ABSTRACT
This project evaluates the level of capital adequacy of three Nigeria commercial banks including the Union Bank of Nigeria Plc, First Bank of Nigeria Plc and Oceanic Bank International Plc from year 2003 to 2007. It delves into the theoretical framework of capital adequacy by reviewing development in the international capital standards (the Basel I and Basel II accords) for banks, their controversies and prospects in line with effective banking supervision. This work employs the tier I risk-base, total risk-base, leverage capital models, correlation coefficient and regression techniques to reveal that the three evaluated banks are well capitalized and at the same time exhibited dwindling quality of earnings with increase in capital positions in general for the studied periods. Consequently, we recommend a certain percentage of different capital ratios the individual bank should strive to maintain to remain well capitalized and achieve an optimum return on assets invested; that the banks should establish assets management committee to ensure proper investment of their capital in right mix of Risk Assets; that the banks should endeavour to recover most of their problem loans & collaterals to boost the value of its assets; that the regulatory authorities such as CBN and NDIC should adopt a risk-focused and rule-based regulatory framework in setting and reviewing the minimum capital base for banks; that the regulatory authorities should adopt a zero tolerance in data and financial misreporting by banks to them; the banks should adopt a risk focused approach in raising their capital base ( through public issues, merger or acquisition) to reflect the intended or scope and character of their business; and that their should cross fertilization of information and close collaboration among the regulators of the financial system ( eg CBN, NDIC, EFFCC, Ministry of France, the National Assembly and others) to ensure sound legislation and monitoring of the banking system in Nigeria.
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
The proposed reform of the Nigeria banking system announced by the former Central Bank of Nigeria (CBN) Governor Professor Charles Soludo on July 6, 2004, may have come as a surprise to some people. However, to those who have been monitoring the health of the banks, the reform could not have come as a surprise. According to Umoh (2004), the incidence of distressed and technically insolvent banking institutions has been with us for quite some time. The unprecedented liquidation of twenty six (26) Nigerian banks in 1998, in addition to the earlier closure of five (5) banks in 1994/1995, did not put an end to the distress syndrome. Indeed, we have to 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 Nigerian Deposit Insurance Corporation (NDIC) did not have adequate funds in its Deposit Insurance Funds to pay depositors. Also, government was unwilling to provide the needed funds for the exercise as had been done in other countries where
government’s financial support amount to a significant proportion of the Gross Domestic Product (GDP), for example, in Argentina (early 1980-82) 55% of the GDP, Indonesia (1997 to date) about 50% of GDP, Côte d’Ivoire (1988 – 1991) about 25% of GDP, and Malaysia (1997 to date) about 16.4% of GDP.
A number of lessons had been learnt from the liquidation of thirty one (31) banks from 1994 to 1998. Worthy of mention here is the role played by inadequate capital in the failure of the banks. The 1995 collaborative study by the Central Bank of Nigeria (CBN) and NDIC had confirmed the role of inadequate capital in bank 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 management. CBN (2004) and Osho (2004) reiterated that Gross Under capitalization (Capital Inadequacy) in relation to the level and character of bank business is one of the major causes of bank failures.
To forestall the high incidence of banks failures in the country, a number of legislations historically had been put in place to mandate banks to raise their minimum paid-up capital to a certain required level. According to Adekanya (1986), the 1952 Banking Ordinance fixed the minimum capital required for indigenous banks at £12,500 and for expatriate banks at £100,000. Again, section 4 of the 1958 Banking Ordinance reviewed upward the expatriate banks minimum capital to
£200,000 while that of the indigenous banks remained at £12,500. Further more, section 6(1) of the 1969 Banking Decree reviewed upward the minimum capital required for indigenous banks to £300,000 and for expatriate banks at £750,000. It was in section 9(1) of the 1991 Banks and Other Financial Institutions Act then Decree that the Central Bank of Nigeria is empowered to determine from time to time the minimum required paid up capital for banks. As at 2004, the CBN exercised this power to fix the amount of the minimum required capital for licensed banks in Nigeria to the tune of Twenty Five Billion Naira (N25, 000,000,000).
However, one thing could be deduced from this continuous upward review of banks minimum paid-up capital is that they failed to stop incessant liquidation of Banks. For instance, twenty two (22) of forty nine
(49) banks that existed in Nigeria between 1952 and 1982 got liquidated within the same period that the above legislative changes were made (Adekanye, 1986).
1.2 Statement of the Problem
Various analysts have opined that bank capital play vital roles in supporting the daily operations and ensuring the long-run viability of commercial banks. According to Rose and Hudgins (2008) and Koch and Macdonald (2003), bank capital:
(i) Provides a cushion against the risk of failure by absorbing financial and operating losses until management can address the institution’s problems and restore its profitability;
(ii) Is a start-up-funds required to finance start-up costs of capital investment in land, plant, equipment, and hire officers and staff before the opening of new banks;
(iii) Promotes public confidence and reassures creditors concerning an institution’s financial strength and credit repayment capacity even if the economy turns down;
(iv) Provides funds for the organization’s growth and the
development new services and facilities for instance the expansion in order to keep pace with its expanding market and follow its customers;
(v) Serves as a regulator of growth, helping to ensure that growth is sustainable in the long run. Both the regulatory authorities and the financial markets require that capital increases roughly in line with the growth of risky assets;
(vi) Finally, capital not only tends to promote public confidence in the financial system but also serves to protect the government’s deposit insurance system (“safety net”) from serious losses.
Considering the Liquidation of 22 banks between 1952 and 1982, 31 banks between 1994 and 1998 in Nigeria, one would be tempted to conclude that regulatory raises of banks minimum capital had failed to stop banks failures
and failed to fulfill the above enumerated functions of bank capital. What then are the needs for capital? Since some banks established since 1982 still exist today, to what extent had legislative reviews of bank minimum capital prevented bank failures? Do banks’ soundness, growth and viability come by legislating minimum capital requirements or by sheer good business practices? Does high capital base implies the adequacy of bank capital or are capital adjudged adequate in relation to risks exposures of the banks (that is in relation to the level and character of bank businesses)? What is the impact adequate capital on earnings potential of banks? These and many more are what this study is set to enquire.
1.3 Objectives of the Study
Having identified the problem, the following objectives are pursued in this study:
To assess the compliance of Nigerian commercial banks in meeting the requirements of the International capital standards for adequately or well capitalized banks.
To evaluate the extent, assets employed by the Nigerian commercial banks generate net earnings or returns.
To determine the relationship between banks pursuit for higher adequacy of capital and higher earnings or returns.
To establish optimum earnings that Nigerian banks would make while maintaining well capitalized status.
1.4 Research Questions
The above objectives of this study are operationalized into the following investigative research questions to give this study a direction:
Are the Nigerian Commercial Banks adequately capitalized?
To what extent do banks’ total assets translate to net earnings or returns?
What is the degree of relationship between Quality of bank’s Earnings and the Adequacy of bank Capitals?
What optimum earnings would Nigerian Commercial banks target while maintaining a well capitalized position?
1.5 Scope and Limitations of the Study
This study is intended to cover evaluation of capital adequacy of three commercial banks in Nigeria and its impact on profitability of those banks for the periods counting from 2003 to 2007. The banks selected are limited to Union Bank of Nigeria Plc, the First Bank of Nigerian Plc, and the Oceanic Bank International Plc. The evaluation is restricted to the requirements of Basel I International Capital Agreement. Basel II new capital accord would be mentioned in passing but not evaluated in this study due to want time. However, this research is not intended to measure capital adequacy of micro finance banks and other non-banks financial institutions other than commercial banks in Nigeria.
1.6 Significance of the Study
This study through its findings and recommendations will be significant in the following ways.
It will provide banks’ managers with procedures for determining the best mix of capital components to maintain a well capitalized status and optimum profitability.
It will provide banks’ stakeholders (depositors, investors, bank staff and legislators) information in following safety and soundness trend of the Nigerian Commercial banks.
It will serve as a useful reference material for lecturers and financial analysts in future assessment of cases of soundness and level of capital adequacy of banks.
It will also bring to bare to bank stakeholders the practical evaluation statistics (models) to assessing capital adequacy of banks in addition to sufficient earnings
It will be useful to the bank regulatory and supervisory
agencies such as the Central Bank of Nigeria (CBN) and the Nigerian Deposit Insurance Corporation (NDIC) in fulfilling their collective mission of maintaining stability and public confidence in the Nigeria banking sector.
And lastly, it will assist bank management to appropriately
focus attention on the bank performance area(s) exhibiting adverse or weak trends.
1.7 Profile of Selected Nigerian Commercial Banks
Among the existing 24 re-capitalized commercial banks, three of which are selected for review in this study. This sample selection is judgmental and the selected banks include the Union Bank of Nigeria Plc, the First Bank of Nigeria Plc, and the Oceanic Bank International Plc.
1.7.1 Union Bank of Nigeria Plc
Union Bank of Nigeria Plc was established in 1917 as a Colonial Bank with its first branch in Lagos. In 1925, Barclays Bank Dominion Colonial and Overseas was formed to take over the activities of the Bank. In 1965, the Bank was legally incorporated in Nigeria as a wholly owned subsidiary of Barclays Bank International Limited and renamed Barclays Bank of Nigeria Limited. The ownership structure of the bank remained unchanged until
1971 when 8.33% of the Bank’s shares were offered to Nigerians. In the same year, the Bank was listed on the Nigerian Stock Exchange. As a result of the Nigerian Enterprise Promotion Decree of 1972, the Federal Government of Nigeria acquired 51.67% of the Bank’s shares, which left Barclays Bank Plc, London with only 40%. A landmark event in the Bank’s history occurred in 1979 when Barclays Bank sold 50% of its shareholding in the Bank to Nigerians. This resulted in the change of the Bank’s name from Barclays Bank of Nigeria Limited to Union Bank of Nigeria Limited to reflect its new image and ownership structure. The remaining share holding of Barclays Bank was disposed off in 1989. Today, Union Bank is the first publicly quoted banking institution that is 100% owned and wholly managed by Nigerians .
1.7.2 First Bank of Nigeria Plc
The Bank was incorporated as a limited company on March 31, 1984 as Bank of British West Africa Limited with Head Office in Liver Pool, UK. In 1969, the Bank was incorporated locally as the Standard Bank of Nigeria Limited in Line with the Companies Decree of 1968. The Bank was converted to Public Company in 1970 and got listed on the Nigerian Stock Exchange (NSE) in March 1972. Changes in the name of the Bank occurred in 1979 and 1991, to First Bank of Nigeria Plc, respectively.
The Bank engages in the business of Universal Banking. That is, it carries on the business of commercial banking, registrar, trusteeship and capital market (First Bank of Nigeria Plc, 2004, 2006, 2007).
1.7.3 Oceanic Bank International Plc
The bank was incorporated in Nigeria under the companies and Allied Act of 1990 as a private limited liability on March 26, 1990. It was granted license on the 10th of April 1990 to carry on the business of commercial banking and commenced business on June, 12 1990. The bank was converted into a public limited liability company 2004. Its shares were listed on the 25th of June 2004 on the floor of the Nigerian Stock Exchange by way of introduction. The bank is wholly owned by Nigerian citizens.
The principal activity of the bank is and has always been the provision of comprehensive universal banking services to all its corporate, commercial and individual customers from its headquarters in Abuja, corporate offices in Victoria Island and other branches/ cash centres spread across the country ( Oceanic Bank Plc, 2007: 21).
1.8 Operational Definition of Key Terms
Asset revaluation reserves: take the form of latent gains on unrealized securities are subject to a discount of 55 percent on the difference between the historic cost book value and the market value
Banker’s Acceptance: A short term credit investment which is
credited by a non-financial firm and whose payment is guaranteed by a bank.
BOFIA: Banks and Other Financial Institutions Act.
CAMD: Companies and Allied Matters Decree
Capital: Funds subscribed and paid by stockholders representing ownership in a bank. Regulatory capital also includes debts components and loss reserves.
CBN: Central Bank of Nigeria.
Commercial loan: An unsecured obligation issued by a corporation or bank to finance its short-term credit needs, such as accounts receivables and inventory.
Distressed bank: A bank undergoing or expected to undergo liquidation or restructuring in an effort to avoid insolvency.
Earning Assets: Loans, investment securities and short term investment that generate interest and yield related fee income.
Equity capital: issued and fully paid ordinary shares/common stock and non- cumulative perpetual preferred stock.
Governor: Means the Governor or any of the Deputy Governments of the CBN.
Guarantee: A contractual engagement to answer for the debt, default or failure of another person.
Insolvency: A situation where banks’ realisable assets value is less than the total value of its liabilities.
Lease: A written agreement under which a property owner allows a tenant to use the property for a specified period of time and rent.
Loan: A sum of money transferred to another for temporary use to be repaid with or without interest according to terms of the loan agreement.
Liquid Assets: Consist of cash, balance held with the CBN, Treasury bills, balances held with other banks, certificate of deposits, bankers acceptances.
Liquidity: Inability of bank to meet its liabilities as they mature for payment.
NDIC: Nigeria Deposits Insurance Corporation.
OECD: Organization for Economic Cooperation and Development.
Subordinated Debts: Type of capital represented by debt instruments whose claim against the borrowing institution legally follows the claims of depositors but come ahead of the stockholders.
Trust Services: refer to the management of property and other valuables owned by a customer under a contract (the trust agreement) in which the bank serve as trustee and the customers becomes the trustor during a specified period of time.
This material content is developed to serve as a GUIDE for students to conduct academic research
EVALUATION OF CAPITAL ADEQUACY IN NIGERIA COMMERCIAL BANKS A CASE STUDY OF SOME SELECTED BANKS
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