The grim monetary policy tightening by the Central Bank of Nigeria (CBN)’s Monetary Policy Committee (MPC) last Monday has elicited knee-jerk market reaction that saw the withdrawal of N400 billion from the banking system through the increase in Cash Reserve Ratio (CRR) to eight percent.
The banks capacity to hold foreign exchange (forex) has also been reduced by almost 80 percent.
The CRR is a portion (expressed as a percent) of depositors’ balances banks must have on hand as cash. With the recent decision of the central bank to increase CRR from four percent to eight percent, the amount banks must play with and should be at hand every time increases, as such banks will not have enough funds to buy forex, and even when a bank has funds, it is limited by the reduction in Net Open Position (NOP) of banks.
Razia Khan, analysts with Standard Chartered Bank, London, in her On The Ground (OTG) on Nigeria said each one percent increase in the CRR is estimated to remove at least N100 billion from the Nigerian economy.
“The higher CRR of eight should result in the immediate withdrawal of N400 billion, about $2.54 billion from the banking system – an amount we estimate to be equivalent of almost seven percent of narrow money supply”, she said.
Narrow money is a category of money supply that includes all physical money like coins and currency along with demand deposits and other liquid assets held by the central bank.
Also, the impact of new NOPs on forex positions will be substantial. For instance, following Monday’s Whole Dutch Auction System (WDAS), at which only $400 million was sold (short of the $737 million demanded), the market was left with an overhang of unmet dollar demand.
However, the impact of the new NOP limits will put brakes on how much forex banks can hold relative to their equity capital. Analysts say the move is more than sufficient to deal with existing demand for forex. In the near term, they expect to see a sharp downward retracement in dollar-naira.
According to Khan, using end-2010 data on shareholder funds from banks financial reports, “we estimate that the country’s five largest banks had a combined equity capital base of N1.29 trillion. At current exchange rates, this translates into $8.21 billion.
She said the combined maximum NOPs of the largest banks prior to the MPC meeting would have been roughly $410 million. With the new one percent NOP from five percent, this will fall to around $82.1 million.
“Even excluding the effect of reduced NOPs for the rest of the banking sector, current excess demand for forex should be more than met as banks cut their long forex positions to comply with the new regulations. However, we stress that these are only rough estimates, and the end-2010 data does not take into account substantial bank recapitalisation since then”, Khan said.
In addition, with banks now paying a higher rate to borrow via the CBN’s standing lending facility (the Monetary Policy Rate (MPR) + 200bps, or 14 percent, compared with 11.25 percent previously), overall tightening is significant.