On Monday, April 8, 2024, the Central Bank of Nigeria (CBN) unveiled a circular prohibiting the practice of obtaining Naira loans using foreign currency-denominated collaterals. This circular, issued to banks, discontinues the practice of accepting foreign currencies as collateral for loans denominated in Naira. This directive can be regarded as a substantial step intended to stabilise the Nigerian Naira’s value and bolster the Nigerian economy.
Thus, this article appraises the implications of this Circular, particularly focusing on its impact on the Nigerian economy as well as various stakeholders such as banks, businesses, and individual borrowers.
Digging Deep into the Circular of April 8, 2024, and its Objective
Prior to the issuance of the CBN Circular on April 8, 2024, Nigerian Banks and Financial Institutions accepted US Dollars, Euros, Pounds, and other forms of foreign currency assets as collateral for loans denominated in Naira. However, by the Circular, the practice of using foreign currency-denominated collaterals to obtain Naira loans has been prohibited.
The Circular however provides for two exceptions in which foreign currency collaterals would be permitted in obtaining a Naira loan. The exceptions are where the foreign currency collateral is Eurobonds issued by the Federal Government of Nigeria and where the foreign currency collateral is guarantees of foreign banks.
The prohibition of foreign currency-denominated collaterals for Naira loans was necessitated due to the challenges posed by the heavy dependence on foreign currency assets as collateral in Nigeria where the devaluation of the Naira to dollar rate has been a major ongoing economic and financial concern. There were inherent risks associated with the Naira depreciation and fluctuating Naira to Dollar rates, whilst engaging in obtaining Naira loans with foreign currency collaterals.
Overtime, the practice of using foreign currency-denominated collaterals for Naira loans largely contributed to the depreciation and devaluation of the Naira as it enabled businesses and individual borrowers to bet against the Nigerian Naira, thus exerting downward pressure on the Naira’s value.
The instability in the Naira to dollar exchange rates in recent times has posed challenges for businesses and individuals alike. By prohibiting foreign currency collaterals, the CBN aims to mitigate the risks associated with the Naira fluctuations and instability, thereby promoting stability in the foreign exchange market. Thus, the CBN Circular of April 8, 2024, mandating financial institutions to only accept Naira-denominated collaterals for Naira loans can be said to be a significant shift in policy and aligns with the broader objective of promoting exchange rate stability and preserving the purchasing power of the Naira.
Implications of the CBN’s Circular of April 8, 2024
While the prohibition of foreign-currency collateral can be said to be a right step in stabilising the value of the Naira, the prohibition would have some implications for financial institutions, stakeholders/ investors, and individual borrowers alike.
Encouraging the use of Naira-denominated collaterals to obtain Naira loans can be said to be a step in strengthening the Naira and enhancing its credibility in the global market. This initiative is poised to diminish reliance on foreign currencies within Nigeria, consequently shifting the focus towards the Naira.
Furthermore, the prohibition of foreign currency collaterals to obtain Naira loans is likely to impact the profitability of banks, especially those with significant exposure to foreign currency-denominated loans. However, over the long term, it may lead to a more stable and sustainable banking sector. Banks will also need to adapt their loan-lending internal policies to comply with the new directive of the CBN. This may include reassessing credit regulations and adjusting collateral requirements for Naira loans.
However, the prohibition of foreign-currency collateral to obtain Naira loans may pose initial challenges to Nigerian businesses seeking to obtain Naira loans. This is because businesses will need to provide collaterals in Naira, and this may affect businesses with significant assets denominated in foreign currencies, such as FinTech companies and Startups.
It is however worthy of note that the ban on foreign currency collaterals will provide businesses and individual borrowers with greater certainty regarding their borrowing costs in the local currency. Consequently, borrowers will have greater clarity and predictability in their financial obligations, where the collateral is in Naira as opposed to depending on the fluctuating exchange rates. The promotion of Naira-denominated transactions is also expected to increase the liquidity and stability of the Naira, which would promote price stability and sustainable economic growth.
Conclusion
The CBN’s decision to ban foreign currency collaterals for Naira loans can be regarded as a deliberate measure to reduce risks in the Nigerian financial system, while simultaneously fostering stability and bolstering the credibility of the Nigerian Naira.
While there may be short-term challenges for stakeholders adjusting to the new policy, the long-term benefits in terms of enhanced financial stability and reduced Naira to dollar fluctuations are significant and justify the policy.
