Conducting Observations

It is in the light of the above developments that new initiatives and control measures have been put forward at various levels with a view to make the banking sector secure. Some of these suggestions are highlighted here under:

1. Good corporate governance.

2. Leadership by good example.

3. Transparent compliance with regulations and guidelines as well as - financial sector standards.

4. Emplacement of corporate contingency plan and framework for risk management (including effective internal control systems).

5. Self-regulations by operators.

6. Due customer diligence.

7. Manpower training and development (Human capacity building).

8. Co-operation and where necessary dialogue with regulatory authorities.

9. Collaborative competition.

10. Policy stability with only needful fine-tuning.

11. Ethics and professionalism.

12. Respect for law, order and rights of others.

13. Consumer care and sensitivity.

14. Proactive supervisory and surveillance activities.

15. Research and development.

16. Use of modern technology.

17. Good corporate citizenship.

18. E-banking regulation.

19. A new sanction execution regime.

4.0 CONCLUSION

It is my view that if a greater proportion of the above are sincerely adopted and implemented, all stakeholders as well as the entire system model would be better for it. To weather the storm and make the financial sector not only resilient but also growth and development oriented, there must be true understanding, co-operation and collaboration between participants in the market.

Finally, the old adage that the customer is "king" may have become an Old Testament phraseology. But the new age is a derivative of the old and without the old, there probably would be nothing new. It should therefore be the vision of regulators and operators to serve, not themselves, but customers and consumers of financial services.

Proper recognition and situation of this fact should elicit a new approach to the management and handling of affairs in financial institutions to ensure that the customers, consumers and indeed, all stakeholders in the system are protected against bank distress and failure whether or not financial institutions are regulated

5.0 SUMMARY

In this unit, we had considered an important unit viz: critical and emerging aspects of banking practices that requires control and regulation.

In the next and final unit, we shall consider the forms and methods by which regulatory authorities carryout their supervisory roles and responsibilities.

6.0 TUTOR-MARKED ASSIGNMENT

1. Why is the banking industry considered unique with regard to regulation?

2. It can be argued that since banks are made up of different departments or units, subjecting all the departments to control can have adverse implications for profit performance. To enhance the profitability of banking operations, it may be advisable to control the activities of some departments but not all. How would you contribute to this argument?

3. Identify the critical areas of banking operations subject to strict regulatory control.

Suggested answers:

The banking industry is unique in terms of regulation because experience has shown that failure of one bank has external consequences. Failure of an individual bank could lead to widespread panic and runs which may be transmitted to other banks leading to instability in the banking system and by extension the entire economy. This phenomenon is known as contagion effect and it is so strong that no matter the size of a bank, its failure may have far-reaching implications for the economy.

Every department of a bank is important to the success of its operations and must be given due attention. However, like in other modern organizations, the systems approach is adopted in the regulation of banking institutions. This approach treats every aspect of banking business as important because its failure threatens the stability of the entire institution. However some segments, departments or units are more sensitive and are therefore regulated more than the others. Therefore each department should be subjected to regulatory controls according to its sensitivity to risk.

Critical aspects of banking practices subject to control include:

 Credit Operations: Loans and advances are the most important as well as the most profitable assets of banks. They are also the riskiest of all banks assets. Being the most profitable, banks are often tempted to give out as much of deposits mobilized as possible in loans because idle cash earns zero returns but this is at the expense of liquidity. The regulatory authorities seek to ensure stability of the banking system through directives requiring banks to maintain different reserve accounts (e.g cash reserve ratio, liquidity ratio) as well as specify the limit of credit exposure to certain sectors, individual borrowers (single obligor), etc. Major instruments of control of magnitude and direction of credit flow include the Banking Decrees/Acts, Monetary Policy Guidelines, Prudential Guidelines, etc.

Apart from the regulatory guidelines on the conduct of the lending function, individual banks formulate in-house policies on lending to ensure that loans are kept liquid, thereby minimizing the incidence of bad debts. A well articulated credit policy should aim at effective administration and control of credits. Specified lending limits should be delegated to Officers

and Committees involved in lending and adequate sanctions clearly stated for violation of delegated lending limits. To ensure compliance to delegated lending authority, lending operations should be closely monitored and supervised.

 Bank Capital: It is widely acknowledged that capital adequacy is a key factor in bank performance measurement and evaluation because bank capital, especially first-tier capital or shareholders’ funds, serves as the last line of defence against depositor’s claims on a bank. It is also a major determinant of a bank’s credit delivery capacity. Emphasis on the control of bank capital by the regulators is underscored by the fact bank regulators in Nigeria have relied heavily on bank capital review in attacking banking sector problems. Bank capital review has featured in virtually every banking sector reform in Nigeria since the 1952 Banking Ordinance.

Bank capital is the first of the first of the five bank performance evaluation criteria, acronymic CAMEL, (capital, assets, management, earnings, and liquidity) recognized and adopted by the Bank of International Settlements (Basel System) for bank performance assessment.

1. Internal Control Systems: The increasing wave of frauds and forgeries in the Nigerian banking industry is of special concern to the regulatory authorities because these unwholesome activities undermine the safety, soundness and stability of industry. The high rate of frauds and forgeries indicate evidence of weak or inadequate internal control systems and if not properly regulated could lead to bank failures with attendant negative implications for banking stability and hence economic growth and development.

2. Cash: Statutorily, banks are required to maintain a proportion of their total deposit liabilities in cash with the Central Bank of Nigeria partly as an instrument of monetary control and partly as a first line of defence against shortfalls in liquidity position. It is therefore a liquidity management tool. The requirement for cash reserve ratio (CRR) was introduced as part of the regulatory tools in the Nigerian banking system in 1976 to control the high level of liquidity in the system. It is the percentage level of cash that banks are mandated to deposit with the Central Bank of Nigeria relative to their total deposit liabilities.

Banks also maintain their own policy on the control and management of cash. Cash is the most vulnerable asset of a bank and must therefore be guarded jealously. It can easily be stolen and its origin can be easily be distorted. Some control measures put in place by banks include the mechanism whereby the vault cannot be opened by only person, putting a cap on the maximum level of cash that can be kept in the vault at a point in time, etc.

3. Corporate Governance: Corporate governance connotes the processes involved in the discharge of the mandate of governance in corporate entities. It is the process through which an organization is governed and controlled. The primary objective of corporate governance is to achieve defined corporate objectives thereby maximizing shareholders’

value while satisfying the legitimate expectations of the various stakeholders. This is achieved through effective management.

Management is a critical component of banking practice subject to control. There is substantial evidence of a positive link between corrupt and inept management and distress in banks. If the management team is corrupt, the bank is doomed to fail because major payment approvals are done at their level. They could approve facilities for themselves

and if their activities are not regulated, they have the capacity to liquidate the bank. Also, if the management lacks the technical and administrative competence to conduct the affairs of the bank, sub-optimal decisions could lead to underperformance. Bank regulation in this regard seeks to ensure that only fit and proper persons occupy management positions in banks. Since the objectives of corporate governance can only be achieved through effective management, emphasis on quality of persons to be entrusted with the management of banking institution is not misplaced. In view of the potential threat of corrupt, poor quality and inept bank management to the stability of the banking system, the regulatory authorities have put in place various codes to ensure sound corporate governance in these institutions.

4. Liquidity: Liquidity refers to the ability to meet short-term maturing obligations. Liquidity is a very vital aspect of banking operations which must be closely monitored because of its importance not only for the stability of the banking system but also that of the entire economy. Inability of bank to meet customer withdrawals, for instance, may prompt customers to invade the bank to ask for their money (bank run) and if not controlled could destabilize the banking system as other banks’ customers may massively approach their banks for withdrawals thereby creating a systemic problem (contagion effect) that may likely upset the stability of the economy.

To ensure that banks maintain a level of liquidity necessary to support their operations, the CBN Act 1958 and its subsequent amendments specify that a minimum certain level of customers’ be set aside as liquid assets. This specified minimum is called the liquidity ratio, calculated as the ratio of specified liquid assets to its total deposit liabilities. Liquid assets have minimal (for instance, treasury bills) or no cost (for instance, cash) of realization and are therefore considered a primary line of defence for banks against expected and unexpected customer withdrawals. Beyond the specified minimum, individual banks determine what proportion of assets to be kept in liquid form based on experience acquired over time in the management of customers’ accounts.

The basic motivation for the strict regulatory control over liquidity of the banking system is the desire to achieve a balance between the need to maintain adequate liquidity to meet depositors’ withdrawal demands and the risk of losing earnings capacity by maintaining a sub-optimal level of in idle balance. Like cash ratios, liquidity ratios are measures of short-term solvency of banking financial institutions.

7.0 REFERENCES/FURTHER READINGS

Ikotun, T. (2014), Banking Law, Ethics and Corporate Governance, Oshogbo-Nigeria: Taikot Publications.

Mishkin, F.S. and Eakins, S.G. (2009), Financial Markets and Institutions (6^th Ed), Boston MA:

Pearson Education, Inc.

Okafor, F. O. (2011) Fifty Years of Banking Sector Reforms in Nigeria (1960-2010): -Past Lessons: Future Imperative, First Bank of Nigeria Research Chair Report, Banking and Finance, Nnamdi Azikwe University, Awka, Enugu: Ezu Books Limited.

UNIT 6 FORMS AND METHODS BY WHICH REGULATORY AUTHORITIES