Nigerian Banks: Reforming Or Deforming The Economy?

Banks play a vital role in society. From their traditional role of “custodians” of money, banks have expanded into other areas. Today, commercial banks in Nigeria provide a full range of services such as payments and collections of money and instruments, investment banking activities, and are supposed to be a principal source of credit to individuals, businesses and nations, both within and across territorial borders. Indeed the development of a sound, reliable, market-oriented banking system is fundamental to all economies, but more so to economies in transition such as Nigeria’s. With the expansion in the range of businesses undertaken by banks and the increasingly competitive environment within which banks operate come increased risks of failure. Like other businesses, banks can fail. The causes of failure range from liquidity crises, poor lending practices and other poor risk management practices, to fraud and bad luck. Unlike other business failures, bank failures are usually very visible and high profile, in part because of the public perception of banks as safe custodians of other people’s monies and assets and in part because of the systemic effect which the failure of one bank could have on the stability of the financial system.

Against this background, it is not clear whether the CBN’s prescription of rigid, minimum capital requirements for all banks irrespective of the nature and size of their businesses and the riskiness is consistent with international approaches to prudential regulation, even in the context of a transition economy such as ours, since everyone knows that banks do not necessarily fail because they have tiny capital; they fail because of problem credits and liquidity difficulties.

A sizeable capital requirement can perform other social functions such as encouraging banks to finance real sectors of the economy. The Role of CBN and NDIC when a bank is failing theory, a bank could become the subject of receivership, either pursuant to a court order where its assets are shown to be in jeopardy, or out of court pursuant to a debenture granted to a creditor by the bank. In addition, section 28(1) of NDICA provides that the NDIC shall act as a receiver of a failed insured bank and section 25(2) of the NDICE.A specifies the powers of a receiver appointed for the purpose of section 25, although it does not in terms itself provide for the appointment of the NDIC or anyone else as receiver. The meaning of these provisions is obscure.

Whatever they may mean, statutory receivership by the NDIC is not a common practice in Nigerian bank failures. In short, the practice regarding bank failures in Nigeria is that failed bank receiverships are a rarity. For one thing, provisional liquidation would always be more appropriate than the antiquated and cumbersome procedure of court appointed receiver. (This is not true of the statutory receivership of NDIC since under section 25(2) of the NDICA, as receiver, the NDIC would have power to realize the assets of the failed bank, enforce the liability of shareholders and directors of the failed bank, wind up the affairs of the failed bank, and pay dividends to its creditors including depositors.) For another, most regulators expressly prohibit banks from granting floating charges over their assets in order to prevent structural subordination of depositors.

Secrecy is paramount to prevent a panic among the public and the running of these banks. That could sink a bank and lead to runs on neighbouring institutions. Banks only retain a percentage of their deposits in cash, and use the rest for things like loans, which means they don’t have enough money on hand if everyone demands their deposits back at once. Created after the failed Banks Tribunal to prevent such scares, the NDIC insures deposits at more than 800 banks, covering up to $100,000 per depositor in most cases. In its role as receiver for failed banks, the Nigeria Deposit Insurance Commission (NDIC) can act as a SWAT team, playing equal parts as secret agent, medical examiner, and salesman and grief counselor. The first 48 hours are typically the most frantic, as the agency must turn a failed bank inside out and oversee its sale — or its orderly liquidity.

To keep a low profile, NDIC officials often use personal credit cards while in town. Many will tell curious strangers they work in insurance. The NDIC allowed a Nigerian media reporters to go along it official assignment, offering a rare window into a little-known government task force. Despite the military-style planning that goes into taking over a bank, during Sani Abacha era, things can go wrong. Another time, NDIC officials hired a hypnotist to get a confused bank employee to remember the vault code. Sometimes, local inhabitants pull up lawn chairs and watch from across the street.The NDIC know when these Banks were in trouble mostly in the case that their capital reserves became evaporated, and the delinquent loans on its books more than doubled in 12 months. Many of the bad loans were tied to government encroachment. The NDIC is still sorting through the bank’s records and would not elaborate. But as Nigeria commercial Banks health seems to worsen; these banks are unable to find a mutual solution on the side of her customers. Regulators can easily pick a date to swoop in.

But frequently, the initial crime doesn’t even involve money. It starts as a simple phone call, and a request for information, such as bank account balances. From there, the data is resold and reused, leading to crimes from simple credit card fraud to full-blown identity theft resulting in car loans or even equity loans. Where the fraud receipts eventually end up is anyone’s guess, but there is evidence that miscreants use credit cards and other bank fraud techniques to support their nefarious activities .They falsify financial information, including: false accounting entries, bogus trades designed to inflate profit or hide losses, false transactions designed to evade regulatory oversight. Self-dealing by banks’ insiders, including: Insider trade, Kickbacks and backdate executive stock options to misuse corporate property for personal gain from individual tax violations by related self-dealing

Others are fraud in connection with an otherwise legitimately-operated interest rates fund: Late trading certain market timing schemes falsification of net asset values, other fraudulent or abusive trading practices by, within, or involving a mutual or hedge fund. Obstruction of justice designed to conceal any of the above-noted types of criminal conduct, particularly when the obstruction impedes the inquiries of the Securities and Exchange Commission (SEC), other regulatory agencies, and/or law enforcement agencies. How on earth does it make sense for a bank to charge such a steep fee to their own account holder to loan them money?

One of the licensing criteria for a bank is that its directors, controllers and managers are fit and proper persons. It is also a condition for the retention of the banking license once granted. In recent times, the CBN has asked directors, controllers and managers to resign from a bank. Early this year, the CBN has issued a Code of Corporate Governance for Banks in Nigeria Post Consolidation. Whilst these are welcome initiatives, they are hardly sufficient. Few, if any, bank liquidations have involved any meaningful consideration of the civil liability of directors, controllers and managers of failed banks to compensate the creditors of the bank. Section 25(2)(b) of the NDICA assumes the possibility of such liability, section 507 of CAMA provides a summary procedure for bringing misfeasance proceedings against company directors .Over eighty percent of the nigeria’s commercial banks charge consumers high overdraft fees without their permission. Consumers are only informed of these charges in the fine print of their account agreements, which can cause them to inadvertently overdraw their accounts when making an ATM or debit card transaction.

Banks that offer this discretionary “courtesy” overdraft coverage in their account agreement disclosures also state they are not bound to pay transactions that overdraw depositors’ accounts. If consumers who receive “courtesy” overdraft loans do not repay the overdraft quickly enough, many banks tack on an additional sustained overdraft surcharge.Penalty fees for insufficient funds checks and overdrafts are a huge and growing burden for accountholders. Increasing overdraft fees are the result of changes in the marketplace and in federal law and the broader use of overdraft fees for transactions other than those involving paper checks, including ATM withdrawals and debt card purchases.

Big banks should encourage consumers to use lower cost services that are already available. Responsible overdraft protection involves a guarantee that overdrafts will be paid, reasonable fees that are clearly disclosed and affordable repayment terms. No matter how good and effective bank supervision is, there is always an element of risk inherent in depositing money with banks. In short, there is no such thing as risk-free deposit. Deposit insurance performs two principal functions. The first is consumer protection by relieving hardship among depositors and, secondly, reduction in systemic risks by preventing deposit runs which could occur absent deposit insurance. However, like all compensation schemes, deposit protection can create a moral hazard in the sense that the availability of deposit protection/insurance might weaken market discipline by encouraging certain banks to undertake riskier activities, offer higher rates of return to depositors with the implied assurance given to depositors that their deposits are insured by the available deposit protection scheme. The way in which the need to protect vulnerable depositors, on one hand, and avoidance of the associated moral hazard, on the other, has been balanced in most systems including Nigeria’s, is to insure only certain types of deposits and to place a relatively modest monetary limit on the amount of insured deposit. No deposit insurance scheme can provide 100% protection. If depositors are relieved of all responsibility for the safety of their deposits, deposits would simply flow to the highest bidder irrespective of risk, which would undermine market discipline and exacerbate the risk of instability in the financial system.

The CBN benchmarked these banks’ capital-base with a N125 billion balance sheets that became custodians of financial assets. The insistence on balance sheet size appears to be to ensure that only relatively large banks qualify as custodians and to emphasize that compliance with minimum recorded regulatory capital alone would not be sufficient. This is a welcome starting point, but is far from sufficient. Irrespective of the relatively large balance sheet requirement, the question must be asked, if a custodian bank fails, what is the status of assets held in custody by the bank on behalf of clients (both wholesale and retail), in particular, are the clients the owners of the custody assessors are they merely unsecured creditors of the failed bank custodian?

The starting point in answering this question is of course to characterize the relationship created when assets are deposited into the custody of a failed bank. Bailment, trust and debt provide the basic framework for analyzing all custody relationships, whether the custody assets are segregated or pooled. Depending upon the terms of the custody arrangement, the nature of the assets held in custody and how the assets are held, three analyses seem possible: first, that the custodian bank is a bailee of the assets held in custody; second, that it is a trustee of the assets; third, that it has merely a simple contractual obligation to return equivalent assets upon demand by the client. If it is bailment or trust, the assets held in custody, save in relation to cash to which different considerations may apply, would generally not form part of the assets of the failed custodian bank available for distribution among its creditors. Instead, they would be returnable to the clients to the extent that they can be identified.

Although the period since the mid 1980s is regarded as being one of financial liberalization in Nigeria, important components of the control regime, in particular the sectoral credit guidelines, and those pertaining to the maturity structure of merchants banks’ loans, remained in force. Interest rates were decontrolled in 1987, but the CBN has stipulated a maximum spread between deposit and lending rates since 1989, and ceilings on bank lending rates were imposed during 1991, removed in the following year and then reimposed at the beginning of 1994. Hence there were administrative constraints on the ability of banks to allocate and price credit according to market criteria. The inconsistency of interest rate policy was a further impediment to allocate efficiency and in particular was likely to have discouraged intermediation in long term financial instruments.

The decontrol of interest rates in 1987 allowed nominal deposit and lending rates to rise but the attainment of positive real rates was impeded by higher rates of inflation. The inflation rate was low in the mid 1980s when the SAP was first introduced, but increased to 38 percent in 1988 and 41 per cent in 1989, largely because of the deficit financing discussed below. Inflation subsided during 1990-91 but accelerated again in the following year, averaging 57 per cent per annum during 1992-94.

Who is to blame for the lies and deceit on loan applications? To get to the bottom of this, you would have to go through every loan case by case. I was shocked earlier this year when applying for a refinance of a loan that I did not qualify. At about 7a.m. on a sanitation designated Saturday, here in Rivers State, one imagines how a “customer” walked through the back door of one of these Banks, who claim they don’t work on Saturdays. The lobby should have been closed for the weekend, but dozens of strangers in odd dressing quietly ascertained as “special” customers were bustling about with cellophanes and files. Someone had just delivered 32 pay-deals

In a free market society, the potential for failure and financial ruin is supposed to keep individuals and businesses inside the white lines of common sense and good business practices. A bailout seems just as objectionable in a free market economy as government regulation. I have had a business fail. I have also had a house repossessed. If all the deposits are safe, I believe nobody is going to have any problems. Recently, the Nigerian banks estimated that it experienced approximately 30 employee embezzlement cases a month, with a resultant loss of $2.5 million a year. No figure was projected for losses incurred due to undetected cases. Of the embezzlement cases uncovered in 2002 by the bank’s investigative auditors, a statistical summary of the perpetrators shows that: 62% were female employees; 38% were male employees,66% had a high school education; 31% had some college; 3% other education, 41% were between the ages of 20 and 25, 25% were between the ages of 26 and 35,82% were working as tellers,47% took cash,71% had less than 1 year of service with these banks.

The last statistic was by far the most important and the primary reason the bank pressed for a pilot program to investigate and prosecute employee embezzlements. The program not only would serve as a deterrent to current employees but also would prevent offenders from finding employment in another bank before the embezzlement was discovered. It is the transient nature of bank employees that compounds the embezzlement problem faced by banking establishments. Due to a proliferation of civil suits, banks usually do not warn other financial institutions of any problems encountered with an employee unless criminal charges have been filed. Therefore, it is important to uncover the crime and charge the person responsible before the embezzler moves on to work at another bank.

It is not easy for 75 government officials and contractors to slip into a corporate banking institution undetected and liquidate a 25-year-old bank without anyone knowing. But that’s what just happened in this old contemporary Nigeria. It’s a scene that’s likely to repeat itself across the country as banks struggle through a painful credit cycle, overwhelmed by troubled mortgages and soured construction loans are absolutely plenty of borrowers to blame. While I am sure there were plenty of cases where lenders completely lied about elements in the loans… most of the cases there were years of “nod, nod, wink, wink” going on between lenders and borrowers. The ongoing increasing prices for real estate and government contracts outside oil and gas system covered these types of actions and simply pushed the next year’s actions to be ever more nonchalant. At some point borrowers even thought of themselves as needing to exaggerate as real estate prices outstripped salaries.

It is the lender’s job to protect their banks against people who cannot pay the loan back (which they obviously failed to do), and the borrower’s job to make the loan payments they agreed to make. What really is aggravating is that I was one of those border cases that could have bought something back in 2002-2003. I would have rolled the dice and looking around today I would have been ok as the appreciation in our area has still left most people in our area in the black if you look back that far.

Government influence and investment was supposed to be reduced/removed the backhand at our commercial banks, but unfortunately, it was not so. We feel that giving banks a stronger incentive to lend by cutting the interest rate on government borrowing will also help. The evidence reported above is only suggestive but it does suggest that where lending is difficult, making lending to the government less lucrative can have a strong effect on the willingness of bankers to make loans to the private sector, because, it is the creditworthy firms that suffer most from this high interest rates of public borrowing.

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