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ANALYSIS OF BANKING RISKS AND THE ROLE OF
INSURANCE INDUSTRY FOR NATIONAL DEVELOPMENT
SUNDAY C. NWITE Ph.D, ACII, ACIB, IRDI
SENIOR LECTURER
DEPARTMENT OF BANKING AND FINANCE
EBONYI STATE UNIVERSITY – ABAKALIKI

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PHONE NO: 080-37743134
E-MAIL: nwitewhite2006@yahoo.com
ABSTRACT
Banks are among the financial institutions that exist in our economy. The
banking industry mobiles funds from individuals, households and corporate
organizations. The money mobilized, part of it are always extended to
borrowers with interest. This is the major ways banks make their profit. There
are various activities of banks like giving out loans, leasing, ownership of
property, vehicles, project financing etc. there are a lot of risks that are
exposed to their activities like interest rate risk, volatility risk, inflation risk, risk
of failure to pay debt, delay in payment of debt and sometimes government
makes some policies against the bank which is a risk. These risks affects the
performance of banks. The insurance industry on its own acts as a shock
absorber by providing covers/polices to ensure adequate protection. It has
been found that banks activities involves a lot of risks both systematic and
unsystematic risks and that insurance industry provides some policies like fire
insurance, theft insurance, legal expenses insurance, credit insurance, fidelity
guarantee insurance. It is concluded that the banking risks need to be

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managed through insurance policy mechanisms. The implication is that banks
are very volatile and if these risks are not property managed, may cause
problems to these banks which can result to distress and distress may lead to
total failure. Recommendations were made that banks should use the
insurance industry to manage their risks and also receive insurance advise to
help reduce the risks exposed to them by taking adequate insurance policies.
KEYWORDS
Hazards, perils, risks, volatility, interest risk, credit risk.
INTRODUCTION
The banking industry is the hub of any economic development of any nation.
The banking practice started with Gold Smith, but the modern banking industry

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practice started in 1890s. The introduction of banking industry has helped in
economic development in various ways such as giving out loans, financing
foreign business among business men, given out money for agricultural
development, infrastructural provision and also in marriages, even buying
vehicles.
Most of these activities of banks involve a lot of risks. These risks includes
credit risk, delay in payment risk, legal expenses risk, fidelity. These risks
arises from the banking transactions. The insurance industry plays active role
in providing some services to the banking industry like advisory role, risk
management, training staff, training on risk management and also insuring
some of their risks. This work therefore wants to look at the risks involved in
banking activities and how such risks can be managed through insurance
process for national development.
THE CONCEPT OF BANKING
The concept of banking can be traced to Gold Smith, when he started
collecting money for deposit and realized that some of the depositors do not
collect them at the same time, he decided to give out some as loan with
interest (Cyole, 2000). Interest rate sends signals to lenders, borrowers,

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savers and investors. Banking in its own has no particular definition. This is
because banking can be seen as a profession, and institution, keeping deposit
and other important documents. Rather, a banker was defined in bill of
exchange Act 1958 that a banker includes a body of persons whether
incorporated or not who carry out the business of banking. Pagets (1972)
Doyle, 1972 Hart (1931) all were given various definitions of a banker not
banking.
Today, the banking industry mobilizes savings from households, individuals
and pay them interest and then give out part of the savings to investors at
higher interest rate. Efficient financial intermediation is an important factor in
economic development process as it has implication for effective mobilization
of investible resources (Nwite, 2009).
HISTORICAL DEVELOPMENT OF BANKING INDUSTRY
Banking is an institution for keeping, lending and exchanging etcetera of
money. It is a moneybox for savings, a stock of money, fund or capital in game
of hazard, (Odo, 2004)

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The history of banking development in Nigeria can be traced back to 1890s.
The African Banking Corporation was the first commercial bank that opened its
first branch in Lagos in 1892, whose founder was Messrs Elder Dempsters
and Co. a shipping firm based in Liverpool.
This bank encountered different initial difficulties and eventually decided to
transfer its interest to elder Dempster and Co in 1893; this led to the formation
of new bank known as British Bank of West Africa (BBWA) in 1893 with the
initial capital of £10,000 which was later increased to £100,000 the same year.
The British Bank of West Africa (BBWA) was the first surviving bank in Nigeria
and registered in London as a Limited Liability Company in March 1894, and
the same year other branches started springing up.
The Barclay Bank Dominion Colonial and overseas (BBDC) was established in
Lagos in 1971 now Union Bank of Nigeria PLC. Another bank, the British and
French Bank in 1949, now called United Bank of Africa PLC was established
in 1949 making it the third expatriate banks to dominate early Nigerian
Commercial Banks. The foreign banks came principally to render services in
connection with international trade, so their relation as at that time was with

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company and with the government. These three banks control closed up to
90% aggregate bank deposits from 1914 to early 1930s, several abortive
attempts were made to establish locally owned foreign monopoly.
In Paton (1949), the indigenous sectors in 1929, industrial and commercial
banks were set up by a handful of patriotic Nigerians. It folded up in 1930s
due to their under capitalization, poor management, aggressive competition
from expatriate banks (Emeka, 1999).
According to CBN (1970) many in indigenous banks were opened and later
dissolved or collapsed between 1947 and 1952, a total of 22 banks were
registered in Nigeria. However a figure as high as 185 banks were quoted
from government records in 2000, but from 2005 till date after banking reform,
22 banks was left for operation and was licensed as commercial banks in
Nigeria.
Today, banking business or industry are licensed to operate as follows;
Merchant bank, Commercial bank, Specialized banks.

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The central bank of Nigeria repealed the universal banking operations in
September 2010 therefore, directed all commercial banks to divert from non-
banking business (Alawiye, 2011).
This reform measure effectively signaled the reversal of the universal banking
operations in the banking industry and making banks to choose International,
National or Regional banking licenses.
VARIOUS ACTIVITIES BANKS ENGAGE IN NIGERIA
Banking is the heart of economic development of any nation. The following are
the activities banks engage in Nigeria.
1. Granting consumer loans: Early in this century, bankers began to
rely more heavily on consumers for deposit to help fund their large
corporate loans. By the year 1920s and 1930s several major banks led
by one of the forerunners of New York’s Citibank and by the bank of
America, had established strong consumer loan departments. This
means consumer loans were among the fastest growing forms of bank
credit.
2. Financial advisory: This is a situation where banks engage in many
financial advisory services, from helping to prepare tax returns and
financial plans for individuals to consulting firms about marketing

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opportunities at home and abroad for business customers. They also
provide financial advisory when it comes to the use of credit and the
saving or investing of funds. (Nwite, 2004)
3. Managing cash: This means that over the years, financial institutions
have found that some of the services they provide for themselves are
also valuable for their customers. And one of the most prominent is cash
management services in which a financial intermediary agrees to handle
cash collections and disbursement for a business firm and to invest any
temporary cash surpluses in interest bearing assets until cash is needed
to pay bills.
4. Offering equipment leasing: This means that many banks and
finance companies have moved aggressively to offer their business
customers the option to purchase equipment through a lease
arrangement in which the lending institution buys the equipments and
rents it to the customer. These equipment leasing services benefit
leasing institutions as well as their customers because as the real owner
of the leased equipment, the lessor can depreciate it for additional tax
benefits.
5. Making venture capital loans: This means that banks, security
dealers and other financial conglomerates have become active in

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financing the start-up cost of new companies. This is because of the risk
involved in such loans, it is generally done through a separate venture
capital firm, that raises money from investors to support young
businesses in the hope of turning a profit when those firms are sold or go
public.
6. Selling insurance policies: For many years bankers have sold credit
life insurance to their customers receiving loans, guaranteeing
repayment if borrowers die or become disabled. Moreover, during the
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19 and early 20 centuries, many bankers sold insurance and provided
financial advice to their customers, though they do that through
organized insurance companies.
VARIOUS RISKS THAT ARISES IN BANKING ACTIVITIES
There are basic risks which are inherent in banking operations. These forms of
risk (Rose, 1999) are as identified and explained below:
1. Credit risk: Banks make loans and take on securities that are nothing
more than promises to pay. When borrowing customers fail to make
some or all of their promised interest and principal payments, these
defaulted loan and securities result in losses that can eventually erode
the bank’s capital. Because owners capital is usually no more than 10

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percent of the volume of bank loans and risky securities (and often much
less than that), it doesn’t take too many defaults on loans and securities
before capital become inadequate to absorb further losses. At this point,
the bank fails and will close unless the regulatory authorities elect to
keep it afloat until a buyer can be found.
2. Liquidity risk: There is also substantial liquidity risk in banking the
danger of running out of cash when cash is needed to cover deposit
withdrawals and to meet the credit requests of good customers. If a bank
cannot raise cash in timely fashion, it is likely to loss many of its
customers and suffers a loss in earnings for its owners. If the cash
shortage persists, this may lead to runs on the bank and ultimate
collapse. The inability of a bank to meet its liquidity needs at reasonable
cost is often a prime signal that it is in serious trouble.
3. Interest rate risk: Banks also encounter risk to their spread – that is,
the danger that revenues from earning assets will decline or that interest
expenses will rise significantly, squeezing the spread between revenues
and expenses, thereby reducing net income. Changes in the spread
between bank revenues and expenses are usually related to either
portfolio management decisions (i.e changes in the composition of banks
assets and liabilities) or interest rate risk. The probability that fluctuating

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interest rates will result in significant appreciation or depreciation of the
value of and the return from the bank’s assets. In recent years, banks
have found ways to reduce their interest rate risk exposure, but such
risks have not been completely eliminated.
4. Operating risk: Bank also face significant operating risk due to
possible breakdowns in quality control, inefficiencies in producing and
delivering services, or simple errors in judgment by management
fluctuations in the economy that impact the demand for each individual
bank’s services and shifts in competition as new suppliers of financial
services enter or leave a particular banks market area. These changes
can adversely affect a bank’s revenue flows, its operating costs, and the
value of the owners investment in the bank, e.g its stock price.
5. Exchange risk: Larger banks face exchange risk from their dealings in
foreign currency. The world’s most tradeable currencies float with
changing market conditions today. Banks trading in these currencies for
themselves and their customers continually run the risk of adverse price
movements on both the buying and selling sides of this market.
6. Crime risk: Finally, banks encounter significant crime risk fraud or
embezzlement by bank employee or directors can weaken a bank
severally and in some instance, lead to its failure. In fact, fraud and

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embezzlement from insiders constitute one of the prime causes of recent
bank closings. Moreover, the large amounts of money that banks keep in
their vaults often proves to be an irresistible attraction of outsides. The
focus of ban robberies has shifted somewhat with changes in banking
technology, theft from ATMs and from and from patrons using those
money machines has becomes one of the moist problematic aspects of
bank crime risk today.
THE ROLE OF INSURANCE INDUSTRY IN THE MANAGEMENT
OF BANKING RISK
The insurance industry from its creation, formation and operation are expert in
risk management.
The insurance industry usually conduct survey, to identify the operational risks
that arises from the environment and other risks. First risks are first identified
by the experts and if they are identified they will be evaluated or measured to
know the magnitude, to find out if such risks can be retained by the
organization or insured by the insurance company. Then the final stage is the
risk control popularly called risk treatment will come in.

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Nwite (2004) opines that the risk treatment can be financial or physical
organizations employ staff, train them organize seminars, conferences,
workshop all on the aim of training their staff.
They also provide safety gadgets for staff and ensure compliance. The flow
chart and the operations are always monitored. Sometimes, tags, fences are
used to protect places that are not meant for visitors. In most cases depending
on the type of organizations, customers are trained that come to the banking
premises.
In the banking industry, they own property, rent or build houses for office use,
electrical appliances are used staff of various categories are employed. They
own vehicles, have keyman, interact with the general public, lend out money
and also participate in some projects jointly.
All these activities are the ways risks arises in insurance practice. These
various categories of risks are managed through avoidance, reduction,
retention, transfer, combination, research diversification and hedging. These
will be discussed in the course of the work.
DEFENSIVE MEASURES AGAINST RISK BEING HANDLED BY
OTHER INSTITUTIONS

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There are other risks of banks which are being handled by other institutions,
these involves the use of the following measures;
1. Deposit with central bank of Nigeria: The deposit funds with the
apex bank is also a measure against the risks involved in banking
business. These deposits are funded through liquidity reserve and cash
reserve which are in many cases compulsory as normally adjusted in
terms of their ratios on period basis. Such funds constitute safety
reserve against a run on the banks.
2. Deposit insurance with NDIC: In Nigeria, it is compulsory for the
banks to insure their deposits with the Nigeria Deposit Insurance
Corporation (NDIC). Hence, the commercial banks and microfinance
banks do insure their depositors funds with NDIC so that in the event of
failure, such customers can be compensated the scheme is designed by
the government to prevent runs on other banks when any particular bank
fails. The scheme therefore promotes the public confidence in the
banking system. The NDIC in conjunction with the apex bank does
guarantee loans for other banks in the event of illiquidity or insolvency.
3. Risk transfer: The banks do insure their operational assets with the
insurance for future compensation in the events of loss occurring from
their inherent perils. It implies that commercial and microfinance banks

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do normally insure their physical assets against operational hazards as
well as environmental hazards. Hence, the banks transfer some of the
risks in banking business to insurance companies with the payment of
premium. The payment is to guarantee reinstatement where the risks
insured against eventually occur.
VARIOUS POLICIES INSURANCE INDUSTRY OFFER TO BANKS
Insurance industry offer a lot of services to the banking industry. Such services
ranges from advisory role, credit management role, risk management role and
acceptance of risk role.
Mordi (1987) outlines such insurance services provided to the banking
industry, such are;
1. Theft insurance policy: Theft according to theft act of 1968 was
defined as taking something which does not belong to you without the
intention of bringing it back. This type of risk is exposed to the banks
2. Fidelity insurance policy: The Nigerian banking industry engage in
employment of staff. Most of the frauds that occur in the banking
industry do arise do to insider abuse among the staff, hence, these evil
practices need to be protected, because of bad moral hazard infidelity to
a keyman’s knowledge is dishonesty.

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3. Legal expenses insurance: Banks can be taken to court by their
customers and the fire, the bank may not pay or if they pay it, it will have
serious effect in the financial statement.
4. Professional indemnity insurance policies. Insurance companies
usually advise people on some financial transactions because they are
held for professional negligence.
5. Keyman insurance: Some staff are very important in any operation,
and that of banking is not exception. So if such happens, the company
will be idle for the period until they employ another capable staff which is
not always very easy.
6. Motor insurance: The banks have motor vehicles and these vehicles
has to be insured on any of the classes of motor insurance like third
party only, theft and fire and comprehensive.
7. Accident insurance policy: The staff of the bank are also exposed
to accident; so they also need to protect the staff against accident.
8. Life assurance policies like group life assurance and workmen
compensation are now made compulsory to enable efficient operation
and safeguard against any unexpected happening.
9. Credit insurance policies: Banks give out loans to customers. There
in any probabilities that such loan may not be paid or delayed in

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payment. Aggregate of such loans may also result to distress in the
banks; hence it needs to be seen.
10. Health insurance scheme, contributory pension scheme. All these are
insurance practices and need to be appreciated by banks to enhance
efficient practice.
11. Cash in transit, money in safe insurance. Every time banks carry money
from one place to the other. They are also exposed to risk and need to
be insured. Even the police or military following the money and the
drivers need to be insured because in most times, categories of people
of this nature have lost their lives.
PROBLEMS OF MANAGEMENT OF BANKING RISKS
Risk is one of the difficult things to manage. There are some problems that
rise on the process of managing risk. They are as follows:
1. Problem of owner’s capital: The owner’s capital or share capital
funds constitute the first line of problem in managing risk in bank
business. This is because capital fund of the bank is normally used to
provide a hedge against the risk of failure. Hence, it is used to absorb
financial and operating losses until management can address the bank’s
problems.

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2. Problem of quality management: Recruitment of quality, seasoned
and experienced bank managers is one of the major problems in
managing risk in banking industry. Such quality management of banks
has to be proactive as well as reactive in their posture so that they can
deal with banks problems. Managing of banking risks involves the ability
of the top managers to move shiftily to deal with a bank’s problems
before they overwhelm the institution.
3. Problem of diversification: The management of a bank can use the
bank can use the bank’s sources and uses of funds to reduce operation
risk. Generally, banks strive to achieve two types problems in risk
diversification, portfolio and geographical diversification.
4. Problem of risk retention: This means that banks normally do not
take insurance policies on minutes items of operations and ill
experience in risk management.
5. Problem of mismatch of assets and liabilities: This is the
problem or the risk banking industry encounter when using short term
finance to finance long term investment. It will connote serious
problems.
CONCLUSION

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The management of banking risk has been discovered as an instrument for
effective operation of banking industry. Though it is being handled by both
the banks and other institutions through appropriate measures, which
involve the apex bank (CBN), Nigeria Deposit Insurance Corporation
(NDIC) and insurance companies. Adequate risk management is the best
way of handling risk in the banking industry.
RECOMMENDATIONS
The recommendations of this work are as follows;
1. There is the need for banks to employ insurance professionals in their
corporate affairs departments to handle the insurance of their physical
facilities. Such professionals would pre-occupy themselves with risk
identification and treatment. They will also liaise with insurance
companies handling their banks insurance policies. They will also be
useful in credit risk analysis and prediction.
2. There is the need for banks to engage in risk research in order to reduce
baking hazards. This is where the employment of insurance
professionals becomes very relevant.

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3. The staff of banks should be appropriately remunerated to eliminate
human attitudes that can aggravate the occurrence of some risks in bank
business.
4. All banks should strive o make use of bullet proof billion vans in order to
eliminate hazards that can lead to attack on cash in transit.
5. All banks should strive to install security doors in their premises to
checkmate the activities of hood hems on their banking halls.
6. Insurance and risk management awareness seminars and conferences.

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