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FINANCIAL SECTOR REFORMS AND ECONOMIC DEVELOPMENT
IN NIGERIA: THE ROLE OF MANAGEMENT
BYDR ESTHER O. ADEGBITE
DEPARTMENT OF FINANCEUNIVERSITY OF LAGOS
BEING A PAPER DELIVERED AT THE INAUGURAL NATIONAL
CONFERENCE OF THE ACADEMY OF MANAGEMENT NIGERIA AT ABUJA,
NIGERIA TITLED MANAGEMENT: KEY TO NATIONAL DEVELOPMENT
NOVEMBER 22 23, 2005 , AT ROCKVIEW HOTEL, ABUJA
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INTRODUCTION
Governmentleddevelopment was the ruling economic development
paradigm in Nigeria up to the 4th quarter of 1986. Under this paradigm
the private sector was a passive partner in development, while the
public sector dominated all other sectors of the economy agriculture,
commerce, services, (especially, transportation) industry etc.
Government designed what are known as National Development Plans,
meant to guide the nation in its development path. In the 1960s and
1970s government had sufficient financial resources to finance a
reasonable proportion of each development plan. By the middle of the
1990s however, the nation had become saddled with an excruciating
external debt burden, falling terms of trade in the international market
place, slow growth of output, high rate unemployment etc, that the
government had to do a rethink of the underlying philosophy of
development in Nigeria. The result was a shift in the economic
development paradigm from government led to private sector led
development. In line with this paradigm shift was the need to relief
every sector of all strangulating regulations that had hitherto
characterised every sector, in governments bid to have firm control
over every sector and ensure that they all move in line with
governments perceived goals for the nation. Therefore, by the 4th
quarter of 1986 a programme was fashioned out for the nation called
the Structural adjustment Programme (SAP). The SAP attempted to
move the country away from government direct control of economic
activities to indirect control, (i.e. control of economic activities
(through the market forces). So, all sectors of the economy were
deregulated trade, exchange, finance, industry etc.
Prior to the deregulation of the economy the financial sector had been
the most highly regulated. The reasons for this are not far fetched.
First to finance development funds are needed, and the stock-in-trade
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of the financial system is fund, so government needed to have a good
grip over that sector especially its banking sub-sector. The financial
system not only provides the intermediation that pools funds from
savers and channel to investors, it also provides the payments system
that facilitates trade and exchange. Furthermore in the working of
governments monetary policy to provide macroeconomic stability for
all economic agents, the financial sector provides the platform for the
working out of this policy.
Given the key position of the financial system especially the banking
subsector, the government rigidly controlled every aspect of their
activities. For instance for the banking subsector government
regulated how much interest banks could charge on the loans that go
the different sectors, and how much loans banks could give (i.e. what
proportion of their loan portfolio) to different sectors. Government
controlled how much interest they could pay on their deposits and at
what rate their credit could grow. There were rigid regulations guiding
entry into the banking system. In the end the financial sector was
repressed, especially the banking subsector which constituted the
greatest proportion of the sector and so could neither generate enough
savings at the ruling rate of interest, nor find enough investment for
meaningful capital formation and development.
Thus at the onset of deregulation the financial sector was also
deregulated; interest rates were freed, and credit became free to
move into whatever sector it desired. Rules concerning entry into the
financial system were relaxed and there was a massive inflow of new
players into the financial sector. By 1992 the number of banks in the
Nigerian banking sector had risen from 56 in 1986 to 120. In the
whole financial system there had been increase in the number of old
type of institutions (e.g. commercial and merchant banks) and entry of
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new kind of financial institutions, (e.g. finance houses, bureaux de
change, Community banks), and entry of a great variety of new
financial instruments etc.
Table 1 below gives the picture of the transformation in the Nigerian
Financial Scene.
Table 1
Institutional Development In The Nigerian Financial sector
After Deregulation.
Banks/Institutions 1990 1991 1992 1993 1994 1995 1996 June 1997
Development Banks 4 4 4 4 4 4 4 4
Specialised banks (i.e A+B) 169 287 629 882 1,089 1,410 1,077 1,077
Community Banks -A - 66 401 611 813 1132 796 721
People's Branches) -B 169 221 228 271 275 275 278 278
Educational Bank - - - - - 1 1 1
Urban Development Bank - - - - - 1 1 1
Maritime Bank - - - - - 1 1 1
Specialised FinancialInstitutions
82 126 871 673 679 745 409 409
Financial Houses - - 618 310 390 368 125 25
Insurance Companies
(Reporting)
80 100 105 105 103 90 90 90
Discount Houses - - - 3 4 4 5 5
Primary Mortgage - 23 145 252 279 280 186 186
Institutions NERFUND 1 1 1 1 1 1 1 -1
NEXIM 1 1 1 1 1 1 1 1
NSITE (NPF) 1 1 1 1 1 1 1 1
Commercial Banks 58 65 66 66 65 64 64 64
Merchant Banks 49 54 54 54 54 51 51 51
Bureaux de change 88 102 132 144 191 223 223 223
Stock Brokerage firms 80 110 140 140 140 162 162 162
Issuing House - - 141 147 162 162 162 162
Registrars 14 14 32 33 40 40 41 41
Source: (i) Umoh, P.N and Ebhodagbe, J.U. (1997) Bank Deposit
Insurance in Nigeria Lagos. NDIC.(ii) CBN (1997) Statistical Lagos, CBN.
However in spite of the increased number and variety of financial
institutions the real economy showed no marked improvement. In fact
by the beginning of the new millenium (2000-2002) all macro
economic indicators were declining. The country was still stuck with a
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suffocating external debt overhang and a suffocating high level of
inflation, as high as 72.8% in 1995, high level of fiscal deficit, and
unemployment low capacity utilization in industry and agriculture. For
the financial sector itself, there was high level insolvency, high level of
non-performing loans and general distress in the system.
Table 2 below shows the degenerating macroeconomic indicators,
while table 3 reveals the deteriorating financial sector performance.
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Table 2.
Selected Macroeconomic Indicators In Nigeria 1990 to 2002.
Real GDPGrowth Rate CapacityUtilization
Rate
InflationRate OutstandingExternal Debt in
billions of Dollars
Balance ofPayments in
billions ofNaira
FiscalDeficit %
of GDP
1990 8.20 40.3 .5 33.1 -5.7 -8.50
1991 4.73 42.0 13.0 33.4 -15.8 -11.00
1992 2.98 38.1 44.0 27.6 -101.1 -7.20
1993 2.64 37.2 57.2 28.7 -42.0 -.15.50
1994 1.33 30.4 57.0 -42.6 -7.70
1995 2.14 29.3 72.8 32.6 -195.3 0.10
1996 3.40 32.5 29.3 28.1 -53.3 1.60
1997 3.15 30.4 8.5 27.1 0.1 -0.201998 2.31 32.4 10.0 28.8 -22.1 -.4.70
1999 2.71 34.6 6.6 28.8 -326.6 -8.40
2000 3.87 36.1 6.9 28.3 314.1 2.90
2001 4.21 42.7 16.5 28.3 24.7 4.70
2002 3.26 44.3 16.1 29.8 -525.7 5.60
Average 3.38 36.18 26.6
Benchmarks
IMF/WBMDG +
East Asia
5.007.00
9.00
Sources (i) Ajakaiye D.O (2003) (See Reference)
(ii) CBN (2002) STATISTICAL BULLETIN + Millenium
Development Goal.(iii) Obadan M. I. (2004) (See Reference)
Note that fiscal deficit which as far back as 1986 the IMF/ World Bank
had recommended that it be not more than 3% of GDP was still as
high as 15.5% in 1993, in spite of the rolling back of government and
the supposed enthronement of the private sector. As for the real
GDP growth rate it was as high as 8.20% in 1990 (i.e. within the first
three years of reform) but by 1994 it has dipped to as low as 1.33%
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which is less than a quarter of its 1990 level. The performance of the
financial sector inspite of the deregulation reforms is also disturbing,
as shown in table 3 below:
Table 3
Performance of the Banking Subsector In The Era of
Deregulation.
Year Total Number
of Banks
Number of
Banks In Distress
Deposits of
Distressed BanksTo Total Deposits
In Banking
Industry
Assets of
Distressed BanksTo Total Assets In
Banking Industry
Amount Required
ForRecapitalization of
Distressed Banks
N billion
1990 107 9 14.6 23.7 2.0
1991 119 8 4.4 16.4 2.41992 120 16 18.1 20.9 2.4
1993 120 33 19.2 18.6 23.6
1994 116 55 29.4 18.6 23.4
1995 115 60 14.1 19.8 30.5
1996 115 50 14.7 11.0 43.9
1997 115 47 9.0 7.6 42.8
1998 89 15 3.5 3.9 15.5
1999 90 13 1.6 1.5 15.3
2000 89 12 2.5 20.0 10.3
2001 90 9 2.0 3.0 12.1
Source : Alashi S.O. (2003) See Reference.
It is important to note that of the 120 banks than were in existence in
1993 four of them had collapsed by 1994 and another one collapsed
by 1995. Of the 115 banks left in the system by 1995, 60 (or more
than half) were distressed. In terms of deposits the proportion of the
distressed banks to the total banking industry was almost 30% in
1994, and to restructure the system the country needed some N23.4
billion naira, this figure almost doubled by 1997 to N42.8 bill. Notice
that even as of 2001 there were still 9 distressed banks while some 26
banks collapsed between 1997 and 1998.
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This trend probably explains why the government through the CBN
came up in July 2004 requesting that all banks beef-up their capital
base from the mandatory minimum of N2 bill to another mandatory
minimum of N25 bill, an increase of over 1000%. The banks were
given till 2005 December to effect the change. One of the reasons
given by the CBN for this latest financial sector reform is that many of
the banks are still in distress, and if they are allowed to fail the
ensuing confidence-crisis might lead to disintermediation,
demonetization, a collapses of the payments system and a serious
depression of the economy.
The questions then arise what went wrong with the reforms? Were
the reform packages inherently faulty? Could the problem have to do
with the management of the reforms? Could the management of the
reforms have been improved upon in terms of management of the
timing of the financial reforms, and the sequencing of the reforms,
coordination of the macro-economic policies that impact the reforms
etc.
These questions form the focus of this paper. While we discuss the
financial sector reforms in general our major focus is on the banking
subsector, for obvious reasons. In sector two of this paper we take a
look at what the literature says concerning deregulation, liberalization
reforms in a repressed economy and economic development.
In section 3 we describe all the reform measures introduced from the
inception of economic deregulation and liberalization policy in 1986 up
to the year 2004. In section 4 we analyse the impact of the financial
sector reforms both on the financial system itself and on the economy
in general. In section five we make a case for sound management of
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the process by the monetary and fiscal authorities as the panacea for
poor reform results, and we also we summarize and conclude the
paper.
2.0 Financial Sector Liberalization Reforms and economic
Development:The Literature.
A discuss of the financial sector reforms and economic development
usually begins with the path-breaking works of McKinnon (1973) and
Shaw (1973). Prior to their studies there had been a general
consensus that there is some positive relationship between the
financial sector development and economic growth. While Schumpeter
(1934) agreed that financial institutions provide efficient means of
mobilizing and allocating funds in the economy and hence assist in the
economic development process, he did not perceive the financial
sector development as being the cause of economic development.
Robinson (1954) has called the financial sector the handmaiden of
economic development. In other words the financial sector is a passive
sector that only responds to the needs of the real sector, and hence
tends to grow as the real economy grows. However the works of
McKinnon (1973) and Shaw (1973) came up with the argument that
the financial sector can be more than an handmaiden to the real
economy, that infact it can be the major driver of economic growth
and development if it can only be relieved of its own fetters. They
argued that when a financial sector is repressed then it can only
respond passively to the real-sector needs. If the financial sector is
liberalized however, it can be the major drive for economic growth and
development. What are the features of a repressed economy?
Mckinnon and Shaw argued that a repressed financial system is
characterized by:
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(i) Administered interest rates both on deposits and loans
(ii) Direct control of allocation of credit
(iii) Ceilings on credit expansion
(iv) Unduly restrictive entry rules into the financial sector
especially into the banking industry.
Williams on and Mahar (1998) arguing along the lines of Mckinnon and
Shaw maintain that if the financial sector is free it can provide the
necessary filip for economic growth and development. They argued
that there are six kinds of reforms that need to be put in place in order
to free a repressed financial system, so that it can take the initiative to
pull up the real sector. These six reforms are:
i. the deregulation/liberalization of interest rates.
ii. Removal of credit controls
iii. Relaxation of Entry-rules into the financial sector especially the
banking subsector
iv. Bank autonomy/which frees the banks from bureaucratic
controls).
v. Privatizing the ownership of banks
vi. Deregulating international capital flows.
Fry (1988) confirmed that when real interest rates are rising the level
of financial intermediation rises and output growth also tend to rise.
Levine et al (2000) also confirmed that as the components of financial
intermediation grow there seems to be positive growth in the real
sector. The causal direction was however not established. When the
financial sector is freed, then the market can, based on the price signal
pool funds and efficiently allocate them. The market signal of price
allows funds to move to where its value marginal product is highest
rather than where some political expediency needs it (Patrick 1966).
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When the financial market is free and the nominal rates of interest
respond to inflation in such a way that the real rates of interest are
positive, savers will be encouraged to save. In the face of a large pool
of financial resources banker themselves are forced to look out for
investors and would be investors encouraging them, and giving
them other needed support as is done in Germany and Japan, so that
the level of investment rises. Freeing the credit allocation function
from the monetary authorities and placing it in the hands of the
market ensures that funds will not go to borrowers that cannot ensure
a meaningful return on the money.
In her study (Adegbite 2004) using the ratio of broad money supply
(M2) to GDP as her measure of financial sector growth and deepening,
found a positive correlation between financial sector growth and real
sector growth in Nigeria. However Adegbite did not attempt to
establish a causal link between the two Beneirenga and Smith (1991)
argued that in a well developed financial system where the securities
market is also developed the ability of the financial system to impart
liquidity to long-term instruments stimulates savers to hold their
wealth in productive assets (debentures, stocks, preferential stocks
etc) and this contributes to productive investment and growth.
Though many do not agree that financial development causes real
sector development as Mekinon (1973) and Shaw (1973) would like to
argue, it is however settled from most research works that there is a
definite, positive and significant relationship between financial sector
growth and real sector growth. Asogwa (2005) identified about ten
indices of financial sector growth and development or financial sector
deepening. These include the rate of growth of broad money relative
to GDP, the interest rate spread, the ratio of financial systems assets
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to GDP and the ratio of gross savings to GDP. As the financial system
deepens the ratio of financial assets to GDP is expected to rise while
the interest rate margin between lending rates and deposit rate is
expected to narrow.
3.0 Financial Sector Reform Measures 1987-2000
Though the deregulation reforms in Nigeria started in the fourth
quarter of 1986 with the setting up of a foreign exchange market in
September 1986, the reforms pertaining to the banking industry
proper did not commence until January 1987. (See Ikhide and
Alawode 2001, Asogwa 2005).
The first reform in the banking sector was the deregulation of the rate
of interest both on loans and on deposits. Banks became free to
charge whatever rates of interest they desired on their different
products based on the forces of demand and supply for them. As
interest rates were being deregulated government also brought out
new rules for setting up of banks and issuing of licenses. The new
rules made entry into the banking system much easier than
previously. The immediate response of the system to these two
policies was a sudden up-surge in the number of banks from 56
(Merchant and Commercial bank) in 1986, the figure rose to 109 by
1990 and 120 by 1992.
As reforms were taking place in the financial sector so were they
taking place in the trade and exchange sectors. In the exchange
sector, the exchange rate was freed from government administration
and a market for auctioning forex was set up. At first there were two
windows, the official window where forex was sourced for government
imports and official transactions at administratively controlled rates,
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and the non-official window where licensed foreign exchange dealers
(usually banks) bid for foreign exchange on behalf of their clients, and
the foreign exchange rate was determined by forces of demand and
supply (See Adegbite 1994).
By 1987 however the two foreign exchange windows were merged to
form one door called the foreign Exchange Market(FEM). By 1988, in
order to absorb the parallel foreign exchange market into the official
market and cater for the needs of small users of forex government
granted licenses for bureau de change operators. As government was
granting licenses to the bureaux de change operators in the trade and
exchange sector, it was also relaxing the rule that had hitherto
forbidden banks from taking up equity position in firms (i.e non-
financial enterprises) while at the same time granting them permission
to engage in insurance brokerage.
In the face of a much greater number of financial institutions
especially banks, than the country had ever had, the government
thought it expedient to protect depositors by setting up a deposit
insurance scheme. Hence the Nigerian deposit insurance corporation
was established in 1988 and started operation in Jan. 1989. The
Central bank of Nigeria deployed some of its staff to start off the
corporation. The NDIC is supposed to ensure financial stability and
provide a healthy banking platform for the economy.
By 1994 another reform measure was introduced. Hitherto banks in
Nigeria had not been paying interest on demand deposits otherwise
known as current account, but now they were granted permission to
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do so. The cash reserve ratio which before the reforms had been
virtually stagnant was revised, to now begin to work as an indirect
instrument of credit control, granting of loans on the strength of
foreign exchange held in foreign accounts was prohibited. All
government deposits held by the commercial and merchant banks
were withdrawn, so that the banks could function without undue
government interference.
In 1993 the Open Market Operations as an indirect instrument of
monetary control was introduced. The first discount house took off in
1993 known as Associated Discount House, subsequently others
followed, and by 2003 there were 5 discount houses. The discount
houses intermediate between the Central bank and the other banks,
off loading government treasury securities from the CBN and
auctioning same to the banks. Where the banks cannot pick-up all of
the treasury securities the discount houses warehouse them. The
reforms introduced also affected the capital base of banks as the
capital funds adequacy ratio was reviewed. The capital adequacy ratio
was moved from 1:12 to 1:10. The purpose of adjusting the capital
adequacy ratio was to ensure that the banks have sufficient capital to
absorb shocks in times of operational losses, and also to ensure that
shareholders in banks have sufficient stake in the system to do a
thorough oversight job of bank management. Hence the prudential
Guideline was released by the CBN in 1990. As this was going on other
reform measures to deepen and expand the financial system were also
going on. Special institutions were in 1989/90 created, this include
the Peoples Bank, the Community Banks, finance companies and
Leasing companies.
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Concerning the capital adequacy issue government through the CBN
Introduced a risk-weighted measure of capital adequacy. The
regulation identified five risk-weights these are 0%, 10%, 20%,
50% and 100%. The banks were told to maintain capital funds of at
least 7.26% of total risk weighted assets. The reform also required
that at least 50% of a banks capital must take the form of core or
primary capital i.e equity plus reserves. In 1990 the equity capital of
commercial banks was raised from N20 million to N50 million, while
that of the Merchant banks rose from N12 million to N40 million.The
1990 Prudential Guideline directed banks to make adequate provisions
for bad and doubtful debt. Banks were required to stop accruing
interest on non-performing loans, while interest that had already
accrued on such accounts should be discountenanced and not be
recognised as income.
Something that used to be in the system before deregulation was
reintroduced this is the stabilization securities. Stabilization securities
are CBNs debt instrument made compulsory for banks to purchase
and they are non-transferable and non-negotiable. The Stabilization
securities carry higher yield than treasury bills.
In 1991 two new decrees were put in place to enhance the powers of
the regulatory and supervisory authorities of the financial system to
enable them manage the reform packages well. The first is, a Central
Bank of Nigeria Decree 24 of 1991 and the, Banks and Other Financial
Institution Decree, 25 of 1991. The new banking sector regulatory
reforms gave the CBN power to issue banking licenses and to revoke
them. It gave the CBN power to apply any type of measure to handle
ailing financial system.
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By 1991 some of the reform measure of 1987 were reversed, a cap
was replaced on interest rates standing at 21% for lending rates and
13.5% for deposit rates. Also a maximum interest rate spread was
specified this was 4%.
By 1992 government divested itself from the seven banks where it had
60% equity holding in line with the new private sector driven
development and privatization. It was believed a full private sector
owned banks would be more efficiently managed and hence more
effective in its operations and have improved performance.
There were reforms in the capital market too which include the freeing
of stock-prices from administrative determination by the Securities and
Exchange Commission (SEC) to a market determined system. By 1997
additional capital market reforms were introduced, while by 1999, fully
foreign owned banks were given licenses to operate. By the year
2000 foreign currency deposits had become institutionalized while by
2001 government went the whole hog and introduced universal
banking, such that a bank can be a single-point unit for an investor,
as a bank with a universal license can carry out merchant banking
functions commercial banking functions insurance functions and also
deal in issue of securities (a capital market function). At the wake of
universal banking government introduced a new capital of N1000
million or N1 billion for each category of banks, and raised it by the
year 2002 to N2 billion. By 2004 July the CBN announced a new capital
base for banks, and this is N25 billion. In the next section as we
analyze the effects of these reforms on the financial system in
particular and the economy in general we will explain the rationale for
the new recapitalization in the banking industry.
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4. Effects Of Financial Reforms On The Nigerian Economy:
1987 2004
The liberalization reforms introduced into any repressed financial
system is supposed to work in the following ways. First free interest
rates especially after a long-time of being kept low by regulation, this
move tends to encourage higher level of savings. In the face of
increased savings all the investment projects at the margin can now
find funding. What is more-with freedom of entry into the system the
increased competition is supposed to ensure that the interest rates are
kept within reasonable limits. The liberalization reforms that brings a
financial sector to the forefront is supposed to transform the financial
system into a supply leading sector. As a supply leading sector the
financial sector is expected to transform the traditional sector (Patrick
1966) by making large funds available (which for instance can
transform a traditional subsistence agricultural sector into a large
commercial plantations., providing latest agricultural implements,
sellings etc). and also making available technical expertise.
The freedom of credit to move is supposed to promote efficiency in
resource use, as credit is expected to move in response to the rate of
return on it in a given sector. This is in contradistinction to the
previous movement of credit to supposedly socially desirable sectors
but that are not able to provide the expected rate of return. As
productive sectors access funds, productivity is expected to rise,
output is expected to rise the rise in output is expected to bring down
prices.
The increasing deepening and expansion of the financial system is
expected to lead to increased variety of financial instruments not only
in the banking subsector but also in the capital market. Greater
availability of varieties of financial institutions and instruments is
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expected to deepen the financial system. Financial deepening can be
measured using several kinds of indices, a few of these are: the ratio
of the growth rate of broad money (M2) to that of the gross domestic
product; ratio of Total banking assets to GDP, Gross Savings in the
economy to GDP as well as Gross Domestic Investment to GDP as well
as the Interest Rate Spread (i.e the difference between lending rate
and deposit rate). The more deepened the financial system the more
expanded the level of output and the rate of growth of output are
supposed to be.
A look at the Nigerian economy since the onset of liberalization
reforms in 1986, especially financial sectors reforms, which started in
1987 really give cause for concern. As shown in section I tables 2 and
3 all of the macroeconomic indicators after the first three years of
reform seem to have taken a plunge downwards. For instance the real
GDP growth rate which used to be in the order of 2.8% to 3% in the
1980 1987, climbed as high as 8.20% by 1990. However from 1991
it started a steady plunge downward which reached its lowest ebb by
1994 when it hit the 1.33% mark. Thereafter the economy struggled
to improve but could not. For the rest of that decade up to the new
millenium the real GDP growth rate did not reach the IMF/WB
recommended 5%, nor the millenium development Goals of 7% nor
the Asian countries performance of 9%.
Inflation climbed down initially from its 2-digit level to get as low as
7.5% in 1990, but by 1995 the season of mass bank failure and
general distress in the financial system, inflation rose to be as high as
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in different sectors of the economy to as low as 6.6% by 1999,since
the new millenium however it has started an upward rise again.
As for financial deepening the result of our analysis shows that midway
into the era of reforms the earlier results of increased financial
deepening started to reverse itself. The table below shows the pre-
Reform And Post Reform level of financial deepening in Nigeria using
some of the includes of financial deepening.
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Table 4
Indices Of Financial Deponing In Nigeria Pre-And Post Financial Sector Reforms.
Year InterestRate
Spread.
Grosssavings to
GDP %
GrossInvestment
to GDP %
CurrencyOutside Banks
to BroadMoney
1980 3.50 11 7 22
1981 4.60 13 5 25
1982 1.25 15 8 25
1983 4.00 17 12 20
1984 3.50 17 17 23
1985 2.25 17 18 21
1986 2.50 19 10 21
1987 5.20 17 11 21
1988 2.67 16 9 221989 5.03 11 5 25
1990 6/64 11 7 23
1991 4.38 12 4 27
1992 10.70 10 2 28
1993 12.58 12 7 29
1994 7.35 12 7 34
1995 7.04 5 2 34
1996 7.80 5 2 31
1997 13.47 6 2 30
1998 12.31 30 9 301999 16.39 30 24 27
2000 13.39 30 25 26
2001 13.08 35 14 26
2002 22.91 4 3 25
Calculate From CBN (2003) Statistical Bulletin
Table four reveals that the interest rate spread which is supposed to
be getting smaller the more efficient a financial system becomes as a
results of deepening, actually started to rise from 1992. Though the
spread came down by 1994, it was never as low as it used to be in
the era of regulation, and in fact from 1997 it rose to much higher
levels than before. This is an indication that whatever reform
happened they did not seen to have improved financial system
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efficiency significantly. With respect to the improved savings -
mobilization effect of reforms there was indeed a great measure of this
from 1998-2001 after the system had experienced a great collapse
that allowed the government introduce more painstaking supervision
and surveillance on financial sector activities especially banking sector
activities. The result of a more closely watched regulation and
supervision after a heavy collapse and some sanitization brought
improved performance in terms of savings mobilization.
The same thing applies to investment, in fact in the case of investment
the years 1994, 1995, 1996 when the financial system was engulfed
in a systemic distress the ratio of investment to GDP plunged to as low
as 2%. What went wrong?
There have been several researches into the banking crisis that
engulfed the Nigerian financial system a few years into the
liberalization reforms (Umoh and Eghodaghe 1977, Alashi 2002,
Adewumni, 2002). What happened is that the liberalization of the
financial sector especially the banking sector posed some immediate
challenges to the sector. First was that of insufficient skilled manpower
to mann the several banks that have suddenly emerged at the same
time. Second was the ability of the banking system to cope with
competition having been stifled of all initiative and steam in the
regulatory era. The third was the incidence of bugging in the system.
This is a situation where borrowers go to borrow with no intention of
paying back (see Kayode and Odusala 2004). This coupled with insider
abuses to ensure that a lot of the loans of some banks went bad. In
fact for some banks as much 70% of the loans went bad. Their
insider-abuses made loan recovery difficult if not impossible;
sometimes the loans were given without collateral, where it was given
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with collateral the collateral were not perfected. Junior managers gave
loans above prescribed limits. All of these were aggravated by
macroeconomic variables, continuously high fiscal deficits which fuelled
inflation, caused lending rates to rise higher, and led to adverse
selection. In the face of rising interest rates there was moral hazard.
As shown in table 3 of section I all of these problems resulted in a
systemic crises which led to the failure of 26 banks by 1997 and to the
failure of another 6 by 2001 Government had to firm up its legal and
supervisory framework by creating new legal instruments to penalize
bank officials and directors that colluded to sap theirs, banks, and by
giving the NDIC and the CBN more powers.
Table 5
Loans and
Advances (N'billion)
Non-Performing
Loans and Advance(N' billion)
Proportion of Non-
performing Loans andAdvances (N' billion)
Year Industry Distressed Industry Distressed Industry Distressed
1989 23.1 4.3 9.4 2.9 40.8 67.1
1990 27.0 6.4 11.9 4.7 44.1 72.8
1991 32.9 5.4 12.8 4.1 39.0 76.5
1992 41.4 15.7 18.8 6.8 45.5 43.0
1993 80.4 25.3 32.9 14.7 41.0 58.0
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1994 109.0 54.6 46.9 29.5 43.0 64.6
1995 175.9 48.9 57.8 29.5 32.9 68.9
1996 213.6 51.7 72.4 33.9 33.9 75.5
1997 290.4 49.6 74.9 40.7 25.81 81.92
1998 327.2 24.2 63.3 18.7 19.3 77.3
1999 370.2 29.1 24.8 21.0 25.6 72.22000 519.0 26.4 111.6 29.0 21.5 75.8
2001 803.0 123.1 135.7 35.4 16.9 28.9
Source: Alashi S. O. (2002).
Table 5 shows the proportion of the banking system loans and
advances that were distressed, the proportion that actually went bad
(i.e of the bad and doubtful loans, which proportion actually became
bad), the proportion of the non-performing loans relative to the loan
portfolio of the institution. For the distressed banks as much as
81.92% of their loans went bad as of 1997.
The effects of the systemic crises were erosion of the publics
confidence, no wonder the proportion of currency relative to broad
money went up (see table 4) as people lost confidence in banking
instruments and would rather hold cash. Portfolio shift as a result of
crises probably account in part for increased capital flight in Nigeria.
The interest rates that are supposed to come down in the face of
competition did not do so investors could not access loans at the
unduly high rates. No wonder ratio of investment to GDP plunged to as
low as 2% in 1994, 1995, and 1996.
By the year 2003 there was still evidence of looming crisis given the
fragile capital base of the banks. The capital base of N2 billion proved
too small for the needed functions of capital i.e provision of cushion for
operating losses, provision of funds for fixed assets and expansion as
well as promotion or fostering depositors confidence.
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Table 6
Ratio of Shareholders Funds to Total Assets of Banks(1995-2003)
(1)Year
(2)Shareholde
rs Funds(Nbillions)
(3)Total assets
(Nbillions)
(4)Ratio (%) (2)/(3)
1995 11.6 414.4 2.8
1996 17.3 491.5 2.8
1997 29.6 627.3 3/5
1998 70.9 760.6 4/7
1999 99.9 1,108.0 9.0
2000 133.8 1,962.6 6.8
2001 183.7 2,449.1 7.5
2002 229.9 2,980.5 7.7
2003 211.1 3,365.2 6.3Source: Umoh P.N. (2004).
Table 6 shows the proportion of bank capital to their total assets. In
1995 it was as low as 2.5%. Such a low stake on the part of
shareholders in the banks can lead to reckless and carefree attitude.
Besides there is need for greater reform in terms of capitalization to
give the banking system a more solid base hence the new N25 billionrecapitalization reform. In the next section we look at ways in which
shrewd management could have helped the reform strategy achieve
its set objective.
5. Skillful Management Of financial sector Reform Process.
5.1 The Role Of Management In Financial Sector Reforms.
It is obvious from the preceding sections that the reform measures inthe financial sector have not been able to achieve the laudable
objectives they were meant to. The question is what went wrong?
Were the reform packages inherently faulty? What role could skillful
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management have played in ensuring that the reform measures
achieved their set goals.
We contend in this section that the reform measures were not
inherently defective given that there are few nations that have used
the same reform packages and got positive results. We argue here
that management of the reform process skillfully would have gone a
long-way in achieving the goals of the country. The question now is
who then are supposed to be the managers of the reform process? It is
the government and the bodies government put in place to oversee
the monetary system in conjunction with the authorities put in place to
oversee the fiscal affairs of the country. In other words the Central
Bank, the Nigerian Deposit Insurance corporation the Ministry of
Finance and the Presidency.
Before we go ahead with our analysis we wish to put in perspective
what management is. Management is said to be the process of
planning organizing, leading and controlling the work of a group of
members of an organization and using all resources available to the
group or organization to reach stated group or organizational
objectives or goals. The managers of any firm, group or nation are
responsible for helping other members of the team achieve the set
goals of the group. In planning, management takes a long-term view,
so that it does not have to take short-term rescue-measures as
unplanned-for-events arise. Also a good management team train
workers for the job they are to perform and raise the quality of those
who will have to supervise others. Good management requires that the
members are encouraged to work closely together rather than focusing
on their divisional distinctions (Stone and Freeman 1992). In line with
the above role of management the monetary and fiscal authorities
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could not work as a team to provide the needed macroeconomic
stability for reforms to work. First as the CBN makes efforts to stabilize
prices, government fiscal indiscipline frustrates those efforts. High
level of inflation was also coupled with high balance of payments
deficit and a fast depreciating exchange rates to negate activities in
the financial sector. Depreciating exchange rates raised the cost of
inputs to the extent that firms that borrowed could not pay back.
So the necessary harmony between the different divisions as good
management practice dictates was not there. What is more-in good
management there is supposed to be long-range planning, not ad-hoc
activities as you stumble along some realities. For instance the deposit
insurance meant to protect depositors and provide stability into the
banking system came three years into the adoption of the reforms,
something that ought to have been put in place ahead of the reform .
The regulatory framework to prevent the fraud and all the malpractices
that came up was not put in place before the reforms.
What is more-in good management the workers are trained for the
job. Both the staff of the supervisors, the NDIC and those of the
regulators the CBN, needed to have gone through intensive training
before the doors were flung open to allow a massive influx of new
banks into the banking industry. The regulators/supervisors could not
cope with the intense demand of the job.
Skillful management also requires that the supervisors must be a step-
ahead of those they must supervise. This would have enable them
detect early the cosmetic dressing of ailing banks books before their
problems become critical.
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Further in planning the timing of the financial sector reforms needed to
have been planned ahead. Time is one of the resources that good
managers plan ahead for. Coming at a time when the trade and
exchange sector had just been liberalized, and the exchange rate was
soaring through the roofs, domestic producers were disadvantaged at
the cost-end and also disadvantaged at the product-price and, as the
imported competing goods somehow were cheaper than home
produced ones. Many of the producers took loans and could not pay
back. Even for the financial sector reforms alone, good management
(on the part of the managers CBN, NDIC, Federal Ministry of Finance
and the presidency) would have meant proper sequencing of the
reforms (See Ikhide and Alawode 2001). Some more appropriate
sequencing have been put forward in the literature. This include the
provision of macroeconomic stability for the on-coming reforms
through reduction in fiscal deficits and hence reduction in inflationary
pressures. Liberalization of the financial sector before the liberalization
of the trade sector and finally the liberalization of the capital account.
Within the financial sector reforms some have argued that before
allowing free entry into the financial system there ought to have been
introduction of indirect monetary instruments first, then the bank
regulatory framework should have been overhauled, then a gradual
relaxation of entry rules into the system while the uncapping of
interest rates should have been lasted. In Nigeria's case the
uncapping of the interest rate came first coupled with exchange rate
depreciating the cost of imported inputs and materials and the high
interest rates drove producers out of the financial markets, and
speculators then had a field day. The Nigerian economy became what
Onimode tagged the CASINO ECONOMY, an economy that only
trades and does not produce anything. All these were due to lack of
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sound management on the part of the managers of the
macroeconomy.
5.2 Conclusion
The adoption of financial liberalization reforms has been a very
laudable initiative given the extent of financial repression that was
prevalent prior to these reforms and the stifling effects of repression
on both the financial sector itself and on the economy as a whole. The
literature had made us expect that if the repressed variables and
aggregates were let loose especially price and direction of credit, that
savings would rise because real interest rates will rise, and investment
will also rise. A look at the table on financial deepening shows that this
expectation did not materialize at least not for any meaningful long-
term. Rather the banks went into a system crisis that made 26 banks
collapse in a single year and another 6 in less than five years after. All
the macro economic indicators do not give cause for cheer. The real
growth rate of GDP is less than the enviable Asian rate of about 9%,
less than the desired one of 7% as envisaged in the Millenium
Development Goals, and even less than the 5% recommended by the
IMF/WB.
We then wondered what went wrong, we know that the fact that some
repressed economies adopted identical measures and had desired
results means it may not be the reforms per se that were faulty but
their management. We looked at the management concept and
analyzed, whether good management practice has been demonstrated
in the management of the reform measures and came to the
conclusion that it have not.
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First the long-term planning of all resources required before the take-
off of a programme was not there, so that there was no NDIC to
protect banking stability until three years into the reforms. Similarly
there was no legal regulatory framework before the plunge into the
reforms. Also provision for necessary macroeconomic stability needed
for the success of the reforms was not made. The necessary harmony
and unity required between different divisions of an organization was
not there as between the fiscal authorities and the monetary
authorities.
Finally the sequencing of the reforms was bad. We suggested as
recommended in the literature a better sequencing (see section 5.1).
We hope the authorities will come together for better synchronization
of fiscal and monetary measures to move Nigeria forward.
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