IFN Monthly Article on Nigeria

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Activities in the Nigerian financial services sector took an interesting turn in October when the Central Bank of Nigeria (CBN) barred individuals and local corporates (excluding commercial banks) from participating in its Open Market Operation auctions. Prior to the directive, these instruments formed a substantial part of the investment landscape and one of the largest investment holdings in the local asset management industry.

Following the announcement, money market rates declined sharply as liquidity increased. This immediately exposed the lack of depth in the interest based market as well as the shortage of real sector credit. Thankfully, Islamic Financial Institutions (IFIs) were somewhat insulated from the shock since they are less dependent (due to a dearth of compliant instruments) on government lending.

Nigeria’s Islamic Finance Institutions should be able to take advantage of the current state of the market; having already structured short-term facilities and managed their liquidity without relying on the CBN’s interest-bearing bills. One area in which they may enjoy a competitive edge is in financing the country’s large trade sector which currently accounts for c.16% of GDP. Nigerian IFIs have well-established collaborations in the real sector and typically leverage on Wakala, Murabaha or Mudaraba transactions to fund short transaction cycles of fast-moving consumer good companies and commodity distribution companies. Although these transactions are yet to be securitized as tradeable instruments, recent developments in organized over-the-counter markets and securities exchanges should enable the propagation of these structures in the near term.

We are just starting to see some fund flows from the conventional system into alternative markets in search of diversification and higher yields; however, I expect to see a more visible shift as competition intensifies among financial institutions towards to end of the year.

The CBN remains very committed to driving economic growth through improving real sector lending. To this end, it recently raised commercial banks’ loan to deposit ratio to 65% from 60% in October 2019 and stipulated a punitive higher cash reserve requirement for defaulting banks. The CBN’s focus is, however, at the heart of the activities of Nigerian IFIs who have erstwhile leveraged on the real sector to provide direct financial intermediation. Therefore, I believe that IFIs will be relatively less disrupted by the further activities of the regulators. As the banking sector is steered back to basic banking, the downside is that competition for quality risk assets is bound to intensify.