Prudential Guideline And The Profitability Of Deposit Money Bank In Nigeria

Project and Seminar Topics with material for Banking and Finance

Abstract

This research project work concerns itself with the prudential guidelines and the effect on the profitability of Deposit Money Bank. The major objective is to examine the effect of prudential guideline on the profitability of Deposit Money Bank. The researcher reviewed literature adequately and accordingly.

The Analysis of Variance (ANOVA) was used to analyze the primary data collected. It was found that prudential guideline has been of benefit to Bank in the area of reducing non-performing loans increased customer satisfaction and management effectiveness. It was therefore concluded that prudential guidelines has impacted significantly on the profitability of Banks in Nigeria. The researcher recommended that Deposit Money Banks need to minimize their operation cost through control of expenses to achieve increased profitability.

Chapter One

Introduction

1.1 Background of the Study

All over the world, the banking industry plays a strategic role in every nation’s economic development. The Central Bank plays a dominant role in both the decision making and managerial process taking place in the economy while other banks do provide the essential financial services needed for effective operation of the economy. Bank failures do have destabilizing impact on the economy of any nation. It is precisely the consequence of these failures that led to the enactment of various legislations, rules and guidelines by relevant authorities to curb the excesses the banks with a view to ensuring that banks operating in Nigeria do so in accordance with the best practices of International banking professional standards.

Banking malpractices alternatively referred to as corruption and economic crimes constitute the genius of what is generally known as and commonly called “Elite or white collar crimes. Legislation governing the banking practice in Nigeria is sourced from three major areas. They are:

Law of General Application:

This is the law that is applicable across the countries under the former British Empire. Such law because it was bequeathed to Nigeria at the Independence is otherwise referred to as “received English laws”.

Statute Law:

These are laws specifically enacted by the nation’s legislature known as the Parliament of the National Assembly to deal with specific subjects or sectors. Example of such statute law are BOFIA (Banks and other financial institution Acts 1991), the CBN Act 1991 and CAMA (Companies and Allied Matters Act) 1990.

Subsidiary Legislations:

These are legislations made under the authorities of existing statutes. Examples are Rules, Orders, and Regulations by laws and ordinances.

The core legislation for this research is the Subsidiary laws and such are made by the apex bank CBN for other banks to observe. The prudential guideline was issued on November 7th 1990 Circular No BSD/DO/23/VOL.1/11 to all licensed Banks addressed requirements for asset classification and disclosure, provisioning, interest accrual and off balance sheet engagements.

In view of the importance of the circular to bank management, bank auditors and bank examiners, the objective of these guidelines is to prescribe the prudential treatment of restructured accounts to provide a transparent mechanism for timely structuring of debts of viable entities facing problems, outside the purview ofBIFR, DRT and other legal proceedings for the benefit of all concerned. The scope of these guidelines are applicable to restructuring/rescheduling of amounts due from all borrowers other than those eligible for restructuring under CDR Mechanism, eligible for restructuring under the debt mechanism for SME’s and restructured on account of Natural calamities for which Reserve Bank has issued a separate set of guidelines.

Casting a look at the size structure, the assets structure, the deposits structure and the volume of credits they grantto the economy, their dominant position becomes evident. In the light of this therefore, their indispensable role of pooling together funds from the surplus economic unit to the deficit unit fast tracks economic activities. Effective management of banks assets and liabilities posed a great concern to all stakeholders because of large scale financial distress. The late 1980s and early 1990s were years of financial boom, as the number of players increased substantially in the system. For instance, between 1986 and 1989, about 38 new commercial and merchant banks were created. The increase in the number of banks over stretched the existing human resources capacity of the banks which resulted into many problems such as poor credit appraisal system, financial crimes, accumulation of poor asset quality among others. The consequence was increased in the number of distress, banks and depositors began to loose confidence on our financial institutions in managing their fund.

Based on these experiences, the Federal Government of Nigeria through the Central Bank of Nigeria (CBN), 1990 indicates that regulation and supervision are essential ingredients for stable and healthy financial system, and that the need becomes greater as the number and variety of financial Institutions increased. The banking sector was singled out for a special protection because of the vital role banks play in an economy. Bank supervision entails not only the enforcement of rules and regulations, but also judgment concerning the soundness of banks assets, its capital adequacy and management (Volker, 1992). Effective supervision leads to healthy banking industry. At this direction, the deposit insurance scheme the assets quality of banks, reduce bad and doubtful debt, and ensure capital adequacy and stability of the system so that the depositor’s fund would be protected.

Banking as essentially an international business, especially now that domestic financial markets are being internationalized, need to develop and continuously review their reporting system which allow for a high degree of comparability of banking performance across national boundaries. Such systems have been evolved in such areas of banking practice as credit portfolio classification, disclosure interest accrual and off balance sheet engagements. The apex institution in Nigeria banking system, the Central Bank of Nigeria (CBN) is continuously moving banks in the country towards compliance with international banking practices.

To this end, the Banking Supervision Department (BSD) issued no November 7, 1990, circular letter No. BSD/DO/23VOL.1/11, to all licensed banks and their auditors. The circular titled “Prudential guidelines for licensed Banks” addressed requirements for asset classification and disclosure, provisioning interest accruals and off-balance-sheet engagements. The prudential guideline is intended as a hand book for target groups such as the bank auditors and the examiners. It is the task of the examiner to prevent bank failure by identifying bank problems at an early stage to allow for intervention and or corrective action before the situation gets out of hand.

1.2 Statement of Problem

The Central Bank of Nigeria (CBN) as a supervisory monetary authority had reasons for introducing the prudential guidelines into the banking scene in order to review banks credit portfolio at least once in a quarter with a view to recognizing any deterioration in credit exposure based on perceived risks of default. In order to facilitate comparability of banks classification of their credit portfolios, the assessment of risk of default should be based on criteria which should include, but not limited to repayment performance borrowers repayment capacity on the basis of current financial condition and realizable value of collateral.

Interest on problem loan/over draft is another area where differences exist among banks. When loans/overdrafts become apparently uncollectible, how should the interest that is calculated on it be treated? While some banks credit their profit and loss account with such unearned interest, others credit their suspense account.

The deregulation of interest in the Structural Adjustment Programme (SAP) period did not help, either interest on non-performing account were credited tothe profit and loss account of most banks to make their performance appear good to investors, the public and supervisory monetary authorities. This “window dressing” performance in most banks shook public confidence in bank’s financial statement in the late 1980 up to 1990, when prudential guidelines was introduced.

Prior to this period, most banks believed that once loans/overdraft was secured, whether the accounts were serviced or not, interest on it should continue to be credited to their profit and loss accounts believing that they would realize the security in case of default in payment. Since 1990 when a prudential guideline was introduced, the questions being asked regarding the prudential guidelines are;

Has the guidelines solved or attempted to solve these problems?
Will the guidelines be a success in the long run?
Will the guidelines create more problems to the system?

In the research, a detailed appraisal of prudential guidelines is to be undertaken, and a forecast of what they have for the Nigeria Banking Industry will be discussed.

1.3 Objectives of the Study

The objectives of this study shall be as follows:

To determine the impact of the prudential guidelines on bank safety and confidence in Nigeria.
To assess the reaction of depositors to the guidelines.
To find out whether there are international supervisory perspectives which affect national experience.

1.4 Research Questions

To what extent has the Prudential Guidelines helped to ensure safety and confidence in Nigerian banking system?
How do depositors react to the guidelines?
Are there international supervisory perspectives to the guidelines?

1.5 Hypotheses of the Study

The hypotheses of this study are as follows:

Prudential guidelines do not enhance safety and confidence in the Nigerian banking system.
Depositors do not react favourably to the prudential guidelines.
There are no international supervisory perspectives which affect national experience.

1.6 Scope of the Study

There are many banks in Nigeria banking industry. To achieve the aim of this research, the researcher has restricted himself to the study of only one- United Bank for Africa (UBA). In this regard, three branches of UBA within Enugu Metropolis are studied. The branches are UBA Main branch at station road, Okpara Avenue 2 (Marble House) and UNEC branch

1.7 Limitations to the Study

The limitations to this work include:

The problem of meeting appropriate officials of the banks who will give the right information required for the work.
The problem of getting all the necessary data became more complex and most of these officers’ do not want to volunteer their official data due to bureaucracy and Red-tapism which hinders the flow of information in Nigeria.
Availability of fund posed a problem to the researcher as this requires adequate finance to enable the researcher visit the necessary places and collect the required data.

1.8 Significance of the Study:

Prudential guidelines have been in the Nigeria Banking system since 1990. It is necessary to examine the impact it has on bank services and performance.

It is also necessary to research on the effects of the guidelines on banks to enable one access the pre-guidelines era and the present tradition it has imposed on bank practices. Such analysis will enable the supervisory authorities make a decision whether to retain, discard or modify prudential guidelines.
The need for this research arises from the fact it will be of immense benefit to students of banking and finance in having knowledge of historical evolvement of rules and regulations and most especially in the area of management of credit portfolio in Nigerian banks.

The duties of the Central Bank of Nigeria (CBN) and Nigeria Deposit Insurance Corporation (NDIC), Central Bank of Nigeria (CBN) and the Nigerian Deposit Insurance Corporation (NDIC).

1.9 Operational Definition of Terms

Bank:

A Bank is a financial house established for the purpose of accepting deposits and other precious commodities from the public for safe keeping.

Portfolio:

This is a collection of investible funds.

Prudential Guidelines:

It is the recognition of credit risk and writing-off same to avoid false picture of balance sheet.

Bad Debts:

There are debts which is not recoverable within the time frame set for their normal recovery period.

Doubtful Debt:

There are doubtful in case of recovery, hence they are termed doubtful debt.

Efficient Portfolio:

A group of asset that yield a maximum return for a given level of risk.

Risks:

An index of the variability of realized from expected returns.

Chapter Five

Summary of Findings, Conclusion and Recommendations.

5.1 Summary of Findings

The summary of findings emanating from this study is as follows:

The guidelines were introduced and imposed by the Apex bank (CBN) on other banks to curtail their excesses in the area of asset management especially as it pertains to credit portfolio management.
Prudential guidelines makes adequate provisions for risky assets and non- performing credits and then regularly reviewing their credit portfolio with view to recognizing deterioration in credit qualities.
The guidelines were meant to improve banks asset qualities and maintain high degree of lending and investments standard.
Banks were grossly undercapitalized; there were many portfolios of uncollectable debts and unrealistic profit declaration by banks.
The guidelines has also helped banks to upgrade their operations and thus reveals the increasing need of banking supervision in order to ensure compliance with the guidelines.
It has also helped to spot signs of distress in banking system; hence the authorities are being urged to step up supervision and examine efforts by conducting more frequently routine and special examination of banks activities as well as seeing the need for maintaining high liquidity by banks to ensure confidence in the system.
Prudential guidelines has also helped to check the mismatch between reported and actual profit. This height is achieved through stipulation that forces banks to provide for classification of loan into performing and non performing Assets.

Despite the benefits of the guidelines, there exist some disagreement over it’s been comparatively equal to the caliber of knowledge devices utilized as a regulatory instrument by develop banking Nations. This means that while it has helped to upgrade the standard of Nigerian commercial banks lending ability, it has to be operated in line with other regulatory devices/instruments to achieve the desired standard. Also, the management quality and awareness programme has been created as a result of the challenges brought about by the introduction of prudential guidelines.

On the problems of smooth implementation of the guidelines, external factors as well as internal were identified. These internal problems as well as external problems are:-

Over regulation of the system.
Adverse interest rate fluctuation
Excessive competition amongst commercial banks.
Inadequate debt recovery mechanism.
Poor staff remuneration
Capital inadequacy
Fraudulent practices like insider abuse
Difficulty in classifying assets held.
Managerial incompetence.

The above factors notwithstanding, prudential guidelines has proved a useful tool in making sure that credit portfolio is being classified properly and their reporting pattern appropriately documented in the financial statements.

5.2 Conclusions

The prudential guidelines have checked the performance of non performing credit facilities and hence have improved asset qualities of commercial banks.

Greater and better security of loan proposals are now experienced due to the demands of prudential guidelines; thus banks are now more loan shy and demand heavier/bigger collateral backing the loans.

The monetary authorities have increase their supervisory activities in a bid to strengthen the banking industry and these banks are required to send their quarterly financial statements so as to quickly recognized early sign of
distress in the industry; thus banks have been witnessing increase in liquidity which shows that the instrument has come to stay and therefore, a new era in banking services. The mismatch between the declared and actual profits in the year prior to the operation of the guideline has so far been checked; the guidelines have warded off any new entrant to the banking business in the country with the belief that banking is all about profit making and not prudence.

Since the introduction of Banks consolidation in 2005, the era of failed banks has been a thing of the past.

5.3 Recommendations

The Central Bank of Nigeria as a matter of fact should ensure that all International laws, rules and regulations guiding the banking industry is also practice here in the country so as to meet the world banking standard. Such laws, rules and regulations should be interpreted in simple form and there should be sensitization exercise on the players.

The guidelines should include the mechanism by which slow loans are retrieved to banks and where there is connivance of insiders such officer should be made to face the law squarely.

Judging from, and based on the findings in this research, it would be pertinent to proffer that monetary authorities takes steps to monitor trends in interest rates in the deregulated economy.

Also regulatory bodies should refrain from promulgating laws which are counterproductive i.e. adversely affecting the industry.

Concerted efforts should be made to discover sickly banks, by imposing stricter penalties for default of any provision. The Central Bank of Nigeria (CBN) as the apex bank should be encouraged as a means of encouraging effectiveness in management and thus avoid distress, this will help curb over competition. In management quality, seminars and special enlightenment program should be encouraged.

The problem of asset classification by banks can be curbed if the regulatory authorities CBN and NDIC subject the prudential guidelines to fit current macro- economic and monetary trends in the country and world all over. Also, the prevalent debt recovery laws should be subject to review, so as to enable banks who are owed the opportunity to effectively enforced collection of debt from their debtors.

Efforts should be made to instill discipline into the banking system in general by continuing the policies of the Abaca’s regime, which saw a lot of liquidation of ailing banks and the trials of fraudsters.

If these recommendations are met, this writer is of a firm belief that the prudential guidelines will not only operate smoothly to achieve its objectives but also in its efforts improve the efficiency of all commercial bank in Nigeria.

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