In the last four years, the Central Bank of Nigeria (CBN) has tightened monetary conditions even as inflation moved into and seemed comfortable in the single digit range — an unusual experience for this economy.

The organised private sector has made much of how these tight conditions, especially high interest rates have made it difficult for businesses to thrive — indeed, may have been responsible for high mortality rates in the middle corporates. Incidentally, these tight monetary conditions have had the added advantage of attracting foreign portfolio inflows (FPI) — the dollar portion of which may have helped the CBN maintain relative stability in the exchange rate markets.

The fate of the naira into which these dollars are converted is, however, a different matter entirely. Does the domestic currency equivalent of the FPI end up with the banks? And if it does, what do the banks with them? The CBN has often charged excessive bank liquidity with being the main source of demand pressure in the foreign exchange markets; and its rate-setting committee (the Monetary Policy Committee — MPC) has repeatedly acted in restraint of this liquidity, by targeting its policy measures directly at the banks’ money-pot.

Imagine my surprise, then, at a meeting two weeks ago with treasurers and market liquidity managers of a few banks (in the space before last week’s MPC meeting), when it emerged that the CBN’s measure of market liquidity might be missing several tricks. The central poser at this meet was “even if we take traditional measures of liquidity, how well does the apex bank’s measure reflect market conditions?”

The CBN has about twelve components that go into its calculation of the numerator of banks’ liquidity ratio — local currency deposits sit at the bottom of this measure. Of the twelve, three are properly liquid: net interbank placements with other banks; net money at call with other banks; and net placements with discount houses. According to one bank treasurer, the rest of the CBN’s measures have a limited degree of acceptability in the market place for liquidity generating purposes.

Indeed, the apex bank also includes the sum of all banks’ closing balances deposited with its standing deposit facility (SDF) in its estimation of market liquidity. Ostensibly, the SDF balances measure cash flow, and not liquidity. This is because a large part of these balances comprises third party funds, including from the recent foreign portfolio inflows. Thus, in those instances where a bank faces large maturing treasury bills obligations, it is difficult to properly argue that its balances with the CBN reflect its net liquidity.

A better assessment of the industry’s liquidity position that includes this measure would benefit a lot from decomposing maturing treasury bills and bonds by holder. Thus disaggregated, i.e. with third party obligations stripped out, the residual on these balances would be made up of banks’ proprietary holdings, based on which industry liquidity may then be properly computed.

Actually, the consensus amongst the banks’ market liquidity managers whom I spoke with is that, currently, Federal Government bonds make up about a third of banks’ liquid assets. True, there is a repurchase market for these instruments. However, the repo market functions in such a manner that these bonds properly speaking are not as liquid as the apex bank makes them out to be. Therefore, not just can they not be easily deployed in banks’ daily operations, but by including them in the computation of banks’ liquidity, the CBN would always arrive at a high computed liquidity ratio for the industry.

It could, on this basis, move to tighten monetary conditions, whereas, in truth, banks face limited cash liquidity. The danger that the CBN might be going at a fly with a sledgehammer is as real, in this case, as the dread that it might have been blitzing a mammoth with a peashooter. Any which way, the economy suffers. Constrained cash liquidity means that banks put up rates across board.

Put aside, briefly, the perennial worry that higher rates mean that the real sector is then denied access to loanable funds. (Truth is that bank lending is necessarily short-term; and if we were truly to develop this economy, we would need to develop different sources of longer-term capital).

Consider instead the threat to the banking industry of a worsening portfolio of dodgy loans, as borrowers buckle under higher interest rate burdens. And/or the resulting incentive for banks to cut corners as they struggle to deliver promised returns on a reduced lending base.