Monetary Policy | |
Monetary Policy | |
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Monday, January 27,
2020 /1o:56 AM / By CardinalStone Research / Header Image Credit: Brand Spur
In
its latest meeting, the Monetary Policy Committee (MPC) announced an increase
in cash reserve ratio (CRR) from 22.5% to 27.5%, the first raise since March
2016. Of all the considerations given for the surprise adjustment, the need to
combat liquidity-driven inflation was notable. The impact of the CRR increase
is likely to be diametrically opposed to that of the loan-to-deposit ratio
(LDR) measure already at play, in our view. Specifically, while the LDR measure
is configured to induce bank lending, the CRR increase could curtail banks' ability to achieve that objective with more funds likely to be sterilized.
We
see the following as broad implications of the policy move:
Despite
the regulatory requirement of 22.5%, effective CRR have ranged between 27.0%
and 35.0% in the sector, according to our recent correspondence with coverage
names. CBN's data also suggests an average effective CRR of 29.4% for deposit
and non-interest banks as at September 2019. Itis unclear if banks' excess CRR
would be applied to their credit upon assessment of compliance to the new
regulatory CRR of 27.5%. Our base case scenario is that the CBN would enforce
the additional 500bps CRR on banks irrespective of their effective positions.
This assumption appears to be consistent with historical precedent that saw a
250bps increase in regulatory CRR to 22.5% in March 2016 cascade to a surge in
effective CRR to 26.0% in March 2016 (vs. 23.7% previously). In contrast, we
note that if banks' excess CRR is applied to their credit in the evaluation of
compliance to the new CRR of 27.5%, the MPC decision is likely to have an
insignificant impact on our coverage names.
In
our view, the 500 bps additional CRR is likely to be applied on already
existing deposits, not on new funds alone. Although some banks have said they
await clarity from the CBN in this regard, historical precedent suggests a
retrospective application is on the cards. This could imply that an additional
N817.5 billion of funds could be sterilized in the banking sector causing the
effective CRR to increase to 34.4%.
Higher
CRR and LDR requirements suggest that banks could potentially have limited
funds for other play, including investments in treasuries. In our view, this
could lead to a scramble for funds especially in consideration of a likely slowdown
in OMO maturities in coming quarters, and possibly slowdown the previously
expected moderation in funding costs for FY'20.
Theoretically,
an increase in CRR invariably results in higher lending rates, given the
resulting liquidity constraint for lending purposes. However, we do not see the
MPC's decision as a signal that the CBN is letting up on its LDR demands to C
January 27, 2020 banks. Hence, taking into cognizance the likely constraint on
investments in government securities, we are slightly worried about prospects
for earnings growth across our coverage. Specifically, while we see slightly
higher than previously expected cost of funds for FY'20, we retain our view that
asset yields could remain depressed in the current year-although fixed income
yields could trend higher, banks abiltiy to deploy funds to fixed income
securities may be constrained by the CBN's measures. Notwithstanding, we expect
the impact to be less severe for UBA and ETI given their hugely diversified
regional operations. We also expect banks with huge FCY deposits to be less
impacted than their peers given the exclusion of FCY deposits from CRR
assessment.
All
in, we see the likelihood of a 4.3% reduction on average for our coverage
earnings projections. However, we expect the impact to be minimal on our target
prices-which could potentially fall by 0.8% on average-and hence, retain our
recommendations.
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