The Effect Of Bank Recapitalization On The Economy Of Nigeria

Project and Seminar Material for Economics

Abstract

One of the major macroeconomic variables that compliment bank performance is availability of capital. Economic theories show that inadequate capital contributes to bank failures and retards economic growth. This study however, examined the impact of bank recapitalization of banking industry on economic growth of Nigeria. It is the aim of this research work to examine the past bank failures as a result of inadequate capital and how recapitalization exercise in the banking industry in Nigeria has increased the minimum paid-up capital and increased the banks’ asset qualities. This research work is carried out to achieve some objectives among which are: to examine the impact liquidity ratio on economic growth in Nigeria pre and post capitalization 2005, to determine the impact of cash reserve ratios on economic growth in Nigeria pre and post capitalization 2005, to examine the impact of money supply on economic growth in Nigeria pre and post capitalization 2005, to examine the impact of loan-to-deposit ratio on economic growth in Nigeria pre and post capitalization in 2005. The methodology adopted for this work was based on the use of tables and charts, which established structured relationship between the variables studied. The data collected were only from secondary data and variable specification used were dependent and independent variable: while GDP was used as dependent variables, money supply, loan-to- deposit ratio and cash reserve ratio are independent variable. The findings indicate that liquidity ratio, cash reserve ratio have no positive and significant impact on economic growth of Nigeria as opposed to money supply to GDP and loan to deposit of commercial bank that have positive but non-significant impact on economic growth in Nigeria. It is, however, recommended that government should make policies that are less stringent and more favourable for the operators to have room to operate more freely.

Chapter One

Introduction

1.1 Background of the Study

Globally, the activities of banks reflect their unique roles as the engine of growth in any economy. The role which comes from both banks and non-banks financial intermediaries and the regulatory framework in stimulating economic growth is widely recognized especially in developmental economics. Uboh (2005) set the pace for the landslide of other works on the interdependent and the relationship between banks and economic growth.
Stressing further, the pioneering work of Guiley and Shaw (1956) on the relationship between real and financial developments shows that financial intermediaries, monetization and capital formation determine the path and pace of economic growth and development of any country. Nevertheless these pivotal roles have not been highly noticeable in Nigeria. The scenario arises as a result of poor performances of Nigeria commercial banks. According to Soludo (2004), “The Nigeria banking system today is fragile and marginal. The system faces enormous challenges which if not addressed urgently could snowball into a crisis in the near future”. Soludo identified the problems of the banks, especially those seen as feeble, as persistent liquidity, unprofitable operations and poor asset base.

Imala (2005) posited that the objectives of banking system are to ensure pure stability and facilitate sustainable rapid economic development. Regrettably, these objectives have remained largely unattained in Nigeria as a result of some deficiencies in the banking system. This phenomenon has necessitated continuous financial sector reforms globally. In 1988, an international agreement among the banking authorities known as Basle agreement was reached. The main objective of this was to apply a common set of rules for capital adequacy in order to minimize the risk of bank failures. In compliance with the Basle agreement, the governor of Central Bank of Nigeria Professor Charles Soludo announced on July 6, 2004 that the banking sector should increase their capital base with about 100% (from initial capital base of _2 million to a whopping _25 billion). The policy directives of this initiative according to the C.B.N Governor are ita alia.

To strengthen the commercial banks thereby intensifying the growth of the economy.
To encourage competition locally and internationally in conformity with the new trend of globalization.

The kernel of this argument is that with this new policy of recapitalization, banks that cannot meet the required amount will have to merge with bigger or stronger ones. Following the implementation of the policy, an unprecedented process of recapitalization has taken place in Nigerian sector shrinking the number of commercial banks from 89-25 banks. No other event is more challenging than this recapitalization policy in the history of Nigeria banking. Prior to the reformation, the state of Nigeria banking sector was very weak. It’s fragile and marginal being plagued by persistent liquidity, unprofitable operations, poor asset base and intermittent failures. It was expected that the reform should promote efficiency, better banking performance, operational stability, profitability and reduce bank failures.

According to Imala (2005), the current structure of the banking system has promoted tendencies towards banking effectiveness and efficiency particularly at the retail level.

1.2 Statement of the Problem

The Nigerian banking system has undergone remarkable changes over the years, in terms of the number of institutions, ownership structure, as well as depth and breadth of operations. These changes have been influenced largely by the challenges posed by deregulation of the financial sector, globalization of operations, technological innovations and adoption of supervisory and prudential requirements that conform to international standards. As at the end of June 2004, there were 89 deposit banks operating in the country, comprising institutions of various sizes and degrees of soundness. Structurally, the sector is highly concentrated, as the ten largest banks account for about 50 percent of the industry’s total assets/liabilities. Most banks in Nigeria have a capitalisation of less than $10 million. Even the largest bank in Nigeria has a capital base of about US $240 million compared to US $526 million for the smallest bank in Malaysia. The small size of most of our banks, each with expensive headquarters, separate investment in software and hardware, heavy fixed costs and operating expenses, and with several branches in few commercial centres – lead to very high average cost for the industry. This in turn has implications for the cost of intermediation, the spread between deposit and lending rates, and puts undue pressures on banks to engage in sharp practices as means of survival.

Inspite of the efforts pulled together by the regulatory authorities to revitalize the institution, Nigerian banking sector continued to witness pockets of distress that led to the consolidation reform agenda. Moreover, while copious studies and reports have provided results for pre and post consolidation exercise in Nigeria, comparatively, little has been done to provide a comprehensive assessment on how the consolidation, merger and acquisition would impact on bank services. It is therefore, necessary to undertake a critical study of how the impact of recapitalization exercise by the Central Bank of Nigeria towards enhancing the performances of commercial banks in Nigeria can lift the economic standards of this country.

1.3 Objectives of the Study

The set objective of this study is as follows:

To examine the impact of liquidity ratios on economic growth in Nigeria, pre and post capitalization exercise in 2005
To determine the impact of cash reserve ratios on economic growth in Nigeria, pre and post capitalization exercise in 2005
To examine the impact of money supply on economic growth in Nigeria pre and post consolidation in 2005
To examine the impact of loan-to-deposit ratio on economic growth in Nigeria pre and post consolidation in 2005

1.4 Research questions

This following research questions will emanate in this study. These are:

To what extent do liquidity ratios pre and post consolidation have positive and significant impact on economic growth in Nigeria.
How far does cash reserve ratios of commercial banks pre and post have positive and significant impact on economic growth in Nigeria
To what extent does money supply have positive and significant impact on economic growth pre and post consolidation.
To what extent does loan to deposit ratio have positive and significant impact on economic growth in Nigeria pre and post consolidation.

1.5 Research Hypotheses

The following research hypotheses will arise for the research question raised above. These are;

Liquidity Ratio of commercial banks does not have positive and significant impact on economic growth pre and post consolidation in Nigeria
Cash reserve ratio of commercial banks does not have positive and significant impact on economic growth in Nigeria pre and post consolidation in Nigeria.
Money supply of commercial bank does not have positive and significant impact on economic growth in Nigeria pre and post consolidation in Nigeria.
Loan to deposit does not have positive and significant impact on economic growth in Nigeria pre and post consolidation in Nigeria.

1.6 Significance of the Study

In the wake of bank failures, the economy suffered severe stress. Many depositors lost their hard-earned money; many suffered starvation because their breadwinners lost their jobs in the process. People from different sphere of life have commented on this seemingly topical issue as it touches the very fabric of the national economic life. The study is being embarked upon as a way of further investigating the issue in a view to justifying the ongoing recapitalization exercise as directed by the Central Bank of Nigeria and how it would affect the Nigerian economy.

The research will be of benefit to practicing bankers, students of Business Studies seeking to study the Nigerian Banking Industry and the entire public who need to have knowledge of the recapitalization and consolidation of the Nigerian Banking Industry.

1.7 Scope of the Study

In carrying out this research, attention would be focused on commercial banks’ consolidation (N25 billion capital base) and its effects on the Nigerian economy. The scope would have included other consolidation exercises around the world’s commercial banks but due to lack of finance and time, this could not be feasible.

1.8 Limitations of the Study

This research work would have been appreciated mostly if it had captured a deep study of consolidation, merger and acquisition of commercial banks in Nigeria but because of the following constraint, it was found difficult.

(i) Financial Constraint:

Financial problem was encountered by the researcher to carry out a detailed study of this research work. Limited capital at the researcher’s disposal restricted is gathering of enough materials for the purpose of undertaking this research work.

(ii) Time Constraint:

Time was not of essence to embark on a more detailed work because the curriculum the degree programme is designed in such a way that courses are registered together with project thereby creating difficulties in conducting intensive work.

Chapter Five

Summary of Findings, Conclusion and Recommendations

5.1 Summary of Findings

Liquidity Ratio of commercial banks does not have positive and significant impact on economic growth pre and post consolidation in Nigeria.
Cash Reserve Ratio of commercial banks does not have positive and significant impact on economic growth in pre–consolidation while it shows a positive but non-significant impact on post consolidation economic growth in Nigeria.
Money supply to GDP of commercial banks has positive and non-significant impact on economic growth in Nigeria, pre and post consolidation in Nigeria.
Loan to deposit of commercial banks have positive and non- significant impact on economic growth in pre–consolidation while it shows a negative but significant impact in post consolidation growth rate in Nigeria.

5.2 Conclusion

As seen, Nigeria is still at a bay in economic growth after a quarter of a century of economic reforms propagated by national policies. The country in comparison with other transition economies of the world is still lagging behind in growth. A major gap in Nigeria’s industrial development process in the past years has been the absence of strong financial system. It is incontestable that an efficient and effective financial system is essential for building a sustained economic growth. The success from the financial system can only be achieved through the safety, soundness and stability of the sector coupled with the effective and efficient management of the sector. It has also proved that the development of the financial sector will help in facilitating the real sector which will result into having a virile economic growth. The Nigerian financial sector has not been virile enough to enhance the real growth that will push the Nigerian economy into realizing her 2020 goal.

It is therefore, against the foregoing that this study examined the impact of banks capitalization on economic growth in Nigeria, pre and post consolidation (1999-2012). Driven by the findings in the study, monetary policy variables in Nigeria have a long way to go for the sector to be productive enough and play the important role it is expected to in relation to contributing to the economic growth.

The intermediation role and investment of the financial sector are targeted only on short term gains which is making the real sector of the economy to continue to look weak and therefore reducing the productivity level of the economy. Although, all the banks in Nigeria agreed to set aside 10 percent of their profit before tax for equity investments in small scale industries, which was aimed in order to stimulate economic growth and generate employment opportunities for country’s growing population, but the banks are reluctant to release the fund due to the inability of the local entrepreneur to provide collateral and good feasibility study. So the liquidity and monetization of the economy does not achieve the expected objective. With these, the growth of the financial sector cannot complement the expected growth in producing sector of the economy. The major challenge to the Nigerian financial sector development is how to engender healthy competition in addition to enhancing investments so as to achieve a desired economic growth and maintain its position as one of the emerging economies.

Therefore, this study concludes that for the Nigerian economy to grow, emphasis should be placed on developing and implementing policies that will address banks applying available credit in critical areas like education, agriculture, etc, as these are growth oriented goals that can move the country forward.

5.3 Recommendations

In line with the specific objectives of this study, we recommend as follows:

Sustained and equitable economic growth is clearly a predominant objective policy. Monetary policy holds great opportunity to promoting economic growth in Nigeria. Government should introduce a specification of the financial structure that is richer than the existing ones, recognizing the negative effect of the liquidity ratio on economic growth.
Government should set up a framework to further stimulate cash reserve ratio and also reduce strict measures on banks to promote more level of transparency and accountability. The government should also endeavour to make the financial sector less volatile and more viable as it is in developed countries. This will allow for smooth execution of the Central Bank monetary policies. Law relating to the operation of the financial institutions could be made a bit less stringent and more favourable for the operators to have room to operate more freely.
Government should formulate policy that is aimed at raising broad money supply so that by so doing it would encourage financial deepening in the country and increase real GDP. Policies should be set up to improve the capital market, correct distortions in interest rate and monitor corporate governance in financial institutions to enhance the effective impact on the economy.
Financial reforms in Nigeria should focus more on deepening the sector in terms of financial instruments so that firms can have alternatives to banks’ credit which proved to be inefficient and detrimental to growth, moreover, government should inculcate fiscal discipline so as to reduce excessive borrowing from the financial sector and thereby crowding out private investment. Secondly the loan given by banks should be checkmated in such a way that the productive sector should be granted loans and not for unproductive purposes so as to have a significant and positive impact on Nigeria economic growth.

5.3.2 Recommendation for further studies

The pursuit of knowledge is inexhaustible. This study recommends the following for further studies. These are:

Studies that will examine the impact of banks capitalization on the performance of the manufacturing sector pre and post consolidation.
Secondly, this study recommends for further studies that will examine the impact of banks capitalization on small business finance, pre and post consolidation.