It is obvious that with increase in the Cash Reserve Ratio (CRR) on public sector funds from 50 percent last year to 75 percent last week, bank earnings will reduce and the cost of funds will increase.
August last year, the Central Bank of Nigeria (CBN) increased the CRR on public deposits to 50 percent, which effectively sterilised public sector deposits by compelling banks to store 50 percent of their deposits from government entities with the CBN.
Consequently, an estimated N1.2 trillion was withdrawn from banks as a result. The new policy however unsettled operators in the industry. With an estimated N45 billion in interest income to be lost, many were thrown off-balance, resorting, as a result, to offloading financial instruments such as treasury bills, and government bonds, among other measures in order to maintain liquidity. An immediate consequence was an upward adjustment in interbank rates, which had a negative impact on some lenders’ net interest margins as a result of higher cost of funding.
Nevertheless, banks will not collapse. They will have to find a way out of the troubled waters. The question is what strategies should the banks deploy in order to remain profitable?
Chukwuka Monye, managing partner, Ciuci Consulting, says to generate increased revenue banks should increase lending to other sectors that have shown signs of growth. These sectors include real estate, agriculture, oil/gas and power sectors. Banks should also increase focus on their retail banking portfolio. Banks need to be innovative in their product development to address the retail segment.
Furthermore, in order to introduce products that address specific needs of customers and also ensure effective customer experience, banks should take time to understand what their customers want through detailed consumer intelligence gathering, Monye says further.
According to him, the increase in CRR from 50 percent to 75 percent will reduce banks’ earnings because it will reduce the amount of money banks have at their disposal to give out as loans and also cause an increase in the cost of funds for the banking system.
The CBN at the last Monetary Policy Committee (MPC) meeting left the Monetary Policy Rate (MPR), Standing Deposit Facility (SDF), Standing Lending Facility (SLF) and the general CRR rates unchanged at 12 percent, 10 percent, 14 percent and 12 percent, respectively. It also indicated that a reduction in interest rates was unlikely before the next electoral cycle.
The CRR on public sector funds was increased to 75 percent, from 50 percent, which according to Samir Gadio, emerging markets strategist at Standard Bank, implies a mop-up of around N657 billion. Overall, the CBN reiterated its commitment to exchange rate stability, but highlighted a number of key upside risks to USD/NGN, including the transition at the CBN in H1:14, the start of QE tapering in the US, as well as the marginal level of oil savings in Nigeria which weighs negatively on market confidence.
Interestingly, the MPC voted five to three to raise the CRR on private sector funds.
The initial squeeze in liquidity with the introduction of the 50 percent CRR on public sector funds in late July 2013, resulted in a sharp short-lived increase in NIBOR rates, but a much less aggressive re-pricing of T-bills, Gadio says.
“We suspect NIBOR rates may display further – albeit temporary – volatility in coming days, especially as the banks, the most exposed to government funds, cope with liquidity shortages. The reaction of the yield curve will however be modest and will not fundamentally alter our general market calls anyway. We continue to recommend the carry trade given the moderate upside risks to USD/NGN in 2014, but are less constructive on duration amid a likely pick-up in bond issuance later this year and more risk-averse positioning in the Nigerian market,” he says.
For Gadio, the CBN has been less aggressive in its sterilisation efforts in recent months as evidenced by the abundant NGN liquidity in the system (over N700bn last week; about N1.044trn today), which offset the impact of the initial introduction of a 50 percent CRR on public sector funds.
This stance reflected the favourable performance of the exchange rate in Q4:13, which made further tightening in effective monetary policy less urgent at the time, but also the elevated cost associated with OMO operations. Thus, the increase in the CRR on public sector deposits highlights the fungibility of liquidity management policies used by the CBN, since the current approach will allow to gradually end the vicious cycle of OMO issuance to mop up previous OMO bills while reducing the cost
of sterilisation.
The decision to raise the CRR on public sector funds also has a pre-emptive character in addressing a likely fiscal slippage later this year. Moreover, it allows the CBN to gradually achieve the liquidity management benefits of the proposed – but never fully implemented – single treasury account reform through the backdoor.
