On January 31st this year, the Central Bank of Nigeria issued a circular to banks. The guideline specifies that banks and fintechs should report their Net Open Position. This guideline specifies what banks must do for the CBN to monitor their foreign currency exposure.
What's Net Open Position (NOP)
NOP is the difference between a bank's assets and liabilities of foreign currencies. It explains the Bank's exposure to foreign currency risks. If a bank has a higher NOP it increases its risks to volatility of FX rates. However, a lower NOP will put the bank in a safety zone.
Net Open Position includes foreign currencies in the vault, short and long terms investment placed in foreign currencies, and loans and advances in those currencies. To understand a bank’s exposure to foreign exchange risks, each foreign currency exposure risk must be calculated separately. Then, the gross average method is used by banks to compute the open positions before netting them.
Importance of computing Net Open Position
The significance of NOP cannot be overstretched. Banks are exposed to lots of risks. From reputational risks to credit risks and of course foreign exchange risks. Since banks accept foreign currencies from their customers, these increase their liabilities. Therefore, banks must invest the currencies on less risky assets, so that, when customers need their FX, it is readily available to them by the bank.
However, due to the depreciation of the Naira against the dollar and other foreign currencies, banks are pushed to own more foreign currencies to benefit from the depreciation of the Naira. Posing the bank into high exposure to FX risks. Banks may also owe long-term assets on foreign currencies. Which increases the risk. Why? If in the long run, the Naira begins appreciating, it will have a great impact on the bank.
Banks will make losses from FX. This will pose a trait to their shareholders funds. When this happens, the CBN will force the shareholders of the bank to pump in more money or fofielt the bank for other investors. Aside from this risk, the bank may not have enough FX to pay their customers. Thereby affecting their reputation. Also, when banks give out loans in foreign currencies, and the borrower fails to pay, it increases the bank's credit risk.
What's in the CBN guideline on NOP?
The apex bank has directed commercial banks to report their Net Open Position daily to the relevant department of the CBN. Also, they are expected to maintain a 20 percent NOP on shareholders’ funds unimpaired by losses. This 20 percent is on short-term foreign currencies exposure. The central has zero tolerance for long-term foreign currency exposure and has forced banks to avoid them with the new directives.
More so, banks are expected to have a reserve for FX (referred to as foreign currency contingency fundings) in other banks. These will help prevent the bank from exposure to the volatility of the foreign exchange. With the new guidelines, banks are forced to clear off any excess FX with them.
In final words, Net Open Position is the difference between the open position of assets and liabilities of a bank’s foreign exchange. The apex bank of Nigeria has directed banks to report their NOP daily and to keep it at 20 percent of their shareholders' funds. This will help protect banks against FX risks.
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