Impact of Nigeria’s bank consolidation

Impact of Nigeria's Bank Consolidation

on

Shareholder's Returns.

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UNITED NATIONS

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NATIONS UNIES

Supervisor : Dr Dipo BUSARI, PhD.

April 2007

INSTITUTAFRICAIN DE DEVELOPPEMENT ECONOMIQUE ET DE PLANIFICATION AFRICAN INSTITUTE FOR ECONOMIC DEVELOPMENT AND PLANNING

(IDEP)

9 1 pj)

Augustine Nart KOLO

Submitted in

partial fulfillment for the award of

a

Master of Arts Degree in

Economic

Policy and Management at the African Institute for Economic Development and Planning

(UN-IDEP, Dakar)

UNITED

NATIONS

^.

AFRICAIN INSTITUTE

FOR ECONOMIC

DEVELOPMENT AND PLANNING

IDEP

This is to certify that

Augustine Nart KOLO

Identification N° 060708

hassuccessfully defended the

M.A. thesis entitled

THE

CHALLENGES AND IMPACT OF NIGERIA'S BANK

CONSOLIDATION ON SHAREHOLDER'S RETURNS

Approved by the

Thesis Committee:

Diéry SECK ^...

Dipo BUSARL

Franklyn LISK.

Supervisor

External

examiner

Medou DIAKHATE

Member

Aloysius A. AMIN

...!

SputyDirector/

Chief, Training Division

Date:

\

DEDICATION

This thesis is specially dedicatedto my loving

wife, Christie Kashi Kolo; and to

my

children: Jemimah, Jedidiah and Josiah.

ACKNOWLEDGEMENT

I wish to thank God for His Mercies, goodness and good

health

to me, my

wife and

children, brothers and Sisters, brethren, colleagues at

work and school and for the

challenges thatthis 18-months

M.A

course

offered

me.

I commend my Director (Mr

T.K.Jinadu), Mr A. Agun (Director of Admin) and The

Permanent Secretary (Dr. Mrs Adah Okwuosah)

for recommending for this

course.

I

wish to recognise the effort and warm

reception of The Research Department of

Security and Exchange

Commission, Abuja especially Ms Bosede Ojo

;

for providing

me

with the currentdata i needed for thisthesis.

I appreciate the Director (Dr

Diery Seek), Head of Training Division (Prof A.A.Amin),

Head of Admin (Ms Wolde Gabriel

KIBBNESH) and the MA Cordinator (Dr. Dipo

Busari) for the Award to

undertake this

programme.

I

am

impressed and commend the

courtesy and decorum of Mrs

Aissatou Sanghare. I

am very

grateful to

my

supervisor,

Dr Busari for guidance and support. I

appreciate Mr Ahmed Ba, Tharcisse Ntilivamunda

and Bertilde Mukanyiligira for their useful guide

and assistance in the

course

of this

course. I will not forget the knowledge impacted

and counsel derived from the useful

medium of Mr. James Arthur, Mr. Wilfred Amoako and Mr. Samba Niang.

Mr. Eric

Guedegbe, the Computer

assistant

was

of much help to

me

which is commended.

I express my deep appreciation to

Pastor and Mrs Joel and the entire congregation of

the Redeemed Christian Church ofGod, Dakar for theirspiritual support and

fellowship.

Thanks to Ven and Mrs P.O. Okunromade and the members of St. Matthew's

Church,

Maitama-Abuja fortheir love and encouragement.

For the set before us I appreciate their guide and love;

while I wish the set after

us

the

very best in their endeavour.

For the fourteen of

us

in the 2005-2007 set,

you

have

impacted an indelible mark on me.

The Santinel's (Martha, Susan and Irene) I

appreciate your company; and

for

my

good friends; Bailio and Comrade Kandege I

commend and appreciate you and will miss you

the most. Sacko, Mica, Bahati,

Aminata, Bibish, Taal, Malick and Samba you are

indeed

my

pals. God bless

you

all.

ii

ABSTRACT

The various financial sector reforms of the past two decades in Nigeria

brought about

some changes in terms of the number of institutions,

ownership structure,

as

well

as depth and breadth of the market. The recent

reforms (2005)

was a

regulatory induced

restructuring which engendered the alignment

and realignment of banks to

ensure sound, responsive, competitive and transparent banking system

suited to the demands

of the Nigerian economy and the challenges

of globalization. A review of the literature

suggests that the value gains

alleged through

expense

reduction, increased market

power, reduced earnings

volatility, and economies of scale have not been verified.

Khotari and Warner (2006) reinforced the use of the

stratified samples to

measure sample securities' mean and

cumulative

mean

abnormal return around the time of

an

event. We used weekly average stock price on a short

horizon

to

get statistically

significant positive abnormal returns to

shareholders of acquiring banks and insignificant

(neutral) abnormal returnsfor target

banks around the announcement date.

iv

RESUME

Les différentes réformes du secteurfinancier des deux dernières décennies ont apporté quelques changements dans le nombre

d'institutions, la structure du capital social, de

même que dans l'ampleur et l'étendue du marché. Les

nouvelles réformes (2005) ont

suscité à une restructuration induite _{par une} réglementation et engendré

l'alignement et

le réalignement des banques pour assurer un

système bancaire sain, adéquat,

compétitif et transparent adapté ^aux

exigences de l'économie nigériane et

aux

défis liés

à la mondialisation. La revue de la littérature montre que la valeur des présumés

profits

à travers la réduction des dépenses, le pouvoiraccru du

marché, la volatilité réduite des

gains, et les économies d'échelle

n'ont

^pas

été testées. Khotari et Warner (2006) ont

renforcé l'utilisation des échantillons stratifiés pour mesurer la moyenne des titres et

la

moyenne cumulée des rendements anormaux

lors d'un événement. Nous

avons

utilisé

la moyenne hebdomadaire des

prix de la bourse de valeur dans

un

horizon court

pour

obtenir des rendements positifs anormaux importants pour

les actionnaires des

banques acheteuses et des

rendements

anormaux

(neutres) insignifiants

pour

les

banques ciblesdés l'annonce de la

date.

v

EXECUTIVE SUMMARY

The various financial sector reforms of the past two decades in Nigeria

brought about

some changes in terms of the number of

institutions, ownership structure,

as

well

as depth and breadth of the market.

The

recent

reforms (2005) prompted regulatory

induced restructuring and engendered the alignment and

realignment of banks and

banking groups into the merger of some

and the acquisition of others to

ensure a sound, responsive, competitive and transparent

banking system suited to the demands

of the Nigerian economyand the challenges

of globalization.

A review of the literature suggests that thevalue gains that ^are

alleged through

expense reduction, increased market power, reduced earnings

volatility, and economies of scale

have not been verified. We attempt to address alternative explanations

and reconcile

the data of continued _merger activitywith eventstudy

methods which

measures

sample

securities' mean and cumulative mean abnormal return around the time of an event.

Khotari and Warner (2006) reinforced the use

of the stratified samples to examine event

study statistical properties

adopted for the Nigerian banking post consolidation and

illustrates that the property ofthe study methods

varies by calendar time period and the

event sample firm characteristics such ^as

volatility. The long-horizon method posed

great challenge by its high

susceptibility

to

joint-test problem therefore

we

used weekly

average stock price derived from Securities

and Exchange Commission's for

a

short

horizon to get precise measurement

of abnormal returns and

more

information of

announcement effects.

The study was designed to examine the effect of bank

consolidation

on

wealth returns

of acquiring banks shareholders during, before and

after the period of announcement.

The ordinary least square model was used to estimate

weekly Average Returns and

Cumulative Abnormal Returns of 22 acquisitions around the announcement date from January through December, 2006. To test the effect

of acquisition size

we

randomly

used samples of the ten most capitalized

banks and twelve medium-to-small

acquisitions. For medium-to-small acquisitions

(merger-of-equal), statistically

insignificant neutral and positive abnormal returns were

found for acquiring banks

vi

during the announcement period. Large

acquisitions in-market

mergers

had significant

positive abnormal returns for all

acquiring banks that

were

documented around the

announcement date. The most notable finding ^was the acquisitions of

FBN and ZIB

which were significantly larger than the abnormal returns

associated with medium-to-

small acquisitions.

The announcement of interstate consolidation produced results similar to the averages of all mergers in the sample. The findings

also showed statistically significant positive

abnormal returns to shareholders ofacquired banks and insignificant negative

abnormal

returns to shareholders of target banks around the announcement

of the

mergers.

There exist vast potential for cross border merger

likened

to

the Amalgamated Bank of

South Africawithin the West African Sub-Region.

We found a pattern of significant influence on

stockholder wealth from the

announcement of a merger, which confirmed the findings of the majority

of studies

on

such periods. There are other factors that could

had influence the stock price movement

of acquiring and target bank around

the

merger

announcement date that

are

not

controlled by this study. In the future similar studies

should try to determine if such

pattern will continue; this is because our

conclusion

was

based

on an

analysis of limited

number of observations and we assume that this virtually static pattern may continue.

Factors that influence abnormal returns before and after announcement of ^an acquisition should be isolated and examined. The relationship between

large gains of

acquiring bank shareholders and the negative and neutral post-merger

performance of

sometargetfirms needsto be investigated and explained.

Corporate governance for institutions was recognized as the single most

important

variable in the survival and growth of corporate institutions. The emerging scenario of mega-banks in Nigeria through the recapitalization of banks and their consolidation through mergers and acquisitions depicts that operators (stakeholders) demonstrated greater commitment to professionalism, good corporate governance and strict

adherence to rules, regulations and other statutory requirements. To check abuses in

the emerging consolidated banking system, the institutionalization of good corporate

vii

governance practices was both necessary

and desirable. The key factors that improved

the quality of corporate governance in

merged banks

were

the development strategy

(NEEDS) anchored on the private sector as

engine of growth; raising

awareness

and

commitment to good corporate ^governance

practices, appointment of knowledgeable

and experienced board members;

education, training and transparent information

disclosure where shareholders rights and wealth are protected and

dispensed.

Acquisitions and Mergers of the Nigerian

banks brought about change management in

the form of right sizing, re-engineering, re-focusing,

business re-inventions and made

the banks to be multi-cultural, multi-market, multi management and in some cases

multi

national. There are also challenges in innovativeness, in product

market development

and IT driven delivery method. This change must

relate

to

existing corporate vision to

encourage the citizens to personal

commitment; since the main driving force in the

market place is not only opportunity share

but profit share from which the wealth effect

is derived. Though most studies argue that majority

of the

mergers are

not beneficial to

the acquired bank, such studies have been

criticized and largely ignored

on

the grounds

that stock market value ofthe acquiring bank ^were compared to that

of

its peers or

the

general index for pre-event periods (the

Nigerian

case

had obvious defect for lack of

information on thetarget bank).

So what the Nigerian shareholder wanted and got from bank

consolidation

were

deals

which created more value through the synergies it yields; the real prospect for ^revenue growth; and cost cut to gain more premiums than the 2006

weekly CAR N13, 915 at

77% every 21 months in the subsequent years. The Shareholder

Association of Nigeria

is crucial to implementation of code of corporate governance and integration of the merged bank. The current trend and its challenges show sign of creating more

wealth

for the consolidated bank shareholders through diversified and off shore banking that

will play active developmental roles in the Nigerian economy and

make it

^a

competitive

player in theAfrican, Regional and Globalfinancial system.

viii

TABLE OF CONTENTS

DEDICATION »

ACKNOWLEDGEMENT "I

ABSTRACT IV

RESUME V

EXECUTIVESUMMARY VI

TABLE OFCONTENTS IX

LISTOFTABLES XI

LIST OFGRAPHS XI

LISTOF ANNEXES XI

ACRONYMS XII

CHAPTER ONE: INTRODUCTION 1

1.0 Background 1

1.1 StatementofProblem 2

1.2 ObjectiveofStudy 3

1.3 JustificationofStudy 3

1.4 Planofstudy 5

CHAPTERTWO: THE REFORMS IN THE NIGERIAN BANKING INDUSTRY 6

2.0 An OverviewoftheNigerian FinancialSector 6

2.1 Reformsin the NigerianBanking Industry 9

2.1.1 TheEarly Measuresin the NigerianIndustry: 1986- 2003 9

2.1.2 PresentReformsin theNigerian BankingIndustry:July 2004-Date 11

2.2 Actionstaken bytheCBNtowardsensuringsuccessfulBanking Consolidationof the

NigerianBanking Industry 14

2.3 The OutcomeoftheBanking SectorConsolidation Programme 16

2.4 Issuesand ChallengesofPost Reform Measuresin theNigerian BankingIndustry 18

CHAPTERTHREE: LITERATURE REVIEW 22

3.1. MergersandAcquisition 22

3.2 ConceptualFramework 24

3.2.1 Financialintermediaries 24

3.2.2Corporate Governance 25

3.2.3. Corporate Governance Mechanisms 26

3.2.4 Stakeholders 26

3.2.5 Shareholder 26

3.2.6. Debt Holders 27

3.2.7. Competition in Product Market and Takeovers 27

3.2.8. Customers: 28

3.2.9. Employees 28

3.2.10. GovernmentandSociety in general: 28

3.3. ScenarioforCorporateGovernanceofIntegrated Banks 29

3.4 Whydo banksmerge? 30

3.5 Empirical FindingsfromPrevious Studies 33

CHAPTER FOUR: METHODOLOGY 35

4.0 Introduction 35

4.1 Model Specification 37

ix

4.2 Statisticalandeconomic hypotheses 39

4.2.1 Cross- Sectionalaggregation 39

4.2.2. Time-seriesaggregation 39

4.3 DataSourceandScopeofStudy 40

4.4 ExpectedResultsandDissemination 40

4.5 SampleDescription 42

4.6 Data Analysis 46

4.6.1. OverviewPerformanceofsomeconsolidated banks 46

4.6.2 Wealth effects ofacquisitionannouncements 48

4.6.3 Value effectsofcross-borderacquisitions 50

4.6.4 OverallShareholders Returns 50

CHAPTER FIVE: POLICY RECOMMENDATION AND CONCLUSION 52

5.0 SummaryofFindings 52

5.01 The Limitation ofStudyand Areaof FurtherResearch 52

5.1 PolicyImplicationandRecommendation 53

5.2 CONCLUSION 54

REFERENCES 56

ANNEX 61

X

LIST OF TABLES

Table 2.1: RatingofBanks Usingthe"CAMEL" Parameters 7

Table 2.2: ComponentMembersof theConsolidated Banks 17

Table 3.1: StockPrice PredictionsatMerger Announcement 33

Table 4.2:StatisticPropertiesof theSample 43

Table 4.3: StatisticalTabulationofSTKPRICE 45

Table 4.4: Performance Ratios of Some Banksasat25th October, 2006 46

Table 4.5: Announcementperiod CARonAcquiringBanks 49

LIST OF GRAPHS

Graph 4.1: TrajectoriesofWeeklySTOCKPRICEANDLOG(STOCKPRICE) 44

October 2005-December2006 44

Graph 4.2: Testfor Normality 44

LIST OF ANNEXES

Annex1: Stock PriceSample(2005-2006) 61

Annex 2a: Stock price MovementforThird Quarter 2005 62 Annex 2b: Stock price Movementfor FirstQuarter 2006 63 Annex 2c: Stock price Movementforsecond Quarter 2006 64 Annex 2d: Stockprice Movement forThird Quarter 2006 65 Annex 2e: Stock price Movement forfourth Quarter 2006 66 Annex 2f: Comparative StaticAnalysis of FBN & ZIB Stock Price

(October 2005^-December 2006) 67

xi

Wsm

ACRONYMS

AFC : Africa Finance Corporation

AR : Average Residual orAverage Returns

AAR : AverageAbnormal Return

ABSA : Amalgamated Banks of South Africa

BCIC : Banking Consolidation Implementation Committee

BOFID : Bank and other Financial Institution Act CAC : CorporateAffairs Commission

CAMEL: Capital Adequacy, Asset Quality, Management,

Earnings, and

Asset/Liability Management

CAR ^: CumulativeAbnormal Returns CBN : Central Bank of Nigeria

DMBs : Deposit Money Banks

e - FASS: the Electronic FinancialAnalysis and Surveillance System

EFCC: Economic and Financial Crime Commission EPS: Earnings Per Share

FBN: First Bank Nigeria Pic

FDI: Foreign Direct Investment

FIRS: Federal Inland Revenue Services FIU: Financial Intelligence Unit

FSRCC: Financial Services Regulation Coordinating Committee

ICT: Information and Communication Technology

M&A: Mergers and Acquisition

NAICOM: National Insurance Commission

NEEDS: National Economic Empowerment and DevelopmentStrategy NDIC; Nigeria Deposit Insurance Corporation

NSE; Nigerian Stock Exchange

OLS: Ordinary Least Square

SEC: Securities and Exchange Commission

SAP : Structural Adjustment Programme

ZIB : Zenith International Bank

xii

CHAPTER ONE:

INTRODUCTION

1.0 Background

The last two decades witnessed several significant reforms and developments

in

Nigeria financial services sector. Since the late

1980s, the nation's banking system

has undergone remarkable changes in terms

of the number of institutions,

ownership structure, as well as depth and

breadth of the market. The reforms had

been influenced largely by challenges posed by

deregulation, globalization,

technological innovations and adoption of

supervisory and prudential requirements

that conform to international standards. In 2001 for example, the Universal banking

scheme was introduced to create a more level-playing field for the financial sector operators and encourage greater efficiency

through economies of scale, and foster

competition.

At the end of 2004, there were 89 universal banks operating in Nigeria, comprising

institutions of various sizes and degrees of soundness. Structurally, the sector ^was highly concentrated, as the ten largest banks in the system account

for about 50

per

cent of the industry's total assets/ liabilities (Soludo, 2004). Many of the banks were small in size and unable to compete with the bigger ones. Some of the small banks

were plagued by high incidence of non-performing loans; capital deficiencies; weak management and poor corporate governance. The nation's banking sector was

fragile, poorly developed and extremely small when compared with the banking

sectors in emerging economies.

The CBN induced reform policies were basically to complement banking

liberalization which faced enormous challenges. Therefore a broad range of

measures aimed at improving the regulatory and supervisory environment were put

in place to restructure and re-enforce it from imminent systemic crisis and collapse

and permanently stop the boom and burst cycles which had characterized the history of the banking industry. Fundamentally, the reforms were aimed at ensuring

1

a sound, responsive, competitive and transparent

banking system appropriately

suited to the demands of the Nigerian economyand the challenges

of globalization.

Specifically, the objectives of the banking

reform, which is part of the general

agenda of the Government's overall

economic reform and

programme

(the National

Economic Empowermentand Development Strategy

(NEEDS), include:

i. Creation of a sound banking system thatdepositors cantrust;

ii. Creation of banks that are investor-friendly and that can finance capital

intensive projects;

iii. Enhancement of transparency, professionalism, good corporate governance and accountability; and

iv. Driving down the cost structure of banks.

The main thrust of the reform package ^was anchored on a

thirteen-point agenda,

which included to consolidate and recapitalize banks by increasing their

shareholders funds to a minimum of =N25 billion (about US$190 million) with effect

from December 31st, 2005. Other highlights include: the adoption of risk-focused

and ruled based regulatory framework; the adoption of zero tolerance in the regulatory framework; enforcement of dormant laws;

revision and updating of

relevant laws, and drafting of ^{new ones} relating to the effective operations of the banking system; etc. The reforms prompted a regulatory induced restructuring

in the

form of consolidation that engendered the alignment and realignment of banks and banking groups into the merger of ^some banks and the acquisition of others. The

emergence of mega banks exposed banks to new challenges, which if not properly

addressed could adversely affect the operations of the payment system and its credibility

1.1 Statement of Problem

The banking system were unable to ensure the expected price stability and facilitate rapid economic development as a result of some deficiencies like low Capital base;

large number of small banks with relatively few branches; the dominance of a few

banks (the top 10 banks control about 50.8% of the aggregate assets; 51.7% oftotal

deposit liabilities and 45% of the aggregate

credits); and

poor

rating of

a

number of

banks. Other operational problems were observed, namely:

a. Weak corporate governance, evidenced by inaccurate

reporting and

non¬

compliance with regulatory requirements, declining

ethics and

gross

insider

abuse that resulted in huge non-performing insiderrelated credits;

b. Insolvency evidenced by negative capital adequacy

ratios of

some

banks

which had completely eroded shareholders' funds caused by

operating

losses; and

c. Over-dependence on public sector deposits and foreign

exchange trading

and the neglect of small and medium scale private savers.

It is evident from the foregoing assessment of the bank performance that it was fragile and played marginal role in the development

of the real

sector.

It

was

in

effect, not in a position to meetthe nation's ideal ofa strong, competitive and

reliable

banking system, which depositors can trust, investors rely ^upon,

and the nation

depend upon to facilitate its economic growth.

1.2 Objective of Study

The main focus of the study is to determine the effect of Merger, Acquisition and

Consolidation of the banking industry on returns to shareholders.

1.3 Justification ofStudy

The concern for how banks should be governed lies precisely with the increasing impact of private corporate behaviour on the collective welfare of the economy. The importance of banks to national economies is underscored by the factthat banking is

a universally regulated industry with access to government safety nets. The

business of banking has a number of intrinsic risks (operating with high leverage

which can make banks vulnerable to losses; dependence on the confidence of depositors and the financial markets for securing necessary funds; general

opaqueness ofthe business of banking; etc) that could jeopardize the entire financial system of an economy. Since corporate governance protect the interests of all

stakeholders and minimize asymmetric information between a

bank's

managers,

its

owners as well as customers, the need for this study will not be overemphasized ^as

banks performance directly affects the growth,

efficiency and stability of

an

economy. As the major holder of the nation's

financial

assets,

the banking sector

present the largest potential risk for financial

reputation

not

only to individual banks

and their shareholders but also to the society as a whole in the event of a corporate

governance failure.

The case for Mergers and Acquisition, ^{as a} preferred form of business growth

and

as a global phenomenon has attracted my interest, due to some

of its inherent

advantages. Besides recenttrends in developed countries many

emerging markets,

including Argentina, Brazil and Korea, their banks strive to become more

competitive

and resilient to shocks and reposition their operations to cope with the challenges of

the increasingly globalised banking systems. The financial sector

reforms in these

countries led to the emergence of a viable banking industry that supported the

overall growth of their economies ^- the Nigerian financial services sector strives to

meetsuch global standards and challenge.

National and cross-national _mergers and acquisitions took place ^{on a} massive scale

that the world is no longer for marginal or fringe players. Consolidation in South

Africa is such a challenge that one bank in South Africa, Amalgamated Banks of

South Africa (ABSA) has an asset base larger than all the Nigerian commercial

banks put together. In Nigeria, there were 89 banks with about 3300 branches and

many of these banks had capital base of less than US$ 10 million; which when compared to 8 banks in South Korea with about 4500 branches or the one bank in

South Africa with larger assets than all our 89 banks, is a big challenge.

Therefore it was necessary to be proactive, and to strategically position Nigerian

banks to be active players and not spectators in the emerging world. The current banking system reform represented the fundamental restructuring needed to

address the structural and operational problems of the system, in order to create a

banking sector which will play active developmental

roles in the Nigerian

economy,

and be competent and competitive player in the global

financial

system.

1.4 Plan ofstudy

The rest of the study is organized into four (4) additional chapters.

In chapter two

we present an overview of the Nigerianfinancial sector,

the reforms in the Nigerian

banking industry before 1986 to 2006 and the

post-consolidation challenges. The

third chapter deals with the review of relevant theoretical and

empirical literature.

In chapter four we under took ^an examination and analysis of returns to

shareholders of 22 merged bank. The last chapter contains the, policy implication

and conclusion resulting from the study.

CHAPTER TWO:

THE REFORMS IN THE NIGERIAN BANKING

INDUSTRY

2.0 An Overviewof the Nigerian Financial Sector

The financial system consists of the regulatory bodies,

market players and the

markets. The regulatory bodies are: the Central

Bank of Nigeria (CBN), the

Securities and Exchange Commission (SEC) and the

National Insurance

Commission (NAICOM). The key markets are the ^money

and capital markets, for

short and long-term financing resources. As at end-December

2004, the bank and

non-bank financial institutions in the money market sub-sector comprised of 89 deposit money banks (DMBs), 753 Community

Banks (CBs), 83 primary mortgage

banks (PMBs), 109 finance houses (FH), 5 discount houses

(DFIs), 3 development

finance institutions (DFIs) and 126 bureaux de change. The capital market

is

regulated by the SEC and consists of the

Nigerian Stock Exchange with branches in

Abuja, Kano, Port Flarcourt and Benin City and 118 insurance

companies which

are regulated by NAICOM.

Prior to 1986, the financial sector in Nigeria was not particularly effective and

efficient in mobilizing and channeling ^resources for investment due mainly to

institutional rigidities and administrative controls. In this connection, the Structural Adjustment Programme (SAP), ^a comprehensive economic reform package for the deregulation and liberalization, of the economy was introduced in 1986, with the

financial sector as the major focus. Under this package, measures and instruments

to deregulate the practice of banking were introduced. The aim was to establish a market-oriented financial system that would support the mobilization of financial savings and encourage a more efficient allocation of financial ^resources. The reform encompassed the discontinuation of the old system of direct credit allocation,

subsidized and regulated interest rates for priority sectors, and project funding by development financial institutions. It also introduced measures to increase competition in the financial sector and strengthen the supervisory role of the regulatory authorities. Entry into the sector was liberalized, permitting a proliferation

of banks and non-bank financial institutions in the system.

Since the liberalization of the sector in 1986, there had been radical, structural and

institutional changes, which engendered competition and

enhanced efficiency in the

allocation of resources. The structural changes included, improvement in

the quality

of service delivery, development of new products, and increased ^use

of information

technology. A major institutional developmentwas the

establishment of the Financial

Services Regulation Coordinating Committee (FSRCC) in 1994, which was

accorded

a legal status by the 1998 amendment to Section 38 of the

CBN Act, 1991.

The major objective of establishing the FSRCC was to

minimize

areas

of conflicts

and regulatory arbitrage that could result from lack of ^proper co-ordination

between

the regulatory institutions and the financial sector in particular.

The committee

comprisesthe Central Bank of Nigeria (CBN), Securities and Exchange

Commission

(SEC), Corporate Affairs Commission (CAC), National Insurance Commission (NAICOM), National Board for Community Banks (NBCB), and the Federal Ministry

of Finance. The members collaborate to address issues of ^common interest, including information sharing and handling of financial crimes.

These reforms, notwithstanding, the Nigerian financial sector continued to experience some problems that impacted negatively on the economy. The major

constraints include: weak capital base, insolvency, weak management, gross insider abuses, overdependence on public sector funds and weak corporate governance.

The surveillance report on table 2.1 by CBN reveals a steady deterioration in the operations of the DMBs since the liquidation of 32 banks in the system (1990-2003).

Table 2.1: Rating of Banks Using the "CAMEL" Parameters

Category ^Number

2001 2002 2003 2004

Sound 10 13 11 10

Satisfactory ^{63 54 53 51}

Marginal ^{8 13 14 16}

Unsound 9 10 9 10

Source: CBN 2004

7

The banking industry around the world witnessed

remarkable changes in recent

decades, because of the increasing wave of globalization,

structural and

technological changes, and integration of financial markets.

McKinnon and Shaw

(1973) in their work on the key roles of banks as

propellants to growth and

development in developing countries observed that ^a

feeble banking system is

repressive, distorts and disconnects the intermediation ^process

and eventually

causes macro-economic instability. Therefore according to Nnanna (2005), policymakers must articulate robust policies that will deepen the financial system to

enable a mostefficient role.

In Nigeria the ability of the banking industry to play its role has been

periodically

punctuated by its vulnerability to systematic distress and macroeconomic volatility.

Nnanna (2005) showed that historically the Nigeria banking industry had evolved in

four stages. The first stage ^can best be described ^as unguided laisez-faire phase (1930 ^- 59), during which several poorly capitalized and unsupervised indigenous

banks failed in their infancy. The second stage was the controlled regime (1960- 1985), during which the Central Bank of Nigeria ensued that only "fit and proper"

persons were granted license, subject to the prescribed minimum paid up capital.

The third stage was the post-SAP or the de-controlled regime (1986-2004) during

which the neo-classical philosophy of "free entry" was over-stretched and banking

licenses ^were dispensed by the political authorities on the basis of patronage. The emerging fourth stage is the era of consolidation (2004 to foreseeable future), with emphasis ^on recapitalization and proactive regulation based on prudential principles.

Consequently, the banking system reforms were focused on liberalization of the banking business, ensuring competition and safety of the system and proactively positioning the industry to perform the role of intermediation and playing ^a catalytic

role in economicdevelopment.

The next section aims at reviewing the various reforms in Nigeria banking industry

since 1986.

8

2.1 Reforms in the Nigerian Banking Industry.

2.1.1 The Early Measures in theNigerian

Industry: 1986- 2003

Empirical studies have shown that

environmental dynamics occasioned by

globalization, the changing

international architecture and technological innovation

have necessitated financial sector reform and the fine-tuning of rules guiding the practice in many areas. In Nigeria prior to

the reforms of 1986, the banking sector

was highly suppressed. Interest rate controls,

selective credit guidelines, ceilings

on

credit expansion and the use of reserve

requirements and other direct monetary

control instrument were typical features of the financial sector in the country.

Entry

into the banking business was restricted and public

sector-owned banks dominated

the industry.

The neo-classical era witnessed the removal of the prolonged regime of economic

and financial control to make _way for increased reliance on the market forces in

1986 in line with the philosophy of economic management under the Structural Adjustment Programme (SAP). The Major reform ^measure

adopted included,

deregulation of interest rates and exchange rate, removal of sectoral credit allocation

and free entry into the banking industry business subject to the satisfaction of the

condition for obtaining the license. Other ^measures implemented ^were the

establishment of the Nigeria Deposit Insurance Corporation (NDIC), strengthening

the regulatory and supervisory institutions, upward review of capital adequacy standards, capital market deregulation and the introduction of indirect monetary policy instruments. The government also promulgated the Central Bank of Nigeria

Act (No. 24) and Bank and Other Financial Institution Act (BOFID No. 25) both in

1991_; which spelt out comprehensive guidelines for bank regulation, supervision and liquidation. Community Banks and People's Banks were also established to achieve

increased financial savings and to enable rural dwellers and the poor to save and

have access to credit at rates lower than the market rates.

The foregoing structural changes were

aimed at enthroning

a

market-oriented

financial system for the effective

mobilization of the financial savings and efficient

resource allocation in the _economy. The liberalization of the

banking industry

resulted in the establishment of _{many new} banks. The number of operating

banks

doubled within three _years into the reform (from 45 in 1987 to 76

in 1989) and tripled

in the fifth year (119 in 1991). This therefore required

re-imposition of the embargo

on bank licensing in 1991 to halt the increasing trend.

Profitability of investment and

access to credit and foreign exchange were among the major motives for

bank

ownership. The competition that resulted from the entry

of

new

banks and the

liberalization of interest brought about sharp rise in nominal deposit and

lending

rates. The average lending and deposit rates doubled in the third year

of

the

reform.

The banking environment that emerged from the reform was inefficient, riskier, illiquid and generated lower return ^on assets relative to the pre-reform period (Sobodu and Akiode 1994). The incidence of fraud and non-performing loans also

increased with the reform as revealed by the CBN/NDIC study of distress in the

financial system. The quality of management which is a major determinant of the

banks long-term survival (Siems 1992; Pentalone and Piatt 1987) and the dearth of qualified personnel to meet the challenges of sudden growth in the industry

contributed to the poor health of the banking industry (Ikhide and Alawode 1994).

Thus, the incidence of distress in the industrywas rampantduring the period.

The supervisory authority therefore adopted various options to address these negative effects on the banking system distress including contingency framework for

distress resolution in order to safeguard the system from systemic failure. So the problematic banks were advised and encouraged to promptly correct deviations from

sound banking practices and failing banks were made to exit before they infected the system. The monetary authorities also adopted a code of good practices in the monetary and financial policies, the international accounting and auditing standard,

as well as a private sector-funded "lifeboat" facility accessible to all Deposit Money

Banks (DMBs) in temporary liquidity problem. The role of market discipline was enhanced through the enforcement of the necessary disclosure requirements to

10

ensued timely publication of credible information to

guarantee safe and sound

banking practice in Nigeria. The reform

had

some

salutary effects

on

the banking

system although some weaknesses

persisted.

In 2001 the Universal banking scheme ^was introduced to create more

level playing

field for the financial sector operators, encourage greater

efficiency through

economies of scale and foster competition by opening ^up various entry points into

the banks. The CBN adopted the core principles of the Basel Committee ^on

banking supervision1

in line with international standard

practice

so as to

promote bank

soundness and financial sectorstability. The statutory role of supervision of the CBN

was also expanded to include non-financial institutions

and the coordination of the

Financial Sector Regulation and Coordinating Committee. Further ^more relevant banking laws were amended to provide additional

safeguards against insider abuse

and promote good governance by defining the functions and responsibilities of ^a

Director and stipulating the procedure under which the Director or related parties

could obtain credits.

2.1.2 Present Reforms in theNigerian Banking Industry: July 2004-Date

In spite of efforts itemized in the preceding section, there were still pockets of distress; dependency of many Nigerian Banks on the public deposits and government revenue collection. Although the distribution among banks was not uniform, the dependence of some banks ^were in ^excess of 70 percent as at June

2004. The implication was that the resource base of such banks ^was weak and volatile, rendering their operation highly vulnerable to swings in government

revenues. Many banks had abandoned their traditional intermediation role of mobilizing saving and inculcating banking habits at household and micro enterprise

level. In addition, the apathy ofsome banks towards small savers, particularly, atthe

grass roots level, had not only compounded the problem of low domestic savings

1The Bank for International Settlement's Core Principles forEffectiveBanking Supervision provides a

comprehensive blueprint foran effective supervisory system and to facilitateimplementation and assessment.

11

and high banking lending rates in the country

but had also reduced

access

to

relatively cheap and stable funds that could

provide

a

reliable

source

of credit to the

productive sectors at affordable rate of interest.

Savings mobilisation at the

grass

roots level was inadvertently discouraged following the unrealistic

requirements by

many banks to open new accounts. The ^summary

effect of the foregoing

was

that

the Nigerian banking system is enormous challenges

which needed

to

be addressed

urgently to enable them perform their catalytic role to enhancing

the growth

process

in the economy. Furthermore a surveillance report by the CBN as at end

March 2004

indicated that 62 banks out of 89 were classified as sound/satisfactory, 14 as

marginal, while the position of unsound banks had deteriorated from 9 at

end-

December, 2003 to 11.

An overview of the industry further revealed the industry was dominated by the top

20-30 banks, with 69 banks out of the 89 licensed who banks operate as marginal players, while 60-70 percent of total deposits are short-term (30-90 days), and little

wonder why banks were not lending to the real sector. Other features included

extension of barely 3-5 percent of total banks' credit to agriculture and manufacturing sectors; and the 89 banks in operation had total assets of $18.0 billion, compared with 58 banks in South Africa, with total assets of$146 billion. The

banks in Nigeria needed to mobilize savings by offering reasonable interest rates to

small depositors (because about N373.1 billion ^was outside the banking system due

to failure of banks). Savings deposits rates averaged 3-5 percent; while lending rate averaged 21-32 percent. Quite a number of banks examined had revealed several weaknesses, including weak corporate governance, evidenced by high turnover in

the board and management staff, inaccurate reporting and non-compliance with regulatory requirements, failing ethics and de-marketing of other banks in the industry; gross insider abuses, resulting in huge non performing insider related

credit. Other indicators were late or non-publication of annual accounts which obviates the impact of market discipline in ensuring banking soundness; insolvency,

as evidenced by negative capital adequacy ratios and complete erosion of

shareholders' funds by operating losses;

over-dependency

on

public sector deposits,

and neglect ofsmall and medium

class savers.2

Mindful of deteriorating condition of the industry, the

regulatory authority decided to

streamline the regulatoryframework and

strengthen its supervisory capacity in order

to forestall the re-emergence of systemic distress and

facilitate attainment of the

vision of strong, competitive and reliable financial

markets that meet international

best practices. To this end, the CBN ^on

July 6, 2004 announced

a

13 point agenda

to reform and reposition the banking industry, as outlined

below:

i. That the banks met _{up a} minimum capitalisation of

N25billion with full

compliance on orbefore

31st

December, 2005;

ii. Phased withdrawal of public sector funds from banks, with effect from

July

2004;

iii. Consolidation ofbanking institution through ^mergerand acquisition;

iv. Adoption of risk focused and rule-based regulatory framework;

v. Adoption of zero tolerance in the regulatory framework, especially in the area of data/information rendition/ reporting;

vi. The automation process for the returns by banks and other financial

institutions through the Electronic Financial Analysis and Surveillance System ( e-FASS) should be installed expeditiously;

vii. Strict enforcement of the contingency planning framework from systematic distress;

viii. Work towards the establishment of an Asset Management Company as an

important element of distress resolution;

ix. Promotion of the establishment 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 offailing by the bank;

x. Revision and updating of relevant laws and the drafting of new ones relating

to the effective operation of the banking system;

2The CBN Research update of 2006

13