European Journal of Economics, Finance and Administrative Sciences

ISSN 1450-2887 Issue 17 (2009)

© EuroJournals, Inc. 2009
http://www.eurojournals.com

A Synthesis of the Critical Factors Affecting Performance of the

Nigerian Banking System

Godwin Chigozie Okpara

Department of Banking and Finance, Abia State University, Uturu
E-mail godgozie@yahoo.com

Abstract
This paper is set out to determine the factors impacting most on the performance of the
banking system in Nigeria. To do this, factor analysis technique was used on the factors
identified by the collaborative study of the CBN/NDIC. The result revealed that factors
such as undue interference from board members, political crises, undercapitalization and
fraudulent practices are the most critical factors inhibiting the efficient performance of the
Nigerian financial institutions.
The author therefore contends that the just concluded N25billion recapitalization
exercise of the central bank was a necessary but not a sufficient measure in the right
direction. The sufficient measure must be one that controls all the identified critical factors
at the same time.

1.0. Introduction
Banks in most economies are the principal depositories of the public's financial savings, the nerve
centre of the payment system, the vessel endowed with the ability of money creation and allocation of
financial resources and conduit through which monetary and credit policies are implemented. The
success of monetary policy, to a large extent, depends on the health of the banking institutions through
which the policies are implemented. As a result of this central role of banks in the economy, their
activities have to be kept under surveillance to ensure that they operate within the law in line with safe
and sound banking practices so that the economy will not be jeopardized. Hence, governments
generally legislate to influence and/or directly control banks’ activities to suit the developmental
objectives of the economy.
However, legislation was absent in the Nigeria banking system from August 1891 that marked
the establishment of commercial banking in Nigeria to 1952 when the banking ordinance was enacted.
These years which recorded tremendous failures in the banking system marked the era of free banking
in Nigeria. The era of supervision, examination and control of banks in Nigeria was necessitated by the
banking ordinance of 1952 and subsequent amendments made especially with the establishment of
Central Bank Nigeria (CBN) Act of 1958. The establishment of CBN created the platform for adoption
or monetary management by indigenous personnel, stricter rules and regulations, and improved
institutional facilities.
The basic reason for bank regulation and supervision is to forestall bank failure. If banks were
not regulated and supervised, their power to create money will be unchecked and on one hand, might
result in excessive monetary creation and hence inflation. On the other hand, excessive money creation
may lead to bank distress through loan defaults and thereby halting further lending and jeopardizing
the payment system. Central banks often manipulate money supply through market operations and its
supervisory power over the commercial banks in order to reinforce the efficacy of monetary policy.
35 European Journal of Economics, Finance And Administrative Sciences - Issue 17 (2009)
Also the need for regulation and supervision of banks for prudential reasons arises to ensure that public
confidence in the banking system is maintained, particularly in relation to total convertibility of deposits
without capital loss and the certainty that receipts and payments will be made for and on behalf of
customers with no loss and at low cost.
In the light of this, the Central Bank of Nigeria’s (CBN) examination process involves frequent on-
site examination of bank operations to ascertain that the bank is operating in a sound manner, to determine
the accuracy of financial reports to the regulator and the public, and to ascertain compliance with the law
and regulations. Bank examinations are usually conducted on a surprise basis (without prior notice) and at
random, on either selected branches or aspects of the operations of the bank. The examination could either
be routine inspection or special in-depth investigation to uncover fraud or risk exposure.
Most bank examination activities involve,
i. Determining financial position of the bank and quality of operations
ii. Assessing management quality
iii. Ascertaining compliance with laws and regulations
iv. Testing accuracy of books, accounts and records
v. Verifying asset quality
vi. Assessing bank solvency.
Other areas of bank examination include detection of the existence of fraud, either perpetuated
by bank management or shareholders of depositors and of illegal activities such as the laundering of
illegal funds (Soyibo, Alashi, Ahmed, 2004).
Routine examinations are carried out to establish the soundness or otherwise of the financial
condition of individual banks, their ability to meet the demands of depositors and creditors, the
competence of their management and observance of regulations, and their solvency and viability as
going concerns. Correctly, the frequency of on-site examinations is, on average, once a year.
Examination coverage generally involves visiting a bank’s head office and major branches. As a
minimum, the head office and the branches visited should account for at least 70% of the total risk
assets of the bank. After every routine examination, there is a follow-up action to monitor compliance
with the recommendations constrained in the report.
Special examinations are conducted when the Central Bank of Nigeria/Nigeria Deposit Insurance
Corporation have reason to believe that a bank is carrying on its business in a manner detrimental to the
interests of its depositors and other creditors, has insufficient assets to cover is liabilities, or is contravening
the provisions of the banking and NDIC decrees.
Another examination process conducted by the CBN/NDIC is off-site supervision. Off-site
supervision basically involves maintaining constant surveillance over the activities of all insured banks
through the analysis of their statutory returns and monitoring of banks’ compliance with laws and
regulations. In collaboration with the CBN, the corporation has put in place an off-site surveillance system
that is relatively comprehensive and is designed to provide early warning signals of emerging problems. To
achieve this, banks are statutorily required to periodically submit financial reports which are analyzed and
compared with established performance benchmarks to arrive at an opinion about the financial condition of
the bank using a bank rating model developed for this purposes by the two bodies. The model generates a
rating based on the composite score arrived at for each bank taking into consideration all quantitative and
qualitative information available on the bank. The model has a rating grid that indicates varying degrees of
the state of health of a bank and provides reasonably objective basis for classifying delinquent banks and
deciding on the nature of supervisory intervention required. The potential of this model for early detection
of emerging financial distress can make a difference between taking timely supervisory action to save a
bank from failure, and waiting to discover that the bank had become terminally distressed. With the model,
the supervisory authority is constantly able to keep abreast of individual bank’s financial condition and the
industry’s safety and soundness.
Apart from the primary purpose of ensuring continuous off-site surveillance to monitor the
financial condition and performance of insured banks as well as to ascertain extent of banks’
compliance with prudential standards, off-site supervision also serves some other secondary purposes
of supervisors and the banks. For the former, it facilitates the efficient allocation of bank examiners’
36 European Journal of Economics, Finance And Administrative Sciences - Issue 17 (2009)
resources towards supervised institutions as it assists in prioritizing on-site examination schedule and
identifying the areas of weakness in bank so that attention could be focused on them during on-site
examination. Hence, off-site surveillance system complements on-site examination by providing
information that will enable the on-site examiners become familiar with the operation of the bank even
before physical inspection of the books and affairs of the bank. Furthermore, off-site surveillance
report is useful in providing information that aids the formulation of macroeconomic policies relating
to banking, fiscal and monetary objectives of government. (NDIC, 1999:70)
However the giant steps taken since 1958 and especially the said innovations of the CBN in
1986 has not been able to provide enough backbone for the financial industry as reflected by the down
turn in the events of late 1980s which were characterized by the unprecedented level of distress as
reflected in large volume of non-performing loans, insolvency, liquidity problem and default in
meeting depositors and inter-bank obligations. This poor state of the banking system was exposed in
1989 with the government directive to withdraw the deposits of governments and other public sector
institutions from banks to CBN.
Thus, the number of distressed banks increased at an increasing rate from 7 in 1989 to 60 in
1995 and decreased to 7 in 2000 while the banking system non performing loan started with
N2.9billion in 1989 and peaked at N44.5 billion in 1995, came down to N17.3 billion in 2000 but
picked up from 19.23 in 2001 to N49.60 billion in 2004. (Okpara, 2009). In view of these, it becomes
necessary to identify and classify the factors responsible for this canker worm called distress.
This paper therefore, is divided into five sections. Section 1 is the introduction. Section 2
discusses the factors affecting bank performance in Nigeria, section 3 deals in data collection and
analysis. While section 4 concerns itself with the result of the findings and discussion, section 5
discusses conclusion and recommendation.

2.0. Factors Affecting Bank Performance in Nigeria

A CBN/NDIC collaborative study of distress in Nigerian financial institution in 1995 revealed that
factors such as bad loans and advances, fraudulent practices, under capitalization, rapid changes in
government policies, bad management, lack of adequate supervision, undue reliance on foreign
exchange, economic depression, political crisis, bad credit policy, and undue interference from board
members are factors responsible for bank and other financial institutions distress. Ogunleye (2003)
grouped these factors into institutional, economic; and political factors; including supervisory
measures. The institutional factors are endogenous factors which are largely within the control of the
owners and management of the banks. The collaborative study of the CBN/NDIC submitted that most
of the financial institutions surveyed attributed the distressed conditions to institutional factors. The
result of their study on the major institutional factors and the extent to which they contributed to
distress in the banking industry are presented in table 1 and 2 as follows.

Table 1: Financial Institutions Assessment of the Causes of Distress in the Industry (Percentages)

All financial Commercial Merchant Community Finance

Causes
institutions Banks banks banks houses
Bad loans &advances 19.5 30.1 12.9 17.2 20.3
Fraudulent practices 16.7 16.4 18.8 18.5 18.9
Under capitalization 11.8 7.6 9.6 12.7 9.0
Rapid changes in Govt. Policies 10.8 9.8 5.5 16.9 13.5
Bad management 17.9 13.1 21.7 14.0 16.4
Lack of adequate supervision 16.9 20.1 29.4 17.5 17.5
Undue reliance on Forex 6.4 2.9 2.1 3.2 4.4
Total 100.0 100.0 100.0 100.0 100.0
Source: CBN/NDIC Collaborative Study of Distress in Nigerian Financial Services Industry:
37 European Journal of Economics, Finance And Administrative Sciences - Issue 17 (2009)
Table 2: Analysis of Financial Institutions Assessment of Factors Responsible for their Being Severely
Distressed (Percentage)

All financial Commercial Merchant Community Finance

Causes
institutions banks banks Banks houses
Economic depression 25.0 23.5 - - 33.3
Political crisis 17.9 17.6 33.4 50.0 -
Bad credit 25.0 29.4 33.3 - 40.4
Undue interference from board members 32.1 29.5 33.3 50.0 26.3
Total 100.0 100.0 100.0 100.0 100.0
Source: A CBN/NDIC Collaborative Study of Distress in Nigerian Financial service Industry

The general institutional factors that led to the identified factors on the banking system can be
discussed as insiders abuse, weak corporate governance, weak risk asset management and inadequacy
of capital. Economic and political factors as well as regulatory and supervisory measures will also be
discussed in brief.

a. Insiders Abuse
The government owned bank suffered from incessant/frequent changes in board membership and many
appointments were made based on political affiliation rather than expertise consideration. Consequent
upon this, board members saw themselves as representative, of political parties in sharing the national
cake emanating thereof and thus, ascribed their loyalty to the party members rather than the proper
running of the bank itself. On the side of the privately-owned banks, shareholders constituted a
problem. According to Olufon (1992), the owner-managers regarded banking as an extension of their
operations by appointing their relatives or friends to key positions instead of relying solely on
professional managers. Thus, their appointees were mere loyalists who cared for the interest of their
masters rather than the business itself. Shareholders quarrels and boardroom squabbles were common
among the banks that management attention deviated in favor of unnecessary squabbles.
In some banks where harmony seemed to exist, another type of insider abuse took the form of
the owners and directors misusing their privileged positions to obtain unsecured loans which in some
cases were in excess of their banks statutory lending limits in violation of the provisions of the Banks
and other Financial Institutions Act (BOFIA) of 1991 as amended. In addition, some of these owners
and directors granted interest waivers on non performing insider-credits without obtaining the CBNs
prior approval as required by BOFIA. Their conversion of bank resources to service their other
business interest such as allocation of foreign exchange without naira cover to insiders, later
crystallized as hard core debts. They also indulge in compelling their banks to directly finance trading
activities either through the banks or other proxy companies, the benefits of which did not accrue to the
banks (Ogunleye, 2003). The highlight of the insiders abuse in lending, given the fact that credit had
gone bad for some banks in liquidation is shown in table 3 as follows.
38 European Journal of Economics, Finance And Administrative Sciences - Issue 17 (2009)
Table 3: Facilities Granted to owners and directors of some Banks

No. of directors Amount as at closure

S/No. Banks (In liquidation % of total risk assets
involved (N)
1 Alpha merchant bank plc 11 1,314,418, 700.43 33%
2 United commercial bank ltd 5 741,755,808.86 30%
3 Financial merchant bank ltd 1 383,061,096,00 100%
4 Highland bank of Nig. Plc 12 33,197,157.58 38%
5 Commercial trust bank ltd 1 247,749,719.10 38%
6 ABC merchant bank ltd 8 272,981,634.00 49%
7 Royal merchant Bank ltd 7 646,940,182.23 69%
8 North-South bank of Nig. ltd 13 240,668,637.62 32%
9 Abacus merchant bank ltd 14 568,888,254.11 47%
10 Credit bank Nig. Ltd 6 379,634,611.47 76%
11 Prime merchant Bank ltd 1 539,292,310.00 64%
12 Amicable bank of Nig. Ltd 7 149,854,896.00 56%
13 Century merchant bank ltd 5 272,072,261.00 32%
14 Group merchant bank ltd 13 595,836,077.20 80%
15 Commerce bank Plc 4 1,294,851,665.64 52%
16 Pinnacle commercial bank Ltd 10 298,766,751.76 20%
17 Republic bank ltd 1 161,375,466.00 38%
Source: Ogunleye (2003)

The table shows that in financial merchant bank limited, all the loans (100%) in the bank were
granted to the directors while 80 percent, 76 percent and 69 percent of the loans were granted to the
directors in Group Merchant Bank, Credit Bank Nigeria Ltd and Royal Merchant Bank Ltd
respectively.

Weak Corporate Governance

As a result of the insiders abuse of recruiting inexperienced and incompetent personnel to hold key
positions in the bank, deterioration of management culture and weak internal control system instigated
by the squabbles among the high rank management decision making team, and non compliance with
laws and prudential standards, mismanagement seemed to play a major role in bank failure in Nigeria.
Bank losses increased and management resorted to hiding the losses in order to buy time and remain in
control.
Many banks granted loans with no collateral or with little or no regard to the ability of the
borrowers to repay the loans. In this regard, Ogunleye (2003) noted that the proportion of non
performing loans in the distressed banks had during the period 1989-2000, been consistently high,
reaching about 80 percent of their loan portfolio. This ratio has significantly exceeded the prudential
maximum ratio of 20 percent.

b. Weak Risk Asset Management and Inadequacy of Capital

A number of banks had poor credit policies that loans are granted without securities and/or ability of
the borrowers to pay back. Okpara (1997) noted that it is not uncommon to find securities being over
valued and sometimes funds are disbursed without securities. Odejimi (1992) noted that the major
factors responsible for the precarious financial condition of the banks were huge uncollectible loans
and advances. In this observation, Ajani (1992) puts it that this maladministration of credit portfolio is
one of the most lapses that can make a high-flyer manager lose ever thing overnight capital inadequacy
has been reoccurent in the banking system that from time to time the CBN continues to articulate on
the increase of the capital base of the banking system. For instance the recent N25 billion Naira
recapitalization exercise was meant to beef up the ailing banks capital base.
39 European Journal of Economics, Finance And Administrative Sciences - Issue 17 (2009)
c. Economic Condition
The banking industry being the nerve centre of the economy is invariably affected by economic and
political environment/condition of the country. For instance the Structural Adjustment Programme
(SAP) introduced in 1986 led to a wide range of economic reforms that affected the banking system.
Also political situation like the political crisis resulting from aborted attempt to return the country to
democratic rule in 1993, led to massive withdrawal of funds that affected banks (especially) those
around Lagos adversely.

d. Regulatory and Supervisory Measures

The regulatory and supervisory measures of the CBN/NDIC were unable to keep pace with the rapid
changes in the banking industry. The CBN brief (1999) noted that the ability of the CBN to perform its
regulatory role had in the past been affected by inadequate manpower both in terms of quality and
quantity. NDIC (1995) in discussing the challenges of bank liquidation and deposit payoff, noted that
closing a bank is a specialized job requiring services of technically skilled people in banking,
accounting, legal, quantity surveying, estate management, information management and technology as
well as facility support and also noted that manpower constituted a problem to its supervisory function.

3.0. Data Collection and Analysis

This study adapts the data collected by the CBN/NDIC collaborative study in a field survey of distress
in the Nigerian financial services. Their field survey adopted a deterministic approach by way of
weighting the opinion of stakeholders operating within the industry. Our objective therefore is to
identify the most deterministic individual factor or group factors that might have adversely affected the
performance of the banking system and consequently leading to bank failure in Nigeria. The
identification of this will be of immense use to the regulatory and supervisory authorities and also to
the industry itself that will take precautionary measures to avert itself of failure.
For the purpose of identifying the deterministic factors, factor analytical techniques were used
to assess the significance of the following eleven factors identified by the CBN/NDIC collaborative
study. The factors are coded thus.

Factors Responsible for Financial Distress in Nigeria

X1=Economic depression
X2=Political crisis
X3=Bad credit policy
X4=Undue interference from board members
X5=Bad loans and advances
X6=Fraudulent practices
X7=Undercapitalization
X8=Rapid changes in government policies
X9=Bad management
X10=Lack of adequate supervision
X11=Undue reliance on forex
Factor analysis is often used in data reduction to identify a small number of factors that explain
most of the variance observed in a much larger number of manifest variables. It seeks to collapse the
numerous operating variables into fewer dimensions of interrelated attributes called principal
components. The eigenvalue determines the principal components, which is orthogonally varimax,
rotated to obtain more evenly distributed variables among components.
40 European Journal of Economics, Finance And Administrative Sciences - Issue 17 (2009)
The mathematical procedure of factor analysis assumes that an n x n matrix “A” has
eigenvalues “λ” if there exists a non-zero vector “X”, called an eigenvector associated with λ, for
which:
Ax = λ x (1)
From equation 1, it follows that the matrix A - λI is singular and therefore that:
det (A - λ) = 0 (2)
Equation 2 is a polynomial equation in λ of degree n from which it follows that A is at most n
eigenvalues. The polynomial det (A - λ) is called the characteristic polynomial of “A”. Some roots of
this characteristic equation are repeated and we have the algebraic multiplicity of the eigenvalue in the
same way as the multiplicity of roots of polynomials. In the even that the multiplicity of an eigenvalue
is greater than the dimension of the vector space spanned by its associated eigenvalues, then the matrix
is defective.
Solving the eigenvalue problem, that is finding eigenvalues and associated eigenvectors is in
general best achieved by solving the characteristic equation (Ebiringa, 2009).
The weighted data of the above variables for the financial institution as given by the result of
the CBN/NDIC collaborative study is presented as follows.
X1 X2 X3 X4 X5 X6 X7 X8 X9 X10 X11
All financial institutions 25 17.9 25 32.1 19.5 16.7 11.8 10.8 19.7 16.9 6.4
Commercial banks 23.5 17.6 29 29.5 30.1 16.4 7.6 9.8 13.1 20.1 2.9
Merchant banks 0 33.4 33.3 33.31 2.9 18.8 9.6 5.5 21.7 29.4 2.1
Community banks 0 50.0 0 50 17.2 18.5 12.7 16.9 14 17.5 3.2
Finance houses 33.3 0 40.4 26.3 20.3 18.9 9 13.5 16.4 17.5 4.4
Source: A CBN/NDIC Collaborative study of distress in Nigeria financial service industry: October 1995.

4.0. Results and Discussions

The estimates of the extent, each factor impacts on the performance of the financial system using the
weighted scores (generated by CBN/NDIC as listed earlier) that are analyzed based on maximum
likelihood extraction analysis are presented as follows.

Communalities

Initial Extraction
X1 1.000 1.000
x2 1.000 1.000
x3 1.000 1.000
x4 1.000 1.000
x5 1.000 1.000
x6 1.000 1.000
x7 1.000 1.000
x8 1.000 1.000
x9 1.000 1.000
x10 1.000 1.000
x11 1.000 1.000
Extraction Method: Principal component analysis

The result of the communalities shows that all the variables are well and completely fitted with
the factor solution, and none could be possibly dropped from the analysis.
41 European Journal of Economics, Finance And Administrative Sciences - Issue 17 (2009)
Total Variance Explained:

Initial Eigenvalues Extraction sums of squared loadings

Component
Total % of variance Cumulative % Total % of variance Cumulative %
1 4.644 42.218 42.218 4.644 42.218 42.218
2 3.626 32.968 75.186 3.626 32.968 75.186
3 1.708 15.531 90.717 1.708 15.531 90.717
4 1.021 9.283 100.000 1.021 9.283 100.000
5 6.16E-16 5.609E-15 100.000
6 3.81E-16 3.471E-15 100.000
7 1.90E-16 1.732E-15 100.000
8 1.27E-18 1.159E-17 100.000
9 -1.27E-16 -1.156E-15 100.000
10 -1.76E-16 -1.607E-15 100.000
11 -4.53E-16 -4.120E-15 100.000

The table shows that four(4) components were extracted under 1.021 eigenvalue minimum. The
clustering of decision factors effecting banks performance deployment within the four components
generated normalized cumulative sums of squared loading of 100 percent. This shows that the four
decision variables depict 100 percent of the characteristics of the eleven(11) isolated factors. In other
words 100 percent of the total variation in the level of hindrance in performance of the Nigerian
financial institutions is explained by cumulative effect of the four components extracted. The four
components are indicative in the screen plot (not shown here). Thus, the surveillance efforts of the
regulatory/supervisory authorities should be articulated more on the four major identified factors.

Component Matrix:

Component
1 2 3 4
X1 -.886 .385 .235 .106
X2 .942 -.043 -.267 -.197
X3 -.834 -.508 .162 .142
X4 .949 .292 -.117 -.010
X5 -.622 .511 -.589 -.070
X6 .424 -.425 .332 .727
X7 .754 .351 .506 -.230
X8 .335 .823 .131 .439
X9 .062 -.828 .514 -.213
X10 .144 -.957 -.231 -.100
X11 -.320 .537 .702 -.340
Extraction Method: Principal Component Analysis

The table shows the loading of the factors into four principle components. Factors, X4 - undue
interference from board members, x2 – political crisis, x7 – undercapitalization and x6 – fraudulent
practices are the most critical factors inhibiting the efficient performance of the Nigerian financial
institutions.
Thus, regulatory/supervisory efforts of the central bank and the Nigerian Deposit and Insurance
Corporation (NDIC) should be articulated more on the identified factors most especially on the undue
interference from the board members which load positively maximum in the component matrix.

Conclusion
The regulatory/supervisory efforts of the central banks and the Nigerian deposit insurance corporation
should be articulated more on the undue interference from board members, political crises,
undercapitalization and fraudulent practices of the insiders. These factors are the most critical factors
42 European Journal of Economics, Finance And Administrative Sciences - Issue 17 (2009)
inhibiting efficient performance of the Nigerian financial institutions and where they can be
simultaneously arrested; the problem of bank failure will be put to a halt.
The just concluded (N25 billion) recapitalization exercise of he central bank was a necessary
but not a sufficient measure in the right direction. The sufficient measure must be one that controls all
the identified critical factors at the same time.

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