Causes of Bank Distress and Resolution Options in Nigeria

Topics: Bank, Central bank, Financial services Pages: 11 (3581 words) Published: August 23, 2010
A meaningful analysis of causes of bank distress and the options for resolution would probably need to be preceded by a brief discussion of the roles of banks in an economy. Bank’s role in any financial system is quintessentially financial intermediation. In this regard, bank’s mobilize financial resources from surplus economic units for on lending to the deficit units. In mobilizing deposits, banks issue demandable claims in favour of the surplus units. However, these savings are pooled and extended to deficit units as illiquid loans and advances with definite and invariably longer maturity than the maturity of the demandable debts. In performing the latter function, banks not only undertake maturity transformation but are also expected to screen the set of borrowing opportunities available to them using unique expertise as well as continuously monitor and obtain repayments. Obviously, by the very nature of banking business, banks are inextricably involved in risk-taking. For instance, banks face the risk of not being able to meet their obligations to depositors to whom they have issued demandable claims. This is called liquidity risk. There is also the likelihood of borrowers failing to repay as agreed, i.e. risk of default or credit risk. Similarly, there is the possibility that the mechanism, processes and controls employed by banks to carry out its functions fail to achieve desired results i.e. operational risk. These are just a few of the risks banks face and their complexities could be astounding. Improper management of these risks is one sure cause of bank distress but this is bank-specific, i.e. endogenous factor. This is in addition to other bank specific factors which also do cause distress.

Besides the fact 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...
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