The current reforms in the Nigerian Banking system may have come as a surprise to some people. However, to those who had been monitoring the health of the banks, the reforms could not have come as a surprise. The incidence of distressed
and technically insolvent banking institutions had been with us for quite sometime.

The unprecedented liquidation of twenty-six (26) banks in 1998 in addition to the earlier closure of five (5) banks in 1994/95 did not put an end to the distress syndrome. Indeed, you will admit that to have cleansed the banking system of distressed and insolvent institutions in 1998, more institutions ought to have been closed. However, that was not done because the Nigeria Deposit Insurance Corporation (NDIC) did not have adequate funds in its Deposit Insurance Fund(DIF) to pay depositors.

Also, government was unwilling to provide the needed funds for the exercise as had been done in other countries where government financial support amounted to a significant proportion of the Gross Domestic Product (GDP) for example, Argentina (early 1980 - 82) 55% of GDP; Indonesia (1997 to date) about 50% of GDP; Cote d’Ivoire (1988 - 1991) about 25% of GDP and Malaysia (1997 to date) about 16.4% of GDP (see Honahan and Klingebiel, 2006).
A number of lessons had been learnt  from the liquidation of the thirty-one (31) banks. One lesson had been that liquidation is a costly and protracted process to be deployed as a last resort. The second lesson is that bank owners are now too willing to deny the failure of their institutions. Consequently, they rush to courts to stop the take-over of such institutions for restructuring and sale or for liquidation.
In the subsequent protracted legal process, depositors are faced with untold hardships, they are unable to access their deposits or benefit from the NDIC deposit payout. The third lesson had been the role played by inadequate capital in the failure of the banks. The 1995 collaborative study by the Central Bank of Nigeria (CBN) and the NDIC had confirmed the role of inadequate capital in the failures. The capital levels of the closed banks were so low that they could not absorb losses occasioned by non-performing risk assets, keen competition and poor management.

Some of the banks were even reported to have commenced business with borrowed capital in spite of efforts at capital verification by the Regulatory Authorities. It was no surprise that the proposed reforms of the banking system announced by the CBN Governor on July 6, 2004 had taken into consideration the aforementioned lessons of experience. One objective of the reforms is to create a sound and more secure banking system that depositors can trust through consolidation and an enhanced operating capital.

The consolidation is expected to address the problem of distressed and technically insolvent institutions without an initial resort to liquidation with all its adverse consequences for depositors.  In this book, we provide a conceptual framework for the proposed capital restructuring of banks to cover justification, principles, approaches, constraints and opportunities.

Banks like other corporate entities have as one objective, the maximization of shareholders wealth. Usually that is reflected in increased share price of the quoted bank. Ordinarily, one would be led to believe that as more capital is deployed to run a corporate entity, the value of the firm would grow correspondingly.

However, Miller and Modigliani (M&M) (1958) demonstrated the irrelevance of capital structure in the determination of corporate value. That conclusion was arrived at under a set of assumptions which included efficient markets, full information, absence of taxes, transactions costs and asymmetric information. When such restrictions were removed, capital structure had been found to be relevant in determining corporate value.

In a world such as ours where the capital market may not have met the Weakly Form Hypothesis of market efficiency a la Fama (1965), where information asymmetry, taxes and transaction costs are high, it is to be expected that firm value can be enhanced by judicious use of equity and borrowed capital.

Thus, the enhanced capitalization of banks called for in the current banking reforms provides an opportunity for banks to attain desired structure for the purpose of increasing market value and shareholders wealth. It is a known fact that banks are the most leveraged companies in an economy, necessitating bank regulators to introduce certain capital adequacy requirements.

Banks are also the first set of financial institutions to be subject to internationally coordinated capital regulation (Berger, Herring & Szego (1995)). This is exemplified by the capital guidelines put out by the Basel Committee on Banking Supervision. Were these not so, some banks would attempt to operate only with depositors funds.
Adequate capital is important in a bank for a number of reasons.

As Spong (1990) put it: “Commercial banks must have enough capital to provide a cushion for absorbing possible loan losses or other problems, funds for its internal needs and for expansion, and added security for depositors and the deposit insurance system. In addition, higher capital Serves to increase the financial stake that stockholders have in the safe and sound operation of the bank. Consequently, bank regulators view capital as an Important element in holding banking risks to an acceptable level”

There is unanimity of opinion amongst bank regulators concerning the role of capital in absorbing operational losses, funding fixed assets and fostering depositor confidence. Greuning and Bratanovic (2003) have argued that in addition to serving as a safety-net for a variety of risk exposures and absorbing losses, adequate capital is a determinant of lending capacity and maximum level of assets. In other words, the volume of loans and advances that a bank is capable of creating is directly related to the level of the bank’s capital, ceteris-paribus.

In an effort to ensure that banks maintain adequate levels of capital for their risk exposures, the Basel Committee on Banking Supervision issued in 1988 what has now been popularly known as the Capital Accord which linked banks’ credit risks to capital. By the beginning of 1998, banks were required to measure and apply capital charges in respect of market risks together with capital charges for credit risk.

The New Capital Accord to be implemented in 2007 shall require capital charges to be made for credit, market and operational risks. The new accord has closely aligned capital to banking risks whilst providing for a supervisory review process and market discipline as reinforcing pillars to the minimum capital pillar.

These efforts by the Basel Committee are geared towards protecting depositors, consumers and the public against losses arising from banking fragility and failure. So far, we have not directly justified why enhanced capital is required by Nigerian banks.
The justification lies in the fragility and distressed condition of the banking sector.

Before the deregulation of the sector in the late 1980s, there existed at least seven (7) insolvent banks which distressed conditions were not resolved. Meanwhile, new banks were licensed with unprecedented rapidity. The NDIC was established in 1988 to insure the banks’ deposits liabilities, including the deposit liabilities of the insolvent institutions.

 Acknowledged as the author of the most significant financial reform ever undertaken in Nigeria (if not in Africa) – the restructuring of Nigeria’s banking sector -   The Governor of Central Bank, Prof. Chukwuma Charles Soludo CFR has now turned his attention to creating a new investment bank for the continent. This ambitious home grown initiative is structured to produce healthy returns on investment while simultaneously funding Africa’s huge infrastructure requirements.

Coming hard on the heels of the governor’s widely lauded restructuring of Nigeria’s previously unruly banking sector, Soludo had once again pulled-off a stunning triumph – as notable for its bold vision and audacious optimism as the simplicity of the concept behind it. For Soludo was spearheading the creation of an investment vehicle that has the potential, no less, to kick-start Nigeria and of-course the continent’s economic revival, though not without casualty.

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