THE CAUSES AND EFFECTS OF FAILURE OF MICROFINANCE BANKS IN NIGERIA

CHAPTER ONE1.0.BACKGROUND OF THE STUDYFinancial instability has been in the scene of Nigerian economy for a long time. Itis obvious that the financial instability is an important topic to develop. The costburden associated with bank failure is so disturbing that the need for continuedstudy of causes of banking financial instability on both the practical and theoreticallevel cannot be overemphasized. Some years back, Nigeria witnessed numerousbank failures. Example Savannah bank, All State Trust Bank, Bank of the North,Ganji bank of Niger limited, Owena bank, Lion bank of Nigeria limited, etc.The central bank of Nigeria (CBN) has said that the only way the nation’sconsolidated banks could be insulated from failure is through adoption andenforcement of corporate governance culture. Sanusi Lamido however, pointed outthat the recent failures of high profit institutions around the world such as Enron,Parmalat, World comm., Barings bank among others, have shown that no companycan be too big to fail, stressing that a common trend that runs through thesemonumental failures was poor corporate governance culture, exemplified in poormanagement, fraud and insider abuse by both management and board members,poor asset and liability management and poor regulation and supervision amongothers. Banks play very crucial roles in the process of economic development of anycountry, by mobilizing funds from the surplus units of the economy and the lending of these funds to deficit units for investment. There has been a growingconsensus among economists on the proposition that financial institutions andparticular commercial banks contribute to the real development of the economy.The process of expansion might occur owing to the improvement in the financialsystem as potential savings is matched with investment. This reasoning which issupported by both the Keynesian and the classical models of economicdevelopment implies the need for adequate financial intermediation. Therefore, anefficient banking system implies availability of credit for capital formulation andinvestment.‘Bank failures are usually followed by unfavourable consequences on stock-holderoutside the failed banks themselves. Sometimes, consequences are felt by the non-banking system as a whole. A failure can result in much harm to employment,earnings, financial development and other associated public interests’, Smiths andWalter (1997). According to Hooks, (1994) and Beston and Kaufman (1996), thefailure of a bank has a great adverse effect on the economy and so it is consideredvery important.Bank failure means different things to some people. To some people, a bank failsonly when it ceases operation even if it has not been liquidated. In a wider context,a bank is said to have failed if it has not succeeded in achieving any objectives forwhich it was established. A bank is considered a failure not only when it ceases operation but also when itcannot meet any of its objectives or obligations. The cessation of operation mayconstitute a serious mild or negligible bank failure depending on the circumstance.The cessation of independent operation or continuance without the assistance ofrelevant authorities such as deposit insurance institutions can be associated withdistress. Bank failure therefore will occur when a fairly reasonable proportion ofbanks in the economy as a whole lack capital assets. As Selgin concludes thatregulation in respect of branching limited contribute to the possibilities of bankfailure by supporting bank risky operation. According to him, the worst regulationis branch restriction. The lower the bank’s capital; the higher the probability of itsfailure. Goodhart et al (1998) agreed with the statements and added that as bank’scapital decreases, the higher its motivation for action towards survival. Thereforethe risk of failure rises with the decline in equity.More so, bank failure is seen as a declaration of insolvency by the chatteringagency or as reorganization to avoid dejure. Failed banks tend to be less efficientand make fewer investments (grant more loans especially bad loans) than boyantbanks. Thus, bank failure occurs when net cash is greater than the bank’s capitalfunds. This implies that a problem bank is one that in the eyes of the federalbanking authorities has violated a law or regulation or engaged in an unsafe orunsound banking practice to such an extent that the present or future solvency ofthe bank is in question (Sinkye, 1975). ‘There is no evidence that bank failure is the thing of the past in Nigeria because itis still on the economic scene. Bank distress has become a common lexicon inNigeria, given many bank failures till date’. Ebhodaghe (2001) stated that when afirm which is either a bank or not is liquidated for its inability to meet itsobligation to creditors, it can be described as having failed. Thus we could usebank failure to describe a situation where, as a result of irremediable bank distress,a bank’s license is revoked and the bank subsequently liquidated. Liquidation isthus, an aftermath of bank failure. In fact, if revocation of license is seen as thedeath of a bank, liquidation is its burial.Bank distress is the fore runner of bank failure. Whereas a bank in distress couldhave chances of regaining health, a failed bank loses every chance of life. Its finaldestination is the mortuary of Nigerian deposit insurance corporation (NDIC) fromwhere it will proceed to its final resting place – liquidation – courtesy of theundertakers. Bank failure also is when the bank system fails, which means whenthe entire bank ATMs and the bank POS machine fail to work. The banks have toshut for a while, because the machines that are inside the bank are broken.Corruption in the banking sector; so-called rich men making deals with bankmanaging directors (MDs), and taking loans without paying back. See what ishappening to some commercial banks and micro-finance banks in Nigeria. Banksthat lent money to people with little or no credit and those people cannot affordwhat was purchased, and then they file bankrupt....