New Cash Reserve Requirement Credit-Negative for Nigerian Banks

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Thursday, January 30, 2020 / 8:55 PM / Fitch Ratings / Header Image Credit: PulseNG

 

The higher cash reserve requirement (CRR) for Nigerian banks announced last week is credit-negative for the sector as it will restrict banks' ability to lend and dampen their profitability, Fitch Ratings says. The Central Bank of Nigeria's (CBN's) decision, designed to reduce excess banking sector liquidity in an attempt to curtail high inflation, clashes with its competing objective to stimulate lending. The CRR increase is an example of the kind of unpredictable regulatory intervention, seen especially since 2019, that poses challenges for Nigerian banks, one of the reasons for our negative sector outlook.

 

The CBN faces competing demands. On the one hand, it wants to support the naira and control inflation, hence the CRR increase to mop up excess naira liquidity. On the other hand, it wants to stimulate lending to help the economy. Increasing the CRR to 27.5% of local-currency (LC) deposits from 22.5% will force banks to park more reserves at the CBN, consistent with the first objective. However, it clashes with the second objective.

 

The CRR in Nigeria was already among the highest in the world and the increase will further limit banks' ability to fund LC loan growth with LC deposits. Last year, the CBN introduced a requirement for banks to achieve a loan-to-deposit ratio of at least 65%, a move to encourage more lending. The higher CRR will make it harder for banks to meet this target, potentially leading to penalties for non-compliance (including having to deposit extra cash reserves over and above the 27.5% requirement.) The higher CRR will also dampen banks' profitability as reserves deposited at the CBN are unremunerated. This makes the CRR a low-cost way for the CBN to mop up liquidity.

 

When customer deposits rise, banks are required to top up their cash reserves at the CBN accordingly. However, when deposits fall, reserves are not released back to banks. As a result, the CBN holds significant cash reserves in excess of the CRR, with cash reserves for some banks as high as 40% of LC deposits - a major drag on their lending capacity and profitability. With the CRR now set even higher, we believe banks may increasingly look to tap wholesale funding, such as LC debt, as an alternative to LC deposits, to support lending while circumventing the high CRR.

 

Bank regulation in Nigeria is increasingly linked to monetary policy and the CBN's interventionist policy measures. Regulatory changes are frequent and often lead to mixed results and unintended consequences, and we view regulatory risk for the Nigerian banking sector as among the highest in the EMEA region. Fitch recently revised its outlook for the sector to negative (from stable), partly due to rising regulatory risks, which pose risks to banks' credit profiles.


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