CBN’s Bold Move Raises MPR to 22.75%: Implications for your finance
The recent decision by the Central Bank of Nigeria’s Monetary Policy Committee (MPC) to raise the Monetary Policy Rate (MPR) by 400 basis points, from 18.75% to 22.75%, has significant implications for you and the Nigerian economy. In this post, we will discuss the implications of this policy shift, exploring key terms like MPR, CRR, and Liquidity Ratio, to understand how these policy changes affect the Nigerian economy, businesses and individuals.
To grasp the implications of the MPR hike, key terms like MPR, CRR (Cash Reserve Ratio), Liquidity Ratio, and the Asymmetric Corridor should be understood.
MPR-Monetary Policy Rate
The MPR is a control mechanism tool, but it is also a double-edged sword. The MPR, or Monetary Policy Rate, acts as a lever for controlling money supply, lending rates, and inflation. It essentially represents the interest rate at which the Central Bank lends to commercial banks. The recent 400 basis points increase signifies a 4% increase, from 18.75% to 22.75%, reflecting the Central Bank’s attempt to curb Nigeria’s current inflation rate which roughly stands at 29.90% as of February 2024 according to the National Bureau of Statistics (NBS), and of course attract investors by offering higher returns on government securities.
While the higher MPR may curb inflation and entice investors seeking higher returns, it also has its challenges. Elevated interest rates can lead to slower economic growth, reduced consumer spending, and higher interest rates on loans. It is worthy to note that if the Monitory Policy Committee seeks to target food inflation through increasing MPR, it may be counterproductive because the Federal Government needs to deal with supply side challenges like security of farmers. The reason for this is that the real issue causing the high prices of food is not just about the cost of borrowing money; it’s also about problems on the farms. Farmers are facing challenges like insecurity, which means they can’t go to their farms to produce enough food. So, even if the MPC raises the MPR, it won’t magically solve the root problem of food inflation. We can’t fix a leaky roof by painting the walls.
CRR-Cash Reserve Ratio
Cash Reserve Ratio is like a savings account that banks (for instance, Stanbic IBTC, UBA, Keystone bank etc.) must have with the central bank. When a bank receives money from its customers, it doesn’t keep all of it for lending. Instead, a portion of that money must be set aside, or reserved, with the central bank. This reserved amount is determined by the Cash Reserve Ratio. For example, if the CRR is 20% and a bank receives ₦100,00.00 from customers, then it has to keep ₦20,000.00 (₦100,000 *20%) aside and can only use ₦80,000.00 for lending or other activities.
The purpose of CRR is to ensure that banks have a certain amount of money securely held with the central bank, which adds a layer of safety to the banking system. Depending on prevailing economic situations, the central bank can adjust the CRR to control the amount of money banks have available for lending.
Now that the CBN has adjusted the Cash Reserve Ratio (CRR) from 32.5% to 45%, this means that banks must now retain 45% of customers’ cash deposits (our cash deposits) with the Central Bank. This move aims to limit banks’ ability to lend excessively, thereby controlling borrowing and encouraging a reduction in cash circulation. However, it also poses the risk of constraining businesses and individuals with higher interest rates (the lower the availability of funds for banks to lend our small businesses, the higher the interest rates we attract if we indeed take those bank loans).
Liquidity Ratio
Liquidity Ratio reflects a bank’s health status and ensures that banks maintain enough assets to cover liabilities and meet its obligations. A healthy ratio protects depositors (you and I) and prevents banks from facing liquidity crises (the unavailability of funds). Imagine going to the bank to take some money and the bank isn’t liquid enough/has run out of cash to give you from the money you deposited with them for safekeeping. This is why a healthy Liquidity Ratio is crucial for ensuring banks can honor customer withdrawals. The recent policy emphasizes the importance of maintaining a minimum Liquidity Ratio of 30%, safeguarding depositors’ interests and overall financial stability.
Asymmetric Corridor
For us to understand the asymmetric corridor, think of it as a range or gap that sets the rules for how the central bank deals with commercial banks. It involves two key interest rates:
- Lending Rate: This is the interest rate at which the central bank lends money to commercial banks.
- Borrowing Rate: This is the interest rate at which commercial banks can deposit their excess money with the central bank.
When commercial banks need to borrow money from the Central Bank, they walk on the side with the higher interest rate (lending rate). On the flip side, if they want to deposit extra money with the Central Bank, they walk on the side with the lower interest rate (borrowing rate).
Now, the asymmetric corridor is like a band around the main interest rate (Monetary Policy Rate or MPR). It sets a higher limit for the lending rate and a lower limit for the borrowing rate. The “+100 basis points” means 1% above the MPR, and “-700 basis points” means 7% below the MPR.
So, if the MPR is, let’s say, 30%, and the asymmetric corridor is +100/-700 basis points, this means:
- Lending Rate (to commercial banks): 30% + 1% = 31% -higher interest rate
- Borrowing Rate (from commercial banks): 30% — 7% = 23% — lower interest rate
This arrangement encourages commercial banks not to keep too much money with the central bank because they can get a better deal by lending the money elsewhere (at a higher rate) or investing it in different sectors. This corridor, set at +100/-700 basis points around the MPR is a way for the central bank to influence how banks use their money and encourage them to participate more actively in the economy (for instance, lending to the real sector) rather than just holding onto cash. This aims to control cash circulation and inflation.
Impact on Businesses and Individuals: You and I
Banks are likely to pass on the increased MPR to consumers, which inadvertently means higher interest rates on loans. The MPR hike’s ripples into various sectors that will feel the impact in higher interest rates because banks are likely to pass on the increased MPR to consumers (businesses and individuals).
For businesses seeking loans from these banks, the interest rates on loans are projected to rise, potentially impacting investment decisions and pricing strategies. Therefore, these businesses might opt to reduce borrowing, affecting their cash flow and spending capacity.
On an individual level, higher interest rates on loans could result in increased costs for consumers (when we as consumers buy from these businesses, the costs may be higher because Chike, Abdul & Femi LTD may have also pushed the higher interest rates to us in form of increased prices). This means that our purchasing power and spending patterns may be affected as well. In the long run, it reduces our propensity to spend.
Financial Strategy for You and Me: Okay where is our gold in all of these?
Phew! Seems like we’ve been on and on with all the boring stuff and seemingly bad news, eh? We want to see the light at the end of the tunnel, where the good stuff is at for us with the CBN’s recent policy move. We’ll get there in a bit.
As the Central Bank of Nigeria takes bold steps to navigate economic challenges, it is necessary that we understand the implications of policy decisions because it comes in handy for making informed financial decisions. Although fraught with uncertainties, the incentivization of higher returns on fixed deposits or treasury bills could encourage investment and savings.
The light at the end of the tunnel– We can reassess our financial strategies and take prudent steps by taking advantage of the CBN’s monetary policy to explore investment options with higher returns. Two main investment vehicles to consider here are: fixed deposits and treasury bills.
Higher Returns on Fixed Deposits and Treasury Bills
The mention of “incentivization of higher returns on fixed deposits or treasury bills” suggests that the CBN is encouraging individuals to invest their money in these financial instruments. Now, let’s understand what fixed deposits and treasury bills are:
Fixed Deposits
When you put money in a fixed deposit, you are essentially lending it to a bank for a specific period at a predetermined interest rate. This interest rate is often higher than regular savings accounts. The money is “fixed” or locked in for a set time, and you receive both the principal (initial amount) and interest at the end of the period.
How It Works: Imagine you deposit ₦100,000 in a fixed deposit for one year at an interest rate of 5%. At the end of the year, you’ll receive ₦105,000 (the initial ₦100,000 plus ₦5,000 in interest).
Treasury Bills (T-Bills):
These are short-term government securities with maturities ranging from a few weeks to a year. When you buy a T-Bill, you are lending money to the government. The government, in return, pays you interest when the bill matures.
How It Works: Suppose you buy a ₦100,000 T-Bill with a 90-day maturity and a 5% interest rate. After 90 days, the government pays you ₦101,250 (₦100,000 principal plus ₦1,250 in interest).
You can invest in T-Bills by:
- Opening a Treasury Bill account with your bank or through the Central Bank (please contact your bank for advice on procedure).
- Choose the desired tenor (maturity period) and bid the amount you want to invest.
- Await the results of the auction to know if your bid was successful (again, your banker can put you through this process, as well as with fixed deposits).
Both T-Bills and Fixed Deposits are secure financial instruments of investments as long as the interest rate is high.
I hope you have found this write-up insightful. Please let me know your thoughts by commenting below. Please like and share if you found this helpful.
(Disclaimer: This article is for informational purposes only and does not constitute financial advice.)