In light of the increasing exposures of Nigerian banks to loans denominated in foreign currency, the Central Bank of Nigeria in November 2001 issued the “Guidelines on Foreign Borrowing for On-Lending by Nigerian Banks”. These guidelines were put in place by the CBN to ensure that risks inherent in foreign borrowings are manageable by Nigerian banks. However, in recent times, especially given the volatility of the Naira vis-a-vis foreign currencies and the significant increase in foreign borrowings by Nigerian banks, the CBN on October 24, 2014, issued a circular No. BSD/DIR/GEN/LAB/07/037 and titled “Prudential Regulations for the Management of Foreign Exchange Risks of Banks” (the ” CBN Circular” or the “Circular”) to further assist Nigerian banks to manage the risks inherent in foreign exchange and other risks related thereto.
Highlights of the CBN Circular
We have highlighted the key prudential and hedging requirements of the CBN Circular as follows:
The aggregate foreign currency borrowing of a bank should not exceed 75% of its shareholders’ funds unimpaired by losses. This excludes inter-group and inter-bank (Nigerian banks) borrowing (“Foreign Borrowing Limit”); Net Open Position (NOP) (i.e. Total Foreign Assets – Total Foreign Liabilities), should not exceed 20% of shareholders’ funds unimpaired by losses (“NOP Limit”); Banks are required to have adequate stock of high-quality liquid foreign assets i.e. cash and government securities in each significant currency to cover their maturing foreign currency obligations; The CBN also introduced hedging requirements to, inter-alia, ensure that banks on lend foreign currency based on terms which mirror their primary borrowing obligations to foreign lenders.
Implication for Nigerian Banks as regards Foreign Lending
Based on the guidelines issued in 2001, Nigerian banks had the liberty to obtain foreign loans within 200% of shareholders’ funds. However, by virtue of the CBN Circular, they are now expected to stay within a highly reduced limit of 75%. Accordingly, banks are now significantly limited in their ability to raise funds through foreign loans and are required to have adequate liquid assets to cover maturing foreign currency debts. Furthermore banks are expected to comply with the NOP Limit (using benchmarks indicated in the CBN Circular) within six months of the effective date of the Circular.
The effect of the CBN Circular on a disbursed foreign loan facility which has been executed between a Nigerian bank and a foreign lender prior the effective date of the Circular seems unclear, especially where the bank has exceeded the 75% limit but within the previous limit of 200%. As the CBN Circular did not address the position of banks who are bound by contract prior to its effective date, the CBN may have put Nigerian banks at a commercial disadvantage and potential default of the terms of the relevant facility agreement in the event that the CBN Circular is construed retroactively.
Furthermore, the recently introduced NOP Limit will require that banks reduce their foreign liabilities within six months of the Circular. This may involve incurring additional transactional fees ranging from break costs/prepayment fees under facilities agreement, unplanned early redemption of foreign bonds and reduction of foreign currency deposits etc. Clearly the strict compliance requirement of the Circular has the potential of putting financial pressures on Nigerian Banks.
Where the bank is unable to stay within the Foreign Borrowing Limit or maintain the NOP Limit, a breach of the Circular will have occurred. In this regard section 45(6) of the CBN Act provides that the CBN has the powers to prohibit such defaulting bank from extending new loans/advances and from undertaking new investments. The CBN may also levy fines as appropriate.
Whilst the rationale for the CBN Circular seems laudable, we are mindful that its provisions are to take effect immediately. Therefore, the banks are required to maintain the Foreign Borrowing Limit and the NOP Limit without regard to their pre-existing contractual obligations and the financial pressures capable of being exerted on Nigerian banks to ensure compliance. We are in doubt that a number of Nigerian banks will be in a position to ensure compliance with the requirements of the Circular without some pain in light of foreign liabilities built over the years. Accordingly and in order to ensure that Nigerian banks are not suspended from undertaking investments in the foreign exchange market, the CBN may consider giving more time for compliance with the recently introduced NOP Limit whilst ensuring that the Foreign Borrowing Limit is not construed retroactively.