Explainer: Should CBN regulate banks’ FX gains?

The Central Bank of Nigeria (CBN)’s directive on banks’ foreign exchange (FX) revaluation gains on Monday has caused a reaction among Nigerians.

The banking and financial institutions regulator on Monday told lenders to not use FX revaluation gains to pay dividends or for other operational expenses.

Concept of Devaluation and Revaluation

According to the CBN a fall (rise) in the value of the domestic currency in terms of other foreign currencies in the case of a fixed exchange rate system is referred to as revaluation (devaluation) under the direct convention.

CBN’s FX role

The Central Bank has the sole responsibility of formulating the exchange rate policy.

The exchange rate policy decision resides with the Board of the Central Bank of Nigeria following a proposal from the MPIC. The management of Nigeria’s exchange rate policy is mainly handled by the Trade and Exchange Department (TED) of the CBN, while the implementation of exchange rate policies in Nigeria is a joint responsibility of all stakeholders.

What CBN’s circular means

The Circular reads, “Banks are required to exercise utmost prudence and set aside the foreign currency (FCY) revaluation gains as a counter-cyclical buffer to cushion any future adverse movements in the FX rate in this regard, banks shall not utilize such FX revaluation gains to pay dividend or meet operating expenses”, the circular reads.”

What the CBN is trying to do is to avoid too much liquidity into the system,” said Muda Yusuf, chief executive officer of the Centre for the Promotion of Private Enterprise.

Read also: Don’t pay dividends with FX revaluation gains, CBN tells banks

“The CBN is struggling to stabilise the exchange rate. I know that the revaluation has affected some people negatively. Most of the multinational companies posted losses as a result of the revaluation of their liabilities.

“If you are revaluing your liabilities, it is like a burden on you as the liability becomes bigger. But if you are revaluing your assets which are in foreign currency, if you revalue them, it will grow bigger and blow up your profits.

Because this money is not coming from any economic activity, it’s coming from revaluation. The CBN is trying to ensure that that money does not flow into the system. So I think it is a liquidity management measure”, Yusuf said.

Regulating banks’ FX gains?

Muda said “Though it is their own money but there is what we call moral suasion even as part of monetary policy. It has to do with moral suasion where the CBN advises them for the interest of the economy. If that does not work the CBN can debit them. So the CBN can use all manner of instruments.”

“I think the directive to banks not to use Fx gains to pay dividends or cover operating expenses is meant to shield them from the volatility in the Fx market,” Uche Uwaleke, professor of Capital Market at the Nasarawa State University Keffi, said.

Read also: CBN urges banks to treat FX gains as protection against future fluctuations

He said rather than distribute such gains to shareholders as dividends, the banks are required to use them as buffers to protect against adverse movements in exchange rates.

Also, exchange rate movements can equally affect obligor limits for banks which according to the Banks and Other Financial Institutions Act BOFIA) is 20 percent of shareholders’ funds.

According to him, a bank is not expected to grant a loan to any single person that is more than 20 percent of its shareholders’ funds, that is its share capital and reserves. Since an asset revaluation on account of FX market volatility could lead to a breach of the Single Obligor Limit (SOL),

“The CBN has done well by saying that it is prepared to grant forbearance and not sanction such banks,” Uwaleke said.