Project

CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
Deposit Money Banks have been globally acknowledged for their unique role as an
engine of growth and development in any economy. Their intermediation role can be said to
be a catalyst for economic growth and development as investment funds are mobilized from
the surplus units in the economy and made available to the deficit units (Adegbaju &
Olokoyo, 2008; Kolapo, Ayeni & Oke, 2012; Mohammed, 2012). Generally, Deposit Money
Banks provide an array of financial services to their customers through which deposits are
mobilized from the banking public while credits granted for investment purposes. It can
therefore be said that the effective and efficient performance of the banking industry is an
important foundation for the financial stability of any nation. But it is pathetic that banking
nowadays is abode of series of challenges that lead to crises and affect the effectiveness of
banking service in the economy.
Crises in banking sector have become threat to economy development, most
especially in a developing and underdeveloped countries. Nigerian banks are not excluded of
the crises and evidence of this is the recapitalization, banks merging, acquisition and lots
more. The crises in banking sector made the monetary authorities and banks regulatory
bodies to take to table the causes of the distresses and crises in the sector and proffered timely
solution to curb the extent at which the banking crises would take effect on the economy.
Despite the relentlessness of the bodies to avert the crises in banking sector and boom
the economy by its services, there are still ugly existence of distress and crises in the banking
sector and this has created big threat to the economy and cause people not to rely on banking
by the belief that their wealth is unsecured. There were rigid regulations guiding entry into
the banking system. In the end, the financial sector was repressed; especially the banking
subsector which constituted the greatest proportion of the sector and so could neither generate
enough savings at the ruling rate of interest, nor find enough investment for meaningful
capital formation and development. Thus, at the onset of deregulation the financial sector was
also deregulated; interest rates were freed and credit became free to move into whatever
sector it desired. Rules concerning entry into the financial system were relaxed and there was
a massive inflow of new players into the financial sector.
By 1992, the number of banks in the Nigerian banking sector had risen from 56 to 120
in 1986 (Adegbite, 2005). However in spite of the increased number and variety of financial
institutions the real economy showed no marked improvement. In fact by the beginning of the
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new millennium (2000-2002) all macro-economic indicators were declining (Adegbite,
2005). In Nigeria, the collapse of banks and the subsequent loss of depositors funds has
resulted in low economic growth, low capacity utilization, unemployment among other
problems.
Soludo (2005) observes that many banks appear to have abandoned essential
intermediation role of mobilizing savings and inculcating banking habit at the household and
micro-enterprises levels. Due to capital inadequacy, lack of transparency and non-performing
loans of many banks in the country, they were faced with high cost of financial distress and
this certainly affected banks’ profitability.
There are series of internal irregularities in the banking nowadays, which have taken
banking from behind and have by one way or the other caused distress in banking. Insider
abuse, inside lending, unsecured lending, fraud and lots of unethical practices are among
these irregularities and despite the time to time regulations, it is still an issue of serious
attention, how banks witness distresses and crises and the economy is at the other side to
suffer.
1.2 Statement of the Problem
Central Bank of Nigeria (CBN), under the governorship of Charles Soludo, set series
of regulations, ranging from recapitalization and other reforms to avert primordial distress.
Yet, banks did witness crises under the governorship of Sanusi Lamido, whose administration
also proved to tailor banking to crises-free and economic-beneficial environment. But,
banking could still not give the testimony of total aversion of distresses and crises along the
line of their services.
The recapitalization policy of 2004/2005 ended up with 14 out of the 89 deposit
money banks disappearing from the scene as a result of their inability to meet up with the
minimum capital base requirement. Although there appears to be many factors attributed to
the incidence of bank failure in Nigeria, a good number of authors have not really established
the key ones.
Obamuyi (2011) found that, although the recent consolidation exercise made the
banks to be heavily capitalized in line with global financial system, it did not guarantee sound
financial stability, as a result of implementation problem. In his study on bank failure in
Nigeria: a consequence of capital inadequacy, lack of transparency and non-performing
loans. Adeyemi (2011) posited that three factors have been the main reasons of the incessant
bank failures: capital inadequacy, lack of transparency and non-performing loans.
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Babalola (2009) examined the perception of financial distress and customers’ attitude
toward Banking and found that, perceived financial distress and bank account customers has
significant negative influence on attitude toward banking.
While Ogundina (1999) sees ownership structure as a factor accountable for bank
failure. Ogubunka (2003) identifies weak/ineffective internal control system, poor
management among others as causes of bank distress/failure.
Therefore, this research aims at determining the determinants of the crises in banking
sector in Nigeria in order to form an opinion whether the identified factors act as a trigger to
bank crisis in Nigeria and to make appropriate recommendations.
1.3 Objectives of the Study
The general objective of this study is to examine the determinants of banking crises;
this broad objective is broken down to the following specific objectives, which are to:
i. Investigate the extent to which lack of transparency has been responsible for bank
crisis among deposit money banks.
ii. Assess the relationship between capital inadequacy and bank crisis among deposit
money banks in Nigeria.
iii. Evaluate the effect of non-performing loans on bank crisis among deposit money
banks in Nigeria.
1.4. Research Questions
Given that final states can be reached from different starting points along various
perspectives in research studies, we have drawn our research question moulds or frame of
reference from the objectives of this study. The major research questions are:
i. What extent has lack of transparency been accountable for bank crisis?
ii. What relationship exists between capital inadequacy and bank crisis among deposit
money banks?
iii. What are the effects of non-performing loans on bank crisis among deposit money
banks in Nigeria?
1.5 Research Hypotheses
The following hypotheses were formulated from the objectives which will be verified
in the course of this research work and will guide us in finding the solution to the problem
that is induced in this research work:
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Hypothesis One;
H0: There is no relationship between lack of transparency and bank crises among deposit
H1: There is relationship between lack of transparency and bank crises among deposit
Hypothesis Two;
H0: There is no relationship between capital inadequacy and bank crises in Nigeria.
H1: There is relationship between capital inadequacy and bank crises in Nigeria.
Hypothesis Three;
H0: There is no relationship between non-performing loans and bank crises among deposit
H1: There is relationship between non-performing loans and bank crises among deposit
1.6 Significance of the Study
The research study is important to the Nigerian banks and deposit money banks to
identify the determinants of distresses and crises in the sector and proffer the solution to curb
the crises. The study of bank crises will assist deposit money banks (DMBs) managers in
understanding the nature of causes of bank crises and how they will be able to predict
banking crises. Moreover, it will also enable them to improve their performance and
efficiency through better managerial practices.
1.7 Scope of the Study
The study covers all the money deposit institutions in Nigeria; however, the study will
be limited to those banks that met recapitalization through mergers and acquisition and are
listed on the stock exchange official lists in Nigeria.
Ordinarily, for a very important and sensitive research study should have been
extended to cover globally. However, such coverage would have made the project
cumbersome, time consuming and unreasonably wide. This will constitute hindrance in
embarking on such a research.
In summary, this research may not cover all the numerous banks in the country as a
result of inadequate time and scarce financial resources at our disposal but will be limited to
the number of banks listed on the stock exchange. The identified constraints will not affect
the validity of the outcome of this research work.
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1.8 Operational Definition of Terms
Bank: a licensing institution which accepts deposits from individual, organizations etc. and
provides them various financial services.
Bank Distress: the inability of a bank to honour its obligation to depositors and other
creditors and meet operating expenses on a day-to-day basis. This means that the total
liabilities are more than total assets.
Bank crises: the condition where bank is unable to meet up with all demands and at the point
the bank is liquidated.
Bank failure: it occurs when a bank is unable to meet its obligations to its depositors or other
creditors because it has become insolvent or too illiquid to meet its liabilities.
Capital inadequacy: inability of a bank to maintain equity capital sufficient to pay
depositors whenever they demand their money and still have enough funds to increase the
banks’ assets through additional lending.
Deposit Money Banks: the resident depository corporations and quasi-corporations which
have many liabilities in the form of deposits payable on demand, transferable by Cheque or
otherwise usable for making payments.
Lack of transparency: hidden agenda or conditions, accompanied by the availability of full
information required for collaboration, cooperation and collective decision making.
Non-performing loans: is a loan that is in default or close to being in default. Many loans
become non-performing after being in default for 90 days, but this can depend on the contract
terms.
5

References
Aburime, T.U. (2009). “Impact of Political Affiliation on Bank Profitability in Nigeria”.
African Journal of Accounting, Economics, Finance and Banking Research vol. 4.No.
4.
Adeyemi, B. (2011). “Bank Failure in Nigeria: Consequences of Capital Inadequacy, Lack of
Transparency and Non-Performing Loans”.Banks and Bank Systems, vol. 6(1).
Adegbaju, A. A. &Olokoyo, F.O (2008). Recapitalization and Banks’ Performance: A Case
Study of Nigerian Banks.African Economic and Business Review, 6 (1), PP. 1 – 17.
Adegbite, E.O. (2005). “Financial Sector Reforms and Economic Development in Nigeria:
The Role of Management”. A Paper Presented at the Inaugural National Conference
of the Academy of Management in Nigeria titled Management: Key to National
Development held on November, 22-23, at Rock view Hotel, Abuja.
Babalola, S. S. (2009). “Perception of Financial Distress and Customers’ Attitude toward
Banking”.International Journal of Business and Management, vol. 4(10), October.
Kolapo, T. F., Ayeni, R. K. & Oke, M. O. (2012). Credit risk and commercial banks’
performance inNigeria: A panel model approach. Australian Journal of Business and
Management Research, 2(2), 31 – 38.
Mohammed, Fatimoh (2012). Impact of Corporate Governance on Banks Performance in
Nigeria. Journal of Emerging Trends in Economics and Management Sciences
(JETEMS), 3(3), 257-260.
Nzotta, S. M. and Okereke, E. J. (2009). “Financial Deepening and Economic Development
of Nigeria: An Empirical Investigation”. African Journal of Accounting, Economics,
Finance and Banking Research vol. 5. No. 5.
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Obamuyi, T.M. (2011). “Incessant Bank Distress and the Policies of Central Bank of
Nigeria”. International Journal of Finance and Accounting, vol. 1 no. 1 (March).
Ogubunka, U.M. (2003). Walking Ahead of Bank Distress. The Secrets of Safeguarding
Your Money in Banks, Lagos: Rhema Enterprises, pp. 19-26.
Ogundina, A. (1999). The Nigerian Banking and Financial Environment, Ibadan
Immaculate Press, pp. 138-151.
Olokoyo, Felicia Omowunmi (2012). The Effect of Bank Deregulation on Bank Performance
In Nigeria. International Journal of Advances in Management and Economics, 1(5),
pp. 31- 36.
7

CHAPTER TWO
LITERATURE REVIEW
2.0 Introduction
The chapter discussions centered on four major platforms. First, the literature review
will focus on relating the component of the predictor and measures of the criterion variable.
Secondly, shall attempt to explain the theoretical foundation on which this study is based. By
this we mean the theories which offered us intellectual map for analysis. The third section
will discuss on past work and contributions of various authors on the predictor variable
(determinants), the criterion variable (banking crisis on deposit money banks). Finally, the
last task deals with appraisals of literature.
2.1 Conceptual/ Theoretical Framework
2.1.1 Conceptual Framework
2.1.2 Concept of Banking
To many people, a bank refers to an institution which accepts deposits from the public
and in turn advances loans by creating credit. It is different from other financial institutions in
that they cannot create credit though they may be accepting deposits and making advances.
Economists on their part have defined a bank in various capacities, some emphasizing its
various functions. However, a bank has been defined broadly as any financial institution that
accepts, collects, transfers, pays, exchanges, lends, invests, or safe- guard’s money for its
customers. This broader definition includes many other financial institutions that are not
usually thought of as banks but which nevertheless provide one or more of these broadly
defined banking services. Summarizing these definitions a bank is simply an institution
which accepts deposits from the public and in turns advances loans by creating credit.
The definition of banking shall be considered under three viewpoints:
a) Definitions of bank or banker by Text-Book Writers
b) Definitions of bank or banker by Status
c) Definitions of bank or banker as expressed by the Courts
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a) Definitions of Bank or Banker by Text-Book Writers:
A bank has been defined by Dr. Hart as “a person or company carrying on the
business of receiving moneys, and collecting drafts, for customers subject to the obligation of
honoring cheques drawn upon them from time to time by the customers to the extent of the
amounts available on the current accounts". In his 8th edition, published in 1972 defined "a
bank or banker as a corporation or person (or group of persons) who accept money on current
accounts, pay cheques drawn upon such account on demand and collect cheques for
customers, that if such minimum services are afforded to all and sundry without restriction of
any kind, the business is a banking business, whether or not other business is undertaken at
the same time; that providing the banking business as so understood is not a mere for other
business, the person or corporation is a banker or bank for the purposes of statutes relating to
banking, other than those where the sole criterion is the satisfaction of some government
department".
Chamber's Twentieth Century Dictionary defines a bank as an "institution for the
keeping, lending and exchanging, etc. of money. Economists have also defined a bank
highlighting its various functions. According to Crowther, "The banker's business is to take
the debts of other people to offer his own in exchange, and thereby create money." A similar
definition has been given by Kent who defines a bank as "an organizational whose principal
operations are concerned with the accumulation of the temporarily idle money of the general
public for the purpose of advancing to others for expenditure."
Sayets, on the other hand, gives a still more detailed definition of a bank thus:
"Ordinary banking business consists of changing cash for bank deposits and band deposits for
cash; transferring bank deposits from one person or corporation (one 'depositor') to another;
giving bank deposit in exchange for bills of exchange, government bonds, the secured or
unsecured promises of businessmen to repay, etc. Thus, a bank is an institution, which
accepts deposits from the public and in turn advances loans by creating credit. It is different
from other financial institutions in that they cannot create credit though they may be
accepting deposits and making advances.
b) Definitions by Statutes:
There are no definitions by statute that are of more value. All we can see from the
statutes are that both the Bills of Exchange Act 1882 and the Stamp Act, 1891 attempted to
9

define a banker as any person carrying on the business of banking. In fact, section 2 of the
Bills of Exchange Act, 1882 provides that "in this Act, unless the context otherwise requires.
A 'banker' includes a body of persons, whether incorporated or not, who carry on the business
of banking". A Bank is "a company which carries on as its principal business the accepting of
deposits of money on current account or otherwise, subject to withdrawal by cheque, draft or
order". The 1958 Banking Ordinance defined banking as "the business of receiving money on
current account, of paying and collecting cheques drawn by or paid in by customers, and of
making advances to customer".
Section 2 of the bills of exchange Act 1958 defines a banker as follows: Banker includes a
body of persons whether incorporated or not who carry on the business of banking.
Section 2 of the Coins Act 1958 state that bankers mean any corporation carrying on
the business of banker or financial agents. Again section 2.1 of the Nigerian Evidence Act
1958 provides that a bank and banker means any persons, partnership or company carrying
on the business of bankers and also include any savings established under the savings bank
ordinance and also any banking company incorporated under any ordinance hereto or
hereinafter passed relating to such incorporation. Also under section 4.1 of the banking Act
1969 the term bank is defined as follows: Bank means any person who carries on banking
business and includes a commercial bank, an acceptance house, a discount house and
financial institution.
c) Definitions as expressed by the Courts:
There are a number of decided cases where the definition of a banker has been made.
For example, there was a traditionally expressed view that no one may be considered a
banker unless he pays cheques drawn on self. This was re-affirmed by Justice J. Mocatta
(1965) and was supported by the Court of Appeal in the celebrated case of United Dominions
Trust Ltd. Versus Kirkwood (1966).
2.1.3. Evolution of Banking
Banking is generally known to have started by the Italian goldsmiths who settled
down into business in London in about the seventeenth century. They began by accepting
deposits of gold coins and other valuables from their customers for safekeeping As the
volume of this business grew they had to build large strong rooms where these customers'
valuable items were kept until demands were made on them by the depositors. But from
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empirical observations, they found out that not all that were deposited were needed at any
particular time. They began giving out part of the money deposited to interested borrowers by
way of loans. They charged some amount of interest. The acceptance of deposits and granting
of loans are still some of the basic banking functions all over the world today. It must be
borne in mind that the forerunner of the modern banking started and performed virtually all
the present functions of modern banking. The acceptance of their customers' letter of
instruction to transfer funds from his or her holding to another represents the present day
cheque system. After all a cheque is merely an instruction on a legalized paper from one
customer to the banker requesting him (the banker) to pay money written on the cheque to a
named beneficiary. The Goldsmiths' receipts to their clients became the first known issue of
notes, though they were not legal tender. These receipts later became transferable
instruments.
As the individual goldsmith's business expanded, it became necessary for them to
organize themselves into groups to form Merchant and Private Banks. As a result of the fast
expanding activities of these goldsmiths and the huge financial involvement by individual
citizens, it became necessary to protect both the depositors and the goldsmiths. In
consequence, therefore, the British Government in 1694 established the Bank of England to
regulate and control these merchant and private banks amongst other functions. In Nigeria,
banking came with the advent of colonial masters the British colonists. The introduction of
the first modern banking dated back to 1892, when the African Banking Corporation was
established in Lagos at the invitation of Elder Dempster and Company. African Banking
Corporation was based in South Africa but merely opened a branch office in Lagos to finance
the shipping business of Elder Dempster and Company who was operating steamship services
between Liverpool and the West Coast of Africa. Probably as a result of the good
performances of the African banking Corporation, another bank opened its branch office in
Lagos in 1894. The bank was The Bank of British West Africa (now known as First Bank of
Nig. Plc), which was registered in London in 1892 with an authorised capital of £100,000 (or
N200,000). This bank enjoyed the monopoly over banking business in Nigeria until 1916.
Until this date, however, the bank (B.B.W.A.) was the sole agent for the custody and
distribution of British silver currency in West Africa as issued by the West African Currency
Board, which was established in 1912. The Bank of British West Africa remained dominant
in the field until 1916 when the Colonial Bank, which was established. As a result of its
11

dynamism, the bank opened fifteen branches within four years it was established in West
Africa.
In 1925, the assets and liabilities of this bank were taken over by a consortium of
banks comprising Barclays Bank, Anglo-Egyptian Bank and the National Bank of South
Africa to form a new bank named Barclays Banks, D.C.O. (Dominion, Colonial and
Overseas). This new bank had to change its name to Barclays Bank of Nigeria Ltd., and later
to Union Bank of Nigeria Limited. The acceptance of their customers' letter of instruction to
transfer funds from his or her holding to another represents the present day cheque system.
After all a cheque is merely an instruction on a legalized paper from one customer to the
banker requesting him (the banker) to pay money written on the cheque to a named
beneficiary. The Goldsmiths' receipts to their clients became the first known issue of notes,
though they were not legal tender. These receipts later became transferable instruments. As
the individual goldsmith's business expanded, it became necessary for them to organise
themselves into groups to form Merchant and private banks. As a result of the fast expanding
activities of these goldsmiths and the huge financial involvement by individual citizens, it
became necessary to protect both the depositors and the goldsmiths. In consequence,
therefore, the British Government in 1694 established the Bank of England to regulate the
control these merchant and private banks amongst other functions.
In Nigeria, banking came with the advent of colonial masters the British colonists.
The introduction of the first modern banking dated back to 1892, when the African Banking
Corporation was established in Lagos at the invitation of Elder Dempster and Company.
African Banking Corporation was based in South Africa but merely opened a branch office in
Lagos to finance the shipping business of Elder Dempster and Company who was operating
steamship services between Liverpool and the West Coast of Africa. Probably as a result of
the good performances of the African banking Corporation, another bank opened its branch
office in Lagos in 1894. The bank was The Bank of British West Africa (now known as First
Bank of Nig. Pic), which was registered in London in 1892 with an authorised capital of
£100,000 (or N200, 000). This bank enjoyed the monopoly over banking business in Nigeria
until 1916. Until this date, however, the bank (B.B.W.A.) was the sole agent for the custody
and distribution of British silver currency in West Africa as issued by the West African
Currency Board, which was established in 1912. The Bank of British West Africa remained
dominant in the field until 1916 when the Colonial Bank, which was established. As a result
of its dynamism, the bank opened fifteen branches within four years it was established in
12

West Africa. In 1925, the assets and liabilities of bank were taken over by a consortium of
banks comprising Barclays Bank, Anglo-Egyptian Bank and the National Bank of South
Africa to form a new bank named Barclays Banks, D.C.O. (Dominion, Colonial and
Overseas). This new bank had to change its name to Barclays Bank of Nigeria Ltd., and later
to Union Bank of Nigeria Limited.
Other expatriate banks such as United Bank for Africa, Arab Bank, International Bank
for West Africa, Bank of India, Bank of America later Savannah Bank and Chase Manhattan
Bank were later introduced into Nigeria. These banks were established by the colonial
government and businessmen and as such they were mainly catering for the interest of
expatriates. The indigenous men and women and their enterprises were severally
discriminated against. This discriminatory attitude of these foreign banks led to the first
known protest by the Nigerian business community in 1892. This was followed by an appeal
from the native traders of Lagos to the Financiers from Great Britain when they visited Lagos
in 1912. The height of these protests was the establishment in Lagos of the first indigenous
financial institution known as the Industrial and Commercial bank in 1929. This protest
"motivated" bank which was established primarily to moderate the effects of the
discriminatory credit and investment policies of the expatriate banks against the indigenous
enterprises went into liquidation 1930.
In 1931 another indigenous banking institutions; the Nigerian Mercantile Bank was
formed with an initial paid-up capital of N3,400. Its total deposits did not exceed N5,000
before it voluntarily liquidated in 1936. This bank had the same Managing Director with first
indigenous bank (the Industrial and Commercial bank) that liquidated in 1930. The failures of
these banks were largely due to inadequate capital, inexperience management and inefficient
and crude accounting method, as well as the prevailing depressed economic conditions at the
time. In spite of these woeful failures the determination of Nigerians to own, control and
manage their own banks continued. However, successful indigenous banking efforts in
Nigeria thus began with the establishment of the National Bank of Nigeria Ltd., in 1933. The
bank started with a nominal capital of N20,000 and the paid-up capital grew from N2,046 in
1936 to N29,108 in 1946. The deposits liabilities grew from N7,830 in 1936 to N345,930 in
1946 and Loans/Advances grew from N9,486 to N220,000 during the same period. The
favorable outcome of the effort the then Western Region of Nigeria Government in
establishing the National Bank of Nigeria; the continuing need to provide banking credits to
the indigenous enterprises and the buoyancy of the economic conditions during the post-
13

world war years encouraged others to establish indigenous banks. In any case, between 1945
and 1960 a total of twenty three indigenous banks were established and twenty of them had
either failed or surrendered their licenses and three survived. The historical development of
commercial banking in Nigeria is well documented. Detailed analysis can be found in various
books. Nigeria appears to be unique among the African Colonial territories in having an early
experience of active indigenous commercial banking, although this sector had constantly
been dwarfed by the expatriate sector in terms of percentage and absolute shares of assets and
liabilities. Indeed, the development of the commercial banking system in Nigeria has been
along oligopolistic lines in which a few expatriate banks control the market. This is to be
expected, given the fact that banking services were established to serve the needs of the
nascent modern sectors (that is, the government, foreign trade, commerce and industries),
which were entirely dominated by the expatriates.
Between 1951 and 1954 many indigenous banks tottered, faltered, limped and died. In
fact these failures were of great magnitude. Various governments in Nigeria have come up
with different measures in order to tackle the problem of bank failure. Some of these
measures have contributed to strengthening the banking sector of the economy. We shall
discuss some of these measures in a latter unit under banking regulation. Nigeria as at today
(2007) has twenty-five commercial banks as a result of the recapitalization policy introduced
by the Central Bank of Nigeria.
2.1.4 The Growth of Banks in Nigeria
In Nigeria, commercial banking pre- dates central banking and laid the foundation of
the Nigerian financial system as far back as the late nineteenth century. The first commercial
bank in Nigeria was the African Banking Corporation which opened its first branch in Lagos
in 1892. The bank experienced some initial difficulties and eventually decided to transfer its
interest to Elder Dempster and Co. in 1893. This led to the formation of a new bank known as
the British Bank of West Africa (BBWA) in 1893 which is today known as the First Bank
Nigeria PLC. Another bank known as the Barclays Bank DCO (Dominion, Colonial and
overseas) opened its first branch in Lagos in 1917. This bank is known today in Nigeria as the
Union Bank Nigeria Plc. British and French Bank, now called United Bank for Africa Plc
was established in 1949 making it the third expatriate bank to dominate early Nigeria’s
commercial banking. The foreign banks came principally to render services in connection
with international trade, so their relations at that time were chiefly with the expatriate
14

companies and with the government. They largely ignored the development of local African
entrepreneurship. These three banks controlled almost about 90% of the aggregate bank
deposits at that time.
From 1914 to the early part of 1930s, several abortive attempts were made to establish
locally owned and managed banks to break the foreign monopoly. This was as a result of the
weakness of those indigenous banks in such areas as capitalization and management; and
given the total absence of regulation by any government agency, the indigenous banks could
not survive the hostile and unfair competition posed by the foreign banks. It was therefore not
surprising that by 1954, a total of 21 out of 25 indigenous banks had failed and went into self
– liquidation. In a nutshell, historically, the Nigerian banking industry had evolved in four
stages. The first stage can be best described as the unguided lassies – faire phase (1930-59),
during which several poorly capitalized and unsupervised indigenous banks failed before
their tenth anniversary.
The second stage was the controlled regime (1960-1985), during which the Central
Bank of Nigeria (CBN) ensured that only “fit and proper” persons were granted banking
license, subject to a minimum paid – up capital. The third stage was the post Structural
Adjustment Programme (SAP) or decontrolled regime (1986-2004), during which the Neo –
liberal philosophy of “free entry” was over stretched and political authorities on the bases of
patronage dispensed banking licenses. The emerging fourth stage is the era of consolidation
(2004-to a foreseeable future), with major emphasis on recapitalization and proactive
regulation based on prudential principles. In the area of Central Banking, the West African
Currency Board (WACB) carried out banking operations in the former British colonies in
West Africa before independence. The problems of the WACB led to the establishment of
Central Banks in these colonies. In Ghana, it came into being in 1957, in Nigeria 1959, Sierre
Leon in 1964, and in the Gambia 1964. The Central Bank of Nigeria (CBN) was established
by the Central Bank Act of 1958. It was to replace the West African Currency Board
(WACB) of the colonial government as part of the preparation for independent Nigeria
Roles of banking
Banks provide funds for business as well as personal needs of individuals. They play a
significant role in the economy of a nation. Capital accumulation in any economy depends on
the following roles of bank:
15

Offering liquidity: Liquidity in Banking refers to assets that can easily be converted into
cash. Money in the form of cash is regarded as the most liquid asset in the banking Industry
(Freixas & Rochet, 2008). Historically, the existence of Banks is credited to this unique
function of providing liquidity to people and cooperative bodies to carry out their daily
business activities. In order to perform this role Banks offer saving, deposit and current
account facilities to the public. When a customer decides to operate an account, and pay a
minimum amount as specified by the banks, the amount deposited on the various account is
held by the bank as deposit liability. In addition to this, banks help in keeping other
convertible equities, like certificate of occupancy, share certificate, deeds of conveyance etc.
The bank is therefore requested by law to make a certain percentage of their deposit liabilities
and capital funds available to the general public, to meet customer demand (Idahosa, 2000).
Payment Service: A Bank is under obligation to pay back to the customer any amount as
specified by the customer according to the value of the account held (Freixas & Rochet,
2008). A bank customer may also want his cheque cashed up to a stated amount and within a
specified period, at another branch of the bank or another bank. Conversely, the customer can
also receive money through the bank when a debtor has decided to pay from a distance with
crossed or open cheque.
Lending function: The deposits kept in banks need not be left idle, because from experience
banks are aware that depositors may not need all the deposits at a time. It is therefore prudent
of the banker to lend such money to investors at a higher rate which brings some revenues to
them. They achieve this through overdraft, loan, bills discounting or through direct
investment (Idahosa, 2000).
International trade services: Banks help to provide the link through which payments for
goods and services bought or sold by importers and exporters can be settled. In addition to
this, they provide guarantee to exporters who need such guarantes before they can release
their goods (Isedu, 2001).
Currency transaction: Banks trade on foreign currencies, especially US Dollars and Pound
sterling. They engage competitively in foreign currency transaction as it provides them a
significant source of revenue. However, foreign exchange transactions laws in every country
are very stringent.
Performance bond services: A performance bond is issued on behalf of customers in the
real sector of the economy where they are required to supply the bond before they can tender
16

for contract. The bond guarantees that the company has adequate financial resources to
execute the contract successfully. When a bank gives such a guarantee it usually takes an
indemnity from the customer so that it can claim against him in case of default (Umole,
1983).
Others include;
1. It encourages savings habit amongst people and thereby makes funds available for
productive Use.
2. It acts as an intermediary between people having surplus money and those requiring money
for various business activities.
3. It facilitates business transactions through receipts and payments by cheques instead of
Currency.
4. It provides loans and advances to businessmen for short term and long-term purposes.
5. It also facilitates import export transactions.
6. It helps in national development by providing credit to farmers, small-scale industries and
Self-employed people as well as to large business houses which lead to balanced Economic
Development in the country.
7. It helps in raising the standard of living of people in general by providing loans for
purchase of consumer durable goods, houses, automobiles, etc.
2.1.5 Regulatory Institutions in the Nigerian Banking Industry
The Nigerian banking industry plays a very important role in the economic growth
and development of Nigeria. This role has been enormous, particularly since the adoption of
the structural adjustment program in the mid 1980’s (Idehai, 1996). Since banking institutions
in the financial system are directly related to the economic system, it is imperative that the
government, through the various regulatory bodies, keeps a watchful eye on the system so as
to eliminate all forms of deficiencies and malpractice that could destroy the entire system. In
addition to this, banks’ regulatory institutions determine the performance of the entire
banking system. This section will therefore address the role of two major regulatory
institutions in the Nigerian banking industry.
17

Central Bank of Nigeria
The Central Bank of Nigeria (CBN) plays a vital role in the Nigerian banking
industry. Osiegbu (2006) argued that the performance of banks depends on the governmental
monetary policy, implemented by the Central Bank of Nigeria. He argued further that, one of
the traditional functions of the Central Bank of Nigeria is to manage the nation’s money and
economy through the use of monetary regulations. These are specifically designed to regulate
and control the volume, cost and direction of the money and lending in the entire economy.
These assertions were further buttressed by Nanna (2001), who claimed that the success of
the CBN to effectively implement the monetary polices depends on the mandate of the
Central Bank of Nigeria as specified in the CBN Act of 1958. It pointed them out as follows:
i. To maintain the Nigerian external reserves
ii. To promote monetary stability and sound financial structure in the banking industry.
iii. To safe guard the international bale of the currency.
iv. To act as a banker and financial adviser to the federal government of Nigeria.
v. Ensuring that banks keep adequacy of equity, liquidity and reserve funds.
vi. Regulating the lending pattern of banks to foreign and indigenous enterprise.
The Central Bank is generally regarded as the hub of the monetary and banking system of
each country. Therefore, the stability of the entire system depends on how effectively the
CBN discharges it mandated role in the banking industry.
Nigeria Deposit Insurance Corporation (NDIC)
Ogunleye (2002) pointed out that the establishment of NDIC was driven by the need to
reform the banking industry in the Nigerian economy. Most especially, one purpose was to
provide polices relating to bank shareholder funds because of the bitter experience of bank
distress in Nigeria and the lessons from other countries with bank deposit insurance schemes.
He emphasized specifically that the institution was established to provide the following
functions in the Nigerian banking industry:
a. Insuring all deposit liabilities of licensed banks and other financial institutions operating
in Nigeria so as to create confidence and trust in the mind of the public.
b. Giving assistance in the interest of depositors, in the case of imminent or actual financial
difficulties of banks, particularly where suspension of payments is threatened and
avoiding damage to public confidence in the banking system. Such assistance includes
the following:
18

i. Taking over the management of a distressed bank.
ii. Specific changes recommended to be made in the management of the distressed
banks.
iii. Recommending cases of merger and acquisition in cases of distress or financial
weakness.
iv. Guaranteeing payments to depositors in case of imminent or actual suspension of
payment by insured banks or financial institutions, up to the maximum amount of
#50,000 of assessable deposit of an insured bank in the event of a failure.
v. Assisting monetary authorities in the formulation and implementation of banking
polices so as to ensure sound banking practice and fair competition of money banks in
the country.
Ogunleye emphasized further that, the institution has made impacts in two areas, namely in
developing banks’ directors and top management as well as assisting in banking with serious
distress. The crucial role of this institution is to assists banks in mobilizing deposit money
from the public for lending purposes.
2.1.6 Meaning of Crisis
Bank crisis is said to occur when a bank or some banks in the system experience
illiquidity or insolvency resulting in a situation where depositors fear the loss of their deposits
and a consequent breakdown of contractual obligations. Banking crisis can be triggered by
weakness in macro-economic variables such as inflation rate, interest rate and exchange rate.
Banking crisis could also be attributable to persistent illiquidity, insolvency, under
capitalization, high level of non-performing loans and weak corporate governance among the
management of the financial institutions. Banking crisis usually starts with inability of the
bank to meet its financial obligations to its stakeholders, which usually results in bank run.
The banks and their customers engage in massive credit recalls and withdrawals which
sometimes necessitate Central Bank’s liquidity support to the affected banks. Some terminal
intervention mechanisms may occur in the form of consolidation, recapitalization and the use
of bridge banks.
While financial crises can take various shapes and forms, in terms of classification,
broadly two types can be distinguished. Reinhart and Rogoff (2009) distinguish two types of
crises: those classified using strictly quantitative definitions; and those dependent largely on
19

qualitative and judgmental analysis. The first group mainly includes currency and sudden
fully irrational asset bubbles are not necessarily harmful or could even be beneficial
(Kocherlakota, 2009). Bubbles can allow for a store of value (“collateral”) and thereby
enhance overall financial intermediation through facilitating exchanges, and thereby improve
overall economic performance. As such, the presence of bubbles per se, whether rational or
irrational, need not necessarily be a cause for concern. Stop crises and the second group
contain debt and banking crises. Regardless, definitions are strongly influenced by the
theories trying to explain crises. While financial crises can take various shapes and forms, the
literature has been able to arrive at concrete definitions of many types of crises. For example,
a currency crisis involves a speculative attack on the currency resulting in a devaluation (or
sharp depreciation), or forcing the authorities to defend the currency by expending large
amount of international reserves, or sharply raising interest rates, or imposing capital
controls.
A sudden stop (or a capital account or balance of payments crisis) can be defined as a
large (and often unexpected) fall in international capital inflows or a sharp reversal in
aggregate capital flows to a country, likely taking place in conjunction with a sharp rise in its
credit spreads. Since these are measurable variables, they lend themselves to the use of
quantitative methodologies. Other crises are associated with adverse debt dynamics or
banking system turmoil. A foreign debt crisis takes place when a country cannot (or does not
want to) service its foreign debt. It can take the form of a sovereign or private (or both) debt
crisis. A domestic public debt crisis takes place when a country does not honor its domestic
fiscal obligations in real terms, either by defaulting explicitly, or by inflating or otherwise
debasing its currency, or by employing some (other) forms of financial repression. In a
systemic banking crisis, actual or potential bank runs and failures can induce banks to
suspend the convertibility of their liabilities or compel the government to intervene to prevent
this by extending liquidity and capital assistance on a large scale. Since these are not so easily
measurable variables, they lend themselves more to the use of qualitative methodologies.
Other classifications are possible, but regardless the types of crises likely overlap. A number
of banking crises, for example, are associated with sudden stop episodes and currency crises.
We examine analytical causes and empirical determinants of each type of crisis in this section
and consider the identification, dating and frequency of crises in the next section.
20

A. Currency Crises
Theories on currency crises, often more precisely articulated than for other types of
crises, have evolved over time in part as the nature of such crises has changed. In
particular, the literature has evolved from a focus on the fundamental causes of currency
crises, to emphasizing the scope for multiple equilibria, and to stressing the role of
financial variables, especially changes in balance sheets, in triggering currency crises
(and other types of financial turmoil). Three generations of models are typically used to
explain currency crises that took place during the past four decades.
The first generation of models, largely motivated by the collapse in the price of gold, an
important nominal anchor before the floating of exchange rates in the 1970s, was often
applied to currency devaluations in Latin America and other developing countries (Claessens,
1991).These models are from seminal papers by Krugman (1979) and Flood and Garber
Earlier versions of the canonical crisis model were Salant and Henderson (1978) and Salant
(1983). (1984), and hence called “KFG” models. They show that a sudden speculative attack
on a fixed or pegged currency can result from rational behavior by investors who correctly
foresee that a government has been running excessive deficits financed with central bank
credit. Investors continue to hold the currency as long as they expect the exchange rate
regime remain intact, but they start dumping it when they anticipate that the peg is about to
end. This run leads the central bank to quickly lose its liquid assets or hard foreign currency
supporting the exchange rate. The currency then collapses.
The second generation of models stresses the importance of multiple equilibria. These
models show that doubts about whether a government is willing to maintain its exchange rate
peg could lead to multiple equilibria and currency crises (Obstfeld and Rogoff, 1986). In
these models, self-fulfilling prophecies are possible, in which the reason investors attack the
currency is simply that they expect other investors to attack the currency. As discussed in
Flood and Marion (1997), policies prior to the attack in the first generation models can
translate into a crisis, whereas changes in policies in response to a possible attack (even if
these policies are compatible with macroeconomic fundamentals) can lead to an attack and be
the trigger of a crisis. The second generation models are in part motivated by episodes like
the European Exchange Rate Mechanism crisis, where countries like the UK came under
pressure in 1992 and ended up devaluing, even though other outcomes (that were consistent
with macroeconomic fundamentals) were possible too (see Eichengreen, Rose and Wyplosz
(1996), Frankel and Rose (1996)).
21

The third generation of crisis models explores how rapid deteriorations of balance
sheets associated with fluctuations in asset prices, including exchange rates, can lead to
currency crises. These models are largely motivated by the Asian crises of the late 1990s. In
the case of Asian countries, macroeconomic imbalances were small before the crisis – fiscal
positions were often in surplus and current account deficits appeared to be manageable, but
vulnerabilities associated with financial and corporate sectors were large. Models show how
balance sheets mismatches in these sectors can give rise to currency crises. For example,
Chang and Velasco (2000) show how, if local banks have large debts outstanding
denominated in foreign currency, this may lead to banking cum currency crisis.
This generation of models also considers the roles played by banks and the self-
fulfilling nature of crises. McKinnon and Pill (1996), Krugman (1998), and Corsetti, Pesenti,
and Roubini (1998) suggest that over-borrowing by banks can arise due to government
subsidies (to the extent that governments would bail out failing banks). In turn, vulnerabilities
stemming from over-borrowing can trigger currency crises. Burnside, Eichenbaum, and
Rebelo (2001 and 2004) argue that crises can be self-fulfilling because of fiscal concerns and
volatile real exchange rate movements (when the banking system has such a government
guarantee, a good and/or a bad equilibrium can result). Radelet and Sachs (1998) argue more
Hallwood and MacDonald (2000) provide a detailed summary of the first and second
generation models and consider their extensions to different contexts. Krugman (1999), in an
attempt to explain the Asian financial crisis, also provides a similar mechanism operating
through firms' balance sheets, and investment is a function of net worth. generally that self-
fulfilling panics hitting financial intermediaries can force liquidation of assets, which then
confirms the panic and leads to a currency crisis.
Empirical research has not been able to differentiate which generation of these models
provides the best characterization of currency crises. Early work had good success with the
KFG model. Blanco and Garber (1986), for example, applied the KFG model to the Mexican
devaluations in 1976 and 1981-82 and showed crisis probabilities to build up to peaks just
before the devaluations (Cumby and van Wijnbergen (1989) and Klein and Marion (1994)).
However, while the KFG model worked well in cases where macroeconomic fundamentals
grow explosively, it was not successful when fundamentals are merely highly volatile and
money-demand unstable. Later empirical work moved away from explicit tests of structural
models. Some studies used censored dependent variable models, e.g., Logit models, to
estimate crisis probabilities based on a wide range of lagged variables (Eichengreen, Rose
and Wyploz (1996), Frankel and Rose (1996), Kumar et al (2003)). Others, such as
22

Kaminsky, Lizondo, and Reinhart (1998) and Kaminsky and Reinhart (1999), employed
signaling models to evaluate the usefulness of several variables in signaling an impending
crisis. While this literature has found that certain indicators tend to be associated with crises,
the outcomes have been nevertheless disappointing, with the timing of crises very hard to
predict (see Kaminsky, Lizondo and Reinhart (1998) for an early review, Kaminsky (2003)
for an update, and Frankel and Saravelos (2012) for an extensive recent survey up to the
2000s). We will revisit the issue of crisis prediction later.
B. Sudden Stops
Models with sudden stops make a closer association with disruptions in the supply of
external financing. These models resemble the latest generation of currency crises models in
that they also focus on balance sheet mismatches – notably currency, but also maturity – in
financial and corporate sectors (Calvo et al., 2006). They tend to give greater weight,
however, to the role of international factors (as captured, for example, by changes in
international interest rates or spreads on risky assets) in causing “sudden stops” in capital
flows. These models can account for the current account reversals and the real exchange rate
depreciation typically observed during crises in emerging markets. The models explain less
well the typical sharp drops in output and total factor productivity (TFP). In order to match
data better, more recent sudden stop models introduce various frictions. While
counterintuitive, in most models, a sudden stop cum currency crisis generates an increase in
output, rather than a drop.
This happens through an abrupt increase in net exports resulting from the currency
depreciation. This has led to various arguments explaining why sudden stops in capital flows
are associated with large output losses, as is often the case. Models typically include
Fisherian channels and financial accelerator mechanisms, or frictions in labor markets, to
generate an output drop during a sudden stop, without losing the ability to account for the
movements of other variables. Following closely the domestic literature, models with
financial frictions help to account better for the dynamics of output and productivity in
sudden stops. With frictions, e.g., when firms must borrow in advance to pay for inputs (e.g.,
wages, foreign inputs), a fall in credit –the sudden stop combined with rising external
financing premium – reduces aggregate demand and causes a fall in output (Calvo and
Reinhart, 2000). Or because of collateral constraints in lending, a sudden stop can lead to a
debt-deflation spiral of declines in credit, prices and quantity of collateral assets, resulting in
a fall in output. Like the domestic financial accelerator mechanism, financial distress and
23

bankruptcies cause negative externalities, as banks become more cautious and reduce new
lending, in turn inducing a further fall in credit, and thereby contributing to a recession
(Calvo, 2000). These types of amplification mechanisms can make small shocks cause
sudden stops. Relatively small shocks – to imported input prices, the world interest rate, or
productivity – can trigger collateral constraints on debt and working capital, especially when
borrowing levels are high relative to asset values. Fisher's style debt-deflation mechanisms
can then cause sudden stops through a spiraling decline in asset prices and holdings of
collateral assets (Fisher, 1933). This chain of events immediately affects output and demand.
Mendoza (2009) shows how a business cycle model with collateral constraints can be
consistent with the key features of sudden stops. Korinek (2010) provides a model analyzing
the adverse implications of large movements in capital flows on real activity.
Sudden stops often take place in countries with relatively small tradable sectors and
large foreign exchange liabilities. Sudden stops have affected countries with widely disparate
per capita GDPs, levels of financial development, and exchange rate regimes, as well as
countries with different levels of reserve coverage. There are though two elements most
episodes share, as Calvo, Izquierdo and Mejía (2008) document: a small supply of tradable
goods relative to domestic absorption – a proxy for potential changes in the real exchange
rate – and a domestic banking system with large foreign–exchange denominated liabilities,
raising the probability of a “perverse” cycle. Empirical studies find that many sudden stops
have been associated with global shocks. For a number of emerging markets, e.g., those in
Latin America and Asia in the 1990s and in Central and Eastern Europe in the 2000s,
following a period of large capital inflows, a sharp retrenchment or reversal of capital flows
occurred, triggered by global shocks (such as increases in interest rates or changes in
commodity prices). Sudden stops are more likely with large cross-border financial linkages.
Milesi-Ferretti and Tille (2011) document that rapid changes in capital flows were important
triggers of local crises during the recent crisis. Other papers, e.g., Rose and Spiegel (2011),
however, find little role for international factors, including capital flows, in the spread of the
recent crisis.
C. Foreign and Domestic Debt Crises
Theories on foreign debt crises and default are closely linked to those explaining
sovereign lending. Absent “gun-boat” diplomacy, lenders cannot seize collateral from another
country, or at least from a sovereign, when it refuses to honor its debt obligations. Without an
enforcement mechanism, i.e., the analogue to domestic bankruptcy, economic reasons,
instead of legal arguments, are needed to explain why international (sovereign) lending exists
24

at all. Models developed rely, as a gross simplification, on either inter-temporal or intra-
temporal sanctions. Inter-temporal sanctions arise because of a threat of cutoff from future
lending if a country defaults (Eaton and Gersovitz, 1981). With no access (forever or for
some time), the country can no longer smooth idiosyncratic income shocks using
international financial markets. This cost can induce the country to continue its debt
payments today, even though there are no immediate, direct costs to default. Intra-temporal
sanctions can arise from the inability to earn foreign exchange today because trading partners
impose sanctions or otherwise shut the country out of international markets, again forever or
for some time (Bulow and Rogoff, 1989a). Both types of costs can support a certain volume
of sovereign lending (see Eaton and Fernandez, (1995) and Panizza, Sturzenegger and
Zettelmeyer (2009) for reviews).
These models imply that inability or unwillingness to pay, i.e., default, can result
from different factors. The incentives governments face in repaying debt differ from those for
corporations and households in a domestic context. They also vary across models. In the
inter-temporal model, a country defaults when the opportunity cost of not being able to
borrow ever again is low, one such case presumably being when the terms of trade is good
and is expected to remain so (Kletzer and Wright, 2000). In the intratemporal sanction model,
in contrast, the costs of a cutoff from trade may be the least when the terms of trade is bad.
Indeed, Aguiar and Gopinath (2006) demonstrate how in a model with persistent shocks,
countries default in bad times to smooth consumption. The models thus also have different
implications with respect to a country’s borrowing capacity. Such models are unable,
however, to fully account why sovereigns default and why creditors lend as much as they do.
Many models actually predict that default does not happen in equilibrium as creditors and
debtors avoid the dead-weight costs of default and renegotiate debt payments. While some
models have been calibrated to match actual experiences of default, models often still
underpredict the likelihood of actual defaults. Notably, countries do not always default when
times are bad, as most models predict: Tomz and Wright (2007) report that in only 62 percent
of defaults cases output was below trend. Models also underestimate the willingness of
investors to lend to countries in spite of large default risk.
Moreover, changes in the institutional environment, such as those implemented after
the debt crises of the 1980s, do not appear to have modified the relation between economic
and political variables and the probability of a debt default. Together, this suggests that
models still fail to capture all aspects necessary to explain defaults (Panizza, Sturzenegger
and Zettelmeyer, 2009). Although domestic debt crises have been prevalent throughout
25

history, these episodes had received only limited attention in the literature until recently.
Economic theory assigns a trivial role to domestic debt crises since models often assume that
governments always honor their domestic debt obligations—the typical assumption is of the
“risk-free” government assets. Models also often assume Ricardian equivalence, making
government debt less relevant. However, recent reviews of history (Reinhart and Rogoff,
2009a) shows that few countries were able to escape default on domestic debt, with often
adverse economic consequences. This often happens through bouts of high inflation because
of the abuse of governments’ monopoly on currency issuance. One such episode was when
the U.S. experienced a rate of inflation close to 200 percent in the late 1770s. The periods of
hyperinflation in some European countries following the World War II were also in this
category. Debt defaults in the form of inflation are often followed by currency crashes. In the
past, countries would often “debase” their currency by reducing the metal content of coins or
switching to another metal. This reduced the real value of government debt and thus provided
fiscal relief. There have also been other forms of debt “default,” including through financial
repression (Reinhart, Kirkegaard, and Sbrancia, 2011). After inflation or debasing crises, it
takes a long time to convince the public to start using the currency with confidence again.
This in turn significantly increases the fiscal costs of inflation stabilization, leading to
large negative real effects of high inflation and associated currency crashes. Debt intolerance
tends to be associated with the “extreme duress” many emerging economies experience at
levels of external debt that would often be easily managed by advanced countries. Empirical
studies on debt intolerance and serial default suggests that, while safe debt thresholds hinge
on country specific factors, such as a country’s record of default and inflation, when the
external debt level of an emerging economy is above 30-35 percent of GNP, the likelihood of
an external debt crisis rises substantially (Reinhart and Rogoff, 2009b). More importantly,
when an emerging market country becomes a serial defaulter of its external debt, this
increases its debt intolerance and, in turn, makes it very difficult to graduate to the club of
countries that have continuous access to global capital markets. Many challenges remain
regarding modeling the countries’ ability to sustain various types of domestic and external
debt. An important challenge is that the form of financing countries use is endogenous.
Jeanne (2003) argues that short-term (foreign exchange) debt can be a useful commitment
device for countries to employ good macroeconomic policies. Diamond and Rajan (2001)
posit that banks in developing countries have little choice but to borrow short-term to finance
illiquid projects given the low-quality institutional environment they operate in. Eichengreen
and Hausmann (1999) propose the “original sin” argument explaining how countries with
26

unfavorable conditions have no choice but to rely mostly on short-term, foreign currency
denominated debt as their main source of capital. More generally, although short-term debt
can increase vulnerabilities, especially when the domestic financial system is
underdeveloped, poorly supervised, and subject to governance problems, it also may be the
only source of (external) financing for a capital-poor country with limited access to equity or
FDI inflows. This makes the countries’ choice of accumulating short-term debt and becoming
more vulnerable to crises simultaneous outcomes. More generally, the deeper causes driving
debt crises are hard to separate from the proximate causes. Many of the vulnerabilities raising
the risk of a debt crisis can result from factors related to financial integration, political
economy and institutional environments. Opening up to capital flows can make countries
with profligate governments and weakly supervised financial sectors more vulnerable to
shocks. McKinnon and Pill (1996, 1998) describe how moral hazard and inadequate
supervision combined with unrestricted capital flows can lead to crises as banks incur
currency risks. Debt crises are also likely to involve sudden stops, currency or banking crises
(or various combinations), making it hard to identify the initial cause. Empirical studies on
the identification of causes are thus subject to the usual problems of omitted variables,
endogeneity and simultaneity. Although using short-term (foreign currency) debt as a crisis
predictor may work, for example, it does not constitute a proof of the root cause of the crisis.
The difficulty to identify the deeper causes is more generally reflected in the fact that debt
crises have also been around throughout history.
D. Banking Crises
Banking crises are quite common, but perhaps the least understood type of crises.
Banks are inherently fragile, making them subject to runs by depositors. Moreover, problems
of individual banks can quickly spread to the whole banking system. While public safety nets
– including deposit insurance – can limit this risk, public support comes with distortions that
can actually increase the likelihood of a crisis. Institutional weaknesses can also elevate the
risk of a crisis. For example, banks heavily depend on the information, legal and judicial
environments to make prudent investment decisions and collect on their loans. With
institutional weaknesses, risks can be higher. While banking crises have occurred over
centuries and exhibited some common patterns, their timing remains empirically hard to pin
down.
Bank Runs and Banking Crises
Financial institutions are inherently fragile entities, giving rise to many possible
coordination problems. Because of their roles in maturity transformation and liquidity
27

creation, financial institutions operate with highly leveraged balance sheets. Hence, banking,
and other similar forms of financial intermediation, can be precarious undertakings. Fragility
makes coordination, or lack thereof, a major challenge in financial markets. Coordination
problems arise when investors and/or institutions take actions – like withdrawing liquidity or
capital – merely out of fear that others also take similar actions.
Given this fragility, a crisis can easily take place, where large amounts of liquidity or
capital are withdrawn because of a selffulfilling belief – it happens because investors fear it
will happen. Small shocks, whether real or financial, can translate into turmoil in markets and
even a financial crisis. A simple example of a coordination problem is a bank run. It is a
truism that banks borrow short and lend long. This maturity transformation reflects
preferences of consumers and borrowers. However, it makes banks vulnerable to sudden
demands for liquidity, i.e., “runs” (the seminal reference here is Diamond and Dybvig, 1983).
A run occurs when a large number of customers withdraw their deposits because they believe
the bank is, or might become, insolvent. As a bank run proceeds, it generates its own
momentum, leading to a self-fulfilling prophecy (or perverse feedback loop): as more people
withdraw their deposits, the likelihood of default increases, and this encourages further
withdrawals. This can destabilize the bank to the point where it faces bankruptcy as it cannot
liquidate assets fast enough to cover its short-term liabilities.
These fragilities have long been recognized, and markets, institutions, and policy
makers have developed many “coping” mechanisms (Dewatripoint and Tirole, 1994). Market
discipline encourages institutions to limit vulnerabilities. At the firm level, intermediaries
have adopted risk management strategies to reduce their fragility. Furthermore, micro-
prudential regulation, with supervision to enforce rules, is designed to reduce risky behavior
of individual financial institutions and can help engineer stability. Deposit insurance can
eliminate concerns of small depositors and can help reduce coordination problems. Lender of
last resort facilities (i.e., central banks) can provide short run liquidity to banks during
periods of elevated financial stress. Policy interventions by public sector, such as public
guarantees, capital support and purchases of non-performing assets, can mitigate systemic
risk when financial turmoil hits. Although regulation and safety net measures can help, when
poorly designed or implemented they can increase the likelihood of a banking crisis.
Regulations aim to reduce fragilities (for example, limits on balance sheet mismatches
stemming from interest rate, exchange rate, maturity mismatches, or certain activities of
financial institutions).
28

Regulation (and supervision), however, often finds itself playing catch up with
innovation. And it can be poorly designed or implemented. Support from the public sector
can also have distortionary effects (see further Barth, Caprio and Levine, 2006). Moral hazard
due to a state guarantee (e.g., explicit or implicit deposit insurance) may, for example, lead
banks to assume too much leverage. Institutions that know they are too big to fail or unwind,
can take excessive risks, thereby creating systemic vulnerabilities. More generally, fragilities
in the banking system can arise because of policies at both micro and macro levels (Laeven,
2011).
Independent variables moderating variables Dependent variable
Figure 1: conceptual framework
In the above diagram, it shows three variables. The independent variables are
classified into endogenous and exogenous variables. The endogenous finance distress
variables usually refer to the internal problems of the company. Therefore, they negatively
affect only a particular firm or a small number of firms within the same network. According
to Karels and Plakash (1987) internal risk factors can be attributed to poor management.
Potential forms of the appearance of bad management are the absence of a sense of a need for
change, inadequate communication over expansion, and mismanagement of projects or fraud.
The exogenous risk factors are pervasive; they can affect all companies in the market.
They include: fluctuation negatively of exchange rates, political instability, and industrial
production, changes in the interest rates, economy weakness, budget shortages and expected
or unexpected inflation among others. Exogenous factors are independent of managerial skills
29
Exogeneous Financial Distress Variables
• Price War With Rivals
• Counter Party Defaults
• Low Price Overseas
• Unfavorable Exchange Rates
• High Credit Interest Rate
• Unfavorable Change In Government Policy

(Karels & Plakash, 1987). The moderating variable in this study is the company
characteristics which includes the company’s size, maturity level of the company, industry in
which it operates and flexibility of it changing its business. The company size plays a big role
in determining whether a company will be in distress or not. There are just a few big
companies that have suffered financial problems as compared to medium or small companies
(Monti & Mariano, 2010). Large companies can easily obtain external finances cheaply
because they can influence the rate of interest to their advantage. Moreover, bigger
companies can be able to survive during times of crises than small companies due to reserves
they could have accumulated (Ooghe & Prijcker, 2008).
There is also theoretical evidence as well as empirical facts that demonstrate that the
return rate of a company increases as the size of its assets increase. This could imply that a
firm with a high asset value would have a lower risk of becoming financially distressed in
comparison to middle or small company even when both show the same financial ratios
values (Alexander, 2001). Similarly, the maturity of a company may influence the financial
stability of a company. According to Ooghe and Prijcker (2008), a young company has to
build up external legitimacy and stable relationship with stakeholders. They are therefore,
very vulnerable. Finally, companies in different industries, even with a similar financial
profile, have a different probability of becoming distressed.
2.1.7 Theoretical Framework
Understanding banking crises requires understanding the theory of financial systems
and banking in general. Thus, I first review the theory of financial systems. These theories
include the following:
2.1.8 Cash Management Theory
Cash management theory is concerned with the managing of cash flows into and out
of the firm; cash flows within the firm and cash balances held by the firm at a point of time
by financing deficit or investment surplus cash. Short-term management of corporate cash
balances is a major concern of every firm. This is so because it is difficult to predict cash
30

flows accurately, particularly the inflows, and there is no perfect coincidence between cash
outflows and inflows (Aziz & Dar, 2006). During some periods cash outflows will exceed
cash inflows because payments for taxes, dividends or seasonal inventory will build up. At
other times, cash inflow will be more than cash sales and debtors may realize in large
amounts promptly (Pandey, 2005). An imbalance between cash inflows and outflows would
mean failure of cash management function of the firm. Persistence of such an imbalance may
cause financial distress to the firm and, hence, business failure (Aziz & Dar, 2006).
2.1.9 Credit Risk Theory
Credit is the provision of goods and services to a person or entity on agreed terms and
conditions where the payments are to be made later with or without interest. During the
contract period, not all debtors will repay their dues as and when they fall due. When the
debtor does not pay their dues on the due date, the lender is exposed to credit risks which
may in turn lead to default. Credit risk is therefore the investor’s risk of loss, financial or
otherwise, arising from a borrower who does not pay his or her dues as agreed in the
contractual terms (Nyunja, 2011).
2.1.10 Entropy Theory
According to the Entropy Theory (or Balance Sheet Decomposition Measure Theory),
one way of identifying firms’ financial distress could be a careful look at the changes
occurring in their balance sheets (Aziz & Dar, 2006). This theory employs the Univariate
Analysis (UA) and Multiple Discriminant Analysis (MDA) in examining changes in the
structure of balance sheets. Univariate Analysis is the use of accounting based ratios or
market indicators for the distress risk assessment (Natalia, 2007). The financial ratios of each
company, therefore, are compared once at a time and the distinction of those companies
through a single ratio with a cut – off value is used to classify a company as either distressed
or non- distressed (Monti & Moriano, 2010). MDA (or Multivariate Statistic or Multivariate
analysis) is a statistical analysis in which more than one variable are analyzed at the same
time (Slotemaker, 2008). The aim of MDA is to eliminate the weakness of univariate
analysis. First, single ratios calculated by univariate analysis do not capture time variation of
financial ratios. This means that accounting ratios have their predictive ability one at a time,
and it is impossible to analyze, for instance, rates of change in ratios over time. Second,
single ratios may give inconsistent results if different ratio classifications are applied for the
same firm. Third, many accounting variables are highly correlated, so that the interpretation
31

of a single ratio in isolation may be incorrect. The single ratio is not able to capture
multidimensional interrelationships within the firm.
Finally, since the probability of failure for a sample is not the same as for the
population, specific values of the cutoff points obtained for the sample will not be valid for
the population (Natalia, 2007). Therefore, if a firm’s financial statements reflect significant
changes in the composition of assets and liabilities on its balance-sheet it is more likely that it
is incapable of maintaining the equilibrium state. If these changes are likely to become
uncontrollable in future, one can foresee financial distress in these firms (Aziz & Dar, 2006).
2.1.11 Gambler’s Ruin Theory
Gambler Ruin theory was developed by Feller, W in 1968 who based it on the
probability theory where a gambler wins or loses money by chance. The gambler starts out
with a positive, arbitrary, amount of money where the gambler wins a dollar with probability
p and loses a dollar with a probability (1-p) in each period. The game continues until the
gambler runs out of money (Espen, 1999). The firm can be thought of as a gambler playing
repeatedly with some probability of loss, continuing to operate until its net worth goes to zero
(bankruptcy). With an assumed initial amount of cash, in any given period, there is a net
positive that a firm’s cash flows will be consistently negative over a run of periods, ultimately
leading to bankruptcy (Aziz & Dar, 2006). The major weakness of this theory is that it
assumes that a company starts with a certain amount of cash. The two main difficulties with
this theory when predicting bankruptcy is that the company has no access to securities
markets and the cash flows are results of independent trials and managerial action cannot
affect the results (Espen, 1999).
2.2 Empirical Framework
2.2.1 Banking crises
According to the Central Bank of Nigeria Annual Report (1995), banking crises is defined
as that which occurs in financial institutions which among other things:
i. fail to meet capitalization requirements;
ii. have weak deposit base; and
iii. are afflicted by mismanagement.
Therefore, there is distress in a situation, in which the bank is having operational,
managerial and financial difficulties. The term ‘distressed banks’ entered into the lexicon of
banking in Nigeria in the period from 1990 and 1995, though it has been in existence since
32

early 20th century. The term to the general public connotes an unmanageable, unviable and
insolvent bank that is tending towards liquidation. In ordinary parlance, distress means ‘being
in danger or difficulty and in need of help’.
Umoh (1999) asserts that “a bank is distressed when it is technically insolvent implying
that the bank’s liabilities exceed the assets”. The CBN/NDIC (1995: 4) describes a distressed
financial institution as “one with severe financial, operational and managerial weaknesses
which have rendered it difficult for the institution to meet its obligations to its customers,
owners and the economy as and when due. Without necessarily implying the degree or nature
of the problem, a bank is said to be distressed when it is either illiquid and/or insolvent to the
extent that its ability to discharge its obligations as at when is impaired. In more precise
terms, illiquidity is a state of inability to meet payments obligations to customers as at when
due, while insolvency is a situation in which the value of the firm’s liabilities is in excess of
its assets’ value, i.e., negative net worth.
The CBN/NDIC (1995: 5) describes banking system distress as “a situation in which a
sizeable proportion of financial institutions have liabilities exceeding the market value of
their assets which may lead to runs and other portfolio shifts and eventual collapse of some
financial firms”. Furthermore, depending on whether public confidence in the system has
been eroded or not, financial system distress is classified into two, namely, generalized or
systemic. If public confidence has not been adversely affected by the incidence of distress,
though widespread among the institutions, it is regarded as a generalized distress otherwise, it
is systemic distress. The CBN (2002) provides a working definition of systemic bank distress
as “those situations where the solvency and/or liquidity of many or most banks have suffered
shocks that have shaken public confidence.
Ogubunka (2003) opines that bank distress has become a common lexicon in Nigeria
given many bank failures in the period of 1994 through 2003. Many people erroneously
interchange bank distress with bank failure, which are technically distinct. Bank distress is
the forerunner of bank failure. Whereas a bank in distress could have chances of regaining
health, a failed bank loses every chance of life. Its final destination is the mortuary of Nigeria
Deposit Insurance Corporation (NDIC) from where it will proceed to its final destination –
liquidation.
Imala (2004) posits that financial sector crises have occurred in many countries in
recent decades, both in developed as well as emerging market economies. These crises have
resulted in substantial macroeconomics and fiscal costs. Bank failures are widely perceived to
have greater adverse effects on the economy than the failure of other types of businesses.
33

They are viewed to be more damaging than other failures because of the fear that they may
spread in domino fashion throughout the banking system, felling solvent as well as insolvent
banks. Thus, the failure of an individual bank introduces the possibility of system wide
failure or systematic risk. Bank failures have been and will continue to be a major public
policy concern in all countries and that explains the fact that banks are regulated more
rigorously than other industries. This study opines that there are three major factors
accountable for bank distress which consequently ends up in bank failure. Each of these
factors is reviewed in the following subsections:
2.2.2 Inadequacy of capital: CBN (1995) claims that banks are expected to maintain
adequate capital to meet their financial obligations, operate profitably and contribute to
promoting a sound financial system. It is for these reasons that the CBN prescribes minimum
capital requirements. This minimum ratio of capital adequacy has been increased from 6 per
cent in 1992 to 8 per cent in 1996. It is further stipulated that at least 50 per cent of the
component of a bank’s capital shall comprise paid-up capital and reserves, while every bank
shall maintain a ratio of not less than one to ten (1:10) between its adjusted capital funds and
its total credit. When a bank’s capital falls below the prescribed ratio, it is an indication that
the bank may be heading for distress. Bank examination reports showed that a good number
of banks operating in Nigeria were grossly undercapitalized. This situation has been
attributed to the low level of initial capital, the effect of inflation, the adverse operating
results mainly due to their inability to make appreciable recoveries from their non-performing
assets and the large portfolio of non-performing loans maintained by some banks. These
factors have combined to erode the capital base of many banks. With the introduction of
Prudential Guidelines, banks were required to suspend interest due, but unpaid, on classified
assets and to make provisions for non-performing credit facilities, a good proportion of which
was subject to losses. Inability to meet stipulated higher minimum capital requirements was
one of the criteria used for classifying banks into either “healthy” or “unhealthy” and the
latter category was barred from the foreign exchange market.
In describing capital inadequacy, Ogundina (1999) argues that capital in any business
whether bank or company serves as a mean by which losses may be absorbed. It provides a
cushion to withstand abnormal losses not covered by current earnings pattern. Unfortunately,
a good number of banks are grossly undercapitalized. This situation could partly be attributed
to the fact that many of the banks were established with very little capital. This problem of
inadequate capital has been further worsened by the huge amount of non-performing loans
34

which have eroded the capital base of some of these banks. Available statistics on banks’
capitalization reveal that as at the end of 1992, 120 operating banks in the country required
the aggregate additional capital to the tune of N5.6 billion to meet the statutory minimum
capital funds set by bank regulators for 1992.
Ogubunka (2003) contends that when a bank is undercapitalized, it ought not to
continue with its magnitude of operations prior to the depletion of capital. If it does without
the introduction of increased capital, distress could ensue. Many banks that became distressed
were affected by inadequacy of capital. Consequently, they could not sustain their operations,
first, as a result of overtrading and second, due to their inability to absorb losses arising from
costs of operations. A function of capital in a bank is to serve as a mean by which losses can
be absolved. Capital provides a cushion to withstand abnormal losses not covered by current
earnings, enabling banks to regain equilibrium and to reestablish a normal earnings pattern.
The need for adequate capital largely informed the decision of the regulatory authorities to
raise the minimum equity share capital of banks over the years. As at 2002, the minimum
paid-up equity share capital is 2 billion for a new bank to be licensed and the existing
universal banks had the deadline of December 31, 2002 to beef up their paid-up equity share
capital to 1 billion. This problem of inadequate capital has been further accentuated by the
huge amount of nonperforming loans which has eroded some banks’ capital base. It has even
been discovered that many of the closed banks in Nigeria started with fictitious capital
through the use of commercial paper. Such debt instruments were paid back soon after
commencement of business with deposits. Many of such so-called bank owners contributed
nothing to own a bank, yet they use the means to amass wealth and ruin the bank at the end of
the day.
Imala (2004) opines that banks are expected to maintain adequate capital to absorb
operational shocks or unexpected losses, support their level of operation, operate profitably
and consequently contribute towards promoting a sound financial system. It is for these
reasons that the CBN periodically prescribes minimum capital requirements in the form of
minimum paid-up and the capital to risk weighted asset ratio. The minimum capital adequacy
ratio requirement has remained at the international standard of 8% and this was expected to
become 10% from January 2004. Inability to meet the minimum capital requirement was one
of the criteria used for classifying banks as unhealthy one.
2.2.3 Disclosure and transparency: Sanusi (2002) posits that disclosure and transparency
are key pillars of a corporate governance framework, because they provide all the
35

stakeholders with the information necessary to judge whether or not their interest are being
served. He sees transparency and disclosure as an important adjunct to the supervisory
process as they facilitate banking sector market discipline. For transparency to be meaningful,
information should be accessible, timely, relevant and qualitative. According to Anameje
(2007), transparency and disclosure of information are key attributes of good corporate
governance which banks must cultivate with new zeal so as to provide stakeholders with the
necessary information to judge whether their interest are being taken care of.
Sanusi (2003) opines that lack of transparency undermines the ethics of good
corporate governance and the prospect for effective contingency plan for managing systemic
distress. Anya (2003) observes that lack of transparency has obscured the way many financial
and economic activities are conducted and has contributed to the alarming proportion of
economic/financial crimes in the financial industry. ‘Trust’ and the fiduciary principle, which
was the cornerstone of banking, has been completely jettisoned as banks now engage in all
forms of sharp practices. Some of these sharp practices involve the deliberate manipulation or
distortion of records to conceal the correct and true state of affairs. These records which form
the bedrock of supervisory oversight by the regulatory authorities in monitoring the
soundness of the system has thus been undermined. Such distortions therefore, would
necessarily result in wrong information being sent to the regulatory authorities, which should
have been in a position to take adequate measures to prevent further deterioration of the
bank’s position. The regulatory authorities are thus handicapped by such concealment until
the bank hit the irreversible point of total collapse. Thus lack of transparency has been
identified as one of the most catastrophic modern societal problems plaguing banks today.
Imala (2004) contends that the issue of transparency has to be taken seriously in the
new dispensation. Transparency has been a recurring problem in the financial industry in
Nigeria, and, unless improved upon, has the potential of making nonsense of the efforts of the
supervisors in implementing the New Accord. It is hoped that the Bankers Committee’s
efforts, through its ethics and professionalism subcommittee and the new code of corporate
governance, would greatly assist in laying a solid foundation for transparency in the industry,
being one of the pillars of the New Capital Accord. The evolutionary nature of the New
Accord increasingly cedes more responsibilities in the measurement of capital adequacy to
the operations. Consequently, a bank has to convince the supervisor of improvement
techniques in order to rise to a higher level in the evolutionary ladder. With the present
situation in the banking industry, many banks may remain at the lowest rung of the ladder of
sophistication in the capital measurement approach.
36

2.2.4 Huge non-performing loans. A major revelation showed that many owners and
directors abused or misused their privileged positions or breached their fiduciary duties by
engaging in self-serving activities. The abuses included granting of unsecured credit facilities
to owners, directors and related companies which in some cases were in excess of their
banks’ statutory lending limits, in violation of the provisions of the law (Oluyemi, 2005). A
critical review of the nation’s banking system over the years has shown that one of the
problems confronting the sector had been that of poor corporate governance. From the
closing reports of banks liquidated between 1994 and 2002, there were evidences that clearly
established that poor corporate governance led to their failures.
Ogundina (1999) observes that the Nigerian financial system over the years has been
under severe stress as a result of large amounts of nonperforming loans. The classified loans
and advances of the whole banking industry in 1990 amounted to N11.9 billion, representing
44.1 percent of the total loans and advances. The problem of bad debts is usually exacerbated
by the negligence on the part of the lending officers. Some of these loans were not granted
without regard to the basic tenets of lending, nor do they comply with any rational lending
criteria. This makes it extremely difficult or impossible to recover a substantial part of the
loans. Also, the devaluation of the naira in the wake of Structural Adjustment Programme has
its toll on the ability of borrowers to repay. A devaluation by more than 600 percent since the
introduction of SAP shore up foreign manufacturing input prices, leading to greater domestic
capacity underutilization and reduced inability of business borrowers to repay their bank
loans and advances. According to CBN (1997), several of the distressed banks suffer from
poor asset and liability management. The portfolios of assets of the majority of these banks
were concentrated on loans and advances that became non-performing. Other assets such as
treasury securities, investments and cash accounted for a small proportion of their asset
portfolio.
Furthermore, merchant banks that were expected to source medium to long-term
funds relied mainly on short-term deposits whose tenor ranged between call/overnight funds
to 3 months. These funds were obtained at excessively high rates of interest. In some cases,
some banks and finance houses borrowed short and lent long, resulting in mismatch of assets
and liabilities. The deterioration in asset quality was not provided for through adequate loan-
loss provisions. This situation increased the vulnerability of the banks to external shocks. The
profile of poor asset and liability management exposed the banks to liquidity risk which
weakened the confidence that the public had in the banking sector.
37

Financial distress can be described in many ways. It can mean liquation, deferment of
payment to short term creditors, deferment of payment to interest or principal on bonds or the
omission of a preferred dividend. One of the problems experienced in examining the
literature on forecasting financial distress is that different authors use different criteria to
indicate distress (Jamshed, 2012). According to Pandey (2005) financial distress occurs when
a firm is not able to meet its obligations.
Adeyemi (2011) defines financial distress as a situation in which an institution is
having operational, managerial and financial difficulties. In this study the working definition
is adopted from Jahur (2012) who defines financial distress as the inability of a firm to pay its
current obligations on the dates they are due.
2.2.3 Causes of Financial Distress
According to Jahur and Quadir (2012), the common causes of financial distress and
business failure are often a complicated mix of problems and symptoms. The most significant
causes of financial distress in young companies are capital inadequacy where the business did
not start with enough capital and has struggled from day one. Capital in any business serves
as a mean by which loses may be absorbed. It provides a cushion to withstand abnormal
losses not covered in the current earning pattern (Adeyemi, 2012).
Where other companies have undertaken management succession planning for key
roles and identified high potential s in their company’s employee’s, usually firms in financial
distress do not prepare at all for top management succession (Galloway & Jones, 2006). This
could lead to recruiting unbalanced management team which lack essential skills to steer the
company ahead. Any wrong investment decision made may plunge the company to financial
distress since some of the decision s involve huge cash outlay and irreversible. The
importance of innovation to a firms’ future has been documented extensively, though the
level of risk associated with innovation has been examined to a small degree (Chao, Lipson &
Loutskina, 2012). The probability that innovation will drive a firm to financial distress is high
especially where the competitors introduces innovative and competitive products which
reduces the attractiveness of the company’s products and services (Jahur & Quadir, 2012).
Therefore, innovation can either give a firm a competitive edge to its rivals or will see its
demise equally.
38

While most companies rely on their financial performances as the key barometer of
financial health, it is important not to ignore managerial and operational signals (Zwaig &
Pickett, 2012). Many profitable businesses have found themselves in trouble due to rapid
expansion like Uchumi Supermarkets or the introduction of a formidable competitor (Zwaig
& Pickett, 2012). In each of these instances, the companies were successful before an
operational event or unheeded signal led to financial problem and in some cases the
subsequent failure of the company. In other countries, the business that were able to
recognize earlier warning signs such as Zellers, Canadians Tire and The Bay have survived
by diffentiating themselves or changing and improving their business model (Zwaig &
Pickett, 2012).
2.3 Appraisal of Literature
The literature review focused on the determinants of banking crisis and identified the
most significant causes of crisis. In the first part, the concept and evolution of banking was
discussed. Similarly, it is obvious from the foregoing that the phenomenal of growth in the
Nigerian Banking Industry has suggested keen competition, which necessitated the adoption
of marketing strategies and adequate credit analysis.
We discussed roles of banking and regulatory institutions in the Nigeria Banking
Industry in charge of the formulation and implementation of rules and regulations which
include; Central Bank of Nigeria (CBN) and Nigeria Deposit Insurance Corporation (NDIC).
Meaning of crises and financial crises which can take various shapes and forms in terms of
classification; using strictly quantitative definitions and qualitative and judgmental analysis
were also discussed in the first part.
The chapter focused on various theories that guided bank operations among which
are Cash Management Theory, Credit Risk Theory, Entropy Theory and Gambler’s Ruin
Theory. It also examined empirical studies in banking crises. We were able to classify various
causes of bank crises and financial distress among which are; capital inadequacy, lack of
transparency, non-performing loans and so on and possibly forcing viable firms into
bankruptcy. Bank crises may also jeopardize the functioning of the payments system and by
undermining confidence in domestic financial institutions.
There is need to therefore to carry out further research to identify how these factors
evolve overtime and ascertain how they shape and determine the banking crises.
39

References
Aziz, M., & Dar, H. (2006). Predicting Corporate Financial Distress: Whither Do We
Stand?
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Allen, F., and Gale, D. (2007). Understanding Financial Crises, Clarendon Lecture Series in
Finance, Oxford: Oxford University Press.
Allen, F., and Carletti, E. (2008). Mark-to-Market Accounting and Liquidity Pricing, Journal
of Accounting and Economics 45, 358-378.
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Allen, F., Carletti, E., and Gale. D. (2008). Interbank Market Liquidity and Central Bank
Intervention, working paper, University of Pennsylvania
Avery, R B., Brevoort, K., and Canner, G. (2007). The 2006 HMDA data, Federal Reserve
Bulletin, vol 93, pp A73-A109.
Chao, R., Lipson, M., & Loutskina, E. (2012). Financial Distress and Risky Innovation
Seminar Presentation at University of Michigan Brown Bag
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Fragility: A Theory of Banking, Journal of Political Economy, 109, 287-327.
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Espen, S. (1999). Assessment of Credit Risk in Norwegian Business Sector (Master’s Thesis,
The University of Bergen, Bergen, Norway)
Fama, E.F., (1980). Banking in the theory of finance, Journal of Monetary Economics
Goldsmith, R. W., 1969. Financial Structure and Development, New Haven: Yale
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Freixas, X. & Rochet, J. (2008) Microeconomics of banking (2nd
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international banking law, 7, 204-16.
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