Financial intermediation – the process of matching savers with borrowers – is a primary function of the banking sector. Intermediation channels excess funds towards productive uses, spreading the risk across a bank’s entire depositor base so no single saver bears the losses in the event of a loan default. However, in Nigeria intermediation is slowing, with lending activity being affected by government borrowing. “When the government is borrowing so much from the economy, it means it is competing with the private sector operators, which also need to borrow from the system,” Marcel Okeke, chief economist at Zenith Bank, told OBG. “The government is crowding out private sector operators, and the interest rate is likely to remain high.” The federal government’s reliance on the domestic market for financing has diverted funds away from the private sector and towards government securities, which offer a risk-free rate of as much as 15%.
Beyond the banking sector’s preference for government securities, one of the major factors limiting financial intermediation in Nigeria is the country’s large informal sector, which by differing estimates accounts for anything between 40% and 60% of GDP. “Financial intermediation is the role of banks everywhere. But as a developing economy, there is still so much money outside of the formal banking system, and that is why a major policy of the Central Bank of Nigeria (CBN) is financial inclusion,” Okeke told OBG. “The purpose of that inclusion is to spread banking to rural areas, to all remote places.”
There have been other factors impacting intermediation, however, including regulatory requirements that limit the ability of banks to deploy assets. Facing increasing inflation, the Monetary Policy Committee of the CBN voted in March 2016 to raise the monetary policy rate (MPR) from 11% to 12%, while also voting to raise the cash reserve ratio (CRR) from 20% to 22.5%. By raising the CRR, which is the percentage of bank deposits that must be held at the CBN in cash, the bank effectively reduced the money supply in the economy, thus limiting the amount of naira available to banks to lend. While the CBN subsequently increased the MPR to 14% in July 2016, the CRR has remained steady at 22.5%.
Similar to the CRR, additional temporary limits have also been placed on the funds available to banks to issue as loans.
“The CBN has sterilised about 35-40% of liquidity, which it has kept in a place where the banks do not have access to it,” Olatunji Odesanya, CEO and managing director of Coronation Securities, told OBG. “Regulations require banks to maintain a liquidity ratio of 30% and a CRR of 22.5%. Putting these cash requirements with the apex bank ensures that 35-40% of banks’ assets are near-cash, therefore limiting the creation of additional bad loans while they work to fix the existing non-performing loan (NPL) book.”
In addition to these commitments, banks are charged a levy of 0.5% of total assets to help fund the Asset Management Corporation of Nigeria, the country’s “bad debt bank”, which was established in the wake of the 2008 domestic banking crisis to stabilise NPLs.
A beneficiary of limited bank lending could be the capital markets, which have sought to expand retail participation. The growth of mutual funds, along with drives by the Securities and Exchange Commission and principal securities exchanges to actively court the retail market, may divert savings away from banks and towards more direct investments in companies. This conversion will take some time, however, as many households and small and medium-sized enterprises remain reluctant to fully embrace capital markets, particularly in light of the losses suffered during the 2008-09 financial crisis. On the borrowers’ side, new products – such as short-term bonds from the FMDQ’s over-the-counter Securities Exchange – are designed to meet the financing needs of businesses that had previously sought capital through bank loans.
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