WHY BANKS FAIL: THINGS TO WATCH OUT FOR

ABSTRACT

The study is based on why bank fail in Nigeria. The study is based

on review of related literature. The study found out that banks fails

because low level of customer patronage; high expenditure and

government policy.

1.0 INTRODUCTION

Bank failure is said to be the inability of a bank to meet up with its

financial obligations to its customers. Banks are seen as financial

distressed when they are technically insolvent and/or illiquid. In

today’s world, banks are one of the main players in the financial

systems, with an active role and thus being necessary to preserve

the public trust in banks. A bank failure has more consequences

both on the financial sector and the nation’s economy with

compared with a company’s bankruptcy. Reason why when it

happens on a large scale it affects the whole banking system which

can be disastrous to the economy.

The most common cause of bank failure occurs when the

value of the bank's assets falls below the market value of

the bank's liabilities, which are the bank's obligations to creditors

and depositors. This might happen because the bank loses too

much on its investments. Bank failures are not uncommon or

unusual, neither are they limited to a few countries. The cost of

bank failure can be high, and if this causes instability in the

financial system, which in turn affects the nation’s growth rate,

then it consequently causes governments or the central bank to

intervene in order to organise a rescue package for the failing

banks. The cost of these rescue packages is high and such

packages are difficult to organise, especially in a competitive

environment. Although bank failures are more commonly observed

in those countries that have deregulated or liberalized their

financial market, they are not uncommon where banks have made

bad loans and carried a high proportion of non-performing loans in

those countries where the financial markets were once highly

regulated and only survived due to government subsidies. Thus, the

question is: why do banks fail. This is why it is important to identify

the main causes and costs of the bank failures, in order to prevent

them, or to avoid at least partially their consequences.

OVERVIEW OF THE NIGERIAN BANKING SECTOR

There has been a wave of restructuring and consolidation of the

banking sector around the globe, particularly in the developed and

the emerging market economies. This has been driven mainly by

globalization, structural and technological changes, as well as the

integration of financial markets. Banking sector consolidation has

become prominent in most of the emerging markets, as financial

institutions strive to become more competitive and resilient to

shocks. It is also promoted by the desire to reposition corporate

operations to cope with the challenges of an increasingly globalized

banking system. It was based on the above premise that banking

sector consolidation, through mergers and acquisitions, was

embarked upon in Nigeria from 2004.

 The Bank consolidation was focused on further liberalization

of banking business; ensuring competition and safety of the system;

and proactively positioning the industry to perform the role of

intermediation and playing a catalytic role in economic

development. The reform was designed to ensure a diversified,

strong and reliable banking sector which will ensure the safety of

depositors' money, play active developmental roles in the Nigerian

economy, and be competent and competitive players in the African,

regional and global financial system.

WHY BANKS FAIL

A) LOW LEVEL OF CUSTOMER PATRONAGE

Customer patronage is achieved when the anticipations of

customers are fulfilled. Excellent customer service does not only

make customers patronize the products, but they also spread

positive word-of-mouth to other people, which is an avenue for

creating profits for the bank. In effect, if customers change their

ways of patronizing, it will have a great impact on the long term

revenue of the bank.

Therefore, when banks do not have high customer patronage it can

lead to failure or liquidity.

B) HIGH EXPENDITURE

High expenditure is another reason why banks fail. When

expenditure is higher than income it can affect the growth of a bank

therefore leading to bank failure.

C) FRAUD AND FINANCIAL IRREGULARITIES

Fraud can be defined as ‘deceit, trickery or sharp practice or breach

of confidence perpetrated for profit to gain some unfair or dishonest

advantage’. Is an intentional mistake or distortions of financial

statement such as misrepresentation or misappropriation of assets.

Fraud is also an intentional deception to cause a person to give up

property or some lawful right.” fraud is the use of one’s occupation

for personal enrichment through the deliberate misuse or

misapplication of employing an organizations resources or assets.”

Fraud in the Nigerian Banking Industry before the recent merger,

acquisition and recapitalization efforts was at alarming rate. It has

caused many banks to collapse, and many investors and depositors

funds were trapped in. Infact it has prevented many banks from

achieving their goals and many businesses went into liquidation.

Honestly speaking it has become a cankerworm that has eating

deep into the financial sector of the Nigerian economy.

D) CBN MONETARY POLICY

Monetary Policy refers to the specific actions taken by the Central

Bank to regulate the value, supply and cost of money in the

economy with a view to achieving Government's macroeconomic

objectives.

This involves the measures through which the central bank

manages the supply of money, in order to stabilize prices. Though

the primary objective of monetary policy is the attainment of low

and stable inflation, the central bank also has the added mandate

to promote economic growth and employment. In practice,

monetary policy plays a counterbalancing role to address price

stability concerns and stabilize the economy.

During a period of high inflation, contractionary monetary policy is

used to reduce the amount of money in circulation while

expansionary monetary policy is used when economic conditions

are weak. Depending on the level of financial development of a

country, monetary policy is usually implemented through the

banking system and financial markets. Implementing monetary

policy involves interactions between the monetary authorities and

financial intermediaries, using tools of monetary policy including

reserve requirements, open market operations, and the policy rate,

amongst others. Various frameworks of monetary policy have been

used including monetary targeting, exchange rate targeting and

inflation targeting, etc.

The primary mandate of the Central Bank of Nigeria (CBN) is

promotion of price stability as enshrined in section 2(a) of the CBN

Act 2007. Price stability is a major monetary policy objective that

enhances predictability of domestic prices, a key requirement for

sound consumer decisions.

HOW TO AVOID BANKRUPTCY

A) REVIEW YOUR STAFFING

One of the ways to avoid bankruptcy is to review your staffing. The

growth of the bank should be synonyms with its staffs. When the

staffs are many, the bank may not be able to pay all its workers.

Therefore, the appropriate thing to do is to review your staffing.

B) CONSIDER MERGERS AND ACQUISITION

Along with globalization, merger and acquisition has become not

only a method of external corporate growth, but also a strategic

choice of the firm enabling further strengthening of core

competence.

Merger and acquisition (M&A) plays an important role in external

corporate expansion, acting as a strategy for corporate

restructuring and control. It is a different activity from internal

expansion decisions, such as those determined by investment

appraisal techniques. Merger and acquisition (M&A) can facilitate

fast growth for firms and is also a mechanism for capital market

discipline, which improves management efficiency and maximizes

private profits and public welfare.

C) WORK TOWARDS RECAPITALIZATION

A banking crisis can be triggered by weakness in banking system

characterized by persistent illiquidity, insolvency,

undercapitalization, high level of non-performing loans and weak

corporate governance, among others.

Capitalization is an important component of reforms in the Nigeria

banking industry, owing to the fact that a bank with a strong

capital base has the ability to absolve losses arising from non

performing liabilities. Attaining capitalization requirements may be

achieved through consolidation of existing banks or raising

additional funds through the capital market.

REFERENCES

References Allen, F., Gale, D., “Financial Contagion”, Journal of

Political Economy 108(1), 2000;

Blejer, M. I., “Central Banks and Price Stability: Is a Single

Objective Enough?” IMF, Journal of Applied Economics, Vol. 1, no.

1 November 1998;

Bongini, P., Claessens, S. and Ferri G., “The Political Economy of

Distress in East Asian Financial Institutions”, Journal of Financial

Services Research project, 19, 2001;

Brown, C., Dinc, S., “The Politics of Bank Failures: Evidence from

Emerging Markets”, The Quarterly Journal of Economics, Vol. 120,

no. 4, November 2005;

Burton, M., Lombra, R., The Financial System and the Economy.

Principles of Money and Banking, third edition, Thomson South-

East Mason, Ohio, 2003;

Caprio, G., Klingebiel, D., “Bank Insolvencies: Cross Country

Experience”, World Bank Policy and Research, WP 1574, 1996;

Chinn, M., Kletzer K., “International Capital Inflows, Domestic

Financial Intermediation and Financial Crises under Imperfect

Information” NBER Working Paper no. 7902, 2000;

Crockett, A., “Why is Financial Stability a Goal of Public Policy?”,

Maintaining Financial Stability in a Global Economy, A symposium

sponsored by The Federal Reserve Bank of Kansas City, 1997;

Das, U., Quintyn, M., Chenard, K., “Does Regulatory Governance

Matter for Financial System Stability? Project materials and

Empirical Analyses”, IMF Working Paper, WP/04/89, May 2004;

Dekle, R., Kletzer, K., “Domestic Bank Regulation and Financial

Crises: Theory and Empirical Evidence from East Asia” NBER

Working Paper no. 8322, 2001;

Demirguc-Kunt, A., Detragiache, E., “Does Deposit Insurance

Increase Banking System Stability?”, IMF Working Papers

00/3/2000;

Dziobek, C. and Pazarbasioglu, C. “Lessons from Systemic Bank

Restructuring: a Survey of 24 Countries”, IMF Working Paper

97/161, 1997;
Gavin, M., Hausmann, R., “The Roots of Banking Crises: The

Macroeconomic Context” in Banking Crises in Latin America, edited

by Hausmann, R. and Rojas-Suarez, L., John Hopkins University

Press, Washington, 1996;

Gupta, P., “Currency Crises, Banking Crises and Twin Crises: a

Comprehensive Review of the Literature”, IMF, 1996