Banking Failure, Causes and Consequences

In Nigeria, your prayer point should always include “may my bank never fail”.  If your bank fails, the money that you saved with the bank may not be repaid to you in full.  The Nigeria Deposit Insurance Corporation (NDIC) that was established by the Government to protect depositors against the loss of their insured deposits can only refund your insured deposit as follows:

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A bank failure occurs when a bank is unable to meet its obligations to its depositors or other creditors because it has become insolvent or lack liquidity to meet its liabilities.

In Nigeria, your prayer point should always include “may my bank never fail”.  If your bank fails, the money that you saved with the bank may not be repaid to you in full.  The Nigeria Deposit Insurance Corporation (NDIC) that was established by the Government to protect depositors against the loss of their insured deposits can only refund your insured deposit as follows:

 

  • Maximum of N500,000 for each depositor in respect of deposits held in each insured bank.
  • Maximum of N200,000 for each depositor in Microfinance Bank and Primary Mortgage Institutions.
  • If your deposit is below N500,000 or N200,000 (for MFB customers) you will get 100% of your deposit – the exact balance in your deposit account.
  • If your deposit is more than N500,000 or N200,000 (for MFB customers) the balance can only be paid as liquidation dividends from funds realized from the sale of the assets and recoveries of debts owed to the failed insured institution.

 

A cursory look at the balance sheet of some banks may lead to a wrong assumption that there are some banks that are too big to fail.  But the collapse of some banks in the past has shown that there is no bank that cannot fail.

 

Professor Nwankwo, Guest Lecturer at the 5th Anniversary of the Money Market Association (MMAN) now Financial Market Dealers Association (FMDA) in May 1994 stated in his paper titled, “crisis of confidence in Nigerian banking system” that:

 

“The crisis of confidence in Nigerian banking system is not new.  It has been with us for quite a long time.  It occurred in the 1930s when all the indigenous banks except one (the National Bank of Nigeria Limited) collapsed.  It occurred again during the banking “boom and crash” period in the late 1940s, when all but four indigenous banks escaped the liquidator’s hammer.”

 

  1. G. Otiti, in his book entitled, “Essays on Banking and Finance” gave the history of bank failures in the country as follows:

 

  • The first indigenous bank called “Industrial and Commercial Bank” was set up in 1929 in Nigeria and it failed within the first year of operation.
  • The Nigerian Penny Bank was set up in 1940 and it failed in 1946.
  • Between 1952 and 1954, 21 indigenous banks were set up and 16 failed within 2 years. The rest failed later.

 

Between 1989 and 1994 the banking crisis that engulfed the financial system in Nigeria led to the failure of about 8 banks according to NDIC Report.

 

In 2010, 6 Banks (Intercontinental, PHB, Afribank, Oceanic, UBN and Spring) were rescued by CBN while the Boards and CEOs were removed for various risk governance issues.  The central Bank of Nigeria subsequently gave the following reasons in the final reform document as the reasons why the crisis occurred:

 

  • Limited skills to cover the Banking Business.
  • Increased risk from affiliate transactions.
  • Improper allocation of depositors fund to high-risk businesses e.g. proprietary trading
  • Limited penetration and specialization, as a result of the lack of clearly defined market.
  • Economic / systemic risk i.e. “too big to fail syndrome”.
  • Regulatory arbitrage / regulator handshakes – shady deals.
  • Weak group corporate governance.

However, we have the example of First Bank and Wema Bank that were established since 1894 and 1933 respectively and survived all the storms e.g.:       

 

  • BBWA (Bank of British West Africa Limited) later renamed First Bank of Nigeria Plc – was registered in 1892 and commenced business in 1894. It was set up to facilitate the business transactions of the British Promoters in Nigeria and West Africa.

 

  • National Bank (Now part of Wema Bank) was the first successful indigenous bank in Nigeria. It was established in 1933 and became part of Wema in 2006.

 

How did First Bank maintained the “staying power” and prevent distress through the years?  The Bank survived by obeying the regulatory prescriptions and strict internal corporate governance principles detailed below:

 

  1. Regulatory compliance. They follow the ever reliable acronyms referred to as CAMEL to run the bank.  These are:

 

  1. Capital Adequacy – they have financial power – strong equity funds that could withstand strong financial winds in Nigeria.
  2. Asset Quality – their loan portfolio is performing – not at 90% prescribed by CBN but they adhere with strictly to prudential regulations as regards provision for delinquent loans.
  • Management – Skillful, disciplined, prudent and stable human resources with excellent provision for future successions.
  1. Earnings – Consistent growth in earnings and value adding to the Shareholders funds.
  2. Liquidity – Strict compliance with the cash reserve requirements (CRR) and liquidity ratio (LR) as may be fixed by the Regulator (CBN) from time to time.

 

  1. Operational Discipline and Controls – there is no bank that lack internal discipline and controls that can go far. Some of these are:

 

  1. A comprehensive Standard Operating Procedures (SOP) to guide the operational activities and processes in the Bank.
  2. Robust ICT (Information and Computer Technology) to link all their branch network and consistent re-engineering of the operational processes.
  • Robust business continuity planning and disaster recovery programs.
  1. Risk prevention steps that could avert disaster and fraudulent practices.
  2. Strong and adequate internal controls and Internal Checks.
  3. Board, Management and Staff involvement on Risk Governance
  • Documentation and Authorization of Trading Limits for Dealers

 

However, we need to know that bank failure can occur in any country.  Barings Bank, a UK Bank, collapsed in 1995 because of the greed and recklessness of Nick Leeson and his Bosses.  The Bank, which was established in 1762 by Sir Francis Baring had  existed for 233 years before it collapsed in 1995.

 

In his book, “the rogue trader”, Nick Leeson (the “Killer” of the Bank) explained that “any bank could fail” if the controls were relaxed and greedy men were put in charge of sensitive duties!  The demise of Barings was made possible when Nick Leeson was appointed as a Derivative Trader and the General Manager of the Bank in Singapore.  He gave the following reasons why he was able to perpetrate the infractions that brought the bank down:

  • Management incompetence. He explained that his Bosses put him charge of operations and marketing as a General Manager in Singapore against the standard control processes.
  • Statutory Bank of England for their inaction even when they knew about the problem.
  • Internal control Department for being weak and lazy.
  • His immediate Bosses for their emphasis on profit instead of the Barings’ survival.

 

The impact of any bank’s failure can be very painful and far reaching.  A brief analysis of the adverse effects on the Stakeholders is detailed in the table below:

Nos.      Stakeholders                   Losses

  1.             Shareholders                       Capital, and future benefits like dividends and bonuses
  2.             Depositors                            May lose their deposits above the Insurance limit of N500,000
  3.             Borrowers                             Source of getting capital to run their businesses
  4.             Employees                            Will lose their jobs.  Temporary stoppage of regular income
  5.             CBN / NDIC                         Stability of the financial system may be adversely affected
  6.             Public                                     A setback in environmental business development
  7.             Board / Management         May not be allowed to run banks again – serious career effect

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