Critical Analysis Of Causes And Problem Of Financial Distress In Banking Sector
(A Case Study Of Afex Bank Plc)
Financial distress in the banking sector can arise from various interconnected causes and problems. One primary factor is the deterioration of asset quality, often stemming from economic downturns, high levels of non-performing loans, or inadequate risk management practices. Additionally, liquidity challenges, where banks struggle to meet short-term obligations, can escalate financial distress. Poor governance, inadequate regulatory oversight, and lack of transparency further contribute to the vulnerability of financial institutions. External shocks, such as global economic crises or sudden market disruptions, can exacerbate these issues. The interconnectedness of financial institutions in the banking sector also means that the failure of one institution can trigger a domino effect, affecting others and potentially leading to systemic risks. Addressing financial distress in the banking sector requires a comprehensive approach that involves effective risk management, robust regulatory frameworks, and proactive measures to ensure the stability of individual institutions and the overall financial system.
Based on the presentation and analysis of data on the topic CRITICAL ANALYSIS OF CAUSES AND PROBLEMS OF FINANCIAL DISTRESS IN NIGERIA BANKING SECTOR” the following are the major findings.
Inefficient management has contributed significantly to the financial distress in Nigeria banking sector. This was approved statistically with the chi-square test techniques.
It was also discovered that fraudulent practices are a big causes of financial distress in Nigeria banking sector.
Based on the presentation of data and chi-square techniques conducted the researcher was right. Furthermore, it was observed that financial distress in Nigerian banking sector has an adverse effect on the economy of Nigeria as a whole.
Finally, it was equally observed that loan mistnaches contributed to the financial distress in Nigeria banking sector.
Title page
Approval page
Dedication page
Acknowledgement
Abstract
Table of content
List of tables
List of figures
CHAPTER ONE
1.0 INTRODUCTION
1.1 Statement of problems
1.2 Purpose of study
1.3 Significance of the study
1.4 Statement of hypothesis
1.5 Scope of the study
1.6 Limitation of the study
1.7 Definition of terms
CHAPTER TWO
2.0 REVIEW OF RELATED LITERATURE
2.1 Historical background of First Bank Plc
2.2 An overview of capital base
2.3 Under capitalization and its effects on the banking sector.
2.4 Multiplication of Banks
2.5 Inefficient management
2.6 Fraudulent practices
2.7 Loan mismatches
2.8 Effect on financial distress in Nigeria banking sector of the economy.
CHAPTER THREE
3.0 RESEARCH DESIGN AND METHODOLOGY
3.1 Sources of data
Primary data
Secondary data
3.2 Sample used
3.3 Method of investigation.
CHAPTER FOUR
4.0 DATA PRESENTATION AND ANALYSIS
4.1 Data presentation and analysis
4.2 Test of Hypothesis
CHAPTER FIVE
5.0 SUMMARY OF FINDINGS, CONCLUSIONS AND RECOMMENDATION
5.1 Findings
5.2 Conclusion
5.3 Recommendation
Bibliography
Appendix
Questionnaire
INTRODUCTION
The importance of capital as a necessity though not sufficient condition for economic growth is recognized in development economy where it is believed that the position of adequate financial resources is a pre-requisite for industrial transformation.
Experiences in some countries notably Japan, India and Germany have shown that banks if sufficiently in their respective countries could serve as an engine of growth to greatly assist the promotion of rapid economic transformation of any nation. Banks all over the world occupy a strategic and lending position in financial sector. Many Nigerians see banks as places nobody can mess up. Hence, their accepting institutions as the safety place for depositing their money. It is equally because of the confidence they have in the industry as a whole that over the years, many of them imbedded this habit of savings, which in turn is very necessary of positive economic development of the nation.
Ekechi (1995) said that confidence is a pre-requisite for economic recovery and sustained growth, but confidence is not a gift. It must be earned through the adjustment effort or rather confidence is rented because it is never yours and because it can be taken away anytime. The adjustable effort has to go on each and everyday”.
One legacy the structural adjustment programe (SAP) left on its trials is the increase in the number of banks in the country before the introduction of SAP in 1986. The number rose to about 127 as at August 1995. This phenomenal growth of banks was initially hailed as a healthy development in the economy because it was to spread the resources in the economy.
Because of the importance of banks monetary authorities pay great attention to the banking industry. In this process, they are sometimes faced with the problems of how best to handle financial distress in Nigeria banking sector. Financial distress in Nigerian banking sector date back to 1930 when the industrial and commercial bank, (ICB) failed one year after its established.
As Hornby defined distress as “great pains, discomfort of sorrow caused by wants of money or other necessary things.
John Ebhodaghe in explaining financial distress “two major problems are usually of serious concern. These are liquidity and insolvency”. He went further to explain liquidity as the inability of banks to meet its inabilities as they mature for payment while insolvent when the value of its realizable asset is less than the total value of liabilities.
The reasons for early distress of banks are summarized in the following features, which characterized the banks since during the period.
1. Foreign banks domination of deposit base, credit availability.
2. Banks services tailored to the needs of the expatriates.
3. Indigenous bank boom and failure resulting from under capitalization and poor quality management.
4. Lack of banking, control and direction.
Recently, it was realized that the development of statistical based, early warning system for problem banks identification would greatly assist regulators on classifying banks into sound and unsound categories. Worthy of notes is Decree No. 26 of August 1992 that prescribed the following for banks to be adjusted healthy.
1. Specified cash reserve
2. Specified liquidity ration
3. Adherence to prudential guidelines
4. Statutory minimum paid up capital requirement Adequate capital ration
5. Sound management.
Any bank, which did not satisfy any or all the listed factors, is adjudged unhealthy. It must be expressed here that there exist a thin dividing line between a distressed and unhealthy banks. This is because a bank, which is unhealthy in the short-run, may become distress in the long run. At the core of distressed bank, are twos basic problems compared to liquidity the later could not be neglected because it is an ominous sign of insolvency.
Therefore, in assessing the financial condition of a bank, it is customary to use the CAMEL framework. Also ownership structure and types of banks are important factors on explaining the financial condition of a bank. The recent NDIC report revealed that ownership structure was used to explain the degree of financial distress seven out of eight banks, that were financially distressed were either owned or controlled by the state government.
Another indicator of a distressed bank used in most countries of the world is classified assets that exceeds 100 percent of shareholders fund. Following from above, it is therefore reasonable to conclude that a distressed bank is one that is technically insolvent the financial distress is caused by a number of factors including macro-economic conditions, the inhibitive policy of government capital adequacy, wide spread incidence of frauds, non-performing loans, unbraided risk by banks and so on. The effect of financial distress in Nigerian banking sector is a distressed economy. The causes and problems and the ways out of this financial distress will be discussed in details in this work.
1.2 STATEMENT OF PROBLEM
Financial distress in Nigerian banking sector dates back to colonial era. One of the early Nigerian indigenous banks, the industrial and commercial banks, the industrial and commercial banks (ICB) failed in the early 1930’s and between 1992 – 1994, the central bank of Nigeria (CBN) and Nigerian Deposit Insurance Corporation (NDIC) were face with the problems on how best to prevent the financial distress in the banking sector. Within this period, more than thirty banks had been adjudged financially distressed.
The question remains what are the causes of these financial distresses in the banking sector? According to Charles worth, research arises when there is problem to solve, peculiarities or puzzle about a phenomena or the question to attaching meaning to identify and examine the causes and problems of financial distress in Nigerian banking sector.
1.3 OBJECTIVES OF THE STUDY
in writing this project, the researcher had certain objectives in mind. In line wit this following are the objectives of this write up.
1. To identify the extent to which low capital base has contributed to the financial distress in Nigerian, banking sector.
2. To identify to the extent to which multiplicity of banks has contributed to the financial distress in Nigerian baking sector.
3. To ascertain how inefficient management has contributed to financial distress in Nigerian banking sector.
4. To identify to a large extent how fraudulent practices has contributed to the financial distress in Nigerian banking sector.
5. To identify the effects of financial distress in Nigerian banking sector.
6. To recommend possible ways of preventing financial distress in Nigerian banking sector.
1.4 SIGNIFICANCE OF THE STUDY
This study will be immense benefits to the Nigerian banking sector. This will enable them to know the causes of financial distress in Nigerian banking sector, and based on the recommendation of this study, they will know how to prevent financial distress.
Government will also benefit. As the operators of the economy, they will know the causes and effects of financial distress in the economy. Likewise, the depositors and potential investors will also benefits. There is a need for a development conscious country like Nigeria, to evaluate the performance of her financial sectors so as not to jeopardize her development efforts. It is helped that these findings will add to existing literature on causes and problems of financial distress in Nigerian banking sector.
1.5 STATEMENT OF HYPOTHESIS
To come out with a reliable result, the following hypothesis were formulated and tested statistically.
1. Ho: Low capital base has not contributed to the financial distress in Nigerian banking sector.
Hi: Low capital base has contributed to the financial distress in Nigerian banking sector.
2. Ho: Inefficient management has not contributed to the financial distress in Nigerian banking sector.
Hi: Inefficient management has contributed to the financial distress in Nigerian banking sector.
3. Ho: Fraudulent practices have not contributed to the financial distress in Nigerian banking sector.
Hi: Fraudulent practices have contributed to the financial distress in Nigerian banking sector.
1.6 SCOPE AND LIMITATIONS OF THE STUDY
This research work covers the causes and problems of financial distress in Nigerian banking sector with reference to AFEX Bank Plc. In the cause of this study, the researcher could not carry out the work extensively due to the following constraints.
TIME CONSTRAINTS: Time was my greatest enemy as I had to cope with my class work, assignments, home work, and the project work at the same time, and more over, most of the materials for the project work are not located in one place.
FINANCIAL CONSTRAINTS: Finance was my major constraints since I don’t have enough fund for running around and this hindered the full coverage of the work.
1.7 DEFINITION OF TERMS
BANKS: Banks are financial institutions, which hold themselves out to the public (individuals, firms, organization, and governments) by accepting deposits and giving out advances as well as performing other customers.
FRAUDS: Fraud is intentional distorting twisting or changing of financial statement or using criminal deception to deceive someone in order to achieve illegal advantage
LIQUIDITY: Liquidity is inability of a bank to meet its liabilities as they mature for payment.
INSOLVENCY: Insolvency is when the value of realizable assets of a bank is less than the total value of its liabilities.
CAPITAL ADEQUACY: Capital adequacy is when banks through proper fund management has enough capital to serve as a fall back and at course, shock absorber in the event of losses resulting from business transactions.
SHAREHOLDERS: shareholders are the owners of the bank, whose names were described to the memorandum of the bank when the bank is registered. This is done through the purchase of the bank’s shares.
PAID UP CAPITAL: This refers to that part of the issued capital, which has been paid-up.
DISTRESS: This means great pains; discomfort or sorrow caused by wants money or other necessary things.
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Critical Analysis Of Causes And Problem Of Financial Distress In Banking Sector:
Financial distress in the banking sector is a complex issue that can have far-reaching consequences for the stability of the financial system and the broader economy. It’s important to critically analyze the causes and problems associated with financial distress in the banking sector to understand its impact and potential solutions. Here’s a critical analysis:
Causes of Financial Distress in the Banking Sector:
- Asset Quality Issues: One of the primary causes of financial distress in banks is the deterioration of asset quality. This can result from lending to borrowers with poor credit quality, inadequate risk assessment, or exposure to industries facing economic downturns.
- Inadequate Risk Management: Many financial institutions fail to adequately assess and manage risks. This includes underestimating the risks associated with their investment portfolios, such as complex financial products or exposure to interest rate fluctuations.
- Liquidity Risk: Banks often rely on short-term funding to finance long-term assets. If these funding sources dry up, it can lead to liquidity problems and ultimately financial distress.
- Regulatory Changes: Frequent changes in banking regulations can pose challenges for banks in terms of compliance and can impact their profitability. Compliance costs can rise, and profitability can be affected if banks are required to hold more capital as a buffer against losses.
- Economic Factors: Broader economic factors, such as recessions or economic crises, can significantly impact the banking sector. During downturns, loan defaults tend to rise, and asset values can decline, putting pressure on a bank’s balance sheet.
Problems Associated with Financial Distress in the Banking Sector:
- Systemic Risk: When a major bank experiences financial distress, it can trigger a domino effect in the financial system, leading to a broader financial crisis. This systemic risk can result in a severe economic downturn.
- Loss of Confidence: Financial distress can erode public and investor confidence in the banking sector, leading to deposit withdrawals, a loss of trust, and potentially bank runs.
- Government Bailouts: Governments may be forced to step in and bail out failing banks to prevent a collapse of the financial system. This can result in a moral hazard problem where banks take excessive risks, knowing they will be bailed out if they fail.
- Credit Crunch: During times of financial distress, banks may become reluctant to lend, leading to a credit crunch that can stifle economic growth.
- Job Losses and Economic Impact: Bank failures can lead to job losses and have a negative impact on the broader economy, affecting businesses and households.
Solutions and Mitigation Measures:
- Improved Risk Management: Banks need to enhance their risk assessment and management practices to identify and mitigate potential risks effectively.
- Enhanced Regulatory Oversight: Regulators should maintain strong oversight of the banking sector to ensure compliance with prudent lending and risk management standards.
- Diversification of Funding Sources: Banks should diversify their funding sources to reduce reliance on short-term funding, making them more resilient to liquidity shocks.
- Stress Testing: Regular stress testing of banks’ balance sheets can help identify vulnerabilities and ensure they have adequate capital buffers to withstand economic downturns.
- Transparency and Disclosure: Improved transparency and disclosure can help build trust among investors and the public, reducing the risk of panic and bank runs.
- Resolution Frameworks: Developing effective resolution frameworks for failing banks can help minimize the need for government bailouts and reduce moral hazard.
In conclusion, financial distress in the banking sector is a multifaceted issue with significant implications for the economy. Addressing its causes and problems requires a combination of prudent risk management, regulatory oversight, and systemic safeguards to ensure the stability of the financial system.