Nigerian banks increasingly rely on short-term commercial papers (CPs) to navigate liquidity challenges as the Central Bank of Nigeria (CBN) enforces stringent cash reserve policies, significantly driving up the cost of deposits.
The move highlights the growing pressures on financial institutions in the face of aggressive monetary tightening measures by the apex bank.
Access Holdings Plc, the country’s largest bank by assets, along with at least three other financial institutions, have either recently issued or are in the process of issuing commercial papers to bolster liquidity. The decision to embrace CPs comes as banks struggle to attract deposits while grappling with rising funding costs imposed by the CBN’s policies aimed at stabilizing the naira and curbing inflation.
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Since the central bank raised the cash reserve ratio (CRR) to 50% in September 2023, it has withdrawn approximately N26.6 trillion in liquidity from the banking system. The CRR policy effectively doubles the cost of raising deposits for financial institutions, as a significant portion of customer deposits is locked away at the CBN rather than being available for lending or investment.
Data from January 2024 shows that while the average rate for a six-month deposit stood at 19%, banks faced an effective cost of 36% due to the high CRR. Analysts point out that this reality significantly limits lenders’ ability to operate efficiently.
Chika Mbonu, Chief Executive Officer of KSBC Advisory Partners Ltd., explained that the effective cost soars to 36% because only half of the total deposits are available for lending.
“Assuming the customer deposit was obtained at 18%, the effective rate will be 36%, because of the high CRR rate, he told Bloomberg.
This situation has left banks searching for alternative funding mechanisms to keep their operations running smoothly.
CBN’s Interest Rate Hikes Intensify Liquidity Squeeze
Beyond the high CRR, Nigerian banks are also feeling the heat from the CBN’s sustained monetary tightening. Since early 2023, the apex bank has raised its benchmark interest rate by 875 basis points, bringing it to 27.5%. Additionally, the standing lending facility rate—a key tool used by banks to access short-term liquidity—has surged to 31.75%.
These measures, while intended to curb inflation and stabilize the currency, have made it increasingly difficult and expensive for banks to secure funding through traditional deposits. As a result, commercial papers, that offer short-term financing without the burden of CRR deductions, have become a more attractive option for banks seeking liquidity relief.
Commercial Papers Gain Favor Over Certificates of Deposit
The banking sector’s shift towards commercial papers reflects the rising cost of wholesale deposits and the need for more flexible funding options. Unlike certificates of deposit (CDs), which are subject to CRR deductions, CPs provide a workaround that allows banks to access funds without additional liquidity restrictions.
Samuel Sule, CEO of Renaissance Capital Africa, noted that CPs are becoming an increasingly preferred funding tool for banks. He explained that wholesale deposit rates are currently higher than commercial paper rates, and wholesale deposits often come with shorter tenors, making CPs a more viable alternative for liquidity management.
With CPs gaining traction, it is expected that more Nigerian banks will follow suit in issuing these short-term instruments to cushion the impact of CBN’s tightening measures.
“Other banks will follow to issue commercial papers as this is one of their funding tools,” he said.
Wider Implications for the Nigerian Banking Sector
The rising cost of funding and persistent liquidity constraints are poised to reshape Nigeria’s banking industry. Analysts suggest that the CBN’s aggressive monetary policies may continue to exert pressure on financial institutions in the near term.
While issuing commercial papers offers a temporary solution, the long-term sustainability of this approach remains uncertain. Banks will need to adapt to the evolving regulatory environment by exploring innovative financing models and diversifying their funding sources.
The continued reliance on costly short-term debt instruments such as CPs could also impact banks’ profitability and lending capabilities, potentially leading to reduced credit availability for businesses and consumers.