CHAPTER ONE

BANK BASIC OPERATION

Before we proceed to more detailed study of how banks manage their
assets and liabilities in order to make maximum profit, we should understand what
bank operations are.
Generally, banks make profits by selling liabilities with one set of
characteristic (a particular combination of liquidity, risk and return) and using the
proceeds to buy assets with a different set of characteristics. Banks therefore
provide services to the public by transforming one type of asset into another.
Instead of making a mortgage loan to a neighbour, a person can hold a
saving deposit that enables a bank to make the loan to the neighbour. The bank has
in effect transformed the savings deposit into a mortgage loan. This process of
transforming assets and providing a set of services (cheques clearing, record
keeping credit analysis, etc.) is like any other production process in a business
firm. If the bank produces desirable services at low cost and earns substantial
income on its assets then it earns profit, if not, the bank suffers losses.

ASSETS AND LIABILITY MANAGEMENT

The bank manager generally has three primary concerns: Firstly is to make
sure that the bank has enough ready cash to pay its depositor when there are
deposit outflows that is when deposits are lost because depositors make
withdrawals and demand payments.
The manager also is to keep enough cash on hand, the bank must engage in
‘liquidity management’, the acquisition of sufficient liquid assets to meet the
obligation of the banks depositors.
Secondly, of primary concern to managers is to minimize risk by acquiring
assets that have a low default risk, and by diversifying asset holding (asset
1
management). Thirdly, of concern to managers is to acquire funds at low cost
(liability management).

ASSETS MANAGEMENT
In order to maximize profits a bank must seek the highest returns possible
on loans and securities, at the same time trying to minimize risk and making
adequate provisions for liquidity by holding liquid assets.
First and foremost, banks try to find borrowers who will pay high interest
rates and are unlikely to default on their loans. They seek out loan business by
advertising their borrowing rates and by approaching corporations directly to
solicit for loans. It is up to the banks’ loan officer to decide if potential borrowers
are good credit risks who will make interest and principal payments on time.
Typically, banks are conservative in their loan policies; he default rate is usually
less than 1% it is, however, important that banks not be so conservative that they
miss out on attractive lending opportunities that earn high interest rates.
Secondly banks try to purchase securities with high returns and low risk.
Thirdly, in managing their assets, banks must attempt to minimize risk by
diversifying. They accomplish this by purchasing many different types of assets,
and approving many types of loans to a number of customers.
Banks that have not sufficiently sought the benefits of diversification often
come to regret it later. For example, banks that had overspecialized in making
loans to energy companies, real estate developers, or farmers suffered huge losses
in the 1980s with the slump in energy, property and farm prices. Indeed, many of
these banks went broke because they had “put too many rotten eggs in one basket”.
Finally, the bank must manage the liquidity of its assets so that it can
satisfy its reserve requirement without bearing huge costs. This means that will
hold liquid securities even if they earn somewhat lower return than other assets.
2
The bank must decide for example, how much excess reserves must be held to
avoid costs from a deposit outflow.
In addition, it will want to hold federal government securities as secondary
reserves so that even if a deposit outflow forces some costs on the banks, these will
not be terribly high. Again, it is not wise for a bank to be too conservative. I it
avoids all costs associated with deposit outflows by holding only excess reserves
earn no interest, while the banks liability against the increased earnings that can be
obtained from less liquid assets such as loans.

LIQUIDITY MANAGEMENT
Before 1960s liability management was a staid affair. For most part banks
took their liabilities as fixed and spent their time trying to achieve an optimal mix
of assets. There were two main reasons for the emphasis on asset management.
Firstly, over 60% of the sources of bank funds were obtained through checkable
(demand) deposits that by law could not pay any interest. Thus banks could not
actively compete with each other for these deposits and so their amount was
effectively given for an individual bank.
Secondly, because the markets for making overnight loans between banks
were not well developed, banks rarely borrowed from other banks to meet their
reserve needs.
From 1960 onwards many large banks in key financial centres began to
explore ways in which the liabilities on their balance sheets could provide them
with reserves and liquidity. This led to the expansion of overnight loans markets,
such as the federal funds market, and the development of new financial instruments
such as CDs which could enable money large and centre banks to quickly acquire
funds.

3
 With new flexibility management, banks no longer needed to depend on
checkable deposits as their primary source of bank funds, and as a result no longer
treated their sources of funds (liabilities) as given. Instead, they aggressively set
target goals for their assets growth, and tried to acquire funds (by issuing
liabilities) as they were needed.
For example, today when a money centre or large bank finds an attractive
loan opportunity, it can acquire funds by selling a negotiable CD. Or if it has a
reserve short fall, funds can be borrowed from another bank in the federal funds
market without incurring high transaction costs.
While negotiable CDs and bank borrowing have greatly increased in their
importance as source of bank funds in recent times, checkable deposits have
decreased in importance. The new found flexibility in liability management and the
search for higher profits also has stimulated banks to increase the proportion of
their assets held in loans, which earn higher income.

PRINCIPLES OF LOAN MANAGEMENT

Adverse selection in loan market always occurs because those most likely
to default on their loans are ones who usually line up for loans. Borrowers with
very risky investment projects have much to gain if their projects are successful,
and so they are the most anxious to obtain loans. Clearly however, they are the
least desirable borrowers, because of the greater possibility that they will be unable
to pay back their loans as at when due.
To be profitable therefore, banks must overcome the adverse selection and
moral hazard problems that make loan defaults more likely to happen. Attempts by
various banks to solve these problems help explain the following loan management
principles of screening and monitoring, establishment of long-term customer

4
relationships and line of credit; collateral and compensating balance requirements,
and credit rationing.
(a) Screening: - it is creditable venture to the bank if it is able to screen the bad
borrowers out of the long list of borrowers on queue in order to give the
loans to good borrowers. In order to accomplish this onerous task the bank
must collect sufficient reliable information from prospective borrowers.
Effective screening and information collection from an important principle
of loan management.
(b) Banks give put forms that seek a great deal of information about the
borrowers’ personal finances. They seek to know about your salary, bank
accounts, other assets (such as cars, insurance policies, furnishing) and
outstanding loans. Records of loan credit card and charge account payments
the number of years you have worked and who your employers have been.
You also (as a borrower) are asked personal questions such as your age,
marital status and number of children.

The bank uses the result or answer to the request above to evaluate how
good a credit risk you are by calculating your “credit score”, a statistical measure
derived from your answer that predicts whether you are likely to have trouble in
making your loan payments or refund.
Because deciding on how good a risk to the bank is cannot be wholly
scientific, it is pertinent for the bank to use judgment also. The loan officer of the
bank might call your employer or talk to some of the personal references you
supplied. She might even make a judgment based on your demand or your
appearance.
The process of screening and information collection is similar when banks
make business loan. It collects information about the company’s profit and losses
5
(income) and about its assets and liabilities. The bank needs to evaluate the likely
future success of the business. In addition also a loan officer might ask series of
questions about the company’s future plans, the way the loans will be used and the
competition in the industry. She may even visit the company to obtain a first-hand
look at its operations. In fact to hedge against risk therefore whether the loan is
personal or business, bankers need to be nosy.

Specialization in Lending:-
(i) Some banks often specialize in lending to local firms or by lending
mainly to firms in particular industries, say oil industry. In one sense
this bank’s behaviour appears surprising since the concerned banks are
not diversifying their portfolio of loans thus exposing itself to more
risk. From another perspective however specialization makes perfect
sense. It is easier for a bank to collect information about local firms and
thus determine their credit-worthiness than to collect such information
from firms that are far away. Similarly, by specializing its lending
firms in specific industries, the bank becomes more knowledgeable
about these industries, and is therefore able to predict whether the firms
it lends to will be able to make timely payments on their debt.
(ii) Monitoring and Enforcement of Restrictive Convenience:-
(iii) The amount a loan is made, the borrower has an incentive to take on
risky activities that make it less likely for the loan to be refunded. To
reduce the likelihood of such moral hazard; banks must adhere to the
loan management principle that a bank should write provisions (called
restrictive convents) into loan contracts that restricts borrower from
engaging in risky ventures.

6
 This is done by monitoring borrowers activities to see assess their
compliance with the restrictive covenants, and by enforcing the covenant if they
are not; banks can make sure that borrowers are not taking in risk at the bank
expenses. The need for banks to engage in screening and monitoring explains why
successful banks spend much money on auditing and information activities.

LONG TERM CUSTOMER RELATIONSHIP

When prospective borrowers have had checking or savings accounts or
other loans with the bank over a period of time a long officer could look at past
activities on the account and learn quite a bit about the borrower. The balances in
the checking and saving accounts tell the banker how liquid the potential borrower
is and at what time of the year the borrower has strong need for cash.
Long-term customer relationship reduces the cost of information
collection, and therefore makes it easier to screen out good from the bad (credit
risk) borrowers. The customer benefits from this long term relationship. For
example a firm with a previous relationship will find it easier to obtain a loan at a
low interest rate since the bank has an easier time determining if the prospective
borrower is a good credit risk, and as such fewer costs involved in monitoring the
borrower.
Long-term customer relationship enables the banks to deal with moral
hazard contingencies even if they did not think of them ahead of time. It thus
suggests that such relationship create closer ties between corporations and banks
that might be beneficial to each other. One way of creating such ties is for banks to
hold equity stakes in companies they lend to and for banks to have memberships
on the board of directors that manage these companies.

7
LINES OF CREDIT: -
Banks can also create long-term relationships and gather information by
issuing a ‘Line of credit’ to a commercial customer. Line of credit therefore is a
bank’s commitment (for a specific period of time) to provide a firm with loans up
to a given amount at an interest rate that is tied to some market interest rate.
The advantage the firm has is that is has a source of credit whenever it
needs it. A line of credit arrangement is a powerful method for reducing the bank’s
costs for screening and information collection.

COLLATERAL AND COMPENSATING BALANCES: -

Requirements for collateral for loans have been one of the major bank
management tools. Collateral which is a property promised to the lender if the
borrower defaults, lessens the consequences of adverse selection since it reduces
the lender’s losses in the case of a loan default. If the borrower defaults on a loan,
the bank can sell the collateral and use the proceeds to make up for its losses on the
loan. One particular form of collateral required when a bank makes commercial
loans is called “compensating balances”.
A firm receiving a loan must keep a required minimum amount of funds in
a checking account at the bank. For example, a business getting a N10 million loan
may be required to keep compensating balances of at least N1 million in
compensating balances then can be taken by the bank if the loan defaults to make
some of the losses on the loan.
Apart from saving as collateral, compensating balances help increase the
likelihood that a loan will be paid off. They do this by helping the bank to monitor
the borrower and consequently prevent moral hazards. Specifically by requiring the
borrower to use a checking account at the bank, the bank can observe the firm’s

8
cheque payment practices- which may yield a great deal of information about the
borrower’s financial conditions.
Any significant change in the borrower’s payment procedures is a signal to
the bank that it should make inquiries. Compensating balances therefore make it
easier for banks to monitor borrowers more effectively and are another important
management tool.

CREDIT RATIONING: -
Another way that successful banks deal with adverse selection and moral
hazard is by credit rationing. In some cases lenders can refuse to make loans even
though borrowers are willing to pay the stated interest rate or even higher rate.
Credit rationing takes two forms. The first occurs when a bank refuses to make a
loan of any amount to a borrower, even when the borrower is willing to pay a
higher interest rate. The second occurs when a bank is willing to make a loan but
restricts the size of the loan to less than the borrower would like.
The first type might puzzle students, for the more fact that, after all, even if
the potential borrower is a credit risk, why doesn’t the bank just give the loan but
at a higher interest rate? The answer is that adverse selection prevents this solution.
Individuals and firms with the riskiest investment projects are exactly those who
are willing to pay the highest interest rates.
On the other hand a bank may wish to make such a loan because the
investment is high risk and likely outcome is that the borrower will not succeed
and the bank will not be paid back. To guard against moral hazard, banks engage in
a second type of credit rationing. Banks grant loans to borrowers but not loans to
borrowers but not loans as large as they want.
Credit rationing is necessary because the moral hazard problem becomes
more severe with larger loans since the benefits from moral hazard are much
9
greater. If a bank gives you N1000 loan for example, you are likely to take actions
to enable you pay it back since you don’t to hurt your credit rating for the future.
On the other hand, if the bank lends you N10 million, you are more likely to fly to
London, U.S.A etc. To celebrate. The larger your loan, the greater your incentives
to engage in activities that makes it less likely for you to repay the loan. Since
more borrowers repay their loans if the loan amounts are small, banks ration credit
by providing borrowers with smaller loans than they prefer.

10
 CHAPTER TWO
BANK BALANCE SHEET
THE NATURE OF BANK BALANCE SHEET
Bank deals in money and other financial assets. This is quite unlike manufacturing
companies and some other trading organizations that deal in goods. As such there
are basic differences between the balance sheet of banks and those of
manufacturing and most other trading companies.
A proper understanding of the nature and composition of bank balance
sheet is important both to the bank management and to the general public. The
balance sheet shows the financial position of a business at a particular date. A good
bank management must constantly monitor and manage all the items contained in
their balance sheet. The public in turn is interested in bank balance sheet because it
helps them to access the performance of a bank. This explains why the law made it
mandatory for each bank to properly display its balance sheet in its banking hall.
To fully understand the nature of bank balance sheet, the reader is advised
to get a recent balance sheet of any bank and compare it to a copy of that of a
manufacturing company. This will reveal some basic difference. Note also that
most of the issues discussed in the subsequent chapters if this book centre on the
management of the various balance sheet items.

DIFFERENCES BETWEEN A BANK BALANCE SHEET AND THAT OF A

MANUFACTURING COMPANY.
The basic difference between the balance sheet of a bank and that of
manufacturing and in fact most other trading companies are as follows:

1. Bank assets are usually listed in their order of liquidity while assets of
manufacturing companies are listed in the order of illiquidity. Cash being
11
 the most liquid of all assets appear last. The reverse is the case with
manufacturing companies which usually list fixed assets first.

2. The item “inventories” (stock), which is usually a large item in the list of
the assets of manufacturing firms is conspicuously absent in the balance
sheet of banks. This is because banks hold no stock.

3. The major assets in bank balance sheet are loans and advances whereas
the major assets of manufacturing companies are Fixed Assets. Debtors or
Accounts receivable which is similar to the loans and advances of banks is
only a small percentage of manufacturing company assets, while fixed
assets constitute less than 15 percent of bank assets.

4. Banks hold a wider variety of highly liquid assets, while the highly liquid
assets of manufacturing enterprises are only cash in hand ad cash at bank.

5. On the liabilities side, money owed by manufacturing companies is small

(usually less than 30 percent of assets), while money owed by banks,
represented mainly by customers deposits and other creditors is very large,
making up over 70-80 percent of bank assets’

6. The proportion of capital to total assets is more for manufacturing

companies than for banks. For a bank, capital is normally less than 10
percent of total assets whereas capital of manufacturing companies is over
25percent of total assets.

12
BANK BALANCE SHEET ITEMS
The items included in commercial bank balance sheet vary from bank to
bank, but they are generally similar in appearance. They only differ in the use of
terms. Most of the items that appear in the published accounts are only a summary
of other smaller items. These accounts are normally accompanied by footnotes that
give their details. To help us have a broader view, we shall first of all look at the
published balance sheet of one of the major commercial banks in Nigeria (Name
Withheld), (Table 4.1) and then, statement of assets and liabilities of all the
commercial banks in Nigeria as presented by the Central Bank of Nigeria (Table
4.2)
TABLE 4.1
XYZ BANK PLC
BALANCE SHEET AS AT 31ST DECEMBER, 1993

The XYZ Bank Balance Sheet (Table 4.2) indicates that the published
balance sheet of a bank has three sections namely; the Assets, Liabilities and
Shareholders’ fund (or capital and reserves) section. According to accounting
principles the sum of Assets is equal to liabilities plus shareholders’ funds.
The assets section lists the properties of the bank and its other claims
against people. The liabilities represent amounts owed to other people while the
shareholders’ fund (capital and reserves) indicate what the bank owes its
shareholders (the owner of the bank). The statement of Assets and Liabilities of all
commercial banks in Nigeria (Table 4.2) helps to reveal the details of the
individual items under each of the three sections

13
ASSETS AND LIABILITIES OF ALL COMMERCIAL BANKS IN NIGERIA
AS AT 31ST DECEMBER, 1993
1. Other Assets include;
i. Money at call outside banks
ii. Fixed assets
iii. Customers Liabilities (per contract)
iv. Others.
2. Capital Account include;
i. Capital (authorized/issued, paid-up and outstanding)
ii. Reserve fund and
iii. Debentures.
Assets
a. Cash and Short-term Funds
In a bid to portray to depositors that the bank is liquid enough to meet their
withdrawal demands, the first item shown in the balance sheet of most Nigerian
banks is the cash and short-term funds. This represents the money primarily
available to repay depositors. It lumps together cash in the bank vault, balances
with the Central Bank of Nigeria, and balances held with other banks. These are
the cash assets of the bank. Although most banks follows this practice of lumping
them together and showing the details by way of notes to the account. Some banks
create a separate heading for balances with other banks and financial institutions.
Vault cash is the amount of notes and coins held by the banks.in its tills,
and strong rooms of all the branches and head office for normal day-to-day
transactions. This category of assets is unprofitable to the bank because idle cash
yields no returns, instead money is spent on security for protecting it. This
notwithstanding, they are still held to guard against loss of confidence which could

14
arise when the customer is told to come the next day for his money. However,
banks out of experience and prudence keep idle cash at a minimal level.
As the bankers’ bank, banks maintain some working balances with the
central bank of Nigeria on their current accounts. Such balances are used to make
interbank settlement when payments are made through the clearing system, and for
inter branch transfers of cash. They are also withdrawn to meet customers’
withdrawal demands when there is excessive cash demand by customers beyond
the cash in vault. In addition to these working balances, banks are also required by
law to deposit some money with the central bank of Nigeria for meeting the cash
reserve ratio requirement. This category of assets is also unprofitable to the bank. It
earns no returns for the bank.
The other item normally included as a part of short-term funds is balances
with other banks and financial institutions. This represents amounts deposited with
other banks and discount houses within and outside Nigeria, including the bank
subsidiaries and foreign branches. Balances with banks also include the bank’s
claim against other banks for cheques and other items in course of collection.
Cheques in the course of collection arise when the customer of a bank pays
in cheques drawn on another bank. Such cheques increases the banks liability to
the customer but the bank cannot collect the proceeds of such cheques until they
are cleared through the clearing system. Currently, this normally takes 5 working
days to clear a cheque drawn on the same locality, 7 days for cheques drawn on
banks outside the locality but within the same state (intra-state), and 14 working
days for inter-state cheques. Since it takes some days to clear these cheques, it
implies that on the balance sheet date, there will be many outstanding cheques
including those paid in on the balance sheet date in all the branches of the bank. By
implication, the banks on which those cheques are drawn are owing the collecting
bank. Hence, the collecting bank has to include the total value of these cheques in
15
course of collection. This item appears to be highly liquid because it is listed
among cash assets. It is not as liquid as it appears. As cheques in course of
collection are cleared new cheques are sent for collection. Thus cheques in course
of collection cannot be used to meet the liquidity need of the bank. In recent times,
Nigerian banks have been laying un-necessary emphasis on liquidity. As such the
percentage of bank assets kept in cash and short term assets has increased
tremendously.

b. Bills Discounted
This is the next group of highly liquid assets held by Nigerian banks. It represents
the bank investment in Federal Government of Nigeria Treasury Bills and Treasury
Certificates, Trade bills discounted and Bankers acceptances. These documents are
debt instruments which the issuers or acceptors promise to pay in a determinable
future date. By selling these instruments the issuer of the instrument gets money.
Banks in turn offer to buy the instruments from the holder for an amount below the
face value (i.e. at a “discount”) and thus make cash immediately available to them.
This is a form of credit facility. The difference between the face value and the
account paid for the bills represents the interest on the amount advanced for the
period left to maturity. This is a profit to the bank.
The bills thus discounted are held by the bank as liquid assets. In times of
serious cash shortage the bank can in turn discount or re-discount such bills with
the discount houses or the Central Bank discount window. These assets are often
separated by banks from other investments because they are more liquid. They
provide liquidity as well as minimal profitability for the banks. The liquidity of
bills discounted comes from their high marketability. Treasury bills and treasury
certificates have government and central bank backing, while Bankers acceptance
bills that have been given backing by a bank accepting to pay if the customer fails
16
to pay. This makes the bills less risky and marketable. It is pertinent to note that
the central bank of Nigeria grouped this asset under loans and advances (see Table
4.2). This is because it is a form of credit extension. In meeting the stipulated
liquidity ratio of banks, bills discounted are usually included in Central Bank of
Nigeria’s list of specified liquid assets.

c. Investment
Apart from the short term investment in bills, banks also make other long-
term investment in stocks and shares of companies, debentures, and government
development and other stocks. Although most of the securities are long-term in
nature, they are often regarded as liquid because they can readily be sold in the
stock market. Most of the shares and stock invested in are those quoted in the
Nigerian stock exchange. One other form of security investments that has become
significant for banks is investment in stabilization securities. In most cases banks
are compelled to buy these stabilization securities by the central bank of Nigeria as
a means of mopping up excess liquidity in the system.

Investment in securities is one of the major sources of bank income. Its

income comes either through the interest or dividend received from the issuers, or
appreciation in their market prices which will give the bank some capital gains
when resold. From the statement of bank assets and liabilities shown in table 4.2,
this item was equal to 25 percent of the total assets. The increase in the percentage
was caused by the percentage of stabilization securities which alone was 10 per
cent of total assets. During the year 1993 banks were perceived to be excessively
liquid. They were, therefore, compelled by the central bank to buy stabilization
securities. When the percentage of stabilization securities is removed, investment
will only represent 14.9 percent of commercial bank assets.
17
 c. Loans and advances
This category of bank assets is usually the single largest item in the balance sheet
of Nigerian banks. It includes all forms of credit extension by banks. The statement
of assets and liabilities of all Nigerian commercial banks table 4:2 shows that this
was 19.7 percent of all commercial banks assets in 1993. This shows a sharp
decline from what obtained in previous years. The decline in the percentage of
loans and advances is attributable to two factors: the impact of the prudential
guidelines which the provision of loan losses: and the issuance of stabilization
securities by the CBN to curb excessive liquidity and hence lending. This assets
heading is of much importance to banks because it is the greatest earning assets of
the banks. However, it is also the most liquid, and the greatest source of losses for
banks.
The loans and advances of banks is also among the asset most keenly
monitored and regulated by monetary authorities. This is basically to guard against
excessive lending by banks. Most analysts of banks balance sheet are also keenly
interested in this asset heading especially the footnotes to loans and advances. Such
footnotes normally give some clues to the lending problems of a bank. They show
the classification of loans and advances under performing and nonperforming loans
and advances. And the provisions made for them as required by the central bank
prudential guidelines.
One of the items included in loans and advances that needs specific mention is
money at call. This represents loans given out by a bank to other banks or discount
houses on a day-to-day basis banks that have short-term liquidity problems can
contact another bank that has excess liquidity either directly or through the central
bank to lend money to them. Such loans are repayable on demand (or call), hence
the name money at call. Apart from cash assets this items is the most liquid assets
of a bank. Banks and discount houses that have liquidity problems have to first of
18
all seek for call money before going to borrow from the central bank of Nigeria as
a last resort.

e. Other assets
The item ‘other assets’ is a catch all title used to describe those other assets that
have not been specifically classified under any of the asset headings. This includes
such things as advance payments in respect of equipment’s yet to be supplied,
accrued income and other nonbanking debts owed the bank.

f. Equipment on lease
This is seen in the balance sheet of those banks that engage in equipment
leasing. Leasing is an arrangement under which the owner of an asset (called the
lessor), allows another person (called the lessee) the use of his assets in
consideration of regular payment (called the rent). This is a source of income for
banks that engage in it. With increase in level of awareness of leasing, many
Nigerian banks now engage in leasing business.

g. Fixed assets
This assets category comprises those assets of a bank that are expected to retain
their form beyond one accounting period and are not to be disposed off in the
normal course of business. Example of fixed assets include bank premises, head
office and other buildings, equipment (including computers), and motor vehicles
belonging to the bank. This group forms only a small percent of total most liquid
assets of a bank.

LIABILITIES
a. Deposits and other customers’ accounts
19
 Deposit collection is a major aspect of banking business. Money collected from
customers are regarded as loans to the bank. Thus, the items “deposits and other
accounts” represents the amount owed by the banks to its customers. It is the
largest item in the balance sheet of banks. During the year 1993 it represented 47.7
percent of all bank assets. Under normal situation this percentage ought to be
higher. However, there was mass withdrawal of deposits from banks in 1993 due to
the political crises that followed the annulment of election results that year.

Some banks have the practice of separating this item into current (demand),
savings, and time deposits depending on the sources from which the deposits are
received. Certificates of deposits issued by banks also come under this heading as
deposits. It also includes balances held I foreign currency and other accounts for
customers, and also balances held for other banks. The notes to the accounts
normally indicate the maturity profile of deposits.

b. Taxation
The figure shown as taxation is the provision made by the bank for potential tax
liability as it relates to the year’s profits. It represents the amount of tax due but not
yet paid by the bank.

c. Other liabilities
This is a catchall title for those other liabilities not specifically mentioned in the
bank balance sheet. This will normally include the dividend announced by the bank
but not yet paid to shareholders. It will also include the figure for creditors who
may have supplied stationary and other minor items to the bank. Banks do not
normally buy goods on credit since they do not deal in goods.

20
SHARE CAPITAL AND RESERVE (SHAREHOLDERS FUNDS)
The total sum of capital and reserves represents what a bank owes to its
shareholders (owners). It is the shareholders equity or net worth of the bank.
Although a bank is said to be owing its owners, it does not mean that the owners
can get back this amount unless the bank is liquidated. However, when there is a
rise in the value of the firm, shareholders may benefit by selling their shares to
other investors at a higher price than they bought them. The shareholders also
benefit from dividends which are normally paid when the business is profitable.
The figure for share capital represents the book value of all the called up and
fully paid-up shares of the firm, while the reserves are amounts set aside over the
years from profit as retained earnings or for planned future payments. The figure
for reserves also includes statutory reserve. This type of reserve is a legal
requirement. According to section 16(1) of the banks and other financial institution
decree no. 25 of 1991, every bank is required to maintain a reserve fund and shall,
out of its net profit for each year (after due provision is made for taxation) and
before any dividend is declared, transfer to the reserve fund a sum equal to not less
than 30 percent of the net profit, where the amount of reserve fund is less than the
paid-up share capital; or, transfer an amount equal to not less than 15 percent of the
net profit, where the reserve fund is equal to or in excess of the paid up share
capital. No such transfer shall be made until all identifiable losses have been made
good.

21
 CHAPTER THREE
THE MANAGEMENT OF BANK PROFIT
THE NEED FOR PROFIT
Traditionally, profit maximization is the goal of every business organization. Even
when this proposition is argued against and being replaced with the goal of wealth
maximization, the need to accord a top priority to profit still remains. The primary
duty facing the management of any bank is to make enough profit. The extent to
which the management is able to perform this duty is often used to assess its
performance. When the management makes enough profit the investors will be
satisfied and the bank will be in a better position to meet the demands of other
interest groups.

Specifically, a bank needs to make adequate profit for the following reasons:
1. Cost absorption: In running a bank several costs are incurred. For instance,
staff salaries and wages must be paid, and interest must be paid on time
and savings deposits. Apart from these two major cost items, other
expenses are incurred. Banks must make profits, at least, enough to cover
those costs. Failure to cover those costs through profits may mean that the
banks capital has to be spent on the expenses which will deplete the capital
funds, or that customers deposit is used to cover the expenses. The last
option will make it difficult for banks to repay their customers deposit.
Apart from regular expenses of the bank, profit is needed to cover
depreciation and to make adequate provisions for losses. Adequate
provisions from profit will help to absorb the adverse pressures on the
banks operations arising from unexpected losses and bad debts.

22
2. Reinvestment: To contribute to a steady growth of the company, well
managed companies may decide to retain and reinvest part of the profit
made in to the company. This is called retained earning financing. Retained
earnings are distributed profits, and can also help to ensure a steady growth
in the shareholders’ funds (or capital investment).
3. Attraction of further financing: A bank in need of further financing may
resort to the capital market to raise funds. Before investing in such a bank,
investors in the capital market will normally make a critical analysis of the
bank’s profitability. A good record of profitability must, therefore be
maintained for the bank to be able to attract additional funds from the
market. Adequate profitability enables the bank to pay dividend to current
shareholders to retain their finance. Moreover, past profit records also
influences the price and terms of new issues in the capital market.

4. Retention of public confidence: For any bank to be able to attract deposit

funds from the general public and even other financial institutions, it must
be able to win and retain public confidence. A bank that has good profit
record will obviously find it easier to win such confidence than a bank
known for making losses.

5. Motivation for expansion: Good profit records serve as a motivation both

for expansion and innovativeness. When a bank is constantly recording
losses, its major concern will be how to survive. It will be more difficult
for such a bank to think of expansion.

23
HOW TO INCREASE BANK PROFIT
The net income of a bank represents the difference between the total revenue
and its total costs (expenses). In accounting equation, this is expressed as follows:
NET INCOME = Total revenue – Total costs
In planning to increase the profit of a bank the basic idea expressed in the
above diagram must be considered. Since profit comes from the difference (or gap)
between the two total revenue and the total cost curves, it follows that the wider
the difference, the more the profit. The area covered by profit in the above diagram
can be increased by lowering the total cost curve or by increasing the total revenue
curve as indicated by the arrows. This therefore, implies that the net income of a
bank can be increased in any of these two ways: by either increasing the earnings
from the various sources of revenue, or by reducing the various costs incurred by
the bank, or both. The second approach (cost reduction) may be more difficult to
implement because not all costs are controllable, especially in the short run. While
the variable costs vary with volume of activity (or output), the fixed costs remain
relatively fixed in the short run. Such fixed costs include rent paid for office
accommodation and staff salaries. The same rent must be paid whether the bank
has enough customers or not as long as it remains in the same office
accommodation. Again, a bank must retain its staff whether there is a period of
boom or not. Hence, staff salaries are fixed expense item.
It is, however, pertinent to note that in the long run even the fixed cost
items can be controlled. This can be accomplished through technological and other
organizational changes.
Whichever approach the bank finally adopts to increase its profit, it may
be necessary to effect changes in one or more or all of the following areas:

24
 A. REVENUE INCREASE (Option 1)
1. Interest rates on loans and advances
2. Rates of return on investments and other earning assets
3. Level of fees charged on services
4. Size and composition of bank assets
B. COST REDUCTION (Option 2)
1. Interest rates payable on deposit and other accounts
2. Technological improvements
3. Improved use of resources
4. Expansion of services
5. Employee salaries and wage rates.

REVENUE INCREASE APPROACH

Since the bulk of bank income comes from interest on loans and advances, an
increase in the interest rate will definitely increase the net income. Banks,
however, do not effect changes in interest rates on loan arbitrarily. Certain factors
have to be considered. One of them is the regulatory constraints. At times, the
interest rates on particular types of loans are predetermined by the regulatory
authorities. Where the same size of loans and advances is maintained, and interest
rate increases, the net income will increase.
· Then next major source of bank income is investment in various securities. In
some cases, the interest rate or discount rates applicable to such securities are
predetermined. However, some of the rates are negotiated by the bank, especially
in the case of discounting of bills. An increase in the rate of returns on those
securities will also increase profit. Through wise purchase decisions, the bank can
equally make capital gains on purchases.

25
· The bank can also increase the level of fees and commissions earned by the
various services it renders such as rents charged on leasing, and service charges on
its deposit accounts. While emphasizing the rate of interests and level of fees
charged, the size and composition of bank assets must not be over looked. Banks
that have larger amount of assets composed mainly of earning assets will obviously
earn more income even when their interest and other charges are the same. A bank
that wants to increase its income should strive to increase the size of earning assets
in its assets portfolio. This may mean granting more loans and advances.

Illustration 1
Assuming that two banks: bank A and B, charge an average of 20% interest on
their loans and advances, which of them will earn more returns on its assets if their
assets composition are as known below?

Assume same total cost of #1,500,000.00 for each bank.

COST REDUCTION APPROACH

Any attempt to reduce the costs incurred by banks should include the
interest rates payable on bank deposits. One advantage that banks have over other
companies is that they have the power to influence the cost of their raw material.
However, this is subject to competitive pressures and regulatory provisions. Under
a highly regulated economy, the rates may be pegged within a given range or at a
particular amount. Another way of reducing bank expenses is to embark on
technological improvement such as computers can be used to perform jobs that
were previously done manually. This can reduce the number of staff in a particular
section of the bank. Those staff whose jobs are taken over may be transferred to

26
another section. This will reduce the number of staff and hence the amount spent
on salaries and wages.
Improvement in the use of human and material resources can also reduce
the banks overall cost. Employment of experts for instance, will not only reduce
the resources wasted in training fresher’s but will equally reduce the number of
employees. Besides, with experts employed, the wastage of time and even
stationary is reduced. The use of resources can also be improved on through the
reduction of bureaucratic bottlenecks and excessive redtapism in the system. These
measures will lead to an overall improvement on the organizational structure.
Expansions of services have a double sided effect. First it helps to
generate more revenue with the same resources where the banks operation is below
its capacity. This can also reduce fixed cost per unit, especially where the same
amount of resources is still being used or where only a minimal increase in the
staff strength is required. For instance, a bank with 150 staff on its employ, and
provides only deposit collection services to two or more areas and still utilizes the
same staff. These staff may be made busier, but the sources of revenue would be
increased. This will provide more chances of covering the fixed costs per unit of
revenue centre.
In recent times the amount of salaries payable to bank employees has risen
so much. A bank can also reduce its cost by adopting a realistic wage rate for its
employees. Arbitrary increases in wages and salaries can lead to increase in the
expenses on salaries and wages. Being cautious in fixing wage rates will help to
reduce costs. However, when this measure is adopted care must be taken to still
keep the employees motivated.
In real life, none of the two approaches is adopted singlehanded as a
means of increasing the profitability of banks. What normally obtains is a

27
combination of income increasing measures, and cost reduction measures to
complement each other.

Profit And Loss Statements Of Bank

28
 CHAPTER FOUR
BANK FAILURE
INTRODUCTION
Banking as a business is plagued with risks. Although some of these risks like
liquidity risks and credit risks have been touched in the preceding chapters, this
chapter is meant to discuss the issue of bank failure. It has been given a serious
attention because the issue of failure has risen to a position of serious concern in
the current Nigerian banking scene. To end our discussion on banking methods and
processes without discussing such crucial issue will obviously leave a gap.

THE ISSUE OF FAILURE

Failure is a word almost nobody would like to be associated with.
Everybody would like to succeed, to grow bigger, to excel, rather than to fail.
Hence in the words of Frear, “the problems associated with contraction and failure
have received little attention compared to those of growth and expansion”! As
such, the issues of searching for ways of averting failure is often neglected until it
is too late. The fact however, remains that business does fail and banking business
is no exception.
In the immediate past, up to the turn of this decade, it was only an issue of
debate whether or not banks will fail again in Nigeria after the mass bank failure of
the 1950s. Initially, such failure seemed unlikely because the Nigerian banking
industry appeared to have been resilient in its “boom”. Banks kept on reporting
huge profits which, in fact, were mere. “paper profits”. This created the impression
that all was well with the industry. This euphoria led to the emergence of new
banks (both merchant and commercial) and other financial institutions.
Unfortunately, many banking experts erroneously believed that the fears of bank
failure were unfounded. In an attempt to dispel such fears, Nwankwo even argued
29
that “though well founded in the early history of banking in the country should be
recalled that the environment is different”. His argument were that banks are now
better capitalized and managed than then, there is a lender of last resort – the
Central Bank of Nigeria, and there is the Nigerian Deposit Insurance Corporations
both of which will come to the rescue ot banks. How correct these assertions are is
left for time to determine.
With many banks in Nigeria being classified by the Central Bank as
distressed, some licenses withdrawn and some banks acquired by the Central Bank
of Nigeria at the shameful purchase price of N1 per bank (when even a biro pen
currently sells for N10), the issue has ceased to be whether banks will fail or not.
Almost every concerned person is rather asking what will be the possible causes of
such failures, how can problem banks be identified, and how can bank failures be
averted. Even Nwankwo changed his views in 1991 when he observed that “in an
environment where euphoria exists that banking highly profitable, where banks are
encouraged to go on all out competition... risks are bound to escalate. The
proverbial omelette cannot be made out without breaking the egg”

BANK FAILURE DEFINED

In many cases, the words “failure”. “Distress” and insolvency are often used
interchange ably as if they mean the same thing. However, each refers to a
different situation.
Bank failure is defined by Munn in the Encyclopaedia of Banking and
Finance as “the situation when a bank is closed temporarily or permanently on
account of financial difficulties, and including banks whose deposit liabilities were
assumed by other banks at the time of closing. With the aid of loans or purchase of
assets by Federal Deposit Insurance Company (thus in effect consisting “hidden
failure”)”. He also defined bank insolvency as the inability to pay deposit
30
liabilities.” Frear sees both business failure and insolvency as meaning the same
thing inability of a company to pay its debts as and when they fall due Derek and
Seward in their Dictionary of Management defined insolvency as the state of being
“unable to or having ceased to pay debts as they fall due”.
In Nigeria, the failed Banks (Recovery of Debts) and Financial Malpractices
in Banks Decree 1994 defined “failed bank” as “a bank other financial institution
whose license has been revoked or which has been declared closed, placed under
receivership or otherwise taken over by the Central Bank of Nigeria or Nigeria
Deposit Insurance Corporation”. Going by this legal definition, a bank is declared
failed depending on these conditions: the banks license is revoked, or the bank is
declared closed, or is placed under receivership, or is taken over by CBN or NDIC.
This agrees with Munn’s definition.
Both failure and insolvency go together. It is the state of insolvency that
forces a bank to close its doors. However, Munn’s definition suggests that a bank
may be unable to repay deposit liabilities (insolvent), but it has not failed unless it
has closed its doors on account of that. However, he equally stated that even when
the deposit liabilities are being repaid with loans, the bank has a “hidden failure”.
In conclusion, we shall assume that bank failure is the same with insolvency.

Distress on its own refers to financial difficulties. A bank is classified as

distressed” in Nigeria based on the CAMEL” bank examination rating system. This
is a memory aid (mnemonics) for capital adequacy (C), assets quality (A).
Management competence (M). Earning strength (E),. And liquidity sufficiency (L).
Using these criteria, a bank is assigned a rating of 1(best), to 5 (worst) . A bank
that receives a rating of four (4) or five (5) on any of these issues by a bank
supervisor is designated a problem bank. If the problem is widespread, the bank is
labeled a distressed bank. Once a bank begins to have problems with the issues
31
covered under (CAMEL) rating system, it is bound to fail unless serious corrective
measures are taken in good time.

TYPES OF BANK FAILURE

The following types of failure can be identified from the above definition:
temporary, permanent, hidden, and open bank failures.
In the case of temporary failure, the bank closes its doors for a while because
of financial difficulties. It may take a loan from the Nigeria Deposit Insurance
Corporation, or take other corrective measures and open its doors again. But in the
case of permanent failure it goes completely out of business or is taken over by the
Central Bank or the Nigerian Deposit Insurance Corporation. Hidden failure is a
case in which the bank is able to take a loan or make other arrangement to settle its
deposit liabilities before its financial difficulty becomes apparent. It is an open
failure it such corrective measures can no longer conceal the financial difficulties
from the eyes of its customers and the public.

CAUSES OF BANK FAILURE

Opinions differ among authors as to the actual causes of bank failure in
general and bank failure in particular. A study carried out in U.S.A. by Dun and
Bradstreet came to the conclusion that “93 percent of the causes of failure stemmed
from “managerial inexperience and incompetence”, the rest being ‘neglect” 2
percent, fraud 2 percent, “disaster” 1 percent, and “unknown 2 percent. Managerial
incompetence and inexperience, according to their to research is evidenced by:

Inadequate Sales ... 44 per cent

Competitive Weakness ... 22 per cent

32
Heavy Operating Expenses ... 9 per cent
Excessive Fixed Assets ... 4 per cent

Inadequate Inventory Control ... 4 per cent

Poor Geographical Location ... 2 per cent

Others ... 4 per cent

They further pointed out that lying behind these “causes” is, failure to plan
(or bad planning) and failure” to control the consequences of the plan Concurring
to this view, Ajayi observed that “a good management should not only be able to
plan ahead but also should control”.
In the case of banks the ‘inadequate sales” in above findings refers to
inadequate patronage by deposit and credit customers.
Specifically on bank failures, Pant alone and Platt concluded in their own
research that “the principal cause of bank failure remains poor bank management,
resulting in excessive risk-taking or lack of controls that permit fraud and
embezzlement.”
While stressing the contribution of bad management to bank causes of
business failure in Nigeria into internal and external failure, external factors must
not be ignored. Nwoye grouped external factors. While her internal factors
included the causes already discussed, the major external factors according to her
are the constant change of government in Nigeria and consequent changes in
government policies.

33
 The factors which constitute current threats/challenges facing Nigerian
banks which have contributed to the failure of banks in Nigeria, according to an
independent research carried out by the author are as follows:”

1. Cut-throat Competition: The increase in licensing of new banks and non-

bank financial institutions following the deregulation of Nigeria economy in
1988 led to a sharp increase in the number of new entrust into the financial
system. The result was a sharp rise in the level of competition among banks
and between banks and other financial institutions with the implication that
competitively weak banks unable to meet the level of competitiveness that
now obtains lost their footing and Becomes distressed.

2. Inconsistent and Severe Policies: Both the government and monetary

authorities increased both the frequency and severity of monetary and
banking policies some of which have threatened the survival of banks. Such
policies includes the withdrawal of government deposits in 1989,
introduction of the prudential guidelines in 1990 licensing of new banks and
introduction of specialized banks, increase in minimum capital requirements,
promulgation of over six separate banking-related decrees between 1991 and
1995. Apart from the severity, the frequency of these policies makes it
difficult for banks to embark on effective long-range planning. The timing of
their implementation also had negative impacts on banks.

3. Mismanagement and Inexperience: This was found to be the most serious

problem- facing Nigerian banks. A good manager will be able to handle as
competition, and be able to envisage and plan against policy changes. 83.6
percent of bank personnel who against responded to the questionnaires of the
34
 said research agreed that responded mismanagement is a big threat to
Nigerian banks.

4. Fraud and Fraudulent Practices: The crime wave and lack of integrity among
the Nigerian society have risen so high in recent times. The banking industry
being a sub-set or the larger society is no exception. With the increased
emphasis on materialism and influence by the society, and current high cost
of living high cost of living, bank fraud and fraudulent practices in banks
have increased both in severity and frequency, while new systems of fraud
are being devised daily. This unhealthy development prompted the
promulgation of the Failed Banks (Recovery of Debts) and Financial
Malpractices in Banks Decree 1994. This notwithstanding, fraud remains a
big threat to Nigerian banks.

5. Bad-debt/injudicious Lending: When many bank officials grant loans and

advances to bank customers who are neither qualified for Such loans nor
possess adequate security for the loans, they are preparing the grounds for
bank failure. Such loans are normally approved on grounds contrary to all
known banking practices because of personal agrandisement. If a bank
manager collects some percentage of the loan granted to a customer as bribe,
he loses the moral justification and courage to take appropriate measures to
recover the loan if the customer fails to pay. The result is that most bank
loans end-up being writ ten off as bad loans. This is worsened by current
harsh economic conditions which have made debts which would have
ordinarily been regarded as good loans to go bad.

35
 6. Recruitment of Staff Based on Personal Connections: A rather unfortunate
development in the banking industry in Nigeria is that banks hardly
advertise for vacant positions. The author’s research reveals that in most
cases bank staff are not employed on merit and professionalism, but rather
on “whom you know, or your connections. The extent of harm this is doing
to the banking industry and individual banks are more gracious than can be
imagined. A simple illustration of the impact of this “canker worm” is
shown in fig. 12.1 below. As shown in that diagram a person employed on
personal connection or other reasons than merit will lack professional
challenge. He will believe that he will still be protected by his god-fathers”.
This will influence his actions in the office negatively. He will also serve as
a stage in helping the “god-fathers” to perpetuate frauds. In the end, this will
lead to bank failure.

The right thing is to base staff recruitment on merit. Fig. 4:2 illustrates what this
can give rise to.
Fig. 4.1 Chain Result of Employment Based on Personal connections.

Official behaviour/actions
-Flouting of laid down bank policy
-Aiding the “god-father(s) in fraud
Job by *Lack of Professional -Lack of innovation
Connection Challenge -Unethical banking practices
*God-fatherism feeling
-Insubordination to Superiors
-Oppression of subordinate
-Witch-hunting/petition

-Inefficiency

-Mismanagement
-Non-performance
of bank

36
BANK FAILURE
 Fig. 4:2 Chain Result of Employment by Merit
-Innovativeness
-Professional challenge -Adherence to bank policy
Job by
-Success depends on -Some Banking practices
merit/Professionalism high
merit feelings
-Integrity
-Increased efforts
-Cordial relationship
-Efficiency
-No undue influence

-Good Management
-Improved Performance

BANK GROWTH

7. Others: Other factors are low patronage of income yielding services, high
investment in fixed assets, Over centralisation of authority at the head office, and
heavy Operating expenses. On the issue of low patronage the current wave of
distress in the banking industry has adversely affected the banking habit of
Nigerians. Head-office bureaucracy has also made it difficult for loans to go to
some good customers.

BANK FAILURE PREDICTION AND MEASUREMENT OF FAILURE

RISK
The high rate of business failure of the 1930s stimulated the first interest at the
prediction of failure in the United States of America. Since then, many studies
have been carried out by various authors in this regard. The approaches suggested
for the prediction of failure include the use of ratios, trend analysis of profit figures

37
and share prices, on-site examination, the use of early warning models, and
observation of failure symptoms.

THE USE OF RATIOS

Opinions differ among finance experts as to which ratios should serve as the best
measure of failure. As early as 1930, Smith gave an indication of the data which
appear to be relevant to the prediction of business failures, most of which were in
the form of ratios. Apart from him, many others have made their own findings
including Altman (1968).” Frear (1985). And Nwankwo (1991).

Despite the variation in their opinions, the following ratios are useful in predicting
bank failure:
1. Price/Earnings Ratio: This ratio measures how long it will take an investor
in the bank to recover, his initial investment. The higher the ratio, the longer
the period it will take and hence the more the risk of failure as a result of
poor performance. Since the market price of shares is determined by the
public in the market place, this ratio helps to assess public assessment of the
bank. It is measured thus:
P/E Ratio = Market Price Per Share Earnings Per Share

2. Net worth to Fixed Assets Ratio: This ratio measures the percentage of fixed
assets being financed by shareholders’ fund. It also indicates the relationship
between the net worth of the bank and total investment in fixed assets. A
low ratio will mean that the investment in fixed assets per naira of net worth
is very high. This is a danger signal since excessive investment in fixed
assets can lead to bank failure. A high ratio is an indicator of good
performance. The Ratio is calculated thus:
38
Net Worth to F Assets Ratio = Net worth Fixed Assets

3. Net worth to Total Assets: This ratio reveals the extent to which the asset of
the bank is being financed by shareholders funds or owner(s) equity. A
higher ratio indicates improved performance while a lower ratio means that a
larger part of the firm’s assets are being financed by borrowed funds. The
formula for this ratio is as follows:
Net worth to T Assets Ratio = Net worth Total Assets

4. Net worth to Risk Assets Ratio:

The ratio compares net worth to risky assets. Since the shareholders are the
ultimate risk bearers of the bank, this ratio measures the extent (or number
of times) risky assets are covered by the Net worth of the firm. The higher this
ratio, the safer the bank is. This is measured thus:
Net worth to Risk Assets Ratio = Net worth Risk Assets

5. Return on Total Assets: This ratio measures the rate of returns earned by
each naira invested in assets. A low ratio may mean that the bank has
invested too much in assets or that its profit is declining. The lower this
ratio, the closer the bank is to failure.
R.O.T.A= Net profit Total Assets

6. Return on Equity: This measures the returns per naira of shareholders’

funds. An increase in this ratio shows improved performance, while a
continuous decline is a failure signal. The ratio is measured thus:
R. O.E= Net profit Net worth

39
 7. Purchased Funds to Equity: Purchased funds are the same as debt. This ratio
is the same as debt/equity ratio. It measures the extent of debt used in
financing the bank in relation to equity financing, It is calculated as follows:
Purchased Funds To Equity = Purchased Funds Net worth
A continuous increase in this ratio is a danger signal.

8. Purchased Funds to Assets: This ratio measures the proportion of bank’s

assets that is financed by debt. It shows the extent to which borrowed funds
are used in the bank. A rise in this ratio indicates an increase in leverage
risk, and is, therefore, a danger signal. The ratio is calculated thus:
Purchased Funds Total Assets

THE VALIDITY OF RATIOS AS PREDICTORS

Although ratios can indicate weakness in companies, their use is very much
limited. One of their major limitations is their failure to reveal whether corrective
actions have been taken. Johnson argued that the use of ratios is unable to
differentiate companies which will fail and companies which almost failed”. He
concluded that ratios seem best suited after the fact. Secondly, as Frear observed,
most empirical studies draw samples of data from a population of failed
companies. There is, therefore, an immediate bias in the data because we do not
know how many companies were saved from the failure by the reaction of
managers to the very data under consideration. This is confirmed by Tamari’s
earlier observation that a large proportion of successful (non-failed) companies in
his sample had at least one weak ratio; some had two or even three. In view of this
it will be wrong for an analyst to conclude that a bank will fail based on ratios
alone.

40
Another problem with ratios is the lack of agreement among various studies as to
which ratios are the best predictors of failure. There is also the problem of lateness
of information. Altman, who attempted to “assess the analy tical quality of ratio
analysis using a “multivariate analysis” found that the predictive accuracy reduced
with more accuracy at a time when it will, be almost impossible to increase in
number of years, that they are more accurate the year just before failure. This
implies that failure can only be sensed with more accuracy at a time when it will be
almost impossible to prevent it. This raises a question not only as to the validity of
ratios as predictors of failure, but also their usefulness to the management

TREND ANALYSIS OF PROFITS AND SHARE PRICES

Apart from ratios, another approach to failure prediction is the analysis of trends in
profit figures and equity prices. Using this approach, a continuous decline in the
trends will indicate a failure signal. Tamari in his study confirmed that profit trend
(fitting a trend ine to profit figures over the recent past) is a good predictor of
failure”

Trend analysis of profit figures equally has its own problems. Profit figures are
arrived at based on accounting conventions. The application of these conventions
differs among firms, and this can cause a bias in information. Besides, profit
figures during inflation can be very deceptive, and mere paper profits.

Trend analysis of median market prices of bank equity seems the best approach to
bank failure prediction. Since the market price of bank shares serves as an
indicator of pubic valuation of the bank, a continuous decline of the median market
price is a good danger signal. This is especially applicable because banks thrive on
public confidence. Many finance experts agree that firms that perform better than
41
others have higher stock prices. Pandy pointed out that the wealth created by a
company through its actions reflected in the market value of the company’s share.
Beaver also observed in his own study that “the median market price of the equity
of the failed companies declined at an increasing rate of failure approached,
compared with that of non-failed companies. This, however means that trend
analysis of share prices has no short-coming. The predictive accuracy of all the
trend analysis. Thus, the improves few years or months before failure. Thus, the
information is often too late for corrective measures to be taken.

THE USE OF FAILURE SYMPTOMS

Another approach to failure prediction is the observation of failure symptoms.
Argenti in his own study concluded that “in the last few months before failure, the
symptoms of failure become more frequently observable and more severe”. Thus
the severity of failure symptoms can serve as a predictor of failure. The symptoms
of business failure which can also apply to banks are discussed in the next sub-
section of this chapter. Plantalone and Platt suggested various approaches in which
the symptoms of failure can be observed. These include on-site examination by
supervisory authorities to ensure compliance with statutory provisions for sound
loan and investment decisions: periodic analysis of call report data by regulators
using ratios and other analysis; and the use of early warning model which reduces
large amount of information to a summary statistic to assess the probability of
failure.

SYMPTOMS OF BANK FAILURE

Various researches have been carried out to find out the symptoms of failure in
business. Most of these also apply to banks Ajayi in her own work identified the
following symptoms:
42
 a. Inability to pay worker’s salaries and fringe benefits regularly.

b. Withdrawal of fringe benefits.

c. Retrenchment of workers (or policy of “no recruitment, no replacement

and no retrenchment”)

d. Low profit ratios or no profit at all.

e. Inability to contribute to the welfare of their community.

f. Cash flow problems (Liquidity).

Argenti also, gave an indication of symptom that can easily be noticed by the
public. He simply stated that in the last few months before failure, the stock market
will already have reduced the price of the company’s securities. But even now, top
managers are protesting that all is well, that the embarrassment is temporary or
non-existent “The case of some of the quoted distressed banks in Nigeria justifies
this. One other symptom that is noticeable from the case of many distressed banks
is that a few months before being classified as distressed, those banks were sent out
of the Central Bank clearing house.

In conclusion, there is no magic formula for knowing whether or not a bank will
fail. The above approaches only serve as a guide.

43
AVERTING BANK FAILURE
It is not enough to identify problem banks. Serious efforts must be made by both
the management of the particular bank serious involved, the government and, in
fact, the general public to avert bank failure. This is necessary because, unlike
other business failure, the failure of a bank can have a contagious effect on other
banks in the system, and, in 1act, on the entire economy. The failure of a major
bank can shake public confidence in the entire system and further dampen the
already low banking habit of Nigerians. If this should happen, economic activities
will gradually become paralysed. The experiences of Britain, U.S.A, and Germany
during the bank failure of 1930, and 1974 in these countries buttress this point.

Generally, every effort being made to avert bank failure must begin early, and be
able to address the various causes of bank failure already discussed at the
beginning of this chapter. The first step in averting failure is to recognise that
failure is possible. The Bible puts it this way “He who thinks he stands let him take
heed lest he falls.

Recognizing that failure is possible will make each bank and its management to be
careful in whatever they are doing. At the turn of this decade, many people held the
belief that the existence of the Central Bank of Nigeria, and the Nigerian Deposit.
Corporation makes it impossible for banks to fail. The turnout of events has
however proved them wrong. Neither the CBN nor the NDIC handles the day to
day running of banks. They can only come to the rescue of banks when the trend of
events that culminate in failure has already set in. At that point, it may be too late
to rescue the bank. One thing to remember is that prevention is always better than
cure.

44
In particular, each individual bank should ensure that it recruits the right personnel
based on merit rather than personal connections. This will ensure that banking
experts who are worth their opinions are employed. It will also ensure proper
management of the bank. In addition, banks should also, help to train and retrain
their key personnel. Some of the bank personnel should be sponsored for inductive
courses overseas. These trainings and travels can expose them to standard banking
practices and enhance their knowledge of banking. Banks should equally be more
innovative and improve on the quality of services rendered to their customers. This
will ensure their continued patronage, and give the bank a competitive edge over
others. Each bank should also formulate sound policies to cover all its area of
operations especially loans and investments.

Appropriate machineries must be set in motion to ensure that such policies are
followed by managers and other executives. Adequate punishment should be meted
to erring staff to serve as a deterrent to others. In Case of loan default, the
securities used for borrowing should be enforced in good time to reduce the
incidence of bad debt. Adequate incentives should also be provided to motivate
and retain bank staff. Finally, banks with serious problems should consider the
option of a merger, Take-over, or acquisition. This can have a synergic effect on
their performance.

The government on its own should exercise proper restraints, and be cautious in
the licensing of new banks and other non-bank financial institutions. This will
ensure that competition in the industry remains at a healthy level. Currently,
Nigeria cannot be said to be under-banked per se. He country is rather under-
branched since we practice the branch banking system. Branch expansion into the
rural areas should be encouraged. Moreover, both the government and monetary
45
authorities should be cautious in the formulation, timing and implementation of
government policies on banks. This will ensure consistency once they are
introduced, and reduce the frequency of policy changes. The negative impact of
such changes will equally be reduced. The government should reduce their
interference in state-owned banks. Banks should not be seen as one of the arms of
the government. The Central Bank of Nigeria should also properly monitor and
supervise the activities of banks to guard against window-dressing and other
hocus-pocus by banks. Similarly, the Nigerian Deposit Insurance Corporation
should increase the amount of indemnity payable to a bank customer on the event
of bank failure. This will increase public confidence in banks. Lastly, the
government should set a minimum qualification for bank managers and other
executives. This will help to reduce mismanagement.

In addition, the general public should be co-operative with the efforts of the
government, and the banks, and make suggestions on areas of improvement from
time to time.

46
 CHAPTER FIVE
BANKING PRACTICES AND OPERATIONS

DEFINITION OF A BANK:
Several attempts have been made to define Bank or Banker, starting from the time
of J. W. Gilbert, who defined a banker as “a dealer in capital or money is an
intermediate party between the borrower and lender.” He borrows from one party
and lend to another.

The patrons’ commission of 1948 whose report led to the enactment of the first
banking ordinance of 1952, however, defined banking as “the business of receiving
from the public, or current account money which is repayable on demand by
cheques, and of making advance to customers.

The modified definition from the above in 1958 and 1962 however was retained
until 1969 when the banking Act of that year comprehensively defined Banking
as:- “The business of receiving monies from outside sources as deposits,
irrespective of the payment of interest, and the granting of money loans and
acceptance of credits, or the assumption of guarantees and other warranties for
others, or the effecting of transfers and clearings, and such other transactions as the
commission on recommendation of the CBN, by order published in the federal
Gazette as banking business.”

In Nigeria, therefore, any institution that carries on banking business as defined

above can be called a bank. These include commercial Bank, Acceptance Houses
or other financial institutions.

47
Different people visit banks for different reasons, which some people go cash their
personal cheques issued in their favour by third parties; others go to deposit cash or
cheques into their accounts.

Some people visit banks occasionally to purchase drafts or travellers’ cheques. As

the banker customer relationship is a contractual one, it is important to establish
clearly who a bank customer really is. For a bank to enjoy the protection accorded
it under the

Nigerian Bills of Exchange Act of 1964, the Banker must:-

(a) Receive payment for a customer. A customer must have some type of
account, either a deposit or current account, or some similar relation,
and that a person who has been cashing cheques from the defendant
bank over several years was not a customer of the bank by merely
cashing cheques, and

(b) Act in good faith and without negligence. A banker customer

relationship starts as soon as the first cheque is paid in, and accepted
by the banker for collection. The essential condition the has been
adopted in Nigeria is that a person must have opened an accounts with
the banker and have at least one transaction on the account before he
can be classified or called a customer to the bank.

BANKER CUSTOMER RELATIONSHIP:-

The basic relationship between the banker and the customer is contractual. It is the
relationship of debtor (banker) and creditor (customer), with the position reversed
when the customer overdraws his account. To be a customer, an account (current
48
or deposits) must be opened. The money which the customer deposits for the credit
of his account is not in banking law, held in trust for the customer, but borrowed
from him with a promise to repay it or any part of it on demand.

The banker is therefore obliged to honour the customer’s request for repayment,
addressed to the branch where the account is kept in writing during banking hours.

The relation of customer and banker is neither a relation of principal and agent nor
a relation of a judiciary nature, trust or the like but a simple relation. It may be one-
sided or it may be two sided of a creditor debtor.

The banker is not in the general case, the custodian of money paid in, despite the
popular belief. It is simply consumed, (i.e., used for purpose of his business) by the
banker, who gives an obligation of an equivalent amount.

Unlike in ordinary debtor-creditor relationship, where the accepted rule is that the
debtor must seek out his creditor and settle his debt, the banker is obliged to seek
his customer in order to pay his debt.
Rather the customer is requested to make a demand on the banker the banker by
issuing his cheques whenever he wants part or all his money.

The debtor-creditor relationship of Banker and customer extends to principal and

agents also, when the banker is acting as collecting banker for cheques paid in by
customers.

When a customer keeps valuables with his Danker Tor safe custody, the bailer-
bailer relationship is established. When granting an advance or loan secured by real
49
estate or other tangible assets are mortgaged to the bank. When a bank takes such a
mortgage the relationship of mortgager-mortgage is established.

The banker/customer relationship can be summarized as follows:-

(a) The basic relationship of banker and customer is that of debtor and creditor
respectively.

(b) A banker is not a trustee for money deposited by a customer and is free to
use the money the way he likes.

(c) In accepting deposit from the customer, the banker is not acting as an agent.
He is free to act as if the money is his own. However, he must be in a
position, to repay the amount in part or in full on demand.

(d) Money deposited with the bank is not for safe custody. Hence a customer
cannot demand to be repaid with the exact notes he paid in.

(e) While performing other banking functions, the relationship can become that
of agent and principal e.g. as collecting banker for cheques paid in by
customers, or as investment adviser, insurance agent etc. When a banker
receives items for safe custody, he is called a bailee and when he acts as
executor of a will or administrator of a trust, he becomes a trustee.

DUTIES OF THE BANKER

Principal Duties: - The major duties of bankers are:
(a) To receive money, cheques and other instruments for collection and
subsequent credit to the customers’ current or deposit accounts.
50
(b) To pay cheques and other withdrawal authorities, properly drawn by the
customer during banking hours at the branch where the account is kept or
elsewhere as agreed in paying customers cheques, the bank runs onerous
risk, The banker must ensure that the cheque bears the genuine signature of
the customer, and if it bears a forged signature, the bank will have no
mandate and cannot debit the customer’s account, except where the
customer adopts the signature as genuine or if his conduct leads the banker
to believe the cheques to be in order, or fails to report when the forgery is
discovered.

(c) To maintain secrecy concerning the customer’s account and other affairs.

(d) To give reasonable notice to a customer before closing his accounts

especially a credit account.

(e) To pay agreed interest on deposits and to ensure that the

(f) To avoid wrongful dishonour of his customers’ cheques. If a customer’s

cheque is dishonoured wrongly, the banker may be liable to pay substantial
damages. The banker must therefore ascertain beyond all reasonable doubts
that the customer has no funds in his account before any cheque is returned
unpaid. Even when the customers account is in debt, the banker cannot
dishonour his cheque when operated within the approved limit.

(g) To render statements of account to the customer periodically or upon

request.

51
 (h) To exercise proper care and skill in carrying out any business he has agreed
to transact for his customer.

Duty of Secrecy:-
The banker is entitled to disclose information about his customers’ affairs in four
instances only, as follows:-
(a) Where disclosure is under compulsion of law, e.g. where he is required to
give evidence in legal proceedings.
(b) Where there is duty to the public to disclose, e.g. where he knows is
customer is trading with the enemy of the country during war.
(c) Where the interest of the bank requires disclosure, e.g. where legal
proceedings are required to enforce payment of an overdraft, or where a
guarantor asks to know the extent to which his guarantee is being relied
upon by the bank.

(d) And where the disclosure is made by the express or implied consent of the
customer, e.g. where he supplies a reference for his customer.

The duty of secrecy remains in force when an account has been closed, except
when information is released under one of the four instances listed above. The
secrecy to be observed is so strict that it is inadvisable to discuss with a husband
the state of his wife’s account or vice versa unless there is implied or express
authority to do so. This duty of secrecy leads us to the discussion of Bankers right,
lien, set off and responsibilities.

Basic Banking Rights:-

The followings are the most important rights of the Commercial banker:-
52
 (a) To charge his customers reasonable commission for services rendered to his
and to charge interest on loans made to him.

(b) The repayment on demand from the customer of any Over-drawn balance
which has been permitted on a current account. A reasonable period of
notice must be given where the terms and circumstances of the contract of
lending clearly imply such notice.

(c) To be indemnified by the customer for expenses and liabilities incurred

while acting for him.

(d) To dispose of his customer’s money as he pleases, provided he honours his

customers’ valid cheques.

(e) To expect his customers to exercise due care in drawing cheques

(f) To exercise a lien over any of his customer’s securities that are possession,
other than those deposited for safe custody, for any money Owing to him

(g) To exercise the right of set off.

LIEN:-
This is the right of a person holding property, that belongs another and to hold on
to the property until the owner has fulfilled certain obligations or paid off specified
debts to the holder. This can be illustrated by a simple example. The second type of
lien, also Known as general lien is a right which can be exercised generally over all
assets by the person holding the property or assets if certain problems arise.
53
A lien does not normally give the person in possession of property, the right to sell
it, is a mere right to retain the property. However, a banker’s lien, which is a
general lien is like a pledge and as a pledge (creditor), the banker is entitled to the
exclusive possession of the property until the debt is repaid. Also, upon giving
adequate notice to the customer, the banker can sell the property.

In Nigeria, the banker’s right of lien covers bills, notes, cheques and other
negotiable instruments and also bonds. Bank security forms especially in respect of
guarantees, usually contain clauses under which guarantor agrees to the bank,
exercising a right of lien over all properties coming into the hands of the bank.

SET OFF:
This is a legal right a debtor has to set off against the debt due to him, sums due by
the creditor. The right of set off can only be exercised if both debts are in the same
right and of known amounts. Thus a banker has a right of set off in respect of
different accounts of his customers. One in debt and the other in credit, provided
there is no express agreement to the contrary. This is usually done after giving due
notice to the customer. This notice is essential because if the customer has issued
cheques on the account with the credit balance and such cheques are dishonoured;
the banker runs the risk of paying damages to the customers for the wrongful
dishonour of cheques.

The banker’s right of set off dominates in the following instances:-

(a) On the death, bankruptcy and mental incapacity of a customer.

(b) On the bankruptcy of a firm or when a Company is put into liquidation.

54
 (c) On the receipt of a garnishee order.

(d) On receipt of notice of assignment of the credit balance once on an account.

Before a right of Set off can be exercised, the requirements that must be fulfilled
are as follows:-
(i) The sum involved must be specific, certain and known

(ii) The amounts must owe between the same parties However, if a planner agrees
to be jointly and severally liable to the debts of the partnership, his personal
account can be set off against the partnership debts.

(iii) The debts must be in the same right. For instance, where a trust element is
apparently, the right of set off cannot be exercised.

DUTY TO HONOUR CHEQUES:-

A Banker has a duty to honour his customers’ cheques without delay to the extent
of the balance standing in his credit (or if the amount of the cheque is within the
limits of an agreed overdraft and the cheque is regularity drawn and presented for
payment during banking hours at the branch in which the current account is held).
In other words, the banker must pay his customers’ cheques, if the following
conditions are fulfilled:-

(a) The customer’s account is in credit (with sufficient funds to cover the
amount on the cheque) or it enjoys credit facilities.

(b) The cheque is properly drawn and it is regular on the face of it.

55
 (c) The customer has made the demand during banking hours, and at the branch
where the account is maintained.

(d) There is no legal cause inhibiting the payment. This could happen where a
third party laying claim to the funds on the account has sued the customer in
a court of law, and the court has ordered the bank to stop any further
payments from the account until the case is disposed.

And also, going by Freezing Account Decree of 1984, which provides that where
the Head of State has reasonable cause to suspect transactions in any account of
any person with any bank, such as may involve the offences of bribery, corruption,
extortion or abuse of office, he may direct the manager of the bank where the
accounts are Kept to freeze forthwith all transactions in the account(s) concerned.
DISHONOURING CUSTOMERS’ CHEQUES:-
A bank that dishonours the customer’s cheque carelessly without just cause will be
liable for damages for breach of contract. The extent of damages will however,
depend on whether the customer is in business or not. If the customer is in
business, serious injury can be done to his commercial credit hence substantial
damages can be awarded.

OPENING AN ACCOUNT
Before a new account is opened a banker must be satisfied as to the character and
standing of the prospective customer. The application forms submitted by the
customer, otherwise called the “mandate”, contain the following information and
details-
i. Full names and address(es) of the Customer
ii. Occupation/designation;
56
iii. Specimen signature(s) of the customer; and
iv. References.
As well as details of any facilities extended at other branches of the bank including
any previous and existing relationships with other banks.

If more than one person is authorised to draw on the account, specimen signature
of all signatories must be obtained together with their full names and other
particulars.

The next step is for the bank to take up the references by writing other previous
bankers of the applicants and to the referees (e.g. employers for employed people
or accountants for the self-employed). It is only after satisfactory references have
been made and obtained that the account may be operated and a cheque book
issued.

Taking proper references is very important and should be taken very seriously. If
the names given by a prospective customer are non-customers and are known to
the bank, it may be necessary to obtain an opinion from their bankers. Thereafter, it
is necessary to approach the references themselves and obtain their opinion in
writing and even have a chat with them. These extra precautions are necessary
now in Nigeria to curb the activities of men of the underworld that open account to
defraud banks.

PROCEDURES FOR CLOSING AN ACCOUNT

When an account is in credit, it may be closed for the following reasons:-
i. Dormancy
ii. Drawing out the whole amount.
57
iii. Transfer of the balance at the Customers request to another branch or bank
iv. Unsatisfactory nature of account.

When an account has remained dormant for a considerable length of time with a
small credit balance, it is the practice of bankers to Contact the customer and
politely suggest that, the account be closed as it does not appear to be needed any
more. He should be advised to draw cheque for the whole balance and return any
unused cheques.

If as sometimes happen, the customer cannot be traced, the account may be closed
after a reasonable notice has been given. When an account is closed in this manner,
the customer can still withdraw his money whenever he calls at the bank. Such
monies are not appropriated by the bank, but merely transferred to an unclaimed
balance account for convenience.

TERMINATION OF BANKER’S AUTHORITY TO PAY

The Bills of Exchange Act Cap. 21 (1978) S.75 stipulated the circumstances under
which the authority of a banker to pay a cheque drawn on him by his customer is
revoked or determined. These are:-
i. Countermand of payment, and
ii. Notice of the customer’s death.
Other events which may terminate the banker’s authority to pay include:-
i. The mental incapacity of the customer;
ii. The bankruptcy of the customer;
iii. A garnishee order on the customer’s account;
iv. Assignment of the credit balance to a third party, and
v. Winding up (in the case of a limited liability company).
58
DEATH:-
Death cancels all mandates and authorities given by the customer and the rights
and liabilities. Upon receipt of notice of a customer’s death the account must be
stopped immediately, until the appropriate legal documents are produced, i.e.
probate or letters of administration.

From the data of receipt of notice, no further cheques must be honoured. However,
cheques received and paid before receipt of notice can be debited to the account,
but bills accepted by the customer before his death should not be paid. No credit
must go through the account upon receipt of notice of death. All such deposits
must go into a separate account opened by the personal representatives of the
deceased, otherwise called the executors or administrators. Cheques received
before probate or letters of administration should also be credited to a separate
account.

MENTAL INCAPACITY
Upon receipt of notice that a customer is suffering from mental incapacity, the
banker should immediately stop the customers account. Where no notice was
received, but the bank learns from a reliable source of the mental illness, he (the
banker) should suspend all operations on the account until a court order is received
or the customer shows evidence of full recovery

BANKRUPTCY:-
If the account is in credit, it must be stopped immediately and the balance
transferred to the trustee in bankruptcy. Where the account is overdrawn or in debt,
it must be stopped upon receipt of notice of an act of bankruptcy or presentation of

59
a petition. Only debts incurred prior to the date of the receiving order and without
such notice are recoverable.

GARNISHEE ORDER
A garnishee order is an order obtained by a judgement creditor from the court,
ordering that a debt owing by a debtor to the creditor be paid through the court.
Another object of a garnishee order is the attachment by the judgement creditor of
monies of the judgement debtor in the hands of a third paty- the garnishee. Bankers
receive such orders occasionally.

Garnishee order is an interim order which places the banker on notice and restrains
him from parting with any money due to the judgement debtor. Thereafter, the
debtor is summoned to the court debt to show case why the funds shall not be
taken in satisfaction of his debt.

When a debtor is issued with such an order or summons, the banker is also
notified. The bank should immediately request the debtor to admit the debt in
writing.

The amount involved should be transferred to a separate account pending payment

to court. If the order is for a specific and limited amount, if the order attaches all
funds available to the customer, then his account must be stopped immediately. All
cheques in hand at the time of the order must be returned unpaid with the owners
account attached.

60
Upon the issue of an ‘Absolute’ order, they (i.e. the garnishee) must pay over to
the judgement creditor through the court, the amount of the order and costs of the
available balance on the customer’s account if less than the order.

TYPES OF BANK CUSTOMERS

There are several categories of customers to a bank, these are the personal
customers, and the special customers.

Personal Customers:- These are mainly workers whose salaries and wages are paid
directly to banks for the credits of their accounts. Other categories of personal
customers are pensioners and students who receive cheques for their maintenance.
In order to open a personal account, the bank’s application form needs to be
completed. The information required on the form includes the full name, address
and occupation of the applicant. Most banks require a new current account
customers to be introduced by two referees who may be customers of the bank or
another bank. The referees are required to attest to the fact that the applicant is
considered a suitable person to operate an account.

A letter of introduction from the employer of the applicant will in most cases be
sufficient reference for the opening of an account. This is the only method used by
banks to ascertain that a new customer is responsible and reputable, a bank takes
all the necessary precautions before opening a new account, it will receive full
protection of the law, even where a person who is not the true owner of a cheque,
uses it to open an account. The bank must however act in good faith and without
negligence. Failure to obtain and follow up references in good and faith to and
obtain name and address of the employer of a new account customer would be
deemed to be negligence in the part of the bank;
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SPECIAL CUSTOMERS:
Special Customers include MINORS, JOINT ACCOUNTS, TRUSTEES, CLUBS,
SOCIETIES, MARRIED WOMEN, EXECUTORS, LIQUIDATORS-
RECEIVERS, PARTNERSHIP, LIMITED LIABILITY COMPANIES, ETC. For
each of these groups different banking considerations may apply.
(a) Minors:
In Nigeria, a person is regarded as a minor, and in fact, if he/she is under 21 years
of age. A banker must be careful while dealing with such a person who has not
attained full age as their capacity to enter into contractual obligations is limited. A
minor is only bound to a reasonable price for necessaries supplied to him.
Although, a minor can operate banking account, yet the account must always be in
credit and must not be over drawn as repayment of a loan granted to a minor
cannot be enforced in court of law; even if he obtained the loan by inflating his
age. If a minor obtains credit facilities from a bank on behalf of a partnership, the
loan will be binding on the other partner, though the minor will not himself be
liable as credit facilities extended to a minor cannot be enforced.

(a) Joint Account:

This is an account conducted by more than one person. Customers operating joint
accounts have the same rights and obligations as individual account holders. The
most common joint account holders are husband and wife; and other similar
combinations.

When a joint account is opened, the banker must have clear instructions in respect
of the mandate, and the liabilities and powers of each party or signatories to the
account. The mandate must be signed by all parties to the account, and must
clearly specify the number of joint account holders with authority to sign cheques
62
and other documents. Unless such a mandate is given, it means all parties to the
account must sign cheques before they can be honoured. A mandate may be
revoked at any time by any of the account holders, hence such accounts must be
stopped whenever there is a serious dispute of disagreement. Death, bankruptcy or
insanity or insanity of any of the parties to the account will result in stopping the
account

RETURN OF CHEQUES UNPAID TO CUSTOMERS:

The following are the list of approved reasons for returning cheques in Nigeria as
approved by the clearing house committee.
1. Refer to drawer
2. Refer to drawer present again.
3. Amounts in words and figures differ.
4. Amount in words required.
5. Material alternation requires drawers confirmation.
6. Payment stopped, payment countermanded or orders not to pay.
7. Account closed.
8. No account.
9. Account attached.
10.Crossed to two bankers.
11.Requires bankers crossing.
12.Out of date or stale.
13.Post-dated.
14.Date incomplete.
15.Effects unclear.
16.Effects unclear, present again.
17.Endorsement irregular.
63
 18.Endorsement required.
19.Endorsement requires bankers confirmation.
20.Payee’s endorsement required (1st and 2nd)
21.Signature differs.
22.Second/further signature(s) required
23.Drawers signature required.
24.Cheque drawn in foreign currency-please present special
25.Cheque mutilated.
26.Drawer deceased.
27.Receipt stamp required.
28.Wrong delivery.
29.Cheque incompletely drawn.

The reason for returning must be written in full and boldly on the face of the
cheque and must be the true reasons why the cheque is being returned unpaid.

BANK CLEARINGS AND CORRESPONDENCE BANKS CLEARING

HOUSE:
The clearing house is where banks exchange cheques. Each commercial bank
sends a representative to the clearing house to deliver cheques drawn on other
banks and receives the cheques drawn on it. If a drawer and payee of a cheque
have accounts in the same branch of a bank or even at different branches of the
same bank, there is no clearing house involvement in the clearing of their cheques.

Apart from Lagos clearing house there are clearing houses in lbadan, Kaduna,
Kano, Jos, Maiduguri, Sokoto, Port-Harcourt, Enugu, Calabar, Ilorin, Benin,

64
Abeokuta, Ondo, Oweri, Makurdi, Yola, Bauchi and Minna, i.e. all the state
capitals with CBN Branches including Abuja recently.

Each clearing house is managed by clearing house committee, comprising a

chairman appointed by the CBN or the Branch controller or his representative in
the case of up-country clearing houses, and representatives of all member
banks.Each clearing area is defined in the rules and regulations governing it. The
Lagos Clearing area consists of Lagos Island, Mainland, Apapa, Ikeja, llupeju and
Agege. Each of the up-country clearing areas are similarly defined.

The clearing of cheques described above consists only of cheques drawn on banks
within that defined area.

PAYMENT OF CHEQUES:
After cheques have passed the clearing system, and they get to the branch on which
they are drawn, the next step is the payment of the cheque. The branch must ensure
that the cheques are properly drawn and that the branch has authority to debit the
customers’ account.

The branch must make sure that the customers have not stopped payment of any
cheque, and that the accounts are in funds. The signatures on the cheques must be
critically examined to ensure that they are genuine, and that the cheques are signed
in accordance with the mandate given to the bank. For instance if two signatories
are required to sign, the bank must ensure that this is complied with. The cheque
itself must be scrutinized to ensure it is properly endorsed and that it is not post-
dated, stale, mutilated or altered.

65
SPECIAL CLEARING
If a customer is in urgent need of funds, and wants the proceeds of a cheque to be
credited to his account on the same day, or wants to know the fate of a cheque on
the same day, he can ask his bank to send the cheque for special clearing or to
arrange special presentation. In this case, the branch sends the cheque direct to the
drawee bank’s branch through a messenger or clerk for payment.

If the cheque is in order and paid, the drawee’s bank will debit its customer’s
account immediately and send a banker’s payment, the account of the payee is
credited with the proceeds of the cheque the same day.

A fee is normally charged for this service, but as stated above enables the customer
to know the fate of a cheque on the same day and to have immediate use of the
funds when in need.

CORRESPONDENT BANKING:
Correspondent system of banking is a private network among banks. It connects
banks and eliminates many of the disadvantages that would otherwise follow, from
having so many small, isolated banks.

In this system, country or community banks in most cases keep deposit. Primarily
demand deposits, with large city correspondent banks, frequently with several of
them. These deposits are large enough, amounting to about 1.5% of all deposits.

The city large banks pay for these deposits by providing their country or
community correspondent banks with many services. One important service it
provides, IS the clearing of cheques in a more convenient way than the Central
66
Bank does. In addition, city or large banks provide direct loans to community or
smaller banks; and also participate with them in making loans that are too large for
community or smaller banks to make on their own. Or, conversely, a community or
smaller bank experiencing t00 little loan demand can participate in a profitable
loan made by a city bank.

Other services that city correspondent banks provide to country or village

correspondent banks includes:
(a) The sale of or purchase of securities
(b) Access to the Central Bank’s capital market;
(c) Investment advice and general business advice;
(d) And buying or selling of foreign exchange for its customers.
City correspondent banks therefore provide many of the services that the head
office of a large branch bank provides for its branches to their subordinate friendly
banks.

BRANCH BANKING:
Quite recently in Nigeria Banking system, Unit banks, i.e. a bank without branches
have given way to large banks with branches throughout the states of the
Federation. A branch bank must offer the usual type of deposits in order to be
classified as a branch.

In recent years; large banks engage in credit operations on a national scale have set
up offices in major cities for the purpose of doing business more conveniently for
their borrowers. These offices are not regarded as branches even though they
engage in almost all banking activities except offering regular deposits and making
loans to local customers.
67
Regulations of some states, especially in advanced countries do not allow banks to
have branches, branches of the bank must be within the city or county in which the
bank is located. Supervisory officials must approve both the formation of new
branches and mergers with other banks. Restrictions on branch banking are
gradually breaking down.

Resistance to branch banking is due partly to the reluctance ot bankers and bank
owners in rural areas to give up control of their banks.

Many small communities appear to prefer local control of their banking

institutions. It is a matter of dispute which type of bank, the branch bank or the unit
bank can best serve the needs of rural communities and suburbs.

Unit bank can obtain many of the services that branches have, by maintaining a
correspondent relationship with larger banks. Several studies have concluded that
the economies of scale in banking are relatively small and are less than the
diseconomies of branch banking.

On the other hand, one important statistical study concluded that large banks with
branches are, on the average more profitable than large unit banks of comparable
size.

68
 CHAPTER SIX
LIQUIDITY MANAGEMENT
INTRODUCTION
Banking as a business centres on trust and confidence. The depositor leaves his
hard-earned money with the bank in the belief that his money is safe. He has a
strong confidence in the bank’s ability to repay his money on demand. However,
by the fractional reserve system of banks only a fraction of the depositors’ funds is
left in the bank vault.

Another major nature of banking business is maturity transformation. The bank

collects short-term deposits which are given out on loan for a period longer than
the maturity of such deposits. This is done in the belief that as long as public
confidence is retained. New deposits will be received and used to repay depositors,
and that all depositors will not come for their money at the same time. Thus, there
is a constant risk that funds may not be available to meet deposit withdrawals, or
loan draw-downs and other cash outflows. This calls for proper management oft
bank liquidity. Liquidity management appears more crucial than other aspects of
bank management because illiquidity cannot be hidden for long. A bank may
succeed in Concealing low profitability or capital inadequacy for long. But a bank
that becomes illiquid may not be able to conceal it for more than one day. Once
there is an increased demand for currency the problem of illiquidity will surface.
This can have a grievous consequence for the bank.

In liquidity management, neither excess liquidity nor illiquidity should be the aim.
The emphasis is rather the maintenance of adequate liquidity.

69
PROBLEMS OF EXCESS LIQUIDITY
While trying to ensure that money is always available to settle depositors, the bank
must be careful not to keep excess liquidity.
The dangers of excess liquidity are as follows:

1. Loss of Profitability: Excess liquidity can only be held at the expense of

profitability. Those assets that provide liquidity yield no or minimal income to
the bank. Cash in vault do not yield any income. The interest rate earned on
short-term liquid assets is minimal. To keep a large percentage of the bank
fund in liquid assets will mean that the returns which the money would have
earned if invested otherwise is forfeited. The opportunity cost of keeping
excess liquidity is that proportion of profit forgone.

2. Increase in Cost Of Security: To keep cash and to safeguard it is costly. When

excess cash is held there may be need for larger vault, and the installation of
more protective devices. More security staff maybe required. All this will help
to increase the bank’s costs while reducing its profit.

3. Mismanagement: With excess liquidity to play around. It becomes easier for

the management to misuse funds. Such funds may be misappropriated by
embarking on white-elephant projects, or increase in fringe benefits to staff,
unnecessary donations, or by other means.

4. Increase in Fraud And Theft: Funds kept in liquid form is easy to steal or
tamper with. Moreover, the constant sight of liquid assets such as cash can, in
itself, lure criminally minded staff to engage in cash related frauds. Excess
liquidity also makes it difficult to discover pilfering.
70
5. Unsatisfied Credit Needs Of The Community: Keeping bank funds in liquid
form will mean that genuine credit requests of the community will be turned
down. Long-term loans needed for development projects may never be
considered because of the unnecessary emphasis of liquidity.

In view of the forgoing, a bank must try to keep its investment in liquid assets as
low as possible. However, it must also try to avoid getting to the point of
illiquidity. That too is even more dangerous for the bank operations.

DANGERS OF ILLIQUIDITY
A bank is said to be illiquid when it is unable to settle short-term and maturing
obligations at short notice, or does not possess enough assets that can be easily
converted to cash without involving any considerable loss. Such a situation will
mean that depositor’s funds cannot be repaid on demand. This can have the
following adverse consequences for the bank.

1. Loss of Public Confidence

Once a bank is illiquid such that it becomes unable to repay its customers on
demand, it faces the risk of loss of public confidence. This alone can send the bank
out of business because confidence is the pivot on which banking business
revolves. Adequate liquidity will enable the bank repay customers deposit on
demand, and to meet their loan demands. This will help the bank both to gain and
retain public confidence.

2. Inability to Seize Profitable Opportunities

Opportunities for profitable investment and lending often arise without notice. A
bank that is illiquid cannot seize such opportunities when they come. For instance,
71
if a business firm that the bank has been working hard to secure as customer finally
presents a loan request, the bank cannot seize such opportunity if it is not
adequately liquid.

3 Forced Sale of Assets

A bank that does not have adequate liquidity may be forced to sell its assets at
unfavourable terms when faced with liquidity problems. Liquidity problem
normally comes when there is a large increase in the demand for currency. This
can happen because of seasonal and unexpected loans and deposits fluctuations. In
such cases the bank acts like a fire-fighter and is forced to sell its assets to raise
cash.

3. Involuntary Borrowing
In crisis period, a bank that does not have readily disposable assets may be forced
to borrow involuntarily from the discount window of the Central Bank of Nigeria,
or the National Deposit Insurance Corporation as a last resort. Such a bank, which
is now at the mercy of the monetary authorities, may be forced to hand over its
management to the Central Bank. This gives the impression of insolvency and has
adverse impact on the bank’s image. Moreover such borrowing is normally done at
very unfavourable terms.

4. Non-Compliance with Statutory Requirement

The Central Bank normally stipulates a liquidity ratio that must be maintained by
banks to ensure the safety of customer’s deposit. Failure to meet this ratio attracts
some penalty. When a bank fails to maintain adequate liquidity, it cannot comply
with that statutory requirement. Adequate liquidity is, therefore, necessary to avoid
this and other consequences already discussed.
72
SOURCES OF BANK LIQUIDITY
Bank liquidity comes from two major sources -stored liquidity and purchased
liquidity.

a. Stored Liquidity: Stored Liquidity is the liquidity got from the Bank’s
holding of liquid assets in which funds are temporarily invested. This source
of liquidity is internal to the bank. Funds kept in form of liquid assets can
easily be turned into cash by selling them when liquidity is needed. Stored
liquidity, therefore, consists of cash and short-term funds, call money sold to
other banks, short-term government securities, certificates of deposits,
bankers acceptance and various commercial papers, and other marketable
securities held. All assets held as primary and secondary reserves are
included in this category. Stored liquidity is asset-based. It is also referred to
as warehoused liquidity.

b. Purchased Liquidity: This is based on the liability side of the balance sheet.
Purchased liquidity refers to funds got by borrowing from the money market.
These include certificates of deposits and bankers unit funds sold, borrowings
from the Central Bank, call money from other banks deposits and other
liabilities. The availability of purchased liquidity is highly dependent on the
availability of developed money market and the willingness of the central
Bank to lend to banks.

LIQUIDITY DOCTRINES
Various schools of thought exist on how best a bank should conduct its affairs to
ensure that adequate liquidity is maintained.

73
These schools of thought which have been applied by banks over the years in the
management of bank liquidity are referred to as liquidity doctrines or liquidity
theories. All the theories of bank liquidity fall into two groups. The first group
which is asset-based emphasizes that the liquidity of a bank depends on the assets
composition and as such, liquidity management should concentrate on bank assets.
The second group, while accepting that liquidity comes from bank assets, pointed
out that liquidity Can also come from the liabilities of a bank because liquidity can
also be purchased from the money market by borrowing.
Among these two groups, five separate doctrines exist. These are the liquid assets
doctrine, commercial loans (or Real bills) doctrine, the shiftability doctrine. The
anticipated income doctrine, and liability management doctrine:

Asset-Based Liquidity Doctrines

1. The Liquid Assets Doctrines
This is the oldest liquidity theory practised since the London goldsmith era. It
states that for a bank to remain adequately liquid large proportion of its assets must
Consist of liquid assets as a cushion against customers demand for payment. This
implies that as long as the bank is able to hold liquid assets in large amounts it will
remain liquid.
Merits
(a) This theory ensures maximum liquidity at all times from internal sources.

(b) It saves the bank the pains of having to scout for scarce funds in the money
market at unfavourable rates during periods of liquidity squeeze.
Short Comings:
(a) By depending on the assets side of the balance sheet, it ignores the fact that
liquidity could be purchased through borrowing from the money market,
74
 (b) It ignores the profitability needs of the bank owners and investors. Holding
large proportion of liquid assets means that profit is sacrificed at the altar of
liquidity.

(c) It is difficult to determine accurately the actual amount of liquid assets to be

held at each time.

2. The Commercial Loan Theory (or Real Bills Doctrine)

According to this theory, a bank’s liquidity is maintained if it grants only self-
liquidating working capital or production circle loans (i.e commercial loans). This
implies that the bank must desist from granting long-term loan, and such loans as
agriculture, real estate and consumer loans because they are not self- liquidating.
The only loans to be granted are those to be used in financing the movement of
goods through the various stages of production.

Merits
(a) This theory ensures that loans are repaid in the normal course of business.

(b) By investing short-term loans, the credit risk is reduced.

Short-Comings
(a) It fails to consider that bank deposits have relative stability based on the
principles of maturity transformation. Rather than wait for loans to be
repaid, new deposits are received continuously to match withdrawals as long
as confidence is maintained.

75
 (b) It ignores the long-term credit needs of the community which help to finance
capital investments necessary for economic development.

(c) Its assumption of normal economic circumstances with no room for

fluctuation that may affect the repayment of commercial loans is unrealistic.
In periods of economic stress, even commercial loans may not be repaid.

(d) Low Profitability. Short-term loans are less profitable than long-term loans.

3. Shiftability Doctrine
This theory was propounded to overcome some of the shortcomings of commercial
loans theory, especially its inability to meet the long term credit needs of the
community. Proponents of this theory maintain that a bank will remain adequately
liquid as long as it holds assets that could be shifted, sold or transferred to other
investors or lenders, to obtain immediate cash. According to this theory the
criterion to be used by banks in deciding assets to hold is not whether it has short-
term maturity, but whether those assets could be sold or converted to cash without
delay and appreciable loss.
While the commercial loan theory emphasizes maturity assets, shiftability
theory emphasizes marketability. For assets to marketable it should be of high
quality and also of shorter maturity. However, where long-term loans are properly
secured the collaterals could be sold or transferred to the Central Bank when cash
is needed. Many bankers subscribe to this theory that is needed. Many bankers
subscribe to this theory.

76
Merits:
(a) It helps to meet the long-term credit needs of the community by de-
emphasizing short-term lending.

(b) Marketable securities serve as good secondary reserves while meeting the
profitability needs of the investors.

Short-Comings
(1) The theory cannot hold in periods of serious economic slump. In Such
periods, market prices for securities fall and assets could not be transferred
except at a loss. This was the case during the economic depression of the
1930s when many banks applying this theory had serious liquidity problems.

(2) It fails to recognize that liquidity could be purchased. That is, it is asset-
based.

4. The Anticipated Income Theory

The emergence of this theory followed the development of amortization and
systematic loan repayments applicable to various types of term loans. While
recognizing the applicability of previous theories, the anticipated income theory
holds that the liquidity of banks is ensured if loans are given to reputable
customers with good future earning power such that the scheduled loan repayment
can be planned to meet liquidity needs of the bank. Even if there are various long-
term loans in the bank’s portfolio, liquidity can still be ensured through planned
regular instalment repayment of principal and interest which ensures continuous
cash inflows.

77
According to this theory loan repayment should be related to anticipated income
rather than much reliance on collaterals.

Merits
(a) It accommodates the long-term credit needs of the community. Such loans as
agricultural, real estate and business term loans with amortization can still be
provided.

(b) Surplus cash inflows from loan repayment in periods of low demands can be
conserved to meet liquidity needs in periods of increased demand.

Short-Comings
(a) By relying mainly on regular loan repayment as a source of liquidity, it also
ignores that liquidity can also be got from the liability side of the balance
sheet through borrowing.

(b) Since the future cannot be predicted with certainty, the anticipated income
flow of borrowers cannot be predicted with certainty. In periods of economic
distress credit risk is increased which may result in non-repayment of loans
as scheduled.

Liability-Based Liquidity Theory

The Liability Management Theory
While the liquidity theories discussed so far are based on the assets side of the
balance sheet, the liability management theory assets side acknowledges that
liquidity could also be got from the liability side of the balance sheet. This school
of thought insists that banks can purchase all the funds needed to meet liquidity
78
requirements from the money market and as such, there is no need to store large
amount of liquid assets. It recognizes that liquidity could be got by borrowing from
the Central Bank or by bidding higher in the money market. In a broader sense this
approach will also include the process of getting funds from depositors and other
creditors and the sale of certificates of deposits to meet liquidity requirements.

Merits
(a) By reducing the proportion of liquid assets which earns low or no returns, the
bank’s profitability is enhanced. This satisfies the shareholders and other
investors.

(b) By de-emphasizing the holding of liquid assets, the credit needs of the
community is properly accommodated thereby. Enhancing economic
development.

(c) It recognizes the fact that liquidity can be purchased which is ignored by the
other theories.

Short-Comings:
(a) It wrongly assumes stable and normal economic condition without
recognizing that periods of economic recession do arise when there may be
no funds to borrow.

(b) It also assumes in error that the market will always have unshaken
confidence in the banks credit worthiness.

79
Summary
In managing bank liquidity. No singular theory among the five discussed above is
followed as the best. Instead, banks apply all the various theories or at the least
adopt two or more of them at various times.

MEASUREMENT OF BANK LIQUIDITY

To avoid plunging into serious liquidity problems. And to determine the bank’s
liquidity needs, the management of each bank needs to measure the bank’s
liquidity from time to time. Besides the regulatory authorities often measure bank
liquidity to ensure that they comply with statutory requirements while interested
public assesses the liquidity of banks to ensure the safety of its money.

There are three approaches to measuring bank liquidity, namely: The statutory
requirements, the use of other ratios (stock approach), and the cash flow approach.
The first two are the mostly used, the last requires an accurate forecasting of cash
needs and receipts over a given time. All these liquidity measures attempt to
measure both how liquid the bank is, and the existence of liquidity risk, which is
the risk that funds will not be available for the bank to meet its short-term and
maturing obligations when due. It is pertinent to note however, that of all the three
approaches each has some advantages and shortcomings, but none of them has
incorporated a measurement of the purchased liquidity. The ability of the bank to
get liquidity through good liability management is therefore ignored. It is, of
course, difficult to correctly assess the bank’s access to purchased funds. This
depends on the financial market condition, and the bank’s credit rating in the eyes
of lenders and other investors.

80
Statutory Requirements
To be considered liquid, a bank must comply with the basic statutory requirements
tor liquidity. In this regards, Nigerian banks are required under the Banks and other
Financial Institutions Decree 1991 to maintain two types of ratios: cash reserve
ratio, and liquidity ratio

(a) Cash Reserve Ratio: This is the ratio of each bank’s total deposit liabilities
which it must maintain at all times in the form of cash reserves with the
Central Bank. The prescribed percentage is given by the Central Bank of
Nigeria at the beginning of each year in the monetary policy circular.
It is calculated thus:
Total deposit liab . Prescribed cash Ratio
Cash Reserve Requirement = 1 × 100

(b) Liquidity Ratio: This is defined as the minimum ratio of specified liquid
assets to deposit liabilities of each bank which must be held by the bank.
Total Specified Liquid Assets
Liquidity Ratio = Total deposit Liabilities

The Specified Liquid assets, according to the Banks and other Financial
Institutions Decree, l991, are as follows:
(i) Currency notes and coins which are legal tender in Nigeria (i.e cash).

(ii) Balances at the Central Bank of Nigeria less any shortfalls on Loans for
agriculture and residential buildings;

(iii) Net balances at any licensed bank (excluding unclear effects), and money at
call in Nigeria;
81
(iv) Treasury Bills and Treasury certificates issued by the Federal Government:

(v) Inland bills of exchange and promissory notes rediscount able at the Central
Bank of Nigeria;

(vi) Stocks issued by the Federal Government with such dates of maturity as may
be approved by the Central Bank of Nigeria:

(vii) Such other negotiable instruments as may from time to time, be approved by
the Central Bank of Nigeria for this purpose.

When measuring the liquidity of a bank based on the statutory requirements it

should be remembered that the ratios given are just the minimal requirements.
Based on prudence and experience, banks will normally go beyond the prescribed
minimum to take care of fluctuations in deposits and loan demands. A bank is
normally asked to curtail its lending activity if it fails to comply with these reserve
requirements.

Stock Concept (Ratios)

The stock concept attempts to measure the stored liquidity of a bank through the
use of certain financial ratios. The ratios help to indicate the liquidity level by
revealing the relationship among key balance sheet items. In this regard, three
groups of items are of particular importance. First is the liquid assets (Cash and
cash assets).These being the most liquid of all assets, the proportion or cash and
cash assets held points to how liquid a bank is. The next group is the Loans and
advances. Loans are the most illiquid assets.
82
The more the loans in relation to other assets and liabilities the less liquid the bank
is. The next group is the deposit liabilities.

Deposits have the highest requirement for liquidity Unlike other liabilities banks
can be called upon at any time to repay the deposit liabilities. Some ratios are,
therefore, used to measure the proportion of deposits in relation to cash and cash
assets which are immediately available to meet depositors demand. The problem
with using ratios to measure liquidity is that ratios are static. They are based on
figures as at balance sheet date, but liquidity is not static. A bank may be liquid
today, and become illiquid tomorrow.

The ratios normally used are as follows:

a. Cash To Deposits Ratio
This ratio relates the cash in the bank’s vault which is immediately available to
settle depositors directly to the deposit liabilities of the bank. It shows the extent
the bank can repay the depositors within the banking hall or offices without going
to collect the money held in other banks and the Central Bank of Nigeria. The
higher this ratio is, the more liquid the bank.
Cash
Cash to Deposits Ratio= Total Deposit
This is a very good measure of liquidity. By relating cash directly to deposits the
liquidity immediately available is compared to immediate liquidity needs. Its major
Shortcoming, however, is that it is asset based, ignoring the fact that liquidity can
be purchased. It also ignores that other short-term assets can be used to meet
liquidity needs. It also assumes that liquidity is static since it is based on the
figures as at a given date.

83
 b. Cash-to-Assets Ratio
Cash is the most liquid of all assets. The cash-to-assets ratio ensures the proportion
of bank assets held to meet immediate liquidity needs of a bank. When this ratio is
high, it means that more cash is held, and hence the bank is considered more
liquid. This ratio is calculated as follows:
Cash
Cash-to-Assets Ratio= Total Asset
The merit of this ratio is that it shows the bank’s ability to react to liquidity needs
immediately. A bank may have enough cash assets with the Central Bank and other
banks, but if customers who come for withdrawals are asked to wait until the bank
have gone to the impression of insolvency may be created. However, this ratio
shares the same shortcomings with the first.

(c) Cash Assets to Deposits Ratio

Cash assets consist of vault cash, balances held with the Central Bank of Nigeria,
and balances held with other banks. These assets appear in most Nigerian bank
balance sheets as cash and short-term funds. Closely related cash to deposits ratio,
the cash assets to deposits ratio measures the extent to which the bank can meet
depositors withdrawal demand it allowed time to cash its own deposits with the
Central Bank and other banks.
It is calculated as follows:
Cash Assets
Cash Assets-to-Deposits Ratio = Total Deposit

A rise in this ratio indicates improved liquidity. The merit of this ratio is that it
recognizes that balances held with other banks and the Central bank is also
84
available to meet liquidity needs instead of relying only on cash. The problem with
this ratio however is its assumption that all cash assets are available to meet
liquidity needs. This does not hold. Some cash assets like the statutory reserves and
special deposits with the central bank are not always available. For instance, in
August 1993 many banks in Nigeria faced serious liquidity problems because of
the increase in customers withdrawal at the wake of the crises that followed the
annulment of the election held on June 12, 1993, but the Central Bank of Nigeria
refused to refund them the amount held in stabilization securities of the Central
Bank.

This ratio also excluded other liquid assets which can easily be converted into cash
to meet liquidity needs such as short-term government securities. And, like other
assets based ratios, it fails to recognize that liquidity can be got through borrowing.

(d)Cash Assets Ratio

The cash assets ratio is used to measure the proportion of bank assets held as cash
assets. Since cash assets are the highest category of liquid assets, next to cash. A
high ratio of cash assets to total assets implies that the bank is in a good liquidity
position. The ratio is stated as follows:
Cash Assets
Cash Assets Ratio= Total Asset
This ratio is assets based. Apart from the fact that it included balances with other
banks, it still suffers the same shortcomings as cash assets to deposit ratio. It
excludes the fact that liquidity can come from other short-term assets, and also
from borrowed funds.
(e) Loan-to-Deposit Ratio

85
This ratio is based on the fact that loans are the most illiquid assets of a bank,
while deposits require more liquidity than all other liabilities. This ratio indicates
that the proportion of deposits that went to loans indicates that the bank tends to
illiquidity, while a fall in this ratio is an indication of improved liquidity. This ratio
is one of the ratios used by the Central Bank of Nigeria to measure bank liquidity.
It is calculated thus:
Total Loans∧Advances
Loan-to-deposit ratio = Total deposit liability

A bank with a high loan to deposit ratio is highly exposed to liquidity and credit
risks. To correct this position it must have to reduce its lending activities.

Although this ratio is a simple way of measuring liquidity, it is difficult to say what
size of ratio can be considered high. With the emergence of the liability
management theory of bank liquidity more Nigerian banks may be willing to
accommodate a high loan to deposit ratio. Since the early 1990s the loan-to-deposit
ratio of Nigerian banks has been declining as a result of the undue emphasis on
Table 6.1 below shows the loan-to-deposit ratios of commercial and merchant
banks for the years 1984 to 1993.

Another deficiency of the loan-to-deposit ratio is that it assumes that all loans have
the same level of illiquidity without considering the quality and maturity of the
individual loans within the loan portfolio. It also fails to recognize that other
liabilities can drain bank funds apart from deposits.

(f) Loan-to-Liabilities ratio

86
Rather than concentrate only on deposits, this ratio relates a bank’s loans and
advances to the total liabilities of the bank. This is a better approach because
despite the fact that deposits make more demand on bank liquidity, other liabilities
can also drain bank funds.

LOAN-TO-DEPOSIT RATIOS OF COMMERCIAL AND MERCHANT BANKS

IN NIGERIA (1984-1993)

Year Commercial Merchant

banks banks

1984 81.9 *
1985 66.9 *
1986 83.2 118.4
1987 72.9 123.1
1988 66.9 91.7
1989 80.4 190.6
1990 66.5 158.6
1991 59.8 140.0
1992 55.2 92.3
1993 42.9 69.4

*Computation of Merchant banks loan-to-deposit ratio by the Central Bank

started in 1986.
The loan-to-liabilities ratio is measured as follows:
Table 6.1 LOAN-TO-DEPOSIT RATIOS OF COMM. AND MERCH. BANKS.
Source: Central Bank of Nigeria Statistical Bulletin
Vol. 4. No.2, 1993.

87
 Total loans∧advances
Loan-to-liabilities ratio = Total Liabilities
Apart from the inclusion of other liabilities, this ratio shares the short-comings of
the loan-to-deposit ratio. A rise in this ratio also indicates illiquidity.

(g) Loan to Assets ratio

This ratio measures the level of illiquidity of bank assets as a means of determining
bank liquidity. Loans being the most illiquid assets, this ratio attempts to measure
the proportion of bank assets that is in the form of loans and advances. It is
calculated thus:
Total Loans∧Advances
Loan-to-Assets ratio= Total Assets
The higher the proportion of loans and advances in the bank assets, the less liquid
the bank is considered. This ratio suffers the same short comings as the loan-to-
liabilities ratio.

THE CASH FLOW APPROACH

The basic shortcoming of the use of ratios under the stock concept is that they are
based on financial statement figures which reveal only the past financial position
of a bank as at a given date. The stock concept therefore wrongly assumes that
liquidity is static. Cash flow approach to liquidity measurement was developed to
overcome this short-coming.

The cash flow approach is based on the banking principle of maturity

transformation and the anticipated income theory of bank liquidity. This approach
analyses the maturity structure of bank loans and advances and the expected
deposit and withdrawal pattern of bank customers to determine the availability of
funds at each point in time to meet the bank liquidity needs. Using this approach
88
the maturity ladder of bank loans, and deposit expectation becomes the basis for
measuring bank liquidity.

The basic idea is that while bank liquid funds is being reduced by deposit
withdrawals and loan draw-downs, it is also being increased by new deposits
coming in, and instalment or balloon repayments of loans previously extended.
Where the maturity ladder is properly managed to minimize or remove mismatch,
the bank will remain liquid. However, this calls to a lot of forecasting ability on the
part of the bank management. It also requires availability of enough data on the
maturity pattern of assets and liabilities. Even when the forecasting ability and the
data are all available, the future cannot be predicted with certainty. Credit risk still
exists because some adverse developments can arise in the future which will make
a borrower not to honour the loan contract as agreed. Adverse economic conditions
can also affect the expected deposits. These made the cash flow approach to have
serious limitations. The inflow and out flow of liquid funds is illustrated in fig. 6.2
below:

89
 Depositors Funds

ww
hN

td
dw

ww
de
tdN

dN
w

w
td

td
N

hN

w
he

e
td
e

de

h
d
i

i
Jan. Feb. March April May

BANK LIQUID FUNDS FLOW

Jan. Feb. March April May

lo
w
N

n
e

s
an

pa

an

e pa
Lo

yLo
lo

an

pa
w

lo Lo
RN
e

a
an

pa
an

pa

R
Lo

Lo

N e

R
lo

lo

e
w

y
N

N
e

eR
e

e
y

w
Funds from borrowers

Fig. 6.2 the Flow of Bank Liquidity

LIQUIDITY FORECASTING
Despite the various approaches to measuring bank liquidity, there is no magic
formula for ensuring that a bank that is considered liquid at present will remain
liquid in the future. Bank liquidity is not static. To remain liquid a bank must be
able to forecast its future liquidity needs and make adequate plans on how to
source such liquidity when the need arises. This can be accomplished through
liquidity forecasting.

However, there are many movements in both the national and international
economy which make it difficult for bank liquidity to be forecasted with certainty.

90
Such movements, which must be put into consideration in planning or forecasting
bank liquidity, are the irregular. Seasonal, cyclical, and secular movements
irregular Movements are those movements that do not follow a particular pattern,
such as acts of God (earthquakes, flood etc). War, strikes and other unusual
economic and political developments. Seasonal Movements are those that repeat
themselves at certain seasons of the year such as harvest seasons, and Christmas
seasons.

In the same way, loan demand increases during expansionary periods of business
cycle, while secular trends like a fall in demand as a result of changing
consumption pattern can affect investments and hence loans demands.

Causes of Changes in Liquidity Position

Before delving into the forecast of liquidity needs of a bank, it is necessary to note
the factors that can give rise to a change in the liquidity position of a bank. Those
factors are as below:

(a) Variation in deposits level

The existing level of deposits held by the bank may increase or reduce. An increase
in the deposit level will make the bank to get more liquid funds, while a reduction
in the deposit level will make the bank to lose liquid funds. In view of this factor,
the first step in forecasting bank liquidity is to forecast the expected level of net
deposit during the forecast period.

(b) Variation in the level of loans and/or investments

Variation from the existing level of loans and/ or investments can deplete or
increase bank liquid funds. An increase in loans and investments will result to a
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depletion of the liquid funds, while a decrease in the existing loans and/or
investments will lead to increased liquidity from loan repayments. The second step
in liquidity planning is therefore to forecast the expected loans and/or investments.

(c) Variation in legal reserve requirement

As deposits increase or decrease, legal reserve requirement varies with it in similar
direction even when the required rate of reserve has not changed. This too, must be
incorporated into a liquidity forecast. Because any part of the deposits set aside as
legal reserve requirement is no longer available for meeting liquidity needs.

Liquidity Forecasting
Once the above factors have been considered, the next step in liquidity forecast is
to construct a table of estimates of changes in deposits, loans, and legal reserve
requirements. Using the schedule, determine the periodic changes in each of these
variables. From the estimates calculate the liquidity needs. This can be presented in
the format given in table 6.3 below, for a liquidity forecast. Alternatively the
liquidity needs/surpluses and the cumulative liquidity needs/ surpluses can be
calculated directly as shown in table 6.4 on page 116.

Illustration 1
The total deposits, and total loans outstanding in the books of Brethren Bank plc as
at 31st December 19x1, were N25,021,000 and N16,163,600 respectively. The
following estimates have been made for its outstanding deposits and loans for the
four quarters of next year.

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 1st 2nd 3rd 4th
qtr qtr qtr qtr

Deposits 25,000,000 25,500,000 27,000,000 26,000,000

Loans 16,360,000 15,000,000 18,500,000 20,500,000

Calculate the liquidity needs of the bank assuming a

Required:
Calculate the liquidity needs of the bank assuming a minimum legal reserve ratio
of 30%.
Solution:
Step 1: Estimate the expected liquidity changes.
Table 6.2
Estimates of Liquidity Changes
Deposit Changes Changes Loans Changes
from in reserve from
prev
prev. qtr Reqt. month
N N N N N
Dec. 25.021.000 - - 16,163,600 -

1st qtr 25,500,000 +21,000 -6,300 16,360,000 +196,400

2nd qtr 25,500,000 500,000 +150,000 15,000,000 -1360,000
3rd qtr 27,000,000 1,500,000 +450,000 18,500,000 +3,500.000
4th qtr 26.000.000 1.000.000 -300.000 20.000.000 2500.000

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Step II: Prepare the Liquidity Forecast
Table 6.3
LIQUIDITY FORECAST FOR THE YEAR 19×12
1st 2nd 3rd 4th
qtr qtr qtr qtr
N N N N

Increase in Liquid Funds:

Net Increase in Deposits - 500,000 1,500,000 -
Net Decrease in Loans - 1,360,000 - -
Net Decrease in R.Reqt 6,300 - - 300,000
Total Increase in Liquidity (A) 6,300 1,860,000 1,500,000 300,000
Less: Decrease in Liquid Funds:
Net Decrease in deposits 21,000 - - 1,000,000
Net Increase in Loans 196,400 - 3,500,000 2,000,000
Net Increase in reserve reqt - 150,000 450,000 -

Total decrease in Liquidity(B) 217,400 150,000 3,950,000 3,000,000

Liquidity needs/surplus (A-B) (211,100) 1,710,000 (2,450,000) (2,700,000)
Opening Liq. Surplus - (211,100) 1498,900 (951,100)
Cumm. Liq. Needs/Surplus (211,100) 1498,900 (951,100) (3,651,100)

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Notes:
The liquidity need or surplus for each period is arrived at by subtracting the total
decrease in liquidity for that period from the total increase in liquidity. If the
increase in liquidity is more than the decrease in liquidity, the result is a liquidity
surplus, but, where the total decrease in liquidity exceeds the total increase in
liquidity, the result is a liquidity need. Liquidity needs appear in negative
(brackets). The existing liquidity surplus (opening balance) is added to the liquidity
need/surplus to arrive at the cumulative need or surplus at the end of the period. If
a liquidity need is forecasted at the end of a period, the bank must make adequate
arrangements to supplement its liquidity base.

LIQUIDITY NEED ESTIMATES

Period Deposit Changes Changes Loans Changes Liq. Cum. Liq.
from in reserve from needs/ Needs (-)/
prev. qtr reqt. month Surplus(+) Surplus(+)
(a) (b) b(0.30) (d) (e) b-c-e

Dec. 25,021,000 - - 16,163,600 - -

1st qtr 25,000,000 -21,000 -6,300 16,360,000 +196,400 -211,100 -211,100

2nd qtr 25,500,000 +500,000 +150,000 15,000,000 -1,360,000 +1,710,000 +1498,900

3rd qtr 27,000,000 +1500,000 450,000 18,500.000 +3,500,000 -2,450,000 -951,100

4thqtr 26,000,000 -1,000,000 -300,000 20.500,000 +2.000,000 -2.700,000 -3,651,100

Table 6.4 LIQUIDITY ESTIMATION

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NOTES:
The liquidity needs or surpluses are arrived at by subtracting both the changes in
reserve requirements(R) and the changes in loans/investments) from changes in
deposits ( D).
Thus: LQ = D - R- L
The cumulative liquidity needs/surpluses are derived by adding the liquidity
needs/surplus of the preceding periods to liquidity needs/surpluses of the present
period.

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 CHAPTER SEVEN
FRAUD AND DISTRESSE AMONG NIGERIAN BANKS

WHAT IS FRAUD
This is a criminal deceptive act of a person. While International Auditing
Guidelines (IAG) define it as a particular type of irregularities, that involves the
use of deceit, to obtain an illegal or unjust advantage of monetary item. Fraud may
involve any of the following:-

(a) Recording transactions without s substance.

(b) Misapplication of accounting policies if this is intentional and deceitful.
(c) Manipulation, falsification or alteration of records or documents.
(d) Misappropriation of Assets.
(e) Suppressing or omitting transactions from records or documents.

Whichever way fraud is looked at, it connotes an intentional distortion of financial

statements for whichever purpose the misappropriation of assets, whether or not
accompanied by distortions of financial statements. The issue of fraud has become
a thorn in the flesh of many corporate bodies in recent times.

TYPES OF FRAUD:
There are many types of fraud within the Nigerian financial sector, among the
major noticeable ones are as follows:-
i. Lending to ghost borrowers
ii. Impersonation
iii. Over-invoicing
iv. Unauthorized lending

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 v. Defalcation
vi. Forgeries
vii. Double pledging
viii. Suppression
ix. Theft and embezzlement
x. Fictitious contracts
xi. Claim of supernatural influence.

(i) LENDING TO GHOST BORROWERS

The granting of loans and overdrafts to non-existing customers is fraudulent act.
Whether such loans are being repaid by the Ghost borrowers or not. Experience
has revealed that some unscrupulous bank managers grant banking facilities to
themselves using fake names, signature and non customers as fronts.

(ii) IMPERSONATION:
This is the impersonation by third party to fraudulently obtain new cheque books
which are consequently used to commit – bank fraud, However, cases of
impersonation may not succeed if the passport photograph of the bonafide account
holder is properly identified and referred to, during the fraudulent transaction,
since customers signatures could be perfectly forged.

(iii) OVER-INVOICING:
This type of fraud is normally the purchasing as well as the submission of fake
and/or inflated Hospital bills, for payment by an authorizing Government or
privately managed agency.

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(iv) UNAUTHORISED-LENDING
This unauthorized lending, granting of banking facilities without adequate security
and verifiable accounting information intentionally, is yet another form of fraud,
which is also rampant amongst credit officers and commercial bank managers. Any
lending that does not accord with laid down regulations of the bank or does not
receive prior approval by superior accounting officer is fraudulent.

(v) DEFALCATION:
This fraudulent practice is done to customer’s deposits, either by conversion or
fraudulent alteration of deposits vouchers by either the bank cashiers or customer
agents. Customers, during reconciliation of their banking statements in most case
discover them.

(vi) FORGERIES
These are forging of customers’ signatures to draw money fraudulently from
customers account. This may be targeted as Savings Account, Deposit Account,
Current Account or Drafts and mailed transfers.

(viii) DOUBLE PLEDGING:

This fraudulent banking loans act involves using false or non-existing collateral to
obtain banking loans or other facilities.

(vii) SUPPRESSION:-
Suppression deals with cash and cheques. It is usually the suppression or acquiring
of the customers’ surplus deposits which the receiving cashier or note counters,
deliberately refuse to declare.

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(ix) THEFT AND EMBEZZLEMENT
This act could be in terms of monetary items such as cash, travellers cheques,
foreign monies, and other liquid assets of the bank.

(x) FICTITIOUS CONTRACTS:-

There could be thousands of different contracts awarded to non-existing or ghost
contractors, that could run into millions of Naira or Dollars.

(xi) CLAIM OF SUPERNATURAL INFLUENCE:-

These fraudulent acts are normally cases where cashiers release cash to their
accomplices and later claim that they were misdirected or influenced by certain
evil forces. In many cases, many such cashiers usually abscond from their duty
posts immediately the fraud has been uncovered.

CAUSES OF FRAUD
As criminologists put it; that fraud is caused by three elements and the exit that is
the escape called WOE; that is Will, Opportunity and Exit. Fraud Opportunity by
the individual, and Exit. To explain it further, it is the Will to commit fraud by the
individual, the opportunity to execute it, and the exit, that is the escape from
sanctions. Because of the get-rich-quick syndrome, fraud has proved to be a global
phenomenon not limited to the banking sector only. The following have been
identified to be specifically responsible for the enormous fraud that normally bring
Banks and other such financial institutions to their knees

(a) STAFF INFIDELITY:

There are cases when staffs borrow money from the cashier and O.U. from the
officer in charge of the ‘strong room. This usually parts with borrowing a few
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Naira that were not paid back overtime, the amount involved increases and the
willingness and ability to repay has declined. Some of such staff even abscond
from the bank thereby leading to loss of depositor’s funds.

(b) If a limit of lending powers is not properly regulated and defined, it makes it
very possible for Bank managers to engage in reckless and fraudulent granting
of loans and advances without seeking approval from a higher authority. Many
of such loans and advances end up in bad debts resulting in huge losses to the
bank.

(c) ABSENCE OF REGICOPES CAMERA:-

Operation without Regicopes Camera encourages payee/fraudsters of a third
party’s cheque to commit fraud, since his or her photograph will not be taken and
therefore hiding his or her identity after committing the fraudulent act. It allows for
withdrawing large sums of money fraudulently, without identifying the real
culprits.

(d)FAULTY ACCOUNT OPENING PROCEDURE

Many banks do not adhere strictly to the rules and regulations regarding the
opening procedures of new accounts. For example such banks do not take serious
interest in visiting the residential and office address of the customers that open new
accounts in their various branches.

(e) NON-CONFIRMATION OF CHEQUES:

The practice of confirming cheques of large amounts are not regularly carried out,
especially when such cheques are not drawn in customers usual manner. Also their
failure to confirm customer’s instructions received either from third parties across
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the counter or through inward mails led to colossal loss of depositor’s funds to
fraudsters.

(f) AUTHENTICATION OF SPECIMEN SIGNATURES

When specimen signatures, passport photographs and ledger cards are not
authenticated, large sums of depositor’s funds are lost due to familiarity of the
Bank Cashiers and their customers. Such lapses induce the Bank Cashiers to
perpetuate fraud in the system.

(g) ABSENCE OF SURPRISE CHECKS:

Investigations have revealed that Bank inspectors collaborate with the Bank
officials alerting them of their visit. This awareness enhances chances of fraudulent
practices, as most of their pitfalls could be corrected and rearranged before the visit
of such ‘unsurprised’ checkers.

(h) ABSENCE OF CLOSE CIRCUIT TELEVISION:

Lack of a close circuit Television makes the detection of fraudulent activities in
such banks difficult. The presence of such a facility helps in the monitoring of staff
activities in the Bank.

(I) INADEQUATE INTERNAL CONTROL:

Inadequate, or in certain cases total lack of Internal control system makes it very
easy for fraudulently inclined staff to cheat the Bank and the customers alike.

(j) NON-SEGREGATION OF DUTIES:

Lack of segregation of duties in the banking system encourages a single staff to
initiate and complete all the stages of a particular transaction from the beginning to
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the end, thus making it very difficult if not impossible for early detection of some
kinds of fraud. The bank could continuously lose large sums of money for a long
time to fraudulent staff undetected.
In some cases, some managers have been reported to have accumulated their
annual leave to enable them cover-up their mischiefs for a long time without
management questioning. Going on leave could reveal the perpetuated fraud by the
new manager on relief duty at the branch concerned.

(k) INADEQUATE TRAINING:

The management of certain banks do not extend the privilege of training and
retraining to its members of staff. This has resulted to poor performance that
breeds fraud.

EFFECTS OF FRAUD ON BANKS/CUSTOMERS:

Fraudulent practices in Banks have effects on the Bank concerned and the
customers of those banks.

(a) DISTRESS AND FAILURE OF BANKS:-

Incessant fraud in a Bank causes a reduction in the loanable funds in the bank,
resulting in stagnation in businesses, as there will be lack of investments etc. This
eventually will lead to the distress and outright failure of the bank.

(b) REDUCTION OF LOANABLE FUNDS:

Lack of confidence in the bank discourages potential depositors from further
investment in the bank. While many investors/depositors who are afraid of what
might happen to their deposits could withdraw them from such a bank to the other.

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This could lead to reduction of the amount of funds that could be available for the
granting of loans and investment.

(c) LOSS OF PUBLIC CONFIDENCE ON THE BANK

Trust and confidence is regarded as the corner stone of banking. It is because of
this trust that members of the public repose in the bank that they keep their most
valuable possession, money, with them. The confidence of the society and the
Citizens are always seriously threatened whenever there are reports of fraud in the
bank.

(d) LOSS OF DEPOSITORS’ FUNDS:

With the distress and outright failure of the bank, it will be difficult if not
impossible to meet its financial obligation to its customers. Depositors could no
longer withdraw from their deposits. Depositor’s funds are thus assumed to be lost.

(e) PROFIT REDUCTION AND LOSSES

With the stagnation of business and the distresses in Banks, profits continue to fall
until there are outright losses. Fraud affects the future of every business venture.
The profitability of the business continue to decline until every profit has been
eroded and losses incurred. Profit stimulates the management to work harder as it
measures the success of the business venture.

FRAUD PREVENTION IN BANKS

The major way of preventing fraud in many financial outfits including Banks is
Good Condition of Service. A good working atmosphere in which people are
treated fairly and frankly, are motivated and are given a feeling that the
organization genuinely cares about their wellbeing, and is willing to discuss
104
problems and propose solutions, also contribute in some measure towards
minimizing the risk of frauds.

In absence of such atmospheres, individuals may in certain circumstances feel

resentful towards the organization, and may resort to dishonest means to, as they
see it, redress the balance unless they feel they can discuss their problems freely
with someone who has the commitment and authority to take decisions.

In addition, training and re-training of their staff, would increase the awareness of
the implication of the risk of fraud in the bank.

Furthermore, management should adequately compensate and protect any member

of staff who either gives information on persons intending to defraud or who
assisted in frustrating an attempt to defraud the bank.

Other preventive measures that could enable Banks and other financial Institutions
to operate fraud-free by banks include the strict adherence to operational manual.
Effective Internal control, Periodic and regular auditing. Good management and
snap checks, proper book keeping, job rotation and segregation: Annual leave and
Scrutiny of cheques presented over the counter. Other positive measures to combat
fraud include the provision of Regiscope Camera, and Closed Circuit Television
with proper account opening procedure. Statements of accounts should be
dispatched regularly to all customers. Customers should be advised to read through
such statements on receipts, immediately and to report any unreconciled
differences to their branch managers for resolution.

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BANK DISTRESSES:
Among the reasons for the financial handicap of many commercial banks
especially in Nigeria are distresses in banks. Like bank fraud, there are many
reasons that cause bank distresses. Notable among them are as follows:

(a) INADEQUATE CAPITAL BASE:

For a bank to enjoy confidence of depositors, it must have a strong capital base as
evidence of strength. Also it is important to the bank to operate profitably for the
shareholders funds to increase through accreditation of statutory and general
reserve. In most cases, many distressed banks have neither strong asset based on a
strong liquidity level.

(b) EXECUTIVE FIAT:

Political office holders use executive fiat, this has been not been identified as the
cause for the distress of many banks especially joint ownership banks with state
governments in Nigeria. This is because of the ownership structure of the banks
concerned.

(c) INADEQUATE PLANNING:

Many Banks in Nigeria that are distressed in the industry today attribute their
failure to poor planning. With little or no planning and with avowed objectives and
targets, make it very difficult to assess the performance of such banks.

(d) BOARDROOM CRISIS:-

Many serious problems that result to bank distresses arise from boardroom
quarrels, unhealthy rivalry between the chairmen, Managing directors and

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shareholders with conflicting targets and objectives also afflict a number of banks
from their very beginning stage.

(e) RISKY ASSETS PORTFOLIO

This however is a reflection of poor management. Most of the distressed banks do
not have clear investment and there are absolutely no controls on credits. Most of
the credits are usually not collateralized and the belief that, “my Bank” makes such
people forget that depositors funds are involved. The result is hard-core credits in
form of advances to customers and trading in commercial papers to the public.

(f) FRAUD AND FORGERIES

Fraud and forgeries are of special concern to Nigerian banks and general public; as
they have far reaching implications in undermining the safety, soundness and
stability of the banking industry.

Various fraudulent activities, ranging from outright theft, forgery or manipulation

of constructive theft by way of credits, in respect of which the security lodged was
entirely insufficient.

The result of frauds and forgeries in the Nigerian banking system are indications of
the weaknesses in banks internal control system, and the erosion of moral and
ethical values of the society.

(g) BAD MANAGEMENT:

Banks should not have failed in Nigeria, as we do not have enough to be compared
with those in advanced countries. Failure of any Nigerian bank is not as a result of
competition. Some bank’s branches have more than 600 different accounts.
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The failure however is as a result of lack of experience and gross irresponsibility.
Other prominent causes are weak Credit processes that allows for a poor quality
portfolio weak internal controls usually undermined by the same higher officers
that should have strengthen them, uncompetitive human resources pool.

Dwindling profitability, various schemes to hide the thin financial position of the
bank from the regulatory authorities, unreliable information data base, high
liquidity leakages; and self-serving schemes designed to enrich the incumbent
management along with sometimes members of the board.

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