Layman Understanding of the MPR decision by the CBN

CBN increases MPR rate and guys are asking question to what does that mean.

For the sake of learning purposes, let's look at what the numbers are.

In simple terms, MPR rate is the rate that banks and Other financial Institutions (OFI) used to set their own interest rate. Before, the MPR rate is 18.75%, the MPC just increased it 22.75%.

If you step into Gtbank to collect loan, they are going to use their own methodology + 22.75% to arrive at the actual interest rate they will charge you If you will borrow.

Before, bank interest rate on borrowing is around 25% to 30% but now, expect the rate to be around 30% to 35%.

The purpose of this is to discourage people from borrowing in the bank thereby reducing cash in circulation. There are companies out there that borrows billions of naira from the bank. Imagine borrowing N5 billion naira with 35% interest rate.

This means that unless absolutely necessary, companies would reduce borrowing. If companies decide to reduce borrowing, it means they won't have cash at their disposal to spend on a lot of things.

If there is no cash to spend on a lot of things, demand in the market will reduce decrease in demand will further affect prices of commodities thereby reducing inflation.

Lack of cash in circulation reduce inflation, although some people have counter argument that such may not always be the case.

Another way to reduce cash in circulation is to incentivise people to invest the money they have so that they can get huge returns, How?

High interest rate means high investment returns.

If you have N5 billion in your corporate bank that you don't have immediate need for, you can easily call access bank manager and ask him how much will be the interest if you fixed that N5 billion in deposit?

If the interest rate before today is 10%, after this MPR hike, rest assured that the interest you will get on a N5 billion fixed-deposit will be around 15% or even more depending on your negotiation skills.

If bank refuse to give you 15% interest or more, just wait for treasury bills, you will get something higher. The logic is that the government is forcing you to lock your funds by giving you incentive to do so.

As you lock them up, we have less cash in circulation thereby taming you from frivolous spending.

No frivolous spendings = less demand

Less demand = lower price levels

I know you will say its theory but na you sabi??

I used to tell people that in economics, what is good is also bad as well.

If i want to import laptops and I need to import those laptops as a matter of necessity and the only option I have is to go to the bank and get borrowed funds, then the wahala start be that, Bank will lend me funds for my import or whatever I wanna do with it with an interest rate of say 35%.

Because of high interest rate, I have to consider increasing the laptop price to accommodate my repayment plan of the funds I borrowed.

You see the wahala

Now imagine Geometric Power plants in Aba needed some borrowed funds to kick start operation and banks can only give them loan at 30%. Tariff rate must be adjusted to accommodate repayment plan and cash flow security.

This is just an example of the effect of high MPR rate, both negative and positive angle.

Imagine you have $50,000 in savings in UK, you work in the UK and you realise that fixed-deposit in Nigeria or treasury bills is given 20% interest earnings. As a smart investor, what will you do?

Change that $50k to Nigerian naira = N80m (N1.6k/$)

Invest that N80m in treasury bills and you will earn 20% which is N16m p.a after a year, cash out your N96m (excl taxes) and re convert your funds to dollars at the prevailing exchange rate.

Do you know what I just did? I created a scenario that incentivise foreign investors to demand for naira

More and more demand for naira means stronger naira and the exchange rate will be great. All this is part of the strategy for increasing MPR.

There are other benefit as well as demerits of increasing MPR rate.

Let me cut it here and let's briefly look at CRR.

Cash Reserve Ratio

CRR was adjusted from 32.5% to 45%. What does that mean?

It means if Gtbank recorded a daily deposit of N10 billion, they have to compute 45% (N4.5b) and sent to CBN for safekeeping, what will remain with them is just 55% (N5.5b) which is what they will used to give out loans. This is actually meant to restrict or force the banks not to have enough cash to even give loans.

On one hand, you're discouraging companies from borrowing because of high interest rate, on the other hand you're forcing the bank to have higher reserve which will make them give out little to no loan at all. Do you see the strategy??

The next one is the Liquidity ratio (LR)

It means bank at all times must have a minimum LR of 30% This means for every deposit of N100, the banks must kept N30 in their vaults to make sure that immediate withdrawal demand by customers are fulfilled, this is to protect depositors.

Not to bore you with technicals, the objective is that, Banks must at all times have enough money to give out to depositors in case they came to withdraw their hard earned monies'.

No be that Ajo woman that suddenly goes blind after collecting people's money.

The last one is the Asymmetric corridor.

This involves a transaction between commercial banks and central bank. Some of you know might not know but there are transactions of borrowing and lending between commercial banks and central bank and it involves interest rate too.

100 basis point = 1%

700 basis point = 7%

MPR rate is 22.75%

If Gtbank want to borrow money from CBN, then they will pay 23.75% interest rate (22.75% + 1%)

Gtbank may need to borrow money from CBN if they are facing problems of lack of liquidity or they need cash to solve an urgent 2k problem.

On the other hand, if Gtbank has ample or excess cash and wants to deposit the cash with CBN to earn interest-on-deposit, then CBN will give them 15.75% (22.75% - 7%) as deposit interest.

if I be Gtbank CEO, why will I take my excess cash to CBN to earn just a meagre 15.75%? I will rather look for people who need loan and give them loan at 30% interest, easy peasy.

The koko is where will you have excess cash when your CRR is 45% and LR 30%, it's a bit tricky??

Please lets have your contributions, corrections and opinions.