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 lossof 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.
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