A few weeks ago when the Monetary Policy Committee members of the Central Bank of Nigeria voted to reduce Monetary Policy Rate (MPR), not all bankers and financial analysts were enthused. There is a reason for this lack of enthusiasm.
An MPR reduction is ideally supposed to have positive outcomes for banks’ lending rate and the economy in general. However, such a policy move by the CBN can only be effective if some other factors are duly considered and adjusted accordingly. But for certain reasons, that was not quite the case during the last MPC meeting. Some experts who spoke to Nairametrics explained this in details, as you shall see shortly.
First, here’s CBN’s reason for reducing MPR
As Nairametrics had reported, the MPR was reduced from 13.50% to 12.50% during the last MPC meeting that was held on May 28. Governor of the Central Bank, Godwin Emefiele, explained that the decision was informed by the negative impacts of the COVID-19 pandemic on the economy, including high inflationary pressure and restrictions in international trade. Therefore, the reduction in MPR was to, among other things, help reduce cost of capital in order for businesses to be able to afford loans, thereby reinvigorating the economy.
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The question, however, is whether the policy move is capable of accomplishing the purpose for which it was intended. This is a critical question, bearing in mind that all the other metrics (such as the liquidity ratio and the cash reserve ratio) were retained; even though they ought to have been adjusted as well. Wole Oluyemi, a Strategy & Financial Advisor who spoke to Nairametrics on this issue, raised this point when he said:
“It was a pleasant surprise when I heard that the MPR was reduced by 100 basis points to 12.5%. The last time the MPC changed the MPR was in March 2019.
“Unfortunately, the CBN decided to retain the Cash Reserve Ratio (CRR). As banks are facing liquidity constraints due to the CRR expectations, this may impede their ability to advance more credits that is expected to stimulate economic activities.”
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So, is the MPR still useful?
For Ighodaro Alonge, a fixed-income expert, the Monetary Policy Rate under the current CBN regime headed by Godwin Emefiele, has lost its usefulness. And the reason for this is because Governor Emefiele and his team have recently been more interested in regulating liquidity in the system using Open Market Operations (OMO) bills. He explained:
“MPR has lost its usefulness under this current CBN regime. It doesn’t just work anymore because normally, the MPR is the rate with which the CBN uses to control liquidity.
“So, when it raises MPR, it tightens up other interest rates; other interest rates tend to follow – standing lending facility, standing deposit facility, lending rates banks will use to lend to their customers, even fixed deposit rates and then normal savings rates on accounts. MPR usually adjusts all these rates. If you raise MPR, all the other rates go up, if you drop MPR all those rates go down.
“But we have a CBN that is using Open Market Operations (OMO) bills to regulate liquidity in the system. This is why back when the MPR was 14%, OMO bills were as high as 16% to 17%; they didn’t raise MPR. Why didn’t they raise MPR? It was more political because he didn’t want it to seem like he was tightening the economy.
“Eventually, they have reduced MPR to 12.5%, slashing it by 100 basis points. But the rate for 1-year treasury bills is at 5%. So, it shows that MPR is useless. It doesn’t work with the other rates. The CBN prefers to use OMO because that is a quicker way to control liquidity than MPR. As they issue more OMO, they are able to get out all the liquidity from the system. So, interest rates start to pick up. That’s what they were doing in 2016, 2017, and 2018 until they reversed the whole thing in 2019. They even prevent local investors from accessing the local market. Then they lowered interest on OMO bills. OMO bills are doing like 6, 7, 8%. But where’s MPR? MPR is at 12.5%. So, I think the CBN is just interested in having MPR where it is just for documentation. The reduction doesn’t affect anything.”
Some experts believe the MPR reduction is beneficial, but…
Meanwhile, the Principal Consultant at Hatytude Consultancy Services Ltd, Olufemi Hassan, is one of those who believes that the MPR reduction was a good move by the CBN. He took time to explain some of the ways this could positively influence banks’ ability to lend, although he also pointed out some of the issues that other analysts raised.
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“The purpose of the MPR reduction is basically to stimulate the economy. Because of this COVID-19 pandemic, there has been a lot of inactivity in various segments of the economy. And the best way to stimulate that is if you have investors/businessmen having access to credit facilities at good rates. So, if for instance, the banks have been saying that their cost of funds have to be taken care of, their cost of risk has to be taken care of, reducing the MPR helps to ensure that the cost of funds invariably reduces for the banks. This will then make it possible for them to be able to avail loans to good investors/businesses at the rates that those investors are comfortable with. This is important because some of the large borrowers are also very pricey in terms of negotiation of their interest rates to the banks. So, typically, the banks may not be able to expand the disbursement to them because they cannot afford the loan rates these borrowers are asking for. But with the reduction in MPR, that could be enhanced.
“Of course, most of these large borrowers end up having a very huge value chain which involves the suppliers, the distributors, some vendors, and so many other people within the value chain. Invariably, the money will trickle down to them and the banks are usually more comfortable with that. So, that way, the economy gets stimulated. The bank lends are able to avail more loans to the large good borrowers, and the good borrowers are able to enhance their productive capacity.
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“But having said that, it’s also a bit sticky because, on one hand, the Central Bank has actually reduced the MPR while on the other hand, they are also debiting the banks. I think the CBN needs to be lenient on the banks with regards to the loan to deposit ratio. It will take some time before banks are able to meet the requirement. Loan appraisal/loan disbursement is not something you do in a rush. The banks will to do their appraisals and measure their risks before they can end. This helps to ensure that they don’t deplete their shareholders’ funds by lending anyhow. Now, because the banks need to consider all these things, they may not be able to meet the LDR as quickly as the CBN wants them to. So, the CBN really needs to calm down a little bit and be lenient because if you keep debiting them, where will the funds they give out as loans come from? On one hand, you are trying to stimulate the economy by lowering MPR, on the other hand, you are debiting the banks and the cash you debit will become sterilised in the CBN vaults.”
Financial Expert and Nairametrics’ economic commentator, Kalu Aja, also agreed that the MPR reduction is a good move. However, he noted that the reduction may not be enough to effect any desired change.
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“A policy rate reduction is intended to drive down cost of capital to the economy positively impacting SMEs cost of doing business. I think it’s positive, but not a big change to actually impact materially. In terms of impact on banks? On paper, the banks can lend at a lower rate. Again, I am critical it’s not a large drop. Remember, perception is important,” he said.
The next Monetary Policy Committee meeting of the scheduled to hold in July this year, according to the CBN’s MPC calendar for 2020. It remains to be seen whether any further adjustments will be made to the rates by then. Also, Nairametrics will monitor the market to observe whether there is a drop in banks’ lending rates following the MPR reduction.
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