• Saturday, June 15, 2024
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Is there an economic case for linking loan deposit ratio to cash reserve ratio?


Something quite interesting struck me during one of the panel sessions at the just concluded Africa 3i summit I attended (organised by the Bank of Ghana)—the BoG decided recently to link loan to deposit ratio (LDR) to cash reserve ratio (CRR). Since LDR measures the ratio of total loans to deposits that a bank holds on its balance sheet, it makes sense to not apply one single LDR ratio that, for the longest time, has stood at over 60 percent in Nigeria and currently stands at 50 percent across the board.

Read also: Loan growth seen falling 15% after CBN raised Banks’ Cash Reserves Ratio

The Bank of Ghana, in its bid to encourage the flow of capital to businesses in Ghana considering the high interest rate environment, decided to do the following:

Banks with LDRs below 40 percent are required to park 15 percent of total deposits as cash reserves with the Central Bank.

Banks with a loan-to-deposit ratio a loan-to-deposit ratio between 40 and 55 percent are required to park 20 percent of their total customer deposits as CRR with the Central Bank.

Banks with an above-55 percent loan-to-deposit ratio (which implies high exposure and possibly a high non-performing loan book) are expected to park 25 percent of their total customer deposits with the Central Bank.

Historically, in Nigeria, the CRR has always been below 15 percent; as a matter of fact, in 2014, the Cash Reserve Ratio stood at 15 percent, and this remains the global index average that is recommended globally by the Bank of International Settlements for Central Banks. CRR, being a tool a central bank uses to manage liquidity in the system and control inflation, became one of three major sources through which the immediate past management of the Central Bank of Nigeria, along with other tools (public sector CRR and quantitative easing), was used to finance record budget deficits that violated 5 percent of the previous year’s real revenues, as was previously stipulated in the CBN Act of 2007 prior to amendment to 15 percent in 2023.

Within the last decade, the Central Bank of Nigeria has created 30.6 trillion naira in cash through quantitative easing, for which it has not generated enough taxes and revenues to match growth terms as a means to match productivity. This excessive money supply created cost-push inflation and raised the cost-price index from 14 percent to a record 33.69 percent in April 2024.

In order to reduce the liquidity in the system, which currently stands at 93.72 trillion naira, the Central Bank is offering Treasury bills in OMO operations at double-digit interest rates of between 20.5 and 23 percent for yields. It has hiked the cash reserve ratio to 45 percent, which is three (3) times the global recommended average for CRR, to reduce supply in the system at the risk of private sector growth.

The antithesis of this move is that, while it makes sense to raise CRR, banks are also battling with a single obligor limit, weak asset quality in terms of their minimum capital, and high non-performing loan ratios that threaten their capital adequacy ratio. The million-dollar question we should ask as we gear towards rebalancing the financial system in the same year where the banks have been asked to recapitalize is:

“Does it make sense to link the loan deposit ratio to the cash reserve ratio in such a way that banks can get a lower CRR to lend to the private sector for growth (as a tool to fight demand pull on the cost price index curve) according to the quality of their LDR and non-performing loan book? Can a bank be rewarded with a lower CRR based on how well its loan-to-deposit ratio is?’’

And this conversation is especially critical because, in a high inflation environment where the pull isn’t only a cost push but also a demand pull, you need to incentivize access to credit for the real sector to produce as a means of reducing inflation, which will in turn slow down the imperative to raise the interest rate to narrow the yield curve differential and in turn reduce the non-performing loans on the balance sheet of banks. If banks cannot lend because they are afraid of companies asking for restructuring on high pendency, and they also cannot lend because the central banks obligate them to park 45 percent of every customer deposit that is gathered at the central bank, we have two edges of a bad sword.

At the forthcoming 295th meeting of the MPC, I expect the rates to be raised by another 150 basis points, but we cannot continue to apply a linear brush stroke to a complex problem. It makes sense for the CBN to not only think outside the box but also for the fiscal authorities to realise that the burden isn’t only that of the apex bank.

Kelvin Ayebaefie Emmanuel is an economist.