Some financial analysts have supported the Central Bank of Nigeria (CBN)’s move to eliminate foreign currency-denominated collateral, expecting it to stabilize the economy by improving dollar availability in the foreign exchange (FX) market while addressing currency liquidity challenges.
The Central Bank of Nigeria (CBN) has prohibited the utilization of foreign currency-denominated collateral to secure naira loans, with exceptions outlined under specific conditions.
Dr. Adetona S. Adedeji, Acting Director of the Banking Supervision Department at the CBN, communicated this directive via a circular distributed to all Nigerian banks recently.
In an exclusive interview with Nairametrics, the experts expressed hope that the initiative will contribute to economic stability and FX liquidity boost.
They commended the policy’s focus on using more sensible collateral like Federal Government Eurobonds and foreign bank guarantees to relieve pressure on foreign exchange reserves.
They frown at the practice of using foreign currency-denominated collateral, advocating for hedging currency risks through purchasing forwards or Eurobonds to enhance currency circulation.
The analysts expressed optimism that such measures would significantly enhance FX liquidity, providing a positive outlook for the market.
Recommended reading: CBN bans use of foreign currency-denominated collaterals for naira loans
CBN’s ban on the use of foreign currency-denominated collaterals for naira loans
Nairametrics reported recently that the CBN has banned the use of foreign currency-denominated collaterals for obtaining naira loans, except under specific conditions.
The circular noted CBN’s observations of the prevalent use of foreign currency (FCY) as collateral by bank customers seeking naira loans. In the light of these observations, the CBN resolved to prohibit this practice, aiming to stabilise the financial market and ensure the prudent use of foreign currency within the economy.
However, the directive comes with notable exceptions. Foreign currency collateral will still be permissible if it is in the form of Eurobonds issued by the Federal Government of Nigeria or guarantees from foreign banks, including Standby Letters of Credit.
This move signifies the CBN’s effort to maintain a balanced approach, recognising the importance of specific international financial instruments and guarantees in the banking sector.
What financial experts are saying
Olatunde Amolegbe, Managing Director of Arthur Steven Asset Management Limited and former President of the Chartered Institute of Stockbrokers (CIS), reacting to the development in an exclusive interview with Nairametrics, criticized the use of foreign currency-denominated collateral as an anomaly that contributed to distortions in the FX market.
He argued that it essentially amounted to betting against the Naira with US dollars, which should ideally be in circulation rather than locked up in banks’ books as collateral.
Amolegbe suggested that to hedge currency risks, it would be more appropriate to purchase forwards or Eurobonds and utilize them as collateral.
This approach, he noted, would ensure that the currency is put into circulation. He expressed optimism that the measure has the potential to significantly increase FX liquidity, providing a positive outlook for the market.
- “Those currencies should be in circulation and not locked up in a bank book as collateral. If you need to hedge currency risks, either buy forwards or Eurobonds and use that as collateral.
- That way, at least the currency finds its way into circulation. I think the measure has the potential to increase fx liquidity substantially,” he said
Victor Chiazor, Analyst and Head of Research at FSL Securities Limited, in an exclusive chat, also weighed in on the CBN’s decision to prohibit the use of foreign currency-denominated collateral for bank loans.
He observed that this trend in collateralization surged due to the prevailing belief that the Naira’s value would continue to decline, prompting individuals to opt for dollar assets as a hedge against purchasing power erosion, regardless of actual dollar needs.
Chiazor, however, views the CBN’s policy as a well-considered strategy. He argues that it facilitates the utilization of Eurobonds issued by the Federal Government and guarantees from foreign banks as collateral, which he deems more logical compared to the current practice of using foreign currency held in domiciliary accounts or dollar placements as collateral for Naira loans.
He anticipates that this policy will alleviate some pressure on foreign exchange reserves, particularly by redirecting loan exposures currently collateralized with foreign currency back into Naira or Naira-denominated assets.
Furthermore, Chiazor predicts that individuals still interested in holding dollar assets will be incentivized to lend to the Federal Government by investing in Federal Government Eurobonds.
Tajudeen Olayinka, an Investment Banker and Stockbroker, emphasized the pressing economic challenges facing Nigeria.
He described the current state of the economy as being in dire straits, with concerted efforts underway to restore it to a more stable condition.
Olayinka said that the CBN’s decision to eliminate foreign currency-denominated collateral from bank lending aligns with this goal of stabilizing the economy.
He suggested that this measure could lead to an improvement in dollar liquidity in the foreign exchange market in the short to medium term, which is a key objective of the CBN.
- “This brings us to the state of economic emergency we are as a country. The economy is in bad shape, and all efforts are being made to bring it back to a reasonable level of equilibrium.
- Elimination of foreign currency-denominated collateral from bank lending in Nigeria could help to improve dollar liquidity in the foreign exchange market in the immediate to near term. That is the target of CBN,” he said.
However, Mr. David Adonri, Managing Director of Highcap Securities Limited, highlighted that the CBN has yet to provide a clear rationale for its directive.
According to him, he finds the directive perplexing because holding foreign currency-denominated collateral may seem less risky, given the stability of foreign currencies.
- “To realize such collateral securities in the event of default may be less cumbersome because of prompt responsiveness of foreign courts in dispensing justice.
- However, I think that CBN is worried about the quality of some foreign securities as collaterals hence its prescription of the kinds of foreign currency assets that are permissible,” he said.