CBN Cracks Down on Banks Violating FX Net Open Position Rules

The Central Bank of Nigeria (CBN), in a new circular to banks said it 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 (FX) and other risks, according to the CBN.

Nigerian banks have placed significant foreign currency (FX) with the central bank in the form of derivative transactions (including swaps and forwards), and now there are indications that some of those outlays may violate the net open position (NOP) guidelines of the regulator.

“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 CBN said.

Prudential Requirements

1. The Net Open Position (NOP) limit of the overall foreign currency assets and liabilities taking into cognizance both those on and off-balance sheet should not exceed 20% short or 0% long of shareholders‘ funds unimpaired by losses using the Gross Aggregate Method.

2. Banks whose NOP exceed 20% short and 0% long of their shareholders‘ funds unimpaired by losses are required to bring them to prudential limit by February 1, 2024.

The swaps positions are equivalent to $21 billion while there is a further $6.8 billion exposure in the form of FX forwards, banking sources tell MoneyCentral.

Banks are not expected to have more than 20% of their unimpaired shareholders’ funds as net open position limits.

At a time when the central bank is rationing its foreign-currency allocations to the economy, there is a risk that the central bank may decide to temporarily prolong those contracts beyond their original maturity date.

A material delay in repayment could then lead to the banks facing their own foreign-currency (FX) shortages and constrain their ability to repay their foreign currency liabilities.

“This is one of the things I have advocated some months ago. The banks are taking advantage of Naira weakness to build long foreign currency position (meaning they are keeping more foreign currency assets than their foreign currency liabilities), and this is why they are reporting unprecedented foreign currency gains,” an economist and former banker, told MoneyCentral.

“With this new rule, any bank that has more foreign currency assets than liabilities would have to sell the excess foreign currency position to the market or the CBN. This would increase the supply of foreign currency to the market and moderate the demand/supply gap.

Whilst the effect of this policy on the Naira would be one-off and transitory, it should help calm the pressure in the market and stabilize the Naira over the next few days, especially if the CBN follows through the policy with strong oversight to avoid infractions or disguised compliance.

This policy brings an end to what some would refer to as “abnormal profit” of banks arising from foreign exchange gains, as banks are going forward expected to either square out their foreign currency open position or have a short position, which would mean having more foreign currency liabilities than assets.

Indeed, the allowance to have a 20% short open position is an inventive for any bank which believe Naira is undervalued to raise foreign currency liabilities and step it down to Naira, with hope of making gains from such strategy when Naira appreciates in the future. So, the CBN wants to use this policy measure to increase FX supply from banks, with hope that such would help stabilize the Naira in the interim.

Whilst banks would be able to keep their FX gains made thus far, this policy puts an end to future prospect for FX gains and may begin to reflect on the valuation of banks stocks going forward,” he said.

Get More of our proprietary news and analysis as MoneyCentral is now on WhatsApp Channels  Follow the MoneyCentral Nigeria channel on WhatsApp: Click here!