CBN's Ban on Foreign Currency-Denominated Collaterals
Implications and What You Need to Know
CBN's Ban on Foreign Currency-Denominated Collaterals
Implications and What You Need to Know
In a recent move, the Central Bank of Nigeria (CBN) announced a ban on using foreign currency-denominated collaterals for Naira loans.
Foreign currency-denominated collaterals are assets pledged as security for a loan or financial transaction, where the value is in a currency other than the local currency of the country involved. For instance, if a business owner seeks a loan of ₦1,000,000 and uses their 1,000 USD U.S. stocks as collateral, this constitutes foreign currency collateral.
The rationale behind the CBN's prohibition lies in their recognition of the practice where individuals often leverage foreign currency assets as security for Naira loans, exposing the financial system to risks associated with exchange rate fluctuations.
The Central Bank has given a 90-day grace period for Banks to wind down these loan balances.
Exceptions were made for instruments like Eurobonds issued by the Nigerian government and guarantees from foreign banks, such as standby letters of credit.
So What?
The policy officially ends the use of foreign currency as collateral for Naira loans. People and Businesses who had received capital or funding in Dollars usually kept those funds abroad and then used those funds as collateral to get loans in Naira. The idea was to “spend the dollars” without having to face the liquidity issues in the Nigerian Foreign exchange market.
This loophole also meant they could borrow more if the Naira fell, benefiting from a weaker domestic currency. It also meant that if the Naira rose in value sharply, they would become a problem for themselves and their banks.
The CBN has two aims with this policy, reduce the bank exposure to the foreign currency risk we just highlighted, but just as important is the increase in dollar supply this policy will bring as those leveraging this structure will have to sell their Dollars for Naira and this should improve the supply of Dollars in the Nigerian exchange market.