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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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