10,000 3,000

Topic Description



  • Background of the Study

In many societies, liquidation is an unpleasant word because of its negative connotations. It connotes wiping out what was once in existence, winding up a company, killing what was once alive or destroying what had been carefully built over time. When the word is applied after a bank, it is even more frightening. This is so because banks are expected to be safe havens for people’s money and valuables; thus the thought of liquidating such havens is understandably uncomfortable. The discomfort arises from the potential losses that might be sustained by the banks’ stakeholders, namely depositors and the society at large (NDIC, 2008: 2).

With many banks in Nigeria classified as distressed, some licenses withdrawn and some banks acquired by the Central Bank of Nigeria (CBN) at a shameful purchase price of N1 per bank, the issue has ceased to be whether banks will fail or not (CBN / NDIC, 1995). Almost every concerned person is rather asking what will be the possible causes of bank distress, how can problem banks be identified and problems averted (Anyanwaokoro, 1996: 208).

Committee on Banking Supervision (2001) traces the history of financial distress in the Nigerian banking system back to the 1930s when about 21 bank failures were recorded prior to the establishment
of the CBN in 1958. The financial crisis was attributable to a number of reasons including the under-capitalization of banks, weak management, inappropriate corporate governance structures, reckless use of depositors’ funds, excessive growth (over-trading), lack of regulation and supervision, politicization and non-performing loans. Poor loan quality had its roots in the informational problems which afflict financial markets, and which are most acute in developing countries.

In Nigeria, many indigenous banks which commenced operations in the early 1950s went into voluntary liquidation in the mid-1950s with such rapidity that confounded society. Some of the depositors were reported to have lost their lives as a consequence. At that time, there were neither banking regulations nor an institution to see to the orderly liquidation of failed banks. The banks simply closed their doors, never to reopen them (NDIC, 2008:2).

Another financial crisis in Nigeria, which started in 1989 with the identification of seven distressed banks, worsened gradually until 1993 when it led to the collapse of the inter-bank market and spread to all segments of the financial system. The ability of the supervisory agencies to contain, manage and resolve the distress syndrome was severally handicapped due to the absence of a comprehensive regulatory framework for distress management.

Banks provide important benefits to the community, and facilitate the objectives of financial liberalization, by boosting competition in banking markets, stimulating improvements in services to customers and expanding access to credit, especially to domestic small and medium-scale businesses. Financial liberalization in Nigeria brought in its wake a variety of financial institutions operating in the country. Commercial banks increased from 29 in 1986 when financial sector reforms began, by over 124% to 65 in 1992. New deposit-taking financial institutions also came on stream as a result of financial sector reforms. Among banks, these included community banks, the people’s bank
and Mortgage banks, officially called primary mortgage institutions (PMIS). Among non-bank financial institution (NBIS) are finance houses or companies, unit trusts, and discount houses (Soyibo, 1996a). Unfortunately, the attainment of the benefits of financial liberalization in Nigeria has been jeopardized because banks have been vulnerable to financial distress (Brownbridge, 1998). Substantial numbers of banks have failed, mainly due to non-performing loans.

Uche (1997) in his article titled ‘Rethinking Deposit Insurance in Nigeria’, traces the origins of bank distress in Nigeria to the colonial era, during the indigenous banking crisis of 1950s, which necessitated
to the passing into law of the 1952 Banking Ordinance. The ordinance

required the indigenous banks in the British West African Colony
of Nigeria to:

(1)     Have a nominal share capital of at least £25,000 of which not less than £2,500 should be paid up.

(2)     Be licensed by the financial secretary in order to be able to carry on banking business.

(3)     Abstain from granting loans and advances on the security of their own shares and granting unsecured loans and advances in excess
of £300 to any one or more of its directors or to a business
in which it or any one or more of its directors had any interests.

(4)     Maintain adequate cash reserves.

(5)     Maintain a reserve fund out of net profit of each year of not less than 20 percent of such profit until the reserve fund equals the share capital.

(6)     Refrain from paying a dividend until all their capitalized expenditure not represented by tangible assets had been written off, and

(7)     Make periodic returns to the financial secretary.

More damaging to these indigenous banks, however, were sections 5(2) and 6(2) of the ordinance which gave the existing banks three years with which to comply with the provisions of the ordinance or to discontinue banking business. The fact that the indigenous banks were given
a maximum period of three years to meet with the requirements
of the ordinance or face liquidation coupled with the fact that there was no deposit insurance scheme in place to compensate depositors in the event of such liquidation, precipitated a run on these indigenous banks. This contributed to the eventual failure of several of these banks. Between 1953 and 1954, for instance, 17 of the 21 indigenous banks then in existence failed. Not withstanding the fact that most of these banks were poorly capitalized and poorly staffed, the last stages that triggered their mass failure was the government action of regulation.

Thereafter, the banking system remained fairly stable until 1986 when the Babangida Administration under pressure from the International Monetary Fund and World Bank, launched the Structural Adjustment Programme, (SAP). An integral part of this programme was the deregulation of the banking system. Bank licensing policy was liberalized giving rise to a proliferation of banks and other finance institutions. According to Uche (1998), between 1985 and 1992, the number of licensed commercial and merchant banks in the country increased from 40 to 120. Most of these new banks were no more than bureaude changes. The deregulation of the economy, loopholes and sometimes out right evasion of the law made it possible for some of the new banks to survive and prosper by mainly buying and selling foreign exchange.

The deregulation of the economy created both risks and opportunities for the banks and there was increased competition, not just among banks but also with finance houses which were also a creation
of government deregulation. SAP therefore fundamentally changed the structure of banking in the country. The new spirit of competition meant that the decision as to whether banks should fail or not was now to be determined by market forces. Government therefore focused on protecting the depositors, hence the establishment of the Nigerian Deposit Insurance Corporation (NDIC).

The origin of banking crises in the 1990s was, perhaps, the sudden decision, by the Federal Government in 1989, to withdraw public sector deposits from all commercial and merchant banks, leading to serious liquidity crisis in at least nine banks. This prompted NDIC to set
up a liquidity support programme, valued at N2.3 billion, for the affected banks. The government further stretched Nigerian banks with excessive taxation. Government fiscal indiscipline also helped to sabotage macro-economic stability which, in turn, further entrenched distress
in the Nigerian banking sector.

  • Statement of the Problem

Situations where the solvency and / or liquidity of several banks have suffered shocks that shake public confidence have been a source of concern to bank regulators, the government, depositors and the general public. One worrisome aspect of the result of liberalization of the financial sector in Nigeria has been the extent of distress in the sector. For instance, 31 banks were closed between January 1994 and January 1998. The year 1994 witnessed 4 bank closures (1 commercial bank and 3 merchant banks); 1 commercial bank was closed in 1995; 3 banks were closed in 2000; 1 bank was closed in February, 2002; and 1 bank was closed in February 2003. There are also reports that 60 out of the total
of 115 surviving banks in Nigeria in the year 1995 were distressed, representing 52.2% of all the banks existing at the time (NDIC, 2003). A very high proportion of both community banks and finance houses were also reportedly distressed. In 2004, the CBN Governor, Professor Charles Soludo, was quite revealing in his analysis of the distress position of Nigerian banks existing at the time when he classified 62 banks as sound, 14 banks as marginal, 11 banks as unsound, while 2 banks did not render returns. He concluded by saying that, while the state of the Nigerian banking system can be adjudged satisfactory, the state of some of the banks was less cheering (Soludo, 2004:35).

  • Purpose of the Study

In order to better understand the problem necessitating this study, the researcher intends to empirically ascertain determinants of bank distress in Nigeria, as a means of identifying and curbing future incidents of distress in the Nigerian banking industry.

  • Scope of the Study

There are two aspects to bank distress. These are illiquidity and insolvency. The scope of this study is delimited to insolvency as an indicator of bank distress in the Nigerian banking industry.

  • Objectives of the Study

The researcher aims that this study achieves the following objectives:

  • Empirically ascertain whether capital size is a significant determinant of bank distress in Nigeria.
  • Empirically ascertain whether insider lending is a significant determinant of bank distress in Nigeria.
  • Empirically ascertain whether loan quality is a significant determinant of bank distress in Nigeria.
  • Empirically ascertain whether extent of government ownership
    is a significant determinant of bank distress in Nigeria.


  • Research Questions
  • Is capital size a significant determinant of bank distress
    in Nigeria?
  • Is insider lending a significant determinant of bank distress
    in Nigeria?
  • Is loan quality a significant determinant of bank distress
    in Nigeria?
  • Is extent of government ownership a significant determinant
    of bank distress in Nigeria?


  • Research Hypotheses

A hypothesis is a prediction or a conjecture stated well in advance of observance (or actual collection of data) about what can be expected to occur under stated or given conditions (Asika, 1990). Streamlined
to the aforementioned objectives and research questions, the following null hypotheses have been formulated and shall be subjected to suitable empirical tests.

Null Hypothesis 1

HO1:  There is no significant relationship between capital size and bank distress in Nigeria.

Null Hypothesis 2

HO2:  There is no significant relationship between insider lending and bank distress in Nigeria.

Null Hypothesis 3

HO3:   There is no significant relationship between loan quality and
bank distress in Nigeria.

Null Hypothesis 4

HO4:  There is no significant relationship between extent of government ownership and bank distress in Nigeria.

  • Significance of the Study

One advantage of academic research is that it investigates matters which practitioners and policy makers find useful but have little time to study. The significance of this study stems from the important
position banks hold in every economy, developed or undeveloped. Banks are catalysts, around which all other economic activities revolve. A distressed banking sector may be a serious obstacle to economic activity and aggravate the effect of adverse shocks. For instance, when banks are distressed, firms may be unable to obtain credit to deal with a period of low internal cash flow. In fact, lack of credit may force viable firms into bankruptcy. Similarly, lack of consumer credit may worsen declines in consumption and aggregate demand during recession, aggravating unemployment. In extreme cases, bank-run and bank failure can threaten the soundness of payment system, and by extension, the economy. It is against this backdrop that studies on the empirical determinants of bank distress in Nigeria are inevitable as:

–        The study shall be of great importance in minimizing incidence
of bank distress in Nigeria.

–        The study shall be of policy relevance to NDIC and the CBN towards evaluating and managing bank distress conditions
in Nigeria.