Monetary Policy

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The Conduct of Monetary Policy

The Performance of Monetary Policy Since 1986
The Structural Adjustment Programme (SAP) was adopted in July, 1986 against the crash in the international oil market and the resultant deteriorating economic conditions in the country. It was designed to achieve fiscal balance and balance of payments viability by altering and restructuring the production and consumption patterns of the economy, eliminating price distortions, reducing the heavy dependence on crude oil exports and consumer goods imports, enhancing the non-oil export base and achieving sustainable growth. Other aims were to rationalise the role of the public sector and accelerate the growth potentials of the private sector. The main strategies of the programme were the deregulation of external trade and payments arrangements, the adoption of a market-determined exchange rate for the Naira, substantial reduction in complex price and administrative controls and more reliance on market forces as a major determinant of economic activity.

The objectives of monetary policy since 1986 have remained the same as in the earlier period - the stimulation of output and employment, and the promotion of domestic and external stability. In line with the general philosophy of economic management under SAP, monetary policy was aimed at inducing the emergence of a market-oriented financial system for effective mobilization of financial savings and efficient resource allocation. The main instrument of the market-based framework is the open market operations. This is complemented by reserve requirements and discount window operations. The adoption of a market-based framework such as OMO in an economy that had been under direct control for long, required substantial improvement in the macroeconomic, legal and regulatory environment.

In order to improve macroeconomic stability, efforts were directed at the management of excess liquidity; thus a number of measures were introduced to reduce liquity in the system. These included the reduction in the maximum ceiling on credit growth allowed for banks; the recall of the special deposits requirements against outstanding external payment arrears to CBN from banks, abolition of the use of foreign guarantees/currency deposits as collaterals for Naira loans and the withdrawal of public sector deposits from banks to the CBN. Also effective August, 1990, the use of stabilization securities for purposes of reducing the bulging size of excess liquidity in banks was re-introduced. Commercial banks' cash reserve requirements were increased in 1989, 1990, 1992, 1996 and 1999.

The rising level of fiscal deficits was identified as a major source of macroeconomic instability. Consequently, government agreed not only to reduce the size of its deficits but also to synchronize fiscal and monetary policies. By was of inducing efficiency and encouraging a good measure of flexibility in banks' credit operations, the regulatory environment was improved. Consequently, the sector-specific credit allocation targets were compressed into four sectors in 1986, and to only two in 1987. From October, 1996, all mandatory credit allocation mechanisms were abolished. The commercial and merchant banks were subjected to equal treatment since their operations were found to produce similar effects on the monetary process. Areas of perceived disadvantages to merchant banks were harmonized in line with the need to create a conducive environment for their operations. The liquidity effect of large deficits financed mainly by the Bank led to an acceleration of monetary and credit aggregate in 1998, relative to stipulated targets and the performance in the preceding year. Outflow of funds through the CBN weekly foreign exchange transaction at the Autonomous Foreign Exchange Market (AFEM) and, to a lesser extent, at Open Market Operation (OMO) exerted some moderating effect. The reintroduction of the Dutch Auction system (DAS) of foreign exchange management in July, 2002 engendered relative stability, and stemmed further depletion of reserves during the second half of 2002. However, the financial system was typically marked by rapid expansion in monetary aggregates, particularly during the second half of 2000, influenced by the monetization of enhanced oil receipts. Consequently, monetary growth accelerated significantly, exceeding policy targets by substantial margins. Savings rate and the inter-bank call rates fell generally due to the liquidity surfeit in the banking system through the spread between deposit and lending rates remained wide. Specifically, 2003 policy measure were design to promote a stable macroeconomic environment to achieve a non-inflationary output growth rate of 5 per cent. In pursuit of its development effort, the Bank, in collaboration with the Bankers� Committee, established the Small and Medium Industries Equity Investment Scheme (SMIES). In 2003, credit delivery to real sector was encouraged through the SMIEIS and an incentive of lower Cash Reserve Requirement (CRR) regime was prescribed for those banks that increased their credit allocation to the real sector by 20 per cent or more. Moreover, the Bank provided guarantees for agricultural loans under the Agricultural Credit Guarantee Scheme (ACGS)

In recognition of the fact that well-capitalized banks would strengthen the banking system for effective monetary management, the monetary authority increased the minimum paid-up capital of commercial and merchant banks in February 1990 to N50 and N40 million from N20 and N12 million, respectively. Distressed banks whose capital fell below existing requirement were expected to comply by 31st March, 1997 or face liquidation. Twenty six of such banks comprising 13 each of commercial and merchant banks were liquidated in January, 1998. Minimum paid up capital of merchant and commercial banks was raised to a uniform level of N500 million with effect from 1st January, 1997, and by December 1998, all existing banks were to recapitalize. The CBN brought into force the risk-weighted measure of capital adequacy recommended by the Basle Committee of the Bank for International Settlements in 1990. Before then, capital adequacy was measured by the ratio of adjusted capital to total loans and advances outstanding.

The CBN in 1990 introduced a set of prudential guidelines for licensed banks which were complementary to both the capital adequacy requirement and Statement of Standard Accounting Practices. The prudential guidelines, among others, spelt out the criteria to be employed by banks for classifying non-performing loans. The CBN has continued to examine and monitor banks in order to promote stable banking system. Also the Bank handles the problem of distressed and illiquid banks. The CBN imposes holding actions and revokes licenses of affected banks as well as encourages mergers and acquisitions. In an effort to improve the operations of the money market, an auction-based market for treasury securities was introduced in 1989; and these treasury instruments were made bearer bills to enhance transferability and promote secondary trading. The developments in the money and capital markets were mixed in 1998. While the activities in the money market were influenced largely by developments in the Autonomous Foreign Exchange Market (AFEM), the capital market witnessed increased transactions in terms of volume despite the observed decline in market capitalization. The sanitization and restructuring of the financial sector by the CBN continued in 1999 and 2000, resulting in the decline in the number of distressed banks. Moreover, the CBN in the context of its surveillance role carried out routine and target examinations of the financial institutions to ensure compliance with guidelines and ensure efficiency in their operations. The non-bank financial institutions, whose operations did not meet the prescribed standard, were either closed or had their operating licenses withdrawn. In order to improve the efficiency of the payment systems, some measures were put in place including the introduction of N200 currency note in 2000. The operational environment for banks was further liberalized in 2001 with the introduction of universal banking, while the supervisory framework of the financial system was enhanced with the establishment of a new department in the Bank to supervise other financial institutions. In 2002, monetary policy implementation was faced with some challenges as the problem of excess liquidity persisted, and the demand pressure in the foreign exchange market intensified. In order to encourage banks to reduce interest rate on lending, the Minimum Rediscount Rate (MRR) was reviewed downward accompanied with moral suasion. These developments led to a fall in bank deposit and lending rate, particularly during the second half of 2002. In pursuit of its commitment to improve the payments system, the CBN ensured the full installation of Magnetic Ink Character Recognition (MICR) in all the clearing zones, and was involved in the live-run of the Nigerian Automated Clearing System (NACS) in the Lagos clearing zone in 2002.