Central Bank of Nigeria (CBN) is ready to do whatever it takes to reduce inflation rate, CBN Acting Director, Banking Supervision Department, Dr. Adetona Adedeji has said.
He disclosed this in CBN Talk Today, a podcast titled: Loan to Deposit Ratio Adjustment, posted on the apex bank’s website and monitored from Lagos.
Domestic headline inflation further rose to 33.2 per cent in March, higher than 31.70 per cent in February and 29.90 per cent in January 2024.
The CBN listed key drivers of inflationary pressure as the strong exchange rate pass-through to domestic prices, high cost of energy and other production inputs, lingering insecurity, especially in food producing areas and legacy infrastructure deficits.
Reiterating dangers of high inflation, Adedeji said that inflation has killed many economies, and CBN is committed to ensuring that inflation rate in the country drops using the right monetary policy tools. He said last week’s decision of the apex bank to cut Loan to Deposit Ratio (LDR) from 65 per cent to 50 per cent was a significant approach to put soaring inflation under check.
He said current LDR aligned with the CBN’s current monetary tightening plan. Accordingly, the CBN has decided to reduce the LDR by 15 percentage points to 50 per cent, in a similar proportion to the increase in the Cash Reserve Ratio (CRR) for banks.
He directed all commercial banks to maintain the LDR level and ensure that average daily figures are continually applied to assess compliance.
Adedeji explained that LDR rate is crucial in assessing banks’ capacity to lend, manage risks and ensure financial system stability, stating that LDR evaluates a banks’ lending activities, relative to their deposit base.
“We try to combat inflation in different ways but the ultimate objective is to combat inflation. And that is exactly what central bank is doing today. Whatever it takes to fight inflation, we’re going to do that,” he stated.
Adedeji said fighting inflation will also require reducing the volume of credit banks can lend to customers and also boosting the quality of such credits.
“Sometimes it’s not the quantum of credit that you’re able to churn out that matters, but the quality of the credit you’re able to package. In line with the CBN mandate, the apex bank is utilising orthodox monetary policy to manage the economy and LDR is one of the metrics used to evaluate banks’ lending activities, relative to their deposit base,” he stated.
On how the apex bank came to rely on LDR to control inflation, he said it started since 2019, when it was observed there was a massive slowdown in credit growth.
“This policy was created to ensure that money flows into the real sector of the economy. The LDR then was set at 60 per cent, and later increased to 65 per cent before it was last week reduced to 50 per cent. And if you want to combat inflation using the orthodox method, you need to balance what you do with the monetary policy tools and other measures,” he said.
On the connection between LDR and rising inflation, he said the last Monetary Policy Committee (MPC) took the decision to mop up excess cash in the economy by raising Monetary Policy Rate (MPR).
The MPC last month, raised the MPR by 200 basis points to 24.75 per cent from 22.75 per cent; adjusted the asymmetric corridor around the MPR to +100/-300 basis points.
He explained that the MPC decision limited the ability of bank customers to take loans, and for those who must take the loans, the volume of loans had to drop because of the high interest rates. That move, he added, limited the volume of cash in circulation.
He said that any policy that enables banks to lend more, will indirectly increase money supply and raise inflation rate. “There is an inverse relationship between loan to deposit ratio, monetary policy rate and cash reserve ratio. If you are going contractionary, you have to increase both the MPR and CRR. But to achieve your results further, what you need is to reduce the LDR to control inflation, and that was what the CBN did,” he said.
Adedeji explained that when money supply is reduced, the interest rate will also go up. “The contractionary measure of the CBN means that it wants to reduce money supply. And when an economy is experiencing inflationary pressure as it is currently with Nigeria, it is the duty of the apex bank to ensure price stability. To achieve this, the apex bank uses diverse means including option of adjusting the money supply, the best option is to bring down the LDR to ensure that banks’ ability to lend more to the economy and circulate more cash is reduced,” he said.
He said although the policy could lead to unemployment, but there must be tradeoff for the economy to move forward.
“If you look at the traditional Phillips curve, it says you cannot fight two things at the same time, there could be trade off. If you are fighting inflation, you cannot fight unemployment at the same time”.
“The Phillips curve states that inflation and unemployment have an inverse relationship. Higher inflation is associated with lower unemployment and vice versa. Even if you are going to fight it, it will not be at the desired level. So, you have to chose either to fight inflation or unemployment. Both are key macroeconomic objectives that are very critical to the development of the economy,” he stated.
He explained looking at economies that inflation has killed, one will not talk of economic growth but focus on tackling inflation.
“We will continue to fight inflation, and when we bring inflation down, we will start talking of economic growth,” he said.
