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The Causes
And Consequences Of Bank Failure On Nigerian Economy
ABSTRACT
One may not
be wrong to say that banks play a very crucial role in the development of any
economy, and the distress or failure of these banks could result to
underdevelopment. No bank in any nation is too big or too small to fail, but
the only way these banks especially Nigerian banks can be insulated from
distress or failure is by proper management by both internal and external
authorities. The Central Bank of Nigeria (CBN) has said that the only way a
nation can be free from bank failure is through the adoption and enforcement of
corporate governance culture that will help eradicate poor management , fraud
and insider abuse by both management and board members, poor assets and
liability etc. Experience has shown that bad debt or non performing loans has
been the main cause of bank failure and has militated against development.
CHAPTER ONE
1.1 BACKGROUND OF THE STUDY
Financial
instability has been in the scene of Nigerian economy for a long time. It is
obvious that the financial instability is an important topic to develop. The
cost burden associated with bank failure is so disturbing that the need for
continued study of causes of banking financial instability on both the
practical and theoretical level cannot be overemphasized. Some years back,
Nigeria witnessed numerous bank failures. Example Savannah bank, All State
Trust Bank, Bank of the North, Ganji bank of Niger limited, Owena bank, Lion
bank of Nigeria limited, etc.
The central
bank of Nigeria (CBN) has said that the only way the nation’s consolidated
banks could be insulated from failure if through adoption and enforcement of
corporate governance culture. Sanusi Lamido however, pointed out that the
recent failures of high profit institutions around the world such as Enron,
Parmalat, World comm., Barings bank among others, have shown that no company
can be too big to fail, stressing that a common trend that runs through these
monumental failures was poor corporate governance culture, exemplified in poor
management, fraud and insider abuse by both management and board members, poor
asset and liability management and poor regulation and supervision among
others.
Banks play very crucial roles in the process
of economic development of any country, by mobilizing funds from the surplus
units of the economy and the lending of these funds to deficit units for
investment. There has been a growing consensus among economists on the
proposition that financial institutions and particular commercial banks
contribute the real development of the economy. The process of expansion might
occur due to the improvement in the financial system as potential savings is
matched with investment. This reasoning which is supported by both the Keynesian
and the classical models of economic development implies the need for adequate
financial intermediation. Therefore, an efficient banking system implies
availability of credit for capital formulation and investment.
Bank
failures are usually followed by unfavourable consequences on stock-holder
outside then failed banks themselves. Sometimes, consequences are felt by the
non-banking system as a whole. A failure can result in much harms to employment
earnings, financial development and other associated public interests, Smiths
and Walter (1997: 158). According to Hooks, (1994: 99) and Beston and Kaufman
(1996: 105), the failure of a bank has a great adverse effect on the economy
and so it is considered very important.
Bank failure
means different things to some people. To some people, a bank fails only when
it ceases operation even if it has not been liquidated. In a wider context, a
bank is said to have failed if it has not succeeded in achieving any objectives
for which it was established.
A bank is considered
a failure not only when it ceases operation but also when it cannot meet any of
its objectives or obligations. The cessation of operation may constitute a
serious mild or negligible bank failure depending on the circumstance. The
cessation of independent operation or continuance without the assistance of
relevant authorities such as deposit insurance institutions can be associated
with distress. Bank failure therefore will occur when a fairly reasonable
proportion of banks in the economy as a whole lack capital assets. As Selgin
concludes that regulation in respect of branching limited contribute to the
possibilities of bank failure by supporting bank risky operation. According to
him, the worst regulation is branch restriction. The lower a bank’s capital,
the higher the probability of its failure. Goodhart et al (1998: 49) agree with
the statements and adds that as bank’s capital decreases, the higher its
motivation for action towards survival. This leads to more dangerous taking
operations. Therefore the risk of failure rises with the decline in equity.
Moreso, bank
failure is seen as a declaration of insolvency by the chattering agency or as a
reorganization to avoid dejure. Failed banks tend to be less efficient and make
fewer investments (grant more loans especially bad loans) than non-failed
banks. Thus, bank failure occurs when net cash is greater than the bank’s
capital funds. This implies that a problem bank is one that in the eyes of the
federal banking authorities has violated a law or regulation or engaged in an
unsafe or unsound banking practice to such an extent that the present or future
solvency of the bank is in question (Sinkye, 1975).
There is no
evidence that bank failure is the thing of the past in Nigeria because it is
still on the economic scene. Bank distress has become a common lexicon in
Nigeria, given many bank failures till date. Ebhodaghe (2001) states that when
a firm which is either a bank or not is liquidated for its inability to meet
its obligation to creditors, it can be described as having failed. Thus we
could use bank failure to describe a situation where, as a result of
irremediable bank distress, a bank’s license is revoked and the bank
subsequently liquidated. Liquidation is thus, an aftermath of bank failure. In
fact, if revocation of license is seen as the death of a bank, liquidation is
its burial.
Bank
distress is the fore runner of bank failure. Whereas a bank in distress could
have chances of regaining health, a failed bank loses every chance of life. Its
final destination is the mortuary of Nigerian deposit insurance corporation
(NDIC) from where it will proceed to its final resting place – liquidation –
courtesy of the undertakers. Bank failure also is when the bank system fails,
which means when all the bank ATMs and the bank eft pos machine fails to work.
When the banks have to shut for a while because the machines that are inside
the bank are broken. Corruption in the banking sector, so-called rich men
making deals with bank managing directors (MDs) and taking loans without paying
back. See what is happening to some commercial banks and micro-finance banks in
Nigeria. Banks that lent money to people with little or no credit and those
people cannot afford what was purchased, then they file bankrupt.
Also,
reserve requirement is a position of cash to total deposit which banks are
obliged to maintain. This ensures prudential and fiscal control of activities
of banks. White (1999: 11) adds that government obliges banks to reserve funds
in order to improve the actual need for base money. Friedman (1960: 122) stated
that bank failure arises because banks do not keep all their deposit in a
statutory reserve fund. Hempel and Simonson (1999: 18) noted that some
regulatory bodies exercise forbearance. This action contributes to banks crises
by permitting distressed banks to continue their operations instead of
liquidating them. This action aims at assisting banks in making profits. Its effect is rather
disadvantageous to banks because usually when banks lack adequate funds and
remain in operation, their capital situation deteriorates. The government uses
the lender of last resort mechanism to help some stakeholders of banks which
are falling.
The adverse
effect of bank failure on the economy of any nation is not a respecter of the
level of development. Ebhodaghe (1997: 100) whether a country is
industrialized, developed, big or small, underdeveloped, bank failure affects
the economy if not well managed. When a bank is distressed, many are unemployed
and people’s money is tied down. Financial distress/failure reduces the number
of qualified borrowers, the contraction in bank’s net worth forced reduction in
the supply of bank loans to qualified borrowers, even those with a strong
balance sheet. The bank failures of 2009 led to an expansion of the discount
window and 420 billion naira bail out fund which would have been channeled to
other critical needs of the economy.
1.2 STATEMENT OF THE PROBLEM
Available
literature has identified a long list of potential causes of failure in a
financial system to include weak management, inadequate capital base,
fraudulent and corrupt practices of owners and managers, poor assets and
liability management, macroeconomic instability, political instability/
interference and inadequate legal framework and structure (CBN/NDIC).
Adewunmi
(1991: 2) states that bank failure emanates from a number of exogenous and
endogenous factors. Exogenous factors which include adverse economic condition,
inhibition policy, environmental management interference, impact of
deregulation, inadequate supervision and regulation. Endogenous factors include
undercapitalization, manpower problem, mismanagement, fraud, etc. hooks,
(1994:5) points out that deteriorating local economic condition, inflation,
interest rate and exchange rate may cause bank failure. He further stated that
macroeconomics such as adverse movement in a country’s term of trade, sharp
fluctuation in the world interest rate, real exchange rate and inflation
worsened by regulations that are imposed on the banks result in bank failure.
He stated further that a limit on deposit interest rate motivate banks to make
risky investment. This is because banks often try to overrule ceiling imposed
by the regulatory authority in higher transaction costs andx lower income.
Instead of decreasing the prospect of bank failure, the ceiling on deposit and
bank interest rate therefore is argued to cause bank failure.
White
(1999:84) states that the government uses the lender of last resort mechanism
to help some banks that are failing or sometimes debt cancellation as experienced when the Central Bank of
Nigeria governor cancelled the debt of Bank of the North. Sometime in August
2009, the governor of CBN noticed some inadequacies in the banking sector,
which was traced to years of consistent manipulation, irregularities and sharp
malpractices in the banking sector. It was revealed that dirty business deals,
short-sighted investments and lack of respect for basic banking procedures were
some of the reasons the apex used to hang five chief executive officers and
their boards to dry on Friday, August 15, 2009. One of such instances was a
case where one of the banks gave an unsecured loan to the turns of N17 billion
to a notable business mogul, a practice that is not only supposed to involve
just the decision of the CEO.
Major
reasons for bank failure include economic, political and institutional factors.
Economic factors arise from negative economic conditions in the macro-economy.
Such adverse economic conditions include; high and rising inflation rate, high
and increasing foreign exchange rate, subsisiting huge foreign debts, huge and
expanding fiscal deficits, inadequacy of foreign exchange, monetary policy
changes, inconsistent or unstable economic policies, unguided economic reform
programmes e.g deregulation, low capacity utilization in the industries, low
per capita income, high domestic debts, dwindling national income. For example,
the combination of high inflation and exchange rates reduce the capacity of
bank customers to save. Thus, deposit mobilization becomes a subject of intense
competition with consequences for higher operational and financial costs. On
the other hand, low capacity utilization and low income per capita reduce the
ability of borrowers to repay their financial obligations. Thus, bad debts develop
with serious consequences for increased provisions, which lead to reduced
profits or increased losses.
Political
factors are politically induced issues, which turn out to have adverse
consequences on the effective management of banks. For instance, political
instability and indeed uncertainty associated with the annulled June 12, 1993
presidential election, engendered fear in the populace. That led to
unanticipated massive withdrawal of funds from the bank. More so, many debtors
either neglected or refused to repay their borrowings while fraud and forgeries
became the order of the day. Again, on political interference on the management
of banks is that most government owned banks were politically influenced to
grant loans and overdrafts, which soon after became hard core and remained
unpaid. Furthermore, appointment of board and management members of such banks
were mainly politically influenced, many a time resulting to using unqualified
and / or inexperienced person to manage banks.
Institutionally,
there are numerous internal causative factors of bank failure. These include;
boardroom squabbles arising from ownership structure, insider abuse, frauds and
forgers, weak / ineffective internal control systems, poor asset quality, lack
of adherence to CBN prudential guidelines, inadequate capita, poor management
and other internal factors. For this reason, consolidation and increase in bank
capital base with the view to strengthening Nigerian banks, and also making
them more reliable was the idea of Professor Charles Chukwuma Soludo (the then
CBN governor).
1.3 OBJECTIVES OF THE STUDY
a. To know the causes of bank failure in
Nigeria.
b. To determine its impact on the Nigerian
economy.
c. To proffer possible strategies to prevent
bank failures in Nigeria.
d. To determine the shortcomings or
constraint facing banks and how it inhibits growth on the Nigerian economy.
1.4 STATEMENT OF HYPOTHESIS
The
following hypothesis are tested on this study;
H0: Bank failures do not have any negative
impact or effect on the growth of
Nigeria.
H1: Bank
failures have negative impact on the Nigerian economy.
1.5 SIGNIFICANCE OF THE STUDY
The
relevance of the study is moved by the fact that most banks fail to perform to
the expected standard thereby contributing low to economic growth and
development. This means that bank failure causes crystallization of risks.
The
usefulness of this research is highlighted in the following ways:
i. It will highlight to the nation as a
whole on how best to manage banks.
ii. It will state categorically the major
causes of bank failure and their impacts on the economy thereby providing
solution to such problems.
iii. It will give the appropriate authorities an
overview of the key to economic growth.
iv. It will suggest useful measures by which
funds can be managed or handled in banks.
v. It will help various authorities in
providing adequate policies which will guide the operation of banks in Nigeria.
1.6 SCOPE AND LIMITATION OF THE STUDY
This work
covers the period of sixteen years (1992 - 2007). The limitations of this study
range from data collection and high costs involved as briefly x-rayed below.
i. Inadequate finance has also limited the
researcher from studying the activities of all the banks in Nigeria and also
limits the volume of data collected.
ii. Time constraint has limited the
researcher in arriving at more balanced conclusion, the research was carried
out under a short period.
iii. Inability to get access to some banks’
library to get more about the records and some other useful information about
the work also limit the researcher form data collected.
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