The Central Bank of Nigeria (the “CBN”) on 31 January 2024 issued a circular titled the “Harmonisation of Reporting Requirements on Foreign Currency Exposures of Banks” (the “Circular”), which it stated is aimed at managing risks and preventing potential losses that could pose significant challenges to the Nigerian financial system. The Circular comes as the CBN expressed its concerns over the escalating foreign currency exposures of banks, particularly through their Net Open Position (NOP) and their involvement in foreign currency speculations that involves purchasing or holding foreign currencies with the expectation of profiting from exchange rates fluctuations.
The Net Open Position (NOP) is a financial metric used to assess the overall risk exposure of a financial institution, typically in the context of foreign currency assets and liabilities. It represents the difference between a financial institution’s long (buy) and short (sell) positions in a specific currency or a basket of currencies. NOP could be in form of “Long Position” (where a financial institution holds assets denominated in a particular currency with the expectation that the value of that currency will increase) or “Short Position” (where a financial institution has sold assets denominated in a specific currency with the expectation that the currency’s value will decrease). Essentially, the NOP measures the difference between a bank’s foreign currency assets and its foreign currency liabilities.
We have highlighted below the key Prudential requirements that banks must comply with as set out in the Circular;
- The NOP limit for overall foreign currency assets and liabilities, including both on and off-balance sheet items, must not exceed 20% short (holding more foreign currency assets than liabilities) or 0% long (not holding more foreign currency assets than the bank’s shareholder funds unimpaired by losses) of shareholders’ funds unimpaired by losses, using the Gross Aggregate Method;
- Banks with current NOP exceeding 20% short and 0% long are required to bring them within the prudential limit by February 1, 2024;
- Banks should compute their daily and monthly NOP and Foreign Currency Trading Position (FCTP) using provided templates in the Circular (this approach by the CBN is aimed at enhancing transparency in reporting and ensure that banks adhere to the regulatory framework); and
- Banks must maintain an adequate stock of high-quality liquid foreign assets, such as cash and government securities in each significant currency to cover maturing foreign currency obligations. Additionally, establishing foreign currency contingency funding arrangements with other financial institutions is also required of banks.
Other Requirements which banks must comply with as outlined in the circular are:
- Banks should borrow and lend in the same currency to mitigate currency mismatch risks associated with foreign currency exposure;
- The interest rate for borrowing should align with that of lending to avoid mismatches in floating and fixed interest rates, mitigating basis risk associated with foreign currency borrowing interest rate risk;
- In the case of Eurobonds, any clause for early redemption must be at the issuer’s instance, and approval from the CBN is required, even if the bond does not qualify as tier 2 capital;
- All banks are required to adopt adequate treasury and risk management systems to oversee foreign currency exposures and ensure accurate and timely reporting; and
- Banks are expected to promptly bring all their exposures within the set limits and ensure that all returns submitted to the CBN accurately reflect their balance sheets.
If the purpose of the Circular is realized, banks are anticipated to close their net long positions by selling foreign currency into the market. This action could promptly ease pressure in the foreign exchange market and potentially lead to an appreciation of the Naira.
According to the CBN, non-compliance with the specified NOP limit will result in immediate sanctions and/or suspension from participation in the foreign exchange market.