Anxiety has pervaded the money, stock and fixed income markets as nervous operators and investors closely monitor the effect of the outcome of last week's Monetary Policy Committee (MPC) meeting on the market. Nigerian banks had over the years depended heavily on public sector funds. The perceived apathy of some banks towards small savers in the country was largely attributed to the amount of returns they got from holding public sector funds.

In fact, these huge public sector deposits that are commonly lent back to the government via trading in FGN bonds, treasury bills and open market operations (OMO) securities at high interest rates were responsible for the structural liquidity surfeit in the banking system. But disturbed by this development, the Central Bank of Nigeria's (CBN's) MPC which put the total amount of public sector funds sitting in banks at over N1.3 trillion, decided to sterilise public sector funds as it raised the cash reserve requirement (CRR) for public sector funds to 50 per cent. But the CRR for private sector funds was left unchanged at 12 per cent.

The CRR is a monetary policy tool. With this development, 50 per cent of public sector deposits, comprising deposits of all tiers of government, their ministries, departments, agencies and companies that are deposited in banks must be kept at the central bank and not lent out. The CBN said it intended to use this method to drain the excess money with banks meaning that banks would have fewer funds available as the funds are sucked out of circulation. The move is also expected to strengthen the beleaguered naira.

However, it was estimated that about N2.08 trillion would be withdrawn from the banks. For instance, at the end of the first quarter of 2013, public sector deposit made up of local, state and central governments deposits with banks accounted for 36 per cent or N5.45 trillion of the total banking system deposits of N15.09 trillion. At that time, a total of N1.47 trillion in reserve requirement was deposited with the CBN. Therefore, applying the 0.76 per cent growth in broad money in the first half of the year to the banks' deposits figures, analysts at BGL Securities estimated that the total deposits and public sector deposits in the banking system currently would be about N15.16 trillion and N5.47 trillion respectively.

It assumed that if the banks were in full compliance with the initial 12 per cent CRR prior to last week's MPC decision, an estimated N2.08 trillion represents the total amount of funds the banks would have to be mobilise and transferred to their respective reserves accounts with the CBN immediately.

Although the central bank has announced that the implementation of the MPC decision would take effect from the next CRR maintenance period which commences on August 7, 2013, operators in the money market have been having sleepless nights over how to cover their position amidst a potential liquidity crisis.

Findings showed that most financial institutions have started initiating strategies to mobilise deposits from other sources in the economy. For instance, THISDAY gathered that since last Tuesday when the MPC took the decision, commercial banks had been working out modalities to revive some of their retail and treasury products to make them attractive to customers. Also, some of banks might adopt a strategy that would hinge the monthly salaries and other emoluments on target.

The naira appreciated at the interbank market last week as it gained 70 kobo to close at N160.60 to a dollar on Friday, from the N161.29 to a dollar it was the preceding Friday. Also yields on the various FGN bonds climbed last week, compared to the preceding week, obviously in response to the outcome of the meeting. Nonetheless, the MPC left the Monetary Policy Rate (MPR) unchanged at 12 per cent. Also the Standard Deposit Facility and Standard Lending Facility were also held steady, at 10 per cent and 14 per cent respectively.

Central Banks' Concern To the CBN Governor, Mallam Sanusi Lamido Sanusi, the introduction of CRR on public funds became necessary in order to, among other things, check "the perverse incentive structure" under which deposit money banks (DMBs) "source huge amounts of public sector deposits and lend same to the government."

Sanusi said: "First of all you've got liquidity surplus in the banking industry. As I speak to you there's over N1.3 trillion or so, sitting in banks and belonging to government agencies. "Now basically, they (surplus) are at zero percent interest and the banks are lending about N2 trillion to the government and charging 13 to 14 per cent. Now that's a very good business model, isn't it? Give me your money for free and I lend it to you at 14 per cent. So why would I go and lend to anyone."

Continuing, he said: "Now if you want to discourage such perverse behaviour, part of it is to basically take away some of that money and therefore, the reserves requirement is supposed to make sure that excess liquidity in banks' balance sheets is evenly distributed. We've got about six or seven banks that already account for the bulk of these deposits. We are not going to put them into distress." The CBN governor further warned that if spending continues and the concerned about the liquidity conditions continues, there might be continued increase in the CRR across the board to continue to maintain the tight liquidity conditions.

"In election years, everywhere in the world, not just in Nigeria, politicians spend money and spending money means pressure on the exchange rate, pressure on reserves and pressure on inflation. "So the next 12 months would be difficult; we would have to respond at every stage and make sure that no matter what happens we do not have stability threatened," he declared.

Implications for the market To the Head of Research, BGL Securities, Mr. Femi Ademola, the move by the CBN was to block public sector cash round tripping in banks. He agreed that banks' appetite for government securities was responsible for the sluggish growth of private sector credit. "We have argued in the past that as long as this incentive structure exists there could be little reason for banks to invest in costlier and riskier credit creation. This has been the basis of our consistent argument for downward revision in the MPR before it got to the current 12 per cent level.

"We believe that the use of macro-prudential tool that targets the concentrated systemic liquidity could be more appropriate at tackling the liquidity problem while the interest rate is revised downward to the benefits of private sector credit growth. In this regard we align with the action of the committee as a positive measure to encourage the banks to focus more on lending to the private sector. We expect that as the effect of this action unfolds, the committee would consider revising the benchmark interest rate downward in the medium term," he added.

Furthermore, he noted that potential assets sell down by the banks may drag the markets downward. Also, analysts at the Consolidated Discount House Limited (CDL) argued that banks would seek to shore up their non-public sector deposits, adding that deposit rates would go up as banks resume fight for deposit liabilities. The firm also anticipated that banks would seek to re-price risk assets as cost of funds spike. "High lending rates could lead to a slowdown in risk asset creation and drop in imports. High yields on FGN bonds could stimulate carry trade. The market had largely been nervous in the early part of trading of July 24th but calm gradually returned on news that the maintenance period for the 50 per cent CRR on public sector deposits will be at the end of July. "We expect some keen interest from foreign portfolio investors as this new tightening outlook improves the profile of the carry trade in the short term. On the equity space, we believe the hurried exit of investors from banking stocks will be moderated by the kick-off of first half earnings season. Dividend hunters may seek names like GTBank and Access which traditionally pay out half year dividends," a CDL report added.

On his part, the Emerging Market Strategist at Standard Bank, Mr. Samir Gadio, noted that the risk to the Nigerian economy remained that a new leg of fiscal expansion would materialise ahead of the 2015 elections. According to Gadio, the fragile fiscal position and decline in government revenue were potential threats to macroeconomic stability. "The tightening in liquidity conditions will most likely lead the short end of the yield curve to shift up in the immediate future and result in a re-pricing of the long end, but will probably weigh positively on the naira. "It also implies that investors will be able to source bonds at higher yields in coming days after a preliminary sell-off. More importantly, we expect NIBOR rates to surge in the aftermath of the MPC meeting and the related squeeze in liquidity," he added.