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Monetary Policy Reforms

Following the prolonged use of direct controls, the pervasive government intervention in the financial system and the resultant stifling of competition and resource misallocation, a comprehensive economic reconstructuring programme was embarked upon in Nigeria in 1986 with increased reliance on market force. 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 mis-directed 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 Operating Institutions
One of the objectives of the liberalization policy was to encourage the establishment of new financial institutions through relaxed entry requirements. Also, innovative institutions were encouraged to take advantage of the opportunities created through deregulation. 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. The most visible reform for enhancing competition was the substantial increase in the number of operating licences issued to financial operators. 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 has been expanded several fold since the reforms started. For instance, the minimum capital requirements of banks stand at =N=500 million with effect from December, 1998 compared with the levels of =N=10 million and =N=6 million for commercial and merchant banks, respectively in 1989.

Improved Service Deliver and Products Development
Another positive effect of the reform efforts in the financial sector is the continuous drive by the institutions to improve service deliver through innovations and product development. With the use of modern technology including computers, queues in banking halls which used to be the common feature of banks in Nigeria have reduced significantly. Also, automated teller machines which dispense cash at designated points were being introduced to further reduce the reliance of depositors on the banks for encashment of small amounts. The use of bank cards was also being popularized by some banks to reduce the risk of carrying cash for transactions.

Improved Approach to Monetary Management
It would be recalled that the direct approach to monetary management constituted the main techniques before the introduction of the SAP. Between 1986 and 1993, efforts were made by the authorities to create an enabling environment for the introduction of indirect approach to monetary management. A major action taken as part of monetary reform was the initial rationalization and eventual elimination of credit ceilings for sound banks. After meeting the initial necessary conditions, monetary management shifted to indirect method in which open market operations (OMO) is the main instrument. The conduct of OMO has greatly improved the ability of the CBN to manage liquidity in the financial system. The primary and secondary markets for treasury securities have also 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.

Enhanced Interest Rate Management
In August, 1987, all controls on interest rates were removed, while the CBN adopted the policy of fixing only its minimum rediscount rate to indicate the desired direction of interest rate changes. 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 only required to maintain a specified spread between their average cost of funds and their 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 since October, 1996.

One of the principal mandates of the Central Bank of Nigeria (CBN) is to promote monetary stability and soundness of the financial system. To achieve this, the Bank conducts regular surveillance of financial institutions under its purview in order to ensure compliance with relevant laws and other directives stipulated by the monetary authorities. This helps to enhance orderly operations and quality of financial services. CBN’s surveillance activities can be broadly categorized into two: on-site examination and off-site supervision and other financial institutions supervision.

Improved Payment System.
The payments system is a vital element in a financial system, which facilitates intermediation through the transfer of the value of money from a payer, the one who deposits fund, to the payee, the receiver of the fund, in the process of exchanging goods and services. Thus, the system is the channel through which liquidity and credit are transferred from one participant to another in the financial system. A more comprehensive definition by Balino et al, 1996, puts the system to incorporate, not only instruments,, but organizations, operating procedures and information and communications system used in initiating and transmitting payment information from a payer to payee and in settling payments in the process of money transfer. Banks are better positioned and equipped to play the role of payment intermediaries, because they hold the accounts of those who engage in economic activities, and also provides the liquidity for the payments process to operate effectively in the economy.

Efficient payments system minimizes liquidity risks, as well as, settlement, systemic, credit and operational risks which are inherent in financial transactions. Because of the central role payments system play in a country’s financial system, monetary authorities are concerned about the integrity of their payments system and they seek to put in place adequate and effective legal and institutional arrangements for the efficient performance of the system. The efficiency of the system will depend on the instruments used in the financial sector to promote the transfer of funds, which include commodities such as cowries, livestock and salt in the medieval times to currency, cheques and electronic retransfers in modern times. In recent times, a wide range of instruments, have evolved following the worldwide financial liberalization and deregulation, which are also driven by the users’ changing needs and technologies as well as competition among banks.

An efficient payments system, underlies the optimal utilization of resources, enhances implementation of monetary policy as well as the maintenance of monetary stability. In Nigeria, the modernization of the process for handling payment started with the Magnetic Ink Character Recognition (MICR) implementation programme, 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 Dutch Action System (DAS)
In a bid to address these adverse developments and enthrone sanity in the foreign exchange market, the CBN re-introduced 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.

Automation of the Payment System
The CBN continue to promote the automation of the payment 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.

Read The CBN Act
Read the CBN Act (Decree No 41 of 1991)
Read the Banks & Other Financial Institutions Act (BOFIA)
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