CBN Issues Directive to Banks: End Use of Foreign Currencies as Collateral for Naira Loans

The Central Bank of Nigeria (CBN) has intensified efforts to enhance foreign exchange liquidity in the economy by issuing a new circular mandating Deposit Money Banks (DMBs) to discontinue the use of foreign currencies as collateral for naira-denominated loans within 90 days.

This directive, issued by the CBN, comes amidst positive developments such as the appreciation of the naira against the US dollar in both official and parallel markets on Monday.

The CBN has consistently implemented measures to increase dollar liquidity in the financial system, aiming to support the naira against the US dollar. The recent circular expressed concerns over the use of foreign currencies as collateral for naira loans and was titled “The use of foreign-currency-denominated collaterals for naira loans” (Reference: BSD/DIR/PUB/LAB/017/004).

While this is not the first time such a directive has been issued, the CBN observed continued use of foreign currencies as collateral for naira loans by bank customers. Consequently, the CBN has decided to prohibit this practice.

The circular instructs banks to phase out all existing loans secured with foreign currency collaterals within 90 days. Failure to comply will result in a 150% capital adequacy ratio computation as part of the bank’s risk assessment.

Under the new directive, borrowers will no longer be able to use dollar deposits in their domiciliary bank accounts as collateral to obtain naira loans, with specific exceptions like Eurobonds issued by the Federal Government of Nigeria or guarantees from foreign banks, including standby letters of credit.

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The CBN’s decision is motivated by concerns over currency mismatch risks that could pose significant financial risks for banks. Some borrowers prefer borrowing in naira rather than converting their dollars to naira, anticipating that the cost of repurchasing dollars might exceed the interest rates on naira loans. However, this speculative behavior can affect exchange rates.

The CBN aims to ensure sufficient foreign exchange supply in the market while supporting the strengthening of the naira through these measures.

In addition to the prohibition on foreign currency collaterals for naira loans, the CBN recently adjusted the exchange rate for Bureau De Change (BDC) operators and plans to sell foreign exchange to facilitate legitimate transactions within the retail market.

Experts have praised the CBN’s actions, anticipating that they will increase dollar supply, strengthen the naira, and discourage speculative activities in the currency market.

This directive is expected to lead to negotiations between banks and customers to liquidate existing loans secured with foreign currency collaterals, releasing additional foreign exchange liquidity into the economy.

In summary, the CBN’s latest circular reflects its commitment to maintaining exchange rate stability and enhancing foreign exchange liquidity in Nigeria’s economy, ultimately supporting economic growth and stability.

You can also read: CBN raises interest rate to 24.75%