Managing monetary policy in trying times, By Uddin Ifeanyi

Arguably, one of the more Augean challenges confronting financial services regulation in the country today, is the ongoing transition in industry practice from bread-and-butter intermediation to what is now commonly referred to as “market-based” intermediation. In large part, this passage reflects the industry’s response to the competitive round triggered by its deregulation in the mid-80s. Supply (89, or so banks, then) confronted a peculiar market (structural bottlenecks in the economy meant that demand remained static. Even today, only a little over 53% of eligible nationals have access to formal financial services. Thus, operators have constantly sought to meet investors’ expectations of a return on their investments either through increasingly risky operations (“margin lending” in the run up to the central bank’s 2009 “special audit”), or non-traditional activities (as in the current dominance of treasury bills in most banks’ asset portfolios).

In result, even as most parts of the local financial services infrastructure is stuck in medieval times (the formal financial services sector is an adjunct to diverse “traditional” intermediation offerings between savers and investors), regulators are struggling to cope with the predictable (and unintended) consequences of (what the IMF refers to in its most recent Global Financial Stability Report as) “banks playing more of a nontraditional role by relying on fee-based income sources, trading activities, and non-deposit liabilities; a relatively large role for nonbank financial institutions in the inter-mediation process; and greater use of new financial products such as securitisations and derivatives”. Yet, unlike in other economies where a similar transition has taken place, in Nigeria, this efflorescence of new models and financing instruments has failed to broaden popular access to financial services.

Indeed, the adoption of novel intermediation models by banks operating in the country does not appear to have made the banking sub-sector any stronger, either. There are sub-narratives that give context to this, especially the argument around the extent to which the industry may be expected to rouse itself sustainably even as the rest of the economy is prostrate. We could engage endlessly this debate (its chicken-and-egg quality will guarantee a no less sterile outcome). Nevertheless, we can no longer ignore the fact that the sub-sector, and this in spite of the regulator’s best effort, appears condemned to lurch from one disaster to another. The central bank, through its resolution outfit (AMCON) only just finished infusing the sub-sector. Concerns over who bears the cost of this rescue operation have not been sufficiently attended to, and we are hearing new worries about the tradability of the sub-sector’s bond portfolio.

If the industry is not as healthy as the surfeit of mouth-watering profit figures that its operators have been releasing recently suggest, then we may be vulnerable to the de-stabilising effect of any shock (whether particular to one institution or of a systemic bent). Now, this is where things get nettlesome. Effective today, Nigerian government bonds will be included in J P Morgan’s government bond index. Consensus is that this should drive renewed interest in the country’s debt instruments. As it were, yields on domestic debt instruments trump anything that is currently available in Europe and North America. So the general expectation is that the economy will witness significant inflows of capital into the economy over the short-term. One estimate is of an inflow of close to US$1bn up to end-December 2012.

This higher inflow could have any of several effects. (1) It could push up the exchange rate of the naira. And (2), it could increase the rate at which the external reserves grow. On the other hand, the naira exchange rate bit could cut either way. In theory, by pushing up the naira’s exchange rate, it could affect the economy’s competitiveness. Local exporters could suddenly find it difficult to reach traditional markets. We are however considerably “lucky” in this regard: we produce very little that any other economy is interested in (besides crude oil, that is). Conversely, by lowering import costs (in an import-dependent economy), a “stronger” naira should help contain short-term pressure on domestic prices.

Still, we are concerned here with capital inflows at the short end of the market (“hot money”). So even when the central bank may yet contain these effects by issuing securities to “mop up” the additional forex liquidity, there is a danger of an asset price bubble inflating in the economy. This threat is that much more, if it is true that year-to-date, 80% of transactions on the floor of the Nigerian Stock Exchange have been fueled by foreign funds. The big bother is not so much that once again the economy may be susceptible to a shock, or a combination thereof. It is that this vulnerability might happen at a time when a central pillar of the financial settlement and payment system (the banks) is barely afloat.