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CBN's moral stipulation 09 Mar 2020

Moral suasion is used by central banks as a monetary policy tool. It entails the use of persuasion to get commercial banks to adhere to the policy direction of their respective central banks. Moral suasion involves appealing to reason; it eschews the use of force.
    
The Central Bank of Nigeria (CBN) has over the years been trying to persuade the commercial banks to increase lending to the real sectors of the economy, including manufacturing, agriculture and small and medium scale enterprises (SMEs). The rationales for this include the need to increase domestic production, create jobs, and broaden the country’s external trade.

As long as the real sectors remain weak, deprived of adequate level of funding, the economy would remain susceptible to frequent cycles of boom and bust. Cyclical economic downturns caused by oil price shocks have occurred three times in the last 12 years: 2008, 2014 and 2016. At such times, the credit portfolios of Nigerian commercial banks are hit by significant levels of losses due to too much reliance on the oil economy.

The cyclical downturn of 2008 severely threatened financial collapse in Nigeria. At the first instance, the CBN had to inject N650 billion into distressed banks in 2009, sack a number of bank directors and create the Asset Management Company (AMCON) to hold bad bank assets. As at December 2019, AMCON still held N1.7 trillion in Eligible Bank Assets (EBAs).

The 2014 economic downturn was moot. Oil prices falling from above $100 per barrel (pb) did not hit the bottom. But by 2016, oil prices had crashed to $30 pb. This time, the country went into a deep recession.

But despite the threat of financial implosion and the economic collapse, the commercial banks have been little persuaded to take the advice of the CBN on increasing lending to the real sectors. As a result, the apex bank has recently reinvented moral suasion as “moral stipulation”, employing the force of penalties to get the deposit money banks (DMBs) to increase lending to the sectors of its prescription.

First in July 2019, the CBN directed the DMBs to increase their loan-to-deposit-ratio (LDR), from industry average of 40 per cent, to 60 per cent. Two months later, the CBN doubled down on this directive, citing the positive response of the banks. DMBs were to raise their LDR to 65 per cent.

It was not up to the banks to comply or decide which industries/segments in the private sector to channel credit. The CBN assigned a higher weight of 150 per cent to credit made by the banks to SMEs, retail, mortgage as well as individual and household consumers. Banks that failed to meet the LDR target were levied additional Cash Reserve Requirement of 50 per cent of the lending shortfall. This will be the case going forward.

The CBN has tripled-down in furtherance of the policy. From its stipulation on the use of deposits by banks, it has restricted individuals and non-bank corporate entities in the domestic economy from participating in its Open Market Operation (OMO).

These policies have generated mixed fortunes for various market participants. On the positive side, for the CBN, its Monetary Policy Committee (MPC) meeting in January 2020 disclosed that aggregate credit in the economy grew by N2 trillion over the past six months. The MPC also reported that the nonperforming loans (NPLs) of the banks fell by 0.5 percentage point in the fourth quarter of 2019 to 6.1 per cent, although still above the prudential benchmark of 5 per cent. These are strong validations for the CBN.

But while the banks have made out more loans and have been able to drive NPLs in the opposite direction, it is still too early to know the medium- to long-term impacts of CBN’s monetary engineering. Afterall, the policy that seeks to stimulate production by directing banks to increase lending, cannot produce its full effects in just six months.

However, as may be expected, money market rates have consequently crashed. From a monthly weighted average rate of 11.42 per cent in November, inter-bank call rate tumbled to 3.50 per cent as at February 21; Open Buy Back (OBB) rate similarly plunged in the period. This was as a result of a liquidity surfeit in the banks. Given this, the deposit interest rates have crashed to under 2 per cent, gravely serving to discourage savings.

The January MPC meeting touted the seemingly positive impacts that these policies have had in the equities market. The All-Share Index (ASI) had appreciated by 8.47 per cent between its October 2019 open and its close on January 24th, 2019, when CBN read the communique of its last MPC meeting. Exactly one month later, however, the ASI had shed 7.57 per cent value. This indicates the problematic of judging the effectiveness of the CBN’s new moral stipulation too early.

But the following observations could be made for now, as the CBN continues to monitor the market impacts of these policies. One, savers are now greatly disadvantaged in the market. While offering sub 2 per cent interest rates to depositors, banks are generally lending to businesses at above 20 per cent.

Two, the CBN has, at best, rendered its Monetary Policy Rate (MPR) irrelevant by leaving it at 13.5 per cent while depressing money market rates.

Three, it may be argued that the CBN’s policies aim to discourage deposits – like in Europe and Japan where deposit rates have been negative at times since the 2009 financial crisis – and encourage productive investment. But such markets of negative deposit rates, unlike Nigeria, are low-inflation environments where the policy interest rates are at Zero Lower Bound. With inflation at 12.18 per cent in January, the CBN is, indeed, the Punisher of savers – for no justifiable reason. And even in the advanced markets, investors are little-encouraged to invest in the real economy. Instead, they are using their cash reserves to buy back their stocks.

Four, the Central Bank of Nigeria should not be restricting Nigerians from its safe-haven investment instrument like the OMO bills, while foreign investors can participate in it. A Nigerian public institution should not be enacting policies that discriminate against Nigerians and favour foreign entities, not even if we badly need foreign exchange.

As the CBN has been arguing recently, some of its policies have been necessitated by fiscal policy lacuna. The fiscal policy doldrum notwithstanding, the CBN is not expected to undermine its own traditional monetary policy tools. In employing extraordinary monetary policy since the Great Recession, the major central banks consolidated the monetary tools; they did not undermine the normal tools.