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

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CHAPTER ONE

INTRODUCTION

1.1    BACKGROUND OF THE STUDY

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

Although such statements contain an element of truth, they do not adequately express the complete nature of the protective functions of banks capital funds. Most weak looking bank assets can be phased out with relatively little loss given sufficient time, competent management, reasonable earnings, and the workings of the business cycle (Liewellyn, 1999:5). Therefore, the primary function of bank capital is to keep the bank open and operating so that gain and earnings can absorb losses in other words, to inspire sufficient confidence in the bank of the part of depositors and the supervisor so that it will not be forced into costly liquidation. In this sense, capital services to protect the stockholder as much as, if not more than the depositor (ibid).

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

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

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

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

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

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

These are;

 

 

1958The share capital for foreign banks increased to £20,000. That of the indigenous one remained unchanged
1962The minimum share capital for indigenous bank increased from £12,500 to £250,000. This was a 1,900 percent increment, with 7 years of grace period.
1969Sec. 6 of Banking Act increased the share capital to £300,000 and £750,000 for indigenous and foreign banks, respectively
1988It was raised to N10m
1990N20m
1991N50m
2000N1bn
2002N2bn

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

This represents an increase of 1250 percent from that of two billion naira (Uche, 1998:31-32. Eke, 2005:1).

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

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

 

1.2    STATEMENT OF PROBLEM

A clear understanding of the role of banks in the economy is to improve the standard of living of its citizenry and impact positively on the economy by providing financial resources to absorb unexpected losses. A major engine of economic growth of any country is its capital adequacy, hence without adequate capital from the bank the economy may be starved of the long-term funding for sustainable development.

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

 

1.3    OBJECTIVES OF THE STUDY

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

 

Therefore, the specific objectives of this study are;

  1. To examine the impact of capitalization of banking sector in boosting the economy
  2. To determine how capitalization of banking sector is enhancing the lending ability of banks.
  • To ascertain the rate of growth in the development of recapitalization of banking sector in the Nigeria capital market.
  1. To recommend what can be done to maintain or enhance efficiency n the contribution of banking sector.

 

1.4    RESEARCH QUESTIONS

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

The questions are;

  1. Has recapitalization of banking sector aid the process of development of Nigeria economy?
  2. How has capitalization of banking sector enhanced the lending ability of banks?
  • Is there a speedy development of recapitalization of banking sector in Nigeria capital market?
  1. What can be done in capitalization of banking sector in order to enhance development and efficiency.

 

1.5    RESEARCH HYPOTHESES

The following hypothesis form the frame work for carrying out this study.

Hypothesis 1

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

Hypotheses II

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

Hypotheses III

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

 

Hypotheses IV

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

 

 

1.6    THE SIGNIFICANCE OF THE STUDY

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

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

  1. To strengthening the banking system in Nigeria, reducing the fear of financial distress and promoting depositor and investors confidence and friendliness.
  2. Reducing the interest rate in the economy from its present high level which discourages investment particularly the long term ones.
  3. Encouraging partnership particularly with government and strengthening the capital market.
  4. Enhancing competition among banks and eliminating the armchair banking phenomenon in Nigeria.
  5. Launching Nigeria into international financial intermediation in a big way and enhancing foreign investment inflow.

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

  • It will bring to light the various views on the current twenty five billion naira (N25bn) capitalization debate.
  • In the academia, this work will help to broaden the knowledge of students on the issues concerning the capitalization of banking industry and other macro-economic issues.

 

1.7    THE SCOPE OF THE STUDY

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

1.8    OPERATIONAL DEFINITION OF TERMS

  1. Acquisition: Is an act of acquiring effective control by one company over assets or management of another company without any combination of companies.
  2. Bank Capital: This is the paid up capital and reserves, unimpaired by losses, in other words, it is the share holders funds as published in the balance sheet.

iii.      Merger: A merger is said to occur when two or more companies combine into one company or they may merge with an existing company or merge with a new company.

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

iv.      Banking sector soundness

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