The decision by the Central Bank of Nigeria (CBN) to raise the Cash Reserve Requirement (CRR) for public sector deposits in banks to 50 percent has continued to unsettle operators in the industry.

The new monetary policy mandates banks to keep 50 percent of public sector funds, which comprise deposits of all tiers of government as well as ministries, departments and agencies (MDAs), with the CBN.
The policy initiative targets high-powered money (bank reserves plus vault cash) as a policy tool to curb inflationary threats that emanate from fiscal excesses, and possible currency weakness.

With this development, it is anticipated that the naira will appreciate due to increased foreign exchange supply, reduction in the Wholesale Dutch Auction System (WDAS) funding, short-term inflow of hot money, the accretion in the external reserves among others.


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Banks’ Heavy Dependence on Public Sector Funds
Nigerian banks had over the years depended heavily on public sector funds. In fact, the perceived apathy of some banks towards small savers in the country as well as the declining credit to small businesses in the country was largely attributed to the amount of returns the financial institutions get from playing with public sector funds. Therefore, some commentators argued the policy signaled the end of ‘easy money’ for banks. Some, however, said it had exposed the shallowness and fragility of the banking system.
This, according to them, was evident in the fact that the withdrawal of about N1.2 trillion from the system while implementing the policy, led to an 80 percent increase in the range of money market rates.

Thus, in order to maintain their liquidity position in the short-term, THISDAY learnt that most banks have since resorted to sell of some of their financial instruments such as treasury bills, FGN bonds, AMCON bonds, to remain liquid, while they strategise on how to commence aggressive deposit mobilisation from the private sector.

Central Banks’ Concern
To CBN Governor Mallam Sanusi Lamido Sanusi, the introduction of CRR on public funds became necessary in order to, among other things, check “the perverse incentive structure” under which deposit money banks (DMBs) “source huge amounts of public sector deposits and lend same to the government.”
Sanusi said: “First of all you’ve got liquidity surplus in the banking industry. As I speak to you there’s over N1.3 trillion or so sitting in banks and belonging to government agencies.

“Now basically, they (surplus) are at zero percent interest and the banks are lending about N2 trillion to the government and charging 13 to 14 per cent. Now that’s a very good business model, isn’t it? Give me your money for free and I lend it to you at 14 per cent. So why would I go and lend to anyone.”

Continuing, he said: “Now if you want to discourage such perverse behaviour, part of it is to basically take away some of that money and, therefore, the reserves requirement is supposed to make sure that excess liquidity in banks’ balance sheets is evenly distributed. We’ve got about six or seven banks that already account for the bulk of these deposits. We are not going to put them into distress.”

The CBN governor further warned that if spending continues and the concern about the liquidity conditions continues, there might be continued increase in the CRR across the board to continue to maintain the tight liquidity conditions.

“In election years, everywhere in the world, not just in Nigeria, politicians spend money and spending money means pressure on the exchange rate, pressure on reserves and pressure on inflation.
“So the next 12 months would be difficult; we would have to respond at every stage and make sure that no matter what happens we do not have stability threatened,” he declared.

Also, the Deputy Governor, Financial System Stability, CBN, Dr. Kingsley Moghalu, explained that the monetary policy would benefit the banking industry ultimately by creating an incentive for banks to look for other deposits from the real sector and individuals at competitive deposit rates.

He said: “We often see lending rates rise in response to the Monetary Policy Rate (MPR) set by the CBN in its efforts to tighten money supply to reign in inflation, but a very little corresponding increase in rates banks pay depositors.”
Furthermore, Moghalu also argued that the banks had been “banking on the perverse incentive of government deposits, which they then turn around and lend to government and the CBN (in this case through Open Market Operations) at extremely profitable rates for too long.”

The Deputy Governor, Operations, Mr. Tunde Lemo, maintained that Nigerian banks had more than half of the money they required.
Lemo said: “So the excess liquidity should have gone into creating credit by now. But most of the banks are sitting on excess liquidity. In fact, they collect these monies from the government and purchase treasury bills and in so doing, lend back to the government.”

Implications for the Market
To the Managing Director/Chief Executive Officer, Financial Derivatives Company Limited (FDC), Mr. Bismarck Rewane, the policy has exposed the vulnerability of the banking system’s dependence on government deposits as well as the “corruption-riddled brokerage paid to government officials and bank staff”.

Rewane said: “The total sum of money to be quarantined is N890 billion. The percentage of total debits (N890 billion) to M2 (broad money supply) is about 5.7 percent, while the percentage of total debits (N890 billion) to total deposits is about 6.4 percent.”
“Banks could follow the alternative route through repurchase of maturing Asset Management Corporation of Nigeria (AMCON) bonds to CBN. Banks will be expected to take one-off losses of N1 billion to N5 billion on this position, depending on the size of their public sector funds.

“Either way will lead to a squeeze in banks’ net interest margins. Accordingly, banking stocks are expected to be discounted further as earnings capacity declines,” he declared.

The policy, according to him, would also see banks’ loan portfolio shrink due to trade-off between liquidity and profitability.
Similarly, the Head of Research, BGL Securities, Mr. Femi Ademola, insisted that banks’ appetite for government securities was responsible for the sluggish growth of private sector credit.
“We have argued in the past that as long as this incentive structure exists there could be little reason for banks to invest in costlier and riskier credit creation. This has been the basis of our consistent argument for downward revision in the MPR before it got to the current 12 percent level.

“We believe that the use of macro-prudential tool that targets the concentrated systemic liquidity could be more appropriate at tackling the liquidity problem while the interest rate is revised downward to the benefits of private sector credit growth. In this regard we align with the action of the committee as a positive measure to encourage the banks to focus more on lending to the private sector. We expect that as the effect of this action unfolds, the committee would consider revising the benchmark interest rate downward in the medium term,” he added.

Also, analysts at the Consolidated Discount House Limited (CDL) noted that deposit rates would go up as banks resume fight for deposit liabilities.

The firm also anticipated that banks would seek to re-price risk assets as cost of funds spike.
“High lending rates could lead to a slowdown in risk asset creation and drop in imports. High yields on FGN bonds could stimulate carry trade. We expect some keen interest from foreign portfolio investors as this new tightening outlook improves the profile of the carry trade in the short term. On the equity space, we believe the hurried exit of investors from banking stocks will be moderated by the kick-off of first half earnings season,” a CDL report stated

But some bank chief executives expressed concern that the policy could have adverse effects on the banking industry as well as a spiral effect on the economy.

The Group Managing Director/Chief Executive Officer, Zenith Bank Plc, Mr. Godwin Emefiele, said: “To me, in terms of impact of the introduction of the 50 per cent CRR through the withdrawal of statutory government funds from the banking industry, there are basically two major risks that this poses for the banking industry. One of them is liquidity risk and the other is interest rate risk.

“For banks that took public sector funds and granted them as loans, they will face great liquidity and interest rate risks and, of course, they will not be able to call back the loans that they had granted to their customers. For banks that collected those deposits and placed them in treasury bills and other government instruments, they will face only interest rates risk, which is left there in terms of impact on them”.

Continuing, the Zenith Bank CEO said: “But in terms of the effect on lending rates and borrowing, what you will see effectively is that the withdrawal of these funds from the banks will lead to private sector depositors asking for higher rate of returns on their deposit and as this happens, naturally what you will see is that borrowers who are taking monies from banks will have to pay more for borrowing from banks.

“What you will also see effectively is that because interest rates on loans will go up, you will find that this will adversely impact on productivity because productivity level will drop if you have companies that are unable to borrow at reasonable rates. It will affect the productivity of industries and you will have price level going up.”

Emefiele pointed out that considering the federal government’s desire for banks to lend to borrowers at low interest rates, what was required was to allow the banks to maintain the public sector deposits as it used to be.
On his part, the Group Managing Director/CEO of Skye Bank Plc, Mr. Kehinde Durosinmi-Etti, explained that the liquidity of banks was thin, saying that although banks maintained high liquidity ratio, they were subjected to measures that could impact negatively and quickly on them.

“So, they say there is excess liquidity, but I do not think so from my own assessment and it depends on what you are looking at really. The central bank wants us to keep a minimum liquidity ratio of 30 per cent, so you add a factor that makes you feel fairly safe above that. If you maintain a liquidity ratio that is close to 30 per cent and they come out with this kind of measure, it impacts on you,” he added.

House of Representatives’ Position
The House of Representatives Committee on Banking and Currency, however, lent its support to the policy. To the Chairman of the committee, Hon. Chukwudi Onyereri, the decision was in line with the clamour of the lawmakers in the last two years. Onyereri said the committee had been pushing for the withdrawal of public sector funds from commercial banks to correct the perceived imbalance in the system.

Onyereri said in the long run, the policy would bring the much-needed respite for consumers from high bank charges, lack of banking incentives and high interest rates.

“We have stressed the need for the withdrawal of public funds from commercial banks so that banks can go back and focus on their core banking functions.

The withdrawal of public funds from commercial banks will force banks to look for alternative funds, which will in turn lead to offering better incentives to the public, including higher deposit rates and an increase in private sector lending,” he said.

Way Forward for Banks
Following the development in the industry, the General Manager, Retail Banking, Skye Bank Plc, Mrs. Arinola Kola-Daisi, said banks would have to reinforce their retail banking strategy. Kola-Daisi described retail banking as a very important business for all banks as it has to do with the provision of banking services to individuals and small businesses.

She explained: “Everybody knows that in Nigeria, the government is the biggest spender so you can never move out of government funds. There is no bank that is going to move out of banking the government in as much as we are allowed to bank the government, but of course, we now have to start to look more critically at retail banking business where there is large number of customers.”

Continuing, she said: “All commercial bank must be interested in retail business because that is really what banks are set up for. Banks are set up to meet the financial requirements of the banking public and that cuts across a wide spectrum from the lower, to middle high net worth individuals and to those running small businesses. That is essential banks’ function and for all commercial banks in this country, it should be something that they should be keenly interested in.

“The strength of retail is in numbers, so when you look at the different businesses in the bank, you may have some businesses that the profitability is on few large transactions and of course you need the numerical strength and numbers of many people in many locations across the country all adding up to give the profitability that you want because if you look at yourself as an individual, everybody runs a bank account and a lot have been said about financial inclusion.”