AHAM NZENWATA
ABSTRACT
This
paper investigated the use of bank supervision as a tool for attaining banking
industry safety and stability. The paper shows that bank supervision can be
either onsite or offsite. In addition to the above, bank supervision can be
approached on the bases of transaction, consolidated or risk based approach
although recent literature indicate that risk based supervision is the most
prevalent following the recommendations for the adoption this method for
effective supervision. Furthermore, the paper indicates that bank supervision
in Nigeria is the joint responsibility of the NDIC and the CBN in accordance
with established standards of The Basel Accord for bank supervision. Thus, the
CBN in collaboration focus on core banking operations during supervisions.
These core banking operations include the following: capital requirement, loan
concentration, liquidity ratio, provisioning, internal control and management
among others. The supervisory authorities compare the performance of deposit
money banks to already determined standards and templates. Where they fall
short, corrective measures are set in motion. finally, the paper shows that
bank supervision by the CBN as much as possible strives to comply with the
supervisory guidelines and standards.
1 INTRODUCTION
Bank
supervision involves monitoring the financial performance and operations of
banks in order to ensure that they are operating safely and soundly and
following rules and regulations. Bank supervision also involve the monitoring/enforcement
of the written rules that define acceptable behavior and conduct for financial
institutions.
In
recognition of the fact that a well functioning economy requires a stable
banking system, banking supervision is entrusted with the responsibility of
ensuring that the desired conditions are achieved in the sector through
monitoring the sector's activities and maintaining investor confidence. Weakness
of the regulation and supervision of the financial system is viewed as a major
factor, contributing to and the emergence of bank failures and financial crisis
(Noy, 2004).
Demirgüç-Kunt
and Detradiache (1998) argue that if financial liberalization is accompanied
with weak prudential supervision of the banking sector, then it will result in
excessive risk taking by financial intermediaries and a subsequent crisis.
Thus, banking supervision is an essential aspect of modern financial systems,
seeking crucially to monitor risk-taking by banks so as to protect depositors,
the government safety net and the economy as a whole against systemic bank
failure and its consequences.
Banking
supervision has been generally set the tasks of helping to prevent the
occurrence of systemic risk to the banking sector, as well as to increase the
transparency and effectiveness of the banking sector and contribute to the
protection of small depositors (Davis, & Obasi, 2009).
In
recognition of the importance of bank supervision in a country's financial
system and the economy in general, this paper is aimed at investigating the use
of bank supervision as a tool for ensuring banking industry safety and
stability.
2 CONCEPTUAL FRAMEWORK
Banking
supervision has been generally set the tasks of helping to prevent the
occurrence of systemic risk to the banking sector, as well as to increase the
transparency and effectiveness of the banking sector and contribute to the
protection of small depositors.
Essentially,
there are two types of bank supervision.
These are On-site bank supervision
and off-site bank supervision. While in On-site
bank supervision, the supervisory agencies visit the banks to examine the
concerned bank's records and facilities. In Off-site supervision, the concerned banks are expected to submit
their records to the offices of supervisory agencies for analyses.
In
most cases, there is an overlap between onsite and offsite supervision. For
example, onsite supervision may require that the supervisory agencies take
certain records belonging to the banks to their offices for further analyses. On
the other hand the supervisory agencies may find it expedient to take a trip to
the bank to confirm the contents of sum of the records that have been submitted
by the bank whose records is being examined.
Whether
onsite or offsite, bank supervision is likely to take the form of any of the
following approaches:
·
Transaction Based
Supervision Approach
·
Consolidated
supervision Approach
· Risk
Based Supervision Approach
2.1 Transaction Based Supervision Approach
The transaction based supervisory
approach focuses on individual entities for examination. Individual entities
are supervised on a solo basis according to the capital requirements of their
respective regulators. The Transaction’s Based Type of Supervision of
individual entities is complemented by a general qualitative assessment of the
group as a whole and, usually, by a quantitative group-wide assessment of the
adequacy of capital.
2.2 Consolidated supervision Approach
Consolidated
supervision Approach involves the process where the supervisor can satisfy
himself about the health of the entire group’s activities which may include
bank and non bank companies, financial affiliates as well as branches and
subsidiary companies. Consolidated supervision has the following objectives:
·
To support the
principle that no banking activity, and the associated risk no matter where
located, escapes supervision.
·
To prevent
over-leveraging of capital- double counting
·
To evaluate the
strength of a group to which a licensed bank belongs, in order to assess the
potential impact of other members of the group on the licensed bank.
·
To consolidate the
financial returns i.e. consolidation of accounts of the licensed entity using
quantitative approach, while ensuring that the qualitative approach evaluates
the material risks on the financial position of the licensed bank.
Consolidated
supervision will entail the following:
·
Adequate knowledge of
the structure of a group and the risks there in;
·
Adequacy or otherwise
of capital measured on a group basis;
· Measurement
of larger exposures on a group basis.
2.3 Risk Based Supervision Approach
According
to the NDIC, the dynamism of the global economic environment requires more
robust tools and skills to mitigate risks arising from the rapid development of
the financial sector. In response to the changing financial landscape,
advancement in, and widespread use of information/communications technology, a
more effective approach is required.
Although
effective risk management has always been central to safe and sound banking
activities, it has assumed added importance for two main reasons. Firstly, new
technologies, product innovation, size and speed of financial transactions have
changed the nature of banking. Secondly, there is need to comply fully with the
Basel Core Principles on Supervision and to prepare an enabling environment for
the implementation of the New Capital Accord.
Risk
Based Supervision assesses the efficacy of a bank’s ability to identify,
measure, monitor and control risks. It designs a customized supervisory
programme for each bank and focuses more attention on banks that are considered
to have potentially high systemic impact. By the very nature of banking
business, banks are inextricably involved in risk-taking.
The
major risks banks face in the course of business include, but not limited to,
credit, market, liquidity, operational, legal and reputational risks. In
practice, a bank’s business activities present various combinations of these
risks, depending on the nature and scope of the particular activity. To the
financial sector regulatory and supervisory authorities, what constitute risks
are those factors that pose threat or portend danger to the achievement of
statutory objectives.
3 THEORETICAL FRAMEWORK
Theories
proposed to explain bank supervision can be broadly divided into two based on
whose interest is paramount in the process of supervision. These are the public
interest view and private interest view (Barth et al, 2004).
On
the public interest view, the
government provides supervision that tries to capture completely all aspects of
banking business/activities from start to finish. The purpose of this view is
twofold: (a) to prevent or mitigate the fallout of market failures (b) to
discipline erring banks and bankers. Basically, the public interest view is
proposed to protect the interest of the generality of the populace who use bank
services.
On
the other hand, in the private interest
view, the government and its agencies only provide light supervision and
the banks are on the whole allowed to operate without much hindrance to their
activities. The banks are also allowed to operate in a range of markets and
activities that may not necessarily be core bank activities. In the private interest view, bank can become
so powerful and pervasive that they can capture and make the supervisory
agencies to act in their interests.
Other
theories are closely related to those discussed above. for example, the political/regulatory capture view is
closely related to the public interest view but holds the opinion that
politicians may be the ones to "capture" the supervisory agencies and
induce them to act in a manner that is in their individual interest like
channeling bank credits to politically motivated activities or to firms where
the politicians have pecuniary interests Hamilton, et al (1988)
The
private empowerment view as proposed by Grossman and Hart (1980) is closely
related to the private interest view. This theory proposes that the powers of
supervisory agencies be restricted but at the same empower supervisors
sufficiently to force banks to make adequate disclosures that can be used to
monitor their activities by private agents.
Finally,
the independent supervision view put forward by Beck et al (2013) attempts to
overcome the problems of poor credit allocation and supervisor capture which
are inherent in the public/political interest view and private interest/private
empowerment views by proposing the establishment of an officially sanctioned
bank supervision agency that is independent of government interference.
4. SUPERVISORY ACTIVITIES OF CBN AND NDIC
The CBN/NDIC during bank supervision and
examination focus on the main aspects of banking operations. These include
capital requirement, loan concentration, liquidity ratio, provisioning,
internal control and management among others. The supervisory authorities
compare the performance of deposit money banks to already determined standards
and templates. Where they fall short, corrective measures are set in motion.
Capital
Requirements
Adequate
capital is very important for any business, and banking is not an exception.
The importance of adequate capital in banking stems from the following
functions being performed by capital, viz: capital provides a cushion for
absorbing operational losses; it provides a measure of shareholders’ confidence
and stake in the bank; it reveals the bank’s ability to finance its capital
expenditure and fixed assets; and it provides protection to depositors’ funds,
among others. It is therefore necessary to have enough capital so that
depositors’ risks could be minimized. Government, on the advice of the monetary
authorities, prescribes the minimum paid-up capital for banks. (NDIC, 2015).
Using banks’ total risk-weighted assets
ratio for example, the supervisory authorities classify banks as adequately
capitalized, marginally under-capitalized, significantly under-capitalized,
critically under-capitalized or technically insolvent, depending on the value
of their risk-weighted asset ratios. While a bank with risk-weighted asset
ratio of 10 percent and above is classified as adequately capitalized, a bank
with a negative risk-weighted assets ratio is classified as technically
insolvent. This classification is an attempt at establishing bench-marks for
prompt supervisory intervention.
Loan
Concentration
Considering the fact that it is risky
for a bank to concentrate its lending operations in a single sector or
borrower, the regulatory authorities usually direct banks to diversify their
lending activities. Also, banks are required to report large borrowings to the
CBN in the statutory returns.
Liquidity
Ratio
Banks are required to maintain a minimum
liquidity requirement by ensuring that the level of cash flows is matched by
expected receipts so that they can meet their obligations as they fall due.
Liquidity is achieved through effective fund management. Given the critical
role of liquidity in banks’ operations, it is essential for banks to provide
for both the expected as well as the unexpected fluctuations in their
businesses as reflected in their balance sheets and to provide funds for growth.
Provisioning
There is the need for banks to make
provisions for non-performing credit facilities. The provisioning should be
adequate so as not to mislead the depositors and the general public on the true
state of affairs of the bank. These provisions are made on the basis of
perceived risk of default on specific credit facilities. The provisioning is
also applicable to performing loans because these loans also carry some
elements of risk loss, no matter how small. The issues relating to provision
for performing loans is extensively treated under prudential guidelines for
deposit money banks.
Internal
Control
Good internal control is very essential
in order to minimize fraud and other malpractices which can lead to loss of
assets. It also helps in ensuring compliance with laid down rules and
regulations on banking business by the operators. These reasons explain why
bank examiners focus on the internal control systems of banks.
Management
The CBN is responsible for approving the
board and changes in the boards of banks in the country. Parameters such as
competence, experience and integrity of the person(s) or group of persons
involved are considered to ensure that only qualified and responsible people
are put on the boards of banks in order to safeguard depositors’ fund and
enhance public confidence in the banking system. Good management in banks is a
must as the quality of management has been found to be the primary determinant
of success or failure of a bank the world over.
5 SUPERVISORY GUIDELINES & STANDARDS
Supervisory Standards and Guidelines are
set by supervisors with a view to ensuring effective supervision. Similarly,
the committee of banking supervisory authorities develops supervisory standards
and guidelines with the hope that member countries will adapt them with a view
to encouraging convergence towards common approaches and standards
The
Basel Accord’s Core Principles for Effective Bank Supervision
This
supervisory approach focuses on individual/group entities. Individual entities
are supervised on a solo basis according to the capital requirements of their
respective regulators. The Transaction’s Based Type of Supervision of
individual entities is complemented by a general qualitative assessment of the
group as a whole and, usually, by a quantitative group-wide assessment of the
adequacy of capital.
The
Basel committee on Banking Supervision, with the endorsement of the Central
bank Governors of the Group of ten countries in collaboration with Supervisory
authorities in fifteen emerging market countries developed a set of twenty-five
basic principles for supervisory system to be effective. The principles are
comprehensive and represent the basic elements of an effective supervisory
system. The 25 principles are enumerated below:
(1) Objectives, Independence, Powers,
Transparency and Cooperation; (2)
Permissible Activities;
(3) Licensing Criteria;
(4) Transfer of Significant Ownership;
(5) Major Acquisitions;
(6) Capital Adequacy;
(7) Risk Management Process;
(8) Credit Risk; (9) Problem Assets,
Provisions and Reserves;
(10) Large Exposure Limits;
(11) Exposures to Related Parties;
(12) Country and Transfer Risks;
(13) Market Risks;
(14) Liquidity Risks;
(15) Operational Risks;
(16) Interest Rate Risk in the Banking Book;
(17) Internal Control and Audit;
(18) Abuse of Financial Services;
(19) Supervisory Approach;
(20) Supervisory Techniques;
(21) Supervisory Reporting;
(22) Accounting and Disclosure;
(23) Corrective and Remedial Powers of
Supervisors;
(24) Consolidated Supervision;
(25) Home-Host Relationships (NDIC,
2014)
Prudential
Guidelines
To facilitate off-site supervision, a
set of prudential guidelines is introduced by the CBN for licensed banks to
ensure a stable, safe and sound banking system. It is meant to serve as a guide
to banks to:
i.
Ensure a more prudent
approach in their credit portfolio classification, provisioning for
non-performing facilities, credit portfolio disclosure and interest accrual on
non-performing assets;
ii.
Ensure uniformity of
their approach
iii.
Ensure the reliability
of published accounting information and operating results.
The ultimate justification for
prudential guidelines is the failure of the market, not only to reflect a
depositor’s risk exposure but more importantly, to control such exposures. The
objectives of prudential regulations are therefore to protect the interest of
depositors and the financial system as a whole.
Statements
for Accounting Standards
Many
banks have adopted inconsistent accounting policies and reporting practices
which make the assessment and comparison of their performances very difficult.
Some banks have allegedly overstated reported profits, while some banks
continue to accrue interest on non-performing credits, declare unearned profit
and thereafter appropriate such profits as provisions for bad and doubtful
debts.
It is the belief of the monetary
authorities that there is need to sustain public confidence in the financial
statement of banks. The new uniform accounting standards therefore seek to
provide a guide for accounting policies and accounting methods that should be
followed by banks in the preparation of their financial statements.
Other
Regulatory Directives
Other regulatory directives to the banks
included the following:
i.
Code of Corporate
Governance for banks: to ensure ethical practices by banks post consolidation,
the CBN issued code of Corporate Governance guidelines for banks. This is with
a view to encouraging transparency and accountability of management of banking
institutions and the curtailment of risk appetite of banks.
ii.
Circular on the
Development of Risk Management Systems in Nigerian Banks.
iii.
Framework for
Risk-Based Supervision of Banks in Nigeria;
iv.
Circular on Unethical
and Unprofessional Practice of De-marketing Colleagues/Other Banks in the
Industry by spreading Rumours among others.
6 CONCLUSION
This
paper investigated the use of bank supervision as a tool for attaining banking
industry safety and stability. The paper shows that bank supervision can be
either onsite or offsite. In addition to the above, bank supervision can be
approached on the bases of transaction, consolidated or risk based approach
although recent literature indicate that risk based supervision is the most
prevalent following the recommendations for the adoption this method for
effective supervision.
Furthermore,
the paper indicates that bank supervision in Nigeria is the joint
responsibility of the NDIC and the CBN in accordance with established standards
of The Basel Accord for bank supervision. Thus, the CBN in collaboration focus
on core banking operations during supervisions. These core banking operations
include the following: capital requirement, loan concentration, liquidity
ratio, provisioning, internal control and management among others.
The supervisory authorities compare the
performance of deposit money banks to already determined standards and
templates. Where they fall short, corrective measures are set in motion.
finally, the paper shows that bank supervision by the CBN as much as possible
strives to comply with the supervisory guidelines and standards.
REFERENCES
Barth, J., Caprio, G. & Levine, R.
(2004): Bank Regulation and Supervision: What works best?, Journal of Financial
Intermediation, 13(2)
Beck. T., Demirguc-Kunt. A. & Levine,
R (2003): Bank Supervision and Corporate Finance. World Bank Policy Research
Working Paper 3042, May 2003.
Bank for Int'l Settlement (2012): Core
Principles for Effective Banking Supervision (PDF) www.bis.org/publ/bcbs230.pdf
Davis, P. E., & Obasi, U (2009) The
Effectiveness Of Banking Supervision, Brunel University and NIESR, London
Demirgüç-Kunt A. and Detragiache E.
(1998). Financial Liberalization and Financial Fragility. The World Bank Policy
Research Working Paper, No: 1917, The World Bank
Grossman, R. S. & Hart, O. (1980): Disclosure Laws and Takeover Bids”, Journal
of Finance 35.
Hamilton, J. & Whiteman, C. (1988):
The Observable Implications of Self-Fulfilling Expectations, Journal of Monetary
Economics 16
Noy I. (2004). Financial Liberalization,
Prudential Supervision and the Onset of Banking Crises. Emerging Markets
Review, No:5, pp. 341-359.
For
comments, observation or other feedback or if you need assistance with your
research projects/papers, you can contact the author via E-mail:
researchmidas@gmail.com or call/Whatsapp (+234)0803-544-6622
No comments:
Post a Comment