bank /discount house invests directly in the instrument in which it also serves as issuer, the transaction shall be treated as an on-balance sheet item,” says the CBN.

The liquidity glut and the treatment question of CPs and BAs in banks’ books have made the short debt instruments unpopular. While CP is an unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities, BAs are secured by banks with the banks promising to pay the creditor if the borrower defaults.

For instance, the CBN in its latest first quarter economic report said, “commercial papers (CPs) constituted 0.001per cent of the total value of money market assets outstanding, compared with 0.019 per cent at the end of the preceding quarter.

Also, investments in bankers’ acceptances (BAs) showed a decline by deposit money banks and discount houses, with only 0.16 per cent of the total value of money market assets outstanding at the end of the quarter. The development was attributed largely to the fall in government bonds outstanding and the activities on the Nigerian Stock Exchange (NSE) in the First quarter 2013, which were mixed.”

An analysts at Afrinvest said, “Lower yields outlook (our forecast is 10% for 2013) is pushing the DMBs to “real banking” and new competition frontiers: i.e., to seek and finance real sector projects. Consequently holding of CPs and BAs should ordinarily decline in 2013 as expected returns on them become relatively less attractive.

“From a macro perspective, we nurse no fears of any negative implication of the observed decline, in fact we see an upside as banks seek alternative (although more risky) investment options in the real sector (particularly infrastructure, agriculture, oil and gas, and telecoms) given the banking industry low loan to deposit ratio of 58 percent, said the analyst.

BusinessDay investigations show that not even the introduction of the special Open Market Operations (OMO) auctions recently by the CBN to augment its regular OMOs and PMA sales could save the high liquidity in the system.

Similarly, Rewane who observed that the CBN has mopped up over N4trn or 25% of money supply from the system since January this year, said conventional logic would suggest that interest rates should have increased significantly. But in reality, interest rates have remained low and are trending downwards.

“This notwithstanding, interest rates are yet to firm up. As at the end of March, the money market recorded a net outflow of N57.24bn and average NIBOR was 11.42% compared to 13.14% in February, according to FMDA. So far in April the trend has remained the same- frequent CBN interventions while interest rates remain soft,” he said.