EFFECT OF CAPITALIZATION ON THE FINANCIAL INSTITUTION IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.1       Background of the Study

The Oxford mini-dictionary explains that capital is “accumulated wealth” or “money with which a business is started’ in banking, capital has these two meanings. At the out-set, capital in the form of issued and paid up shares is money with which the business is started. Overtime, the capital funds of the bank reflect the accumulated (addition of depletion of capital in goods producing business, the needed for capital is obvious as this is required to provide for substantial fixed capital resources in the form of building, plant and machinery and even working capital in form of raw material. The need for capital is not the same for business organizations. In the financial services industry, market forest and contemporary history have accentuated the need for higher capitalization of banks. The professional know how of the operators is another key factor in the inter mediation between the savers and the borrowers. Thus the first banker the Gold smith did not require additional capital beyond what he had. However, today the ingenuity of the banker has been developed so much that we can talk of the banker being engaged in financial engineering.

The federal government of Nigeria, in its annual 1997 budgets, announced the decisions to raise minimum paid-up capital for new banks to N2 billion leaving the existing one to its N500 million. The reason for the N2 billion minimum capital requirements could be broadly classified into the following:

a.   To curb the current distress in the banking industry by injecting fresh funds into the system with a view to enhancing the financial viability of the banking industry. It was banks which have had their capital bases eroded by inflation believe that the injection of new funds in the form of capitalization would give a new lease to live to most banks operational losses and bad credits.

b.    To ensure capital adequacy in providing initial an subsequent basic infrastructure for banks operation and expansion without undue reliance on external funding.

c.   To ensure conformity with international standard in view of the depreciation of the country’s currency vis-à-vis other major international currencies.

In the recent times, when the Apex Bank realized that the paid up capital did not yield tangible success in terms of management of financial institutions from being distress, the central Bank of Nigeria (CBN) in July 2004 came up with a major policy reform that required bank licensed in Nigeria to increase their paid-up capital to a minimum of N25 billion on or before December 31st2005.

The new requirement initially raised a lot of dust and became a subject of desirability and feasibility of such high quantum of capital base. However, the emphasis of players in the industry has since shifted o the modus operandi for attaining the target amount by the stipulated date. In the months following the pronouncement, many of the banks resorted to private placements with high net worth individuals and institutional investors to raise the short fall (between the current balance sheet figures and the new required amount). The inadequacy of that option only became apparent when many of the banks (led by all states Trust Bank and four others) began to initiate and sign memorandum of understanding (MOUS) for merger and acquisition with one another.