AN EVALUATION OF THE IMPACT OF SUPERVISION AND CONTROL OF THE CENTRAL BANK ON THE PERFORMANCE OF COMMERCIAL BANKS
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EVALUATION OF THE IMPACT OF SUPERVISION AND CONTROL OF THE CENTRAL BANK ON THE
PERFORMANCE OF COMMERCIAL BANKS
ABSTRACT
This
research project tends to evaluate the impact of supervision and control of the
Central Bank on the performance of commercial banks. Access Bank Nig Plc Lagos
Branch was used as the case study. To aid this research both primary and
secondary data were collected. The instruments used to collect data are
questionnaires and oral interviews. The respondents comprised of male and
female from the bank and the population put together is 150 and sample size is
109. The research design used for this work is the survey research method. In
the course of this research the researcher found out that supervisory and
control functions when conducted on a timely and unbiased manner ensures
capital adequacy, high standard of conduct, moderation of bank charges and
profitability. The researcher recommends that bank inspections should continue
to be regular and timely enough; control measures of the CBN should not be too
stringent as to have long negative impact on banking operations. Finally only
competent, skilled and unbiased bank examiners should be engaged in bank
supervision.
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 30
and 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.
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.
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
To analyse
the objectives of supervision and control of commercial banks in view of the
existing monetary policies of the CBN.
To examine
the effectiveness of the supervisory and control techniques of the CBN
specifically the ability detects malpractice on time.
To assess
the impact of supervision and control on the performance of commercial banks
with regards to liquidity.
To appraise
the ongoing reforms of the CBN.
1.4 RESEARCH
QUESTIONS
The
following questions will be addressed in this study
To what extent do the relationship between
the current monetary policies of the CBN and the performance of commercials
banks as it affects granting loans/credit?
To what
extent do the supervisory and control techniques effectives enough to detect
misconduct on time?
How can
these functions of the CBN have any effect on the liquidity of commercial banks?
To what
extent do the ongoing reforms by the CBN affect the performance of the
commercial banks?
1.5
SIGNIFICANCE OF THE STUDY
The
significance of the study derives its usefulness from many respects. Firstly,
the monetary authorities (CBN) and federal government will find the study very
useful. This is because the study will examine the various techniques of
supervision and control of commercial banks and identify their deficiencies and
constraints. This information will then enable the government and the CBN to
take remedial measures which will be suggested in this study.
This study
will also be useful to the banking and non banking financial institutions. It
will provide information on why many of them operate and perform dismally under
the CBN supervisory and control functions. This will give these institutions an
understanding of their weakness and the information will enable them to take
corrective actions which again will be suggested in this study.
Again,
investors and banking public will appreciate this study because of the
information it contains. The study will enable them to understand the role of
the CBN in ensuring safety of their funds in the banks and this will help in
sustaining their confidence in the banking industry.
Finally the
study will be useful to students who will carry out related studies; it will
serve as a relevant material to them.
1.6 SCOPE OF
THE STUDY
The study
focuses on the importance of the CBN supervision and control on the performance
of the commercial banks. Thus, its scope covers the need for supervision and
control as well as goals, techniques and effects of these exercises on
commercial banks operations and performances
1.7
LIMITATIONS OF THE STUDY
The
limitations of the study may include.
The
difficulty of obtaining primary information from CBN and some commercial bank
staff their uncooperative attitude may adversely affect primary data
collection.
Inadequate
finance which may pose a restriction with regards to travelling outside Enugu
to include many more commercial banks for an extensive study. Therefore the
study may be restricted to Enugu metropolis only.
The
difficulty of combining the research with other academic works in the school.
1.8
DEFINITION OF TERM
1. BOFIA-
Bank and other financial institution act.
2. NDIC-
National deposit insurance corporation.3. AMCON- Asset management corporation
of Nigeria
4. CBN-
Central bank of Nigeria.
5. NSE-
Nigerian stock exchange.
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