NIGERIAN BANKING SECTOR CRISIS: AN APPRAISAL OF CAUSES AND THE EFFECTS

NIGERIAN BANKING SECTOR CRISIS:  

AN APPRAISAL OF CAUSES AND THE EFFECTS 

ANDAH, David 

Abstract 

In recent times, the Nigerian economy has witnessed the progressive depreciation of the financial sector which is caused by Bank failures. The financial sector of an economy performs an important role in economic growth and development. In Nigeria, the financial sector constitutes the life blood of the economy because of its financial intermediation. This paper examines the causes and effects of the banking sector crisis using a qualitative analysis of existing secondary sources.The performance of the health of the economy is in fact a reflection of the efficient functioning of the entire economy. The failure of the financial industry in a manifestation of the failure of the economy, the weaknesses in the regulatory framework and governance of the Banks. The CBN injection financial bail out to bail out distressed Banks must be sustained along with streteghned risk management infrastructure. 

Introduction 

Bank distress, insolvency and failure have often been used interchangeably when describing the operational condition of a bank. However, these terms depict degrees of banks operational problems. Umunnaehila (1996) identifies two types of insolvency. Technical insolvency which arises from inability of a bank to meet its 'obligation on temporary basis because of illiquidity and operational insolvency which means that the bank is in such a financial distress not just in the short run but even from the long run. In the first situation mobilization of its short term invested funds can remedy the situation. 

According to Ebhodaghe (1996) "Bank distress is a situation of persistent weakness facing a bank with low or negative capital base requiring assistance from supervising/ regulating authority. Bank distress may also be viewed from the point of illiquidity of the affected bank resulting in a situation where the bank is unable to satisfy the simultaneous demand for funds by depositors as in the short run. Bank failure on the other hand is a situation of a more serious financial problem of a bank resulting in the cessation of its operation. 

Alashi (1985) defines bank failure as being a state of complete cessation of operation by affected banks or continuance of normal operation with the assistance of regulatory/supervisory authorities. This definition somewhat is similar to the definition of failed bank under the failed bank (recovery of Debt and Financial Malpractice in Banks) Act 18 of 1994.  

The Act defines failed bank thus:-  

"Failed Bank" means a bank or other financial institution whose license has been revoked or which has been declared closed, placed under receivership or otherwise taken over by the Central Bank of Nigeria or the Nigerian Deposit Insurance Corporation".  

While the two definitions above emphasizes ceasure of the normal operation of the bank and the intervention of the regulatory institution as indices of failure, it has been argued that insolvency or distress is often seen from different view point in that it may not result in the complete cessation of the operation of the bank, withdrawal of its license and subsequent intervention by regulatory institution. Therefore if adequate financial measures are taken, an insolvent or distress banks may be taken out of such situation and thus avoid a situation of failure.  

Bank failure often have some symptoms through which it can be detected or diagnosed' and even remedied. Though, often times; the manifestations of these symptoms are normally followed by cover up rather than seeking remedy to the problem. The symptoms include deteriorating cash-flow. It is evident that an adverse cash-flow must be the commonest warning signal to the banker. When these situations do occur and the bank is unable to remedy it that would be practical signal of impending failure. Distress can also be seen when a bank resorts to creative accounting through revaluation of Assets to produce a bank surplus to cover trading loss etc. (Falegan, 2008).  

This paper examines the nature of crisis in the Nigerian banking system and the role of regulatory authorities with a view to addressing the emerging crisis. 

Causes of Bank Failure 

Several factors account for bank failure in Nigeria. These factors can be extraneous factors i.e. factors outside the control of the banks and internal factors which are within the banking industry.  

The success of the financial sector is to a large extent dependent on the performance of the economy. Nigeria, in recent times have had a high level of macro economic instability which has adversely affected the performance of the banking sector, most especially when considering the inconsistent and frequent changes in macro economic policies. The introduction of SAP in 1986 and the fixing of interest rates and later deregulated in 1987 and later fixed again in 1991 are some of the inconsistencies. These have negative effect on macro economic indicators like money supply, fiscal policies, inflation and exchange rates. The high deficit financing embarked upon by government due to the downturn in the economy which is normally financed by banking sector has the effect of high injection of liquidity into the economy with resultant high rate of inflation and exchange rate depreciation. The worst of it is that the fiscal deficits are not expended on productive ventures. Its effect on the exchange rate has eroded the value of the Naira thereby expanding the debt stock of the banks, eroding the real value of incomes and distorting the operating environment (Umunneahila, 1996).  

Deregulation led to dramatic proliferation of "wonder banks" which polluted the financial system and eroded confidence in the System (Ekechi, 1995). The Banks deposit insurance scheme believed to be a stabilization factor could not check the tide of distress, as it was highly criticized in many quarters because it was argued that when Insurance premiums are unrelated to the expected cost of failure, it gives banks the incentive to take excessive risk than they otherwise would.  

Ekechi (1995) opines that “…deposit insurance has probably been the most criticized government policy related to banks. Many economist, believe the deposit insurance encourages banks to take excessive risks, thereby increasing their chances of failing". The assertion is no doubt true when considering the fact that irrespective of the insurance scheme, many banks still went distressed and had to be wound up.” 

Another exogenous factor responsible for bank failure was the lack of autonomy for the regulatory authorities. The CBN was never autonomous. It was regarded as a parastatal of government. It was first placed under the supervision of the Ministry of Finance and later the presidency. The CBN became subject of political interference instead of being allowed to perform its specialized financial role. Apart from being saddled with the responsibility of managing government debt burden, it was also engaged in retail banking. It could therefore not effectively supervise the growing number of licenced banks. This left the banks to operate without effective supervision and the reckless operators in the industry cashed in on the ineffectiveness of the CBN to ruin the banks.  

Another very important factor worth mentioning here is government ownership of banks. According to the CBN monitoring guideline of 1985 the Federal Government had 60% shareholding in most of the big banks. State governments also followed suit to establish their banks. Because of its majority share holding, the Federal Government appointed majority of the directors of the banks. State owned banks became political tools in the hands of government to finance its unviable projects. Appointments to the boards were on political consideration rather than professional competence. Unsecured loans were •granted to government and its agencies and officials without collateral. Poor management coupled with high level of non performing assets mostly granted to government and its cronies took a toll in the general performance of the bank. This was evident in the erosion of the capital base of the bank leading to failure of most of the banks in this category (Ogwuma, 1987). 

  

Until recently, the Federal Government saddled itself with the responsibility of licensing banks in Nigeria. That was the era of the socalled 'banking boom. The government, without the necessary technical ability to assess the feasibility of banks, simply granted most of the licences as patronage to friends and well-wishers without restraint. In fact, the management-of CBN On numerous occasions did advice the government to exercise caution in licensing new banks but, it was over-ruled. Even when it became apparent that the friends of the government were no longer in a position to manage the banks, the CBN was prevailed upon to ensure that none died (Oche, 2004). 

The consequence of this most disgustful government policy was that unviable banks were sustained by government fund, while the CBN virtually had no control• over those that were badly, managed. Thus it was rightly observed by Sanusi (2009), that; no amount of CBN supervision could have saved banks that were badly managed, as a result of criminal insider abuse and other inadequacies. 

The radical posture adopted by the present CBN Governor and subsequent dissolution of Boards and Management of seven Banks, namely Union Bank Plc, Intercontinental Banks Plc, First Inland Bank Plc, Oceanic Plc, Spring Bank Plc, AfriBank Plc and Bank PHB Plc and appointment of new management has brought sanity to the Banks. "From now on, sanctions, including the suspension or revocation of  banking or authorized dealership licences, shall be imposed decisively (on erring banks). Indeed, the riot act has been read. What now remains is the implementation. It is believed that the new governor of the apex bank would breathe in a new lease of life into the banking sector and the national economy generally.  

The problem of capital inadequacy has lead to several recapitalization problems. A banks capital is an important means through which losses are absorbed. It also cushions shock on the soundness and stability of a bank enabling it to regain equilibrium in the face of abnormal losses not covered by current earning and to re-establish a normal earning pattern (Shamsuddeen, 2003). 

The most unfortunate feature of the banking boom era was undercapitalization. Most of the banks licensed at that time were established with inadequate capital. Even though section 9 (2) of BOFIA 2004 as amended has prescribed N25 billion as the minimum paid up capital for commercial banks, Banks were still granting credit facilities over and above their paid up capital. Most of these loans which were none performing eroded the capital base of many banks thereby making them insolvent. 

According to Odozi (1998), Liquidity is the ability of a bank to meet its liabilities as and when they fall due. In the banking industry, the banks ability to meet its demand, savings and time deposit withdrawals as and when such withdrawals are demanded or are due shows that such banks have no liquidity problem.  Odozi (1998) opines that the banking boom era was characterized by illiquidity as most banks could not meet their obligation and request for cash. Furthermore, many banks had no good asset base which could be converted to cash to meet obligations. The excess regulation of the financial system made capital and money market a little bit stiff and inaccessible as a ready source of cash. This saw many banks struggling to meet their obligation because of the lack of cash.  

The quality of management constitutes one of the most important elements for the success of a bank. According to Ebhodaghe (1996):  

"Poor bank management had in the past resulted in excessive risk-taking. Such banks were often at 'fault through excessive operating expenses, inadequate administration of loan portfolios and overtly aggressive growth policy to attract deposits interest rate speculation coupled with other instances of poor judgment resulted in stress for their bank," as graduates of English, Music, Religions studies found themselves in banks as managers and supervisors. As would be expected, technical incompetence was evidenced in the banking industry. Good management basically entails technical competence, leadership and administrative ability, compliance with banking regulations, ability to plan arid respond to changing circumstances, adequacy of and compliance with internal policies, depth and succession and  demonstrated willingness to serve the legitimate banking needs of the economy. All these qualities were lacking in most banks. This resulted in the distress of many banks in the system (Ebhodaghe, 1996).  

According to Oboh, (2005), Banking malpractice and insider abuse which came in different forms have in no small way contributed to bank failure in Nigeria. These malpractices are usually perpetrated by outsiders, staff, and even some top management staff. They include fraud and forgeries of different kinds which types are never exhaustible as new methods and devise are invented on a daily basis.  

Other types of bank malpractices include over-invoicing for services to the bank, opening and operating of fictitious account together with the creation of false credit balances, diversion of bank funds, embezzlement or outright theft of cash. Foreign exchange malpractice, advances to non existing customers, double pledging, cheque kiting, computer fraud, cheque clearing fraud, money laundering and advance fee fraud (419), letter of credit fraud, and money transfer fraud etc. all these were features of the banking industry in the banking boom era which contributed immensely to bank-failure in Nigeria. 

It was these incidents that led to the prosecution of many banks directors and customers under the Failed Banks Act. Evidence led in quite a number of the cases disclosed that the directors were advancing colossal sums of depositors funds to themselves by use of fronts, and in some cases, to companies in 'which they have substantial interests. What the Failed Bank Act has done in this instance is to lift the veil of incorporation so that such directors could be held personally liable for the debts of the banks.  

Perhaps poor loan administration was the most endemic cause of bank failure going by the ongoing recovery of debts by the failed bank tribunal. It constitute the greatest; internal problem for the Nigerian bank. The staggering volume of non-performing, assets or bad debts resulting from poor loan administration has left many banks in precarious financial situations. Many loans granted are not properly appraised. Others are not secured. In some banks, there is no detailed operational manual resulting in poor internal control measures and unregulated limits of lending powers. Prevalent also are cases of unauthorized lending and lending to ghost borrowers.  

Many directors and management staff have used their positions to grant credits to their private 'companies, friends and relatives without going through the due process of appraisal. Some of the loans are granted on speculative criteria and without collateral security. This normally result in difficulty of recovery of such loans and in most cases is written as bad and doubtful debts. There is no doubt that an unhealthy bank practices lead to bank failure.  

It was the intervention of the government of the time that brought these sharp practices to the fore. The appointment of the NDIC as provisional liquidator which invariably suspended the powers of the board of directors and the promulgation of the failed bank Act pursuant to which the Failed Bank Tribunals were established, facilitated the prosecution  of Bank directors (NDIC v FMB Ltd, (1997). 

Poor internal control accounted for some of the problems. Internal control refers to the whole system of controls, financial and otherwise, established by the management in order to carry on the business of banking in an orderly manner; safeguard its assets and secure as far as possible the accuracy and reliability of its record.  

Alo (1999) Opines that this system of control must be put in place for orderly conduct of business. Most banks in Nigeria, especially, during the banking boom lacked internal control. This resulted in fraud and forgeries, unauthorized lending, disregard to lending rules, and contraception of regulatory guidelines. The existence of porous and unenforceable financial and administrative control no doubts account for internal cause of bank failure in Nigeria.  

Discussion and Findings   

The effect of bank failure is mostly felt by depositors and also has a macro effect on the economy (Alo, 1999). This is so because the depositors provide the funds for which the banking system uses to service the financial sector of the   economy. In other words, the banks are there because of depositors and because the depositors patronize the banks, the bank can service the financial sector  

When a bank fails, the worst hits are the depositors. This is so because they lose their outstanding balances in the bank. Such losses depending on the circumstances of each case are capable of crippling the entire business of the depositor. Apart from this, life saving depositors becomes psychologically and mentally troubled as they realize that their life savings are gone. Although it could be argued that the deposit insurance by the NDIC to the tune ofN50,000 provides a relieve to depositors below N50,000, this is nothing but a drop in the bucket to huge investors. Furthermore, while NDIC only insured deposit of banks, other finance companies and mortgage banking institution were left without an insurance scheme. The distress which also hit these classes of banks further eroded confidence in the banking system. Consequently depositors had to resort to the archaic way of home hoarding money in their homes. This no doubt reduces the amount of loanable funds available.  

The importance of the financial sector to any economy cannot be over emphasized. In a cash economy like Nigeria, banks perform two basic functions, Savings mobilization and Credit delivery which is very important for economy growth and development (Oboh, 2005). Based on these two important functions, the development of the economy is directly or indirectly tied to its banking or financial sectors. This therefore means that an unhealthy banking sector means an unhealthy economy and a failed banking sector would result in the crumbling of the economy.  

The most important role of the bank in the economy is acting as an intermediary through which they generate funds from the surplus units that have more than they need for immediate consumption which are deposited with banks. The surplus funds are then made available to the deficit unit for investment in the productive sectors of the economy. Bank failure greatly hampers the performance of this role. No doubt the economy capacity for capital formation and the pace of economic growth will be drastically reduced.  

Economic activities would be slowed down if not impossible especially international transactions. As pointed out by Ebhodaghe, money is the pivot of the economy. The banks facilitate the circulation of money in any economy. The velocity of money will be thus retarded which can put the economy under a great heat. Finally, failure of banks results in mass lay off of staff. This creates unemployment situation as a social set back for the economy. 

Given the pivotal roles banks play in the nation’s economy, it is expected that all should join hands to final a solution to the current banking distress. It is not enough to look for scapegoats or engage in wishful thinking. In the search for solutions, bank boards, bank management, other banks, depositors, supervisory authorities and the government all have roles to play. We can examine here some of the expected roles.  

As owners of Banks, the board and indeed the shareholders should be at the forefront ensuring that the Banks is sound and liquid. This could be done by ensuring that the directors repay loans and advances they had taken from the banks either for themselves or their companies. Another area is to explore further recapitalization of the banks. Unfortunately, it has been observed that shareholders are rather reluctant to do this. They claim they have no funds but at the same time are reluctant to allow those with the money become shareholders, fearing equity dilution. We note that this selfish attitude is symptomatic of the high level of greed and opportunities in the Nigerian psyche. 

Bank directors, should always bear in mind that as owners of a failed financial institution, they are by law prohibited from owning another financial house. Indeed, directors who are responsible for the distress of their banks ought not to hide behind the veil of limited liability but should face the full force of the law and be made to return depositors’ funds even if that means selling their personal assets. That is to say that the directors’ liability should not be limited to their equity stakes in their failed banks but should extend to their personal assets. In this connection, appropriate legal processes must be put in place to try fraudulent cases and malpractices. The assistance and cooperation of the Police, the Judiciary, EFCC and the Ministry of Justice would be necessary for prompt handling of cases. It is recommended that a special court be established with constitutional backing to try such cases.  

Conclusion and Recommendations 

It is well known that management can make the difference between a healthy and a distressed institution. Where a bank is already distressed due to managements’ action or orientation, such management should find ways to address the distress. It is the duty of management to draw up credible turn-around plans (TAP) for boards’ approval. Such plans should include aggressive debt recovery drives (especially in respect of directors’ loans), rationalization of staff, offices and expenses. The idea here is for management to embark on self restructuring of the bank so as to reverse its declining fortunes and thus prevent forced restructuring or liquidation by the regulatory authorities.  

Management can also seek merger partners for their banks. The NDIC Act of 1988, Section 34, provides for the assistance of the Corporation to enable a failing bank merge with any other insured bank.  When some banks in the system are distressed, it is in the best interest of the non-distressed ones that an effective resolution of the distress be carried out. This is because the distress in one bank which leads to a loss of confidence in the affected bank can also affect confidence in the entire banking system. Also, we saw recently how interbank rates escalated as a result of distressed borrowing. The otherwise healthy banks which loaned substantial amount to the distressed ones got dragged into distress also. For these reasons, all insured banks should cooperate to rid the system of distress.  

In order to resolve the distress in the system, the Corporation requires enormous amounts of money which it does not have at the moment, given its age and the size of the insurance fund. It was in anticipation of this situation that the NDIC Act, Section 21, Subsection 3, made room for special contribution from insured banks equal to “the amount of the annual premium” to he paid to the Corporation towards assisting distressed, insured institutions. Insured banks should be ready to make this sacrifice for the sake of the banking system of which they are a part.  

In addition to the special contribution to the Corporation to address distress, banks can offer assistance to colleagues in financial difficulty. These banks can do through a self regulatory organization by applying sanctions and disciplining erring members.    

It should be borne in mind that the deposit insurance scheme of the Corporation was designed to protect small depositors. This is so the world over where explicit deposit protection schemes exist. The idea is that small depositors are usually ignorant about financial matters, being unable to read and understand financial reports of banks for an enlightened choice of banks to place deposits. Besides, this group of depositors forms the bulk of a typical commercial bank’s array of depositors. Consequently, they are singled out for protection under a Deposit Insurance Scheme.  

Large depositors who are not fully covered by a Deposit Insurance Scheme are encouraged, in the event of a bank distress, to commit a part of their uncovered deposits to the distressed bank’s shares or debentures. That 

way, they become owners or creditors of the bank and are thus in a position to collectively take action to mitigate their loses.  

At the moment, the supervisory authorities in Nigeria, through the Joint CBN/NDIC Committee on Problem Banks impose holding actions on distressed banks; have taken over seven banks for restructuring and eventual sell. However, a lot more needs to be done to return the system to financial stability. 

The system has to be more strictly supervised with adequate performance standards emplaced. Failure by banks to meet the minimum standards should be met with prompt and appropriate sanctions. Prompt supervisory intervention in distressed institutions may be necessary to reduce systemic effects and the cost of restructuring. Also, there is an urgent need for a clear-cut framework for regulatory intervention within a specified time frame. Such timely intervention would prevent serious deterioration in the financial condition of distressed banks.  

In addition, there is the need for legislation to facilitate the recovery of debts in failed banks through establishing a special court with constitutional powers to try loan defaulters. This measure will eliminate time consuming adjournments/injunctions usually with normal courts for debts recovery exercise.  

Governments the world over guard jealously their financial systems and seek to protect them from systemic crises. A recent case was the massive failures of the Savings and Loans in the United States of America and that government’s response to that crisis. A Failure Resolution Trust Corporation was set up under the supervision of the Federal Deposit Insurance Corporation (FDIC). The US government then provided billions of dollars to see to the resolution of the distress. The CBN has now injected the sum of $400,000 into the seven distressed Banks with a view to rejuvenating them. This is a welcome development and the tempo of control by CBN must be sustained. 

Finally, it is important to note that the fortunes of the Nigerian economy are intricately interwoven with the fortunes of the Nations Banks. Consequently, all hands must be on deck to resolve the problem for a better tomorrow. 

References: 

Alashi  S. O. (1985). “Focus on Bank failure, Bankruptcy; some recent Experience” Nigerian Journal of Financial Management Vol. Iv. 

Oboh, G. A. T. (2005). The Banking Industry and the Nigerian Economy. Post – Consolidation. A paper presented at Proceedings of 2005 Page 

National Seminar on Banking and Allied Matters, CIBN and NJI. 

Alo, O. (1999), Address Presented at FITC Seminar on “The Bank of the Future”, 1999 at FITC Lagos. 

Usman, S. (2003). Strategies for coping with the New Minimum 

Capitalization of Banks, a paper presented at FITC workshop 2003. 

Ebhodaghe, J. U. (1996). “The implication of Distress Banks in a Depressed Economy” prospects for survival and growth. A paper Presented to sec 18 NIPSS Kuru, March. 

Ekechi, A. O. (1995). “Minimizing Risk of Bank failures” Business Times, May 1st. 

Falegan, S. B. (2008). “External Borrowing and public policy” paper presented at Nigerian Institute of international Affairs 9th November. 

Oche, P. N. (2004), Machinery for control of Banks and Banking in Nigeria. 

Jos, Business Heirs Great commission. 

Ogwuma, P. (1987). Opening Remarks on Directors Seminar at Bank Directors Seminar at FITC. 

Umunneahla, A. (1996), Bank Failures in Nigeria. Foundation Publishers 1st ed. Ibadan. 

Odozi, V. A. (1998). Welcome Address at FITC Bankers Seminar June, 1998 Lagos. 

Statues: 

Banks and other financial institutions Act (BOFIA) 1991 as (amended) LFN 2004.  

Central Bank of Nigeria Act NO: 24 LFN 2007.  

Companies and Allied Matters Act, LFN 2004. 

Failed Banks (Recovery of Debt and financial malpractices) Act NO 18, 1994. 

Nigerian Deposit Insurance Corporation Act, (NDIC) LFN 2004 

Table of Cases 

Pharmatek Industry Ltd v Trade Bank Nigeria Plc (1997) 7 NWLR pt 514 at 639. NDIC v FMB Ltd (1997) 4 NWLR Pt 501 at page 519. 

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