In an unexpected move, the Central Bank of Nigeria’s (CBN) Monetary Policy Committee (MPC) raised the cash reserve ratio (CRR) to 27.5 percent of Friday from 22.5 percent previously.
The CRR in Central Bank parlance is the amount of funds that banks have to maintain with the CBN. If the central bank decides to increase the CRR, the amount available with the banks for disbursal comes down. It is often used to drain excess liquidity from the system.
The MPC chose to maintain all other variables with the monetary policy rate (MPR) kept unchanged at 13.5 percent, Liquidity Ratio at 30 percent and asymmetric corridor at +200/-500 basis points around the MPR.
It is clear that the MPC and by extension the CBN regards the CRR as the key policy transmission mechanism in its price/monetary stability mandate.
With total banking sector local currency deposits standing at circa N16.6 trillion as at September 2019, analysts estimate additional CRR debits of between N800 billion and N1.3 trillion as a result of the hike.
There are two main drivers of the decision to hike, inflation and growing liquidity in the banking system.
The MPC expressed concern about the rising inflation, which increased consecutively in the last 4 months as at December 2019 to 11.98 per cent and higher than its target range of 6-9 percent.
According to the MPC, this rising price level is attributable to a combination of structural and supply side factors, expansionary fiscal policy; and growth in money supply arising from rising liquidity surfeit in the industry due to changes in the Bank’s open market operations (OMO) policy.
With anticipated medium term liquidity surfeit from maturing OMO securities held by institutional investors, which were not eligible to be rolled over, the MPC considered it prudent to raise the CRR.
The MPC may have partial justifications for its actions as some of the drivers of inflation are largely out of its control.
For instance, inflation has been creeping upwards over the past four months largely due to the Federal Government’s policy of land border closures impacting food prices, and also the recent rise in VAT and expectations of an increase in electricity tariffs.
However the potential ‘liquidity overhang’ the MPC spoke of is largely of the CBNs own making as it stems primarily from the CBN’s decision to bar resident non-bank financial institutions from participating in OMOs, even as large OMO maturities are set to hit the markets.
Banks are already having to deal with a multiplicity of regulatory headwinds and it is likely that the new 27.5 percent CRR will have a negative impact on earnings going forward.
There is already a punitive CRR that banks face in the event that they fail to meet the stipulated minimum loan to deposit ratio (LDR) levels set by the CBN.
There is also the recent announcements by the CBN on a cut in fees that banks can charge for various services rendered as well as the slide in yields which has depressed interest income in recent months.
However banks have remained highly profitable over the past 3 years despite a recession and slow growing economy, a sign of the huge profit levers they can pull, especially those with large balance sheets.
BusinessDay analysis of the 2019 nine months performance of the banks revealed that they generated about N716.9 billion in net profit for the period. Assuming the profit trend continues till year end, the annualized 2019 net profit is expected to reach N955.8 billion.
In the two years post-recession, the profitability of the 13 banks have grown from N447.8 billion to N858.4 billion in 2018, marking a 92 percent growth. With profits expected to exceed N900 billion in 2019, this will mean that banks have been able to double their profit in just 3 years post-recession (see full story in our Markets Intelligence Section today).
The NSE Banking index has returned +10.46 percent less than a month into the New Year, a rally that mimics the broader gains in equities (+10.38% YTD for NSEASI) as liquidity from the CBNs regulatory actions on OMO pours into stocks.
The announcement by the MPC to hike the CRR signals a tightening of liquidity, and near-term, analysts expect market interest rates to adjust higher to this, most likely at the front-end of the curve. This would be somewhat negative for equities even if continued OMO maturities offset rising yields.
A higher floor in yields would push Pension Funds and other institutional investors to see fixed income as relatively more attractive than equities.
In a sense the CBN’s quest to preserve currency stability and ongoing concern over the price level, could bring a screeching halt to the rally in equities it engineered some 5 months ago.