Professor Lisa Cook.



The Nigerian banking system was in crisis for much of the 1990’s and early 2000’s. The reforms of 2005 were ambitious in simultaneously attempting to address safety, soundness, and accessibility. This paper uses published and new survey data through to investigate whether bank consolidation and other measures achieved their stated goals and whether they also enhanced development, efficiency, and profitability. Following the reforms, banks are better capitalized, more efficient, and less involved in the public sector but not more profitable and accessible to the poor. While there is greater supervision and less fragility, recorded distress was artificially low. The improved macroeconomic environment also explains some of the variation in observed outcomes and likely enhanced the efficacy of reforms.

The recent global financial crisis provides the latest evidence that resolving banking crises can be costly in any country. Losses typically represent a larger share of income in developing countries than in industrialized countries. For example, between 1987 and 1993, Norway, Sweden, and Finland had bank insolvency crises whose resolution cost 4.0, 6.4, and 8.0 percent of GDP. At approximately the same time similar crises in Mauritania, Senegal, and Cote d’Ivoire cost 15.0, 17.0, and 25.0 percent of GDP.1 Such potential losses provide a compelling reason for economists to identify and for policymakers to develop and adopt policies to prevent such episodes in the poorest

countries. A recent literature has focused on analyzing which policies promote the development, efficiency, corporate governance, and accessibility of banks, e.g., Barth, Caprio, and Levine (2001, 2008), Abiad and Mody (2005), and Beck and Demirgü.-Kunt (2009). Another literature makes the further link between finance and growth, e.g., King and Levine (1993a, 1993b), Levine and Zevros (1998), and Rajan and Gonzales (1998). Given that African countries have lagged other countries in adopting bank reforms, knowing whether the findings from cross-country evidence are relevant is difficult.

Nigeria’s banking reform of 2005 provides a natural experiment in which to test theefficacy of best practices in Africa. Did the banking regulation and supervision reforms of 2005 make the financial system more sound? Did they contribute to development, efficiency, and accessibility of the banking system? If so, which mechanisms were most important? Data from Nigeria’s experiment are combined with new survey data to address these questions. I find that in the immediate aftermath of the policy changes, the financial system was more stable than it was previously. While it is found that development and efficiency have increased, the successes in introducing more small savers and borrowers to the formal banking sector have been more limited. Seventy-four percent of Nigerian residents remain unbanked, including 70 percent or more of business owners and traders. This has large implications with respect to changing the incentives and constraints facing most economic agents in Nigeria.

  1. The Nigerian Bank Reform of 2005

The 2005 Nigerian banking reform was a watershed event. To put its significant changes in historical perspective, I will review the principal institutional features of Nigerian banking preceding reform.

Recent Reform Efforts: A nationalization effort in the 1970’s and 1980’s left Nigeria’s banks subject to extensive state intervention and control. Before Nigeria initiated its Structural Adjustment Program (SAP) in 1986, the banking sector was plagued by problems characteristic of many African and poor countries at the time. Direct intervention by the state was accomplished using a number of instruments, including credit and interest-rate controls and restrictions on entry. There were few banks – commercial banks and 12 merchant banks for a population of 84 million. There was little activity outside the government sector, as it accounted for 80 percent of commercial banks’ and 45 percent of merchant banks’ assets. There was little competition, entry, and exit. The financial liberalization program accompanying SAP was designed to address these issues and to extend lending and other banking services. Specifically, its measures included reducing barriers to entry, liberalization of lending and savings rates, introducing an interbank foreign exchange market, deregulating interbank lending, and privatizing a number of banks and financial institutions. The success of this reform was mixed. The number of market participants increased. Eight times the number of banks entered annually from 1987 to 1990 than had in the previous decade. Yet, much of the resulting banking activity was not concentrated on lending to the private sector and households but on exploiting new arbitrage opportunities in foreign-exchange operations and money-market interest-rate spreads.

If consistent with cross-country evidence, this outcome of reform would limit the breadth and depth of the banking sector. The number of banks peaked at 120 in 1991. Simultaneously, banks began accumulating nonperforming loans at an increasing rate, and the share of distressed banks doubled from 26 percent in 1991 to 52 percent in 1995. There was a bank run in 1993, and the banking sector entered a period of sustained crisis. To address bank insolvency, minimum capital requirements were increased in 1988 and 1989. They were increased again in 1991, and other measures were implemented to enhance the regulatory and supervisory powers of the Central Bank of Nigeria (CBN) in the Banks and Other Financial Institutions Law of 1991. The licenses of 26 banks were revoked in 1998, and, by 2002, only 16 percent of banks were insolvent. Nonetheless, this was still high by international standards, as was the ratio of non-performing loans to the total, 25 percent in 2002. New policies and institutional changes in 2001 were aimed at increasing the stability of the banking system. In addition, to increase the flow of credit to and speed up the development of the private sector, universal banking was adopted in 2001, and the distinction between commercial and merchant banking disappeared.


  1. The Need for Reform

While relatively more credit flowed to the private sector, the fundamental issue of insolvency had not been addressed by the 2001 law nor by incremental increases in capital requirements and still threatened the system. By 2004, many banks were undercapitalized, despite having met minimum capital requirements of roughly $7.5 million for existing banks and $15 million for new banks. Shareholders’ funds had been reduced by operating losses, further contributing to insolvency. More than one third of all banks were “marginal” or “unsound” according to CBN criteria. Twenty-eight percent of bank loans were non-performing.6 While bank concentration was falling, it was still high with 10 banks accounting for half the deposits and assets of the banking system. Other conditions prevailing in 2004 that threatened bank development, bank efficiency, corporate governance, and accessibility were overreliance on public-sector deposits, weak corporate governance and substantial insider lending that resulted in large portfolios of non-performing loans, and neglect of small and medium-sized savers.7 Many of the problems in the larger banking sector were reflected in the microfinance sector among community banks, the latest institution designed to address the lack of access to finance among firms, households, and the rural poor. An additional threat to the market for microfinance was regulatory arbitrage, because operators could select to which body they would report and, by extension, by whom they would be regulated – the central bank or the National Board of Community Banks, which was appointed by the Ministry of Finance.

In July of 2004, the Governor of CBN, Charles Soludo, announced an ambitious, 13-point reform agenda to comprehensively reform the banking system. The centerpiece of the proposed changes was a more than 10-fold increase in the minimum capital requirement for banks from NN 2 billion to NN 25 billion (roughly $190 million). Meeting the new capital standard could only be accomplished by mergers, acquisitions, or injections of new capital. This type of bank consolidation was a novel feature of reform, because there were no such restrictions in earlier rounds of raising capital requirements and because there was little history of mergers and acquisitions in the Nigerian banking sector. Other major elements of the reform program were a phased withdrawal of public sector funds from Nigerian banks, adoption of a rule-based regulatory framework that was more risk-focused, and restructuring of the information-gathering and reporting mechanism to ensure greater compliance and transparency. Importantly, while insider lending had been identified as a major problem, corporate governance was on the list of reforms, and a Code of Corporate Governance was enacted by the CBN for banks in March 2006, corporate governance was given less attention relative to bank consolidation and higher capital requirements. The central bank also anticipated higher capital requirements, NN 20 million, and greater supervision and separation of the microfinance sector, since community banks were found to have inadequate capital relative to lending risk and weak institutional capacity. In the remainder of the paper, I will assess the effects of these regulatory changes in the banking sector.

  1. Outcomes

The bank-consolidation process was largely complete as mandated by the end of 2005. All but four banks participated in mergers and acquisitions. Fourteen banks which failed to sufficiently increase their capital base lost their licenses, and 25 banks remained. Community banks were also asked to increase their capital base and convert to microfinance banks (MFBs) starting in 2006. By the end of 2008, 603 of the 757 community banks had converted, applications for new banks were received, and the number of MFBs totaled 840.12 Some larger banks also acquired community banks. A number of auxiliary institutions were created or invited to participate in the microfinance support network, including the MFB Development Fund, the National Microfinance Consultative Committee, the Association for Microfinance Institutions, a credit reference bureau, credit rating agencies, and programs for deposit insurance. Before embarking on graphical and empirical analysis, I describe the data collected and their sources.

  1. Data

Bank- and system-level data sets are constructed for analysis. Bank-level data are collected from the financial statements of individual banks and from Statistical Bulletins, Banking Supervision Annual Reports, and Annual Reports of CBN for various years. Banks are required to report balance-sheet and profit data to CBN, and a subset of these data are reported in these publications. Given the small number of banks, each can be tracked over time, and a panel data set is constructed for the years 12 CBN (2008). Not all community banks converted to MFBs due to insolvency and subsequent license revocation.

Other Sources of Data: 2001 to 2008. System-wide data are gleaned from several sources for the years 1990 to 2008. In addition to the aforementioned CBN sources, aggregate data have been collected from Beck and Demirgü.-Kunt (2009), Beck, et al. (2009), International Financial Statistics 2010 (IMF), and the Economic Intelligence Unit (EIU). Data on consumer finance are taken from the 2008 national survey of 25,000 households conducted by EFinA. Data on the Nigerian banking system are also extracted from three rounds of surveys of bank regulatory and supervisory authorities to identify features of bank regulation, supervision, and structure found in Beck, Demirgü.-Kunt, and Levine (2000, 2004, 2007).

  1. Major Stated Objectives

The ratio of distressed banks to total dropped from 14 percent in 2005 to four percent in 2006 to zero percent in 2007 and that the share of non-performing loans relative to total loans and advances fell from 28 percent in 2004 to eight percent in 2008. As anticipated, there is less government intervention in the banking sector, whether measured by deposits or ownership of government securities (Figure 3), and the level of bank concentration, typically a measure of competitiveness in a banking system, had fallen by the end of 2008. Credit to the public sector fell as credit to the private sector rose (Figure 5). However, Figure 6 shows that the ratio of bank credit to deposits has increased markedly since 2004, which means that banks must rely on other sources of funding, e.g., capital markets, to support significantly higher lending activity. I return to this point below.

Bank supervisors and banks were charged with taking greater account of risk. Data on capital adequacy, liquidity, and asset quality demonstrate the extent to which this happened. Although the minimum capital adequacy ratio is 10 percent, most banks have significantly exceeded the prescribed ratio since 2005. The liquidity ratio increased by more than 50 percent before settling slightly above the 2005 ratio. In tandem with the decline in the share of non-performing loans was a reduction in bad-debt provisioning from 27 percent of total loans and advances to six percent, which freed up resources for other uses. Using data from the Levine, et al. survey capital regulatory and official supervisory power indices were constructed as in Barth, et al. (2001). Higher levels of the index imply better positioning of the financial system with respect to initial and overall capital stringency and official supervisory power. While the capital regulatory index was unchanged between 2000 and 2007, the index of supervisory power improved more than 10 percent between 2000 and 2007. This would be consistent with increases in the scope and depth of CBN’s supervisory role stemming from the 2005 reforms.

  1. Other Financial Indicators

With respect to bank development, financial deepening increased between 2004 and 2008, using a variety of measures. As in King and Levine (1993), a broad measure of financial depth is the ratio of liquid liabilities (currency plus demand and interest-bearing liabilities of banks and other financial intermediaries) to GDP. This ratio fell initially and then rose from 2006. M2/GDP nearly doubled from 19.8 percent to 38 percent, and credit to the private sector more than doubled from 13.2 percent to 33.5 percent.14 Financial development may also be measured by the relative importance of deposit money banks’ assets to central bank assets. The ratio of deposit money bank assets to deposit money bank assets and central bank assets has increased from 0.83 in 2004 to 1.15 in 2008.15

How much better were Nigerian banks at intermediating society’s savings into private sector credits than before? Cross-country evidence, e.g., Beck and Fuchs (2004), shows that higher interest spreads are inversely related to credit to the private sector as a fraction of GDP demonstrates that Nigerian banks are more efficient at intermediation than prior to 2005, as measured by bank credit to bank deposits. Figure 7 shows that they are more efficient by other measures, i.e., by declining overhead costs as a fraction of total assets.

  1. Microfinance Institutions

In tandem with activity in the larger banking sector, the MFBs’ capital-to-asset ratio increased from 24 percent in 2003 to 30 percent in 2008 (see Table 8). With respect to accessibility, MFBs have increased their lending relative to deposits from 59 percent in 1998 to 69 percent in 2008. However, according to a large national household survey conducted in 2008, large swathes of the population, including farmers, traders, owners of firms, and the poorest, remain without access to banking services. Results from analysis of these data appear in Tables 2 to 7. More than three quarters of respondents have had neither a savings nor a checking account. Two percent of respondents have ever had a loan from a community bank. In terms of loans to the rural population, 1.1 percent of the adult population has or once had a loan from MFBs compared to 0.7 percent from commercial banks.17 Ninety-three percent of those in the sample prefer to receive cash as payment, and the share is 0.99 for business owners. Since these are cross-section data, it is unclear whether over time small savers and earners have benefited from the recent reforms, but it is clear that most in Nigeria remain unconnected to formal means of saving and borrowing. Some time-series data exist from other sources. The CBN reports that lending by MFBs to manufacturing, transportation, and communications has fallen dramatically as a share of the total, while the share of lending for trading activities has increased from 36 percent to 44 percent between 2001 and 2008. There are no data on lending to households, and it is unclear among sectors of economic activity which may be better for microenterprises and, by extension, poverty alleviation. Nonetheless, given innovation and excess demand in transportation, e.g., “okada” motorbikes as a form of transportation, and communications, e.g., rapid increases in penetration of mobile phones, there may exist some missed opportunities among microenterprises.

Another indicator of access is the number of banks reporting significant investment in microfinance activities. In 2008, six large banks report having MFBs as subsidiaries or microfinance units in their banks, and four report investing in two MFBs, including Accion MFB Ltd.19 In this instance, too, it is difficult to evaluate changes that may benefit the poor. More formal assessments of the reforms have been mixed. Ezeoha (2007) finds evidence of a fundamental change in the financial structure but suggests that the sustainability of reforms will depend on continuously improving macroeconomic conditions and on public confidence in the government’s commitment to reform. Hesse (2007) analyzes pre-reform interest-rate spreads and are the best candidates among other potential borrowers for credit extension, since many manufacturing activities depend on exploiting economies of scale. However, there is no test of the effect of intervention on post-reform spreads. World Bank (2006) uses bank-level data from 2000 to 2005 to test the effect of overhead costs and other covariates on two different measures of interest spreads and finds support for increased efficiency of intermediation among Nigerian banks. Somoye (2008) examines key financial variables and simultaneously rejects the null of no change, e.g., in total assets and bank capitalization, and fails to reject the null of no change, e.g., in efficiency and bank lending to the private and non-banking sectors. Onaolapo (2008) evaluates the relation between bank capitalization and financial soundness using data on the Nigerian banking sector from 1990 to 2006. He finds evidence of a positive relation between bank capitalization, distress management, and asset quality. These analyses were able to exploit at most one year of post-reform data. The passage of time allows a more comprehensive analysis to be undertaken, which is the contribution of this paper.

  1. Reform and Changes in Financial Indicators

The empirical strategy in the paper rests on using different measures of bank efficiency and risk management to test the null hypothesis of no effect on banks and the banking system. It is anticipated that the set of reforms will allow banks to become more efficient at intermediation.

  1. Efficiency

A time-series data set is constructed from all banks and financial intermediaries operating in the period 1992 to 2008. Two measures of bank efficiency are used in the empirical analysis. Following Stulz (1999), Demirgü.-Kunt and Levine (1999), and Demirgü.-Kunt and Huizinga (2009), I conjecture that financial development and structure affect firm performance and, more particularly, bank performance. Bank efficiency also depends on overhead cost. One model uses bank efficiency measured by the ex ante interest margin, i.e., interest-rate spreads, or the difference in saving and lending rates. Another model uses bank efficiency measured by the ex post interest margin, i.e., net interest margins, or the ratio of net interest income to total assets, which accounts for the possibility that banks that charge high interest rates may experience high default rates. To distinguish the effect of cost, development, structure, and bank reform from general economic conditions, macroeconomic variables are included in estimation. Specifically, I estimate the basic regression


EFt = α + βOV/tat + γBDSt + δXt + ζ2005t + η2005* OV/tat + εt , (1)


where EFt is the interest spread or net interest margin at time t; OV/tat is overhead cost scaled by total assets at t; BDSt are financial-development and -structure variables – bank assets/GDP, bank concentration as measured by the ratio of the three largest banks’ assets to total assets, and loans/liabilities (measures extent of intermediation by the banking system); Xt contains measures of opportunity costs and macroeconomic variables – liquid assets/deposits, equity, the real treasury bill rate, inflation rate, and log of industrial production at t; and εt is a random error term. It would be important to control for opportunities and opportunity costs associated with liquidity and capital, as Nigerian banks had high levels of both following bank consolidation. There is reason to believe that a mechanism most affected by reforms was cost, since the cost of allocating resources should fall. The inclusion of a measure of liquidity and of equity follow Martinez Peria and Mody (2004) in their analysis of Latin America. They reflect the fact that high levels of liquidity will increase costs that are passed on to borrowers and

increase spreads, while high levels of capital will impose opportunity costs with respect to equity.


  1. Risk Management and Bank Performance

If there is less distress in the system, e.g., a lower share of nonperforming loans to the total, it is anticipated that banks would require fewer resources for loan loss provisioning. Alternatively, the ratio of loan loss provisions to total loans may indicate portfolio quality. The bank-level sample is constructed from banks existing in 2006.23 The sample period is 2001 to 2008. In these regressions the dependent variable is the provision of bad debt to total loans and advances. Specifically, the model estimated is


PBDit = α + βBANKit + γBDSt + ζ2005t + ηMACROt + εit , (2)


A sample is constructed from variables available from uniform reports on individual large banks available from 2001. Where PBDit is provision for bad debt/total loans and advances, and the indicators of bank development and bank structure are bank assets to GDP and bank concentration. BANKit comprises controls for bank-specific characteristics: the ratio of equity to lagged total assets, dummies for new (or merged) bank and foreign ownership, and bank and year dummies. The macroeconomic indicators included in MACROt are GDP growth rate and inflation rate. To account for a structural break in the dependent variable, Driscoll-Kraay standard errors are calculated and reported with estimated coefficients in Table 12. I find that the estimated coefficient on the year 2005 is not significant when accounting for bank and macroeconomic characteristics. Consistent with the findings of Demirgü.-Kunt and Huizinga (1998) and Bikker and Hu (2002), this evidence is suggestive that asset quality will be positively affected by higher growth and lower inflation. Further, it is consistent with Beny and Cook (2009) that shows that better economic management was correlated with Africa’s growth spurt in the early 2000’s. The evidence suggests that a larger capital base is correlated with the ability to manage expected bankruptcy costs.

The findings from this study are largely in line with previous studies. Only one major result is challenged by the analysis in this paper – Somoye’s (2008) failure to reject the null hypothesis of significant change in bank efficiency and lending to the private sector. Tests of structural breaks require testing the relative significance of several adjacent years to the candidate year, and earlier tests would not have had post-2005 data available for checking maximum significance. One limitation of this analysis and that of others is that recorded distress may have been artificially low. Recall that CBN reported no banks in distress between 2006 and 2008, despite such signals as a decline of 46 percent in the Nigerian All-Share Index in 2008. Nigerian banks were overextended in 2008 when the loans-to-deposits ratio exceeded 1.5 which was similar to that of Western banks prior to and during the financial crisis of 2008. This should have alarmed bank regulators earlier than it did. In late 2009, two stress tests were executed on the 24 banks, and significant distress and poor corporate governance were identified in the banking system. Ten banks failed the tests, and the CBN determined that the system required a capital and liquidity injection of $4.12 billion. It is estimated that rescued banks held N2 trillion ($13.3 billion) in “toxic” loans. Executives at one third of all banks were forcibly removed and arrested. As aforementioned, while corporate governance was among the reform items, it did not feature prominently in the reform program prior to 2009. These events suggest that the reforms of 2005 may have protected the banking system from a worse crisis than may have evolved but that additional reform on the part of the banks and the central bank is required. In particular, it seems that better internal controls and bank monitoring are warranted, along with timely and relevant determination of distress.

  1. Conclusion

This paper examines the consequences of major reforms undertaken in the Nigerian banking sector in 2005. Firm-level and time-series data allow the extension of analysis conducted shortly after the reforms. A statistically significant break is identified in most financial series at the year 2005. There is increased banking-sector development and greater competition and less government intervention in bank activity. Further, I find that banks are more efficient than prior to the reforms and that this change is correlated with overhead costs generally and from 2005. Asset quality increased between 2005 and 2008, which is correlated with a higher capital base. Favorable macroeconomic conditions likely enhanced the impact of the reforms. Nonetheless, it is ambiguous whether changes in the microfinance sector aided the poor. While the reforms of 2005 increased safety and soundness by several measures, the analysis suggests that bank distress was un- or under-reported after 2005. Along with non-performing loans, corporate governance, which received less attention than other reforms, may require more examination and oversight than in the recent past.


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