All banks are regulated by the Central Bank in its country of operation. In Nigeria, the regulation body is the Central Bank of Nigeria. And as part of its regulatory measures, certain policies have been put in place to ensure for proper control of the banks and protection of members of the public.
Let us quickly take a look at this policies or tools used by the CBN to regulate the banks in Nigeria.
Cash Reserve Ratio (CRR) - As the name implies, this is a certain percentage of cash or deposit which every commercial bank is supposed to leave with the Central Bank as reserves. This fund remains permanently in an account of CBN and generates no interest to the banks. It helps in controlling liquidity in the banking system and also ensure that banks do not run out of cash to pay their customers at any given time.
This percentage of reserves is usually set in accordance to the guidelines of the Central Bank of a particular country. In the case of Nigeria, the Cash Reserve Ratio is 22.5%. The higher the CRR, the more difficult it becomes to access loans from banks. This is because a high CRR simply means that a bank is obligated to reserve more funds with the CBN thereby leaving them with just a small amount to give out as loan and to meet up with other financial obligations. Sometimes, when it seems that banks are being too difficult with regards giving out loans, you probably might guess right that the CBN have tightened the CRR a bit (Though this is not always the case). How this works is that for every cash received by the bank, they are expected to set aside 22.5% of it with the Central Bank while the balance can be used for their other lending/investment or credit purpose. For example, a customer makes a deposit of ₦100,000 into his account with a certain Nigeria bank; by mode of operation, the bank is expected to remit the sum of ₦22,500 to CBN while the balance of ₦77,500 remains with the bank for their activities. This example only illustrates how the system works and does not mean that it is applied this way for every deposit made in the bank. In a more realistic way, it is practiced by keeping aside 22.5% of a bank’s total deposit at all time with CBN.
In a way, this is supposed to boost the confidence of members of the public; ensuring that banks always meet up with their obligation of paying their customers. Also, it controls banks’ lending ability and ensures that they do not give out so much money as loan without having enough to serve her customers. You may want to ask ‘What Happens when Banks Do Not Have Enough Money to Serve Her Customers; Does it mean that Customers’ Monies are lost?’ The answer is NO. One of the key roles the CBN plays as a regulator is to be a bank to all the banks. This simply means that CBN give loans to banks when they are in need which definitely comes at a cost (Nothing is ever free). This cost is determined by the MONETARY POLICY RATE (MPR) in the country.
MONETARY POLICY RATE (MPR) - The Monetary Policy Rate is the interest rate at which banks can borrow from the CBN. In a situation where a bank does not have enough liquidity in the system, they can always run to CBN for a bail out. The rate availed to them also determines the rate at which the banks will also lend to customers. This means therefore that the higher the MPR, the higher the interest rate of banks for lenders and vice versa. Currently, MPR in Nigeria stands at 14%.
Most banks currently cap their lending rate at 31% meaning that a bank will typically enjoy a spread of 17% on every successful loan given to her customers. Good Business!!
Well, for the fact that the CBN is always there to serve as bankers last resort, they also have a means of monitoring banks to know their level of liquidity (cash or near cash) at every given time. When a bank begins to borrow money too often from the CBN, it is a pointer that something might have gone wrong and needs to be checked. The fastest way of checking this is by looking at their liquidity level. To achieve this, the Central Bank of Nigeria also set a measure known as Liquidity Ratio.
LIQUIDITY RATIO- This term is not just a banking term but used across all sectors of business. However it becomes related to the banks when coming from the Monetary Policy Committee. It means the amount of liquid assets (Cash and near cash) banks have to meet their financial obligations; especially customers withdrawals. This is a further cut from the CRR earlier discussed and also determines the amount of money banks can do business with. In Nigeria, the Liquidity ratio has been set at 30%. When a bank’s liquidity ratio is 30%, it simple means that the bank is very liquid and can readily meet up with her financial obligations. However, when a bank’s liquidity ratio is far from 30%, it could be a negative pointer which requires the immediate intervention of CBN. Usually, what CBN does when they notice this trend over a period is to change the Management of the Bank, inject more funds, change certain policies of the bank and pay more attention to that bank.