Nigeria: Leaked CBN Letter to Bank Reiterates 2015 Circular Prohibiting Naira Overdrafts Secured by Foreign Currency Deposits

A confidential letter from the Central Bank of Nigeria (CBN) to a commercial bank has surfaced, exposing a firm directive from the central bank regarding Naira overdrafts backed by foreign currency deposits. This instruction forbids borrowers from utilizing dollars deposited in their bank accounts as collateral to secure a loan in Naira.

The rationale behind this directive likely stems from borrowers seeking to hedge against potential spikes in foreign currency values, which can often be more costly than interest rates.

Dated August 17, 2023, the leaked letter, signed by Mr. Haruna B. Mustafa, the Director of Banking Supervision at the CBN, highlights findings from a recent supervisory review. It was discovered that the bank in question had been offering Naira overdraft facilities secured with foreign currency deposits.

The letter states, “This practice is not only fraught with the risk of currency mismatch, but is capable of limiting FX liquidity in the market, thereby creating scarcity and exerting pressure on the exchange rate.”

The CBN’s stance against this practice stems from concerns over currency mismatch, which could introduce significant financial risks for banks. Instead of converting their dollars to Naira, borrowers sometimes prefer to borrow in Naira, as the cost of repurchasing the dollars might outweigh the interest rate they pay for borrowing in Naira. However, this can create a ripple effect on the exchange rate due to its speculative nature.

There is a legitimate concern that these actions could diminish foreign exchange liquidity in the market. Rather than allowing the dollars to serve as collateral, the CBN would prefer that companies sell them to create liquidity, rather than hoarding them. Reduced liquidity can lead to scarcity, which can subsequently exert pressure on the exchange rate, disrupting the financial stability the CBN seeks to uphold.

Furthermore, the CBN emphasizes that the bank’s actions contradict its previous circular titled “Currency Substitution and Dollarization of the Nigerian Economy.” This circular was put in place to discourage practices that could undermine the nation’s economic stability.

In light of this discovery, the CBN instructed the bank to cease these offerings immediately. The bank was also directed to replace foreign currency collateral on existing overdrafts with other acceptable asset types within two weeks. Failure to comply would require the bank to unwind these facilities.

“This incident highlights the importance of transparency in banking operations and the vigilant oversight of the CBN in ensuring adherence to its policies, especially as they aim to shield Nigeria’s economy from potential pitfalls.”

The circular cited by the central bank from 2015 warned against dollarizing the economy by pricing goods and services in foreign currency. It deemed such actions illegal and advised banks to desist from the collection of foreign currencies for payment of domestic transactions.

Despite this circular, the Nigerian government has often auctioned assets in dollars, particularly during privatization processes.