AN EVALUATION OF THE IMPACT OF SUPERVISION AND CONTROL OF THE CENTRAL BANK ON THE PERFORMANCE OF COMMERCIAL BANKS (A CASE STUDY OF ACCESS BANK NIG PLC LAGOS BRANCH)

CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
The roles of commercial banks play in the process of economic development in
every country are crucial. They through financial intermediation increase the
levels of national savings and investments by mobilising idle funds from surplus
spending units (savers) and channel them to deficit spending units(borrowers) for
investments in the economy . (UGBAJA 1999)
By playing these roles within a particular country, the independence of global
economics created the need for global interbanking, a trend which in turn
emphasizes the need for the stability of the banks involved in intercontinental
banking transactions.
Also, banking business carries a lot of risks and banking public needs assurance
about the safety of their confidence in the banking institutions.
The need for supervision and control of commercial banks activities is to ensure
that they adhere to the stipulated monetary policies, rules and regulations as well as accepted ethical conducts. However the major contributing factor that has led to the failure of Nigerian banks in the past can be described as moral hazard (adverse incentives). Moral hazards or adverse incentives are a concept with relevance to a variety of principal agent relationships characterized by asymmetric information. The moral hazard concerns the adverse incentives on banks chief executives to act in ways which are contrary to the interests of the banks creditors (mainly depositors or the government if it explicitly or implicitly insures deposits) by undertaking risky
investment strategies (such as lending at high interests rates to high risk borrowers) which, if successful, would ` jeopardise the solvency of the bank. Bank owners have incentives to undertake such strategies because with limited liability, they bear only a portion of the downside risk but stand to gain through higher profits, a large share of the upside risk. In contrast, the depositors (or the
deposit insurers) gain little from the upside risk but bear most of the downside risk. The inability of depositors to adequately monitor bank directors, because of the asymmetric information allows the latter to adopt investment strategies while entail higher levels of risks. Moral hazard on bank executives can be exacerbated by a number of factors. Firstly, an increase in the interest rate may lead borrowers to choose investments with higher returns when successful but with lower probabilities of success (Stieglitz and Weiss 1989) hence a rise in deposit rates could induce banks to adopt more risky investment strategies. A rise in bank lending rates can have a similar incentive effects on the banks borrowers. Secondly, macroeconomic instability can also worsen adverse incentive if it were to affect the variance of the profits of the bank borrowers especially when there
is a co-variance between borrower’s profits. (E.g. if a large share of borrowers are in the same industry) or if loan port folios are not well diversified among individual borrowers.(McKinnon 1988)
Thirdly, the expectation that the government will bail out a distressed bank may weaken incentives on bank executives to manage their asset port folio prudently and incentives on depositors to monitor banks and choose only banks with a reputation of prudent management. Deposit insurance also reduces incentives for depositors to monitor banks. Fourthly, moral hazard is inversely related to bank capital. The owners of poorly capitalized banks have little of their own money to loose from risky investment strategies. By implication, financial distress in the bank itself worsens moral
hazard because, as the value of the bank’s capital falls, the incentives on its owners to pursue strategies which might preserve its solvency are reduced (Berger et al.1995 pp 398-99) for similar reasons intensified competition in banking market can also encourage moral hazard by reducing the franchise value of banks future profits. Moral hazard becomes even more acute when the bank lends to projects connected to its own directors or managers (insider lending). In such cases the
incentives for imprudent and fraudulent bank management are greatly increased in that all of the profits arising from the project are internalized.(in the case of loans unconnected borrowers the project returns are split between lender and borrowers)whereas that part of the losses borne by depositors or task payers are externalised. Not surprising, insider lending is a major cause of bank failure around the world. These ills going on in the commercial banks, as stated above make it imperative for the central bank of Nigeria (CBN) to be on the watch at all times through their
supervisory and control functions so as to protect them from going insolvent which usually impacts negatively on the economy in general. Confidence plays a key role in bank operations. Any information whatsoever implying that the financial position of a bank has worsened can have a negative impact on all the cash flow in that bank. Therefore, every bank will attempt to conceal the problem of insolvency. Banks are highly successful in this respect and
therefore, the problem of insolvency is often not recognised in time by the
government agencies entrusted with bank supervision.
Problems in the banking system or in the economy as a whole occur when a
number of banks become insolvent, or when a relatively large share of the
liabilities of the banking system is not covered by good assets. The occurrence of
such problems indicates that the efficient asset and liability management is
present in a significant portion of banking, if a large part of banks asset is
allocated to unprofitable projects. There will be a reduction in investment
efficiency and thereby a slowdown on economic growth.
These could be decrease or seizure of loans grants to the public when the
problems of bank insolvency begin to be resolved. When banks attempt to restore
solvency by ceasing to grant loans to bad clients and raising the interest speeds,
there is less available loan and they are more expensive. One consequent can be
the negative selection of clients. Enterprises that do not have alternative sources
of financing will be ready to accept higher bank interests rate independently of
whether the projects to be financed are profitable or less profitable. Such a trend
could also exert a negative impact upon investment efficiency.
If banks attempt to solve the problems of insolvency by raising additional funds,
interest’s rates will rise and there will be pressure to conduct a softer monetary
policy. Banks also seize additional liquidity in foreign countries which affects the
trends in the balance of payments.
The right which the central bank of Nigeria has to supervise and control the
banking industry is backed by the CBN Act no 24 of 1991 now CBN ACT 2007 and
the banks and other financial institution Act no 25 of 1991 (now BOFIA 2004).
These laws empowers the CBN to carry out a supervisory and control functions on
all commercial banks and other banks in the country
The powers as specified by section 39 of the CBN Act which may be expressed by
the CBN from time to time in the supervisory and controlling functions include the
powers to specify critical ration to call for information from banks and to inspect
the books of any bank to under condition of secrecy.(Afolabi 2000: 10s)
Section 30and 7 and 8 of the banks and other financial acts no. 25 of 1991 (now
BOFIA 2004) stipulates that every banks shall produce on demand all the books, accounts documents and information as the CBN examiners may deem fit in the
exercise of his functions. It also stipulates as punishable the wilful refusal of any
bank to produce such documents as well as negligence or wilful furnishing of false
information to CBN.
The control of the banking industry by CBN is carried out in partnership with the
federal government, which has the overall authority over the system. Thus the
CBN initiates the guiding policy measure and implements them only as approved
by the government. The CBN measures to control the banks through a number of
stages which include the identification of the objectives and targets of policy.
Policy formulation, policy implementation and review as well as other extra
measures for commercial banks (ogwuma 2004:2).
Supervision and control by the CBN impact significantly on the activities and
performance of commercial banks between 1986 and early 2010, the supervisory
and control measures of the CBN seemed ineffective on a number of occasions
and this contributed to the hitherto, distress in the banking sector. Since 2004,
there has been series of new supervisory and control measures introduced by the
CBN into the banking system with the aim of improving the performance of the
banking sector.
8
Against this background, however the study, however, the study is geared
towards examining the impact of supervision and control of CBN on commercial
banks in view of how their performance is affected from the negative and the
positive perspectives with concentration on the roles that CBN played from 2004
to 2011.
1.2 STATEMENT OF THE PROBLEM
The supervision and control of commercial banks by CBN sometimes impact
adversely on the operations and performance of the former. This is as a result of
difficulties associated with the supervision and control mechanism.
With respect to supervision, it appears that the CBN apparatus are not effective.
Banks examination are often not timely, not regularly carried out or haphazardly
done.
Secondly, some of the CBN examiners are not sufficient competent and thirdly,
they are not large enough to supervise all the commercial banks effectively. The
result is that deficiencies to the operations of these banks are not timely
discovered and adequately controlled. All these adversely affect the commercial
banks.
9
With regard to the control, often times the measures are too stringent for
effective operations and performance of the commercial banks. Restrictive
monetary control measures limit the liquidity and capacity of commercial banks
to grant loans or credit. Besides, direct interactions in banking activities by the
CBN, sometimes have adverse effects too.
In the light of the aforementioned, attempt will be made to appraise the impact
of central banks supervision and control on the performance of commercial
banks.
1.3 OBJECTIVES OF THE STUDY
In lieu of the problems stated above, the objectives of the study are
1. To analyse the objectives of supervision and control of commercial banks in
view of the existing monetary policies of the CBN.
2. To examine the effectiveness of the supervisory and control techniques of
the CBN specifically the ability detects malpractice on time.
3. To assess the impact of supervision and control on the performance of
commercial banks with regards to liquidity.
4. To appraise the ongoing reforms of the CBN.