BAF 3304 Banking

Regulations and
Supervision
Module 5 Banking Stability
Dr Nuruddeen Abba Abdullahi
BUK
 Banking Stability
Content
Sources of Instability in the Banking Sector
Regulatory Authorities Efforts at Stabilizing the
Financial System
Critical and Emerging Aspects of Banking Practices
Subject to Control and Regulation
Forms and Methods by which Regulatory Authorities
Carry out Supervisory Functions in Banks
Sources of Instability in the Banking Sector

 Banking crises
 The banking sector is an important component of the financial system; it can affect the economic
growth through raising and mobilizing the savings, channeling the funds to the productive uses
and enhancing the efficiency.
 The deteriorations in the banking sector stability may negatively affect the economic growth
through preventing the efficiently functioning of the aforementioned interaction channels.
 The term "banking crisis" refers to a situation of major disruptions in a country's banking sector
which may not just be minor downturns or disturbances.
 Banking crises are often associated with bank runs, banking panics, and systemic banking crises.
 Many countries around the world have experienced various episodes of banking crises
throughout the history.
 Banking crisis occurs when the capital of the banking sector has been depleted due to loan
losses, resulting in a negative net worth of the banking sector.
 There are a number of exogenous and endogenous factors that can precipitate instability
in the banking system.
 The exogenous or external factors include macroeconomic shocks which emanate from
negative effects of financial liberalization, globalization and rapid technological changes.
 The endogenous or internal factors include inappropriate corporate governance and
inadequate regulatory and supervisory capacity among others.
 Some of these internal factors are:
• Macroeconomic Environment
• Asymmetric Information
• Weak Management
• Inappropriate Corporate Governance Structures
• Inadequate or Poor Regulatory and Supervisory Capacity
• Macroeconomic Environment - It is easier to achieve sound banking system under a stable
macroeconomic environment than an unstable one. Whereas an unsound banking system could
trigger off macroeconomic instability, hence the symbiotic relationship between the banking system
and macroeconomic environment.
• Asymmetric Information - any misinformation about the soundness of banks and the safety of
their deposits can cause panic withdrawals, creating runs on the banks with potentials of contagion
and loss of credit confidence. Similarly, poor loan selection due to information asymmetry leading to
funding of unviable projects could lead to having very high volume of non-performing loans.
• Weak Management - poor management is often reflected in poor asset quality, insider abuse,
inadequate internal controls, and fraud, including unethical and unprofessional conduct, squabbles
and high staff turnover rate. Weak risk-control systems have been a major factor in the emergence of
a number of crises, leading to a variety of balance sheet differences, including large and undetected
mismatches on the balance sheet or poor asset quality, leading to large unrealizable losses.
• Inappropriate Corporate Governance Structures – effective corporate
governance practice incorporates transparency, openness, accurate
reporting and compliance with statutory regulations, among others. From
history, a lack of good corporate governance in banks leads to financial
crisis.
• Inadequate or Poor Regulatory and Supervisory Capacity – can
contribute to instability in the financial system. Thus, there is the need for
strong regulatory and supervisory capacity capable for effective
monitoring of the system. Regulatory Supervisors must exhibit a high level
of integrity, competence and be equipped with modern facilities, in order
to meet the challenges of contemporary banking practices
Regulatory Authorities Efforts at Stabilizing the
Financial System

 Banking Regulation
Regulation focus is to reduce the risk of bank insolvency
and the potential cost of bank failure to depositors.
The bank also strengthened its regulatory framework,
with emphasis on creating an environment for
competitiveness, efficiency, financial soundness and
sustainable growth.
 Banking Supervision
 CBN undertakes both off-site and on-site supervisory activities on banks and non-
bank financial institutions.
 Emerging issues from such supervisory efforts include poor/weak management
structure, weak internal control systems, under-capitalization, inadequate
collateralization of facilities granted and exceeding the single obligor limits are
quite revealing, and are of great concern to the monetary authorities.
 In addressing these problems, the CBN introduced prudential guidelines
encompassing capital adequate ratio, mandatory uniform accounting standards and
strict enforcement of licenses which are issued to only those who are fit and proper
to operate. All banks and non-bank financial institutions are required to comply with
the appropriate guidelines relevant to them. compliance.
Good Corporate Governance
 Poor corporate governance has been identified as a major challenge to the
survival of banks in Nigeria.
 Major causes of distress in the Nigerian banking sector in the 1990s were
identified to include weak management, poor capital base, inadequate credit
policy and fraudulent and corrupt practices. These undoubtedly were
reflections of unsound and inadequate corporate governance structures in the
sector.
 The enthronement of the good corporate governance framework for DMBs
and other financial are geared towards sound and stable banking business in
the country.
 Critical and Emerging Aspects of Banking
Practices Subject to Control and Regulation

Emerging Issues
 Globalization and Financial Openness
 Transparency Information Disclosure
 Emphasis on Good Corporate Governance
 Combating Money Laundering, Advance Free Fraud (419) and Terrorism
 Competitiveness
 Superior Service Quality
 Market Orientation
 Product Innovation
Adequate Capitalization
Investment in Technology
Capacity Building
Social Demand on Financial Institutions
Imposition of Sanctions
Legal Tussle between CBN and Other Banks
 Control measures and possible remedial actions
 The authorities have developed control measures with a view to making the banking sector
secure. These include:
• Good corporate governance
• Leadership by good example
• Transparent compliance with regulations and guidelines as well as - financial sector
standards
• Emplacement of corporate contingency plan and framework for risk management (including
effective internal control systems)
• Self-regulations by operators
• Due customer diligence
• Manpower training and development (Human capacity building)
• Co-operation and where necessary dialogue with regulatory authorities
• Collaborative competition
• Policy stability with only needful fine-tuning
• Ethics and professionalism
• Respect for law, order and rights of others
• Consumer care and sensitivity
• Proactive supervisory and surveillance activities
• Research and development
• Use of modern technology
• Good corporate citizenship
• E-banking regulation
• A new sanction execution regime.
 Methods Use by Regulatory Authorities to
Carry out Supervisory Functions in Banks

• Concept ‘Supervision’
• Forms of Supervision
• Conditions for Effective Banking Supervision
• Global Supervision, Foreign Bank Branches and Cooperation with
Foreign Supervisors
• Roles and Responsibilities of Stakeholders in ensuring Good Ethical
Conduct in the Banking Industry
• Ethical Principle for Using Organisational Assets
• Intellectual Property
 Concept of Bank Supervision
 This is a supervisory function charged with the responsibility of ensuring the safety and soundness of the banking
system as a whole. Books and affairs of every licensed insured institution are examined as a means of meeting its
supervisory mandate.
• It is performed through the off-site surveillance and on-site examination of the books and affairs of the banks, which
exceptions are reported and recommendations made on how the observed lapses can be corrected, and the
implementation of such recommendations is monitored through scheduled post examination visits to the affected banks.
• Bank supervision comprises the enforcement of rules and regulations as well as judgments concerning the soundness of
bank assets, its capital adequacy and management (Volcker, 1992).
• Regulation involves providing input into developing and interpreting legislation and regulations, issuing guidelines, and
approving requests from regulated financial institutions.
• Regulation and effective supervision leads to healthy banking industry.
• To maintain confidence in the banking system, the monetary authorities have to ensure banks play by the rule.
Accordingly, the deposit insurance scheme and prudential guidelines were adopted to improve the assets quality of
banks, reduce bad and doubtful debt, ensure capital adequacy and stability of the system, and protect depositors’ funds
(Oladipo, 1993, Oguleye, 2005).
• The three main types of supervision are Transaction
Based, Consolidated and Risk Based Supervision.
 Transaction Based Supervision; this supervisory approach
focuses on individual group entities. Individual entities are
supervised on a solo basis according to the capital
requirements of their respective regulators.
 It is complemented by a general qualitative assessment of the group
as a whole and, usually, by a quantitative group-wide assessment of
the adequacy of capital.
 Consolidated supervision; is a group-wide approach to
supervision whereby all the risks undertaken by a group of
companies are taken into account in the supervisory process.
 This will entail the identification of the risks to which the components of
the group are exposed to and the impact of such risks on the group
operational activities.
 Consolidated supervision entails the process whereby the supervisor can
satisfy himself about the health of the entire group’s activities which
may include bank and non bank companies, financial affiliates as well as
branches and subsidiary companies.
 Consolidated supervision will entail the following:
o adequate knowledge of the structure of a group and the risks there in;
o adequacy or otherwise of capital measured on a group basis;
o measurement of larger exposures on a group basis.
 Consolidated supervision should not be seen as a substitute for the supervision
of individual bank, but rather be regarded as being complementary.
 There is the need for the various supervisory agencies to cooperate to ensure
that the group financial activities are comprehensively supervised taking into
consideration various risks that could affect the health of the individual entities
and the group.
 Risk Based Supervision; RBS is a robust, proactive and sophisticated supervisory
process, essentially based on risk profiling of a bank. It enables the supervisor to
prioritize efforts and focus on significant risks by channeling available resources to
banks that have high-risk profiles.
 RBS assesses the efficacy of a bank’s ability to identify, measure, monitor and control
risks. It designs a customized supervisory programme for each bank and focuses
more attention on banks that are considered to have potentially high systemic
impact.
 RBS has assumed added importance for two main reasons.
o New technologies, product innovation, size and speed of financial transactions have changed the
nature of banking.
o The need to comply fully with the Basel Core Principles on Supervision and to prepare an
enabling environment for the implementation of the New Capital Accord.
 RBS presents a framework with which banks are assessed regarding the probability and
impact of risks as opposed to the intuitive assessment by the traditional approach. (The
traditional form of supervision which is biased in favour of risk-avoidance and hence
against innovative products and services, risk-based supervision treats risks mitigating
and offsetting as valid approaches to risk management.)
 Risk-based supervision identifies, measures and controls risks; and monitors the risk
management process put in place by a financial institution during a supervisory period.
 The main objective of risk-based supervision is to sharpen supervisory focus on:
1. The activity(ies) or institution(s) that pose the greatest risk to banks and financial institutions
and/or financial system; and
2. The assessment of management process to identify, measure, monitor and control risks
 The main benefits of RBS approach to supervision include:
1. The allocation of supervisory resources according to perceived risk, i.e.
focusing resources on the bank’s highest risk or devoting more supervisory
efforts to those banks that have a high-risk profile. It will, therefore, enable
the regulator to target and prioritise the use of available resources.
2. The supervisor will be better placed to decide on the intensity of future
supervision and the amount and focus of supervisory action in accordance
with the perceived risk profile of the bank.
3. The supervisor may also focus more attention on banks whose failure could
precipitate systemic crisis.
 Forms of Supervision
 Supervisory authorities (CBN & NDIC) carry out their functions through bank
examinations.
 Bank examination may be defined as the examination of the books and records
of a bank for the purpose of ascertaining that the affairs of the bank are being
conducted in a safe and sound manner.
o Main areas of focus are: adequacy of capital, asset quality, board and management,
earnings, liquidity, adequacy of internal controls, adequacy of accounting system and
record keeping as well as compliance with both the individual banks’ internal policies and
prudential regulations.
o This task of examination is accomplished by bank examiners through both off-site and on-
site supervision functions.
• On-site supervision - entails physical presence of regulators (CBN and NDIC) in
the financial institutions to evaluate their internal controls, compliance with the
laws and regulations governing their operations with a view to determining their
overall risk exposure. On-site supervision is carried out by the Bank Examination
Department of the regulatory bodies.
• Off-site supervision - is carried out by the Banking Supervision Department of
the CBN/NDIC and involves essentially the appraisal of banks returns. Essentially,
it serves as an early warning device to detect a bank’s emerging financial
problem. It involves analyzing key bank financial ratios covering such areas as
earnings, asset quality, capital and reserves and liquidity as well as analyzing
other financial data that are generated from periodic bank financial reports that
are submitted to the supervisor.
 Nature of Bank Examination
• Maiden examination - usually carried out after six months of operations by a new bank to
determine if the conditions and premises for granting of banking license by the CBN and the
business objective of a bank are being pursued.
• Routine examination - is the normal examination, currently carried out on a yearly basis
to review the prudential operations, information-processing systems, foreign exchange
operations and the anti-money laundering control of banks to determine the continued
conduct of banking business in a safe and sound manner.
• Target/Special examination - usually carried out when serious issues of regulatory
concern arise in bank, e.g. persistent illiquidity, lingering boardroom squabbles,
deteriorating assets quality etc. In such a situation, the examination effort is concentrated
primarily on the identified areas of regulatory concern.
• Investigation/Spot checks - These arise from the discovery of abnormal banking practices,
complaints and petitions by the banking public and other stakeholders of issues bordering
on unprofessional and unethical conduct by a bank.
Conditions for Effective Banking Supervision
A suitable legal framework for banking supervision is in
place to provide each responsible authority with the
necessary legal powers to:
o authorise banks,
o conduct ongoing supervision,
o address compliance with laws, and
o undertake timely corrective actions to address safety and
soundness concerns.
 The conditions necessary for effective banking supervision include:
1. Sound and sustainable macroeconomic policy is a critical success factor in the application of the core
principles for effective banking supervision (BCBS) , which set out the best practices in supervision
worldwide.
2. Effective market discipline which requires that there exist a culture of financial transparency and the
presence of good corporate governance.
3. Procedure for the efficient resolution of problems in banks. The BCBS core principles note the need
for supervisory authorities to be vested with the power and authority required for effective distress
resolution.
4. Mechanism for providing an appropriate level of systemic protection for financial safety net. The key
aspects of financial safety net include prudential regulation and supervision, a lender of last resort
facility and deposit insurance according to financial stability form (FSF) in 2001.
5. A well developed public infrastructure. This is another profound aspect for effective banking
supervision.
 Global Supervision, Foreign Bank Branches and Cooperation with Foreign Supervisors
 Few Nigerian banks operate offshore. Currently there are only 8 DMBs with international authorisation:
• Access Bank Plc.,
• Fidelity Bank Plc.
• First City Monument Bank Limited.
• First Bank of Nigeria Limited.
• Guaranty Trust Holding Company Plc.
• Union Bank of Nigeria Plc.
• United Bank for Africa Plc.
• Zenith Bank Plc.
 These banks operate branches outside Nigeria, with their offshore operations always been subject to supervision
by the authorities with the cooperation of the host supervisors.
 Indeed, issues related to cross-border supervision are not relevant to Nigerian banks as their activities are
predominantly domestic in nature.
 Roles and Responsibilities of Stakeholders in ensuring Good Ethical Conduct in the
Banking Industry
 The code of ethics and professionalism serves as the foundation upon which banks must make
decisions based on honesty, integrity, confidence and trust (Sanusi, 2010).
 A code of ethics reflects the standards and establishes a realistic mode of behaviour that applies to
everyone in the bank, from the board of directors to the lowest level of workers in the bank. Thus,
high ethical standards are expected to guide operations in the banking industry.
 Organizational ethics is understanding what is right or wrong in the workplace and then doing
what is right.
 'Stakeholder' is any group which has an interest in, involvement with, dependence on,
contribution to, or is affected by, the organization.
 So, the term stakeholder is broader than the conventional ideas about shareholders, investors and
partners, etc.
 A Stakeholder is any individual or group of people who could lose or gain something
because of the actions of the organization.
 Some important Stakeholders in the operations of the CBN include groups such as
Board of Directors, Top Management, Staff, the Nigerian Public/the Parliament,
Contractors, Consultants, Suppliers, Financial Services Sector Operators,
Government MDAs, Customers, Civil Society, The Mass Media, The International
Business Community, Foreign Governments, Local and international businesses,
Operators in the informal sector of the economy.
 The banking code of ethics has given all stakeholders the right to raise issues related
to unethical behavior that may emanate from the board, management, or customers;
where the board is involve such complaint can be raise to the regulatory authorities
through the whistle-blowing mechanism.
 Notwithstanding that the banks want to uphold the principles of
profitability and productivity, they are obliged to obey certain ethical
principles of banking profession and organizational ethics, which include
honesty, integrity, social responsibility, accountability and fairness.
 The Banks and Financial Institutions Act (BOFIA) 2020, S.3 provides that
“any person whose appointment with a bank has been terminated or who
has been dismissed for reason of fraud, dishonesty or conviction for an
offence involving dishonesty or fraud shall not be employed by any bank
in Nigeria”. This is aimed at sanctioning wrong ethical behavior of
banking employees.
• Corporate Code of Ethics - Each bank is expected to have
Corporate Codes of Ethics to guide their staff of what is expected of
them. The code should be made available to each staff right from the
point of entry and should form part of the induction process.
• Code of Corporate Governance for Banks - The Bankers’
Committee has issued a Code of Corporate Governance for banks and
other Financial Institutions in Nigeria in 2003. This is to strengthen
the need for corporate managers to adhere to processes to ensure
good ethical behaviour in matters bordering on decision making and
management of the organization.
 The Stakeholders' Roles and Ethical Responsibilities
 The expected roles and responsibilities of the Stakeholder must be properly defined and every Stakeholder would be expected
to be guided in all action by the Rule of Law.
 Ethical Principles for Using Organisational Assets
 "Assets" are not limited to money but include assets such as Physical Property, Funds, Intellectual Property ( Official
Information, or other Intangible Property), and Official Records.
 These principles should be codified as rules, and should cover matters like ethical use of organizational assets, responsibility
for physical property, responsibility for funds, etc.
 Intellectual Property
 This includes the ideas discoveries, and inventions of the people who work for the organization. These original ideas and
creations have value in the marketplace. Just like physical property, they have an owner/creator and are given rights of
protection.
 Examples of banks intellectual property are Technical data, Bids/Pricing, Personnel information, Investment/Financial data,
Confidential information, Future plans, Market studies and Proposed products.
 It is employee duty and responsibility to protect the organization's intellectual property, and act responsibly with the sensitive
information of others; protect private personnel information from those inside or outside the organization, among others.
Conflicts of Interest
 A conflict of interest happens when personal interests influence (or appear
to influence) ability to act in the best interest of an organization.
 Organizational information and resources should not be used for personal
gain. Employees should never use their contacts or positions with the
organization to advance their own private businesses or financial interests.
 The adverse effect of conflict of interest may arise from different
perspectives, including employees at all levels, family members and close
associates engaging in organisational business transactions.
References:
• National Open University of Nigeria, e-Courseware:
BFN305 BANKING LAWS AND REGULATION.
• Paseda, O. (2020). Banking Regulation in Nigeria: A
Review Article. IOSR Journal of Humanities And Social
Science (IOSR-JHSS), 25(8), Series 4,38-58.
www.iosrjournals.org
Thank you.