ASSESSMENT OF THE IMPACT AND CHALLENGES OF BASEL II

IMPLEMENTATION ON THE RISK MANAGEMENT PRACTICES

IN NIGERIAN BANKS

BY

SALAMI, SIKIRU ADIO

MATRIC NO: 129022064

A RESEARCH PROJECT SUBMITTED TO THE SCHOOL OF POST

GRADUATE STUDIES DEPARTMENT OF ACTUARIAL SCIENCE AND
INSURANCE, UNIVERSITY OF LAGOS, IN PARTIAL FULFILLMENT
OF THE REQUIREMENTS FOR THE AWARD OF THE MASTERS OF
RISK MANAGEMENT

DECEMBER, 2014

CERTIFICATION

This is to certify that this project entitled:

ASSESSMENT OF THE IMPACT AND CHALLENGES OF BASEL II
IMPLEMENTATION ON THE RISK MANAGEMENT PRACTICES
IN NIGERIAN BANKS
was carried out by
SALAMI, SIKIRU ADIO
with Matriculation No: 129022064
under my supervision.

PROF. J. N. MOJEKWU
Supervisor

DATE

PROF. R. O. AYORINDE
Head of Department

DATE

ii

DEDICATION
All praises and adoration are due to the Almighty Allah whose dominion transcends all
limitations. I dedicate this research project to the Almighty Allah for His grace and
mercy upon my life and family. The project is further dedicated to the memory of my late
sister Halimah Salami. May Allah accept her to the fold of the righteous.

To Allah alone be all thanks and glory!

iii

ACKNOWLEDGMENTS
In conducting this research, I received assistance from a number of people and various
banks. In particular, I want to express my sincere gratitude to my supervisor, Professor
J.N. Mojekwu whose guidance and demand for thoroughness made this research a
successful adventure. I also want to specially thank Mr. Jide Oyewo, Mrs. Juliet Ibili of
H. Pierson, and Mr. George Okonkwo CFA, FRM for their input into this research effort.
Thanks are also due to all my friends and associates in some of the sampled banks
because they saw to the response to my questionnaires.

iv

ABSTRACT
Risk management plays an important role in ensuring the safety and survival of banking
institutions. Basel II Accord is an international regulatory attempt aimed at
strengthening the risk management practices in the internationally active banks. The
Basel II Accord is the framework developed in 1999 by the Central Banks of G10
countries to regulate the risk management process in large internationally active banks
in their domains and in the Organization for Economic Cooperation and Development
(OECD) member countries. The framework was issued principally to address the issue of
the minimum capital requirements that have to be kept aside by banks, to be able to face
any economic stress, and for protecting the international financial system from financial
crises that could lead to the collapse of banks. This research examines the impact and
challenges of Basel II on the risk management practices in Nigerian banks, and the extent
of progress the banks have made in implementing the Accord within the milieu of the
Central Bank of Nigerias guidelines. The sample population comprised all the banking
institutions in Nigeria, including commercial banks, mortgage banks, finance houses and
merchant banks. A random sample of 15 commercial banks was taken from which
sampling units of 60 respondents with risk and control functions were purposively
selected from each of the sampled banks. What informed the choice of the commercial
banks as the sample source was because the Central Bank of Nigeria appeared to have
considered the commercial banks as the centre focus of Basel II implementation for a
start. Four hypotheses were formulated to validate the observations that necessitated the
study. All the hypotheses were tested at 0.05 level of significance using the ANOVA,
regression and t-test models. The following findings were made from the study after

testing the hypotheses formulated for the study: All the Nigerian banks face almost the
same sets of challenges in implementing Basel II requirements; the Basel II Accord
caused significant change in capital measurement and allocation; the Accord has
improved the risk management practices in Nigerian banks, and Nigerian banks have
made some progress in Basel II implementation project. At the end of the research, it was
recommended that the Central Bank of Nigeria increase the level of awareness on Basel
Accord; that the CBN should immediately enforce the Basel II regulations on all
operators in the banking industry rather than focusing on commercial banks; that the
banks should enlighten their Boards and senior management staff on the implications of
Basel Accord on the banks businesses, and finally that the banks should find smarter
ways to raise further capital in response to Basel II requirement.

vi

TABLE OF CONTENT
Content

Page

Title Page

Certification

ii

Dedication

iii

Acknowledgment

iv

Abstract

Table of Content

vii

List of Tables

ix

Chapter One Introduction

1.1 Background to the Study

1.2 Statement of the Problem

1.3 Purpose of the Study

1.4 Research Questions

1.5 Research Hypotheses

1.6 Significance of the Study

Chapter Two Literature Review

2.1 Introduction

2.2 Review of Related Studies

Chapter Three Research method

49
vii

3.1 Introduction

49

3.2 Research Design and Instrument Used

49

3.3 Population of the Study

50

3.4 Sample and Sampling Technique

50

3.5 Method of Data Collection

51

3.6 Method of Data Analysis

52

Chapter Four Presentation and Analysis of Data

53

4.1 Presentation of Data

53

4.2 Data Analysis

63

Chapter Five Summary, Conclusion and Recommendation

68

5.1 Summary of findings

68

5.2 Conclusion

70

5.3 Recommendation

71

References

74

Appendix

79

viii

LIST OF TABLES
Table 4.1 Age of the Respondents Classified by their Qualification

53

Table 4.2: Qualification of the Respondents Classified by their length of Service

53

Table 4.3: Qualification of the Respondents Classified by their Departments

54

Table 4.4: Respondents Classified by License Categories of their Banks

54

Table 4.5: Impact of Basel II Accord on Risk-Based Capital

55

Table 4.6: Impact of Basel II Accord on Risk Organization in Nigerian Banks

57

Table 4.7: Cadre of the Banks Chief Risk Officers

58

Table 4.8: Impact of Basel II Regulation on Capital Allocation and Consumption

58

Table 4.9: Descriptive Statistics on Priority Given to Basel II Regulations

59

Table 4.10: Descriptive Statistics on Risk Reporting

60

Table 4.11: Descriptive Statistics on Spending Areas for Basel II Implementation

61

Table 4.12: Descriptive Statistics on Compliance with BASEL II Accord

62

Table 4.13: Descriptive Statistics on BASEL II Implementation challenges

62

Table 4.14: Impact of Basel II on Capital Adequacy Ratio Computation

64

Table 4.15: Opinion on Challenges of Basel II Implementation Relative to Banking

License Category
64
Table 4.16: ANOVA Results on the Extent of Implementation of BASEL
Requirements

65

Table 4.17: Correlation and Regression Results on the Impact of Basel II on Risk
Management Practices in Banks

66

Table 4.18: ANOVA Results on the Impact of Basel II on Risk Management Practices in
Banks
67

ix

CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
The survival of any organization in the 21st century depends to a large extent on its ability to
anticipate and prepare for the disruptions in the business environment, rather than waiting for
those changes and reacting to them. This reality underscores the very essence of risk
management in the modern age. The primary objective of risk management is not to deter an
organization from taking risk, but to ensure that it takes such risk consciously with appreciable
knowledge, purpose and firm resolve so that such risks can be adequately measured and
mitigated. Risk management also prevents an institution from suffering unacceptable loss that
may cause the institution, especially a bank here, to not only lose its competitive position, but
also impoverish the interest of key stakeholders in the entity. Functions of risk management in
a bank should be dictated by the balancesheet size, structure and quality, complexity of
functional activities, technical manpower, and more importantly, IT infrastructure put in place
in that bank.
Banking is a highly regulated business endeavour, and risk management in banks is an area
that has in recent times enjoyed strong regulatory enforcement supports. To this effect, we
have Basel Capital Accord aimed at instilling risk management practices in banking
institutions across the world. According to Akinyooye (2006), Basel II Accord is a regulatory
framweork developed in 1999 by the Central Banks of G10 countries to regulate the risk
management functions in international banks in their respective domains and, including other
1

interested countries. The author noted that the focus of the new Accord is on the provision of
risk-based regulatory capital for all the exposures of these systemic banks to enable them
withstand any threat to their solvency.
Banking is the financial bedrock of any nations economy and the business of banking is built
around the concepts of financial intermediation, asset transformation, and money creation. The
three banking roles are interwoven. Financial intermediation means that a banking institution
acts as an intermediary between the surplus spending units and the deficit spending units in an
economy. This process involves a bank taking deposits from the economic agents with surplus
and channelling same to those running deficits. Financial intermediation function inheres a
whole lot of risks, and when such risks crystallize, not only would the banking entity bleed, the
risks could also affect the economy where the entity is located, including several other
stakeholders with vested interest in therein.
Another role that a bank plays is asset transformation, and this is a process of creating new risk
assets such as loans and advances from deposit liabilities. By this, a bank runs the risk that a
sudden and massive change in market interest rates may impoverish the profit it makes on its
loan assets since such a bank must charge a lending rate that is higher than the interest it pays
on its deposits (Moghalu, 2012). Money creation is the third banking function, which relates to
the process of generating additional money in the financial system through the continual
lending of an initial deposit in a bank in line with the principle of fractional reserve. This
practice, according to Moghalu (2012), can create macroeconomic risks because the amount of
money created in a fractional reserve banking system depends on the level of reserves banks

are required to maintain from deposits. It suffices to therefore to note that risk taking is an
integral part of banking business.
It is important that the concept of risk be defined at this early stage. The word risk derives
from an Italian word Risicare which means To Dare. It is an expression of danger of an
adverse deviation from any expectation, which may be positive or negative outcome of an
event. Risk has been variously defined by several authorities. According to Wikipedia, risk is
the possibility of losing something of value, relative to the chance of gaining things of value.
The Websters comprehensive dictionary perhaps gives a more precise definition of risk as a
chance of encountering harm or loss, hazard, danger or to expose to a probable event of
loss. Banks for International Settlement (BIS) appears to give a more practical and robust
view of risk as the threat that an event or action will adversely impact a banks ability to
achieve its objectives and give effect to its strategies.
Risk Management on the other hand is a planned method of handling the potential loss or
damage arising from sudden change in expectations and this can be regarded as an ongoing
process of appraising risk using various methods and tools which continuously identify what
could go wrong. Risk management can also be used to ascertain which risks should be given
priority in the scale of events and the strategies required to deal with those risks. In other
words, risk management involves identifying, assessing, and rating risks through a proper
deployment of resources in a way that helps monitor, control and reduce the probable
occurrence of downside events, and optimise business opportunities.

The consideration of the concepts of Risk and Risk management above now lays bare the role
that Basel II Accord could play in the Nigerian Banking Industry. Basel regulations are
essentially an attempt to give genuine effect to risk management practices in banking
institutions. The extent, to which this lofty purpose has been achieved in the Nigerian banking
sector, is a subject of interest to this research study.
1.2 Statement of the Problem
Basel norms, at least a watered down version of them, have been in existence in the Nigerian
banking environment since the early days of Basel I, and the CBN for instance, through its
circular BSD/11/2003 of August 4, 2003 (effective January 2004) re-calibrated the capital
adequacy measurement of the Basel 1 Accord in an effort to make it fit into the Nigerian
business environment. Basel II was however introduced as an attempt to reduce the systemic
effect of banking failures in the nations economy as was witnessed recently, and such failures
are suspected to be mostly due to regulatory laxity on one hand and poor risk management
practices in banking institutions on the other. The implementation of Basel II in Nigeria is
aimed at broadening and deepening risk management practices in the Nigerian banks, which
seem to be lacking in depth for a long period of time in the industry. It is meanwhile believed
that the regulatory attempt at enforcing Basel II implementation in Nigeria may not be an easy
task.
To the best of our knowledge, no adequate study has thus far been carried out to identify the
factors suspected to be responsible for the implementation challenges and how Basel II norms
have affected the risk management practices in Nigerian banks.

1.3 Purpose of the Study

The general objective of the study is to assess the extent to which Nigerian Banks have
implemented Basel Capital Accord as part of their risk management processes and practices.
More specifically, the study is an attempt to:
i.

identify major areas of risks that Nigerian banks are exposed to;

ii.

identify major aspects of Basel II Accord;

iii.

assess the impacts of Basel II implementation on the risk management processes in

Nigerian banks;
iv.

identify the challenges facing the implementation of Basel II norms by Nigerian banks;

v.

assess the impact of Basel II Accord on capital measurement, management and

allocation in Nigerian banks.

1.4 Research Questions
In order to address the areas of concerns on Basel II implementation by Nigerian banks, the
study seeks to answer the following questions:
i.

What are the categories of deposit money banks in Nigeria?

ii.

What are the areas of risk confronting Nigerian banks?

iii.

What are the areas of risk management practices in Nigerian banking industry?

iv.

What are the key areas of Basel II Accord?

v.

How does Basel II implementation influence risk management practices in Nigerian

banks?

vi.

What are the key aspects of Basel II implementation?

5

vii.

What are the challenges faced by Nigerian banks in implementing Basel Capital
Accord?

viii.

What is the impact of Basel II implementation on Banks capital measurement?

ix.

How are Nigerian banks responding to the possible impact of Basel II

implementation?

x.

What are the roles of external ratings agencies in Basel II Accord implementation?

1.5 Research Hypotheses

The need to validate the observations noted on the challenges and impact of Basel II
implementation in Nigeria is imperative. In view of this, the study seeks to test the following
hypotheses:
i.

Pre-Basel II Capital adequacy ratio is not significantly different from Basel II

Capital ratio.

ii.

Implementing Basel II Accord does not pose challenge to the Nigerian banks.

iii.

There is no significant difference in the level of progress made by Nigerian banks in

Basel II implementation.

iv.

Basel II Accord will not improve risk management practices in Nigerian banks.

1.6 Significance of the Study

The study evaluates the extent to which Basel II affects the risk management practices in
Nigerian banks, and level of milestones that the banks have achieved in implementing Basel II
norms. Theories typically suggest that banking institutions risk portfolios and capital are often
6

interrelated. According to the Reserve Bank of India (2008), a sound risk management is the
basis for an effective assessment of the adequacy a banks capital. This research work is
motivated by the desire to better appreciate the impact of Basel Capital Accord on risk
management practices in Nigerian banks. The study would be of huge relevance as it
addressed the key challenges faced by Nigerian banks in Basel implementation, and how those
challenges were dealt with.
The findings from this research work, we hope, would provide basis for policy measures
aimed at softening the Basel II implementation for industry operators, and ultimately achieving
robust risk management practices that could ensure the safety of the Nigerian banking system.
More importantly, the study became more imperative in view of the dearth amount of
professional discourse and academic writings on Basel Capital Accord in Nigeria.

CHAPTER TWO
LITERATURE REVIEW
2.1 Introduction
In this chapter, effort was made to review various literatures, regulatory circulars and
guidelines on risk management processes and transition to Basel II; the benefits, impacts and
the challenges of Basel II implementation for the Nigerian Banks risk management practices.
The Literature Review was considered in three key categories, viz: First, the study surveys
general issues in risk management processes and practices, and second, it chronicles the
theoretical background of Basel Accord, with particular emphasis on Pillar 1 of Basel II.
Finally, the study considered the peculiarities of Basel II implementation in the Nigerian
banking sector; progress recorded so far; impacts and challenges of implementation amongst
other issues.

2.2 Review of Related Studies

Risk and uncertainties are parts and parcel of business dynamics and the outcomes of most
business decisions are never certain (ACE and KPMG 2010). Moghalu (2012) in his view
noted that the local consequences of events on a global scale, such as terrorism, pandemics
and financial market volatilities, are mostly unpredictable, and such events may also include
valuable opportunities such as sudden changes in social trends and consumer tastes.
According to Hopkin (2010), the concept of risk derives from this unpredictability, and so
there is need for a process of identifying, measuring and managing risks. According to

Moghalu (2012), such process is required to ensure that an organization achieve its strategic
objectives and attain corporate sustainability.
BCSB (2010a) noted that the fluidity of the banking environment in the modern age, as
evidenced by the recent world financial crisis, has continued to put the risk management
processes in banking institutions to test. ACE and KPMG (2010) stated that more than ever
before, perhaps as a fall out of the crisis, the financial regulators across the globe are
tightening the noose of banking regulations. According to Reserve Bank of India (2008), the
lesson of the recent financial crises was that no country wished to bail out financial
recklessness of the so-called too-big-to-fail banks with tax-payers money any more. RBI
(2008) noted that the new rule is straight-forward: To stay in business today, banking
institutions are now required to be adequately capitalized to bail out their possible future
failure. BCBS (2010a) stated that with the emerging banking regulations, banks are required to
strengthen their risk management processes to prevent banking failure, or where such failure
does eventually happen, mitigate its impact on the financial system.
According to Rodrguez (2002) and RBI (2008), risk is the potential that expected and
unexpected events may have an adverse impact on a banks capital or its earnings, and the
expected loss is usually passed to the borrower through adequate loan product pricing, and
through reserves created out of the earnings. Such loss, Moghalu (2012) noted, is mostly due
to default risk and counterparty risk. The authors whereas averred that the unexpected loss
arising from the whole loan portfolios would be entirely borne by the bank itself. According to
BCSB (2006) therefore, the expected losses are covered by reserves and provisions, while the
unexpected losses require adequate capital base for coverage.
9

Dionne (2013) noted that a pure risk is a combination of the probability or frequency of an
event and its consequences, which is usually negative. The author also averred that uncertainty
on the other hand is less precise because the probability of an uncertain event is often
unknown, as is its consequence.
According to Crockford (1982), Harrington and Niehaus (2003) and Williams and Heins
(1995), the study of risk management dated back to 1955-1964, after the Word War II. Dionne
(2013) stated that the issue of risk management in the financial services sector was
revolutionized in the 1970s, when financial risk management became an issue of concern for
many banks, insurance companies, and other non-financial enterprises exposed to various
market rates volatilities such as risks related to interest rates, stock market returns, exchange
rates, and the prices of raw materials or commodities.
Risk management, according to Hopkin (2010), provides a framework for organizations to
deal with and to react to uncertainty and the modern practice of risk management is a
systematic and comprehensive approach, drawing on transferable tools and techniques. These
basic principles according to Moghalu (2012), are sector-independent and should improve
business resilience, increase predictability and contribute to improved returns. Doerig (2001)
noted that there is growing pressure to avoid things going wrong while continuing to improve
corporate performance in the new environment, and thus there is need for an uptight risk
management process. Harrington and Niehaus (2003) and Dionne (2013) in their view
however stated that an integrated risk management approach must evaluate, control, and
monitor all risks and their dependences to which the company is exposed.
10

The key functions of banking business, according to Moghalu (2012), are financial
intermediation, asset transformation and money creation, and these underscore the relevance of
banking institutions to the financial stability of any economy. Omosebi (2012) noted that,
given the nature of their business, banks are generally exposed to various risks in pursuit of
their objectives. BCBS (2006) identified the basic ones among these risk categories as credit
risk, market risk, and operational risks. Failure to properly handle these risks could expose
banks not losses that may threaten their survival and sustainability as business entities thereby
endangering the stability of the financial system (CBN, 2007; Suares-Rojaz, 2001; RBI, 2008).
CBN (2007) noted that in view of the critical role of risk management in enforcing
sustainability and resilience in banking practice and regulation, the need to issue the guidelines
for developing framework for the management of risk elements in banks, became imperative.
In the said guidelines, the CBN identified key risk types facing a bank as comprising credit
risk, market risk, operational risk, reputational risk, strategic risk, and compliance risk.
Based on Basel II Accord, CBN (2012) stated that credit risk arises when there is possibility
that an obligor (borrower or counterparty) in respect of a particular asset will default in full or
in part on the obligation to a bank in relation to the asset. Patil (2010) in other words, noted
that credit risk is the risk of loss arising from counter party or customers inability or
unwillingness to meet obligations in relation to lending, trading, hedging, settlement and other
financial transactions.
BCSB (2006) observed that market risk is a risk of loss caused by changes in the key market
variables such as foreign exchange rate, interest rate, commodity price and equity price.
11

According to CBN (2012), market risk can further be categorized into interest rate risk, foreign
exchange risk, commodity price risk and equity price risk. BCSB (2006) further noted that
market risk includes the degree of volatility of market prices of bonds, securities, equities,
commodities, foreign exchange rate which will change daily profit and loss over time.
Basel Committee (2006) contended that operational risk is an important phenomenon that
impacts heavily on banking business, and this is risk of loss resulting from inadequate or failed
internal process, people and systems or from external events. According to BCBS (2006),
operational risk includes the risk of loss arising from fraud, system failures, trading error and
many other internal organizational risks as well as risk due to external events such as fire,
flood, wars, and pandemic. The losses arising from operational risk can be direct as well as
indirect, and this depend whether such loss results directly from an incident or it arises from
impact of an incident, (BCBS, 2003). Doerig (2001) in his view however noted that
operational risks are primarily institutional, bank-specific, internal, context dependent,
incredibly multifaceted, often judgemental, interdependent, and often not clearly discernible.
In specifics, Abkowitz (2008) identified failure to follow procedures, deferred maintenance,
design flaws, construction flaws, schedule constraints, inadequate training, and poor planning
as some of the events of operational risk failure. Managing operational risk is therefore very
imperative, and this is not so much about capital and models but about providing diligent and
adequate supports for the survival and stability of a firm (Doerig, 2001).
Ekpo (2013) observed that strategic risk is another notable risk that banks have to contend with
and such risk is the possibility of incurring loss on account of poor strategic business
12

decisions. The author noted that this risk is usually associated with poor implementation of
business plans and strategies. Omosebi (2012) on her part identified legal risk as another
prominent risk that bank face, and such risk relates to situations where an institution may not
be able to enforce its contract terms against counterparty. In this context, legal risk is the
possible risk of loss due to the unenforceable contract which forms the basis of banking
transactions (Ekpo, 2013).
According to Greg (2013), banks in the 21st century are hugely exposed to reputational risk
which according to Ekpo (2013),

relates to potential loss due to damage or erosion of

goodwill as a result of failed risk management; weak corporate governance practices;

environmental, social and ethical performance; poor customer relationship management
practices; non-compliance with regulatory and statutory requirements. And lastly there is
compliance risk which Odutola (2013) noted to be the risk of loss in earnings or capital arising
from non-adherence to the prescribed practices, laws, regulations, or ethical standards, and
such loss could come in form of huge fines and penalties, or loss of regulatory privileges.
For a bank to maintain sound risk management practices, Odutola (2013) had a belief that such
bank must adhere to effective balancing of risk and reward by aligning business strategy with
risk appetite, pricing for risk appropriately, diversifying risk and mitigating risk through
preventive and detective controls. According to Ernst & Young (2012), banks business
segments and process owners ought to take responsibility for active management of their risks,
with direction and oversight provided by the relevant Committee of the Board through the
Management and other functional departments and also carry out rigorous assessment of risks
in relationships, products, transactions and other business activities.
13

Odutola (2013) further noted that such banks must avoid activities that are not consistent with
its values, code of conduct or policies, as one of the ways of managing reputational risk.
Banks, The author averred that banks need to establish clear market segmentation into retail
banking, corporate banking, mortgage banking, investment banking etc. in order to mitigate
risks, by knowing their clients and ensuring that they provide suitable services.
CBN (2010) and Hopkin (2010) identified certain key elements of an effective risk
management process that a bank ought to implement and such elements include a risk
management structure which covers the oversight role of the Board and senior management;
processes, procedures and systems for risk identification, measurement, monitoring and
control, and risk management framework review mechanism.
According to RBI (2008), capital and risk management generally interest regulators and some
other stakeholders such as employees, depositors, bank shareholders, and other competing
lenders. This is more so as Banks assets, funded by capital and deposits follow a geometric
Brownian motion characterized by a volatility level (Elizalde 2007).
According to Ashraf and Arner (2012), the Basel Committee on Banking Supervision (BCBS)
was established by the central-bank Governors of the Group of Ten countries in 1974 to serve
as global forum for regular cooperation on banking supervisory matters. The objective of the
committee is to enhance understanding of key regulatory challenges and improve the quality of
banking supervision across the globe (BIS, 2014). Dierick et al, (2005) stated that the
Committee in 1988 introduced a capital measurement process commonly referred to as the

14

Basel Capital Accord and this system provided for the implementation of a credit risk
measurement framework with a minimum capital standard of 8% by 1992.
Since 1988, this framework has been progressively introduced not only in member countries
but also in almost all other countries that have internationally active banks (Patil, 2010).
According to Aboyarin (2012), Basel I framework was initially introduced into G-10 member
countries, currently comprising Belgium, Spain, Canada, France, Germany, Japan,
Luxembourg, Netherlands, Sweden, Switzerland, Italy, United Kingdom and the United States
of America. The author further noted that most other countries, over 100 of them, have also
adopted, at least in name, some of the principles prescribed under Basel I.
According to Elizalde (2007), Basel I Accord seemed to provide a level playing field by
stipulating the amount of capital that internationally active banks need to maintain in order
ensure that the international banking system was sound and safe. Essentially, the point of
emphasis for Basel I was credit risk as it only made periphery mention of market risk; while
operational risk enjoyed no attention at all (Patil, 2010). Although Basel I was praised for
achieving its initial objectives, it has been seriously criticized for the low risk sensitiveness of
its capital requirements which may provoke further risk taking and regulatory capital arbitrage
practices by banks (BCBS, 1999, and Jones, 2000).
In Nigerian case, Aboyarin (2012) stated that the Central Bank of Nigeria in 1990 issued a
circular respect of capital adequacy computation based on the Basel I framework. According
to the author, the CBN directed the Nigerian banks to maintain a minimum of 7.25% of risk-

15

weighted assets as capital and to maintain a minimum of 8% Capital Adequacy Ratio with
effect from January, 1992.
According to Malloy (2004), the Basel Committee in 1999 issued a proposal to revise Capital
Adequacy Framework which consisted of three pillars: minimum capital requirements, which
seeks to refine the capital rules set provided for in Basel I; supervisory review of an banks
risk assessment process and capital adequacy; and use of disclosures to enforce market
discipline. Patil (2010) noted that on the 26th of June, 2004, the committee issued the final
form of the Basel II Accord after six years of continuous efforts with different stakeholders of
the banking system and central banks all over the world, to update the proposal of the accord.
According to Dierick et al, (2005), there were more than one draft of Basel II issued in 1999,
2001 and 2004 until the final form of the accord was issued under the title, International
Convergence of Capital Measurement and Capital Standards: A revised framework.
The Basel II Accord, according to RBI (2008), was issued principally to target the issue of the
minimum capital requirements that have to be kept aside for banks to be able to face any
economic stress, and for protecting the international financial system from financial crises that
could lead to the collapse of banks. The accord also seeks to strengthen the risk management
practices in banking institutions and provide mechanisms for capital allocation and
management (BCBS, 2006).
Basel Committee(2001) identified some objectives of Basel II as including, promoting the
safety and soundness of the financial system; aligning economic and regulatory capital closely
as much as possible; enhancing competitive equality; enhancing transparency issues
16

concerning providing customers with needed information about risks that their banks face;
creating capital adequacy assessments; focusing on internationally active banks while
following the principles to be flexible enough to have applications to a number of banking
operations, and finally encouraging continuous improvement in a bank's internal risk
assessment capabilities.
According to BCBS (2006), the Basel II framework is based on three mutually reinforcing
pillars put together to allow banks and monetary authorities to evaluate properly the various
risks that banks face and align regulatory capital more closely with underlying risk portfolios.
BCBS (2006) and CBN (2012) identified the three key pillars as Pillar I: Minimum Capital
Requirements; Pillar II: Supervisory Review Process, and Pillar III: Market Discipline.
RBI (2008) noted that the Basel II framework as detailed in BCBS (2006) seeks to strengthen
the link between capital requirements and organisational complexities of banks, exploiting
synergies in the management of those banks and in supervisory assessments and actions.
Banks governing bodies, according to Odutola (2013) play a key role in risk management and
control. Nigerian banks are required by CBN (2010), inter alia, to develop risk management
strategies and policies; verify their continuing effectiveness and efficiency; outline the duties
and roles of the various departmental functions and units and, more generally, ensure that all
the risks to which they could be exposed to, are adequately covered.
According to BCBS (2006), the first pillar of Basel II sets out minimum capital requirement
for banks and the framework maintains minimum capital requirement of 8% of risk assets, and
it seeks to ensure that banks hold an amount of capital that is consistent with level of risk they
17

take. In computing capital adequacy ratio, BCBS (2006) noted that due regard has to be given
to credit risk, market risk and operational risk. In other words, economic capital charges ought
to be computed for these three classes of risk as part of the overall risk-weighted assets (RBI,
2008).
Supervisory review process which is the fulcrum of second pillar, according to Acharya
(2003), has been introduced to ensure that banks have adequate capital to support all their risk
exposures and also develop and use better risk management methodologies and techniques in
measuring, managing and monitoring their risk exposures. In other words, the supervisory
review process is key to ensuring that all risks are identified and appropriate regulatory actions
are taken in a timely manner as well as ensuring that banks and banking groups have adequate
internal capital management plans (CBN 2012; RBI 2008; BCBS 2006).
The second pillar, according to BCBS (2006) and CBN (2013), has four key principles viz:
banks should have a process for assessing their overall capital adequacy in relation to their risk
profile and a strategy for monitoring their capital levels; monetary authorities should review
and evaluate banks internal capital adequacy assessments and strategies, as well as their
ability to monitor and ensure their compliance with regulatory capital ratios; monetary
authorities should expect banks to operate above the minimum regulatory capital adequacy
ratios and should have the ability to require banks to hold capital in excess of the minimum,
and finally supervisors should make effort to intervene at an early stage to prevent a banks
capital from going below minimum level and should seek immediate remedial action if
shortfall is about to happen.

18

The third pillar of the Basel II captures the disclosure requirements concerning capital
adequacy, risk exposure and the features and nature of the risk management and control
processes and systems in banking institutions so as to enable key stakeholders make informed
decisions (RBI 2008, CBN 2013). According to Dierick et al. (2005), market discipline
compels banks to carry out their business in a safer, sounder and more effective manner, and it
is designed to be effected through a series of disclosure requirements on capital, risk exposure,
risk limits and capacity, so that important stakeholders could assess a banks capital adequacy,
risk appetite, risk capacity and exposures. The CBN (2013) required that these risk disclosures
be made at least semi-annually and more frequently if appropriate. According to BCBS (2004),
qualitative disclosures such as risk management objectives and policies, definitions etc. have
to be published annually.
According to Elizalde (2007), there are a lot of gaps in Basel I which necessitated the need for
Basel II, and Dierick et al. (2005) identified some areas of comparison between the two Basel
regulations. Basel I rules offer a simplified and rigid quantification of credit risk, while Basel
II significantly refines the frameworks risk sensitivity by requiring higher levels of capital for
high-risk borrowers (RBI, 2008). By relating capital more closely to a banks own risk
exposure, Basel II better narrows the gap between regulatory capital and economic capital than
Basel I (Dierick et al, 2005). According to Elizalde (2007), one important drawback of the
Basel I stems from its unintended incentives for capital arbitrage through techniques such as
securitisation, a challenge that Basel II has taken care.
In addition, Rojas-Suarez (2001) contended that Basel I lacks rules for proper market
disclosure and therefore does not support market discipline, and that this is in comparison to
19

Basel II which according to Dierick et al, (2005), has a framework dedicated to Market
Discipline. The author further noted that Basel I regulations offer no guidance for the
supervisory review of banks risk management practices, compared to Basel II which has a
dedicated framework on supervisory review. RBI (2008) however noted that similar to what
applies under Basel I, off-balance sheet exposures are for capital purposes transformed into
assets through the application of credit conversion factors. The main changes compared to
Basel I relate to the use of external credit ratings as the basis for determining the risk weights
and the greater differentiation in the possible risk weights (Frank et al, 2005).
According to Dierick et al. (2005) and Elizalde (2007)there is now a considerable
differentiation in the risk weights applicable under Basel II and the weight for investmentgrade firms has declined considerably (e.g. to 20 % for AAA), whereas in the non-investment
grade segment, a risk weight of 150% applies to firms rated below BB-. Under Basel II,
unrated firms now obtain the same risk weight as that formerly obtained by all corporates
under Basel I and finally, for claims on banks, the former distinction between institutions from
OECD (20% risk weight) and non-OECD countries (100%) is no longer applicable under
Basel II (Dierick et al, 2005).
BCBS (2004) reckoned that banking regulators might want to consider certain factors when
determining the population of banks to which Basel II should apply and such factors include,
size of the bank (e.g., share of balancesheet size in the banking system); nature and complexity
of its operations; involvement in significant activities or business lines, such as settlement and
clearing activities, or possession of a sizeable retail base); international presence (e.g.,
proportion of assets held in/income from overseas offices); interaction with international
20

markets; bank's risk profile and risk management capabilities, and other supervisory
considerations, such as resources which will be available for initial validation and ongoing
monitoring, and the trade-off between the additional complexity of implementing and
validating these approaches vis--vis the increased sensitivity of the resulting capital
requirements.
Basel II Accord provided by BCBS (2006) provides spectrum of approaches for the
measurement of credit, market and operational risks to determine the capital required by a
bank. The spread and nature of the ownership structure of any bank plays key role in
determining the ease with which the bank could raise capital as may be required by the
regulator (Patil, 2010). While getting support from a large body of shareholders is a difficult
proposition when the banks performance is poor, a smaller shareholder base constrains the
ability of the bank to garner funds (RBI, 2008).
Tier I capital is available to cover possible unexpected losses, as it is not owed to anyone and
more importantly it has no maturity or repayment requirement, and therefore, it is expected to
remain permanent as core capital of the bank (RBI, 2008). While Basel II currently requires
banks to have a capital adequacy ratio of 8% with Tier I ratio not less than 4%, the CBN
(2013) has mandated 15% capital adequacy ratio for internationally active Nigerian banks, and
10% for those with National license. Ogere et al (2013) stated that the maintenance of capital
adequacy ratio is like aiming at a moving target as the composition of risk-weighted assets gets
changed every time on account of fluctuations in the risk profile and exposure of a bank. Tier I
capital provides permanent and readily available support to the bank to meet the unexpected
losses (RBI, 2008).
21

According to Aboyarin (2012), the CBN in the recent past, had had to rescue some Nigerian
banks with over N600 billions in bail out with taxpayers money and in doing so, Sharad et al
(2014) noted, the government was not acting as a prudent investor as return on such capital
was never a consideration. Beyond this, the CBN at a later date established a bad loan bank
called, Asset Management Company of Nigeria (AMCON) to acquire some of the rescued
banks on the verge of collapse. All this regulatory engineering came at a cost to the
government, and hence, the need for banks to hold enough capital for their own rescue in the
event of unexpected losses (Aboyarin 2012; Moghalu 2012).
According to Patil (2010), capital adequacy provides an economic measure of long-term
survival and soundness of banks, and the aggregate risk exposure of banks is usually estimated
using Risk-Adjusted Return on Capital (RAROC) and Earnings-at-Risk (EaR) techniques. The
author noted that RAROC method is used often by internationally active banks and the
RAROC process is used to estimate the cost of Economic Capital & the expected losses that
might arise in the worst-case scenario and then generate the capital cushion to be provided for
any potential loss. Elizalde (2007) averred that RAROC is the first step towards examining the
institutions entire balance sheet on a mark-to-market basis, at least, to understand the riskreturn trade-off that the bank has made.
As banks carry on the business on a wide area network basis, it is critical that they are able to
continuously monitor the exposures across spectrum of their products and processes, and
aggregate the risks so that an integrated view can be taken (Abkowitz, 2008). The Economic
Capital is the amount of the capital (besides the Regulatory Capital) that the firm has to put at
22

risk so as to cover the potential loss under the extreme market conditions (Siddiqi, 2013). This
is the difference in mark-to-market value of assets over liabilities that the bank should aim at
or target. As against this, the regulatory capital is the actual Capital Funds held by the bank
against the Risk Weighted Assets (BCBS, 2010b). After measuring the economic capital for
the bank as a whole, banks actual capital has to be allocated to individual business units on
the basis of various types of risks (BCBS, 2010b).
NAIC (2014) did a comprehensive work on risk-based capital which it defines as a method of
assessing the minimum capital that is appropriate for a bank to support its overall business
operations taking account of its size and risk profile. According to Miller (2014), the adoption
of risk-based capital as a regulatory measure for financial institutions, is a consequence of
Basel II and Solvency II regulations. Miller (2014) clearly noted that regulatory capital rules
over the years have progressed from prescriptive (rule-based) to proscriptive (principlesbased) methodologies, such that banks are now required to hold capital that is consistent with
their risk profile.
Aboyarin (2013) and Miller (2014) however noted implementing risk-based capital does not
relieve monetary authorities of their supervisory oversight role. CBN (2013e) stated the
Central the banking regulator in Nigeria presently has its supervisory mechanism by way of
on-site examination and off-site monitoring on the basis of the audited balance sheet of a bank.
In order to facilitate the supervisory mechanism, the CBN (2013) has decided to put in place, a
risk-based supervision process. Under risk based supervision, monetary authorities are
expected to direct their efforts towards ensuring that banking institutions use the risk-based
capital measurement process to identify, measure and control risk exposure (BCBS, 2010). In
23

view of this change in capital measurement, the CBN is expected to focus supervisory
attention on banks based on their individual risk profile (Odutola, 2013).
According to Akinyooye (2006) and Patil (2010), the transaction based audit and supervision
is being replace with risk focused audit, and risk based supervision approach is an attempt to
overcome the deficiencies in the traditional transaction-validation and value based supervisory
system. Risk-based supervision is forward looking and proactive, as it enables the supervisors
to distinguish between banks, and to focus greater attention on those within high risk category.
According to the authors, the implementation of risk based supervision implies that greater
amount of reliance is placed on the internal auditors role for mitigating risks. By focusing on
a sound risk management process, the internal auditor would offer remedial actions for
trouble-prone areas and also anticipate problems to play an appropriate role in protecting the
bank from risk hazards (Odutola, 2013).
Before the eventual release of Basel II Accord, Rojaz-Suarez (2001) had noted that the crux of
the debates among the banks and regulators was on what constitute regulatory capital, equity
only or equity plus subordinated debt. According to the author, there was also argument on
who should set the capital standards, the regulators or the markets, and whether external rating
or internal rating be used for credit assessment.
CBNs Guidance Notes on Regulatory Capital (2013a) establishes the procedures for
determining regulatory capital, and this is computed as the sum of Tier 1 Capital and 33.33%
of Tier 2 Capital. According to the guideline, Tier 1 Capital (Core Capital) comprises of
paidup share capital, perpetual non-cumulative preference shares, share premiums, retained
24

profit, general reserves, SMEEIS reserves, regulatory risk reserves and statutory reserves. The
author further stated that deductions have to be made for goodwill and increase in equity
capital resulting from a securitization; investment in own shares; losses carried forward and
losses for the current financial year; intangible assets.
Meanwhile, CBN (2013a) noted that Tier 2 Capital comprises revaluation reserves, general
provisions, hybrid (debt-equity) capital instruments, subordinated debt etc. and that certain
items are to be deducted 50% from Tier 1 and 50% from Tier 2 capital. Such items include
investments in unconsolidated banking and financial subsidiaries; investments in the capital of
other banks and financial institutions and significant minority investments in other financial
entities (CBN, 2013a).
CBN (August, 2014) has excluded the Regulatory Risk Reserve (RRR) from regulatory capital
of Nigerian banks for the purposes of capital adequacy measurement. The regulator also stated
that Collective Impairment on loans and receivables and other financial assets would no longer
form part of Tier 2 capital, and that the Other Comprehensive Income (OCI) reserves would be
recognized as part of Tier 2 capital subject to the limits set in paragraph 3.2 of the Guidance
Notes on the Calculation of Regulatory Capital earlier referred to.
In computing capital requirement for credit risk under the Basel II Accord, BCBS (2006)
makes provision for three different approaches such as Standardized Approach, Foundation
Internal Rating Based Approach and Advanced Internal Rating Based Approach.
With Standardized Approach, BCBS (2006) as well as the CBN (2013b) provided a simple
methodology for risk assessment and calculating capital requirements for credit risk.
25

Specifically, CBN (December, 2013) directed Nigerian banks and discount houses to use this
approach for credit risk. CBN (2013b) provided that under this approach, at least 10 classes of
assets can be identified viz: Exposures to Sovereigns; Exposures to Public Sector Entities;
Exposures to States & LGA; Exposures to foreign Development Banks; Exposures to Banks;
Corporate Exposures; Retail Exposures; Residential Mortgages; Commercial Mortgages;
Other Assets. According to CBN (December, 2013), Nigerian banks are to use Standardized
Approach to compute capital requirement for credit risk for the next 2 years.
CBN (2013b) discussed the standardized approach under a number of areas, such as
assignment of risk weights, which means all the exposures of a bank are first classified into
various asset or customer types as defined in BCBS (2006). Thereafter, for the purpose of
calculating risk weighted assets, standard risk weights are assigned to all assets either on the
basis of customer type or on basis of the asset quality as determined by rating of the asset.
(CBN, 2013b).
Another important area is external credit assessments, which according to CBN (2013b) means
that the risk rating has to be done by External Credit Assessment Institutions. RBI (2008)
noted that better rating means better quality of assets and lesser risk weights and thus lower
capital requirement. CBN (2013b) provided risk weights for other categories of exposures that
are not subject to external ratings. According to the author, banks that intend to use credit
assessments from ECAIs are to furnish the CBN with a list of ECAIs of their choice; banks are
not allowed to use credit assessments issued by connected ECAIs; credit assessments are to be
used consistently and banks that decide to use credit quality assessments from an ECAI for a
certain class of exposures must use them for all the exposures belonging to that class; banks
26

are to use only credit quality assessments of ECAIs that consider total exposure (both principal
and interest) in their assessment; and finally external ratings for an entity within a group
cannot be used to risk weight other companies within the same group.
According to Dierick (2005) and CBN (2013b), Basel II rules recognize collaterals and
guarantees as two key securities that banking institutions use to hedge against credit risk
associated with loans and advances, and these are often termed Credit Risk Mitigants. CBN
(2013b) provided certain weights for all varying classes of assets on a banks balancesheet for
the purpose of computing risk-weighted assets and these weights depend on the risk potentials
of the issuers of underlying instruments. According to Patil (2010), Elizalde (2007) and
Dierick (2005), when computing risk-weighted assets, onbalance sheet exposures ought to be
multiplied by the appropriate risk weight, while off-balance sheet exposures are multiplied by
using the appropriate credit conversion factor (CCF) before applying the respective risk
weights. CBN (2013b) however stated that all exposures that are subject to the standardized
approach should be riskweighted net of individual and collective impairments.
BCBS (2006) provided for Advanced Approaches for calculating capital requirement for credit
risk and these approaches rely heavily on a banks internal assessment of its borrowers and
exposures. These advanced approaches according to Dierick (2005) are based on the internal
ratings of the bank and are usually called Internal Rating Based (IRB) approaches.
However, the use of the IRB approaches, BCBS (2006) noted, is subject to an explicit
supervisory approval, which depends on meeting certain minimum requirements from the
onset and on an ongoing basis. These requirements are aimed at the IRB system providing an
27

adequate assessment of the banks exposures, a meaningful differentiation of risk and a

reasonably good estimate of risk (Dierick et al, 2005).
Dierick et al. (2005) noted that under the IRB approaches, the computation of required
minimum capital depends on the probability distribution of losses arising from default risk in a
portfolio of financial instruments or loans, and that the time horizon of the risk assessment is
most often pegged at one year. The author further averred that the IRB model assumes a
99.9% confidence level suggests that once in a thousand years, the actual loss would exceed
the models result estimate.
According to Tetteh (2012), the calculation of capital requirements for a loans default risk
under these advanced approaches requires four major input parameters to the supervisory risk
weight variables which are loss given default (LGD); probability of default (PD); exposure at
default (EAD) and effective maturity of the loan (M).
Baixauli and Alvarez (2009) define Probability of Default (PD) as the estimate of the
likelihood of the borrower defaulting on its obligations within a given horizon. PD is
computed for each of the loan customers (e.g for wholesale banking) or for a portfolio of
clients with similar attributes (e.g. for retail banking).
The LGD however is defined as the loss incurred in the event of default and it is equal to one
minus the recovery rate at default (Baixauli and Alvarez, 2009). Tetteh (2012) noted that
Moody's LGD assessments are opinions about expected loss given default on fixed income
obligations expressed as a percent of principal and accrued interest at the point of resolving the
default. The author however stated that LGD assessments are assigned to individual loans. The
28

bank-wide LGD rate is a weighted average of the expected LGD rates on its individual
liabilities, where the weights equal each obligation's expected share of the total liabilities at
default (Cantor et al., 2006).
Meanwhile according to Baixauli and Alvarez (2009), the total loan value that a bank is
exposed to at the time of default or the outstanding balance of the borrowers debt is what is
termed as Exposure at Default (EAD). Every loan asset that a bank has is given an EAD value
and it is identified within the bank's internal credit system (Tetteh, 2012). Using the internal
ratings board (IRB) approaches, banking institutions will often use their own risk management
default models to calculate their respective EAD systems (Dierick et al, 2005).
When using IRB Approaches, the banks can consider two possible options such as Foundation
Internal Rating Based (FIRB) Approach and Advanced Internal Rating Based (AIRB)
Approach, and the two approaches have some key areas of difference (Dierick et al, 2005).
Both the author and Patil (2010) identified some comparisons between the two approaches
such as the fact that probability of default under the two approaches is provided based on
banks own estimates. The authors further stated that under the Foundation IRB, LGD
constitute the supervisory values set by the Basel Committee, while under Advanced IRB,
LGD is based on banks own estimates. In addition, the authors noted that under FIRBA,
exposure at default and effective maturity are based on supervisory values set by the Basel
Committee, while under AIRBA, they are based on banks own estimates.
CBN (2013c) directed that, under the Pillar 1 of Basel II, the banks and banking groups in
Nigeria were to comply on an ongoing basis with capital requirements for risks generated by
29

operations in markets for financial instruments, foreign exchange and commodities. Capital
requirements, according to BCBS (2006) and CBN (2012) may be calculated using a
standardised measurement method or an internal models approach subject to compliance with
organisational and quantitative requirements and prior authorisation by the supervisory
authority which in Nigerian case is the Central Bank of Nigeria.
The Standardized Approach, according to Dierick et al, (2005) allows banks to calculate their
total capital requirement using a building-block approach, under which the total requirement is
obtained by summing the individual capital requirements for equity position risk, interest rate
risk, foreign exchange risk and commodities risk. CBN (December, 2013) directed banks and
discount houses in Nigeria to use the Standard Approach for capital charges on market risk for
the next two years. The author provided full guidance in CBN (2013c) on how the standard
approach is to be adopted in computing capital requirement for market risk.
For the purpose of calculating capital requirements for market risks under this approach, CBN
(2013c) required that market positions be measured at fair value at the close of each business
day. CBN (2013c) noted that in the case of off-balancesheet transactions without a reference
instrument (e.g. forward rate contracts or interest rate swaps), the notional principal amount
would be used, except where one of the present values or sensitivity methods set out under the
treatment of position risk in the supervisory trading book applies. Also, the author pointed out
that for off-balancesheet transactions involving options and warrants, one of the methods set
out under the treatment of options in the relevant Guidance Notes apply. CBN (2013c) further
required that foreign exchange transactions should be converted into naira at the spot exchange
rate at the close of each business day, and un-hedged off-balancesheet transactions other than
30

unsettled spot transactions may be converted into Naira at the current forward exchange rate
for maturities equal to the residual life of the transaction.
Internal models for calculating the market risk capital requirements however, according to
CBN (2012) is based on the daily control of risk exposure, calculated using an approach based
on statistical Value-at-Risk procedures (VaR). In this case, Elizalde (2007) and CBN (2012)
noted that banks have to cover the scope of application of the internal model, both positions in
debt securities and in equity securities. The author stated that the model can be extended in
order to include commodity and foreign exchange risks. For the determination of the capital
requirement against the specific risk on debt securities, McNeil (2008) stated that a model such
as VaR may be used in order to encompass at least the idiosyncratic risk, but it may not fully
account for the qualitative and quantitative standards that are consistent with the IRB
approach. To be able to use this approach, a bank must obtain regulatory approval from the
CBN, after having certain quantitative and qualitative requirements. Currently however,
Nigerian banks are not allowed to use this approach (CBN, 2013c).
According to Dierick (2005), CBN (2012), Sundmacher (2007), Basel II Accord makes
provision for three key approaches for computing capital requirement for operational risk,
which include Basic Indicator Approach (BIA), The Standardized Approach (TSA), and
Advanced Measurement Approach. While the Advanced Measurement Approach relies on a
financial institutions internally generated loss data and internally developed measurement and
management methodologies, the first two approaches are often used as directed by regulatory
authorities (Sundmacher, 2007).

31

CBN, (2013d) noted that under the basic indicator approach (BIA), the Nigerian banks are
required to hold capital for operational risk equal to 15% (denoted as alpha) of the average of
Annual Gross Income for three years. The BCBS (2006: 145) defines GI as net interest
income plus net non-interest income. According to Sundmacher (2007), this income figure is
gross of operating expenses, provisions; income from investment, realised profits or losses
from the sale of securities in an institutions banking book, and any irregular items. CBN
(2013d) however defined Gross Income as net interest income plus net non-interest income,
excluding realized profit/losses from the sale of securities in the banking book and
extraordinary and irregular items. CBN (2013) directed Nigerian banks to use this approach
for computation of capital requirement for operational risk, and this is to be used for the next
two years.
According to Tarantino (2008), a banking institution that uses the Standardized Approach
(TSA) will usually map its overall annual GI into eight business lines, which are pre-defined
by the Basel Committee. BCBS (2006) divided banks activities into such eight business lines
as retail banking, corporate finance, trading and sales, commercial banking, agency services,
payment and settlement, asset management and retail brokerage. Within each business line,
Tarantino (2008) noted, gross income is considered as a broad indicator for the likely scale of
operational risk, and capital charge for each line of business is computed by multiplying gross
income by a factor (often denoted as beta) assigned to that business line. According to CBN
(2013d) and Sundmacher (2007), total capital charge for operational risk is computed as the
three-year average of the simple summations of the regulatory capital across each line of
business in a year.
32

According to Sundmacher (2007), CBN (2013d) and BCBS (2006), certain betas are assigned
to the 8 business lines as follows: trading and sales (18%); retail banking (12%); corporate
finance (18%); commercial banking (15%); agency services (15%); payment and settlement
(18%); asset management (12%), and finally, retail brokerage (12%). The total capital charge
under TSA may be expressed as follows: KTSA = {years1-3 max[(GI1-8 * 1-8), 0]}/3 (Where:
KTSA = Capital charge under TSA; GI18 = Annual gross income in a given year for the eight
business lines; 1-8 = The fixed percentages for the 8 business lines).
The advanced measurement approach (AMA) requires banking institutions to develop and
deploy their own methodologies based on internal loss data and risk rating systems
(Sundmacher 2007, Tarantino 2008). Under this approach, CBN (2012) and Patil (2013) noted
that the regulatory capital should be consistent with the risk measures generated by the banks
internal risk measurement process and system using the prescribed quantitative and qualitative
parameters. Dierick et al (2005) stated that with this approach, banks have to take account of
actual internal, external loss data, as well as scenario analyses and factors relating to their
business and control environments.
BCBS (2006) and Tarantino (2008) noted that before this approach can be approved by
monetary authorities in relevant jurisdictions, the model has to achieve certain level of
statistical soundness that is fairly comparable to that of the Internal Rating Based approach,
where capital charges are based upon a one-year time horizon and a 99.9% level of confidence.
Banks that use the AMA, are at least in principle able to mitigate capital charge for operational

33

risk, by improving their operational risk management, for instance by introducing enhanced
controls into the business process (Dierick et al, 2005).
Dierick et al. (2005) contended that there are open methodological questions still remain with
respect to how AMA can be used in a sound and practical manner. Sundmacher (2007) in
particular concluded that it is not possible to apply the AMA to annual report data as the
approach is based on internally-gathered data, validated by external data and are further reliant
on internally-developed measurement methodologies. In general however, Sundmacher (2007)
stated that it is often assumed that banking institutions which move along this spectrum of
approaches benefit from a decreasing capital charge. The author also said that the use of
sophisticated approaches is assumed to bring about a better alignment of actual risks taken by
the institution and the minimum capital the institution is required to hold.
According to Patil (2010), Capital Adequacy Ratio (CAR) is the ratio of regulatory capital to
the total weighted assets and it is a measure of financial stability of a banking institution.
Ogere et al (2013) also stated that Capital adequacy ratio is an important metric for assessing
the safety and soundness of banks and other depository institutions as it serves as a buffer or
cushion for absorbing losses. CAR, according to Kolathunga (2010) and RBI (2008), serves as
a key metric monetary regulators use to measure the long-term solvency and sustainability of a
bank. Under Pillar 1 of Basel II Accord, banking institutions are expected to keep a minimum
capital adequacy ratio of 8% just as it was applicable under Basel I (Dierck et al (2005). CBN
(2013a) however, required minimum of 15% CAR for internationally active Nigerian banks
and banking groups, and 10% for those with National license, considering the Nigerian
economic status.
34

The computation of Capital Adequacy Ratio under Basel I is that Qualified Capital and
Reserves represent the nominator, while total risk weighted assets constitute the denominator
(BCBS (1988). Under Basel II however, CBN (2013a), BCBS (2006) and Dierick et al (2005)
stated that capital adequacy ratio can be computed as sum of Tier 1 capital and Tier 2 capital
(subject to regulatory restriction) as numerator, and sum of credit risk-weighted assets and
12.5 of the sum of the required capital for both operational risk and market risk as
denominator.
According to Sommer and Spielberg (2011), the Pillar 2 of Basel II Accord is structured along
two separate but complementary stages viz: The Internal Capital Adequacy Assessment
Process (ICAAP) and The Supervisory Review and Evaluation Process (SREP). The general
idea of Basel Accord, according to RBI (2008) and CBN (2013e) is that banking institutions
should capital buffers that are consistent with the quantum of risk taken. RBI (2008) noted that
adequacy of capital can never be a substitute for a banks faulty risk management processes.
The ICAAP therefore requires banks to institute adequate corporate governance mechanisms,
an organisational framework with clear lines of responsibility, and effective internal control
systems (CBN, 2013e).
CBN (2013) required Nigerian banks to ensure that they document their ICAAP and subject it
to independent internal review. CBN (2013e) noted that the respective banks boards are
entirely responsible for the ICAAP, and are expected to independently establish the design and
organisation in line with the banks risk appetite. The author further stated that the banks
Boards of Directors are responsible for the implementation and annual update of the ICAAP
35

document and the resulting calculation of internal capital in order to ensure it is still in
conformity with the banks operations and environment.
According to Pfetsch et al (2011), an ICAAP addresses such issues as comprehensive
identification of risks; risk appetite and philosophy; sound capital assessment; stress testing;
corporate governance; monitoring and reporting and internal control review. Sommer and
Spielberg (2011) stated an ICAAP report should enable the monetary supervisor to conduct a
complete and documented assessment of the key qualitative features of the capital planning
process, the overall exposure to risks and the consequent calculation of total internal capital.
CBN, (2013e) stated that the ICAAP report is to be transmitted by the Nigerian banks along
with the relevant board resolutions and senior management reports containing their comments
on the ICAAP, in accordance with their respective roles and functions.
Sommer and Spielberg (2011) stated that a countrys monetary supervisor usually conducts
Supervisory Review and Evaluation Process (SREP) on banks and banking groups on an
annual basis in order to verify that they have established capital and organisational
arrangements that are appropriate for the risks they face and ensures overall operational
equilibrium. According to CBN (2013e), it is the responsibility of the board and senior
management of banks to ensure that their banks maintain capital adequacy, but BCBS (2006)
however noted the supervisor (in this case, the CBN) has the prerogative to take early
interventionist step to prevent a banks capital from dropping below the required level.
In the event that a bank is not able to maintain adequate capital, the CBN may have to take
remedial action to save the financial system (Moghalu, 2012). CBN (2013e) provided such
36

remedial actions as including, altering the risk profile of the bank through business or
operational restrictions;

directing banks to raise additional capital; strengthening of the

systems, procedures and processes concerning risk management, control mechanisms and
internal assessment of capital adequacy; prohibition of distribution of profits or other elements
of capital; directing the bank to hold an amount of regulatory capital greater than the legal
minimum for credit risk, counterparty risk, market risk and operational risk; using other
measures as contained in the CBN Supervisory Intervention Framework (SIF) and the BOFIA.
According to Cardiou and Mars (2013), policy makers such as the International Accounting
Standards Board (IASB) and the Basel Committee on Banking Supervision (BCBS) have
made significant efforts to improve market reporting with the introduction of IFRS 7 and Pillar
3 of Basel II respectively. Rodrguez (2002) stated that the third pillar of the three-pronged
approach of the Basel II Accord is market discipline, which according to BCBS (2006) seeks
to deepen disclosures that could enable market participants to adequately assess the capacity
and strength of individual banks. Cardiou and Mars (2013) averred that Pillar 3 has introduced
substantial new public disclosure requirements, which represent a huge increase in the amount
of information that banks make publicly available, on capital structure, capital adequacy, risk
management and risk measurement.
According to CBN (2013f), Pillar 3 requires that Nigerian banks put in place appropriate
internal controls and independent validation process over the generation of financial and risk
disclosures, and to achieve this, Cardiou and Mars (2013) noted that appropriate independent
skilled resources need to be put in place. According to BCBS (2006), banks need to establish
a coherent disclosure and communication strategy around their risk management processes so
37

as to enforce market discipline. For banks to therefore present a clear and credible picture of
their risk profile and capital positions to the financial markets, Hassan et al (2010), Cardiou
and Mars (2013) and CBN (2013f) stated that they need to ensure consistence between their
IFRS risk and capital management disclosures and the corresponding Pillar 3 disclosures.
Considering the consequences and impacts of implementing Basel II Accord, Patil (2010)
noted that change in Capital Risk Weighted Assets Ratio (CRAR) of banks is an immediate
possibility. Basel I focused mainly on credit risk, whereas Basel II considers three key risks
such as credit risk, operational risk and market risks, and as Basel II Accord factor in all these
three risks in determining capital requirements, there is possibility of a decline in the Capital
Adequacy Ratio (Chronican, 2011; Helmreich and Jger, 2008). Renaissance Capital (2014)
for instance averred that compliance of most Nigerian lenders with Basel II has seen their
capital levels drop by 100-400 basis points to near the regulatory minimum of 15 percent,
further noting that some of the banks would have to actually reduce dividend payments and
loan growth in the year 2014 in order to conserve cash.
FBN Capital (2014) stated that given the possible impact of Basel II on their Capital Adequacy
Ratios, a couple of Nigerian banks, have been making efforts to raise more capital, both Tier 1
and Tier 2. Orija (2014) estimated that some top Nigerian banks might raise as much as N405
billion ($2.5 billion) this year 2014 compared to N342 billion ($2 billion) raised in 2013.
Egwuatu (2014) reported in the Vanguard Newspaper that Nigeria's Access Bank met with
domestic investors recently to gauge interest in a possible rights issue of N60-70 billion naira
($369-$431 million) by the fourth quarter of 2014 to bolster its core capital.

38

According to Afrinvest (2014), the impact of the ongoing Basel II implementation on capital
management and allocation in Nigerian banks might be massive, given the recent policy
introduced by the CBN. According to Proshare (2014b), the CBN vide its circular dated 5th
August 2014 has now excluded the Regulatory Risk Reserve from regulatory capital for the
purpose of assessing the capital adequacy ratio. The author further quoted the CBN as noting
that Collective Impairment on loans and receivables and other financial assets would no longer
form part of Tier 2 capital, and that the Other Comprehensive Income (OCI) Reserves will
now be recognized as part of Tier 2 capital subject to the limits set in paragraph 3.2 of the
Guidance Notes on the Calculation of Regulatory Capital.
Proshare (2014b) noted that according the CBN circular, the total Tier 2 capital (including OCI
Reserves) is now limited to 33.33% of total Tier 1 capital, and that unaudited Other
Comprehensive Income (OCI) gains will no longer be recognized as part of equity while
unaudited OCI losses will be fully deducted from the banks capital in arriving at total
regulatory capital. Afrinvest (2014) stated in view of these new stringent capital rules,
Nigerian banks would now be strategically reviewing their capital management priorities
across geographic and political boundaries, legal entities and business lines. FBN Capital
(2014) corroborated this, contending that in view of the new capital rules, aligning economic
capital with regulatory requirements and reallocating capital based the new risk-weights are
now the key drivers of changes in capital management in Banks.
According to Akinyooye (2006) and Oracle Financial Services (2009), full implementation of
the Basel II framework will require up-grade of the bank-wide IT infrastructure and this would
entail huge budget and may also raise IT-security concerns. Patil (2010) noted that the
39

implementation of Basel II can also raise the need for improved HR skills and a sound
database management. Akinyooye (2006) however noted small and medium sized banks in
Nigeria may lack the financial muscle to acquire required technology, as well as to train staff
in terms of the risk management activities. The author averred that Nigerian banks might
spend heavily in deploying sophisticated risk software, especially as they start implementing
internal models. On the flipside however, local IT companies, with expertise in finance
software, stand to gain a lot if they venture into risk modelling software, as for now huge
amount of foreign exchange would be lost to foreign risk software providers (Patil, 2010).
Akinyooye (2006) and RBI (2008) averred that one of the key impacts of Basel II
implementation is that it will tighten the risk management processes, improve regulatory
capital and ultimately strengthen the global banking system. Patil (2010) and Miller (2014)
noted that Basel II may have discriminant impact on the banking system as higher cost of
capital for smaller banks may queer the pitch in favour of the bigger banks and therefore give
the big players undue advantage in raising capital in the capital markets.
According to Rojas-Suarez (2001), Basel II requires a higher risk weight for project finance
and this will obviously discourage banks from advancing loans for critical real estate and
infrastructural projects. BCBS (2010a) and Acharya (2003) contended that the long-term
impact of this could be disastrous, as it may slow down growth in the real sector of the
economy.
Fischer (2002) stated that in principle, the three-pillar structure of the new Accord will provide
stronger incentives to strengthen domestic supervision and for banks to be more sophisticated
40

in the management of their risk portfolios. The author however noted that the supervisory
agencies in several emerging market and many developing economies are understandably
concerned that Basel II sets a standard that they cannot reasonably hope to meet.
Ernst and Young (2012) stated that Basel II Accord may impact on the risk management
processes of banks in a number of ways, and one such ways is the increase in Board of
Directors oversight on the banks risk profile and culture. The author noted that based on
recent research, the amount of time banks now devote to risk issues may have increased, as did
the range of risk reports provided to the Boards. Ernst and Young (2012) further noted skill
level and experience in banking and risk are some of the criteria banks now should use in their
Board appointments, and that the Boards now appears to focus on such important areas as risk
appetite, liquidity, culture and compensation. The author however stated that Board members
complain of too much undigested material, high expectations from regulators and difficulties
challenging business models.
Ernst and Young (2012) further stated that the breadth and scope of responsibilities of the
Chief Risk Officers in banks appear to have expanded well beyond the traditional focus areas
of credit and market risk, as CROs now appear to be involved throughout the chain of
decisions from new product throughput to strategy formulation and implementation. Miller
(2014) also stated with increasing sophistication in risk management practices in banks, many
of the big banks now have specialized sub-units within their risk management department
manned by specialists.

41

On the comparison between Basel I and II, McNeil (2008) stated that the economic capital
models in place before Basel II implementation often underestimated the size and risk of
certain exposures, particularly across business units. Elizalde (2007) noted that correlations
were far too optimistic and many models ignored important risk types under Basel I, and this
according to Aboyarin (2012) perhaps partly explained why some Nigerian banks failed in
2009. With Basel II framework, there is now much more coverage of business risks and risks
not in VaR, consolidation across groups and conservatism in correlations (Dierick et al, 2005).
Under Basel II Accord, Engelmann and Rauhmeier (2011) stated that increasing the internal
transparency in banks is now a heightened area of focus with stress testing, stress VaR,
counterparty risk and liquidity risk which will enjoys critical attention in years ahead.
Ernst and Young (2012) noted that with Basel II regulations, banks may now be required to
increase their buffers of liquid assets; enhance liquidity stress testing; introducing more
rigorous internal and external pricing structures; elevate the discussion and approval of
liquidity risk appetite and contingency planning to the board level; and give the CRO more
responsibility and involvement in liquidity management.
According to CBN (2013e), stress testing procedures required under Basel II are central to
improving risk governance, and the evolving regulatory environment in Nigeria is expected to
raise bank managements attention towards strengthening internal stress testing strategies and
processes. CBN (2013) required Nigerian banks to carry out Internal Capital Adequacy
Assessment Process on an annual basis as at 31st December, and forward copies of such report
to the CBN for review, not later than 30th April of the following year. Pfetsch et al (2011)
averred that ICAAP process involves some challenges, the most prominent of which is the
42

sheer amount of time it takes to conduct bottom-up stress testing. Many banks are still
struggling with resource constraint in executing manual process of conducting stress tests and
generating results across their various business portfolios (Ernst & Young 2012; Sommer and
Spielberg, 2011).
Doerig (2003) noted that operational risk which was missing in the Basel I, and is now gaining
huge attention among banks at the twilight of Basel II adoption. This, the author noted, is due
to increasing complexities of operations, systems, people and processes in financial
institutions. Abkowitz (2008) stated that operational risk management is taking centre stage in
recent times in view of the increasing incidence of banking failures attributable to inadequate
business process, people and systems.
According to Patil (2010), Basel II Accord confers a whole lot of benefits to all relevant
stakeholders in the banking system and this includes ensuring better allocation and
management of capital and reduced event of moral hazard effected through measures aimed at
limiting the scope of regulatory arbitrage. By aligning the amount of capital required for each
risk exposure, the Advanced Approaches under Basel II dont have to use the simplistic risk
weights applicable under the Basel I capital rules (Acharya, 2003; Dierick, 2005).
RBI (2008) noted that Basel II is a framework that is designed to more accurately align
regulatory capital with risk, and thus leads to improved quality of capital. In reality however,
BIS (2010) noted that this may not necessarily be so, and this is the more reason why Basel III
that emphasises on liquidity is being enforced too. In addition, Rojas-Suarez (2001) averred
that Basel II will ensure improved credit risk management in banks as a result of improved risk
43

rating exercise recommended by the framework. The author noted that one of the principal
objectives of the Basel II is to more closely align capital charges with risk bearing in mind that
as a banks risk exposure increases, either the loss given default (LGD) or the probability of
default (PD) increases.
According to Miller (2014) and Fischer (2002), Basel II will ensure more efficient use of
required bank capital, and increased risk sensitivity and improvements in risk assessment will
enable regulators achieve their prudential objectives more efficiently. Another important point
noted by Patil (2010) is that Basel II recognizes and accommodates continuing innovation in
financial products by focusing on the fundamentals behind risk rather than on static product
categories.
In addition, Basel II according to CBN (2012) is expected to enhance supervisory feedback as
all the three pillars of the Basel II framework aim to engender end-to-end feedback from banks
and banking groups on their risk positions. Proshare (2014a) noted this is what the yearly
filing of ICAAP report by Nigerian banks may help address, as enhanced feedback could
further strengthen the Nigerian banking system.
Another salient point CBN (2012) noted about Basel II is market discipline, which according
to Illing and Pauling (2005), may be achieved through improved disclosure. More specifically,
CBN (2013f) required Nigerian banks to make specific disclosures relating to their risk
measurement and risk management in their annual reports as this would enable the banks key
stakeholders make informed decisions.

44

Fischer (2002), Akinyooye (2006), BCBS (2004), Oracle Financial Services (2009) and Patil
(2010) carried out extensive studies on the challenges of implementing Basel II. According to
Oracle Financial Services (2009), the most major impact of Basel II is lies in the improved risk
management and measurement systems and this seeks to give impetus to the use of internal
rating system by the banks. Akinyooye (2006) and Patil (2010) however noted that
implementing some of these sophisticated systems can be very costly, especially for small and
medium scale banks.
According to Layegue (2013), many banks and even the regulators still face lack of adequate
internal expertise to assess and assist in Basel II implementation, in view of the complexities
inherent in banking regulations and Basel II framework. The author noted that dearth of skilled
personnel is a major impediment for many banks in Nigeria in spite of the considerable efforts
made by them and the CBN to bridge the competence gap.
According to Fischer (2002), Basel II does not create a level playing field, but rather an
uneven one, as bigger banks are more able to implement to sophisticated risk systems than
smaller ones, and thus able to raise more capital. BIS (2010), Miller (2014) and Dierick et al
(2005) noted that increased pro-cyclicality is another important challenge that Basel II
implementation may pose, because increased importance attached to credit ratings under Basel
II could actually imply that the minimum requirements would become pro-cyclical as banks
would naturally be required to raise more capital for loan creation in times of economic
meltdown. Saunders and Wilson (2001) observed some level of sensitivity of business-cycle in
the relationship between bank charter value and capital for risk-taking incentives, and this
shows direct relationship between capital adequacy and economic cycles.
45

Gottschalk (2006) noted that low degree of corporate rating penetration is another key
challenge of Basel II implementation in low-income countries. According to the author, only
internationally active banks, institutional fund managers and foreign investors usually show
interest in corporate ratings, thus making the use of rating less common in developing
economies. Layegue (2013) expressed this same sentiment about Nigeria where he stated that
the activities of external credit rating agencies are still very low, making the use Standardized
Approach recommended by the CBN for credit risk a bit difficult.
Another challenge Layegue (2013) noted about Basel II implementation in Nigeria is that, we
still have asymmetric supervision process, making different market participants are regulated
by separate supervisors. The author averred that the fact only banks in Nigeria are required to
comply with Basel II, and not the other financial services providers might make it difficult to
maintain comparable levels of vigilance and quality of objectives in policy formulation.
Patil (2010) stated that as Basel II is being implemented across the world major economies, the
banks with foreign branches or subsidiaries would likely be required to compute their capital
adequacy ratios in line with the multiple regulatory guidelines as prescribed by the monetary
authorities in all countries where they operate. These jurisdictional guidelines, according to the
author, can differ with respect to implementation timelines and formalities, and compliance
with Basel II regulations, and will understandably impose considerable pressure on the banks.
Oracle Financial Services (2009) however suggested that an integrated data warehouse system
with in-built capacity to support multiple jurisdictional guidelines on Basel II Accord should
help achieve multijurisdictional capital adequacy computations in an efficient manner.
46

According to Layegue (2013) and Akinyooye (2006), data may be a significant challenge for
Nigeria banks because Basel II is a data-intensive framework and Basel II Pillar I requires data
on credit risk, market risk and operational risk at varying levels of granularity. In Oracle
Financial Services (2009)s view, these challenges include issues surrounding data availability
and quality, and data collection and storage. To ensure that the issues are properly addressed,
the author suggested that a detailed data-gap analysis study be completed in the initial phases
of the Basel II implementation project. The author averred that when the banks implementing
the framework fail to carry out this initial gap analysis exercise, they may experience time and
cost overruns.
Layegue (2013) stated that prior to the CBNs preliminary attempt at bringing Basel II
principles into the consciousness of the banking sector operators in Nigeria, with the
document, New Regulatory Framework for Prudential Supervision of Nigerian Banking
System, issued in 2012, a number of internationally active Nigerian banks had expressed their
willingness to implement some advanced risk-based capital methodologies. According to the
author, there had been varying degree of readiness among Nigerian banks, as the common
approach has mainly been that of a phased implementation of Basel II requirements.
Rodrguez (2002) averred that Basel II leaves so much discretion to supervisory authorities on
the areas of the framework to be implemented. In view of this, CBN (2013) itemised the areas
of national discretion concerning Basel II implementation, as shaped by Nigerian sovereignty
and economic policy choices and priorities. The areas of national discretion on Basel II as
noted by CBN (2013) include non-recognition of Tier 3 capital such as short term
47

subordinated debts, as part of the components of regulatory capital; non-recognition of all

exposures to export credit agencies in the computation of capital requirement; exposures to
banks whose maturity is 3 months or less attract 20% risk weight, and the exposures to
securities firms, however credible and solvent such firms are, have a minimum risk weight of
100%. According to Proshare (2014a), the CBN didnt accede to Basel II proposition that all
corporate exposures be subject to a blanket risk weight of 100% without regard to external
rating, but it did accede to increase in risk weight for claims secured by residential mortgages,
and that unsolicited ratings may be used.

48

CHAPTER THREE
RESEARCH METHOD
3.1 Introduction
This chapter gives a brief description of the research design adopted; the population
considered as well as discusses the sample and sampling procedures used. It also discusses the
sources of data; the data collection procedures and the type of research instrument used. The
chapter also captures the type of data and data techniques and analysis adopted for the study.

For the purpose of the study, grounded theory was adopted as philosophical basis of the
research methodology. According to Glasser and Strauss (1967), the knowledge that is
acquired from any scientific enquiry is grounded in the data the researcher is able to gather,
and as such, the findings of such research depend largely on the analysis of the results
achieved. Descriptive and qualitative study approaches which involve intensive review of
literature and collection of primary data were adopted. More facts and data were obtained from
journals, banks annual reports, CBN reports and circulars, textbooks; materials sort from
internet, Newspaper articles and seminars papers. The data collected were properly classified,
grouped and summarized for ease of analysis.

3.2 Research Design and Instrument Used

In this study, we gathered both the quantitative data and qualitative from primary and
secondary sources for our analysis.

49

A qualitative approach will typically enable a researcher obtain relevant information from the
sample subjects without colouring their response choices on the issues raised in the research
instrument used. Both questionnaire and interview methods were used in collecting the
required information. Other relevant data were obtained from annual reports, government
briefs, regulatory circulars, Newspapers, Journal materials, as well as various published and
unpublished articles and papers on the subject.
In this study, the Questionnaire Method was adopted in eliciting relevant information from
staff in some of the Nigerian banks, whose work involve risk and control functions. The
questionnaire was divided into eight sections. Section A consisted of the demographic
information about the respondents. Section B consisted of items on institutional information of
banking institutions where the sample subjects work. The section C consisted of items on
awareness about Basel II regulations. The sections D and E consisted of items on risk
organogram and reporting structures in Nigerian banks. The sections F and G contained issues
of compliance and impact of Basel II implementation. Finally, both sections H and I consisted
of issues of Basel II action plan and implementation challenges.
3.3 Population of the Study
The population of the study consisted of all the banks that make up the Nigerian banking
system. The Nigerian banking industry is made up of 21 commercial banks, 36 newly
recapitalized mortgage banks, 1 fully Interest-free bank, 64 finance houses, 2 merchant banks,
and 794 microfinance banks.
3.4 Sample and Sampling Technique
50

The study took a random sample of 15 banks from which sampling units of 60 respondents
who handle risk and control functions, were purposively selected from each of the commercial
banks. What informed the choice of the commercial banks as the sample source was because
the Central Bank of Nigeria appeared to have considered the commercial banks as the centre
focus of Basel II implementation for a start. The study used purposive sampling technique in
drawing the sampling units. The choice of the this technique was motivated by the fact that the
information on Basel II implementation is specific and only those whose job is directly related
to Basel II regulations may be able to give information or opinion that is relevant and reliable.
It was in view of this that the research instrument was administered to respondents whose roles
cut across risk and control functions at the sampled banks.
3.5 Method of Data Collection
The primary data were results from responses to issues raised in the questionnaire
administered to a sample space of purposive but randomly selected respondents. Prior to the
administration of the research instrument, the researcher made personal contact to some of the
respondents to seek their understanding and gain their confidence. The researcher also used
online platform to administer the questionnaire to some banks personnel who could not be
reached physically. For the personnel whom the questionnaires were personally administered,
the researcher made persistent calls and visits to them for the questionnaires to be completed
and recovered.
In view of time constraint, the researcher gave one week time frame for the completion of the
research instrument. A total of 60 questionnaires were administered after which 44 were
recovered. This represented 73.3% percent recovery rate. The secondary data are classified
51

data extracted from annual reports, journals and regulatory reports and circulars and other
relevant publications.
3.6 Method of Data Analysis
Data obtained from copies of the research instrument retrieved were subjected to both
descriptive and inferential analysis techniques with the aid of the SPSS software (version
17.0). Statistics such as percentage analysis, range (R), Mean (M), Standard Deviation (SD)
and cross tabulation were used to explore the characteristics of variables.
Inferential statistics such as Analysis of Variance (ANOVA), correlation and regression
analysis were also utilised, deducing inferences at 5% level of significance. The Analysis of
Variance (ANOVA) was used to examine the differences in the opinion of respondents on the
various issues on risk management captured in the research instrument, using parameters such
as: educational qualification, length of work experience, department and size of business
(proxied by banking license categories) as grouping variables. The correlation analysis was
used to examine the nature of relationships (direction of relationship-either positive or
negative; strength of relationship-weak, semi-strong or strong; and statistical significance of
the relationship) subsisting among study variables. The Ordinary Least Square (OLS) multiple
regression technique was used to develop a model for the adoption of the BASEL risk
management model. Test such as model ANOVA, VIF, co-efficient of determination (rsquare), and regression co-efficient significance were used to analysis the fitness and
appropriateness of the model.

52

CHAPTER FOUR
PRESENTATION AND ANALYSIS OF DATA
4.1 Presentation of Data
Table 4.1 Age of the Respondents Classified by their Qualification
Qualification of respondents
Below Degree/HND Post graduate
Degree
and above

Total

Age of respondents Below 30

14

30-50
Below 50

0
2

14
2

10
2

24
6

20

20

44

Total
Source: Study Questionnaire

Table 4.1 shows the age distribution of the respondents relative to their qualifications. As the
table shows, 40 of the 44 respondents hold at least a degree or HND, and 24 of these are aged
between 30 and 50. 14 of the respondents are aged below 30, and 12 of them hold at least a
Degree or HND.
Table 4.2: Qualification of the Respondents Classified by their length of Service

Qualification
of respondents

Length of service
0-3 Yrs 4-7 Yrs

8-10 Yrs Over 10 Yrs

Below Degree

Degree/HND
Post graduate
and above

2
8

2
8

12
0

4
4

20
20

10

10

16

44

Total

Total

Source: Study Questionnaire

Table 4.2 shows the qualifications of the respondents relative to their years of experience. Out
of the 44 respondents, 30 hold a minimum of Degree or HND and also have at four years
53

work experience. This represents 68.2% of the respondents. 2 of the respondents that hold less
than a Degree are however well experienced.
Table 4.3: Qualification of the Respondents Classified by their Departments
Departments of respondents

Qualificatio
n of
respondents

Below
Degree
Degree/HN
D
Post
graduate and
above

Total

Total

Internal
Audit

Enterprise
Risk Mgt

Credit
Control

Financial
Control

Others

20

20

12

10

44

Source: Study Questionnaire

Table 4.3 shows the qualifications of the respondents relative to their departments at the
sampled banks. Out of the 44 respondents, 20 hold at least a Degree or HND and also work in
either Enterprise Risk Management or Credit Control department. This represents 45.5% of the
respondents. 20 of the respondents that hold above a Degree are spread across all the
departments under study.
Table 4.4: Respondents Classified by License Categories of their Banks
Frequency Percent
International
License
Valid National License
Regional License
Total
Source: Study Questionnaire

14

31.8

29
1
44

65.9
2.3
100.0

54

Valid
Cumulative
Percent
Percent
31.8
31.8
65.9
2.3
100.0

97.7
100.0

Table 4.4, shows the distribution of the research instrument among the banks, classified into
the three tiers according to the licenses given. 31.8% of the instruments were administered to
staff of internationally licensed banks, 65.9% to nationally licensed banks, and 2.3% to
regionally-licensed banks.
Table 4.5: Impact of Basel II Accord on Risk-Based Capital
STATEMENTS
Your bank has done a gap analysis
between current risk management
practice and new capital requirement
for credit risk.
Your bank has done a gap analysis
between current risk management
practice and new capital requirement
for market risk.
Your bank has done a gap analysis
between current risk management
practice and new capital requirement
for Operational risk.
Your bank has established an action
plan to achieve the Basel II
requirements for credit risk.
Your bank has established an action
plan to achieve the Basel II
requirements for market risk.
Your bank has established an action
plan to achieve the Basel II
requirements for operational risk.
Source: Study Questionnaire

YES

NOT
SURE

NO

TOTAL

MEAN

34

44

2.68

12

16

16

44

1.91

26

14

44

2.50

36

44

2.73

12

22

10

44

2.05

24

14

44

2.41

In Table 4.5, when the respondents were asked if their banks have carried out gap analysis in
respect of credit risk, 77% of the respondents answered in the affirmative, while 14% said No.
The mean value of 2.68 suggests that majority of the sampled banks have carried out gap
analysis in respect of capital requirement for credit risk.

55

In Table 4.5, when the respondents were asked if their banks have carried out gap analysis in
respect of capital requirement for market risk, 27% of the respondents answered in the
affirmative, while 36% said No, and 36% were not sure of the status. The mean value of 1.96
suggests that only a few of the sampled banks have carried out gap analysis in respect of
capital requirement for market risk. It thus appears not so much progress have been made in
respect of market risk.
In Table 4.5, when the respondents were asked if their banks have carried out gap analysis in
respect of capital requirement for operational risk, 59% of the respondents answered in the
affirmative, while 32% said No, and 9% were not sure of the status. The mean value of 2.50
suggests that a good number of the sampled banks have carried out gap analysis in respect of
capital requirement for operational risk. It thus appears some progress is being made in respect
of operational market risk.
In Table 4.5, when the respondents were asked if their banks have an action plan in respect of
Basel II requirement for credit risk and operational risk, 82% and 55% of the respondents
answered in the affirmative respectively, while 9% and 32% said No. The mean values of 2.73
and 2.41 respectively suggest that majority of the sampled banks have an action plan in respect
of capital requirement for credit risk and operational risk. However, there appears to be slow
progress in the area of market risk as only 27.2% of the sampled banks have an action plan for
capital requirement on market risk.

56

Table 4.6: Impact of Basel II Accord on Risk Organization in Nigerian Banks

YES

NO

NOT
SURE

TOTAL

MEAN

Your bank has a Chief Risk Officer

(CRO).

44

44

3.00

Your bank has a distinct Board Risk

Committee.

40

44

2.91

Your bank has separate manager

handling Credit risk roles.

44

44

3.00

Your bank has separate manager

handling Market risk roles.

20

22

44

2.41

30

10

44

2.59

STATEMENTS

Your bank has a separate manager

handling Operational risk roles.
Source: Study Questionnaire

In Table 4.6, when the respondents were asked if their banks have own Chief Risk Officer
(CRO), all the respondents answered in the affirmative. The mean value of 3.00 suggests that
all the sampled banks have own Chief Risk Officers.
In Table 4.6, when the respondents were asked if their respective banks have a distinct Board
Risk Committee, 91% of the respondents answered in the affirmative, while 9% said No. The
mean value of 2.91 suggests that majority of the sampled banks have own Board Risk
Committee.
In Table 4.6, when the respondents were asked if their banks have separate manager handling
each of the risk areas, all the respondents answered in the affirmative in respect of credit risk,
while 45% did in respect of market risk, and 68% noted that their banks have Operational Risk
Managers. The average mean value of 2.67 suggests that majority of the sampled banks have

57

separate managers handling each of the risk areas, except for market risk. This suggest many
banks dont have separate managers handling market risks.
Table 4.7: Cadre of the Banks Chief Risk Officer?
Frequency Percent
Valid
Cumulative
Percent
Percent
Below General
9
20.5
20.5
20.5
Manager
General Manager
31
70.5
70.5
90.9
Valid
Above General
4
9.1
9.1
100.0
Manager
Total
44
100.0
100.0
Source: Study Questionnaire
Table 4.7 contains responses on the cadre of Chief Risk Officers in banks. The result shows
that 70.5% of the CROs in sampled Nigerian banks are of General Manager cadre; 20.5%
Below General Manager cadre, and only less than 10% are Above General Manager level.
Table 4.8: Descriptive Statistics on Priority Given to Basel II Regulations
N
Credit Risk -What degree of priority
does your bank give to the new
Basel regulatory framework?
Market Risk -What degree of
priority does your bank give to the
new Basel regulatory framework?
Operational Risk -What degree of
priority does your bank give to the
new Basel regulatory framework?
How does your bank view Basel II
regulation

Minimum Maximum Mean

44

4.95

Std.
Deviation
.302

44

3.14

.510

44

3.23

.774

44

4.95

.302

Source: Study Questionnaire

Table 4.8 contains result on priority Nigerian banks give to the BASEL II regulation. The
degree of priority given to the Basel II regulatory framework in the area of Credit Risk is
58

topmost M= 4.95, SD=.302) because it has the highest mean and the lowest dispersion (SD),
meaning that the opinion of all respondents is almost unanimous on this, as this area of credit
risk has the lowest SD. This is followed by operational risk, and then the market risk.
Also, almost all respondents view the Basel II regulation as an opportunity to enhance risk
management (M= 4.95, SD=.302), rather than mere regulatory constraint.
Table 4.9: Impact of Basel II Regulation on Capital Allocation and Consumption
STATEMENTS
Given your bank's risk profile as at
date, there is an unavoidable need
for increased capital requirement
under Basel II.
The idea behind the Basel 2 Accord
is that once regulatory capital was
strong and kept strong consistently,
it could act as a buffer to a
commercial bank during economic
downturns.
As at date, your bank has had cause
to estimate the regulatory capital
required for each of its business
lines.
Your bank allocates or intends to
allocate economic capital for credit
risk by business lines.
Your bank allocates or intends to
allocate economic capital for market
risk by business lines.
Your bank allocates or intends to
allocate economic capital for
operational risk by business lines.
Your bank will close activities with
high capital consumption.
Your bank is likely hedge against
selected Risk.
Source: Study Questionnaire

YES

NO

NOT
SURE

TOTAL

MEAN

40

44

2.91

38

44

2.73

18

22

44

2.32

34

10

44

2.77

14

24

44

2.18

20

10

14

44

2.14

30

10

44

1.86

10

24

10

44

2.00

59

In Table 4.9, when the respondents were asked if their banks now have an unavoidable need to
increase their capital base to meet increased risk profile, 91% answered in the affirmative. This
is further supported by a mean value of 2.91. Also with a mean value 2.73, majority of the
respondents that once regulatory capital is strong and kept strong consistently, it could act as a
buffer to a commercial bank during economic downturns.
In table 4.9, when respondents were asked if their banks allocate regulatory capital for all lines
of their business, a 41% affirmative response suggests that no many have seen or realized the
need to allocate regulatory capital according to business lines.
And as the responses suggest, many of Nigerian banks lack the sophistication required to
isolate areas of business with huge capital consumption and take decision either to close such
business line or hedge against the identified risk. The hedging instruments are understandably
scarce in Nigerian banking sphere, and this creates another challenge.
Table 4.10: Descriptive Statistics on Risk Reporting
N
Minimum Maximum Mean
Credit Risk- What purpose drives
you risk reports?
Market Risk - What purpose
drives your risk reports?
Operational Risk - What purpose
drives your risk reports?
How frequent is your Credit Risk
reporting?
How frequent is your Market
Risk reporting?
How frequent is your Operational
Risk reporting?
Source: Study Questionnaire

44

5.00

Std.
Deviation
.000

44

3.32

.857

44

4.95

.302

44

3.00

.000

44

3.32

.740

44

3.00

.000

60

Table 4.10 shows how Basel II impacts on risk reporting in banks. The first item of the table
suggests that business decisions and not fear of regulatory sanction significantly drive the
purpose of credit and operational risk reports in banks. This is evidenced by mean of 5.00 and
4.95 for credit risk and operational risk respectively. The market risk reports are majorly
generated for market monitoring purpose other than regulatory compliance. This is why the
mean is 3.32, and Standard Deviation is 0.857.
On the frequency of risk reporting, majority of the respondents noted that their banks generate
risk reports majorly on monthly basis across all risk areas, as furnished by requisite statistics
including; Credit Risk (M= 3.00, SD=.000), Market Risk (M= 3.32, SD=.740), and Operational
Risk (M= 3.00, SD=.000).
Table 4.11: Descriptive Statistics on Spending Areas for Basel II Implementation
Frequency Percent
IT systems
Training
Valid
Human capital
Total
Source: Study Questionnaire

4
39
1
44

9.1
88.6
2.3
100.0

Valid
Percent
9.1
88.6
2.3
100.0

Cumulative
Percent
9.1
97.7
100.0

In Table 4.11, 88.6% of the respondents noted that training constitutes the highest spending
area banks Basel II implementation project.

61

Table 4.12: Descriptive Statistics on Compliance with BASEL II Accord

N
Credit Risk -Which approach does your 44
bank currently use in computing capital
requirement?
Market Risk -Which approach does 44
your bank currently use in computing
capital requirement?
Operational Risk -Which approach does 44
your bank currently use in computing
capital requirement?
Source: Study Questionnaire

Minimu Maximum Mea

Std.
m
n
Deviation
3
3
3.00
.000

3.00

.000

1.00

.000

Table 4.12 shows the response on the compliance with the provisions of Basel II Accord as
recommended by the Central Bank of Nigeria. As the mean figures for the first and second
items on the table suggest, all the banks use Standardized Approach for the computation of
capital charges on credit risk and market risk. In the same vein, all banks use Basic Indicator
Approach for the computation of capital charge for operational risk (M= 1.00, SD=.000). This
is obviously due to regulatory requirement. Nigerian banks are required to use these
approaches for the next two years.
Table 4.13: Descriptive Statistics on BASEL II Implementation challenges
N
Minimum Maximum Mean
Std.
Deviation
Challenges
System Integration issues
44
5
5
5.00
.000
44
5
5
5.00
.000
Database Design Issues
Faulty Models
Limited Budgets
Data gathering Issue

44

4.95

.302

44

4.75

.651

44

4.95

.302

62

44

4.95

.302

Non-availability of IT
infrastructure

44

2.91

.421

Scarcity of credible rating

agencies
Lack of top level
management support
Low awareness level
amongst staff
Source: Study Questionnaire

44

5.00

.000

44

4.50

1.303

44

4.73

1.020

Limited Human resources

Table 4.13 shows the key areas of challenges that banks appear to be facing in Basel II
implementation. As the mean and standard deviation figures for majority of the items on the
table suggest, all the banks see the various implementation issues as high risk for the project,
except for non-availability of IT infrastructure.
4.2 Data Analysis
A hypothesis is a conjectural statement made about an event or feature of a population that can
be proved or disproved based on available sample data. According to Kothari (2004),
hypothesis is a proposition made as an explanation for the occurrence of phenomenon either
asserted merely as a provisional conjecture to guide some investigation or accepted as highly
probable in the light of established facts. For the purposes of this study work, hypothesis
chosen are deemed true before the conduct of the study. They are then subjected to tests that
may prove them untrue.
In order to test the hypothesis which states that pre-Basel II capital adequacy ratio is not
significantly different from Basel II ratio in the Nigerian banks, t-test for equality of means
was applied and the results are shown on Table 4.14 below:
63

Table 4.14: Impact of Basel II on Capital Adequacy Ratio Computation

t-test for Equality of Means
t
df Sig. (2Mean
Std. Error
95% Confidence
tailed) Differenc Difference
Interval of the
e
Difference
Lower
Upper
3.004 14
.009 6.02375
2.00512 1.72318 10.32431
Equal variances
assumed
CAR
Equal variances 3.004 11
not assumed
.
Source: Secondary Data

.012

6.02375

2.00512

1.61226 10.435235

From the table 4.14 above, the calculated p-value of 0.009 is less than the critical value of
0.05. This shows that the null hypothesis is rejected, while the alternate hypothesis is accepted.
This therefore implies that there is significant difference between Pre-Basel Adequacy Capital
Ratio and Basel Capital Ratio.
Furthermore, in order to test the hypothesis which states that implementing Basel II Accord
does not pose challenge to the Nigerian banks, Analysis of Variance (ANOVA) was adopted
and the results are shown on table 4.14 below:
Table 4.15: Opinion on Challenges of Basel II Implementation Relative
to Banking License Category
Sum of
Df
Mean
F
Sig.
Squares
Square
Between
.055
2
.028
.370
.693
Groups
Within Groups
3.067
20
.075
Total
3.123
22
Source: Study Questionnaire
From the table 4.15 above, the calculated p-values of 0.693 is greater than the critical value of
0.05. This shows that the null hypothesis is accepted, while the alternative hypothesis is

64

rejected. This therefore implies that there is no significant difference in the implementation
challenges faced by all banks, irrespective of license category.
In addition, in order to test the hypothesis which states that there is no significant difference in
the level of progress made by Nigerian banks on Basel II implementation, Analysis of
Variance (ANOVA) was also adopted and the result is shown on table 15 below:
Table 4.16: ANOVA Results on the Extent of Implementation of BASEL
Requirements
Sum of
df
Mean
F
Squares
Square
Between
.240
2
.120
.344
Credit Risk - How far
Groups
has your bank gone in
Within
14.305
41
.349
the implementation of
Groups
Basel II action plan?
Total
14.545
43
Between
.012
2
.006
.250
Market Risk - How far
Groups
has your bank gone in
Within
.966
41
.024
the implementation of
Groups
Basel II action plan?
Total
.977
43
.463
2
.231
.885
Operational Risk - Between
How far has your bank Groups
gone
in
the Within
10.719
41
.261
implementation
of Groups
Basel II action plan?
Total
11.182
43
Source: Study Questionnaire

Sig.
.711

.780

.421

Since P value for Credit risk (P=.711), Market risk (P=.780) and operational risk (P=.421) is
greater than 0.05 in all cases, there is no statistically significant difference in the extent of the
BASEL II implementation among Nigerian Deposit Money Banks; then we conclude on
average that Nigerian banks are at the same stage in the implementation of Basel II.

65

Finally, in order to test the hypothesis which states that Basel II Accord will not improve risk
management practices in Nigerian banks, correlation and regression techniques and Analysis
of Variance (ANOVA) were adopted and the results are shown on tables 4.17 and 4.18 below:
Table 4.17: Correlation and Regression Results on the Impact of Basel II on Risk
Management Practices in Banks
Model
Unstandardized Standardized
T
Sig.
Coefficients
Coefficients
B
Std.
Beta
Error
(Constant)
10.500 .000
60620402.9
.000
-1.000 .000
-.518
.000
Does your bank have Chief
46778526.9
Risk Officer?

Given your banks risk

profile as at date, do you see
an unavoidable need for
increased capital requirement
under Basel II?
Does your bank have own
Board Risk Committee?

-.500 .000

-.877

44174925.1

.000

1.100E- .000
.000
.000 1.000
013
-1.161E- .000
.000
.000 1.000
CHALLENGES
013
a. Dependent Variable: Impact of Basel II on risk management practices in Nigerian
banks
Source: Study Questionnaire
Table 4.18: ANOVA Results on the Impact of Basel II on Risk Management Practices
in Banks
Model
Sum of
df
Mean
F
Sig.
Squares
Square
14.545
4
3.636 2255774927
.000b
Regression
881694.000
1
Residual
.000
39
.000
Total
14.545
43
a. Dependent Variable: Impact of Basel II on risk management practices in Nigerian banks
b. Predictors: (Constant), Does your bank have Chief Risk Officer? Given your banks risk
profile as at date, do you see an unavoidable need for increased capital requirement under
Basel II?, Does your bank have own Board Risk Committee?
Source: Study Questionnaire
66

From the tables 4.17 and 4.18 above, the calculated p-value of 0.000 is less than the critical
value of 0.05. This shows that the null hypothesis is rejected, while the alternate hypothesis is
accepted. This therefore implies that Basel II Accord will improve risk management practices
in Nigerian banks.

67

CHAPTER FIVE
SUMMARY, CONCLUSIONS AND RECOMMENDATIONS
5.1 Summary of the Study
The following findings were made after analysing the research questions and the hypotheses
formulated for the study:
The study observed that the Nigerian banks faced a number of challenges in the course of
implementing Basel II requirements to their risk management processes. Such challenges
include data gathering issue, scarcity of local rating agencies, faulty risk models, limited
expertise in risk models, database design issues, and limited budget. It was observed that under
Basel II models, capital adequacy ratio of Nigerian banks reduced, thus leading increased
capital raising exercise by the banks whose capital ratio fell short of the regulatory threshold.
The drop in capital adequacy ratio was largely explained by the changes in the composition of
regulatory capital and increased capital requirements for each of the risk areas.
A number of Nigerian banks have reached an advanced stage in implementing Basel II
requirements for credit risk and operational risk, except for market risk, where not much
progress has been made. The slow progress made in implementing Basel II for market risk was
largely due to lack of depth in the Nigerian financial markets. The Nigerian secondary debt
market is still not fully developed. For example, only the Federal Government Bonds and
Treasury Bills appear to be the only liquid debt instruments in the secondary financial markets
for now. State and Corporate Bonds are most often held till maturity. Therefore, they are not
often factored into the computation of capital requirement for market risk.
68

The study further revealed that Basel II implementation is changing the face of the risk
management processes and practices in the Nigerian banks. The Basel regulations allow banks
to introduce substantial improvements in their overall risk management capabilities, improving
risk based performance measurement, capital allocation and consumption, and increased
market disclosures.
The increasing demand on banks to maintain strong capital to be able to withstand economic
stress as required by Basel II now appear to limit dividend pay-out. As an alternative to capital
raising exercise with its attendant troubles sometimes, Nigerian banks now appear to be
considering building up reserves from their annual profits.
Further findings revealed that the Boards in many of the Nigerian banks are becoming
stronger, and issue of risk is now taking front burner at the Board discussions. Majority of
these banks respectively have a dedicated Board Risk Committee. This thus indicate that such
matters as risk appetite and risk capacity are now enjoying mentions within the sphere of
Nigerian banks corporate strategy. In addition, the Chief Risk Officers in many of these banks
are senior management staff who are now involved in various key decisions of the banks.
Finally, the study also observed that with the ongoing Basel II implementation in Nigeria,
banks are fast changing their risk models. The economic capital models in place before Basel
II implementation often underestimated the size and risk of some exposures, particularly
across business units. With Basel II framework, there is now much more coverage of key
business risks. Increasing internal transparency has also been a heightened area of focus with
stress testing, stress VaR, counterparty risk and liquidity risk which would enjoy critical
attention in years ahead. Some of the Nigerian banks used VaR in the early part of 2014 to
69

stress test their performances, and this trend is expected to follow upward pattern in years
ahead.

5.2 Conclusion
The important thing that this research has brought to focus is the relevance of Basel II
regulations to the risk management practices in Nigerian banks. Banking is the financial
bedrock of any nations economy and the business of banking is built around the concepts of
financial intermediation, asset transformation, and money creation. Each of these areas of
banking business bears huge amount of risks. The failure of any major banking entity to
manage these risks could cause serious damage to the confidence reposed in the countrys
financial system. The ultimate losers in any banking failure are the deposit customers who are
mostly not privy to the decisions that often account for such failure. In view of this, the need
for Nigerian banks to adopt sound risk management practices has been established by this
research. Therefore, strengthening the risk management processes in banks is exactly what the
Basel II Accord seeks to achieve.
Basel II Accord is an international banking regulation which seeks to ensure that banks
maintain adequate capital that is consistent with the level of their risk exposures. The Central
Bank of Nigeria has issued several guidelines and circulars to enforce the Basel regulations in
the Nigerian banking space. The banks in Nigeria, mostly commercial banks, have achieved
some milestone in the implementation of key requirements of Basel II Accord. Many of these
banks are however still lagging in some aspect of market risk requirements.

The

implementation effort has not been without some institutional, structural and operational
70

challenges. Regulatory arbitrage remains an important challenge to the financial system, as

Basel II has not yet been seriously enforced on other key players in the system other than the
commercial banks.
The new regulation has heavily impacted the capital measurement, management and allocation
in the Nigerian banking industry. Lastly, the study concludes that the Basel II regulations have
significantly improved the risk management practices and processes in the Nigerian banks, just
as it is putting the banks under increasing pressure to strengthen their core capital in order to
withstand economic stress.
5.3 Recommendations
Based on the above conclusions, the following policy recommendations are suggested:
The Central Bank of Nigeria should enlighten the public more on the implications of Basel II
framework on the financial system. The regulator could achieve this by sponsoring policy and
academic papers on the subject of risk management and Basel II Accord. In addition, CBN
should partner with professional bodies such as Chartered Institute of Bankers of Nigeria
(CIBN), Institute of Chartered Accountants of Nigeria (ICAN), and Risk Managers
Association of Nigeria (RIMAN) to widen the scope of their syllabi to cover key aspects of
Basel Accords.
Basel II Accord typically requires banks to make volumes of disclosures on their various risk
decisions for the benefit of their stakeholders. These disclosures include some sophisticated
risk models and assumptions which underlie the decisions being taken. Therefore, Nigerian
71

banks should educate their Boards and senior management staff on the implications of Basel II
on their key business functions especially in such areas as capital requirements, capital
allocation and consumption, risk models and disclosures.
In view of the recent closure of Quantitative Easing Programme in the United States which
appeared to be driving out foreign investors from the Nigerian capital markets; recent
unsavoury drop in the crude oil prices, followed by contractionary monetary policy decisions
of the CBN, Nigerian banks should consider exploring alternative credible channels for raising
capital. The option of foreign corporate bonds may not be advisable at this critical time. The
banks may consider the option of private placement to raise more capital in compliance with
Basel II requirement. They may also consider issuing some exotic hybrid or convertible debt
securities that can favourably compete with government bonds.
While the current regime where Nigerian banks are required to file Internal Capital Adequacy
Assessment Process (ICAAP) report annually should be maintained, the CBN should further
require the banks to carry out stress test on their performance at least on a quarterly basis, with
a view to recognising potential future losses and provisioning for them early enough. The
purpose of this regular exercise is to ensure banks report more objective and realistic profit
figures. The implication of this is that banks would be able to withstand the future shocks and
economic stress, and thus, there might be less incidence of banking failures.
The regulatory authorities should immediately take active steps to enforce Basel II regulations
on other specialized banks such as mortgage banks, microfinance banks, finance houses rather
than focusing on only commercial banks and discount houses. The CBN should also encourage
72

other regulators such as Securities and Exchange Commission (SEC), National Insurance
Commission (NICOM), Pension Commission (PENCOM) etc., to enforce the aspects of Basel
Accord or Solvency II applicable to their domains. By this effort, there would be lower
incidence of regulatory arbitrage.
Market discipline is the third pillar of Basel II Accord, and it requires increased level of risk
disclosures on the part of the banks. International Financial Reporting Standards (IFRS) also
mandates entities to make huge level of financial disclosures. Nigerian banks should
adequately align the disclosure requirements of both Basel II and IFRS in order to ensure that
only relevant information and details are made available to the stakeholders. The CBN may
need to strictly enforce the Guidance Notes issued in this regard, so as to avoid a situation
where banks burry important information into needless disclosure details.

73

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78

APPENDIX 1
QUESTIONNAIRE
I am Sikiru Salami Adio, a Masters of Risk Management (MRM) student at University of
Lagos. I am working on a research project titled ASSESSMENT OF THE IMPACT AND
CHALLENGES OF BASEL II IMPLEMENTATION ON RISK MANAGEMENT
PRACTICES IN NIGERIAN BANKS. In this regard, I request you to kindly spend your
valuable time to fill this questionnaire. The information gathered with this instrument will be
used only for academic purpose and will be kept confidential.
Key terms
Basel Accord: A set of agreements set by the Basel Committee on Bank Supervision (BCBS),
which seek to ensure that financial institutions have enough capital on account to meet
obligations and absorb unexpected losses.
Credit risk: This refers to the risk that a borrower will default on his obligations by failing to
make required payments as and when due.
Market Risk: This refers to risk of loss arising from changes in market rates or prices.
Operational Risk: This refers to risk of loss arising from inefficient or failed systems, people
and processes in an organization.
A. DEMOGRPAHIC INFORMATION
Kindly check the appropriate box (double click the appropriate option)
Age
Below 30 years ( )

30-50 Years ( ) Above 50 Years ( )

Department
Internal Audit/control ( ) Enterprise Risk Management ( ) Credit Control ( )
Financial Control ( )
Others ( )
Qualification
Below Degree ( )

Degree/HND ( ) Post graduate and above ( )

Length of experience
79

0-3 yrs ( )

4-7 yrs (

8-10 yrs (

over 10years (

B. INSTITUTIONAL INFORMATION
1. What banking license does your bank have?
International License

National License

Regional
License

2. What tier does your bank fall into based on balancesheet size?
First tier (Above N1.5
trillion)

Second (N800Billion1.5trillion)

Third tier (Below

N800 Billion)

C. AWARENESS OF BASEL II REGULATIONS (Kindly check each box as appropriate:

double click the appropriate option)
1. What is your assessment of your banks readiness for the Basel II with respect to capital
requirements?
Fully
Prepared

Partially
Prepared

Not Yet
Prepared

Credit Risk
Market Risk
Operational Risk

2. Has your bank done a gap analysis between current risk management practice and new
capital requirements?
Yes

No

Not Sure

Credit Risk
Market Risk
Operational Risk

3. What degree of priority does your bank give to the new Basel regulatory framework?
Very

Important Not sure

80

Important
Credit Risk
Market Risk
Operational Risk

4. How does your bank view Basel II regulation: as an opportunity to enhance the risk
management process, or as a mere regulatory requirement or Not sure?
Opportunity to
enhance risk mgt

Regulatory
constraint

Not Sure

D. ORGANISTIONAL STRUCTURE
1. Does your bank have a Chief Risk Officer (CRO):
YES

NO

NOT SURE

2. If yes, whats the cadre of your banks CRO?

Above General Manager

General Manager

Below General
Manager

3. Who does the Chief Risk Officer (CRO) report to in your institution?
Executive Director

Board and CEO

CEO only

Directly to the Board Only

4. Does your bank have a distinct Board Risk Committee?

YES

NO

NOT
SURE

5. Does your bank have separate manager handling each of Credit risk, Market risk and
Operational risk roles in your bank?
Yes

No

Not Sure

Credit Risk
Market Risk
Operational
81

Risk
6. How many people work in each of these departments?
None

1-5

6-10

>10

Credit Risk
Market Risk
Operational
Risk
ERM
E. REPORTING ABILITY
1. What purpose drives your risk reports in each of these risk areas?
Regulatory Monitoring Business
purpose
decisions
Credit Risk
Market Risk
Operational Risk

2. How frequent is your internal risk reporting? (Tick as many as applicable)

Daily

Weekly

Monthly

Annually

Credit Risk
Market Risk
Operational
Risk
ICAAP
F. COMPLIANCE WITH BASEL II ACCORD
1. Which approach does your bank currently use in computing capital requirement?
Basic
Standardized Foundation Advanced
Indicator Approach
IRB
Approaches
Approach
Credit Risk
Market Risk
Operational Risk
82

2. Given your banks risk profile as at date, do you see an unavoidable need for increased
capital requirement under Basel II?
YES

NO

NOT SURE

3. The idea behind the Basel 2 Accord is that once regulatory capital was strong and kept
strong consistently, it could act as a buffer to a commercial bank during economic downturns.
Do you agree with this notion?
YES

NO

NOT SURE

G. IMPACT OF BASEL II ON CAPITAL ALLOCATION

1. As at date, has your bank ever had cause to estimate the regulatory capital required for each
of its business lines?
YES

NO

NOT
SURE

2. Will your bank outsource or close activities with high capital consumption?
YES

NO

NOT
SURE

3. Is your Bank likely securitize or hedge against selected Risk?

YES

NO

NOT
SURE

4. Does your Bank allocate or intend to allocate economic capital by Business lines?
Yes

No

Not Sure

Credit Risk
Market Risk
Operational Risk

83

H. BASEL II ACTION PLAN

1. Has your bank established an action plan to achieve the Basel II requirements?
Yes

No

Not Sure

Credit Risk
Market Risk
Operational Risk

2. How will (or has) your bank executed this action plan?
Internal
External
Both
Resources Resources
Credit Risk
Market Risk
Operational Risk

3. In your banks Basel implementation project, what has (or will) the largest spending area
be?
Options
IT systems
Training
Human capital
Service
outsourcing
Specify other, if any
4. How far has your bank gone in the implementation of Basel II action plan?
Not
Realized

Partially
Realized

Fully
Realized

Credit Risk
Market Risk
Operational Risk

84

I. IMPLEMENTATION CHALLENGES
What difficulties do you foresee (or already faced) in implementing this Basel II risk? Kindly
rate as appropriate.
Challenges/Rating
System Integration issues
Database Design Issue
Faulty Models

High Medium Low

Limited Budgets
Data gathering Issue
Limited Human resource
Non-availability of IT
infrastructure
scarcity of credible rating agencies
Lack of top level management
support
Low awareness level amongst staff

85