Banking Stability in Nigeria
Banking Stability in Nigeria
Banking Stability in Nigeria
This study investigates the determinants of banking stability in Nigeria. Banking stability is crucial
for the stability of any financial system in the world. Financial system regulators understand that a
loss of confidence in the banking system can have devastating consequences for the entire
financial system. For this reason, banking stability has always been a top regulatory and
supervisory policy objective for regulators. Nigeria has an emerging banking sector which is
ranked ‘third’ in Africa after South Africa and Egypt. Nigeria has experienced many episodes of
financial and economic recession within the last two decades, and this has brought the fragility of
Nigerian banking and finance onto the front burner of discourse by academics and policy makers.
Many studies have identified some determinants of banking stability such as financial development
levels, bank efficiency and systemic interconnectedness, among others. But much of these studies
have focused on developed economies. One major issue that is not clearly understood in the
literature is the determinants of banking stability in emerging economies, given that their financial
structure is less sophisticated than that of developed economies.
So far, the literature on bank stability determinants in Africa is rather scanty, and the studies that
examine the Nigerian context are quite few. Therefore, there is need to identify the determinants of
banking stability in Nigeria. In theory, bank capital and abnormal credit cuts are the two biggest
predictors of bank failure (Diamond and Rajan, 2009; Mendoza and Terrones, 2012). Focusing on
bank capital, bank regulators in Nigeria want banks to keep sufficient capital for the risks they take
and to mitigate unexpected losses (CBN, 2010). However, some experts believe that capital
resources alone are not sufficient to achieve banking stability in emerging economies due to
debates about what constitutes bank capital (Farag et al, 2013, Ozili, 2017a). Considering these
arguments, it is needful to identify the determinants of banking stability in Nigeria.
This study differs from prior studies in that it is primarily interested in aggregate outcomes rather
than in individual bank performance. Using aggregate outcomes allows us to focus on the changes
occurring in the Nigerian banking industry. The study uses the z-score as the measure of banking
stability. The explanatory variables include bank performance variables, macroeconomic variables
and financial structure variables. The findings indicate that nonperforming loans, regulatory
capital, bank efficiency, financial depth and banking concentration have a significant effect on
banking stability in Nigeria depending on how banking stability is measured. The findings are
robust to alternative estimation techniques.
This study contributes to the literature in two ways. Firstly, it aligns with studies that explore bank
stability and regulation (e.g. Ozili 2017a; Allen and Gale, 2004; Brunnermeier et al., 2009;
Segoviano and Goodhart, 2009; Ozili, 2019). These studies attempt to identify the sources of
fragility or potential factors that influence financial stability. This study adds to this literature by
examining the case of Nigeria since studies on banking stability determinants in Nigeria are scanty.
Secondly, from a policy standpoint, insights gained from this study would help bank supervisors
understand the importance of assessing how bank-factors, macroeconomic factors and financial
structure could affect the stability of the banking system in the Nigeria.
In recent years, the Nigerian economy has encountered domestic and external shocks. The
economy has continued to grow to roughly 6.7 percent annual estimate since 2009. Efficiency in
financial institutions has continued to improve, although there are still some anti-crisis emergency
measures that need to be in place. The need for sustaining financial stability in spite of the crisis
and in the face of significant internal and external threats are drivers of the Central Bank (CBN)'s
crucial and broad-based policy response.
The CBN has taken an extensive range of remedial measures after the crisis. Substantial liquidity
has been injected; a full guarantee has been given to depositors as well as to banks interbank and
foreign loan lines. The Asset Management Company of Nigeria (AMCON) was set up to buy
banks’ Non-Performing Loans (NPLs) in return for zero-coupon bonds and injection funds to take
assets to zero. Other measures taken were the strengthening of financial laws, regulations to
enhance corporate governance and other oversight functions while also abandoning the Universal
Banking Model and also instructing banks to set up holding companies (Kaminsky and Carmen,
1999; Laeven and Levine, 2009).
In spite of the procedure towards a favourable macroeconomic outlook, a significant risk in the
financial system persists. There have been bank and other financial service failures such as a
substantial decline in the value of asset prices, liquidity shortages, the inability of these institutions
to meet their financial obligations and finally stock market crashes. These kinds of financial crises.
Also, an overview of the non-banking financial institutions in the country shows the need for
additional regulations. For instance, the insurance sector requires the better implementation of
compulsory insurance; improvements in requirements of product disclosure; and the resolution of
unviable businesses.
Given the different regulatory frameworks instituted to forestall crises in the financial sector in
Nigeria such as the CBN’s emergency liquidity assistance (ELA), the Nigeria Deposit Insurance
Corporation (NDIC) and AMCON’ indemnity of banks’ nonperforming loans (NPLs); in addition
to current security situation and legal and political laxities, the questions remain: how stable is the
financial sector in Nigeria? How diverse is the financial sector in Nigeria? What is the effect of the
financial sector on economic growth in Nigeria? This study, therefore, examines the stability and
diversity of the Nigerian financial sector.
The main objective of this study is to assess the stability and diversity of the Nigerian Financial
sector. The specific objectives include to empirically:
i. Examine the stability of the financial sector in Nigeria.
ii. Analyze the level of diversity in the Nigerian financial sector using their concentration index.
iii. Investigate the effect of the financial sector on economic growth in Nigeria.
This study's will highlight the problems that militate against the realization of the monetary policy
objectives and focus attention on the prospects of minimizing the effect of the problems
outstanding in terms of financial instability. These problems should be eliminated to have the
advantages of a stable and efficient financial system's monetary policy objectives.
1.7 Scope and Limitation of the Study
The study therein considered banking system and the stability of financial institutions. The study
can be expanded and the study can be expanded to different safety and soundness of the banking
system conditions. There is a great need on the part of the researcher to reveal certain problems
encountered in the course of writing this project. There were some constraints which as limiting
factors are worth mentioning first, the issues of time there was not enough time for the researcher
to adequately carry on indent worth. This was due to the high schedule of the school political
impasses in this study.
Secondly, it was certainly not easy for the researchers to get vital information from the company
understudy as they were termed confidentially. Most of the workers too declined to accept
questionnaires. In depth analysis could not be carried out because of shorter time period.
Finally, despite these difficulties, justifiable and acceptable work has been done to this research
work. However, there were some constraints that impinged on the research, these are;
Financial constraint: The cost of sourcing information and administering questions was quite on
the high side, which included issuing out questionnaires to students.
Time Constraint: The limited time frame given to achieve the research was also a constraint to
the study.
Monetary base: This is also known as high-powered money or reserve money and comprises
certain CBN liabilities, including currency with the non-bank public and total bank reserves.
Money stock or money supply: This refers to the total value of money in the economy, and this
consists of currencies (note and coins) and deposits with the commercial and commercial banks.
Macro-economic: This is the study of aggregate, average or whole covering the entire economy.
Interest Rate: The interest rate provides a link between the change in a monetary variable
(instrument) and the level of output, income and employment.
Financial stability: This is the financial system's resilience to unanticipated adverse shocks while
enabling the financial system's intermediation process is continuing smooth functioning.
Open Market Operations (OMO): This involves sales or purchasing government securities in the
open market, whether the economy is inflationary or deflationary.
Inflation: Means a sustained rise in the average price of goods and services in the country, without
a corresponding increase in the quantity.
Liquidity: This is the excess of the money supply over money demand.
CHAPTER TWO
LITERATURE REVIEW
In Nigeria, the financial service sector comprises of financial institutions, financial markets,
specialized development finance institutions and other various institutions. Under the financial
institutions, we have both bank and non-bank institutions. Bank involves commercial banks,
mortgage banks, merchant banks, etc., while non-bank involves insurance companies, pension
firms, finance firms, and exchange offices. The financial markets are both the money and capital
markets where loans are secured for various reasons. The specialized development finance
institutions are set up to support economic development particularly in developing countries such
as the Bank of Industry (BOI) and Nigerian Export Import Bank (NEXIM).
The Nigeria financial service sector also includes the supervisory authorities charged with the
responsibility of regulations. They are the Central Bank of Nigeria (CBN), Nigerian Deposit
Insurance Corporation (NDIC), Securities and Exchange Commission (SEC), National Insurance
Commission (NAICOM), Nigerian Stock Exchange (NSE) and the Federal Ministry of Finance
(FMF). The financial sector in Nigeria has experienced several reforms to improve its efficacy.
Financial stability refers to the absence of systemic financial shocks or crises. It is merely the
avoidance of a financial crisis in an economy (Macfarlane, 1999). The emphasis on systemic
shocks or crisis is essential in this definition, as financial instability does not only connote
financial Ill-health of a particular bank, firm or household but extended to cover the entire
financial system in an economy.
According to foot (2003), financial stability is attained if:
i. Monetary stability is achieved.
ii. The employment level in an economy is close to its natural rate.
iii. The public reposes complete confidence in the operations of critical financial institutions and
markets and there is relative stability in the price movement of both real and financial assets. By
inference, financial stability cannot be achieved in an economy characterized by rapid inflation or
high unemployment rate. Similarly, high incidences of bank failures or financial institutions'
inability to perform their intermediary financial role either for individuals or corporate customers
are symptoms of financial instability, leading to a gradual erosion of public confidence in the
financial system. The implication is a slowdown in economic growth due to credit's nonavailability
or high financial intermediation cost. Simply put, "financial stability is a state of affairs in which
an episode of financial crisis unlikely to occur, so that fear of financial instability is not a material
factor in an economic decision taken by household or businesses" (Allen & Wood, 2005). It is
important to emphasize that financial instability could have occurred if the financial shock or stress
is significant enough to cause substantial damage to a large group of customers and counterparties.
2.1.3 Banking System Stability
The Basel Committee on banking supervision established an initial set of guidelines (Basel I) to
complement banking regulations to improve the stability of the banking system and to fill the
synchronization gap that led to prior financial crises. It was, however, discovered that Basel I was
ineffective owing to rapid financial development caused by innovation and risk management.
Basel II was subsequently developed in 2004, which was based on three pillars: supervisory
review, market discipline and minimum capital requirement. The implementation of the Basel II
framework was both slow and difficult. Then, the 2007–2010 global financial crises had a massive
impact on global banking system stability. The unpredictable business environment characterized
by increased financial distresses and bank failures required that immediate attention be paid to the
banking system in particular and other financial institution in general. Many issues were raised,
and due to the impact that they had on the economies the desire to solve the problems became top
priority for financial experts, academics, policy makers and researchers. (Neem, 2019).
The micro prudential regulation assumes a partial-equilibrium condition and is aimed at averting
the failure of individual financial institutions. According to Sere-Ejembi, Udom, Salihu, Atoi and
Yaaba (2014), the paradigm of micro-prudential supervision views that risks arise from individual
malfeasance.
Therefore, micro-prudential regulation focuses on the stability of the components of a financial
system. The regulation seeks to enhance the safety and soundness of individual financial
institutions by supervising and limiting the risk of distress. The principal focus is to protect the
clients of the institutions and mitigate the risk of contagion and the subsequent negative
externalities in terms of confidence in the overall financial system.
2.2.2 Macro-Prudential Approach
The macro prudential approach, on the other hand, adopts the general-equilibrium condition and is
aimed at safeguarding the entire financial system (Charles, 2015). Macro prudential policies aim to
increase the overall resilience of the financial system, contain the build-up of systemic risk over
time. It is also reputed to address vulnerabilities stemming from structural relationships between
financial intermediaries. (Ananthakrishnan, Heba & Pilar, 2016) The macro-prudential approach
argues that safety and soundness of the entire financial system is not necessarily guaranteed by the
safety and soundness of the individual financial institutions. In fact, there are times when
individual actions of the financial institutions aimed at keeping such institutions safe and sound
may pose dangers to the stability of the entire system. (Charles, 2015) According to
Ananthakrishnan, Heba and Pilar, (2016), a macro prudential policy framework should ideally
encompass:
(i) A system of early warning indicators that signal increased vulnerabilities to financial stability;
(ii) A set of policy tools that can help contain risks ex ante and address the increased
vulnerabilities at an early stage, as well as help build buffers to absorb shocks ex post; and
(iii) An institutional framework that ensures the effective identification of systemic risks and
implementation of macro prudential policies.
Micro and macro-prudential supervisions are interlinked. Macro-prudential supervision cannot
achieve its objective except it has some level of impact on supervision at the micro-level.
METHODOLOGY
The research design to be used for this study is a quantitative description survey research design.
Survey is a research method which involved the researcher using it to get information about certain
groups of people who are representative of some larger group of people of interest to them.
Population here refers to the total number of workers targeted to form the focus of this study. The
objective of the data collection process is draw conclusions about the population. It is therefore
imperative to have a clear picture of what constitutes the research population. The total number of
customers of financial institutions in Abeokuta South Local Government is over hundred after
taking census of the various industries (Adeyanju, 2018).
According to Egbu (2010), sampling involves the section of a number of study units from a
defined study population. The technique to be used for this research study is the simple random
technique. A sample is therefore, a small representative of a large population. In drawing a small
sample for the study, the researcher considered how many people that are needed in the sample and
their categories first to be selected.
A total number of one hundred (100) questionnaires were distributed among respondents and sixty
(60) were fully filled and returned.
A source of data includes primary data which will assist the researchers to make a thorough
analysis of the problem at hand. Primary data were obtained through the use of questionnaire to
gather accurate information.
3.6 Method of Data Collection
The method of collection for this study will be questionnaire. Questionnaire was used for
collection of data needed for this study. The reliability of the information of this study depends
largely on the ability of the selected sample size to provide accurate and measureable answers to
questions on the questionnaire.
Quantitative method will be used for data analysis in the research work. Data collection through
questionnaire will be presented in tables and analyzed using sample percentage.
Research instrument that will be used for this study will be questionnaire. To ensure the validity of
the study, the questionnaire will be shown to the supervisor before final administration to avoid
misunderstanding of any questions drawn.
This research work will be accorded with a close supervision as the supervisor will read, made all
necessary corrections in the areas where lapses occurred and after which the corrections has been
made, he approves validation of the work.
The research instrument to be used is reliable because the information obtained has been tested
over and over again and yet same result was gotten hence, reliable.
The following multiple linear regression model has been formulated to guide the research in the
investigation:
Y = f (x)
X = independent variable
Y = Dependent variable
Y = Tool for decision Making
Y = a+b(x)
Financial analysis = a +b (Tool for Decision making)
X1 = Investment
X2 = Decision making
X3 = Competitive environment
Y = f(x1+x)