By Amienyaru Enobakhare, FDC
The derived demand relationship between the motor and steel industries can be likened to that which exists between a reserve bank and the nation‘s capital market. In economies worldwide, the central bank‘s primary function is to maintain monetary stability by focusing on the monetary policies.
While it might seem that CBN actions do not have a direct impact on the capital market; CBN policies, to a large extent, determine the state and direction of the capital market. The events in the Nigerian financial system in the last one year paint a vivid picture of this relationship.
Banking Stocks: A major determinant of NSE performance
Prior to CBN‘s action on August 14th 2009, the ASI and market capitalization were 24,482.52 and N5,612 billion respectively while the banking index at that time was 282.44. The banking sector had a market cap of N2.8trillion reflecting 51.09% of the index. As events unfolded in anticipation of the final CBN audit result, investors scrambled to sell off bank shares. The final results were released in October 2nd 2009 and at the end of the month the banking index had declined 12.05% closing at 248.41 while the all-share index had dropped by 10.94%.
To guard against a bank crisis, the CBN bank injected N620billion into the ailing banks. These funds were meant to prevent a run on the banks. However as the bank‘s new management team embarked on recovery with market uncertainty; the primary function of lending was neglected. This resulted in a steep fall in interest rate which did not instantly translate to capital market appreciation.
AMC to the Rescue
The confidence which every financial system - especially banks and deposit money institutions - thrives on began to decline sharply. Given the current scenario, the CBN governor took a cue from banking reforms embarked on by countries like Malaysia, Singapore and Thailand. CBN proposed an AMC bill, primarily owned by the FGN (100%) to buy up the bank‘s toxic asset at a premium to the market.
The immediate impact of the AMC law will be to improve the capital adequacy ratio of the banking institutions. It will also serve as a booster shot for the institutional investors who are either too scared or shy to place bets in a market that is probably fairly undervalued.
The market reaction to the passage of the bill in the lower house was instantaneous (see chart below). The ASI recorded a gain of 1.35% as at close of trade on March 23rd, 2010 when the bill was passed by the lower house.
To further buttress the bullish charge of the news; the ASI has gained 10.14% from March 23rd to April 22nd 2010.
Impact on Nigerian Capital Market
The above CBN actions have affected the market in several ways giving rise to unintended and intended results. An example of the unintended action is the effect on the bond market. The bank saga and subsequent credit squeeze has led corporate institutions to look for new avenues of raising funds. This resulted in attraction for bond issuance both from the banks and other corporates. Furthermore investors have taken a liking to the bond market due to its safety and the current unattractive money market rates.
The Securities and Exchange Commission (SEC) has gone further to ensure that the bond market is made more active by reviewing the transaction charges. The likelihood of reviewing these charges is an increase in activities in bond trades on the NSE floor. Thus in essence, the actions of CBN have spurred increased activity in the once dormant bond market. Among the intended outcomes of the apex bank reforms was to unlock the credit and money markets.
CBN has taken a couple of measures one of which was to reduce standing deposit facility rate to 1% from 2% in the March MPC meeting. This was to ensure the banks start lending; however the outcome has been a further exacerbation of excess liquidity as banks still remain reluctant to lend. What is expected in the short term is confidence building and certainty guaranteeing pronouncement of policies that will encourage banks to resume lending.
Also, recent CBN actions have made the bankers more conscious and sensitive to strict regulatory requirements like transparency, good corporate governance and voluntary disclosures. Banks now want to be seen as transparent and responsive to all stake-holders, while some have gone ahead to adopt International Financial Reporting Standard (IFRS) ahead of the apex bank December 2010 deadline.
If the banks navigate this delicate path of transparency as envisaged, it will bring more credibility and build confidence in the equities market. This increased confidence in the most capitalized sector of the exchange will further attract local and foreign investors, thereby leading to an improved performance of the Nigerian capital market. A successful and early passage of the synchronised AMC bill will not only help to unfreeze credit to the real sector but will also aid the flow of funds into the capital market.
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