Nigerian Banks $27.8bn FX Swaps/Forwards Violate Net Open Position Rules

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.

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.

“The conversations with CBN has been on for some time and I think the banks need to come to terms with reality just as the new leadership of CBN needs to be considerate that the funds are backed by liabilities in the books of the banks, so they have to pay back but the question is how?” an economist and former banker, told MoneyCentral.

“Opaque nature of the swap transactions and perhaps some inconsistencies and weak governance surrounding the transactions may also be questionable, so banks may not be able to seek a completely rationale deal.”

Moody’s Investors Service estimates that, as of June 2022, Nigerian financial institutions (including commercial and national development banks) had placed at least $14.2 billion with the central bank through various foreign-currency derivative contracts, including around $10.4 billion placed by rated Nigerian commercial banks.

Senior banking sources tell MoneyCentral that that number has risen to $21 billion as at June 2023, with the major Tier-One banks heavily exposed.

Sources say the CBN needs to effectively determine any contravention of the 20% net open position limits, and step down any excess into Naira as that is an evidence of arbitrage from such banks.

One approach would be to restructure the swaps in a way that ensures the banks are able to meet their obligations while spreading the timing for CBN payment over a considerable period.

Once the CBN has effectively determined the true positions of all banks and correct for contravention, it should then work collaboratively with the banks to determine the timing and true FX cashflow of the banks and use such knowledge to negotiate a restructuring of the Swaps with the banks, sources told MoneyCentral.

“This is important to avoid undue default of any bank on its obligations but also critical to ensuring the sustainability of the system and strengthen the position of the CBN in effectively managing the current liberal FX system,” another source said.

The foreign-currency derivatives instruments are included in the country’s $33.22 billion of gross foreign-currency reserves as of October 12, 2023.

Some banks have over recent years gradually reduced the duration of their foreign-currency derivative contracts, and/or the size of the amounts placed with the central bank (including through rolling over only a portion of maturing balances).

According to Moody’s, for most banks, the tenor of most of the contracts does not currently exceed 12 months, down from up to 24 months in the past.

However, the risk for the bank is that the central bank could resort to repaying the existing foreign currency swaps in local currency (as opposed to US dollars), or force the banks to enter into new foreign-exchange swaps transactions.

Analysts say such a policy would potentially undermine financial stability.

The country’s net foreign-exchange reserves remain relatively low and were recently estimated at $3.7 billion by JP Morgan Chase in an August 2023 note to clients, thereby providing less buffer for the sovereign.

The economist says banks should expect to be penalized for contravention of the NOP regulation, which states that the excess of a bank’s foreign currency assets over foreign currency liability must not be more than 20% of the bank’s unimpaired shareholders fund, and any penalty is subject to CBN discretion.

“If the contravention is as a result of unexpected FX movement, it may be forgiven and the bank may be asked to correct it as soon as possible otherwise it may be penalized, including charges for all the revaluation gains that such bank may have made on the back of the contravention. I think the essence and target of CBN investigation at this time should not be for penalizing the banks, rather for ensuring that the excess FX position is stepped down,” he said.