A confidential letter from the Central Bank of Nigeria (CBN) to a commercial Bank Plc has been leaked, revealing a stern directive from the apex bank concerning Naira overdrafts backed by foreign currency deposits.
This means a borrower cannot use dollars deposited in their bank account as collateral to obtain a loan in naira.
The preference for these borrowers is likely due to the need to hedge against foreign currency spikes which can be costlier than interest rates.
In the leaked letter dated August 17, 2023, and signed by Mr. Haruna B. Mustafa, the Director of Banking Supervision, the CBN highlighted its findings from a recent supervisory review.
It was uncovered that the Bank had been offering Naira overdraft facilities that were secured with foreign currency deposits.
“This practice is not only fraught with the risk of currency mismatch, but is capable of limiting FX liquidity in the market, thereby creating scarcity and exerting pressure on the exchange rate.”
The CBN’s stance against such practices arises from concerns of currency mismatch, which could introduce substantial financial risks for banks.
Rather than convert their dollars to naira, some borrowers will rather borrow in naira as the cost of buying the dollars back might be higher than the interest rate they pay for borrowing in naira. However, this can have a ripple effect on the exchange rate due to its speculative tendencies.
There is a genuine apprehension that these activities might reduce the foreign exchange liquidity in the market. Thus rather, than have the dollars secured as collateral, the apex bank will rather the company sell it to create liquidity than to save it.
When there’s less liquidity, there tends to be scarcity, which can subsequently apply pressure on the exchange rate, disrupting the financial stability the CBN aims to maintain.
Moreover, the CBN emphasized that the Bank’s actions contradicted its previous circular titled “Currency Substitution and Dollarization of the Nigerian Economy”.
This circular was set in place to deter practices that might undermine the country’s economic stability.
Following this discovery, the apex bank directed the Bank to stop these offerings immediately. The bank was also instructed to switch out the foreign currency collateral on existing overdrafts to other acceptable asset types within a fortnight. Non-compliance would mean that the bank would have to unwind these facilities.
- “Consequently, your bank is hereby directed to cease granting FCY secured Naira overdrafts forthwith and immediately replace the FCY collateral on existing overdrafts with other acceptable asset types within two (2) weeks, failing which the facilities should be unwound without delay.
- Evidence of compliance with this directive should reach the Director, Banking Supervision Department, CB not later than September 7, 2023.”
This incident underscores the necessity of transparency in banking operations and the vigilant oversight of the CBN in ensuring adherence to its policies, especially as they aim to shield Nigeria’s economy from potential pitfalls.
What the 2015 circular says
According to the circular cited by the central bank warned Nigerians against dollarizing the economy by pricing goods and services in foreign currency.
- “The general public is hereby warned that it is illegal to price or denominate the cost of any product or service (Visible or Invisible) in any foreign currency in Nigeria and no business offer or acceptance should be consummated in Nigeria in any currency other than the Naira.
- Consequently, deposit money banks operating in Nigeria are advised to desist from the collection of foreign currencies for payment of domestic transactions on behalf of their customers and the use of their customers’ domiciliary accounts for making payments for visible and invisible transactions (fees,charges, licenses e.t.c) originating and consummated in Nigeria.”
Despite this circular, the Nigerian government has typically sold assets in dollars, especially during its privatization processes.
I am concerned by this development because it erodes confidence in the Nigerian financial system and suggests arbitrariness on the financial institutions regulator. It is bad enough CBN made this move but worse that it ties to FX supply. It shows desperation and is suggestive of pressuring private citizen holding FCY assets(dollar) to sell off their assets to fund national dollar needs. It is a tendency towards totalitarian monetary management. By extension, it could fuel again the speculation and fear that it could commandeer domiciliary deposits in an extreme case. To begin with, CBN by its guidelines on Net Open Position(NOP) permits banks to have their balance sheets hold up to 20% of Shareholders Fund as open positions. If there was no breach, this letter was needless. Secondly, a good understanding financial products should point out that such customers could explore derivatives such as currency swaps which produce the same effect. So would the regulator outlaw this and stifle or stunt the market? It cannot not even ring-fence it as the credit worthiness of the customers is not diminished by this stipulation. The banks could still lend clean and rely on GSI for extra protection. The role of the regulator is to create an enabling environment by increasing confidence not eroding it. It should not make an incursion into the realm of business decisions. If CBN wants to boost supply, it knows what to do: free up the traditional supplies of FX that existed before the technical shutdown of the 2WQ market i.e. oil company sales, NNPC, NPA, NIMASA, NGOs etc. Once stability is achieved, the fixed income securities returns become attractive to foreign capital. Right now, the exchange risks are greater than the returns on the assets. No foreigners investor will take a plunge into a financial disaster! Moves as this letter compound the crisis of confidence by adding regulatory risks as well as signaling sovereign risk. It is time to quit the blame game. Really, speculation is a deep part of capitalism; all arbitrage arrangements( buy low, sell high) across all trades of tangible or intangible goods are belied by speculative considerations. Basic economics teaches that, individuals hold money for 3 motives – transactional, precautionary and speculative motives. It is even hard to determine that dollar assets or savings are held for speculative motives. A problem known is half redressed because one would not aim in the wrong direction or achieve counterproductive outcomes!
You must have misunderstood the directives of the Apex bank or worse lack the implications of borrowing naira with FCY in your account. Let’s say I have 1000$ in my bank account and borrowed #300k in February, today, not only will I not pay the interest but the bank will still have to pay me until because of the mismatch. Nigeria has its own currency, naira and should be transacting in Naira. If you must hedge then buy gold or other scarce minerals. Nigeria will never grow with such a dubious mindset of economic sabotage.
The CBN is very right on this one. It is a currency mismatch risk for the Bank and piles more pressure on the Naira due to the speculative structure. The FCY deposits should be use as collateral for a FCY risk asset or facility but not a LCY loan. It is like trying to eat your cake and have it. The collateral for any Naira facility must be valued in Naira. If their are concerns with regards to FX risk, available instruments such are FX forwards or Naira settled OTC FX Futures that can be used an hedge to address that.
Safe to say … One of many … #dollarisation of the economy
The CBN should also caution the Federal government against sales of government assets to local investors in dollars, as adeptly captured in the last sentence of this article.
The CBN have been guessing, we are heading the Argentine and Venezuelan route. My fear is that soon every dollar in Nigerian banks will be converted to Naira, and that will be the end no court will save us. So called expats here’s are paid in USD, some schools still charge USD, some landlords also collect USD, most oil and gas contracts are in USD. We need to be clear on what we want and adhere to it, so investors can also see us as serious people.
Tell me which of the money’s and financial instruments are not subject to fluctuations…either in naira or dollars.
These instruments … including permanent ones like land documents, shares, etc…then Treasury instruments, bonds, stocks are all used as securities for debts., even naira savings accounts.
Why should dollar with history of growing strength against naira, shouldn’t…
If the country couldn’t operate dollar dom accounts it stop it…