THE EMPIRICAL DETERMINANTS OF BANK DISTRESS IN NIGERIA
ABSTRACT
This study was a historical survey of determinants of bank distress in Nigeria. The research population comprised banks operating in Nigeria between 1998 and 2004. Data used in the study were all observational panel data obtained from t he published accounts of the elements of the research population. A total of 113 complete bank observations were utilized in the study. The researcher visited the Nigerian Deposit Insurance Corporation ( NDIC), the Central Bank of Nigeria ( CBN), the Chartered Institute of Bankers of Nigeria ( CIBN) and the Financial Institutions Training Centre ( FITC) to obtain t he data ut ilized in the study. The relationships outlined by the data set were empirically analyzed via multiple regression tests. All t he data for the purpose of the study were manually computed and then calibrated into the SPSS regressio n module for extensive stat ist ical analysis. The empir ical results indicated that loan quality is a significant determinant of bank distress in Nigeria, while insider lending and extent of government ownership are insignificant.
TABLE OF CONTENT
Title Page
TITLE PAGE i
DEDICATION ii
ACKNOWLEDGEMENTS iii
ABSTRACT v
TABLE OF CONTENT vi
LIST OF TABLES ix
LIST OF FIGURES x
CHAPTER ONE – Introduction 1
Background of the Study1
Statement of the Problem5
Purpose of the Study5
Scope of the Study5
Objectives of the Study6
Research Questions6
Research Hypotheses6
Significance of the Study7
Limitations of the Study8
References8
CHAPTER TWO – Review of Related Literature 10
What is Bank Distress?10
Determinants of Bank Distress12
Insider Lending13
Share Capital Requirement14
Bank Ownership15
Fraud and Fraudulent Practices17
Lending to High-Risk Borrowers18
Macro-economic Instability19
Liquidity Support and Prudential Regulation20
Inadequate Supervision21
Weak Corporate Governance21
Consequences of Bank Distress23
Erosion of Public Confidence23
Contagious Effects24
Economic Effects25
Global Effect26
Bank Distress in Nigeria26
Origin of Bank Distress in Nigeria26
Current Early Warning System (EWS) Employed
in Identifying Bank Distress in Nigeria 27
Ownership Structure as a Determinant of Bank Distress
in Nigeria 29
Tackling Bank Distress in Nigeria – A Regulatory Approach30
Distress Rationale for Banking Sector Reforms in Nigeria32
Conclusion35
References35
CHAPTER THREE – Research Design and Procedure 38
Research Design38
Research Population38
Nature, Sources and Size of Data38
Method of Data Collection38
Model Specification39
Variables’ Definitions39
Mode of Data Analysis40
References41
CHAPTER FOUR – Data Analysis 43
Visual Tests for Outliers43
Kolmogorov-Smirnov and Shapiro-Wilk Tests for Normality46
Correlation Matrix Test for Multicollinearity47
The Regression Estimates48
Correlation Test for Existence of First-Order
Autoregressive Schemes 48
Durbin-Watson Test for Existence of First-Order
Autoregressive Schemes 50
Answering the Research Questions and Testing
the Research Hypotheses 51
Research Question 1 and Research Hypothesis 151
Research Question 2 and Research Hypothesis 251
Research Question 3 and Research Hypothesis 352
Research Question 4 and Research Hypothesis 452
References53
CHAPTER FIVE – Summary of Findings, Conclusion and Recommendations 54
Summary of Findings54
Conclusion54
Recommendations55
Reference55
BIBLIOGRAPHY 56
APPENDIX I 60
APPENDIX II 63
APPENDIX III 83
LIST OF TABLES
Table Page
Table 2.1 – The Magnitude of Insider Abuse in Lending 13
Table 2.2 – Extent of Insider Loans in Liquidated Banks
(December 1996) 22
Table 2.3 – Weights of CAMEL Factors in Use in Nigeria 28
Table 4.1 – SPSS Case Processing Summary 46
Table 4.2 – SPSS Tests for Normality 46
Table 4.3 – Correlation Matrix of the Regressors 47
Table 4.4 – Correlation Results for Yt and Yt-1 48
Table 4.5 – Correlation Results for X1,t and X1,t -1 49
Table 4.6 – Correlation Results for X2,t and X2,t -1 49
Table 4.7 – Correlation Results for X3,t and X3,t -1 49
LIST OF FIGURES
Figure Page
Fig. 1 – Outliers in Solvency Ratio vs. Capital Size 43
Fig. 2 – Outliers in Solvency Ratio vs. Insider Loans 43
Fig. 3 – Outliers in Solvency Ratio vs. Loan Quality 44
Fig. 4 – Outliers in Solvency Ratio
vs. Extent of Government Ownership 44
Fig. 5 – Specific Identification of the Outliers 45
CHAPTER ONE
I NTRODUCTI ON
Background of the Study
In many societies, liquidation is an unpleasant word because of it s negative connotations. It connotes wiping out what was once in existence, winding up a company, killing what was once alive or destroying what had been carefully built over t ime. When the word is applied after a bank, it is even more fr ightening. This is so because banks are expected to be safe havens for people’ s money and valuables; thus the thought of liquidating such havens is understandably uncomfortable. The discomfort arises from the potential losses that might be sustained by t he banks’ stakeholders, namely depositors and the society at large ( NDIC, 2008: 2).
With many banks in Nigeria classified as distressed, some licenses withdrawn and some banks acquired by the Central Bank of Nigeria ( CBN) at a shameful purchase price of N 1 per bank, the issue has ceased to be whether banks will fail or not ( CBN / NDIC, 1995). Almost every concerned person is rather asking what will be the possible causes of bank distress, how can problem banks be identified and problems averted ( Anyanwaokoro, 1996: 208).
Committee on Banking Supervision ( 2001) t races the history of financial distress in t he Nigerian banking system back to the 1930 s when about 21 bank failures were recorded prior to the establishment of the CBN in 1958. The financial crisis was attributable to a number
of reasons including t he under- capitalization of banks, weak management, inappropriate corporate governance structures, reckless use of depositors’ funds, excessive growth ( over- t rading), lack of regulation and supervision, polit icization and non- performing loans. Poor loan qualit y had it s roots in the informational problems which afflict financial markets, and which are most acute in developing countries.
In Nigeria, many indigenous banks which commenced operations in the early 1950 s went into voluntary liquidation in the mid- 1950 s with such rapidity that confounded society. Some of the depositors were
reported to have lost their lives as a consequence. At that t ime, there were neither banking regulations nor an inst itut ion to see to the orderly liquidation of failed banks. The banks simply closed their doors, never to reopen them ( NDIC, 2008:2).
Another financial crisis in Nigeria, which started in 1989 with the identification of seven distressed banks, worsened gradually until 1993 when it led to the collapse of the inter- bank market and spread to all segments of t he financial system. The ability of the supervisory agencies to contain, manage and resolve the distress syndrome was severally handicapped due to the absence of a comprehensive regulatory framework for distress management.
Banks provide important benefits to the community, and facilitate the objectives of financial liberalization, by boosting competition in banking markets, stimulating improvements in services to customers and expanding access to credit, especially to domestic small and medium- scale businesses. Financial liberalization in Nigeria brought in it s wake a variety of financial inst itutions operating in the country. Commercial banks increased from 29 in 1986 when financial sector reforms began, by over 124% to 65 in 1992. New deposit- taking financia l inst itut ions also came on stream as a result of financial sector reforms. Among banks, these included community banks, the people’s bank and Mortgage banks, officially called primary mortgage inst itut ions ( PMIS). Among non- bank financial inst itution ( NBIS) are finance houses or companies, unit t rusts, and discount houses ( Soyibo, 1996 a). Unfortunately, the attainment of the benefits of financial liberalization in Nigeria has been jeopardized because banks have been vulnerable to financial distress ( Brownbridge, 1998). Substantial numbers of banks have failed, mainly due to non- performing loans.
Uche ( 1997) in his article t it led ‘Rethinking Deposit Insurance in Nigeria’, t races the origins of bank distress in Nigeria to the colonial era, during the indigenous banking crisis of 1950 s, which necessitated to the passing into law of the 1952 Banking Ordinance. The ordinance
required the indigenous banks in the British West African Colony of Nigeria to:
(1) ) Have a nominal share capital of at least £25, 000 of which not less than £2, 500 should be paid up.
(2) ) Be licensed by the financial secretary in order to be able to carry on banking business.
(3) ) Abstain from granting loans and advances on the security of their own shares and granting unsecured loans and advances in excess
of £300 to any one or more of it s directors or to a business in which it or any one or more of it s directors had any interests.
(4) ) Maintain adequate cash reserves.
(5) ) Maintain a reserve fund out of net profit of each year of not less than 20 percent of such profit until the reserve fund equals the share capital.
(6) ) Refrain from paying a dividend until all their capitalized expenditure not represented by tangible assets had been written off, and
(7) ) Make periodic returns to the financial secretary.
More damaging to these indigenous banks, however, were sections 5( 2) and 6( 2) of t he ordinance which gave the existing banks three years with which to comply with the provisions of the ordinance or to discontinue banking business. The fact that the indigenous banks were given a maximum period of three years to meet with the requirements of the ordinance or face liquidation coupled with the fact that there was no deposit insurance scheme in place to compensate depositors in the event of such liquidation, precipitated a run on these indigenous banks. This contributed to the eventual failure of several of these banks. Between 1953 and 1954, for instance, 17 of the 21 indigenous banks then in existence failed. Not withstanding t he fact that most of these banks were poorly capitalized and poorly staffed, the last stages that t riggered their mass failure was the government action of regulation.
Thereafter, the banking system remained fairly stable until 1986 when the Babangida Administration under pressure from the International Monetary Fund and World Bank, launched the Structural Adjustment Programme, ( SAP). An integral part of this programme was the deregulation of the banking system. Bank licensing policy was liberalized giving r ise to a proliferation of banks and other finance inst itut ions. According to Uche ( 1998), between 1985 and 1992, t he number of licensed commercial and merchant banks in the country increased from 40 to 120. Most of these new banks were no more than bureau de changes. The deregulation of t he economy, loopholes and sometimes out right evasion of the law made it possible for some of the new banks to survive and prosper by mainly buying and selling foreign exchange.
The deregulation of t he economy created both r isks and opportunities for the banks and there was increased competition, not just among banks but also with finance houses which were also a creation of government deregulation. SAP therefore fundamentally changed the structure of banking in the country. The new spirit of competition meant that the decision as to whether banks should fail or not was now to be determined by market forces. Government therefore focused on protecting the depositors, hence the establishment of the Nigerian Deposit Insurance Corporation ( NDIC).
The origin of banking crises in the 1990s was, perhaps, the sudden decision, by t he Federal Government in 1989, to withdraw public sector deposits from all commercial and merchant banks, leading to serious liquidity crisis in at least nine banks. This prompted NDIC to set up a liquidity support programme, valued at N2. 3 billion, for the affected banks. The government further stretched Nigerian banks with excessive taxation. Government fiscal indiscipline also helped to sabotage macro- economic stability which, in turn, further entrenched distress in the Nigerian banking sector.
Statement of the Problem
Situations where t he solvency and / or liquidity of several banks have suffered shocks t hat shake public confidence have been a source of concern to bank regulators, the government, depositors and the general public. One worrisome aspect of the result of liberalization of the financial sector in Nigeria has been the extent of distress in t he sector. For instance, 31 banks were closed between January 1994 and Januar y 1998. The year 1994 witnessed 4 bank closures ( 1 commercial bank and 3 merchant banks); 1 commercial bank was closed in 1995 ; 3 banks were closed in 2000 ; 1 bank was closed in February, 2002 ; and 1 bank was closed in February 2003. There are a lso reports that 60 out of the total of 115 surviving banks in Nigeria in the year 1995 were distressed, representing 52. 2% of all t he banks existing at the t ime ( NDIC, 2003). A very high proportion of both community banks and finance houses were also reportedly distressed. In 2004, the CBN Governor, Professor Charles Soludo, was quite revealing in his analysis of the distress position of Nigerian banks existing at the t ime when he classified 62 banks as sound, 14 banks as marginal, 11 banks as unsound, while 2 banks did not render returns. He concluded by saying that, while the state of the Nigerian banking system can be adjudged sat isfactory, the state of some of the banks was less cheering ( Soludo, 2004:35).
Purpose of the Study
In order to better understand the problem necessitating this study, the researcher intends to empirically ascertain determinants of bank distress in Nigeria, as a means of identifying and curbing future incidents of distress in t he Nigerian banking industry.
Scope of the Study
There are two aspects to bank distress. These are illiquidity and insolvency. The scope of this study is delimited to insolvency as an indicator of bank distress in the Nigerian banking industry.
Objectives of the Study
The researcher aims t hat this study achieves the fo llowing objectives:
(i) ) Empirically ascertain whether capital size is a significant determinant of bank distress in Nigeria.
(ii) ) Empirically ascertain whether insider lending is a significant determinant of bank distress in Nigeria.
(iii) ) Empirically ascertain whether loan quality is a significant determinant of bank distress in Nigeria.
(iv) ) Empirically ascertain whether extent of government ownership is a significant determinant of bank distress in Nigeria.
Research Questions
( i) Is capital size a significant determinant of bank distress
inNigeria?
( ii) Is insider lending a significant determinant of bank distress
inNigeria?
( iii) Is loan quality a significant determinant of bank distress
inNigeria?
( iv) Is extent of government ownership a significant determinant
of bank distress in Nigeria?
Research Hypotheses
A hypothesis is a prediction or a conjecture stated well in advance of observance ( or actual collection of data) about what can be expected to occur under stated or given conditions ( Asika, 1990). Streamlined to the aforementioned objectives and research questions, the fo llowing null hypotheses have been formulated and shall be subjected to suitable empirical tests.
Null Hypothesis 1
HO1 : There is no significant relationship between capital size and bank distress in Nigeria.
Null Hypothesis 2
HO2 : There is no significant relationship between insider lending and bank distress in Nigeria.
Null Hypothesis 3
HO3 : There is no significant relationship between loan qualit y and bank distress in Nigeria.
Null Hypothesis 4
HO4 : There is no significant relationship between extent of government ownership and bank distress in Nigeria.
Significance of the Study
One advantage of academic research is that it investigates matters which practitioners and policy makers find useful but have lit t le t ime to study. The significance of this study stems from the important position banks hold in every economy, developed or undeveloped. Banks are catalysts, around which all other economic activities revolve. A distressed banking sector may be a serious obstacle to economic activity and aggravate the effect of adverse shocks. For instance, when banks are distressed, firms may be unable to obtain credit to deal with a period of low internal cash flow. In fact, lack of credit may force viable firms into bankruptcy. Similarly, lack of consumer credit may worsen declines in consumption and aggregate demand during recession, aggravating unemployment. In extreme cases, bank- run and bank failure can threaten the soundness of payment system, and by extension, the economy. It is against this backdrop that studies on the empirical determinants of bank distress in Nigeria are inevitable as:
⦁ The study shall be of great importance in minimizing incidence of bank distress in Nigeria.
⦁ The study shall be of policy relevance to NDIC and the CBN towards evaluating and managing bank distress conditions in Nigeria.
⦁ The study shall significantly add to the existing body of literatures relating to bank distress in Nigeria.
Limitations of the Study
The limitation of any study are in the nature of constraints and bottlenecks, which could have created deficiencies, restrictions, biases, prejudices and confinements to the conduct, findings and limitations of the study. For this study, the limitations include:
(i) ) Paucity of stat ist ical data
(ii) ) Lack of willingness to release information by bank officials.
(iii) ) Difficulty in accessing information from information technology for this study.
(v) ) Observational Data Limitations:- Observational data pose major challenges to econometric attempts to est imate causal effects, and the tools of econometrics to tackle these challenges. In the real world, levels of “treatment” are not assigned at random, so it is difficult to sort out the effect of t he “treatment” from other relevant factors ( Stock and Watson, 2007: 10).
(vi) ) Abnormality of the Dataset:- While analyzing the data ut ilized for the purpose of this study, the researcher observed abnormalit y of the entire dataset. Since regression analysis is a parametric statist ic, the complete abnormality of the dataset amounts to a fundamental stat ist ical flaw which adversely affects the reliable interpretation of t he regression est imates derived via the dataset as well as their generalizability.
References
Anyanwakoro, M. ( 1996) Banking Methods and Processes. Enugu: Hosanna Publications.
Asika, N. ( 1990) Research Methodology in Behavioral Science.
Nigeria: Longman.
Brownbridge, M. ( 1998) “The Causes of Financial Distress in Local Banks in Africa and Implications for Prudential Policy” UNCTAD/ OSG/DP/132.
CBN / NDIC ( 1995) Distress in the Nigerian Financial Service Industry: A CBN / NDIC Collaborative Study. Lagos: Page Publishers Services Ltd.
Committee on Banking Supervision ( 2001 ) “Frame work for Contingenc y Planning for Banking Systemic Distress and Crises”.
Nigeria Deposit Insurance Corporation ( 2003) Annual Report and Statement of Accounts. Lagos: Nigeria Deposit Insurance Corporation.
Soludo, C. ( 2004) “25 bn Capital Base: Implications on the Economy”.
This Day, Lagos, July 4, p. 35.
Soyibo, A. ( 2004a) “A Positive, Normative Analysis of Bank Supervision in Nigeria”. AERC Research Paper 145.
Soyibo, A. ( 1996 b). Financial Sector Liberalization in Africa: Some Empirical and Policy Issues. Nairobi: African Economic Research Consortium.
Stock, J. H. and Watson, M. W. ( 2007) Introduction to Econometrics
( Second Edition). Boston: Pearson Education, Inc.
Uche, C. U. ( 1997) “Rethinking Deposit Insurance in Nigeria”.
.