CHAPTER ONE
1.0.BACKGROUND OF THE STUDY
Financial instability has been in the scene of Nigerian economy for a long time. It
is obvious that the financial instability is an important topic to develop. The cost
burden associated with bank failure is so disturbing that the need for continued
study of causes of banking financial instability on both the practical and theoretical
level cannot be overemphasized. Some years back, Nigeria witnessed numerous
bank failures. Example Savannah bank, All State Trust Bank, Bank of the North,
Ganji bank of Niger limited, Owena bank, Lion bank of Nigeria limited, etc.
The central bank of Nigeria (CBN) has said that the only way the nation’s
consolidated banks could be insulated from failure is through adoption and
enforcement of corporate governance culture. Sanusi Lamido however, pointed out
that the recent failures of high profit institutions around the world such as Enron,
Parmalat, World comm., Barings bank among others, have shown that no company
can be too big to fail, stressing that a common trend that runs through these
monumental failures was poor corporate governance culture, exemplified in poor
management, fraud and insider abuse by both management and board members,
poor asset and liability management and poor regulation and supervision among
others.
Banks play very crucial roles in the process of economic development of any
country, by mobilizing funds from the surplus units of the economy and the
lending of these funds to deficit units for investment. There has been a growing
consensus among economists on the proposition that financial institutions and
particular commercial banks contribute to the real development of the economy.
The process of expansion might occur owing to the improvement in the financial
system as potential savings is matched with investment. This reasoning which is
supported by both the Keynesian and the classical models of economic
development implies the need for adequate financial intermediation. Therefore, an
efficient banking system implies availability of credit for capital formulation and
investment.
‘Bank failures are usually followed by unfavourable consequences on stock-holder
outside the failed banks themselves. Sometimes, consequences are felt by the non-
banking system as a whole. A failure can result in much harm to employment,
earnings, financial development and other associated public interests’, Smiths and
Walter (1997). According to Hooks, (1994) and Beston and Kaufman (1996), the
failure of a bank has a great adverse effect on the economy and so it is considered
very important.
Bank failure means different things to some people. To some people, a bank fails
only when it ceases operation even if it has not been liquidated. In a wider context,
a bank is said to have failed if it has not succeeded in achieving any objectives for
which it was established.
A bank is considered a failure not only when it ceases operation but also when it
cannot meet any of its objectives or obligations. The cessation of operation may
constitute a serious mild or negligible bank failure depending on the circumstance.
The cessation of independent operation or continuance without the assistance of
relevant authorities such as deposit insurance institutions can be associated with
distress. Bank failure therefore will occur when a fairly reasonable proportion of
banks in the economy as a whole lack capital assets. As Selgin concludes that
regulation in respect of branching limited contribute to the possibilities of bank
failure by supporting bank risky operation. According to him, the worst regulation
is branch restriction. The lower the bank’s capital; the higher the probability of its
failure. Goodhart et al (1998) agreed with the statements and added that as bank’s
capital decreases, the higher its motivation for action towards survival. Therefore
the risk of failure rises with the decline in equity.
More so, bank failure is seen as a declaration of insolvency by the chattering
agency or as reorganization to avoid dejure. Failed banks tend to be less efficient
and make fewer investments (grant more loans especially bad loans) than boyant
banks. Thus, bank failure occurs when net cash is greater than the bank’s capital
funds. This implies that a problem bank is one that in the eyes of the federal
banking authorities has violated a law or regulation or engaged in an unsafe or
unsound banking practice to such an extent that the present or future solvency of
the bank is in question (Sinkye, 1975).
‘There is no evidence that bank failure is the thing of the past in Nigeria because it
is still on the economic scene. Bank distress has become a common lexicon in
Nigeria, given many bank failures till date’. Ebhodaghe (2001) stated that when a
firm which is either a bank or not is liquidated for its inability to meet its
obligation to creditors, it can be described as having failed. Thus we could use
bank failure to describe a situation where, as a result of irremediable bank distress,
a bank’s license is revoked and the bank subsequently liquidated. Liquidation is
thus, an aftermath of bank failure. In fact, if revocation of license is seen as the
death of a bank, liquidation is its burial.
Bank distress is the fore runner of bank failure. Whereas a bank in distress could
have chances of regaining health, a failed bank loses every chance of life. Its final
destination is the mortuary of Nigerian deposit insurance corporation (NDIC) from
where it will proceed to its final resting place – liquidation – courtesy of the
undertakers. Bank failure also is when the bank system fails, which means when
the entire bank ATMs and the bank POS machine fail to work. The banks have to
shut for a while, because the machines that are inside the bank are broken.
Corruption in the banking sector; so-called rich men making deals with bank
managing directors (MDs), and taking loans without paying back. See what is
happening to some commercial banks and micro-finance banks in Nigeria. Banks
that lent money to people with little or no credit and those people cannot afford
what was purchased, and then they file bankrupt....
