1ADEGBITE- Financial Sector Reforms

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FINANCIAL SECTOR REFORMS AND ECONOMIC DEVELOPMENT

IN NIGERIA: THE ROLE OF MANAGEMENT

BYDR ESTHER O. ADEGBITE

DEPARTMENT OF FINANCEUNIVERSITY OF LAGOS

BEING A PAPER DELIVERED AT THE INAUGURAL NATIONAL

CONFERENCE OF THE ACADEMY OF MANAGEMENT NIGERIA AT ABUJA,

NIGERIA TITLED MANAGEMENT: KEY TO NATIONAL DEVELOPMENT

NOVEMBER 22 23, 2005 , AT ROCKVIEW HOTEL, ABUJA

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INTRODUCTION

Governmentleddevelopment was the ruling economic development

paradigm in Nigeria up to the 4th quarter of 1986. Under this paradigm

the private sector was a passive partner in development, while the

public sector dominated all other sectors of the economy agriculture,

commerce, services, (especially, transportation) industry etc.

Government designed what are known as National Development Plans,

meant to guide the nation in its development path. In the 1960s and

1970s government had sufficient financial resources to finance a

reasonable proportion of each development plan. By the middle of the

1990s however, the nation had become saddled with an excruciating

external debt burden, falling terms of trade in the international market

place, slow growth of output, high rate unemployment etc, that the

government had to do a rethink of the underlying philosophy of

development in Nigeria. The result was a shift in the economic

development paradigm from government led to private sector led

development. In line with this paradigm shift was the need to relief

every sector of all strangulating regulations that had hitherto

characterised every sector, in governments bid to have firm control

over every sector and ensure that they all move in line with

governments perceived goals for the nation. Therefore, by the 4th

quarter of 1986 a programme was fashioned out for the nation called

the Structural adjustment Programme (SAP). The SAP attempted to

move the country away from government direct control of economic

activities to indirect control, (i.e. control of economic activities

(through the market forces). So, all sectors of the economy were

deregulated trade, exchange, finance, industry etc.

Prior to the deregulation of the economy the financial sector had been

the most highly regulated. The reasons for this are not far fetched.

First to finance development funds are needed, and the stock-in-trade

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of the financial system is fund, so government needed to have a good

grip over that sector especially its banking sub-sector. The financial

system not only provides the intermediation that pools funds from

savers and channel to investors, it also provides the payments system

that facilitates trade and exchange. Furthermore in the working of

governments monetary policy to provide macroeconomic stability for

all economic agents, the financial sector provides the platform for the

working out of this policy.

Given the key position of the financial system especially the banking

subsector, the government rigidly controlled every aspect of their

activities. For instance for the banking subsector government

regulated how much interest banks could charge on the loans that go

the different sectors, and how much loans banks could give (i.e. what

proportion of their loan portfolio) to different sectors. Government

controlled how much interest they could pay on their deposits and at

what rate their credit could grow. There were rigid regulations guiding

entry into the banking system. In the end the financial sector was

repressed, especially the banking subsector which constituted the

greatest proportion of the sector and so could neither generate enough

savings at the ruling rate of interest, nor find enough investment for

meaningful capital formation and development.

Thus at the onset of deregulation the financial sector was also

deregulated; interest rates were freed, and credit became free to

move into whatever sector it desired. Rules concerning entry into the

financial system were relaxed and there was a massive inflow of new

players into the financial sector. By 1992 the number of banks in the

Nigerian banking sector had risen from 56 in 1986 to 120. In the

whole financial system there had been increase in the number of old

type of institutions (e.g. commercial and merchant banks) and entry of

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new kind of financial institutions, (e.g. finance houses, bureaux de

change, Community banks), and entry of a great variety of new

financial instruments etc.

Table 1 below gives the picture of the transformation in the Nigerian

Financial Scene.

Table 1

Institutional Development In The Nigerian Financial sector

After Deregulation.

Banks/Institutions 1990 1991 1992 1993 1994 1995 1996 June 1997

Development Banks 4 4 4 4 4 4 4 4

Specialised banks (i.e A+B) 169 287 629 882 1,089 1,410 1,077 1,077

Community Banks -A - 66 401 611 813 1132 796 721

People's Branches) -B 169 221 228 271 275 275 278 278

Educational Bank - - - - - 1 1 1

Urban Development Bank - - - - - 1 1 1

Maritime Bank - - - - - 1 1 1

Specialised FinancialInstitutions

82 126 871 673 679 745 409 409

Financial Houses - - 618 310 390 368 125 25

Insurance Companies

(Reporting)

80 100 105 105 103 90 90 90

Discount Houses - - - 3 4 4 5 5

Primary Mortgage - 23 145 252 279 280 186 186

Institutions NERFUND 1 1 1 1 1 1 1 -1

NEXIM 1 1 1 1 1 1 1 1

NSITE (NPF) 1 1 1 1 1 1 1 1

Commercial Banks 58 65 66 66 65 64 64 64

Merchant Banks 49 54 54 54 54 51 51 51

Bureaux de change 88 102 132 144 191 223 223 223

Stock Brokerage firms 80 110 140 140 140 162 162 162

Issuing House - - 141 147 162 162 162 162

Registrars 14 14 32 33 40 40 41 41

Source: (i) Umoh, P.N and Ebhodagbe, J.U. (1997) Bank Deposit

Insurance in Nigeria Lagos. NDIC.(ii) CBN (1997) Statistical Lagos, CBN.

However in spite of the increased number and variety of financial

institutions the real economy showed no marked improvement. In fact

by the beginning of the new millenium (2000-2002) all macro

economic indicators were declining. The country was still stuck with a

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suffocating external debt overhang and a suffocating high level of

inflation, as high as 72.8% in 1995, high level of fiscal deficit, and

unemployment low capacity utilization in industry and agriculture. For

the financial sector itself, there was high level insolvency, high level of

non-performing loans and general distress in the system.

Table 2 below shows the degenerating macroeconomic indicators,

while table 3 reveals the deteriorating financial sector performance.

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Table 2.

Selected Macroeconomic Indicators In Nigeria 1990 to 2002.

Real GDPGrowth Rate CapacityUtilization

Rate

InflationRate OutstandingExternal Debt in

billions of Dollars

Balance ofPayments in

billions ofNaira

FiscalDeficit %

of GDP

1990 8.20 40.3 .5 33.1 -5.7 -8.50

1991 4.73 42.0 13.0 33.4 -15.8 -11.00

1992 2.98 38.1 44.0 27.6 -101.1 -7.20

1993 2.64 37.2 57.2 28.7 -42.0 -.15.50

1994 1.33 30.4 57.0 -42.6 -7.70

1995 2.14 29.3 72.8 32.6 -195.3 0.10

1996 3.40 32.5 29.3 28.1 -53.3 1.60

1997 3.15 30.4 8.5 27.1 0.1 -0.201998 2.31 32.4 10.0 28.8 -22.1 -.4.70

1999 2.71 34.6 6.6 28.8 -326.6 -8.40

2000 3.87 36.1 6.9 28.3 314.1 2.90

2001 4.21 42.7 16.5 28.3 24.7 4.70

2002 3.26 44.3 16.1 29.8 -525.7 5.60

Average 3.38 36.18 26.6

Benchmarks

IMF/WBMDG +

East Asia

5.007.00

9.00

Sources (i) Ajakaiye D.O (2003) (See Reference)

(ii) CBN (2002) STATISTICAL BULLETIN + Millenium

Development Goal.(iii) Obadan M. I. (2004) (See Reference)

Note that fiscal deficit which as far back as 1986 the IMF/ World Bank

had recommended that it be not more than 3% of GDP was still as

high as 15.5% in 1993, in spite of the rolling back of government and

the supposed enthronement of the private sector. As for the real

GDP growth rate it was as high as 8.20% in 1990 (i.e. within the first

three years of reform) but by 1994 it has dipped to as low as 1.33%

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which is less than a quarter of its 1990 level. The performance of the

financial sector inspite of the deregulation reforms is also disturbing,

as shown in table 3 below:

Table 3

Performance of the Banking Subsector In The Era of

Deregulation.

Year Total Number

of Banks

Number of

Banks In Distress

Deposits of

Distressed BanksTo Total Deposits

In Banking

Industry

Assets of

Distressed BanksTo Total Assets In

Banking Industry

Amount Required

ForRecapitalization of

Distressed Banks

N billion

1990 107 9 14.6 23.7 2.0

1991 119 8 4.4 16.4 2.41992 120 16 18.1 20.9 2.4

1993 120 33 19.2 18.6 23.6

1994 116 55 29.4 18.6 23.4

1995 115 60 14.1 19.8 30.5

1996 115 50 14.7 11.0 43.9

1997 115 47 9.0 7.6 42.8

1998 89 15 3.5 3.9 15.5

1999 90 13 1.6 1.5 15.3

2000 89 12 2.5 20.0 10.3

2001 90 9 2.0 3.0 12.1

Source : Alashi S.O. (2003) See Reference.

It is important to note that of the 120 banks than were in existence in

1993 four of them had collapsed by 1994 and another one collapsed

by 1995. Of the 115 banks left in the system by 1995, 60 (or more

than half) were distressed. In terms of deposits the proportion of the

distressed banks to the total banking industry was almost 30% in

1994, and to restructure the system the country needed some N23.4

billion naira, this figure almost doubled by 1997 to N42.8 bill. Notice

that even as of 2001 there were still 9 distressed banks while some 26

banks collapsed between 1997 and 1998.

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This trend probably explains why the government through the CBN

came up in July 2004 requesting that all banks beef-up their capital

base from the mandatory minimum of N2 bill to another mandatory

minimum of N25 bill, an increase of over 1000%. The banks were

given till 2005 December to effect the change. One of the reasons

given by the CBN for this latest financial sector reform is that many of

the banks are still in distress, and if they are allowed to fail the

ensuing confidence-crisis might lead to disintermediation,

demonetization, a collapses of the payments system and a serious

depression of the economy.

The questions then arise what went wrong with the reforms? Were

the reform packages inherently faulty? Could the problem have to do

with the management of the reforms? Could the management of the

reforms have been improved upon in terms of management of the

timing of the financial reforms, and the sequencing of the reforms,

coordination of the macro-economic policies that impact the reforms

etc.

These questions form the focus of this paper. While we discuss the

financial sector reforms in general our major focus is on the banking

subsector, for obvious reasons. In sector two of this paper we take a

look at what the literature says concerning deregulation, liberalization

reforms in a repressed economy and economic development.

In section 3 we describe all the reform measures introduced from the

inception of economic deregulation and liberalization policy in 1986 up

to the year 2004. In section 4 we analyse the impact of the financial

sector reforms both on the financial system itself and on the economy

in general. In section five we make a case for sound management of

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the process by the monetary and fiscal authorities as the panacea for

poor reform results, and we also we summarize and conclude the

paper.

2.0 Financial Sector Liberalization Reforms and economic

Development:The Literature.

A discuss of the financial sector reforms and economic development

usually begins with the path-breaking works of McKinnon (1973) and

Shaw (1973). Prior to their studies there had been a general

consensus that there is some positive relationship between the

financial sector development and economic growth. While Schumpeter

(1934) agreed that financial institutions provide efficient means of

mobilizing and allocating funds in the economy and hence assist in the

economic development process, he did not perceive the financial

sector development as being the cause of economic development.

Robinson (1954) has called the financial sector the handmaiden of

economic development. In other words the financial sector is a passive

sector that only responds to the needs of the real sector, and hence

tends to grow as the real economy grows. However the works of

McKinnon (1973) and Shaw (1973) came up with the argument that

the financial sector can be more than an handmaiden to the real

economy, that infact it can be the major driver of economic growth

and development if it can only be relieved of its own fetters. They

argued that when a financial sector is repressed then it can only

respond passively to the real-sector needs. If the financial sector is

liberalized however, it can be the major drive for economic growth and

development. What are the features of a repressed economy?

Mckinnon and Shaw argued that a repressed financial system is

characterized by:

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(i) Administered interest rates both on deposits and loans

(ii) Direct control of allocation of credit

(iii) Ceilings on credit expansion

(iv) Unduly restrictive entry rules into the financial sector

especially into the banking industry.

Williams on and Mahar (1998) arguing along the lines of Mckinnon and

Shaw maintain that if the financial sector is free it can provide the

necessary filip for economic growth and development. They argued

that there are six kinds of reforms that need to be put in place in order

to free a repressed financial system, so that it can take the initiative to

pull up the real sector. These six reforms are:

i. the deregulation/liberalization of interest rates.

ii. Removal of credit controls

iii. Relaxation of Entry-rules into the financial sector especially the

banking subsector

iv. Bank autonomy/which frees the banks from bureaucratic

controls).

v. Privatizing the ownership of banks

vi. Deregulating international capital flows.

Fry (1988) confirmed that when real interest rates are rising the level

of financial intermediation rises and output growth also tend to rise.

Levine et al (2000) also confirmed that as the components of financial

intermediation grow there seems to be positive growth in the real

sector. The causal direction was however not established. When the

financial sector is freed, then the market can, based on the price signal

pool funds and efficiently allocate them. The market signal of price

allows funds to move to where its value marginal product is highest

rather than where some political expediency needs it (Patrick 1966).

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When the financial market is free and the nominal rates of interest

respond to inflation in such a way that the real rates of interest are

positive, savers will be encouraged to save. In the face of a large pool

of financial resources banker themselves are forced to look out for

investors and would be investors encouraging them, and giving

them other needed support as is done in Germany and Japan, so that

the level of investment rises. Freeing the credit allocation function

from the monetary authorities and placing it in the hands of the

market ensures that funds will not go to borrowers that cannot ensure

a meaningful return on the money.

In her study (Adegbite 2004) using the ratio of broad money supply

(M2) to GDP as her measure of financial sector growth and deepening,

found a positive correlation between financial sector growth and real

sector growth in Nigeria. However Adegbite did not attempt to

establish a causal link between the two Beneirenga and Smith (1991)

argued that in a well developed financial system where the securities

market is also developed the ability of the financial system to impart

liquidity to long-term instruments stimulates savers to hold their

wealth in productive assets (debentures, stocks, preferential stocks

etc) and this contributes to productive investment and growth.

Though many do not agree that financial development causes real

sector development as Mekinon (1973) and Shaw (1973) would like to

argue, it is however settled from most research works that there is a

definite, positive and significant relationship between financial sector

growth and real sector growth. Asogwa (2005) identified about ten

indices of financial sector growth and development or financial sector

deepening. These include the rate of growth of broad money relative

to GDP, the interest rate spread, the ratio of financial systems assets

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to GDP and the ratio of gross savings to GDP. As the financial system

deepens the ratio of financial assets to GDP is expected to rise while

the interest rate margin between lending rates and deposit rate is

expected to narrow.

3.0 Financial Sector Reform Measures 1987-2000

Though the deregulation reforms in Nigeria started in the fourth

quarter of 1986 with the setting up of a foreign exchange market in

September 1986, the reforms pertaining to the banking industry

proper did not commence until January 1987. (See Ikhide and

Alawode 2001, Asogwa 2005).

The first reform in the banking sector was the deregulation of the rate

of interest both on loans and on deposits. Banks became free to

charge whatever rates of interest they desired on their different

products based on the forces of demand and supply for them. As

interest rates were being deregulated government also brought out

new rules for setting up of banks and issuing of licenses. The new

rules made entry into the banking system much easier than

previously. The immediate response of the system to these two

policies was a sudden up-surge in the number of banks from 56

(Merchant and Commercial bank) in 1986, the figure rose to 109 by

1990 and 120 by 1992.

As reforms were taking place in the financial sector so were they

taking place in the trade and exchange sectors. In the exchange

sector, the exchange rate was freed from government administration

and a market for auctioning forex was set up. At first there were two

windows, the official window where forex was sourced for government

imports and official transactions at administratively controlled rates,

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and the non-official window where licensed foreign exchange dealers

(usually banks) bid for foreign exchange on behalf of their clients, and

the foreign exchange rate was determined by forces of demand and

supply (See Adegbite 1994).

By 1987 however the two foreign exchange windows were merged to

form one door called the foreign Exchange Market(FEM). By 1988, in

order to absorb the parallel foreign exchange market into the official

market and cater for the needs of small users of forex government

granted licenses for bureau de change operators. As government was

granting licenses to the bureaux de change operators in the trade and

exchange sector, it was also relaxing the rule that had hitherto

forbidden banks from taking up equity position in firms (i.e non-

financial enterprises) while at the same time granting them permission

to engage in insurance brokerage.

In the face of a much greater number of financial institutions

especially banks, than the country had ever had, the government

thought it expedient to protect depositors by setting up a deposit

insurance scheme. Hence the Nigerian deposit insurance corporation

was established in 1988 and started operation in Jan. 1989. The

Central bank of Nigeria deployed some of its staff to start off the

corporation. The NDIC is supposed to ensure financial stability and

provide a healthy banking platform for the economy.

By 1994 another reform measure was introduced. Hitherto banks in

Nigeria had not been paying interest on demand deposits otherwise

known as current account, but now they were granted permission to

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do so. The cash reserve ratio which before the reforms had been

virtually stagnant was revised, to now begin to work as an indirect

instrument of credit control, granting of loans on the strength of

foreign exchange held in foreign accounts was prohibited. All

government deposits held by the commercial and merchant banks

were withdrawn, so that the banks could function without undue

government interference.

In 1993 the Open Market Operations as an indirect instrument of

monetary control was introduced. The first discount house took off in

1993 known as Associated Discount House, subsequently others

followed, and by 2003 there were 5 discount houses. The discount

houses intermediate between the Central bank and the other banks,

off loading government treasury securities from the CBN and

auctioning same to the banks. Where the banks cannot pick-up all of

the treasury securities the discount houses warehouse them. The

reforms introduced also affected the capital base of banks as the

capital funds adequacy ratio was reviewed. The capital adequacy ratio

was moved from 1:12 to 1:10. The purpose of adjusting the capital

adequacy ratio was to ensure that the banks have sufficient capital to

absorb shocks in times of operational losses, and also to ensure that

shareholders in banks have sufficient stake in the system to do a

thorough oversight job of bank management. Hence the prudential

Guideline was released by the CBN in 1990. As this was going on other

reform measures to deepen and expand the financial system were also

going on. Special institutions were in 1989/90 created, this include

the Peoples Bank, the Community Banks, finance companies and

Leasing companies.

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Concerning the capital adequacy issue government through the CBN

Introduced a risk-weighted measure of capital adequacy. The

regulation identified five risk-weights these are 0%, 10%, 20%,

50% and 100%. The banks were told to maintain capital funds of at

least 7.26% of total risk weighted assets. The reform also required

that at least 50% of a banks capital must take the form of core or

primary capital i.e equity plus reserves. In 1990 the equity capital of

commercial banks was raised from N20 million to N50 million, while

that of the Merchant banks rose from N12 million to N40 million.The

1990 Prudential Guideline directed banks to make adequate provisions

for bad and doubtful debt. Banks were required to stop accruing

interest on non-performing loans, while interest that had already

accrued on such accounts should be discountenanced and not be

recognised as income.

Something that used to be in the system before deregulation was

reintroduced this is the stabilization securities. Stabilization securities

are CBNs debt instrument made compulsory for banks to purchase

and they are non-transferable and non-negotiable. The Stabilization

securities carry higher yield than treasury bills.

In 1991 two new decrees were put in place to enhance the powers of

the regulatory and supervisory authorities of the financial system to

enable them manage the reform packages well. The first is, a Central

Bank of Nigeria Decree 24 of 1991 and the, Banks and Other Financial

Institution Decree, 25 of 1991. The new banking sector regulatory

reforms gave the CBN power to issue banking licenses and to revoke

them. It gave the CBN power to apply any type of measure to handle

ailing financial system.

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By 1991 some of the reform measure of 1987 were reversed, a cap

was replaced on interest rates standing at 21% for lending rates and

13.5% for deposit rates. Also a maximum interest rate spread was

specified this was 4%.

By 1992 government divested itself from the seven banks where it had

60% equity holding in line with the new private sector driven

development and privatization. It was believed a full private sector

owned banks would be more efficiently managed and hence more

effective in its operations and have improved performance.

There were reforms in the capital market too which include the freeing

of stock-prices from administrative determination by the Securities and

Exchange Commission (SEC) to a market determined system. By 1997

additional capital market reforms were introduced, while by 1999, fully

foreign owned banks were given licenses to operate. By the year

2000 foreign currency deposits had become institutionalized while by

2001 government went the whole hog and introduced universal

banking, such that a bank can be a single-point unit for an investor,

as a bank with a universal license can carry out merchant banking

functions commercial banking functions insurance functions and also

deal in issue of securities (a capital market function). At the wake of

universal banking government introduced a new capital of N1000

million or N1 billion for each category of banks, and raised it by the

year 2002 to N2 billion. By 2004 July the CBN announced a new capital

base for banks, and this is N25 billion. In the next section as we

analyze the effects of these reforms on the financial system in

particular and the economy in general we will explain the rationale for

the new recapitalization in the banking industry.

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4. Effects Of Financial Reforms On The Nigerian Economy:

1987 2004

The liberalization reforms introduced into any repressed financial

system is supposed to work in the following ways. First free interest

rates especially after a long-time of being kept low by regulation, this

move tends to encourage higher level of savings. In the face of

increased savings all the investment projects at the margin can now

find funding. What is more-with freedom of entry into the system the

increased competition is supposed to ensure that the interest rates are

kept within reasonable limits. The liberalization reforms that brings a

financial sector to the forefront is supposed to transform the financial

system into a supply leading sector. As a supply leading sector the

financial sector is expected to transform the traditional sector (Patrick

1966) by making large funds available (which for instance can

transform a traditional subsistence agricultural sector into a large

commercial plantations., providing latest agricultural implements,

sellings etc). and also making available technical expertise.

The freedom of credit to move is supposed to promote efficiency in

resource use, as credit is expected to move in response to the rate of

return on it in a given sector. This is in contradistinction to the

previous movement of credit to supposedly socially desirable sectors

but that are not able to provide the expected rate of return. As

productive sectors access funds, productivity is expected to rise,

output is expected to rise the rise in output is expected to bring down

prices.

The increasing deepening and expansion of the financial system is

expected to lead to increased variety of financial instruments not only

in the banking subsector but also in the capital market. Greater

availability of varieties of financial institutions and instruments is

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expected to deepen the financial system. Financial deepening can be

measured using several kinds of indices, a few of these are: the ratio

of the growth rate of broad money (M2) to that of the gross domestic

product; ratio of Total banking assets to GDP, Gross Savings in the

economy to GDP as well as Gross Domestic Investment to GDP as well

as the Interest Rate Spread (i.e the difference between lending rate

and deposit rate). The more deepened the financial system the more

expanded the level of output and the rate of growth of output are

supposed to be.

A look at the Nigerian economy since the onset of liberalization

reforms in 1986, especially financial sectors reforms, which started in

1987 really give cause for concern. As shown in section I tables 2 and

3 all of the macroeconomic indicators after the first three years of

reform seem to have taken a plunge downwards. For instance the real

GDP growth rate which used to be in the order of 2.8% to 3% in the

1980 1987, climbed as high as 8.20% by 1990. However from 1991

it started a steady plunge downward which reached its lowest ebb by

1994 when it hit the 1.33% mark. Thereafter the economy struggled

to improve but could not. For the rest of that decade up to the new

millenium the real GDP growth rate did not reach the IMF/WB

recommended 5%, nor the millenium development Goals of 7% nor

the Asian countries performance of 9%.

Inflation climbed down initially from its 2-digit level to get as low as

7.5% in 1990, but by 1995 the season of mass bank failure and

general distress in the financial system, inflation rose to be as high as

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in different sectors of the economy to as low as 6.6% by 1999,since

the new millenium however it has started an upward rise again.

As for financial deepening the result of our analysis shows that midway

into the era of reforms the earlier results of increased financial

deepening started to reverse itself. The table below shows the pre-

Reform And Post Reform level of financial deepening in Nigeria using

some of the includes of financial deepening.

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Table 4

Indices Of Financial Deponing In Nigeria Pre-And Post Financial Sector Reforms.

Year InterestRate

Spread.

Grosssavings to

GDP %

GrossInvestment

to GDP %

CurrencyOutside Banks

to BroadMoney

1980 3.50 11 7 22

1981 4.60 13 5 25

1982 1.25 15 8 25

1983 4.00 17 12 20

1984 3.50 17 17 23

1985 2.25 17 18 21

1986 2.50 19 10 21

1987 5.20 17 11 21

1988 2.67 16 9 221989 5.03 11 5 25

1990 6/64 11 7 23

1991 4.38 12 4 27

1992 10.70 10 2 28

1993 12.58 12 7 29

1994 7.35 12 7 34

1995 7.04 5 2 34

1996 7.80 5 2 31

1997 13.47 6 2 30

1998 12.31 30 9 301999 16.39 30 24 27

2000 13.39 30 25 26

2001 13.08 35 14 26

2002 22.91 4 3 25

Calculate From CBN (2003) Statistical Bulletin

Table four reveals that the interest rate spread which is supposed to

be getting smaller the more efficient a financial system becomes as a

results of deepening, actually started to rise from 1992. Though the

spread came down by 1994, it was never as low as it used to be in

the era of regulation, and in fact from 1997 it rose to much higher

levels than before. This is an indication that whatever reform

happened they did not seen to have improved financial system

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efficiency significantly. With respect to the improved savings -

mobilization effect of reforms there was indeed a great measure of this

from 1998-2001 after the system had experienced a great collapse

that allowed the government introduce more painstaking supervision

and surveillance on financial sector activities especially banking sector

activities. The result of a more closely watched regulation and

supervision after a heavy collapse and some sanitization brought

improved performance in terms of savings mobilization.

The same thing applies to investment, in fact in the case of investment

the years 1994, 1995, 1996 when the financial system was engulfed

in a systemic distress the ratio of investment to GDP plunged to as low

as 2%. What went wrong?

There have been several researches into the banking crisis that

engulfed the Nigerian financial system a few years into the

liberalization reforms (Umoh and Eghodaghe 1977, Alashi 2002,

Adewumni, 2002). What happened is that the liberalization of the

financial sector especially the banking sector posed some immediate

challenges to the sector. First was that of insufficient skilled manpower

to mann the several banks that have suddenly emerged at the same

time. Second was the ability of the banking system to cope with

competition having been stifled of all initiative and steam in the

regulatory era. The third was the incidence of bugging in the system.

This is a situation where borrowers go to borrow with no intention of

paying back (see Kayode and Odusala 2004). This coupled with insider

abuses to ensure that a lot of the loans of some banks went bad. In

fact for some banks as much 70% of the loans went bad. Their

insider-abuses made loan recovery difficult if not impossible;

sometimes the loans were given without collateral, where it was given

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with collateral the collateral were not perfected. Junior managers gave

loans above prescribed limits. All of these were aggravated by

macroeconomic variables, continuously high fiscal deficits which fuelled

inflation, caused lending rates to rise higher, and led to adverse

selection. In the face of rising interest rates there was moral hazard.

As shown in table 3 of section I all of these problems resulted in a

systemic crises which led to the failure of 26 banks by 1997 and to the

failure of another 6 by 2001 Government had to firm up its legal and

supervisory framework by creating new legal instruments to penalize

bank officials and directors that colluded to sap theirs, banks, and by

giving the NDIC and the CBN more powers.

Table 5

Loans and

Advances (N'billion)

Non-Performing

Loans and Advance(N' billion)

Proportion of Non-

performing Loans andAdvances (N' billion)

Year Industry Distressed Industry Distressed Industry Distressed

1989 23.1 4.3 9.4 2.9 40.8 67.1

1990 27.0 6.4 11.9 4.7 44.1 72.8

1991 32.9 5.4 12.8 4.1 39.0 76.5

1992 41.4 15.7 18.8 6.8 45.5 43.0

1993 80.4 25.3 32.9 14.7 41.0 58.0

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1994 109.0 54.6 46.9 29.5 43.0 64.6

1995 175.9 48.9 57.8 29.5 32.9 68.9

1996 213.6 51.7 72.4 33.9 33.9 75.5

1997 290.4 49.6 74.9 40.7 25.81 81.92

1998 327.2 24.2 63.3 18.7 19.3 77.3

1999 370.2 29.1 24.8 21.0 25.6 72.22000 519.0 26.4 111.6 29.0 21.5 75.8

2001 803.0 123.1 135.7 35.4 16.9 28.9

Source: Alashi S. O. (2002).

Table 5 shows the proportion of the banking system loans and

advances that were distressed, the proportion that actually went bad

(i.e of the bad and doubtful loans, which proportion actually became

bad), the proportion of the non-performing loans relative to the loan

portfolio of the institution. For the distressed banks as much as

81.92% of their loans went bad as of 1997.

The effects of the systemic crises were erosion of the publics

confidence, no wonder the proportion of currency relative to broad

money went up (see table 4) as people lost confidence in banking

instruments and would rather hold cash. Portfolio shift as a result of

crises probably account in part for increased capital flight in Nigeria.

The interest rates that are supposed to come down in the face of

competition did not do so investors could not access loans at the

unduly high rates. No wonder ratio of investment to GDP plunged to as

low as 2% in 1994, 1995, and 1996.

By the year 2003 there was still evidence of looming crisis given the

fragile capital base of the banks. The capital base of N2 billion proved

too small for the needed functions of capital i.e provision of cushion for

operating losses, provision of funds for fixed assets and expansion as

well as promotion or fostering depositors confidence.

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Table 6

Ratio of Shareholders Funds to Total Assets of Banks(1995-2003)

(1)Year

(2)Shareholde

rs Funds(Nbillions)

(3)Total assets

(Nbillions)

(4)Ratio (%) (2)/(3)

1995 11.6 414.4 2.8

1996 17.3 491.5 2.8

1997 29.6 627.3 3/5

1998 70.9 760.6 4/7

1999 99.9 1,108.0 9.0

2000 133.8 1,962.6 6.8

2001 183.7 2,449.1 7.5

2002 229.9 2,980.5 7.7

2003 211.1 3,365.2 6.3Source: Umoh P.N. (2004).

Table 6 shows the proportion of bank capital to their total assets. In

1995 it was as low as 2.5%. Such a low stake on the part of

shareholders in the banks can lead to reckless and carefree attitude.

Besides there is need for greater reform in terms of capitalization to

give the banking system a more solid base hence the new N25 billionrecapitalization reform. In the next section we look at ways in which

shrewd management could have helped the reform strategy achieve

its set objective.

5. Skillful Management Of financial sector Reform Process.

5.1 The Role Of Management In Financial Sector Reforms.

It is obvious from the preceding sections that the reform measures inthe financial sector have not been able to achieve the laudable

objectives they were meant to. The question is what went wrong?

Were the reform packages inherently faulty? What role could skillful

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management have played in ensuring that the reform measures

achieved their set goals.

We contend in this section that the reform measures were not

inherently defective given that there are few nations that have used

the same reform packages and got positive results. We argue here

that management of the reform process skillfully would have gone a

long-way in achieving the goals of the country. The question now is

who then are supposed to be the managers of the reform process? It is

the government and the bodies government put in place to oversee

the monetary system in conjunction with the authorities put in place to

oversee the fiscal affairs of the country. In other words the Central

Bank, the Nigerian Deposit Insurance corporation the Ministry of

Finance and the Presidency.

Before we go ahead with our analysis we wish to put in perspective

what management is. Management is said to be the process of

planning organizing, leading and controlling the work of a group of

members of an organization and using all resources available to the

group or organization to reach stated group or organizational

objectives or goals. The managers of any firm, group or nation are

responsible for helping other members of the team achieve the set

goals of the group. In planning, management takes a long-term view,

so that it does not have to take short-term rescue-measures as

unplanned-for-events arise. Also a good management team train

workers for the job they are to perform and raise the quality of those

who will have to supervise others. Good management requires that the

members are encouraged to work closely together rather than focusing

on their divisional distinctions (Stone and Freeman 1992). In line with

the above role of management the monetary and fiscal authorities

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could not work as a team to provide the needed macroeconomic

stability for reforms to work. First as the CBN makes efforts to stabilize

prices, government fiscal indiscipline frustrates those efforts. High

level of inflation was also coupled with high balance of payments

deficit and a fast depreciating exchange rates to negate activities in

the financial sector. Depreciating exchange rates raised the cost of

inputs to the extent that firms that borrowed could not pay back.

So the necessary harmony between the different divisions as good

management practice dictates was not there. What is more-in good

management there is supposed to be long-range planning, not ad-hoc

activities as you stumble along some realities. For instance the deposit

insurance meant to protect depositors and provide stability into the

banking system came three years into the adoption of the reforms,

something that ought to have been put in place ahead of the reform .

The regulatory framework to prevent the fraud and all the malpractices

that came up was not put in place before the reforms.

What is more-in good management the workers are trained for the

job. Both the staff of the supervisors, the NDIC and those of the

regulators the CBN, needed to have gone through intensive training

before the doors were flung open to allow a massive influx of new

banks into the banking industry. The regulators/supervisors could not

cope with the intense demand of the job.

Skillful management also requires that the supervisors must be a step-

ahead of those they must supervise. This would have enable them

detect early the cosmetic dressing of ailing banks books before their

problems become critical.

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Further in planning the timing of the financial sector reforms needed to

have been planned ahead. Time is one of the resources that good

managers plan ahead for. Coming at a time when the trade and

exchange sector had just been liberalized, and the exchange rate was

soaring through the roofs, domestic producers were disadvantaged at

the cost-end and also disadvantaged at the product-price and, as the

imported competing goods somehow were cheaper than home

produced ones. Many of the producers took loans and could not pay

back. Even for the financial sector reforms alone, good management

(on the part of the managers CBN, NDIC, Federal Ministry of Finance

and the presidency) would have meant proper sequencing of the

reforms (See Ikhide and Alawode 2001). Some more appropriate

sequencing have been put forward in the literature. This include the

provision of macroeconomic stability for the on-coming reforms

through reduction in fiscal deficits and hence reduction in inflationary

pressures. Liberalization of the financial sector before the liberalization

of the trade sector and finally the liberalization of the capital account.

Within the financial sector reforms some have argued that before

allowing free entry into the financial system there ought to have been

introduction of indirect monetary instruments first, then the bank

regulatory framework should have been overhauled, then a gradual

relaxation of entry rules into the system while the uncapping of

interest rates should have been lasted. In Nigeria's case the

uncapping of the interest rate came first coupled with exchange rate

depreciating the cost of imported inputs and materials and the high

interest rates drove producers out of the financial markets, and

speculators then had a field day. The Nigerian economy became what

Onimode tagged the CASINO ECONOMY, an economy that only

trades and does not produce anything. All these were due to lack of

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sound management on the part of the managers of the

macroeconomy.

5.2 Conclusion

The adoption of financial liberalization reforms has been a very

laudable initiative given the extent of financial repression that was

prevalent prior to these reforms and the stifling effects of repression

on both the financial sector itself and on the economy as a whole. The

literature had made us expect that if the repressed variables and

aggregates were let loose especially price and direction of credit, that

savings would rise because real interest rates will rise, and investment

will also rise. A look at the table on financial deepening shows that this

expectation did not materialize at least not for any meaningful long-

term. Rather the banks went into a system crisis that made 26 banks

collapse in a single year and another 6 in less than five years after. All

the macro economic indicators do not give cause for cheer. The real

growth rate of GDP is less than the enviable Asian rate of about 9%,

less than the desired one of 7% as envisaged in the Millenium

Development Goals, and even less than the 5% recommended by the

IMF/WB.

We then wondered what went wrong, we know that the fact that some

repressed economies adopted identical measures and had desired

results means it may not be the reforms per se that were faulty but

their management. We looked at the management concept and

analyzed, whether good management practice has been demonstrated

in the management of the reform measures and came to the

conclusion that it have not.

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First the long-term planning of all resources required before the take-

off of a programme was not there, so that there was no NDIC to

protect banking stability until three years into the reforms. Similarly

there was no legal regulatory framework before the plunge into the

reforms. Also provision for necessary macroeconomic stability needed

for the success of the reforms was not made. The necessary harmony

and unity required between different divisions of an organization was

not there as between the fiscal authorities and the monetary

authorities.

Finally the sequencing of the reforms was bad. We suggested as

recommended in the literature a better sequencing (see section 5.1).

We hope the authorities will come together for better synchronization

of fiscal and monetary measures to move Nigeria forward.

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Documents

1ADEGBITE- Financial Sector Reforms