In a salutary move that transcends its primary mandate of maintaining price stability, the Central Bank of Nigeria through its Monetary Policy Committee recently unveiled plans to adopt a ‘’heterodox approach’’ to strengthen the flow of credit to the private sector. This novel approach includes tweaking the reserves requirement for real sector-friendly Deposit Money Banks in what it terms the ‘’Differentiated Dynamic Cash Reserve Requirement regime’’. This was one of the high points of the recently concluded 262nd meeting of the MPC held on 23rd and 24th July, 2018.
Citing concerns about the liquidity impact of the 2018 expansionary fiscal budget, increasing FAAC distribution arising from rising prices of crude oil, the build-up in election related spending ahead of the 2019 general elections, the effects of the sustained monetary policy normalization in the United States with implications for capital flow reversals as well as the threat to disinflation posed by incessant herdsmen-farmers crisis in some major food producing states, the MPC had compelling reasons to leave the policy parameters unchanged in order not to jeopardize the primary mandate of the Central Bank.
At the same time, the MPC took cognizance of the need to strengthen the country’s weak economic recovery against the backdrop of a shallow intermediation system (measured by the ratio of private sector credit to GDP – well below that of peer countries) and so saw the wisdom in incentivising Deposit Money Banks to increase the flow of credit to the real economy. Addressing a long-standing concern of the DMBs and ‘’the preference of the public for loosening’’ the MPC had stated in its communiqué that ‘’a heterodox approach to reform the market in order to strengthen the flow of credit would be appropriate at this time. Consequently, credit constrained businesses, particularly the large corporations are encouraged to issue commercial paper to meet their credit needs and the Central Bank of Nigeria may, if need be, buy those instruments to complement the efforts of the DMBs. In addition, as a way of incentivising deposit money banks to increase lending to the manufacturing and agriculture sectors, a differentiated dynamic cash reserves requirement (CRR) regime would be implemented, to direct cheap long term bank credit at 9 per cent, with a minimum tenor of seven (7) years and two (2) years moratorium to employment elastic sectors of the Nigerian economy’’. Through these initiatives, the CBN has demonstrated a willingness to be flexible and responsive to the yearnings of the public while at the same time keeping a handle on its primary mandate of maintaining price stability.
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A number of studies have shown that unremunerated reserve requirements act as a tax on banks and thus push up cost of credit. By extension, reserve requirements act as a limitation on DMB’s capacity to make loans. According to an IMF Working Paper on ‘’Central Bank Balances and Reserve Requirements’’, prepared by Simon Gray in February 2011, some central banks have applied differential CRR to different types of banks. In fact, China, India, Brazil and many other emerging economies have used CRR to direct credit towards sustainable investments. For instance, the central bank of Lebanon has used differentiated reserve requirements to funnel credit to critical sectors. According to the Banque du Liban, its target is to “facilitate financing investments in specific economic sectors by exempting banks from part of the required reserve requirement to finance these projects at low cost”. With respect to Green Finance, the Banque du Liban supports green credits by lowering the reserve requirements of a commercial bank by 100 – 150 per cent of the loan value if the bank can provide proof of the energy savings potential of the financed project. Such a policy, introduced in 2010, where banks with a higher share of green lending are subject to lower reserve requirements, has proved a remarkable success in the country’s Green initiatives.
Quoting a report by China’s state news agency Xinhua, Reuters had disclosed that “since the start of 2011, the central bank has already started using dynamic differentiated required reserve ratios as a tool in its monetary and credit controls,” adding that ‘’the Xinhua report served to underscore that differentiated reserves have, in fact, become an essential component of China’s monetary policy toolkit’’. China had previously imposed differentiated reserve requirement ratios on banks as a way to punish unbridled lending. In a study on the ‘’effects of differentiated reserve requirement ratio polcy on the earthquake-stricken area in China’’, Guo Xiaohu and Tajul Ariffin noted that the Peoples Bank of China had actually introduced Differentiated Reserve Requirement Ratio (DRRR) policy since April, 2004. The initial purpose of the policy was to limit loan expansion of those financial institutions with inadequate capital and poor asset quality by imposing a higher CRR. Following a devastating earthquake in the Sichuan Province in May 2008, a lower CRR was applied to financial institutions operating in the Province to help with reconstruction efforts. Guo Xiaohu and Tajul Ariffin equally documented that the Central Bank of Brazil, the Banco Central do Brasi, had in the past used heterogeneous reserve requirements in order to facilitate credit and foster growth in poorer regions of the country.
There is no doubt that the DCRR will create conditions for DMBs to reduce interest rates on loans and improve access to credit. Together with the Collateral Registry already in place, this initiative will manifest in a higher ranking for Nigeria in the World Bank Ease of Doing Business index for 2019. It will be recalled that the country was placed 145th position out of 190 countries in 2018 with the best performance recorded in the area of ‘getting credit’ in which Nigeria ranked 6th out of 190 countries from 32nd position in 2017. An improved ranking will boost foreign investors’ confidence in the economy. The extra liquidity released as a result of implementing the DCRR has the potential of increasing corporate earnings and shareholders wealth, a positive development for the capital market as the unlocked funds feed into the process of capital formation.
The flip side though is that the attendant increase in liquidity will take a toll on the apex Bank’s finances. Granted that the CBN is a policy–driven not-for-profit institution, the likelihood of a weak balance sheet is nevertheless real. The current high cost of liquidity management is stoking concerns about its negative impact on the financial position of the CBN and by extension the stability of the country’s financial system. According to the CBN Annual Activity Report 2017, the cost of liquidity management in 2017 surged to circa N1,5 trillion, from N922.31 billion in 2016 due primarily to the ‘’increased number of OMO auctions to moderate the excess banking system liquidity’’ Given that the government is the major source of excess liquidity in the Nigerian banking system, there is a need to explore ways of sharing the cost of liquidity management with the government. To this end, strong cooperation between fiscal and monetary authorities to reduce the incidence of fiscal surprises and the consequent mop-up operations via costly CBN Bills is crucial.
Much as an asymmetric use of reserves requirements across sectors and financial institutions can help direct credit to ease liquidity constrains in specific sectors of the economy, it is vital to recognize that for competitive reasons and administrative simplicity, it is better for all banks to be subjected to the same CRR regulations. There is ample evidence in literature to show that using the CRR framework to subsidize directed credit for too long can complicate liquidity management and prove suboptimal in the long run. Although the PBC did not confirm it, reports say that China had to abandon the dynamic differentiated reserves requirement regime at some point ‘’because the formula for determining them was too complex’’. Therefore, the CBN’s DCRR framework should incorporate a sunset clause to avoid moral hazard on the part of DMBs.
That said, the policy trajectory of central banks has never been cast in stone. So, beyond the primacy of price stability, the CBN should continue to fine-tune its policy toolkit in support of inclusive economic growth.
Uche Uwaleke is a Professor of Finance & Capital market and the Chair of Banking and Finance Department at the Nasarawa State University Keffi