Causes of Bank Distress and Resolution Options in Nigeria Essay Example

that individual bank’s incompetence at managing risks is a cause of bank distress, there are also some exogenous factors beyond banks’ control that could precipitate bank distress. These includes adverse developments in the macroeconomy and policy reversals.

Furthermore, lapses in the regulatory/supervisory framework as well as the legal/judicial system also contribute to the incidence of distress. From the multiplicity of causes and the complexity of the distress phenomenon, it is apparent that its resolution cannot be a one-size-fits-all solution.

Bank distress may be localized or widespread among depositors. For each scenario, a menu of options is available. This paper examines the broad factors causing bank distress and the array of resolution options.

To this end the rest of this paper is structured into 4 parts. Section 2 examines the meaning of bank distress while section 3 presents detailed discussion of the main causes of bank distress as they relate to Nigeria in particular. Section 4 provides a review of the literature on resolution options as well as an enumeration of resolution options adopted to address bank distress in Nigeria.

Section 5 summarizes and concludes the paper.

Literature Review

In ordinary parlance, “distress” connotes being in danger or difficulty and in need of help.

According to Smith and Wall(1992), it is a state of “inability” or “weakness” which prevents the achievement of set goals and aspirations, Bentson, (1986) associates distress with a cessation of independent operations or continuance only by virtue of financial assistance from the banking system’s safety net such as the supervisory/regulatory agency or a deposit insurer. Ologun, (1994) describes a financial institution as unhealthy if it exhibits severe financial, operational and managerial weaknesses.

CBN/NDIC(1995) describes a distressed

financial institution as “one with severe financial, operational and managerial weaknesses which have rendered it difficult for the institution to meet its obligations to its customers, owners and the economy as and when due”.

Without necessarily implying the degree or nature of the problem, a bank is said to be distressed when it is either illiquid and/or insolvent to the extent that its ability to discharge its obligations as at when due is impaired.

In more precise terms, illiquidity is a state of inability to meet payments obligations to customers as at when due, while insolvency is a situation in which the value of the firm’s liabilities is in excess of its assets’ value i. e. negative net worth. The above description relates to an individual banking firm.

However, when a sizeable proportion of the banks in the system are experiencing this phenomenon to the extent that their inability to honour their obligations threatens the stability of the entire banking system, the banking system is said to be distressed.

CBN/NDIC, (1995) describes banking system distress as “a situation in which a sizeable proportion of financial institutions have liabilities exceeding the market value of their assets which may lead to runs and other portfolio shifts and eventual collapse of some financial firms”. In a similar tone, the Federal Reserve Bank of San Francisco(1985) describes distressed financial system as one in which “there is a sharp reduction in the value of financial institutions’ assets, resulting in apparent or real insolvency of many financial institutions accompanied by some runs and possibly the collapse of some institutions”.

Furthermore, depending on whether public confidence in the system has been eroded or not,

financial system distress is classified into two namely, generalized or systemic.

If public confidence has not been adversely affected by the incidence of distress, though widespread among the institutions, it is regarded as generalized distress otherwise, it is systemic distress. CBN(2002) provides a working definition systemic bank distress as “those situations where the solvency and/or liquidity of many or most banks have suffered shocks that have shaken public confidence”.

To operationalise this, threshold were set using some indicators of deterioration in the aggregate performance of banks. Specifically, a systemic distress would be said to have occurred when at least two of the following situation arises: ? Where the banks that are critically distress control 20% of the industry’s total assets; ? 15% or more of total deposits are threatened and ?35% of banking system’s total loans and advances are not performing.

The significance of the use of thresholds is twofold.

One is that it provides transparent and objective criteria for public understanding and assessment of any noticeable crisis in the banking system. Second, because these criteria conform with the global standard on banking system supervision, incidence and impacts of distress become more comparable across time and countries. Given the above conceptual description of distress for individual bank as well as for the banking system, we now examine the causes of bank distress which of course are the in reference to individual banks but which in aggregation amounts to the causes of distress for the banking system.