How CBN's new directive to banks on forex will affect Nigerians

On Wednesday, January 31, 2024, the Central Bank of Nigeria (CBN) issued a circular titled "Harmonisation of Reporting Requirements on Foreign Currency Exposures of Banks."

The circular, aimed at curbing banks’ forex speculation activities, was released at a time when the naira fell to an all-time low trading at ₦1,530 against the dollar in the parallel market.

Even though the content of the circular was directed at all Deposit Money Banks across the country, foreign exchange matters have in recent times been a subject of general discourse among Nigerians at all levels.

So, for every Adekunle Ciroma Chukwuma seeking to understand the import of the CBN’s directive, here is an explainer breaking it down in layman’s English.

What exactly is the CBN saying?

The opening paragraph of the circular states, “The Central Bank of Nigeria (CBN) has noted with concern the growth in foreign currency exposures of banks through their Net Open Position (NOP). This has created an incentive for banks to hold excess long foreign currency positions, which exposes banks to foreign exchange and other risks.”

The apex bank believes some commercial banks are involved in foreign currency speculations by buying or holding foreign currencies with the expectation of profiting from the fluctuating exchange rates.

For instance, when a bank obtains $1 million worth of forex either by borrowing, buying or through CBN’s allocation, and then holds back half of it instead of lending it to its customers for their needs or putting it into other use, it means the bank deliberately hoards its forex to sell it when the exchange rate is high.

This practice is called speculation and it allows such a bank to make profits from currency depreciation. This behaviour also contributes to the dollar scarcity in Nigeria, which further fuels the depreciation of the naira.

So, to address this issue, the CBN introduced some prudential requirements centred around the Net Open Position (NOP) for all commercial banks.

The NOP is a financial metric used to assess the overall risk exposure of a financial institution, typically within the context of foreign currency assets and liabilities.

This essentially measures the difference between a bank’s foreign currency assets (what it owns) and foreign currency liabilities (what it owes).

So, in its directive, the CBN set the NOP limit for overall foreign currency assets and liabilities, including both on and off-balance sheet items, to not exceed 20% short or 0% long.

The 20% short implies banks holding more foreign currency assets than liabilities while the 0% long indicates not holding more foreign currency assets than their shareholders’ funds.

In light of this, the CBN urged banks whose current NOP exceeds 20% short and 0% long to bring them within the prudential limit by Thursday, February 1, 2024.

The apex bank directed banks to calculate their daily and monthly NOP and Foreign Currency Trading Position (FCT) using a certain template provided in the circular.

The CBN directive also requires banks to maintain adequate stocks of high-quality liquid foreign assets, such as cash and government securities, in each significant currency.

Other CBN requirements

In addition, the apex bank in its bid to address forex issues asked banks to comply with the following requirements:

• Banks should borrow and lend in the same currency to mitigate currency mismatch risks associated with foreign currency.
• The CBN wants banks to ensure the basis of the interest rate for borrowing should be the same as that of lending i.e. there should be no mismatch in floating and fixed interest rates, to mitigate basis risk associated with foreign borrowing interest rate risk.
• With respect to Eurobonds, any clause of early redemption should be at the instance of the issuer, and approval obtained from the CBN in this regard, even if the bond does not qualify as tier 2 capital.
• The apex bank also advised banks to ensure the basis of the interest rate for borrowing matches that of lending, thereby mitigating basis risk associated with foreign borrowing interest rate risk.

What’s this meant to achieve?

The ultimate goal of these requirements is to curb the speculative activities in the banking sector.

If the intent of the circular is realised, banks will be expected to liquidate their net long positions by releasing the ‘hoarded’ forex into the market.

If the above is achieved, it’ll stop the naira’s free fall and prompt it to appreciate against the dollar.

What if banks do not adhere to these requirements?

The CBN has already warned that non-compliance with the NOP limit would result in immediate sanctions and possible suspension from participating in the foreign exchange market.