THE EFFECTS OF CBN CURRENT REFORMATION OF THE NIGERIAN BANKING SECTOR
Abstract
The paper investigates the impact of the banking sector reforms on the Nigerian economy using the Ordinary nLeast Squares (OLS) technique in assessing the data on variables from 1980 to 2012. The result showed that the minimum capital base which is at the heart of the banking sector reform has a positive and significant relationship with the level of economic growth. This is an indication that the banking sector recapitalization has
been beneficial and capable of generating the desired level of economic progress in Nigeria. The result shows that the high interest rate policy has been detrimental to the level of economic progress in Nigeria. The result
further revealed that the expansionary monetary policy has been crucial and critical in the development process in Nigeria. It is thus recommended amongst others that the monetary authorities should further increase the
minimum capital base and there should be perpetuation of the expansionary monetary policy.
Keywords: Banking Reforms, Capitalization, Expansionary Monetary Policy, Economic Progress
Introduction
The banking industry as a key unit of the financial system, all over the world, plays fundamental role in the development and growth conditions of the economy by acting as bulldozers in the mobilization of funds and the creation of wealth. The effectiveness and the efficiency of performing its roles, particularly the intermediation between the .surplus and the deficit units of the economy, depend largely on the level of development of the financial system and so banking reform is imperative when existing structures are defective as was the case in Nigeria’s pre-reform era. It is with the intent to ensuring its soundness that the financial sector appears to be the most regulated and controlled by the government and its agencies. There is therefore no doubt why the consensus opinion has been that such a formidable sector must be kept healthy and steadily forceful through regular reforms. Accordingly, is observed that the success of other reforms depends on the health of the financial
system ( World Bank,1996).
It is increasingly recognized that the financial system plays a crucial role in the process of economic development (Todaro and Smith,2011).The surveillance role of the regulatory/supervising authorities is critical to ensuring the soundness and efficiency of financial institution in order to build up confidence and stability of the system. Some of the components of the financial system include the money market comprising commercial banks, Central Bank of Nigeria (CBN); Nigeria Deposit Insurance Corporation (NDIC), the capital market and its connection with the Security and Exchange Commission (SEC) among others.
Policy responses such as fiscal adjustment, trade globalization, financial deregulation as well as privatization programmes were embarked upon by countries especially the less developed countries (LDCs) with a view to redressing the problems of slow growth, debt overhang as well as ameliorate the external and internal shocks.
In Nigeria, the banking fundamental restructuring as orchestrated by successive banking reforms and policy have sought to improve the process of financial intermediaries that would fund and foster stronger economic growth.
Consequently, banking sector reforms in Nigeria could conveniently be discussed under the following eras: the post-SAP era –
(1986 -1993). The Reforms Lethargy (1993- 1998), the pre-Soludo era. The first is the financial systems reforms of 1986 to 1993 which led to deregulation of the banking industry which hitherto was dominated by indigenized banks with over 60% Federal and State governments’ stakes, in addition to credit, interest rate and foreign exchange policy reforms. The second phase began in the late 1993 -1998, with the re-introduction of regulations.
During this period, the banking sector suffered deep financial distress which necessitated another round of reforms designated to manage the distress. The third phase began with the advent of the present civilian regime in 1999 which saw the return to liberalization of the financial sector accompanied with the adoption of distress resolution programmes. This era also witnessed the resolution programmes. This era also witnessed the
introduction of universal banking which empowered the banking and non-banking financial markets. The fourth phase began in 2004 till date and it is informed by the Nigerian Monetary Authorities who asserted that their
catalytic role in promoting private sector led growth could be further enhanced through a more pragmatic reform( Balogun, 2002).
The fourth phase of the banking reforms in Nigeria essentially started with the appointment of Charles Soludo as governor of the CBN by the Obasanjo civilian administration in 2004. The phase also embraces the extant regime of Sanusi Lamido Sanusi which, with intense globalization attendant with increased pressure on financial performances brought about significant changes in the financial sector as the country adopted comprehensive adjustment programme designed to promote a stable macroeconomic environment and provide a versatile institutional arrangement necessary for a free market economy. (Aderibigbe, 1997).
The rest of this paper proceeds as follows: Section 2 briefly reviews the relevant literature. Section 3 describes conceptual and theoretical framework; section 4 presents model specification and analysis of results and finally section 5 presents policy implications and concluding remarks
. Review of the relevant literature
Banking sector reform, according to Olekah (1993) is a policy measure designed to deregulate the financial sector system and transform its structure with the view to achieving a liberalized market oriented system within an appropriate regulatory framework.
Prior to the economic deregulation measures of 1986, the Nigerian banking industry was highly characterized by control in interest rate, selective credit guideline, ceiling on credit expansion and the use of reserve requirement and other direct monetary control instrument. The banking system was dominated by the state owned banks while entry into the industry restricted consequent upon the adoption of the structural Adjustment Programme (SAP) in 1986. The framework for banking reform in the country was put in place with the primary objective of the stemming the expansionary impact of government modernization of oil export proceeds and the monetary financing of budgeting deficits. The banking sector thus focuses on measure to promote a more competitive and safe system through enhanced surveillance activity by the monetary authorities with the view of moving the Nigeria economy productivity and positioning the banking system to perform the role of intermediation and playing a catalytic role in the economic development (CBN 2005).
In Nigeria, the ability of the banking industry to play its role has been periodically punctuated by its vulnerability to systematic distress and macro-economic volatility, making policy tuning inevitable.
Nnanna (2005) showed that historically, the Nigeria banking industry had evolved in four stages; the first stage can be described as the unguided less-fair phase, during which several poorly capitalized and unsupervised
indigenous banks failed before tenth anniversary. The second stage was the controlled regime during which the central bank of Nigeria ensures that only “fit and proper” persons were granted banking license, subjected to a mini paid-up capital. The third stage was the post SAP or the control regime (1986-2003), during which the neoliberal philosophy of “free entry” was over stretched and the banking license were dispensed by the political authorities on the basis of patronage. The emerging fourth stage is the era of consolidation (2004 to a foreseeable future) with major emphasis on the recapitalization proactive regulation based on prudential principles.
The financial industry is reconstructing and consolidating at an unprecedented pace around the globe, particularly in the United States and Western Europe, transactions are numerous and breath taking is not only a
Nigeria thing, but all around the world.
Alan (2010) categorized financial reform into two, namely financial reform, which is essentially the process of eliminating state of distress in financial institutiong4s as well as main causative factors. The second is financial
reform proper which is the processes of changing institutions and adding new ones and also eliminating the distorting financial policies and practice with greater mobilization and allocation of scarce resources. These two
forms of reforms have been simultaneously used in Nigeria depending on the objectives of the government.
Conceptual and Theoretical Framework
Banking reforms is the changing of banking system architecture, technological innovation, and fine-tuning the rules guiding the practice of banking in many jurisdictions, Okagbue and Aliko (2004). Ajayi (2005) pointed out that reforms are predicated upon the need for reorientation and reposition of existing status quo in order to attain an effective and efficient state. Okeke (2007) posits that reforms are deliberate action
by the government to fast track and consolidate specified sector of the economy to achieve desired objectives.
Alan (2004) opined that banking reform is the process of changing structures, adding new policies, eliminating distorted banking policies and practices and generally establishing the basis of greater efficiency in both the mobilization and the collection of resources.
Banking reform thus focused on the establishment of necessary macro-economic framework and financial environment that would engender and promote a more competitive and safe system through enhanced surveillance activity by the authorities with a view to moving the economy forward, proactively positioning the banking system to perform the role of intermediation and playing a catalytic role in economic development CBN
The reform measures are agreed towards improving credit quality of banks. The goal is to see whether the banking reform will have effect on macro-economic indicators of the economy (Soludo, 2004). Sundararajan and Balino (1991) identified several ways by which financial reform could increase the fragility of
both financial and non-financial sector which includes relaxed freedom to entry into the financial sector and freedom to bid for funds through interest rates and new investment, which could lead to excessive risk-taking.
Changes in the institutional structure of the banking system that emerges during reforms, led to concentration of power in banking and interlocking ownership and lending pattern.
– Excessive reliance on economic rather than prudential regulations, which should focus on bank solvency and credit risk.
– Mismatch of investments; the de-regulation of interest rate could affect financial institutions that have large exposure to long-term assets funded by short-term liabilities, which carry fixed interest rates.
– Inadequacy of instrument of monetary control or insensitivity to the need for the control of interest rates during de-regulation.
The manner of the implementation of the reform may facilitate the occurrence of any of the mentioned events, leading to banking crisis.
August (2004) opined that one reason de-regulation has been linked closely with bank failure is the simultaneous occurrence of the two events; bank failure and de-regulation of bank; the rapid rise in bank failure often takes place at a time of substantial de-regulation of the financial sector.
When these two events occurred at the same time it may not necessarily mean that one has cause the other neither does it mean that one has not caused the other. De-regulation is often accompanied by increased market competition. It compels banks to compete with one another for core deposits, their level of exposure to risk may increase as the spread between the cost of funds and the return on funds as a narrow (Sundararajan 1991).
In view of the important roles, which a well-developed financial market can play, the CBN is placed in a unique position to ensure the soundness and efficiency of the financial sector and market operations at both the micro
and macro levels to support the economic objectives of government. CBN has also adopted various policy options to address problem of distressed banks. These policies adopted are: financial restructuring which attempts to restore solvency by improving bank balance sheet, by raising additional capital of N25 billion capital base enhancing supervision and prudential regulator studies which have that have explored the correlation between the banking sector and economic growth include Stigliz and Weiss (1981), who developed some of the first banking –related models, based on utility and profit maximization. The studies focused on the role played by asymmetric information in resource allocation. Also, in the same vein, King and Levine (1993) have established that the banking sector’s development correlated with economic growth and also a source of long term growth. Also, subsequent works resting on King and Levine have been able to demonstrate that financial markets are a source of economic growth (see for example, Nnana (2004), Lavine and Zervos (1996), De Gregorio and Guidolti (1995). Several empirical studies have been conducted on consolidation, recapitalization and banking sector reforms in Nigeria (see for example, Balogun (2007). studies lend credence to the impact of
reforms in banking sector on economic growth
Model Specification and Analysis of Results
The model to be estimated is thus stated functionally below:
RGDP = FCR, MS, MCBASE, FINDEEP, REFDUM
Where,
RGDP = Real Gross Domestic Product
MS = Money Supply
R = Interest Rate
MCBASE = Minimum Capital Base
FINDEEP = Financial Deepening
REFDUM = Banking sector reform dummy. It assumes the period of 0 during non reforms and 1 during banking
sector reform period.
Ut = Error term
This could be stated linearly below:
RGDP = b0+ b1R+b2MS+b3MCBASE+b4FINDEEP+b5REFDUM+Ut
b2, b3, b4, b5 > 0, b1 < 0
Economic theory suggests that a well managed banking sector reforms is expected to increase the level of
economic growth, all things being equal.
The data to be used for the study are secondary in nature and covered the period between 1980 and 2012 period which include the pre-Structural Adjustment Programme (SAP) and the SAP period. The data include those on Real Gross Domestic Product, minimum capital base, interest rate, financial deepening and a banking sector reform dummy variable which assumes the period of 1 during banking sector reform period and 0 in other period.
