• Wednesday, February 28, 2024
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BusinessDay

Banking on Circulars

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The Central Bank of Nigeria (CBN), released 2 circulars in the past week and a half that have the potential to alter the current landscape of the domestic banking sector.

On Wednesday July 3, the CBN issued a notice to all banks in a circular with reference number BSD/DIR/GEN/MDD/01/045, signed by Ahmad Abdullahi, director, banking operations, directing them to maintain a minimum Loan to Deposit Ratio (LDR) of 60 percent by September 30, 2019.

It said the ratio “shall be subject to quarterly review.”

The apex bank warned that failure to meet the stipulated minimum LDR by the specified date “shall result in a levy of additional Cash Reserve Requirement (CRR) equal to 50 percent of the lending shortfall of the target LDR.”

The LDR is ratio that is used in determining the amount of loans that a bank has out versus the amount of current deposits on hand.

A high loans to deposits ratio means that the bank is issuing out more of its deposits in the form of loans, while a very low ratio means that the bank is risk averse, and not issuing as much loans as it could compared to its level of deposits.

Our calculations show that as at the end of the First Quarter of 2019, a number of the big banks were below the 60 percent threshold for LDR, meaning they would need to boost loans to comply with the guidelines.

The CRR refers to a certain percentage of total deposits the commercial banks are required to maintain in the form of cash reserve with the central bank.

Another Circular was released barely a week later on July 10th by the CBN, limiting the amount of excess cash Banks can park with it and earn interest on.

In the circular FMD/DIR/CON/OGC/12/019 to all banks and discounts houses titled ‘Guidelines on Accessing the CBN Standing Deposit Facility (SDF)’, signed by Angela Sere-Ejembi, director, financial markets department, the CBN said the remunerable daily placement by banks shall not exceed N2 billion.

The SDF is basically a liquidity mop-up mechanism which the CBN uses without necessarily issuing government securities.

Prior to November 2014, banks could deposit as much liquidity at their disposal with CBN and be remunerated (paid interest) for same.

The CBN capped the minimum remunerated deposit through the window at N7.5 billion in November 2014, however banks could keep excess cash with the CBN earning zero percent as they wished.

With the new framework, the allowable daily deposit through the SDF that will now be paid interest on by the CBN is now capped at N2 billion at the applicable Monetary Policy Rate (13.5% today) minus 500 basis points, equivalent to 8.5 percent.

Perhaps the CBN should look into cutting the CRR to 10%. It is currently officially at 22.5% but some banks say the effective rate is closer to 40%. In South Africa the CRR is 2.5%, Ghana 9.5% and Kenya 5.3%.

So what exactly is the CBN trying to achieve with these rapid issuance of Circulars?
Clearly the first Circular is designed to increase the amount of loans banks give out in relation to deposits, while the second one seeks to curb the incentive banks have to keep excess funds with the CBN earning 8.5 percent per-annum, rather than lending those same funds out and earning higher rates (in double digits), which should be a no brainer for banks under normal circumstances.

But Nigerian banks do have a reason to be cautious or risk averse, since they are just coming out of a bad loan crises, which led to the formation of the Asset Management Corporation of Nigeria (AMCON), and also a number of bank failures, leading to intervention by the CBN.

The CBN’s stated objectives in issuing the Circulars are to ramp up growth of the Nigerian economy through investment in the real sector, and to encourage SMEs, retail, mortgage and consumer lending, by banks.

We would not fault the CBNs goals as access to credit is a major problem in Nigeria, which is also limiting the ability of firms to grow and job creation.

However one question would be, could this have been done differently?

The question is pertinent because normally banking sector regulators introduce maximum LDR thresholds to limit risk taking by banks.

However, in Nigeria, this introduction of a minimum LDR by the CBN encourages banks to undertake more risk at a time when the macroeconomic environment remains weak.
The regulation also encourages banks to lend to sectors (mortgages, unsecured credit cards, SMEs) that they have historically been uncomfortable lending to, which could worsen asset quality.

Perhaps the CBN should look into cutting the CRR to 10%. It is currently officially at 22.5% but some banks say the effective rate is closer to 40%. In South Africa the CRR is 2.5%, Ghana 9.5% and Kenya 5.3%.

Cutting the CRR will immediately do two things.

One it will flood the system with liquidity, and secondly it would crash interest rates (on government securities) to 5 percent or below, especially if the CBN simultaneously reduces its open market operations (OMO) issuance or liquidity mopping.

So far so good. Now those banks that see earning 5 percent as too low especially compared to their cost of funds will be incentivized to naturally begin to perform their core function of lending to the real economy.

However, there is still one problem, which is the impossible trinity, a concept in international economics which states that it is impossible to have all three of the following at the same time: a fixed foreign exchange rate, free capital movement, and an independent monetary policy at the same time.

According to the impossible trinity, a central bank can only pursue two of the above-mentioned three policies simultaneously.

In our case that may mean forgoing the stable exchange rate or fixed naira policy of the CBN, as lower rates on government securities may make current foreign portfolio investors to exit, leading to pressure on the naira, in addition to the earlier excess liquidity from a cut in CRR.
Lower interest rates however, should stimulate economic growth and reduce the crowding out effect of government borrowing (as well as reduce the government’s interest expense).

Other gains from FX flexibility and low rates would be domestic export competitiveness.
There is no doubt that the CBN is in a pickle regarding boosting economic growth (dismal for now at 2%) and currently is getting zero lift from the fiscal side. However the best policy responses though are usually those made by taking tough decisions!

 

Patrick Atuanya