THE IMPACT OF CAPITALIZATION ON THE BANKING INDUSTRY AND THE NIGERIAN ECONOMY (AN EVALUATION)

ABSTRACT

The CBN in  its search for a more robust, stronger and stable banking system, reeled out a 13  point reform agenda in  July 6,  2004 direct among other things, that operators in the banking sub-sector should raise their capital base to N25 billion with full compliance by December 31, 2005. Although the minimum capitalization  segment  of  the  bank  consolidation  exercise  has  since  been achieved,  In the light of the above, the study aimed at evaluating the impact of capitalization on the banking industry and the Nigeria economy.  However,  the objective of the study include:   Examining the extent to which Banking industry capitalization  has  boosted the Nigerian economy, whether the capitalization of banking   industry   sector   enhanced   the   banks   lending   ability,   How   the capitalization  had   contributed  towards  the  growth  and  development  of  the Nigerian  economy and to proffer recommendations,  to ascertain this,  banking industry capitalization was used to correlate with industrial  sector Gross domestic product (GDP). The study covered a period of Eight years. Being an Expo Factor research design,  Regression Analysis was used to test the hypotheses  using the following variables: Banks lending rates; Banking industry capitalization, manufacturing sector utilization rates, industrial sector Gross (GDP) of the economy.  The study found that,  the capitalization  of banking industry  had  no significant  positive  impact  on  the  growth  and  development  in  the  Nigeria economy as in a bid to survive in the highly competitive banking industry. On the other  hand,  it was found  out that,  the capitalization  enhanced  banks lending ability within  the  period.  However,  this was  as a result from the test  model, although, the capitalization of banking industry cannot enhanced banks lending, if capitalization  of  Banking    industry  had  no  significant  positive  impact  on the growth and development in Nigerian economy.

CHAPTER ONE

INTRODUCTION

1.1      BACKGROUND OF THE STUDY

The ultimate strength of a bank lies  in  its  capital  fund.  Banking,  like any other business, requires adequate capital to function effectively (Nwankwo,   1991 :45).  Though  by nature,   banking  is  a  highly  leveraged industry,  the degree of leverage  averaging  88% and 95% in  the United States,  compared with  between 24% and 70% of non financial  firms (ibid). life  of a bank like  any other business,  it  plays the role of a cushion for losses resulting from crystallization for the various risks a business entity is exposed  to  (lmala,  2004:74).  Adequate  capital  is  required  to  maintain public confidence  by standing  ready  to  absorb  unexpected  or  unusual losses  not absorbed by normal  earnings (Nwankwo,  1991 :45).  Thus,  it  has often been said that the primary function of bank capital is to protect the depositor against loss.  How true is this statement?

Although such statements contain an element of truth, they do not adequately  express  the  complete  nature  of  the  protective  functions  of banks capital  funds.  Most weak looking  bank assets can be phased out with relatively little loss given sufficient time, competent management, reasonable earnings,  and the workings of the business cycle (Liewellyn,

1999:5). Therefore, the primary function of bank capital is to keep the bank open and operating so that gain and earnings can absorb losses in  other words,  to inspire sufficient confidence in the bank of the part of depositors and the supervisor so that it will  not be forced into costly liquidation.  In this sense,  capital  services to protect the stockholder as much as,  if  not more than the depositor (ibid)

The other functions of bank capital,  is  that of purchasing fixed assets and working capital. In  fact put in  another ways,  capital  is  needed to supply put in  another  way,  capital  is  needed to supply the working  tools  of the bank’s banking quarters,  equipments  needed to begin operations and the working capital.

Thus  for   a   bank  to  function   effectively   it   needs  sufficient   and adequate capital. This capital  is  defined by Central  Bank of Nigeria  (CBN)

2004:1  as  paid – up capital  and serves  unimpaired  by losses.  Therefore banks owe some basic responsibilities to their communities. The traditional functions  which  they  render  in  form  of financial  intermediation,  must  be effectively  delivered to retain the confidence of their client. The bank must also sustain the interest and confidence of the public by being sufficiently responsive to their needs; housing all maturing obligations avoiding actions that will  lead  to distress and failure  in  the system.  Banks must also meet the credit needs of their customers and thus sustain the productive process (Nzotta,  1999:282)

Thus bank capital serves tripartite functions viz; protective, regulative and operational.  The protective  function  is to protect depositors against the risk  of non – payment of deposits  on demands while the regulatory function is  that of meeting up with  the monetary authorities  requirement and helps the authorities  assess a banks health.  The operational  functions  has to do with  the  procurement  of  what  banks  need  to  take  off  business,  which means that the operational function  is to kick- start the banking operations.

Meanwhile,  in  the  Nigerian  environment  bank capital  legislation  did not start,  until the introduction  of banking ordinance in  1952.

According   to   Uche  (1998:30),   before   1952   there  was   no  legal minimum  capital  requirement  for  banks  operating  in  the  Nigeria  colony. Despite this fact, foreign banks were able to operate in  the Nigeria colony without any  banking failure.  However,  things changed  with  the  advent of indigenous  banks,  most of who  were  poorly – capitalized,  poorly  staffed and  in  most cases  interested  with  fraud.  In  the  opinion of the writer,  the above  tripartite   malaise  of  the   indigenous   banks  contributed   to  their failures.  This led  the colonial  government to invite  G.D Paton,  a consultant for  the  bank  of  England,  to  investigate  the  Nigeria  banking  environment with the possibility of introducing  regulation. A minimum share capital was subsequently recommended.

The outcome of that legislation was disastrous. This was rendered by “Uche” (1998:31) thus “the  resultant effect was that  banks that could  not meet up with  the dead line  for re-capitalization  failed – mass failure with  at least 17 indigenous banks failing in  1953/54.  Ever since, there have been recurring bank capital  legislations.

These are;

1958    The share capital  for foreign  banks increased  to £20,000.  That of the indigenous one remained unchanged

1962    The minimum share capital  for indigenous  bank increased  from £12,500

to £250,000.  This was a 1,900  percent increment,  with 7 years of grace period.

1969    Sec.   6  of  Banking  Act  increased  the  share  capital   to  £300,000  an

£750,000 for indigenous and foreign banks,  respectively

1988     It was raised to N10m

1990     N20m

1991     N50m

2000    N1bn

2002    N2bn

The  banks were  still setting for  the  new minimum  capital  requirement, when  the  big  bang Twenty  five  billion  naira  (N25bn)  capitalization  was announced.

This represents an increase  of 1250  percent from that of two billion naira

(Uche,  1998:31-32.  Eke, 2005:1).

What were the reasons for the continual  increments have any desired effect on the economy and the industry?

Reports have shown that, with any increment on the banks capitalization, course such inflation that makes nonsense of the increase (if Uche, 1998:32).   To what extent has the minimum capital legislation prevented bank failures? How has depositors fared in the aftermath? What are the likely consequences  of the recently introduced,  N25bn minimum capital  legislation?  These  and  many  more  is  what  this  study  is  set to enquire.

1.2     STATEMENT OF PROBLEM

A  clear  understanding  of the  role of  banks  in  the  economy  is  to improve the standard of living of its citizenry and impact positively on the economy by providing financial resources to absorb unexpected losses. A major engine of economic growth of any country is  its  capital  adequacy,

hence without adequate capital from the bank the economy may be starved of the long-term  funding for sustainable development.

Having been acquainted with the fact that bank contribute to the development   of  any   nation,   therefore,   it   is   pertinent  to  carry   out  a performance evaluation  of such an important sector industry with  regards to its contribution towards the nations development.

1.3     OBJECTIVES OF THE STUDY

Since the  economy  of  any  country  rest on the  banking system’s contribution,  it then means that,  adequate capital  is required to maintain public confidence  which  should  have  a  lasting  effect  on the  economic indicators like the bank credit to the economy GDP and industrialization (Industrial sector GDP).

Therefore, the specific objectives of this study are;

1.    To examine the impact of capitalization  of banking sector in boosting the economy

11.   To determine how capitalization  of banking sector is  enhancing the

lending ability of banks.

iii. To ascertain the rate of growth in the development of recapitalization of banking sector in the Nigeria capital  market.

iv. To recommend what can be done to maintain or enhance efficiency n the contribution of banking sector.

1.4     RESEARCH QUESTIONS

The  following  research  questions  have  been formulated  to  simplify the objectives  of the study and to guide the researcher in  finding solutions to the problems this research study intends to solve.

The questions are;

1.     Has recapitalization of banking sector aid the process of development of Nigeria economy?

11.    How has capitalization  of banking sector enhanced the lending ability of banks?

iii.  Is there a speedy development of recapitalization of banking sector in

Nigeria capital market?

iv. What  can  be done  in  capitalization  of  banking sector  in  order  to enhance development and efficiency.

1.5     RESEARCH HYPOTHESES

The following  hypothesis form the frame work for carrying out this

study.

Hypothesis 1

The banking industry capitalization  does not have a positive and significant impact in the Nigeria economy.

Hypotheses II

The capitalization  of banking industry  has not enhanced the banks lending to the industrial sector in Nigeria.

Hypotheses Ill

Banking industry capitalization  has not contributed to the growth of Nigeria economy.

Hypotheses IV

The development of the banking industry capitalization does not depend on the economic stability in Nigeria.

1.6     THE SIGNIFICANCE  OF THE STUDY

The need for a study about the impact  of the bank capitalization  on the Nigeria economy from year 2001 to year 2008 is paramount. Within this period  many financial  and economic  laws  and  reforms were  made and undertaken. These may have in one way or the other affected the performance  or  activities  in  the  capitalization,  hence  the  need for  this research.

The banking sector laws and reforms both to the operators and the economy as a whole include:

1.        To strengthening the banking system in  Nigeria, reducing the fear of financial distress and promoting depositor and investors confidence and friendliness.

2.      Reducing the interest rate in the economy from its present high level which discourages investment particularly the long term ones.

3.    Encouraging  partnership  particularly  with  government  and strengthening the capital market.

4.      Enhancing competition  among  banks and eliminating  the armchair banking phenomenon in Nigeria.

5.       Launching Nigeria  into  international  financial  intermediation  in  a big

way and enhancing foreign investment inflow.

In the light of the above discussion, this research work will be beneficial to policy makers and administrators,  the equity holders in assessing the effect of the laws  they made in  the economy.  It  will  also benefit the operators in the banking sectors and the host communities.

•    It  will  bring to light the various  views on the current twenty five billion naira (N25bn) capitalization  debate.

•    In  the  academia,  this  work  will   help  to  broaden  the  knowledge  of students  on  the   issues  concerning  the  capitalization   of  banking industry and other macro-economic issues.

1.7     THE SCOPE OF THE STUDY

This research work will  cover all the activities  in  the capitalization  of banking industry between the period of 2001  and 2008 fiscal years.

1.8     OPERATIONAL  DEFINITION OF TERMS

1.          Acquisition:  Is  an act of acquiring effective  control  by one company over assets or management of another company without any combination of companies.

11.          Bank Capital:  This is the paid up capital and reserves,  unimpaired by

losses,  in  other words,  it  is  the share holders funds as published in the balance sheet.

111.               Merger:  A  merger is  said to occur when two  or more companies

combine  into  one  company  or  they  may  merge  with   an  existing company or merge with a new company.

iv.      Consolidation:  A  consolidation  is  a  combination  of two  or  more companies  into  a  new  company.  All  the  companies  get  legally dissolved and a new entity is created.

iv.      Banking sector soundness:  Is  an assessment of the health of the

banking sector indicated that the banks were generally sound.

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