Banks drop Letters of Credit as FX scarcity persists

Deposit Money Banks (DMBs) in Nigeria may have stopped issuance of Letters of Credit (LC), as the dearth of foreign exchange (FX) persists in the financial market, BusinessDay investigation reveals.

Nigeria is dependent on imports, which banks facilitate via the opening of letters of credit. The customer typically repays these after imports are sold; the customer therefore earns naira, and then approaches the bank to source FX from the CBN (or goes to the black market), with which the correspondent bank is repaid.

With the CBN struggling to provide sufficient FX to meet importers’ FX demands and banks prevented from accepting FX deposits, not only have importers been unable to repay their obligations, they have also struggled to keep afloat – among them are import-dependent manufacturers.

The implication of this is that businesses are beginning to crumble with the attendant job losses, which trickle down to high rate of poverty.

The development brought about uncertainty in the FX market with the attendant negative impact on naira, which has continued to depreciate at the autonomous market.

Consequently, the margin between the official and parallel market is creating incentive for round tripping or speculation.

But because the CBN cannot supply much needed FX, banks find it difficult to meet demand of customers in their quest for importation of basic items into the economy.

Investigation shows that firms that are suffering from importation of raw materials as a result of banks not issuing letters of credit have resorted to restructuring of operations, resulting to job losses.

Analysts say some of the antidote to this development is liberalisation and devaluation of the naira to narrow margin and make FX available for import dependent economy.

According to Adesoji Solanke, a banking analyst at Renaissance Capital, as importers have struggled to access FX, the Nigerian banks have used their FX liquidity to settle with the correspondent banks (given the LCs are guarantees), in anticipation of the CBN providing liquidity.

Feedback from the banks remains that the CBN has been unable to meet FX demand, with estimates of the backlog at $2 – $5 billion and rising. The banks have therefore significantly slowed the issuance of new LCs, further hurting the general commerce and manufacturing sectors.

“With the CBN maintaining the view that the backlog of FX demand is largely speculative, it has requested that the correspondent banks submit a list of outstanding obligations, although we understand it has been unable to fully meet this FX demand,” he said in a report.

Ituah Ighodalo, a Lagos-based financial analyst, in telephone chat, said: “Banks not issuing LCs as a result of scarce FX is a temporary measure to shore up naira and build foreign reserve. Very soon it will open up a bit.”

The immediate measure is for the government to start import restriction to only essential items, he said, saying the long-term measure is to increase production capacity.

Olutola Oni, analyst at WSTC Financial Services Limited, said: “We believe the banking sector can deepen its role of financial intermediation to support businesses and economic recovery. Also, we believe the government should provide and support a market-friendly economic environment that will encourage investments. We consider this vital for economic activities to thrive.”

“Banks could not open LCs for their clients as they use to do because there is no FX to back it up, which means reduced income for the industry. Credit to clients also shrank as the economic growth slows down,” Agbola Bolade, executive director, Cash Craft Asset Management, said in an emailed response.