THE IMPACT OF CAPITALIZATION ON THE BANKING INDUSTRY AND THE NIGERIAN ECONOMY (AN EVALUATION)

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CHAPTER ONE

INTRODUCTION

1.1    BACKGROUND OF THE STUDY

The ultimate strength of a bank lies in its capital fund. Banking, like any other business, requires adequate capital to function effectively (Nwankwo, 1991:45). Though by nature, banking is a highly leveraged industry, the degree of leverage averaging 88% and 95% in the United States, compared with between 24% and 70% of non financial firms (ibid). life of a bank like any other business, it plays the role of a cushion for losses resulting from crystallization for the various risks a business entity is exposed to (Imala, 2004:74). Adequate capital is required to maintain public confidence by standing ready to absorb unexpected or unusual losses not absorbed by normal earnings (Nwankwo, 1991:45). Thus, it has often been said that the primary function of bank capital is to protect the depositor against loss. How true is this statement?

Although such statements contain an element of truth, they do not adequately express the complete nature of the protective functions of banks capital funds. Most weak looking bank assets can be phased out with relatively little loss given sufficient time, competent management, reasonable earnings, and the workings of the business cycle (Liewellyn, 1999:5). Therefore, the primary function of bank capital is to keep the bank open and operating so that gain and earnings can absorb losses in other words, to inspire sufficient confidence in the bank of the part of depositors and the supervisor so that it will not be forced into costly liquidation. In this sense, capital services to protect the stockholder as much as, if not more than the depositor (ibid).

The other functions of bank capital, is that of purchasing fixed assets and working capital. In fact put in another ways, capital is needed to supply put in another way, capital is needed to supply the working tools of the bank’s banking quarters, equipments needed to begin operations and the working capital.

Thus for a bank to function effectively it needs sufficient and adequate capital. This capital is defined by Central Bank of Nigeria (CBN) 2004:1 as paid – up capital and serves unimpaired by losses. Therefore banks owe some basic responsibilities to their communities. The traditional functions which they render in form of financial intermediation, must be effectively delivered to retain the confidence of their client. The bank must also sustain the interest and confidence of the public by being sufficiently responsive to their needs; housing all maturing obligations avoiding actions that will lead to distress and failure in the system. Banks must also meet the credit needs of their customers and thus sustain the productive process (Nzotta, 1999:282)

Thus bank capital serves tripartite functions viz; protective, regulative and operational. The protective function is to protect depositors against the risk of non – payment of deposits on demands while the regulatory function is that of meeting up with the monetary authorities requirement and helps the authorities assess a banks health. The operational functions has to do with the procurement of what banks need to take off business, which means that the operational function is to kick- start the banking operations.

Meanwhile, in the Nigerian environment bank capital legislation did not start, until the introduction of banking ordinance in 1952.

According to Uche (1998:30), before 1952 there was no legal minimum capital requirement for banks operating in the Nigeria colony. Despite this fact, foreign banks were able to operate in the Nigeria colony without any banking failure. However, things changed with the advent of indigenous banks, most of who were poorly – capitalized, poorly staffed and in most cases interested with fraud. In the opinion of the writer, the above tripartite malaise of the indigenous banks contributed to their failures. This led the colonial government to invite G.D Paton, a consultant for the bank of England, to investigate the Nigeria banking environment with the possibility of introducing regulation. A minimum share capital was subsequently recommended.

The outcome of that legislation was disastrous. This was rendered by “Uche” (1998:31) thus “the resultant effect was that banks that could not meet up with the dead line for re-capitalization failed – mass failure with at least 17 indigenous banks failing in 1953/54. Ever since, there have been recurring bank capital legislations.

These are;

 

 

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