Troubled Banks: Contending 2011 Money-Politics!

After Dr. Lamido Sanusi steered CBN sacked five ailing banks’ directors, what happens next becomes a nightmare. Perhaps banks should not be allowed to grow so large that they cannot be allowed to fail. My recollection is that until about 2 years ago we had such regulations. Banks were prohibited from getting too large and engaging in risky investments with depositors’ money. Not many people know that perfectly good projects are devalued and destroyed due to the government failing to act quickly to save the projects, and in most cases it does not take that much. It is unfortunate that nobody is investigating this failing on the part of CBN, years later we will read that billions went down the drain unnecessarily all because somebody did not care.

If you want to fix what is ailing this country, you need to destroy the worthless debt out there, you have to shut down the culprits, liquidate their assets. Many of the auctioned loans are considered “performing,” meaning the borrowers are current on their payments. But a portion of them are delinquent. The borrowers, like the chanchangis, suddenly find themselves dealing with aggressive out-of-state loan consolidators, rather than local banks with long-standing community ties. And the consolidators’ primary objective often is to immediately collect on the debt, or seize the collateral.

Banking regulators are particularly interested in improved failure prediction models for several reasons. Foremost is the belief that failure can be avoided, or the bailout costs minimized, through early detection of an institution’s troubled status and intervention by regulatory authorities. An accurate and timely identification of a bank’s potential for failure would also assist in the targeting of audits and allow for a more effective allocation of resources. Failure prediction models help to identify causes of failure and lead to a better understanding of bank operations.

While an early-warning system could never replace on-site examinations, it can complement the on-site process by identifying troubled institutions that need early examination or possible intervention. Banks go under when they are no longer able to meet their obligations. They might be unable to pay the bills, or a bank failure may arise because they can’t provide cash when depositors demand it.

In light of apparent systemic risks facing the banking system, the adequacy of CBN’s financial backing has come into question. Beyond the N25billion capital base of each of the banks under the CBN supervision and the apex bank’s power to charge commercial banking premier, CBN is additionally assured by the Federal government. Has the five troubled banks actually failed?

A bank failure occurs when a bank is unable to meet its obligations to its depositors or other creditors. More specifically, a bank fails economically when the market value of its assets declines to a value that is less than the market value of its liabilities. As such, the bank is unable to fulfill the demands of all of its depositors on time.

Throughout the 1980’s and the 1990’s Asia’s economic growth astonished the world. The region’s stock markets soared to new heights unprecedented economic growth rates was recorded and an acquisitive new middle class emerged. Then overnight, it all fell apart. The question now being asked is: Who brought the party to an end? The story of the Asian Crisis is a tale of greed and sorrow, of intelligent people making unforgivable mistakes and of a collective misunderstanding about the management of economic expansion. Asia will undoubtedly recover, but the speed and strength of its re-emergence will depend on how well it has learned its lessons. The concluding chapter of the book outlines the many issues that need to be addressed and provides a template for the future development of the region’s finance industry.

The Japanese banking crisis provides a natural experiment to test whether a loan supply shock can affect real economic activity. Because the shock was external to U.S. credit markets, yet connected through the Japanese bank penetration of U.S. markets, this event allows us to identify an exogenous loan supply shock and ultimately link that shock to construction activity in U.S. commercial real estate markets. We exploit the variation across geographically distinct commercial real estate markets to establish conclusively that loan supply shocks emanating from Japan had real effects on economic activity in the United States.

The failure of a bank is generally considered to be of more importance than the failure of other types of business firms because of the interconnectedness of banking institutions. It is often feared that the effects of a failure of one bank can quickly spread throughout the economy and possibly result in the failure of other banks, whether or not those banks were solvent at the time. As a result, banking institutions are typically subjected to rigorous regulation, and bank failures are of major public policy concern in countries across the world.

Resolving insolvent banks efficiently, particularly when they are very large, presents a challenge that has been poorly met in almost all countries in recent years. Insolvent banks have generally been resolved only at a high cost to the country in which the bank is located. The costs are of two types. The first is transfer costs arising from the use of taxpayers’ funds to reduce or eliminate losses to some or all claimants of insolvent banks—for example, depositors, other creditors, and, on occasion, shareholders. These claimants usually bear the cost of bankruptcies in most non-bank failures. The second type is real costs associated with the misallocation of resources from the often prolonged operation of insolvent banks; this misallocation reduces a country’s aggregate income below potential.1

Both types of costs are magnified when reluctant bank regulators fail to move swiftly to resolve institutions when they first become insolvent. Ironically, such regulatory forbearance is motivated in large measure by a fear of high societal costs from officially recognizing and resolving insolvencies sooner. Depositors may perceive themselves as losing when legal closure and official recognition transform unrecognized implicit losses into explicit losses. They may also experience liquidity problems if they lose immediate and full access to the funds when the insolvent bank is legally closed. Borrowers may experience liquidity problems if they are unable to access their credit lines. Again, the payment system may be interrupted. It is widely feared that the effects of these problems may spill over beyond the banks and have adverse consequences for the economy as a whole.

We inside “nigeria4betterrule” examine the efficiency of the resolution process for Nigerian banks and consider whether CBN face additional potential problems when these institutions experience financial difficulties. As banking is becoming increasingly global, prudential regulation and insolvency resolution have remained national. Nigeria banking crisis may result from this government dichotomy in domestic bank resolution

Obtaining useful, timely, and accurate financial data may be difficult for CBN, especially when the affected banks are operating through branches. But even if accurate financial information were available, host country regulators’ ability to move promptly to take corrective action may be hampered by the need to share prudential supervision, regulation, and enforcement with home country regulators. These overlapping responsibilities introduce the possibility of delays not only in sharing relevant Information but also in legally closing insolvent institutions.

Potential resolution problems may be compounded when CBN deals with financial institutions from many different branches operating under different deposit insurance and failure resolution schemes. These variations can result in differences in both

the treatment of creditors and in supervisory and resolution policies. For example, the payment of claims is governed by rules that specify when insured depositors at insolvent institutions are paid, the office at which the claims are booked, when and how much uninsured depositors and other creditors are paid, and whether the insurance agency contacts the eligible claimants or the claimants have to file claims individually.

Differences in supervisory and resolution policies also depend upon how strict prudential sanctions are and how the closure rule is structured and enforced. The latter affects how long insolvent banks are kept open and operating before legal closure takes place. As the number of branches from different home countries operating in a given branches increases, so does the possible number of different deposit insurance and resolution systems that will have to be reconciled should institutions fail. Therefore, large-scale foreign bank presence could increase the potential confusion both before and after one or more institutions become insolvent.

Using domestic taxpayer money out of government coffer to make deposit insurance
Payments to depositors in the five affected banks could, if nothing else proves to be politically difficult. Indeed, on occasion, the problems that arise in resolving banks, particularly those involving branches, may be so severe that that crosses border banking in this form may be too costly to permit as a matter of public policy despite the well recognized benefits in terms of intensified competition and improved management that may be associated with the entry of foreign banks.

The first modern experiment with Islamic banking was undertaken in Egypt under cover without projecting an Islamic image—for fear of being seen as a manifestation of Islamic fundamentalism that was anathema to the political regime. The pioneering effort, led by Ahmad Elnaggar, took the form of a savings bank based on profit-sharing in the Egyptian town of Mit Ghamr in 1963. This experiment lasted until 1967 (Ready 1981), by which time there were nine such banks in the country. In an Islamic mortgage transaction, instead of loaning the buyer money to purchase the item, a bank might buy the item itself from the seller, and re-sell it to the buyer at a profit, while allowing the buyer to pay the bank in installments.

However, the fact that it is profit cannot be made explicit and therefore there are no additional penalties for late payment. In order to protect itself against default, the bank asks for strict collateral. The goods or land is registered to the name of the buyer from the start of the transaction. This arrangement is called Murabaha. Another approach is EIjara wa EIqtina, which is similar to real estate leasing. Islamic banks handle loans for vehicles in a similar way (selling the vehicle at a higher-than-market price to the debtor and then retaining ownership of the vehicle until the loan is paid).

An innovative approach applied by some banks for home loans, called Musharaka al-Mutanaqisa, allows for a floating rate in the form of rental. The bank and borrower forms a partnership entity, both providing capital at an agreed percentage to purchase the property. The partnership entity then rent out the property to the borrower and charges rent. The bank and the borrower will then share proceed from this rent based on the current equity share of the partnership. At the same time, the borrower in the partnership entity also buys the bank’s share on the property at agreed installments until the full equity is transferred to the borrower and the partnership is ended. If default occurs, both the bank and the borrower receive the proceeds from an auction based on the current equity. This method allows for floating rates according to current market rate such as the BLR (base lending rate), especially in a dual-banking system like in Malaysia.

As the 2011 election draws near, a large number of businesspeople who are into politics and a large number of politicians who are into business have queued up at scheduled banks to have their debts rescheduled. According to a report, top leaders of the two major political parties are ‘rushing to the banks to update their loan portfolios as well as coax interest waivers from the bankers using their political clout’. The report also points out that there had been frantic lobbying in the last few days of the immediate-past government by some political leaders to have their classified loans rescheduled for clean reports from the central bank’s credit information bureau ahead of the next general elections, scheduled to be held sometime in April 2011. The reason is simple: the electoral laws do not allow a loan defaulter to run for a public office. That the desperate dash for debt servicing has been neither shocking nor surprising is reflected in the central bank’s instruction to the scheduled banks to strictly adhere to the rescheduling policy ‘without fear or favour’.

The instruction is indeed timely and hence welcome. The directive should improve the financial discipline of the banking sector, which has been reeling under a huge burden of bad debt for years now, and also restrict direct influence of money and muscle in the next elections. Elections in Nigeria are more often than not preceded by incidents of political violence. Many aspiring candidates pour in loads of money to hire musclemen with a view to swaying the electoral process in their favour. Strict enforcement of the loan rescheduling policy, we believe, will prevent a sizeable amount of money being channeled to hired hoodlums and substantially reduce the scope for intimidation and coercion of voters before, during and after the elections. This, in turn, could contribute to making the elections less expensive.

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