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| Chapters: 1-5
| Pages: 70
IMPACT OF CENTRAL BANK OF NIGERIA PRUDENTIAL GUIDELINES ON THE FINANCIAL STATEMENT OF LICENSED BANKS
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
All over the world, the banking industry plays a strategic role in every nation’s economic development. The Central Bank plays a dominant role in both the decision making and managerial process taking place in the economy while other banks do provide the essential financial services needed for effective operation of the economy. Bank failures do have destabilizing impact on the economy of any nation. It is precisely the consequence of these failures that led to the enactment of various legislations, rules and guidelines by relevant authorities to curb the excesses the banks with a view to ensuring that banks operating in Nigeria do so in accordance with the best practices of International banking professional standards. Banks are very important in the economic development of any nation. They constitute the central part on which other sectors of the economy revolve. They mobilize resources from the surplus sector of the economy and lend to the deficit sectors for investment purpose. Hence they are obliged to comply with certain regulatory requirement, which are generally not applicable to other –sectors of the economy. Loans and advances make up a major part of the lending. A careful look at the balance sheet of any commercial banks in Nigeria will reveal that loan and advances are by far the longest single items in the assets structure. Apparently, loan and advances make up the major sources of the operating income in banks. Because they are the most profitable assets for the employment of banks funds. Regardless of this fact, they could turn out to be bad and doubtful debts.
In November 7, 1990 the central bank of Nigeria issued a circular entitled “Prudential Guideline” for licensed banks. It stipulated minimum requirements for assets classification and disclose, provision of interest accrual and off balance sheet engagement (CBN) circular No. BSD/20/23 Vol.1 /11. in particular, the guideline imposed new and somewhat far-reaching requirements in the classification of risk assets and provision for bad and doubtful debts. (Nwankwo G.O 1990). The guidelines also emphasized the time recognition of determination in the quality of assets and the classification of credit facilities into “performing s” and “ non-performing” accounts. Furthermore, in order to ensure the reliability of their published operating results, banks have been directed to cease charging accruing interest on non-performing credit facilities and interest and interest accrued on such accounts should not be recognized as income.
The guideline made it mandatory for all licensed banks to review their credit portfolio continuously, at least once in three months, with a view to recognizing our determination in their quality according to Eghodaghe (1993) more so, prior to the issuance of the guidelines, it was common to find institutions declaring paper profit, which resulted from interest, accrued in non-performing facilities being taken into statement of financial position. The non-performing assets in financial institutions were not uniformly classified; neither was adequate provision made for such facilities. These practices not only made compassion between institutions difficult, they also ended to hide inefficiencies and distort performance. Banking malpractices alternatively referred to as corruption and economic crimes constitute the genius of what is generally known as and commonly called “Elite or white collar crimes. Legislation governing the banking practice in Nigeria is sourced from three major areas. They are:
· Law of General Application: This is the law that is applicable across the countries under the former British Empire. Such law because it was bequeathed to Nigeria at the Independence is otherwise referred to as “received English laws”.
· Statute Law: These are laws specifically enacted by the nation’s legislature known as the Parliament of the National Assembly to deal with specific subjects or sectors. Example of such statute law are BOFIA (Banks and 67 other financial institution Acts 1991), the CBN Act 1991 and CAMA (Companies and Allied Matters Act) 1990.
· Subsidiary Legislations: These are legislations made under the authorities of existing statutes. Examples are Rules, Orders, and Regulations by laws and ordinances
The core legislation for this research is the Subsidiary laws and such are made by the apex bank CBN for other banks to observe. The prudential guideline was issued on November 7th 1990 Circular No BSD/DO/23/VOL.1/11 to all licensed Banks addressed requirements for asset classification and disclosure, provisioning, interest accrual and off balance sheet engagements. In view of the importance of the circular to bank management, bank auditors and bank examiners, the objective of these guidelines is to prescribe the prudential treatment of restructured accounts to provide a transparent mechanism for timely structuring of debts of viable entities facing problems, outside the purview of 67 BIFR, DRT and other legal proceedings for the benefit of all concerned. The scope of these guidelines are applicable to restructuring/rescheduling of amounts due from all borrowers other than those eligible for restructuring under CDR Mechanism, eligible for restructuring under the debt mechanism for SME’s and restructured on account of Natural calamities for which Reserve Bank has issued a separate set of guidelines. Casting a look at the size structure, the assets structure, the deposits structure and the volume of credits they grant to the economy, their dominant position becomes evident. In the light of this therefore, their indispensable role of pooling together funds from the surplus economic unit to the deficit unit fast tracks economic activities. Effective management of banks assets and liabilities posed a great concern to all stakeholders because of large scale financial distress. The late 1980s and early 1990s were years of financial boom, as the number of players increased substantially in the system. For instance, between 1986 and 1989, about 38 new commercial and merchant banks were created. The increase in the number of banks over stretched the existing human resources capacity of the banks which resulted into many problems such as poor credit appraisal system, financial crimes, accumulation of poor asset quality among 67 others. The consequence was increased in the number of distress, banks and depositors began to lose confidence on our financial institutions in managing their fund. Based on these experiences, the Federal Government of Nigeria through the Central Bank of Nigeria (CBN), 1990 indicates that regulation and supervision are essential ingredients for stable and healthy financial system, and that the need becomes greater as the number and variety of financial Institutions increased. The banking sector was singled out for a special protection because of the vital role banks play in an economy. Bank supervision entails not only the enforcement of rules and regulations, but also judgment concerning the soundness of banks assets, its capital adequacy and management (Volker, 1992). Effective supervision leads to healthy banking industry. At this direction, the deposit insurance scheme the assets quality of banks, reduce bad and doubtful debt, and ensure capital adequacy and stability of the system so that the depositor’s fund would be protected. Banking as essentially an international business, especially now that domestic financial markets are being internationalized, need to develop and continuously review their reporting system which allow for a high degree of comparability of banking performance across national boundaries. Such systems have been evolved in such areas of banking practice as credit portfolio classification, disclosure interest accrual and off balance sheet engagements. The apex institution in Nigeria banking system, the Central Bank of Nigeria (CBN) is continuously moving banks in the country towards compliance with international banking practices. To this end, the Banking Supervision Department (BSD) issued no November 7, 1990, circular letter No.BSD/DO/23VOL.1/11, to all licensed banks and their 67 auditors. The circular titled “Prudential guidelines for licensed Banks” addressed requirements for asset classification and disclosure, provisioning interest accruals and off-balance-sheet engagements. The prudential guideline is intended as a hand book for target groups such as the bank auditors and the examiners. It is the task of the examiner to prevent bank failure by identifying bank problems at an early stage to allow for intervention and or corrective action before the situation gets out of hand.
1.2 STATEMENT OF THE PROBLEM
The Central Bank of Nigeria (CBN) as a supervisory monetary authority had reasons for introducing the prudential guidelines into the banking scene in order to review banks credit portfolio at least once in a quarter with a view to recognizing any deterioration in credit exposure based on perceived risks of default. In order to facilitate comparability of banks classification of their credit portfolios, the assessment of risk of default should be based on criteria which should include, but not limited to repayment performance borrowers repayment capacity on the basis of current financial condition and realizable value of collateral. Interest on problem loan/over draft is another area where differences exist among banks. When loans/overdrafts become apparently uncollectible, how should the interest that is calculated on it be treated? While some banks credit their profit and loss account with such unearned interest, others credit their suspense account. The deregulation of interest in the Structural Adjustment Programme (SAP) period did not help, either interest on non-performing account were credited to 67 the profit and loss account of most banks to make their performance appear good to investors, the public and supervisory monetary authorities. This “window dressing” performance in most banks shook public confidence in bank’s financial statement in the late 1980 up to 1990, when prudential guidelines was introduced. Prior to this period, most banks believed that once loans/overdraft was secured, whether the accounts were serviced or not, interest on it should continue to be credited to their profit and loss accounts believing that they would realize the security in case of default in payment. Most often banks were not too bothered as to whether the collateral was perfected or not thereby making realizability of collaterals difficult, if not out rightly impossible. Consequently, the prudential guidelines were expected to address the following;
A. To enhance public confidence in banking system in the country.
B. Harmonization of credit administration in the country with what is obtainable in other parts of the world.
C. Timely recognition of deteriorating risk assets.
D. To create a healthy banking environment in our economy.
E. To create uniformity in loans/overdraft classification among banks in the country.
1.3 OBJECTIVES OF THE STUDY
The objectivity of the study is to examine measures introduced by banks and how effective that will be in order to meet the requirement of the prudential guidelines of the central banks in Nigeria as follows:
i. To determine the impact of the prudential guidelines on bank safety and confidence in Nigeria.
ii. To assess the reaction of depositors to the guidelines.
iii. To find out whether there are international supervisory perspectives which affect national experience.
iv. To trace the history of bad debts in the banks and how the new measures will facilitate the recovery of the debts.
1.4 RESEARCH QUESTIONS
For the successful completion of the study, the following research question was formulated:
i. To what extent has the Prudential Guidelines helped to ensure safety and confidence in Nigerian banking system?
ii. How do depositors react to the guidelines?
iii. Are there international supervisory perspectives to the guidelines?
1.5 HYPOTHESES OF THE STUDY
The hypotheses of this study are as follows:
H0: Prudential guidelines do not enhance safety and confidence in the Nigerian banking system.
H0: Depositors do not react favorably to the prudential guidelines.
H0: There are no international supervisory perspectives which affect national experience.
1.6 SCOPE OF THE STUDY
There are many banks in Nigeria banking industry. To achieve the aim of this research, the researcher has restricted himself to the study of only First Bank Of Nigeria plc (FBN). In this regard, three branches of UBA within Enugu Metropolis are studied. The branches are FBN Main branch at Aka road, 2 Oron road and Banking avenue 2lane uyo
1.7 LIMITATIONS TO THE STUDY
The limitations to this work include:
1. The problem of meeting appropriate officials of the banks who will give the right information required for the work.
2. The problem of getting all the necessary data became more complex and most of these officers’ do not want to volunteer their official data due to bureaucracy and Red-tapism which hinders the flow of information in Nigeria. 3. Availability of fund posed a problem to the researcher as this requires adequate finance to enable the researcher visit the necessary places and collect the required data.
1.8 SIGNIFICANCE OF THE STUDY
Prudential guidelines have been in the Nigeria Banking system since 1990. It is necessary to examine the impact it has on bank services and performance:
i. It is also necessary to research on the effects of the guidelines on banks to enable one access the pre-guidelines era and the present tradition it has imposed on bank practices. Such analysis will enable the supervisory authorities make a decision whether to retain, discard or modify prudential guidelines.
ii. The need for this research arises from the fact it will be of immense benefit to students of banking and finance in having knowledge of historical evolvement of rules and regulations and most especially in the area of management of credit portfolio in Nigerian banks.
iii. The duties of the Central Bank of Nigeria (CBN) and Nigeria Deposit Insurance Corporation (NDIC), Central Bank of Nigeria (CBN) and the Nigerian Deposit Insurance Corporation (NDIC).
1.9 OPERATIONAL DEFINITION OF TERMS
BANK: A Bank is a financial house established for the purpose of accepting deposits and other precious commodities from the public for safe keeping.
PORTFOLIO: This is a collection of investible funds.
PRUDENTIAL GUIDELINES: It is the recognition of credit risk and writing-off same to avoid false picture of balance sheet.
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
All over the world, the banking industry plays a strategic role in every nation’s economic development. The Central Bank plays a dominant role in both the decision making and managerial process taking place in the economy while other banks do provide the essential financial services needed for effective operation of the economy. Bank failures do have destabilizing impact on the economy of any nation. It is precisely the consequence of these failures that led to the enactment of various legislations, rules and guidelines by relevant authorities to curb the excesses the banks with a view to ensuring that banks operating in Nigeria do so in accordance with the best practices of International banking professional standards. Banks are very important in the economic development of any nation. They constitute the central part on which other sectors of the economy revolve. They mobilize resources from the surplus sector of the economy and lend to the deficit sectors for investment purpose. Hence they are obliged to comply with certain regulatory requirement, which are generally not applicable to other –sectors of the economy. Loans and advances make up a major part of the lending. A careful look at the balance sheet of any commercial banks in Nigeria will reveal that loan and advances are by far the longest single items in the assets structure. Apparently, loan and advances make up the major sources of the operating income in banks. Because they are the most profitable assets for the employment of banks funds. Regardless of this fact, they could turn out to be bad and doubtful debts.
In November 7, 1990 the central bank of Nigeria issued a circular entitled “Prudential Guideline” for licensed banks. It stipulated minimum requirements for assets classification and disclose, provision of interest accrual and off balance sheet engagement (CBN) circular No. BSD/20/23 Vol.1 /11. in particular, the guideline imposed new and somewhat far-reaching requirements in the classification of risk assets and provision for bad and doubtful debts. (Nwankwo G.O 1990). The guidelines also emphasized the time recognition of determination in the quality of assets and the classification of credit facilities into “performing s” and “ non-performing” accounts. Furthermore, in order to ensure the reliability of their published operating results, banks have been directed to cease charging accruing interest on non-performing credit facilities and interest and interest accrued on such accounts should not be recognized as income.
The guideline made it mandatory for all licensed banks to review their credit portfolio continuously, at least once in three months, with a view to recognizing our determination in their quality according to Eghodaghe (1993) more so, prior to the issuance of the guidelines, it was common to find institutions declaring paper profit, which resulted from interest, accrued in non-performing facilities being taken into statement of financial position. The non-performing assets in financial institutions were not uniformly classified; neither was adequate provision made for such facilities. These practices not only made compassion between institutions difficult, they also ended to hide inefficiencies and distort performance. Banking malpractices alternatively referred to as corruption and economic crimes constitute the genius of what is generally known as and commonly called “Elite or white collar crimes. Legislation governing the banking practice in Nigeria is sourced from three major areas. They are:
· Law of General Application: This is the law that is applicable across the countries under the former British Empire. Such law because it was bequeathed to Nigeria at the Independence is otherwise referred to as “received English laws”.
· Statute Law: These are laws specifically enacted by the nation’s legislature known as the Parliament of the National Assembly to deal with specific subjects or sectors. Example of such statute law are BOFIA (Banks and 67 other financial institution Acts 1991), the CBN Act 1991 and CAMA (Companies and Allied Matters Act) 1990.
· Subsidiary Legislations: These are legislations made under the authorities of existing statutes. Examples are Rules, Orders, and Regulations by laws and ordinances
The core legislation for this research is the Subsidiary laws and such are made by the apex bank CBN for other banks to observe. The prudential guideline was issued on November 7th 1990 Circular No BSD/DO/23/VOL.1/11 to all licensed Banks addressed requirements for asset classification and disclosure, provisioning, interest accrual and off balance sheet engagements. In view of the importance of the circular to bank management, bank auditors and bank examiners, the objective of these guidelines is to prescribe the prudential treatment of restructured accounts to provide a transparent mechanism for timely structuring of debts of viable entities facing problems, outside the purview of 67 BIFR, DRT and other legal proceedings for the benefit of all concerned. The scope of these guidelines are applicable to restructuring/rescheduling of amounts due from all borrowers other than those eligible for restructuring under CDR Mechanism, eligible for restructuring under the debt mechanism for SME’s and restructured on account of Natural calamities for which Reserve Bank has issued a separate set of guidelines. Casting a look at the size structure, the assets structure, the deposits structure and the volume of credits they grant to the economy, their dominant position becomes evident. In the light of this therefore, their indispensable role of pooling together funds from the surplus economic unit to the deficit unit fast tracks economic activities. Effective management of banks assets and liabilities posed a great concern to all stakeholders because of large scale financial distress. The late 1980s and early 1990s were years of financial boom, as the number of players increased substantially in the system. For instance, between 1986 and 1989, about 38 new commercial and merchant banks were created. The increase in the number of banks over stretched the existing human resources capacity of the banks which resulted into many problems such as poor credit appraisal system, financial crimes, accumulation of poor asset quality among 67 others. The consequence was increased in the number of distress, banks and depositors began to lose confidence on our financial institutions in managing their fund. Based on these experiences, the Federal Government of Nigeria through the Central Bank of Nigeria (CBN), 1990 indicates that regulation and supervision are essential ingredients for stable and healthy financial system, and that the need becomes greater as the number and variety of financial Institutions increased. The banking sector was singled out for a special protection because of the vital role banks play in an economy. Bank supervision entails not only the enforcement of rules and regulations, but also judgment concerning the soundness of banks assets, its capital adequacy and management (Volker, 1992). Effective supervision leads to healthy banking industry. At this direction, the deposit insurance scheme the assets quality of banks, reduce bad and doubtful debt, and ensure capital adequacy and stability of the system so that the depositor’s fund would be protected. Banking as essentially an international business, especially now that domestic financial markets are being internationalized, need to develop and continuously review their reporting system which allow for a high degree of comparability of banking performance across national boundaries. Such systems have been evolved in such areas of banking practice as credit portfolio classification, disclosure interest accrual and off balance sheet engagements. The apex institution in Nigeria banking system, the Central Bank of Nigeria (CBN) is continuously moving banks in the country towards compliance with international banking practices. To this end, the Banking Supervision Department (BSD) issued no November 7, 1990, circular letter No.BSD/DO/23VOL.1/11, to all licensed banks and their 67 auditors. The circular titled “Prudential guidelines for licensed Banks” addressed requirements for asset classification and disclosure, provisioning interest accruals and off-balance-sheet engagements. The prudential guideline is intended as a hand book for target groups such as the bank auditors and the examiners. It is the task of the examiner to prevent bank failure by identifying bank problems at an early stage to allow for intervention and or corrective action before the situation gets out of hand.
1.2 STATEMENT OF THE PROBLEM
The Central Bank of Nigeria (CBN) as a supervisory monetary authority had reasons for introducing the prudential guidelines into the banking scene in order to review banks credit portfolio at least once in a quarter with a view to recognizing any deterioration in credit exposure based on perceived risks of default. In order to facilitate comparability of banks classification of their credit portfolios, the assessment of risk of default should be based on criteria which should include, but not limited to repayment performance borrowers repayment capacity on the basis of current financial condition and realizable value of collateral. Interest on problem loan/over draft is another area where differences exist among banks. When loans/overdrafts become apparently uncollectible, how should the interest that is calculated on it be treated? While some banks credit their profit and loss account with such unearned interest, others credit their suspense account. The deregulation of interest in the Structural Adjustment Programme (SAP) period did not help, either interest on non-performing account were credited to 67 the profit and loss account of most banks to make their performance appear good to investors, the public and supervisory monetary authorities. This “window dressing” performance in most banks shook public confidence in bank’s financial statement in the late 1980 up to 1990, when prudential guidelines was introduced. Prior to this period, most banks believed that once loans/overdraft was secured, whether the accounts were serviced or not, interest on it should continue to be credited to their profit and loss accounts believing that they would realize the security in case of default in payment. Most often banks were not too bothered as to whether the collateral was perfected or not thereby making realizability of collaterals difficult, if not out rightly impossible. Consequently, the prudential guidelines were expected to address the following;
A. To enhance public confidence in banking system in the country.
B. Harmonization of credit administration in the country with what is obtainable in other parts of the world.
C. Timely recognition of deteriorating risk assets.
D. To create a healthy banking environment in our economy.
E. To create uniformity in loans/overdraft classification among banks in the country.
1.3 OBJECTIVES OF THE STUDY
The objectivity of the study is to examine measures introduced by banks and how effective that will be in order to meet the requirement of the prudential guidelines of the central banks in Nigeria as follows:
i. To determine the impact of the prudential guidelines on bank safety and confidence in Nigeria.
ii. To assess the reaction of depositors to the guidelines.
iii. To find out whether there are international supervisory perspectives which affect national experience.
iv. To trace the history of bad debts in the banks and how the new measures will facilitate the recovery of the debts.
1.4 RESEARCH QUESTIONS
For the successful completion of the study, the following research question was formulated:
i. To what extent has the Prudential Guidelines helped to ensure safety and confidence in Nigerian banking system?
ii. How do depositors react to the guidelines?
iii. Are there international supervisory perspectives to the guidelines?
1.5 HYPOTHESES OF THE STUDY
The hypotheses of this study are as follows:
H0: Prudential guidelines do not enhance safety and confidence in the Nigerian banking system.
H0: Depositors do not react favorably to the prudential guidelines.
H0: There are no international supervisory perspectives which affect national experience.
1.6 SCOPE OF THE STUDY
There are many banks in Nigeria banking industry. To achieve the aim of this research, the researcher has restricted himself to the study of only First Bank Of Nigeria plc (FBN). In this regard, three branches of UBA within Enugu Metropolis are studied. The branches are FBN Main branch at Aka road, 2 Oron road and Banking avenue 2lane uyo
1.7 LIMITATIONS TO THE STUDY
The limitations to this work include:
1. The problem of meeting appropriate officials of the banks who will give the right information required for the work.
2. The problem of getting all the necessary data became more complex and most of these officers’ do not want to volunteer their official data due to bureaucracy and Red-tapism which hinders the flow of information in Nigeria. 3. Availability of fund posed a problem to the researcher as this requires adequate finance to enable the researcher visit the necessary places and collect the required data.
1.8 SIGNIFICANCE OF THE STUDY
Prudential guidelines have been in the Nigeria Banking system since 1990. It is necessary to examine the impact it has on bank services and performance:
i. It is also necessary to research on the effects of the guidelines on banks to enable one access the pre-guidelines era and the present tradition it has imposed on bank practices. Such analysis will enable the supervisory authorities make a decision whether to retain, discard or modify prudential guidelines.
ii. The need for this research arises from the fact it will be of immense benefit to students of banking and finance in having knowledge of historical evolvement of rules and regulations and most especially in the area of management of credit portfolio in Nigerian banks.
iii. The duties of the Central Bank of Nigeria (CBN) and Nigeria Deposit Insurance Corporation (NDIC), Central Bank of Nigeria (CBN) and the Nigerian Deposit Insurance Corporation (NDIC).
1.9 OPERATIONAL DEFINITION OF TERMS
BANK: A Bank is a financial house established for the purpose of accepting deposits and other precious commodities from the public for safe keeping.
PORTFOLIO: This is a collection of investible funds.
PRUDENTIAL GUIDELINES: It is the recognition of credit risk and writing-off same to avoid false picture of balance sheet.
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