THE EFFECT OF BANKING INDUSTRY DISTRESS ON THE NIGERIAN ECONOMY

CHAPTER ONE

INTRODUCTION

1. Background of the Study

The financial system of a country which the banking industry is part, refers to the totality of the regulatory and participating institutions as well as instruments involved in the process of financial intermediation.

An efficient system is widely accepted as a necessary condition for an effective functioning of a nation’s economy. The state of development of the financial market in a country, as noted by Varsh (1991), serves as barometer for measuring the stage of development of the economy. The mix of these financial intermediaries varies from country to country, reflecting the stage of development and the degree of sophistication of the country’s economic agents. The market provides services that are essential to a modern economy by offering access to a variety of financial instruments that enable economic agents to poll, price and exchange risk. This is done through assets with attractive yield and marketability.

In addition to the intermediation role, a nation’s financial links the domestic economy with the rest of the world by providing the means for the settlement of international transactions. It has also been observed that growth in the financial industry, if transmitted well, would result in the growth of real sector and the opposite is possible if the financial sector is repressed and inefficient (Cameroon, 1972). The component of the financial system that is at the centre of the intermediation role and the greasing of the engine of economic growth and development is the banking sector.

1. Statement of the Problem

Bank distress occurs when a bank or some banks in the system experience illiquidity or insolvency resulting in a situation where depositors fear the loss of their deposits and a consequent breakdown of contractual obligations.  While a bank is said to be illiquid when it could no longer meet its liabilities as they mature for payment, it is said to be insolvent when the value of its realization is less than the total value of its liabilities (a case of “negative networth”). These could lead to bank runs as depositors lose confidence in the system and seek to avoid capital loss. The uncertainty generated as a result of distress in banking institutions, if left unchecked, often raises real interest rates, creates higher costs of transactions and disrupts the payment mechanism with the attendant economic consequence.

The uncertainty generated as a result of distress in banking systems, if left unchecked, often raises real interest rates, creates higher costs of transactions and disrupts the payment mechanism with the attendant economic consequence.

The extent and dept of the banking distress can be of generalized nation or systematic generalized distress exists when its occurrence is spreading fast and cots across in terms of the ratio of total deposits of distress institutions to the total deposits of the industry: the ratio of total assets deposits of distressed institutions to total branches of the industry among others has not adversely affected the confidence of the public in the banking system.

The problem may become systematic and of serious concern to the relevant supervisory/regulatory authorities when its prevalence and the contagious effects become endemic and pose threats to the stability of the entire system, saving mobilization, financial intermediation process and depositors confidence (Balino 1991). Under this situation, the ratios of the relevant variables should have risen to a level that public confidence in the system would be completely eroded.

The current distress condition in Nigeria’s financial industry has been attributed to a variety of causes, ranging from institutional, social, economic and political factors. However, these were largely impressions, which had not been subjected to any empirical verification at least with respect to the Nigerian situation.