The impact of corporate governance and risk management on bank performance

CHAPTER ONE:

INTRODUCTION

1.1 BACKGROUND TO THE STUDY

As the prime movers of economic life, banks occupy a significant place in the economy of every nation. It is therefore not surprising that their operations are perhaps the most heavily regulated and supervised of all businesses (Soyibo and Adekanye, 1991). The high degree of regulation which characterizes the banking sector fundamentally derives from its exposure to various types of risks (Isu, 1991; Jimoh, 1992)

Over the years, the Nigerian banking sector and/or system has undergone tremendous changes. These changes have their roots in the management of risks in the banking system and problems in the system of corporate corporate governance (Sanusi, 2010). According to Bangudu (2010), the most fundamental problem confronting the Nigerian banking sector is its risk exposure, the inability to manage risks and poor corporate governance structures in the banking system. The purpose of this study, therefore, is to examine and understand the relationship between corporate governance, risk exposure and its management in the context of the Nigerian banking system.

Based on its findings upon the conclusion of a special audit to determine the health of banks operating in Nigeria in 2009, the Central Bank of Nigeria (CBN) declared that, not only were many of the 24 banks deficient in quality leadership, but they were also guilty of poor risk management culture and poor corporate governance practices. In a similar manner, Philips (2010) points out that Nigerian banks are extremely risky, despite a N620bn bailout of the sector in 2009. Philips argues that:

“The Nigerian banking system is still highly risky. The ratings we have for the banks are in the single ‘B’ category, it‘s a very low level compared to most banks in the world.”  Philips argues that there was still a long way to go in the ongoing reform of the banking sector by the Central Bank of Nigeria. “We continue to see the Nigerian banking system as very high risk. In regulatory reform, there is still a long way to go,” he added. Philips continues that, “What Nigerian banks really need is to continue improving their risk management culture, particularly in developing strong asset quality measures” (pp. 12-13).

According to Blaauw (2009), the 1998 amendment to the 1988 Basel 1 accord for market risk has not been implemented yet in Nigeria. As a result, there is no explicit regulatory capital requirement for market risk taken in banks’ proprietary trading activities. Other than in other countries, stockbrokers’ capital requirements are not representative of risks they take in proprietary trading. Market risk capital requirements in other countries have promoted the development of the derivative markets. Limited market risk management practises in Nigeria has also limited growth in derivatives, key instruments in mitigating market risk. Overall, market risk management practises in Nigeria is under-developed and lagging behind other emerging markets. Blaauw (2009) further argues that, “Developing the depth in Nigeria’s capital markets is key to the future growth of the economy and achieving the 2020 aspirations. Existence of sound market risk management practises is crucial to promote investors confidence required for capital market development. Regulators of the Nigerian financial system should therefore take a lead role and adopt the Basel I and II market risk management requirements for implementation by banks and other financial institutions as a national priority.

There is also a relationship between corporate governance and risk management. According to Goje (2010), the weaknesses experienced in the past few years in the Nigerian Banking system in Corporate Governance arrangements, may have led to the current state whereby banks cannot safeguard against excessive risk taking.

The CBN in April 2006 traced the need for a new Code of Corporate Governance in Nigerian banking industry to the poor Corporate Governance practices in the Banks which has been identified as one of the major factors in virtually all known instances of corporate collapse of financial institutions in the country. Citing a survey by the Securities and Exchange Commission (SEC), Corporate Governance was at a rudimentary level in only about 40% of quoted companies in Nigeria as at the period before year 2003.

Among other things, the Central Bank of Nigeria (CBN) identified weaknesses in Corporate Governance practices of Banks in Nigeria as poor risk management practices resulting in large quantum of non-performing credits including insider-related credits. In a related development, the then governor of the Central Bank of Nigeria (CBN) Sanusi (2010) notes that proper risk management is a great antidote to bank failure since it underscores good corporate governance.

According to Olajide (2011), risks management encompasses the whole structure, processes, procedures and policies which an organization has instituted to identify and control the risk inherent in its activities. It is the opinion of this student that, it was the failure of regulation and risk management (the twin important key factors to financial industry) that have been identified as the causes of the global economic meltdown and more specifically, the ongoing crisis in the Nigerian banking sector. Therefore, the primary rules of risk management are: to identify the appropriate risk-return trade off, implement processes and courses of action that will reflect the chosen level of risk and to take appropriate action when actual risk levels exceed planned risk levels. Risk Management involves; managing costs, simplifying complexity and promoting risk culture and disclosure standards, among others.

1.2       STATEMENT OF THE PROBLEM

From the foregoing discussion, it is apparent that corporate governance and risk management is a crucial element in our nation’s quest to sanitize the banking and monetary system. To be able to compete in the global economic system, Nigerian banks must be able to manage their assets in a risk-free environment. Unfortunately, most commentators on the Nigerian banking system have shown that the management of risk is problem area that must be overcome if our monetary policies are to achieve their stated objectives. In this project, we see risk management as a crucial area worthy of exploration in order to understand whether or not our banks are adhering to the principles of corporate governance and risk management, and if not what could be done to rectify the problem.

1.3       OBJECTIVES OF THE STUDY

The general objective of this study is to understand the principles of corporate governance, risk exposure and risk management and its implication on the performance of the banking sector. From the problem statement, we can see that one of the major problems facing the Nigerian banking sector is the inability of the banks to manage risk exposure and poor corporate governance. Consequently and specifically, the objectives of this study are:

(i) To ascertain if the banks selected for this research have instituted risk-management policies and strategies in their organizations.

(ii) To understand whether or not the banks selected for this study understand the concept and usefulness of risk management strategies in the banking system.

(iii) To understand the relationship between corporate governance and risk management.

(iv) To evaluate if risk management systems have impact on the health and efficiency of a bank.

(v)  To make suggestions on ways to adopt and implement risk management strategies in the banking system.

1.4       RESEARCH QUESTIONS

The ability to institute good corporate governance structures and manage risk exposure by banks is crucial for the growth of the Nigerian economy. Therefore, an understanding of corporate governance, risk exposure and strategies for managing risk in the Nigerian banking industry is important. In order to achieve these objectives, the following research questions were used and as a guide for the formulation of the questionnaire used for this study.

1. Do Commercial banks formulate and implement risk management policies and strategies in their organizations?
2. Do bank officials understand the concept and usefulness of risk management   strategies in the banking system?
3. Do bank officials understand the relationship between corporate governance and risk exposure?
4. Do bank officials understand the relationship between corporate governance and risk management?
5. Does risk management have any impact on the operational efficiency of a bank?