The first 9 months of this year have been characterized by macroeconomic headwinds. Added to this, the banking industry faced hawkish regulations that generally constrained banks' capacity to create risk assets and trade within a fully functional foreign exchange market. Furthermore, the directive by the President on the full implementation of the Treasury Single Account (TSA) tightened liquidity in the financial system and inevitably jerked up interbank money market rates -- having reached year highs of over 100.0%.
These were some of the considerations at the September 2015 Monetary Policy Committee (MPC) meeting, coupled with concerns over the slowing economic growth (Q2:2015 GDP growth rate at 2.35%) and weak consumer and investment spending. The Committee hence reached a decision to reduce the harmonized Cash Reserve Requirement (CRR) from 31.0% to 25.0%.
Consequent on the implementation of the revised CRR, approximately N740.0bn was credited to the DMBs, which buoyed liquidity levels of banks dousing the effect of the funds of the Federal Government and its agencies (approximately N1.3tn) that had left the banking system to the CBN. That said, liquidity opening balance of DMBs has averaged N673.0bn in the past two weeks relative to average liquidity level of N222.5bn in September. Surprisingly, the CBN is yet to conduct any OMO auction to mop up the excess liquidity in the last 4 weeks. We suspect that this may be deliberate as the CBN moves to foster lending to the real sector, in line with the agenda of the current CBN Governor.
Asides, inflation in recent times has been driven by high cost of production (not demand pressure); thus allaying concerns that the increase in liquidity in circulation will pressure consumer prices. In addition, the CBN's administrative measures in the FX market has also limited the tendency of market players to speculate.
In response to the high liquidity levels, money market rates have declined, with average NIBOR rate falling to 12.8% from 16.2% recorded the day before the September MPC meeting was concluded. Treasuries and Bonds have also rallied with majority of the benchmark FGN bonds currently trading above their par value while average bond and treasuries yields across all tenors have fallen 100bps and 521bps to berth at 14.1% and 8.4% respectively. Analysis of the recently concluded DMO auction indicates approximately 3.0% decline in the marginal rates of both JUL 2034 and FEB 2020 which were reopened.
With stronger liquidity position, competition for deposits among DMBs will likely taper. This will in turn lower cost of deposits for banks in Q4:2015 as term deposits are likely to be re-negotiated downwards upon maturity to reflect the current liquidity dynamics. Although this may be a disincentive to bank customers to save, hence buoying discretionary spending. On the back of current lower yields in the fixed income market, banks' net interest margin may be pressured in Q4:2015.
However, this may spur banks to reallocate assets by creating more risk assets in the retail space to buoy assets turnover. In addition, longer tenor instruments currently present attractive options within the bond market. Moreover, stock market players may also decide to take medium to longer term positions on fundamentally sound stocks with valuations expected to be bolstered by lower discount rate and risk premium.
More importantly, we expect the high monetary and funding liquidity to translate into low rates in the credit markets and possible buoy loan growth to the real sector in the 4th quarter of 2015. However, in the absence of clear-cut fiscal economic policy direction to complement the monetary stimulus, risk appetite of investors and DMBs will remain weak relative to potential. This raises a question...Can the CBN Win this Time?