The Central Bank of Nigeria (CBN), has mandated the Nigeria commercial banks to address all loans currently secured with the dollar-denominated collateral within 90 days, a failure of which shall make banks prone to risk -weighted for Capital Adequacy Ration Computation, in addition to other regulatory sanctions.
This was contained in the Apex bank circular titled “The use of foreign-currency-denominated collateral for naira loans”, issued Monday with reference details as follows BSD/DIR/PUB/LAB/017/004, and made available on the Central Bank of Nigeria website.
This development indicates another remarkable step in Central Banks’ fight to boost foreign exchange liquidity in the economy and happened as the naira rose against the greenback at both the official and parallel markets on Monday.
Although this is not the first time the bank has prohibited the use of FCY, it said it had observed the use of foreign currency by bank customers as collateral for naira loans hence, the decision to prohibit its use.
Historically, in 2023, in a confidential letter to commercial lenders, the apex bank issued a stern directive against naira overdrafts backed by foreign currency deposits.
In the leaked letter dated August 17, 2023, and signed by the Director of Banking Supervision, Mr. Haruna B. Mustafa, the CBN said the development followed its findings from a recent supervisory review.
It was uncovered that the banks had been offering naira overdraft facilities secured with foreign currency deposits. Despite this warning, the new directive indicates that banks have continued to engage in such practices.
In the latest circular signed by Adetona Adedeji, the acting director, Banking Supervision Department, the apex bank said it observed the use of foreign currency by bank customers as collateral for naira loans.
As such, the regulator directed banks to trim all existing loans with foreign currency collaterals to 90 days or attract a 150 per cent capital adequacy ratio computation as part of the bank’s risk.
The new directive means a borrower may no longer use dollar deposits in their domiciliary bank accounts as collateral to obtain naira loans.
According to stakeholders, the practice is partly due to the need to hedge against foreign currency spikes which can be costlier than interest rates.
“The Central Bank of Nigeria has observed the prevailing situation where bank customers use foreign currency as collaterals for Naira loans.
“Consequently, the current practice of using foreign currency-denominated collaterals for Naira loans is hereby prohibited except where the foreign currency collateral is Eurobonds issued by the Federal Government of Nigeria or guarantees of foreign banks, including standby letters of credit.
“In this regard, all loans currently secured with dollar-denominated collaterals other than as mentioned above should be wound down within 90 days, failing which such exposures shall be risk-weighted 150% for Capital Adequacy Ratio computation, in addition to other regulatory sanctions,” the circular read.
The CBN’s stance against such practices arises from concerns of currency mismatch, which could introduce substantial financial risks for banks.
Rather than convert their dollars to naira, some borrowers will rather borrow in naira as the cost of buying the dollars back might be higher than the interest rate they pay for borrowing in naira.
However, this can have a ripple effect on the exchange rate due to its speculative tendencies. The CBN maintained that it was on a mission to ensure adequate foreign exchange in the market even as the naira gains strength.
Meanwhile, Eurobonds, according to the Hong Kong and Shanghai Banking Corporation, are bonds issued offshore by governments or corporations denominated in a currency other than that of the issuer’s country, usually long-term debt instruments and are typically denominated in US dollars.
In the same vein, the International Trade Administration, defines Letter of Credit as the contractual commitments by the foreign buyer’s bank to pay once the exporter ships the goods and presents the required documentation to the exporter’s bank as proof.
As a trade finance tool therefore, Letters of Credit are designed to protect both exporters and importers. According to the reports the apex bank’s previous circular to all the banks signed by its former Director, Corporate Communications Department, Ibrahim Mu’azu, the bank said its attention was drawn to the increasing use of foreign currencies in the domestic economy as a medium of payment for goods and services by individuals and corporates.
It has also been observed that some institutions price their goods and services in foreign currencies and demand payments in foreign currencies rather than the domestic currency (the Naira), which is the legal tender in Nigeria. The CBN stated, “For the avoidance of doubt, the attention of the general public is hereby drawn to the provisions of the CBN Act of 2007, which states inter-alia that “the currency notes issued by the Bank shall be legal tender in Nigeria…for the payment of any amount.”
The Act further stipulates that any person who contravenes this provision is guilty of an offence and shall be liable on conviction to a prescribed fine or six months imprisonment.
Import to note is the fact that, the naira has maintained its appreciation on the official and parallel markets against the United States dollar, strengthening to N1,230/$ at the official market and N1,220/$ on the black market at the close of trading activities on Monday.
This new rate which follows the decision by the CBN to adjust downward, the rate it sells to the Bureau Change Operator, showed a 3.33 per cent appreciation over the N1,240/ dollar it exchanged on Friday at the parallel market. Again, the CBN on Monday reviewed the exchange rate for the Bureau De Charge Operators to N1,101 per dollar from N1,251/$1 as it plans to sell $15.88 million to 1,588 eligible BDCs.
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