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By Chinwendu Obienyi
Last week was an unstable week for the naira going by the standards of Nigeria’s knotty foreign exchange market.
Firstly, the naira node-dived by 36 per cent after the Central Bank of Nigeria allowed a change in the method for setting its rate in the official FX market and cracked down on misleading price reporting by traders and speculations against the currency by banks.
The apex bank also eased rules on international money transfers to net billions of dollars sent home by Nigerians living in the Diaspora. Furthermore, it was no surprise that the exchange rate between the naira and dollar depreciated by 37.6 per cent to close the month of January 2024 at N1,455.59/$1 from N907.1/$1 recorded in December 2023.
But as the dust settles, the apex bank’s recent rejig of commercial banks’ FX exposure in a bid to tame the raging FX crisis and ultimately sanitize the money market, could prove decisive for the fortunes of the worst performing currency (Naira).
According to its guidelines to all banks titled; Harmonization of Reporting Requirements of Foreign Currency Exposures of Banks, the CBN directed that all commercial banks in the country must borrow and lend in the same currency to avoid currency mismatch associated with foreign currency risk.
The guidelines, the CBN said, is aimed at addressing the net open position (NOP) limits of banks on foreign currency assets and liabilities. NOP limits set the maximum amounts for the single and total instrument exposure for all asset classes on forex.
A bank which holds NOP (whether long or short) in foreign currencies is exposed to the risk that exchange rates may move against it. The open positions may be either trading positions or, simply exposures caused by the bank’s overall assets and liabilities.
In the new guidelines, the CBN said the NOP limit of the overall foreign currency assets and liabilities of banks shall not exceed “20 per cent short or 0 per cent long of shareholders’ funds”. The apex bank said the move was due to concerns over the growth in foreign currency exposures of banks through their NOPs.
“Banks whose current NOP exceed 20 per cent short and 0 per cent long of their shareholders’ funds unimpaired by losses are required to bring them to prudential limit by February 1, 2024. Banks are required to compute their daily and monthly NOP and Foreign currency trading position (FCTP) using the attached templates. Banks are also required to have adequate stock of high-quality liquid foreign assets, i.e. cash and government securities in each significant currency to cover their maturing foreign currency obligations. In addition, banks should have in place a foreign exchange contingency funding arrangement with other financial institutions”, It said.
The apex bank also said the basis of the interest rate for borrowing should be the same as that of lending “There should be no mismatch in floating and fixed interest rates, to mitigate basis risk associated with foreign borrowing interest rate risk,” It said.
The CBN thereafter warned that non-compliance with the NOP limit will result in immediate sanction and/or the suspension from participation in the foreign exchange market.
Experts react
This move by the CBN, according to analysts is seen as step in the right direction to address immediate concerns in the FX market. However, they further noted that a more holistic approach needs to be strategically taken to avoid unsatisfactory outcomes of its new reporting template.
For starters, foreign exchange exposure refers to the risk that a business or entity faces due to fluctuations in exchange rates. The risk arises when there are changes in the value of one currency relative to another, impacting the financial performance of businesses engaged in international trade or investment.
Hence, to ensure this move works effectively, there is a need to improve the natural or inherent sources of FX inflows. Senior Economist at FDC, Dumebi Oluwole, whilst disagreeing with the notion that banks were sitting on FX, said that the CBN is helping banks to hedge against FX losses and reduce activities in the FX-demand market at the official window.
“When you look at the activities ongoing at the FMDQ, you will realise that banks are pretty much the largest players in that market and what the CBN is trying to do with that particular circular is in two thoughts; First, try and help the banks hedge against FX losses because the NOP for banks is pretty easy to lose when you start the trading day and secondly, help to reduce too much activity at the FX market outweighing supply and so it is so much of a win-win to an extent”, Oluwole explained.
She stressed that dollar liquidity remains a big challenge and that Nigeria’s FX market is distorted.
“There is a challenge with market equilibrium. By the next MPC meeting, we should see some level of cohesion in all these policies that the CBN is dropping in triples. We need to see crude oil production significantly increase so that oil receipts increase and from investment side, confidence has to be instilled to attract FDIs and FPIs. We need to see a more hawkish CBN, increase in interest rates so that it is able to narrow the inflation interest rate differential and reduce the negative real returns on investments”, Oluwole said.
For their part, analysts at Afrinvest in an emailed note, stated that even though the new guidelines on FX exposure of banks might deliver a short-term relief to the currently unsettled FX market, the move is not a silver bullet to the ongoing FX challenges.
“Hence, we advise that measures that would enhance organic FX inflow channels – crude oil production and sales, diaspora remittance, and FPIs & FDIs – be enhanced, while other FX leakage channels in the public sectors are completely blocked”, they said.
