A confidential letter from the Central Bank of Nigeria (CBN) to a commercial Bank Plc has been leaked, revealing a stern directive from the apex bank concerning Naira overdrafts backed by foreign currency deposits.
This means a borrower cannot use dollars deposited in their bank account as collateral to obtain a loan in naira.
The preference for these borrowers is likely due to the need to hedge against foreign currency spikes which can be costlier than interest rates.
In the leaked letter dated August 17, 2023, and signed by Mr. Haruna B. Mustafa, the Director of Banking Supervision, the CBN highlighted its findings from a recent supervisory review.
It was uncovered that the Bank had been offering Naira overdraft facilities that were secured with foreign currency deposits.
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.
There is a genuine apprehension that these activities might reduce the foreign exchange liquidity in the market. Thus rather, than have the dollars secured as collateral, the apex bank will rather the company sell it to create liquidity than to save it.
When there’s less liquidity, there tends to be scarcity, which can subsequently apply pressure on the exchange rate, disrupting the financial stability the CBN aims to maintain.
Moreover, the CBN emphasized that the Bank’s actions contradicted its previous circular titled “Currency Substitution and Dollarization of the Nigerian Economy”.
This circular was set in place to deter practices that might undermine the country’s economic stability.
Following this discovery, the apex bank directed the Bank to stop these offerings immediately. The bank was also instructed to switch out the foreign currency collateral on existing overdrafts to other acceptable asset types within a fortnight. Non-compliance would mean that the bank would have to unwind these facilities.
This incident underscores the necessity of transparency in banking operations and the vigilant oversight of the CBN in ensuring adherence to its policies, especially as they aim to shield Nigeria’s economy from potential pitfalls.
According to the circular cited by the central bank warned Nigerians against dollarizing the economy by pricing goods and services in foreign currency.
Despite this circular, the Nigerian government has typically sold assets in dollars, especially during its privatization processes.
