The Effect Of Bank Distress On Nigeria’s Economic Growth

ABSTRACT

This study examines Bank Distress and its effect on the economic growth of Nigeria. Economy for the period of 1980 to 2009. Using the Classical Linear Regression Model the ordinary Least Square Method (OLS) of analysis was adopted for the analysis of the work. The result shows that the distress in the banking sector has a significant effect on the growth of GDP in Nigeria. We recommend among others that the government should impose strict loan administration on banks and checkmate their activities closely to ensure that loans are properly appraised before granted to customers. Finally, we conclude that the Federal Government should immediately implement all the reforms necessary to make the regulatory and supervisory bodies of the banking sectors (CBN/NDIC) more effective in Nigeria to ensure good corporate governance, monitoring of credit risks and inside lending, sound investment policy, overall loan surveillance and protection from political interference among others. This will result in efficiency and stability of the banking system and their overall support to the Nigerian economy.

CHAPTER ONE

INTRODUCTION

1.1     BACKGROUND OF THE STUDY

Banks are critically important and useful to the economic growth and development of every nation. This explains why each country seeks to take far reaching steps to forestall or to remedy bank distress and failure. A viable and profitable banking system provides a formidable bulwark for economic growth, which in turn provides a healthy environment for banks to thrive and be successful. According to Ehikmeaku (1998), a well developed and stable banking system is a sine-qua non for economic growth and development.

In addition to the intermediation rule, a nation’s banking system links the domestic economy with the rest of the world by providing the means for the settlement of international transactions. It has been observed that growth in banking sector, if transmitted well, would result to the growth of real sector and the opposite occurs if the financial sector is repressed and inefficient.

Banking distress occurs when a bank experiences and is faced with illiquidity or insolvency (Ehikmeaku(1998). The problem of liquidity occurs when a bank can no longer meet it’s liabilities when due, while insolvency occurs when the value of its realizable asset is less than the total value of liabilities.

Both scenarios are fraught with a lot of consequences for the depositors, shareholders and the entire economic system. With widespread distress that eventually leads to bank failures, depositors loose their lifetime savings and shareholders loose their investments. Furthermore, bank failures may lead to a loss of confidence in the banking system which is a bottleneck to the development of banking habit among a population to which banking business largely appears as an alien activity. Bank failures also results in the cutting off of credit to enterprises desirous of such credits for expansions and curtailment of the numerous services that banks provide to their clients with adverse consequences on economic growth. Apart from posing as a means of mobilizing domestic household and business sector savings for profitable  investment, a well- developed banking system with positive real interest rate has great potentials to attract foreign investments, thus enhancing the nation’s rapid economic development.

Between 1989 and 2002 the incidence of distress on Nigeria’s banking industry worsened from 10 percent to 50 percent. The Central Bank of Nigeria revoked the operating licenses of 35 terminally distressed banks within that period. 4 in 1994, 2 in 1995, 26 in 1998, 2 in 2000 and 1 in 2002.

The liquidation of the banks that failed in spite of efforts by supervisory authorities (CBN and NDIC) to manage their liquidity problems was necessary in order to contain the contagious effect of bank failure in the economy.

A number of banks in the economy witnessed an increased number such that between 1986 and 1988 the number of banks increased form 42 to 66. With the increased competition between banks fuelled by deregulation, fears of banking failures increased and the federal government of Nigeria established the Nigeria Deposit Insurance Corporation (NDIC) through Decree act of No.

22 of 1988. The federal government conceived the NDIC as an institution to act as a financial guarantee to depositors in the event of bank failures and also to add weight to the existing supervisory and control capabilities of the monetary authorities, Olaitan (1988).

The theory underlying the relationship between banking stability and economic growth is well known. Gurley and Shaw (1976), among others, observes strong evidence of a positive correlation between real growth of output and bank assets.

1.2     STATEMENT OF THE PROBLEM   

The Nigerian banking sector has undergone more distress and reforms than any other sector of the Nigerian economy. Therefore, a well functioning banking system promotes rapid economic growth and development. While a banking system that is fraught with massive failures and distress, leading to asset depletion, would impede economic growth and development. The uncertainty generated as a result of distress in banking institutions, if left unchecked, often raises real interest rates, creates higher cost of transaction and disrupts the payment mechanism with the attendant economic consequences.

The extent and depth of the banking distress can be of serious concern to the relevant supervisory/regulatory authorities when its prevalence and the contagious effects become endemic and pose threats to the stability of the entire system, savings mobilization, and financial intermediation process and depositors confidence, Balino (1991). The ratios of relevant variables should have risen to a level that public confidence in the system would be completely eroded.

The condition of the bank distress in Nigeria from 1980-2009 has been attributed to a variety of causes ranging from institutional, social, economic and political factors. According to Ezeuduji (1997), the real causes of distress in individual banks lies in the way they manage their portfolios under existing circumstances. Poor portfolio management by banks is viewed as the primary cause of bank distress and failure in Nigeria at the period under review. While those factors that inhibited the efficiency of portfolio management constitute the secondary or remote causes. According to him, portfolio management was characterized by lax supervision of corporate governance among banks lending to wholesome and unethical banking practices by some bank chief executives without recourse to the board of directors, granting of huge credit facilities without adequate securities commensurate with such facilities. This led to the accumulation of non-performing loans which turned out to be bad and doubtful debts.

1.3    OBJECTIVES OF THE STUDY

The main objectives of this research are to ascertain the effect of bank distress on Nigeria’s economic growth. The specific objectives of this study are:

1. To identify the immediate causes of the banking sector crises.

2. To identify and analyse the effects of bank distress on Nigeria’s economic growth.

3. To analyse the roles of monetary authorities CBN/NDIC during the period.

4. To make appropriate recommendations based on the findings of the study.

1.4     SIGNIFICANCE OF THE STUDY  

The significance of the study includes:

1. The research work will contribute immensely to academic works, as it is a contribution to the body of knowledge on the effect of bank distress on the financial system and the economy at large. It would also aid other researchers to carry out more studious research on areas not covered by this study.

2. This study will also help financial analysts, financial consultants and professionals alike to improve their analytical, consulting and operational strategies to boost their clients’ performance in the face of bank distress and likely recapitalization of banks.

3. This study will also help the banking industry by highlighting the areas that need improvement in their existing operations and corporate governance and it’s impact on the bank’s liquidity.

4. This research will also be useful to the government (CBN, NDIC in particular) in enhancing it’s regulatory and supervisory roles as well as formulation of policies to strengthen the financial system being the determinant of economic stability and liability. Finally, the research will help the government to put in place measures to ensure good governance and risk management in the banking sector of the Nigerian economy.

1.5     RESEARCH HYPOTHESIS  

In order to pursue the objectives of the study, we thereby formulate the following hypothesis.

Ho:     The distress in the banking sector has no adverse effect on the growth of GDP in Nigeria.

Hi:      The distress in the banking sector has an adverse effect on the growth of GDP in Nigeria.

1.6     SCOPE AND LIMITATION OF THE STUDY  

For the purpose of this study, attention is focused on the effects of bank distress on Nigeria’s economic growth from 1980-2009, to capture the major bank crisis in Nigeria.

For the limitations of this study, the major constraints of the research were sourcing relevant information from banks concerning bank distress and how it has impacted on their performance. Most of these banks were unwilling to release such information considered as critical to their survival and maintaining shareholders and public confidence.