CHAPTER ONE

INTRODUCTION

1.1     BACKGROUND TO THE STUDY

In the ordinary parlance, the word distress connotes unhealthy situation or state of inability or weakness which prevents the achievement of a set goals and aspirations. A financial institution will be described as unhealthy; when it exhibits severe financial, operational and managerial weaknesses where sustainability and stability are missing in business. A business is any activity that seeks to make profit by providing goods and services to the society by using inputs from the environment and transform them into outputs that add meaning to human existence. A business can be one’s regular employment, profession, occupation and can be an organization established through the pooling together of resources by various investors with the aim of providing products or services to the economy, contribute to the development of the economy and earn returns on their investments. Nigerian businesses can be classified into three major segments viz: Private enterprises, Private limited Liability Companies and publicly quoted companies. The banking sector belongs to the private limited liability companies and the publicly quoted companies. While some banking institutions are privately owned by investors, some are publicly quoted on the Nigerian Stock Exchange. The banking sector is part of Nigerian financial system, and financial system refers to the totality of the regulatory and participating institutions, including financial markets and instruments, involved in the process of financial intermediation. The major objectives of investing in the banking sector are to provide financial services to the economy and earn compensatory returns on capital employed.

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The Bills of Exchange Acts Cap 21, Laws of the Federation of Nigeria 1958 states that a ‘banker’ includes a body of persons whether incorporated or not who carry on the business of banking. By S.2 Coins Act Cap 34, laws of the Federation of Nigeria, 1958, bank and banker mean any persons, partnerships or company carrying on the business of bankers and also any saving bank established under the Saving Bank Ordinance, and also any banking company incorporated under any ordinance heretofore or hereafter passed relating to such incorporation. S.21 (1) Nigerian Evidence Act, Cap.62, laws of Federation of Nigeria, 1958, also provides in like manner. (Olulana, 1999:16). The Banks and other Financial Institutions Act No 25 of 1991 defines bank as one licensed under the Act and banking business as the business of receiving deposits on current, saving or other similar account, and paying or collecting cheques-S.62 BOFIA. The industry is the enabling hub of national and global payments system by facilitating trade transactions within and amongst numerous national, regional and international economic units and by so doing; it enhances commerce, industry and exchange. The banking industry in Nigeria is the bedrock of the economy.

According to Onoh (2002:10-13),the establishment of modern banking in Nigeria dates back to the colonial era when the African Banking Corporation was formed in 1892 to distribute currency notes of the Bank of England for the British treasury. Subsequent developments were encouraged by colonial entrepreneurs who needed banking institutions to back up the colonial trade. In the bid to address the credit needs of indigenous entrepreneurs, Nigerians later ventured into the banking business, initially through private individuals and later through deliberate government policy. According to

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CBN and NDIC (1995:1), the problem of distress in the financial sector, including bank failure, has been observed in Nigeria as far back as 1930 when the first bank failure was reported. Between 1930 and 1958 when Central Bank of Nigeria CBN was established, about 22 banks were liquidated (appendix 1). In 1992, 3banks were liquidated while in 1994, 4banks were liquidated. The degree of intensity and scope of the distress has never been as serious as has been observed since June,1989 when the Government directive to withdraw deposits of government and other public sector institutions from banks to the CBN exposed the weak financial condition of most financial institutions. This led to the increase in the number of distressed institutions and the severity of the problem has been on the increase. The intensity of the problem led to the liquidation of 26banks in 1998(appendix 2).

According to CBN (2004:1), following the deregulation of the Nigerian financial sector in 1986 during era of structural adjustment programme (SAP), the banking industry witnessed remarkable growth, both in the number of deposit money banks and other types of financial institutions. However, in the early 1990s, Nigerian banking institutions faced many challenges, including increased competition and harsh economic conditions. Against this background, the incidence of financial sector distress induced by undercapitalization, liquidity crisis and high degree of non-performing loans characterized the banking industry in Nigeria. Some of the banks were faced with the threat of liquidation, while some were resuscitated as a result of the timely intervention of the regulatory authorities.

Several measures have been taken by the supervisory agencies to tackle the problem of distress in the financial system most especially the banking industry to stem the

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deterioration in the financial conditions of ailing banks with the ultimate aim of restoring confidence in the financial system. These varied from financial assistance, imposition of holding actions and supervisory intervention to the outright liquidation of some distressed banks. As a way of minimizing the distress in the banking system, the Central Bank in 1990 introduced the Prudential Guidelines on early recognition of loan losses and required banks to make adequate provisions for bad and doubtful debts, a factor which was responsible for the insolvency of some banks.

The Central Bank of Nigeria explained that based on bank examination reports, the supervisory authorities drew the attention of the Boards and Managements of distressed banks to a number of shortcomings such as poor credit policy, large portfolio of non-performing assets, weak internal controls, insider abuses. All the recommendations were unheeded. The regulatory authorities had to impose holding actions on such banks, the implementation of which was time bound. The CBN in collaboration with the NDIC granted liquidity support to illiquid banks to assist them meet their obligations as and when due. This helped to achieve some measure of success and restore public confidence. Technical assistance was provided by the supervisory agencies in form of advisory services and secondment of staff when the need arose. Owing to limited success in the application of Holding Actions, the CBN assumed control and management of some distressed banks with the intention to acquire, restructure and subsequently sell them to the public. In order to sanitize the banking system and install market discipline, the licences of some banks were revoked in the system in 1992, 1994, 1998 and 2005.

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According to Eghodaghe (1993) and cited by CBN/NDIC (1995), a financial institution in distress is usually one where the evaluation depicts poor condition in all or most of the five performance factors as follows:

(a)  Gross undercapitalization in relation to level of operation;

(b)   High level of classified loans and advances;

(c)  Illiquidity reflected in the inability to meet customers’ cash withdrawals;

(d)  Low earnings resulting from huge operational losses, and

(e)    Weak management as reflected by poor credit quality, inadequate internal controls, high rate of frauds and forgeries, labour turn-over, etc.

Based on the extent and depth of the problem, it is evident that Nigeria has been experiencing generalized type of distress. The generalized type of distress exists when its occurrence is spreading so fast and cut across all the sub-sectors of the industry but its depth, in terms of the ratio of total deposits of distressed institutions to total deposits of the industry; the ratio of total assets of distressed institutions to total assets of the industry; and the ratio of total branches of distressed institutions to total institutional branches of the industry; among others, has not adversely affected the confidence of the public in the financial system. This situation arose because of the highhandedness of the Board of Directors and Management of the various institutions. The Managing Directors and Chief Executive Officers of these banks had influencing and controlling power over operational issues which have breached the tenets of corporate governance. The four pillars of corporate governance of Accountability, Fairness, Transparency and Independence have been thrown into the dustbin. Non-compliance with monetary and fiscal policies and regulatory authorities principles and regulations have resulted into