corporate failure and survival in banking industry
TRANSCRIPT
CORPORATE FAILURE AND SURVIVAL IN BANKING INDUSTRY: AN EVALUATION OF TURNAROUD STRATEGIES
1.1 INTRODUCTION
In the last two decades, banking industry witnessed an upsurge in the number of
banks and an equal demise of many of them into the oblivion. This is attributable to
variety of complex factors that range from distorted management incentives to macro
economic imbalances. Banks therefore need to fight entropy in order to remain
relevant and survive in a turbulent and competitive business environment. This is the
essence of developing and implementing sound survival strategies. This paper is
divided into five sections. Section one is this brief introduction. The second section
examines the concept of bank distress while section three explores the major causes of
distress in banks. Section four evaluates the turnaround strategies employed to turn
distressed banks around. The final section is devoted to recommendations and
conclusions.
1.2 CONCEPT OF FAILURE AND BANK DISTRESS
A variety of terms, all unpleasant, have been employment in different contexts to
explain the concept of 'failure': collapsed, failed, bankrupt, broke, and bust (Argenti:
1976:01), distress, insolvency etc. In short, failure is the inability of an organisation to
survive.
Bank failure may differ from failures in other organisations because of its contagious
nature. Bank failures are contagious and the collapse of one bank tends to undermine
the confidence of the community and start runs on others. In addition, if bank failures
continue on a wide scale, business concerns, as well as individuals will be
increasingly likely to withdraw their accounts and hold liquid cash.
Distress in the banking industry generally occurs when banks are either illiquid and/or
insolvent and depositors fear the loss of their deposits and so there is a breakdown of
contractual obligations (Ebhodaghe, 1997:57). Sign of illiquidity appears when a
bank can no longer meet its liabilities or obligations as they fall due. Insolvency on
the other hand manifests when the value of a bank’s realisable assets is less than its
total liabilities. Ekpenyong (1994:16) concurs that a bank shows early sign(s) of
distress when it is unable to meet its financial obligations that fall due (illiquidity)
such as inter-bank indebtedness and depositors’ funds. Such a situation as he further
adds can be caused by the weak deposit base of the bank, its inability to meet its
capitalisation requirements and poor management. Other indices of bank distress
include the following: gross under capitalisation in relation to the level of operation;
illiquidity, reflected in the inability to meet customers’ cash withdrawals; low
earnings, resulting from huge operational losses; and weak management, reflected in
poor credit quality, inadequate internal controls, high rate of frauds and forgeries.
1.3 CAUSES OF DISTRESS IN THE NIGERIAN BANKING INDUSTRY
Bank distress in Nigeria was caused by many factors. Some of these factors are
discussed at length below.
ECONOMIC ENVIRONMENT - The introduction of the Structural Adjustment
Programme (SAP) in form of macro-economic reforms in 1986 and particularly the
devaluation of the naira and the deregulation of the interest rate structure further
compounded the situation. Escalating cost of manufacturing inputs leading to greater
domestic capacity under-utilisation effectively curtailed the ability of corporate
borrowers to repay their loans.
POLICY ENVIRONMENT - Closely related to the economic condition is the policy
environment itself. According to Nkwopara (1995:08), the banking sub-sector over
the years has been repressed and highly regulated. Ebhodaghe (1997:59) observes
that banks were subjected to substantial restrictions on their products and activities
which, apart from undermining their innovation and resourcefulness also limited their
ability to adapt to changing market conditions. Banks were forced to perform several
developmental roles such as mandating banks to provide subsidised credit to priority
sectors and public enterprises This consequently contributed to mismanagement of
the loans in the so-called priority sectors and the alarming level of non-performing
loans in the industry. Another instance is the compulsory participation by banks to
expand beyond their management capability. Though Rural Banking Programme has
assisted in mobilisation of deposits and also contributed greatly in developing the
banking habit of Nigerians, the scenario imposed substantial cost burden on the
commercial banks and most of their rural branches turned out to be unviable.
INTERVENTIONS AND CONTROLS – These also contributed to distress syndrome
in the Nigerian banking industry. For instance, CBN in 1988 directed banks that
Naira backing for foreign exchange application is lodged with CBN. This was
followed in 1989 by another directive requiring public sector deposits to be
transferred from the commercial and merchant banks to CBN. This generally affected
all the banks, the most affected being the state banks. The sudden loss of government
huge deposits as experts observe affected all commercial banks liquidity and their
customers. In essence, these two directives exposed the precarious liquidity position
of such banks. What was then thought to be a temporary liquidity problem for a few
banks soon caught up with a lot more banks.
POLITICAL CRISIS - The deepening crisis in the industry as Molokwu (1994:48)
observes, could also be remotely ascribed to the political crisis in the second half of
1993. The crisis in June and November of that year (Ebhodaghe, 1997:58) led to
massive movement of people from various parts of the country and engendered
withdrawal of funds from the banking industry. Molokwu (1994:48) also adds that
many depositors who fled their usual place of residence withdrew their deposits from
banks and other finance houses, while those who remained behind made
precautionary withdrawal. He further adds that the volume and timing of these
withdrawals contributed to exacerbating the crisis of confidence within the industry,
and most of the adversely affected banks have remained unstable since then. The
crisis of July to August 1994, which resulted in the closure of banks and other
financial institutions, has further eroded public confidence (Ebhodaghe 1997:58)
MANAGEMENT AND ORGANISATION - There is a general agreement among
economists and management practitioners that the capability and quality of bank
management is a major determinant of performance (Mamman and Sunday, 1994:59).
Management is seen therefore as the single most important variable in the survival
and growth of a bank. Kubr and Wallace (1993) note that for improperly managed
business organisations like banks, even massive injection of finance and material
resources, as well as super human efforts, produce only fleeting improvements. This
underlines the argument that bank distress in Nigeria was exacerbated by poor
management.
Gbadamosi (1993:13) particularly argues that:
Because of poor management, many of the commercial banks gave out loans in large sums without proper collateral securities. Personal relationships were considered as basis for issuing out loans. Such loans were never paid back, which inevitably led to liquidity problems.
The central argument here is that poor management breeds other undesirable
behaviour, which further compounds bank distress. Some of these are further
discussed:
Fraud - In the context of Nigeria’s commercial banking sub-sector, management’s
inability to put in place adequate control measures had resulted in series of fraudulent
activities by management themselves and staff and huge losses that wipe out large
part of some banks’ income (Mamman and Sunday, 1994:63). The NDIC reported
that in aggregate terms, the sum of N1, 377.15 million was involved in commercial
banks’ fraud and forgeries in 1993 compared with N351.9 million in 1992. This
represents an increase of about 291 percent. In the succeeding years, the figures
increased geometrically. Nkwopara (1995:07) examines fraud from a social
perspective, illustrating how personal ties affect human venality:
Family and social norms have made bank staff to collude with outsiders to defraud banks. While directors collude with management to acquiesce to lend to unviable companies related to the bank directors even when they are aware that such companies are being used as vehicles to siphon the bank’s fund to the private pockets of such directors. Some bank managers also collude with customers to defraud their banks.
It is also appropriate to add that apart from direct involvement of management staff in
fraud and forgeries, their inefficiency also indirectly promotes fraud across other
categories of staff. Reports show that various categories of staff including
accountants, managers, supervisors, clerks, and even drivers connive to defraud banks
of large sums of money that run into several billions of Naira (NDIC: various issues).
Among the practices used to perpetrate fraudulent activities are blotting of account
numbers and cheque numbers, forging signatures, conversion of bank money and
giving out large sums of money in the name of loans to friends and relatives without
putting a well structured machinery in place to recover the sum.
Internal Squabbles – This could be between the management and board, or between
board members which are detrimental to the sustenance of distress-free operations. A
case in point is a liquidated merchant bank, where board disagreement played a key
role in destabilising the bank. Bank Examination Report in 1993 shows that as early
as 1991, two years before liquidation “there were clear indications that members of
the board of this bank were not always working in harmony for the benefit of the
bank”. Consequently, the resources of the banks are used to fight expensive,
prolonged legal battles leading to erosion of public confidence and wiping off the
goodwill they had, and distress creeps in slowly.
Large Portfolio Of Non-Performing Assets – This is another recipe for distress. For
many distressed banks in Nigeria, the process of deterioration in their financial
conditions began with poor lending practices. For example, management’s lack of
attention to the details of the loan functions, concentration of credits extended to
directors/shareholders and related companies opened the door to credit weaknesses
and left many banks vulnerable to economic changes.
GROSS INADEQUACY AND SHORTCOMINGS IN THE SUPERVISORY APPARATUS
This is due to the following
Rapid changes in the enabling environment have indeed outpaced the rate of
regulatory reforms. The rate of increase in the number of banks was faster
than the rate at which the supervisory capability of the monetary authorities
was enhanced.
Closely related to this is the shortage of manpower, corruption, and sometimes
incompetence, which make it difficult to detect the warning signals in the bank
operations, and many of them were left uncontained until their problems were
out of control.
Bank regulatory agencies in Nigeria often shy away from enforcing sanctions
on erring operators. The statutory roles of the supervisory banks were not
faithfully carried out. The Citizen Magazine (1994, Jan 10:15) observes that
“part of the blame of the distressed commercial banks also go to the regulatory
bodies for not being alive to their responsibilities to the commercial banks”.
The regulators do not act promptly and swiftly and they even engage in
regulatory forbearance thereby allowing more ailing banks to break the law,
hoping that time and economic recovery would resolve the problem perhaps
following the dictum of benign neglect that says ‘a problem deferred is
problem half solved’.
Other problems relate to the enforcement power of the bank regulators i.e.
they do not have in most cases adequate powers to deal decisively with
distress syndrome. Sometimes far-reaching decisions are subject to approval
from the government, which eventually comes late.
OWNERSHIP STRUCTURE
This has also played a major role in promoting financial distress in the banking
industry. The ownership factor has relevance to the management set up of the banks.
The influence of their owners determines who holds what position in the bank’s
hierarchy especially in government-owned banks. Most of the banks were often
treated as political banks (Ebhodaghe, 1993:19) and were characterised by inept
management with unstable tenure. Appointments to the board and key management
position were based on subjective measures (Nkwopara: 1998).
Many banks employed mediocre and appointed inexperienced managers who could
not manage the business effectively. Worse still, some of these managers were people
who studied courses not related to banking.
INADEQUATE CAPITALISATION
This has also been identified as a contributory factor to the distress condition in the
banking industry. In Nigeria, poor capitalisation has for long remained a key problem
of the Nigerian banking system. Many of the banks were established with very little
capital and in other cases; the problem has been worsened by the huge amount of non-
performing loans, which have eroded the banks’ capital base.
5.4 CONSEQUENCES OF BANK DISTRESS
The concomitant bank distress had far-reaching consequences not only on the
economy but also virtually on every Nigerian.
5.4.1 Effect on Economic Variables
Banks find it difficult fulfilling their roles as engines of growth in the economy,
which they may not be able to do efficiently under the present crisis situation because
of the difficulties in mobilising deposits from the surplus sector. Ebhodaghe
(1994:30) concurs that bank distress retards economy’s rate of capital formation;
reduce its level of employment and ultimately the pace of economic growth.
5.4.2 Effect on Confidence in the Industry
Bank distress also engenders crisis of confidence in the entire industry. This clearly
paralyses the development of a good banking culture. Several circumstances in
Nigeria contributed to the crisis of confidence: withdrawal of public sector deposits;
June 12 crisis; and even the promulgation of Failed bank Decree. These sent an
alarming signal to the public who made huge withdrawals and made it impossible for
even marginally stable banks to meet their deposit commitment. The bank run
affected even the healthy banks since investors do not know which of the banks are
actually distressed. This development increases the banks’ cost of intermediation, as
banks need to pay higher returns to attract and retain deposits. Many banks at the
height of the tension offer interest rates on deposits higher than the prevailing market
rates to boast their deposits and lure customers, and this further complicated the
situation. Coupled with the high cost of intermediation, there will be great and
pervasive uncertainty such that the perceived real return on financial assets will be
lowered. Frequent government intervention through the regulatory authorities adds to
other indirect cost. Finally, depositors’ fund in the event of liquidation will be lost at
least recoverable to the extent of N50, 000 where there is explicit/implicit provision
for protecting depositors.
5.4.3 Effect on Credit Market
Gilbert and Kochin (1994), and Ebhodaghe (1996) concur that expenditure of
economic agents are constrained by the quantity of credits made available to them.
Developments that reduce the total quantity of bank credit or disrupt the operations of
banks as intermediaries will reduce spending and consequently will affect aggregate
economic performance adversely. To the extent that bank failures disrupt the process
of financial intermediation, including credit-granting activities of banks, aggregate
economic activities may be adversely affected.
5.4.4 Effect on Other Stakeholders
Apart from the threats posed by bank distress to the economy which affect everybody
directly or indirectly, it is worth discussing the other stakeholders that suffer when a
bank is in distress or when it is liquidated.
(i) Owners
In Nigeria, the inability or refusal of owners to recapitalise distressed banks
culminated into their liquidation and total loss of investment by owners of such banks.
This exposes them to risk and indirectly discourage their future participation in
banking business or even other productive activities within the economy and therefore
promotes investment abroad.
(ii) Employees
The employees of distress banks also suffer. Rehabilitation and turnaround measures
involve re-sizing of banks and consequently certain jobs may be eliminated or
contracted. The loss of jobs leads to economic disenfranchisement of many families
thus confounding the challenges of the trying environment (Udezue: 1997). The
attendant substantial increase in the unemployment level negates government’s
current efforts at addressing the unemployment problem, and partly explains the
current social unrest particularly amongst the youth.
(iii) Depositors
Depositors also suffer when a bank is in distress and incur some costs. In the event of
liquidation, they lose everything except if there is implicit/explicit insurance cover.
They also incur additional cost of re-establishing relationship and good rapport with
other banks, which they have for long developed with the failed banks.
Despite the preceding arguments that see distress as negative and dysfunctional, there
exits arguments too that distress could indeed be functional, albeit to some limited
extent. Oboh (1999: 05) observes that bank distress experience increase awareness of
the ethics and demands of the banking profession. Thus, the regulatory authorities,
banks, and the public are red-alert on the legal and professional banking practice. It is
also a fact that it has helped to expunge the ‘bad eggs’ and prepare the grounds for
improving the industry and restoring stability.
From the foregoing, it is clear that adequate measures must be put in place to forestall
future occurrences. This is more important as bank distress has many spill over
consequences.
1.4 EVALUATION OF TURNAROUND STRATEGY
Banks are like living organisms. They evolve in cycles and in certain period of their
development undergo phases of rupture, which improve changes of direction and
make survival their central preoccupation (de-Carmoy, 1990:200). To remain
relevant and maintain their identity, they need to improve their competitive standing
and operational efficiency. The right strategies are the turnaround strategies
(Wheelen and Hunger: 1992, Colin and Keith: 1992), also referred to as strategies of
change (de-Carmoy: 1990).
According to Rue and Holland (1989: 51), a turnaround strategy is designed to reverse a
negative trend and to get the organisation back on the track to profitability. Turnaround
strategies usually try to reduce operating costs, either by cutting excess fat and operating
more efficiently or by reducing the size of operations. It thus involves the adoption of a
new strategic direction, the activation of which almost by definition involves
retrenchment as a first step. A turnaround strategy therefore involves a reallocation of
resources from one strategic thrust to another and focuses attention on the transitional
issues involved (John and Richard: 1987).
A turnaround strategy involves many changes and the most primary is management
change. Apart from management change, other turnaround elements involve revenue
generation, product market refocusing, liquidation of assets, divestment of parts of the
business, and costs reduction. At any rate attempting a turnaround necessarily,
depends on the root of poor profitability and the urgency of any crisis.
Turnaround effort is one sure way of reversing a declining fortune and improving the
competitive standing of a distress bank. In the banking sector, turnaround efforts could
be observed from three angles, based on internal source when induced by
management of the troubled bank and external when restructuring and reorganisation
of a bank is done by the regulatory or other bodies set-up to address the issue; or a
combination of the first two options (Ndekwu:1997).
Over the years, the Regulatory Authorities have employed several failure resolution
options aimed at ensuring the safety and soundness of the industry. The measures
adopted by the authorities as Ndekwu (1997) observes constitute restructuring
techniques, which are akin to a combination of UK model (lifeboat fund) and US
Model (deposit Insurance). These are restructuring models developed and adapted in
UK and US as a response to financial crises and distress. Therefore, since both
institutions (CBN and NDIC) jointly tackle distress in banks, the adoption of
combined UK-US Model has evolved in the Nigerian (CBN/NDIC) Model. The
hybrid model essentially consists of a number of strategies and measures. The
turnaround strategies in the model were to be initially formulated and implemented by
the banks as earlier observed. Failure to come up with effective strategy led to the
various measures by the regulatory authorities. The actions of the regulatory
authorities was informed by the widespread and numerous adverse or multiplier
effects of distressed banks on the economy.
Financial assistance in form of accommodation facility extended by NDIC in
collaboration with the CBN is one of the elements contained in the model. The
Corporation in collaboration with the CBN extended accommodation facility to banks
with liquidity problems in 1989 (Umoh and Ebhodaghe 1997:117), The financial
assistance strategy granted to our sample banks did not succeed due to poor diagnosis
of the problem and poor implementation. In fact, as it turns out to be, majority of
beneficiary banks were in a state of insolvency which mere liquidity support could not
resolve. This underlies the inherent weaknesses of the NDIC and CBN to separate
insolvent from solvent banks, especially following the explosion in the number of
banks which over stretched their supervisory capacity and the deliberate manoeuvres
by management of banks to conceal their state of affairs (poor information
disclosure). In addition, was the absence of timely management changes and staff
restructuring to effectively manage such resources. The lack of complete autonomy
on the part of NDIC due to government’s stance on the use of tax payers’ money
affected the implementation of the strategy.
The CBN/NDIC also introduced moral suasion with a view to hold discussions and
consultations with the owners and management of insured banks and making them
embrace healthy and corrective practices that would enhance the performance of their
institutions (Sanusi, 1997:09). It was also with the view of making the owners of
such banks realise the need for prompt and decisive action in resolving the problems
of their banks and to review the progress made towards the implementation of the
turn-around programmes (Ebhodaghe, 1997:161). He posits further that the approach
was necessitated by the fact that most of shareholder state government would view
regulatory actions from political perspective. The pervasiveness of poor management
in the commercial banking sub-sector affected the success of moral suasion. Since
81.8 percent of the management of the sample banks it is opined are characterised as
‘inept and self-serving’, it is not surprising that they failed to embrace healthy and
good corporate governance in the operations of their banks, which are the rubrics of
moral suasion strategy. In many cases (about 54.5 percent) it was further opined,
management skills were lacking and there was inadequacy of professionally trained
and competent manpower (63.6 percent). All these point to the fact that the strategy
could not have succeeded. This concurs with the views of the prevalent position in
the literature that moral suasion works well with highly principled and professional
bankers as against ‘rogue’ banks and fraudulent managers.
Imposition of Holding Actions is yet another strategy. According to Herbert
(1997:15), a holding action is a regulatory imposition with an option allowing the
directors of a distressed bank the first opportunity to undertake self-restructuring
measures in a bid to salvage the bank and stem the tide of financial deterioration.
Those banks identified as distressed, after a special examination, are placed under
close supervision and restrictions (Umoh and Ebhodaghe, 1997:122). Up to the end
of 1996, CBN/NDIC imposed holding actions on about fifty-two (52) distressed
banks. Herbert (1997:15) further argues that holding action is a list of regulatory
actions, requirements, do’s, and don’ts imposed on a distressed bank ranging from
restrictions on advertisement for deposits to injecting of further capital funds and
taking necessary steps to ensure adequate control measures to safeguard the books,
records, and assets of the banks. Evidence suggests that between 1991 and 1997, the
regulatory/supervisory authorities had virtually imposed holding actions on over 40
percent of all the commercial banks operating in Nigeria. Despite this, many banks
did not respond positively to the holding actions prescriptions. The following are
attributable to the failure of the strategy:
The fact that the strategy in majority of the cases was implemented
when the banks’ net worth was already negative means that the banks
had long qualified for liquidation. The measures constituted only a
post-mortem exercise.
The punitive actions contained in the strategy as the analysis reveals
succeeded only in constraining the ability of the banks to grow out of
their distressed conditions. Prescriptions such as barring distressed
banks from Autonomous Foreign Exchange Market (AFEM)
participation, suspension from the clearinghouse, sanctions on granting
loans and advances for deposit mobilisation endangered public
confidence in the banks and affected their ability to make profits.
The recapitalisation prescription under the holding action it is observed
could not be attained considering the deteriorated conditions of the
banks, which largely degenerated due to prolonged and sustained
losses. Besides, the shareholders of such banks were least concerned
with the survival of the banks considering the huge amount needed for
recapitalisation, which skyrocketed due to the high presence of insider
dealings and unperfected loan procedures. In addition, the
managements were busy taking excessive and inordinate risks and
playing internal power politics and in the process violating rules and
contravening the prescriptions of holding actions.
The absence of timely management changes also affected the ability to
pursue vigorous, unbiased, and efficient staff rationalisation. The
incumbent management in most cases due to emotional reasons and
intense interference of their BODs and owner-state governments did not
pursue the process objectively. Yet in many successful turnarounds,
staff rationalisation has often remained a key to success.
Though the assumption and control of management strategy was positive because it
attempted to deal with the problem at the root by wrestling control of the management
of the ailing banks from incumbent boards and transferring same to boards appointed
by the regulatory authorities, it failed to empower the IMB/TSB to aggressively
pursue a turnaround programme for the distressed banks. Instead, it focused more on
arresting further deterioration on the affairs in the distressed institutions. According
to Jimoh (1993:17) even the composition of the task-force was such that the longer it
takes to resolve the problems of the banks, the higher the cost, and the more
precarious the banks’ position. He adds further that in some cases those appointed
had their own banks, whose interest could not have been subjugated to the interest of
distressed banks.
Experts also echo the desirability to redress bank distress through Merger and
Acquisition option since they are antidotes to financial distress in order to avoid the
many adverse effects of going into voluntary or involuntary liquidation (Omachonu
et’al, 1997). However, up to 1998 no bank was saved through merger except for two
banks that where saved through acquisition.
Following the failure of many of the strategies, the CBN opted to liquidate the
terminally distressed banks. Though some experts argue that the liquidation of banks
in 1998 marks another leap forward toward sanitisation of the banking industry,
others see the liquidation option as undesirable and costly since it spreads many
negative externalities. For instance with the liquidation of twenty-six (26) banks,
depositors in those banks lost about N10 billion while about six thousand employees
lost their jobs creating more social problems
1.5 CONCLUSIONS AND RECOMMENDATIONS