Nigeria’s central bank is using discretionary Cash Reserve Ratio (CRR) debits as a backdoor of mopping liquidity in the banking sector following the balance sheet damage done by issuing Open Market Operations (OMO) bills at high interest rates over the past three years, according to sources familiar with the matter.
By debiting banks over CRR breaches, the Central Bank of Nigeria (CBN) is able to mop up liquidity in the system at zero expense, marking a subtle departure from years of paying high interest rates issuing OMO bills to achieve the same purpose of liquidity mopping, while straining its balance sheet.
The CBN spent N1 trillion in interest payments on OMO bills in 2019, more than the federal budget for education and health combined.
In 2018, the CBN spent close to N2 trillion in interest payments after selling as much as N22 trillion worth of OMO bills, two times the N11 trillion sold in 2017 and more than three times the N7.8 trillion sold in 2016, according to data from the CBN’s 2018 financial statement.
“It is part of the unconventional ways the CBN is trying to repair its beleaguered balance sheet after years of offering high interest rates to foreign investors,” a banking source familiar with the matter says.
“Using the CRR in this manner however squeezes banks profitability and reduces the incentive to lend, which contradicts the CBN’s mantra to boost lending to the real sector, and is negative for the economy,” the source, who does not want to be named because the practice is unofficial, states.
The CBN’s spokesperson, Isaac Okorafor, did not respond to phone calls seeking comment.
Sources say the bulk of money taken from the banks by the CBN under the guise of breaching CRR or LDR (loan to Deposit Ratio) guidelines has also been recycled to the Federal Government in CBN overdrafts, and forms a large chunk of the single-digit loans doled out to what the CBN deems as priority sectors.
They say it leaves the financial system on the receiving end of its backdoor strategy to rein in on OMO costs.
“The CBN started digging a hole for itself when it began using OMO bills to stabilise the exchange rate by selling it at high interest rates to foreigners in order to get their dollars. It’s a pity that it’s the banks and the entire financial system, which includes local investors and pensioners that are paying for that recklessness on the part of the CBN,” another source, who does not want to be quoted as criticising the CBN, states.
The Open Market Operation is designed to be a short-term market instrument the CBN uses to control the supply of money in the economy. But the CBN started to use the instrument as a means of attracting dollars needed to stabilise the foreign exchange market.
For most of 2019, the CBN increasingly issued OMO bills at high yields to attract foreign portfolio investments, buttress foreign reserves, and stabilise the exchange rate.
The stock of CBN bills grew substantially, hitting the equivalent of $55 billion by year-end with yields at 12.2‒15.3 percent, with about a third of the issues held by foreigners. That drew the criticism of analysts who note that the practice was unsustainable and would excessively strain the CBN’s balance sheet.
“Risks stem from the central bank’s policy of attracting portfolio investments in its short-term OMO bills through high yields and hedging instruments offered to non-resident investors at low cost, despite a wide spread between the naira and dollar interest rates.
“As a result, non-resident holdings of the CBN’s OMO bills soared to $17 billion by end-August, equivalent to 40 percent of foreign-currency (FX) reserves at the time,” Fitch Ratings said in August 2019 when it downgraded Nigeria’s outlook to negative.
The CBN continued to sell OMO bills to foreigners even after revising the rules by banning non-bank local corporates from buying and trading the bills, but with interest rates collapsing into single digits this year coupled with the dollar illiquidity in the country, foreigners started losing appetite in the bills.
“What is happening now, CBN is no longer getting dollars from OMO auctions because foreigners who have their dollars trapped in the country are now using the naira they have to buy OMO and sell to the banks while they are stuck here. The CBN is trying to rein in on that by mopping bank liquidity through the CRR so that they don’t have enough cash to buy the OMO bills off the foreigners,” a trader with one of the tier-one banks says.
“The banks are on the receiving end of the CBN’s effort to salvage its balance sheet from the damages caused by the OMO issuances of the past three years,” the trader states.
The discretionary debits are also used by the CBN as a viable administrative tool for foreign exchange management. Sources familiar with the matter say the debits are usually made days before an FX auction.
By draining the banks of naira liquidity, the CBN is able to reduce how much they are able to bid for FX, thereby reducing pressure on the CBN for FX.
Hammered by the fall in oil export receipts, Nigeria’s major earner of dollars, the CBN has struggled to meet the dollar demand of investors and importers, leading to a backlog that is frustrating investors and manufacturers.
With dollar inflows declining and its external reserves under increasing pressure, the CBN has resorted to demand management strategies last seen in 2016, during an acute dollar scarcity.
CRR/LDR debits hit N2.2trn.
The CBN took total bank debits over CRR or LDR breaches to N2.2 trillion after it debited banks to the tune of N118 billion July 3. The N118 billion debit was the fourth such action by the CBN this year alone.
The move brings “further downward pressure on banks liquidity ratios and earnings,” according to Tunde Abidoye, an analyst at Lagos-based FBN Quest.
Unlike previous debits for which Zenith and United Bank for Africa (UBA) were the most affected banks, Stanbic IBTC and GTBank were the hardest hit this time around, both with debits of N15 billion each.
“Based on the total sum each bank has been debited this year, and our NIM assumptions for each bank, we estimate an aggregate opportunity cost of funds of N86 billion for our universe of banks coverage,” Abidoye says in a note to clients.
Due to the sizable debits on their accounts with the CBN, Zenith and UBA have the highest opportunity cost of funds at N34.4 billion and N15.8 billion, respectively.
In contrast, Fidelity Bank and Access Bank are the least impacted, with opportunity cost of funds of N2.9 billion and N3.8 billion, respectively.
By twisting its official CRR rule, which mandates banks keep 27.5 percent of their deposits with the apex bank at zero interest, the CBN now holds as much as 60 percent of deposits, more than double the official rate. That means for every N100 the banks hold in deposits, N60 is with the CBN earning zero interest.
The 60 percent effective CRR rate, the highest globally, is even higher for some banks, putting a strain on profitability and draining the banks of much needed liquidity.
“I find the CBN’s CRR and LDR policies very contradictory, because while the CBN is trying to boost lending to the real sector through the LDR policy, which mandates banks lend at least 65 percent of their deposits, it is curtailing liquidity by raising the CRR guidelines,” notes Bongo Adi, a senior lecturer at the Lagos Business School.
“It’s important the CBN works towards aligning its policy objectives so that they don’t become counterproductive,” Adi advises.