ASSESSMENT OF THE EFFECTIVENESS OF THE
BANKING REFORMS ON THE NIGERIAN
ECONOMY
BY
NDIELI NGOZI FELICIA
PG/ MBA/ 2004/ DL/ 0780
DEPARTMENT OF MANAGEMENT
FACULTY OF BUSINESS ADMINISTRATION
UNIVERSITY OF NIGERIA
ENUGU CAMPUS
DECEMBER 2005
T I TLE PA G E
ASSESSMENT OF THE EFFECTIVENESS OF THE
BANKING REFORMS ON THE NIGERIAN
ECONOMY
BY
NDIELI NGOZI FELICIA
PG/ MBA/ 2004/ DL/ 0780
M R . CH U KW U C . O .
D EC EM BER 2005
CERTIFICATION
NDIELI NGOZI FELICIA, a post-graduate student of the Department of
Management with registration number P G / M B A/ 2 0 0 4 / D L/ 0 7 8 0 , has
satisfactorily completed the requirements of the course work and the
research work for the award Masters Degree in Business Administration.
The work embodied in this report is original and has not been submitted in
part or full for any other degree of this or any other University.
________________
Mr. Chukwu C.O.
Supervisor
________________
Mr. Chukwu C.O.
Head of Department
Ndieli Ngozi Felicia
Student Researcher
DEDICATION
To God the Father, God the Son, Jesus Christ and God the Holy Spirit; and our Blessed
Virgin Mary, Mother of God.
ACKNOWLEDGEMENT
Many thanks to the people who helped me during the research and writing of this project.
Ekenedilichukwu Ndieli, sister, for her inspiration and consultancy.
Patrick Chukwuemeka Ndieli, brother, for his tremendous help.
Felix Okuefuna Ndieli, my dad, for his support and words of encouragement.
Fidelia Udoku Ndieli, my mum, pillar of strength.
Frank Kelechukwu Egele, supportive friend.
Ayobami Samuel Fadele, colleague and a source of help.
Mr. Yusuf, Lecturer.
Mr. CO. Chukwu, Supervisor.
May God bless them and grant them their heart desires, Amen.
ABSTRACT
This paper reviews the perspective of banking sector reforms since 1970 to date.
It notes four eras of banking sector reforms in Nigeria, viz.: Pre-SAP (1970-85),
the Post-SAP (1986-93), the Reforms Lethargy (1993-1998), Pre-Soludo
(1999-2004) and Post-Soludo (2005-2006). Using both descriptive statistics and
econometric methods, three sets of hypothesis were tested: firstly that each phase
of reforms culminated in improved incentives; secondly that policy reforms
which results in increased capitalization, exchange rate devaluation; interest rate
restructuring and abolition of credit rationing may have had positive effects on
real sector credit and thirdly that implicit incentives which accompany the
reforms had salutary macroeconomic effects. The empirical results confirm that
eras of pursuits of market reforms were characterized by improved incentives.
However, these did not translate to increased credit purvey to the real sector. Also
while growth was stifled in eras of control, the reforms era was associated with
rise in inflationary pressures. Among the pitfalls of reforms identified by the
study are faulty premise and wrong sequencing of reforms and a host of conflicts
emanating from adopted theoretical models for reforms and above all, frequent
reversals and/or non-sustainability of reforms. In conclusion, the study notes the
need to bolster reforms through the deliberate adoption of policies that would
ensure convergence of domestic and international rates of return on financial
markets investments.
v
TABLE OF CONTENTS
Contents
Pages
Title Page
i
Certification page
ii
Dedication
iii
Acknowledgement
iv
Abstract
v
Table of contents
vi
Chapter One
1.0
Introduction
1-2
1.1
Statement of Problem
2-3
1.2
Historical Background
3-4
1.3
Objectives of the Study
4
1.4
Research Hypothesis
5
1.5
Significance of Study
5
1.6
Definition of Terms
6-7
1.7
Scope
7
1.8
P l a n o f Study
8
References
9
Chapter Two
2.0
Literature Review
10-12
2.1
Measurement of Financial Sector
12-16
2.2
An Overview of Nigerian Financial System
16-17
2.3
Structure of the Nigerian Financial System
17-19
2.4
The Development of Nigerian Banking Industry
19-21
2.5
Functions of Commercial Bank
21-24
2.6
Reforming the Banking Sector-Outcome
24-29
2.7
Objective of the Reform
29-31
2.8
Profitability of Nigerian Banks Post-Consolidation
31-36
2.9.0 Reforms: The Last Lap. a New Beginning
36-38
2.9.1 Banking and Finance
38-41
2.9.2 Banking Supervision
41-43
2.9.3 Bank Supervisors and Inspectors
43
2.9.4 Bank Supervision in Nigeria
43-44
2.9.5 Problems in the Banking System
44-49
2.9.6
The Core Principles of Basle
49-54
2.9.7
Conclusion and Recommendation
54
References
55-57
Chapter Three
Research Methodology
3.1
Reforms and Banking Sector
58-64
3.2
Effects of Reforms on Real Sector Credit
64-65
3.3
Policy Reforms and Economic Performance
66-68
References
69
Chapter Four
4.1
Pitfalls of the Eras of Reforms
70
4.2
Faulty Premise and Inappropriate Sequencing of Reforms
70-71
4.3
4.4
4.5
4.6
Conflicts Emanating from Adopted Theoretical Model
for Reforms
71-73
Conflicts Emanating from Foreign Exchange Market
Segmentation
73-74
Conflicts or Trade-offs in Fostering Internal and
External Balance via the Monetary Approach
74-75
Ambivalent Theoretical Underpinning of Reforms
75-76
References
77-78
Chapter Five
5.1
Future Policy Options and Concluding Remarks
79
5.2
Getting Domestic Interest Rates Right
79-80
5.3
Getting External Investment Opportunities Right
80-81
5.4
Concluding Remarks
81
Bibliography
82-86
CHAPTER 1
1.0
INTRODUCTION
There is a fair agreement in the literature that economic reforms, especially what
came to be tagged structural adjustment programs (SAP), have almost always
been mounted in response to national financial distress whose foundation could
be traced to macroeconomic distortions (World Bank 1986). While such distress
manifest mainly as deep economic deterioration (stagflation and huge external
debts), distortions are often evident in the pursuit of unsustainable fiscal,
monetary and exchange rates policies in addition to widespread government
intervention in enterprises that can best be handled by the private sector. In
general, several analysts believe that economic mal-adjustment is associated with
policy pursuits which depart from free market pricing policies (Chiber, et al
1986; Ray 1986). Economic reforms are therefore seen as pursuits of fiscal
reforms and market liberalizations, which focus on extensive privatization of
state owned enterprises as well as liberalization of financial and foreign exchange
markets, with the government limited to provision of the right enabling
environment for a private sector led growth.
There is a consensus in the literature that at the heart of economic reforms is the
need to address a two-fold task: restructure or get policy incentives right as well
as restructure key implementation institutions. Financial sector reforms is that
aspect of economic reforms which focus mainly on restructuring financial sector
institutions (regulators and operators) via institutional and policy reforms. As
part of the financial sector, banking sector reforms is that aspect which focuses
mainly on getting incentives right for the banking sector to take the lead role in
empowering the private sector to contribute more to economic growth.
In Nigeria, we recognize four phases of banking sector reforms since the
commencement of SAP. The first is the financial systems reforms of 1986 to
1993 which led to deregulation of the banking industry that hitherto was
dominated by indigenized banks that had over 60 per cent Federal and State
governments' stakes, in addition to credit, interest rate and foreign exchange
policy reforms. The second phase began in the late 1993-1998, with the
re-introduction of regulations. During this period, the banking sector suffered
deep financial distress which necessitated another round of reforms, designed to
manage the distress. The third phase began with the advent of civilian democracy
in 1999 which saw the return to liberalization of the financial sectors,
accompanied with the adoption of distress resolution programmes. This era also
saw the introduction of universal banking which empowered the banks to operate
in all aspect of retail banking and non-bank financial markets. The forth phase
began in 2004 to date and it is informed by the Nigerian monetary authorities who
asserted that the financial system was characterized by structural and operational
weaknesses and that their catalytic role in promoting private sector led growth
could be further enhanced through a more pragmatic reform.
Although these reforms have been acclaimed to be necessary, it is however
debatable if they yielded the anticipated results. The objective of this paper
therefore, is to assess the relative effectiveness of the reforms as well as gauge the
likely impact of the outcomes on economic performance. Thereafter, the pitfalls
which militated against the effectiveness of the reforms would be identified and
future policy options recommended.
1.1
S T A T E ME N T O F PROBLEM
Financial system is the organization and arrangement concerned with lending,
borrowing, investing and managing money or funds (Oyejide, 1981). It
comprises of financial sector plus the entire rules and regulations of financial
economy. The financial sector of the economy comprises of financial
instruments, financial institutions and financial markets (Keufmen, 1973).
In a nutshell, financial sectors perform the role of financial intermediation and
which is a pre-requisite for rapid growth and development for every modern
economy. Introduction of Structural Adjustment Programme (SAP) in 1986
witnessed tremendous growth in financial sector. For instance, commercial
Banks operations in Nigeria rose from 11 in 1960 to 120 in 1992 while total
number of branches rose from 1900 to 2100 in the same period. Assets rose from
N137m in 1960 to N37bn in 1985 to N219.2bn by the end of November 1992
(Ekpenyong, 1994, CBN Journal, 1991). Both, banks deposit and assets including
the Central Bank of Nigeria increased tremendously.
By December 1991, a total of 568 finance companies of all sizes, nature, structure
and complexities had applied to the Central Bank of Nigeria <CBN) for licensing
(Ekpenyong, 1991).
The phenomenal growth and expansion in banks and other Financial Institutions
resulting from financial sector liberates many economies, but some financiers
argued that it resulted to failures instead of success. This is because the number of
banks classified as distressed increased from 8 to 52 (CBN Journal, 1997).
Central Bank of Nigeria revoked the license of 5 banks as at 1995 and took over
the management of 18 distressed banks between 1994 and 1996. With regards to
this, the failure of banks with its multifarious nature gives concern to the
economy. In other to grow the economy and make it attractive to investors,
Central Bank of Nigeria reduced the number of banks to 25 in 2005, and so far it
has resulted to success.
1.2
HISTORICAL BACKGROUND
Banking is an institution which receives money and other valuables from people
for safekeeping on the understanding that such money will be paid on demand.
Banking originated from British Empire under the London Goldsmiths because
of the nature of their business which had strong rooms in which gold and other
valuables could be kept safely.
In 1964, the first private Bank of England was established by the government.
Commercial Banks were established in England and Scotland and developed the
use of cheques and notes which brought about industrial revolution in England.
Because these banks were small without branches, they could not withstand the
bank crisis of 1825 - 1826 which led to their failure.
The second phase of private banks started by amalgamation of small banks and
establishment of branches. By 1890, banking developed to the extent that 10
banks had a total of 949 branches. These branches helped one another when there
is need. There are two groups of commercial banks in Nigeria, the Expatriate or
Foreign banks and Indigenous banks. Expatriate banking started in 1894 with the
establishment of the Bank of West Africa, which is a consortium of British
Bankers such as Lloyd, Standard Bank of South Africa and West Minster Bank.
In 1926, the Barclays bank D.C.O which changed to Union Bank of Expatriate
Banks with branches throughout West Africa was formed with little assistance
to local businessmen whom they did not trust and who has little or no
collateral/securities for loan.
It was because of the need to help the indigenous businessmen that in
1926, the first indigenous bank, the Industrial and Commercial Bank
was found but could not succeed. In 1933, another bank, National
Bank Limited was founded by late Chief Obafemi Awolowo. This was
the first indigenous bank to succeed. Mercantile Bank w hich
collapsed in 1936 was founded by Dr Maja Doherty. The Arab Bank
was founded in 1937 by Dr Nnamdi Azikiwe. This bank which later
changed to African Continental Bank in 1948 served as Bank of Biafra
between 1967 and 1970 and changed to its former name, other banks
include Bank of Africa, the Muslim Bank of Nigeria, Wema Bank
Limited and so on. Many of these banks became distressed in the
1950's that led to the establishment of central Bank of Nigeria in 1958
as Apex Institution.
1 .3
O B J E CT I VE S O F T H E S T U D Y
The main objectives of this study are;
i.
Market liberalization for the promotion of a more efficient
resource
allocation.
ii.
Expansion of savings mobilization base.
iii.
Promotion of investment and growth through market based
interest
rates.
iv.
Improvement of the regulatory and surveillance framework.
v.
Fostering healthy competition in the provision of services.
vi.
Laying the basis for inflation control and economic growth.
1 .4
S T A T E ME NT O F
M E T H O DO L G Y
1)
HO = Banking brings about economic growth
H1 = It does not
2)
HO = Banking is a profession
H1 = It is not
3)
HO = Government policies enable banks to spice up the economy
H1 = It does not
1 .5
H Y PO T H E S I S
AND
RE S E A R CH
S I G NI FI C A N CE O F S T UD Y
Essentially, commercial banks are financial intermediaries; collecting
funds from surplus spending economic units and making it available
for the deficit spending economic units that is, fund seekers.
The sector plays an important role in economic development hence,
the significance of this study. These include;
1. It tends to reveal the need for recapitalization of the commercial
banks in order to reduce the number of banks in Nigeria economy
for closer monitoring of banking activities in or der to totally
forestall the incessant distress in the banking industry and bring
about renewed and increased public interesting banking.
2. It will help policy makers to find anti -bank distress policies
realizing that the structure of economic activities is
significantly influenced by public policy. This means that
anti-policies based on empirical analysis will restore public
interest in the campaign of making the country a cashless
society.
The study serves as a means to unveiling the growth of the economy
through banking reforms. The extensive review of the literature is of
a great advantage to business and management standards and
researches on related areas. It is also a means of educating the public
on the activities of commercial banking.
1 .6
D E FI NI T I O N O F T E RM S
 B A NK : Bank is an institution which receives money and other
valuables from people for safekeeping on the understanding that
such money or valuables will be paid on demand.
 R E C API T A L I S A T I O N:
increases its capital base.
When
a
financial
institution
 P O L I C Y: A plan of government to guide the financial system
of Nigeria.
 L I Q UI DI T Y: When a financial institution is not able to meet
her customers cash withdrawals.
 F I N A N CI A L S YS T E M: It refers to all the institutions which
influences the credit conditions and are themselves affected by
the financial flows of the economy.
 M A RK E T : Where large sum of money and other valuables are
exchanged.
 R E G UL A T O RS : They are bodies who control financial
institution and regulate the dealings in security markets with the
object of ensuring that financial institutions are able to labor the
commitments before they have access to relevant information
before entering into contract including stock exchange.
 C O MM E R CI AL B A NK : It receives money or financial
documents representing money from or on behalf of customers,
for the credit of their clients account on deposit, current,
savings, fixed etc. they transfer money worldwide on behalf of
their customers. Also, precious stones, wills etc are kept on
behalf of customers by them as well as offer advice to people.
 C A PI T A L B AS E : It is an evidence of financial institutions
strength, which give confidence to the depositors.
 I NA D E Q UA T E C A PI T A L : When the capital base is not
enough.
 F R A U D: It is described as any act of crimin al deceit, trickery or
falsification by a person or group of person(s) with the intention
of altering facts in order to obtain undue personal monetary
advantage or illegal authorization of signatures.
 D A T A CO L L E CT I O N : Facts taken as true as the starting
point of a piece of reasoning, these facts are vital to achieve any
meaningful survey.
 R E S E AR CH : Scientific study in order to discover new facts.
 Q UE S T I O N NAI R E : It is a set of questions designed to gather
information/data for analysis.
 I NF O R M AT I O N: To make known or tell about something
unknown to people.
 P O P UL AT I O N S A M PL E : It is a census of all items or subject
that possess the characteristics, or that have knowledge of the
phenomenon being studied.
 S T U D Y: To work at a subject in order to learn it.
 A N A L Y S E : It is a way of separating out the different materials
of which a mixed material is made up.
 A S S E T S : Funds or property which belongs to a man and used to
pay his debts or help others in need.
 R I S K : To be in danger of failing.
1 .7
S CO PE
Recapitalization is an ongoing process. It is geared towards reforming
the financial sector in order to boost the confidence of stakeholders
and customers in Nigerian banks as well as bring about growth in the
Nigerian economy. It is on this basis that thi s research is carried out to
over period of 2005 to date bearing in mind the limitations which
includes scarcity of time at the disposal of researcher, money and date
collection problems.
1 .8
P L A N O F S T U DY
Chapter Two will be based on literature revi ew or theoretical
framework culminating in a review of relevant literature on the
subject of study. Chapter Three is on research methodology. It
involves the methodology employed during the study. Chapter Four is
a presentation of the results arising from the study.
Chapter Five summarizes the work, outlining the problem and
implications of the findings. This Chapter also outlines constraints
and gives recommendation on the study.
R E FE RE N CE S
Anolue Festus(1994)
Nature and Causes of Inflation
19861992
(Econometric
Approach) Longman, Nigeria.
Bain, A. D. (1981)
The
Economics
of
the
Financial
System
Martin
Robertson and Co. Limited,
Oxford.
Central Bank of Nigeria (1997)
Financial
Sector
Distress
Research Department, Series
No 97, 11 June, 1997.
Chiber, R. and J. Wilton, (1986)
Macroeconomic Policies and
Agricultural Performance in
Developing
Countries".
Finance & Development, 23(3):pp.
6-9.
World Bank (1986)
World Development Report. ©
1986
World
Bank,
Washington.
CHAPTER 2
2.0
LITERATURE REVIEW
The literature is replete with studies which show that the objectives of financial
sector reforms are broadly the same in most countries of Sub-Sahara Africa.
Omoruyi (1991), CBN (2004) and several financial sector analysts summarized
these objectives to include: market liberalization for the promotion of a more
efficient resource allocation; expansion of savings mobilization base, promotion
of investment and growth through market-based interest rates. It also means the
improvement of the regulatory and surveillance framework; fostering healthy
competition in the provision of services and above all laying the basis for
inflation control and economic growth.
There also seems to be a universal agreement within the literature that these
objectives could be attained through deregulation of erstwhile regulated domestic
money and foreign exchange markets, adoption of market based approach to
credit allocation and the pursuit of sustainable fiscal and monetary policies. It
could also require the restructuring of financial markets via legislative changes
and the active use of prudential regulations and enforcement of capital adequacy
requirements.
With regard to the banking sector, the literature is of the view that its reform is
imperative if it is to "to play a key role in pricing and trading risks and
implementing monetary and fiscal policies" as part of the process of "a shift in
emphasis to a private sector led economy". It is further argued by this school of
thought that reforms which foster institutional efficiency is imperative if the
banking sector is to play the desired catalytic role in the real sector" (NPC 2004).
The arguments are that for efficiency, such reforms should address the issues
which militate against the efficiency of the banking sectors such as: the "shallow
depths of the capital market, dependence of financial sector on public sector and
foreign exchange trading as sources of funding; apparent lack of harmony
between fiscal and monetary policies and above all, the poor loans repayments
performance as well as bad debts (Ojo 2005; Nnanna 2005).
In terms of policy thrust therefore, the banking sector reforms is expected "to
build and foster a competitive and healthy financial system to support
development and to avoid systemic distress" (Soludo, 2007). It is further argued
that deepening the banking sector in terms of asset volume and instrument
diversity could lead to drastic reduction of fiscal deficit financing and freeing
resources for lending to the private sector. In general therefore, banking sector
reforms is interpreted to mean embarking on a comprehensive process aimed at
substantially improving the financial infrastructure, strengthening the regulatory
and supervisory framework to address the issue of low capitalization and a
structured financing for cheap credit to the real sector and financial
accommodations for small and rural credit schemes.
There is also a fair agreement within the literature on the transmission
mechanisms between reformed policies and macroeconomic outcomes. The
traditional view in general is that banking sector reforms is encapsulated in
institutional, monetary and exchange rates restructuring, and can therefore be
analyzed via the study of their transmission mechanisms. The main thrust of this
argument is that policy actions of the monetary authorities which arc
implemented by the banking sector have as its ultimate target inflation control
and growth stimulation. The response of the banking sector to these policies
represents in principle the transmission mechanisms which hold the key to the
realization of these ultimate targets. Masson and Pattillo (2003) notes four such
channels between instruments of monetary policy and its ultimate targets
(inflation and real output) as: (i) direct interest rate effects, which influence
investment decisions and the choice between consuming now and consuming
later; (ii) indirect effects via other asset prices, such as prices of bonds, equities
and real estate, which will influence spending through balance sheet and cash
flow effects; (iii) exchange rate effects, which will change relative prices of
domestic and foreign goods, influencing net imports, and also the value of foreign
currency denominated assets, with resulting balance sheet effects; and (iv) credit
availability effects, which may include credit rationing if there are binding
ceilings on interest rates.
Method of Analysis
In order to give an objective assessment of the outcomes of the banking sector
reforms, there is the need to specify evaluating criteria. Given the fact that four
phases of banking sector reforms had been undertaken since 1986 to date, I have
proposed to use descriptive statistics to test the hypothesis that each phase
culminated into improved incentives for the provision of better services to the
economy as whole. The assumption is that the post reforms values of measures of
institutional and policy response performance represents significant
improvements over the pre-reforms value. Among these measures are: branch
networks, increased supply and improved access to credit, improvement in
selected financial sector and distress ratios, and above all increased profit
earnings, as well as increased ability to compete within the global economy.
It should however be noted that several factors exist besides the reforms measures
that could explain the trend in these indicators. In order to ascertain the relative
efficiency of the reforms, we posit that increases in asset base should lead to
increase in lending to the real sector at lower interest rates. Interest rates reforms
should lead to positive real savings rate, as well as the convergence, and/or
narrowing down of the premium between the savings and prime lending rates.
Foreign exchange market reforms should correct overvaluations and foster
relative stability of the exchange rate of the naira vis-a-vis world trading
currencies, in addition to eliminating divergence inherent in the current multiple
exchange rates system.
In order to assess the likely effects of these changes on economic performance,
we posit that the emergent changes in incentives structure may have had the
desired effects on real sector credit and performance during the period. On this
score, it is proposed here that we test two postulates: the first, hypothesizes that
policy reforms which results in increased capitalization, exchange rate
devaluation; interest rate restructuring and abolition of credit rationing may have
had positive effects on real sector credit. The second, from the macroeconomic
perspective, tests the hypothesis that implicit monetary and exchange rates
incentives which accompany the reforms had salutary macroeconomic effects
reflected in the trends in aggregate economic growth and inflation.
2.1
MEASUREMENT OF FINANCIAL SECTOR
Model Specification
In its implicit form, the first model can be rendered as:
P C R / T C R = ʃ( C A P B R , C R R , L R , S R , M R R , E X R , B B r )…………… (1)
Whereby PCR = Production Sector Credit by Commercial Banks; TCR = Total
Credit to the Economy; CAPBR = Capital and Reserves of the Banks; CRR =
Cash Reserve Requirements;
LR = Prime lending rates; SR = Savings Rate; MRR = Minimum Rediscount rates
or monetary policy rates; EXR = Exchange rates, BBr = No. of branch networks
of commercial banks. This equation is proposed to be estimated using single
equations systems.
The second hypothesis would be investigated through two sets of equations
rendered as follows:
G D P = ʃ ( M 2 , M R R , C P , C G , E XR ) ...... (2)
C P I = ʃ ( M 2 , M R R , C P , C G , EX R ) ......... (3)
Whereby GDP and CPI are defined as real Gross Domestic Product and
Consumer Price Index; M2 = Money Supply; CP = Private Sector Credit; CG =
banking sector credit to government, while MRR and EXR are as defined in
equation (1). Given the fact that the equations have common explanatory
variables, and the ample evidence that the two dependent variables are known to
granger cause each other, it is intended that a simultaneous equations model
which includes the autoregressive and distributed lags as part of the systems of
equation may be more appropriate to its estimation. If we denote the matrices of
the explanatory variables as X, the simultaneous equation form of (2) and (3) in
explicit forms becomes:
𝐺𝐷𝑃𝑡 𝑎𝑜 + 𝛽1 𝐺𝐷𝑃𝑡−1 + 𝛽2 𝐺𝐷𝑃𝑡−2 + 𝑎1 𝑋𝑡𝑡 + 𝑎2 𝑋𝑡−1 + 𝑎3 𝑋𝑡−2 + 𝜇𝑡 … . (4)
𝐶𝑃𝐼𝑡 𝑎𝑜 + 𝛽1 𝐶𝑃𝐼𝑡−1 + 𝛽2 𝐶𝑃𝐼𝑡−2 + 𝑎1 𝑋𝑡𝑡 + 𝑎2 𝑋𝑡−1 + 𝑎3 𝑋𝑡−2 + 𝜇𝑡 … . (5)
Given the fact that the purely exogenous variables in the models are about five,
equation 4 and 5 can be rendered in more complete and general form as:
𝐺𝐷𝑃𝑡 = 𝑎𝑜 + 𝛽1 𝐺𝐷𝑃𝑡−1 + 𝛽2 𝐺𝐷𝑃𝑡−2 + 𝛽3 𝐶𝑃𝐼𝑡−1 + 𝛽4 𝐶𝑃𝐼𝑡−2+ Σ 𝑎0 + 𝑘𝑋𝑘𝑡 + Σ𝑎0 + 𝑘𝑋(𝑡−1) + Σ𝑎0 + 𝑘𝑋(𝑡−2) + 𝜇𝑡 … . (6)
𝐶𝑃𝐼𝑡 = 𝑎𝑜 + 𝛽1 𝐺𝐷𝑃𝑡−1 + 𝛽2 𝐺𝐷𝑃𝑡−2 + 𝛽3 𝐶𝑃𝐼𝑡−1 + 𝛽4 𝐶𝑃𝐼𝑡−2+ Σ 𝑎0 + 𝑘𝑋𝑘𝑡 + Σ𝑎0 + 𝑘𝑋(𝑡−1) + Σ𝑎0 + 𝑘𝑋(𝑡−2) + 𝜇𝑡 … . (7)
Whereby: the autoregressive variables are as defined earlier on, while the
distributed lag components (Xk) can be defined as:
X1 = M2t; X2 = MRRt; X3 = CPt; X4 = CGt and X5 = EXRt
X6 = M2 (t-1); X7 – MRRt-1; X8 = CPt-1; X9 = CGt-1, and X10 = EXRt-1,
X11 = M2 (t-2); X12 = MRRt-2; X13 = CPt-2; X14 = CGt-2 and X15 = EXRt-2
Thus equations 6 and 7 would be estimated through a simultaneous regression
estimation procedure. This estimation procedure is often adjudged to yield better
and more efficient estimates of the parameters and coefficients of the regression
than the single equation models.
Data Sources and Adjustments
Following our specification, the measure of real GDP is the volume index based
on 2000 = 1000, and the consumer price indices for domestic prices. Money
supply is captured by broad money (M2) as reported in IMF, IFS and CBN
monetary survey data, while the potential crowding out effect of domestic credit
to the government is captured in the model, by the relative share of both the
government and the private sectors in banking systems' credit to the economy.
This variable is expected to embody the net outcome of monetary policy pursuits
via reserve control and/or the implicit credit allocation bias which monetary
policy induces. The bias and incentives created in favour of holding public debt
instruments and/or recourse to rediscount facilities is presumed to be embodied in
the treasury bills and/or minimum rediscount rates. In this study, the MRR is
adjudged to be a better measure of interest rate policy since it is the benchmark
rate often determined by the monetary authorities as part of its interest rate
operating procedures. It is thereby adjudged to be the compass rate that steers all
other interest rates, especially treasury bills rate and/or rates on special monetary
authority's certificates issued as instruments of indirect monetary control. This
rate can have significant bearing on inflation in the face of frequent recourse to its
use, especially when the monetary authority sterilize such funds as part of its
monetary control measure and the burden of debt service arising there from is not
absolved by the fiscal authorities. With regard to exchange rate variable, it is
measured in terms of local currency per $, so as to reflect appropriately the
direction of change which devaluations implies and its increasing effects on
domestic consumer prices.
Many writers have proposed a number of indicators for measuring the state of any
financial institution. Among these is the CAMEL rating which is an acronym
indicated thus;
Capital
Adequacy
Asset
Quality
Management
Competence
Earnings
Strength
Liquidity
Sufficiency
According to Ekpenyong (1994), CBN and NDIC laid down the
"Capital-Adequacy" criteria as an important signal that a bank is liquid or not. To
determine the Capital-Adequacy, the minimum and maximum limits are
established. Ekpenyong (1994) reports that the minimum limit establishes the
relationship between the qualifying capital and the total risk assets expressed as a
percentage thus;
Minimum Level = Qualifying Capital x 100 (<) 8%
Total Risk Assets
While maximum limit establishes the relationship between the adjusted
qualifying Capital (adjusted to reflect any possible losses in the operations
including provisions for loan losses) and the net loans and advances thus;
Maximum Level = Adjusted Qualifying Capital (>) 1:10
Net loans and Advances
This implies that maximum level of capital adequacy ratio should not be
maintained at a level higher than 1:10 and minimum level ratio of Qualifying
Capital (shareholders funds) to the total risk assets (total loans and advances)
should be below the barest minimum of 8%.
Ebhodagbe (1997), Ekpenyong (1994) and CBN Journal (1997) explained further
that the performance of a financial institution is compared with pre-determined
financial ratios which include Capital Adequacy ratio, liquidity ratio,
loan-to-deposit ratio, liquid-asset-structure ratio, profitability ratio and ratio of
non-performing loans. The analysis of these ratios to shareholders fund enables
the authorities to state that a financial institution is healthy, which is the reason
for recapitalization of banks from 89 banks to 25 banks in 2005.
It is imperative to note that at times the set criteria may not be sufficient to
classify an institution as being distressed since it could be a temporary liquidity
problem. Hence, more comprehensive indicators have been developed by the
CBN for a more effective measurement of the state of distress.
These comprehensive indicators are linear combination of the CAMEL
parameters with the weights appropriately determined by the supervisory
authority. The rating based on composite score by NDIC could be categorized
into; (Ebhodagbe, 1997).
• Very sound (86- 100%)
• Sound (71 - 85%)
• Satisfactory (56 - 70%)
• Marginal (41-55%)
• Unsound (Distressed) (0 - 40%)
2.2
AN OVERVIEW OF NIGERIA FINANCIAL SYSTEM
The Nigerian Financial System refers to all the institution which influences the
credit conditions and is themselves affected by the financial flows in the economy
(Agba, 2000). The core of the financial system is the financial inter-mediation
with the fund supplier, the surplus economic units as key players.
Stressing the role of financial system in the economy, Professor Nwankwo, G.
(1980), argued that the quality of the services provided by the financial system
affects performance of the economy as a whole. However, he opined that the
evaluation of the performance of the system must be made in the context of its
place in the economy; its effectiveness in savings mobilization and allocation to
achieve full employment, generate non-inflationary growth and stability in
macro-economic aggregates. The story of financial services in Nigeria is at the
moment mainly about banking. Banking activities make up an estimated 90% of
formal financial services activity in Nigeria, and most of that is in the wholesale
and corporate sector. But the industry is also undergoing a development
revolution that is making gradual inroads into the retail sector. It is also
expanding from banking to other financial services such as insurance and funds
management. The hope is that all this will accelerate the transition away from
Nigeria's "cash and carry" financial system and create the kind of efficient and
modern financial services sector that is needed in a growing economy. One of the
promising signs of development in the banking industry is the recent introduction
o f MasterCard, credit and debit and stored-value cards as an alternative to cash
transactions, and the installation of automated teller machines in major cities.
There are also initiatives under way to encourage the use of cheques and to place
the national infrastructure for payments clearing and settlement on former legal
and technological footing (Corporate Governance Journal 2005/2006).
2.3
STRUCTURE OF THE NIGERIAN FINANCIAL SYSTEM
Bain (1981), viewed financial system as not just market with and embodiment of
money market and capital market but where large sum of money are involved in
financial markets. On this basis, he concluded that countries should have
regulatory bodies that monitor, supervise and control the financial institutions
and regulate the dealings in security markets with the object of ensuring that
financial institutions are able to labour and commit themselves such that people
have access to relevant informations before they enter into contract.
In view of this, the Nigerian Financial System has undergone remarkable changes
in terms of ownership structure of its investments with the recent N25 billion
capitalizations, the number of institutions involved and the regulatory framework
within which the system operates. It is worthy of note to point out that it was not
only the banking sector that was asked to recapitalize by the CBN Governor,
Professor Chukwuma Charles Soludo, but also the Insurance sector. The
recapitalization for Insurance Companies was to N6 billion, that is, the insurance
companies increased its capital reserve requirements to N6 billion naira. Thereby,
reducing the total of 118 insurance companies in Nigeria to 71. Just as banks
merged and raised funds from the public the insurance companies did same.
Insurance companies like banks, tend to focus on government and corporate
markets rather than on retail markets. Most Nigerians, barring the wealthiest
among them go uninsured against risks on both the property/casualty and the life
and health side. Pension's provision is also virtually unknown at the retail level;
where private coverage exists; it is purchased by large employers and distributed
to employees. But, all these are a thing of the past as the new reforms has brought
about change in the economy (Corporate Governance Journal 2005/2006).
According to Umoh (1993), a typical financial system consists of institutions,
market participants and financial instruments. The system has the presidency as
the Apex organ and is highly regulated with many supervisory agencies. These
comprises of the following;
1)
The Central Bank of Nigeria (CBN) - established in 1958 and started
operation in 1959. Its function is to determine the monetary policies. It is
the supervisory authority of the money market and financial companies.
Money market comprises of the discount houses, commercial banks and
microfinance banks.
2)
Nigeria Deposit Insurance Corporation (NDIC) - established by decree 22
of 1998 to insure banks. It pays depositors a maximum of N50, 000 in the
cause of liquidation of banks. It is by this function the supervisory
authority for money market.
3)
The Security and Exchange Commission (SEC) - it is the apex government
regulatory institution in the capital market. It was established through the
Securities and Exchange Commission of 1979 which took effect
retroactively on April 1, 1998 and started its functions. This was expanded
by the Companies and Allied Matters Decree 1990 under its capital market
which regulates the Nigerian Stock Exchange.
4)
The Federal Ministry of Finance (FMF) - in co-operation with the CBN
formulates monetary policies and has participated in licensing banks in the
past. It has a direct supervisory authority on Bureau de Change.
5)
National Insurance Commission (NAICOM) - there was no regulatory act
governing insurance business in Nigeria until 1961 Act, which created an
office of the Registry of Insurance to supervise the industry. In 1964,
Insurance miscellaneous Provision Act was enacted. In 1969, another Act
was promulgated to establish National Insurance Corporation of Nigeria as
the monopolist of government insurance business Act of 1976 was enacted
to repeat all the past Acts. In 1991, a new insurance decree No 58 was
promulgated which among others raised the minimum equity capital of
Insurance companies. Decree 62 of 1992 established National Insurance
Commission (NAICOM) and was made the supervisory agency of the
insurance industry (Umoh, 1997). It has other financial institution under its
control.
6)
Federal Mortgage Bank of Nigeria (FMBN) - was established in 1977 with
an equity capital of N150 million. Its major function is to provide
Mortgage Finances. The institution was made primarily to regulate
mortgage market and other financial institutions, by Decree 53 of 1989,
which became effective in 1990.
2.4
THE DEVELOPMENT OF NIGERIA BANKING INDUSTRY
Okigbo (1981) states that "banking system is the most important subsystem of a
financial system of any economy. As the parent of the whole financial markets,
banks assist in channeling funds from surplus economic units to deficit ones, to
facilitate business transactions and economic development in general".
The banking industry development in Nigeria can be grouped into phases. The
first period 1892 - 1952, was characterized with free-for-all banking and this was
as a result of no regulation or licensing of any sort to control the operation of
banking.
The rush for bank establishment was in 1892, when the first commercial bank,
African banking Corporation in South Africa opened its branch in Lagos.
Although, the African Banking Corporation short-lived, it gave way to the
establishment of two British owned banks, the Bank of British West African
(BBWA) with branches in almost all British West African colonies, and the
Barclays Bank of Nigeria in 1894 and 1917 respectively.
These expatriate banks monopolized the Nigerian Banking environment until
1929 when the first indigenous bank, The Industrial and Commercial Bank was
found but was unsuccessful. In 1933, the first successful indigenous banks
established 1926 - 1947 went underground as a result of under-capitalization,
poor management, fraud, unplanned rapid expansion of branches, lack of
regulatory policies, over-trading, foreign competition with the expatriate banks,
inadequate government supervision and undeveloped business environment
among others.
For instance,
•
Industrial Commercial Bank established in 1926 got distressed/failed in
1930.
•
Nigerian Mercantile Bank (2nd indigenous bank) established in 1931 failed
in 1936.
•
Nigerian Penny Bank collapsed in 1946.
•
Nigerian Farmers and Commercial Bank established in 1947 was
liquidated in 1953.
•
Arab Bank founded in 1937 was changed to African Continental Bank in
1948, served as Bank of Biafra 1967-1970 and got distressed in 1995.
The failure of many of these banks especially Nigerian Penny Bank and the
subsequent losses sustained by a large number of small depositors was the
immediate cause of the setting up of the Patton's Commission in 1948, this report
formed the basis for the banking ordinance of 1952.
The first time an attempt was made to regulate the business of banking in Nigeria.
The ordinance introduced important regulations designed to promote orderly
commercial banking and prevent the establishment of unviable banks and led to
the enactment of Central Bank Act.
The period 1958-1986, which may be described as the regime of intensive
banking regulation began with the enactment of the Central Bank of Nigeria Act
of 1958, which made the establishment of CBN in 1959 as the apex bank of the
country. Further legislations are the Companies Act of 1968 and the Banking Act
of 1969 as well as the vigorous application of the Exchange Control act of 1962
thus, the CBN was able to outline regulatory measures to effectively stem the tide
of bank failure that followed the first banking period.
In 1970, the Indigenous Degree propagated which nigerianised the foreign banks.
The Bank of British West Africa which was the first bank to obtain banking
license under the 1952 ordinance change to First Bank of Nigeria while the
Barclays Bank changed to Union Bank of Nigeria. At this time, banking was too
slow, what is termed "crawling or elephantine banking". This was taken care of
through the deregulation of the entire economy in 1986 which resulted in
financial liberalization still brought about distress of banks. It was the adoption of
the Structural Adjustment Programme in 1986. Also, the Central Bank of Nigeria
decree 24 of 1991 brought about further deregulation of the sector and the effect
was the exposure of banks to economic reality and as such distress in banks
between 1993 and 1996.
The resultant effect of bank failure on the economy brought about
recapitalization of banks in 2005, and since then to-date there has been no distress
as the evolved 25 banks are very strong and so no bank in the country now can be
termed small. Central bank of Nigeria has a lot of measures in place beyond
recapitalization to monitor activities of banks, as CBN has assured that bank
distress will remain a thing of the past. Some o f these measures are;
I.
Publishing a code of conduct for banks with standards of good governance,
and conducting background checks on candidates for bank directorship.
II.
Adopting a risk-focused and rules based regulatory framework.
III.
Automating the process for reporting bank results.
IV.
Establishing confidential telephone and online channels for Nigerians
wishing to share information with the CBN on the operation of any bank.
V.
Instituting a phased withdrawal of government deposits to reduce bank
dependence on them.
2.5
FUNCTIONS OF COMMERCIAL BANK
As an important institution of the economy, commercial banks perform vital
functions within the economy. The usual functions which they perform include;
1. Banking Functions
Commercial banks receive money or financial document representing money
from or on behalf of customers for the credit of their clients account on deposit,
current, term, fixed or other forms of account and accept money for the purpose
of transferring it from one part of the world to the other. They also accept
valuables such as jewelry, precious stones and metals and classes of documents
eg will for safe keeping.
2.
Money Lending
Commercial banks provide money advances and loans to individual societies,
partnerships through a number of financial instruments such as bonds and
guarantees, bills of exchange, promissory notes, letters of credits, commercial
papers, bankers' acceptance, fixed or floating notes and other obligations.
Commercial banks also provide other forms of credit such as over draft, or other
short term credit for working capital, discounting bills and securities and term
loans including equity participation for financial capital investment programmes.
They also do corporate finance in form of equipment leasing, debt and equity
issues, underwriting capital issues, stock brokerage through their stock broking
affiliates, subsidiary project financial factoring and syndication of loans.
Commercial banks arrange syndicated facilities by policing by pooling a
consortium of banks, sometimes including other financial institutions like
insurance companies when a customer's borrowing requirements exceed the
capital of one bank to supply.
3.
Foreign Trade Services
Banks process foreign exchange and advise clients on foreign exchange matters
including procedure, exchange rates and cover, and current regulations.
They also assist customers to establish letters of credit at home, through agencies,
offshore branches, affiliates or worldwide through
correspondents; and to make foreign currency remittance or transfers to all parts
of the world.
They also assist in identifying export products and their buyer abroad. They also
provide product and market research services.
4.
Executorship and Trusteeship
Commercial banks act as executors and trustees of wills, settlements and trust
deeds of all kinds made by customers. For example, a will may be viewed as an
instrument, which the maker employs to dispose of her property in accordance
with her wish. It enables the maker to put down in writing how her affairs are to
be handled and to whom properties are to be given by the appointed executor after
the customers' death.
To be able to act as executors of wills including providing assistance in drawing
up wills, banks act as trustees for the holders of any shares, stocks, debentures,
bonds, loans and other financial obligations or securities. Commercial banks help
to establish and manage future benefit plans in the areas of pensions, gratuities,
provident funds, insurance endowment and the real and personal property of
individual and corporate clients.
5.
Financial Advisory Services
Commercial banks offer advisory services in all areas of banking such as set up of
accounting books, account reconciliation through e-business products,
information on current foreign exchange at home and abroad, on foreign
exchange cover, on exchange rate movement, on methods of fund remittance
(domestic and international trade), on products and market research in oversea
countries and on current import and export regulations at home and abroad.
6.
Developmental Roles
The Okigbo report of 1976 has led to the expansion of function of licensed banks
to include the following developmental roles;
a)
Active facilitation in the transformation of rural environment and near
communities by promoting rapid expansion of banking facilities and
services. Most importantly, they serve as vehicles for creating credit in
form of equity and loans to small-scale farmers and entrepreneurs in the
rural areas.
b)
Identify fully with Nigerian aspirations by taking a more active part in the
financing of programmes of national priority. Thus, apart from their
deposit taking and payment functions which permit commercial banks to
serve as the ultimate source of liquidity for production and consumption,
they also serve as channels through which government monetary and credit
policies are implemented. For example, they participate in schemes such as
Agricultural Credit Guarantee Scheme Fund (ACGSF) and the
Small-Scale and Medium Enterprises scheme (SMFS).
2.6
REFORMING THE BANKING SECTOR - OUTCOME
On July 6, 2004, Charles Soludo, Governor of the Central Bank of Nigeria
(CBN), told the country's numerous and typically under-funded banks that they
must raise their minimum capital base more than twelve fold
to 25 billion naira ($250 million) from 2 billion naira ($15 million) within 18
months.
Banks that do not meet the target by the December 2005 deadline risk being
barred from accepting government deposits and participating in the CBN's
foreign exchange auctions. Moreover, their failure to meet the standard will be
made public: the CBN governor said he will publish the names of banks that
qualify by 31 December 2005. The announcement touched off a scramble by
banks to meet the deadline - as well as a debate over whether the remedy is too
drastic and the deadline too short.
The announcement led to merger and acquisitions which at the end of 2005, 25
banks emerged out of the 89 banks. The 25 billion naira capital requirements
include paid-up capital and reserves unimpaired by losses unlike the 2 billion
naira which was just the minimum paid-up capital before the reform in 2005.
Twenty-five banks emerged from 75 banks, out of a total of 89 banks that existed
as at June 2004. The successful banks account for about 93.5% of the deposit
liabilities of the banking system. In the process of complying with the minimum
capital requirement, N406.4bn was raised by the banks from the capital market
out of which N360bn was verified and accepted by the CBN; and also the process
led to the inflow of FDI (Foreign Direct Investments) of US $652m and 162,000
pounds sterling. Aside from the shrinkage of banks to 25 and the heavy capital
mobilization, there are other benefits;
The liquidity engendered by the inflow of funds into the banks induced
interest rates to fall drastically while an unprecedented 40% increase has
been recorded in lending to the real sector.
With higher single obligor limit, our banks now have greater potential to
finance big ticket transactions.
Already, more banks now have access to credit lines from foreign banks
(one recently received $250 million from two foreign banks) this was
unprecedented.
Ownership of the banks has been diluted. This will in no small way tame
the monster of insiders and corporate governance abuse.
With virtually all the banks now publicly quoted, there is wide regulatory
oversight; with Stock Exchange Commission (SEC) and Nigerian Stock
Exchange (NSE) joining the team. Regulatory resources would now be
focused on fewer and more stable banks.
Depositors confidence is bound to be greater and interest rate on deposit
lower due to "safety in bigness" perception by depositors.
The banks will of course enjoy economies of scale and consequently, pass
on the benefit in the form of reduced bank charges to their customers.
The capital market deepened and consciousness about it increased
significantly among the population. The market has become more liquid
and the total capitalization markedly increased.
As is to be expected, there are bound to be integration challenges in the new
banks. In this regard, the CBN is poised to address such concerns. Some of the
measures intended to address the corporate governance and integration issues in
the consolidated banks are:

A new draft code of corporate governance for banks has been issued to the
industry in the spirit of transparency and constructive consultation. At a
later date, a stakeholder's forum will deliberate on the new Code of
Conduct before we finalize it.

The CBN will closely monitor the banks to ensure that the provisions of the
merger schemes documents are complied with.

The CBN maintains a black book of discredited practitioners in the system.
The black book is being automated for easy identification of persons on the
list. Meanwhile, the list of debtors of banks is being screened to ensure that
no non-performing debtor is left on the Board of the 25 banks.

Zero tolerance regarding infractions; misreporting, non-transparency etc.
This was one of the 13 points in the reform programme which CBN intend
to strictly apply now that the first phase of the programme has been
concluded.
The supervisory process is also being reformed:
o
The prudential supervision arm of the CBN is migrating to a risk based
approach to supervision. The framework for this has been released and
implementation process is close to launch.
o
The capacity of supervisors is being enhanced through training especially
in risk management.
o
The supervision software deployed in the CBN has been significantly
upgraded and is now being operationalized.
A post consolidation due diligence exercise was carried out on all the banks
within the first quarter of 2006. The exercise involved a re-verification of each
banks' capital to prevent or eliminate any incidence of "bubble capital". This is to
prevent failure of a bank later although CBN has a contingency plan to forestall
that; which is getting stronger banks to acquire any shaky bank as well as CBN
playing the role of lender of last resort.
At the expiration of the December 31, 2005 deadline, a number of banks failed to
secure merger partners and were not able to make the minimum capitalization
requirement on their own. Towards the end of the first phase of the exercise, eight
banks hurriedly formed themselves into a group (Alliance Group) when they
failed to secure merging partners. All of them were bedeviled by poor operational
performance, insider abuse, poor corporate governance and negative net worth.
The group negative shareholders fund was N54.3bn. the CBN compassionately
reviewed the proposal for merger and granted a conditional approval-in-principle
on the strong affirmation by the promoters of the group that they would recover
and pay into a CBN escrow account the sum of N10.5bn insider-related debts
before December 30, 2005.
The Alliance Group did not comply with the conditions of the AIP and CBN on
January 4, informed the group that the AIP had lapsed as a result of its inability to
meet the stipulated conditions.
Another group of 6 banks that could also not meet the recapitalization conditions
were characterized by precarious financial conditions. This brings the number of
unhealthy banks in the system to 14. In CBN's last ditch effort to save these
banks, the 25 healthy banks were invited to absorb any bank of their choice
among the group. Unfortunately, no serious effort has been made to absorb any of
the weak banks.
The 14 banks that did not make it are;
1. African Express Bank
2. Allstates Trust Bank (later absorbed by Eco bank)
3. Assurance Bank of Nigeria (later absorbed by Afribank)
4. City Express Bank (later absorbed by UBA)
5. Eagle Bank
6. Fortune International Bank
7. Gulf Bank
8. Hallmark Bank (later absorbed by Eco bank)
9. Lead Bank
10.Liberty Bank
11.Metropolitan Bank
12.Societe Generale Bank
13.Trade Bank (later absorbed by UBA)
14.Triumph Bank
Banks that met 25 billion naira;
1. Access Bank
2. Afribank
3. Diamond Bank
4. Eco Bank
5. Equitorial Trust Bank
6. First City Monument Bank
7. Fidelity Bank
8. First Bank Plc
9. First Inland Bank
10.Guaranty Trust Bank
11.IBTC - Chartered Bank
12.Intercontinental Bank
13.Nigeria International Bank
14.Oceanic Bank
15.Platinum Bank
16.Skye Bank
17.Spring Bank
18.Stanbic Bank
19.Standard Chartered Bank
20.United Bank of Africa
21.Sterling Bank
22.Union bank
23.Unity Bank
24.Wema Bank
25.Zenith Bank
2.7
OBJECTIVE OF THE REFORM
The objective for the reform is to strengthen the operational capacity of the local
banks and enhance their competitiveness in the international financial market.
With the consolidation of the banking institutions through mergers and
acquisition, enhanced capitalization and adoption of risk-focused and rule-based
regulatory framework, coupled with good corporate governance, the Nigerian
banking sector should be able to withstand market shocks and meet the
challenges of globalization.
The reforms have focused on structural and institutional reforms such
as;
i.
Strengthened the institutional framework for the conduct of monetary
policy.
ii.
Bank recapitalization/consolidation.
iii.
Programme to possibly eliminate or reduce government ownership of
any bank (to no more than 10 percent).
iv.
Improved transparency and corporate governance.
v.
Zero tolerance to misreporting and data rendition and strict adherence
to the antimony laundering regulations.
vi.
Implementation of Basel II Principles and risk based supervision.
vii.
Payments system reforms for efficiency especially the e-payment.
viii. Reforming the Exchange rate management system - adoption of the
Wholesale Dutch Auction System (WDAS) and increased
liberalization of the forex market (which since 2006 led to the
convergence of the parallel and official rates of the first time in 20
years).
ix.
Restructuring the Nigerian Security Printing and Minting Pic.
x.
Addressing issues of technology and skills in the banking industry
especially in risk management and ICT.
xi.
Launching of a new micro finance policy and regulatory framework to
serve the unserved 65 percentage of the bankable public.
xii.
Ongoing Pension, Consumer credit, and Mortgage system reforms.
xiii. Forging strategic alliances and partnerships between Nigerian banks
and foreign financial institutions especially in the area of reserve/asset
management.
xiv.
Establishment of Africa Finance Corporation (AFC), as first private
sector led African Investment Bank.
xv.
Encouragement of Nigerian banks to go global, leading to more than
doubling of branch network in West Africa since 2004; setting up of
subsidiaries in London as well as Nigerian banks successfully issuing
Eurobonds and getting listed on the London Stock Exchange.
The grand objective in the banking sector reforms was to re-engineer and fast
track a system that will engender confidence and power a new economy. So far,
the grand objectives of that policy are being achieved, and the consolidation
programme has been adjudged about the most successful and at least cost to the
taxpayers in the world. The total deposits trapped in the failed banks as
percentage of GDP is about 0.7% (the lowest in the world), and no private sector
depositor would lose a kobo of his/her deposit. The banking system is the safest
and soundest it has ever been in history.
Deposits and credits have more than doubled and non-performing loans as
percentage of total loans have gone down from about 23% before consolidation to
about 7% currently. Individual banks now finance big projects valued at hundreds
of millions of dollars and also operate in the oil and gas sector, a feat they never
could do before now. Interest rates are gradually coming down (with average
lending rate at about 16.9% from 25%). Currently, commercial bank branches
have gone up from about 3,200 before reforms to over 4,100 and total
employment in the sector has gone up.
2.8
PROFITABILITY OF NIGERIAN BANKS
POST-CONSOLIDATION: CONSOLIDATION
GAINS
Before the consolidation exercise took place between July 2004 and December
2005, the Nigerian banking industry was characterized by poor performance in all
major indices compared to its peer - asset base, profitability, gross earnings,
shareholders' fund, etc.
From example, the capital base of all 89 banks in the country put together was the
size of the fourth largest bank on South Africa. For a progressive nation like
Nigeria, it was not possible for this dismal situation to be sustained. But thanks to
consolidation, the story of the Nigerian banking system is changing:
 From 89 mostly frail banks to 25 strong reliable banks.
 20 out of the 25 Nigerian banks now rank among the top 100 banks in
Africa while 17 of them are among the top 40.
 Nigerian banking industry is now the fastest growing in Africa and one
of the fastest growing in the world.
 Unprecedented growth in all major indices - assets, deposits, credit,
branch network, profitability, etc.
 For example, banking industry's credit to the domestic economy
increased by 55% in just one year, from N l .83trillion as at December
2005 to N2.84trillion in December 2006.
As the performance indices are improving, so are the industry's challenges
dropping. A report released by the NDIC this week shows that insured banks'
non-performing credit in 2006 fell by 38 per cent to N225.08bn from N368.76bn
recorded in 2005 (Economic intelligence weekly vol. 2, No. 28, August 31,
2007). Post consolidation, this is not surprising since the liquidated banks
accounted for much of the poor quality assets in the industry before now.
Moreover, banks in the new regime are more meticulous about quality of their
assets, paying closer attention to global best practices in credit risk management.
As a result, recent industry statistics show that banks' asset quality as ratio of
non-performing credit has improved significantly, decreasing from 20.13 per cent
in 2005 to 7.92 per cent in 2006. Ratio of non-performing credits to shareholder's
fund has also decreased from 59.01 per cent to 22.06 per cent between 2005 and
2006.
Profitability: With the improving performance, it is no wonder that the
profitability of Nigerian banks has also improved significantly in the last two
years, with some of the top banks recording an annual average of 70% growth
rate in their profit ratio since the consolidation.
Profitability of Top 10 Nigerian Banks Since Consolidation
Banks
Zenith Bank
9.16
15.15
23.3
First Bank
15.5
16.1
22.1
Intercontinental Bank
6.71
8.15
21.5
United Bank of Africa
6.52
12.81
12.5
Union Bank
11.95
12.35
12.3
Guaranty Trust Bank
7.00
10.0
11.6
Oceanic Bank
7.27
11.21
10.0
Diamond Bank
3.52
5.29
8.79
Access Bank
0.75
1.12
8.0
AfriBank
0.79
3.9
7.2
As a result of growing profitability and the attendant enhanced return on
investments (capital appreciation, bonuses, and dividends), Nigerian banks,
especially those quoted on the stock exchange, have become the toast of
investors, topping chart during every trading session.
From trends, it is certain that Nigerian banks will continue to improve their
profits and other growth parameters, especially as most of them have set fro
themselves the target of achieving a minimum capital base of $ 1 bn before 2010.
At least 5 banks have already crossed this mark and are still craving for more.
2 .9 .0 R E F O R M S : T H E L AS T L AP , A N E W B E G I N NI NG
Even in the heat of the build-up to the general elections in April, the tempo of
reform efforts remained quite high during the first quarter 2007, affecting the
shape and trend of all socio-economic indicators. The fast-tracking and
consolidation of some reform programmes and projects that marked the close of
2006 continued into 2007. New policies and project in sectors like financial
services, energy and power, oil and gas, solid minerals, aviation, telecom and
maritime were carried on with renewed gusto. Reforms in the public service,
agriculture, tax, external debt management, privatization, socio-economic
infrastructure, among others, also received serious attention during the period.
In specific terms, the quarter was marked by the conclusion of the consolidation
exercise in the insurance industry (on February 28, 2007); avalanche of new
supplementary offers by banks seeking to further increase their capital base; the
introduction of new coins and redesigned bank notes into circulation; inflow of
foreign equity investment into a number of banks; BB—rating for the country the second time by Fitch Rating Agency and Standard and Poor's. Other features
of the quarter include pursuit of Nigeria's exit from the London Club of Creditors;
increased foreign exchange earnings owing to high oil prices in the international
market; recapitalization in the aviation industry and revocation of refinery
licenses, among others.
These developments culminated in various economic indices attaining or
surpassing projected outcomes; thus, inflation rate (year-on-year) not only
stabilized at single digit, but dropped from 8.2% as at end-December 2006 to
about 7.5% by the close of the first quarter 2007. It stood at 7.7% at the end of
February. These are already below the 2007 Appropriation Act inflation rate
benchmarked at 9.0%. This trend is attributable to a number of factors, including
relative stability in the cost of fuel/transportation, low prices of a few food items
and some monetary management measures during the period. Similarly, the
national currency recorded marginal appreciation against the dollar during the
quarter: from N127/US$1 at the end of last year to N126.98/US$1 at end-march
2007. All through the period too, the gap between the parallel and official market
exchange rates also kept narrowing. The Central Bank of Nigeria, in
demonstration of its confidence in this heartening development, increased banks'
Open Position Limit (OPL) in the market, to enable them handle big ticket
transactions in foreign currency.
All through the quarter, interest rate dipped due mainly to sustain excess liquidity
in the system. The average monthly interest rate measured by the Nigerian
Inter-bank Offered Rate (NIBOR) thus dropped to about 11.5% at end-March
compared to its level of 12.20% in February and 13.0% in January. This was as a
result of the injection of some excess crude funds, monthly statutory Federation
Account allocations and spending by politicians towards the general elections in
April. It is also observed that the introduction of the Monetary Policy Rate (MPR)
late last year has largely stemmed the usual volatility in the inter-bank rate,
leaving it within the lending and deposit standing facility rates of the CBN at 13%
and 7% respectively.
Favourable oil prices in the international market, especially towards the close of
the quarter, aided the sustenance of the country's robust foreign reserves trend.
Oil prices have been consistently above the USD$40/barrl that is the benchmark
for the 2007 budget; infact, all through March, prices remained around the
USD$60/barrel level. Thus, despite exit settlements to Paris and London Clubs of
Creditor, Nigeria's external reserves still remained in excess of USD$40 billion
by the close of the quarter.
In the capital market, activities were upbeat both in the primary and secondary
segments of the Nigerian Stock Exchange. Thus, market capitalization which
stood at N5.12 trillion at end-December 2006, closed the quarter at N7.133
trillion, an increase of 10.58% over the N6.45 trillion recorded in February. These
increases were attributable mainly to the gains recorded by highly capitalized
stocks - examples are First Bank and Zenith Bank which recorded capitalizations
of N393.67 billion and N370.62 billion respectively at end of March to remain at
the top of the market capitalization ladder. The Nigerian Stock Exchange All
Share Index (ASI) which stood at 33,189.30 at end-December 2006 closed the
first Quarter 2007 at 43,456.14.
The bond segment of the capital market was very much alive during the first
quarter 2007. The Debt Management Office on behalf of the Federal Government
offered and sold a total of N110 billion worth of FGN bond of different maturities
during the quarter. The January auction of the First Series of the 4 lh FGN 2010
Bond received the highest subscription level of 312.15 per cent while the
February auction of the Second Series of the 4th FGN 2010 received the lowest
coupon rate of 9.50 per cent. However, compared to the bonds issued last year,
the coupon rates for all the bonds issued in the first quarter 2007 were low. The
3-year bond dropped from 12 to 10.75 per cent; 5-year bond from 12.90 to 9.50
per cent, while 7-year bond dropped from 12 to 10.70 per cent. This was
attributable to a number of factors including the persistent high liquidity in the
market, drop in inflation rate as well as the take off of the primary dealership and
active secondary segment of the bond market, among others.
2 .9 .1 B A NK I NG A N D FI N A N CE
The new phase of consolidation in the banking industry, mainly market induced,
continued with momentum during the quarter - with a number of banks rushing
back to the capital market with hybrid offers to raise additional funds from the
public. Others negotiated and sealed deals with reputable foreign equity
investors, just as some had to play in the global Eurobond market. Negotiations of
mergers and acquisitions between some foreign and Nigerian banks also
progressed substantially. The acquisition of a number of the 'failed banks' by
some of the existing banks by way of "cherry picking" also continued during the
quarter. A number of banks cashed in on the consolidation in the insurance sector
which ended during the quarter, to either fully acquire some of the insurance
firms or increase equity holding in them. Intensifying competition, positioning
and quest for greater market share by all the banks gave rise to the churning out of
plethora of new products/services - mainly customer-oriented and e-based.
Specifically, no fewer than four banks wrapped up their plans or actually made
public offers to raise money in the capital market during the first quarter. While
United Bank for Africa and Oceanic Bank came to the market to raise N54 billion
and N55 billion respectively, First Bank got set to mobilize N100 billion.
Ecobank Transnational Incorporated (ETI) was also set to raise fresh N38.1
billion (USD$300 million) from Nigerian Stock Exchange, Ghana Stock
Exchange and the Stock Exchange in Abidjan, Cote D'Voire. This is part of its
drive to hit a capital base of N152.4 billion (USD$1.2 billion). Applications by a
few other Nigerian banks to raise various sums in the capital market were, by the
close of the quarter, at different levels of processing by the regulatory authorities.
On their part, some other banks sealed deals with foreign investors who were
partaking in their ownership through equity investments. A consortium led by
Act Capital LLP, is injecting USD$130 million (N16.78 billion) into Diamond
Bank; the equity investment which has been endorsed by the consortium and the
board of the bank, is undergoing necessary approvals by the regulatory
authorities. Also, some foreign institutional investors led by Helios Investment
Partners, as strategic investor, acquired about 16 per cent shareholding worth
N10 billion in the First City Monument Bank. Other prominent investors include:
CDC, an investment arm of the British Government; Soros Private Equity Funds
and overseas Private Investment Corporation (OPIC), an agency of the United
States Government.
Also during the quarter, the International Finance Corporation (IPC), the private
sector arm of the World Bank Group granted a USD$50 million (N6.5 billion)
convertible loan to UBA; this convertible debenture when converted gives IFC
control of about two per cent equity of UBA. Moves by UBA to acquire City
Express Bank and Metropolitan Bank through "cherry picking" also continued
during the quarter. Intercontinental Bank has also sealed a deal with a consortium
of five international financial institutions, including Vectis Capital from Greece,
for a USD$161 million (N20.25 billion) investment in the bank. The investment
is in form of a convertible preferred equity. Guaranty Trust Bank, on its part,
played on the international capital market, where it issued a five-year USD$300
million Eurobond that was over-subscribed.
The merger arrangement between IBTC-Chartered Bank and Stanbic Bank (a
subsidiary of Standard Bank of South Africa) advanced further, with the Central
Bank of Nigeria granting its Approval-in-Principle (AIP) to the deal. Approval
processes by other regulatory agencies, including the Securities and Exchange
Commission and the Nigerian Stock Exchange are yet ongoing. Under the merger
deal, the enlarged IBTC will retain its brand name and operate as a Nigerian bank
and remain quoted on the Nigerian Stock Exchange. It will however, become a
member of the Standard Bank Group.
Banks also continued with vigor, their branch network expansion efforts, moving
into semi-urban areas and the country side - places hitherto poorly banked or
completely un-banked. The efforts also continued offshore, where a number of
banks either opened new branches, representative offices or full subsidiaries.
Notable outing in these regards was the opening of Zenith Bank (UK) Limited in
London - a wholly owned subsidiary of Zenith Bank (Nigeria) PLC. Zenith Bank
obtained the banking license from the UK Financial Services Authority after
meeting very stringent requirements; thus, it became the first Nigerian bank to be
granted license to set up a bank in UK. Other Nigerian banks had operated either
as branches or subsidiaries of their UK parent banks. Zenith Bank also opened a
Representative Office in Johannesburg, South Africa.
In its own expansion drive, UBA commenced operations in the United States of
America with a branch in New York. Skye Bank on its part, sealed a deal with the
Deutche Bank of Germany - the two banks are to work together in the area of
external reserves management, private equity investment, risk management, fund
administration and training. The Ecobank Transnational Incorporated (ETI)
carried on with its own expansion, by purchasing majority shares in the
International Bank for Africa in Chad Republic. An agreement in respect to the
takeover was signed in N'djamena, Chad's capital city.
Banks, as in the last quarter 2006, continued to attract lines of credit from several
reputable multilateral financial agencies, just as the increased their presence in
the funding and execution of big ticket transactions hitherto treated as the
preserve of foreign banks and institutions. Thus, in the first quarter 2007, Zenith
Bank led five other banks to arrange N20 billion loan facility for the completion
of the Aviation Terminal II at the local wing of the Murtala Mohammed
International Airport, Lagos. Zenith Bank was also the lead arranger and its
subsidiary, Zenith Capital, the financial adviser for a USDS 1.5 billion (N193
billion) facility by a consortium of 10 banks for Zenon Oil. The consortium
included the French BNP Paribas.
In a similar vein, Standard Bank (through its Nigerian wing: Stanbic Bank
Nigeria) in collaboration with some Nigerian banks, raised USD$125
million (N16 billion) of project financing for Eleme Petrochemicals Plant, Port
Harcourt (Rivers State). The fond is for the revamping of the ailing plant. Seven
Nigerian banks also collaborated with five other financial institutions in the
country to syndicate a USD$222 million (N28.80 billion) credit facility for
Notore Chemical Industries Limited (former National Fertilizer Company of
Nigeria (NAFCON) for its turnaround.
During the quarter under review, the CBN came up with a number of policies in
its monetary management efforts. Among them was the release by the apex bank
to deposit money banks, some of the funds (8 per cent of their cash) it sterilized
late last year in a bid to control inflation. The CBN also early in the year,
appointed 17 banks and three discount houses as dealers I money market
instruments. The appointed primary dealer now conduct sale of treasury bills in a
manner to fast-track the actualization of the CBN's monetary management
policies. The CBN has also commenced its electronic Financial Analysis and
Surveillance System (eFASS) in full -the test-run began October 2006. The
system enables deposit money banks and discount houses to submit electronic
copies of the summary of their daily operations to the CBN within 48 hours.
The 18 month recapitalization exercise in the Nigerian insurance industry ended
on February 28, 2007. Consequently, the industry's regulator - the National
Insurance Commission - re-licenses a total of 71 operators out of the 164
insurance and reinsurance companies that existed before the exercise. These
comprise 43 non-life insurance companies, 26 life insurance companies and two
reinsurance companies. The recapitalization exercise was marked by numerous
mergers and acquisitions, private placements as well as offers for subscription.
The Federal Government on September 5, 2005, mandated insurance and
reinsurance companies operating in Nigeria to raise their minimum capital base
as follows: N2 billion for life business; N3 billion for non-life business, and N10
billion for reinsurance business.
2 .9 .2 B AN K I N G S U PE RVI S I O N
In 2004, the Ethics and Professionalism sub-committee of the Bankers
Committee handled complaints among banks, as well as between banks and their
customers. As in the preceding years, most of the complaints bordered, among
others, on excess charges by banks; manipulation and fraudulent practices on
customers' accounts; conversion of investment funds; irregular clearing of
customers' cheques, and non-refund of wrong debit to customers' accounts, etc.
The importance of banks in a financial system is generally well known. They are
vehicles used in national payment systems and also, facilitate international
payments for trade and travels. At their optimal performance level, they
contribute towards the stabilization of the economic environment and represent
the medium for the transmission of monetary policies from government
regulatory agencies. Any time a bank, anywhere in the world runs into serious
problem, the effects are usually far reaching. There is the case of a Nigerian
businessman who had a commercial court case in the UK in the early 1990's. The
case involved a branch of a foreign bank there and had dragged on for about 3
years. A few days after the Nigerian won the case, he was handed a draft for over
one million pounds and he dropped the instrument in BCCI, London say on a
Friday. He went over to see the branch that he lodged the funds into the very next
Monday morning, but Lo and behold! the gates of the bank were firmly locked.
The bank had failed.
A strong man, the Nigerian had suffered a mild stroke and managed to come out
of it about 12 months later! The underlying reasons for the bank's failure included
the familiar ones of poor risk assessment and control, fraud, inadequacy in
capitalization and management.
The international consequence of bank failures is not limited to the micro
situation just described. Serious problems in the banking system of a country,
whether developing or developed, can threaten financial stability both within that
country and internationally. All men of goodwill need to take steps to check the
consequences of the misfortune!
When Mexico threatened to default on its short term debt obligation in 1995,
President Clinton got America to come to its rescue with a loan package of about
US$25 billion to save that country and its banking system as well as the US
economy and indeed banks from its effects, without the approval of the US
congress. Mexico repaid the loan within 2 years and the world cheered a president
with guts and foresight!
Indeed, part of the problems of bank failures has to do with regulations and their
rigorous enforcements or otherwise. Regulatory enforcements take place at
national levels or as dictated by prevailing legal circumstances. Sometimes,
government's, discretionary actions prevail, even where they may not be the best
advised.
2 .9 .3 B AN K S U P E RV I S O RS A ND I N S PE CT O R S
In the context of this discussion, Bank supervisors and Inspectors are individuals,
(usually employees but not necessary so) duly authorized by banking regulatory
agencies, top of which is the Central Bank to carry out a review of any functions
to be and indeed being performed by duly constituted and licensed banks or
financial institutions in accordance with relevant laws.
The principle objective of Bank Supervisors is to ensure the safety and soundness
of the banking system. Nigeria Deposit Insurance Corporation (NDIC)
complements the Supervisory roles of the Central Bank in this respect. The two
principal banking legislations for Nigeria are Central Bank Act 24 of 1991 and
the Banks and Other Financial Institutions Act 25 of 1991. Clearly, therefore the
Bank Supervisors perform their duties with the backing of certain laws and carry
with them the powers of the state.
2 .9 .4 B AN K S U P E RV I S I O N I N NI G E RI A
In Nigeria, the official agency of the Nigerian Government responsible for the
Supervision of Financial Institutions is the Central Bank (CBN). Institutions
covered in this respect are the deposit money banks, the discount houses, primary
mortgage
institutions,
community
banks,
finance
companies,
bureaux-de-changes and development finance institutions. The supervisory
function of the CBN is structured into two departments -Banking Supervision
Department (BSD) and Other Financial Institutions Department (OFID).
The Banking Supervision Department carries out the supervision of banks and
discount houses while the Other Financial Institutions Department supervises
community banks and other non-bank financial institutions. The supervisory
process involves both on-site and off-site arrangements, all on elaborate and
expensive scales. Appropriate levels of government, however, appreciate that
inadequate attention to supervision could be far more expensive and chaotic.
A.
B A NK I NG S U PE R VI S I O N D E P A RT ME NT ( B S D)
The on-site aspect of the department's function includes independent on-site
assessment of banks corporate governance, internal control system and checks for
the reliability of information provided by banks, among others. The field
examinations carried out by the department is grouped into Maiden, which is
usually conducted within six months of commencement of operation by a new
bank; Routine which is the regular examination and Target, which addresses
specific areas of operation of a bank e.g. credit. Special Examination is carried
out as the need may arise and as provided in section 32 of the Banks and Other
Financial Institutions Act. The department also conducts spot-checks for quick
confirmations/verifications.
The off-site aspect reviews and analyzes the financial conditions of banks using
prudential reports, statutory returns and other relevant information. It also
monitors trends and developments for the banking sector as a whole. Industry
reports are generated on monthly and quarterly basis.
B. OTHER FINANCIAL INSTITUTIONS DEPARTMENT ( O F I D)
The department handles the supervision of community banks (CBs), primary
mortgage institutions (PMIs), finance companies (FCs), bureaux de changes
(BDC) and development finance institutions (DFIs).
In spite of the laudable structures put in place to supervise the system, the
banking system still has problems that threaten its very existence. For our
purpose, we reviewed several reports from the Banking Supervision Department
between year 2000 and year 2004 which highlighted some of these.
2 .9 .5
PR O B L E M S I N T H E B AN K I NG S YS T E M
In the year 2000, the CBN, in its Banking Supervision Department report listed
the following public complaints against some banks in the financial system;
i.
Exploiting the ignorance of unsuspecting customers through
excess commissions and illegal charges.
ii.
Refusal to open certain types of accounts e.g. salary accounts.
iii.
Failure to issue bank statements regularly to customers.
iv.
Illegal disposal of customers' properties pledged as collateral
for credit facilities.
v.
Shortages in cash withdrawals.
vi.
Unilateral application of
negotiated with customers.
vii.
Refusal to honor the terms performance bonds.
interest
rates
outside
the
terms
viii. Excess charges on bank drafts.
ix.
Introduction of extraneous terms into contracts with customers,
to short-change them.
x.
Unauthorized/arbitrary debiting of customers' accounts.
xi.
Release of funds transferred from overseas to impersonators.
xii.
Imposition of previously undisclosed charges on customers'
accounts.
xiii. Failure to credit customers' ledgers with the amount deposited.
At the level of regulators, thirty one (31) banks were in various stages of
liquidation owing to inadequate capitalization, poor asset control, insider
dealings involving bank directors and frauds (NDIC 2000 Annual Report and
Statement of Accounts).
It is pertinent to observe that the trend of public complaints against banks has
been on the rise in recent times. The high level of complaints in spite of the huge
expenditure on systems and technology constitutes a drag on the integrity of the
profession and debases the service level below quality grade, especially since it is
well known fact that the quality service generates income.
During the year 2004, the Ethics and Professionalism sub-Committee of the
Bankers Committee handled complaints among banks, and banks and their
customers. As in the preceding years, most of the complaints bordered, among
others, on excess charges by banks; manipulation and fraudulent practices on
customers' accounts; conversion of investment funds; irregular clearing of
customers' cheques, and non-refund of wrong debit to customers' accounts, etc.
The CBN Annual report for 2004, Monitoring Banking Sector
Soundness stressed that "the operational performance of banks revealed mixed
developments. The rating of licensed banks, using the CAMEL parameters,
revealed that ten (10) banks were "sound", fifty one (51) were "satisfactory",
sixteen (16) were rated "marginal" and ten (10) banks were rated "unsound".
However, the performance of banks since 2001 exhibited a deteriorating trend as
the number of "satisfactory" banks had declined steadily from 63 in 2001 to 51 in
2004. In the same vein, the number of banks that were "marginal" increased from
8 in 2001 to 16 in 2004. "Unsound" banks also increased from 9 in 2001 to 10 in
2004. The marginal and/or unsound banks exhibited such weaknesses as
undercapitalization, illiquidity, weak/poor asset quality and poor earnings.
Rating Of Banks Using the "CAMEL" Parameters
Category
Sound
Satisfactory
Marginal
Unsound
Numbers
2001
2002
10
13
63
54
8
13
9
10
2003
11
53
14
9
2004
10
51
16
10
The total assets of the industry grew by 23.0 per cent to N3, 393.0 billion at
end-December 2004. Further analysis showed that, "of the Nl, 463.0 billion
outstanding credit, 21.6 per cent was non-performing, while insider credit
accounted for 6.3 per cent."
The same Report also had comments on the Surveillance Activities of Financial
Institutions both on-site and off-site of licensed banks and other financial
institutions in 2004 undertaken by the surveillance departments of the CBN. "The
surveillance activities during the year involved the wholesale examination of
fifty-nine (59) deposit money banks, five (5) discount houses and eight (8)
offshore outfits of some Nigerian banks. The routine examination covered
prudential regulations; foreign exchange operations; anti-money laundering
controls and know-your-customer (KYC) directives. The examinations were
aimed at determining the extent to which banks complied with the banking rules
and regulations as well as their financial condition.
The CBN also conducted follow-up examinations on some financial institutions
to determine their compliance with the CBN recommendations contained in
previous examination reports. The prudential examinations revealed various
lapses in some of the institutions, including: undercapitalization, weak internal
control systems, granting of credit with inadequate collaterization, poor asset
quality, violation of the single obligor limit, and weak corporate governance.
Specifically, in 2004, 54 banks contravened various CBN regulations and
guidelines 99 times, as against 37 banks that contravened 66 times in 2003.
Sanctions were appropriately imposed on the erring institutions. The routine
examinations of foreign exchange operations of the banks revealed various
breaches, including: noncompliance with open position limits, failure to
repatriate interest earned on FEM funds, non-distribution of the naira proceeds
repatriated on letters of credit transactions to eligible customers, excess charges
by banks on foreign exchange transactions, recycling of airline tickets for
invisible trade transactions, disbursement of foreign exchange without complete
documentation, and failure to render specified returns to the CBN.
These concerns must any one who cares and it must have bothered the present
crop of the board of CBN to the point of initiating the 13 point Elements of
Banking Sector Reform which is listed below:
1.
The requirement that the minimum capitalization for banks should be N25
billion with full compliance by December 31, 2005;
2.
The phased withdrawal of public sector funds from banks, starting in July
2004;
3.
The consolidation of banking institutions through mergers & acquisitions;
4.
The adoption of a risk-focused, and rule-based regulatory framework;
5.
The adoption of zero tolerance in the regulatory framework, especially in
the area of data/information rendition/reporting;
6.
The automation for the rendition of returns by banks and other financial
institutions through the enhanced Financial Analysis and Surveillance
(e-FASS);
7.
The establishment of a hotline, confidential internet address
([email protected]) for all those wishing to share any confidential
information with Governor of the Central Bank on the operations of the
any bank or the financial system;
8.
The strict enforcement of the contingency planning framework for
systemic banking distress;
9.
The establishment of an Assets Management Company as an important
element of distress resolution;
10.
The promotion of the enforcement of dormant laws, especially those
relating to the issuance of dud cheques, and the law relating to the
vicarious liabilities of the board members of banks in cases of failing by
the bank;
11.
The revision and updating of relevant laws, and the drafting of new ones
relating to the effective operations of the banking system;
12.
Closer collaboration with the Economic and Financial Crimes Commission
(EFCC) in the establishment of the Financial Intelligence Unit (FIU), and
the enforcement of the anti-money laundering and other economic crime
measures; and
13.
The rehabilitation and effective management of the Nigerian Security
Printing and Minting (NSPM) Plc to meet the security printing needs of
Nigeria, including the banking system which constitutes over 90 per cent
of the NSPM's business.
To be fair, none of the reform provisions can be faulted as they represent
corrective measures to counter well known system limitation and improve service
quality.
Of course, the high point of the reform is the uniform N25 billion banks
recapitalization requirement but also a number of these measures answer the
concerns of unfulfilled parts of the core principles of the Basle Committee when
the World Bank Financial Sector staff assessed Nigeria's compliance level. This
issue is discussed further below.
We believe that the Central Bank should be commended for measuring its own
performance by international standards. The frustration to get the banking system
up and running since 1946 must constitute a Supervisor's nightmare and the need
to learn from the experience of others must have informed the step to align with
international standards!
2.9.6 THE CORE PRINCIPLES OF BASLE
The phenomenon of international capital movements has also substantially made
national boundaries almost irrelevant and the need to stabilize the financial
system on a global basis has therefore long been recognized.
Official international bodies like the World Bank, International Monetary Fund,
the Bank for International Settlements and the Basle Committee on Banking
Supervision have consequently taken the lead to strengthen the financial systems
through out the world.
On its own, the Basle Committee on Banking Supervision, consisting of senior
representatives of banking supervisory authorities in Japan, Germany, France,
Belgium, UK, Italy, Netherlands, Switzerland, Sweden, Canada and USA,
developed what is called "Core Principles for Effective Banking Supervision" (Basle Core Principles) over a period of 22 years. The views of many other
countries were sought as the assignment progressed with the principal aim of
setting standards so as to strengthen banking supervision in all countries. The
Committee regards the standards set from the principles as minimum because
environmental conditions in each country may necessitate a further strengthening
of the principles for desired effects.
There are 25 core principles and they are detailed in their issue with comments,
which have been excluded here. They can be very easily picked up on relevant
Internet sites using some of the well known search engines, including Google.
LIST OF CORE PRINCIPLES FOR EFFECTIVE BANKING
SUPERVISION:
Preconditions for Effective Banking Supervision
1.
An effective system banking supervision will have clear
responsibilities and objectives for each agency involved in the
supervision of banking organizations. Each such agency should
possess operational independence and adequate resources. A suitable
legal framework for banking supervision is also necessary, including
relating to authorization of banking organizations and their ongoing
supervision; powers to address compliance with laws as well as
safety and soundness concerns; and legal protection for supervisors
and protecting the confidentiality of such information should be in
place.
Licensing and Structure
2.
The permissible activities of institutions that are licensed and subject to
supervision as banks must be clearly defined, and the use of the word
"bank" in names should be controlled as far as possible.
3.
The licensing authority must have the right to set criteria and reject
applications for establishments that do not meet the standards set. The
licensing process, at a minimum, should consist of an assessment of the
banking organization's ownership structure, directors and senior
management, its operating plan and internal controls, and its projected
financial condition, including its capital base; where the proposed owner or
parent organization is a foreign bank, the prior consent of its home country
should be obtained.
4.
Banking supervisors must have the authority to review and reject any
proposals to transfer significant ownership or controlling interests in
existing banks to other parties.
5.
Banking supervisors must have the authority to establish criteria for
reviewing major acquisitions or investments by a bank and ensuring that
corporate affiliations or structures do not expose the bank to undue risks or
hinder effective supervision.
Prudential Regulations and Requirements
6.
Banking supervisors must set prudent and appropriate minimum capital
adequacy requirements for all banks. Such requirements should reflect the
risks that the banks undertake, and must define the components of capital,
bearing in mind their ability to absorb losses. At least for internationally
active banks, these requirements must not be less than those established in
the Basle Capital Accord and its amendments.
7.
An essential part of any supervisory system is the evaluation of a bank's
policies, practices and procedures related to the granting of loans and
making of investments and the ongoing management of the loan and
investment portfolios.
8.
Banking supervisors must be satisfied that banks establish and adhere to
adequate policies; practices and procedures for evaluating the quality of
assets and the adequacy of loan loss provisions and loan loss reserves.
9.
Banking supervisors must be satisfied that banks have management
information systems that enable management to identify concentrations
within the portfolio and supervisors must set prudential limits to restrict
bank exposures to single borrowers or groups of related borrowers.
10.
In order to prevent abuses arising from connected lending, banking
supervisors must have in place requirements that banks lend to related
companies and individuals on an arm's-length basis, that such extensions
of credit are effectively monitored, and that other appropriate steps are
taken to control or mitigate the risks.
11 .
Banking supervisors must be satisfied that banks have adequate policies
and procedures for identifying, monitoring and controlling country risk
and transfer risk in their international lending and investment activities,
and for maintaining appropriate reserves against such risks.
12.
Banking supervisors must be satisfied that banks have in place systems that
accurately measure, monitor and adequately control market risks;
supervisors have power to impose specific limits and/or a specific capital
charge on market risk exposures, if warranted.
13.
Banking supervisors must be satisfied that banks have in place a
comprehensive risk management process (including appropriate board and
senior management oversight) to identify, measure, monitor and control all
other material risk and, where appropriate, to hold capital against these
risks.
14.
Banking supervisors must determine that banks have in place internal
controls that are adequate for the nature and scale of their business. These
should include clear arrangements for delegating authority and
responsibility; separation of the functions that involve committing the
bank, paying away its funds, and accounting for its assets liabilities;
reconciliation of these processes; safeguarding its assets; and appropriate
independent internal or external audit and compliance functions to test
adherence to these controls as well as applicable laws and regulations.
15.
Banking supervisors must determine that banks have adequate policies,
practices and procedures in place, include strict "know-your-customer"
rules, that promotes high ethical and professional standards in the financial
sector and prevent the bank being used, intentionally or unintentionally, by
criminal elements.
Methods of Ongoing Banking Supervision
16.
An effective banking supervisory system should consist of some of both
on-site and off-site supervision.
17.
Banking supervisors must have regular contact with bank
management and thorough understanding of the institution's
operations.
18.
Banking supervisors must have a means of collecting, reviewing and
analyzing prudential reports and statistical returns from banks on a solo
and consolidated basis.
Banking supervisors must have a means of independent validation of
supervisory information either through on-site examinations or use of
external auditors.
19.
20.
An essential element of banking supervision is the ability of the
supervisors to supervise the banking group on a consolidated basis.
Information Requirements
21.
Banking supervisors must be satisfied that each bank maintains adequate
records drawn up in accordance with consistent accounting policies and
practices that enable the supervisor to obtain a true and fair view of the
financial condition of the bank and the profitability of its business, and that
the bank publishes on a regular basis financial statements that fairly reflect
its condition.
Formal Powers of Supervisors
22.
Banking supervisors must have at their disposal adequate supervisory
measures to bring about timely corrective action when banks fail to meet
prudential requirements (such as minimum capital adequacy ratios), when
there are regulatory violations, or where depositors are threatened in any
other way. In extreme circumstances, this should include the ability to
revoke the banking license or recommend its revocation.
Cross-border Banking
23.
Banking supervisors must practice global consolidated supervision over
their internationally-active banking organizations, adequately monitoring
and applying appropriate prudential norms to all aspects of the business
conducted by these banking organizations worldwide, primarily at their
foreign branches, joint ventures and subsidiaries.
24.
A key component of consolidated supervision is establishing contact and
information exchange with the various other supervisors involved,
primarily host country supervisory authorities.
25.
Banking supervisors must require the local operations of a foreign banks to
be conducted to the same high standards as are required of domestic
institutions and must have powers to share information needed by the
home country supervisors of those banks for the purpose of carrying out
consolidated supervision.
The World Bank, the IMF and other similar world bodies were encouraged to use
these standards in their effort to support countries to promote their overall
macro-economic and financial stability.
Since Nigeria has endorsed the Basle Core Principles, a World Bank Financial
Sector Mission in 1999 earned out an assessment of compliance by the Central
Bank.
A close review of the 25 provisions would show that it's best that the entire
banking system either as Supervisors or Operators comes to term with the
minimum standards of Basle. For Nigeria bankers, this would appear to be an
imperative since the official government regulators have endorsed the standards
and would apply them. For the safety of the huge investment in capital and their
deposits, the general public and students of Economics, Banking and Finance
need to be familiar with the provisions. Of course, Accountants and Auditing
firms have a more than passing interest in the matter since they generate the audit
of the financial condition of banks for analysis and rating.
2.9.7 CONCLUSION AND RECOMMENDATION
Like other businesses, Banks can still fail even with Supervision. Too much will
constrain initiatives and too little will generate laxity. The essence of bank
supervision and inspection, we submit, is to stem failures from wreaking havoc to
the banking public, creating loss of confidence, causing tax payers' money to
rebuild confidence in the system even as it deals with erring bank personnel for
deliberate misdemeanour.
What is adequate supervision is a product of experience learnt in the field and can
be drawn from global knowledge base which is now so much easier to access.
Disregard for the safety of investors and depositors' funds could adversely affect
the confidence of the general public in the financial system and result in
economic chaos.
REFERENCES
Agba Akomeye V. (2000: 18)
The Nigerian economy, Alpha
Millennium Associates Lagos.
Anolue Festus (1994)
Nature and Causes of Inflation in
Nigeria, 1986- 1992
(econometric approach),
Longman Nigeria.
Asika Nnamdi (2000)
Research methodology in the
behavioral sciences, Longman,
Nigeria.
Bain A.D. (1981)
The Economics of the Financial
System, Martin Robertson and
Co. limited, Oxford.
Nnanna, O. J. (2005)
Central Banking and Financial
Sector Management in Nigeria:
An Insider View" in Fakiyesi, O.
O. & S. O. Akano (Eds), Issues in
Money, Finance and Economic
Management in Nigeria (Essays in
Honour o f Professor Obasanmi
Olakankpo), pp. 99-120.
Nwankwo G.O. (1980)
The Nigerian Financial System;
Macmillan Press Limited,
London.
Ojo, J. A. T. (2005)
Central Banking and Financial
Sector Management in Nigeria:
An Outsider View" in Fakiyesi,
O. O. & S. O. Akano (Eds), Issues
in Money, Finance and Economic
Management in Nigeria (Essays in
Honour of Professor Ob as an mi
Olakankpo), pp. 35-98.
Okigbo P.N.C. (1981)
Nigeria's Financial System;
Structure and Growth, Longman
group, UK.
Omoruyi, S. E. (1991)
The Financial Sector in Africa:
Overview and Reforms in
Economic Adjustment
Programmes. CBN Economic and
Financial Review, 29(2).-pp. 110-124.
Soludo, Charles C. (2007)
Macroeconomic, Monetary and
Financial Sector Developments
in Nigeria". CBN website:
www.cenbank.org .
Umoh Peter N. (1993)
Principles of Finance; Second
Edition, Publisher's Services
Limited, Lagos, Nigeria.
UNPUBLISHED WORK
Banking Supervision Department (2006) List of banks that have made 25
billion.
C E O S (1994)
Are banks still to be?
Economic Intelligence Weekly (2007)
Financial Services: Banking
Vol.2 No. 28 August 31.
Obafunmilayo Agusto (2006)
Challenges and Opportunities in
the consolidating Nigerian
Banking Sector.
JOURNALS, MAGAZINES ETC.
Ahmad, M.K. (1998: 75-78)
Distress in Banks; a
general overview of the
role of directors and
auditors, journal Vol.8
March/June, No. 112,
National Deposit
Insurance Corporation.
Central Bank of Nigeria (2006)
Component members of
consolidated banks
Central Bank of Nigeria (2006)
Code of Corporate Governance
for banks in Nigeria post
consolidation.
Central Bank of Nigeria (1997: 2 -7)
Financial Sector distress;
Research Department,
Series no.97/11, June.
Corporate Nigeria (2005/2006: 80 -86)
Banking, Finance and
Insurance overview,
IMC publication, Switzerland.
Kendal G. and Buckland W.R. (1992)
A dictionary of statistical
term, Third Edition,
Longman Group Limited,
London.
Zenith Economic Quarterly (2006: 24 -36)
Driving wealth creation
through reforms, Zenith
Bank Plc Journal, Vol.1
No.7, July.
Zenith Economic Quarterly (2007: 6 -10)
Reforms-2; the journey,
the milestones,
Zenith Bank Plc Journal,
Vol.2 No. 10, April.
CHAPTER THREE
RESEARCH METHODOLOGY
Three major outcomes of the empirical tests are discussed in this section. The first
presents the descriptive statistics which show the trends and interclass difference
between pre- and post-reforms variables and its implication for banking sector
incentives. The second presents the results of equation (1), while the third section
discusses the results of equations 6 and 7.
3.1 Reforms and Banking Sector
Institutional Strength and Investment Behaviors
Prior to SAP, aside from indigenization which gave government 60 per cent stake
in otherwise foreign banks that operated in the country, there was no limit to the
capital base requirements for banks. However, following the adoption of SAP, a
limit of N1.0 billion was prescribed for commercial banks and about N500
million for merchant banks. This was however increased subsequently to N2
billion prior to Soludo. In Soludo's era, the commercial banks were mandated to
recapitalize from a minimum capital base of N2 billion to N25 billion. As a
corollary to asset base requirements, both prudential and monetary policy
guidelines were prescribed for the banking sector. In pre-SAP era, banks operated
in an environment of credit allocation, interest rate subsidy, fixed exchange rate
and foreign exchange rationing. This however gave way to liberalization
post-SAP era.
An assessment of the outcome of the reforms over time is as shown i n Table 1. As
can be deduced from the figure, post-SAP era witnessed rapid expansion in
number and branches networks of banks, from 40 and 1323 commercial/merchant
banks in 1985 to 120 and 2382 in 1993. During the Post-Reform lethargy era,
some of the banks became distressed and were liquidated, reducing their number
to 89 and 2220 branch networks i n 1998. Although the Soludo reforms
consolidated the banks through mergers, acquisitions and new issues to 25 banks, their
total branch networks increased to about 4500 in 2006 (Soludo 2007).
Memorandum item
Table 1: Basic Indicators of Banking Sector Performance Pre-SAP, 1st, 2nd, 3rd and 4th phases
eriod
Pre-SAPre-SAP
tem
Post-S Post-SAP
R e f o r m r e f o r m s L e t h e rPgrye - S o P r e - S o l u d o
SoludoSoludo
1970
1980
1985
1986
1990
1993
1994
1997
1998
2000
2002
2004
2006
15
26
40
41
107
120
1 16
115
89
89
89
89
25
273
752
1323
1394
2013
2382
2547
2477
2220
2306
3123
3382
4500
1.2
17.3
37.0
48.1
1 17.4
341.7
357.5
681.7
818.4
1 707.0
2766.6
~32?R<r
6555.0
1.6
32.1
37.0
14.5
13.0
15.6
16.2
31.1
37.4
15.6
21.9
24.2
51.1
0.1
0.4
1.1
1.5
5.2
10.9
9.1
35.2
72.9
394.6
821.9
1050.0
957.0
0.0039 0.0160
0.0282
0.0364
0.0484
0.0906 0.0789
0.3058
0.8186
4.4335
9.2348
1 1.797S
38.2< S O (
Liquidity Ratio1
94.5
47.6
65.0
36.4
44.3
42.2
48.5
40.2
46.8
58.0
48.8
41.5
Cash
5.2
10.6
1.8
1.7
2.9
6.0
5.7
7.8
8.3
10.0
1 1.6
5.9
52.9
6.T
51.3
66.7
66.9
83.2
66.5
42.9
60.9
76.6
74.4
46.2
78.4
85.4
97.5
21.89
21.89
109.55
126.40
No. of Hanks
No. of
Hank
Branches
Total Asset
Base of
Banks
(VBillion)
Total
\assets
Base of
Banks
($'Billion)
Capital and
Reserves
(N'Billion)
V\. Cap. a n
d
Reser\ es per Bank
(N'Billion)
Reserve
Ratios"
.oun-toDeposit
Ratio'
I'.xchuAverage
rate
rate
0.71
0.54
1.00
3.32
9.00
21.88
22.00
1/ L i qu id ity ra t io i s t h e ra t io o f t o t a l sp eci fie d l iq ui d a ss ets to to ta l cu r rent lia bi lit ie s 21
Ca s h re se rv e ra t io i s t h e ra t io o f ca sh re serv e r eq ui re me nt to to ta l c ur rent lia bi lit ie s 3/
Lo a n- t o - D epo s it ra t io i s t he ra t io o f to ta l lo a n s a n d a dv a nce s to to ta l cur re nt l ia b il iti e s
So u rce: Ce nt ra l B a n k o f Nig eria , A b uja
Signs of institutional weakness were apparent through out the period under
review. In pre-SAP era, average asset base per bank declined from N l .2 billion
i n 1980 to N0.924 billion in 1985. Thereafter, there was apparent growth in Naira
terms post-SAP era as the average was above the recommended N2 billion marks.
However, following devaluations of exchange rates, these figures were the
equivalent of US $0,122 billion i n 1993 to US $0,272 billion in 2004. These
figures tended to suggest that Nigerian banks were too weak to compete globally.
Although a number of analyst have often argued that this outcome could be the
result of assets undervaluation in the face of exchange rate depreciation, a
number of the banks were adversely affected especially those saddled with
external debt service burdens. The institutional ratios attested to this. In pre-SAP
era, both the liquidity and cash reserve ratios deteriorated and the situation
persisted in post-SAP era as they were quite below the prescribed minimum by
the monetary authorities.
With regard to credit purvey, the banking sector exhibited mixed performance.
The immediate post-SAP witnessed increased attention given by the banking
sector to the production sectors. The share of agricultural and manufacturing
sectors in banking sector credit increased post-SAP and the production sector as a
whole accounted for an annual average of 58.3 per cent of total to the economy
(see Table 2). However, during the era of reforms lethargy, miscellaneous
lending crowded out production credit, to the extent that even in post-Soludo era,
it accounted for about 70.6 per cent of total credit. While it can be argued that
post Soludo's
Table 2 : Sectoral Distribution of Commercial Banks Loans
Sector
\Av. Ann. Total
Agric
Man.
Period
N'Million
% Share
% Share % Share
Mining
R.E&.C.
Productn
% Share
% Share %
Misccl.
Svs/Others
Total
% Share
% Share
73.5
100.0
Share
Prc-S \P 1970-79
3,952.9
2.3
12.5
0.9
8.9
24.7
1.8
■
Pro-SAP 1980-85
1 1,978.3
7.2
23.7
1.0
17.1
49.0
4.7
46,3
100.0
post-SAP 1986-93
32,053.4
14.7
31.0
1.6
11.0
58.3
5.0
36.6
100.0
Reims l.eth.1994-1998
202,177.9
13.0
34.7
8.7
0.0
54.7
34.6
10.6
100.0
Pre-Soludo 1999-2004
3,248,367.7
6.1
25.0
8.3
0.0
39.4
57.2
3.4
100.0
Soludo 2004
5,686,669.2
4.6
23.0
9.1
0.0
36.7
61.1
22
100.0
Post Soludo 2005
7,392,670.0
3.8
19.9
9.1
0.0
32.8
65.5
1.7
100.0
Post-Soludo 2006
9,684,397.7
3.2
16.9
.8.0
0.0
28.1
70.6
1.3
100.0
Source: Computed from CBN Statistical Bulletin
reforms may have helped to build and foster a competitive and healthy financial
system, it is debatable if the structure of their portfolio investments has the
capacity to support the desired economic development aspiration of the
proponents. This could be inferred from Table 2 which shows that despite the
rapid increase in lending to the economy, the share of production sectors of the
economy especially agriculture and mining remained low and indeed declined
proportionately over time suggesting that the new monies may have been
channelled into miscellaneous activities. Yet agriculture is known to contribute a
major share to the GDP, even under conditions that it is not getting new funds. A
significant proportion of the production loans go to manufacturing, probably to
finance imports of raw materials, machineries and component assembly
activities.
Exchange Rates Reforms and Incentives Structure
Prior to SAP (1970 to 1985), banks operated under highly regulated
environment, characterized by fixed exchange rates structures guided by official
financial markets. In particular, an official foreign exchange market was operated
by central bank which allocated foreign exchange to end users based on import
licensing procedures at predetermined rates. Incidentally, this system led to huge
unpaid trade arrears and external debts coupled with exchange rate
overvaluation. With the adoption of SAP, this procedure was abolished and
replaced with a two-tier market structure. While the official window was initially
retained for special government transactions and debt service, the Second Tier
Foreign Exchange Market, a Dutch-Auction System in which financial institutions
Period/Era
Table 3: Average Exchange Rates, Interest Rates and Consumer Price Indices for Nigeria & US
NER
NEER
MRR
TBR
DR
SR LR
Inflation CPI
Pre-SAP 1970-79
Pre-SAP 1980-85
Post-SAP 1986-93
0.65
6709.10
n .a
8.3 9.4
15.9
0.7
30.4
18.0
2.2
56.2
73 .X
8.0
9.70
1201.00
16.1
20.4
15.7 15.620.3 27.8
8.9
240.17
13.5
12.4
11.4 8.7 19.3 36.0
66.0 90 .7
115.44 93.90
17.3
16.5
14.1 5.0 21.6 12.9
129.2 103.4
132.58 107.74
15.0
14.3
13.7 4.4 19.2 17.6
1 76.1109 .7
13-1 .27 123.81
13.0
8.6
10.5 3.6 18.0 15.0
227.1 " l 12.9
127.46 133.03
13 .7
11 .2
9.6
392.0
21.91
Post-Soludo 2006
7.2
7846.26
Pre-Soludo 1999-2000
Post Soludo 2005
n .a
0.72
Refms Leth. 1994-1999
Soludo 2004
4.3
3 .2 6.8
4.0
3.1 16.8 12.8
use PI
Source: Computed from IFS, CBN and National Bureau of Statistics Data base.
bid to purchase foreign exchange at the market-clearing rates for their intended
beneficiaries, was introduced. This system laid the foundation for exchange rates
devaluation and the emergence of multiple exchange rates systems in Nigeria.
However during the Reforms Lethargy era (1994 to 1998), which was
characterized by adjustment fatigue with lots of policy reversals following the
change in government, there was a return to regulation. The foreign exchange
market was segmented into two: official window which accommodated
government transactions at a special rate of $ 1 = N22, and the other window at $
1 = N80. The market segmentation laid the foundations for the gross abuse of the
markets and which seemed to defy any practical solutions even as of today.
According to Ojo (2005), ".. .the malfunctioning of the foreign exchange market
has made the various attempts at determining a realistic naira exchange rate
prove elusive" and contributed in no small measure towards fuelling domestic
inflation. He also maintained that malfunction permitted various malpractices in
the market which include: spurious purchases and disbursements without
complete documentation, charging of excessive fees and commissions by the
dealing banks; failure to repatriate export proceeds and non-payment of interest
earned to customers that operate letters of credit and domiciliary accounts.
With the advent of civilian democracy in Nigeria in 1999, there was an apparent
return to the path of economic reforms again. Although for the first two years of
this period, the basic framework for foreign exchange management continued to
focus on periodic changes in the rules of the interbank foreign Exchange Market
(IFEM), by July 2002, the Dutch Auction System (DAS) which was jettisoned in
1992 for leading to rapid exchange rate devaluation was reintroduced. The DAS
has remained in operation up till today, even in the Soludo era.
In terms of incentives structure, Table 3 shows that the Naira was highly over
valued in pre-SAP era, while rapid depreciation in post SAP era narrowed the gap
between the nominal and real effective exchange rates with an equilibrium
attained in pre-Soludo era. Subsequently, continuous depreciation resulted in
undervaluation of the Naira that was only corrected in Soludo's era. Many
economic analysts believed that DAS has resulted in a nebulous exchange rates
structure and has fostered abuses. Ojo (2005) supports the view that DAS is at the
root cause of the problem of continuous depreciation and multiplicity of
exchange rates within the economy, which hitherto, resulted in the entrenched
speculation and arbitrage by the banking sector. Among the malpractices which
he identified are: "spurious bidding by authorized dealers in line with their
penchant to channel almost all resources to foreign exchange bidding to
guarantee successful bids. This will, in turn, lead to a drying up of loanable funds
and consequent return to higher and rising interest rates".
Monetary Control Techniques and Interest Rates Structure
Prior to SAP and immediate post SAP, monetary management relied on direct
controls of reserves and interest rates structure of banks. However, in 1993, an
important reform of the monetary management strategies was the introduction of
open market operations (OMO). OMO became the dominant instrument of
liquidity management complimented by reserve requirements and discount
window operations. Unfortunately, the new approach was yet to find its footing
when macroeconomic management returned to an era of regulation by
1994-1998. Irrespective of the market fundamentals, the monetary authorities
pegged minimum rediscount rates at 13.5 per cent, as well as specified interest
rates limits to not more than 21 percent for lending rates, while the spread
between savings and lending rates was expected not be more than 7.5 per cent. As
it turned, the introduction of OMO followed by a return to interest rates control
opened up another investment portfolio to the commercial banks. This manifested
mainly in the new opportunity offered the savings public to diversify their
portfolio investments from traditional savings and the stock markets into money
markets. The banks were also offered the opportunity to diversify from traditional
credit purveys, and foreign exchange markets transactions to trading in money
market instruments especially treasury bills and repos transactions at the OMO.
Table 3 shows that the yield rates on OMO and treasury bills transactions were
comparatively more attractive than savings rate, while the alternative investment
portfolio which would require borrowing to meet working capital requirement
were priced out of the profitability threshold of the investing public. While low
savings rate encouraged holders of idle cash balances to invest in money market
instruments, it also encouraged financial institutions to shy away from the more
risky lending portfolio and its associated high transactions costs to the relatively
safe portfolio with little or no costs, with the guarantee of very good returns.
In the face of credit apathy, financial sector operators found investment in foreign
exchange and public debts instruments especially treasury bills very lucrative as
the returns on them moved in tandem with the MRR. Thus, the policy created a
dilemma in the form of tradeoff costs reflected in the arbitrage gains for
speculators in the financial markets. Ironically, rather than serve as a penalty rate
for borrowing from the central bank, the attractive treasury bills rate which
followed the rise in MRR, saw the central bank borrowing from the banks and the
public as part of its monetary control functions. Such funds were sterilized but
which upon maturity the central bank was duty bound to pay the interest rates
accrual, probably via the creation of high powered money with adverse
implications for inflationary control. One may argue that if the CBN issued the
debt instruments in favour of the government that the burden of debt service
should be borne by it. Unfortunately, during this period, fiscal authorities were
known to resort to ways and means advances far above the permissible limits, and
which were usually written off at the end of the day.
The changes in the structure of treasury bills holdings attested to this. Prior to the
commencement of SAP, CBN accounted for a significant proportion of the
treasury bills outstanding. However, with the sharp rise in treasury bills rate, the
situation changed, with the deposit money banks and the public now accounting
for the major share. The shift in investment portfolio of the banks to this segment
of the markets is quite rational. Indeed, the banks ceased the opportunity of the
permissive financial operating environment to mobilize funds cheap, and invest
in relatively secure instruments.
Also, their liability structure attested to this. The main sources of fund are
demand deposits, time, savings and foreign deposits, central government deposits
reserve accounts and unclassified liabilities. While the costs of funds from
demand deposits, reserve accounts, and central government deposits is known to
be very low, that of savings deposits have been seen to also be low in recent time.
Indeed, less than 30 per cent of their funds are mobilized from the more
expensive sources. The point to be made is that a significant proportion of their
investible funds are sourced cheap, but arc channelled into secure portfolios
(money market instruments). One is not surprised that since 1999 that the
financial institutions that survived the distress emerged to become very sound
and have had outstanding record of profitability, derived mainly from the
defective interest rate structures.
3.2 Effects of Reforms on Real Sector Credit
The regression results of equation (1) are as shown in Table 4. The econometric
property of the estimated equation for each reform era is remarkable, as the
overall goodness of fit is high, while the coefficient of the explanatory variables
displayed the right signs. The analysis show that increases in capital and reserves
(CAPBR) which had significant positive effects on credit to the production sector
in pre-SAP era became insignificant in post-SAP era, and indeed exhibited an
inverse relationship since the reforms lethargy era to date. With regard to interest
rates structure, savings rate which hitherto had insignificant influence in pre- and
post-SAP era, exhibited a negative but significant effects to lending to production
sector during the Reforms Lethargy era. It is quite interesting to note also that
MRR (a monetary policy rate) exhibited a significant inverse relationship with
the dependent variable, suggesting that erstwhile interest rates policy penalize
lending to the productive sectors. Also, eras of fixed exchange rates
Tabic 4: Regression Results of the Effects of Reforms on Real Sector Credit
Period
Dependent Variables
Independent Variables
C
LOG(CAPBR)
LOG(SR)
LOG(MRR)
LOG(LR(-2))
LOG(EXR)
LOG(BBR)
LOG(CRR)
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-W'atson stat
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob(F-statistic)
Pre-SAP
(1970-85)
Log(PCR/TCR)
Coef.
t-Stat
-10.910
0.226
Post-SAP
(1986-93)
Log(PCR/TCR)
Coef.
t-Stat
-17.26
6.39
Reforms Lethargy
(1993-98)
Log(PCR/TCR)
Coef.
t-Stat
-3.060-5.24
0.010
78.544
Pre/Post Soludo
(1999-2006)
Log(PCR/TCR)
Coef.
t-Stat
3.87
1.13
-0.939
-2.10
4.076
5.67
-0.140
-.00
0.112
0.86
0.068
1.90
-0.785
-1.99
0.293
3.22
-0.557
-4.95
-0.053
-2.79
-1.252
-3.97
-0.063
-0.64
-0.370
-2.93
-0.033
-1.43
0.430
1.65
0.170
0.92
-1.201
-11.02
0.009
0.96
-4.571
-2.58
-0.374
-1.19
1.448
9.72
0.328
3.41
-5.689
-3.10
-0.22S
-2.62
-0.108
-2.65
-0.027
-1.23
-3.019
-2.36
-0.165
-2.14
0.992
0.971
0.826
0.969
0.991
0.962
0.750
0.960
0.071
0.010
0.142
0.035
0.264
0.002
0.322
0.030
79.494
96.016
17.690
66.142
1.281
0.775
1.304
1.413
-1.397
-0.563
-0.483
0.745 7
0.053
0.283
-0.93-1
0.177
-2.344
-6.070
-0.807
-3.634
-2.067
-5.693
-0.415
-3.267
948.641
101.218
10.831
1 107.51
0.000
0.000
0.000
0.000
policies especially pre-SAP and Reforms Lethargy displayed negative and
significant effects on the dependent variable confirming our a priori expectation
that overvaluation penalizes lending to the productive sectors. Also, the growth in
network of bank branches which hitherto positively influence credit purvey in
pre- and post-SAP era, had negative effect on production credit during the era of
reforms lethargy and had remained so in pre- and post-Soludo's era. Finally, the
coefficient of the CRR variable confirm the assertion that reserve operating
procedures limits the credit creating ability of the banks.
3.3 Policy Reforms and Economic Performance
Table 5 and 5a presents the Log linear and the linear regression results estimated
with seemingly unrelated regression (SUR) methods of the simultaneous
equations model made up of a system of equations (6) and (7). For the purpose of
this study, let us examine the effects of the purely exogenous variables on the
dependent variables. The result shows that in pre-SAP era, monetary and
exchange rates policies were relatively ineffective. While MRR had an inverse
influence on the GDP variable, credit expansion to government represented the
main source of inflationary pressures. During the immediate post-SAP era,
monetary and exchange rates policy were largely ineffective in influencing
growth and inflationary control as almost all the parameter estimates were not
significant. While expansionary money supply hurts real domestic output (GDP),
it contributed to fuelling inflationary pressure as the parameter estimate is
significant in the CPI dependent structural equation during the period. Exchange
rate variable also had significant influence on CPI at 5 per cent level (see Table 5)
and indeed, the only significant variable in Table 5a, suggesting that devaluation
resulted solely to fuelling inflation in this period.
Table 5: Simultaneous Equation Model of Monetary and Exchange Rate Policies on GDP and CPI
Period
Dependent Variables
independent Variables
Log(GDP(-l))
Log(GDP(-2))
log(CPI(-l))
log(CPI(-2))
C
Log(M2)
Log(CG)
I.og(CP)
Log(MRR)
log(EXR)
Observations: 62
R-squared
Adjusted R-squared
S.E. of regression
Durbin-Watson stat
Mean dependent var
Prc-SAP (1970-85)
Log(GDP)
Coef.
t-Stat
1.57S0
7.41
-0.6669
7.12
-0.0758
1.87
0.0772
.94
0.3165
.59
-0.0026
0.29
0.0047
.69
0.0113
.80
-0.0344
2.24
0.0002
.01
0.9979
0.9976
0.0354
2.0445
.9813
S.D. dependent var
.1425
Sum squared resid
.0077
Period
Dependent Variables
Independent Variables
Log(GDP(-l))
Log(GDP(-2))
iog(CPi(-i))
log(CPI(-2))
C
Log(M2)
Log(CG)
Log(CP)
Log(MRR)
log(EXR)
Observations: 24
R-squared
Adjusted R-squared
S.E. of regression
Durbin-Watson stat
Mean dependent var
S.D. dependent var
Sum squared resid
LogfCPl
Coef.
1-0.1102
t-Stat
0.42
-0.1281
.47
-1.1571
.78
1-0.3807
3.28
2-1.1020
3.10
-0.0359
.37
00.0447
.26
00.0521
.26
-0.0225
.50
00.0957
1.43
Observations: 62
0.9979
0.9976
0.0354
2.0445
3
.0004
0
.7186
0
.0650
Reforms Lethargy (1993-98)
Log(GDP)
Log(CPI
Coef.
t-Stat
Coef.
t-Stat
1.1002
7-2.0358
.33
0.29
-0.1287
--0.6193
0.86
0.09
0.0002
01.0985
.04
.53
0.0088
2-0.3662
.01
1.76
0.1065
15.5541
.42
.56
-0.0151
-0.3717
2.37
.24
0.0017
2-0.0162
.55
0.51
0.0059
10.2167
.73
.34
0.0068
3-0.0044
.58
0.05
0.0240
20.0677
.43
.15
Observations: 24
0.9997
0.9955
0.9995
0.9926
0.0010
0.0471
2.2216
1.8258
4
.4631
.9466
0
.0469
.5460
0
.00001
.0311
Post-SAP (1986-93)
Log(GDP)
Coef.
t-Stat
1.7327
6.28
0
-0.7164
7.04
9
0.0231
.20
-0.0156
1.07
0.0315
.28
1
-0.0096
1.11
2
-0.0007
0.34
1
-0.0024
0.50
0
0.0074
.10
0.0001
i
.06
Observations: 29
0.9995
0.9993
0.0035
2.1297
0
.2461
0
.1332
0
.0002
I,og(CPI)
Cel.
21 . 8 1 2 2
t-Stat
1.64
-2.9703
-
-1.81
1.1614
2
6.87
-0.6004
-
-1 5S
-2.0S19
0
-1.15
0.2925
-
2.10
-0.0001
-
0.00
-0.0123
-
-0.16
0.1589
1
1.45
0.0577
0
1.63
Observations: 29
0.994 1
0.9912
0.0568
1.7884
4
2.0573
0
0.6064
0
0.0612
Pre/Post Soludo (1999-2006)
Log(CDP)
Log(C'PI
Coef.
t-Stat
Coef.
l-Slat
1.1999
7
-0.51
-7.2371
.40
-0.3084
2.5754
1.13
2.02
5
-0.0007
1.3986
11.10
0.08
0.0105
-0.6147
1
-4.26
.09
1
0.2845
-3.7370
2
-13)7
.25
1
-0.01
11
0.1891
2.49
2.19
0.0021
-0.0244
1
-0.97
.23
1
0.0244
-0.1264
2
-0.98
.82
-0.0066
0.0023
0.04
1.60
0
-0.0004
-0.4326
-3.25
0.05
Observations: 32
Observations: 32
0.9998
0.9972
0.9997
0.9960
0.0019
0.0285
2.1995
2.2558
3
4
5.0487
.7045
0
0
0 4536
.1090
0
0
0.0179
.0001
The regression result for the Reforms Lethargy era (1993-1998) is most
interesting. All the coefficients of the explanatory variables for the GDP
dependent structural equation were significant. In particular, expansionary
money supply had negative effects on GDP, while the pursuit of fixed interest and
exchange rates policies reflected in MRR and EXR variables had positive effects.
Ironically, these policy variables had no significant effect on the consumer price
index during the period. Indeed, the deliberate maintenance of fixed interest rates
and the return to credit allocations during this period with the result that more
credit went to the production sector could explain the positive effects on GDP.
The result of the exchange rate variable also confirms the a priori expectation
that stabilization of exchange rates in a country whose production base is foreign
dependent augurs well for that economy. This is particularly true for Nigeria
during this period, as she depended to a large extent on imports for capital goods,
raw materials and final consumer products to augment the inadequate production
and domestic supplies. The return to reforms in pre/post Soludo's era changed the
economic incentives structure. The GDP dependent equation show that while
monetary expansion led to its contraction, it resulted in significant increases in
consumer prices. Banking sector credit to the private sector had significant
positive effect on GDP while that to the government sector had adverse effects on
it. However, in line with theoretical expectation, credit to government variable
had positive and significant effect on consumer prices, confirming the traditional
view that it is inflationary. A salutary development in this era is that exchange
rates policy had moderating effect on inflationary pressures.
Table 5a: Simultaneous Equation Model of Monetary and Exchange Rate Policies on GDP and CPI
Period
CP
Dependent Variables
Independent Variables
GDP(-l)
GDP(-2)
CPI(-l)
18.35415
CPI(-2)
C
M2
M2(-l)
M2(-2)
Prc-SAP (1970-85)
Post-SAP (1986-93)
GDP
CPI
GDP
Coef.
1.523373
-0.573244
-2.89707
t-Stat
18.03347
-6.887858
-2.634146
Coef.
t-Stat
0.002301
1.187175
4.906553
12.64045
3.922911
3.407464
0.000376
-0.000424
3.59154
2.90932
2.723148
-3.019453
-0.510676
-5.347885
-2.65E-05
-3.093142
4.87E-05
5.023733
CG
CG(-2)
Coef.
1.761436
-0.762661
Coef.
0.861691
0.256137
8.44E-05
t-Stat
15.667
-6.747812
0.578821
6.557099
-4.0 -2.739669
6E-05
(). 196384
EXR(-I)
Observations: 62
R-squared
0.994112
Observations: 62
0.997424
Observations:
0.998719
Adjusted R-squared
0.993348
0.997143
0.998631
0.990783
S.E. of regression
0.577618
0.04842
0.337856
0.544109
Durbin-Watson stat
2.056624
1.917743
1.569237
1.420242
54.09516
7.082382
18.01667
Mean dependent var
S.D. dependent var
Sum squared resid
1.280323
0.905899
0.12895
Observations: 20
32
Observnt
0.9910S
69.56562
9.129944
3.310247
Observations: 32
R-squared
0.998853
0.98265
0.99969
0.997974
Adjusted R-squared
0.998718
0.981686
0.999669
0.997674
S.E. of regression
0.133767
2.773107
0.223624
4.612951
Durbin-Watson stat
1.784612
1.603668
1.958547
1.936863
Mean dependent var
87.845
65.9915
1 1 1.0875
174.2816
S.D. dependent var
3.736234
20.49173
12.28883
95.64048
Sum squared resid
0.30419
138.4222
1.450229
574.5415
A Linear model estimated using seemingly unrelated regression methods after eliminating insignificant variables
REFERENCE
Balogun, E. D. and M. F. Otu (1991)
Credit
Policies
and
Agricultural Development in
Nigeria". CBN Economic
and Financial Review,
29(2):pp. 138-155.
Central Bank of Nigeria, Lagos, (1992)
The Impact of Structural
Adjustment Programme
on Nigerian Agriculture
and Rural Life. © 1992
CBN/NISER
Central Bank of Nigeria, Lagos, (1993)
Perspectives of Economic
Policy Reforms in Nigeria.
1993 CBN
Chiber, R. and J. Wilton, (1986)
Macroeconomic Policies and
Agricultural Performance in
Developing Countries".
Finance & Development,
23(3):pp. 6-9.
Jhinghan, M. L. (2003)
Macroeconomic Theory,
11th Revised Edition. ©
M. L. Jhinghan, Delhi.
Kates, Steven (1998)
Say's Law and the
Keynesian Revolution:
How
Macroeconomic
Theory Lost its Way.
Edward Elgard Publishing
Limited.
ISBN
978-1-85898-748-4.
CHAPTER FOUR
4.1
PITFALLS OF THE ERAS OF REFORMS
The review of the incentives structure and impact of reforms so far show that the
outcome fell short of expectations and that this was doomed to be so because of
some pitfalls which militated against it. Among these arc faulty premise for
reforms, wrong sequencing of reforms, conflicts emanating from adopted
theoretical models for reforms and above all, frequent reversals and/or
non-sustainability of reforms.
4.2
Faulty Premise and Inappropriate Sequencing of Reforms
The review of eras of reforms in Nigeria shows that the premise was to get price
incentives right for the banking sector through the abolition of foreign exchange
and credit rationing in favour of liberalized domestic money and foreign
exchange markets. The concern was more with reducing government intervention
with the hope that there exists a virile private sector to fill the gap effectively.
Unfortunately, the Nigerian financial markets was far from being virile, as it was
characterised by dualistic financial markets, whereby the commercial banks
operated side by side with rural, curb and parallel markets. While the government
succeeded, albeit after a long period, of divesting her interests in the banking
sector, market segmentations persisted and perhaps remain at the root of policy
compromises which tended to thwart the reforms efforts till date. Thus, one of the
pitfalls of the reforms programme therefore is the premise that there exist virile
private sectors that can successfully implement the reforms agenda.
Related to the above is the poor sequencing and coordination between policy
reforms initiatives, the timing of implementations and sustainability. This was
particularly problematic in post-SAP era when the monetary authorities have had
to subject the banking sector to liquidity shocks via discretionary monetary
policy in order to tame the foreign exchange market. Nnanna (2005) is of the
view that such shocks was detrimental to the performance of the banking sector
and further exposed them to increased risks in the face of macroeconomic
instability, arising from the weakening oil market, exchange rate and financial
sector crises. According to him, one such shock during this period occurred in
1988 when the monetary authority decided that the back-log of naira deposits for
foreign exchange applications yet to be approved be moved from deposit money
banks (DMBs) to the CBN. The second shock stemmed from the order that public
sector funds in DMBs be transferred to the CBN. These combined actions
precipitated the liquidity crisis in the period and subsequent large scale
withdrawal of deposits from the financial system. Although, distress resolution
measures were taken by the CBN through accommodating some of the banks as a
lender of last resort, very few regained viability, while many of them had their
licenses revoked and were subsequently liquidated.
4.3
Conflict Emanating from Adopted Theoretical Model for Reforms
This was a common pitfall that characterizes the four models of reforms
implemented in Nigeria so far, viz.: institutional and capital base reforms,
adoption of the DAS market approach, model of monetary control and interest
rates reforms.
With regard to institutional reforms, the assumption is that banking sector
liberalization accompanied by increased capital base requirements is a necessary
condition for improved performance of the banking sector. This was echoed by
the proponents of the initial banking sector reforms in SAP era and re-echoed by
the pre/post Soludo era. The underlying argument draws its strength from the
neo-classical supply-side economics, rooted in Say's Law that "supply creates its
own demand" (Jhinghan, 2003). That is, increased capital base may imply
increased availability of loanable funds. This should lead to a fall in interest rate
and should be capable of stimulating or eliciting a demand following response as
envisaged by Say's Law of Markets. However, the major pitfalls of this
assumption is reflected in the trade-offs costs which manifested in the various
eras of reforms in Nigeria. In particular, the post-Soludo reform era, which is
believed to have drawn into the banking sector a significant proportion of
currency outside banks and new monies from both the domestic and international
money markets (with the result that there was a remarkable increase in the capital
and reserves of banks), did not result in increased credit purvey to the productive
sector. Contrary to the expectation that this should enhance the ability of banks to
create credit, systemic leakages resulted in banks investing their funds on
alternative and secure portfolios, in addition to exhibiting detrimental credit
apathy.
The second major pitfalls emanates from the wrong perceptions by the monetary
authorities especially in Soludo's era that reforms via increased capitalization and
financial strength can foster economic growth. This posture departs from earlier
classical stance to agree with the Keynesians that cheap money policy which
leads to lower interest rates and increased investment, could lead to increases in
income, output and employment. However, an important qualification to this
assumption in Keynesian analysis is that this is feasible when the economy is
known to operate below the full employment level. However, conflicts arise
when the economy operates beyond full employment level, as has often been
claimed by the monetary authorities who frequently resort to liquidity mop-up as
part of monetary control measures. The adoption of a Keynesian monetary policy
stance which shifts the equilibrium money supply towards intersecting with the
demand for money curve at the precautionary and speculative level could
generate this type of conflict. And indeed, with the advent of universal banking in
Nigeria since the pre- and post-Soludo era, the demand for the new funds, is
guided by the precautions that meeting the demand of real sector credit is risky;
short term trade financing, especially imports yields quick returns, while
opportunities to invest in bonds and treasury bills and other money market
instruments offer a lucrative returns. There is therefore very slim chance that the
new money would find its way into investment, given the general level of credit
apathy on the part of financial markets, and it is therefore an illusion that being
'big' and 'strong' connotes 'tremendous increase' in credit creation ability and by
inference, rapid growth.
The third conflict revolves around the apparent inability of the monetary
authority to monitor and supervise the conduct of the emerging few but strong
'oligopolies' in the domestic money and foreign exchange markets. One argument
often advanced for liquidity mop up by the monetary authorities is the need to
keep a tab on monetary expansion as an instrument to stabilize the foreign
exchange market. The operating procedure usually is to limit the capacity of
banks to make outrageous bids for foreign exchange, through the control of their
money reserves. This task was arduous when the banks were many and have a
lower capital base. However, let us for once imagine the monster the monetary
authority would have to contend with given the fewer but richer number of banks
equipped to manipulate the foreign exchange market to their advantage. The
foreign exchange market would remain their niche and the likelihood is there that
they may become sharper and wiser in that market than in other investment
portfolios markets. If anything, the recapitalization has strengthened them further
to accentuate their rent seeking behavior, and domestic monetary policy appears
inadequate to address this problem.
A conflict that is peculiar to the Soludo reforms is the monetary authority's stance
that the inability to recapitalize, and/or forged a merger and acquisition
relationships with others implies institutional weakness and which led to the
liquidation of such banks. This is in spite of the fact that the NEEDS' (2004)
document which laid the foundations for this era of banking sector reforms
admitted " “…. that despite h i g h p r o f i t l e v e l s , the sector does not appear to
be playing a catalytic role in the real sector". It means that some of these banks
were profitable ventures, but had failed to play the envisaged catalytic role in the
real sector. The pertinent question is: can small not be beautiful? If at the level of
their capitalization they were doing good business, why should they be liquidated
on the ground that they needed to be big to make 'bigger profits'? Here lies the
contradiction in policy. The financial distress experienced by this group of banks
is policy induced as some of them were actually not distressed in the true sense of
that word. Ironically, one of the elements of the financial sector reforms is the
promotion of small holder and development finance institutions expected to grant
concessionary loans to small holder enterprises. Indeed, the monetary authorities
agree that small is beautiful, but prefers to kill the 'small' for the 'big'.
4.4
Conflicts Emanating from Foreign Exchange Market
Segmentation
The review so far shows that a major element of the banking sector reforms is the
introduction of a foreign exchange market that metamorphosed from SFEM to
FEM and IFEM. However, the major hallmark of the markets is the adoption of
DAS for the allocation and pricing of foreign exchange. The Nigerian DAS is a
wholesale market dominated by the CBN as a monopoly supplier while the
financial institutions are a buying cartel purportedly on behalf of their clients.
These banks however retail foreign exchange to individuals and corporations
through a second window the inter bank foreign exchange market (IFEM) which
operates more like a spot market. In addition to these markets there is the bureau
de change that sells foreign exchange to meet the needs for travels and personal
allowances. Thus, in practice, the Nigerian foreign exchange market is segmented
into: DAS, the wholesale segment which is monopolistic in supply and
oligopolistic in demand, and the second: inter bank, which is olipolistic in supply
to ultimate users of foreign exchange, complemented by bureau de change
operations and parallel markets.
The major dilemma or conflict arising from the segmentation of the spot market
is the tendency of participating financial institutions in the DAS to convert
purchases from the wholesale market to speculative operations at the inter bank
market as well as in their retailing activities to individuals and corporations for
arbitrage gains. This was the main source of multiple exchange rates, widened
divergence between parallel and official exchange rates and indeed the
continuous depreciation in post reforms and pre-Soludo eras. Although the
monetary authority has often thought that what is needed to rectify this anomaly
is increased funding of the wholesale market through very frequent interventions,
the problem had persisted, with the result that rent-seeking behaviour assumed a
more complex dimension. This has further dimmed the prospect for exchange
rates convergence, especially so as the monetary authorities is content with
periodic interventions through DAS for the purposes of monetization of foreign
exchange reserves in favour of the fiscal authorities.
4.5
Conflicts or Trade-offs in Fostering Internal and External Balance
via the Monetary Approach
A common trend in all the eras of reforms is the adoption of a monetary approach
for the attainment of internal and external balance. The monetary approach can be
expressed in the form of the following relationship between the demand for and
supply of money (Jhinghan 2003):
M D = ʃ(Y,P, i ) ... ..... (1)
M s = NDC+ NFR (2)
M D =M S ................... (3)
Or M D = NDC+ NFR [since M s = NDC+ NFR] ... (4)
Whereby M D is the demand for money which is a stable function of income (Y),
prices (P) and rate of interest (i); M s is the money supply, which is a multiple of
monetary base (m) and consists of net domestic money (credit) (NDC) and
country's foreign reserves (NFR). A balance of payment deficit or surplus is
represented by changes in the country's reserves such that:
 NFR= A M D - A NDC .......... (5)
Or NFR = BOP ...................... (6)
Equating equations 5 and 6, then: BOP = M D - NDC ............ (7)
Where BOP is the balance of payment and it is equal to the change in demand for
money less the change in domestic credit. From equation (5) and (7), a balance of
payment deficit means a negative BOP which reduces the NFR and the money
supply. On the other hand, a surplus means a positive BOP which increases the
NFR and the money supply. When BOP = 0, it means BOP equilibrium or no
disequilibrium of BOP.
The adoption of this model in eras of balance of payment deficit was appropriate.
However, in pre- and post-Soludo era, we were faced with a situation of a BOP
surplus, which therefore suggests that expansion in money supply would have its
origin from equation (4), such that: ... [M s = NDC+ NFR] ... (4)
This can be interpreted to mean that, although domestic money supply may
exceed the demand for money, the excess money is not from domestic borrowing
but from draw-down on reserves. Although the potential of such funds to swell
the reserves of deposit money banks exist, it may not be inflationary given the
credit apathy exhibited during this era. It could at best amount to 'insipid liquidity'
at the disposal of these banks for other investments portfolios. The ability of such
funds to compromise monetary policy pursuits is therefore limited and should not
be of any primary concern to the monetary authority. However, experiences show
that during the pre/post Soludo era, the monetary authority chose to mop up this
liquidity through instruments of indirect monetary controls. In the face of dearth
of instruments, since fiscal authorities were not borrowing from the public, the
monetary authority has had to create its instruments to mop it up. Although it is
often argued that it is a desirable pre-emptive action, such a precautionary
reaction may in fact be the root cause of inflation of a monetary origin, as she had
had to service the associated debt obligations upon maturity through fiat money
creation. The contradiction of this approach is that the monetary authority has
chosen to stab itself in the foot by helping the fiscal authorities to monetize
reserves which it has to periodically struggle to control, even when such money is
not a threat to rapid monetary expansion via domestic credit creation.
4.6
Ambivalent Theoretical Underpinning of Reforms
From the analysis so far, it could be inferred that during the SAP era, a monetary
approach rooted in a monetarist stance held sway as the foundation for banking
sector reforms. The focus was to strike a balance
between internal and external balance through a combination of exchange rates
adjustments and the use of both reserves and interest rates operating procedures,
with the sole objective of inflationary controls. However, as the pains of
adjustments became severe, a Keynesian perspective was introduced as an
attempt to use monetary policy to stimulate growth. However, the return to credit
allocation, interest and exchange rates control despite supply shortages brought to
the fore the short comings of Keynesian approach. There was an apparent return
to a monetarist model in pre-Soludo era for fostering macroeconomic balance but
with general believe that this time around it could yield a Keynesian result
fostering development as well as taming inflation. The post-Soludo reforms
represents a marked departure of erstwhile theoretic model of reforms. In
thoughts, the Soludo's approach to reforms is Classical with deep foundations in
Say's Law that supply creates its own demand. However, it is obvious that he
adopts the Monetarist view for fostering internal and external macroeconomic
balance as it often resorted to liquidity mop up as the major instruments for
monetary and inflationary control. Experience during the period showed that
rather than tame inflation, it seems to be the driving force behind domestic
inflation of monetary origin. However, to the extent that post-Soludo reforms
favoured interventions both in the foreign and domestic money markets, the
monetary authority acted Keynesian, believing that the unseen hand of the state is
capable of moving the economy in the desired direction. Perhaps, it is this
ambivalence that is the root cause of the conflicts and tradeoffs which the
Soludo's reforms elicited.
REFERENCE
Axel Leijonhufvud, 1968
On Keynesian Economics &
the Economics of Keynes: A
Study in Monetary Theory.
Oxford University Press.
ISBN 0-19-500948-7.
Balogun, E. D. and M. F. Otu (1991)
Credit
Policies
and
Agricultural Development in
Nigeria". CBN Economic
and
Financial
Review,
29(2):pp. 138-155.
Central Bank of Nigeria, Lagos, (1992)
The Impact of Structural
Adjustment Programme on
Nigerian Agriculture and
Rural
Life.
©
1992
CBN/NISER
Central Bank of Nigeria, Lagos, (1993)
Perspectives of Economic
Policy Reforms in Nigeria. ©
1993 CBN
Chiber, R. and J. Wilton, (1986)
Macroeconomic Policies and
Agricultural Performance in
Developing
Countries".
Finance & Development,
23(3):pp. 6-9.
Jhinghan, M. L. (2003)
Macroeconomic
Theory,
11th Revised Edition. © M.
L. Jhinghan, Delhi.
Kates, Steven (1998)
Say's Law and the Keynesian
Revolution:
How Macroeconomic Theory
Lost its Way. Edward Elgard
Publishing Limited. ISBN
978-1-85898-748-4.
National Planning Commission (NPC), Nigeria (2004). The National Economic
Empowerment and Development
Strategy (NEEDS). © 2004, NPC,
Nigeria.
Soludo, Charles C. (2007)
Macroeconomic, Monetary
and
Financial
Sector
Developments in Nigeria".
CBN
website:
www.cenbank.org.
Tomori, S. (2005)
Macroeconomics
and
Monetary
Policy:
The
Nigerian Experience" i n
Fakiyesi, O. O. & S. O.
Akano (Eds), Issues in
Money,
Finance
and
Economic Management in
Nigeria (Essays in Honour of
Professor
Obasanmi
Olakankpo), pp. 9-34.
World Bank (1986)
World Development Report.
© 1986 World Bank,
Washington.
CHAPTER FIVE
5.1
Future Policy Options and Concluding Remarks
Going by our analysis so far, the choice for future policy options for banking
sector reforms would be to bolster and move the Soludo's reforms towards a
clearly neo-classical supply side economics beyond the ambivalence of Say's
classical and Keynesian monetary stance. This choice is imperative if we are to
reconcile monetary and fiscal policies for the purpose of attaining the twin
objectives of growth and inflationary controls. Such reconciliation would mean
that the monetary authority should be less concern with expansionary fiscal
stance, for as long as its origin is not through domestic borrowing. Under such a
scenario, it should rely mostly on interest rate operating procedures for
macroeconomic management with the sole objective of moving towards the 'law
of one market' in both the domestic and international money markets. The
overriding objectives would be to minimize interest and exchange rates risks that
can adversely affect the rate of return on domestic and international financial
investments in the countiy. That way, the right incentives would be created for
the inflow of foreign and domestic investment into the country. This requires the
urgent need to fine-tune the Soludo's banking sector reforms through the
deliberate adoption of policies that would ensure convergence of domestic and
international rates of return on financial markets investment. This would require
getting prices right in all the markets.
5.2
Getting Domestic Interest Rates Right
On the domestic scene, there is the need to narrow the gap in interest rates
structures of alternative financial markets investment portfolios. In particular,
there is the critical need to determine the appropriate benchmark for interest rates
policies. Although the newly introduced monetary policy rate is targeted at this,
the extent of adjustment is inadequate. A situation whereby the interest rate
premium between the MPR and the Savings Rate is so wide suggest that arbitrage
activities informed by this development would continue to issue distorted signals
for the viability of credit portfolios and real sector investments on the one hand,
and alternative investments in securities and money market instruments on the
other hand. Although a market based supply side policies was expected to attain
this, the monetary authority would need to be less concern with the perceived
adverse trade off implicit in their current approach. Indeed contemporary
experiences of similar economies lend support to this approach. Thus, countries
with best practices like the United States, United Kingdom keep their monetary
policy rates close to their deposit rates especially savings rate. Also countries
within Africa which belong to a monetary zone maintained the same tradition as
it is evident from the data on Senegal and South Africa. However, Botswana and
Nigeria are classic examples of undesirable interest rates structures, induced by
the failure of the monetary authorities to prescribe an appropriate reference rate in
line with best practices (see Table 7)
_____________________________________________________________________
Botswana
Savings Bob Lend
Table 7: Interest rates Structure in Selected Countries 2004 -2006
Senegal
South Africa
United States
United Kingdom
Discount
Deposit
Deposit
Discount Discount Federal
3-montlis
IBR
Nigeria
MRRMll'R 3-.MD
R
7.8
14.3
4.0
3.5
6.7
8.0
2.0
1.0
4.2
4.0
15.(1
7.6
14.3
4.0
3.5
6.9
8.0
2.0
1.0
4.6
4.4
15.0
15.6"
Sav.rate
4.4
4.4
7.6
7.7
14.3
14.3
4.0
4.0
3.5
3.5
6.5
6.0
7.5
7.5
2.6
3.2
1.4
2.0
4.9
4.9
4.7
4.7
15.0
15.0
13.1
13.2
13.0
S.5
14.3
4.0
3.5
6.1
7.5
3.6
2.5
4.9
4.7
13.0
12.4
4.0
S.4
14.0
4.0
3.5
6.0
7.0
4.0
2.9
4.9
~47
13.0
11.4
3.3
4.4
4.4
1
8.1
14.3
4.0
3.5
5.9
7.0
4.6
3.5
4.6
4.4
13,0
9.4
3.7
7.2
14.5
4.0
3.5
6.2
7.0
5.2
4.0
4.6
4.4
13.0
8.9
3.3
6.7
15.0
4.0
3.5
6.6
7.0
5.5
4.5
4.6
4.4
13.0
9.3
3.0
6.6
15.0
4.0
3.5
6.6
7.5
6.0
4.9
4.7
4.5
14.0
6.2
15.0
4.3
3.5
7.3
8.0
6.3
5.3
4.9
4.7
14.0
3.5
9.8
9.7
2.9
cc: I M F International Financial Statistics
5.3
Getting External Investment Opportunities Right
On the international scene, it is critical to foster the emergence of a rate of return
on foreign investments especially in the Euro-Dollar markets based on real
changes in financial assets in question and not gains from nominal exchange rates
adjustments. Luckily enough, the stabilization of exchange rates so far is a good
omen, but the monetary authority should also compliment this with the
adjustment of domestic interest rates to coincide with Euro Dollar interest rates so
as to put paid to this speculations arising there from. This would require actions
not only to synthesize the segmented domestic foreign exchange market, but also
to ensure synergy between the foreign exchange market and the domestic money
market. One way to achieve this will be to look at the market fundamental of the
Nigerian foreign exchange market, especially the DAS vis-a-vis the inter bank,
with a view to permanently merging the two markets.
Although it has often been argued the wholesale DAS is inevitable and that it is
doubtful if the supply base can be broadened such that central banks intervention
is eliminated while the perfect competitive outlook of the spot market is
improved. In my view this is feasible if the central bank
concede their role as major supplier to the commercial banks. This can be done
via fiscal reforms which would enable all the tiers of government to negotiate
their realized foreign exchange through spot market operators instead of the
wholesale market. By this act, the wholesale auction market would be eliminated
and the window for speculation and arbitrage permanently foreclosed. It also
means a conscious move towards the law of one market. In particular, this should
mean that domestic interest rate should converge with the Eurodollar market
rates. That way speculations based on inter-country differences will be
eliminated.
5.4
Concluding Remarks
Overall, the major challenge to the Nigerian financial sector reforms is how to
engender healthy competition in addition to enhancing investments. This
demands the need to evolve an investment friendly interest rate regime that is
supportive of the growth objective of the government. The only way this can
happen given the recapitalization schemes, is to allow increases in money
supplies to be reflected in the costs of borrowing. The lower costs of borrowing
would induce the desired credit expansion, which would give fillip to investment
activities. Although this may be inflationary in the short run, it is still more
beneficial since its origin is not from high powered money.
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Appleyard, D. R. and A. J. Field, JR, (1998)
International Economics.
© Irwin/McGraw-Hill Boston.
Axel Leijonhufvud, 1968
On Keynesian Economics &
the Economics of Keynes: A
Study in Monetary Theory.
Oxford University Press. ISBN
0-19-500948-7.
Balogun, E. D. and M. F. Otu (1991)
Credit
Policies
and
Agricultural Development in
Nigeria". CBN Economic
and Financial Review,
29(2):pp. 138-155.
Central Bank of Nigeria, Lagos, (1992)
The Impact of Structural
Adjustment Programme
on Nigerian Agriculture
and Rural Life. © 1992
CBN/NISER
Central Bank of Nigeria, Lagos, (1993)
Perspectives
of
Economic
Policy
Reforms in Nigeria. 1993
CBN
Chiber, R. and J. Wilton, (1986)
Macroeconomic Policies and
Agricultural Performance in
Developing
Countries".
Finance & Development,
23(3):pp. 6-9.
Jhinghan, M. L. (2003)
Macroeconomic Theory,
11th Revised Edition. ©
M. L. Jhinghan, Delhi.
Kates, Steven (1998)
Say's Law and the
Keynesian Revolution:
How
Macroeconomic
Theory Lost its Way.
Edward Elgard Publishing
Limited.
ISBN
978-1-85898-748-
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1986
World
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C E O S (1994)
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