The recent monetary policy committee meeting on the 7th of July,2009 took some far reaching decisions that seem to point the Central Bank of Nigeria (CBN) clearly towards a new policy direction of addressing the fundamental issues of the banking industry and the economy.

The decision to cut interest rates was obviously the most highlighted by analysts as it finally recognized the fact that we are in a recession. When an economy is in a recession, the CBN usually cut interest rates to stimulate the economy.

The decision to fix the liquidity problems of the economy by intervening in the interbank market (The Cash Market), by guaranteeing the interbank placements (deposits) and reduce counterparty risks seem to me, the most fundamental policy shift.

The disruption in the interbank market after the wave of bank failures of the early 1990s, has been the most significant component of the liquidity crisis and the instability that has dogged the Nigerian Banking industry. Every other problem, whether the astronomical rise in lending rates or the unbridled pursuit of deposits at all cost, which has since created other moral hazards and accompanying corruption, all have their root in the failure to solve the problems associated with the interbank market.

Before the crash of the interbank market, the principal benefit of being a bank was that you could lean on other banks for liquidity support whenever you needed it. It was not uncommon for a bank in those days to make a loan of several millions which it did not have in its position. All that was required, was for its treasury department to go into the interbank market to source for the money needed even at rates that may not be favorable or matching the tenure of the loan been granted.

That was only the first part of the job for the treasury department, next part will be for the treasury department to daily seek other sources of funds that will match the tenure of the loan and at rates that will make that loan profitable while it pays off the expensive bridging position it took to meet the commitment on the day the loan needed to be disbursed.

This simple operation kept banks busy and profitable in doing the business they were licensed to do. This arrangement was so robust, it covered even Merchant Banks that were not technically, deposit takers in the market . The magic then, was that all the placement flows went through the CBN.

Whether a bank was taking a placement from another bank through the interbank or it was repaying same. Even though there was no explicit undertaking by the CBN to guarantee these interbank transaction loans to the various participants, it was assumed. It was the shirking of this responsibility by the CBN that eventually killed the workings of the arrangement that literally kept all banks in the system liquid and working to serve the economy.

One will wonder why the CBN will let a system that has worked so well, collapse and no attempt to revive the system, until now. It was the season of indiscipline, it was the military era, Generals owned banks. Some of their banks over borrowed their positions, and instead of been sent out of clearing, they were allowed to carry on, until they brought many other banks down with them.

The impact of the interbank system can only be understood if you examine the role it plays in other climes. The importance of this quick access to funding and cheap source of wholesale money, was demonstrated when it became necessary for the US treasury to grant special status to Goldman Sachs to enter into the American interbank system as a way to save it from the fate of the failed Lehmann Brothers in the recent American financial markets meltdown. Goldman Sachs as an investment Bank, was normally not allowed into the interbank market. Imagine the absence of the Fed wire system in American banking, or the London interbank offered rate (LIBOR) in the UK.

The interbank system for money works like a whole sale shop to buy money at the right volume and at a competitive rate. The fact that all available excess cash in the system is available in one large market at rates available to all banks with no consideration for risk, makes the financing process efficient. The reason there is no risk consideration, is that the market is only for banks and the CBN being the regulator, makes enforcement of contracts effective.

Any bank in default is debited with the loan, and credit, given to the lending bank. Any negative balance or debit positions held longer than necessary at the CBN will attract penalties including being sent out of clearing. There is nothing worse than being sent out of clearing, because that means your customers cannot clear their cheques, in other words you are technically not a bank.

 It is this important role the CBN plays in the interbank system, that makes the new policy to guarantee interbank placements a welcome development. This is fundamental if we are to fix the cash market which ensures credit for our banks. When our banks can get credit from the system, they can lend it to us, as customers and the economy can run on the fuel called money.

A working interbank, will enhance liquidity, reduce lending rates and return banking to its prestigious days while eliminating the fraud and corruption that now surrounds deposit takings. Hopefully, it will also eventually eliminate the need for ladies to go around begging for deposits, a phenomenon that has only manifested in Nigerian banking in the recent years.

--Victor Ogiemwonyi
md@partnershipcapitalmarkets.com