The Current State of the Nigerian Banking Industry
The last few years have been traumatic for the Nigerian banking industry. Accustomed to steady profits and little or no problem since 1959 when the Central Bank of Nigeria (CBN) was established, the industry has, in recent times, produced the largest number of technically insolvent and undercapitalised banks. Although distress in the history of the Nigerian banking sector is not an entirely new phenomenon, the manifestation of the current problem became discernible with some policy shocks starting in 1988 with the CBN directive to banks that Naira backing for foreign exchange application be lodged with the CBN. This was followed in 1989 by another requiring public sector deposits to be transferred to the CBN. These two developments exposed the imprudent management practices and significant weakness in credit control in several banks thereby bringing into open, the precarious liquidity positions of some banks and the inherent distress in the system. In response to this development, marginal banks embarked on inter- bank borrowing in the form of overdrafts at very high costs. Failure of some of these banks to honour these overdrafts placed the entire payments system under great stress and resulted in pyramiding of defaults as transactions were truncated midstream. What was then thought to be a temporary liquidity problem for a few banks soon caught up with a lot more banks. This development spurred the supervisory authorities to more rigorously examine the safety and soundness of the banks by assessing the health status of the banks on a continuous basis. The result of this exercise has remained disturbing. For instance, the number of distressed banks that stood at 9 in 1990 rose to 16 in 1992. As at December 1994, there were 55 distressed banks compared with 38 in December 1993. The number rose to an unprecedented level of 60 at year end of 1995. This implies that at the end of 1995, the NDIC classified about I out of every 2 bank in the industry as distressed. At the end of 1996, the figure stood at 52. Thus, the 1990s can be rightly characterised as a period of upheaval for the banking industry.
The capital invested by the owners in the distress banks had been completely lost, principally because of insider loans, frauds (and forgeries as well as large amount of non-performing credits. For the 60 distressed banks, the amount required for reeapitalisation stood at about N24.3 billion as at December 1995 and about N40 billion by September 1996. While the option of sourcing funds to recapitalise the banks from the private sector could be in consonance with the present administration’s determination to remove distortions in the economy and restore depositors’ and investors’ confidence, the magnitude of the funding requirements are however enormous.
The insurance risk exposure of the NDIC to the 60 distressed banks was estimated at N36.4 billion, which was more than six times the Corporation’s insurance fund of about N6 billion as at December 1995. This figure had been adjudged to be grossly inadequate by the Corporation’s auditors in meeting the attendant depositors’ pay-off in the event of liquidating all the terminally distressed banks whose financial conditions are already tending towards irreversible distress situation. The cost of liquidating such banks is up to Nl8 billion. Given that these funds have alternative uses which will have their multiplier effects on the economy, the loss to the economy as a result of this magnitude of bank failure is better imagined than quantified. Although there has been some improvement in the distress condition, (measured by the various parameters), of the industry in 1996 as indicated in Table 19.1, the level and depth of distress still remain disturbing.
The problem of banking instability in Nigeria which has manifested itself in the form of dramatic increase in the rate of bank failures, has been adduced to various causes which include: inept management, fraudulent practices, inadequate capital, inexperienced personnel, political interference, adverse economic condition, among others.
In response to the above disturbing development, the regulatory/supervisory authorities have employed several failure resolution options aimed at ensuring banking stability in the country. While some of the measures have had some salutory effects, more still needs to be done by all the parties concerned towards evolving a stable banking system in the country.
The Expected Role of the NDIC in Banking Stability
Section 5 of the Nigeria Deposit Insurance Corporation Decree No. 22 of 1988, states the functions of the NDIC, as follows:
i) Insuring all deposit liabilities of licensed banks and such other financial institutions operating in Nigeria so as to engender confidence in the Nigerian banking industry;
ii) Giving assistance in the interest of depositors, in case of imminent or actual financial difficulties of banks, particularly where suspension of payments is threatened; and avoiding damage to public confidence in the banking system;
iii) Guaranteeing payments to depositors, in case of imminent or actual suspension of payments by insured banks or financial institutions up to the maximum amount N50,000;
iv) Assisting monetary authorities in the formulation and implementation of banking policies so as to ensure sound banking practice and fair competition among banks in the country; and
v) Pursuing any other measures necessary to achieve the functions of the Corporation provided such measures and actions are not repugnant to the functions of the Corporation.
These functions form the core of the expected role of the Corporation in banking stability. In order to perform this role effectively, the NDIC engages in the following major activities: supervision and distress management.
Supervision
The Corporation supervises insured banks in order to gauge their financial health. This is with a view to ensuring timely and appropriate supervisory intervention. The supervisory efforts can be divided into off-site and on-site surveillance.
(a) Off-site Surveillance
This entails the receipt and analysis of periodic returns from insured banks. The returns are checked for completeness, accuracy and consistency, before they are analysed, with the aim of identifying salient problem areas in the banks’ operations. Thereafter, appropriate remedies are proposed to the banks. However, on-site examinations are often needed to confirm the extent of bank distress. On confirmation of distress through field examination, supervisory measures are adopted to contain the situation and thereby maintain stability.
(b) On-site Examination
The on-site examination is conducted by field examiners. In particular, the examiners conduct appraisal of board and management to determine competence and compliance with rules and regulations; assets, with emphasis on quality; liabilities, with emphasis on capital adequacy. In addition, the effectiveness of the internal control system is also examined. This examination enables the Corporation to identify/confirm the health of banks and recommendations are made where deficiencies are observed. Such recommendations are aimed at protecting the interest of depositors, shareholders and the general public.
Distress Management
If there is a significant deterioration in the condition of a bank, such a bank is officially declared to be distressed and placed under close supervision. The bank will normally be required to submit additional returns to the CBN/ NDIC, so that the implementation of the various corrective measures imposed on it can be monitored. Over the years, the CBN and the NDIC have undertaken a number of such distress management measures to handle the problems of distressed banks. The measures are discussed below:
(a) Moral Suasion
As a first step in distress management, the CBN and the NDIC hold regular discussions and consultations with the owners and management of the affected banks with a view to making them embrace healthy practices that would enhance their performance, as well as, take prompt and decisive actions to revitalise their banks. Although this approach has helped in making the owners and management of most problem banks to focus greater attention on certain areas of operational problems, not much has been achieved in addressing the fundamental problems of under-capital is at ion and debt recovery.
(b) Imposition of Holding Actions
Banks that are identified to be distressed, after a special examination, are placed under close supervision and restrictions through the imposition of holding actions. The aims of the holding actions are to allow the troubled banks to undertake self-restructuring measures as a first line of self-salvaging action and to arrest further deterioration in their financial condition. This approach is anchored on the belief that given determined management and boards, the declining fortunes of the problem banks could be reversed.
Each distressed bank on which the holding actions have been imposed, is required to furnish the CBN and the NDIC within 30 days of being served the holding actions, details of its strategic plan for the revitalisation and effective management of the bank. Such a turn-around plan is expected to be credible and to include proposals for debt recovery, rationalisation of costs and staff, injection of additional capital, training, etcetera.
Also, each bank on which the Holding Actions are imposed is expected to notify its staff of the measures and ensure that adequate steps are taken to comply with them. Officials of the CBN/NDIC monitor the compliance from time to time. The effects of these holding actions on the distressed status of the affected banks would normally suggest the next set of supervisory measures to adopt.
The experience of the regulatory authorities has been that these holding actions have not materially reversed the distressed status of most of the banks because the heavy accumulated losses put the recapitalisation requirement beyond the means of the shareholders. In addition, the debt recovery efforts have not been successful because the chronic debtors are mainly insiders to the affected banks who are usually unwilling to repay their debts, or who had not provided adequately perfected collaterals which could be foreclosed. The implementation of the Failed Banks Decree has however had some salutory effects in this area.
(c) The implementation of Failed Banks ‘Decree
Among the various factors responsible for widespread banking distress in the system as noted earlier are the problems of insiders abuse, fraud, outright stealing of depositors’ funds by bank directors and officers who, in breach of their fiduciary duties and at times in connivance with customers, loot the banks. In order to stem these problems and restore sanity to the, nation’s banking system, the NDIC alerted the Federal Government of Nigeria of these problems and the government promptly responded by promulgating a law that would expeditiously and effectively deal with the erring bank directors, officers and customers found to be involved in any of these malpractices. The promulgation and implementation of the Failed Banks (Recover of Debts) and Financial Malpractices in Banks Decree No. 18 of 1994 apart from punishing individuals involved in the monumental incidence of financial malpractices have also assisted in the recovery of debts owed to distressed banks in the system.
The Corporation has taken full advantage of the Decree in the sanitisation of the nation’s banking system. It has assisted in collating information and supporting documents on frauds and malpractices in banks for police investigation. The Corporation also liaises with prosecutors (appointed by the Honourable Attorney General of the Federation), for the successful prosecution of criminal cases brought before the tribunals. In addition, the Corporation appoints solicitors to file before the tribunals applications to recover debts owed to failed banks, and monitors such recoveries.
As a result of the implementation of the Failed Banks’ Decree, many debts otherwise classified as either not collectable or lost have been recovered from recalcitrant debtors who hitherto had refused or neglected to honour their obligations to banks. Many high-networth individuals who were hitherto considered to be untouchable are being made to answer for their various actions or inactions in wrecking some banks in the system. To date, over N43 billion has been recovered by the distressed banks under the control and management of the regulatory/supervisory authorities since the Decree became operational in mid-1995. Pursuant to the various offenses relating to financial malpractices created by the Decree, a number of directors, officers, employees and other conspirators have either been prosecuted or are undergoing prosecution at the Failed Banks’ tribunals.
Recent Developments
As you are well aware, the Federal Government has amended the NDIC Decree of 1988 to empower the Corporation to liquidate failed banks expeditiously.
To this end, all distressed banks not adequately recapitalised by March 31, 1997 will be liquidated whilst the non-distressed banks are given up to March 31, 1998 to meet the recapitalisation requirement.
In order to implement government’s policy in this regard, the Corporation has carefully worked out implementation strategies that would ensure the orderly liquidation of the failed banks without a contagion. The Corporation would require about N20 billion to payoff depositors in the failed banks and meet liquidation expenses. However, the Corporation’s Deposit Insurance Fund (DJF) for this purpose is a mere $7.8 billion or 39 percent of the required amount. At the moment, we are exploring a number of options for raising the needed funds including direct government support/loans as are done in other countries facing similar problems.
It may also interest you to know that through the efforts of the Corporation, the Federal Government has agreed to pay its indebtedness and that of State Governments to banks this year. Although the payment would be of only the principal without interests, we are confident that the gesture of government in this regard will put it on high moral ground in its support of the implementation of the provisions of the Failed Banks’ Decree. Moreover, the payment will provide the banks (most of which are distressed) the much needed liquidity.
Vision for Effective and Efficient Financial System in Nigeria
Introduction
The central and crucial roles that the financial system plays in any economy have been widely acknowledged. However, for the financial system to make important contributions to the economy, it must be efficient in the delivery of financial services and effective in its contributions to growth and development.
The Nigerian financial system has been widely acclaimed as the “most dynamic and diversified in Sub-Sahara Africa” (World Bank, 1993); however, the system is beset with many problems which have impeded its efficiency and effectiveness. The list of the problems is long and I do not intend to catalogue them here, but it should suffice to say that the problems have culminated in the widespread distress evident in the system. The efforts at tackling the distress and by extension their causes have generally not been quite successful; the reason being that some of the problems arc structural, requiring new structures, whilst others are exogenous, requiring better planning and anticipation.
I intend therefore in this essay to discuss my vision of a financial system befitting Nigeria, given its size, population, natural endowments and international posture. While I will readily admit that the current efforts of government in guidedly deregulating the financial system has borne evident fruits, I intend to examine areas where more can be done. In this connection, I shall review areas of needed improvements in licensing of new financial institutions, supervision of the institutions, financial markets, and failure resolution.
Licensing Process for New Institutions
The current distress in the Nigerian financial system has amply underscored the need for a much more rigorous licensing procedure for new institutions. In the past, licences for new institutions were given out to people who, in retrospect, were not “fit and proper persons “, with sufficient expertise, proven management competence and integrity to operate financial institutions in a safe and sound manner. The initial personal stakes in the form of equity capital provided by some promoters were rarely thoroughly investigated as to source and quantum. Consequently, some promoters were able to establish financial institutions ab initio with borrowed funds and therefore without personal stake in the institutions. Hindsight being perfect vision, we can now see that some promoters of financial institutions had intended to use their institutions to promote personal interests at the expense of depositors and the financial system.
Although one would agree that the country never had enough financial institutions (and still does not have enough), however, the licensing of new institutions had rarely been properly sequenced. If we take the banking subsector as an example, the number of banks (commercial and merchant) at the end of 1989 stood at 81 but by 1990 year-end, the number was 107. In other words, 26 new banks opened their doors in the space of a year! In this regard, the story was even worse for finance companies and later primary mortgage institutions (PMIs) as well as community banks.
Another area of licensing lapse had been the absence of clear exit criteria. Whilst what was required to start and run an institution was somewhat clear, the exit criteria was not so clear. Consequently, operators continued to run their financial institutions so long as they were able to pay depositors or serve clients, even when their institutions were technically insolvent.
There is no doubt that these lapses and the absence of adequate supervision (which I intend to comment on later) were at the root of the current distress in the financial sector. Therefore, my vision of Nigeria’s robust financial sector would have the following licensing requirements as a necessary, though not a sufficient condition for stability:
· The introduction of new institutions is to be properly timed and sequenced over a given number of years.
· There should be established clear entry and exit criteria which would be understood by all operators.
· Potential promoters/shareholders of new institutions would be thoroughly investigated to establish:
– Source of initial capital;
– Sufficiency of the capital; and
– Related interests.
· The board of the institutions must be composed of people of integrity who are knowledgeable in financial matters.
· The management teams must convince the regulators that they are competent, have sufficient expertise and integrity to manage the institutions.
Supervision
Regular and effective supervision remains the most potent antidote against widespread deterioration in the operating condition of financial institutions. Supervision should be a continuous process of assessment of operating conditions for timely identification and resolution of emerging problems.
The capacity to supervise effectively should be an important determinant of the number of institutions to be licensed. Unfortunately, this had not been the case in the recent history of licensing financial institutions in Nigeria. For example, hundreds of finance companies were licensed in the early 1990s but were never supervised; consequently, the companies failed as rapidly as they were licensed.
Happily, the 1997 National Budget has directed the Central Bank of Nigeria (CBN) to “control and supervise” all deposit-taking financial institutions in the financial system and to regulate non deposit-taking institutions like the development banks whilst the Securities and Exchange Commission (SEC) shall continue to monitor the institutions in the capital market. Also, the budget formally adopted the existing Financial Services Coordinating Committee (FSCC) as the organ to coordinate supervision in the money and capital markets through shared information; however, this time under the chairmanship of the Honourable Minister of Finance.
The NDIC had been complementing the supervisory roles of the CBN over commercial, merchant and community banks through on-site and off-site examinations. As an insurer of deposits in commercial and merchant banks, the Corporation sees itself as a greater stakeholder in the safety and soundness of these banks. However, given the expected increase of tempo in the receivership and liquidation activities of the Corporation, our on-site examinations would be restricted to target examinations while the CBN would continue to do the routine ones. The off-site supervision which is presently being computerised would continue to be jointly conducted by both institutions.
Ideally, off-site surveillance of banks should provide the inputs and direction for on-site examinations. However, in our circumstance, the returns received from some operators are usually doctored and window-dressed with the result that such information do not provide the CBN and NDIC the requisite early warning signals expected from them. This situation has put the supervisory institutions in a position of having to rely too heavily on on-site examinations.
In addition, on-site examinations are ideally expected to be conducted on a “consolidated basis” that is, to include all the activities conducted by an institution either directly or indirectly through subsidiaries and affiliates. However, in our situation, some institutions engage in unauthorised activities which are unknown to supervisors and this behaviour has the potential of increasing risk to depositors. For example, it is now common knowledge that some distressed banks became distressed because depositors’ funds were used by the banks for trading directly in such goods as cement, fish, sugar et cetera. Not being experienced traders, the banks lost the depositors’ funds through trading losses or through 419 scams.
Another problem area in supervision is the inability of Nigerian supervisors to readily identify connected lending, which is the extension of bank credit to the bank owners or their related companies. The current distress in the banking subsector has revealed large amounts of uncollaterised and non-performing credits extended to bank directors and or their related companies, oftentimes in contravention of laws concerning disclosure and adequate collateralisation. These acts must be severely punished because of their potentials for instability and loss of depositors’ funds.
In other countries, external auditors of financial institutions provide an efficient and independent source of cross-checking and cross-referencing information on financial institutions, thus complementing the supervisory activities of the authorities. However, in Nigeria, most auditors’ reports are often too general, vague and stereotyped as if prepared merely to meet legal requirements. Auditors have been known to have given some financial institutions a clean bill of health only to be discovered that the institutions are indeed insolvent and illiquid! It would seem that some audit firms are afraid to lose their clients because of qualifying audit reports. Perhaps, it is time for the supervisory authorities to do more to assure the external auditors that they do not stand to lose their clients because of providing accurate reports on the clients’ affairs. One way of providing such assurance is for the supervisory authorities to appoint external auditors for the institutions, pay them hut recoup such payment later through a direct debit of the institution’s account with the regulatory authorities.
By way of summary, supervisory efforts should be streamlined, properly focused and executed bearing the following in mind:
· Availability of supervisory resources should be an important determinant of the number of institutions to license and no financial institution should remain unsupervised in a year.
· Supervisors should be adequately trained and be made to specialise in a given subsector of the financial system.
· Stiff penalties should be imposed on managers (not banks) which send doctored returns to supervisory authorities as such returns sabotage supervisory efforts by suppressing distress signals.
· Financial institutions should stand to lose their licences for engaging in unauthorised activities (such as trading) which are incompatible with their charter.
· Directors and managers should be barred from obtaining loans for sell and or connected companies without approval from the supervisory authorities and failure to obtain such approval should be ground for disqualification of the manager or director from holding office.
· External auditors for financial institutions should be appointed and paid by the supervisory/regulatory authorities but such payment should be subsequently recouped from the institutions.
Financial Markets
Financial markets occupy a central place in the financial system and enable deficit spending units to access the funds of the surplus spenders for consumption and investment which have direct links with the national output. For effective intermediation, financial markets must have breadth, depth and resiliency as well as be efficient in the weakly-form sense (a’ la Fama, 1965), that is, have many buyers, sellers, instruments and the price changes to be random as well as unpredictable. The financial markets in Nigeria fall short of these ideals and efforts must be intensified to remedy their deficiencies.
The money market has historically been dominated by government short-tenored instruments, principally treasury bills (TBs) and treasury certificates (TCs). A situation where government raises over 90 per cent of the funds in the market is not healthy for the growth of the market. Private sector borrowings through such instruments as commercial papers (CPs) and bank acceptances need to be increased, so that in time, such instruments would dominate the market.
The recent distress in the money market has not helped the growth and development of the market. In recent times, there has been the anomalous situation where strong banks are awashed with liquidity and interest rates have reportedly crashed, however without borrowers asking for loans. Ways must be found to direct such liquidity into production so that jobs can be created for the teeming unemployed populace. In this regard, government can guarantee bank loans to small scale businesses able to meet some predetermined guidelines.
The capital market which is now 36 years old has not fared any better, particularly when compared to markets in emerging markets comparable in age to the Nigerian market. In spite of the thousands of registered companies in Nigeria, less than 200 raise long-term funds in the capital market such that equity capitalisation is a mere 10 percent of GDP at 1995 prices. Ways must be found, additional to the reduced listing requirement in the Second Tier Market, to induce registered companies to seek quotation on the market. Some countries have done this through much reduced listing requirements, discriminatory taxation where quoted companies pay less tax than the unquoted ones, through other incentives the SEC can come up with, or through coercion.
Also, the market records low trading activities because of the paucity of traded securities; because of the large blocks of such securities held by institutional investors and because of the unwillingness of Nigerians to sell their shares even when such shareholders are short of funds. Efforts must be made to break the buy-and-hold attitude of Nigerian investors through enlightenment and availability of other investment opportunities with good yield.
In addition, high transaction costs have contributed to the reluctance of registered companies to enter the market. Where it costs a company as much as 10 per cent of amount raised compared to about 5 to 6 per cent in emerging markets, it is evident that such cost can be a disincentive to raise funds in the market. The Securities and Exchange Commission (SEC) and the Nigerian Stock Exchange (NSE) must find ways of bringing down the cost of entering the market to encourage greater patronage.
Finally, the market must have efficient telecommunication systems so that transactions are concluded faster than now obtains. In this regard, the proposed central securities clearing, settlement and custodian system should be installed and commissioned. Similarly, the call-over trading system needs to be automated.
The traditional mortgage market is virtually non-existent in the country, yet we talk about housing for all.
It is a well-known fact that the primary mortgage institutions (PMIs) are not lending for housing, neither are the banks. Where then are Nigerians expected to source long-term funds for housing development? Is it possible to entice liquid banks into the housing market? Perhaps with some guarantees, those banks able to source core deposits may be interested, particularly if there is an active secondary market for mortgage loans.
In the insurance market, the newly created National Insurance Commission (NAICOM) has many problems awaiting resolution. The problems include the perennial poor image of insurance companies in Nigeria arising from inability and sometimes unwillingness to scale claims promptly, inadequate capital and inadequate supervision. The distress in the subsector has to be addressed along with the reeapitalisation of the solvent companies as well as capacity building.
In summary, the financial markets can be improved along these lines:
* Concerted efforts must be made to address the distress in the various financial markets expeditiously.
* There is need for greater private sector borrowing in the money market using new instruments that vary in tenor and yield to counter the prominence of government in the subsector.
* Ways must be found to redirect the excess liquidity in the money market into the mortgage market which at the moment can be said to be non existent.
* The capital market must find ways of increasing its market capitalisation much higher than the current average of 10 per cent of GDP through creative programmes to encourage market patronage and through reduced cost of raising funds in the market.
* Adequate capacity building is a must in the markets, particularly in the insurance market which appears to suffer the most from public apathy.
20.5 Failure Resolution
An assessment of the current health of the institutions in the Nigerian financial system would reveal many failed institutions in the various subsectors. That the failed institutions are allowed to remain in the system is indicative of the absence of clear exit procedures for the licensed institutions. Where such procedures may be available, it would seem that the regulatory/supervisory authorities have displayed lack of courage in seeing to the exit of the failed institutions.
Allowing failed institutions to remain in the financial system poses dangers to the stability of the system and exacerbates the losses to be borne by depositors and sundry creditors. Such institutions have been known to borrow at almost any rate of interest to stay in business and such distressed borrowing distorts the rates’ structure in the market and denies viable institutions the borrowed funds which could have been profitably utilised to benefit the economy. Since the institutions have already failed, the new depositors stand ab initio to lose their principal not to mention the promised interest. Such losses are capable of precipitating runs on marginal institutions, in addition to depositors’ loss of confidence in the system.
It is for the above reasons that regulatory/supervisory authorities should have clear, enforceable exit procedures for failed institutions. In this regard, there should be clear legal framework and procedures for intervention in, and liquidation of, the failed institutions to protect depositors and the system. The framework and procedures should be such that would allow the authorities to negotiate restructuring and mergers of the institutions, to appoint a Receiver, and to liquidate the assets in an orderly manner.
The intervention by the authorities must be prompt to prevent a contagion. The early intervention can be through formal or informal enforcement actions. For example, if an institution fails to meet prudential requirements, say of a required capital ratio, the authorities should intervene promptly to propose corrective actions. In extreme cases, the authorities may have to remove management and or board or bar some of the members from ever operating in the financial system.
Given the high incidence of distress in the Nigerian financial system and the small proportion of the distress resolved, the following proposals are made for early resolution of distress:
* In the banking sector the NDIC should work out modalities for the early liquidation (starting in April 1997) of the identified critically distressed commercial and merchant banks not sold on or before March31, 1997.
* A programme should be worked out by the CBN or its nominated agents to resolve the overhung distress in finance companies, primary mortgage Institutions, insurance companies and community banks.
* A comprehensive framework for failure resolution in the financial system should be worked out by the apex regulator that would allow for removal of management/board, compulsory mergers, acquisitions, restructuring and liquidation of distressed institutions.