CBN’s new FX rules to shore-up dollar supply, stabilise naira

… Banks’ future FX gains at risk

The new foreign exchange (FX) rule released on Wednesday by the Central Bank of Nigeria (CBN) is expected to shore-up dollar supply from commercial banks and stabilise naira in the immediate terms, according to analysts.

The new foreign exchange rule released on Wednesday by the Central Bank of Nigeria (CBN) is expected to help shore up dollar supply from commercial banks and stabilise naira in the immediate term, according to analysts.

The CBN said the net open position (NOP) limit of banks’ overall foreign currency assets and liabilities both on and off-balance sheet should not exceed 20 percent short or zero percent long of shareholders’ funds unimpaired by losses, using the gross aggregate method.

This was disclosed in a circular to all banks signed by Hassan Mahmud, director trade and exchange department of the CBN, and Rita Ijeoma Sike, for the director, banking supervision department.

NOP refers to the difference between a bank’s foreign currency assets and liabilities, both on- and off-balance sheet items.

The circular mandates that banks must adhere to a NOP limit, ensuring it does not surpass 20 percent short (holding more foreign currency assets than liabilities) or zero percent long (not holding more foreign currency assets than the bank’s shareholder funds unimpaired by losses).

It asked banks currently exceeding these prescribed NOP limits to make adjustments to their positions to align with the new regulations by February 1, 2024.

“This is one of the things I advocated some months ago. The banks are taking advantage of naira weakness to build long foreign currency position (meaning they are keeping more foreign currency assets than their foreign currency liabilities), and this is why they are reporting unprecedented foreign currency gains,” Abiola Rasaq, former economist and head of investor relations at United Bank for Africa Plc, said.

With this new rule, he said any bank that has more foreign currency assets than liabilities would have to sell the excess foreign currency position to the market or the CBN.

“This would increase the supply of foreign currency to the market and moderate the demand/supply gap. Whilst the effect of this policy on the naira would be one-off and transitory, it should help calm the pressure in the market and stabilise the naira over the next few days, especially if the CBN follows through the policy with strong oversight to avoid infractions or disguised compliance,” he said.

According to Rasaq, this policy brings an end to what some would refer to as “abnormal profit” of banks arising from foreign exchange gains, as banks are going forward expected to either square out their foreign currency open position or have a short position, which would mean having more foreign currency liabilities than assets.

He said: “Indeed, the allowance to have a 20 percent short open position is an incentive for any bank which believes naira is undervalued to raise foreign currency liabilities and step it down to naira, with hope of making gains from such strategy when naira appreciates in the future. So, the CBN wants to use this policy measure to increase FX supply from banks, with hope that such would help stabilise the naira in the interim.

“Whilst banks would be able to keep their FX gains made thus far, this policy puts an end to future prospect for FX gains and may begin to reflect on the valuation of banks stocks going forward. Interestingly, the CBN also seeks to ensure banks do not take excessive risk in respect of foreign currency liabilities, by minimising interest rate and duration mismatches that can arise from Eurobonds and other wholesale foreign currency liabilities. It’s an important policy measure to ensure the sustainability of the system.”

Ayodele Akinwunmi, relationship manager corporate banking at FSDH Merchant Bank, said if any bank holds more than the prescribed benchmark, it will need to sell. “Therefore, the policy will not allow any bank to hoard the FX at the expense of the entire market.”

Analysts at Comercio Partners said the new regulations may impact banks’ profitability, especially if they are holding significant net-long positions that need to be liquidated.

They said: “Banks may need to adjust their strategies to comply with the guidelines, affecting their revenue streams.

“The CBN’s circular is a significant regulatory intervention aimed at curbing speculative practices in the banking sector. The impact on liquidity and the economy will depend on the extent to which banks comply with the guidelines and how swiftly the market adjusts to the new regulations. In the coming days, it is crucial to closely monitor market reactions, compliance levels among banks, and any potential ripple effects on broader economic indicators.”

According to the circular, banks are also required to have adequate stock of high-quality liquid foreign assets, i.e. cash and government securities in each significant currency to cover their maturing foreign currency obligations. It said banks should have in place a foreign exchange contingency funding arrangement with other financial institutions.

It said banks should borrow and lend in the same currency, known as natural hedging, to avoid potential mismatches associated with foreign currency exposure.

“The basis for the interest rate for borrowing should align with that of lending, i.e. there should be no mismatch in floating and fixed interest rate, to mitigate basis risk associated with foreign borrowing interest rate risk,” the central bank said.

With respect to Eurobonds, it said any clause of early redemption should be initiated by the issuer, and approval must be sought from the CBN, even if the bond does not qualify as tier 2 capital.