Nigerian interbank lending rate spiked 7.75 percentage points on Wednesday to 18 percent for overnight placement ahead of the central bank’s withdrawal of around 750 billion naira ($5 bln) to enforce a new cash reserves rules on public sector deposits.

Nigeria’s central bank two weeks ago raised cash reserve requirements for banks to hold government sector deposits to 75 percent, from 50 percent, in a bid to tighten liquidity and support the weakening naira currency.

Fund providers were quoting higher rates on short tenor placements on Wednesday, dealers said as they were expecting the central bank to tighten liquidity before the close of market.

Overnight placement was 10.25 percent the previous day.

“Rates have suddenly jumped because of the signal … to debit banks’ accounts, though the money is yet to be debited,” one dealer said. ($1 = 162.7 naira)

Source: Reuters (by Oludare Mayowa)

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Overview

The MPC met for its first meeting in 2014 on January 20 and 21. Key considerations included the dwindling external reserves despite high oil prices in 2013, a slowdown in FDI and portfolio flows in Q4-13 on the back of expectations of QE tapering, and the increasing spread between the inter-bank and BDC exchange rates. Following a thorough analysis of the mentioned challenges, the MPC decided to counteract these issues through the tightening of monetary policy by a unanimous decision to raise the cash reserve requirement (CRR) on public sector funds from 50% to 75%. Given the change in public sector CRR policy? and the likely future increase to 100% (in line with the implementation of the Treasury Single Account) ?It has become imperative to analyse the generalized potential impact of this development on the banking sector, acknowledging that certain banks are in a better position to navigate the now harsher operating environment.

Why is the CBN raising CRR on public sector funds?

Issues around public sector CRR hike in recent times are centered on rent-seeking activities of the banking system, and the pressure on the local currency. The MPC has raised concern about the situation whereby banks borrow funds from the government at very cheap rates and subsequently lend back to the FG at much higher rates through the acquisition of higher yielding T-Bills, bonds and OMO bills. This free lunch has reduced the incentive for banks to support real economic activities through the creation of loan assets. The existence of this risk-free opportunity saw broad money growth taper from the end of 2012 through the first half of 2013 given the attractive yields in the fixed-income market, and the banking sector’s increasing risk-aversion following heavy write-downs linked to impaired legacy loan assets.

Are further CRR hikes in 2014 in the pipeline?

The CRR Policy appears to have moved further to encompass issues surrounding exchange rate stability? giving its impact on price stability. Exchange rate stability now appears to be at the forefront of monetary policy considerations giving the fact that the MPC tied the latest hike in public sector CRR to its increasingly explicit mandate of achieving a stable Naira.  With this in mind, it becomes clear that forecasting the likely path of CRR requires careful analysis of the external reserves, the Naira/Dollar exchange rate, and the general level of liquidity in the system. We are of the view that the direction of the foreign reserve in 2014 is to the downside despite our expectation of stable oil prices at current levels. In our view, weaker-than-expected crude oil production and fiscal leakages are key headwinds for the external reserve. Furthermore, expectations of a slowdown in capital flows? which constitute an increasing part of the foreign reserve ? and potential reversals on the back of QE tapering,  suggests that the external reserve is in for a tumultuous 2014. In light of these considerations, we see the current account balance coming under pressure this year and this should weigh on the Naira at the RDAS and other segments of the foreign exchange market. Declining reserves and a weaker Naira should see the MPC hike the CRR on public sector funds to 100%. The move to establish the Treasury Single Account strongly supports our expectation of a 100% CRR on public sector funds as the CBN appears bent on indirectly fast tracking the process.

FYE 2013 Results Outlook: Can management deliver?

From a historical perspective, the average profitability of the banking sector improved in FYE 2012, with FY12 ROaE up by 166.7% relative to FY11 ROaE, driven by: 1) Higher Net Interest Margin (NIMs) reported due to higher fixed-income yields 2) Improving cost efficiency 3)  Improvements in asset quality in FY11 led to lower cost of risk in FY12 and 4) Very strong asset growth as banks shifted focus from recovery to growth.  While banks have ridden off the tailwind of rising interest rate – creating positive endowment effect (with little effort), the key question is: can management deliver in 2013?

The outlook for banking sector performance in Q1-14

Giving the recent CRR development and our expectation of a further increase in public sector CRR (and a higher probability of an increase in private sector CRR), we are of the view that the banking sector is in for a tough 2014. That being said, certain banks are in a better position to mitigate the negative effect of the policy change on their earnings giving the varying exposure to public sector funds. Our analysis will focus on Q1-14. We expect the divestment of fixed-income instruments by banks (especially those in the tier-2 category) with heavy exposure to public sector funds during the first quarter, and this should weigh on interest income/trading income (depending on categorization). In addition, reduced liquidity should impede on banks’ ability to create higher-yielding longer-dated risk assets as banks must reorganize their balance sheet to reduce roll-over and interest rate risk. We also expect to see rising cost of funds going forward. As at the time of writing, the average inter-bank rate was bounded by a narrow range (11.40%-11.65%) but we expect it to trend higher as the CRR hike takes effect on February 4 2014, the CBN continues its aggressive OMO operations, and as capital outflows linked to US monetary tightening increase.

Source: Cordros Capital

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Following the increase of the Cash Reserve Requirement on public sector deposits from 50 per cent to 75 per cent last week by the Monetary Policy Committee, the Central Bank of Nigeria will on February 4 withdraw an estimated sum of N1tn from the Deposit Money Banks when the policy takes effect.

The CRR is the volume of cash in their possession that the banks have to keep with the central bank and is used to drain out excessive liquidity from the system.

If the central bank decides to increase the CRR, the available amount with the banks reduces.

The latest CBN statistical bulletin showed that as of September 2013, public sector deposits in the banks stood at N4.06tn and accounted for 25.71 per cent of their total deposits.

Of the N4.06tn, about N2.03tn was sterilised by the CBN following the implementation of the 50 per cent CRR.

The latest increase in the CRR to 75 per cent by the MPC last Tuesday may lead to an additional withdrawal of close to N1.01tn on February 4, if the deposit structure in the banks maintains this trend.

According to the CBN data, the banks’ total deposits as of September 2013 stood at N15.795tn; while the public sector accounted for N4.061tn, the private sector deposits stood at N11.734tn.

As of September 2013, the CBN had sterilised about N2.03tn.

When the CBN withdraws the estimated N1.01tn from the banking system on February 4, the total amount sterilised by the central bank will be around N3.046tn if the deposit structure in the banks remains on the same trend.

The CRR increase, according to the MPC, is to strengthen the naira and reaffirm the CBN’s commitment to price and exchange rate stability.

The CBN had last July expressed concern over the excess liquidity in the balance sheets of the DMBs and subsequently imposed 50 per cent CRR on all government deposits with the banks from 12 per cent previously.

The decision, which came as a major shock to the banks, made some of the lenders to record marginal drop in their third quarter profits.

For example, United Bank for Africa Plc, Access Bank Plc, Fidelity Bank Plc, Skye Bank Plc, Union Bank Plc and Unity Bank Plc recorded lower nine-month profits after tax, compared to the third quarter of the previous year.

Analysts and some bank executives noted that the 50 per cent CRR would also affect negatively the fourth quarter results of some of the banks due to be released next month.

Some analysts had predicted that the latest increase of the CRR to 75 per cent was likely to lead to the sterilisation of additional N600bn to N800bn.

Financial and economic analysts have said this year, which is the penultimate year to the 2015 elections, will be very difficult for the monetary policy as patronage politics will lead to excess liquidity in the system.

The redemption of N1tn Asset Management Corporation of Nigeria’s bonds to institutional investors may have also led to increased liquidity in the system, analysts said.

Financial Derivatives Company Limited, a Lagos-based economic and financial advisory firm, said the MPC might also need to increase the CRR on private sector deposits to curb excess liquidity.

Source: Punch (by Oyetunji Abioye)

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