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The CBN has since 2002 adopted a medium term monetary policy framework to free monetary policy implementation from the problem of time inconsistency and minimize over-reaction due to temporary shocks. However, periodic amendments are made to the Policy Guidelines in the light of developments in the financial markets and performance of the economy during the period under review. Thus, in 2005 some new reforms were introduced as “amendments and addendum” to the 2004/2005 monetary policy circular No. 37. These include:
Exchange Rate Band (of +/-3.0%)
Interest Rate Policy
Wholesale Dutch Auction Forex Market (DAS)
National Savings Certificate
Cash Reserve Requirement (CRR) -
Public Sector Deposits
Monetary Policy Targets
Monetary Policy Programme
Appraisal of Monetary Policy
Monetary Policy Before 1986
The most popular instrument of monetary policy was the issuance of credit rationing guidelines, which primarily set the rates of change for the components and aggregate commercial bank loans and advances to the private sector. The sectoral allocation of bank credit in CBN guidelines was to stimulate the productive sectors and thereby stem inflationary pressures. The fixing of interest rates at relatively low levels was done mainly to promote investment and growth. Occasionally, special deposits were imposed to reduce the amount of free reserves and credit-creating capacity of the banks. Minimum cash ratios were stipulated for the banks in the mid-1970s on the basis of their total deposit liabilities, but since such cash ratios were usually lower than those voluntarily maintained by the banks, they proved less effective as a restraint on their credit operations.
From the mid-1970s, it became increasingly difficult to achieve the aims of monetary policy. Generally, monetary aggregates, government fiscal deficit, GDP growth rate, inflation rate and the balance of payments position moved in undesirable directions. Compliance by banks with credit guidelines was less than satisfactory. The major source of problem in monetary management were the nature of the monetary control framework, the interest rate regime and the non-harmonization of fiscal and monetary policies. The monetary control framework, which relied heavily on credit ceilings and selective credit controls, increasingly failed to achieve the set monetary targets as their implementation became less effective with time. The rigidly controlled interest rate regime, especially the low levels of the various rates, encouraged monetary expansion without promoting the rapid growth of the money and capital markets. The low interest rates on government debt instruments did not sufficiently attract private sector savers and since the CBN was required by law to absorb the unsubscribed portion of government debt instruments, large amounts of high-powered money were usually injected into the economy. In the oil boom era, the rapid monetization of foreign exchange earnings resulted in large increases in government expenditure which substantially contributed to monetary instability. In the early 1980s, oil receipts were not adequate to meet increasing levels of demands and since expenditures were not rationalised, government resorted to borrowing from the Central Bank to finance huge deficits. This had adverse implications for monetary management.
Monetary Policy since 1986
The objectives of monetary policy since 1986 have remained the same as in the earlier period - the stimulation of output and employment, and the promotion of domestic and external stability. In line with the general philosophy of economic management under SAP, monetary policy was aimed at inducing the emergence of a market-oriented financial system for effective mobilization of financial savings and efficient resource allocation. The main instrument of the market-based framework is the open market operations. This is complemented by reserve requirements and discount window operations. The adoption of a market-based framework such as OMO in an economy that had been under direct control for long, required substantial improvement in the macroeconomic, legal and regulatory environment.
In order to improve macroeconomic stability, efforts were directed at the management of excess liquidity; thus a number of measures were introduced to reduce liquidity in the system. These included the reduction in the maximum ceiling on credit growth allowed for banks; the recall of the special deposits requirements against outstanding external payment arrears to CBN from banks, abolition of the use of foreign guarantees/currency deposits as collaterals for Naira loans and the withdrawal of public sector deposits from banks to the CBN. Also effective August, 1990, the use of stabilization securities for purposes of reducing the bulging size of excess liquidity in banks was re-introduced. Commercial banks' cash reserve requirements were increased in 1989, 1990, 1992, 1996 and 1999.
The rising level of fiscal deficits was identified as a major source of macroeconomic instability. Consequently, government agreed not only to reduce the size of its deficits but also to synchronize fiscal and monetary policies. By was of inducing efficiency and encouraging a good measure of flexibility in banks' credit operations, the regulatory environment was improved. Consequently, the sector-specific credit allocation targets were compressed into four sectors in 1986, and to only two in 1987. From October, 1996, all mandatory credit allocation mechanisms were abolished. The commercial and merchant banks were subjected to equal treatment since their operations were found to produce similar effects on the monetary process. Areas of perceived disadvantages to merchant banks were harmonized in line with the need to create a conducive environment for their operations. The liquidity effect of large deficits financed mainly by the Bank led to an acceleration of monetary and credit aggregate in 1998, relative to stipulated targets and the performance in the preceding year. Outflow of funds through the CBN weekly foreign exchange transaction at the Autonomous Foreign Exchange Market (AFEM) and, to a lesser extent, at Open Market Operation (OMO) exerted some moderating effect. The reintroduction of the Dutch Auction system (DAS) of foreign exchange management in July, 2002 engendered relative stability, and stemmed further depletion of reserves during the second half of 2002. However, the financial system was typically marked by rapid expansion in monetary aggregates, particularly during the second half of 2000, influenced by the monetization of enhanced oil receipts. Consequently, monetary growth accelerated significantly, exceeding policy targets by substantial margins. Savings rate and the inter-bank call rates fell generally due to the liquidity surfeit in the banking system through the spread between deposit and lending rates remained wide. Specifically, 2003 policy measure were design to promote a stable macroeconomic environment to achieve a non-inflationary output growth rate of 5 per cent. In pursuit of its development effort, the Bank, in collaboration with the Bankers’ Committee, established the Small and Medium Industries Equity Investment Scheme (SMIES). In 2003, credit delivery to real sector was encouraged through the SMIEIS and an incentive of lower Cash Reserve Requirement (CRR) regime was prescribed for those banks that increased their credit allocation to the real sector by 20 per cent or more. Moreover, the Bank provided guarantees for agricultural loans under the Agricultural Credit Guarantee Scheme (ACGS)
In recognition of the fact that well-capitalized banks would strengthen the
banking system for effective monetary management, the monetary authority
increased the minimum paid-up capital of commercial and merchant banks in
February 1990 to
The CBN in 1990 introduced a set of prudential guidelines for
which were complementary to both the capital adequacy requirement and Statement
of Standard Accounting Practices. The prudential guidelines, among others, spelt
out the criteria to be employed by banks for classifying non-performing loans.
The CBN has continued to examine and monitor banks in order to promote stable
banking system. Also the Bank handles the problem of distressed and illiquid
banks. The CBN imposes holding actions and revokes licenses of affected banks as
well as encourages mergers and acquisitions. In an effort to improve the
operations of the money market, an auction-based market for treasury securities
was introduced in 1989; and these treasury instruments were made bearer bills to
enhance transferability and promote secondary trading. The developments in the
money and capital markets were mixed in 1998. While the activities in the money
market were influenced largely by developments in the Autonomous Foreign
Exchange Market (AFEM), the capital market witnessed increased transactions in
terms of volume despite the observed decline in market capitalization. The
sanitization and restructuring of the financial sector by the CBN continued in
1999 and 2000, resulting in the decline in the number of distressed banks.
Moreover, the CBN in the context of its surveillance role carried out routine
and target examinations of the financial institutions to ensure compliance with
guidelines and ensure efficiency in their operations. The non-bank financial
institutions, whose operations did not meet the prescribed standard, were either
closed or had their operating licenses withdrawn. In order to improve the
efficiency of the payment systems, some measures were put in place including the
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