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NDIC QUARTERLY

Volume 17 September/December Nos 3/4 TABLE OF CONTENTS Content Page Review of Developments in Banking and Finance in the Third and Fourth Quarters of 2007 By Research Department The nation’s economy, particularly the financial services industry and the banking sub-sector, witnessed series of developments during the third and fourth quarters of 2007. Following the inauguration of a new government in May29, 2007, a new economic agenda to be pursued by government was announced during the period under review. Secondly, a post-consolidation merger between IBTC Chartered Bank Plc and Stanbic Bank (Nigeria) Limited was completed during the period under review. At the regulatory level, the Central Bank of Nigeria (CBN) issued new guidelines to further liberalize the foreign exchange market and the use of Global Depository Receipts by Nigerian banks to raise funds from the international financial market. Details of these developments and others including the report on interest rates on major financial instruments, the naira exchange rate as well as the average performance of quoted banks’ shares on the Nigerian Stock Exchange (NSE) as at the end of 2007, are presented below. Financial Condition and Performance of Insured Banks in the Third and Fourth Quarters of 2007 By Research & Off-Site Supervision Departments The conditions of the insured banks were generally sound whilst the industry witnessed positive performance in the period under review. Total assets of the banks increased. However, asset quality deteriorated as the proportion of non-performing loans to total credit increased. In terms of earnings and profitability, the industry performed creditably well as profit before tax increased significantly by more than 114.72 percent. Details of these and other indicators are contained in this paper.

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Proactive Measures to Guard against Fraud/Cash Theft in The Banking Industry And In Organisations BY G. A. Ogunleye, OFR Managing Director/Chief Executive The paper examines the modus operandi of fraudsters in perpetrating fraud in our environment with a view to creating a high level of awareness amongst the citizenry. Also discussed in the paper are the causes, the nature and various types of frauds. Finally, the author identifies the needed measures to be taken in order to deter, prevent and detect fraud in a timely and effective manner Bank Directors and Related Party Transactions By Professor Peter N. Umoh, FCIB Executive Director (Operations) The paper first examines the laws and regulations governing directors’ transactions with their banks. That is followed by the lessons of such business experience in Nigeria. From lessons of experience, the author concludes that in spite of the provisions of the law and the regulators’ guidelines on such relationship, some directors found ways to evade the laws/regulations and exploit the relationship for selfish ends. However, he opines that the recent banking consolidation which has produced relatively stronger banks with better corporate governance ethos would promote a healthy business relationship between banks and their directors The Northern Rock Crisis By Research Department The paper critically examines the Northern Rock Crisis in the United Kingdom. In that respect, the paper discusses the causes of the crisis. It also reviews the reactions of regulators and depositors as well as possible lessons which could be learnt from the U.K. experience.

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MAJOR DEVELOPMENTS IN THE BANKING SECTOR

DURING THE THIRD AND FOURTH QUARTERS 2007

By

Research Department

1.0 Introduction

The nation’s economy, particularly the financial services industry and the

banking sub-sector, witnessed series of developments during the third and

fourth quarters of 2007. First, the Minister of Finance announced a new

economic agenda to be pursued by government. Secondly, IBTC Chartered

Bank Plc and Stanbic Bank (Nigeria) Limited completed their merger

arrangement. Thirdly, the apex regulatory body, the Central Bank of Nigeria

(CBN) issued new guidelines during the period under review and amongst

the notable ones were those related to further liberalization of the foreign

exchange market and the use of Global Depository Receipts by Nigerian

banks to raise funds from the international financial market. Other notable

developments during the period included the federal government

announcement of N2.45 trillion budget for 2008. Details of these

developments and the report on interest rates on major financial instruments,

the naira exchange rate as well as the average performance of quoted banks’

shares on the Nigerian Stock Exchange (NSE) as at the end of 2007, are

presented below.

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2.0 Listing of Guaranty Trust Bank (GT Bank) Plc’s Global Depository

Receipt (GDR) on the London Stock Exchange (LSE)

During the period under review, Guaranty Trust Bank (GT Bank) Plc Global

Depository Receipt (GDR) was listed on the London Stock Exchange. The listing

of the GT Bank Plc on Thursday, July 26, 2007 was the first international listing on

the London Stock Exchange (LSE) by a company quoted on the Nigerian Stock

Exchange and indeed the first African bank.

Global Depository Receipt (GDR) is a dollar-denominated instrument issued in

international financial markets through a registered depository bank. It is a

negotiable certificate, which represents ownership of a certain equity securities that

are issued and traded in a local market as well as ownership of a certain number of

shares of a company. It can be listed/traded independently from the equity

securities. GDRs are typically used by companies from emerging markets to raise

capital and access investors in international markets.

3.0 Announcement of New Economic Agenda by Government

During the period under review, the Honourable Minister of Finance, outlined the

new economic agenda of the government. According to the Minister, the new

agenda was designed to present a working roadmap towards accelerating the

economic transformation by sustaining and improving on the relative

macroeconomic stability. He emphasized that the key values that will underpin the

framework were:

· Upholding the constitution and the rule of law

· Respect for due process and

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· Integrity, Accountability and Transparency

The Minister enumerated the major areas of focus in the new reform process to

include:

i. Accelerating Institutional Reforms.

The need to broaden and intensify the institutional reform carried out

under the pilot scheme of the first phase of the public sector reforms was

emphasized. That would encompass both in-house cleansing within the

Ministry and in a number of its agencies where there was a fundamental

lack of focus.

ii. Budget and Debt Management.

While acknowledging the commendable role and achievement of the

Debt Management Office (DMO) in the recent exit of Nigeria from the

Paris and London club debts as well as the restructuring of the country’s

internal debt, the Minister announced the Federal Governments intention

to take the reforms to a higher level with some specific measures. Some

of the measures included:

a) Raising the required funding for key infrastructural projects, such as

roads and railways from both the Bond and Capital Markets,

b) Encouraging states to initiate and pass their own Fiscal Responsibility

laws.

c) Setting up of a standard IT platform for effective and timely linkage

with all the relevant agencies on the Federal, States and Local

Government loans.

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d) Ensuring earlier submission of proposed budget and greater

consultation with the stakeholders in the earlier, critical, planning

stages of the Budget.

e) The Ministry of Finance was to ensure full compliance with current

regulations that require Ministries, Departments and Agencies to

prepare and submit their final accounts to the Office of the Auditor

General of the Federation (OAGF) not later than March 31st,

following the end of each financial year. This along with other

periodic (quarterly) reporting would ensure greater accountability in

Government accounts and assist the office of the Auditor General of

the Federation in performing its audit function better and reporting to

the National Assembly.

(iii) Tax Reform

Part of the reform announced by the Minister was tax reform. These would involve

the review of existing legislation or enacting new ones, where such legislation is

non- existent. In addition, steps would be taken to improve the coordination

between the Federal Inland Revenue Service (FIRS) and the relevant Departments

of the Ministry, most especially the Revenue and Fiscal Departments so as to

ensure that they do not work at cross purposes.

(iv) Capital Market

Some of the specific measures that would be put in place to strengthen the nation’s

capital market as explained by the Minister during the press briefing would

include:

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a) Broadening and deepening the market through the introduction of additional

financial instruments. In that regard SEC and the DMO would be expected

to work closely in the development of the bond market and its greater use by

the Federal, States and Local Governments, as well as by corporate bodies.

b) Developing stronger mechanisms to check insider dealings and other forms

of market abuse.

c) Creating greater public awareness and utilization, of the capital market,

especially the Abuja Commodities and Securities Exchange and

d) Reducing the cost of doing business in the Nigerian capital market.

(v) Economic Management Team (EMT)

The Minister announced the new membership of the Economic Management Team

(EMT) which was recently reconstituted by the President. The Membership of the

EMT was as follows:

1. Minister of Finance - Chairman

2. Minister of National Planning - Vice Chairman

3. Minister of State, Finance - Member

4. Minister of State, Petroleum - Member

5. Hon Strategic Adviser to the President on Energy-Member

6. Economic Adviser to the President - Member

7. Deputy Governor (Economic Policy, CBN) -Member

8. Special Asst to the President (Power) - Member

9. Special Asst to the President (Petroleum)-Member

10. Chairman FIRS - Member

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11. Director of Research & Statistics (CBN) - Member

Technical Support was to be provided by the following:

1. Group Managing Director, NNPC

2. Director-General, DMO

3. Accountant-General of the Federation

In addition, representatives of the Nigeria Economic Summit Group and the

Nigerian Economic Society were to serve in the Committee.

4.0 IBTC Chartered Bank Plc and Stanbic Bank (Nigeria) Limited

Completed Merger Arrangement

During the period under review, the merger arrangement between IBTC Chartered

Bank Plc and Stanbic Bank (Nigeria) Limited, which had previously received the

approvals of the shareholders of both banks, the Securities & Exchange

Commission (SEC), the South African Reserve Bank and the Central Bank of

Nigeria, was approved by the Federal High Court on Monday, September, 24 2007.

With the merger which became unconditional and effective from that date, IBTC

Chartered Bank Plc had now acquired all the assets, liabilities and undertakings of

Stanbic (Nigeria) bank and Stanbic (Nigeria) bank had been dissolved without

being wound up. The new bank that emerged from the merger was named Stanbic

IBTC Bank PLC. That development reduced the total number of deposit money

banks in the system to 24 as at the end of December, 2007.

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5.0 The Central Bank of Nigeria (CBN) Circular on Further Liberalization

of the Foreign Exchange Market

During the period under review, the CBN further liberalized the foreign exchange

market through the review of rules and regulations guiding transactions in the

market. The amendments/reviews included the following:

i. National Youth Service Corps (N.Y.S.C) discharge certificate or

certificate of exemption where applicable was no longer part of

documentation requirements for remittance of school fees for Post

graduate studies abroad.

ii. Where an applicant is proceeding on a business trip duly authorized

by a corporate body where the applicant is an employee, the latter

(employee) would be eligible to purchase Personal Travel Allowance

(PTA), in addition to the normal Business Travel Allowance (BTA)

subject to relevant documentation.

iii. Authorized Dealers that had huge cash deposits from Ordinary

Domiciliary Account holders as indicated in Circular could avail such

for their BDC window and its equivalent from WDAS winnings

transferred to their Nostro Account. Accordingly, any Authorized

Dealer that wants to avail itself to the arrangement should inform the

CBN a day to the Auction date.

Authorized Dealers, Bureau de Change operators and indeed the general public

were reminded that it was a very serious offence (for which offenders could be

liable to prosecution) to use fictitious/spurious documents to purchase foreign

exchange in the Foreign exchange Market (FEM).

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6.0 Ecobank Nigeria Plc to Run Non-resident Naira Settlement Accounts

During the period, the Central Bank of Nigeria approved Ecobank Nigeria Plc’s

bid to run non-resident Naira Settlement Accounts for African educational

institutions. The approval was to ease the payment process for Nigerian students

studying in other African countries. This followed a high demand and requests by

several African educational institutions. These institutions were said to have

requested that Ecobank act as their collection bank for school fees and other

administrative charges for their increasing number of Nigerian students. By this

development, Nigerian students and their parents can now pay tuition fees and

expenses in Naira through Ecobank directly into the account of their educational

institutions with Ecobank affiliates.

Ecobank, the Pan African Bank, currently has an integrated retail network of over

200 locations in Nigeria and with subsidiaries in 19 other countries is seen by

many as the gateway to West, Central and Eastern African markets, being one of

the few banks that undertake transactions in popular currencies used on the

continent such as the Cedi and CFA.

7.0 The Federal Government Announced A N2.45 Trillion Budget For 2008

The Federal Government, during the period under review, announced a budget of

N2.45 trillion for fiscal year 2008. The budget proposal showed that Security and

the Niger Delta got a lion share of N444.6 billion, which is about 20 percent of the

entire budget, as against 6.5 percent in the previous year. Education got N210

billion; Energy, excluding National Integrated Power Projects billed to be

implemented through alternative funding was given N139.78 billion. Agriculture

and Water Resources got N121.19 billion. A total of N38.17 billion was allocated

to the Health Sector, while N73 billion was budgeted for Transportation.

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Described by the President as a “Budget for the Common man”, the fiscal plan

sought to make life more comfortable for the average man on the street through

employment generation and access to micro credit facility among others. The

budget proposal was based on an exchange rate of N117 per dollar.

8.0 New Guidelines On Bank Mergers And Acquisitions

The Central Bank of Nigeria (CBN) issued new guidelines for mergers and

acquisitions by banks in the country in order to streamline such transactions in the

post-consolidation period. Under the new arrangement, any bank wishing to

acquire or merge with another bank must initiate preliminary discussions with the

target bank at the highest level, that is, the Board of Directors/key shareholders of

the institutions. Thereafter, the bank involved must notify it in writing and obtain a

“no objection” response before proceeding with further discussions or negotiations.

All the banks involved were expected to continue to provide the CBN with regular

updates on the progress made in the discussions. The CBN stated further that banks

must at all times comply strictly with all the relevant laws and regulations

including the provisions of the Banks and Other Financial Institutions Act – 1991

(as amended); Investment and Securities Act 1999; and the Companies and Allied

Matters Act 1990, in the conduct of the transaction.

9.0 Access Bank Commenced Operations in Sierra Leone

Access Bank PLC, during the period under review, opened a subsidiary bank in

Sierra Leone. The new bank is known as Access Bank Sierra Leone Limited. The

bank commenced operations after receiving necessary approvals from the Bank of

Sierra Leone and the Central Bank of Nigeria.

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10.0 Uniform Titles for Deposit Money Banks

During the period under review, the Central Bank of Nigeria (CBN) adopted

uniform job titles for banks’ senior management staff to ensure simplicity and

comparison across banks. The exercise was also meant to harmonize such

designations with the already well-known ones. The conventional titles and their

acceptable equivalent in the banking industry are as shown in table 1 below:

TABLE 1.1

Conventional And Acceptable Job Titles In Banks

S/N Conventional Titles Acceptable Equivalent

1 Managing Director/CEO Managing Director/CEO

2 Deputy Managing Director Deputy Managing Director

3 Executive Director Executive Director

4 General Manager Senior Vice President

5 Deputy General Manager Vice President

6 Assistant General Manager Assistant Vice President

7 Principal Manager Principal Manager

8 Senior Manager Senior Executive Assistant

The apex bank also forbade banks from creating the positions of Executive Vice

Chairman, Group Director and Regional Director for their senior management

staff. The CBN categorically stated that such titles are alien to the banking

industry.

The CBN also stated that the position of the Chairman must be separate and

distinct from that of the Chief Executive Officer in accordance with the Code of

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Corporate Governance. The directive took immediate effect.

11.0 New Rules On Global Depository Receipts (GDRs)

The Central Bank of Nigeria (CBN) issued new guidelines to regulate the issuance

of Global Depository Receipts (GDRs) by banks selling their shares to

international investors. The new regulatory framework mandated banks selling

GDRs to furnish the apex bank with details of the beneficial investors on a copy of

the Certificate of Capital Importation issued in favour of such banks. The

Guidelines became necessary, according to the CBN, in view of the resort of banks

to GDRs with the principal aim of raising capital and selling shares, and the need

to align the new development with the requirements of CCI issuance to foreign

investors as well as build their confidence in the GDRs. It would be recalled that

during the period under review, not fewer than five banks raised funds through the

GDRs.

12.0 145 Community Banks Closed Shop

During the period under review, the Central Bank of Nigeria (CBN) disclosed that

a total of 145 Community Banks (CBs) closed shop due to their inability to beef up

their share capital to N20 million as prescribed by the apex bank. This was

disclosed in a Circular dated December 21, 2007 addressed to all the Chairmen,

Directors, and other stakeholders of the affected banks.

13.0 All Federal Government Bonds Re-Classified As Liquid Assets

The Central Bank of Nigeria (CBN), during the period under review, classified all

Federal Government Bonds that are actively traded on the secondary market as

liquid assets for banks. This is irrespective of the tenor of such bonds. Prior to the

decision by the CBN, only Federal Government bonds with three years maturity or

less were considered as liquid assets of banks.

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According to the CBN, the decision was taken to deepen the financial market and

enhance the information content of the yield curve for effective price discovery as

well as bench mark international best practices. By the new decision, only FGN

bonds actively traded on the secondary market shall qualify as eligible instruments

for the computation of liquidity ratio of the banks. In addition such FGN bonds

would serve as collateral for lending/repo at the CBN window.

14.0 Interest Rates

The interest rates for major financial instruments during the second half of 2007

are presented in Table 1.2. As revealed in the table, the Prime Lending and

Savings deposit rates as at end of the year remained the same at 24.0 and 6.3 per

cent respectively when compared to those obtainable as at July, 2007, the

beginning of the review period. Rates on Call and 7-Day money decreased, as at

the end of December 2007, by 1.0 and 0.9 percentage points respectively, during

the period under review whereas rates on other deposit instruments with varied

maturities witnessed some slight appreciation. For instance, whilst rate on 90-day

grew by 0.5 percentage point during the period, rate on one-year deposits attracted

an increase of 0.8 percentage point. Rates depicting the stance and direction of

monetary policy enjoyed the highest increase during the period: MPR increased by

1.5 percentage points during the period under review while Treasury Bills rate

grew by 2.4 percentage points during the same period. The FGN Bond Rates, as

evidenced in Table 1.2, decreased by 1.8 percentage points from 10.8 percent in

July to 9.0 percent in December, 2007.

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Table 1.2

Average Interest Rates For The Period July-December, 2007 Financial Instrument

Rates (%)

Increase/(Decrease) between July and December, 2007

July,2007

August,2007

Sept,2007

October,2007

November,2007

December,2007

Savings

6.3 6.3 6.3 6.3

6.3

6.3

-

Call

7.3 12.6 6.1 7.9

10.0

6.3

-1.0

7-Day

8.8 8.8 7.0 9.5

9.9

7.92

- 0.9

30-Day

12.0 12.8 12.1 12.5

12.6

12.50

0.5

60-Day 12.3 13.8 12.6 13.0 12.8 12.90 0.6

90-Day 12.6 13.00 12.6 12.9 13.0 13.13 0.5 180-Day

12.3 12.8 12.6 13.0

12.8

13.2

0.9

360-Day

12.3 12.6 12.3 13.0

12.6

13.1

0.8

Prime Lending

24.0 24.0 24.0 24.0

24.0

24.0

-

MPR

8.0 8.0 8.0 9.0

9.0

9.5

1.5

T/Bills Rate

6.1 6.2 6.1 6.2

6.6

8.50

2.4

FGN Bond

10.8 9.9 9.9 9.9

9.9 9.0 - 1.8

Source: NDIC Market Survey

15.0 The Naira Exchange Rate

A major development in the nation’s foreign exchange market during the period

under review was the release of a Circular to all authorized dealers, Bureau de

Change and members of the general public with respect to further liberalization of

the foreign exchange market (see report in Section 5.0). In addition, the Central

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Bank offered 25billion Naira ($209.81 million) worth of one-year treasury bonds

on Wednesday the 7th November 2007, which attracted substantial interest from

foreign investors. Aside the inflow from foreign investors, the market was mostly

driven by speculative transactions among dealers. The massive inflows coupled

with the dollar’s decline in the international market led to a steady appreciation of

the Naira against the US dollar during the period under review.

The average Naira exchange rate against the US Dollar for the second half, 2007

is presented in Table 1.3 with the comparative changes in rates between the months

of July and December, 2007. As evidenced in the table, the Naira appreciated in

the three segments of the market, namely Wholesale Dutch Auction System

(WDAS), Bureau De Change (BDCs) and Parallel market. The Naira exchange

rate was N1178.76 to a US dollar in December, 2007 as against N127.27 in July,

2007 at the WDAS depicting an appreciation of 8.1 percent of the Naira. In the

Bureau De Change, the Naira exchanged for N119.8 for a US dollar in December

as against N128.5 in July, 2007. In the parallel market from our survey, the Naira

appreciated by about 7 percent against the US dollar as shown in the table.

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Table 1.3 Average Naira Exchange Rate As at For the Period July-December,

Source

Exchange Rate (Naira to $1)

% Change in the value of Naira/US

dollar between July

and December,

2007

July 2007

August

2007

September

2007

October

2007

November

2007

December

2007

WDAS

127.27

125.05

125.05 125.14

122.72

118.758

8.1

Bureaux De Change

128.50

128.50

128.02 127.35

123.1

119.8

7.3

Parallel Market

129

129

129.12 128.50

123.6

120.6

7.0

Source: NDIC Market Survey

16.0 Performance of Banks Quoted on the Nigerian Stock Exchange (NSE)

A major development in the capital market during the period under review was the

First City Monument Bank’s (FCMB) Public Offer which was opened to the public

on October 16, 2007 following the approval of the offer by the regulatory

authorities. The offer closed on November 13, 2007.

Like in the previous months, the shares of the banking sub-sector continued to

dominate the market as they remained the most actively traded stocks on the floor

of the Nigerian Stock Exchange during the period under review. Presented in

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Table 1.4 is the performance of banks’ shares on the floor of NSE as at December

27, 2007 in comparison to the position as at July 25, 2007. As evidenced in the

table, United Bank of Africa Plc took the price leadership position while Zenith

Bank Plc occupied the second with the quoted prices of 4,845 kobo and 4,609

kobo respectively. Others that trailed behind included First Bank of Nigeria Plc,

Union Bank of Nigeria Plc, Intercontinental Bank Plc, Oceanic Bank Plc, Guaranty

Trust Bank Plc and Afribank Nigeria Plc with quoted prices of 4,242kobo,

4,140kobo, 3,8645kobo, 3,393kobo, 3,240kobo and 3,049kobo respectively.

A comparison of the two periods (July and December, 2007) also revealed that

Fourteen (14) out of the twenty-one (21) banks quoted on the floor of NSE had

upward movements in their share prices in December, 2007. Afribank PLC

enjoyed the highest upward price movement (63.3%) followed by FirstInland Bank

PLC with 57.77%. IBTC enjoyed the least upward price movement during the

period under review as it gained 0.75%. On the other hand, six (6) banks had a

downward (decrease) movement in their prices during the period under review. The

affected banks were United Bank for Africa Plc, Zenith Bank Plc, Sterling Bank

Plc, Diamond Bank Plc, Platinum-Habib Bank Plc and Ecobank Plc with decreases

in prices of 311kobo or 6.03%, 1,761kobo or 2.76%, 76kobo or 9.45%, 31kobo or

31.18%, 428kobo or 14.37% and 165kobo or 17.19% respectively.

Only one (1) bank which is Spring Bank Plc retained the share price of 559kobo on

the floor of the NSE during the period under review. At the close of business on

December 27, 2007, Twelve (12) banks closed on bid while no bank closed on

offer.

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Table1.4 Performance of Insured Banks’ Shares on the Nigerian Stock Exchange (NSE)

As At July 25 And December 27, 2007.

BANK

Par value (k)

Quotation (k)

Price Change Increase/decrease

Year’s High (k)

Year’s Low (k)

Earnings P/share (k)

Price/Earning Ratio (%)

July Dec

ACCESS BANK NIGERIA PLC

50

1.892 2222

330

2303

696

1.16

19.16

AFRIBANK NIGERIA PLC

50

1,867 3,049

1,182

3689

1151

1.42

21.47

DIAMOND BANK NIGERIA PLC

50

1,810 1,779+

-31

2278

747

0.73

27.11

ECOBANK NIG. PLC 50 960 795 -165 1042 498 0.28 28.39

FIDELITY BANK PLC

50

1,140 1,183

43

1271

215

0.30

39.43

FIRST BANK OF NIG. PLC

50

4,242 4,315 +

73

5741

3200

1.17

36.88

FIRST CITY MONUMENT BANK PLC

50

1,570 1,789+

219

1810

405

0.95

18.83

FIRSTINLAND BANK PLC

50

843

1,330

487

1464

339

0.47

28.30

GUARANTY TRUST BANK PLC

50

3,188 3,240 +

52

3796

1815

1.26

25.71

IBTC – CHARTERED BANK PLC

50 1,100 1,920 +

820

2094 705 0.56 34.29

INTERCONTINENTAL BANK PLC

50

2,600 3,864 +

1.264

3864

1360

1.24

31.16

OCEANIC BANK PLC

50

2,748 3,393 +

645

3393

1248

1.51

22.47

PLATINUMHABIB BANK PLC 50 2,979 2,551 +

-428 3526 292 1.27 20.09

SKYE BANK PLC 50 1,330 1,719 389 1780 352 0.58 29.64

SPRING BANK PLC

50 559 559 0 716 380 0.16 34.94

804

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BANK

Par value (k)

Quotation (k)

Price Change Increase/decrease

Year’s High (k)

Year’s Low (k)

Earnings P/share (k)

Price/Earning Ratio (%)

July Dec

STERLING BANK PLC 50 728 -76 1010 300 0.20 36.40 UBA PLC

50

5,156 4,845+

-311

5775

2531

1.90

25.50

UNION BANK NIG. PLC

50

3,980 4,140 +

168

5033

2291

1.63

25.40

UNITY BANK PLC 50 620 850+ 238 889 250 0.00 0.00

WEMA BANK PLC

50

1,099 1,500 +

481

1500

318

0.55

27.27

ZENITH BANK PLC

50

6,370

4,609 +

-1,761

6897

2440

1.90

24.26

Source: The Nigerian Stock Exchange, Lagos Key: - = Supply (Offer) + = Demand (Bid)

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FINANCIAL CONDITION AND PERFORMANCE OF INSURED BANKS IN THE THIRD AND FOURTH QUARTERS OF 2007 BY RESEARCH & OFF-SITE SUPERVISION DEPARTMENTS 1.0 INTRODUCTION The conditions of the insured banks were generally sound whilst the industry

witnessed positive performance in the period under review. Total assets of the

banks increased by 4.3% during the period under review: from N10.00 trillion as at

the end of the third quarter of 2007 to N10.43 trillion as at the end of the fourth

quarter of 2007. On a similar note, the industry’s total loans and advances

increased by 13.22 percent, from N3.36 trillion as at the end of September, 2007 to

N3.80 trillion as at the end of December, 2007. However, asset quality deteriorated

as the proportion of non-performing loans to total credit increased from 7.09

percent as at the end of the third quarter to 7.39 percent as at the end of the last

quarter of 2007. Profit before tax (PBT) which amounted to N184.31 billion as at

the end of the third quarter increased significantly by 114.72 percent to N395.75

billion as at the end of the fourth quarter. Also capital to risk-weighted asset ratio

increased slightly by 0.31 percentage points from 20.78 percent at the end of

September 2007 to 21.09 percent at the end of December 2007. The industry

average liquidity ratio also increased significantly by 6.28 percentage points from

55.72 percent as at the end of September 2007 to 61.98 percent as at the end of

December 2007.

The rest of the paper is divided into three sections. Section 2 presents the structure

of assets and liabilities of the banking industry, while section 3 examines the

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financial condition of insured banks. Section 4 concludes the paper.

2.0 STRUCTURE OF ASSETS AND LIABILITIES

The total assets of the banking industry increased from N10.00 trillion as at the end

of September to N10.43 trillion as at the end of December 2007. The structure of

banks’ total assets and liabilities as at the end of the third and fourth quarters of

2007 are presented in table 1 below.

TABLE 2.1

STRUCTURE OF BANKS’ ASSETS AND LIABILITIES AS AT THE END OF SEPTEMBER AND DECEMBER 2007

Assets (%)

3rd Quarter

4th Quarter

Liabilities (%)

3rd Quarter

4th Quarter

Cash & Due from Other Banks

20.21

17.27

Deposits

55.26

51.36

Inter-bank Placement 6.60 4.20 Inter-bank Takings 3.68 2.43 Government Securities

15.44 15.19

CBN Overdraft

0.08

0.19

Other Short-term Funds 4.04

4.71

Due to Other Banks

2.06

1.71

Loans & Advances

33.57

36.45

Other Borrowed Funds 0.00

0.00

Investments 7.29 8.55 Other Liabilities 22.22 26.01 Other Assets 9.08 9.63 Long-term Loans 1.90 2.52 Fixed Assets

3.77

4.00

Shareholders’ Funds (Unadjusted)

1.47

1.45

Reserves 13.33 14.33 Total 100.00 100.00 Total 100.00 100.00 Source: Bank Returns NOTE: TOTAL ASSETS (=N= TRILLION) 3RD QUARTER OF 2007 10.00 4TH QUARTER OF 2007 10.43 OFF-BALANCE SHEET (As a Proportion of Balance Sheet Items) 23.75% 24.74%

23

05

10152025303540

3rd Quarter 4th Quarter

CHART 1 A: STRUCTURE OF BANKS' ASSETS FOR THE 3RD AND 4TH QUARTERS OF 2007

Cash & Due from Other Banks Interbank Placements

Government Securities Other Short-term Funds

Loans & Advances/Leases Investments

Other Assets Fixed Assets

24

As usual, the largest proportion of total assets during the third quarter of 2007 was

Loans & Advances, which accounted for 33.57 percent. This item increased

slightly by 2.88 percentage points to 36.45 percent as at the end of the fourth

quarter. The relative share of Cash & Due from Other Banks declined from 20.21

percent as at the end of September 2007 to 17.27 percent as at the end of December

2007, which represents a decline of 2.94 percentage points though it retained its

position as the second largest component of total assets. Government Securities

which constituted 15.44 percent of total assets in the third quarter of 2007

maintained its third position on the log. However, its relative contribution declined

0

10

20

30

40

50

60

3rd Quarter 4th Quarter

CHART 1 B: STRUCTURE OF BANKS' LIABILITIES FOR 3RD AND 4TH QUARTERS OF 2007

Total Deposits Interbank Takings CBN Overdrafts

Due to Other Banks Other Borrowed Funds Other Liabilities

Long-term Loans Shareholders' Funds (Unadjusted) Reserves

25

slightly by 0.28 percentage points to 15.18 percent in the fourth quarter but still

maintained its position as the third largest component of total assets. Other

components of the banking industry’s assets whose relative contributions increased

in the fourth quarter of 2007 compared to the situation in the third quarter of 2007

were Other Short-term Funds, Investments, Other Assets and Fixed Assets

which increased by 0.67, 1.26, 0.61, and 0.23 percentage points respectively.

On the liabilities side of the balance sheet, Deposits accounted for 51.36 percent of

the total as at the end of December 2007 but this was lower than its contribution in

the third quarter by 0.90 percentage points. The second largest liability of the

banking industry as at the end of the fourth quarter of 2007 was Other Liabilities

which accounted for 26.01 percent. That was 3.79 percentage points higher than its

contribution in the third quarter. Other sources of funding in the industry during the

fourth quarter of 2007 included the following: Inter-bank Takings (2.43%); Due

to Other Banks (1.71%); Long-term Loans (2.52%); Shareholders’ Funds

(1.45%); and Reserves (14.33%).

3.0 ASSESSMENT OF THE FINANCIAL CONDITION OF INSURED

BANKS

3.1 Asset Quality

The industry’s total loans and advances increased by 13.19 percent from N3.36

trillion as at the end of September 2007 to N3.80 trillion as at the end of December

2007. However, the quality of those assets deteriorated during the same period.

Table 2.2 and Chart 2 present the indicators of insured banks’ asset quality for the

third and fourth quarters of 2007. Non-performing Loans increased by 22.36

percent from N317.07 billion in the third quarter to N388.00 billion in the fourth

quarter of 2007. Thus, the proportion of Non-performing Credit to Total Credit also

26

increased from 7.09 percent at the end of September 2007 to 7.39 percent at the end

of December 2007. Similarly, the proportion of Non-performing Loans to

Shareholders’ Funds increased slightly by 2.16 percent from 21.82 percent as at the

end of September 2007 to 23.98 percent as at the end of December 2007.

TABLE 2.2 INDICATORS OF INSURED BANKS’ ASSET QUALITY FOR THE THIRD AND FOURTH QUARTERS OF 2007 Asset Quality Indicator (%)

Industry 3rd Quarter of 2007

4th Quarter of 2007

Non-performing Credit to Total Credit

7.09

7.39

Provision for Non-performing Loans to Total Non-performing Credit

81.88

85.35

Non-performing Credit to Shareholders’ Funds

21.82

23.98

Source: Bank Returns

27

3.2 Earnings and Profitability

The banking industry recorded an 85.59 percent increase in Interest Income from

N477.41 billion in the third quarter to N886.02 billion in the fourth quarter of 2007.

Similarly, Non-Interest Income increased appreciably from N153.20 billion in the

third quarter to N408.97 billion in the fourth quarter of 2007. Thus, total Profit

Before Tax (PBT) of the banking industry increased significantly by 105.49

percent from N184.31 billion as at September to N379.75 billion as at December of

the same year. Following the same trend, Operating Expenses also increased from

0

10

20

30

40

50

60

70

80

90

3rd Quarter 4th Quarter

CHART 2: INSURED BANKS' ASSET QUALITY FOR THE 3RD AND 4TH QUARTERS OF 2007

Non-performing Credit to total Credit

Provision for Non-performing Loans to non-performing Credit

Non-performing Credit to Shareholders' Funds

28

N232.35 billion as at the end of September 2007 to N579.20 billion as at the end of

December 2007. Table 2.3 and Chart 3 present the Earnings and Profitability

Indicators for the third and fourth quarters of 2007.

TABLE 2.3 EARNINGS AND PROFITABILITY INDICATORS FOR THE THIRD AND FOURTH QUARTERS OF 2007 Earnings/Profitability Indicator

Industry 3rd Quarter

4th Quarter

Return on Assets (%)

1.84

3.64

Return on Equity (%)

12.69

23.07

Net Interest Margin (%)

3.85

7.27

Yield on Earning Assets (%)

7.26

12.65

Profit Before Tax (=N= Billion)

184.31

395.75

Interest Income (=N= Billion)

477.41

886.02

Operating Expenses (=N= Billion)

232.35

579.20

Non-Interest Income (=N= Billion)

58.07

52.67

Source: Bank Returns

30

3.3 Liquidity Profile

The industry average liquidity ratio increased during the fourth quarter of 2007

relative to the third quarter of the same year. Table 2.4 presents the indicators of

insured banks’ liquidity profile for the third and fourth quarters of 2007. The

average liquidity ratio increased from 55.72 percent as at the end of September

2007 to 61.98 percent as at the end of December 2007, representing an increase of

6.26 percentage points. Thus, the ratio remained higher than the 40 percent

minimum regulatory requirement.

TABLE 2.4 INDICATORS OF INSURED BANKS’ LIQUIDITY PROFILE FOR THE THIRD AND FOURTH QUARTERS OF 2007 Liquidity

Period 3rd Quarter of 2007

4th Quarter of 2007

Average Liquidity Ratio (%)

55.72

61.98

Net Loans to Deposit Ratio (%)

76.16

91.76

Inter-bank Takings to Deposit Ratio (%)

6.66

4.73

No. of Banks with Liquidity Ratio of Less than the prescribed 40%

5

2

Source: Bank Returns From Table 2.4, it can be observed that the industry slightly reduced its dependence

on inter-bank takings as the ratio of Inter-bank Takings to Deposits decreased by

1.93 percentage points from 6.66 percent as at September 2007 to 4.73 percent at

the end of December 2007. The number of banks that could not meet up with the

31

liquidity ratio of 40 percent prescribed by the regulatory authorities also declined

from 5 in the third quarter to 2 at the end of December 2007.

3.4 Capital Adequacy

On the aggregate, the banking industry remained adequately capitalized as at the

end of the fourth quarter of 2007. The average Capital to Risk -Weighted Assets

Ratio far exceeded the required minimum of 10 percent. Thus, the industry

required no additional capital. Table 2.5 and Chart 4 below show insured banks’

capital adequacy positions as at the end of September and December 2007.

TABLE 2.5

INDICATORS OF INSURED BANKS’ CAPITAL ADEQUACY POSITION FOR THE THIRD AND FOURTH QUARTERS OF 2007. Capital Adequacy Indicator

Period 3rd Quarter of 2007

4th Quarter of 2007

Capital to Risk Weighted Asset Ratio (%)

20.78

21.09

Capital to Total Asset Ratio (%)

14.51

16.08

Adjusted Capital to Loan Ratio (%)

33.87

36.34

Source: Bank Returns

32

The Capital to Risk Assets Ratio increased by 0.31 percentage points from 20.78

percent as at the end of September to 21.09 percent as at the end of December

2007. Following the same trend, the Ratio of Capital to Total Assets for the

industry increased slightly from 14.51 percent in September to 16.08 percent in

December 2007. The Adjusted Capital to Loan Ratio also increased from 33.87

percent as at the end of the third quarter to 36.34 percent as at the end of the fourth

quarter of 2007. The observed improvement in the various capital adequacy ratios

may be due to the fact that even after the completion of the first phase of the

consolidation programme, banks were still shoring up their shareholders’ funds,

probably as a result of competition.

05

10152025303540

3rd Quarter

4th Quarter

CHART 4: INSURED BANKS' CAPITAL ADEQUACY FOR 3RD AND 4TH QUARTERS OF 2007

Capital to Risk Weighted Asset RatioCapital to total Asset RatioAdjusted Capital to Loan Ratio

33

4.0 CONCLUSION

The overall financial condition and performance of the insured banks during the

fourth quarter of 2007 were better relative to the third quarter. The total assets of

the industry increased during the period under review. On the other hand, there was

a slight increase in the ratio of non-performing credit to total credit during the

period in question. In terms of earnings and profitability, the industry performed

creditably well as profit before tax increased significantly by more than 114.72

percent.

34

PROACTIVE MEASURES TO GUARD AGAINST FRAUD/CASH THEFT IN THE BANKING INDUSTRY AND IN ORGANISATIONS1

BY

G. A. OGUNLEYE, OFR

Managing Director/Chief Executive

1.0 INTRODUCTION

Fraud is recognized as a significant threat facing Governments, Businesses and

Individuals all over the world. In our own environment, fraud appears to have

assumed a tragedy of epic dimension. Fraudsters are not only becoming more

sophisticated, innovative and refined in the planning and execution of their

nefarious act, but are becoming daring as well. Our everyday living experiences

are awash with stories of fraudulent acts being committed in our businesses and on

individuals

Fraud losses impact every business and every household. It results in huge

financial losses to banks and other organizations, their shareholders and customers.

In particular, fraud leads to loss of confidence in business, insolvency or winding

up of businesses, bankruptcy, failure of creditors’ business with attendant loss of

employment, revenue to the government, lenders and investors. The costs of fraud

are always passed on to society in the form of increased customer inconvenience,

opportunity costs, unnecessary high prices for goods and services, and criminal

activities funded by the fraudulent gains. It was established that fraud was one of

the main causes of distress in our banking system that led to the closure of many

banks in the 1990s. As a matter of fact, some recent bank failures were caused by

fraud. 1 Original Paper was delivered at a One-Day Security Enlightenment Forum organized by Police Community Relations Committee, Garki Division, Garki, Abuja, F.C.T

35

The subject of fraud is of great concern to an organization like the Nigerian

Deposit Insurance Corporation ( NDIC) that is saddled with the responsibility of

protecting depositors of banks and other financial institutions. Section 35 and 36

of NDIC Act No. 16 of 2006 require all insured banks in Nigeria to render to the

Corporation, returns on frauds and forgeries or outright theft occurring in their

organizations and also report on any staff dismissed, terminated or advised to retire

on the grounds of fraud. The purpose of obtaining these information is not only for

statistic, but to assist the Corporation in understanding the tricks, antics and tactics

employed by fraudsters to perpetrate their nefarious acts with a view to devising

counter measures that will checkmate and frustrate their efforts. The information is

to also assist in ensuring that fraudsters are not allowed to circulate in our financial

system.

What is fraud? There is no precise legal definition of fraud just as there is no single

offence that can be called fraud. Nevertheless, it is usually taken to have elements

including an intentional and unlawful misrepresentation which causes prejudice,

most often misappropriation, which is the removal of cash, or asset to which the

fraudsters is not entitles as well as false accounting in which records and numbers

reported are falsified to give and create false impression. Black’s Law Dictionary

defines fraud as |an intentional perversion of truth for the purpose of inducing

another in reliance upon it to part with some valuable thing belonging to him or

surrender a legal right”. Fraud is therefore a false representation intending to

mislead, whether by word, conduct that deceives and is intended to deceive another

so that he shall act upon it to legal injury. From the definition, it is obvious that the

subject matter of fraud is very wide ranging from the simple theft or petty cash or

cheques fraud to a major one. Fraud can be committee by employees, customers or

other operating independently or in conspiracy with others inside or outside the

36

organisation.

The purpose of this paper is to examine the modus operandi of fraudsters in

perpetrating fraud in our environment with a view to creating a high level of

awareness and a sense of urgency in order to stem its tide in our businesses by way

of developing and implementing proactive measures. The Second Part of this

paper therefore examines the causes of fraud in our environment while Part Three

looks at the nature and various types of frauds. The paper in Part Four identifies

the needed measures to be taken in order to deter, prevent and detect fraud in a

timely and effective manner. The conclusion is given in Part Five.

2.0 FACTORS CAUSING FRAUD AND ITS EXTENT

There are many factors that cause fraud in Nigeria and these can be classified into

three main groups, namely: institutional, social and individual.

2.1 Institutional Factors

Many institutions unconsciously create conditions that allow fraud to flourish. In

such institutions a lot of loopholes are allowed to exist which fraudsters easily

identify and exploit to commit their acts. The common institutional causes of fraud

are highlighted hereunder.

2.1.1. Inadequate Internal Control

Internal control has long been prescribed as an antidote to fraud. As such, poor

internal control creates incentive and fertile grounds for fraud to thrive.

Weaknesses occur where the controls designed to prevent people using the system,

for an improper or unauthorized purpose, do not operate effectively and efficiently.

The simplest example would be a failure in access controls that allow unauthorized

individuals into the premises or sensitive areas of business, for instance computer

network. Ineffective internal audit, poor staff supervision, absence of segregation

37

of duties and lack of dual control over sensitive documents and keys are all

manifestations of inadequate internal control which aid fraud.

2.1.2. Inexperience of Staff/Inadequate Staff Training

In instances where organization recruit and place their staff in positions far beyond

their capabilities and competence for reasons ranging from political patronage to

family connection, fraud becomes easy to perpetrate through such staff. Because

of their lack of experience and knowledge fraud easily pass through them without

being detected.

Lack of adequate training and re-training of staff on their job schedules result in

poor performance which breeds fraud. Failure to give staff on-the-job training as

well as sending them to relevant courses also lead to unsatisfactory performance

which eventually creates room for fraud.

2.1.3. Employment Disaffection

The motive for fraud is often due to staff disaffection, based on being passed over

for promotion, inadequate pay reward, or a feeling of carrying more than a fair

workload. The number of employees who see themselves threatened and therefore

could turn into potential malefactors has been on the increase mainly due to

management practices that are considered negative and inbibitive. Management

practices bordering on reorganization, restructuring, reengineering and downsizing

or rightsizing have resulted in employee lay-offs. In fact, restructuring in some

organizations seem to have become a way of life with its attendant loss of jobs.

This creates job insecurity in the minds of the generality of employees which in

turn increases the population of potential fraudsters and breeds fraudulent practices

as well.

38

2.1.4. Poor Management

It is the responsibility of board and management to ensure the security and integrity

of the business assets by putting in place appropriate control and procedures.

Where a management is ineffective, incompetent or self-serving, the tendency is

for the controls not to be in place or to be overridden and compromised thereby

allowing fraud to flourish. In such organizations, managements are not only

facilitators but active collaborations in perpetrating fraud. It is therefore not

surprising that those organizations record higher incidence of fraud than those with

effective management.

Management style is also known to be a factor in committing fraud. An autocratic,

aggressive or domineering management facilitates overriding of controls and

prevents questioning by others. This style may end up permeating the whole

organization thereby creating a closed environment where corporate policies and

culture yield to individual’s whims and caprices, and fraud in this circumstance can

go unchallenged. Where performance goals set by management appear overly

aggressive given conditions in the marketplace, for instance the unrealistic deposit

targets being given by banks to their staff, breeds all sorts of fraud.

2.1.5. Negligence of Staff/Customers

Staff negligence is found to be a cause of fraud in many instances. Negligence

itself is a product of several factors, including poor supervision, lack of technical

knowledge, apathy, workload, pressure, etc.

Similar, negligence of customers is also a great factor in perpetrating fraud.

Customers who fail to adequately secure documents and other assets related to their

business transactions, e.g. cheque books, stock records, company seals, etc, create

conductive environment for fraud. Failure to also carry out accounts reconciliation

39

assists in facilitating fraud.

2.1.6. Automation and Computerization

Computerization and automation of business processes are known to facilitate

fraud especially where there is no proper project planning and execution including

adequate training of people to use the system. Computers have become powerful

instruments and ready tools in the hands of fraudsters for perpetrating fraud

because of ease in usage and difficulty in tracing trail.

2.2 Social Factors

2.2.1. Societal Values

The value system in our society today is such that reputation, respect, honour and

other social status are conferred on people mainly on the basis of their material

wealth. Access to political power, chieftaincy titles, religious positions and

influence are seen to be for money bags. People are no longer respected for

honesty, integrity and wisdom. Instead, recognition is accorded to materialism.

People are therefore driven to commit fraud as a means of easy acquisition of

money and properly which in our today’s world translate into recognition and

power.

2.2.2. Poor Economy

It is being argued that the poor state of our economy has been a contributory factor

to fraud perpetration. The level of unemployment and poverty in the polity due to

recession has been a major cause for concern to all and sundry. Hash economic

conditions can drive people to commit fraud. The individual must necessarily

satisfy the basic needs of food, cloth and shelter otherwise he will readily succumb

to fraud if opportunity presents itself.

40

2.2.3. Slow and Tortuous Legal Process

The law enforcement and judicial process of bringing fraudsters to justice has been

extremely slow and tortuous. Cases of fraud reported to the police take a long time

to investigate and prosecute. Many other cases are not investigated to prosecution

to serve as deterrent. The delay in investigation and prosecution can perhaps be

explained because the police and courts are poorly equipped and remunerated.

However, the understanding that our laws are weak in promptly bringing fraudsters

to justice send wrong signals that people can commit fraud and get away with it.

2.3 Individual Factors

These are factors that pertain to the person, that is, those that are peculiar to the

individual who may encourage him to live a fraudulent life. These factors include;

i) Biological make-up – e.g. Kleptomania

ii) Poor moral upbringing

iii) Criminal background, and

iv) Weak mind

The above factors are identifies to cause fraud in many instances.

2.4 Extent of Fraud in the Economy

The extent of the havoc that fraud wrecks on the Nigerian economy is difficult to

determine for reason of lack of comprehensive and reliable data. However, if the

information available from the banking industry can be regarded as a good

representation, it is obvious that the damage to the economy by means of fraud is

colossal. It can be said to be the most costly of all criminal activities in the

country. Table 1 gives the total number of fraud cases, total amount involved and

total expected loss in the banking industry for the years 1995 to 2003.

41

Table 1

Fraud in Banks

YEAR TOTAL NO. OF FRAUD CASES

TOTAL AMOUNT INVOVLVED (N’m)

TOTAL EXPECTED LOSS (N’m)

1995 141 1,011 229

1996 606 1,601 375

1997 487 3,778 228

1998 573 3,197 692

1999 195 7,404 2,730

2000 403 2,851 1,081

2001 943 11,244 906

2002 796 12,920 1,300

2003 850 9,384 857

2004 1,175 11,754 2,610

2005 1,229 10,606 5,602

2006 1,553 10,006 2,769

8591 80,582 19,378

Source: NDIC Annual Reports (1995 – 2006)

It should be noted that the amount involved and expected loss should be far higher

than the reported figures in Table 1 because many banks reneged on rendering the

required returns on fraud. As can be seen from Table 1, the amount involved in

fraud increased steadily over the twelve-year period except in 2000, 2003, 2005

and 2006. From N1.01 billion in 1995, it increased to N12.9 billion in 2002 before

declining to N9.4 billion in 2003. Thereafter, it increased to N11.754 billion in

2004 but decreased slightly in 2005 and 2006. Total expected loss also behaved in

like manner. From N0.2 billion in 1995, it jumped to N2.7 billion in 1999 before

42

declining to N1.1 billion and N0.9 billion in 2000 and 2001 respectively. It

increased to N1.3 billion in 2002 and then declined again to N0.9 billion in 2003.

In 2005, the expected loss jumped significantly to N5.6 billion and as at the end of

2006, it had gone by almost 100% to stand at about N2.8 billion. In a nutshell,

Table 1 just gives a tip of the iceberg on the costs of fraud in one sub-sector of the

Nigerian economy so as to appreciate its devastating consequences on the overall

economy. Table 2 provides information on the extent of involvement of banks’

staff in fraud and forgery cases.

Table 2

Involvement of banks’ Staff in Fraud and Forgery Cases

Involvement of Staff in Fraud and Forgeries

Source: NDIC Annual Reports (1995 – 2006)

A total of 4578 staff of banks was dismissed, retired or their appointments

Rank Number 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Supervisors & Manager

151 218 203 112 178 132 55 16 25 157 169 118

Officers, Accountants & Executive Assistants

142 96 154 72 144 101 60 48 41 129 124 90

Clerks & Cashiers 172 145 124 82 92 137 30 13 25 61 54 50

Typists, Technicians & Stenographers

18 19 20 12 37 20 - - - 18 16 16

Messengers, Drivers, Cleaners, Security Guards & Stewards

123 66 57 26 127 81 5 4 7 15 12 7

Temporary Staff 16 5 5 5 15 8 2 4 8 3 3 50 Un-categorised Staff 3 3 2 2 3 14 - - - - - -

Total 625 552 566 311 596 493 152 85 106 383 378 331

43

terminated because of their involvement in fraudulent activities during 1995 to

2006 as can be seen from Table 2. In 1995, 625 members of staff of banks were

involved in fraud. That number reduced to 311 by the end of 1998 only to increase

substantially to 596 in 1999. In 2002, only 85 staff of different grades were

involved in fraud or the other, the least during the twelve-year period. Only 383,

378 and 331 staff were involved in fraud in 2004, 2005 and 2006. As can be

observed from table, banks’ staff involvement n fraud and forgeries did not follow

any pattern. However, the noticeable decrease in the number of banks’ staff

involved in fraud in some of the years could be partly attributed to the failure of

banks to render the required return. The decrease notwithstanding, the amount

involved in fraud in some of the years was astronomical when compared with other

years when Table 1 and 2 are compared.

3.0 NATURE AND TYPES OF FRAUD

It is of importance to understand the nature and types of fraud as that will be of

great assistance to organizations in checkmating and combating it. Generally,

fraud is categorized on the basis of its perpetrators. This way, it could be internal,

external or mixed. Internal perpetrators of fraud are staff under the employment of

the organization either as directors, management staff, officers, supervisors or other

employees while the external ones are those outside the organization. Mixed

perpetrators are those involving members of staff of an organization colluding with

outsiders to carry out their fraudulent activities. Another way of classifying fraud

is on the basis of methods employed in perpetrating it. Given the sophistication,

inventiveness and ingenuity of fraudsters in devising ways to carry out their trade,

it will be practically impossible to list and discuss all of them. However, the most

important and common ones are highlighted hereunder.

44

3.1. Theft

Theft involves the removal of cash or assets to which fraudster is not entitled. Any

business asset can be stolen by staff or their parties. The nature of theft may vary

according to the asset being misappropriated and the identity of the perpetrator.

The most common types of theft in our system are:

i) Direct theft of cash or any asset of the business, e.g. stock, computer

equipment, stationary, intellectual property, price lists or customer lists,

etc.

ii) False expense claim which can be anything from claiming for private

entertainment expenses to large scale projects.

iii) Payroll fraud involving the diversion of ex-employees or fictitious

employee payments to the benefits of perpetrators.

iv) Rolling debtors’ receipts that is misappropriating debtors’ receipts and

substituting subsequent receipts.

v) Payments against fictitious jobs or supplies.

vi) Inflation of contracts.

3.2. False Accounting

The main aim of false accounting is to present the results and affairs of an

organization in a better light than the reality. Frequently, there are commercial

pressures to report an unrealistic level of earnings. Whatever the purpose, the

features that are common to all cases of false accounting are the falsification of

records, alteration of figures, and perhaps the keeping of two or more sets of books.

The reasons for all these include:

i) to obtain more financing from banks and creditors;

ii) to manipulate share prices;

iii) to improve results over the year-end and generate performance related

remuneration to which the perpetrator would not otherwise be entitled;

45

iv) to cover up a theft;

v) to attract customers by appearing to be more successful than in reality;

and

vi) to prevent or delay intervention by supervisors/regulators.

This is a typical “corporate fraud” and the amount involved which is colossal, is

hardly reported. The management is usually the architect of this type of fraud.

3.3. Advance Fee Fraud (“419”)

This is a very popular type of fraud in our environment. It is internationally

referred to as Nigerian scam. A method of perpetrating this type of fraud is for

numerous letters to be sent to unsuspecting individuals by fraudsters soliciting for

assistance to transfer large sum of money belonging to them but which is being

held by government. The assistance requested will be in the form of advance fee

which will be uses to settle perceived government officials and the details of the

off-shore foreign accounts of such individuals.

3.4. Computer Fraud

Computer fraud refers to fraud being committed using computer rather than

traditional method of paper and pen. This type of fraud includes:

i) Disguising the true nature of a transaction by manipulating input and or

data including tampering with programme.

ii) Hacking into an organisation’s computer system to steal or manipulate

information.

iii) Unauthorised electronic transfer.

iv) Posing as a legitimate business on the internet using it to defraud the

public.

46

v) Theft of intellectual property, e.g. engineering drawings, trade secrets, e-

books, music, etc.

3.5. Foreign Exchange (FX) Fraud

Foreign exchange transactions have been veritable source of fraud as a result of

sharp practices involving banks and other parties. The most common types

include:

i) Round Tripping – This arise in a situation where banks obtain FX through

official sources at a regulated exchange rate for qualified transaction and

simply sell to autonomous users at a black market exchange rate.

ii) Documentary credit fraud – This can be quite varied and will involve

forgery of FX documents, e.g. import duty receipts, shipping documents,

Clean Report of Inspection and attested invoices. It can be carried out

with the objective of transferring FX for non-existent transaction or by

way of over invoicing.

iii) Travelers’ Cheque (TC) Fraud – This is done by illegal purchase of TCs

which are then uploaded in the black market.

3.6. Loan Fraud

Loans and other forms of credit extensions to business and individual scustomers

constitute the main function of financial institutions. In the process of credit

extension, fraud may occur at any stage, from the first interaction between the

customer and the bank to the final payment of the credit. Loan fraud which is a

typical type of”corporate fraud” in banks occurs when credit is extended without

following the credit policy, law, rules and regulations. Inadequate or absence of

collaterals for loans which by law or policy should be fully collateralized and

diversion of loan for other uses different from which it is given constitute fraud.

Advanced perpetrations of credit fraud go to the extent of applying credit facility

47

approved for one customer to the credit of another who is often unrelated to the

first customer. That is to say, a credit facility for a customer “A” yet to be drawn

down is diverted fro a customer “B”. Failure to make provision in accordance with

Prudential Guidelines also constitutes fraud. The amount involved in loan fraud is

gargantuan.

3.7. Cheque Fraud

The use of cheques as a means of paying for financial obligations is an essential

feature of modern economy. Cheque fraud is now common involving millions of

naira annually. Common types of cheque are personal, business, government,

travelers’ certified, draft and counter cheques, with each having its own

characteristics and vulnerabilities or fraudulent use. The most common cheque

fraud involves that are stolen, forged, counterfeited, altered or cloned.

3.8. Money Laundering Fraud

This is a means to conceal the existence, source or use of illegally-obtained money

by concerting the cash into untraceable transactions. The cash is disguised to make

the income appear legitimate. Fraudsters are known to employ various means in

order to launder their money. These include depositing laundered funds with

banks, using illegally-obtained money to purchase stocks in the capital market,

investing funds of questionable source in real assets, etc.

3.9. Manufacturers Fraud

Manufacturers in the country have been discovered to disregard adherences to

stipulated standards, with the result that more quantity or less quality of the same

product is unleashed into the market for unjust gain.

3.10. Identity Fraud

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This type of fraud is committed by individuals who assume names and identities of

others living or dead with a view to gaining employment, using their stolen credit

or value cards to secure some monetary benefits like pension or other payments.

3.11. Insurance Fraud

In this type of fraud, insurance agents sell policies to clients and refuse to deliver

premium collected to the insurance companies, or state-manage accidents in order

to replace old or defective vehicles, or “causing firs to come from heaven” to burn

houses after previously removing choice items of value for the purpose of making

undue claims from the insurance companies.

4.0 MEASURES TO GUARD AGAINST FRAUD

The best defenses against the risk of fraud in any organization are proactive

measures. For an organization to create a corporate environement that prevents,

deters and timely detects fraud, it needs to understand why fraud occur, types and

methods of perpetration as well as identify its business areas that are at risk and

implementing appropriate procedures to address them. It is a well established fact

that before fraud can take place there must be:

i) an item worth stealing;

ii) a potential perpetrator willing to steal; and

iii) an opportunity for the crime to take place.

It follows therefore that successful prevention of fraud in an organization lies in

the isolation of the perpetrators from the assets and from the opportunity and

knowledge required for access. In other words, walls of policies, procedures,

devices and controls need to be erected to surround and isolate each factor in the

equation to combat fraud. It is for this reason that the system of internal control

is identified as very critical in minimizing the incidence of fraud in any business

49

organization. Internal control can be defined as the whole system of controls,

financial and otherwise, established by the management to carry on the business

of the enterprise in an orderly and efficient manner, ensure adherence to

management polices, safeguard the assets and secure as far as possible the

completeness and accuracy of the records.

Management has overall responsibility for ensuring the security and integrity of

the assets of a business by putting in place appropriate controls and review

procedures. However, it needs to be emphasized that the controls required for

each business will be specific to that business, depending on the way in which

departments or processes function, the systems in place, the number of

personnel and so on. That is to say, every organization needs to assess and

determine the area in which fraud could occur and implement the controls that

are considered necessary to mitigate it. Some of the direct controls that need to

be considered include:

i) Timely and periodic reconciliation of bank accounts, cash in hand,

inventory and other items of value.

ii) Dual signatories and authorization limits.

iii) Segregation of duties.

iv) Management review.

4.1. Other Organisational Measures

Other measures that should be adopted in the fight against fraud are those

relating to the attitude and culture of the organization and the way in which it

deals with fraud. These are indirect controls which convey the message that

fraud will be detected, that action will be taken and that the repercussions could

be severe. Some of these measures include:

50

4.1.1. Physical Security/Access Controls

Operating effective access controls is essential, be it within the premises

themselves, particular departments or offices, computer systems, database, bank

accounts or other areas critical to the business. The role of security tags, which

allow someone’s progress around the building to be monitored, CCTC cameras

or other surveillance equipment, should not be underestimated. Particular

attention should be paid to access controls over computer systems, which should

include the rigorous use of passwords, firewalls and/or other measures to

prevent or detect hacking into the system.

4.1.2. Effective Internal Audit

An effective internal control function is very critical in managing fraud risk in

any organization. For maximum effectiveness, ensure that your internal audit

department has enough resources to carryout its functions, that it is focusing on

the most important risk area of your business, that it is independent and free to

establish the scope of its activities without let or hindrances by management,

and that it is reporting fully and directly to the highest authority, ideally the

board of directors or its audit committee. Internal auditors should be given

comprehensive training in fraud prevention, deterrence and detection.

4.1.3. Pre-employment Screening

The fight against fraud should start even before a new employee joins the

organization. You must have an effective recruitment policy which ensures that

employees are recruited based on their capabilities, competence and integrity

rather than exterior motives. References must be sought and checked

thoroughly, while temporary staff should be vetted just like permanent ones.

Background checks should be conducted on employees to assure of their

integrity.

51

4.1.4. Conducive Working Environment

The motive for internal fraud is often employee dissatisfaction, personal

financial problem, and gambling, drugs or drink problems. Create a favourable

working environment to ensure that employees are not placed under undue

duress to reach impossible goals and that they are not intimidated by supervisors

or superior officers that they are afraid to challenge instructions to commit

fraud. Let there be procedures that give them the opportunity to air their

grievances and discuss aspirations and concerns. Also ensure that your

organization has an “employee assistance program” which the staff trust to be

confidential and can help them deal with their personal problems. In effect,

create a culture of openness, transparency and trust as against that of secrecy,

mistrust and autocracy.

4.1.5. Fraud Policy

There should be fraud policy in organizations. Fraud policy is a formal, written

statement recording the organisation’s attitude to fraud. It may be part of

general ethics statement or code of conduct that records the way in which the

organization deals with its customers, suppliers and staff. In particular, the

policy should make it clear that fraud is unacceptable and that all instances of

suspected fraud will be treated seriously and with dispatch.

4.1.6. Make It Known How You Deal With Fraud

When fraud occurs, resolve it promptly and effectively. Then communicate to

employees how it was resolved. While care should be taken to avoid

defamation, communication of the outcome reinforces in employees the

organisation’s commitment to the issue of fraud and gives them practical

example to help make appropriate decisions in the future and to deter

52

recurrence.

4.1.7. Fraud Training

Promote fraud training in your organizations. All new employees should be

provided with the organisation’s fraud policy statement. Fraud deterrence,

prevention and detection programs that deal with practical issues should be

included in your induction and continuous career training.

4.1.8. Whistle-blowing Policy

Employees and third parties should be encouraged to report their suspicions of

fraud or other irregular activity without fear or reprisal. To encourage

reporting, whether anonymous or not, an E-mail or telephone fraud hotline can

be implemented. The existence of such facilities should be well publicized and

their roles in deterring or detecting fraud should be made known to all.

Information should be treated on a confidential basis to reassured reporters, and

management should be seen to be fair and just in handling such confidential

information.

4.1.9. Contingency Plan

It is important that every company has in place a contingency plan, which sets

out the steps that should be taken in the even that fraud is suspected. The

existence of the plan, and the fact that it will make clear to prospective

fraudsters that the company will take swift, decisive action and involve the

police or appropriate authorities, should serve as an effective deterrent.

4.1.10. Controls over the IT environment

Significant amounts of information are now held in database and other formats

to aid communication within companies. If improperly managed, however, this

53

concentration of information provides an increased risk. Sensitive data could be

compromised and end up in the hands of unauthorized individuals. Necessary

physical and logical access control over the computer system should be

provided.

4.1.11. Insurance policy

In addition to taking measures to minimize the risk of fraud, management

should ensure that, should the worst happen, the business has appropriate and

adequate insurance cover.

4.2. Role of Government

Government in every society plays a key role in the protection of life and

property of its citizens. It is for this reason and in order to ensure a disciplined

society that government promulgates appropriate statutes, establishes relevant

institutions and ensures enforcement of various legal provisions. Amongst such

relevant statutes and institutions that exist in Nigeria are Central Bank of

Nigeria (CBN), Bank and Other Financial Institutions Act No 25 of 1990 as

amended, NDIC, Security and Exchange Commission (SEC), National

Insurance Commission (NAICOM), Companies and Allied Matters Act No. 1 of

1990 as amended, EFCC , ICPC and Monetary Laundering Act, Police,

Judiciary, NAFDAC, and Standard Organization of Nigeria (SON) among

others. These government agencies in their various activities have been

preventing and controlling fraud.

4.2.1 The CBN/NDIC

The subject of fraud in the financial system is of special concern to the

monetary and supervisory authorities, particularly the CBN and NDIC. These

government agencies are concerned about the safety of individual institution

54

and the soundness of the banking system. The prudential regulations/

supervision put in place of the CBN/NDIC are also aimed at preventing and

controlling fraud. For example, the provision of the prudential guide lines for

licensed banks that all banks should review their credit portfolio quarterly

would help in the early detection of any act of fraud, forgeries and financial

malpractices relating to loans and advances granted under suspicious

circumstances.

Again as supervisors of the system, the agencies have powers to deal with

members of a bank’s board and management who are found to have grossly

violated the government’s code of conduct or who are found to have been

engaged in financial malpractices, or have condoned such offences of other

erring staff. In effect, examination recommendations emanating from the CBN

or NDIC must be treated with all seriousness by the banks and must receive the

backing of the board of directors, management and shareholders of the affected

banks.

There is also statutory requirement for banks and other financial institutions to

employ external auditors to check their books and affairs. For banks not to

exercise undue influence on external auditors, their appointment and

termination is subjected to the approval of the CBN.

4.2.2. Other Government Agencies

The agencies in this category include the Securities and Exchange Commission

(SEC) for the capital market operators, the National Insurance Commission

(NAICOM) for insurance companies, National Communications Commission

(NCC) for telecommunication operators, National Food and Drugs

Administration and Control (NAFDAC) for drug and food manufacturers,

55

Standard Organisation of Nigeria (SON) for industrial goods manufacture,

Economic and Financial Crimes Commission (EFCC) for economic and

financial crimes including money laundering. All these governmental

organizations supervise the relevant institutions/industry for their safety and

soundness and equally curtail fraud in those institutions.

4.3. Role of General Public

The general public on its part must be vigilant and cooperate with government

and related agencies in efforts to rid the nation and its institutions of fraud and

its perpetrators. Many a time people with knowledge of fraud being planned or

committed against others will not raise alarm on the belief that it does not

concern them and that they are not the victims. That is far from being correct.

We are all victims and the fight against fraud is our fight. We need not to wait

to be direct victims before we take action. If today is the turn of an anonymous

victim, tomorrow may be our turn. It is therefore necessary for everybody in

the society to be at alert about fraud. Its fight should be a collective

responsibility of the businesses, citizens, police, judiciary and other government

agencies.

5.0 CONCLUSION

Fraud in our environment no doubt is on the increase and one can safely say that it

has reached a disturbing proportion so much that it constitutes veritable threat to

the financial health of our banking institutions and other organizations and by

extension, the economy at large. Fraud costs businesses a lot of money every year.

It is one of the causes of banking distress and collapse of the 36 banks that are

presently under receivership in NDIC.

The threat of fraud in our organizations can be contained by taking the right steps.

56

A business organization that is alert to the risks that affect its business, that puts in

place appropriate controls and procedures, monitors the operation of these controls

and their effectiveness, creates favourable working environment and maintains an

anti-fraud culture, is going to be better placed to deter, prevent, and at worst, detect

fraud timely. Above all, the fight against fraud required a holistic approach

through the efforts and cooperation between individuals, organizations, law

enforcement agencies and other stakeholders.

6.0 REFERENCES

Ebhodaghe, J. U. (1994), “Effective Internal Control: Basis for Preventing and

Detecting Frauds”, A paper presented at the Community Banks’ Third Anniversary

Conference at Kaduna

Financial Institutions’ Training Centre (2004), Workshop ON Fraud Detection,

Prevention and Control, Lagos September

57

BANK DIRECTORS AND RELATED PARTY TRANSACTIONS BY

PROFESSOR PETER N. UMOH, FCIB EXECUTIVE DIRECTOR (OPERATIONS)

1.0 INTRODUCTION

Bank directors are persons appointed to the Board of a bank to superintend

over the affairs of the bank. The directors select the bank’s management

team and establish with the Management, the bank’s business objectives and

policies. The directors, through the Board, are also expected to monitor

operations of the bank to ensure compliance with all applicable

laws/regulations as well as to oversee the bank’s business performance to

ensure achievement of stated objectives of profitability and adequate

liquidity.

In view of the onerous responsibilities foisted on bank directors, such men

and women are expected to be persons of proven integrity, of sound

judgment and experience in business/finance. They are expected to provide

leadership to the bank by ensuring that the ladder leans against the right wall

and that the right things are done.

Bank board directors are expected to bring business to their banks. The

nature of such business, the expected business relationship with the bank, the

laws governing such business and the lessons of experience in Nigeria of

such business relationships are the issues to be explored in this paper.

In addition to this Introduction, the paper first examines the laws and

regulations governing directors’ transactions with their banks. That is

58

followed by the lessons of such business experience in Nigeria. Thereafter,

the paper is concluded.

2.0 LAWS/REGULATIONS GOVERNING DIRECTORS’

BUSINESS TRANSACTIONS WITH OWN BANKS

The laws/regulations governing directors’ business transactions with their

banks are encapsulated in the Banks and Other Financial Institutions Act

(BOFIA) 1991 as amended, the Code of Corporate Governance For Banks In

Nigeria Post Consolidation (effective April 3, 2006) and Guidelines issued

from time to time by Banking Regulators. Typically, such business

transactions in Nigeria involve primarily bank/customer loan relationship

where the director and/or related interests enjoy the bank’s credit facility.

Sometimes, the relationship would be one where the director and/or his/her

related party would render service to the bank for a fee. Both types of

relationship are guided by laws and regulatory guidelines.

Section 20(5) of the Banks and Other Financial Institutions Act (BOFIA) of

1991 as amended in Nigeria defines a bank director to include wife, husband,

father, mother, brother, sister, son, daughter and their spouses. This broad

definition implies for example, that credit obtained by a director’s father or

mother from the bank where the son is a director would be governed by the

same laws and regulations that would apply to a credit obtained by the son-

director, in spite of the fact that the parents are deemed to be separate, legal

persons from the son-director!

Section 18(3) of BOFIA requires a director to declare to all board members

in writing his/her interest in a loan or advance from the bank. It should be

59

noted that the declaration is expected to be in writing, not a verbal

expression of interest as some directors would prefer. A written declaration

is more likely to remain a permanent record than oral declaration. The

written declaration cannot be easily denied in future, particularly where the

credit had become non-performing, and regulatory sanctions of the director

necessary.

Similarly, Section 18(8) of BOFIA requires a director to declare interest in

any office or property if such interest is likely to conflict with his duties as a

director of the bank.

The point here is to prevent possible conflict of interest that could arise from

the director’s other interests in a property/office or both. For instance, if a

bank plans to lease a property owned by a director, it is required that the

director’s interest in the property should be disclosed to the other board

members. That way, such other board members would take more than

ordinary interest in the transaction and ensure that the transaction is

consummated at alms-length, without undue favour to the director landlord.

In the case of the leased property, the board would, for example, ensure that

the rent charged is competitive with similar properties in the neighbourhood.

For services rendered to the bank for a fee by a director, this section of

BOFIA is also relevant.

In addition, the Code of Corporate Governance For Banks In Nigeria Post

Consolidation, issued by the Central Bank of Nigeria (CBN) effective April

3, 2006 requires that such disclosure be made to the board of the bank and to

the CBN. In other words, the regulatory authorities are equally interested in

the service provided by the bank director to its bank. The quality of such

service and its pricing are key areas of interest.

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Section 20(1) of BOFIA requires a bank to obtain CBN approval in writing

before granting a loan/advance to a bank’s director or any other customer for

an amount in excess of 35% of the bank’s shareholders’ funds unimpaired by

losses. Here, the thrust of the law is to prevent inappropriate concentration

of credit in a few individuals/companies. For banks in Nigeria with

minimum shareholders’ funds of N25 billion, this section of BOFIA prevents

granting a loan of over N8.75 billion to an individual or entity. Were that

permissible, three individuals or companies could conceivably receive the

entire loans of a bank. No bank or bank regulator would allow such

concentration risk!

Banks make money when loans are granted at rates above the cost of funds

plus a margin and when the amounts loaned are returned at the maturity of

the loan to the bank. Where loanable funds are not returned to the bank,

such banks face the risk of illiquidity and insolvency. It is in an effort to

prevent banks’ illiquidity and insolvency that BOFIA requires in Section

20(2)(a)) that no bank without CBN approval in writing should permit a

director’s loan or a loan to his/her related company that is unsecured to be

non-performing. Also, the CBN’s Code of Corporate Government earlier

cited requires in Section 6(1)(8)) that a director whose facility remains non-

performing for more than one year should cease to be on the bank’s board

and could be blacklisted from sitting on the board of any other bank.

Besides the contractual obligation that such a director has in ensuring that

the loan performs, the director also has a moral obligation to ensure his

61

loan’s performance. Being a member of a bank board that approves loan

policy for implementation, a serving director has a moral obligation to abide

by the provisions of the loan policy, the major thrust being that all loans

should perform. It is noteworthy that the approval of the CBN is required

particularly where the loan is unsecured or is poorly secured. Adequate

security protects the bank in the event of default, provided that the security

can be realized.

Banking practice allows the grant of interest waivers to debtors to encourage

them to repay bank loans. However, bank directors are not to be so

accommodated, particularly where their loans are non-performing. BOFIA

20(2) does not allow a bank to grant interest waiver on a director’s non-

performing credit without CBN approval. If the bank is a closed bank, such

grant of waiver must have NDIC approval. These provisions are necessary

to avoid a situation where a bank board proceeds to waive the entire accrued

interest for a serving director. Such a waiver could undermine the bank’s

profitability and sometimes solvency. Besides, it is self-serving for a

director to waive accrued interest for himself/herself!

A bank director is expected to be a “fit and proper person” at all times. He is

not expected to compound with his creditors. It is for that reason that

BOFIA Section 44(2)(b)) provides that no one shall remain a director of a

bank if he/she is unable to repay a loan/advance from the bank or from other

creditors. This provision of BOFIA is supported by Paragraph 20 of the

Code of Conduct For Directors of Licensed Banks. The Paragraph says that

bank directors that are bankrupt, suspend payment or compound with

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creditors shall cease to hold office. Similarly, Paragraph 21 of the Code

states that a bank director shall be disqualified if any of his/her loans in a

bank is classified lost by Bank Examiners of Regulatory Authorities.

Thus, the above provisions set very high ethical standard for bank directors.

This is to be expected, given the nature of banking. Banks are custodians of

peoples’ deposits – cash and valuable items. Someone who oversees and/or

offers to protect such valuables must be above board, trustworthy, and

respected. Where bank directors fail to meet these requirements, the public

is likely to lose confidence in their banking institutions. Loss of public

confidence implies loss of business. However, business opportunities are

never lost: if you fumble it, your competitor will find it!

Whilst bank directors are encouraged to bring business to their banks, such

businesses should yield win/win dividends to the banks and the directors.

Where a director takes a loan on his/her behalf or stands behind his/her

company to take a bank loan, such facility should be profitable to the bank.

For it to be profitable to the bank, it must of necessity be profitable to the

director and here is the essence of the expected win-win situation.

To ensure that loans taken by directors are repaid, the Regulatory Authorities

insist on realizable securities for such loans. For example, in 2001 Circular

issued by the CBN on insider-related facilities, directed that before granting

any advance, loan or credit facility to any director, a blank share transfer

form must be duly signed by the director transferring his shareholding

63

interest to the bank. Such share transfer can be done without prejudice to

other collateral arrangements made by the director. The essence of having

the director endorse the share transfer form is to enable the bank sell the

shares in the event of the loan default. This presumes of course that there is

a “market” for the shares and that such shares can be easily sold. The

Circular further disqualifies any director with non-performing credit from

receiving dividend payments. Such dividends should be applied in full to

redeem the outstanding debt of the director to whom the dividend was

payable.

It should be evident that the Circular cited was intended to protect the

interest of the bank against loan defaulting directors. Sometimes, the

purported protection is inadequate, particularly where the bank is not doing

well enough to pay dividends and/or where the shares of the bank cannot be

sold.

3.0 DIRECTORS’ BUSINESS TRANSACTIONS WITH OWN BANKS IN

NIGERIA

Nigeria over the years had witnessed bouts of banking failures starting with

the failures of wholly indigenous banks in the 1950s, culminating in the

2006 revocation of the licences of 14 banks for not meeting the required

capitalization. Between the 1950s and 2006, the revocation of the banking

licences of 26 banks in 1998 stood out for the large number of banks ever

liquidated in the country at a go. The failure of the banks occurred under the

watch of directors who were expected to have oversight over management

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for effective running of their banks. Such directors were expected to

formulate policies and monitor the implementation of such policies for the

growth and survival of their banks. Available evidence points to the

Directors’ failure in their oversight function and the failure had been directly

linked to the banks’ insolvency. Perhaps, most worrisome had been linkages

between directors’ business transactions with own banks and the failure of

such banks.

Directors’ business transactions in Nigeria with own banks had traditionally

involved the grant of bank credit to such directors or their related companies.

That had been followed by Directors providing some services to their banks

for a fee through related companies. In addition, directors had been known

to act as landlords or lessors for properties leased by own banks. As noted

earlier in the previous section on laws and guidelines governing such

transactions, the business relationships between directors and own banks

should be strictly aligned with applicable laws/regulations. Unfortunately,

available evidences from failed banks indicate otherwise. The relationship is

expected to be mutually beneficial to the bank and the director. Again,

unfortunately the evidence from failed banks had shown the relationship to

be largely detrimental to the bank. Indeed, in some of the banks, it had been

the detrimental relationship that caused the failure of the banks.

3.1 Managers’ Assessment of Directors’ Role in Distress/Failure

Following the failure of five (5) banks in 1994/95 and the distressed

condition of many banks, the CBN and NDIC collaborated in a study

65

on distress in the financial sector in 1995. The findings of the study

which was published in October 1995 revealed the roles deemed to

have been played by financial industry stakeholders in the distress of

their institutions. When financial managers were asked to list the

factors that were responsible for their institutions’ state of severe

distress, their responses were as summarized here in Table 3.1.

Table 3.1

Financial Managers’ Assessment of Factors Responsible for their

Institutions’ Severe Distress.

NOS. FACTORS %

1 Economic Depression 25.0

2 Political crises 17.9

3 Bad Credit Policy 25.0

4 Undue Interference by Board Directors 32.1

100.0

Source: CBN/NDIC: Study of distress in the Nigerian financial

services industry, October 1995.

The table shows that of the four (4) factors cited, undue interference

by Board Directors in the management of the institutions was given as

the most important factor in the severe distress. The financial

66

managers interviewed felt that the interference by directors was

responsible in 32.1% of the failure cases, followed by bad credit

policy and economic depressions which tied for the number two spot

at 25% each. To the Managers, political crisis was the least

contributory factor at 17.9%.

When asked further about the nature of the directors’ interference, the

majority of the managers mentioned directors’ interference in credit

allocation and administration. The finding was not that surprising

with respect to directors’ role in credit allocation, but it was rather

unexpected that directors were involved in credit administration.

Bank directors were expected to approve credit policies and monitor

the implementation of such policies through the Board Credit

Committee and the Board of Directors. Credit administration was

expected to be done by management through the bank’s Credit

Unit/Division and committees as arranged.

As the findings of the study were being discussed, it was common to

find financial directors blaming financial managers in return. To most

directors, managers had the greater blame if not the sole blame in poor

bank credit allocation and administration. The issue almost became a

case of buck passing: the managers blaming directors and directors

blaming managers.

However, in a different section of the study, all healthy

commercial/merchant banks, community banks, primary mortgage

67

institutions, development banks, finance houses, insurance companies,

issuing houses, stock brokers and the stock exchange were asked to

enumerate factors responsible for their healthy status. Among such

factors as strong capital, high liquidity, good management, discipline

and minimum fraud listed, the healthy institutions included non-

interference by directors. The listing of non-interference by directors

as a factor for health was indicative of the institutions’ general

perception of rampant interference by directors and the belief that such

interference led to distress and sometimes failure.

3.2 Evidence of Directors’ Role in the 1994-2000 Failures

Between 1994 and 2000, a total of 34 banks had their licences

revoked. The liquidation of the banks was handled by NDIC which

was set up for the purpose. The Corporation (NDIC) amongst other

liquidation activities compiled deposit and loan registers for each of

the 34 banks. From the loan registers one could see those who took

the banks’ loans and their repayment records. The records of

collaterals were also located. Whether collaterals were perfected or

not was also determinable. Of great interest were the extent to which

directors were indebted to their own banks, the classification of the

loans as performing or non-performing and the collaterals (if any)

tendered as security for the loans. Table 2 shows 10 banks with the

highest levels of directors’ or insiders’ loans and advances.

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Table 3.2

Ten (10) Banks with the Highest Insider Loans in the 34 Banks

Closed Between 1994 and 2000

NOS. BANKS RATIO INSIDER LOANS

TO TOTAL LOANS (%)

1 Financial Merchant Bank 66.89

2 Republic Bank 64.90

3 United Commercial Bank 81.00

4 Credite Bank 76.00

5 Prime Merchant Bank 80.70

6 Group Merchant Bank 77.60

7 Nigerian Merchant Bank 99.94

8 Royal Merchant Bank 69.00

9 Alpha Merchant Bank 55.00

10 Commerce Bank 52.00

Source: NDIC: Bank Liquidation in Nigeria (1994 – 2004).

Table 3.2 shows that in one of the banks, almost 100% of the banks’

loans and advances were collected by insiders. Among the 10 banks,

insiders in Commerce Bank availed themselves of 52% of the total

loan portfolio and that was the smallest proportion. It should be noted

that in the 34 banks, the ratio of non-performing loans to total loans

averaged about 100%, implying that all the insider loans were also

69

non-performing. It is no wonder that the banks failed and were

liquidated and for the 10 banks in Table 2, one can say categorically

that the insiders killed the banks.

Among the 34 banks were some State-owned banks in which board

directors were not necessarily shareholders of the banks but people

appointed by government, sometimes on the basis of political

patronage, to oversee the management of the banks. Such directors

tended to see the bank as an avenue for self-serving activities and as

an avenue for easy access to bank credit. Such credits were usually

obtained without collateral and without any intention of repayment.

Also in such banks, loans and advances were similarly extended to

owner State governments and their agencies without collateral.

Needless to say that the loans and advances remained uncollectible.

The inability to collect the loans manifested first in the banks’

illiquidity and subsequently insolvency, as the owner State

governments were unable/unwilling to recapitalize the banks or repay

the loans. Before the banks were closed, changes in some of the

governments led to changes in the boards and managements of the

respective banks. The instability engendered by such changes, which

were sometimes quite frequent, hastened the demise of the banks.

Other than the State-owned banks, there were banks owned by private

individuals, usually businessmen, who used the banks as the funding

sources for their other businesses. To meet the then regulatory

requirement of geographical spread in bank ownership, some key

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promoters of the private banks, would appoint proxies in other

geographical zones of the country, allocate shares to such proxies, but

the shares would be paid for by the key promoters. Thus, the bank

would be wholly owned by the key promoters and their families. The

selected management teams by the key promoters would have had no

free hand to run the banks as the key promoters took major decisions,

particularly on the allocation of the bank’s credit, which more often

than not, went to their numerous businesses. The loans usually had no

collaterals and where some were obtained, such were not perfected.

The loans usually suffered other deficiencies, particularly in

documentation, which made the loan recovery difficult and often

impossible.

3.3 Evidences of Directors’ Roles in the 2006 Failures

In addition to the licences of 34 banks revoked between 1994 and

2000, the licences of Savannah Bank of Nigeria Plc and Peak

Merchant Bank Limited were revoked in 2002 and 2003 respectively.

When the NDIC got winding up orders to liquidate the banks and pay

the insured sums to depositors, the erstwhile owners of the banks went

to court to challenge the revocation of the licences and the

appointment of NDIC as Liquidator. To date, the cases are in court

and the innocent depositors are yet to be paid. The Nigeria Police was

mandated by the courts to safeguard the banks’ assets. After the court

proceedings, the story of how the owners and insiders in the two banks

brought the institutions to their knees shall be told. For now, we can

look at the story behind the 14 banks that lost their licences in 2006.

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In July 2004, the CBN gave the 89 banks operating at the time up to

December 2005 to shore up their shareholders’ funds to N25 billion

through mergers and/or acquisitions. That requirement became

necessary because of the poor financial conditions of many of the

banks. It was expected that the much enhanced capital level would

save the banking industry from the bouts of distress it witnessed

cyclically. It was to enable Nigerian banks have enough financial

resources to lend to the real sector and to be able to compete

internationally. Many of the banks resorted to the capital market to

raise fresh funds and those unable to meet the new capital requirement

through access to the capital market were acquired whilst some found

merger partners. By the deadline of 31st December 2005, a total of 25

consolidated banks emerged whilst 14 banks were unable to meet the

recapitalization requirement.

Consequently, in January 2006, the licences of the 14 banks were

revoked by the CBN, and the NDIC was to apply to the courts for

winding up orders for the banks. To date, such orders have been

obtained for 10 banks whilst the erstwhile owners of 4 banks are still

in court challenging the revocation of their banks’ licences.

In the banks where the Corporation had been able to complete closing

activities, bids for the banks’ assets had been solicited from the 25

surviving banks. The successful bidder banks would not only acquire

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the assets, they would also be allowed to assume the deposit liabilities

of the closed banks. The CBN had been paying the shortfall between

the value of the acquired assets and private sector deposit liabilities

assumed while the NDIC had been paying the insured deposits, for

both public and private sector depositors. Thus, the partial Purchase

and Assumption (P & A) method adopted for the closed banks has

enabled depositors to continue banking services uninterrupted in the

assuming, healthy banks.

The statistics from closing exercise of the first 3 banks indicate that

like the 34 banks liquidated earlier between 1994 and 2000, the story

of insider dealings in the 14 banks had not been different. Table 3.3

shows the level of insider borrowing in 3 of the banks.

Table 3.3

Insider Loans in some Banks Closed in 2006

NOS BANKS RATIO INSIDER LOANS

TO TOTAL LOANS

1 Assurance Bank Ltd 17.0

2 Allstates Trust Bank 61.0

3 African Express Bank Ltd 95.0

Source: NDIC: Receivership and Liquidation Department.

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The table shows that for Allstates Trust Bank, which was the first

closed bank under the P & A, 61% of the loan portfolio of N25.4

billion went to insiders and the major promoter of the bank availed

himself of 95% of the insider loans. For African Express Bank, the

entire loan portfolio of N16.4 billion was nearly taken by insiders and

primarily by the major promoter of the bank. For Assurance Bank

with a small loan book of N6.4 billion, insiders took N1.1 billion.

Needless to say that the loans were not adequately collaterised. Where

some collaterals were taken, such were not perfected. Most of the

loans were taken to finance directors’ other businesses. Where those

businesses ran into financial difficulty, the banks were directly

affected. Some of the loan monies were used to finance real property

construction which were subsequently leased to the banks at

exorbitant rates. For such banks, it was a case of double jeopardy!

The foregoing malpractices, nay abuses by insiders, took place in spite

of the laws and regulations guiding directors’ businesses with own

banks. The logical question at this point would be: “what did the

regulators do when all these happened?” “Did they turn a blind eye to

these?” We shall attempt to address this question in the next section.

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4.0 MONITORING BANKS’ COMPLIANCE WITH APPLICABLE

BANKING LAWS AND REGULATIONS

Best practice in banking supervision dictates that a bank should be examined

at least once a year. Prior to the establishment of NDIC in 1989, the CBN

alone did not have adequate capacity to examine each bank yearly. Indeed,

some banks were examined once in 3 years, at best once in 2 years. Since

NDIC joined in examining insured banks in 1989, the examination cycle had

been brought in line with best practice of once a year.

Monitoring banks’ compliance with applicable laws in respect of loan

portfolio allocation and administration had over the years been somewhat of

a sore point between the examiners and bank officials. For a start, examiners

insist that banks must have loan policies that had been approved by the

banks’ board of directors. Second, examiners expect banks to be guided by

the approved policies in the granting of loans and advances. Third,

examiners expect complete documentation of loans and advances as well as

the meeting of collateral requirements where the loan policy so requires.

Fourthly, examiners expect bank officials to be guided by the Prudential

Guidelines in credit portfolio review/classification, particularly in making

adequate provisions for loan losses and other known losses of the bank.

Above all, examiners expect bank officials to comply with all laws and

guidelines concerning bank credit.

In many of the closed banks, loan policies were developed and approved by

the banks’ boards, principally to meet supervisory requirement. The policies

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were not followed, if followed, not faithfully. The loans documentation left

much to be desired. Some loans were granted without even an application!

Where collaterals were required, such were not taken and if taken, they were

not perfected, thus hampering collateral realization should that become

necessary. In many of the banks, the Chairmen of the Board were the major

promoters who also insisted on chairing the Boards’ Credit Committees, thus

reporting to themselves! It took regulatory and supervisory efforts over time

to get such chairmen to disengage from the Boards’ Credit Committees.

However, such disengagement did not stop the pervasive influence of major

shareholders in credit allocation.

Stopping the grant of loans and advances to the major promoters’ companies

had been a problem for examiners. In the first place, the promoters would

fail to disclose their interest in the companies and the examiner would have

no way of recording what had not been disclosed. Secondly, where the

board directors were proxies for the major promoter, disclosure of the major

promoter’s interest to such proxies would not happen. In many cases, the

major promoters acted as the de facto Chief Executive Officers (CEOs)

whilst the de jure CEOs were often willing to do the bidding of the major

promoter, including hiding required information from examiners. There

were cases where loan decisions were taken at family breakfast tables and

the de jure CEO would be directed to implement appropriately. A few

professional CEOs resigned on account of that type of influence but would

refuse to inform the regulatory authorities.

Perhaps the most contentious area of disagreement between bank officials

76

and bank examiners had been (and still is) loan classification. Examiners are

interested in banks making adequate provisions for loan and other known

losses of the bank in line with the Prudential Guidelines. For loan classified

as substandard, doubtful and lost, provisions of 10%, 50% and 100%

respectively are required; and for performing loans, a provision of 1% is

expected. Bank officials seldom agree with examiners on their loans’

classification. They argue that they have intimate knowledge of their loan

customers such that even when repayment had been missed, the bank

officials would remain optimistic that the loans would be repaid. However,

the Prudential Guidelines are quite clear on how long an unpaid loan would

remain to qualify for a specific classification!

Examiners follow the Prudential Guidelines which give objective criteria for

loan classification, but bankers prefer their undocumented subjective criteria.

Without proper classification and adequate provisioning, banks are able to

declare profits that would not take into account loan losses. Such inflated

profits would not reflect the banks’ risk exposures. Such inflated profits

would form basis for promotion, bonuses and shareholders’ dividends not to

mention their impact on the banks’ quoted price at the stock exchange. In

their efforts to beat examiners in this area, some banks had been known to

resort to wholly unprofessional practices aimed at “ever-greening” their loan

portfolios. Such practices include showing loan repayments where no

repayment had been made, to convince examiners that loans were

performing.

Bank directors with non-performing loans in their banks for more than one

77

year are expected to be blacklisted and removed from the boards. Such

blacklisted erstwhile directors would no longer serve on their bank boards or

on the board of any financial institutions under the purview of the CBN.

Whilst the measure seems quite strict, some directors are not deterred as they

still harbour non-performing loans in their banks under a pseudonym. Those

caught and removed in the past would usually find excuses for their

situations. Some blamed the work of their “enemies” or their banks’

personnel for exposing them.

In situations where removal of director or management was not required, but

monetary penalties were imposed for infractions of laws and regulations,

bankers would willingly pay. Thus, for monetary penalty to be a deterrent, it

would have to be raised so high that the benefit from infraction would be

exceeded by the monetary penalty. But very high monetary penalties portray

regulators as greedy and such high penalties are hardly in line with

international best practice. Bankers tend to forget that the real cost of

monetary penalty paid is always more than the monetary value of the

penalty. The real cost includes the monetary value of penalty and a certain

cost for reputational risk. The more penalties a bank pays, the greater the

reputational risk facing the bank. Because banks are expected to be

reputable institutions that depositors, customers and the general public

should be able to trust, such incremental erosion of reputation can hardly

help the bank’s image.

BOFIA Section 20(2) forbids a bank from granting interest waivers on

directors’ non-performing loans without CBN approval. In the closed banks,

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instances of unauthorized waivers were found. In some instances, part or

whole principal had equally been waived. In such instances, the NDIC on

closing the bank would reverse such waivers and instruct the directors to

repay the loans forthwith. Such funds are usually utilized to pay uninsured

depositors of the closed banks.

In the course of closing failed banks, the NDIC had sometimes come across

cases of abuse of office by bank directors that had not been known to

supervisors. Such cases, if they are known to be criminal in nature, are

usually reported to an appropriate government agency for investigation and

prosecution. The Corporation does not fold its hands and watch bank

directors dissipate depositors’ funds. The mandate of the Corporation is to

protect depositors, particularly the small ones who are the bulk of bank

customers.

5.0 CONCLUSION

The history of business relationship between banks and bank directors in

Nigeria had not been quite healthy. Banks had tended to be the major losers

in the relationship with consequent dissipation of depositors’ funds. The

state of affairs had usually been facilitated by poor corporate governance in

the banks. Before 2006 such banks were fragile and dominated by family-

owned or State-owned banks in which the major shareholders usually

exercised perverse influence, particularly in loans allocation. In spite of the

provisions of the law and the regulators’ guidelines on such relationship,

some directors found ways to evade the laws/regulations and exploit the

relationship for selfish ends. Regulators/supervisors were usually

handicapped in discovering abuses because of a systematic process of

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information denial to bank supervisors. Where disclosures were made on

infractions, appropriate sanctions were imposed including being blacklisted

from holding office as a director in any financial institution.

Happily, the recent banking consolidation that has produced relatively

stronger banks with better corporate governance ethos, promises a healthy

business relationship between banks and their directors. Following from the

banking consolidation and the lessons of experience of past bank failures,

bank regulators have recognized the need to train and retrain bank directors

on their expected functions. Such training has been taking place

collaboratively between the Financial Institutions Training Centre (FITC)

and the CBN. Also, the regulators have succeeded in convincing the banks

to appreciate the importance of separating the function of the office of the

Board Chairman from that of the Chief Executive Officer. In addition,

Board Chairmen and CEOs no longer insist on chairing the Boards’ Credit

Committees. Besides, the proposed introduction of independent directors on

the boards of insured banks should assist in improving corporate governance

and assuring that directors’ businesses with their banks would be transparent

and mutually beneficial as expected.

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6.0 REFERENCES

Central Bank of Nigeria, Code of Conduct for the Directors of

Licensed Banks, Lagos.

______Code of Corporate Governance for Banks in Nigeria

Post Consolidation, March 1, 2006, Abuja.

______Prudential Guidelines for Licensed Banks.

Central Bank of Nigeria/Nigeria Deposit Insurance Corporation,

Distress in the Nigerian Financial Services Industry, Lagos,

October 1995.

Federal Government of Nigeria, Banks and Other Financial

Institutions Act, Lagos, 1991.

Nigeria Deposit Insurance Corporation, Pocket Guide for Bank

Directors, Lagos, 1991.

______Bank Liquidation in Nigeria (1994-2004), Abuja, 2005.

Umoh, P. N. “Bank Depositor Protection: The Nigerian Experience”,

NDIC Quarterly, Vol. 12, No. 2, June 2002.

81

THE NORTHERN ROCK CRISIS BY

RESEARCH DEPARTMENT

1.0 INTRODUCTION

Northern Rock is Britain’s fifth largest mortgage lender. Over the years, it had

saved itself the cost of raising deposits from the public by selling its loans into the

wholesale market. This was a profitable strategy until the ‘bubble’ burst. The

crisis that ensued threatened the stability of the U.K financial system prompting

Government to provide blanket guarantee while the Bank of England offered the

required liquidity support.

There is no doubt that the intensification of cross-border financing, and the

growing complexity of financial structures globally has resulted in new

international inter-linkages which has increased international interdependence. The

transmission of negative shocks in one country to others via the international

financial system has demonstrated the potential for financial crises and economic

disruptions to spread on a global scale. These concerns were brought to the

forefront with recent developments in the sub-prime mortgage market in the United

States and its contagion effect on financial systems in other parts of the world.

Indeed, it revealed that in today’s globalised and increasingly internationally

integrated financial markets, seemingly isolated events in a small segment in one

markets could have far reaching and vastly magnified implications in other

financial markets across the world.

These changes in the international environment have also exacerbated the

challenges to financial institutions and the regulatory authorities for understanding

and managing risks. They have also brought to the forefront concerns on the

effectiveness of financial safety nets as well as institutional arrangement for the

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regulation and supervision of banks.

The purpose of this paper is to critically examine the Northern Rock Crisis in the

United Kingdom. The rest of the paper is segmented into five sections. After the

introduction, Section2 examines the cause of the crisis. Section 3 looks at the

concept of securitization while sections 4 and 5 review reaction of regulators and

depositors as well as possible lessons which could be learnt from the U.K.

experience. Section 6 concludes the paper.

2.0 CAUSE OF THE PROBLEM

Northern Rock, a specialized housing lender over the years saved itself the cost of

raising deposits from the public by selling its loans into the wholesale market

through a process called securitization2. This was a profitable strategy until

Northern Rock ran into trouble when concerns about bad loans in the U.S. sub-

prime mortgage business led to credit crunch worldwide. Northern Rock failed to

insure itself against this contingency. While Northern Rock did not invest in the

“sub-prime” mortgage sector itself, the collapse of this market in the US had seen

borrowing rates soar on the global markets, badly affecting Northern Rock.

Northern Rock was particularly vulnerable to other banks’ reluctance to extend

loans because it had relied predominantly on capital markets, rather than consumer

deposits, to finance its own lending.

Since the 1990s, banks especially in the US have come to see securitization as an

indispensable tool. Global lenders such as Bank of America, Citigroup, JP Morgan

Chase, among others use it to manage their balance sheets, since selling loans frees

2 Securitization is a process of conversion of either existing assets such as mortgages, credit card receivables and other financial assets or future cash flow into marketable securities. While the conversion of existing assets into marketable securities is known as asset-backed securitization, the conversion of future cash flows into marketable securities is known as future-flows securitization.

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up capital for new business or for return to shareholders. Northern Rock was

particularly hit by the difficulties that it had in accessing longer term funding from

the mortgage securitization market, on which Northern Rock is particularly reliant.

In all, the problem of the bank was that of illiquidity as it was considered ‘still

solvent and profitable and in ‘no danger of going bust’ by the Authorities.

The problem had the effect of shaking public confidence in the bank. In addition,

shortly after the Northern Rock crisis erupted, the shares of institutions dedicated to

lending for house purchase collapsed. Also, the announcement by the Bank of

England that a ‘lender of last resort’ facility was to be extended to Northern Rock

contributed in no small way towards worsening the level of public confidence in

the mortgage institution. Indeed the panic of depositors was prompted by the very

announcement designed to prevent it. A more efficient response may have been an

announcement of an ‘open ended’ lender of last resort facility in the light of the

market turmoil at the time which would allow individual banks to seek support

against various types of collateral which would have meant not disclosing

individual names of banks.

The Northern Rock crisis will without doubt call into question the effectiveness of

the elaborate and indeed innovative risk-based system of supervision adopted by

the FSA in U.K. From preliminary observations it seems the FSA grossly

underestimated the risks associated with the business model adopted by Northern

Rock in the more extreme periods of market turbulence. The FSA indeed claimed

that Northern Rock was solvent, otherwise it would not have allowed it to remain

open for business. Despite this claim, Callum McCarthy, the FSA Chairman

described the business model adopted by Northern Rock as “extreme” in its

reliance on securitization for funding. As highlighted in the Times excerpt of the

question and answers from the Treasury Select Committee: Mr. McCarthy

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admitted to Members of Parliament that “the FSA had turned out to be wrong in its

assessment that Northern Rock was a low probability risk”. Therefore the FSA

considered Northern Rock to pose little risk to it in achieving its regulatory

objectives because it was thought that there was very little chance of the risk

crystallizing.

The FSA said that Northern Rock had not been subjected to a thorough supervisory

health check for 18 months (the last full risk assessment of Northern Rock banks

was carried out between December 2005 and February 2006). Since then, FSA

staff had paid visits to the company once every two to three months to review

particular aspects of its operations, including its arrangement for managing credit

and liquidity risk. Most of the work was done by two or three case officers.

However, a full risk assessment of Northern Rock, known as an “Arrow” review,

was carried out only once every three years. Mr. Hector Sants, the FSA Chief

Executive told MPs that in the case of Northern Rock and with the benefit of

hindsight, three years had proved too long.

3.0 SECURITISATION

3.1 The Concept

Securitization is the process of conversion of existing assets or future cash flows

into marketable securities. In other words, securitization deals with the conversion

of assets which are not marketable into marketable ones. For the purpose of

distinction, the conversion of existing assets into marketable securities is known as

asset-backed securitization and the conversion of future cash flows into marketable

instruments is known as future-flows securitization.

Some of the assets that can be securitized are loans like car loans, housing loans, et

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cetera and future cash flows like ticket sales, credit card payments, car rentals or

any other form of future receivables.

3.2 Why Securitization?

Major reasons why companies consider securitization include the following:

a) to improve their return on capital, since securitization normally requires

less capital to support it than traditional on-balance sheet funding;

b) to raise finance when other forms of finance are unavailable (in a recession

banks are often unwilling to lend – and during a boom, banks often can not

keep up with the demand for funds);

c) to improve return on assets – securitization can be a cheap source of funds,

but the attractiveness of securitization for this reason depends primarily on

the costs associated with alternative funding sources;

d) to diversify the sources of funding which can be accessed, so that

dependence upon banking or retail sources of funds is reduced;

e) to reduce credit exposure to particular assets (for instance, if a particular

class of lending becomes large in relation to the balance sheet as a whole,

then securitization can remove some of the assets from the balance sheet);

f) to match-fund certain classes of asset that require long term finance;

securitization normally offers the ability to raise finance with longer maturity

than is available in other funding markets;

g) to achieve a regulatory advantage, since securitization normally removes

certain risks which can cause regulators some concern, there can be a

beneficial result in terms of the availability of certain forms of finance (for

example, the UK building societies consider securitization as a means of

managing the restriction on their wholesale funding abilities).

Establishing the primary rationale for the securitization activity, is a vital part of

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the preparation for a securitization transaction, since it influences the extent of

administrative tasks which need to be developed as well as the transaction

structures themselves.

3.3 Typical Asset Characteristics

Assets which can be securitized easily have a number of characteristics, including

the following:

3.3.1 Cash-Flow

A principal part of the asset is the right to receive a cash flow from a debtor

in certain amounts (or amounts defined by reference to a market or

administered rate) on certain dates i.e. the asset can be analyzed as a series of

cash flows.

3.3.2 Security

If the security available to collateralize the cash flows is valuable, then this

security can be realized by a special purpose vehicle (SPV). For instance,

for a mortgage loan, there is security over the property and other collateral,

which will make a significant contribution towards recovering any losses

which might otherwise arise.

3.3.3 Homogeneity

Assts have to be relatively homogenous – this means that there are not wide

variations in documentation, product type or origination methodology.

Otherwise, it again becomes more difficult to consider the assets as a single

portfolio.

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3.3.4 No Executory Clauses

The contracts to be securitized must work, even if the Originator goes

bankrupt. Certain clauses are therefore difficult to include in a securitizable

contract – e.g.: in a photocopier lease, the inclusion of a clause stating that

the Originator will maintain the photocopier would make that lease difficult

to securitize. These sorts of contract are normally referred to as “executory

contracts”.

3.3.5 Capacity

It must be possible for the necessary transactions which are needed for the

securitization to take place in relation to the assets concerned – for instance,

if the assets contain specific prohibitions against assignment, then they will

not be securitizable in the traditional sense.

3.4 The Process and Participation

In the traditional lending process, a bank makes a loan, maintaining it as an asset

on its balance sheet, collecting principal and interest, and monitoring whether there

is any deterioration in borrower’s creditworthiness. This requires a bank to hold

assets (loans given) till maturity. The funds of the bank are blocked in these loans

and to meet its growing fund requirement a bank has to raise additional funds from

the market. Securitization is a way of unlocking these blocked funds.

Consider a bank, ABC Bank. The loans given out by this bank are its assets. Thus,

the bank has a pool of these assets on its balance sheet and so the funds of the bank

are locked up in these loans. The bank gives loans to its customers. The customers

who have taken a loan from the ABC bank are known as obligors.

To free these blocked funds the assets are transferred by the originator (the person

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who holds the assets, ABC Bank in this case) to a special purpose vehicle (SPV).

3.5 Special Purpose Vehicle (SPV)

The SPV is a separate entity formed exclusively for the facilitation of the

securitization process and providing funds to the originator. The assets being

transferred to the SPV need to be homogenous in terms of the underlying assets,

maturity and risk profile.

What this means is that only one type of asset (e.g. auto loans) of similar maturity

(e.g. 20 to 24 months) will be bundled together for creating the securitized

instrument. The SPV will act as an intermediary which divides the assets of the

originator into marketable securities.

3.6 Role of Rating Agencies

In order to facilitate a wide distribution of securitized instruments, evaluation of

their quality is of utmost importance. This is carried out by rating the securitized

instrument which will acquaint the investor with the degree of risk involved.

The rating agency rates the securitized instruments on the basis of asset quality,

and not on the basis of rating of the originator. So particular transaction of

securitization can enjoy a credit rating which is much better than that of the

originator.

High rated securitized instruments can offer low risk and higher yields to investors.

The low risk of securitized instruments is attributable to their backing by financiel

assets and some credit enhancement measures like insurance/underwriting,

guarantee, etc used by the originator.

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3.7 Impact on Banking

Other than freeing up the blocked assets of banks, securitization can transform

banking in other ways as well. For an originator (ABC bank in the example

above), securitization could serve as an alternative to corporate debt or equity for

meeting its funding requirements. As the securitized instruments can have a better

credit rating than the company, the originator can get funds from new investors and

additional funds from existing investors at a lower cost than debt.

In order to meet the credit needs of potential borrowers, banks could securitize

loans they have given out and use the money brought in to extend more credit to

their customers.

Not only this, securitization also helps banks to sell off their bad loans (or non

performing assets - NPAs)) to Asset Management Companies (AMCs). AMCs,

which are typically publicly/government owned, act as debt aggregators and are

engaged in acquiring bad loans from the banks at a discounted price, thereby

helping banks to focus on core activities.

4.0 REACTIONS OF REGULATIORS AND DEPOSITORS

Given that the problem of the bank was illiquidity, the monetary authorities agreed

to give emergency financial support to the Northern Rock. This liquidity facility

was expected to help Northern Rock to fund its operations during the period of

turbulence in financial markets while Northern Rock was expected to secure an

orderly resolution to its liquidity problems.

The decision to provide a liquidity support facility by the Bank of England at the

inception of the problem made depositors to believe that the problem was severe

and that heightened their anxiety which precipitated a run on the bank. In effect,

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the offer of liquidity assistance from the Bank of England was insufficient to

eliminate the panic because the public feared Northern Rock was insolvent.

The run on Northern Rock, the first run on a U.K. bank in over 100 years, was the

most dramatic symptom of the contagion gripping the U.K. financial markets. In

order to address the panic withdrawals and prevent the adverse effects from

spreading to other parts of the financial system, Government had to provide blanket

guarantee to all depositors of Northern Rock.

The Authorities also observed the limitations of the U.K. depositors/investor

protection scheme in engendering public confidence in the nation’s financial

system. Accordingly, the Chancellor of Exchequer advocated for setting the limit

at an absolute figure as against the subsisting co-insurance which covered only 100

per cent of the first £2,000 and 90 per cent of the next £33,000. By October 2007,

the deposit insurance coverage limit was increased to £35,000 and co-insurance

was abolished. It could be said that the process of dealing with the Northern Rock

debacle clearly brought to the fore the importance of a coherent public awareness

strategy that actually assists in forming and managing the expectations of the

public and avoiding a possible panic.

5.0 LESSONS FROM THE UK EXPERIENCE

The following lessons can be drawn from the recent UK banking crisis:

5.1 Globalization

Globalization has ushered in significant growth in the number of new cross-sectoral

financial participants, many of which have a global reach. This development has

resulted in an increased number of potential channels through which economic and

financial shocks can be created and transmitted. The foregoing describes the

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problem of Northern Rock, a primary mortgage institutions in the UK, which had

its origin from the problems of mortgage industry in the USA. The lesson here is

that our financial system is not completely immuned from adverse developments in

other jurisdictions. The fact that a large amount of funds are provided by foreign

banks in the wholesale markets means the risk of contagion can easily spread to

other overseas markets. There is therefore the need for constant monitoring of

global developments in the financial industry and for the regulatory/supervisory

institutions to take appropriate proactive measure(s) to minimize the impact on the

domestic financial system. In that regard, there is the need for enhanced capacity

building by the Regulatory/Supervisory authorities in order to enable them

effectively monitor global developments with a view to taking appropriate

measures to contain adverse effects of such developments on the nation’s financial

system.

5.2 Single Regulatory/Supervisory Structure

The recent banking crisis involving Northern Rock, has cast doubt on the

effectiveness of a single regulatory/supervisory structure such as that of the FSA in

the UK. It indicates that under such arrangement, there is the tendency to pay less

than adequate attention to all operators in the different segments of the market. If

the above can be said about the U.K. system where the ingredients that enhance

regulatory/supervisory effectiveness (such as sound corporate governance by

operators, sound accounting and financial reporting regime, adequate disclosure

regime and sound and effective legal regime) are in place, there may therefore be

the need to have a re-think of the proposed super regulatory/supervisory structure

under the FSS 2020 for Nigeria.

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5.3 Depositor Protection Scheme

The U.K. regulatory/supervisory structure habours the depositor/investor protection

scheme, Financial Services Compensation Scheme (FSCS). From its structure, it

could be observed that there was no operational independence for the scheme.

That would have accounted for the apparent lack of attention to the importance of

public awareness which is critical for the effectiveness of a DIS. That situation had

blurred the scheme’s existence to the depositors/investors that it seeks to protect,

which an effective public awareness programme would have addressed. The bank

run on the Northern Rock which threatened the stability of the U.K. financial

system, is a clear indication of inadequate public Awareness of the scheme which

was not considered important presumably because bank failure was a rare

occurrence in the U.K. That was against the dictate of best practice which indicates

that the impact of public awareness on the effectiveness of DIS is more when it is

done in normal times than in periods of crisis. There is therefore the need to

continue to attach importance to public awareness. There is currently a call for the

introduction of the USA type of DIS that is alert to its responsibilities.

The scheme in the UK adopts a co-insurance type of coverage. The presumption

that co-insurance works well in a system with enlightened public was not proved

by the experience of the U.K. There is therefore the need to specify the coverage

limit in absolute terms such that depositors can know with certainty what they

expect in the event of bank failure.

The adequacy of the coverage limit is another lesson that can be learnt from the

Northern Rock banking crisis. At the inception of the crisis, the scheme in the

U.K. covered only 100 per cent of the first £2,000 and 90 per cent of the next

£33,000. The U.K. scheme would therefore have paid out a maximum of £31,700

to any one individual with a protected claim. That amount was rather too low to

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engender the required public confidence in the scheme given the level of

development of the U.K. economy. That explains why the coverage limit was

increased to £35,000 per depositor/institution in October 2007 and co-insurance

was abolished. There is therefore, the need to keep the coverage limit adequate and

in absolute terms while not being unmindful of the moral hazard implications, so as

to ensure the relevance of the scheme.

5.4 Claim Settlement Period

The time scale in which claims are to be processed and compensation paid to

depositors had also raised some concerns. The UK position was rather vague on

the speed with which payments should be made. Under the relevant EU legislation,

compensation to depositors should be paid within 90 days of a valid claim being

lodged with the FSCS; an extension of six months is permitted in exceptional

circumstances. However, as indicated by Campbell and Cartwright, the length of

time it takes to pay out compensation in the UK does not seem to comply with the

EU directive.

5.5 Adoption of Blanket Coverage

The run on the Northern Rock was so massive that it was considered to be capable

of spreading to other financial institutions, including the healthy ones, if

depositors’ confidence was not restored. Based on that realization and the fact that

the crisis could degenerate to a systemic one, the authorities responded by

announcing a blanket coverage for all depositors of the Northern Rock. The

announcement had the desired impact as it doused the tension and the queue of

depositors wishing to withdraw their deposits from the bank gradually disappeared.

The lesson here is that while limited coverage is the best practice for any DIS,

blanket coverage may be desirable when the entire system stability is threatened

which can have its adverse impact on the nation’s payment system. The funding of

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such coverage is however, borne by Government as it is usually beyond the

capacity of the depositor insurer and since the objective in that respect is to prevent

total collapse of the nation’s financial system.

5.6 Securitization/Financial Product and Transparency

Securitization has long become a global financial instrument that serves as an

alternative to corporate debt or equity for meeting corporate entities’ funding

requirements. Its application is gaining popularity around the globe including

developing countries like Nigeria. The use of this instrument however places

heavy reliance on transparency of transactions. The problem of Northern Rock has

brought to the fore the critical role of transparency in financial innovation and

transactions. Investors need to know who is holding what and how it should be

valued. Regulators could force investment banks to reveal more about the

performance and price of privately traded asset-backed instruments. The relevant

authorities should ensure consistent valuation of securitized assets across firms.

More information on the vehicles that issue asset-backed commercial paper would

also help.

Whereas the use of securitization is rampant in the developed world, such is not the

case in developing countries like Nigeria. The use of securitization in Nigeria is

still in its infancy. What is rampant in our banking system is the proliferation of

financial products. All these products have their inherent risks which most often

are not fully disclosed by the promoting banks. Investors need to know the features

of these products to enable a reasonable assessment of inherent risks. The

regulatory Authorities are therefore encouraged to compel banks to disclose all the

features of their products in order to promote market discipline. In the main

therefore, there should be more focus on greater transparency by the operators than

hitherto. That requires that regulators and supervisors should be well trained in the

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area of new products and their impact on banking. In addition, the capacity of the

operators to effectively manage the inherent risks should be a subject of continuous

evaluation.

5.7 Information Management

As indicated in the earlier section, the run on Northern Rock was precipitated by

the offer of liquidity support by the Bank of England. The lesion from this

development is that Regulatory/Supervisory Authorities should carry out their

intervention role in a discrete manner so as not to generate unintended effects for

the problem institution in particular and the overall financial system in general.

5.8 Public Awareness

The need for a public awareness/enlightenment programme which could have gone

a long way in improving the public’s understanding of the UK depositor protection

system and its limits cannot be over-emphasized. The process of dealing with the

Northern Rock bank run clearly revealed that there was no coherent public

awareness strategy which could have helped in forming and managing the

expectations of the public and avoiding a possible panic.

5.9 Prudential Regulation and Supervision

While lending and deposit-taking remain the primary functions of banks, the

profile of credit markets has changed significantly. Today, conventional credit

products are being offered alongside the growing significance of asset

securitization and credit derivative activities. This has had a profound impact on

the nature of banking. The rapid development of these synthetic credit markets,

coupled with an extended period of ample liquidity in the global financial system,

has expanded the avenues for banks to engage in more aggressive lending practices

that are funded by borrowing from the wholesale money markets, and by

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repackaging and selling loans to other investors in the form of asset-backed

securities. This represents a significant shift from the more traditional banking

models where loans are predominantly funded by deposits.

There is no doubt that sound risk management by banking institutions reinforced

by prudential regulation and supervision will continue to remain the first line of

defence against financial crisis. The last few years have witnessed important

strides being achieved at both the international and national levels towards

strengthening the prudential regulatory and supervisory frameworks of banking

institutions in response to the changing nature and scope of banking activities.

These efforts would need to be improved upon and carried out in a more timely and

proactive manner.

6.0 CONCLUSION

The paper has reviewed the Northern Rock crisis in the U.K by highlighting the

cause of the problem and the reactions of both the regulators and depositors. From

both the cause and reaction of the key participants, a number of lessons have been

deduced. Chief among these lessons are the need to monitor developments in the

global financial market, need to exercise caution with respect to the proposed

single regulatory structure, need to ensure adequate public awareness for DIS as

well as need to keep the coverage limit adequate. Others are the need to ensure

proper information management and need to ensure a comprehensive disclosure

regime in order to promote market discipline. It is our belief that the lessons will

go a long way in strengthening the nation’s financial system.

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REFERENCES:

Aziz, Z. A. (2007), “Deposit Insurance and Consumer Protection” Keynote address

delivered at 6th International Association of Deposit Insurers (IADI) Annual

Conference held at Westin Hotel, Kuala Lumpur 31 October 2007.

Campbell, A. and Cartwright, P. (1995), “Deposit Insurance: Consumer Protection,

Bank Safety and Moral Hazard” Vol. 10 European Business Law Review 96;

see also M. Andenas, “Deposit Guarantee Schemes and Home Country

Control” in R. Cranston (ed) The Single Market and the Law of Banking,

London, Lloyds of London Press.

FSA Statement for depositor (2007): Northern Rock

http:www.fsa.gov.uk/pages/Library/Communication/statements/2007/nr15.s

html

Hosking Patrick (2007), “Northern Rock had not had full check-up for 18 months,

FSA admits. http://business.timesonline.co.uk/tol/business/industry-

sectors/banking-and-finance/article2625471.ece

The Economist (2007), “The Great Northern Run”, September 20th.