A bizarre directive from the CBN

Recently, the Central Bank of Nigeria called on banks and large corporate organisations to issue new debt at single digit in an investment environment where the risk-free rate is around 13 percent.

Specifically, Godwin Emiefele, CBN governor asked banks to provide loans to institutions in employment elastics sectors of the economy looking to fund new projects at 9 percent interest rate while he also called on corporate institutions to issue long dated commercial papers with interest rate below 10 percent.

This request was formally communicated to these institutions through the CBN communiqué of the monetary policy committee (MPC) meeting held last month, the same meeting where the MPC chose to hold its own monetary policy rate at 14 percent. The monetary policy rate is the rate of interest at which CBN lends to commercial banks to sure up liquidity in the banks.

In a rational investment environment, it is virtually unthinkable for investors to invest in risky securities that provide a negative risk premium or in simpler terms nobody will invest in things that cannot at least match the Treasury bill rate. But the Central Bank has a plan to ensure this new policy succeeds.

CBN told banks that as a way to incentivise them 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.

Emiefele explained further that when banks create these loans for the real sector, the Central Bank will reduce the bank’s reserve requirement, thus channelling cash that would have ordinarily earned nothing parked in the vaults of CBN to interest earning loans for the real sector.

Banks will be very careful in taking up this invitation as earning nothing on reserved cash may be better than lending at a single digit rate in a country where 2017 industry non-performing loans was as high as 15.1 percent according to World Bank.

CBN is yet to provide full details on how this new lending policy will work but analysts expect it to increase the industry credit risk when the policy takes effect as the fragile economic recovery still poses risks to lending to the real sector.

More disturbing is the request for large corporate institutions to sell long dated commercial papers with tenure of 5-7 years at single digit interest rates when the 5 year and 7 year federal government bond yield is currently at 12.75 percent and 13.53 percent respectively.

It will virtually be impossible for such commercial papers to float successfully in the money market where average issue yield on commercial papers is currently 15.96 percent. No sane investor will buy uncollaterized or even collaterized 5 year commercial papers at a rate lower than the FGN 5 year bond yield. Investors will rather invest the money in risk free assets which will allow them earn decent returns above inflation than assume a default risk without any form of compensation.

CBN stated in the communiqué that 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 these commercial papers.

In effect, CBN is saying it is open to starting quantitative easing in a market where it has chosen to hold rates as high as 14 percent. Central Bank did not state the maximum limit of how much they will be willing to invest in a commercial paper or if they will also be willing to participate in buying these bills in the primary market. Since investors won’t put a dime in buying up commercial papers at single digit when opportunities for riskless higher yields are bountiful in the money market, these corporate institutions will have to depend on CBN buying up 100 percent of these commercial papers in the money market.

If this happens, CBN will be in direct competition with the deposit money banks it regulates. Since the banks won’t be able to match the single digit interest rate Central Bank is willing to accept on the commercial papers, banks and institutional investors will be competed out of the commercial paper space by the apex monetary authority.

This could significantly distort financial markets if both policies take effect in the current investment environment considering where the monetary policy rate, Treasury bill rate and FGN bond yield are currently sitting. The larger the amount CBN invests in both policies, the more distorted will be the financial market at the end of the day.

In spite of the request by CBN on single digit commercial papers, it appears the market isn’t listening. Only last week, Sterling Bank completed the issuance of its new commercial paper which it raised at 12.7 percent, far off from CBN’s single digit interest rate prescription.

If the CBN want rates in Nigeria to go below 10 percent, it needs to start by bringing down its own monetary policy rate to single digit first. The MPR is the key benchmark rate for all interest rate. If it stays in single digit, it is unlikely interest rates will fall to single digit.