Why we must return to an orthodox CRR policy

That the new leadership of the Central Bank of Nigeria (CBN) has continued with the asymmetric cash reserve requirement (CRR) policy put in place by its predecessor is not as strange a development as it would seem at first blush. The CRR is money that banks are required to keep with their regulator, and which is available for use by the latter in the event of a run on individual banks. Because banks have no access to them in the ordinary course of their business, banks may not lend these reserves. And their regulator — usually the country’s central bank — may or may not pay interest on the funds held. Because banks may not lend the balance on their reserves with the central bank, it reduces their ability to create credit. By raising the cash reserve requirement, therefore, a central bank may tighten monetary conditions, and vice versa.

Up until March 2016, the CRR was calculated at 22.5 per cent of domestic banks’ deposit liabilities, until rising to 27.5 per cent in January 2020. And 32.5 per cent by September 2022. On the face of it, the central bank looked to have been tightening domestic monetary conditions through this period. Except that over the same time, its benchmark interest rate, the one with which it is supposed to address its price stability remit, was falling.

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What was happening? And what is the relationship between whatever was afoot, then, and what is happening now? Muddiness was the central attribute of macroeconomic policymaking in the Buhari years. It is thus difficult to describe a timeline for most events, which occurred then, and with the lasting impact on the economy that we are witnessing today. But it is a safe bet that at some point in that administration’s mismanagement of the economy, the CBN extended to it its first ways and means advance. Put simply, the central bank lent money to the government. And lent. And lent. When government borrows from the domestic economy through traditional methods, it issues paper to domestic economic actors promising to pay its debt back at some future date and at an agreed interest rate. Effectively, the sum borrowed from domestic actors is no longer available for use by them. Central bank lending to government is not burdened by this dynamic, however. It is against the apex bank’s balance sheet, and thus nearly always overheats the economy. This is why where it is envisaged at all by the CBN’s enabling statute it is as a capped overdraft.

Mr Godwin Emefiele, the then governor of the CBN however, imagined central bank lending to the federal government as a development finance tool. The cost to government of this borrowing was pegged to the apex bank’s policy rate. Thus, the higher the rate, the more costly this form of government borrowing. There was, of course, a great incentive for the apex bank to help hold the cost of the Buhari government’s massive borrowing appetite down.

Despite Nigerians’ love of the story around our economy’s exceptional status, orthodox economics has a word for this: fiscal dominance. Orthodox economics also says that this path and level of funding government operations by the central bank was always going to put upward pressure on domestic prices. Aware of this latter vulnerability, yet reluctant to tighten monetary conditions through orthodox means, the Emefiele-led CBN resorted to raising the cash reserve requirement. But that was not enough, as bank treasurers will tell you. The CBN’s imposition of the deposits associated with the elevated CRR became both erratic and eccentric.

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Unsure the rate at which and when the apex bank would apply the next CRR debit, bank treasuries promptly squirreled away any and all liquid funds. And in this dynamic, it made sense to sequester such monies in instruments with a 1 per cent coupon than to have the central bank seize it and keep it in non-interest-bearing balances. Thus, while it may not be strange that this capricious policy has continued under the apex bank’s new leadership. And while it may support the federal government’s continued hunger for cheap funds, it is not in the long-term interest of the nation’s financial services space, or the larger economy that it supports.

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