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The Central Bank of Nigeria was established by the CBN Act of 1958 and commenced operations on July 1, 1959.

The major regulatory objectives of the bank as stated in the CBN act of 1958 is to: issue legal tender, maintain the external reserves of the country, promote monetary stability and a sound financial environment, and to act as a banker of last resort and financial adviser to the federal government. The central bank's role as lender of last resort and adviser to the federal government has sometimes pushed it into murky regulatory waters. After the end colonial rule, the desire of the government to become pro-active in the development of the economy became visible especially after the end of the Nigerian civil war, the bank followed the government's desire and took a determined effort to supplement any short falls in credit allocations to the real sector. The bank soon became involved in lending directly to consumers, contravening its original intention to work through commercial banks in activities involving consumer lending. However, the policy was an offspring of the indigenisation policy at the time. Nevertheless, the government through the central bank has been actively involved in building the nation's money and equity centers, forming securities regulatory board and introducing treasury instruments into the capital market.

Authorizing Legislation

In 1948, an inquiry under the leadership of G.D Paton was established by the colonial administration to investigate banking practices in Nigeria. Prior to the inquiry, the banking industry was largely uncontrolled. The G.D Paton report, an offshoot of the inquiry became the corner stone of the first banking legislation in the country: the banking ordinance of 1952. The ordinance was designed to prevent non viable banks from mushrooming, and to ensure orderly commercial banking. The banking ordinance triggered a rapid growth in the industry, with growth also came disappointment. By 1958, a few number of banks had failed. To curtail further failures and to prepare for indigenous control, in 1958, a bill for the establishment of Central Bank of Nigeria was presented to the House of Representatives. The Act was fully implemented on July 1, 1959, when the Central Bank of Nigeria came into full operation.

Policy Implementation and Criticism

The CBN's early functions were mainly to act as the government's agency for the control and supervision of the banking sector, to monitor the balance of payments according to the demands of the federal government and to tailor monetary policy along the demands of the federal budget. The central bank's initial lack of financial competence over the finance ministry led to deferment of major economic decisions to the finance ministry. The bank operated through some major guidelines. Overtime, it's guidelines were known to be non effective. A key instrument of the bank was to initiate credit limit legislation for bank lending. The initiative was geared to make credit available to neglected national areas such as agriculture and manufacturing. By the end of 1979, most of the banks did not adhere to their credit limits and favored a loose interpretation of CBN's guidelines. The central bank also failed to effectively curtail the prevalence of short term loan maturities. Most loans given out by commercial banks were usually set within a year. The major policy to balance this distortion in the credit market was to create a new Bank of Commerce and industry, a universal bank. However, the new bank also failed in its mission. Another policy of the bank in concert with the intentions of the government was direct involvement in the affairs of the three major expatriate commercial banks in order to forestall any bias against indigenous borrowers and consumers. By 1976, the federal government had acquired 40% of equity in the three largest commercial banks. The bank's failure to curtail inflation by financing huge deficits of the federal government has been one of the sore points in the history of the central bank. Coupled with its failure to control the burgeoning trade arrears in 1983, the country was left with huge trade debs totaling $6 billion.

The CBN also has had mixed results in its policy objectives since the early 1980's. Currently, under the leadership of Charles C.Soludo, the CBN is going through a relative phase of success in comparison to recent history. The bank's recent success is partially due to the rise in crude oil prices. Increase in crude prices has limited the financing of external debt, a tremendous achievement which will lower the burden of committing scarce resources for foreign debt financing. The bank's use of capitalization has given more strength to the banking sector against an earlier failure by the central bank to control the spectacular fall of many merchant banks and commercial banks in the early 1990's. By 1990, the liberalizing agenda of an adopted Structural Adjustment Programme led to unprecedented growth in the banking sector. However, a large number of banks in the sector where mainly engaged in arbitrage and seeking government funds to stay afloat. By 1995, most of the banks were in distress.

Minimum capital base would increase by 1150 percent to 25 billion Naira ($185 million). Public sector deposits would be withdrawn from banks. This would be attained by encouraging mergers and acquisitions and if possible shoring up healthy banks with foreign reserves. According to some account of the proceedings, the CBN governor did not mince words when he stated to the audience that by the time this reform is over, a lot of the executes seated there and their banks would be history.

You can't help but read some valuable meaning into what Mr. Soludo is about to embark on. I have personally desisted from passing any judgments since his appointment. As a keen observer, if his remarks are anything to go by, it is safe to say that; he could be a guy who would take care of business in the banking sector, just as Ngozi Okonjo-Iweala is taking good care of business in the Finance Ministry, Nasir El-Rufai holding forth in the Federal Capital Territory, Nuhu Ribadu ruffling feathers in the Economic Crimes desk (EFCC) and Dora Akunyili kicking ass in the Food/Drug Control Agency (NAFDAC). Considering the pivotal role of the banking industry and its failure to live up to expectation, the system is overdue for a radical transformation to meet the challenges of both domestic economic imperatives and emerging global competition.

…Logic of Events.

You would recall that long before the birth of the current banking structure in the late 1980s through the process of liberalization by Babangida's administration, the Nigerian banking system was dominated by older and larger banks; namely United Bank for Africa, Union Bank and First Bank, plus a host of other state-owned banks, some of which are now transformed or moribund. The liberalization policy of Babangida's administration helped spur new nimble players into the market; like Zenith Bank, Guaranty Trust Bank (GTB) and Investment Banking and Trust Company (IBTC) to mention a few. This new generation banks were smart, dynamic and hungry.

Right from the get-go the new banks were plagued with the problem of low capitalization and stiff competition from well established ones. Over time, most of the newer banks transformed to nothing more than glorified bureau-de-change with the attendant round tripping, trading in forex and treasury bills and beautifying their financial statements. As the fortunes of banks rose through this less-than-ethical means, the economy as a whole continued to falter, which begged the question as to how the banks were posting those impressive returns. To be fair, the new banks gave the more established ones a run for their money and actually energized the industry. Some young banks are today already in the big league.

Measures targeted to curb sharp practices by the banks, were quite draconian, vindictive, misguided and rather short-lived during the Abacha era. This was akin to putting a fox in-charge of chickens. Not until the ascension of Joseph Sanusi in 1999 as the Governor, was there any serious and unbiased attempt to sanitize the system and instill some discipline. For starters a universal banking policy was introduced to dismantle the restrictions between investment and commercial banking activities, fashioned after the US Financial Services Modernization Act of 1999.

Some banks were known to have been suspended from the foreign exchange auction as their owners cum top-level executives were stripped of their coveted positions.

…Research Findings.

Over the last 15 years, the banking system in Nigerian has indeed achieved some measure of progress. I was quite impressed with the talent and dynamism withnessable in the early 1990s, during my research on the "Critical Role of the Banking Industry in Implementing the Structural Adjustment Program (SAP) in Nigeria".

That research culminated in my doctoral dissertation in 1992. The study showed that:

1. At its peak, there were over 120 banks in the early to mid 1990s as opposed to less than 20 in 1980 or 89 today. The bank branches also grew phenomenally, albeit within urban areas and there was a rising level of foreign participation, and systematic global integration of the Nigerian banking industry - Nigeria hadn't been blacklisted by the Financial Action Task Force (FATF) as a non-cooperative country in the fight against international money laundering and fraud.
2. Almost all the banks often did not meet the regulatory requirement for funding agriculture, manufacturing and other productive sector, (i.e. the ratio of their loans and advances that must be channeled to "real sectors"). The emphasis for most of them was to fund so-called "short-term deals" with rapid turnover, going as far as importing fast-moving-consumer-goods (FMCG), thereby exerting undue pressure on the foreign exchange market.
3. A majority of the banks were quite aggressive in pursuing and attracting customers as opposed to the armchair banking style of the bigger/older banks. With time, some banks took that aggression too far by recruiting pretty female bankers to go after affluent and institutional customers.
4. The newer banks were more likely to be financially unstable, due to low capital base, often relying on a single or few public sector deposits for sustenance.
5. Our conclusion was that, the system was far from adequate, but would improve as financial institutions attain a higher level of maturity over time - these conclusions are yet to fully materialize.

Opinions abound as to why such problems persist, ranging from the usual Nigeria factor up to weak infrastructure and dual economic structure. Consider that as banks continue to clamor for public sector deposits, over 400 billion Naira ($2,9 billion) remains untapped outside the banking system. Secondly, according to the CBN, more than 20 billion Naira ($151 million) has been amassed over the last 5 years in the Small and Medium Enterprise Investment Fund, yet bankers maintain that there are not enough bankable ideas in the country, preferring to fund importation of merchandise at the expense of local manufacturing as average capacity utilization lags at less than 70 percent.

…Which Way Out?

Succeeding in the current economic climate in Nigeria is hard enough, even the bankers complain, so given these systemic deficiencies, isn't it preposterous to suggest that the system doesn't deserve such a quantum leap. I fully concur that these changes would be in the long-term interest of the national economy and here are some reasons why:

• Low level of capitalization and high loan-loss ratio, resulting in long-term financial instability and heightened risk of failure. At the end of March this year, the Central Bank rating of all the banks showed that 62 banks could be considered as sound or satisfactory, 14 as marginal and 11 as unsound while 2 of them did not render any returns at all during the period under review.
• Fragmented market structure, with a preponderance of small to mid-sized banks, incapable of funding major long-term projects necessary to galvanize the economy. Even the largest bank in Nigeria has a capital base of $240 million versus the smallest bank in Malaysia with over $500 million in capital.
• Inability to adequately assimilate the informal sector, by either mobilizing untapped financial resources or financing micro and small-scale entrepreneurs who form the fabric of the economy.
• Declining standard of corporate governance, lack of transparency and poor accountability, leading to incessant malpractices, outright fraud and unnecessary bad debts. The new Central Bank governor indicated that an analysis of the financial reports of the marginal and unsound banks showed that, these banks account for 19.2 per cent of aggregate assets of the banking system, 17.2 per cent of total deposits. The non-performing assets of the banking sector stands at 19.5 per cent of total assets.
• Inability to respond to the needs of a growing domestic economy or meet the challenges of an increasingly competitive regional/global market arena.

Critics argue that the banks should be allowed to implement internal reforms or be given more time to meet the new minimum capital requirement. Is it possible to expect Nigerian banks in this current situation to wake up to serious new challenges on their own, without being adviced, cajoled or forced to? Why should they want to change, if most top-level bankers are comfortable and satisfied with the status quo? - it would be interesting to know what an opinion poll of top bankers on this issue would show. To most of the banks, I imagine that the perception might be that the system is not broken, so why fix it? but to depositors and the economy at large the banking system is fragile, not pulling its weight and therefore needs fixing.

…Forward Ever.

The Glass-Steagal Act of 1933 and the Financial Services Modernization Act of 1999 in the US were enacted in reaction to new realities and challenges. Russia in a free-market environment is still grappling with re-occurring banking crises, both in 1998 and probably an impending crises as we speak, because it is yet to aggressively and radically reform its financial system. Several developing countries like Malaysia, India, and Turkey that had aggressively tackled their banking problems now have stronger, virile and more globally/regionally competitive banking institutions.

The long-term repercussion of the reform process in Nigeria is that, some smaller banks would be absorbed by larger and more successful ones, while their top and mid level executives could possibly lose their positions. However, the institutional framework would become strengthened. Nigerian banks would become stronger and successful international or regional players, depositors and the federal government would have greater confidence in the system, and possibly place more of their funds with banks. Imagine the effect of mobilizing at least 60 percent of the untapped resources idling away under the mattresses; that alone would translate into the minimum share capital of 10 stronger banks. Consider also if the federal government would agree to domicile at least half of its $10 billion foreign reserves with Nigerian banks. The result of all these actions would mean a huge plus for the domestic economy. If no action or short-gun measures are taken, the consequences would be costly; continued economic stagnation and ultimate collapse of the banking industry, just like the debacle of finance houses in the mid 1990s

Radical banking reform is practicable and inevitable in Nigerian. It should be glaring that economic empowerment and grass-roots development won't take hold without such a serious shake-up. As I continue to maintain, it would not require brain surgery to move Nigeria forward; a few bold steps could do the magic. The new CBN governor already indicated that for an economy like Nigeria's, that is $65 billion in size, the banking system is a far cry from adequate. The reform package should make provision for specialized financial institutions in such areas like mortgage lending, investment advisory and community saving/loans scheme, either as stand-alone entities or subsidiaries of major banks. Overall, such institutions should actually cease to function as pure banks, but rather become specialized niche players.

Charles Soludo's mandate will be to stick to his guns and pursue the reform agenda to the later. As an outsider and experienced economist for that matter, it is possible that Mr. Soludo possesses a macro-perspective of the banking system and knows how it interplays with the economy in a manner that, he and his team can possibly discern the problems and their solutions. These solutions should form some of the key pillars of National Economic Empowerment and Development Strategy (NEEDS). The fact that Obasanjo's administration saw it fit to appoint a reform-minded individual to run the CBN and hand him a Carte blanch to turn the banking system around might probably go down as one of the greatest achievements so far, that is, if the reforms succeed.

Recapitalsation of Banks

Last year, Charles Soludo, governor of the Central Bank of Nigeria and a leading member of the country's economic-reform team, stunned bank bosses when he ordered banks to raise their minimum capital base twelvefold, to 25 billion naira ($190m), within 18 months or face being banned from holding public-sector deposits and participating in the foreign-exchange markets.

Mr Soludo's directive was intended to spur on a consolidation of Nigeria's fragile and overcrowded banking sector, mainly through mergers. The aim is eventually to reduce the number of banks from 89 to about 12. Many banks are family-owned and exist only because of their close connections to Nigeria's political elite.

Oil-rich Nigeria is Africa's most populous country, with 130m people. Its economy is still largely lubricated by cash. Mr Soludo wants to see more banks offering the right services to ordinary depositors, which in turn will help stabilise the lending environment in one of the continent's biggest economies.

“Some of our banks are not engaged in strict banking business in terms of savings intermediation. They are traders—trading in foreign exchange, in government treasury bills, and sometimes in direct importation of goods through phoney companies. This is not healthy for the economy,” Mr Soludo told the banks' executives.

 Merge and survive

With seven months to go before the capitalisation deadline, results have been mixed. Preliminary consent has been given for a merger between two of Nigeria's biggest banks, United Bank for Africa and Standard Trust Bank. Around 60 formerly independent banks have formed 18 new groups that are in various stages of agreements on mergers.

But analysts say that the mergers may not rid the industry of its sleazy reputation. They also worry that the problems of integration, such as how to restructure branch networks, may be buried in the rush to meet Mr Soludo's deadline.

According to Bismarck Rewane, an analyst at Lagos-based Financial Derivatives, many of the banks have managed to meet the capitalisation benchmark by raising capital through share offerings and entering into special treaties which sometimes involve the exchange of loans for deposits. “There has been a lot of recapitalisation. But there has been no real consolidation in the sector, just a lot of playing with mirrors,” says Mr Rewane.

Around a dozen banks have raised money through initial public offerings (IPOs). However, in March four banks were asked to return the equivalent of around $380m because they had funded IPOs through shareholder deposits and illicit foreign money. Meanwhile, the central bank has been forced into propping up the banks, for fear that its reforms may provoke a systemic collapse. It suspended the recall of 74.5 billion naira of public-sector deposits from banks last year, which had been intended to lessen banks' dependence on cyclical government funds. More recently, the central bank said it would cancel 80% of the debts owed to it by eight troubled banks, in order to avoid a crisis of confidence and to make the banks attractive to buyers. Mr Soludo has said that this would be a one-off measure.

Apparently undeterred by the continuing difficulties facing some institutions—and by the country's lack of an international credit rating—foreign banks are eyeing the Nigerian market for bargains. South Africa's biggest retail lender, Absa, is set to acquire a majority stake in a Nigerian group formed by the merger of three banks. Absa itself is coming under the control of Britain's Barclays. Analysts estimate that there is probably room for three or four larger foreign banks to help consolidate the Nigerian market.

But because the fiddling by many of the banks has ensured that they will survive Mr Soludo's planned consolidation, there will probably have to be another round of mergers before the central bank's target is met. Still, unless the central bank is prepared to stand behind the banks for ever, some will have to fall by the wayside as both foreign and bigger Nigerian banks sweep up the vast potential market for deposits and mortgages.