The fall in crude oil price in the international market, which is the main source of the nation's foreign currency earnings, continues to exert pressure on the Naira and has prompted the Central Bank of Nigeria (CBN) to issue new Foreign Exchange (FX) policies/guidelines. The guidelines include the adoption of a single foreign exchange market structure and the introduction of derivatives such as forward and futures. Under this new regime, the exchange rate is determined by the forces of supply and demand at the close of each trading day.
Whilst many have argued that the new regime would reflect the true value of Naira against other currencies; one can safely say that it has also impacted negatively on all existing FX denominated contracts and credit facilities. This is primarily because most of the facilities denominated in other currencies especially the United States Dollars (USD) are created without provisions to mitigate the risks associated with the volatility of the exchange rate.
Consequently, Banks and their borrowing customers are now faced with the onerous tasks of meeting their obligations under the terms of these facilities. In other words, some Banks have existing obligations to fund credit facilities albeit at a higher cost of funds and the borrowers are now constrained to bear the cost of the lending at an extremely higher cost for the remainder of the tenor of the facility. This is because where repayment is to be made in FX, the cost of funding and repaying the facility will fluctuate on a daily basis as a result of the flexibility of the current FX regime. Indeed, the situation becomes even more precarious where the borrower's repayment source is naira denominated.
On a slightly related note, a flexible foreign exchange regime will also affect the adequacy of the assets provided as security for FX denominated facilities. Ordinarily, the availability and adequacy of the asset(s) provided as security is one of the conditions for the grant of any facility. It is expected that when it becomes non performing and is eventually cancelled, the assessed and forced sale value of the asset would be sufficient for the repayment of the facility. Thus, where the collateral is valued in Naira and matched against the value of the FX denominated facility at the time of creation, the possibility that the value of the collateral would depreciate when there is a decline in the value of the Naira as against the currency of the facility becomes inevitable. In other words, the Naira value of the collateral may become insufficient for the purposes of securing the borrower's continued indebtedness to the Bank under such facilities.
The questions that now beg answers are, what could have been done differently at the time of creating these facilities and what can be done to reduce the impact of the current flexibility in the FX market? First, perhaps the inclusion of clauses that anticipate a fluctuation in the exchange rates such as currency indemnity clauses, may have mitigated the risk. With this clause, the Bank would have created an obligation for the borrower to indemnify it for any difference in the value of the facility arising as a result of the fluctuation in the exchange rate. Second, to the extent there is no such provision and the facilities are now where they are, expensive and onerous to service by the Bank and the borrower, banks should consider restructuring the terms of these facilities so that this clause and others that will mitigate the effect of the risks that have now arisen. In fact, the Banks will also do well to request for additional security in case of devaluation of the assets or explore more ingenious means of creating security interests to protect their interests during these interesting times.
Without a doubt, the more pertinent issue remains the continued stability of the financial system in spite of the current state of the economy. Hence, one would expect Banks to do all that is reasonable fair to ensure the performance of their loan assets and Borrowers will find a more affordable approach to meeting their obligations under any facility.
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