The Effect Of Bank Distress On Nigeria’s Economic Growth

Project and Seminar Material for Economics

The Effect Of Bank Distress On Nigeria’s Economic Growth


Abstract


The study aimed at establishing the various factors that affect the real GDP of the NIGERIAN economy, however great emphasis is on the effect of bank distress on the performance of the economy. The study used a time series data for the period from 1985 to 2015.The study applied a Vector Error correction model as determined by the presence of cointegration through the use of the Johansen test of cointegration. The period of consideration was crucial since it shows the critical dynamics the banking industry has evolved from, especially from the narrow traditional money depositing and borrowing obligations to the diversification of such roles to the provision of loan facilities to various stakeholders namely households, small savers, industries or even the government. Despite the major objective of the study being to assess the effect of bank distress on the NIGERIAN economic performance, the study incorporated a number of factors which seem to have either a direct or indirect impact on the loan performance but a direct influence on the NIGERIAN economic performance. The variables of analysis were; foreign direct investment, real effective exchange, remittances, government revenue, total investments and Bank distress. The study found out that existence of bank distress had a significant and retrogressive effect on the NIGERIAN real GDP performance, on the other hand the other factors namely Foreign Direct investment(FDI), Government revenue and proportion of GDP spent on investment had positive and significant effect on real GDP growth except the latter two which were insignificant. The appreciation of the NIGERIAN currency also did reveal an improvement in the real GDP contrary to expectation however this could be due to cheaper importation of efficient inputs. Finally, the study was able to establish that when all the other factors are held constant there will be (significant/insignificant) decline in the NIGERIAN economic growth, therefore we do conclude that despite the various regressors having varying effects on the real GDP, other factors not captured in the econometric equation have a negative effect on GDP growth.


Chapter One


Introduction

Background of the Study

Distress in the financial sector is a situation where financial institution has more liabilities than the value of their assets in the market. This can result to portfolio shifts which eventually cause the collapse of the financial system. Bank distress is many times confused with bank failure. In theory, these two terms are different. Bank distress comes before a bank failure. A distressed bank can recover whereas a failed bank has no chance of recovery.

Bank distresses have various unfavorable consequences which among them are on stakeholders and failure of banks. Sometimes the effects are felt by other sectors in the whole economy. A bank failure results to too much damage in the economy. This is because it affects the employment, earnings, financial development and other associated public interest.

Brownbridge (1989) states that in the 1980’s, there was closure of two local banks as well as taking over ten non-banking financial institutions by central bank of NIGERIA. Mamo (2001) also holds that after the financial regulation in 2000, NIGERIA suffered 39 bank failures which cost 10% of its GDP in terms of loans and grants.
Aburime (2009) stresses that bank distress means detrimental condition, immense pain in the banking activities which could be as a result of various factors. Some of these factors include discontinuity, policies and forgeries which are not consistent, mismanagement of poor loans and advances, board members interference and internal control which is poor. Bank distress is caused by bank conditions which may either be extrinsic or intrinsic. Ultimately, bank failure and unpleasant changes in the economic conditions of banks could be observed.

According to Mishra and Aspal (1991), the development of a country’s economy depends more on real factors such as the growth of industries growth and their development, upgrading of agricultural expansion of both internal and foreign trade. In the development of a nation, we cannot under estimate the important role of the banking sector and its financial way of doing things. In economic planning, banks and financial institutions play a very significant role which is crucial. They set specific goals and allocate the exact amount of money to the government to ensure implementation of economic policies. A performance of any economy can be measured by the performance of the banking sector. The role played by a healthy banking system to the socio-economic and industrial growth of an economy is very important. It is the banking system that has been allocated the role of financing the planned economic growth. According to CBN (2008), the NIGERIAN banking sector was weighed down by a huge portfolio of Non-Performing Loans (NPLs) in the 1980’s and 1990’s. This led to the collapse of some banks. Borrowers who borrowed consecutively from various banks with an aim to default the loans were the major reason of this. This was possible due to lack of information between the creditors and the borrowers.

The Banking (Credit Reference Bureau) Regulations of 2008 oversee operation, licensing, and supervision of banks through CBN. CRBs offer help to the lenders; they enable them make faster decisions which are accurate. They collect, manage and make the lenders know the customer information within a provided regulatory framework. Since banks play a central role in improving financial services in an economy, credit bureaus help lenders to accurately make decisions within the shortest time possible.

According to CBN, NIGERIA’s financial system has improved significantly over the last few years and has become the largest in West Africa. NIGERIAN banking sector is credited for its size and diversification. NIGERIA has a variety of financial institutions and markets unlike other regions in East Africa. However, according to Beck et al (2010), there have been constrains in the growth of the sector especially in 1980’s and 1990’s due to factors such as non-performing loans and weakness in corporate governance leading to a number of commercial banks failing. Banks in NIGERIA are said to continue facing challenges, among them being financial distress.

According to Cheserek (2007), one of the important requirements for a stable economy which is growing is a healthy financial sector in the banking industry. Due to this, the primary goal of many stakeholders is to assess the banks’ financial conditions. Quick action by the supervisory authority is required to ailing banks so as to salvage them before they collapse because the cost of bank failure is too much in an economy.


Purpose of the Study

This study focused attention on the effect of bank distress in NIGERIA which threatens growth and development of the NIGERIAN economy. Specifically, the study sought to:

Investigate the effect of bank distress on NIGERIAN economy. Offer policy recommendations that can be used to reduce bank distress.


Statement of the Problem

One of the key roles of banks in the economy is financial intermediation. This is the process of accepting deposits and giving out loans. Banks earn profits from the difference in interest rates paid and charged to depositors and borrowers who either get loans or make deposits.

This greatly contributes to the growth and development of any economy. Therefore, to ensure a smooth running of the economy, the study of banks and any interference is very crucial. A healthy financial system is very important in the economic growth and development of any country. As a result, every country attempts to maintain such. The performance of any economy is determined by the performance of the banking sector. Financial distress has been a great problem all over the world which cannot be ignored. Amongst other impacts, bank distress leads to bankruptcy which eventually leads to bank failure. NIGERIA is not an exception and many banks have collapsed due to financial distress. Brownbridge (1998) states that between 1984 and 1996 nine local banks and 20 non-banking financial institutions were closed down or taken over in NIGERIA. 10.2 billion Was lost by the CBN, which was equivalent to 3.8% of the GDP for the year 1993, due to banks that collapsed within that short period. This therefore shows how crucial the topic of bank distress is. In addition, prediction of the banks if they are in financial distress is very important. This is because they are able to salvage themselves before it is too late and avoid failure.


Research Hypothesis

HO: Banking distress does not significantly affect the NIGERIAN economy. Ha: Banking distress significantly affects NIGERIAN economy.


Significance of the Study

The stability of the entire economic system is threatened by bank distress; this is in the form of mobilization of savings, financial intermediation process and the self- assurance of depositors. Under this circumstance, the public confidence of the banking system is completely eroded by bank distress. Hence there is need to empirically investigate how the NIGERIAN economy is affected by bank distress.

This study will enlighten the public about the policies of the Central Bank of NIGERIA and the reform programs to ensure the banking industry is safe. The work will also unveil the quality of loans given by banks in NIGERIA as well as give insight of how to manage credit in the NIGERIAN banking industry. The results of the study will be used by economic policy makers; they will ensure the banking system remain safe and sound. In addition, the study will minimize the far- reaching negative effects on the national economic well being caused by bank distress, which include job losses and strangulation of sources of finance for security/protection.

The study immensely benefits all NIGERIAN banks; it is of great help to researchers conducting studies either on the same or related topic. Bank executives as well as board members also know the causes of bank failures and distress, and take the necessary steps to avoid further mistakes of the same nature in future.


Organization of the Study

The rest of the study is organized as follows: the relevant literature is reviewed in the second chapter, methodology and the specification of various equations in chapter three, discussion of the estimation techniques chapter four and conclusion remarks in chapter five.


Chapter Five


Summary Conclusions and Recommendations

Introduction

In this chapter, the summary of the whole research is given, the conclusions, policy recommendations as well as the areas of further study.


Summary of the Study

The performance of the banking sector determines the performance of any economy, due to its key role of financial intermediation. Financial distress has been a great problem all over the world which cannot be ignored. Amongst other impacts, bank distress leads to bankruptcy which eventually leads to bank failure. NIGERIA is not an exception.

The study sought to investigate the effect of bank distress on the NIGERIAN economy. Time series data was collected from year 1985 to 2015.Bank distress was measured as the ratio of non-performing loans to that of total loans. All the pre diagnostic tests involving time series were done. Due to the presence of co integration, the vector error correction model was picked for the analysis of the data.

The results proved statistical significance of the bank distress in the economy which had a negative effect on the real GDP. Other variables that were used in the study were; the foreign direct investment, remittances, real effective exchange rate, total investment as well as the government revenue. Most of the variables showed the statistical significance in the GDP with an exception of government revenue and total investment but some had a positive effect while others had a negative effect.


Conclusion

The overall conclusion that is made from the results obtained in this study is that; bank distress is statistically significant in an economy and has a negative effect on the real GDP. Therefore, it should be put under consideration and taken care of, if economic growth is desired.


Policy Implications

This research paper presents some interesting results which can be utilized by the policy makers to ensure a better economy. First and foremost, there is need of stringent measures in the banking industry so as to minimize the non-performing loans which could eventually lead to bank distress. For instance, banks should carefully evaluate loan applicants to ascertain their ability to repaying before advancing loans. In addition, banks should discourage insider borrowing because it is one of the causes of non-performing loans


Study Limitations

The study had some limitations which could have in one way or another affected the results. One of the limitations was lack of some required data that was essential in the study; for instance the data available on the ratio of non-performing loans to that of total loans was from 1998 the data before that period was not available. Other variables had missing data of various years where you would get the data available skips a year or two. The other issue was on which data to include in some variables; for instance in the foreign direct investment and the remittances there is a quagmire of whether to get the inflows or the outflows. This maybe could yield different results depending on which one is considered.


Areas of Further Study

The study on the bank distress is so limited in the third world countries such as NIGERIA; therefore very little is known in this sector. This study sought to investigate the effect of bank distress in the NIGERIAN economy and the data which was used was time series and it combined all the banks in the same pool. There is therefore need of one to investigate what happens when banks are treated differently and independently. That is; the data is collected for each bank and evaluated .In this case, there would be panel data of all the banks and the effect on the economy investigated.


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