Monetary Policy Reforms

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Economic Reforms and Monetary Policy
Direct controls, pervasive government intervention in the financial system resulting in the stifling of competition and resource misallocation, necessitated the introduction of the Structural Adjustment Programme (SAP) in 1986. SAP was a comprehensive economic restructuring programme which emphasized increased reliance on market forces. In line with this orientation, financial sector reforms were initiated to enhance competition, reduce distortion in investment decisions and evolve a sound and more efficient financial system. The reforms which focused on structural changes, monetary policy, interest rate administration and foreign exchange management, encompass both financial market liberalization and institutional building in the financial sector. The broad objectives of financial sector reform include:

• Removal of controls on interest rates to increase the level of savings and improve allocative efficiency;
• Elimination of non-price rationing of credit to reduce misdirected credit and increase competition;
• Adoption of indirect monetary management in place of the imposition of credit ceiling on individual banks;
• Enhancing of institutional structure and supervision;
• Strengthening the money and capital markets through policy changes and distress resolution measures;
• Improving the linkages between formal and informal financial sectors.

The implication of these reforms on
monetary policy is the focus of this section

Increase in the number of Banking Institutions
One of the objectives of financial reforms was to provide a liberalized and level playing field for the emergence of effective and efficient institutions that would serve as an engine of growth for the economy. Consequently, innovative institutions were encouraged to take advantage of the opportunities created by the financial liberalization policies. The structural changes in the financial sector were designed to increase competition, strengthen the supervisory role of the regulatory authorities and streamline public sector relationship with the financial sector. As part of the reform programme, operating licences for opening bank house were liberalized. Prior to 1986, Nigeria had only 40 banks, but the number increased progressively to 120 in 1992. By 1998, however, the number of banks in operation declined to 89 as a result of the liquidation of over 30 terminally distressed banks. Other types of financial institutions also increased substantially. Indeed some of these institutions, such as the discount houses and bureaux de change were not in existence before 1986. The capital base of all the financial institutions was also increased. For instance, the minimum capital requirements of banks stood at N500 million with effect from December, 1998 compared with N10 million and N6 million for commercial and merchant banks, respectively, in 1989.

New Products Development
The reforms in financial sector created certain salutary effect on the financial system. Some of such effects include improved service delivery through new innovations and product development. The use of modern technology enhanced service delivery and eliminated queues in banking halls which used to be the common feature of banks in Nigeria. Also, Automated Teller Machines (ATMs) were installed at designated points across the country to further reduce customer traffic to banks for cash withdrawals. The use of debit and credit cards was also being popularized by some banks to reduce the risk of carrying cash for transactions. Thus, the 1986 reform introduced e-money in Nigeria’s banking lexicon.

Shift in Monetary Policy Management
It would be recalled that the direct approach to monetary management was the main technique of monetary policy implementation in Nigeria before the introduction of the Structural Adjustment Programme (SAP). Between 1986 and 1993, the CBN made efforts to create a new environment for the introduction of indirect approach to monetary management. A major action taken as part of the monetary reforms programme was the initial rationalization and eventual elimination of credit ceilings for selected banks that were adjudged to be sound. After the initial test run of the indirect monetary management approach, monetary management shifted to the indirect approach in which Open Market Operations (OMO) was the principal instrument of liquidity management. Since the introduction of the indirect approach, the primary and secondary markets for treasury securities have been developed to take advantage of liberalization introduced through the reforms. Discount houses, banks and recently some selected stockbrokers are now very active in the primary market for treasury bills.

Interest Rate Regime
In August, 1987 the CBN liberalized the interest rate regime and adopted the policy of fixing only its minimum rediscount rate to indicate the desired direction of interest rate. This was modified in 1989, when the CBN issued further directives on the required spreads between deposit and lending rates. In 1991, the government prescribed a maximum margin between each bank’s average cost of funds and its maximum lending rates. Later, the CBN prescribed savings deposit rate and a maximum lending rate. Partial deregulation was, however, restored in 1992 when financial institutions were required to only maintain a specified spread between their average cost of funds and maximum lending rates. The removal of the maximum lending rate ceiling in 1993 saw interest rates rising to unprecedented levels in sympathy with rising inflation rate which rendered banks’ high lending rates negative in real terms. In 1994, direct interest rate controls were restored. As these and other controls introduced in 1994 and 1995 had negative economic effects, total deregulation of interest rates was again adopted in October, 1996.

The Payment System
The Nigerian payments underwent substantial modernization of the process for handling payments with the implementation of the Magnetic Ink Character Recognition (MICR), which involved the phased adoption of MICR technology for processing of inter-bank transfer and in-house cheques. This was followed by the establishment of Automated Teller Machine (ATMs) by most banks for cash dispensing, account balance enquiry and payment of utility cheques. The ATMs in addition provided the basis for setting up electronic links to on-line customers and other accounts system among bank branch network to facilitate payments service. To further improve the efficiency of the payment system, the CBN in 2004 issued the broad guidelines on electronic banking (e-banking). E-banking practice in Nigeria will continue to be promoted in line with global trend. The Bank will continue to encourage banks to install ATM machines for cash withdrawals. Also, in order to encourage the use of electronic money (e-money), in line with international best practices, the Bank continues to issue specific guidelines on standards and use of e-money products such as credit cards, debit cards, digital cash etc. With the recent revolution in the telecommunication sector, the environment for efficient e-banking service delivery has been laid.

The CBN has continued to promote the automation of the payments system to reduce delays in the clearing of payment instruments; reduce cash transactions; and enhance the transmission mechanism of monetary policy. In order to deal with large-value payments and settlements, the CBN has embarked on the implementation of Real Time Gross Settlement (RTGS) system. The RTGS will eliminate the risk in large-value payment, and increase the efficiency of the payment system.

Foreign Exchange Management
As part of the reforms, the foreign exchange market was liberalized with the reintroduction of the Dutch Auction System (DAS) in July 2002 with the objectives of realigning the exchange rate of the naira, conserving external reserves, enhancing market transparency and curbing capital flight from the country. Under this system, the Bank intervened twice weekly and end-users through authorized dealers bought foreign exchange at their bid rates. The rate that cleared the market (marginal rate) was adopted as the ruling rate exchange rate for the period, up to the next auction. DAS brought a good measure of stability in exchange rate as well a reduction in the arbitrage premium between the official and parallel market rates.

To further deregulate the foreign exchange market and also demystify access to Travelers’ Cheque (TCs) by end-users, Travelex Global and Financial Services and American Express (AMEX) commenced the direct sale of TCs to end-users in February 2002. The initiative, among others, was aimed at addressing some travel-related problems associated with foreign exchange utilization. Specifically, the objectives were to: facilitate easy access to travelers’ cheque by end-users; reduce the transaction cost to end-users of travelers’ cheque; eliminate the use of spurious documents in obtaining TCs; reduce the gap between the official and parallel market exchange rates; and encourage the growth of bureaux de change operations.

Other measures adopted to enhance the operational efficiency of the foreign exchange market included the unfettered access granted holders of ordinary domiciliary accounts to their funds, while utilization of funds in the non-oil export domiciliary accounts were permitted for eligible transactions. Furthermore, inward money transfers became payable in the currency of remittance. All oil and oil service companies were allowed to continue to sell their foreign exchange brought into the country to meet their local expenses to any bank of their choice, including the CBN. Procurement of foreign exchange for Business Travel Allowance (BTA) and Personal Travel Allowance (PTA) remained eligible in the foreign exchange market, subject to a maximum of US$2,500.00 per quarter for BTA and US$2,000.00 twice a year for PTA for beneficiaries above 12 years old. For travels to countries in the ECOWAS sub-region, BTA and PTA are issued in ECOWAS travellers’ Cheques.