CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

In any modern economy, the efficient production and exchange of goods and services depends on money, and banks are the main institutions through which money is made available. Banks collect funds from surplus units and channel them to deficit units for investment, which supports output and economic growth. Because of this intermediating role, the failure of a bank differs from the failure of an ordinary firm. Banks are closely interconnected, and the costs of a failure can spread through the system and fall on solvent institutions as well as weak ones (Enebeli-Uzor & Ifelunini, 2021). The loss of confidence that follows a failure discourages savings and investment and hurts small and medium-scale businesses, which drive growth in the economy (Enebeli-Uzor & Ifelunini, 2021). Bank failure also brings job losses, losses to shareholders and a general erosion of confidence in the banking sector (Enebeli-Uzor & Ifelunini, 2021). For these reasons the financial health of banks is a matter of concern to government, regulators, bankers and the general public.

Banking in Nigeria developed in phases, and for the purpose of this study two broad phases are considered: the era of free banking, up to 1952, and the era of regulated banking that followed. Nigeria’s first bank, the African Banking Corporation, was established in 1892, and no banking legislation existed until 1952 (Library of Congress, 1991). By 1952 the country had three foreign banks, namely the Bank of British West Africa (now First Bank of Nigeria), Barclays Bank (now Union Bank) and the British and French Bank (now United Bank for Africa), together with two surviving indigenous banks, the National Bank of Nigeria and the African Continental Bank (Library of Congress, 1991). Banks established in the free banking era generally had little or no regulation and a weak capital base to absorb shocks, and as fast as banks were opened many of them collapsed (Adeyemi, 2010).

The failures of the period led to a commission of inquiry headed by G. D. Paton, whose report provided the basis for the Banking Ordinance of 1952, the first law to regulate banking in Nigeria (Central Bank of Nigeria [CBN], n.d.). The ordinance was designed to ensure orderly commercial banking and to prevent the establishment of unviable banks, and it introduced bank licensing, minimum capital requirements, reserve funds and bank examinations (CBN, n.d.; Library of Congress, 1991). It did not, however, stop bank failures, and the Central Bank of Nigeria, which began operations in 1959, took over the examination and supervision of banks (Adeyemi, 2010).

Financial distress in the Nigerian banking industry in its modern and most severe form is of more recent origin. The liberalisation of the financial sector in 1986 under the Structural Adjustment Programme eased the requirements for bank licences, and the number of commercial banks rose from 40 in 1985 to 120 in 1992 (Enebeli-Uzor & Ifelunini, 2021). The banks were too many to operate efficiently, and failures and distress became increasingly common in the 1990s (Enebeli-Uzor & Ifelunini, 2021). Political instability in 1992 and 1993 caused runs on bank deposits and a prolonged crisis, and a large number of banks failed between 1993 and 2004 (Adeyemi, 2010). The Nigeria Deposit Insurance Corporation (NDIC) was established in 1988 to protect depositors in licensed banks against bank failure (Library of Congress, 1991), and the Banks and Other Financial Institutions Decrees of 1991 strengthened the powers of the CBN, including its power to withdraw the licences of distressed banks and appoint liquidators (CBN, n.d.). Poor credit management and weak documentation of loan security were identified as significant contributors to distress and bank liquidation, with 69 banks liquidated between the pre-independence period and 2011 (Adegbie, 2011).

The authorities responded with recapitalisation. In July 2004 the CBN raised the minimum capital of banks from N2 billion to N25 billion, to be met by the end of 2005. Twenty-five banks emerged from the exercise, and the licences of the fourteen that could not meet the requirement or find merger partners were revoked (Enebeli-Uzor & Ifelunini, 2021). Even so, the global financial crisis of 2007–2009 exposed new weaknesses. A special examination by the CBN and NDIC found nine banks in a dire state, and the authorities injected N620 billion into them and replaced the chief executives of eight of the nine. Three banks were later taken over through bridge banks, and the Asset Management Corporation of Nigeria (AMCON) was set up in 2010 to buy the non-performing loans of banks. The net cost of stabilising the system was estimated at N1.75 trillion, about 5.85% of GDP (Enebeli-Uzor & Ifelunini, 2021).

Research points to several causes of distress. They include a sharp rise in non-performing loans, a high cost-to-income ratio, inadequate equity capital and the ownership and management structure of the bank (Enebeli-Uzor & Ifelunini, 2021). Weak credit management is a particular concern (Adegbie, 2011). Distress is also reflected in profitability: return on average assets was negative for distressed banks in a study of Nigerian banks covering 2006 to 2015 (Enebeli-Uzor & Ifelunini, 2021), and studies of Nigerian commercial banks show that non-performing loans and credit-risk indicators have a significant relationship with profitability (Nwosu et al., 2020; Onyeiwu et al., 2020). This study therefore examines the causes and problems of financial distress in the Nigerian banking sector and its effect on the profit growth of commercial banks, using Afex Bank Plc as the case study.

1.2 Statement of the Problem

Widespread financial distress among banks threatens the banking habit and weakens the payment system. When confidence is lost, depositors and businesses withdraw their funds and take fewer risks, and they tend to move their money to banks they regard as safe, as happened in the runs on deposits during the crisis years (Adeyemi, 2010; Enebeli-Uzor & Ifelunini, 2021). This reduces the funds available for lending and investment, and it can slow economic growth (Enebeli-Uzor & Ifelunini, 2021).

In addition, distress damages the financial performance of the banks themselves. High levels of non-performing loans and weak credit risk management reduce profitability (Nwosu et al., 2020; Onyeiwu et al., 2020), and distressed banks have been found to record negative returns on assets (Enebeli-Uzor & Ifelunini, 2021). Efforts by regulators have not removed the problem, as distress has recurred after each reform (Enebeli-Uzor & Ifelunini, 2021). This study is therefore concerned with evaluating the impact of bank financial distress on the profit growth of commercial banks, using Afex Bank Plc as a case study.

1.3 Purpose and Objectives of the Study

The main purpose of the study is to analyse critically the causes and problems of financial distress in the Nigerian banking sector, using Afex Bank Plc as a case study. The specific objectives are to:

1. evaluate the causes of financial distress in the Nigerian banking sector;
2. find out the impact of financial distress on the profit growth of commercial banks; and
3. find out the possible prevention strategies and failure-resolution options for bank distress.

1.4 Research Questions

The study seeks answers to the following questions:

1. What are the causes of financial distress in the Nigerian banking sector?
2. What is the impact of financial distress on commercial banks?
3. What is the profit growth rate of the commercial bank under study during the period of distress?
4. What are the effects of bank distress on depositors, the economy and the banking industry?
5. What are the possible solution options to this problem in the banking sector?

1.5 Research Hypotheses

The following hypothesis, stated in null (H0) and alternative (H1) form, guides the study:

H0: Financial distress has no significant effect on the average profit of commercial banks.

H1: Financial distress has a significant effect on the average profit of commercial banks.

1.6 Significance of the Study

The study will be useful to the following groups:

1. New-generation banks. They will see the implications of bank distress for the industry and learn how to restore customers’ confidence and sustain an efficient payment system.
2. The Nigeria Deposit Insurance Corporation (NDIC). The findings will assist the NDIC in distress management, prevention strategies and failure-resolution options in the banking industry, areas that studies have also urged regulators to strengthen (Enebeli-Uzor & Ifelunini, 2021).
3. Students and researchers. They will learn the extent and trend of financial distress in the banking industry and how it affects modern banking, and the work will serve as a reference for further research.

1.7 Scope, Limitations and Delimitations of the Study

In theory, the population of the study is the banks affected by financial distress in Nigeria. The study is designed to analyse critically the causes and problems of financial distress in the Nigerian banking sector, and it is delimited to Afex Bank Plc as a case study. It analyses the trend in the bank’s profit over a period of three years, from 2015 to 2017. Because the study relies on a single bank and on published financial information, its findings may not be generalised to all banks in Nigeria.

1.8 Definition of Terms

Distress: a state of difficulty arising from a shortage of money or from danger and adversity. In banking, a bank is said to have failed when it cannot meet its obligations to depositors or other creditors because it has become insolvent or too illiquid, and distress is the condition that leads to this point (Enebeli-Uzor & Ifelunini, 2021). Under the CBN’s prudential threshold, a bank is considered distressed when the ratio of its equity to total assets falls below 10% (Enebeli-Uzor & Ifelunini, 2021).

Evaluation: the process of assessing or judging something, including working out its value in numerical terms.

Impact: the strong effect that one thing has on another, for example the effect of financial distress on a bank’s profit.

Commercial bank: a bank that provides services such as accepting deposits, granting business loans and offering basic investment products. The term can also refer to a division of a bank that deals mainly with deposits and loans from corporations or large businesses, as opposed to retail banking for individual members of the public.

References

Adegbie, F. (2011). Bank credit management and its effects on profitability profile in the Nigerian banking industry. The Nigerian Banker (Chartered Institute of Bankers of Nigeria), January–March, 45–51.

Adeyemi, B. (2010). Banking crisis in Nigeria: Causes, consequences, resolution options and preventive measures (Paper LV10074). Academy of Business Research Institute conference proceedings, Las Vegas.

Central Bank of Nigeria. (n.d.). Our history. https://www.cbn.gov.ng/AboutCBN/History.html

Enebeli-Uzor, E. S., & Ifelunini, A. I. (2021). Analysis of bank distress and failure predictability in Nigeria (AERC Research Paper 456). African Economic Research Consortium.

Library of Congress, Federal Research Division. (1991). Banking and finance. In Nigeria: A country study. https://countrystudies.us/nigeria/66.htm

Nwosu, C. P., Okedigba, D. O., & Anih, D. O. (2020). Non-performing loans and profitability of the Nigerian commercial banks. Central Bank of Nigeria Economic and Financial Review, 58(3), 35–58.

Onyeiwu, C., Ajayi, G., & Muoneke, O. B. (2020). The impact of credit risk on bank profitability in Nigeria. Journal of Banking and Financial Economics, 2020(13), 5–22. https://doi.org/10.7172/2353-6845.jbfe.2020.1.1