CBN moves to prevent banks from engaging in speculative foreign exchange trading
January 31, 2024982 views0 comments
Business a.m
The Central Bank of Nigeria (CBN) has released a new circular containing guidelines aimed at addressing suspected cases of excessive foreign currency speculation and hoarding by Nigerian banks.
The circular, which is titled “Harmonisation of Reporting Requirements on Foreign Currency Exposures of Banks,” outlines a set of guidelines designed to reduce the risks associated with these practices.
“The Central Bank of Nigeria (CBN) has noted with concern the growth in foreign currency exposures of banks through their Net Open Position (NOP). This has created an incentive for banks to hold excess long foreign currency positions, which exposes banks to foreign exchange and other risks. Therefore, to ensure that these risks are well managed and avoid losses that could pose material systemic challenges, the CBN issues the following prudential requirements,”the statement read in part.
Regarding prudential requirements, the CBN noted that the Net Open Position (NOP) limit for the overall foreign currency assets and liabilities of banks, taking into account both on-balance sheet and off-balance sheet items, should not exceed 20% short or 0% long of shareholders’ funds unimpaired by losses. The NOP limit will be calculated using the Gross Aggregate Method, which takes into account the net position of all foreign currency assets and liabilities of the bank.
Furthermore, the CBN noted that banks whose current NOP exceeds the 20% short and 0% long limits must bring their NOP to the prudential limit by February 1, 2024.
As part of the new guidelines, banks are required to compute their daily and monthly NOP and Foreign currency trading position (FCTP) using the attached templates.
In addition to the above requirements, the CBN also requires banks to have adequate stock of high-quality liquid foreign assets, in the form of cash and government securities, in significant currencies to cover their maturing foreign currency obligations. This is intended to ensure that banks have sufficient funds to meet their obligations, even in times of market stress.
Furthermore, banks must have a foreign exchange contingency funding arrangement in place with other financial institutions.
In order to avoid the risks associated with currency mismatch, the CBN directed banks to borrow and lend in the same currency, i.e. to “naturally hedge” their foreign currency exposures. This means that banks should borrow foreign currency to fund their foreign currency assets, rather than relying on domestic currency funding.
In addition to naturally hedging their foreign currency exposures, the CBN has also directed banks to ensure that the basis of the interest rate for borrowing is the same as the basis for lending. This is to prevent a mismatch between floating and fixed interest rates, which can result in a risk known as “basis risk.”
The CBN stated further that any early redemption clause in Eurobonds should be at the sole discretion of the issuer, and that approval from the apex bank is required before any such clause can be exercised. This applies even if the bond does not qualify as Tier 2 capital.
In addition to the requirements, the CBN has also stated that banks must adopt adequate treasury and risk management systems to provide oversight of all foreign exchange exposures. This is to ensure that the banks are able to accurately assess and manage the risks associated with their foreign exchange exposures. Furthermore, the CBN directed that banks must report their foreign exchange exposures on a timely basis, using the CBN’s prescribed reporting templates.
The CBN also made it clear that banks are expected to bring their foreign exchange exposures within the set limits immediately, and to ensure that the returns they submit to the CBN accurately reflect their balance sheets.
The CBN has also warned that any non-compliance with the NOP limit will result in immediate sanctions, up to and including suspension from participating in the foreign exchange market.