Vol. 2 No. 1 January 2006 - Zenith Bank Plc 2 No 1 January 2006.pdf · 2017-05-30 · 2 ZENITH ECONOMIC QUARTERLY : : January, 2006 N From The Editorial Suite igeria’s chequered

Vol. 2 No. 1 January 2006

ZENITH ECONOMIC QUARTERLY : : January, 2006 1

E D I T O R I A L T E A M

CHRIS 'E ONYEMENAMEditor-in-Chief

MARCEL OKEKEEditor

EUNICE SAMPSONAssistant Editor

MICHAEL MUSAProduction Assistant

UKUT SYLVESTERLayout/Design

E D I T O R I A L B O A R D O F A D V I S E RSUDOM EMMANUEL

GIDEON JARIKREPAT NWARACHEOCHUKO OKITI

UGO ANYANWU

ZENITH ECONOMIC QUARTERLYis published four times a year by Zenith Bank Plc.

The views and opinions expressed in this journaldo not necessarily reflect those of the Bank.

All correspondence to:The Editor,

Zenith Economic Quarterly,Research, Economic Intelligence &

Franchise Enhancement Group,Zenith Bank Plc

7th Floor, Zenith HeightsPlot 87, Ajose Adeogun Street,

Victoria Island, Lagos. Tel. Nos.: 2781046-49,2781064-65| Fax: 2703192.

E-mail: [email protected],[email protected]

ISSN: 0189-9732

C O N T E N T S

PERISCOPEDevelopments in the various sectors of theeconomy in the whole of 2005 but the lastquarter in particular, are here captured andanalysed. Pg. 4-12

POLICYIn a move to actualise the emphasis of theFederal Government on Micro-enterprises,the CBN issues the “Micro Finance Policy,Regulatory and Supervisory framework forNigeria.” Pg. 13 - 22

ISSUES (I)The re-newed importance and relevance ofauditors as well as their techniques and toolsof trade are here explored. Computer AidedAuditing is also highlighted. Pg. 24 - 29

ISSUES (II)After the frenzy that marked consolidationefforts of the 89 banks, the re-capitalisationdeadline came year-end 2005. Now otherchallenges and trends are emerging in theindustry. Pg. 31 - 36.

ISSUES (III)The winners and losers in the first phase ofthe bank consolidation have emerged.Those that made it are now exploring sev-eral other frontiers in a continuing consoli-dation. Pg. 38 - 48

FOREIGN INSIGHTGiven financial scandals and the resultingnew mandates, firms find themselvespressed to develop strong codes of ethics toguide the behaviour of board members,managers, and employees. Pg. 50 - 65.

GLOBAL WATCHUsing several indicators, economic devel-opments across the key centres of the worldin 2005 are examined and prospects for 2006are also explored. Pg. 67 - 73.

FACTS & FIGURESEconomic indices are used in tabular andgraphic forms to x-ray developments in theeconomy. Pg. 75 - 80.

ZENITH ECONOMIC QUARTERLY : : January, 20062

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From The Editorial Suite

igeria’s chequered experience at economic growth and develop-ment illustrates the many definitions of ‘reform’and ‘transforma-tion’ in the literature. Nigerians generally seem agreed on theessence of economic reform- a paradigm shift from government’scontrol of ‘commanding heights’ of the economy (with the domi-nance of ‘state owned enterprises’), to a market determined, pri-vate sector led, economic growth and development (with gov-ernment limited to its traditional sovereign functions and nominalrole of regulatory intervention). However, there seemed to beno consensus on how to handle the cost and forgone alternativesrequired to effect the shift.

The Nigerian nation-state (apologies to critics) has truly trans-formed-from the era when Agriculture accounted for over 60% ofGDP growth, the several gigantic projects under the variousNational Development Plans from the early 1970s to the days ofthe austerity measures and economic reform fuelled by the oilboom-doom phenomenon. Like a plague, the international crudeoil market got reformed and transformed and then events began to

occur in quick succession locally, the rest is history.Nigeria had caught the dreaded ‘Dutch disease’- that perva-

sive dislocation of the economic and social fabric of a societyresulting from unbridled spending of the proceeds of economicprosperity arising from the discovery of a natural resource (e.g.crude oil) - exchange rate effects, the economy’s absorption ca-pacity problems, revenue volatility and expenditure stabilization,debts, the dilemma of revenue exhaustibility/saving for the future,consequent degenerating economic performance, diminishedaccountability (corrupt practices and ‘value for money’ issues),rising failure rate in governance schemes, etc. End product? –Poverty, economic down turn, social and political instability, etc

At the peak of it, Nigeria was a pariah nation internationally.How a country, so well endowed in natural and human resources,could now become so deficient with a bleak future, painting asorry state of despair... Reforms became inevitable. There hadbeen a handful with limted successes especially in the 1980s.Nigerians had become impatient and ‘reform fatigued.’ The di-lemma grew worse with continuing fluctuations in crude oil prices

and increasing public sector inefficiencies. But only a reform ofgargantuan proportion could create a window of opportunity forachieving a new Nigeria. And reforms have their costs, trade-offsand benefits. Remember the Marshall Plan, Poland’s debt cancella-tion deal and the Asian success story?

Lee Kuan Yew’s account of the rise of Singapore ‘From ThirdWorld to First: The story of Singapore 1965-2000, highlights the levelof staying power, the pains, costs and benefits of a successfulreform and aptly captures the wisdom in such an effort.

Recent reform efforts, (the NEEDS) if sustained, would helpstrengthen the foundation for unleashing the growth necessaryfor activiating the process of transforming Nigeria from a ‘thirdworld’ to ‘first world’.

Just think of it: the Paris Club Debt exit scheme and the end tohigh debt servicing as an expenditure item (discount the econom-ics against huge lump sum pay out). Then the improved fiscal/public expenditure management, institutional reforms - civil ser-vice reforms (monetisation), tax reform legislation, accelerated

privatisation programme, concessioning of public utili-ties and infrastructure. Also the improved macroeco-nomic environment - exchange rate stability, growingexternal reserves (thanks to the consistently high priceof crude oil) improving fiscal deficits level. Finally thepervasive sector reforms – telecommunication, elec-tric power sector , pensions reform, Trade reforms. Thelist can be longer.

The success of the financial sector reforms- publicdebt restructuring, consolidation in the Insurance and

Banking sectors, is very critical because the sector plays a cata-lytic role in the economy. The hope it holds out for the entireeconomy is, to say the least, reassuring.

And so in this edition of the ZEQ, Mr. Marcel Okeke’s contri-bution on Reforms: Rising Tempo and Deepening Impact, focuseson how reforms are beginning to set the stage for the expectedtransformation. Dr ‘Biodun Adedipe and Mr. Mike Uzor in theircontributions x-ray the genesis and importance of the bankingsector reforms, the race to meet the recapitalisation deadline, theoutcome, the new challenges and the future direction of bankingin Nigeria. Mr. Nnadi’s contribution focuses on auditing and cor-porate governance, complementing Dr. J.D Sullivan’s internationalperspective on Business ethics as an essential component of cor-porate governance. Global watch gives a brief insight into thefuture outlook in 2006 based on a review of 2005. The segment onfacts and figures gives an overview of the economy in the lastquarter of 2005.

Nigerians had become impatient and ‘reform fatigued.’ Thedilemma grew worse with continuing fluctuations in crudeoil prices and increasing public sector inefficiencies. But onlya reform of gargantuan proportion could create a windowof opportunity for achieving a new Nigeria. And Reformshave their costs, trade-offs and benefits.


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R * By Marcel Okeke


the reforms was recorded in virtually all sectors including pensions, insurance, capital market,oil and gas, telecommunications, energy/power, maritime, solid minerals, mortgage/housing,agriculture, tourism, among others. During the year, the reforms were so evident and perva-sive that 2005 has come to be seen as a re-defining year in the annals of the country’s economicdevelopment.

Apparently, as initial fruits of the ‘comprehensive’ reforms during the year (especially inthe last quarter), all economic indicators improved in desired directions, either hitting or sur-passing set targets. The exchange rate of the Naira remained stable; the inflation rate droppedwhile foreign reserves kept growing steadily. Both deposit and lending interest rates plum-meted, with seminal effects on the real sector; foreign direct investment (FDI) inflow im-proved, just as the nation’s external debt overhang got whittled down significantly. Industrialcapacity utilization improved in most sub-sectors.

eforms in various sectors of the Nigerian economy assumed a very high pitch in2005, especially by the last quarter of the year when the first phase of the bank-ing industry consolidation came to an eventful close. Phenomenal progress in


PERISCOPE

As the year drew to an end,the tempo of activities in all insti-tutions and agencies associatedwith reforms rose to a feverishpitch. In fact, the reforms literallymoved to an advanced phase.Specifically, the Central Bank of Ni-geria, for example, was immersedin the run-up to the close of thefirst phase of its bank consolida-tion programme which culminatedin the collapsing of the hitherto 89deposit money banks in the bank-ing industry to 25 re-capitalizedones. Fourteen others that couldnot meet the requirement are al-ready facing liquidation by theregulatory authorities.

By the close of 2005, the apexbank also formulated and issued the “Micro Finance Policy,Regulatory and Supervisory Framework” for the provi-sion of diversified microfinance services on a long-termand sustainable basis. This was an integral part of thepackage for the International Year of Micro-credit as (2005was) declared by the United Nations. The Bureau of PublicEnterprises (BPE) similarly rounded off the sale ofnot a few public–ownedcompanies during thequarter while the Na-tional CommunicationsCommission (NCC) wasfashioning the modali-ties for the enthrone-ment of the unified li-censing regime. TheEconomic and FinancialCrimes Commission (EFCC)made ‘big catches’ in the anti-graft drive during the pe-riod, just as the Debt Management Office (DMO) took con-crete steps in the domestic debt securitization/bond is-sues.

Exchange ratesThe stability of the exchange rate of the Naira against

major world currencies stands out as one of the key gainsof the economy-wide reforms in the past two years. Likein 2004, the national currency rather than depreciate in2005, remained generally stable and even made slight ap-preciations at some points. Through some policy mix, in-

cluding the introduction ofthe special forex auction ses-sions, the CBN realized itsplus/minus three percentband in the Naira exchangerate fluctuation. Thus, on theaverage, the exchange rateof the Naira remained stableat around N130 to the dollarin the Dutch Auction System(DAS). The Naira also appre-ciated against the PoundSterling and the Euro in boththe official and parallel mar-kets.

In the last quarter 2005,the weighted average ex-change rate of the Naira vis-à-vis the US dollar appreci-

ated from N129.61 per dollar in September to N129.54 perdollar in October. It further appreciated to N129.39 perdollar in November, closing at N129.00 per dollar at year-end. Both inter-bank and parallel market rates followed asimilar trend during the period. As at October, the parallelmarket exchange rate of the Naira was about N144.50 to

the dollar, appreciating toN143.30 in November and

rounded off the year atN143.20 to the dollar.

The implication ofthis is continued

narrowing of thegap between the

official and parallel/black market exchange

rates of the national cur-rency. This, in point of fact, is a

pointer to the determination of theCBN to achieve a partial or total convergence of the vari-ous ‘exchange rates’ of the Naira in the market. Thus, theapex bank introduced ‘special auctions’ in the market atthe beginning of the second half of the year, and throughthis, intervened to moderate actual or perceived gyra-tions in the Naira exchange rate. Further to this, the CBNvery early in January 2006, liberalized the utilization/dis-bursement of export proceeds by exporters - a develop-ment that has eased pressure on the Naira at the DAS -reflecting in marked drop in the demand for foreign ex-change.

Source: CBN Economic Report for First Half 2005

The relative stability of the exchangerate of the Naira all through the

review period is also partlyattributable to the consistently rising

inflow of foreign exchange.


PERISCOPE

The relative stability of the exchange rate of the Nairaall through the review period is also partly attributable tothe consistently rising inflow of foreign exchange. This waslargely due to the steady increase in oil receipts, owing tothe burgeoning oil prices in the international market. Onthe average, oil receipts accounted for about 75% of themonthly foreign exchange inflow for the better part of 2005.

External ReservesAs a concomitant of the consistently rising foreign ex-

change proceeds from oil, the nation’s external reservesrose steadily in 2005, from US$16.9 billion at year-end 2004to nearly US$29 billion. This trend was however, slightlydisrupted in October sequel to Nigeria clearing of US$6.3billion in Paris Club (PC) arrears during that month in ac-cordance with the debt treatment earlier agreed betweenthe country and the PC members. Under the debt reliefgranted Nigeria in June 2005 by the PC members, Nigeriais to pay in tranches, theUS$18 billion involved in thedeal, subject to a successfulconclusion of a ‘Policy Sup-port Instrument’ (PSI) ap-proved by the InternationalMonetary Fund.

Thus, Nigeria’s gross ex-ternal reserves at end-Octo-ber, 2005 stood at US$23.92billion, indicating a decline of16.5 per cent from theUS$28.64 billion recorded inSeptember, 2005. Beside this isolated drop, the externalreserves rose from month to month all through 2005, adevelopment that was partly sustained by the mutual de-cision of the Federal and state governments to sterilizeexcess crude oil revenues. This is in line with the oil-price-based fiscal rule which makes for partial de-linking of bud-geting from the oil price and therefore leads to a fiscalsurplus. Under the National Economic Empowerment andDevelopment Strategy (NEEDS) programme, external re-serves target for 2005 was merely US$9.7 billion.

Inflation LevelOne of the major challenges that confronted the mon-

etary authorities all through 2005 was that of achievingstable prices under an expansionary fiscal policy regime—marked by some monetization of higher oil receipts. Thus,year-on-year inflation level at year-end 2005 stood at 11.6per cent, missing the target of 10 per cent or a lower fig-

ure. The Consumer Price Index (CPI), the most widelyaccepted measure of inflation levels, which stood at9.80per cent in January 2005, rose to a worrisome figure of28.20 per cent in August but maintained a downward trendthereafter for the rest of the year. While the figure forSeptember was 24.0 per cent, it dropped to 18.6, 15.1 and11.6 per cent in the subsequent months of September, Oc-tober, November and December, respectively.

The consistent drop in the inflation level in the lastquarter, 2005 was attributable to two factors namely: thecontinued harvesting of agricultural produce, which mod-erated rising food prices and the relative stability in theprices of petroleum products. For the greater part of theyear, inflation pressures were driven essentially by risingfood prices. Thus, food price inflation (year-on-year)jumped from 18.0 percent in June to 35.6 per cent in Julyand 36.1 per cent in August, according to the National Bu-reau of Statistics.

On the other hand, thenon-food (or core) infla-tion declined from 16.2 percent in June to 10.76 percent in July but rose to 13.0per cent in August (mea-sured on year-on-yearbasis). Overall, the non-food or core inflation hasremained stable, whilethe food price inflationhas been volatile and ris-ing almost steadily. Thus,

because of the high weight attached to food under thecurrent methodology for arriving at the CPI (about 63%),food-price impact on overall inflation levels remained quitesubstantial.

In 2005, despite the good food harvest, prices of food-stuffs remained high for some reasons including: the newinitiative to export cassava which has reduced domesticsupply and the draught in the neighbouring Niger Repub-lic that necessitated increase in the export of staple foodproducts from Nigeria. Also, imported inflation arising fromincreases in the pump price of petroleum products—whichincreased inflationary pressures in most countries of theworld—impacted on the domestic price level.

Interest RatesFor most part of 2005, there was a general decline in

banks’ deposit and lending rates, relative to the previousyear. The CBN reviewed downward the Minimum Redis-

Source: CBN Monthly Reports


PERISCOPE

count Rate (MRR) from 15 per cent to 13 per cent, while stillmaintaining the maximum lending rate at MRR+4.00%. Thiswas obviously to further reduce lending rates in theeconomy. In the same vein, the CBN reduced the CashReserve Ratio (CRR) from 11.00 per cent to 5.00 per cent,while the difference of 6.00 per cent would be invested inspecial CBN instruments with tenor of 91 days at 3.00 percent per annum. This reduction in CRR shows the inclina-tion of the apex bank to drag down the cost of funds (tobanks) and by doing so, impact positively on interest rates.

In line with this trend, interest rates in the inter-bankmarket were lower in 2005 than in the previous year. Theaverage Nigeria Inter-bank Offer Rate (NIBOR) for 7-daytenor and 90-day-tenor in 2005 were 14 per cent and 16 percent respectively, as against 19 per cent and 17 per cent in

year 2004.In the last quarter 2005, the CBN introduced into the

money market, the 182-day Treasury Bill (TB) partly to as-sist in restructuring the debt profile of the Federal Gov-ernment. This instrument during the year attracted thehighest and lowest spot rates of 16 and 5 per cent respec-tively.

However, in the tail end of 2005, the liquidity manage-ment strategy of the apex bank in form of withdrawal of

public sector funds from deposit money banks, put someupward pressure on inter-bank rates. Thus, the weightedaverage inter-bank call rate which stood at 8.2 per cent inOctober, rose significantly to 16.9 per cent in November2005, reflecting the liquidity squeeze in the banking sys-tem. Mainly, the transfer of the Nigeria National Petro-leum Corporation (NNPC) funds from the commercialbanks to the CBN compounded the liquidity crunch towardthe year-end.

Banking sectorThe run-up to the close of what has become the first

phase of the banking sector reforms dominated activitiesand attention in the entire financial services sector duringthe later part of last year. Alignment and re-alignment of

merging bank groups trying to achieve the required N25billion minimum capital base created a thick air of uncer-tainty and apprehension among a broad spectrum of op-erators as well as the banking public. Up to the last minuteon December 31, 2005, when the Central Bank of Nigeria(CBN) drew the curtain on the re-capitalization exercise,several mergers and acquisitions (M & A) deals were yetbeing sealed.

Source: CBN


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However, on January 2, 2006, the CBNreleased the outcome of the consolida-tion exercise, showing that 25 banksemerged from 75, out of a total of 89 banksthat existed as at June 2004. According tothe apex bank, the successful banks ac-counted for about 93.5% of the deposit li-abilities of the banking system. In the pro-cess of complying with the minimum capi-tal requirement, N406.4 billion was raisedby banks from the capital market out ofwhich N360 billion was verified and ac-cepted by the CBN. The exercise also ledto an inflow of Foreign Direct Investmentof US$652 m and £162,000.

Further to the release of the list of the 25 emergingbanks, the CBN subsequently revoked the licenses of 14unsuccessful ones. In the words of the CBN Governor,Prof. Charles Soludo while sealing the fate the un-recapi-talized: “in the exercise of the powers conferred upon usby the Banks and Other Financial Institutions Act, the op-erating licenses of the 14 banks are hereby revoked”. Theaffected banks are: African Express Bank, Allstates TrustBank, Assurance Bank of Nigeria, City Express Bank, EagleBank, Fortune International Bank, Gulf Bank and HallmarkBank. Others include Lead Bank, Liberty Bank, Metropoli-tan Bank, Societe Generale Bank, Trade Bank and TriumphBank.

Pursuant to the liquidation of these banks, the CBNalso removed their directors and appointed an interimmanagement for each of them. The management com-mittees are expected to “determine the overall conditionof the banks; ascertain the level of the asset-stripping (ifany), and to advise regulatory authorities of specific waysto satisfy the key stakeholders of the bank”. One bankwhich featured neither among the recapitalized ones noramong those “under liquidation” was African InternationalBank Limited; its acquisition by Diamond Bank howevergot consummated soon afterwards.

Despite the far-reaching and desperate efforts whichsaw many operators breasting the recapitalization tape, afew banks were able to ‘stand alone’ and made/surpassedthe N25bn minimum capital requirement. In this categoryare two leading and wholly Nigerian banks, namely, Ze-nith Bank Plc and Guaranty Trust Bank Plc. Others thatmade up this group include four banks with either foreignaffiliation or outright ownership—Nigeria InternationalBank (Citibank Group), Standard Chartered Bank, StanbicBank and EcoBank.

Capital Market DevelopmentsLike the first three quarters in 2005, activities in the

capital market during the last quarter were still largelydriven by the recapitalization exercise in the banking sec-tor and its concomitants. By the close of the year, therewere about 49 applications for new issues valued at N693.0bn as against 37 applications for new issues valued atN518.0 bn in the previous year. A breakdown of the figuresshows that the banking sector accounted for 34 applica-tions valued at N517.6 bn, representing about 75 per centof the total value while the Federal Government Bond is-sued accounted for N140 bn during the entire year.

Activities in the secondary segment of the capital mar-ket in 2005 resulted into a marginal rise by 1.0 per cent inthe Nigeria Stock Exchange All-Share Index. The NSE-ASIclosed the year at 24,085.76. In 2004, the Index increasedby 18.5 per cent. The stunted rise of the index in 2005 wasattributable to a number of reasons: the banking sectorreform caused much of investment interest to be shiftedto the primary segment of the capital market; unimpres-sive results by companies moved many shareholders toswitch their investments to patronizing new issues; poorliquidity/paucity of investible funds attendant to the CBN’sfunds withdrawals from the financial system, etc.

In sync with developments in the banking sector dur-ing the year under review, the industry accounted for 70.14per cent of the volume of transactions in the capital. Mar-ket capitalization increased by 31.03 per cent to close atN2.5trn. The total turnover for the year under review was26,838,911,431, an increase of 35.56 per cent over the pre-ceding year. In value terms, the market turnover in 2005stood at N263.7trn, an increase of 16.62 per cent over the2004 level. The significant difference in volumes between

Source: NSE

the two periods was due to the additional shares of banksthat were listed from Private Placements, Initial Public Of-fers Rights Issues and Public Offers.

Federal Budget 2006On October 12, 2005, the Federal Executive Council

approved a N1.695 trillion draft budget for fiscal 2006, withprojected revenue of N1.52 trillion, subject to legislativedeliberations and approval. Of the sum, N442bn was capi-tal expenditure, while N686bn would go into recurrent ex-penditure, including payroll and pensions. The 2006 bud-get proposal is N100bn less than the N1.8 trillion passed bythe National Assembly for fiscal 2005. The deficit in the2006 budget proposal is N170bn, as against N201bn in 2005and N142bn in 2004.

The projected revenue of N1.52 trillion is premised onan oil price benchmark of US$33 per barrel, at an annualcombined production estimate of 2.5 million barrels perday. An inflation rate of 9.5% is envisaged, while the ex-change rate of the Naira is expected to stay at betweenN132 and N134 to the US Dollar. Unlike in the past, theFederal Government would be setting aside N75bn to sup-port petroleum products subsidy; while the state govern-ments would provide another N75bn to bring the total sub-sidy to N150bn in 2006.

Some key thrusts of the 2006 budget proposal includethe completion of about 500 uncompleted projects, cre-ation of employment and the provision of basic infrastruc-ture (like power and roads), agriculture and healthcare.Also, settlement of debts owed local contractors ranksamong the priorities in the budget. At present, the Federal

Government owes local contractors almost N1trillion; someof these would be paid through bonds issuance, especiallydebts to contractors and pensioners.

Overall, education, health and works sectors have thehighest allocations in the budget. Education would gulpabout N126bn, as against N27bn in 2005; health N86bn, asagainst N21bn in 2005; and works N90bn.

Paris Club Debt TreatmentDuring the last quarter 2005, Nigeria achieved a major

stride in her external debt management by clearingUS$6.3billion in the Paris Club arrears. Nigeria had earlierin the year struck a deal with the Paris Club (PC) of credi-tors in which 60 per cent of her US$30 billion indebtednessto the PC members, amounting to US$18 billion, would bewritten off, leaving the country with a balance ofUS$12billion to pay up. The agreement was with a condi-tion that Nigeria obtained a Policy Support Instrument (PSI)from the International Monetary Fund (IMF), attesting tothe country’s economic reforms.

Under the agreement, the payment of the US$12.4 bil-lion will be in three tranches within a two-year period. TheUS$6.3 billion paid last October was the first of the tranches.With this, it is expected that six months thereafter, Nigeriawould ‘buy back’ the remaining US$8.3 billion in debt, at a24% discount for US$6.1 billion. This will result in total debtcancellation of around US$18billion and the country’s even-tual exit from PC-indebtedness. It is expected that Nigeria’spublic external debt will fall to 5% of GDP on conclusion ofthe deal by April 2006.

PrivatizationThe Bureau of Public Enterprises

(BPE)—the driver of the nation’sprivatization efforts—in March 2005,launched an agenda of privatizing21 enterprises during the rest of theyear. This was a sequel to thechange of leadership at the agencyby the end of the first quarter 2005.By year-end 2005, the Bureau hadbrought a total of 24 enterprises tofinancial bid stage, with a substan-tial number of them handed overthe strategic investors. All thesetranslated into fresh revenue ofabout N43billion for the federal gov-ernment. The effort to sell NITELwas however unsuccessful; it is now

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Source: Nigerian Stock Exchange


slated for a Public Offer soon in the capital market.During the period, the BPE made efforts towards con-

cluding the reform of the port sector and introduction ofprivate sector participation through the concessionprogramme. The power sector reforms also got some pushthat saw the establishment of the regulatory agency—theNigerian Electricity Regulatory Commission (NERC). Theseven-man Commission was inaugurated in October 2005and has since commenced work. Further to this, the un-bundling of NEPA (now Power Holding Company of Nige-ria) was concluded in November 2005, with the incorpora-

tion of 18 successor companies to PHCN at the CorporateAffairs Commission.

Out of the 18 successor companies that were incorpo-rated, eleven are to operate as distribution companieswith their registered offices located in Enugu, Ibadan,Abuja, Jos, Benin, Port-Harcourt, Kaduna, Kano, Eko (Lagos

Island), Ikeja and Yola. Each of the successor companieshas o paid-up share capital of N5 million and theshareholding for each firm is 80% by the BPE and 20% bythe Ministry of Finance Incorporated (MOFI) on behalf ofthe Federal Government.

During the period under review, the BPE also executedits reform agenda in the areas of the transport and down-stream oil sectors. In the transport sector, the Bureau de-veloped a new Transport Policy which key features includethe establishment of a new regulatory framework, the pro-motion of the principle of inter-modal transport amongst

the various modes of transport that ex-ist, the establishment of a National Trans-port Commission, etc.

The New Power ProjectsDesirous of improving the power gen-

eration/supply situation in the country, theFederal Government offered the exten-sion of Petroleum Profits Tax Act fiscalincentives to upstream oil companies todevelop Independent Power Projects(IPPs). This incentive has paid off, withvirtually all Exploration and Production(E & P) oil companies building powerplants to relieve the worrisome shortagein power generation in the country. Sill,Government, on its part, has madeprogress with the location and buildingof some power plants, especially in theNiger Delta area.

By year-end 2005, the Federal Gov-ernment had embarked on seven newpower projects in the Niger Delta. Theseinclude the Omoku Thermal Power Sta-tion in Rivers State; Gbaran/Ubie Ther-mal Power Station, Bayelsa State; SapeleThermal Power Station, Delta State andIkot Abasi Thermal Power Station, AkwaIbom State. Others include Eyaen Ther-mal Power Station, Edo State; EgbemaThermal Power Station, Imo State and

Calabar Thermal Power Station, Cross River State.Apart from these, Government has also embarked on

the following power projects in other parts of the country:Geregu Thermal Power Station, Kogi State; OmotoshoTherma Power Station, Ondo State; Papalanto ThermalPower Station, Ogun State and the Alaoji Thermal Power

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Source: R&EIG/Budget Office


Station, Abia State. There are also ongoing IPP projectsby some state governments, at Omoku (Rivers state),Obajana (Kogi state), Ibom power (Akwa Ibom state).

The E & P oil companies’ involvement in the IPP com-menced with the Shell Petroleum Development Company(SPDC) entering into a ‘Repair, Operate and Transfer’, ROT,agreement with the Federal Government on the Afam 1-IV plants, and ‘Lease, Operate and Transfer’, LOT, accordon Afam V plant (all in Rivers state). Subsequently, otheroil firms embraced the IPP, with Total Nigeria building onenear its gas-gathering facility at Obite. ExxonMobil, Chev-ron and others are at various stages of Building their IPPs.Agip in 2005 completed one of 480 MW capacity at Okpai,Delta State. It is projected that all these will boost Nigeria’spower generation from the current level of about 3,000MW to 10,000MW by 2007.

Tax & Trade ReformsWith regard to tax policy, nine pieces of legislation

amending existing Personal Incomes Tax, Value AddedTax, Company Incomes Tax laws and other taxes and lev-ies were sent to the National Assembly for enactment in2005. There is also legislation designed to strengthen tax

administration and better po-sition the Federal Inland Revenue Service to be amodern revenue agency.

As at year-end 2005, the National Assembly had heldpublic hearings on these legislation. The thrust of the taxreform is to simplify our tax system, reduce the multiplic-ity of levies and get better compliance. Generally referredto as the Federal Inland Revenue Service Bill 2005, somethe Tax Reform Bills before the National Assembly include:the Federal Inland Revenue Service Bill, Company IncomeTax Act Amendment, National Sugar Development Coun-cil Act Amendment and Petroleum Profit Tax Amendment.Others are: the Personal Income Tax Act Amendment,Value Added Tax Act Amendment, Customs Excise Tariff

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Consolidation Act, National Automotive Council ActAmendment, etc.

In a related measure, the Federal Government beganimplementation of the ECOWAS Common External TariffOctober 1 2005. This means that all goods that arrive Ni-gerian ports or customs points from October 1, 2005, wouldbe subject to the new tariffs. The CET simplifies Nigeria’strade regime by bringing the tariff bands down from 20 to5 as follows: 0% for necessities such anti-retroviral drugsand for machinery and equipment (this is being imple-mented for a year only in the first instance); 5% for rawmaterials; 10 % for intermediate goods; 20% for finishedgoods and 50% for goods in which the country has a com-parative advantage for production, also for certain luxurygoods.

Solid Minerals Sector Reforms and developments in the Solid Minerals sec-

tor in 2005, were a reflection of the new premium and pri-ority being accorded the sector by the Government. Thus,the Ministry of Solid Minerals Development (MSMD) dur-ing the period under review undertook measures aimedat attracting investors (foreign and local) into the sector.

These include putting in place the processes forthe review of existing legislation, the enactment

of fresh ones, massive public enlightenmentof the opportunities and incentives in the

sector, etc. There is also the estab-lishment of a world class Geologi-cal Survey of Nigeria Agency toprovide reliable data for invest-

ment decisions in the industry.During the period under review, a num-

ber of parastatals and agencies under the Min-istry were packaged for privatisation to make it func-

tion as a ‘market facing entity’. These include the Nige-rian Coal Corporation, the Nigerian Mining Company,among others. A new Minerals Policy Framework with em-phasis on private sector management of the sector andgovernment regulatory role and was concluded by theMinistry and approved by the National Council onPrivatisation. During the last quarter 2005, the Ministryalso put in place a framework for a bid round for coal andbitumen concessions along the principles of the NigerianExtractive Industries Transparency Initiative (NEITI).(* Marcel Okeke is the Editor, Zenith Economic Quarterly)

During the last quarter 2005,Nigeria achieved a major stride inher external debt management by

clearing US$6.3billion in theParis Club arrears.

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Chapter 1

Introduction1.1 Robust economic growth cannot be achieved with-

out putting in place well focused programmes to reducepoverty through empowering the people by increasing theiraccess to factors of production, especially credit. The la-tent capacity of the poor for entrepreneurship would besignificantly enhanced through the provision ofmicrofinance services to enable them engage in economicactivities and be more self-reliant; increase employmentopportunities, enhance household income, and createwealth.

1.2 Microfinance is about providing financial servicesto the poor who are traditionally not served by the conven-tional financial institutions.Three features distinguishmicrofinance from other formalfinancial products. These are: (i)the smallness of loans ad-vanced and or savings collected,(ii) the absence of asset-basedcollateral, and (iii) simplicity ofoperations.

1.3 In Nigeria, the formal fi-nancial system provides ser-vices to about 35% of the eco-nomically active populationwhile the remaining 65% are ex-cluded from access to financial services. This 65% are of-ten served by the informal financial sector, through Non-Governmental Organization (NGO)-microfinance institu-tions, money lenders, friends, relatives, and credit unions.The non-regulation of the activities of some of these insti-tutions has serious implications for the Central Bank ofNigeria’s (CBN’s) ability to exercise one aspect of its man-date of promoting monetary stability and a sound financialsystem.

1.4 A microfinance policy which recognizes the existinginformal institutions and brings them within the supervi-

Micro Finance Policy, Regulatory andSupervisory Framework for Nigeria

sory purview of the CBN would not “only enhance mon-etary stability, but also expand the financial infrastructureof the country to meet the financial requirements of theMicro, Small and Medium Enterprises (MSMEs). Such apolicy would create a vibrant microfinance sub-sector thatwould be adequately integrated into the mainstream ofthe National financial system and provide the stimulus forgrowth and development. It would also harmonize operat-ing standards and provide a strategic platform for the evo-lution of microfinance institutions, promote appropriateregulation, supervision and adoption of best practices. Inthese circumstances, an appropriate policy has becomenecessary to develop along-term, sustainable microfinancesub-sector.

1.5 The purpose of this policy paper, therefore, is topresent a National MicrofinancePolicy Framework for Nigeriathat would enhance the provisionof diversified microfinance ser-vices on a long-term, sustainablebasis for the poor and low in-come groups. The policy wouldcreate a platform for the estab-lishment of microfinance banks;improve the CBN’s regulatory/supervisory performance in en-suring monetary stability and li-quidity management; and pro-vide an appropriate machineryfor tracking the activities of de-

velopment partners in the microfinance sub-sector in Ni-geria.

1.6 This policy has been prepared in exercise of thepowers conferred on the Central Bank of Nigeria by theprovisions of Section 28, sub-section (1) (b) of the CBN Act24 of 1991 [as amended] and in pursuance of the provisionsof Sections 56-60 (a) of the Banks and Other Financial Institu-tions Act [BOFIA] 25 of 1991 [as amended].

1.7 The policy paper has benefited from wide consulta-tions, through the conduct of a baseline Survey on the ac-tivities of micro finance institutions (MFls) in Nigeria, na-


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tional and international consultative stakeholders’ fora,as well as study tours to India, Pakistan, Indonesia, Philip-pines and Uganda.

Chapter 2

Overview of Microfinance Activity in Nigeria2.1 The practice of microfinance in Nigeria is culturally

rooted and dates back several centuries.The traditional microfinance institutions provide ac-

cess to credit for the rural and urban, low-income earners.They are mainly of the informal Self-Help Groups (SHGs)or Rotating Savings and Credit Associations (ROSCAs)types. Other providers of microfinance services includesavings collectors and co-operative societies. The infor-mal financial institutions generally have limited outreachdue primarily to paucity of loanable funds.

2.2 In order to enhance the flow of financial services toNigerian rural areas, Government has, in the past, initi-ated a series of publicly-financed micro/rural creditprogrammes and policies targeted at the poor. Not ableamong such programmes were the Rural BankingProgramme, sectoral allocation of credits, a concession-ary interest rate, and the agricultural Credit GuaranteeScheme (ACGS). Other institutional arrangements werethe establishment of the Nigerian Agricultural and Co-operative Bank Limited (NACB), the National Directorateof Employment (NDE), the Nigerian Agricultural InsuranceCorporation(NAIC), the Peoples Bank of Nigeria(PBN), theCommunity Banks (CBs), and the Family Economic Ad-vancement Programme (FEAP). In 2000, Governmentmerged the NACB with the PBN and FEAP to form theNigerian Agricultural Co-operative and Rural DevelopmentBank Limited (NACRDB)to enhance the provisionof finance to the agricul-tural sector. It also cre-ated the National PovertyEradication Programme(NAPEP) with the man-date of providing finan-cial services to alleviatepoverty.

2.3 Micro finance ser-vices, particularly, thosesponsored by govern-ment, have adopted thetraditional supply-led,

subsidized credit approach mainly directed to the agricul-tural sector and non farm activities, such as trading, tailor-ing, weaving, blacksmithing, agro-processing and transpor-tation. Although the services have resulted in an increasedlevel of credit disbursement and gains in agricultural pro-duction and other activities, the effects were short-lived,due to the unsustainable nature of the programmes.

2.4 Since the 1980s, Non-Governmental Organizations(NGOs) have emerged in Nigeria to champion the cause ofthe micro and rural entrepreneurs, with a shift from thesupply-led approach to a demand-driven strategy. The num-ber of NGOs involved in microfinance activities has in-creased significantly in recent times due largely to the in-ability of the formal financial sector to provide the servicesneeded by the low income groups and the poor, and thedeclining support from development partners amongst oth-ers. The NGOs are charity, capital lending and credit-onlymembership based institutions. They are generally regis-tered under the Trusteeship Act as the sole package or partof their charity and social programmes of poverty allevia-tion. The NGOs obtain their funds from grants, fees, inter-est on loans and contributions from their members. How-ever, they have limited outreach due, largely, to unsustain-able sources of funds.

Chapter 3

Justification for The Establishmentof Microfinance Banks

From the appraisal of existing microfinance-orientedinstitutions in Nigeria, the following facts have become evi-dent:

3.1 Weak Institutional Capacity:The prolonged sub-optimal

performance of many existingcommunity banks, micro financeand development finance institu-tions is due to incompetent man-agement, weak internal controlsand lack of deposit insuranceschemes. Other factors are poorcorporate governance, lack of welldefined operations and restrictiveregulatory/supervisory require-ments.

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3.2 Weak Capital Base:The weak capital base of existing institutions, particu-

larly the present community banks, cannot adequatelyprovide a cushion for the risk of lending to micro entre-preneurs without collateral. This is supported by the factthat only 75 out of over 600 community banks whose fi-nancial statements of accounts were approved by theCBN in 2005 had up 10 N20 million shareholders’ fundsunimpaired by losses. Similarly, the NACRDB, with a pro-posed authorized share capital of N50.0 billion, has N10.0billion paid up capital and only N1.3 billion shareholders’funds unimpaired by losses, as at December, 2004.

3.3 The Existence of a Huge Un-Served Market:The size of the un-served market by existing financial

institutions is large. The average banking density in Ni-geria is one financial institution outlet to 32,700 inhabit-ants. In the rural areas, it is 1:57,000, that isless than 2%of rural households have accessto financial services. Furthermore, the 8 (eight)leading Micro Finance Institutions (MFls) inNigeria were reported to have mobilized a to-tal savings of N222.6 million in 2004 and ad-vanced N2.624billion credit, with an averageloan size of N8,206.90. This translates to about320,000membership-based customers thatenjoyed one form of credit or the other fromthe eight NGO-MFls. Their aggregate loansand deposits, when compared with those ofcommunity banks, represented percentages of 23.02 and1.04, respectively. This, reveals the existence of a hugegap in the provision of financial services to a large num-ber of active but poor and low income groups. The exist-ing formal MFls serve less than one million out of theover 40million people that need the services. Also, theaggregate micro credit facilities in Nigeria account forabout 0.2 percent of GDP and less than one percent oftotal credit to the economy. The effect of not appropri-ately addressing this situation would further accentuatepoverty and slow down growth and development.

3.4 Economic Empowerment of the Poor, EmploymentGeneration and Poverty Reduction:

The baseline economic survey of Small and MediumIndustries (SMls) in Nigeria conducted in 2004, indicatedthat the 6,498 industries covered currently employ a littleover one million workers. Considering the fact that about18.5 million (28%oftheavailable work force) Nigerians areunemployed, the employment objective/role of the SMls

is far from being reached. One of the hallmarks of the Na-tional Economic Empowerment and Development Strategy(NEEDS) is the empowerment of the poor and the privatesector, through the provision of needed financial services,to enable them engage or expand their present scope ofeconomic activities and generate employment. Deliveringneeded services as contained in the Strategy would be re-markably enhanced through additional channels which themicro finance bank framework would provide. It would alsoassist the SMls in raising their productive capacity and levelof employment generation.

3.5 The Need for Increased Savings Opportunity:The total assets of the 615 community banks which ren-

dered their reports, out of the 753 operating communitybanks as at end-December 2004, stood at N34.2 billion. Simi-larly, their total loans and advances amounted to N11.4billion

while their Aggregate deposit liabilities stood at N21.4 bil-lion for the same period. Also, as at end-December 2004,the total currency in circulation stood at N545.8billion, out ofwhichN458.6billionor 84.12per cent was outside the bankingsystem. Poor people can and do save, contrary to generalmisconceptions. However, owing to the in adequacy of ap-propriate savings opportunities and products, savings havecontinued to grow at a very low rate, particularly in the ruralareas of Nigeria. Most poor people keep their resources inkind or simply under their pillows. Such methods of keepingsavings are risky, low in terms of returns, and underminethe aggregate volume of resources that could be mobilizedand channeled to deficit areas of the economy. Themicrofinance policy would provide the needed window ofopportunity and promote the development of appropriate(safe, less costly, convenient and easily accessible) savingsproducts that would be attractive to rural clients and im-prove the savings level in the economy.

Owing to the in adequacy of appropriatesavings opportunities and products,savings have continued to grow at a verylow rate, particularly in the rural areasof Nigeria.


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3.6 The Interest of Local and International Communities inMicro financing

Many international investors have expressed interestin investing in the micro finance sector. Thus, the establish-ment of a micro finance framework for Nigeria would pro-vide an opportunity for them to finance the economic ac-tivities of low income groups and the poor.

3.7 Utilization of SMEEIS Fund:As at December, 2004, only N8.5 billion (29.5%) of the

N28.8billionSmalland Medium Enterprises Equity Invest-ment Scheme (SMEEIS) fund had been utilized. Moreover,10% of the fund meant for micro credit had not been utilizeddue to lack of an appropriate frame work and confidence inthe existing institutions that would have served the pur-pose. This policy provides an appropriate vehicle that wouldenhance the utilization of the fund.

Chapter 4

Microfinance Policy4.1 Policy Objectives

The specific objectives of this microfinance policy arethe following:

i. Make financial services accessible to a large segmentof the potentially productive Nigerian population which oth-erwise would have little or no access to financial services;

ii. Promote synergy and mainstreaming of the informalsub-sector into the national financial system;

iii. Enhance service delivery by microfinance institutionsto micro, small and medium entrepreneurs;

iv. Contribute to rural transformation; andv. Promote linkage programmes between universal/de-

velopment banks, specialized institutions andmicrofinance banks.

4.2 PolicyTargetsBased on the objectives listed above, the targets

of the policy are as follows:i. To cover the majority of the poor but economi-

cally active population by 2020 thereby creating mil-lions of jobs and reducing poverty.

ii. To increase the share of micro credit as per-centage of total credit to the economy from 0.9 per-cent in 2005 to at least 20 percent in 2020; and theshare of micro credit as percentage of GDP from 0.2percent in 2005 to at least 5 percent in 2020.

iii. To promote the participation of at least two

thirds of state and local governments in micro credit fi-nancing by 2015.

iv. To eliminate gender disparity by improvingwomen’s access to financial services by 5% annually; and

v. To increase the number of linkages among univer-sal banks, development banks, specialized finance insti-tutions and microfinance banks by 10% annually.

4.3 Policy StrategiesA number of strategies have been derived from the

objectives and targets as follows:i. License and regulate the establishment of

microfinance Banks (MFBs)ii. Promote the establishment of NGO-based

microfinance institutionsiii. Promote the participation of Government in the

micro finance industry by encouraging States and LocalGovernments to devote at least one percent of their an-nual budgets to micro credit initiatives administeredthrough MFBs.

iv. Promote the establishment of institutions that sup-port the development and growth of microfinance ser-vice providers and clients;

v. Strengthen the regulatory and supervisory frame-work for MFBs;

vi. Promote sound microfinance practice by advocat-ing professionalism, transparency and good governancein microfinance institutions;

Vii. Mobilize domestic savings and promote the Bank-ing culture among low-income groups;

viii. Strengthen the capital base of the existing microfinance institutions;

ix. Broaden the scope of activities of micro financeinstitutions; Strengthen the skills of regulators, operators,

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and beneficiaries of micro finance initiatives;x. Clearly define stakeholders’ roles in the develop-

ment of the microfinance sub-sector; andxi. Collaborate with donors, coordinate and monitor

donor assistance in micro finance in line with the provi-sions of this policy.

Chapter 5

The Goals of Microfinance BankThe establishment of microfinance banks has be-

come imperative to serve the following purposes:(i) Provide diversified, affordable and dependable

financial services to the active poor, in atimely and competitive manner, thatwould enable them to undertake and de-velop long-term, sustainable entrepre-neurial activities;

(ii) Mobilize savings for intermedia-tion;

(iii) Create employment opportunitiesand increase the productivity of the ac-tive poor in the country, thereby increas-ing their individual household income anduplifting their standard of living(iv) En-hance organized, systematic and focusedparticipation of the poor in the socio-eco-nomic development and resource alloca-tion process;

(V) Provide veritable avenues for theadministration of the micro creditprogrammes of government and high net worth indi-viduals on a non-recourse case basis. In particular, thispolicy ensures that state governments shall dedicatean amount of not less than 1 % of their annual budgetsfor the on-lending activities of microfinance banks infavour of their residents; and

(vi) Render payment services, such as salaries, gra-tuities, and pensions for various tiers of government.

Chapter 6

Policy Measures and Instruments in the Establish-ment of the Framework for Microfinance Banks.

Private sector-driven microfinance banks shall beestablished. The banks shall be required to be well--capitalized, technically sound, and oriented towards lend-ing, based on the cash flow and character of clients.

There shall be two categories of Micro Finance Banks (MFBs),namely:

(i) Micro Finance Banks (MFBs) licensed to operate as aunit bank, and

(ii) Micro Finance Banks (MFBs) licensed to operate in astate.

The recognition of these two categories of banks doesnot preclude them from aspiring to having a national cover-age, subject to their meeting the prudential requirements.This is to ensure an orderly spread and coverage of the marketand to avoid, in particular, concentration in areas alreadyhaving large numbers of financial institutions.

An existing NGO which intends to operate an MFB can

either incorporate a subsidiary MFB, while still carrying outits NGO operations, or fully convert into a MFB.

(I) MFBs Licensed to Operate as a unit bank (a.k.a. Com-munity Banks)

MFBs licensed to operate as unit banks shall be commu-nity- based banks. Such banks can operate branches and/orcash centres subject to meeting the prescribed prudentialrequirements and availability of free funds for openingbranches/cash centres. The minimum paid-up capital for thiscategory of banks shall be N20.0 million for each branch.

(ii) MFBs Licensed to Operate in a StateMFBs licensed to operate in a State shall be authorized to

operate in all parts of the State (or the Federal Capital Terri-tory) in which they are registered, subject to meeting theprescribed prudential requirements and availability of freefunds for opening branches. The minimum paid-up capitalfor this category of banks shall be N1.0 billion.


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Chapter 7

Organic Growth Path for MFBsThis policy recognizes that the current financial land-

scape of Nigeria is skewed against macro, Small andMedium Enterprises (MSMEs) in terms of access tofinancial services. To address the balance, this policyframework shall promote an even spread ofmicrofinance banks, their branches and activities, toserve the un-served but economically active clients inthe rural and ur-ban areas.

7.1 The level of spread and saturation of the fi-nancial market shall be taken into consideration 1foreapproval is granted to an MFB to establish branchesacross the Local Government Areas and/or States, infulfillment of the objectives of this policy. Specifically,an MFB shall be expected to have a reasonable spreadin a Local Government Area or State before moving toanother location, subject to meeting all necessary regu-latory and supervisory requirements stipulated in theguidelines. This is to avoid concentration in alreadyserved areas and to ensure extension of services tothe economically active poor, and to micro, small andmedium enterprises.

7.2 In order to achieve the objectives of an or-ganic growth path, a microfinance bank licensed tooperate as a unit bank shall be allowed to open newbranches in the same State, subject to meeting theprescribed prudential requirements and availability ofminimum free funds of N20 million for each new branch.In fulfillment of this requirement, an MFB licensed tooperate as a unit bank can attain the status of a StateMFB by spreading organically fromone location to an-other until it covers at least two -thirds of the LGAs ofthat State. When an MFB has satisfactorily covered astate and wishes to start operations in another state, itshall obtain approval and be required to again groworganically by having at least N20 million free fundsunimpaired by losses for each branch to be opened inthe new state.

7.3 An MFB licensed to operate in a State shall beallowed to open a branch in another State, subject toopening branches in at least two-thirds of the local gov-ernments of the State it is currently licensed to oper-ate in the provision of N20.0 million free funds and, if inthe view of the regulatory authorities, it has satisfiedall the requirements stipulated in the guidelines.

7.4 The regulations to be issued from time to timeshall be such that would encourage the organic growth

path of the MFBs at all times.7.5 However, an MFB may wish to start operations as a

State Bank from the beginning and therefore not wish to groworganically from branch to branch. Such an MFB may be li-censed and authorized to operate in all areas of the statefrom the beginning subject to the provision of a total capitalbase of N 1 billion. In other words, the preferred growth pathfor MFBs is the branch by branch expansion to become StateBanks. But anyone wishing to start as a big state institutionfrom the beginning can do so subject to availability of N 1billion and proven managerial competence.

Chapter 8

Ownership of Microfinance Banks8.1 Microfinance banks can be established by individu-

als, groups of individuals, community development associa-tions, private corporate entities, ad foreign investors. Signifi-cant ownership diversification shall be encouraged to enhancegood corporate governance of licensed MFBs. Universal banksthat intend to set up any of the two categories of MFB assubsidiaries shall be required to deposit the appropriate mini-mum paid-up capital and meet the prescribed prudential re-quirements and if, in the view of the regulatory authorities,have also satisfied all the requirements stipulated in the guide-lines.

8.2 No individual, group of individuals, their proxies orcorporate entities, and/or their subsidiaries, shall establishmore than one MFB under a different or disguised name.

Chapter 9

Participation of Existing Financial Institutions inMicrofinance Activities9.1 Universal Banks:

Universal banks currently engaging in microfinance ser-vices, either as an activity or product and do not wish to set upa subsidiary, shall be required to set up a department unit forsuch services and shall be subjected to the provisions of theMFB regulatory and supervisory guidelines.

9.2 Community Banks:All licensed community banks, prior to the approval of this

policy, shall transform to microfinance banks licenced to op-erate as a unit bank on meeting the prescribed new capitaland other conversion requirements within a period of 24months from the date of approval of this policy. Any commu-nity bank which fails to meet the new capital requirement

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within the stipulated period shall cease to operate as acommunity bank. A community bank can apply to convertto a microfinance bank licenced to operate in a State if itmeets the specified capital and other conversion require-ments.

9.3 Non-Governmental Organization -Micro Finance Insti-tutions (NGO-MFls):

This policy recognizes the existence of credit-only,membership-based microfinance institutions which shallnot be required to come under the supervisory purviewof the Central Bank of Nigeria. Such institutions shall en-gage in the provision of micro credits to their targetedpopulation and not to mobilize de-posits from the general public.

The registered NGO-MFls shallbe required to forward periodic re-turns on their activities to the CBN.

NGO-MFls that wish to obtainthe operating licence of amicrofinance bank shall be requiredto meet the specified provisions as stipulated in the regu-latory and supervisory guidelines.

9.4 Transformation of the Existing NGO- MFls:Existing NGO-MFls which intend to operate an MFB

can either incorporate a subsidiary MFB while still carry-ing out its NGO operations or fully convert into an MFB.NGO-MFls that wish to convert fully into a microfinancebank must obtain an operating licence and shall be re-quired to meet the specified provisions as stipulated inthe regulatory and supervisory guidelines.

Chapter 10

Justification for the Capital Requirements10.1 The present capital base of N5 million for com-

munity banks has become too low for effective financialintermediation. Indeed, to set up a community bank, atleast N5 million is required for the basic infrastructure,leaving zero or a negative balance for banking opera-tions. From a survey of community banks, an operatingfund of N50 million is about the minimum capital (owncapital and deposits) a community bank needs to provideeffective banking services to its clients. However, it isrecognized that since many community banks are basedin rural areas, their promoters may not be able to effec-tively raise N50 million as shareholders’ funds. Hence,

the stipulation of N20 million as shareholders’ funds for theunit microfinance banks. The banks are expected to en-gage in aggressive mobilization of savings from micro-de-positors to shore up their operating funds.

10.2 A State coverage microfinance bank that wouldoperate multiple branches would be expected to take offwith funds sufficient to operate a full branch in at least two-thirds of the Local Government Areas in that State. Hence,a minimum paid-up capital of N1.0 billion shall be requiredto obtain the licence to operate a State coverage MFB. Ex-pansion to another State shall be subject to the provision ofN 1.0 billion minimum shareholders’ funds unimpaired bylosses, and after opening branches in at least two- thirds of

the Local Government Areas of the State it is currentlylicensed to operate in, and if in the view of the regulatoryauthorities, it has satisfied all the requirements stipulatedin the guidelines.

10.3 The experience of other countries sheds light onthe level of capitalization required for microfinance banks.In most countries, the level of capitalization depends onthe geographical coverage of the banks, and for some coun-tries, even for a particular scope of coverage (district orprovince), the population and volume of business of thearea further determine the level of capitalization. The capi-talization requirements in other countries were also con-sidered in arriving at the capitalization levels for the twocategories of MFBs in this policy.

Chapter 11

Setting up a Framework for the Supervision ofMicrofinance Banks11.1 Licensing and Supervision of Microfinance Banks

The licensing of microfinance banks shall be the respon-sibility of the Central Bank of Nigeria. A licensed institutionshall be required to add “microfinance bank”; after its name.All such names shall be registered with the Corporate Af-fairs Commission (CAC), in compliance with the Companiesand Allied Matters Act (CAMA) 1990.

Any community bank which fails to meet the newcapital requirement within the stipulated period shallcease to operate as a community bank.


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11.2 Establishment of a National Microfinance ConsultativeCommittee

A National Microfinance Consultative Committee(NMFCC) shall be constituted by the Central Bank of Nige-ria (CBN) to give direction for the implementation and moni-toring of this policy. Membership of the committee shall bedetermined from time to time by the CBN. The MicrofinanceSupport Unit of the CBN shall serve as the Secretariat tothe Committee.

11.3 Credit Reference BureauDue to the peculiar characteristics of microfinance prac-

tice, a credit reference bureau, which shall provide infor-mation on microfinance clients and aid decision making, isdesirable. In this regard, the present Credit Risk Manage-ment System in the CBN shall be expanded to serve theneeds of the microfinance sector.

11.4 Rating AgencyThe CBN shall encourage the establishment of private

rating agencies for the sub-sector to rate microfinance in-stitutions, especially those NGO-MFls which intend to trans-form to microfinance banks.

11.5 Deposit Insurance SchemeSince MFBs are deposit-taking institutions and in order

to reinforce public confidence in them, MFBs shall qualify

for the deposit insurance scheme of the Nigeria DepositInsurance Corporation (NDlC).

1.6 Management Certification ProcessIn order to bridge the technical skills gap, especially

among operators of microfinance banks, the policy recog-nizes the need to set up an appropriate capacity buildingprogramme for MFBs. To this end, the CBN shall put in placea microfinance bank management certification process toenhance the acquisition of appropriate microfinance op-erational skills of the management team of MFBs. A transi-tion period of twenty four (24) months shall be allowed forthe take-off of the programme, with effect from the date oflaunching the policy.

11.7 Apex Associations of Microfinance InstitutionsThe establishment of an apex association of

microfinance institutions to promote uniform standards,transparency, good corporate practices and full disclo-sures in the conduct of MFI businesses shall be encour-aged.

11.8 Linkage ProgrammeThe policy recognizes the importance of the provision

of wholesale funds for microfinance banks to expand theiroutreach. Pursuant to this, the CBN shall work out themodalities for fostering linkages between universal de-velopment banks, specialized finance institutions and themicrofinance banks to enable the latter source for whole-sale funds and refinancing facilities for on-lending to theirclients.

11.9 Establishment of a Microfinance Development FundIn order to promote the development of the sub-sec-

tor and provide for the wholesale funding requirementsof microfinance banks, a Micro Finance Sector Develop-ment Fund shall be set up. The Fund shall provide neces-sary support for the development of the sub-sector interms of refinancing facility, capacity building, and otherpromotional activities. The Fund would be sourced fromgovernments and through soft facilities from the interna-tional development financing institutions, as well as mul-

tilateral and bilateral development In-stitutions.

11.10 Prudential RequirementsThe CBN recognizes the peculiarities

of microfinance practice and shall ac-cordingly put in place appropriate regu-latory and prudential requirements to

guide the operations and activities of the microfinancebanks.

11.11 Disclosure of Sources of FundsLicensed MFBs shall be required to disclose their

sources of funds, in compliance with the Money LaunderingProhibition Act 2004.

11.12 Corporate Governance for Microfinance BanksThe board of directors of MFBs shall be primarily re-

sponsible for the corporate governance of themicrofinance banks. To ensure good governance of thebanks, the board of directors shall be responsible for es-tablishing strategic objectives, policies and procedures

However, it is recognized that since many communitybanks are based in rural areas, their promoters maynot be able to effectively raise N50 million asshareholders’ funds.

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that would guide and direct the activities of the banks andthe means to attain same, as well as the mechanism formonitoring Management’s performance. Thus, while man-agement of the day -to - day affairs of the banks shall be theresponsibility of the Management ‘team, the board of direc-tors shall, however, be responsible for monitoring and over-seeing Management’s actions. Consequently, the licensedmicrofinance banks shall be expected to operate under adiversified and professional board of directors.

Chapter 12

Regulatory Incentives

12.1 The new window of opportunity for the emergingmicrofinance banks in bringing financial services to peoplewho never had access to such services before, would re-quire the support of government and those of regulatoryauthorities. The CBN shall collaborate with the appropriatefiscal authorities in providing a favourable tax treat-ment of MFBs’ financial transactions, such as exemp-tion from value added tax (VAT) on lending, or tax oninterest income or revenue.

12.2 Similarly, the principle of exemption fromprofit tax shall be applied to any MFB that does notdistribute its net surplus but ploughs it back and rein-vests the surplus to finance more economically ben-eficial micro, small and medium entrepreneurship.

12.3 Furthermore, a Rediscounting and Refinanc-ing Facility (RRF) shall be made available to MFBsfor purposes of providing liquidity assistance to sup-port and promote microfinance programmes. This wouldenable MFBs that have met the CBN prudential require-ments to, on a sustainable basis, provide and render microcredits and other services to their clients.

Chapter 13

The Roles and Responsibilities of StakeholdersThe roles and responsibilities of stakeholders shall in-

clude the following:

13.1 GovernmentGovernment shall be responsible for:(i) Ensuring a stable macro-economic environment, pro-

viding basic infrastructures (electricity, water, roads, tele-

communications, etc), political and social stability;(ii) Fostering adequate land titling and other property

rights sufficient to serve the collateral needs of borrow-ers and financial institutions;

(iii) Instituting and enforcing donor and foreign aidguidelines on micro-finance to streamline their activitiesin line with this policy; and

(iv) Setting aside an amount of not less than 1 % of theannual budgets of state governments for on-lending ac-tivities of microfinance banks in favour of their residents.

13.2 Central Bank of Nigeria (CBN)The roles of the CBN shall include the following:(i) Establishing a National Microfinance Consultative

Committee;(ii) Evolving a clear micro-finance policy that spells

out eligibility and licensing criteria, provides operational/prudential standards and guidelines to all stakeholders;

(iii) Evolving a microfinance sub-sector and institu-tional policies aimed at providing regulatory harmony,

promoting healthy competition and mainstreaming mi-cro-financing with formal intermediation;

(iv) Adopting an appropriate regulatory and supervi-sory framework;

(v) Minimizing regulatory arbitrage through periodicreviews of the policy and guidelines;

(vi) Promoting linkage programmes between univer-sal/development banks, specialized finance institutionsand the microfinance banks;

(vii) Continuously advocating market determined in-terest rates for government-owned institutions and pro-mote the channelling of government microfinance fundsthrough MFBs; and

(viii) Implementing appropriate training programmesfor regulators, promoters and practitioners in the sub-


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sector, in collaboration with stakeholders.

13.3 MicroFinance Institutions (MFls)Microfinance service providers shall:(i) Provide efficient and effective financial services, such

as credit, deposits, commodity/inventory collateralization,leasing, and innovative transfer/payment services;

(ii) Undertake appropriate recruitment and retention ofqualified professionals through transparent and competi-tive processes;

(iii) Adopt continuous training and capacity buildingprogrammes to improve the skills of staff; and

(iv) Strictly observe their fiduciary responsibility, remaintransparent and accountable in protecting savers’ deposits.

13.4 Public Sector Poverty Alleviation AgenciesThe MFB policy recognizes the roles of public sector MFls

and poverty alleviation agencies such as the National Pov-erty Eradication Programme (NAPEP) in the developmentof the sub-sector. They shall be encouraged to perform thefollowing functions:

i. Provision of resources targeted at difficult- to-reachclients and the poorest of the poor;

ii. Capacity building;iii. Development of MFls’ activities nation- wide;iv. Nurturing of new MFls to a sustainable level; andv. Collaborating/partnering with other relevant Stake

holders.

13.5 Donor AgenciesDonor agencies offer free or subsidized funds, dona-

tions or technical assistance for the development of themicrofinance industry in Nigeria. They include bilateral andmultilateral institutions, NGOs and missionaries with a pro-poor orientation. The services provided by donor agenciesinclude grants, donations, technical assistance, etc.

The donor agencies, in conducting their microfinanceactivities, shall comply with the relevant provisions of thispolicy. The target clients for donors’ support may include:MFls, NGOs, regulators and other relevant agencies. How-ever, for the purpose of leveraging the evolving micro fi-nancing initiative, donors are expected to direct most oftheir assistance to licensed MFBs to ensure an orderly re-source injection, transparency and synergy.

14.0 Conclusion

14.1 There exists a huge untapped potential for fi-nancial intermediation at the micro and rural levels ofthe Nigerian economy. Attempts by Government in thepast to fill this gap, through supply-driven creation offinancing institutions and instruments, have failed, dueto the poor capitalization of such schemes and restric-tive regulatory and supervisory procedures, among otherfactors. The community banks were designed to fill thegap, but their low capital base and isolated mode of op-eration have not enabled them to make meaningful con-tributions to micro financing.

14.2 The microfinance banks being established in linewith this policy framework shall be adequately capital-ized, appropriately regulated and supervised to addressthe need of financing at the micro levels of the economy.The two categories of microfinance banks shall beMicrofinance Banks licensed to operate unit banks (a.k.a.community banks) and Microfinance Banks licensed tooperate in a State.

14.3 Microfinance Banks licensed to operate unitbanks shall require a minimum paid-up capital of N20million and shall operate branches and / or cash centres.A Microfinance Banks licensed to operate in a State shallrequire a minimum paid-up capital of N1.0 billion and shalloperate multiple branches within a State, subject to sat-isfactory prudential requirements and availability of freefunds for branch expansion.

14.4 The existing community banks shall transformto Microfinance Banks within 24 months of approval ofthis policy, by increasing their shareholders’ funds unim-paired by losses to a minimum of N20.0 million. Any com-munity bank which does not meet the new capital re-quirement within the stipulated period shall cease !o op-erate as a community bank.

14.5 The Central Bank of Nigeria shall supervise andregulate the microfinance banks: The Nigeria Deposit In-surance Corporation shall insure the deposits ofmicrofinance banks.

14.6 The provisions of this policy shall be subject toreview from time to time at the full discretion of the regu-latory authorities.


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ecent developments in the financial world, particularly thecollapse of US energy trading firm ENRON and the reportedcase of WORLDCOM, have triggered a more focused atten-tion on the activities of accountants and auditors. Further-more, as companies continue to struggle with profitability ina sluggish and complex economy, internal audit functionsare further being challenged to demonstrate their contribu-tions to their organisations. There is no doubt that internalaudit functions are increasingly under pressure to meet stra-tegic business goals and support internal value drivers.Terms like internal accounting control, operational auditingand internal audit mean different things to different people.Many public companies and accounting firms are arrivingat potentially dangerous and different interpretations of whatinternal auditing, operational audit and internal accountingcontrol entail.

In this paper, we will evaluate the traditional roles aswell as emerging ways of engaging internal audit towardsenhancing effective corporate governance and ensuringbusiness growth and development.

* By Godson S. Nnadi



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INTERNAL AUDIT: PURPOSE AND NATUREThe role of internal audit has been evolving in response

to changes in business environment and the expectationof management. At the earlier stage, internal audit wasmore concerned with detection of systems failure, fraudsand irregularities. Today, however, it has been observedthat the emphasis of internal audit has significantly shiftedfrom detection to prevention. More and more internalaudit resources are also being directed to functions whichcan contribute proactively to the attainment of businessobjectives. All the same, the role and importance assignedto internal audit depends, to a large extent, on the under-standing of the management of what internal audit is allabout. It is therefore necessary to state one or two defini-tions of internal audit to guide us in this discussion.

Internal auditing had been defined as “ an independentappraisal activity established within an organisation forthe review of operations as a service to management. It is amanagerial control which functions by measuring and evalu-ating the effectiveness of other controls”.

The Institute of Internal Auditors in the US states thatinternal audit “examines and evaluates the planning,

organising, and directing processes to determine whetherreasonable assurance exists that objectives and goals willbe achieved.”

From the above definitions, it is evident that all sys-tems, processes, operations, functions, and activitieswithin the organisation are subject to internal audit evalu-ation. Such evaluation, in the aggregate, provide infor-mation to appraise the overall system of control.

It is an obvious fact that without internal audit, account-ing, internal and other control systems are likely to losetheir steam because there will be no mechanism for moni-toring and evaluating the effectiveness of these systemson a continous basis. The traditional responsibilities ofinternal auditors in an organisation are amongst others:

a) Review and appraisal of the soundness, adequacy,reliability and application of internal accounting controlsand other operating controls and promoting them at rea-sonable costs;

b) Ascertaining the extent of compliance with estab-lished policies, plans and procedures;

c) Ascertaining the extent to which organisations’ as-


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sets are safeguarded from possible losses which may arisefrom fraud, waste, operational inefficiency, mismanage-ment and poor value for money;

d) Examination of financial and operating information.This includes review of means used to identify, measure,classify and report such information and specific inquiryinto individual items including detailed testing of transac-tions, balances and procedures;

e) Recommending operational improvement to man-agement;

f) Making special enquiries at management’s direc-tion;

g) Reviewing operational practices to promote in-creased efficiency and economy;

h) Evaluating the reliability of management informa-tion.

MAKING INTERNAL AUDITORS MORE EFFECTIVEFor internal auditors to be effective in today’s busi-

ness environment, the following minimum conditions mustprevail:

a) An in-depth understanding of the accounting andinternal control systems of the organisation and peopleworking in the organisation.

b) It is essential for the auditor of a computer-basedsystem to be knowledgeable enough about computers andtheir related systems to be able to evaluate that system;he must be able to spot weaknesses both in controls thathave to be adapted from those in manual systems and inthe additional features that are essential if there is to beassurance that a computer-based system will not get outof control. In fact, he has to be knowledgeable enoughabout computers and their functions to be able to do anymeaningful job.

c) Independence: The organisational level of internalaudit function must be high enough to enable it operateindependently. It is preferable if the internal auditor re-ports to a board of directors or an internal audit commit-tee rather than to the chief accountant or the financialcontroller.

d) Segregation of audit functions from accounting func-tions: For internal auditing system to be effective, internalaudit functions must be segreted from the accounting func-tions and should have nothing to do with operating activi-ties.

e) Internal audit reports must be accorded deservedtreatment: The treatment given to internal audit reportsaffects the effectiveness of the internal audit functions. Inan environment where internal audit reports are notpromptly and firmly acted upon, employees are not likelyto comply with company’s rules and regulations. They arealso likely to involve themselves in fraud and other of-fences because they know that no action will be takenwhen such irregularities are discovered and reported byinternal auditors. In such a circumstance, the internalauditor will become just a toothless bull-dog whose re-ports are dumped in a thrash can and this is likely to affecthis morale.

f) Diplomacy of audit staff: An internal auditor musthave the charisma to deal with people. He must thereforecarry out his assignments in a way that suggests that theyare in the interest of his fellow employees. In most cases,internal auditors carry themselves as if they are the po-licemen of their organisations. Although not armed, they

carry out their functions with intimi-dating mien. Their concern is alwayshow to find offenders who should bereported to management. With thisattitude, the internal auditor is alwaysprone to losing sight of his core duty.

THE NEW ROLES OF INTERNALAUDIT

The internal audit function has not been left out of themonumental changes taking place in all spheres of life. Itis now being seen, and rightly too, as a real resource thatmust add value to business growth and development. Theinternal auditor can only respond effectively to these newroles by being proactive. Some of the new roles are brieflydiscussed below:

FOCUS ON THE DESIGN STAGE OF SYSTEMS ANDPROGRAMMES DEVELOPMENT

In the past, internal audit resources were mainly con-centrated on measurement and evaluation of the effec-tiveness of control systems put in place by management.The posthumous approach is no longer adequate astoday’s internal auditors need to focus their attention ongetting the system right from the beginning, if they must

It is an obvious fact that without internal audit, accounting,internal and other control systems are likely to lose theirsteam because there will be no mechanism for monitoringand evaluating the effectiveness of these systems on acontinous basis.


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work closely with management andprovide services that can contrib-ute positively to the achievementof business objectives.

Internal auditors, being a seg-ment of the organisation that un-derstands all facets oforganisation’s operations and prob-lems, must now get themselves ac-tively involved in design stage ofsystems. They should use their ex-pertise to suggest system improve-ment at the design stage.

FOCUSING MORE ON RISKMANAGEMENT

By risk, we mean the probabil-ity that an event or action may oc-cur which will adversely affect theability of an organisation to achieveits goals. All organisations are ex-posed to one risk or the other andthe only way to reduce risk to zerois to cease business. Risk impactson the ability of a company to com-pete, to maintain its financial bear-ing, to maintain the quality of itsproducts or services and to retainhighly competent personnel. Theeffects of risk on a company cantake any of the following forms:

i) Taking erroneous decisionsarising from the case of wrong, un-timely, inadequate or otherwise un-reliable information;

ii) Erroneous record keeping, in-appropriate accounting, fraudulentfinancial reporting, financial lossand exposure;

iii) Inability to adequately safe-guard assets;

iv) Loss of customers’ patron-age, negative publicity and damageto organisation’s image and reputation;

v) Failure to adhere to company’s policies, plans, andprocedures, or not complying with relevant laws and regu-lation;

vi) Failure to achieve established objectives and goalsfor operations and programmes; and

vii) Acquisition of resources in an uneconomical man-ner and/or utilising them inefficiently and ineffectively.

Internal auditors are now focusing on risk assessmentin their organizations. Two reasons can be adduced forthis: one, it is an intrinsic part of internal audit function andsecondly, risk assessment enables internal audit function

IS offers three levels of control which facilitates information management and pro-vides an adequate basis for planning and enhancing an audit work namely: preventive,detective and corrective. It makes the auditors job easier because it enables auto-mated, routine audit checks and inspections, timely automatic notification to manage-ment when fraud indicators are detected, the monitoring of performance of operatorsas well as data extraction and analysis, accurate and complete records as well as riskassessment and scheduling, time-keeping, flowcharting and report generation.

Several IS enabled audit software have since been introduced into the profession.Hence to take full advantage of IS, auditors must be very familiar with ComputerAided Audit Techniques (CAATS). The most common CAATS are: Audit CommandLanguage (ACL), Audit & Security Associate, IDEA Data Analysis Software (Clem-ent Isah & Partners), APEX, Computerised Accounting Records Comparison System(CARCS), Team mate (Audit planning/working papers).

Contemporary auditing is transiting from ‘Traditional Models’ as we know it to theContinuous supervisory process model requiring ‘continuous online auditing’ (COA).This methodology uses online information technology which provides different formsof assurance thus expanding traditional audit to cover a wider scope including elec-tronic commerce.

Benefits of Continuous AuditContinuous audit methodology utilizes online information technology which facili-tates simultaneous /immediate audit trail with wide ranging benefits which helps moni-tor operations, comparing and identifying deviations from standard or expected char-acteristics, alarms are triggered where significant discrepancies occur and must beacknowledged by Operations Managers, Auditors and top management, producesaudit results simultaneously within (or) a short period of time after event occurred, istimelier, closer to event, semi-supervisory function, has potential for independentassurors, stakeholders and firms can introduce new assurance product, is real timeonline reporting ‘key driver’ of this model, is one of the most important introductionsof the Sarbanese/Oxley Act 2002 to IS auditing and professional practice.

Automated Information System: Risks and ThreatsThe technology that enables automated Information Systems ironically poses gravedangers to the system it enables. Major threats come from hackers, viruses, Trojans,spoofing, denial of service (DoS), IP weaknesses, etc. This is a major constraint to anIS based Audit.

In IS Audit and Control, ‘every time you build a better mousetrap, the mice getsmarter’. While the new forms of fraud, error and lack of probity are difficult to predict,a library of tests for known cases of these events can be built and applied againstexisting entity data flows at nominal cost. Auditors must continue to update their ITcapacities and take advantage of the benefits of ‘continuous online auditing (COA) inspite of the infrastructure constraints. IS based audit is a ‘must do’, an important com-ponent of corporate governance in the information society.

For more information, see presentation on the subject by Jim Ovia, MD/CEO,Zenith Bank Plc on www.zenithbank.com or e-mail us at [email protected]

n a world driven by technology, Auditors need to have a firm grip of opera-tions based on the Automated Information Systems (IS) - the entire automationinfrastructure, organization, personnel, components, processes and proce-dures for the collection, processing, storage, transmission, display, dissemi-nation and disposal of information. IS facilitates the acquisition and productionof easily understandable reports.

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to operate effectively. Risk assessment helps the internalaudit staff to know the amount of resources to be commit-ted to each area of the organization, given its level of riskexposure. It also influences the amount of audit work tocarry out in each area.

USING INTERNAL AUDIT AS A TRAINING GROUNDFOR FUTURE MANAGERS

By its nature, internal audit leads her staff to under-stand the organization in its entirety. The scope of theirwork is such that makes it unavoidable to be involved in allfacets of a company’s operations. In order to be able tofunction effectively, internal audit staff need to understandand document their organization’s control environment.This includes management philosophy, the entity’s orga-nization structure, functions of the Board of directors andits committees, the management control methods for moni-toring and following up on performance, the company’shuman resource management policies and practice, andthe competitors.

The need to understand all the various facets of theorganization gives the internal audit staff the “bird’s eyeview” of the organization. Internal audit is therefore an

ideal training ground for future managers of anyorganization.

Furthermore, the training of audit staff for managerialpositions facilitates the audit process when the traineeseventually become managers outside the internal auditfunctions.

INTERNAL AUDITORS AND IRREGULARITIESThe responsibility for prevention of irregularities lies

with the management of any company. As a result, man-agement usually puts in place adquate internal, account-ing and other control measures which can check the oc-currence of irregularities. Internal auditors, on the otherhand, owe it as a duty to ensure that these measures areadhered to and remain relevant at all times.

However, irregularities can still take place in spite ofany control measures because of the following reasons:

i) Beakdown of physical safeguards;

ii) Breakdown of revew procedures that are in place todetect irregularities;

iii) Collusion - possibility that a number of individualsin an organization can enter into an unholy alliance todupe the organization; and

iv) Management override - possibility that manage-ment can use its position to overturn control systems. Thisis most obvious when the fraud or irregularity is designedto benefit the organzation generally.

As we have said earlier, one of the duties of internalauditors is the protection of company’s assets againstlosses that may arise from fraud and other irregularities.In order to perform this role creditably, internal auditorsmust possess investigative skills. In this wise, an internalaudit executive would need a deep understanding of dif-ferent types of fraud that are possible in their organiza-tions. They also need to study their environment and con-sider if there is any potential motive for employees toperpetrate irregularities. If the answer is in the affirma-tive, they should find ways by which the irregularities canbe perpetrated and examine the opportunity to perpe-trate them. They can then come up with procedures thatcan reveal whether such opportunity has been utilised. Itshould also be noted that to be successful in their frauddetection role, internal auditors would need to think as

though they were fraudsters.

REPORTING IRREGULARITIESWhat should an internal auditor do when he de-

tects irregularities? There is no precise answer to thisquestion as the probable action would depend verymuch on the nature of the irregularities, who perpe-

trates them, against whom and for what purpose. Underthis, we are going to consider two possible scenarios:

i) Irregularities by lower and middle level staff againsttheir organization: Where an internal auditor detects these,he has no option than to report them to management ofthe company. His role in this regard should not stop atreporting fraud but also should extend to stating the mag-nitude of the fraud, methods of excution, and the peopleinvolved. Furthermore, he must analyse the weaknessesin the company’s control systems that made the fraudpossible.

ii) Irregularities perpetrated by management againstthe company or third parties e.g. government, customers,suppliers and the general public. The role of the internalauditor under this circumstance is whistleblowing - a termused to describe an unauthorized disclosure or reportingof some management misdeeds to an authority outside

gettyimages.com


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management or to the general pub-lic.

The dilemma that an internal au-ditor faces is whether it is proper forhim to “blow whistle”. In resolvingthis, he will unavoidably experiencepersonal conflicts for two reasons.One, he is employed by managementand his service is expected to be aid-ing management in its activities. Inother words, he, under normal cir-cumstance, must be loyal to manage-ment. Reporting management mis-conduct to a higher authority wouldseem to be tantamount to betrayal oftrust and may cost the internal audi-tor his job. This is also likely to affecthis future career because he mightbe seen as a troublemaker and otherorganizations might be reluctant toemploy him.

On the hand, the internal auditoralso owes allegiance to his concienceand to his creator. The urge to live ahigh moral life geared towards pro-tection of the interests of individuals,the state and the general public mayforce him to report management ir-regularities to outside parties. Fail-ure to report management miscon-duct which is likely to cause harm toshareholders, creditors, governmentor other third parties is nothing butsheer irresponsibility and elevation ofpersonal interest above public good.

Notwithstanding this conflict, thebest line of action to follow is for in-ternal auditors to report to a higherauthority any management irregulari-ties with potential adverse conse-quences. This higher authority maybe the shareholders, police authority,government or the audit committeeset up under Companies and AlliedMatters Act 1990.

The case of WORLDCOM-UStelecom giant buttresses our stand onthis: It was the company’s internalaudit that revealed that transfers of

$3.055 billion for 2001 and $797 millionfor the first quarter of 2002 were notmade in accordance with generallyaccepted accounting principles.

OUTSOURCING OF INTERNALAUDITING SERVICES

Recently, a new dimension in thequest for effective internal auditingwas added: contracting out internalauditing services. This is defined asthe arrangement where anorganisation’s internal auditing func-tions are performed by auditors on acontract or “extended audit service”.

The proponents of this systemposit size factor as well as economicand efficiency factors as reasons foradopting this system; others arguethat the outsourcing will take a finaltoll on internal auditing professionwith more and more internal audi-tors losing their importance andtheir jobs as well as impairing theindependence of external auditors.However, this can be properly har-nessed by contracting internal au-dit services to one accounting firmwhile engaging another firm to per-form external audit functions.

CONCLUSIONIn this paper, we discussed the

need for reinventing internal auditfor effective corporate governance.We started by examining the scopeand traditional roles of internal au-dit and then proceeded to high-lightthe new roles that internal auditmust assume if it must contributeproactively to business growth.

From our analysis, we came tothe conclusion that internal auditmust now focus on preventionrather than detection of errors andirregularities if it is to be able to re-late closely with line managers andprovide services that add value tobusiness survival and growth. We

REFERENCES1. Audit Committees - “ A Framework

for Assessment”. The Institute ofChartered Accountants in Englandand Wales (1997).

2. Auditing Standards Committee ofthe Institute of CharteredAccountants of Nigeria (ICAN)“Auditors’ Independence”.The Nigerian Accountant January/March 1992 vol. XXV No. 1.

3. Auditing Standards Committee -“Auditing Standards” InternationalOrganisation of Supreme Audit In-stitutions. (June 1992).

4. Beasley, M. S., Carcello, J. V., andHermanson, D. R. - “Top 10 AuditDeficiencies” Journal of Accoun-tancy April 2001 vol. 191 No. 4.

5. Bradley, R. J., Armitage, J. L. “Au-dit Committees.” The NigerianAccountant, January/March 1994vol. XXVIII No. 1. (1994).

6. Financial Accounting Reportingand Auditing Handbook - Centraland Operational Accounting Divi-sion of the World Bank (January1995).

7. Nwakanma, F. - “Understanding theRole of Your Internal Auditor” inthe Nigerian Accountant January/March 1994 vol. XXVII No. 1.

8. Nwoko, C- “The Internal Auditoris the watchdog” The NigerianAccountant. July/September 1985,vol. XVIII No. 3.

9. Statement of Auditing Practice(SAP) 1 - Bank Reports for AuditPurposes. Issued by the AuditingPractices Committee (APC) -Institute of Chartered Accountantsof Pakistan (ICAP).

also emphasized the need for inter-nal audit to focus more attention onrisk management and systems de-sign.

Finally we stressed the need tochange the perception of an internalauditor from that of a policeman tothat of a provider of services. It isour considered opinion that if compa-nies conscientiously adopt the sugges-tions made in this paper, internal au-dit will become the pivot for effectivecorporate governance.

(*Godson S. Nnadi is Executive Sec-retary/Chief Executive Nigerian Ac-counting Standard Board, (NASB))


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* By Mike Uzor

he Nigerian banking industry hasgone through the refinery fire of theCentral Bank and at the end of an 18-month regulatory surgery; theshape of a new banking industry hasbegun to emerge. History has beenmade in the banking reform that wasa regulatory filtering of the entirebanking industry, isolating the weakbanks and creating a new industryfree of financial distress. It was anopportunity to unmask the deep de-fects in the system and tackle finallythe problem of systemic distress inthe industry.

It is indeed a regulatory feat tohave shrunk the 91 banks in the sys-tem to about 26 in a matter of 18months. A change is being madefrom mushroom to mega bankingand banks with much bigger finan-cial muscles have begun to take theirplaces in an industry that is entirelyreborn.

For many banks, the consolidat-ing process took off to a faulty startdue to the inexperience in mergersand acquisitions in Nigeria. But even

31


those numerous memoranda of understanding that weresigned and discarded did put the banking industry in mo-tion that was necessary to maintain depositors’ confidenceas the industry struggled through the most challengingregulatory overhaul.

Banking consolidation strategies have followed twomain approaches and each has its implications on perfor-mance quality in a post consolidated operating environ-ment. The first is using large outstanding reserves to meetthe minimum capitalisation, which is the route followed bythe largest banks. Such banks now have relatively lowvolume of shares in issue, which means rates of returnare not likely to decline.

The second approach is through mega offers that havesignificantly increased the volume of shares in issue. Manyof the banks following this approachare likely to record considerable de-cline in rates of return in the short-term. Only a few of them that aregrowing well above the industry av-erage can rank with the first group interms of ability to preserve rates of re-turn.

The question of what will be the na-ture and challenges of the banking in-dustry in a post consolidated era de-pends on what the banking reform hasbeen able to accomplish and what it hasnot. The answers will yield themselves by consideringwhether those macroeconomic concerns and financialmarkets conditions that prevailed before the policy andeven warranted its introduction have been decisively dealtwith.

Economic Policy QuestionThe state of the Nigerian economy in a post consoli-

dated banking industry remains a matter of great con-cern. There seems to be a presumption that the reform inthe banking sector is all that is required to fix the economy.Recapitalisation of the banking industry has involved draw-ing much of the money from the rest of the economy intothe banking industry and that presents one sided reformthat is not matched with equal capacity building in the realeconomy.

Much of the difficulties that banks were facing beforethe consolidation policy began reflect the inability toachieve stimulatory growth in the real sector as domesticoutput remained subdued and aggregate demand re-mained increasingly insufficient to support the service ca-

pacity of the banking sector. This warranted heavy depen-dence by banks on government business in confirmationthat private sector business is insufficient to support allthe banks in operation. These hard economic funda-mentals have not been addressed in the banking reformand there is no doubt that banks will continue to face thedifficulties emanating from the poor state of the economy.

Notwithstanding some cases of abuse of the credit sys-tem by management in banks, it is important to recall thatstunted growth in the real sector resulted in significantcredit losses for banks as loan repayment difficulties im-paired asset quality conditions industry-wide. The loan re-payment difficulties facing banks is an issue that requiresa comprehensive economic policy approach. It has ledthe operators to become extremely cautious in growing

risk asset volumes. The asset structure ofbanks will therefore most likely continue towear a short-term maturity profile as longas economic performance remains dis-appointing.

Banking consolidation will not in it-self encourage banks to increase lend-ing in a situation of rising creditlosses. The revenue structure ofeven the largest banks shows thatthey have been earning morefrom treasury operations than

from core lending activity over the past severalyears. There are yet no regulatory changes in place toredirect this trend.

The entire economy has been on hold for almost 18months and everything seems to be waiting for the con-clusion of the banking consolidation. The thinking is thatconsolidated banks will use their huge funds to kick startthe economy once the consolidation process is concluded.But this expectation is limited by the fact that banks, beingservice institutions, can only service the operators theysee in the economy.

For the big money the banking sector has mobilised tobe useful to the economy, there needs to be a large num-ber of operators in the real sector ready and able to utiliseit productively. A sign for such readiness is a rising num-ber of new businesses setting up and big expansionprojects taking place in the industrial sector and elsewhereside by side with the capacity building process in the bank-ing sector. What is happening instead are business stag-nation, factory closures and downsizing.

The regulatory authorities need to watch the situationbecause it is a bad signal that there could be a mismatch

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The thinking is thatconsolidated bankswill use their hugefunds to kick-start theeconomy once theconsolidation processis concluded.


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between a consolidated banking industry and the real sec-tor in terms of available investment opportunities and busi-ness volume targets of banks. While there are a lot ofsmall scale businesses and micro enterprises to cater forthere will be big banks looking for volumes not easily avail-able from local businesses.

It is important that the economy does not end up witha banking sector that is oversized to it. There is the needto define clearly the place of small scale and micro enter-prises in a post consolidated banking industry. The banks’SMEIS scheme is not an answer to this because the issuehere is one of businesses that are already accessing bankcredit in the normal course of business coming under threatof being swept aside as big banks naturally weed off rela-tively penny accounts.

In a post recapitalised banking industry therefore therewill be highly capitalised banks but adequate capitalisation

will not make up for the other equally important indices ofmeasuring the soundness of a bank. Recapitalisation willraise liquidity in the short-term but will not guaranty aconducive macro-economic environment required to en-sure high asset quality and good profitability. In the ab-sence of an enabling environment, banks will devise theirown means of attaining those goals and that will not leadto the full realization of the goals of the reform.

One of the major concerns arising from the consolida-tion policy is the limitation of the reform measures to thebanking sector instead of a comprehensive set of macro-economic policies that address real sector-linked chal-lenges facing banks. Because banking is a service indus-try, it ought not to be the starting and ending points ofeconomic reform since it should follow the direction of theindustrial and other sectors it serves.

The Central Bank on its part believes banks should

drive those sectors to recovery and growth. The bankingreform itself was not a vote winning policy in bankingcircles but the Central Bank believes it is the best way ofreorganising the banking sector, uplifting its performanceand advancing it. But without a clear vision of where therest of the key economic sectors are headed and how farthey can go the reform in the banking sector will have alimited impact. There is therefore no clear understanding,agreed strategy or blue print as at now on how the bank-ing sector reform will translate into high economic growth.

Reconciling Size With QualityThe new banking policy has set the operators on a

mission of building size but how this eventually reconcileswith service quality isn’t getting the desired attention yet.The big banks are driven headlong by the objective ofgetting bigger in order to continue to rule the industry in

terms of size and market share. Banks arecompetitively aspiring to attain some highsounding targets on equity base and thesize of the balance sheet but how to dealwith the challenges of managing size isn’treceiving equal attention.

Being big and being efficient haven’tbeen found to go together. The consolida-tion policy has provided the spur for banksto build the sizes of their balance sheet butmost of them haven’t got firm strategies todeal with the challenges of becoming big.One of the major challenges of a post con-solidated banking industry will therefore bethe issue of how to preserve operating ef-

ficiency and service quality of banks. Banks that fail tobuild operating structures that match efficiency with vol-ume growth will face serious pressures on operating effi-ciency and service quality.

A post consolidated banking industry will present lead-ership challenges at the top management levels in banks.There will be a need for new vision; new competitive strat-egies will also be needed. The decision making base ofbanks will need to be broadened and decentralisation ofthe management function will be a major requirement.

The leadership force needed to keep every part of amega banking structure streaming round will need todouble. Consolidation will obviously create in every bank,new demands of management that the present executivecapacity may not posses. There will be the need to de-velop new competences in order to reinforce operatingstrengths and competitive advantages. Banks therefore

Source: CBN / R&EIG


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need to build adequate capacity at top management lev-els to be able to meet the demands for a much more effec-tive leadership in a post consolidated banking industry.

Getting the operating structure right is a key factor inbanks going through mergers and acquisitions. The partsneed to fit into themselves for the new entities to be ableto function properly in the marketplace. This challengebecomes even more pronounced in an environment inwhich mergers and acquisition were imposed rather thana development warranted by identified business opportu-nities.

There is a small group of medium sized banks thatstand as a testimony to the success of new generationbanking. The leading new generation banks, being rela-tively moderate about size, are the banks to watch in apost consolidated banking industry. They are reasonablycautious about the implication growing big has on servicequality and are either adding small banks to themselvesor are standing alone. With growth rates that are aboveindustry average, these more strate-gically focused banks constitute thereal competition in the new industry.

The banking industry is indeedclearly positioned for a leadership con-test between the big old dependables andthe emerging new generation generals.The first generation giants are coming un-der pressure to take the steps that will pre-serve their volume leadership in the indus-try. The high growth driven new generationchallengers will aspire to grow volume withperformance quality. They already have brand reputa-tions that rank them at par with the big banks on safety ofpublic deposits. There is likely to be a situation where theleading new generation banks close in with the big bankson volume while still maintaining the edge on operatingefficiency and performance quality.

The leading new generation banks will come face toface with the challenges of becoming big suddenly almostovernight. A big hurdle in their way is how to manage sizeand defend quality at the same time. There will be pres-sure on efficiency standards and the tendency for perfor-mance quality to weaken. There is the possibility that someof the banks here may suffer a decline in quality stan-dards while those that will be able to sustain their perfor-mance quality benchmarks will have to run an extra mile.

Whether any member of this group will be able to de-fend its superior performance quality in a post consoli-dated banking industry depends on the adequacy and firm-

ness of management responses to the demands of thenew operating environment. A visible change in the styleof management is a necessity for any bank to continue tomaintain leadership in any aspect of banking business inthe post consolidated environment.

The emergence of big banks will tend to level up nichebanking opportunities and make competition flat in theindustry. This means every bank will have a completemenu of essentially the same financial services. The onlyway to maintain competitive edge in the industry will beproduct differentiation and a lot of marketing noise can beexpected in this area. Banks will need new product offer-ings to tap into new markets.

A New Round of Bank ClosuresA number of weak banks that cannot find places under

the consolidating groups risk withdrawal of their bankinglicences and closure by the Central Bank. A new round of

bank closures and liquidation is therefore likely to bea major activity in a post consolidatedbanking industry. More than N200 billionis trapped in the proven cases of fiveterminally distressed banks and thechance is high that some more bankswill join the liquidation list.

Closing the banks will place afinal seal on depositors’ hopes foran eventual survival of the bankssinking with their deposits. Thelikely negative impact of thison public confidence in banks

can be expected to be tempered by the reinforcement thebanking reform has made to the banks standing in a postconsolidated industry. Bank closures and liquidation aretherefore not expected to have a serious negative impacton the banking industry. However, the banks that emergein the base in a new ranking of business volume andcapitalisation may be vulnerable with time, as safety con-scious depositors will gradually seek to move up the lad-der.

The Central Bank’s consolidation policy was only add-ing a regulatory force to an already ongoing industry trend.Long before Prof. Charles Soludo took over the leader-ship of the Central Bank the business of banking had beenshifting to the big banks perceived by the public as safe.The fact that there have been over 90 banks in the systemis only in name. In reality, the business of Nigerian bank-ing is in the hands of not more than 10 banks. With thenumber of banks in a post consolidated industry likely to

A post consolidatedbanking industry willpresent leadershipchallenges at the topmanagement levels inbanks.


ISSUES (II)

stand at more than two and half times that number, it doesnot appear that the industry induced consolidation hasended.

Twenty six banks are still a crowd in an industry thathas for several years been shiftingon its own towards an oligopoly. Abig economic prosperity will be re-quired in the economy to sustainthat number. There are no signalsyet for output and consumption-ledeconomic expansion to happen anytime soon. By post consolidatedbanking industry standards, institu-tions that end up in the category ofsmall banks are not likely to bemajor destinations of safe haven seeking depositors.

It can be expected that the Central Bank induced merg-ers and acquisitions have now been planted in Nigeria’sbusiness culture. The experience has been acquired andbanks can therefore be expected to continue to seek anduse mergers and acquisitions on their own as a tool forstrategic repositioning and stimulating growth. The eyesof corporate boards seem to have been opened to thebenefits derivable from mergers and acquisitions.

This is but the first round; business opportunity inducedconsolidation will comenext. It is highly desirablethat banks, finding them-selves competitively dis-advantaged, will take earlysteps to merge with othersrather than heedlesslyhanging out until they sinkwith depositors’ funds.Apart from troubled insti-tutions it can be expectedthat there will be healthybanks coming together ontheir own seeking to establish competitive edge throughmergers and acquisitions. In the medium-term the num-ber of banks will possibly drop further.

Operating Developments To WatchThe Central Bank believes the enhanced capacity of

banks will place them in a position of strength to concen-trate on their core function of financial intermediation tothe benefit of productive lending in the medium-term.However in an environment of rising credit losses, mostbanks are likely to become extremely cautious with newlending.

Banks will need reinforcing their strength in credit ad-ministration matters preparatory to shifting the new moneyto the high earning asset side of the balance sheet. Theyneed to implement measures and adopt strategies to pre-

serve and enhance risk asset perfor-mance standard for some reasons. Thefirst is the continuing difficulties facingthe industrial sector as already high-lighted. The second is the likelydecentralisation of lending powers thatis a necessity for mega banks. The thirdis that merchant banks entering theretail market for the first time need alot of caution to avoid costly lendingmistakes.

The ability of banks to grow revenue and profit num-bers in the short-term is limited. The banking industry ispresently facing a revenue constraint and three majorfactors are likely to continue to restrict revenue and profitgrowth in the sector. The first is the decline in interestrates, which has reduced the average interest yield pernaira of loans and advances. With a further decline ininterest rates in 2005 following the downward review ofthe minimum rediscount rate from 15 to 13 per cent, bankearnings will come under bigger pressures still. Interest

income, which is the mainrevenue line for banks, hascontinued to slow down, ac-counting for a declining pro-portion of gross earnings.This will continue to have adepressive impact on rev-enue growth.

The second is the discour-agement to grow risk assetvolume in the environmentof rising credit losses and thedifficulties facing the indus-

trial sector. The only way to compensate for the decline inthe lending rate is expansion in credit volume but this isnot happening because the rest of the economy has notbeen equally empowered to create productive opportuni-ties for bank financing.

The third is greater regulatory attention on banks thathave closed cheap profit opportunities. With greater po-licing of the foreign exchange market, a big channel foreasy profit has closed for the banks.

Two main cost elements are likely to strain bank earn-ings. Interest cost isn’t moderating as fast as interest in-

* 2005 & 2006 are estimatesSource: CBN/R&EIG

*


ISSUES (II)

come and this is because competition for funds has re-mained high. Again, the relatively cheap funding windowsin the public sector have been shut against banks. Operat-ing cost is also rising ahead of gross income and that isencroaching deeper into gross revenue.

Likely fallout of the low interest rate objective is dis-couragement of domestic savings. Average deposit ratesof banks have approached the low end of single digit. Thisneeds to be well managed because it has the capacity toerode bank deposit base from two angles. The first will bea natural outflow of financial capital in search of higherreturn in other forms of investments. The second will bethe tendency for many savers to consume their savingsas rising cost of living squeezes the people’s propensity tosave.

One of the major hurdles on the path of low interestrates is the high rate of inflation. The reason that the priceof money went so high in the first place was because thegeneral price level is high and rising. The most potentfactor in attaining the low interest rate objective is there-fore getting inflation rate to single digit as well. That is theonly way the supply of money can be maintained by re-ducing its price.

Dealing with inflation is key because as long as infla-tion rate remains in double digit, investors will press toearn positive real rate of return on their money. Thatmeans banks are not likely to see many depositors willingto give them money they can lend at low interest rate. Theresulting scarcity of loanable funds will be because whilethere is clamour for low interest rates there will be no-body willing to stand still in an inflationary environment tosubsidize the price of money.

A post consolidated banking industry will appear to bea much better risk than hitherto. Banks are therefore mostlikely to press for a reduced deposit insurance premiumto reflect this position. The pressure for a risk weightedpremium can be expected to mount. As deposit liabilitiesof merging banks become aggregated, the deposit insur-ance premium bill will become weighty.

The Nigeria Deposit Insurance Corporation will mostprobably have to yield ground in certain areas. It mayfinally settle for a risk categorisation of banks for the pur-pose of deposit insurance premium, which is in line withthe risk based capital adequacy standard. In the alterna-tive it may consider a reduction in its premium rate, whichis currently 15/16 per cent or limit premium to the maxi-mum amount of deposits covered by deposit insurancenow being increased to N200, 000.

Government Fiscal PolicyThe nature of government fiscal conduct is a major

factor in shaping a post consolidated banking industry.The management of oil revenue presently does not showthat government recognizes the cyclical nature of the oilmarket – a boom is followed by a burst. By running fiscaldeficits at a time that its revenue is at an exceptionallyhigh level, government fiscal behaviour puts the economyat the risk of financial crisis in the event of a downturn incrude oil prices. In the absence of adequate reserve ca-pacity to finance expenditures any time government rev-enue drops, the Nigerian economy skates on a thin iceyear after year. The banking industry needs to appreciatethis risk and provide for it in its contingency plan.

Government spending seems not to be empoweringthe private sector as well. More than 80 per cent of gov-ernment spending constitutes recurrent expenditure,which is not stimulating the nation’s productive capacity.There are neither reasonable savings nor so manyinfrastructural projects to show for the longest running oilboom seen so far in Nigerian history.

The financing of the fiscal deficits is hurting theeconomy from two angles. The first is the inflationary stockof money the Central Bank’s monetization of fiscal deficitsadds to the economy. This keeps inflation rate above thelevel of interest rates and erodes the real value of savingsand investment.

The second is the crowding out effect on the privatesector. By selling government debt instruments to the pub-lic, government is further withdrawing from the alreadythin resources of the private sector to overgrow its size.This is not an appropriate fiscal path for a governmentthat is downsizing and promising to prop up the privatesector. By drawing more resources from the private sec-tor at a time it is handing over more responsibilities to it,government is not creating the environment for a pros-perous private sector.

Government spending pattern needs to strengthen theproductive capacity of the private sector and the CentralBank needs to cut off the supply of inflationary stock ofmoney. A significantly supportive government fiscal con-duct is required to stimulate the industrial sector. Banksmust find a burgeoning private sector to be able to deliverthe rewards of the reform.

(*Mike A. Uzor is a Financial Analyst & Managing Consult-ant at Datatrust Consult, Lagos.)


ISSUES (III)

INTRODUCTIONThe history of the Nigerian banking system is replete withgrowth and burst cycles in the number of operating banks andtheir branches. Usually, growth spurts are experienced whenthe policy environment presents strange business opportuni-ties in the banking sector, or there is a sudden policy shift thatmakes it easy for ordinary business people (not professionalsin banking) to initiate a process that creates access to publicfunds in the name of bank deposits. Perhaps the most far reach-ing of such bursts was in 1947, when as many as 145 bankswere registered because there was no banking legislation inoperation and it was quite fashionable to own an indigenousbank! The opportunistic institutions ended up in liquidation,either on account of inadequate capital and/or liquidity crisisthat got out of hand. In fact, the minimum capital requirementof N25,000 in the 1952 Banking Ordinance resulted in the de-mise of many of the mushroom banks, at which time therewas no consideration for consolidation to meet the capital re-

* By Dr. ‘Biodun Adedipe


ISSUES (III)

quirement.Also, the pattern had always been that of dominant

personalities in most of the institutions, creating avenuefor unwholesome practices that resulted in the collapse ofsuch institutions and substantial losses to their variousstakeholders. This occurred either through unsecured in-sider credit, or foreign exchange transfers that had notangible business basis.

The pattern of going it alone that existed in the systemdid not encourage thought of consolidation. Equally, pre-vious increases in the minimum capital requirements werenot significant as to motivate banks to merge, under what-ever arrangement, in order to comply with the require-ments. As well, consolidation has never been mandatoryfor Nigerian banks, even if it was capital induced.

Bank consolidation has often fallen into two categoriesof voluntary and policy-induced. It is voluntary when anindustry shakeout is market-driven, with players seekingconsolidation partners as a possible route to survival, rel-

evance, growth and profitability. The peculiarity of the vol-untary consolidation is that not many players are involvedat once, and as such the disruptions to business activitiesand the financial system are minimal and have often notposed any serious danger to industry stability. The policy-induced and mandatory consolidation, in spite of its manybenefits, has the capacity to disrupt business activitiesand threaten the stability of the financial system. There isno doubt that the challenges of the latter are more formi-dable, and that is what Nigeria has been grappling withsince the July 2004 pronouncement by the Governor of theCentral Bank of Nigeria.

The challenges also fall into two planks,namely:

1. In-consolidation, representing the period from 6th

July 2004 to 31st December 2005, during which the 89 li-censed banks were supposed to raise their shareholders’funds to N25 billion, through either going it alone or merger/acquisition.

2. Post-consolidation, which represents what the bankswill likely become from January 2006, what the consoli-dated banks must grapple with and what the banking/gen-eral public should expect.

This paper addresses these two planks of the bankconsolidation in Nigeria during 2004/2005, and the expec-tations thereafter. In the first section, a quick review of thepurpose of bank consolidation in global terms is reviewedvis-à-vis the need for it in Nigeria. Section two deals withthe strategies and activities engaged in by the banks toachieve the end-December 2005 hurdle placed beforethem by the Central Bank of Nigeria (CBN), while sectionthree is a prognosis of post-consolidation challenges. Thepaper concludes with a few remarks on the issues need-ing further attention.

WHY CONSOLIDATE?There are as many reasons and strategies for bank

consolidation as there are banking jurisdictions. When theopportunities in the operating environment for banks, ei-

ther within the boundaries of a country, an economiczone or geographical sphere, become amenable onlyto consolidated institutions, there is a tendency formarket-induced consolidation. Many cases of bankconsolidation that have been recorded to date in themodern history of banking are of this kind, and readyexamples are the European and American bank merg-

ers and acquisitions of the 1980s and 1990s.Market-induced consolidation normally holds out prom-

ises of scale economies, gains in operational efficiency,profitability improvement and resource maximization. Theoutcomes have however, not totally confirmed these sup-posed benefits and they have varied across jurisdictions,especially when compared with the particular pre-consoli-dation expectations.

Bankers have always claimed that scale economies isthe primary objective of mergers. As such, there was anaverage of 190 mergers per year through the period from1960 to 1982, rising to 423 per year during 1980 to 1994 toproduce total merger transactions of 6,347. In all these, itwas hard to find any evidence of scale economies. In Eu-rope, there were between 50 and 90 mergers per yearduring 1986 to 1994. The merger of Chase Manhattan andChemical banks in 1995 produced the largest bank in theUSA, representing 8.7% of total assets in the banking sys-tem. This triggers the thought of possible mega merger,involving say, First Bank and Union Bank, or any of thesebanks with Zenith Bank!

The peculiarity of the voluntary consolidationis that not many players are involved at once,and as such the disruptions to businessactivities and the financial system areminimal and have often not posed any seriousdanger to industry stability.


ISSUES (III)

Hughes and Mester (1997) provided evidence to sug-gest that there are scale economies in banking, bank man-agers are risk averse, and banks use the level of theirfinancial capital to signal the level of risk. This is an area ofinterest in Nigerian banking, especially when the returnon equity is calculated in another two to three years andthen compared with the historical industry average.

Rhoades (1996) reported that American banks consoli-dated in response to the removal of restriction on bankbranching across States, while Hughes, Lang, Mester andMoon (1998) concluded that the economic benefits of con-solidation are strongest for those banks that engaged ininterstate expansion, andin particular the expan-sion that diversifies mac-roeconomic risk. VenderVennet (1997) found thatdomestic mergers im-proved profitability andoperational efficiency,but cross-border (na-tional, not inter-State) ac-quisitions were a surersource of cost efficiency.

Hughes, Mester andMoon (2000) provide evi-dence that scale econo-mies exist in banking, butthey are elusive becausethey fail to account forrisk. Thus, scale econo-

mies that result from consolidation and diversification donot produce better performance in banking, unless thatchoice makes the bank’s management more conscious ofrisk and moderates its decisions and actions appropriately.Larger scale of operation that leads to diversification canonly reduce liquidity and credit risk under the ceteris pari-bus assumption, and they argue that this is not always so.The implication for bank consolidation in Nigerian bankingis whether the bigger (not yet mega) banks will seek agood balance between growth and risk management.

Solanes and Penarrubia (2001) examined mergers andacquisitions in European banking, and found that industry

consolidation was beneficial(by providing social benefits)in the first economic integra-tion stages, but could dam-age welfare in the more ad-vanced stages as the few bigbanks safeguard price agree-ments to forestall foreigncompetition. Perhaps themost important social benefitthat Nigerian banks (after thefirst round of consolidationended 31st December 2005)would confer on the bankingpublic and the nationaleconomy is a sharp drop inlending rates. Even if this un-likely scenario occurs, thereis the likelihood that fewer


ISSUES (II)

and colluding banks (especially during the second phaseof consolidation that is envisaged) will pursue their ownbusiness interests more than they would the national orsocial interest!

The other side to European mergers and acquisi-tions was the intent to encourage banks to grow bigand thus become impossible of failure. This, of course,ignores the fact that no bank can ever be too big tofail. All it takes for a bank to fail is for “bad news”about a bank to get to its stakeholders (especiallydepositors) and they all walk in at the same time totake their funds! For such bank to survive, it musthave sufficient liquid assets to meet all maturing andlong-dated obligations.

However, there appears to be divergence be-tween the state of the banking industry in Nigeria vis-à-visthe vision of the government and regulatory authoritiesfor the industry. This, in the main, was the reason for thepolicy of mandatory consolidation, which was not open todialogue and its components also seemed cast in con-crete.

Prior to the major policy shift by the Central Bank ofNigeria (CBN), Nigerian banking experienced a steady in-crease in the number of distressed deposit-money banks,i.e. those rated by the CBN as marginal or unsound. Thiscreated the fear that Nigerian banking could be headingtowards systemic distress. The marginal and unsoundbanks increased in number from 17 in 2001 to 23 in 2002and 2003, and then 27 in 2004. This number represented30% of the operating banks in the system, rising from 17%only three years earlier! It can be argued though that sud-den policy shifts (especially the withdrawal of public sec-tor funds from the banks) was partially responsible for theincrease in the number of marginal and unsound banks in

2004. The corollary is that the institutions concerned havehad inherent and deep-seated weaknesses that the policyshift exposed, and no matter what, they would have even-tually become distressed.

While Nigerian banking had not gotten to systemic dis-tress by end-June 2004, it made a lot of policy sense to

preempt the destabilizing effects of such occurrence byinitiating reforms at the time the Central Bank did. Theagenda had all the ingredients of contemporary bankingreforms, but the implementation plans had some flaws.

As such, there was initial resistance, which nonethelesssoon whittled down to insignificance because of the strongpolitical support the policy had and the sheer executivewill to force it through. When this became clear to thestakeholders in Nigerian banking, the 18-month race tothe tape began in earnest.

It is important to mention here the initial confusion asto whether the new rule applied to the paid-up share capi-tal or the shareholders’ funds. If it was the former, compli-ance would be a massive tall order. The indication by thecentral bank that it was the latter ignited hope in bankingoperators and the race to the tape was fully ignited.

As well, it is to be noted that just before the policypronouncement in July 2004, two of the leading banks inNigeria (Zenith Bank Plc and Guaranty Trust Bank Plc) wentto the capital market to raise substantial sums. The timingof these new issues drew remarks that the managementsof these banks probably had an inkling of the impendingpolicy. Such argument is easy to debunk because the regu-latory approvals were obtained long before the new Gov-

ernor of the Central Bank of Nigeria that introduced thereforms assumed office. The only thing that can besaid about these banks would be that their manage-ments were proactive and had a correct reading of theeconomic climate in Nigeria, and perhaps the globe.

AT THE STARTING BLOCKThe first major interpretation of the policy was to seek

out how many players the regulators/government possi-bly desired at the end of the exercise. This, as would beshown later, should give an indication of what to expectafter the deadline of 31st December 2005.

Based on the capital plus reserves of banks operatingin Nigeria by end-December 2003, assuming no growth

Bankers have always claimed thatscale economies is the primary objectiveof mergers. As such, there was anaverage of 190 mergers per year throughthe period from 1960 to 1982.

Source: CBN


was recorded in 2004, it appeared that the policy shift wasdesigned to reduce the number of operating banks from89 at June 2004 to 11 – a figure derived from splitting theaggregate capital of N291.25 billion for end-2003 amongthe 89 banks in operations. The number improved slightlyto 14, using the aggregate capital at end-2004. See Table 3.This perhaps was why the Central Bank in January 2005indicated it expected 15 mega banks to emerge from theconsolidation exercise.

By the beginning of August 2004, the race proper hadstarted and banks immediately fell into three groups,namely:

1. Those that already had capital in excess of the mini-mum, and could only think of acquiring other banks and/orexpanding their capital base. This group included FirstBank of Nigeria Plc and Union Bank of Nigeria Plc.

2. Those that could go it alone and had the capacity forit. This included those having obvious market recognitionand standing that left no stakeholder in doubt that theycould make it on their own. It is in this category that for-eign banks or banks having substantial foreignshareholding belonged. The other category in this groupwere those that had the hope of breasting the tapealone, but the investing and general public did notsee that possibility – the trust was by and largeself-propelled.

3. Those that obviously had no hope of makingthe N25 million on their own, but had capacity toenhance their capital through new issues in thecapital market or private placement. With their en-hanced capital base, such banks were sure thatthey would be attractive to other banks or bankgroupings.

By the end of 2004, the banking sector was apleasant surprise to most watchers, as the patternof dominance it exhibited over the period from 1999

till date again reflected in the new issuesmarket. The Securities and Exchange Com-mission (SEC) stated in January 2005 thatthe sector accounted for N147.4 billion(78.8%) out of a total capital amount of N187billion raised in the Nigerian capital mar-ket in 2004. Just eight banks accounted forN123.3 billion of this total amount. SeeTable 4 for the details. This developmentwas important in three different ways,namely:

1. The Nigerian capital market had thecapacity to produce the volume of in-

vestible funds demanded by the new minimum capitaliza-tion in Nigerian banking.

2. Some banks were underrated in terms of their abil-ity to mobilize capital from the investing public.

3. Other banks that imagined they had no hope of rais-ing funds from the capital market gained confidence fromthe roaring success recorded by the early movers.

THE JOURNEY TO THE TAPEOne of the initial fears, which still remains an issue, is

that the time limit for the implementation of the consolida-tion programme was rather short. The scramble to meetthe deadline caused banks whose owners ordinarily wouldnot have come together in a business venture or combineto seek shelter under a common umbrella in order to es-cape the possible loss of investment. This brought together“strange bedfellows”, who for the sake of survival cameinto the same boat, but have every tendency to beginbickering post-consolidation.

An indication of this was in the plurality of memoran-dum of understanding (MOU) that banks signed with each

Nigerian Banking: Pre-Consolidation Structure


ISSUES (III)

other, signifying either a big bank that intended to acquirea smaller bank, or two (or more) medium-sized banks aim-ing to merge, with specific amounts for each member toraise from the capital market and then beef up its capitalbase. The latter was what happened in the cases of theinitial Sterling Bank and Astra Bank, whose members haddivergent objectives that led to the collapse of the MOU.

Under the first scenario, several banks sent proposalsto the big banks in the system for outright acquisition. Thearrangement and the stiff timeline put the big banks at anadvantage, dictating terms that were at times quite ridicu-lous. The smaller banks of course, had little or no choice, ifthey wanted to survive. This played out towards the endof December 2005, when a few banks got ditched by thebig banks they were negotiating with. There were twocases of irreparable disagreement over share valuation(Lead Bank with Wema Bank and Trade Bank with Afribank),while the other failed negotiations were largely to do with

the quality of the risk assets and general state of health ofthe banks concerned (Union Bank vis-à-vis Hallmark Bank,Gulf Bank and a few others). There were indications alsothat one of the problems Afribank had with Trade Bankwas the quality of the latter’s risk assets.

The coming together of several small and medium-sized banks also had its problems. There was mutual dis-trust, which largely arose from the possible sharing of keyManagement and Board positions. This resulted in a num-ber of MOUs being abandoned, and new ones signed hur-riedly. For example, what started as Sterling Bank splitinto two groups of one retaining the name “Sterling”, whilethe other group emerged as Skye Bank. This particularsplit was a positive one because the net gain to the bank-ing system and economy were two banks whose com-

bined capitalization came to N57 billion, which togetherthey probably would have not pooled. There was muchcarpet-crossing, although there was no case of litigationon abandoned merger, as the recent celebrated case be-tween Johnson & Johnson and Guidant in the United Statesof America (USA) where the latter sued the former be-cause it threatened to withdraw from the merger negotia-tions on account of loss in market value of Guidant be-cause its investors reacted to a piece of “bad news” aboutthe company! More remote in this environment is the evolv-ing pattern still in the USA of Silicon Valley mergers, wherethe first step is to sue a prospective merger partner, thenfollow with negotiation and eventually merge!

In the course of implementation of the programme,the CBN announced the desire to eliminate family banks,as many of the distressed banks have been found to getinto that situation because of certain dominant figures inthem. This blanket statement did not separate between

the banks that are professionally man-aged from those in which opportunistswere in charge. Coming to see the likes ofOceanic Bank, First City Monument Bankand Diamond Bank come out strongly af-ter the consolidation exercise was a sortof relief. This seemed to confirm the argu-ment that banks fail not because of theirstrong links with particular families, butbecause of poor and/or “rogue” manage-ment primarily. The positive fallout of thisis that these banks are now more widelyheld, than prior to July 2004.

The race to the consolidation tape byNigerian banks also involved considerablefinancial engineering and reengineering,

which was more of a danger to the system than the flawsin the programme itself. The reconstruction of balancesheets of banks towards presenting clean book for mergerpartners and eventually to the regulatory authoritiesraised both professional and ethical issues. While somewere done professionally and would pass the test any-where in the world, there were some that were mere win-dow-dressing to make the tape. The latter were easily andquickly exposed in the course of due diligence (DD), eventhough there were some that probably escaped the sharpeyes of the professionals that conducted the DD.

The Central Bank was quite sure that the DD that banksconducted on themselves was necessary to expose irregu-larities in the merging banks, and should throw out bankswhose cases were bad. Such banks, it was presumed,

Source: Nigerian Stock Exchange


ISSUES (III)

would not find “suitors”. The argument though is that thiscondition is not sufficient to determine the health of aninstitution in the Nigerian scenario. Some banks probablyscaled through for reasons other than the strength of theirbalance sheet, but because of the prospects of the emerg-ing bank, going forward, when it has to compete for busi-ness in order to survive, grow and be profitable. As well,there could be one or two cases of banks that were liqui-dated at the end of the exercise that, for this same reason,whose last minute acquisition should have been allowedwhere some banks indicated intent to acquire them.

The consolidation process was quite expensive, andthere was no indication that the banks got the kind of sup-port envisaged when the regulatory authorities madepromises on tempering the cost implications of theprogramme. The promise was enough to goad thebankers into a frenzy of activities, without sparingcost. There was the case of a bank that spent al-most as much as the amount it managed to raisefrom its public issue!

The banks were also offered incentives in vari-ous forms, ranging from those for acquiring/acquiredand merged banks to forbearance in terms of past mis-deeds that are brought into the open. The latter was quitesignificant because of the extent of rot that was in thesystem and the assurance of escape from prosecution ifthere was self-reporting of such misdeeds. The promiseof forbearance of debit balances in the banks’ operatingaccounts with the Central Bank meant several billions ofNaira, which at first, generated public uproar as to thebasis for selecting which of the distressed banks wouldbenefit from the offer and the allocation formula for theamount earmarked. The end result was that this furtherrevealed how weak and sick the system was.

The x-ray of the journey to the consolidation tape wouldbe incomplete without a mention of the proposed AllianceBank Plc (in formation). Ordinarily, some 20 or so bankswould have been taken out of the industry by the thirdweek of October 2005, when the banks in merger talksindicated to the Central Bank of Nigeria (CBN) their part-ner banks. Most of the banks left out formed Alliance Bank,which was supposed to be a “bridge bank”, designed towarehouse those banks until their collective problems areresolved or their orderly liquidation could be effected. TheCBN then gave them two conditions:

1. Produce an organogram, establishing the manage-ment structure and indicating who will fill each position.

2. Recover some N10.5 billion out of the insider-relatedcredit, which was the major factor in the negative share-

holders’ funds of about N77 billion.While the bank (in formation) had no difficulty meeting

the first condition, although there were doubts as to whyany member of the management team that mismanagedthe member banks, in the first place, should aspire to be inthe team that will manage the bridge bank. Though notspecifically disclosed, this could be one of the major rea-sons that made the CBN foreclose the bridge bank idea. Itwas also most unlikely that any acceptable professional(to the CBN) would risk taking the job, unless s/he wasappointed by the CBN and assured of the support neces-sary to achieve turnaround of the bank.

The performance of Alliance Bank on debt recoverywas dismal, as the group managed to raise only some

N5.5 billion (N3 billion from a single borrower of one of thebanks). This meant that the banks were completely out ofthe forbearance window that allowed write-off of the debitbalance in their CBN operating accounts.

The last ditch effort to save the 14 banks that wereeventually liquidated was to allow the banks that hadcrossed the N25 billion mark to propose acquisition of theunattached banks – referred to as cherry-picking. The in-dications were made right on time, but the transactionsfailed because the follow-up step of consummation of theprocess was stipulated by the CBN for one week (whichincluded two days of public holiday). Perhaps one of them(African Express Bank) should have been saved from thehangman’s noose, as it recovered some N3 billion of in-sider credit, had an acquiring bank agreed to restructurethe balance in line with the bank’s restructured balancesheet. The position of CBN remained though that the dead-line was well past – already two weeks into 2006 and be-yond the deadline!

AFTER THE DUST IS SETTLEDThe new challenges that face the Nigerian banking in-

dustry, post-consolidation, include the following that cutacross the operators and regulators.

The other side to European mergersand acquisitions was the intent toencourage banks to grow big andthus become almost impossible of

failure.


ISSUES (III)

Consummating the Mergers and AcquisitionsSome of the mergers and acquisitions that were con-

cluded before the deadline of 2005 evolved from a rushedprocess to comply with the rule. The scenario seems like acomparison of a wedding ceremony with marriage, wherethe former has all the trappings/glamour of posturing andmaking lasting impression on the guests and witnesses,the latter is the reality of living together in peace and pro-ductively.

Integration challenges have often focused on infor-mation and communication technology (ICT), whereas it

is all embracing. Processes, procedures, people, cultures,etc need to be integrated as well. The extent of the chal-lenge this poses is easily appreciated in these two in-stances:

1. A group of banks that had Board and Managementrelationship merged, but the staff of the lead bank in thegroup regard the others as “inferior” somewhat and treatthem as intruders who came to dilute the culture.

2. Another bank that acquired others simply defined

its culture as inviolable, and that the staff of the acquiredbanks must accept its poorer remuneration. If any of suchstaff does not find this acceptable, s/he would be shownthe door immediately.

As such, what is happening is more of creating a façadeof a fully integrated bank, whereas there is real troublewithin that the institutions would never admit outside.There is the likelihood that the integration challenges mighttrigger “divorce” eventually, the worst case in merger his-tory being a transaction that failed after almost ten yearsof unsuccessful efforts to integrate.

Disengagement of Surplus EmployeesOne of the arguments made when the consoli-

dation was announced was the inevitability of dis-engagement of “surplus” staff. The logic was quitesimple. If the number of banks in operation comesdown from 89 to 11, at least 78 bank-managing di-rectors would lose their jobs or be down graded. Ifthis scenario runs through the entire organizations,some jobs would certainly have to go. This producedan estimated figure of 31,980 job losses, which theCBN dismissed as unlikely because the need forexpansion by the bigger banks would mean reten-tion or recall of the affected staff. See Adedipe (2004).

The reality of post-consolidation is that it is prac-tically impossible for a bank that has staff comple-ment of 5,000 or 9,000 (these are real figures) toretain all of these unwanted staff. For sure, dupli-cated positions would have to be streamlined. Iffour banks came together, that means staff occu-pying certain positions would have to be rational-ized – only one out of four company secretaries,training managers, etc! Take Unity Bank for ex-ample, it emerged from the marriage of nine banks.There is no magic that will prevent the bank fromdisengaging 20% to 35% of its staff, if not more.

The unfortunate fallout of this is the high possi-bility that competent hands could be shown the wayout, while mediocres are retained because they rep-

resent certain interests. As well, the eventual filling ofgrowth-induced vacancies is unlikely to be with the samehands that were disengaged. Indeed, this has become anindustry-wide phenomenon.

Return on Banking EquityMaintaining the historical return on banking equity in

Nigeria will pose a formidable challenge to the manage-ment of banks. The five-year average return on equity

Source: CBN Report


was about 43.92% during 1998 to 2002. If the banks mustmaintain this, then a profit figure averaging between N11billion and N19.8 billion would be the new target. The racetowards this is already on.

While the industry picture could follow this expecta-tion, the performance of individual banks will vary consid-erably from the average. Some discerning investors ex-pressed this concern during the capital raising efforts ofthe banks. The argument was that how long would it takethe investor to recoup his/her investment from a bankingstock through dividends, except s/he trades the stock ac-tively to take advantage of capital gains.

Tremendous growth has been observed in the balancesheet of banks that made the N25 billon mark long beforethe deadline of December 2005. This leads into anothermajor challenge – that of risk manage-ment.

Risk ManagementConsolidated banks are bigger and

should reap the benefits of scaleeconomies through their capacity tofinance large ticket transactions thathitherto warranted syndication. Wheresyndications are necessary, even big-ger transactions would now fall withinthe capacity of Nigerian banks. The riskimplications will however, pose a hugechallenge to the banks and requirethem to improve their risk manage-ment capability.

The race to grow the balance sheetand generate commensurate incometo sustain the historical return on eq-uity is a challenge on its own. The average of equity tobalance-sheet footing that ranges between 4% and 5.5%globally suggests that a N25 billion would need to grow itsbalance sheet to a figure between N454.5 billion and N625billion. Certainly, the risk implication of a balance sheetthis size cannot be compared with that of a balance sheetof say, N25 billion.

Another dimension to the risk management challengeis the branch network of the emerging banks, which makesthem become so widespread that control could become amajor issue. Take for example, a bank MD/CEO who wasrunning a bank with branch network of 27 branches sud-denly now having to take charge of 150 branches. It is anentirely different ball game!

Capacity Building and Retention of DeepSmarts

The disengagement of bank staff is likely to be more atthe senior level, where responsibilities cannot be multi-plied anyhow. As such, experienced hands will exit theindustry and create a need to train aggressively theyounger and less experienced hands that are available.

The deep smarts have a combination of experienceand exposure that is not easily replicated in the youngergeneration of bank employees. The challenge then is howto select from among the senior staff those to retain forthe purpose of passing down the deep smarts of their re-spective organizations, and those to release into the labourmarket. This requires a professionally handled staff audit,possibly including the conduct of psychometric tests and

rigorous selection interviews handledby external consultants, to eliminatebias and favouritism.

Good Corporate GovernanceThe preceding challenges will cre-

ate a fresh challenge of their own –maintaining the tenets of good corpo-rate governance. The CBN has helpedin this by announcing a fresh code ofgood corporate governance, but it doesnot have the power to enforce. At best,the apex bank will employ moral sua-sion, and should be well advised to seekcollaboration with the Chartered Insti-tute of Bankers of Nigeria (CIBN). Thereis no better time for a focused and re-structured CIBN that will earn and re-tain the confidence of the leaders in

the banking industry.As well, individual banks should be encouraged to com-

ply and maintain self-discipline. Key to this will be effec-tive and efficient surveillance and supervision. A bankerwho knows that s/he cannot easily escape the peeringeyes of the regulator will become more wary about break-ing the rules.

Conflict and Dispute ResolutionThe reference made earlier in this paper to the hur-

riedly packaged bank mergers being borne of the comingtogether of strange bedfellows brings to mind again theugly incidents of the early 1990s, when bank directors foughtopenly and engaged thugs to attack their fellow directors

ISSUES (III)


over disagreements on how the affairs of the banks shouldbe governed, and the sharing of “loot”.

There is no doubt that merger partners would makestartling discoveries post-consolidation that will drive themto either engage in litigations or seek alternative disputeresolution strategies. The Central Bank should set in mo-tion the machinery for identifying quickly and moving toresolve disputes that arise from the consolidation exer-cise.

Strengthening the CBN’s SupervisoryCapacity

The argument has been made repeatedly that a su-pervisor is effective to the extent of its ability to under-stand fully the operations and antics of the operators. Stay-ing a step ahead of operators, rather than abreast of themis the key to effectiveness of the Central Bank.

The staff of CBN should begin to build capacity in bank-

ing operations from the operator’s perspective, ratherthan what is traditionally referred to as banking opera-tions within the apex bank.

Fresh Capital Raising and MergersPerhaps the greatest challenge of all is the likelihood

of a fresh round of capital raising and mergers that willproduce the real mega banks. Some banks could be aim-ing at N100 billion capital or more (perhaps the equivalentof $1 billion), and begin to dream of balance sheet size ofN1 trillion in a few years’ time. This will also raise the chal-lenge of management capacity.

The pointer is in the direction of preparing future Nige-

rian banking leaders that would be able to hold their ownin the increasingly complex financial world, and sustainthe benefits of the present round of bank consolidation.This applies to the operating banks as much as the Cen-tral Bank of Nigeria.

SUMMARY AND CONCLUSIONThe Nigerian brand of bank consolidation obviously is

unique in several ways. It was sudden and set very highhurdles for operators to scale within such limited time spacethat many were skeptical about its success. There weregaps in the programme, which nonetheless had the strongsupport of the executive arm of government.

Banking operators therefore, scrambled to meet therequirements to beat the deadline, in order to remain rel-evant. Substantial sums were raised from the capital mar-ket, defying all predictions about the capacity of the Nige-rian stock market. At the end of the period of 18 months

allowed, 25 banks (19 consolidated and six stand-alone) scaled through and provided vehicles for 75out of the 89 banks in operation prior to the policyshift.

One major gap in the consolidation programmeis the absence of the Asset Management Company(AMC), even though the CBN promised to establishit. The CBN’s position that it would not fund the AMCtotally ignored the crucial role that the companywould have played in factoring the poor risk assetsof the marginal and unsound banks that had nomerger/acquisition partners. The Malaysians em-ployed this scheme successfully (the company wasnamed Danaharta) during the bank consolidationprogramme of the late 1990s and early 2000s.

The post consolidation challenges in Nigeria areenormous, but their early identification sure holdsout promises of resolving and handling them effec-

tively. Suggestions were made on what needs to be donein respect of each of the challenges discussed. This will bethe signpost to the ultimate destination of Nigerian bank-ing.

Important in the scheme of things would be collabora-tion between the regulators and operators. Dialogue andcontinuous exchange of ideas, as well as mutual trust andrespect are key to the survival and prosperity of the bank-ing system, towards making a more robust contribution toeconomic development.(* Dr. ‘Biodun Adedipe is Chief Consultant, B. AdedipeAssociates Ltd.)

ISSUES (III)

Nigerian Banking: Post-Consolidation Structure


F REIGN INSIGHTS

Business ethics and corporate gov-ernance have become key fac-tors influencing investment deci-sions and determining the flowsof capital worldwide. In part, thisis the result of recent scandals inboth developed and developingcountries. However, in a morepositive sense, the growing de-mand for good governance alsoflows from the lessons learnedabout how to generate rapid eco-nomic growth through market in-stitutions. From this perspective,the emphasis on anti-corruption

* By Dr. John D. Sullivan

and good governance is based bothin moral standards as well utilitar-ian considerations of improvedmarket performance.

While ethics and an ethical busi-ness culture are at the heart of thecorporate governance framework,the two are approached somewhatdifferently. Corporate governanceis concerned mainly with creatingthe structure of decision-making atthe level of the board of directorsand implementing those decisions.In this sense governance can bethought of as steering the corpora-

tion. In fact, the very word gov-ernance itself comes from theGreek word for steering. More-over, corporate governance isabout accomplishing the corevalues of transparency, respon-sibility, fairness, and accountabil-ity. Because these values are alsokey concerns for business ethics,the two can be seen as being di-rectly related. However, the cor-porate governance aspect dealswith setting up the structuresthrough which these values areattained, while ethics is both a

Given financial scandals and the resulting new mandates on business, firms find themselves pressedto develop strong codes of ethics to guide the behavior of board members, managers, and employees.Although the concern with ethics has always been a part of doing business, business leaders todayare beginning to think about ethics as a set of principles and guides of behavior rather than a set ofrigid rules. In this sense, business ethics is not only an attempt to set a standard by which all of theemployees of a firm can know what is expected, but it is also an attempt to encourage employees,managers, and board members to think about and make decisions through the prism of a shared setof values.


F REIGN INSIGHTS

guide for behavior and a set of principles (or a moralcode). While a good ethics system includes the corevalues of responsibility, transparency, fairness, andaccountability, it goes into many other dimensionsas well.

This paper summarizes the general issues of cor-porate governance; provides an overview of the phi-losophy of ethics; discusses business ethics in somedepth; presents some of the various approaches andguidelines for developing an ethical code; reviewssome of the special factors of ethics in business andbanking; and describes the responsibility and ap-proaches that a company or a bank can take to de-velop an ethics program. Finally, the conclusion re-views some of the benefits and challenges arisingfrom the consideration of business ethics in the in-ternational environment.

Review of Corporate GovernanceIn its most basic form, corporate governance is

about creating a set of principles and a decision mak-ing system to govern the modern corporation. His-torically, the concept of corporate governance wasdefined by Berle and Meanes as the principal agentproblem1 – the separation of ownership and control.As the British and American capital markets devel-oped, and to a lesser extent the capital markets incontinental Europe, there came about a separationbetween those who owned the underlying assets ofthe company and the actual hired management.

So the key challenge became how to ensure thatthe owners, or the stockholders, could control anddemand accountability from the hired management,or, in other words, the considerations of shareholderprotection gained importance. Following the Asianfinancial crisis and other international crises, theOrganisation for Economic Co-operation and Devel-opment (OECD) came to develop the “OECD Prin-ciples of Corporate Governance” that today are ac-cepted as the international standard (see Box 1).

The implementation of the OECD Corporate Gov-ernance Principles, however, requires a whole set ofsupporting and enforcing market institutions. As can beseen from the first principle, there is a specific recognitionof the role of market institutions, the framework of lawand regulations. Interestingly, this principle was added in2002 based on the review of the developing countries’ re-alities. The original set of principles assumed that these

institutions were in place, but the recognition of the devel-oping countries’ realities reflects the expansion of corpo-rate governance into emerging markets. In these mar-kets, great consideration has to be given to the overallstructure of institutions, which ensure that corporate gov-ernance does not only exist on paper but is implementedand fairly enforced.

Box 1. OECD Corporate Governance Principles.

1. Ensuring the Basis for an Effective Corporate Gover-nance Framework: The corporate governance frame-work should promote transparent and efficient mar-kets, be consistent with the rule of law and clearly ar-ticulate the division of responsibilities among differentsupervisory, regulatory and enforcement authorities.2. The Rights of Shareholders and Key OwnershipFunctions: The corporate governance framework shouldprotect and facilitate the exercise of shareholders’rights.3. The Equitable Treatment of Shareholders: The corpo-rate governance framework should ensure the equi-table treatment of all shareholders, including minorityand foreign shareholders. All shareholders shouldhave the opportunity to obtain eff ective redress forviolation of their rights.4. The Role of Stakeholders in Corporate Governance:The corporate governance framework should recognisethe rights of stakeholders established by law or throughmutual agreements and encourage active co-opera-tion between corporations and stakeholders in creat-ing wealth, jobs, and the sustainability of financiallysound enterprises.5. Disclosure and Transparency: The corporate gover-nance framework should ensure that timely and accu-rate disclosure is made on all material matters regard-ing the corporation, including the financial situation,performance, ownership, and governance of the com-pany.6. The Responsibilities of the Board: The corporate gov-ernance framework should ensure the strategic guid-ance of the company, the eff ective monitoring of man-agement by the board, and the board’s accountabilityto the company and the shareholders.

For more information see www.oecd.org


F REIGN INSIGHTS

The chart in Figure 1 illustrates corporate governancefrom yet another perspective. Looking at both sides of thechart, one can identify the depth of different agents in theframework of corporate governance. On the one side,corporate governance demands the participation of pri-vate actors, including auditors, accountants, and creditrating agencies. But on the other side, it involves the func-tions of government, securities regulators, capital marketauthorities, and the like. The framework presented in Fig-ure 1 better describes the corporate governance dilemmathat developing countries face, because it recognizes themajor issues in emerging markets, such as the abuse ofminority shareholders, rather than simply dealing with theenforcement of the principle agent requirement.

Another major area of concern in emerging marketshas been the relationship between sources of debt, princi-pally the banking system, and the corporate governanceframework. In the Asian financial crisis, for example, aswell as in Brazil, Russian, and other countries’ financialcrises, the underlying quality of the assets against which

bank loans were made was murky. It was not transparentto the banking system, and, as a result, the banks endedup assuming a greater degree of risk than would haveotherwise been the case. In this sense, a higher standardof transparency and disclosure is of great importance tovarious sources of debt around the world in order to im-prove the underlying quality and stability of the bankingsystem. Also of concern in emerging markets is the areaof privatization – the transfer of ownership of assets fromthe state sector through a corporatization process intoownership by the private sector. The Russian case is theone that comes to mind most often because theprivatization was opaque and state assets in many in-stances were sold well below their market value.

Corporate governance risk stemming from these ma-jor areas – abuse of minority shareholders, lending fromthe banking system, and privatization – is of tremendousimportance to individual transactions, but, to a higher de-gree, it can be seen as a systemic risk to emerging mar-kets.

Source: The World Bank

Figure 1 presents a good overview of the classic corporate structure. Viewed from another perspective, corporate governance is notsimply a principal-agent problem, but it is a part of market structure and societies within which companies operate. In that sense, muchof corporate governance is about corporate discipline.


F REIGN INSIGHTS

From Corporate Governance to BusinessEthics

The relationship between ethics codes and corporategovernance has surged to the fore. When one looks at theWorld Bank chart in Figure 1, ethics, although not directlylisted, is an unstated assumption that runs through manypieces of it. In fact, the New York Stock Exchange (NYSE)

in the U.S. recently released new corporate governancerules, which include a section with very specific require-ments for a code of ethics. These rules, therefore, placethe ethics principles at the heart of its corporate gover-nance provisions. Specifically, Section 10 declares that“listed companies must adopt and disclose a code of busi-ness conduct and ethics for directors, officers, and em-

Commentary: No code of business conducts and eth-ics can replace the thoughtful behavior of an ethicaldirector, officer, and employee. However, such a codecan focus on the board and management on areas ofethical risk and provide guidance to personnel to helpthem recognize and deal with ethical issues, providemechanisms to report unethical conduct, and help tofoster a culture of honesty and accountability.

Each code of business conduct and ethics must re-quire that any waiver of the code for executive officersor directors may be made only by the board or a boardcommittee and must be promptly disclosed to share-holders. This disclosure requirement should inhibitcasual and perhaps questionable waivers and shouldhelp ensure that, when warranted, a waiver is accom-panied by appropriate controls designed to protectthe listed company.

Each code of business conduct and ethics must alsocontain compliance standards and procedures thatwill facilitate the effective operation of the code.

Each company should determine its own policies,but all listed companies should address the most im-portant topics including the following:• Conflicts of interest. A “conflict of interest” occurswhen an individual’s private interest interferes in anyway or even appears to interfere with the interests ofthe corporation as a whole. A conflict situation canarise when an employee, officer, or director takes ac-tions or has interests that may make it difficult to per-form his or he company work objectively and effec-tively. Conflicts of interest also arise when an em-ployee, officer, or director or a member of his or herfamily receives improper personal benefits as a resultof his or her position in the company. Loans to or guar-antees of obligations of such persons are a special con-cern. The listed company should have a policy pro-hibiting such conflicts of interest and providing amean for employees, officers, and directors to commu-nicate potential conflicts to the listed company.• Corporate opportunities. Employees, officers, anddirectors should be prohibited from (a) taking for them-selves personally opportunities that are discoveredthrough the use of corporate property, information, orposition; (b) using corporate property, information, orposition for personal gain; and (c) competing with thecompany. Employees, officers, and directors owe aduty to the company to advance its legitimate busi-

ness interests when the opportunity to do so arises.• Confidentiality. Employees, officers, and directorsshould maintain the confidentiality of information en-trusted to them by the listed company or its custom-ers except when disclosure is authorized or legallymandated. Confidential information includes all non-public information that may be of use to competitorsor harmful to the company or its customers if disclosed.• Fair dealing. Each employee, officer, or directorshould endeavor to deal fairly with the company’s cus-tomers, suppliers, competitors, and employees. Noneshould take unfair advantage of anyone through ma-nipulation, concealment, abuse of privileged informa-tion, misrepresentation of material facts, or any otherunfair dealing practice. Listed companies may writetheir codes in a manner that does not alter existinglegal rights and obligations of companies and theiremployees, such as ‘at will’ employment arrangements.• Protection and proper use of company assets. Allemployees, officers, and directors should protect thecompany’s assets and ensure their efficient use. Theft,carelessness, and waste have a direct impact on thelisted company’s profitability. All company assetsshould be used for legitimate purposes.• Compliance with laws, rules, and regulations (in-cluding insider trading laws). The listed companyshould proactively promote compliance with laws,rules, and regulations, including insider trading laws.Insider trading is both unethical and illegal and shouldbe dealt with decisively.• Encouraging the reporting of any illegal or unethicalbehavior. The listed company should proactively pro-mote ethical behavior. The company should encour-age employees to talk to supervisors, managers, orother appropriate personnel when in doubt about thebest course of action in a particular situation. Addi-tionally, employees should report violations of laws,rules, and regulations or the code of business conductto appropriate personnel. To encourage employees toreport such violations, the listed company must en-sure that employees know that the company will notallow retaliation for reports made in good faith.”

Source: Securities and Exchange Commission: NYSERulemaking, April 2003. http://www.sec.gov/rules/sro/34-47672.htm

Box 2. New York Stock Exchange Provision on Codes of Ethics.


F REIGN INSIGHTS

ployees, and promptly disclose any waivers of the codefor directors or executive officers.”

This was done in response to Enron and other majorcorporations, where the board of directors waived a verysubstantially developed code of ethics and was at the cen-ter of the financial meltdown that occurred in the Enroncrisis. What happened in Enron illustrated what may beone of the determining factors in all codes, not just theones on ethics – simply having a code is not enough. It isjust as important to enforce that code in day-to-day op-erations. The NYSE provision (see Box 2), in that regard,focuses on both aspects of an ethics code – definition andimplementation.

These NYSE provisions have been further developedin filings by the Securities and Exchange Commission (SEC)and other regulatory bodies. These requirements fromthe NYSE should be seen as the beginning of a trend, andindividual companies might want to take a look at theirown standards of ethics and their relationship to corpo-rate governance and compare them to the above listedNYSE requirements.

One of the more contentious elements in today’s envi-ronment that results from these standards is the adoptionof a whistleblower’s policy, which requires boards of di-rectors to establish what is known as a “safe channel” foremployees to report violations of the ethics codes, law, orother regulations directly to a member of the audit com-mittee of the board, bypassing management channels.Implementation of whistleblower standards can spur manydebates as to the best strategy for such a policy. Never-theless, the trend is clearly in that direction. Whether de-velopment banks and other multinational firms adopt theNYSE listing requirements or find some other way to sat-isfy the growing demand for ethics is, of course, an indi-vidual choice.

EthicsFrom the time of the earliest civilizations, public au-

thorities, philosophers, and business leaders have beenconcerned with ethics. This section will attempt to put intosome historical context the concept of ethics and ethicalcodes. One challenge for those in the business commu-nity, particularly those operating in a multicultural or mul-tinational environment, has been to find a source or stan-dard that can anchor an ethics code, independent of na-tional culture or national issues.

To put these kinds of considerations into context, it’suseful to take a step back and look at the historical devel-opment of the concept. The term ethics comes from the

Greek ethikos, which has several meanings.First, ethics can be thought of as dealing with what is

good and bad, with moral duty and obligation.Second, ethics can be seen as a particular set of moral

principles or values. In some settings, these ethical stan-dards are unique to a particular culture, while in others,they might be part of the common cultural heritage of allnations, such as the U.N. Charter.

Third, ethics can be thought of as the principles of con-duct governing an individual or a group. That is, a profes-sional ethics standard such as business ethics, bankingethics, more recently accounting or advertising ethics.Fourth, ethics is also traditionally a branch of philosophy,and is related to the development of the ideas of a marketeconomy.

Many of the original philosophers of markets, such asAdam Smith and David Hume, were quite concerned withestablishing an ethical foundation or a moral code to gov-ern commerce. The feeling that these philosophers sharedand the legacy that they have left, is that in order to guar-antee the orderly transactions within a market system,some standard, some objective utilitarian standard of be-havior, needs to be established in order to ensure thatmarkets could perpetuate over time. In a sense, this is areversal of the traditional Latin or Roman concept of ca-veat emptor, or buyer beware.

When one establishes this type of ethical code, thegoal is to establish the grounds for fair dealing betweenbuyer and seller, borrower and lender, investor and cor-poration2. Over the centuries, philosophers and leadershave attempted to set out both ethical values and generalguides for codes of conduct. They generally took greatcare to try to establish some independent or objectivestandard from which these codes could be derived.

The first recorded comprehensive ethical guide wasthe Code of Hammurabi developed in 1780 B.C.E. Running tosome 282 directives, the Code became the foundation forthe Kingdom of Babylon. Although many of the provisionsin the Code, such as those regulating slavery, will be seenas unethical by modern standards, the code did establisha set of rules making commerce and civilization possible.As such, it is often referred to throughout the Middle East.

Other ancient civilizations developed codes or prin-ciples of their own, including the “Analects of Confucius”(500 B.C.), the “Ten Commandants” of Moses, and the Ko-ran. Each of the civilizations where these principles weredeveloped sought to establish codes of conduct and prin-ciples to ensure that societies could be held together. Fromthe time of the ancient Greeks through the Enlightenment,


F REIGN INSIGHTS

philosophers, scholars, and others have attempted to cre-ate ethical systems, based on general principles, to guidebehavior.

The works of philosophers such as Aristotle andImmanuel Kant are cited in American business schoolstoday. Articles published in business schools3 give futurebusiness leaders grounding in the moral dilemmas thatphilosophers have taken on over the centuries, by pack-aging it in a practical guide so that business leaders beginto think about ethics as a set of principles and guidelinesfor behavior rather than a set of simply rigid rules. Thebusiness world is beginning to recognize one of the keychallenges facing business in a multicultural world – todevelop ethical guidelines that aremeaningful to employees from a widevariety of cultural and geographicalbackgrounds.

Business EthicsGiven the new mandates on

business, such as the one from theNYSE described above, firms findthemselves pressed to developstrong codes of ethics to guide thebehavior of board members, man-agers, and employees. As will bediscussed later, multinational cor-porations are also being requiredto set standards for those in theirsupply chains – in some cases set-ting higher standards than the lawsof the countries in which they dobusiness. There are many differ-ent factors that companies, espe-cially financial companies, need totake into account when developingtheir own code of ethics as part of ageneral corporate governance guideline.

As noted earlier, in this sense, business ethics is anattempt to set out a standard by which all of the employ-ees of a firm can know what is expected. But it is also anattempt to encourage employees, managers, and boardmembers to think about and make decisions through theprism of some shared set of values. What then are thesources from which these values can be derived?

Laws and regulations of the countries in which compa-nies operate constitute one of these sources.

However, it is important to recognize that companiesare no longer simply limited to national law. A set of inter-

national conventions, such as the anti-bribery conventionof the OECD, have to be taken into account. National lawsin many countries are seeking to harmonize with theseinternational standards.

In the area of corporate governance, there are theOECD guidelines on corporate governance, and manycountries are beginning to require corporate governancecodes as a condition of doing business. For example, inRussia, the federal securities regulator requires Russiancompanies to adopt a code of corporate governance thatis consistent with its code of corporate governance or toexplain why they have not done so. The NYSE is anotherexample, and other exchanges are beginning to consider

its same standard.Another area that is driving

the development of corporategovernance and business eth-

ics codes is the notion of socialresponsibility or corporate citi-

zenship, which is the preferredterm in the business community.

Corporate citizenship in-volves building a decision mak-ing system that takes into the ac-count not only internal operat-ing procedures, but also the im-pact of corporate behavior onits stakeholders – employees,investors, and communities.

One starting point to con-sider in developing initiativesto strengthen business ethics

is the difference between brightlines and values. This is a rela-tively new distinction. Brightlines are those standards that

attempt to set out specific andvery finite rules which companies and

individuals cannot break. The sources or guidance on thesebright line rules can start with, for example, the OECDAnti-Bribery Convention, which can be translated into na-tional laws and rules on anti-bribery standard.

Companies could take a considerable amount of timeto develop these bright line standards or to try to identifythem themselves. Fortunately, Transparency International(TI), working with major corporations, has developed itsown set of bright line standards called the TI BusinessPrinciples (see Box 3), applicable to companies of varioussizes, industries, and geographical locations. Similarly, the


F REIGN INSIGHTS

International Chamber of Commerce (ICC) has also de-veloped a set of rules of conduct to combat extortion andbribery (see Box 4).

Although bright line rules, such as those offered by TIor ICC, are often very specific, every individual companystill needs to develop accountability practices to ensurethat employees are indeed following these rules. TI, forexample, has also developed a handbook to help compa-nies develop an entire internal practice to enforce suchinitiatives. Sarbanes-Oxley, the famous U.S. corporategovernance law, also requires documentation standardsof accountability for handling funds and assets in Section404.

In terms of general guidelines for behavior, there area number of different sources for business ethics pro-grams. Historically, one of the more prominent is that de-veloped by Reverend Leon Sullivan, which began with theanti-Apartheid movement in South Africa and has sinceevolved into a global set of principles(GlobalSullivanPrinciples.org) Reverend Sullivan’s prin-ciples have been adapted and expanded by the UnitedNations’ Global Compact into 10 principles (see Box 5). TheU.N. Global compact is an unprecedented effort to coa-

lesce the business community around common principlesand contribute to global development through good busi-ness practices and business leadership.

The 10 principles in the U.N. Global Compact go con-siderably beyond the bright line rules and deal with thelarger issue of values. Another similar set of principleswas developed by the Caux Round Table, an organizationwhere business leaders from different countries came upwith a set of general principles for business behavior (seeBox 6). There is another set of guidelines developed by theOECD: the OECD Multinational Corporation Guidelines.They go even further, attempting to encourage or man-date corporate behavior in a variety of areas, rangingfrom the environment to contributions to society and pro-viding leadership in developing a nation. The OECD Guide-lines can be found at www.oecd.org.

The principles cited above, whether the Caux RoundTable’s or the 10 principles of the U.N. Global Compact,and others go considerably beyond the bright line rules.In this sense, they revert back to the concept of ethics asa code to guide proper behavior, as a code to guide deci-sion-making. And they have tended to bring out and tomerge into corporate citizenship concerns.

The Business Principles• The enterprise shall prohibit bribery in any form

whether direct or indirect• The enterprise shall commit to implementation of a

Programme to counter briberyAimsProvide a framework for good business practices and

risk management strategies for countering bribery. As-sist enterprises to:

a) eliminate bribery;b) demonstrate their commitment to countering brib-

ery;c) make a positive contribution to improving business

standards of integrity, transparency and accountabilitywherever they operate.

Development of a Programme for Countering Bribery• An enterprise should develop a Programme reflect-

ing its size, business sector, potential risks and locationsof operation, which should, clearly and in reasonable de-tail, articulate values, policies and procedures to be usedto prevent bribery from occurring in all activities under itseffective control.

• The Programme should be consistent with all lawsrelevant to countering bribery in all the jurisdictions inwhich the enterprise operates, particularly laws that aredirectly relevant to specific business practices.

• The enterprise should develop the Programme inconsultation with employees, trade unions or other em-ployee representative bodies.

• The enterprise should ensure that it is informed of allmatters material to the effective development of theProgramme by communicating with relevant interestedparties.

Scope of the Programme• Bribes• Facilitation Payments• Political Contributions• Gifts, Hospitality, and Expenses• Charitable Contributions and SponsorshipsProgramme Implementation Requirements• Organization and Responsibilities• Raising Concerns and Seeking Guidance• Business Relationships• Communication• Human Resources• Internal Control and Audit• Training• Monitoring and Review

Box 3. Transparency International’s “Business Principles for Countering Bribery.”


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Building codes of conductCodes of corporate ethics, codes of corporate conduct,

and codes of corporate governance overlap in many ways.Many different organizations offer guidance and adviceon what should be contained within a code of corporateconduct or a code of ethics. In that regard, the most en-compassing list, perhaps, comes from the Ethics ResourceCenter located in Washington, D.C. (www.ethics.org), whichprovides guidance on the issues companies should ad-dress within their code of corporate ethics (see Box 7).

When one looks at the various codes and sources ofcorporate ethics, it is easy to see that the core elementscontain a number of provisions which try to capture threecore areas. The first deals with existing laws and regula-tions, the second one deals with building good businessrelations, and the third one addresses key concerns ofsociety and improves corporate citizenship.

Corporate citizenship starts with a corporate code ofethics. A code of corporate ethics outlines the values andbeliefs of an organization and ties them to an organization’smission and objectives. A good code not only describes anoperational process and regulates the behavior of man-agers and employees, but it also sets long-term goals,communicates the company’s values to the outside stake-holders, and motivates employees giving them pride inworking for the right cause.

The value of a code of eth-ics is that it is more than simplya statement of a company’smoral beliefs. A well-writtencode is a true commitment toresponsible business practicesin that it outlines specific proce-dures to handle ethical failures.Codes of ethics today addressa variety of issues includingwork environment, gender rela- tions, dis-crimination, communications and reporting, gift giving,product safety, employee management relationships, in-volvement in the political sphere, financial practices, cor-ruption, and responsible advertising.

As business ethics have evolved and the scope of busi-ness issues has expanded in the past several decades, sohave the codes. Originally seen as a set of policies de-signed to manage daily issues in the workplace, ethicscodes have grown into extensive documents that addressa variety of issues and serve as corporate complementsto the extensive regulatory and societal pressures on busi-ness to behave in an ethical manner. A code of ethics needs

to define the purpose of an organization. Doing that isimportant because it allows a firm to communicate its mis-sion and objectives as well as core values to its employ-ees, customers, suppliers, and other stakeholders. Clearlydefining organizational values helps create a corporateimage that stakeholders can easily relate to and allowspotential employees and shareholders to have a realisticview of a corporate identity.

To be effective, codes of ethics should be more thanjust a document on a shelf. They need to be created in away that ethical behavior is encouraged and that employ-ees take pride in making ethical decisions. Codes of ethicsshould provide guidance into relationships between stake-holders and corporate decision-making. More importantly,employees at any level of an organization must strive touphold the standards put forth by the code of ethics andthe top management should exemplify those standards,as codes of ethics are of a little benefit if the leadershipignores them.

Supply-Chain CodesOne of the greatest benefits of corporate citizenship is

that it can rationalize and improve a company’s relationswith its supply chains overseas regarding the quality ofthe products, labor practices, and the environmental im-

pact of their activities. Thegrowth of supply chaincodes is most evident insupply chains involvingconsumer goods in emerg-ing markets with weakregulatory environmentsselling to consumers in de-veloped markets. In coun-tries where labor laws areless stringent than interna-

tional norms, the codes have the effect of creatinghigher labor standards and serve as a self-governingmechanism for the enforcement of laws governing work-ing conditions and production standards.

Supply Chain codes fall into several broad categories4:

Buyer CodesMajor companies such as Wal-Mart and Target use

these codes in their supply chain as a prerequisite forpurchasing consideration. The system is such that thebuyer pays for internal monitors and independent audi-tors to review the supplier factories. Suppliers then mustpay for any infrastructure upgrades or other improve-

One starting point to considerin developing initiatives tostrengthen business ethics is thedifference between bright linesand values.


F REIGN INSIGHTS

ments necessary to meet the code standards. The facto-ries’ labor standards are also taken into consideration.Once suppliers are selected, they are continuously moni-tored to make sure they are maintaining that standard.

For buyers, the benefits of these codes are that theyprotect their brand from bad publicity and other civil at-tacks and higher quality goods often result from the up-grades to the quality of the infrastructure and the laborforce.

Agent codesDoing business abroad often requires the use of agents

to facilitate everything from customs and shipping per-mission to finding business partners and arranging intro-ductions with the proper authorities or business leaders.Corporations, governments, and non-governmental or-ganizations working with or through intermediaries abroad

know this can be an area of risk as they are held respon-sible either legally or in the court of public opinion for theactivities of these agents. Shielding companies from thisrisk is increasingly expensive as it involves a great amountof due diligence on the part of the organizations research-ing the background of the agent and verifying the sound-ness of their business practices. At the same time, inter-mediaries seeking to do business with large internationalcompanies can find the approval process to be laboriousand slow, creating extra costs to doing business and caus-ing opportunities to be missed.

Transparent Agents and Contracting Entities (TRACE),an international organization that addresses the void inworking with intermediaries abroad, seeks to meet theneeds of both parties in this process while creating a moreethical business environment. Principals are better pro-tected and intermediaries are better served by this inde-

Transactions.• Article 1: Extortion. No one may, directly or indirectly,

demand or accept a bribe.• Article 2: Bribery and “Kickbacks.” No enterprise may,

directly or indirectly, offer or give a bribe and any de-mands for such a bribe must be rejected. Enterprisesshould not (i) kick back any portion of a contract paymentto employees of the other contracting party, or (ii) utilizeother techniques, such as subcontracts, purchase ordersor consulting agreements, to channel payments to gov-ernment officials, to employees of the other contractingparty, their relatives or business associates.

• Article 3: Agents. Enterprises should take measuresreasonably within their power to ensure: that any pay-ment made to any agent represents no more than anappropriate remuneration for legitimate services ren-dered by such agent; that no part of any such payment ispassed on by the agent as a bribe or otherwise in contra-vention of these Rules of Conduct; and that they maintaina record of the names and terms of employment of allagents who are retained by them in connection with trans-actions with public bodies or State enterprises. This recordshould be available for inspection by auditors and, uponspecific request, by appropriate, duly-authorised govern-mental authorities under conditions of confidentiality.

• Article 4: Financial Recording and Auditing. All finan-cial transactions must be properly and fairly recorded inappropriate books of account available for inspection by

boards of directors, if applicable, or a correspondingbody, as well as auditors. There must be no “off the books”or secret accounts, nor may any documents be issuedwhich do not properly and fairly record the transactionsto which they relate. Enterprises should take all neces-sary measures to establish independent systems of au-

diting in order to bring to light any transactions which con-travene the present Rules of Conduct. Appropriate cor-rective action must then be taken.

• Article 5: Responsibilities of Enterprises. The board ofdirectors or other body with ultimate responsibility for theenterprise should: take reasonable steps, including theestablishment and maintenance of proper systems of con-trol aimed at preventing any payments being made by oron behalf of the enterprise which contravene these Rules

of Conduct; periodically review compliance with theseRules of Conduct and establish procedures for obtainingappropriate reports for the purposes of such review; and

take appropriate action against any director or em-ployee contravening these Rules of Conduct.

• Article 6: Political Contributions. Contributions to po-litical parties or committees or to individual politicians mayonly be made in accordance with the applicable law, and

all requirements for public disclosure of such contribu-tions shall be fully complied with. All such contributionsmust be reported to senior corporate management.

• Article 7: Company Codes. These Rules of Conductbeing of a general nature, enterprises should, where ap-propriate, draw up their own codes consistent with theICC Rules and apply them to the particular circumstancesin which their business is carried out. Such codes mayusefully include examples and should enjoin employeesor agents who find themselves subjected to any form ofextortion or bribery immediately to report the same tosenior corporate management. Companies should de-velop clear policies, guidelines, and training programmesfor implementing and enforcing the provisions of theircodes.

For more information see International Chamber of Commercehttp://www.iccwbo.org/home/extortion_bribery/rules.asp

Box 4. Rules of Conduct to Combat Extortion and Bribery


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pendent, non-partisan organization that undertakes pre-liminary vetting of agents, consultants, and subcontrac-tors.

The process is simple. First, agents apply for member-ship with TRACE. They are then subjected to an extensivedue diligence review, including a lengthy questionnaire,three business references, a financial reference, and amedia search. Candidates are also required to have oradopt a code of conduct addressing bribes, kickbacks, andconflicts of interest and agree to annual ethics trainingprovided by TRACE or by approved lawyers in their coun-try. Once their files are completed, they are made avail-able to a large number of corporations – avoiding the needto replicate packages for each company. The requirements

are the same for every requesting company or organiza-tion, resolving the “best practices” concern that othersare undertaking more extensive due diligence.

TRACE members’ companies benefit by avoiding thetimely documentation gathering process in support of anintermediary. Instead of months to vet a candidate, infor-mation is available upon request and updated annually.The process can be done in a day. TRACE is funded bymember fees to cover the screening process and corpo-rations pay an annual fee or a per-report fee to have ac-cess to the due diligence voluntarily submitted by themembers. Governments and non-governmental organi-zations pay only the cost of copying and postage for eachreport requested.

Factory certification schemesFactories seek certification to prove that they have

been proactive in addressing labor and infrastructure stan-

dards. The factory pays for the certification process, an-nual audits and any needed upgrades or actions requiredto remain certified. CERES Principles, the chemicalindustry’s Responsible Care ISO 14001 is an example ofsuch a process. These standards and certifications aretypically sought out as a marketing and communicationtool for factories to demonstrate their high level of stan-dards and systems. Certification allows some factories toreceive higher fees for their services as certification elimi-nates much of the risk for the buyer to work with them andoften satisfies buyer codes, eliminating the buyer’s over-sight costs.

Other benefits to suppliers to certification or participa-

tion in buyers’ codes would be more competitive contractbidding, higher productivity, innovation and quality, anddeclining employee turnover as health and quality of lifeissues improve for them. Examples include SA 8000 (la-bor), ISO 14001 (environment), and WRAP (labor). Thereare many others.

Other types of codesThe Base Code of the Ethical Trading Initiative (ETI),

and codes from the OECD and other groups all serve asguidelines for companies and countries on appropriatestandards. These codes typically do not have any moni-toring or auditing programs, and their purpose is to pro-vide guidance and best practices. Most codes cover tenpoints and represent principles corresponding to the In-ternational Labor Organization’s Core Conventions includ-ing: forced labor, child labor, freedom of association, andcollective bargaining, discrimination, health and safety,

The vision of the Global Compact is outlined in its ten prin-ciples. Companies that sign on to the Global Compact agreeto uphold these principles in their operations in any coun-try around the world.Human RightsPrinciple 1: Businesses should support and respect theprotection of internationally proclaimed human rights; andPrinciple 2: make sure that they are not complicit in hu-man rights abuses.Labor StandardsPrinciple 3: Businesses should uphold the freedom of as-sociation and the effective recognition of the right to col-lective bargaining;Principle 4: the elimination of all forms of forced and com-pulsory labor;

Box 5. Th e U.N. Global Compact

Principle 5: the effective abolition of child labor; andPrinciple 6: the elimination of discrimination in respect ofemployment and occupation.EnvironmentPrinciple 7: Businesses should support a precautionaryapproach to environmental challenges;Principle 8: undertake initiatives to promote greater envi-ronmental responsibility; andPrinciple 9: encourage the development and diffusion ofenvironmentally friendly technologiesAnti-CorruptionPrinciple 10: Businesses should work against all forms ofcorruption, including extortion and bribery.For more information, please visit www.unglobalcompact.org


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wages and hours of work. Key challenges for the codesare that they can produce inefficiencies and confusion forsuppliers as each buyer has his own code of conduct andaudit procedures. This confusion produces a barrier toentry for suppliers as it is unclear how to demonstratehigh standards and compliance. The audit systems canvary from company to company and be very uneven intheir rigor and application.

This overlap and repetition can produce unnecessaryburdens on both buyers and suppliers as buyers coverthe cost of monitoring and suppliers have to allocate timeand resources to ascertain and comply with a myriad ofcodes. A convergence of codes and procedures is neededto truly realize the benefits of the codes and certificationprograms.

Business Ethics and Anti-Corruption

Over the past several de-cades we’ve witnessed profoundchanges in the way business op-erates in countries around theworld. One of the more notableareas is the businesscommunity’s treatment of cor-ruption-related issues. The pri-vate sector has become one ofthe leaders in global efforts tocurb corruption, developinglandmark and far-reachingtransparency and accountabilitystandards as well as mechanisms to enforce them. Whileethical codes play an important role in driving transpar-ency and accountability reforms, other initiatives that ex-tend beyond internal rules have also made their mark incombating corruption.

As noted earlier, one of the sources from which ethicalvalues can be derived is laws and regulations of countriesin which companies operate. At the same time, quality oflaws and regulations (as well as their enforcement) has adirect bearing on the levels of corruption in a particularcountry. The World Bank’s Doing Business survey of morethan 100 countries, for example, clearly showed that heavybusiness regulation and procedural complexities in thejudiciary are associated with higher levels of corruption.The Heritage Foundation/Wall Street Journal annual Indexof Economic Freedom also illustrates well that higher de-grees of economic freedom are correlated with lower cor-ruption. What one can derive from looking at the Doing

Business survey and the Index of Economic Freedom isthat corruption is directly related to the enabling environ-ment issues. In that sense, efforts to establish the rule oflaw, strengthen the protection of private property rights,and improve the quality of regulations become crucial inanti-corruption reform. Such efforts are also crucial inimproving ethical standards.

For example, the Colombian Confederation of Cham-bers of Commerce (Confecámaras) in the late 1990s rec-ognized that on paper Colombia had a sophisticated set ofnorms and instruments for detecting, controlling, and pun-ishing corrupt practices. However, these mechanismswere often not applied, partly because of fear of politicalbacklash from entrenched, corrupt politicians.Confecámaras therefore attempted to put forth measuresthat would ensure application of anti-corruption initiatives

on the supply-side of theequation – the private sec-tor.

Confecámaras workedwith local businesses to es-tablish clear rules and codesof conduct in procurementprocesses and to demon-strate the benefits of compli-ance. With input from busi-ness leaders, Confecámarasdeveloped local codes ofconduct, which over 1,000businessmen voluntarilysigned in the first year alone.

To ensure transparency in public procurement,Confecámaras also proposed the development of integ-rity pacts. In the first year, 12 integrity pacts were signedbetween local businesses and governments and the totalvalue of the contracts that were signed under integritypact requirements with the Manizales city mayoramounted to $1,039,200. In January 2005, 16 governors and78 mayors delivered on their electoral promises and signedofficial agreements in public, committing themselves to atransparent relationship with the local business commu-nity.

Specific Industry Standards: BankingGoing beyond the general concerns of developing a

code of corporate ethics, development finance institutions,of course, have two related areas of concern. The firstarea of concern deals with developing banking ethics stan-dards to guide their own lending practices. The second

Box 6. The Caux Round Table Principles for Business.1. The Responsibilities of Businesses: Beyond

Shareholders toward Stakeholders2. The Economic and Social Impact of Business:

Toward Innovation, Justice and World Community3. Business Behavior: Beyond the Letter of Law

Toward a Spirit of Trust4. Respect for Rules5. Support for Multilateral Trade6. Respect for the Environment7. Avoidance of Illicit OperationsFor more on the principles see The Caux Round Tablehttp://www.cauxroundtable.org/principles.html


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one deals with their role in promoting standards for indi-vidual interests in individual industries. In the area of bank-ing codes, there is a wealth of sources. Perhaps the mostinteresting is the Swiss banking system, which has devel-oped as one of the market leaders for banking sources.The Swiss banking system and the Federal Banking Com-mission, the Swiss regulatory authority, require bindingcodes of conduct that define good industry practices or, toput it in more modern terms, ethical management. Theyhave a number of guidelines on their web site (http://www.swissbanking.org/). The following are the main ar-eas where codes of conduct, guidelines, or agreementsare available:

1. Agreement on due diligence2. Agreement on depositor protection3. A code of conduct for security traders4. Guidelines for management of country risk5. Guidelines for risk management6. Guidelines on portfolio management agreements7. Guidelines for the treatment of dominant AssetsWhen looking at all of these codes in the banking area,

one observer, Fouad Shaker, General Secretary of theUnion of Arab Banks, presented a list of what he felt wouldbe the 13 principles necessary to create a good code ofbanking ethics5. Dr. Shaker’s list contains, in one form oranother, elements put forth by the Swiss banking regula-tors:

1. Integrity and fairness2. Confidentiality3. Professionalism4. Compliance with direc-

tives5. Monitoring procedures6. Sound implementation7. Transparency of transac-

tions8. Good customer service9. Promotion of banking

services (advertising)10. Transactions giving right to suspicion11. Collecting and keeping customer information12. Handling customer complaints13. Interbank regulations and rotations withother partiesAnother good source to compare corporate gover-

nance and banking codes is the Canadian Bankers Asso-ciation, which also developed a wide range of separateprovisions that can be found on its website, www.cba.ca.In the more narrow interests of securities and exchange

and foreign exchange dealers, the ACI, the financial mar-kets association has developed its own extensive code ofgood conduct or code of ethics, which can be found on itswebsite, www.aciforex.com.

Developing an Ethics Program: The Role of the Board-As noted in the NYSE listing requirements, it is very im-portant for corporations and banks to develop their ownethics program. Simply adopting a code of ethics or a codeof corporate governance with a companion code of ethicsis not sufficient. In fact, the Conference Board conducteda recent study of business ethics around the world and therole of boards of directors in carrying out board oversightof ethics programs6. The Conference Board identified thefollowing elements as being representative of the role ofthe board and of ethics programs in a cross-section ofcountries:

• Codes of conduct• Communication of standards through training• Methods to encourage employees to report possible

violations to management• Enforcement mechanisms through investigation and

discipline• Oversight and review to achieve ongoing improve-

mentThe development of the federal sentencing guidelines

by the U.S. Sentencing Commission several years ago isone element in encouraging such an encompassing pro-gram to be adopted by American corporations. These sen-

tencing guidelines, which canbe found at www.ussc.gov, areintended to guide a companyin dealing with employees whohave engaged in bribery orbroken a law. Doing so is im-portant especially for the man-agement, because the com-pany as a whole can be pun-ished for violations. The sen-

tencing guidelines, in that regards, were intended to givecourts some direction in terms of when to consider thecompany itself responsible for the action of its employ-ees7. The guidelines are:

1. Establishing ethics and compliance standards andprocedures

2. Assessing high-level persons to oversee ethics andcompliance

3. Taking due care in the delegation of substantial dis-cretionary authorities to individuals

4. Effectively communicating standards and proce-

The value of a code of ethics isthat it is more than simply astatement of a company’smoral beliefs.


F REIGN INSIGHTS

dures to all employees and agents through training andalso through printed and electronic materials

5. Monitoring and auditing the operation of the ethicsand compliance program and establishing a retribution-free means, (e.g., a help line) for employees to obtain in-formation about standards and procedures and to reportpossible wrong doing

6. Consistently enforcing discipline of employee viola-tions

7. Responding promptly to any wrongdoing and rem-edying any program deficiencies8

These guidelines from the Federal Sentencing Com-mission have been one of the drivers behind the develop-ment of ethics programs in the U.S. Moreover, as noted in

the ethics resource list provided earlier, and in the ele-ments identified by the Conference Board, they have alsospread worldwide. In fact, the Conference Board carriedout a survey of companies across the world and foundthat not only were these elements quite common, but inmany countries the program was actually established byboard resolution.

In the United States, 66 percent of American compa-nies established the ethics program as the result of theaction of the board of directors, while in Japan, 96 percenttook a similar stance.

Similarly, one of the key things that boards of directorsmust do in the wake of the U.S. Federal Sentencing Guide-

lines and the broader trends internationally is to developways of monitoring compliance and ensuring that theseethics codes are not simply a standard put on thecompany’s web site, but not communicated and imple-mented throughout the company. One of the ways to dothat is by carrying out program audits9.

In U.S. companies, some 45 percent have carried outprogram audits (a number which can be expected to in-crease given recent trends). In contrast, in Japan, 64 per-cent of such companies have carried out program audits.The number is event higher at 67 percent in India, and inWestern Europe, where it is over 75 percent.

Complementing program audits is the concept of di-rectors’ ethics training. The same Conference Board sur-

vey found that directors’ ethics training is becoming quitecommon throughout the world, from a low of 42 percent inWestern Europe to a high of 94 percent in Japan. Manymultinational companies are now routinely putting on eth-ics trainings programs for their directors. The subjectscovered include:

• Fiduciary duties• Corporate opportunities• Principal regulations governing company business• Personal liability• Corporate law• Stock exchange regulations• Insider trading

Employment Practices• Workplace Harassment• Equal Opportunity• Diversity• Fair Treatment of Staff• Work-Family Balance• Discrimination• Illegal Drugs and Alcohol• Use of Organization PropertyEmployee, Client and Vendor Information• Maintaining Records and Information• Privacy and Confidentiality• Disclosure of InformationPublic Information/Communications• Advertising and Marketing• Development and Fundraising• Clarity of Information• Access to Information• Transparency of InformationConflicts of Interest• Gifts and Gratuities• Political Activity

• Outside Employment• Family MembersRelationships with Vendors• Procurement• Negotiating ContractsEnvironmental Issues• Commitment to the Environment• Employee Health and SafetyEthical Management Practices• Accuracy of books and records and expense reports• Proper use of organizational assets• Protecting proprietary informationEmployment Practices• Proper Exercise of Authority• Employee Volunteer Activities Conflicts of Interest• Disclosure of Financial InterestsPolitical Involvement• Political Activities

For more information see Ethics Resource Center at http://www.ethics.org/common_provisions.html

Box 7. Common Ethics Code Provisions (by the Ethics Resource Center.)


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• Business secrets• The employee training program10The role of the board of directors, therefore, is seen as

central to establishing and maintaining a corporate ethicsprogram, and by corollary is a central feature in the over-all subject of corporate governance guidelines and codes.This trend can be expected to continue, driven both bynational legislation, international conventions, and the ex-pectations of investors.11

ConclusionDebates in coming years will center on the relative

roles of business, government, and NGOs in estab-lishing codes of conduct and in reporting requirementsas well as individual industry standards. In each ofthese areas, non-governmental organizations, suchas Transparency International and Social Accountabil-ity International, are leading the way12. These NGOshave worked cooperatively with business and in somecases have presented their demands to business. Ineither case, the triangle of business, government, andNGOs will continue to be the dominant forum for de-bates and discussion of the proper role of business insociety.

From the point of view of the business community,the major issue to consider is the central importanceof corporate governance and business ethics in main-taining a market economy. As noted earlier, AdamSmith, David Hume, and other philosophers and earlyeconomists were very much concerned with the roleof ethics and the role of business behavior in ensuringthat transactions could be conducted not only in re-gional, but also in the multinational setting.

In one sense, one can look at ethics as the solutionto one of the central problems of development. Theproblem is moving from a “cash and carry” or bartereconomy to an economy where transactions can beconducted over time and distance. One of the findingsof the new institutional economics13 is that in coun-tries and in firms with low standards of ethics, with lowstandards of legal regulation, and with low enforce-ment, the costs of contracting become very high. Busi-ness ethics, therefore, are central to ensuring that con-tracts are adhered to, thereby holding down the costsof doing business and improving the flow of capital toemerging markets. On another note, business shouldbe mindful, as should NGOs, that too much pressureis not put onto the multinational corporations in termsof enforcing through corporate codes or supplier-ven-

Endnotes1 Berle, Adolph and Means, Gardiner. The Modern Corpora-tion and Private Property, Transaction Publishers; Reprint edi-tion (May 1, 1991).2 Edwards, Paul. The Encyclopedia of Philosophy, Volume 3.MacMillan Publishing, page 83.3 See for example Hooker, John. Ethics in Six Not-So-EasyLessons. Carnegie Mellon, April 2001.4"Investing in Responsible Business—The 2003 Survey ofEuropeanFund Managers, Financial Analysts and InvestorRelations Officers.” A Deloitte, CSR Europe and EuronextSurvey, November, 2003.5Presentation by Dr. Fouad Shaker, Secretary General, Unionof Arab Banks, to the Regional Corporate Governance Fo-rum, Amman, Jordan, January 25, 2005, sponsored by Centerfor International Private Enterprise and Global CorporateGovernance Forum.6Berenbeim, Ronald E. and Kaplan, Jeffrey M. “EthicsPrograms…The Role of the Board: A Global Study.” The Con-ference Board, New York, 2004. (page 12).7Federal Sentencing Guidelines Manual page 476-477. http://www.ussc.gov/GUIDELIN.HTM8Pittman, Edward L. and Navran, Frank J. “Corporate Ethicsand Sarbanes-Oxley,” The Wall Street Lawyer, July 2003.9Berenbeim, Ronald E. and Kaplan, Jeffrey M. “EthicsPrograms…The Role of the Board: A Global Study.” The Con-ference Board, New York, 2004. (page 21).10Ibid. page 31.11International Corporate Governance Network. http://www.icgn.org12SAI-SA8000 has become the code of conduct of labor stan-dards for supply chain management considerations.12SAI-SA8000 has become the code of conduct of labor stan-dards for supply chain management considerations.13A branch of economics that looks at the importance of prop-erty rights, legal structures, contracts, and other institutionsas key elements of a market economy. For more, please seeCIPE Feature Service article “Local Knowledge and Institu-tional Reform” by Douglass North, Nobel Prize-winning econo-mist.H t t p : / / w w w. c i p e . o r g / p u b l i c a t i o n s / f s / a r t i c l e s /Douglass_North.htm

dor relationships laws and regulations, which are actuallythe concerns of national government. For example, theemerging trend to hold business accountable for humanrights violations in developing countries is worrisome. Insome cases, it may deter multinationals and other sourcesof investment from investing in an emerging market. Wehave to find a way to meet high ethical standards and, atthe same time, ensure that the reputational and collateralrisks assumed by corporations do not inhibit the furtherdevelopment of the emerging markets.(* John D. Sullivan has been Executive Director of CIPE since1991)


C

*By Eunice Sampson

onsidering the pessimism that characterized most forecasts before now, the globaleconomy with at least 3.2% growth in 2005 did not turn out as bad as feared. Mostcountries, especially developing economies and economies in transition, witnessedremarkable growth.

Even for 2006, the growth prospects look brighter; ranging from the earlierpredictions of 2.0-2.5%, to about 3.2%-3.5%. For major economies like the UnitedStates where a near economic gloom had been predicted in 2006, the picture is nolonger so bleak. Having grown by 3.5% in 2005, the US is set to achieve a fifthconsecutive year of economic expansion in 2006 that would be almost as good asthe 2005 pace.

The US dollar after 3 years of consistent decline, appreciated against the majorcurrencies in 2005; 14.6% against the Euro; 15.2% against the yen; 12.6% against abasket of the world’s six main currencies. The dollar appreciation was influenced byinterest rate hikes and the repatriation of profits of most US subsidiary companiesabroad. Interestingly, in most economies, inflation rate was tamed despite the highcost of crude oil.

:


GLOBAL WATCH


Gross Domestic Product (GDP)Developed economies led by the

United States grew by 2.4% in 2005, sub-stantially lower than the 3.2% growthrecorded in 2004. Developed economieswould have done better than this butfor the series of hurricanes and the hikein the price of crude oil, which distortedtheir growth prospects. The United Na-tions estimated a 3.2% real GDP growthfor the global economy in 2005 whileIMF estimated 4.3%; both were a farcry from the 5.1% growth in 2004.

Industrial production was also weak,while most developed countries suffered heavycurrent account deficits, especially the United States whichin 2005 was short by over $700bn.

Growth outlook in Europe was also slow, even thoughthe gap was not as wide as that of the United States sincethe former experienced slow growth even in 2004. Europegrew by 1.2% in 2005 with the eurozone once again beingthe worst hit at 1.1% growth.

Europe has been projected to grow at an average of5% in 2006 and 2007 owing to expected increase in demandand market share, as well as high oil prices, which formany European countries, is a positive trend.

In Japan, GDP grew by an estimated 2.3% in 2005,spurred by high domestic demand and rising householdincomes. With a growth projection of 1.4%-2.5% this year,

the Japanese economy is showing signs of breaking out ofthe stagnation that has gripped it since the burst of theshare market bubble in the early1990s.

According to UN calculations, the developing econo-mies and economies in transition grew by 5.7% and 6.0%,

respectively in 2005; while the highest level of growth wasachieved by the least developed economies, which grewby 6.8%.

In Asia, the East Asian region grew 7.8%, slower thanthe 8.3% achieved in the preceding year. China and Indiacontinue to experience high economic growth, at 9% and8% respectively. Growth in China is forecast to drop to7.6% and 7.4% respectively in 2006 and 2007, while India isprojected to grow 7.2% and 6.5%, respectively over thetwo-year period. For both countries, it is getting more cer-tain that they are on a path of sustainable growth.

In line with the rapid economic growth begun since2001, the African continent grew by 5.1%, in 2005, about the

same level of 2004, and far above the worldaverage of 3.3%.

The oil windfall enjoyed by many Afri-can exporters helped expand GDP in thatcontinent last year; but not much produc-tivity was achieved in the manufacturingsector. Sub-Saharan crude oil exporters likeNigeria, Angola, Chad, Sudan andMauritania grew 7% in 2005 (Angola andChad actually grew double digit). Thegrowth prospects for oil producing Africancountries are greater this year; especiallyin Nigeria and Mauritania where new oilwells are expected to come on stream.

Few sub-Saharan countries, including Cote d’Ivoire,Zimbabwe and Seychelles suffered decline in growth in2005 following major setbacks in their economic mainstay.Minus (-) 4% growth is estimated for Zimbabwe; Coted’Ivoire, a cash-crop-dependent economy which has been

Top 10 Global Economies by GDP (PPP) - US $ Trillion

Source: CIA, World Development Indicators 2005, World Bank

G L O B A L W A T C H


bedeviled with socio-political crises since2002, slipped in growth to -3.8%. For thethree African countries, the prospects forrecovery this year and next is very dim.

Despite the relatively strong growthin 2005 at 5.2%, Nigeria experienced slow-ing growth that year compared to its 2004performance of about 5.5%. But thanksto the increased oil and gas revenuesboosted by higher prices, the countryonce again enjoyed current account sur-plus of $24.3bn in 2005. From its 2.4%growth level in 2004, South Africa’s GDPgrew by 4.5% in 2005 driven by domestic demand and en-hanced export activities.

The persistent recession in the manufacturing sectorof most Sub-Sahara African economies is a growing causefor concern. Despite the AGOA advantage, the value ofSub-Saharan textile and apparel exports to the UnitedStates dropped by 11% last year. This resulted in a rise inunemployment level in these countries. Nigeria’s textileindustry especially suffered great losses in 2005, owing tosmuggling activities and the inconsistencies in the re-in-troduction of the export grant policy. Between 2004 and2005, at least 30,000 jobs have been shed in Nigeria owingto crises in the industry.

Some of the key constraints to global growth in 2005included higher oil prices, resource-sector capacity con-straints, tightening monetary policy in the United Statesand, in some countries, the maturation of the investmentcycle following a year of very fast growth. Rising short-

term interest rates and natural disasters, especially theseries of hurricanes, slowed growth in the United States,from over 4.0% in 2004 to 3.5% last year.

World TradeWorld trade slowed significantly in 2005, from its 9%

growth level in 2004 to about 6.5%. This is attributed tolower economic output worsened by high energy cost. Thedeveloping countries like China, India and the oil export-ing economies, led the world in growth in trade value andvolume last year. China for example grew its merchan-dise export volume by 24%. Much of the trade deficits weresuffered by the developed economies, especially theUnited States and Europe. The IMF calculates that, at anaverage crude oil price of $59 per barrel in the next 5 years,the oil exporters would enjoy an annul average currentaccount surplus of $470bn. Traditionally, agricultural prod-ucts and natural resources/ mining products were the

dominant exports of African countries in 2005; Africa’sexport of commercial services remains minimal.

According to reports released by AGOA in Febru-ary, two-way total trade (exports plus imports) betweenthe United States and sub-Saharan Africa increased37% to over $60.6 billion in 2005, up from $44.4bn in2004. U.S total exports to Africa rose 22% to $10.3 bil-lion, up from $8.6bn the previous year; and U.S. totalimports (AGOA and non-AGOA) from Africa increasedby 40% to $50.3bn, up from $35.9bn in 2004. Like in theprevious years, rise in trade volume and value be-tween the US and Africa was driven predominantly byincreased sales of oil field equipment and parts, air-craft, wheat, vehicles, and electrical machinery. Butonly few African countries accounted for the high vol-ume, especially Nigeria and South Africa. Over 50% ofUS import from Africa comes from Nigeria (predomi-nantly oil); while US export to Africa is dominated by


*2006 figure is projectionSource: UN/DESA; CIA; 2006

Source: WTO, 2006

Product structure of Africa’s merchandiseexports, 2004 & 2005

Real GDP Growth: 2003 - 2005; *Projections for 2006


South Africa. As in the previous year, pe-troleum products accounted for over 70%of US trade relationship with Sub SaharanAfrica.

US crude oil import from Sub-SaharanAfrica was valued at $26.1bn in 2004, andover $30bn in 2005. Other major US importsfrom the continent include apparel, plati-num, diamond, cocoa, etc.

While the US remains the leading im-porter from Africa, China maintains its po-sition as the major supplier to the continent,reaping exports value of $7.5bn in 2003 andover $10bn in 2005.

Despite its relatively stable economicgrowth, the rising profile of the US current account deficitis a source of worry to economists worldwide, even as itonce again widened last year from its $666bn position in2004 to over $700bn. The United States is in trade deficitwith most regions of the world.

Crude OilIn 2005, the all-important place of crude oil in the glo-

bal economy was once again emphasized. The averagecrude oil price for the year was about $58 per barrel, farhigher than the 2004 average of about $50 per barrel. Glo-bal crude oil demand was an average of 83.2 million bar-rels per day last year, while supply was 84.3 million leav-ing a surplus of 1.1 million. This impacted OPEC’s decisionnot to raise production despite high crude prices. The car-tel and other analysts saw the price hike as, not due tosupply shortage but mostly to refining problems andspeculative supply worries.

The economic slowdown among the oil-importing coun-tries (excluding China and India) was sharper, from 5.6%in 2004 to 4.3%. Even for the oil exporting countries (mostof which are developing economies) the fall in refiningand production capacities for most of 2005 and the seriesof internal crises led to a fall in growth, from 6.6% in 2004 to5.7% despite the persistent rise in crude oil proceeds.

Global oil supply is likely to be slightly negative againstdemand in 2006. In the first two months of 2006 supply hasbeen unstable as major oil producing economies like Ni-geria and Iran are faced with internal and external wran-gling. While the former battles insurgency in its oil pro-ducing Niger Delta area, the latter battles the developedeconomies over nuclear ambition. Nigerian authoritiesare already raising fears that the economy might not beable to fund its N1.9 trillion (about $15bn) budget for 2006,as oil revenue might fall short of projections due to disrup-tions to production and the closure of oil wells. If the crisespersist, oil prices might hover between $58 and $60 perbarrel throughout the year.

Foreign Direct InvestmentGlobal foreign direct investment (FDI) inflows rose by

29%, from its $612bn in 2004 to US$897bn. Developed coun-tries attracted about 75% of the total, with a flow of $573bn,a 38% rise from the 2004 level. The huge investment indeveloped economies last year was a significant recov-ery from the 4-year slump experienced since 2001.

A breakdown of the estimated $274 billion FDI flow tothe developing economies show that Sub-Saharan Af-rica moved from its $20bn position in 2004 to $29 billion in2005, but still less than 4% of global FDI flow that year.The rise in Africa’s FDI was accounted for mostly by theoil producing countries.


Source: AGOA; 2006 is Research & EIG projection


Globally, mergers andacquisitions was the domi-nant source of FDI. M&A ac-tivities rose by 40% last yearto a high of $2.9trillion. TheEuropean economies werethe major beneficiaries, es-pecially the UK which re-ceived an inflow of $219bnin 2005. For the first time inalmost 30 years, UK toppedglobal FDI inflow, spurredmostly by the $100 billionmerger of Shell Transportand Trading Company Plcand Royal Dutch PetroleumCompany into Royal DutchShell. The US was the sec-ond highest recipient with aflow of $106 billion, its bestin a long time.

In Asia, Japan’s FDI flowwas once again moderateat $9.4bn. China for the firsttime in almost a decade ex-perienced a negative FDIflow, from $60.6bn in 2004 to$60.3bn, down by -0.5%. Na-tional and international in-vestments slowed in Chinalast year as the countrymade efforts to cool downthe economy to a sustain-able growth level. All re-gions of the world experi-enced improvement in theirFDI flow in 2005.

In Africa, South Africamaintains its position as thelargest recipient of FDI flow.South Africa in 2005 re-ceived 30% of the total FDIflow from the United Statesto Africa while Nigeria wasthe next biggest beneficiarywith 15%. At a paltry $12bnin 2004 and an estimated $15bn last year, the continentattracts less than 1% of total US FDI flow.

Socio EconomicDevelopments

Unemployment – The ILOreport for 2005 shows that glo-bal labour productivity (mea-sured as output per worker)grew by 2.6%, down from 3.0%growth in 2004. The drop is as-sociated with the slower growthin global GDP level last year. TheILO has calculated that “Foreach 1-percentage-point reduction inthe global GDP growth rate, net em-ployment growth will be between 9and ten million fewer around theworld”.

In 2005, global unemploy-ment rate stood at 6.3%, un-changed from the previous yearand 0.3% percentage pointshigher than a decade earlier. Atotal of 191.8 million people wereunemployed around the worldin 2005, up by 2.2 million fromthe 2004 level.

Latin America and the Car-ibbean suffered the highestgrowth in unemployment withthe number of the unemployedrising by over 1million, takingthe unemployment rate be-tween 2004 and 2005 to 7.7%.

The Central and Eastern Eu-rope (non-EU) and CIS regionalso witnessed a year-over-yearincrease in its unemploymentrate, which stood at 9.7%, upfrom 9.5% in 2004. The Asianregion’s unemployment ratesremained unchanged in 2005:East Asia’s unemployment ratestood at 3.8%, the lowest in theworld. South Asia’s unemploy-ment rate stayed at 4.7% andSouth-East Asia and the Pacific’sunemployment rate was 6.1%.

The most remarkable improvement in employmentwas recorded in the Developed Economies. The UnitedStates unemployment rate dropped to 4.7% in January

G L O B A L W A T C HTen Yearly Average Crude Oil Prices

(1946-2006) U.S. Average (in $/per barrel)

Secondary source: inflationdata.com; *2006 is projection

Source: OPEC; 2006 is projection

FDI Inflow by Region and Selected Economies:2003-2005 (Billions of dollars)

Source: UNCTAD; 2006 is Research & EIG Estimate


2006 while 2 million jobs were created lastyear, an average of 166,000 per month.Unemployment rate also declined in theEU zone.

The Middle East and North Africa re-mains the region with the highest unem-ployment rate in the world at 13.2%. Sub-Saharan Africa’s rate stood at 9.7%, downfrom 9.9% in 2004. Further improvement is expected thisyear to about 9.4%.

Natural Disasters – The series of natural disasters in2005, especially the hurricanes, had negative impact onthe growth of the global economy, compounded by thecarry-over of the impact of the Asian tsunami and earth-quake disaster of 26 December 2004.

The disasters among other immediate impact, led tothe destruction of oil facilities especially at the Gulf ofMexico, and took oil prices to the $70 per barrel highs inAugust 2005. On October 8, 2005, over 71,000 lives werelost to an earthquake that struck Pakistan, India and otherparts of South Asia. Over 3 million people were renderedhomeless.

In Africa, Niger Republic was on the news much of2005 following the acute famine and hunger in the landwhich was triggered by droughts. Over 4 million lives,

(mostly children and women) were declared at risk. Thefood crises prompted relief efforts from countries andgroups round the world.

In his 2005 Economic Report, the US President, GeorgeW. Bush described the impact of natural disasters on theUS economy in 2005 thus:

“In addition to the tragic loss of life and the massive destruc-tion of personal property, the two major hurricanes (Katrina onAugust 29 and Rita on September 24) damaged the productivecapacity of the American economy”.

ConclusionAfter about 3.2% growth in 2005, the global economy is

expected to expand by about 3.3%-3.5% this year. The U.S.will remain the dominant global economic growth engine,supported by the European Union and Japan - the trio,

which have for decades accounted for more than70% of world production factor.

But other economies are now better positionedto contribute more to global growth than before;breaking the US monopoly. Massive economictransformation in China and India have propelledthem ahead of the UK and Germany as the big-gest economies in 2005, and they would hence-forth have stronger influence on global economicgrowth prospects more than before.

For most economies, inflation, interest ratesand employment would be major growth factorsin 2006. Other potential hazards to economic growthcould include the continued surge in oil prices, afall in the housing market (especially for the UnitedStates and Europe) and the possibility of majorfinancial upsets such as corporate bankruptcy anda possible repeat of the natural disasters that nega-tively impacted global economic growth prospectsin 2004 and 2005.(* Eunice Sampson is an Assistant Editor, ZenithEconomic Quarterly.)


Source: OPEC; 2006 is projection

World Oil Supply/Demand Balance (Mb/d)

Source: ILO; *2006 is estimate

Global Unemployment Position (%): 2004-2006

Source: ILO, 2006


FACTS & FIGURES

ZEQ DATABANKMacroeconomic EnvironmentNigeria’s macroeconomic environment, by the last quarter of the year 2005, exhibited strong recovery features al-though the inflationary trend remained on the high side. There was significant reversal in the decline in the industrialsector as well as a strong showing in growth potential in terms of spread and size of growth.

The macroeconomic environment benefited immensely from the successful implementation of the first phase of theParis Debt Club exit scheme, the continued strong showing in the prices of crude oil and improved fiscal managementespecially in terms of the sterilization of the ‘excess crude proceeds’. Overall, the economy is in a recovery mode,indicating that the wide range of reforms, if sustained would lead to significant growth rates in the coming years. Theonly challenge has been the question of a successful national population census and general elections in 2006 and 2007respectively.

The expectation is that with the adherence to the debt exit scheme, especially if and when the second tranche in the firstquarter of 2006 is met, external credit guarantee agencies would be favourably disposed to Nigeria, her credit riskrating would improve significantly (as was the case in Poland years ago) and foreign direct investments especially intothe non-oil sector would also improve.

One thing is certain: the overall prospects are brighter than three years ago and government remains determined topursue the economic reforms and fiscal restraint that has helped to achieve significant excess crude oil proceedssterilization and improved public expenditure management.

Gross Domestic Product (GDP)The projection is that the primary (extractive) sectors– Agriculture, mining, Oil and Gas would remain the largestcontributors to the growth in GDP in 2005 and beyond. Given the all-year round showing in the prices of crude oil, theprojected GDP growth rate of 6% would be met if not exceeded. Although oil accounts for over 85% of federal govern-ment revenue, it accounts for less than 25% of GDP. Agriculture, which contributes over 40%, and has been growing atan average rate of 7%p.a. over the past three years, would remain the major source of GDP growth. The GDP isestimated to be over $75.0bn at end of year 2005.

This is consistent with the pattern over the last three years. Hopefully the reversal in decline of the industrial sector asa whole would lead to a meaningful rate of contribution from the manufacturing sector. (With capacity utilizationprojected to be about 52%).

Source: CBN/NPC/R&EIG


FACTS & FIGURES

Manufacturing Capacity UtilizationThe generally low interest rate and seeming adequacy in the supply of foreign exchange to the manufacturing sectorhave impacted positively on the level of capacity utilization. The limited impact is traceable to the poor, though improv-ing, state of infrastructure services. Dramatic improvements are expected in the course of the new year as ongoingpower generation and transmission line projects are completed.

Inflation RateAlthough official inflation figures show a decline in year-on-year rate between third quarter 2005 and the first few weeksof the last quarter, inflation has remained relatively on the high side. CBN’s withdrawals of government funds from thebanking system, the general food price volatility and the M2 growth rate (23% already as against the projected 15% for2005) have contributed to this trend.

The sustained high crude oil prices and the recent increases in the pump prices of petroleum products have impactedthe level of inflation and therefore the projected single digit inflation rate at year end is not realistic. However, a lowerdouble digit –about 18%, is projected by year end.

Source: CBN/R&EIG

Source: CBN/FOS/R&EIG

Nigeria: Inflation All Items Index, 2005 Inflation Rate in Nigeria


FACTS & FIGURES

Foreign Exchange MarketThe foreign exchange market continues to experience CBN special intervention which has been significant in shoring upthe value of the naira against major currencies. With the wholesale dealership arrangement expected to take effectbefore the end of the first quarter in 2006, the stability in the foreign exchange market seem assured over time, (giventhe prices of crude oil and government’s determination to exit the Paris Debt Club as evidenced by the recent paymentof the first installment of about US$7.0bn.). The exchange rate has remained stable at aboutN129.0 to US$1.00.

Source: CBN

As would be expected, transactions in the DAS generally declined as the year comes to a close as indicated by theamount demanded, supplied and bought-same level as with 2004 is expected at year end ($9.43bn as at Nov, 2005,compared with $9.56bn for 2004 for same period).

Expectedly, the manufacturing sector accounted for over 60% of the foreign exchange consumption in the economyduring the period and indeed for the whole year.

Source: CBN


Interest RateThe withdrawal of government funds led to a strong spike in inter-bank interest rate moderated by the now well knownpattern of disbursements of statutory allocations from the federation account. Treasury bills rates have generallyfallen to an all time low especially with the introduction of non-rediscountable bills. CBN has continued to focus onbringing down interest rates.

Though average lending rates went down, mostly large borrowers/corporates benefited from the downward trend.Tenored funds continued to show very good trends especially towards the later part of the last quarter, 2005.

FACTS & FIGURES

Average monthly interest rate (in %) onSavings Account in 2005

Months

%

Source: R&EIG/Money Market

Source: R&EIG/Money Market

Average Lending Rates (Jan - Dec. 2005)

Average Deposit Interest Rate (Jan - Dec) 2005Nibor Rates (Jun - Dec) 2005

% rate


Capital MarketThe market has remained significantly busy due in part to sharp rises in market rates which in turn led to dumping ofsome stocks. Total market capitalization has declined to N4.2tn by mid-quarter, but is expected to close the yearmarginally higher. Banking, petroleum marketing and food, beverages and tobacco sectors have continued to recorddeclining growth in earnings.

FACTS & FIGURES

External ReservesNigeria’s external reserves continue to grow due to prudent fiscal management and the consistently high price of crudeoil. It is estimated that total export revenue would surpass previous year’s by as much as 48%. At US$34.6bn atSeptember ending, external reserves was already almost twice the figure for the same period in 2004. The figure for2005 year end is estimated at US$30.1bn. It is imperative to note that the historical pattern of budgetary expansion-contraction in line with changes in the price of crude oil has been jettisoned.

Source: NSE

Source: CBN/R&EIG

The Nigerian Stock Exchange [All Share Index]: 2004 - 2005


FACTS & FIGURES

Oil and gas SectorOil production has remained fairly stable, in spite of threats of disruption due to unfulfilled expectations during therecent constitutional talks. It has averaged about 2.45mbpd, some 2% above the average for 2004, thus far. Indicationsare that this trend would be sustained for the rest of the quarter, and perhaps into the New Year. Estimated exportrevenue is in the region of $46.0bn. So far marginal changes in price have been witnessed in the months of October andNovember. The trend would be maintained into the New Year. The price level has helped to keep various governmentreform efforts on course, especially the Paris Club Debt exit scheme and the concerted effort at improving powergeneration through massive one-off investment to the tune of about US$2.5bn.

Source: NNPC/OPEC

Crude Oil Production: Nigeria, OPEC & World (10yr trend)Monthly Prices of Bonny Light Crude (Jul - Dec, 2005)

Documents

Vol. 2 No. 1 January 2006 - Zenith Bank Plc 2 No 1 January 2006.pdf · 2017-05-30 · 2 ZENITH ECONOMIC QUARTERLY : : January, 2006 N From The Editorial Suite igeria’s chequered