From global banking crises to cooked domestic goose

The crises (triggered by the implosion of Silicon Valley Bank in the US, where a run saw US$42 billion worth of deposits leave the bank in 24 hours) that has rocked the financial services industry across Europe and North America over the last few weeks was not supposed to have happened. The whole point of the regulatory comeback to the Global Financial Crisis was not to prevent the failures of banks like Silicon Valley Bank. Enactment in the US of the Dodd–Frank Wall Street Reform and Consumer Protection Act and the general adoption by jurisdictions across the world of the Basel III capital and liquidity standards were all designed to strengthen financial sector resilience. And to a great degree, up until now, these responses have had the intended effect. Stress tests have improved regulators’ non-traditional oversight of vulnerabilities in systemically important institutions. Improving the former’s ability to anticipate distress, and to contain this within the affected institutions.

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Until that is, a bank in the US, whose operations fell just beneath the threshold for these levels of macroprudential regulation, demonstrated that the ability of a crisis in one bank to trigger financial contagion is not the preserve of systemically important banks alone. The reflex response from the Federal Reserve, as it tried desperately to keep the financial contagion genie in the lamp and the lamp’s lid firmly in place has since seen central banks in the developed economies tread a narrow and gravel-strewn path between the Scylla that is inflation, and the Charybdis that is financial instability.

And developing economies? No! Nigeria, for obvious reasons?

The worries in the latter case are of both an immediate and remote (by way of speaking) colouration.

First on the “What could possibly happen, here?” menu is concern that an economy that has been needlessly straitened of late by the cackhanded macroeconomic policies of the Buhari administration (only rescued from certain death by a Supreme Court ruling) cannot afford another near-death experience. Then, there is the reminder of the severe moments from then-central bank governor’s relaxed response to the Global Financial Crisis so many years ago. If Nigeria, despite its continuing underdevelopment, was not insulated from the disturbances in the global economy in 2007-2008, the likelihood of it remaining unaffected today is nearer zero.

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Next question: “What channels will the current crisis pass through from Washington and Brussels to Lagos?”

I had the good fortune, last week, to be the fly-on-the-wall in a conversation on this question between some of our best minds. Easily, they dismissed trade lines as a transmission channel. In the normal course of their business, domestic banks get short-term credit extended to them by their foreign counterparts. Nearly always because their business is in naira, they enter into a derivative contract with the central bank in which they exchange the dollars from their trade lines with naira reserves ― which they may then on-lend. The fear was that were banks in the developed countries, startled by the current financial crisis, to call in these lines, the central bank’s reserves might come under pressure strong enough for the economy to feel it.

However, it would seem, if these clever persons are to be believed, that between the central bank’s zero-bound interest rates policy (in an economy with rising inflation), the Buhari government’s dirigisme, and SARS-CoV-2 (the virus that causes COVID-19), non-resident economic actors long since wound down their short-term exposures to the domestic economy (even as others moved their brick-and-mortar operations out of the economy or franchised them to local operators).

That, though, is as far as the good news goes. Apparently, the nation’s gross external reserves remain a huge problem, what with the authorities having run through it in the ultimately futile attempt to support the naira’s exchange rate at levels not borne out by the markets. One effect of the recent financial turmoil has been to stoke a crisis of confidence in the markets. And in such times, market participants are wont to head for safe havens where they can park their wealth with minimal losses. Accordingly, we are seeing the dollar strengthen at the expense of commodities. As the price of crude oil drops, the pressures on Nigeria’s gross external reserves will only worsen. And this is before our now chronic production difficulties in the upstream oil and gas space is factored in.

This unfortunately is not the only transmission channel from the developing global crisis to the domestic economy. As one of the experts I heard speak on the matter, last week, put it, pressure on the gross external reserves “will ask questions of the Central Bank of Nigeria’s (CBN) balance sheet, in particular around the true liquidity of the N14 trillion cash reserve ratio component and the safest way to transfer the N24 trillion ways and means advances from the CBN to the central government off the former’s balance sheet”. Consensus is that the domestic markets are not broad and deep enough to hive the ways and means advances on to, off the CBN’s balance sheet. Neither was there agreement around the possibility of passing this on to the balance sheet of a non-domestic actor like the International Monetary Fund.

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As the meeting adjourned, I could not help but feel that our economic goose is cooked.

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