Nigeria’s monetary plumbing is broken and it’s leaking liquidity into all the wrong places

BY NURUDDEEN USMAN

Despite over a year of monetary tightening, inflation persists, the naira remains under pressure, and liquidity remains abundant. At first glance, this seems paradoxical, but the reality is that Nigeria’s financial plumbing, its central bank’s tools for transmitting monetary policy is outdated, narrow, and inefficient, causing leakage and disconnects from the real economy.

A key contributor to these issues is a narrow collateral framework that channels liquidity into short-term government securities and the Foreign Exchange (FX) market, starving the private sector of affordable, long-term credit.

To access liquidity from the Central Bank of Nigeria (CBN), whether through repurchase agreements, discount facilities, or emergency support measures, banks are required to provide collateral. However, the range of eligible collateral in Nigeria is limited and inflexible, predominantly comprising Treasury Bills, Federal Government of Nigeria (FGN) Bonds, and a select few government-guaranteed instruments.

Eligible collateral includes instruments such as Federal Government of Nigeria (FGN) securities including Treasury Bills, Bonds, and Sukuk-issued instruments like Open Market Operations  (OMO) bills. However, collateral such as corporate bonds, securitized assets, infrastructure papers, and mortgage-backed securities are not accepted, regardless of their credit quality or risk management standards. 

The outcome is a distorted financial system in which banks are deterred from holding or underwriting private sector assets, as such assets tend to become illiquid during periods of stress. Consequently, excess liquidity is primarily directed toward a limited range of instruments: predominantly short-term government securities and, increasingly, the foreign exchange market. The strict eligibility criteria for collateral significantly constrains the effectiveness of monetary policy.

While the central bank may increase interest rates to curb inflation, the transmission mechanism is impeded, as banks are limited in their response due to the structure of their balance sheets. Additionally, some institutions face barriers to accessing liquidity because they do not hold the approved collateral types. 

At the same time, the limited tenor of eligible government debt forces a cycle of short-term sterilization. As open market operations (OMOs) and treasury bills mature, liquidity floods back into the system, and the CBN is forced to reabsorb it  often through aggressive cash reserve ratio (CRR) debits. It’s a Sisyphean effort, with liquidity constantly returning through the back door. 

Where does the rest of the liquidity go? Into speculative sectors. The central bank is left managing symptoms, not causes conducting repeated OMOs to drain liquidity, defending the currency, and raising rates that struggle to bite. The consequences for the real economy are severe. Productive sectors including manufacturing, housing, and infrastructure are starved of long-term credit. The corporate bond market remains shallow, fragmented, and illiquid. Securitization has barely taken root. And banks, wary of holding non-eligible CBN assets, avoid extending longer-tenor loans that align with Nigeria’s development needs.

Worse still, these dynamic fuels a crowding out of private enterprise. Government borrowing, funded by the recycling of bank liquidity into risk-free securities, dominates the financial landscape. The system is skewed toward lending to the sovereign, while firms are left competing for shrinking pools of credit.

The market’s underdevelopment is not just an unfortunate outcome; it is a direct by-product of a policy architecture that disincentives diversity in financial intermediation. While monetary policy and central bank liquidity operations are part of the story, broader financial sector regulation must also evolve. Nigeria’s vast pool of long-term domestic capital, particularly in pensions and insurance remains underutilized in financing the real economy.

Currently, investment guidelines from both the National Pension Commission (PenCom) and National Insurance Commission (NAICOM) impose conservative restrictions that limit exposure to credit assets, particularly corporate bonds, infrastructure securities, and structured finance products. In practice, this means that pension funds and insurers allocate disproportionate shares to sovereign debt and money market instruments replicating the same crowding-in effect visible in the banking system. To unlock patient capital and support market deepening, prudential regulators must create space in a risk-sensitive way for long-term investors to take measured credit risk. This could include:

• Higher caps for investment-grade corporate bonds;
• Clear criteria for infrastructure-linked bonds.
• Guidelines for participating in asset-backed securities or mortgage pools.

By aligning the incentives of institutional investors with market development, these reforms would stimulate primary issuance, diversify portfolio holdings, and support a more resilient financial system. The case for broadening the CBN’s collateral framework is no longer theoretical, it is strategic. A phased expansion to include high-quality corporate bonds, securitized assets with credit enhancements, and infrastructure-backed securities would allow more banks to access central bank liquidity, improve transmission, and channel resources into productive sectors of the economy.

These reforms would require guardrails: minimum credit ratings, conservative haircuts, transparent pricing, and legal certainty in enforcement. But these are manageable, and global precedents exist from the European Central Bank (ECB) broad collateral approach to the Bank of England’s extended liquidity insurance operations. The bigger risk is not doing too much but doing too little. Maintaining the status quo risks reinforcing a financial architecture that favors government financing over private sector growth, short-term speculation over long-term investment, and liquidity management over credit creation.

Nigeria’s macroeconomic challenges: inflation, weak growth, exchange rate volatility, demand coordinated responses. Fixing the country’s monetary plumbing is essential. That means expanding the toolkit, modernizing the collateral regime, and enlisting all financial sector regulators including PenCom and NAICOM in the project of building a credit system that works for development.

The goal is not to dilute standards, but to rebuild the channels through which monetary and financial policies can reach the real economy. Because when liquidity cannot flow where it’s needed most, into homes, factories, roads, and power grids the problem is not just technical. It is structural. And it is fixable. 

Nuruddeen Usman is an economist. He can be reached via[email protected]