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Format: MS WORD
| Chapters: 1-5
| Pages: 72
BASEL /MACRO-PRUDENTIAL TOOLS AND FINANCIAL SYSTEM STABILITY IN NIGERIA
Abstract
This study aimed to determine the level of post-consolidation financial stability in Nigeria and the effect of the Basel I Accord implementation on this stability. Secondary data on post-consolidation aggregate bank profits and liquidity (measures of financial stability) and post-consolidation aggregate capitalization of banks (made in compliance with Basel I Accord) obtained from the Statistical Bulletin, 2014 were analysed using the GARCH model. Research results show that there exists volatility in bank profits (indicating long-term financial instability), withthe relationship between both variables positive; and there exists no volatility in aggregate bank liquidity indicating the existence of financial system stability (short-term/liquidity stability)with a significant relationship existing between Basel I Accord and the bank liquidity. These findings necessitate the immediate implementation of Basel II, II.5 and III with improved supervisory review process, disclosures and market disciplines, enhanced minimum capital and liquidity requirements, enhanced supervisory process for firm-wide risk management and capital management and capital planning, enhanced risk disclosures, market discipline, required liquidity standard, leverage ratio and minimum total capital ratio to check excessive risk taking by DMBs, transmit the positive stability in liquidity to stability in profits of DMBs to improve Nigeria’s short-term and long-term financial system stability, and shield the system from external shocks and cross-border contagion. Aggregate bank capital, bank consolidation, Basel I Accord, bank profits, financial stability, macro-prudential tools, liquidity.
1.0.Introduction
The adoptions of the Basel Accord by the G-10 countries had as its aim, the promotion of sound financial systems in these countries and strengthen the existing stability in the international financial system. The achievement of these goals necessitated the establishment of an equitable and consistent international banking system. With a sound and stable banking system, banks will be able to finance corporate expansions and growth, and foster economic growth and development. The Basel I Accord determined adequate capital for banks using the capital adequacy ratio of 5% of capital considering the percentage of risk-weighted assets to guard against banking risks. Hussain et al (2011) argued that concerns of possible negative effects of capital deficiencies in banks exists as evident in the G-10 countries at the implementation of the Accord with attendant financial system regulation.
Financial system regulation, according to Llewellyn (1986) is increasingly accepted as a tool to ensure soundness in the system and maintain safety. Research results by Oloyede (1994) showed that the banking industry unlike others, are prone to volatility and fragility from either exogenous or endogenous shocks making the industry amenable to regulation and supervision. Ezike and Oke (2013) opined that stability and consistency (as evidenced in the implementation of the Basel I) is imperative in the banking sector as surveillance and regulatory measures of the Central Bank of Nigeria (CBN), have unfortunately been unable to keep pace with the rapidity of the changes in the financial system. On the necessity of regulation in the banking sector, Ogunleye (2005) noted that regulation is necessary to ensure efficiency, diversity of choice, competition, stability of the financial system, macroeconomic stability and development, and the attainment of social objectives. Arguments by Mbizi (2012) supports financial system regulation as, according to him, “they serve as prudential measures that mitigate the effects of economic crisis on the stability of the banking system and subsequent accompanying macroeconomic results; cautioning that excessive regulation may increase the cost of intermediation, and reduce profitability of banks, creating instability in the banking system. Rhetorically, he questioned “what benchmarks of regulations are right?”
From theory and empirical analysis, Hussain et al (2011) noted that capital requirements leads to sudden contraction of bank lending, with negative effects on the economy, bank incomes and financial stability of the financial system. This assertion was supported by Naceur and Kandil (2013). Internationalization and integration of the banking system of less developed countries to the banking systems of developed countries increased banking risks in less developed countries. Furthering, Hussain et al (2011) argued that debts in less developed countries, growth in off-balance sheet activities, deregulation of deposit interest rates, rapid technological change and international bank competition, eroded capital bases of international banks of these countries. Findings by Wagster (1999) of credit crunch in relation to changes in balance sheet accounts and systematic risks of G-10 countries showed that between 1989 and 19992, banks in the United states, United Kingdom and Canadaexperienced asset reallocation from loans to securities and an increase in systematic risk.
The implementation of the Basel I Accord, he added, gave a competitive edge to banks to banks in Canada, the United Kingdom and Germany improving returns to deposit money banks (DMBs). The Central Bank of Nigeria introduced the Basel I Accord in 2004 resulting in increase in capital base of banks to N25 billion. The exercise reduced the number of banks to 25 with all financially stable and sound with more funds to finance economic growth (CBN, 2007). How has the introduction of the Basel I Accord affected financial performances of deposit money banks (DMBs)and overall financial system stability?
1.1 Objective of the study
The Basel I Accord has been successfully implemented in Nigeria with expectations as contained in the Accord. This paper aims to determine the effectiveness of macro-prudential tools in the Basel I Accord in entrenching and maintaining financial stability in the Nigerian financial system.Provision of adequate capital to forestall illiquidity in the financial system and boost bank customer confidence necessitated the bank consolidation exercise in 2004 in Nigeria. This exercise increased the capital base of each bank to N25 billion. Thus, banks in Nigeria had adequate capital to cover total credit advanced and sustain liquidity in the banking system.
1.2 Justification for this study
Studies on the impact of Basel I on micro and macroeconomic variables within and across countries are rife in literature. Peek et al (1995) investigated the short-run impact of Basel I on credit. Berger et al (1994) investigated the long-run impact of Basel I on bank credit in the United States. Hassain et al (2011) tested the impact of the Basel I Accord on credit expansion in developing countries. Nwidobie (2014) investigated the effect of bank credit and GDP in Nigeria. Studies by Ho and Sasaki (1998), Kim and Moreno (1994), Woo (1999) and Honda (2002) were on the impact of Basel I Accord on bank credit. Chiuri et al (2001) focused on Basel I and bank credit in 16 emerging market economies. Barajas et al (2005) conducted similar study on the impact on Basel I Accord on credit crunch in Latin America. Aggarwal et al (2001, 1988) and Jacques et al (1997) investigated the effect of the imposition of capital base regulations on banks through the Accord on banks in developed economies. Husaain and Hassan (2004) conducted similar study on Basel I and risk-taking by DMBs and capital ratio. Study on basel I and financial stability seems non-existent necessitating this study.
1.3 Research hypotheses
To determine the effectiveness of the macro-prudential tools in the Basel I Accord on financial stability in Nigeria, the following hypotheses is tested in this study:
· Ho: Implementation of the macro-prudential requirements in the Basel I Accord has not improved aggregate bank profitability (financial system stability)
· H0: Implementation of the macro-prudential requirements in the Basel I Accord has not improved aggregate bank liquidity (financial system stability)
Abstract
This study aimed to determine the level of post-consolidation financial stability in Nigeria and the effect of the Basel I Accord implementation on this stability. Secondary data on post-consolidation aggregate bank profits and liquidity (measures of financial stability) and post-consolidation aggregate capitalization of banks (made in compliance with Basel I Accord) obtained from the Statistical Bulletin, 2014 were analysed using the GARCH model. Research results show that there exists volatility in bank profits (indicating long-term financial instability), withthe relationship between both variables positive; and there exists no volatility in aggregate bank liquidity indicating the existence of financial system stability (short-term/liquidity stability)with a significant relationship existing between Basel I Accord and the bank liquidity. These findings necessitate the immediate implementation of Basel II, II.5 and III with improved supervisory review process, disclosures and market disciplines, enhanced minimum capital and liquidity requirements, enhanced supervisory process for firm-wide risk management and capital management and capital planning, enhanced risk disclosures, market discipline, required liquidity standard, leverage ratio and minimum total capital ratio to check excessive risk taking by DMBs, transmit the positive stability in liquidity to stability in profits of DMBs to improve Nigeria’s short-term and long-term financial system stability, and shield the system from external shocks and cross-border contagion. Aggregate bank capital, bank consolidation, Basel I Accord, bank profits, financial stability, macro-prudential tools, liquidity.
1.0.Introduction
The adoptions of the Basel Accord by the G-10 countries had as its aim, the promotion of sound financial systems in these countries and strengthen the existing stability in the international financial system. The achievement of these goals necessitated the establishment of an equitable and consistent international banking system. With a sound and stable banking system, banks will be able to finance corporate expansions and growth, and foster economic growth and development. The Basel I Accord determined adequate capital for banks using the capital adequacy ratio of 5% of capital considering the percentage of risk-weighted assets to guard against banking risks. Hussain et al (2011) argued that concerns of possible negative effects of capital deficiencies in banks exists as evident in the G-10 countries at the implementation of the Accord with attendant financial system regulation.
Financial system regulation, according to Llewellyn (1986) is increasingly accepted as a tool to ensure soundness in the system and maintain safety. Research results by Oloyede (1994) showed that the banking industry unlike others, are prone to volatility and fragility from either exogenous or endogenous shocks making the industry amenable to regulation and supervision. Ezike and Oke (2013) opined that stability and consistency (as evidenced in the implementation of the Basel I) is imperative in the banking sector as surveillance and regulatory measures of the Central Bank of Nigeria (CBN), have unfortunately been unable to keep pace with the rapidity of the changes in the financial system. On the necessity of regulation in the banking sector, Ogunleye (2005) noted that regulation is necessary to ensure efficiency, diversity of choice, competition, stability of the financial system, macroeconomic stability and development, and the attainment of social objectives. Arguments by Mbizi (2012) supports financial system regulation as, according to him, “they serve as prudential measures that mitigate the effects of economic crisis on the stability of the banking system and subsequent accompanying macroeconomic results; cautioning that excessive regulation may increase the cost of intermediation, and reduce profitability of banks, creating instability in the banking system. Rhetorically, he questioned “what benchmarks of regulations are right?”
From theory and empirical analysis, Hussain et al (2011) noted that capital requirements leads to sudden contraction of bank lending, with negative effects on the economy, bank incomes and financial stability of the financial system. This assertion was supported by Naceur and Kandil (2013). Internationalization and integration of the banking system of less developed countries to the banking systems of developed countries increased banking risks in less developed countries. Furthering, Hussain et al (2011) argued that debts in less developed countries, growth in off-balance sheet activities, deregulation of deposit interest rates, rapid technological change and international bank competition, eroded capital bases of international banks of these countries. Findings by Wagster (1999) of credit crunch in relation to changes in balance sheet accounts and systematic risks of G-10 countries showed that between 1989 and 19992, banks in the United states, United Kingdom and Canadaexperienced asset reallocation from loans to securities and an increase in systematic risk.
The implementation of the Basel I Accord, he added, gave a competitive edge to banks to banks in Canada, the United Kingdom and Germany improving returns to deposit money banks (DMBs). The Central Bank of Nigeria introduced the Basel I Accord in 2004 resulting in increase in capital base of banks to N25 billion. The exercise reduced the number of banks to 25 with all financially stable and sound with more funds to finance economic growth (CBN, 2007). How has the introduction of the Basel I Accord affected financial performances of deposit money banks (DMBs)and overall financial system stability?
1.1 Objective of the study
The Basel I Accord has been successfully implemented in Nigeria with expectations as contained in the Accord. This paper aims to determine the effectiveness of macro-prudential tools in the Basel I Accord in entrenching and maintaining financial stability in the Nigerian financial system.Provision of adequate capital to forestall illiquidity in the financial system and boost bank customer confidence necessitated the bank consolidation exercise in 2004 in Nigeria. This exercise increased the capital base of each bank to N25 billion. Thus, banks in Nigeria had adequate capital to cover total credit advanced and sustain liquidity in the banking system.
1.2 Justification for this study
Studies on the impact of Basel I on micro and macroeconomic variables within and across countries are rife in literature. Peek et al (1995) investigated the short-run impact of Basel I on credit. Berger et al (1994) investigated the long-run impact of Basel I on bank credit in the United States. Hassain et al (2011) tested the impact of the Basel I Accord on credit expansion in developing countries. Nwidobie (2014) investigated the effect of bank credit and GDP in Nigeria. Studies by Ho and Sasaki (1998), Kim and Moreno (1994), Woo (1999) and Honda (2002) were on the impact of Basel I Accord on bank credit. Chiuri et al (2001) focused on Basel I and bank credit in 16 emerging market economies. Barajas et al (2005) conducted similar study on the impact on Basel I Accord on credit crunch in Latin America. Aggarwal et al (2001, 1988) and Jacques et al (1997) investigated the effect of the imposition of capital base regulations on banks through the Accord on banks in developed economies. Husaain and Hassan (2004) conducted similar study on Basel I and risk-taking by DMBs and capital ratio. Study on basel I and financial stability seems non-existent necessitating this study.
1.3 Research hypotheses
To determine the effectiveness of the macro-prudential tools in the Basel I Accord on financial stability in Nigeria, the following hypotheses is tested in this study:
· Ho: Implementation of the macro-prudential requirements in the Basel I Accord has not improved aggregate bank profitability (financial system stability)
· H0: Implementation of the macro-prudential requirements in the Basel I Accord has not improved aggregate bank liquidity (financial system stability)
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