CBN’s precautionary masterstroke

The Central Bank of Nigeria (CBN) under Lamido Sanusi last week took aim at the easy money at the disposal of Nigerian banks as it introduced a 50 percent Cash Reserve Requirement (CRR) on public-sector deposits.

The higher CRR, which is the minimum balance that the banks are expected to keep with the apex bank, is a tightening measure intended to check the present excess liquidity in the banking industry and stem the crowding-out effect on private-sector borrowing, as well as pre-empt potential increased government spending in the run-up to the 2015 elections. The policy will apply to all deposits from the federal, state and local governments on the balance sheets of banks.

The move, analysts say, represents a significant tightening, given the traditional reliance of the Nigerian banking system on public-sector deposits. Banks are also likely to raise deposit rates as they compete more intensively for other sources of funding. Public-sector funds in the banking sector currently stand at N2.5 trillion, equivalent to 17 percent of the banking sector’s deposits, according to CBN data.

Year-to-date, the distribution of oil revenue from the Federation Account (FAAC), shared among the three tiers of government, and ‘augmentation’ of fiscal revenue from Nigeria’s Excess Crude savings have both increased, leading to pressure on the naira, the CBN’s de-facto monetary policy anchor. The recent non-accretion and dwindling of foreign reserves and the weakening naira exchange rate versus the dollar have been causes of worry for the CBN lately.

Announcing the decisions of the Monetary Policy Committee (MPC) meeting in Abuja, Sanusi stated that the committee sees that principal risks to price stability remain – the loose fiscal stance and rising deficits, excess liquidity in the banking system, exchange rate risks, and a combination of revenue shocks and external developments. The situation, he noted, was worsened by the perverse incentive structure under which banks source huge amounts of public-sector deposits and then lend same to government through securities and to the CBN through Open Market Operations (OMO) bills at high rates of interests.

At present, there is over N1.3 trillion sitting in the banks belonging to government agencies at basically zero percent interest, while the banks are lending about N2 trillion to the government and charging 13/14 percent, “which to them is quite a good business model”, according to Sanusi.

Sanusi warned that this was just the beginning of such drastic measures and that if the monies in the banks were not loaned out, the CBN might be forced in the near future to continuously increase the CRR across board to maintain tight liquidity conditions.

Analysts say by raising the costs associated with public-sector liability mobilisation, initial dislocation in the banking system – with liquidity unevenly distributed as the new CRR on public-sector deposits takes effect – should pressure yields higher, other things being equal.

While we welcome the CBN’s attempt to maintain price stability by raising the CRR, we do, however, sound a note of caution. Some economists, including Bismarck Rewane of Financial Derivatives Company (FDC), have alluded to the fact that the hike in CRR will lead to a reduction in loan availability. Banks may also be forced to re-price loans to reflect higher interest rates. Rewane called the action a band aid, saying he expects the impact to be short term.

It is generally accepted that any policy that threatens loan growth in an economy may also lead to reduced economic activity and expansion. We therefore urge the CBN to closely watch the impact of its action and, if possible, take the necessary policy steps to guard against a liquidity crunch or sustained reduced loan growth.