EFFECT OF FINANCIAL REGULATIONS IN BANKING INDUSTRY ON THE ECONOMIC DEVELOPMENT OF NIGERIA

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CHAPTER ONE

INTRODUCTION

1.1       BACKGROUND TO THE STUDY

The banking sector in any economy serves as a catalyst for growth and development. Banks are able to perform this role through their crucial functions of financial intermediation, provision of an efficient payments system and facilitating the implementation of monetary policies. It is not surprising therefore, that governments the world over, attempt to evolve an efficient banking system, not only for the promotion of efficient intermediation, but also for the protection of depositors, encouragement of the system, competition, maintenance of public confidence in the system stability of the system and protection against systemic risk and collapse (Soludo, 2004). The banking industry in Nigeria plays a very significant role in the economic development of the country (Boyd and Runkle, 1993).

According to Nzotta (2004), banks as part of the Nigerian financial system channel scarce resources from surplus economic units to deficit units and they exert a lot of influence on the pattern and trend of economic development through their lending and deposit mobilization activities. Abdullahi (2002) says the banking industry, in particular, plays a crucial role in economic development by mobilizing savings and channeling them for investment especially in the real sector which increases the quantum of goods and services produced in the economy, thus national output increases and the level of employment improves. Globally, the banking business is highly regulated. This is because of the essential position the financial industry occupies in most economies. An efficient system, it is widely accepted, is a ˜sine qua non’ for efficient functioning of a nation’s economy. Thus, for the industry to be efficient, it must be regulated and supervised in view of the failure of the market system to recognize social rationality and the tendency for market participants to take undue risks which could impair the stability and solvency of their institutions (Alao, 2010).

Regulation of banks remains an integral part of the mechanism for ensuring safe and sound banking practice. At the apex of the regulatory and supervisory framework for the banking industry is the Central Bank of Nigeria (CBN). The Nigerian Deposit Insurance Corporation (NDIC) however, exercises shared responsibility with the Central Bank of Nigeria for the supervision of insured banks. Active co-operation exists between these two agencies on both the focus and modality for regulating and supervising insured banks. This is exemplified in the co-ordinated formulation of supervisory strategies and surveillance on the activities of the insured banks, elimination of supervisory overlap, establishment of a credible data management and information sharing system. In the main, bank supervision entails on-site examination of the institutions and off-site analysis of periodically rendered prudential returns, a process called off-site surveillance. The two activities are mutually reinforcing and are designed to timely identify and diagnose emerging problems in individual banks with a view to prescribing the most efficient resolution options (CBN, 2005).

In line with the prevailing international standards, these agencies (CBN and NDIC) have continued to emphasize risk-focused bank supervision in Nigeria. Similarly, they have developed twenty-five (25) core principles for effective banking supervision as enunciated by the Basle Committee on Banking Supervision as the pivot of the framework for bank supervision. It is worthy to note that what is currently happening in Nigeria does not differ widely from what happened in other nations. Over the years, and specifically since 1952 when the first Banking Ordinance was promulgated, several other Statutes have also been put in place to serve as the legal backbone for the actions of the monetary authorities in regulating the banking industry (Cartwright and Cooper, 1996).

Presently, the major relevant Statutes include Central Bank of Nigeria Decree No 24 of 1991, the Banks and Other Financial Institutions Decree No. 25 of 1991, the Company and Allied Matters Decree No. 1 of 1990, the Nigeria Deposit Insurance Corporation Decree No 22. of 1988 and lately, the Failed Bank (Recovery of Debt & Financial Malpractices) Decree No. 18 of 1994. These enabling laws and other relevant legislations have largely provided for sufficient and comprehensive supervisory power and operational autonomy in bank supervision, which may restore public confidence in banks (CBN, 2005).

The banking industry in Nigeria is able to play positive role only if it is functioning efficiently. However if it is repressed, inefficient and incapable of providing timely and quality services, the banking system could become a major hindrance to economic growth and development. This led to dwindling confidence in the banking industry by Nigerians (Sanni, 2009). Adewoyin (2006) noted that bank failure has been experienced since the 1990’s during which period one out of every two banks was distressed and in the early 2000’s when one out of every three banks was marginally unsound or totally unsound (Sanni, 2009). Soludo (2004) enumerated the fundamental problems of Nigerian banks, particularly those classified as unsound which include persistent illiquidity, poor assets quality and unprofitable operations and stated the major problems as follows: over-dependence on public sector deposits and neglect of small and medium class savers; weak capital base; insolvency as evidenced by negative capital adequacy ratios and shareholders’ funds that had been completely eroded by operating losses; gross insider abuses, resulting in huge non-performing insider related credits; weak corporate governance and risk management practices.

The failure of banks in the 1990’s and early 2000’s made the former Governor of Central Bank of Nigeria, Professor Charles Soludo to announce on July 6, 2004 that the minimum capital requirement base of banks in the country would be raised from N2 to N25 billion. The new policy which required banks to comply with the directive by end of December 2005 was aimed at significantly strengthening the operating environment of banks to perform their intermediation role effectively and efficiently.

Furthermore, as part of efforts to ensure the stability of the banking industry and in response to the lingering problem of distress in the sub-sector, the regulatory/supervision authorities have been applying various failure measures since the late 1990s. Hence depending on the severity and peculiarity of the distress, the NDIC in collaboration with the CBN, has over the years, successfully adopted such measures as provision of liquidity support through accommodation bill, imposition of prompt corrective actions, assumption control and management, restructuring and sale of some distressed banks as well as liquidation of the terminally distressed banks as a last but unavoidable option (Asediolen, 2011).

In specific terms, the following measures have so far been adopted.

• Accommodation facilities were granted to ten (10) banks with serious liquidity crises to the tune of N2.3 billion in 1989 following the withdrawal of public sector funds from commercial and merchant banks and the transfer to the CBN during that year.
• Holding actions were imposed on 46 banks to help stabilize their financial conditions in the mid-90’s.
• Twenty“four (24) banks were temporarily taken over by the regulators to safeguard their assets between the years 1989-1994.
• Seven (7) distressed banks were acquired, restructured and sold to new investors in the late 1990’s.
• From 1994 to 1999, thirty-six (36) terminally distressed banks were closed with minimal disruption to the banking system.
• In 2005, the number of operationally licensed banks in Nigeria numbering 89 (Eighty-Nine) was streamlined through a process of Mergers and Acquisition into 25 (Twenty-Five) viable banking institutions with a capital base of not less than N25 billion each.

The reform of these banks was because of their failure to respond to all the various regulatory initiatives employed to resolve the banks’ problems and the continued degeneration in their financial conditions.

1.2       STATEMENT OF THE PROBLEM

Bank regulation is implemented to ensure a sound and safe financial system in the economy. The measures are mainly concerned with the quality of risk asset in banks, compliance with key ratios such as liquidity ratio, cash reserve ratio, capital adequacy ratio amongst others, the quality of management and other corporate governance issues. However, inadequate supervisory framework and lack of an effective risk asset database and information sharing system have contributed in no small measure in disrupting the activities of banks, thereby leading to the often distasteful incidents of banking distress and liquidation by the regulators (Soludo, 2004).

In line with this problem, various banking legislations/acts have been promulgated as well as the introduction of different strategies all aimed at increasing the efficiency of banking regulatory supervision. Among them are on-site, off-site banking examination, routine examination, special examinations called at the instance of the regulators as well as other methods of surveillance to be discussed in subsequent chapters. These measures are mutually reinforcing and are designed to timely identify and diagnose emerging problems in individual banks with a view to presenting the most efficient resolution directed towards ensuring continued public confidence in the banking system (Soludo, 2004).

1.3       AIMS AND OBJECTIVES OF THE STUDY

The main aim of this research work is to examine the effect of financial regulations in banking industry on the economic development of Nigeria. The associated objectives can be summarized as follow:

1. To examine the impacts of financial regulators (CBN and NDIC) on Nigerian banks.
2. To determine the relationship between banking supervision and economic development in Nigeria.
3. To determine the efficiency and effectiveness of the Deposit Insurance Scheme in Nigerian banks.
4. To examine the effects of money laundering on financial institution.

1.4       RELEVANT RESEARCH QUESTIONS

The following research questions are relevant to the issues being investigated in the study. The generated controversy among bankers and the general public forms an integral part of the research questions. These are:

1. What impact does a financial regulator (CBN and NDIC) have on Nigerian Banks?
2. What is the relationship between banking supervision and economic development in Nigeria?
3. How effective and efficient is the Deposit Insurance Scheme in Nigerian banks?
4. What are the effects of money laundering on financial institution?

1.5  RELEVANT RESEARCH HYPOTHESES

The regulatory authorities have played a significant role in the financial system of any economy through the promulgation of policies aimed at ensuring the prudent management of banks’ assets and liabilities and thereby guarantee the safety of depositors’ funds. They have also promoted compliance to safe and sound banking practices, encourage the institution of an efficient internal control system in individual money deposit banks in order to prevent the incidence of frauds, forgeries and other financial malpractices as well as ensure the stability and engendering of public confidence in the system. This study will therefore test the following two hypotheses.

1. Ho: There is no significant relationship between financial regulators (CBN and NDIC) and the economic development of Nigeria.

H1:     There is significant relationship between financial regulators (CBN and NDIC) and the economic development of Nigeria.

1. Ho: The deposit Insurance Scheme has not boosted depositors’ confidence in the Nigeria Banking System.

H1:     The deposit Insurance Scheme has boosted depositors’ confidence in the Nigeria Banking System.

1.6       SCOPE OF THE STUDY

The study will cover the operation of the regulatory authorities as it relates to the banking industry in the past eleven years prior to the consolidation era and thus, would be limited to the period of 2000-2010. Secondly, the study assumes that the banking system has remained deregulated during the period covered in our study, as most banks practice universal banking, while the CBN/ NDIC act as the regulatory authorities and supervisors of banks in the banking sector.

In view of the technicalities involved, it would be unrealistic to assume that all necessary facts have been gathered in the process of the study. Information gathered is limited to those information made available by the respondents and also those gathered with the aid of local newspapers, magazines, journals and Annual Reports of the Central Bank of Nigeria (CBN), Nigeria Deposit Insurance Corporation (NDIC), Chartered Institute of Bankers of Nigeria (CIBN), Agusto Industry Report and basically the internet. However, the effect of this limitation will be reduced to the barest minimum.

1.7       SIGNIFICANCE OF THE STUDY

The study is significant in that it will help depositors of funds in financial institutions to fully understand the mechanism of banking supervision and the provisions of the law as they relate to the deposit insurance scheme. It also provides a platform for the regulatory authorities to appreciate the impact of their activities on the banking industry, and underscores areas for improvement. It is also imperative to state that a study of this nature provides an independent platform through which the regulators can appraise fundamental tools of supervision in a bid to make reasonable adjustments, where necessary.

The findings of this study will be of immense benefit not only to the Nigerian banking industry and its related institutions, but also to those interested in understanding the inter-relationship between the actions of the regulators on one hand and the banking institutions on the other, as well as providing a platform for promoting an efficient and effective banking practice.

The significance becomes more prominent when the effect of regulation is examined against the background of the consolidation exercise of the present policies of the Central bank of Nigeria. It is worth mentioning that the present state of the nation’s financial industry precipitated out of the supervisory framework of the Central Bank hence, this study would attempt to examine what impact the present consolidation exercise would have on the regulatory framework.

1.8       DEFINITION OF TERMS

There are some terms used in this project that requires clarification to avoid confusion to any reader. These terms include:-

Bank Regulation: A body of specific rules or agreed behaviour either imposed by some government or other external agency, or self-imposed by explicit or implicit agreement within the industry that limits the activities and business operations of financial institutions e.g. CBN/NDIC.

Economic Development: This is the gradual growth of trade, industry, management of money and business of a country.

Financial Intermediation: Financial Intermediation is the mobilization of funds from the surplus spending units at a cost or lending of such funds to the deficit spending units at a price both within and outside the shore of a country.

Bank Supervision: Is the process of monitoring banks to ensure that they are carrying out their activities in accordance with the laws, rules and regulations, and in a safe and sound manner.

Stable Banking System: A stable banking system means that banks have the ability and capacity to meet maturing obligations as they fall due and are making adequate profits from authorized banking business to justify their investment while at the same time keeping banking failures at a minimum within the country.

Prudential Guidelines: Is a body of specific rules imposed by government through the Central bank aimed at ensuring prudent management and administration of banks’ funds so that reports of financial institutions are correct and reflective of their true portfolio.

Deposit Insurance Scheme: Is primarily intended to promote stability of the financial system and to protect the less financially sophisticated depositor by minimizing the risk that depositors will suffer, lender of last resort, effective bank regulation and supervision and efficient payment system.

Financial Stability Form: This states that a deposit insurance system needs to be supported by strong prudential regulation and supervision, sound accounting system and the enforcement of effective law.

REFERENCES

Abdullahi, S.A. (2002). Distress in the Nigerian Banking Industry: A critical assessment of the nature, causes and extent. Journal of Business Administration, 2: pp. 135-154.

Adegbite, E. O. (2004). Financial Institutions And Economic Development In Nigeria in Adejugbe  Mo. O. A (ed) Industrialization, Urbanization And Development In Nigeria, 1950 “ 1999. Lagos Concept Publications.

Adewoyin, A.O. (2006). The Implications of Reform on Banking Sector, Journal of Business Management, 5: pp. 1-13.

Adewunmi, W. (2002). Financial Sector Soundness The Role of Regulatory Authorities in CBN (2002). Enhancing Financial Sector Soundness in Nigeria.

Alao, R.O. (2010). Mergers and Acquisitions in the Nigerian Banking Industry: An Advocate of Three Mega Banks. European Journal of Social Sciences, 15: pp. 554-563.

Asediolen, E. (2011). For the Economic and Financial Interest of Nigeria. Nigerworld: 1 & 2.African Journal of Business Management 5(14), 5938-5945.

Asika, N. M. (1991). Research Methodology in the Behavioural Sciences. Longman press, Lagos

Boyd, J. &  Runkle, D. (1993). Size and Performance of Banking Firms: Testing the predictions of Theory. Journal of  Monetary Economy. 31(7), 67-78

Cartwright, S. & Cooper, C. (1996). Managing Mergers, Acquisition and Strategic Alliance (2nd ed). Woburn, MA; Butter worth “ Heinemann

Central Bank of Nigeria, (2005). Draft of Central Bank of Nigeria. Annual Report for the Year Ended 31 December, 2005. http://www.cenbank.org/OUT/PUBLICATIONS/REPORTS/ RD/2006/ARP-2005-PART1.pdf.

Dixon-Ogbechi, B.N. (2002), Research Methods and Elementary Statistics in Practice, Lagos: PhilGlad Nig. Limited.

Nzotta, S.M., (2004). Money, Banking and Finance: Theory and Practice. Hudson-Jude Publishers, Owerri, Nigeria

Sanusi, L. S. (2010). The Nigerian banking industry: What went wrong and the way forward. Being a Convocation Lecture delivered at the Convocation Square, Bayero University, Kano on Friday 26 February, 2010 to mark the Annual Convocation Ceremony of the University.

Soludo, C.C. (2004). Consolidating the Nigerian Banking Industry to meet the development challenges of the 21^st century. And Address by the CBN Governor at the special meeting of the BANKERS’ COMMITTEE on July 6 2004, CBN Headquarters Abuja. http:// www.bis.org/ review/r040727g.pdf

Somoye, R.O.C. (2008). The performances of commercial banks in post-consolidation period in Nigeria: An empirical review. European Journal of Economics, Finance and Administrative Sciences, 14: 62-73.

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