• Tuesday, June 25, 2024
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Notes on monetary and financial stability

Notes on monetary and financial stability

Central banking regulators frequently fail to provide a transparent justification for their actions. The recent failures in overseeing banks, especially in Western economies, highlight a distinct absence of explicit explanations from these regulators regarding the root causes of these incidents. This lack of accountability, despite their crucial role in regulatory oversight, is a matter of utmost significance and necessitates closer scrutiny.

In recent months, we have observed significant challenges emerging within the core foundations of the global banking sector. With monetary policy as its cornerstone, the pressing need to address the persistent surge of inflation, reaching unprecedented levels in recent times, cannot be ignored. The issue of inflation has become a global phenomenon, impacting even the banks themselves, making it an urgent concern.

In US financial history, the month of March 2023 witnessed a momentous event as a prominent lender succumbed to unprecedented challenges, sending shockwaves through the industry. Silicon Valley Bank (SVB)-you’d be excused for being unaware of Silicon Valley Bank (SVB) until now, has unleashed a chain of events that now raises concerns about the looming specter of another financial crisis.

As the 16th largest bank in the United States, SVB had garnered significant attention and even secured a coveted spot on Forbes’ prestigious list of America’s top banks. With impressive achievements such as a deposit base exceeding $13.9 billion and total assets valued at a staggering $209 billion in 2022, SVB was once considered a force to be reckoned with.

Tragically, SVB’s downfall can be traced back to a series of ill-fated investment decisions. Most notably, the bank allocated billions of dollars into long-term securities, including US treasuries and mortgage bonds, which ultimately proved to have disastrous consequences. The subsequent implementation of interest rate hikes, orchestrated by the central bank to tackle inflationary pressures, dealt a devastating blow to SVB.

Due to the inverse relationship between interest rates and bond prices, the sharp decline in bond prices led to a significant devaluation of SVB’s investment portfolio. The repercussions of these unfortunate events reverberated throughout the financial landscape, prompting profound reflection on the broader implications for systemic stability. It is noteworthy that Silicon Valley Bank now stands as the second-largest bank collapse in American history, trailing only the infamous demise of Lehman Brothers in 2008—a stark reminder of the catastrophic consequences that unfolded.

While contemplating the implications of the recent events surrounding Silicon Valley Bank (SVB), it’s understandable to question how they relate to our Nigerian context. Undoubtedly, you have likely observed the escalating inflationary trajectory, which naturally leads to pondering the effectiveness of monetary tools in the hands of our Central Bank.

The concern arises: Can these tools be wielded adeptly to prevent an SVB-like recurrence from unfolding on our own soil? It remains to be seen how the banking sector will recover from this event, but it is clear that the collapse of SVB has left a significant mark on the economic landscape. This indeed is a litmus test for the Global financial system – and indeed the Central Bank of Nigeria.

As we delve into these critical considerations, it is imperative to recognise the significance of reassessing Nigeria’s financial stability within the scope of monetary policy. However, I emphasise the importance of acknowledging an inherent corollary.

Specifically, monetary policy must possess the capability to effectively respond to macroeconomic implications stemming from market disruptions. Such responsiveness is crucial for shaping the inflation outlook and steering the economy away from deviations that veer off course from the desired inflationary targets.

Let me start with some stark and uncomfortable facts. Nigeria stands at a critical juncture in its pursuit of monetary and financial stability. The country faces mounting challenges as it grapples with rising inflationary trends and market dislocations.

One of the misfortunes of the contemporary Nigerian economy is that there is too much tendency to overlook the fact that the country continues to struggle with record debt, shortages of foreign exchange and a weak naira. The last two decades have seen a marked increase in inflationary rates.

As will be clear from the NBS’s consumer price index (CPI), which measures the rate of change in prices of goods and services, a great deal of evidence shows that CPI rose to 22.22 per cent as of May 2023 up from 22.04 per cent in April 2023, and 21.91 percent in the previous month. The situation is very urgent.

Indeed, it is reasonable to assert that the contagion effects stemming from the US banking crisis, the ongoing conflict in Ukraine, and the geopolitical standoff between the US and China could potentially permeate beyond our borders, impacting our own economic landscape. Domestically, there are several notable risks that have been identified, including the burden of high public debt, elevated levels of inflation, declining oil production, and a moderate recovery in output growth.

Furthermore, the Monetary Policy Committee (MPC) communique released on May 24th remained conspicuously silent regarding the ramifications of the ill-fated Naira design policy implemented by the Central Bank. With regard to the quite spurious anxieties that are often expressed about the naira design, one of the most obvious reasons for redesigning the naira was that it could stimulate a slowdown which has necessitated a series of interest rate hikes by the Central Bank.

Possibly among other factors, President Tinubu’s censure of the Central Bank in his inaugural speech could be attributed to the issues mentioned. In my view, the president’s speech is pertinent and highlights the necessity for a thorough reassessment of the Central Bank’s policy management.

This would involve working towards a unified exchange rate, implementing reforms that redirect funds from arbitrage towards meaningful investments, and fostering job creation to drive the real economy. These initiatives are commendable and form the essential foundations that should be expeditiously realised. By pursuing these actions, the Central Bank will not only fulfil its mandate but also cultivate an environment where dynamism and productivity gains can thrive.

First and foremost, it is important to acknowledge that the Central Bank deserves recognition for implementing effective policies aimed at addressing structural imbalances and market disruptions. Despite the challenges posed by global economic developments, it has managed to maintain stability within the banking system, as evidenced by the performance of the Financial Soundness Indicators (FSIs).

These FSIs, comprising crucial metrics and indicators, serve as a measure of the overall health, stability, and resilience of a country’s financial system. Notably, as of April 2023, the Capital Adequacy Ratio (CAR) stood at 12.8 percent, the Non-Performing Loans (NPLs) ratio at 4.4 percent, and the Liquidity Ratio (LR) at 45.3 percent.

Nevertheless, it is important to highlight that despite the Central Bank’s efforts to control inflation through its stringent monetary policies, it has encountered limited success in achieving its long-term objective of reducing inflation.

It is plausible, based on current knowledge, to suggest that if there were indications of more persistent inflationary pressures, the Central Bank of Nigeria (CBN) may contemplate further tightening of monetary policy. From my perspective, in principle, a stronger tightening of monetary policy would be warranted if there were greater intrinsic persistence of inflation. This holds true, as the primary obstacle to macroeconomic stability in Nigeria continues to be the rise in headline inflation, albeit at a moderate pace.

Picking up on this lattermost point, I hope to explain my understanding of what needs to be done and how monetary policy can be strengthened to tackle inflationary pressures and foster stability. I emphasise from the outset: this is a personal view. In presenting my interpretation, I will focus on three key questions: How can we effectively tackle the issue of inflation? Why should we reassess the role of monetary policy? And how can we address market dislocations and the pressures driving inflation?

These questions hold particular significance given the exceptionally high inflation experienced in recent years and the employment of “unusual” policies over the past decade or so. It is crucial to engage with these important and valid questions to provide further insights into the thought process that may guide future policy decisions.

The issue of inflation

In light of the mounting inflationary pressures that pose significant threats and challenges to Nigeria’s economy, it becomes imperative to reassess the country’s financial stability framework. Consequently, there are two key rationales behind the emergence of such an opinion.

Firstly, undertaking this evaluation would bolster the existing market structure, enhance transparency, and improve risk management practices. Observers have highlighted these aspects as indicative of the necessity for such reassessments.

Secondly, recognising the enduring link between fostering economic growth, implementing structural reforms, and making investments in critical sectors becomes crucial. This further underscores the belief that relying solely on monetary policy tools may be insufficient to effectively mitigate inflationary pressures and promote stability.

Revisiting the role of monetary policy

At the heart of the aforementioned argument lies the recognition that while monetary policy plays a crucial role in Nigeria’s economic recalibration and the preservation of financial stability, achieving price stability necessitates a delicate balance that promotes sustainable economic growth. Hence, it is contended that monetary policymakers can and should adopt a forward-looking approach.

In this context, it is imperative for monetary policy to address the devaluation of the naira in order to alleviate the strain on the real income of businesses and households. Such a judgment necessitates a proactive and nimble approach that involves effective management of interest rates, close monitoring of economic indicators, and the identification of systemic risks.

Given the current transition of power to a new administration, it becomes even more critical to enhance coordination between monetary and fiscal policy. By fostering these synergies, the much-needed macroeconomic stability required for sustainable economic growth can be achieved.

It used to be widely believed that monetary policy was an immensely powerful economic tool. However, a more accurate understanding acknowledges that its effectiveness can be weakened and inefficient if it is burdened with objectives that are inconsistent with its core task.

Consequently, it is crucial to establish a robust framework for collaboration between monetary and fiscal authorities to minimise disruptions within the financial system and ensure cohesive policy implementation.

Addressing market dislocations and inflationary outlook

Further elaboration on the preceding points is warranted. Firstly, it is crucial to acknowledge that market dislocations, exemplified by the collapse of Silicon Valley Bank (SVB), serve as a reminder that Nigeria is not immune to global shocks.

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Given the interconnectedness of global financial systems, these shocks can have a potential impact on Nigeria’s stability. The cautious optimism observed in the markets following the inauguration speech of the new government underscores the need for economic recalibration. Consequently, it becomes imperative to establish a robust regulatory framework that emphasises the resilience of financial institutions.

Additionally, it is important to address the perception that there is still room for enhancing transparency and promoting sound governance. These measures are necessary to safeguard the stability of Nigeria’s financial sector. By bolstering transparency and ensuring sound governance practices, the sector can be better equipped to withstand potential risks and maintain stability.

Finally, let me end by suggesting that it should be contended that the supervisory arm must look to conducting rigorous stress tests and enforcing prudential regulations to prevent undue risks and promote the health of financial institutions. Arguably, this, in turn, fosters a favourable environment for investment, economic growth, and the preservation of long-term price stability.

Omeihe is the President of the Academy for African Studies and serves as a Senior Economic Advisor at Marcel. He holds the position of Associate Professor at the University of the West of Scotland.