Financial Systems Stability In Nigeria: Role Of Deposit Insurance

Dr. Ngozi Okonjo-Iweala, Finance Minister

By GANIYU OGULEYE

Introduction

Prior to the establishment of the Nigeria Deposit Insurance Corporation, there were only two major formalized government-provided safety nets for the Nigerian banking industry These were the lender of last resort facility by the Central Bank (through the provision of temporary liquidity support to solvent depository institutions) and bank supervision. The government provided implicit guarantee to depositors and, by extension, other stakeholders by bailing out troubled banks.

Thus, there was no explicit deposit insurance scheme. The government used its discretionary powers to prop up some failing deposit-taking financial institutions which were mainly state-owned banks.


Under implicit insurance, the government provided protection to depositors, creditors and shareholders alike -a form of blanket insurance. There was also no formal arrangement regarding how the implicit protection could be funded. Funding was largely provided through government budget. Thus, the scheme was a contingent liability on the Federal Government budget and was characterised by uncertainties about the level and scope of coverage. The implicit scheme could not therefore provide the required public confidence.

Other problems associated with the implicit scheme included slow response to crisis due to debate on required budgetary provision and government’s sole burden to resolve banking distress.


In 1986, The Nigerian Government commenced the implementation of a Structural Adjustment Programme (SAP) which entailed liberalization and deregulation of the Nigerian economy. As a result, the number of banks increased phenomenally from 48 in 1988 to 120 in 1990.

The development triggered keen competition as well as increase in the risks to which banks and consequently depositors were exposed. An explicit deposit insurance system (DIS) was therefore considered necessary to protect the depositors, particularly the small ones, from the adverse consequences of risks being taken by banks in the process of competition. The phenomenal growth in the number of banks over-taxed the available managerial capacity in the banking system.


The fore-going necessitated the introduction of an explicit DIS in Nigeria through the enactment of Act 22 of 1988, which established the Nigeria Deposit Insurance Corporation (NDIC), the Agency vested with the responsibility of implementing the system in the country. The NDIC commenced operations in March 1989. The scheme was introduced to provide a further layer of protection to depositors and complement the Central Bank of Nigeria’s (CBN’s) supervisory activities in ensuring a safe and sound banking system. The DIS in Nigeria like most other explicit schemes, has specified maximum insured sum, a clearly defined ex-ante funding arrangement, and a specified administrative structure, Participation in the scheme is compulsory for all licensed deposit-taking financial institutions while the implementing agency is owned by government. The implementing agency, NDIC also has responsibilities for monitoring the health of insured institutions as well as the risk exposure of the Deposit Insurance Fund (DIF) and providing an orderly failure resolution mechanism, as clearly enunciated in the Corporation’s enabling law. In effect, the DIS in Nigeria was designed as a risk minimizer.


To fully appreciate the role of the DIS in ensuring the financial system stability in Nigeria, the next section (Section 2) of this paper takes an overview of the regulatory framework and information-sharing arrangement in Nigeria while Section 3 discusses the functions of the NDIC and the design features of the DIS in Nigeria. In Section 4, we highlight the main contribution of the NDIC to financial system stability in Nigeria. Section 5 summarises and concludes the paper.
10.1 Regulatory Framework In Nigeria


The critical areas of regulation can be broadly grouped into three, namely: entry, risk evaluation and containment; and failure resolution. In essence, regulatory activities in Nigeria span from cradle of a financial institution to its grave.


The main activity in entry is licensing. Regulators should have ability to screen access to ownership and management so as to ensure that only individuals with requisite qualifications, professional competence, experience, financial capacity, and sound ethical standards are allowed to obtain a banking licence. In most emerging markets, this responsibility of licensing is either that of the central bank, or a separate regulatory body or Ministry of Finance for banks and other deposit-taking financial institutions and other regulatory authorities in the capital and insurance markets.


In the case of Nigeria, the Central Bank of Nigeria (CBN) is the apex regulatory authority for the banking industry as enshrined in the Banks and Other Financial Institutions Act (BOFIA) 1991. Under the Act, the CBN has the powers to license banks and other deposit-taking financial institutions and supervise licensed institutions. While under BOFIA, the CBN had licensing power, it was required to obtain the approval of Mr. President to de-license a banking institution. That requirement subjected revocation of banking licence or de-licensing to approval of the political authority.


Consequently, between 1988 and 1998, NDIC was confronted with the agency problem associated with delays in granting approvals for the revocation of the licences of terminally distressed banking institutions.


Indeed, a scenario of "free entry, no exit" prevailed over the period as illiquid and insolvent banks remained open. The requirement of Mr. President’s approval for dc-licensing was however removed in 1998 through an amendment to BOFIA, thus giving the CBN full failure resolution powers.


Furthermore, up to 1998, the CBN had the power to appoint NDIC as provisional liquidator of failed banks and such appointment was deemed to have been made by the Federal High Court (FHC). That arrangement ensured effective exit mechanism. Unfortunately, CBN lost that power when BOFIA was amended in 1998 and NDIC was required to apply to the FHC to be appointed as liquidator. The new dispensation created opportunities for legal challenges and protracted litigations.


Banking supervision in Nigeria is the joint responsibility of the CBN and NDIC. The responsibility is carried out through on-site examination and off-site surveillance. In order to avoid duplication of efforts and role- conflict, the two institutions engage in consultations. In particular, the two institutions meet at the beginning of every year to agree on bank examination programme. This arrangement has guaranteed that a bank is examined once a year. At the end of each examination by any of the institutions, the examination report is sent to the other institution. Banks examined by an institution in a year are allocated to the other institution in the following year to minimise over-familiarity with employees of examined institutions as well as promote peer review mechanism.


In the case of off-site surveillance, the two institutions use the same set of prudential bank returns for appraising financial condition and performance of both the industry and individual institutions.

The two institutions also developed a Bank Analysis System software as a tool for off-site surveillance. This has been enhanced to electronic Financial Analysis and Surveillance System (e-FASS). Bank ratings generated individually by the two institutions are compared to harmonize the results of their off-site analysis.


The two institutions have also established joint committees on supervision both at the executive and technical levels which meet on a regular basis.


This arrangement enables the two institutions to review developments in the banking industry and pro-actively address emerging supervisory challenges.


The NDIC shares the responsibility of failure resolution with the CBN. In order to delineate the roles of individual institutions in that regard, the two institutions jointly developed a Contingency Planning Framework for Banking Systemic Crisis, with thresholds for intervention indicating when and how each institution is to intervene. In order to avoid conflict of role in provision of liquidity support, the two institutions also jointly developed a framework for liquidity support. This framework clearly demarcates when the NDIC liquidity support is needed as against the lender-of-last-resort role of the CBN. When a banking licence is revoked by the CBN, the NDIC serves as Liquidator.


Given that the licensed banks in Nigeria are universal banks engaging in money, capital and insurance markets’ activities with different regulatory authorities, the need for co-operation amongst the regulatory agencies became imperative. The Financial Services Regulation Coordinating’ Committee (FSRCC) with the CBN Governor as Chairman was therefore, established. Other members of the committee are the Chief Executive Officers of the NDIC; the Securities and Exchange Commission, the apex regulatory body for the capital market; the National Insurance Commission, regulatory agency for Insurance business; the Corporate Affairs and a representative of the Federal Ministry of Finance. The specific objectives of the Committee are to:


i) co-ordinate the supervision of financial institutions especially conglomerates;
ii) minimize arbitrage opportunities usually created by differing regulations and supervision standards among supervisory authorities in the economy;


iii) deliberate on problems experienced by any member in its relationship with any financial institution;


iv) eliminate any information gap encountered by any regulatory agency in its relationship with any group of financial institutions;
v) articulate the strategies for the promotion of safe, sound and efficient practices by financial intermediaries; and
vi) deliberate on such other issues as may be specified from time to time.




Source: The Nigerian Observer