ABSTRACT
The banking sector is one of the few sectors in which the shareholders’ fund is only a small proportion of the liabilities of the enterprise hence; the banking sector is one of the most regulated sectors in any economy as is the case in Nigeria. This is to forestall the confusion and consequences of bank failures and distresses. The consolidation of banks has been the major policy instrument being adopted in correcting deficiencies in the financial sector in the world all over and hence the 2005 concluded bank consolidation exercise in Nigeria. It also explains why there have been continued research emphases on finding out how the benefits arising from consolidation has been optimized. Most of the previous studies on the subject, however, made use of data from United States of America, Europe and advanced Asian countries. Such studies undermined the peculiarities of and differences in the operating environments and changing dynamics of business in most developing countries. The objectives of this work are: – To ascertain if the 2005 concluded consolidation has improved the profitability of consolidated banks; to find out if the 2005 concluded consolidation has enhanced cost-saving for consolidated banks; and to ascertain if the 2005 concluded consolidation has reduced the credit risk of consolidated banks. This study used Ex-post facto research design and lies within the measurement of bank performances using variables as Return on Equity (ROE) to measure profitability improvements, Cost Income Ratio (CIR) to measure cost-saving efficiency, and Ratio of Loan Loss Provision to Gross Loans and Advances (LLRGA) to measure credit risk reduction of 6 quoted banks before and after the
2005 bank consolidation, for a 10-year period 2000-2009, to fill this important research gap. Descriptive (narrative) statistical method was used to analyse variables, and compare the pre and post-consolidation performances of sampled banks, while the paired sample t-test statistics was used to test three formulated hypothesis for significant differences between the two sample means of the pre and post-consolidation periods observed at two points in time. The results revealed that the banks recorded decreases and increases in the operating variables in period or the other of the post-consolidation period. However, three out of the six sampled banks had significant differences on profitability as evidenced by the Return on Equity a measure of profitability, two banks had significant differences on cost-savings as evidenced by the Cost Income Ratio, while only one bank had a significant difference on credit risk reduction as measured by Ratio of Loan Loss Provision to Gross Loans and Advances. Thus, the contribution of this dissertation to knowledge is that the Nigerian banking consolidation, an exercise concluded in 2005 has not improved significantly the performances of all the consolidated banks in Nigeria. Therefore, this work recommend as follows:- that banking sector consolidation should be allowed to be market driven in order to achieve the synergies that accompany such exercise; that the CBN should work vehemently to curb inflation because, no matter the capital base of banks, inflation the bogeyman of Nigerian economy will always erode such capital base; regulators of the Nigerian banking sector should come up with such other policies that will enhance cost saving efficiency and eliminate or reduce high credit risk inherent in the Nigerian banking industry.
CHAPTER ONE
INTRODUCTION
1.1: BACKGROUND OF THE STUDY
Adeyemi (2006) points out that the need for a strong, reliable and viable banking system is underscored by the fact that the industry is one of the few sectors in which the shareholders fund is only a small proportion of the liabilities of an enterprise. It is, therefore, not surprising that the banking sector is one of the most regulated sectors in any economy as is the case in Nigeria. Banking reforms have been an ongoing phenomenon around the world right from the
1980s, but it is more intensified in recent time because of the impact of globalisation which is precipitated by continuous integration of the world market and economies (Adegbagu & Olokoye 2008).
Banking reforms involve several elements that are unique to each country based on historical, economic and institutional imperatives. In Nigeria, the reforms in the banking sector preceded against the backdrop of banking crisis due to highly undercapitalization of deposit taking banks; weakness in the regulatory and supervisory framework; weak management practices; and the tolerance of deficiencies in the corporate governance behaviour of banks (Uchendu 2005). Banking sector reforms and recapitalization have resulted from deliberate policy response to correct perceived or impending banking sector crises and subsequent failures. A banking crisis can be triggered by weakness in banking system characterized by persistent illiquidity, insolvency, undercapitalization, high level of non-performing loans and weak corporate governance, among others. Similarly, highly open economies like Nigeria, with weak financial infrastructure, can be vulnerable to banking crises emanating from other countries through infectivity (Adegbagu & Olokoye 2008). Banking sector reforms in Nigeria are driven by the need to deepen the financial sector and reposition the Nigeria economy for growth; to become integrated into the global financial structural design and evolve a banking sector that is consistent with regional integration requirements and international best practices. It also aimed at addressing issues such as governance, risk management and operational inefficiencies, the centre of the reforms is around firming up capitalization (Ajayi
2005).
Capitalization has been an important component of reforms in the Nigerian banking industry, owing to the view that a bank with a strong capital base has the ability to absolve losses arising from non performing liabilities, improve its revenue, and attain cost-efficiency.
Attaining capitalization requirements may be achieved through consolidation of existing banks or raising additional funds through the capital market.
An early view of bank consolidation was that it makes banking more cost efficient because larger banks can eliminate excess capacity in areas like data processing, personnel, marketing, or overlapping branch networks (Somoye 2008). Consolidation is viewed as the reduction in the number of banks and other deposit taking institutions with a simultaneous increase in size and concentration of the consolidated entities in the sector (BIS, 2001). Irrespective of the cause, however, bank consolidation is implemented to strengthen the banking system, embrace globalization, improve healthy competition, exploit economies of scale, adopt advanced technologies, raise efficiency and improve profitability (Adegbagu & Olokoye 2008). Ultimately, the goal is to strengthen the intermediation role of banks and to ensure that they are able to perform their developmental role of enhancing economic growth, which subsequently leads to improved overall economic performance and societal welfare they concludes.
The government policy-promoted bank consolidation rather than market mechanism has been the process adopted by most developing or emerging economies and the time lag of the bank consolidation varies from nation to nation (Somoye 2008). For example, what was termed “government guided” merger was a unique banking sector reform implemented in 2002 by the Central Bank of Malaysia BNM (Bank Negara Malaysia) guiding 54 depository institutions to form 10 large banks (Rubi, Mohamed & Michael 2007). This was partly a response to the banking crises perpetrated by the 1997-1998 Asian financial crises, they noted. BIS (2001) also noted that in Japan during the banking crises of the 1990’s, government funds were deployed to support reconstruction and consolidation in the banking sector.
Soludo (2004) announced a 13-point reform program for the Nigerian Banks. The primary objective of the reforms is to guarantee an efficient and sound financial system. The reforms are designed to enable the banking system to efficiently perform its functions as the pivot of financial intermediation (Lemo 2005). Thus, the reforms were to ensure a diversified, strong and reliable banking industry where there is safety of depositors’ money. Of all the reform agendas, the issue of increasing shareholders’ fund to N25 billion with an option of mergers
and acquisitions and the need to comply before 31st December, 2005 generated so much controversy especially among the stakeholders.
Therefore, this research work tends to assess the significant effect of the concluded 2005 banking sector consolidation in Nigeria on the performances of consolidated Nigerian banks.
1.2: STATEMENT OF THE PROBLEM.
BIS (2001) points out the motives for consolidation to include; Cost savings; Revenue enhancements; risk reduction; change in organizational focus and managerial empire building. It is believed that increased size could potentially increase bank returns, through revenue and cost efficiency gains. It may also, reduce industry risks through the elimination of weak banks and create better diversification opportunities (Berger 2000). Consolidation could increase banks’ propensity toward risk taking because of increases in size, capital and leverage and off balance sheet operations (Ogowewo and Uche 2006). In addition, scale economies are not unlimited as larger entities are usually more complex and costly to manage (De Nicoló et al. 2003).
Consolidation, whether market–induced or government–policy promoted normally holds out promises of:-
– Revenue enhancements and resources maximization.
– Gains in cost-efficiency or costs saving due to economies of scale.
– Risk reduction.
Proponents of bank consolidation are of the opinion that banking sector reform help banks become stronger players, and in a manner that will ensure higher returns especially to shareholders over time. Also, that bank consolidation can lead to increased profits/ revenue for a variety of reasons including; increase in size, increased product diversification, expanding the pool of potential customers, increased size allowing firms to increase the riskiness of their portfolio. However, evidences show that performance improvements of mergers in the EU and US on ROE and ROA are seldom realized and as such, have not had a positive performance.
Nigerian banks before consolidation were made up of small sizes. Each with expensive headquarters, separate investment in software and hardware, heavy fixed costs and operating
expenses, and with bunching of branches in few commercial centres. All these leads to very high average cost for the industry and in turn, has implications for the cost of intermediation, the spread between deposit and lending rates and puts undue pressures on banks to engage in sharp practices as means of survival. Bank consolidation may improve efficiency particularly when weak, poorly managed banks are acquired by stronger, competently managed banks. Large cost-efficiency gains are possible when more efficient banks merge with less efficient banks. However, whether such mergers and acquisitions lead to significant cost-saving is uncertain as some past empirical results found no significant improvements in cost-efficiency in the US bank mergers. There are also reported lack of evidence on the economies of scale and scope for large European banks.
The trend in consolidation has been influenced by factors including risk reduction arising from improved management. Empirical evidence is consistent with the risk-reduction hypothesis and that efficiency may also improve due to greater risk diversification. Banks seeking to reduce default risk via increased size may prefer targets with lower credit risk. Acquiring banks prefer to acquire small and low risk targets and that post-merger risk- reduction is most likely in mergers between high-risk and low-risk targets. However, some scholars argue that more capital does not necessarily mean more safety, and that since capital is costly to raise banks would be under pressure to generate higher returns from the additional capital, thereby forcing them to take on greater risks. Increase in the size of institutions per se tends to be associated with a greater appetite for risk and thus a greater probability of insolvency and credit risk.
1.3: OBJECTIVES OF THE STUDY.
In view of the above, our objectives of the study included:-
(i) To ascertain if the 2005 concluded consolidation has improved the profitability of consolidated banks.
(ii) To find out if the 2005 concluded consolidation has enhanced cost-saving for consolidated banks.
(iii) To ascertain if the 2005 concluded consolidation has reduced the credit risk of consolidated banks.
1.4: RESEARCH QUESTIONS.
The following research questions guided this study.
(i) To what extent has the profitability of consolidated banks improved after the 2005 bank consolidation?
(ii) One of the gains of consolidation is cost-saving; to what extent have consolidated banks achieved this after the 2005 concluded consolidation exercise?
(iii) To what extent has the credit risk inherent in the pre-consolidation period been reduced after the 2005 concluded consolidation exercise?
1.5: RESEARCH HYPOTHESIS.
The following hypothetical statements were tested:
(i) The 2005 concluded bank consolidation has not led to any significant improvement in the profitability of consolidated banks.
(ii) The 2005 concluded bank consolidation has not significantly enhanced cost-saving for consolidated banks.
(iii) The 2005 concluded bank consolidation has not significantly reduced the credit risk of consolidated banks.
1.6: SCOPE OF THE RESEARCH.
This research work was planned to cover all the banks operating in Nigeria before and after the conclusion of the consolidation exercise. However, thirty banks (Table 2.1) were publicly owned and quoted on the Nigerian Stock Exchange before the 2005 concluded consolidation exercise. From the population of thirty publicly owned and quoted banks, a sample was drawn for the purpose of analysis. The choice of this was to ensure data availability to enhance a comparative analysis between the performances of these banks before and after the consolidation exercise i.e. pre and post consolidation periods.
In line with previous empirical studies that identified some sets of variables believed to be major determinants of bank performance, this study focused mainly on three of such variables and are: Profitability as measured by ROE (Return on Equity), cost saving as measured by CIR (Cost Income Ratio), and credit risk or asset quality as measured by LLRGLA (Ratio of Loan Loss Provision to Gross Loans and Advances).
In terms of time, this research work covered a period of ten years from 2000 to 2009. That is, five years of 2000, 2001, 2002, 2003, and 2004 before the consolidation exercise was
concluded in 2005; and then five years of 2005, 2006, 2007, 2008, and 2009 after the conclusion of the 2005 consolidation exercise.
1.7: SIGNIFICANCE OF THE STUDY.
Nigeria presents a good case study of a country that has had persistent and numerous reforms in the banking sector. Despite the increased effort of government to maintain a stable financial system, the age-long problems affecting the banking industry seems unabated.
Existence of a sound banking system will to a large extent bring a turning point in the growth of the Nigerian economy. Considering the acclaimed importance of the banking sector in the growth of the economy, the outcomes of this study would likely prove to be beneficial to banks, policy makers, and future researchers.
The expected benefits to each of the key stakeholders are illustrated as follows:
a. The Regulators.
The outcome of this study is expected to benefit policy makers such as government and its agencies in providing a platform for designing and redesigning policies that will enhance monetary and financial stability policies that will enable banks in Nigeria play its financial intermediation role well, as well as to grow the economy. Thus reiterating the views of (Ogewewo and Uche 2006), for the need for monetary stability which is a prerequisite for a sound financial system. To the regulators of the industry, it will present an analysis that will help them to come up with policies to efficiently supervise and regulate the Nigerian banking system in its quest to repositioning it to be part of the global change. Ensuring that strong,
competitive, and reliable banks are in place to compete favorably in the 21st century. It will
also assist the regulators and supervisors in coming up with policies that will aid them to meet up with the challenges facing a post consolidation scenario such as size and complexity of the mega banks.
b. The Sampled banks.
Specifically, for the banks studied, it will expose to a certain extent their performances in regards to our operational variables and present a comparative analysis of their activities over the studied period of time. Also, the studied banks will see the need to imbibe best-practice in corporate governance, the need to improve on self-regulation, internal control, enhance
operational efficiency, institute IT-driven culture and seek to be competitive in today’s globalizing world.
c. The public.
To the general public that would come to appreciate the soundness and the liquidity position of Nigerian banks and be encouraged to access its services and products. It will also contribute to the enrichment of the literature on bank consolidation in Nigeria as well as serving as a body of reserved knowledge to be consulted and referred to by researchers.
1.8: LIMITATIONS TO THE STUDY.
The conduct of research in Nigeria is imbued with lots of problems. Resource constraints constituted the first major limitation to this study. Collecting 10-year reports of the banks and their components used as case study involved extensive travelling around the country, which invariably implied huge cost outlay. Getting the respective annual reports and statements of accounts of the sampled banks and their merged or acquired components for ten years timeframe posed serious difficulties given the poor habit of preservation of documents and materials in the country. Some of the banks archived reports have either been destroyed or lost, as they were not available at the relevant places.
While it will make sense to expand the timeframe and sample size of this study to cover at least 50% of the total number of quoted banks, doing this could have caused us to encounter many missing observations in the dataset because of the reasons given above. The data is therefore limited in temporal scope to ten years. However, efforts were made to overcome these threatening factors to justify the objectives of this study.
This material content is developed to serve as a GUIDE for students to conduct academic research
THE EFFECT OF BANK CONSOLIDATION ON BANK PERFORMANCE: A CASE STUDY OF THE 2005 CONCLUDED NIGERIAN BANK CONSOLIDATION EXERCISE
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