Financial Sector Reform

The Structural Adjustment Programme (SAP) was adopted in July, 1986 against the glut in the international oil market and the resultant deteriorating economie conditions in the country. It was designed to achieve fiscal balance and balance of payments viability by altering and restructuring the production and consumption patterns of the economy, eliminating priee distortions, reducing the heavy dependence on crude oil exports and consumer goods imports, enhancing the non-oil export base and achieving sustainable growth. Other aims were to rationalize the role of the public sector and accelerate the growth potential of the private sector. The main strategies of the programme were the deregulation of external trade and payments arrangements, adoption of a

market-determined exchange rate for the Naira, substantial reduction in complex pnce and administrative controls and more reliance on market forces as a major determinant of economie activity.

The full financialliberalization process in the Nigerian economy started in 1986 with the introduction of a more dynamic interest rate policy. In that year banks were obliged to negotiate with their customers acceptable interest rates on savings and time deposits;

CBN minimum which was fixed at (8.5 %) per annum. Also ali lending rates were adjusted upwards by 2 percentage points, subject to a maximum of 15 percent.

Consequently, lending rates generally rose and yields on deposits became more attractive.

These were followed by licensing of new banks into the system. The main instrument of the market-based framework was the open market operations (OMO). This was complemented by reserve requirements and discount window operations. The adoption of a market-based framework such as OMO in an economy that had been under direct control for a long period, required substantial improvement in the macroeconomie, legal and regulatory environment.

In order to improve macroeconomie stability, efforts were directed at the management of

ex cess liquidity, th us a number of measures were introduced to reduce liquidity overhang in the system. These included the reduction in the maximum ceiling on credit growth allowed for banks; the recall of the special deposits requirement against outstanding external payment arrears to CBN from banks, abolition of the use of foreign guarantee/external currency deposits as collaterals for Naira loans and the withdrawal of public sector deposits from banks to the CBN. Also effective from August, 1990 the use of stabilization securities for the purpose of reducing the bulging size of ex cess liquidity in banks was re-introduced. Commercial banks' reserve requirements were increased in 1989, 1990, 1992, 1999, and 2002.

The rising level of fiscal deficits was id~ntified as a major source of macroeconomie instability. Consequently, Government agreed not only to reduce the size of its deficits

but also to synchronize fiscal and monetary policies. This was done by inducing efficiency and encouraging a good measure of flexibility in banks credit operations and improving the regulatory environment. Consequently, the sector-specific credit allocation targets were compressed into four sectors in 1986, and to only two in 1987. From October 1996, all mandatory credit allocation mechanisms were abolished. The commercial and merchant banks were subjected to equal treatment since their operations were found to produce similar effects on the monetary process. Areas of perceived disadvantages to merchant banks were harmonized in line with the need to create a conducive environment for their operations.

In recognition of the fact that well-capitalized banks would strengthen the banking system for effective monetary management, the monetary authority increased the minimum paid up-capital of commercial and merchant banks in February 1990 to 50 and 40 from 20 and 12 million Naira, respectively. Distressed banks whose capital fell below existing requirements were expected to comply by 31st March 1997 or face liquidation. Twenty-six such banks comprising 13 each of commercial and merchant banks were liquidated in January 1998. Minimum paid up capital ofmerchant and commercial banks was raised to a uniform level of 500 million naira with effect from )st January, 1997, and effective 2002 the existing banks were to increase their paid up capital to one (1) billion naira while new banks were expected to pay two (2) billion naira. The CBN brought into force the risk-weighted measure of capital adequacy recommended by the Basle committee of the Bank of International Settlements in 1990. Before then capital adequacy was measured by the ratio of adjusted capital to loans and advances outstanding.

The CBN introduced in 1990 a set of prudential guidelines for licensed banks which were complementary to both the Capital Adequacy Requirement and Statement of Standard Accounting Practices. The prudential guidelines, among others, spelt out the criteria to be employed by banks for classifying non-performing loans. The CBN has continued to examine and monitor banks in order to en~ure a stable banking system. Also the Bank handles the problem of distressed and illiquid banks. The CBN imposes holding actions

and revoke licenses of affected banks as well as encourage mergers and acquisitions. In an effort to improve the operations of the money market, an auction-based market for treasury securities was introduced in 1989; and these treasury instruments were made bearer bills to enhance transferability and promo te secondary trading.

By mid-1992, the major hurdle to the introduction of Open Market Operation (OMO) remained the continued imposition of credit ceiling on the banks. From September 1, 1992, the CBN, lifted credit ceiling on individual banks that met CBN specifie criteria on selective basis in respect of statutory minimum paid-up capital adequacy ratio, cash reserve and liquidity ratio requirements, prudential guidelines, sectoral credit allocation and sound management. Meanwhile, the use of stabilization securities for mopping up excess reserves in banks was intensified and three discount houses commenced operation in 1995 and the fifth one in 1996. On the 30th of June, 1993, the CBN commenced OMO in treasury securities with banks through discount houses on a weekly basis. OMO has remained a major tool of monetary policy in Nigeria with its effective use in moderating the system' s liquidity.

2.8.3 The Nigerian Experience in Financial Liberalization

The major elements which have been identified as crucial in any financialliberalization programme are discussed below, taking into cognizance, the Nigerian experienced.

a) Initial Macroeconomie Condition b) Regulation and Supervision of Banks c) The Speed ofReforrn

d) Competition Among Banks e) Deposit Insurance

a) Initial Macroeconomie Condition

While sorne have argued that the current fragility of the financial system emanated from such institutional and structural problems as mismanagement, inadequate supervisory and

regulatory framework, others give prominence to such macroeconomie variables as the volatility of interest rates, inflation, high real exchange rates, volatile capital inflow, balance of payment and fiscal deficits. Prior to the adoption of the reform programme, the macroeconomie environment was highly unstable. For instance the government fiscal deficit as a percentage of GDP rose from 11.3 percent in 1986 to 15.5 in 1993 and the trend continued even though at a reduced rate. The inflation rate at the inception stood at 5.4 percent, however, by 1988, the rate accelerated to 55.9 and 57.2, 57.0 and 72.8 percent respectively for the periods 1993, 1994 and 1995 due to the government's excessive borrowing requirements from the Central Bank. The current account has been negative for most periods while foreign exchange in the AFEM and FEM markets continued to depreciate. The exchange rate instability greatly undermined the economy.

The economie environment was quite unstable from the inception of the programme.

b) Regulation and Supervision of Banks:

The regulatory /supervisory authorities established for the orderly functioning of the financial system include: the Central Bank of Nigeria (CBN), the Federal Ministry of Finance (FMF), the Nigerian Deposit Insurance Corporation (NDIC), the Security and Exchange Commission ( SEC) and the National Insurance Commission (NAICOM). The main sources of CBN legal authority for discharging its responsibility are the CBN Decree No. 24 of 1991 (amended in 1997, 1998, and 1999) and the Banks and Other Financial Institutions Decree (BOFID) No. 25 of 1991 (amended in 1997, 1998 and 1999) which superseded the CBN Act of 1958 and the Banking Decree of 1969 and the later amendments.

The recent laws gave the CBN more flexibility in regulating and supervising the banking sector and other financial institutions which hitherto operated outside any regulatory framewore. These include: primary mortgage institutions, community banks, people's bank as well as development finance institutions.

Although financial sector reform started in 1986, adequate regulatory measures were not in place until 1991 with the promulgation of the Bank and Other Financial Institutions Decree (Decree 25) of 1991. Appropriate regulation would have established minimum capital adequacy necessary for entry in the financial market. This should have been the first step towards the restructuring of the existing banks prior to the establishment of new ones at the commencement of (SAP) in 1986.

c) The Speed of Reform

The nurnber of new commercial and merchants banks in operation between (1986-1992) stood at 79 with 1086 bank branches. In the previous six years, (1983-1988), only 14 new banks with 644 branches operated in the country. Thus, at the end of 1992, the total number of banks was 120, compared with 40 at the end of 1982. The total number of branches increased from 1,323 to 2,391, within the same period. Also by 1990, the number of other financial institutions licensed to operate was as follows: comrnunity bank (1), people's banks branches (169), bureaux de change (92), stock brokerage firms (80) and insurance companies (103). However, by 1992 the number ofthese institutions had risen to 402, 228, 145, 132, 140, 48, 121 and 3 respectively, representing comrnunity banks, peoples' bank branches, mortgage institutions, bureaux de change, stock brokerage firms, finance companies, insurance houses and discount houses respectively (see Annex 8)

The NDIC took effect in February, 1989; the National Insurance Corporation was established in 1997 replacing the Nigerian Insurance Supervisory Board (NISB). The People's bank was established in 1988, the Community bank became effective in December 1999 the Unit Trust scheme became operational in 1990, and the Primary

' '

Mortgage institution started operations in 1989 while the Bureaux de Change was authorized to opera te in 1989. The licensing of new financial institutions was implemented too quickly, as a result, the time adjustment was too short for the development of the required skill under the new system in view of the limited regulation.

---~

d) Competition among Banks

Financial liberalization has increased the number of financial institutions and branch network but the banking structure in Nigeria still remain largely oligopolistic. The few large banks control a greater segment of the market in terms of the total assets total , liabilities as well as total credit in the banking system. Their over bearing influence, and the control of the greater segment ofthe market has narrowed competition in the banking industry. Though financial liberalization has brought in product innovations, the new generation banks lack the spread and capacity for resource mobilization. These banks are mostly concentrated in the urban areas with less impact in the rural areas.

e) Deposit lnsurance

A principal function of many non-market institutions is to help those who have suffered sorne misfortune which entails the provision of insurance. The moral hazard problem arises because of the inability of the insurance firm to monitor the action of the insured.

Consequent! y, in arder to check the unfortunate incidence of moral hazard and enhance confidence in the banking system so as to effect a less painful resolution of problems associated with failed banks, the Federal government, acting on the initiative of the CBN, introduced the system of an explicit deposit insurance scheme in Nigeria. The promulgation of the Nigerian Deposit Insurance Act of 1988 (NDIC Act) established the Nigerian Insurance Corporation (NDIC). The NDIC is charged with the responsibility of insuring deposits of banks and thereby help reduce the impact of bank failure in the economy. The NDIC also provides financial assistance to banks in difficulty and assist in the formulation and implementation ofbanking policies. The act guarantees the payment of up to a maximum of fifty thousand naira (NSO, 000.0) to every depositor of a failed bank. The scheme is primarily to protect small savers.

TABLE 1: SELECTED INDICES OF BANKS IN CRISES (1990- 2001)

YEARS 90 91 92 93 94 95 96 97 98 99 2000 2001 NUMBER OF BANKS 107 119 120 120 116 115 115 115 89 90 89 90 NO. OF DISTRESSED BANKS 9 8 16 33 55 60 50 47 15 13 12 9

RATIO OF DEPOSITS OF 14.6 4.4 18.1 19.2 29.4 14.1 14.7 9.0 3.5 1.6 2.5 2.0 DISTRESSED BANKS TO

TOTAL DEPOSITS (%)

RATIO OF DISTRESSED 23.7 16.4 20.9 16.1 18.6 19.8 11.0 7.6 3.9 1.5 20.0 3.0 BANKS TO TOT AL AS SETS OF

ALL BANKS (%)

AMOUNT REQUIRED FOR 2.0 2.4 55 13.6 23.4 30.5 43.9 42.8 15.5 15.3 10.3 RECAPITALIZATION OF

DISTRESSED BANKSS IN (+>+-'BILLION)

Source. NDIC ANNUAL REPORT (Vartous tssues) and CBN BANKING SUPER VISION ANNUAL REPORT.