DEPOSIT INSURANCE PRACTICE IN NIGERIA

1

• DEPOSIT INSURANCE PRACTICE IN NIGERIA
• by
• S. O. ALASHI
• Director
• FIELD EXAMINATION DEPARTMENT
• NIGERIA DEPOSIT INSURANCE CORPORATION
• Presented at
• IADI REGIONAL CONFERENCE ON
• DEPOSIT INSURANCE IN AFRICA
• ISSUES, CHALLENGES AND PROSPECTS
• VENUE
• CBN AUDITORIUM
• ABUJA
• DATE
• JUNE 21 23, 2004

2
1.0 INTRODUCTION

• Some have viewed deposit insurance scheme as
  making a major contribution to increasing
  confidence in financial institutions and
  increasing the flexibility of monetary policy
  (J.A. Malin, 1969). Speaking on the United
  States scheme, Friedman and Schwartz (1963) on
  their own asserted that A Federal insurance of
  bank depositors was the most important structural
  change in the banking system to result from the
  1933 panic.

3

• In the case of Nigeria, we can confidently say
  that the introduction of the scheme through the
  Nigeria Deposit Insurance Corporation (NDIC) Act
  No. 22 of 1988 is the boldest step taken by
  government to ensure and promote safe and sound
  banking practices in the wake of its deregulation
  of the financial system and the economy.

4

• The rationale for a deposit insurance scheme in
  Nigeria is first discussed. Having done that, we
  would draw the attention of participants to the
  practice of the scheme in Nigeria. The benefits
  of the deposit insurance scheme are also
  discussed before the conclusion in the last part.

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3.0 REASONS FOR ESTABLISHING DEPOSIT INSURANCE
SCHEME IN NIGERIA

• The decision by the Federal Government of Nigeria
  to establish the Nigeria Deposit Insurance
  Corporation in 1988 was informed by a number of
  factors.

6

• 2.1 Lessons of History Bank Failures in Nigeria
• The period between 1947 and 1952 witnessed a
  rapid growth of indigenous banks in Nigeria.
• The increase in the number of indigenous banks
  was followed also by a high rate of failures of
  such banks. By 1954, twenty-one (21) out of
  twenty-five (25) indigenous banks operating in
  Nigeria had collapsed

7

• The failures were attributed largely to
  mismanagement of assets, lack of adequate capital
  and inexperienced personnel. The country had no
  Central Bank at the time to monitor the
  operations and capitalisation of the banks.
  There were no adequate regulation and/or
  legislation for the banking industry, until the
  1952 Banking Ordinance which came into force in
  1954.

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• The experience of bank failures in Nigeria up to
  early 1950's was a sad affair for bank officials,
  depositors and government. Since the Federal
  Government of Nigeria did not want Nigerians to
  relive those experiences, it was considered that
  the establishment of a Deposit Insurance Scheme
  was urgently needed.

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2.2 Lessons from Other Countries

• The former Czechoslovakia was the first country
  to establish a nationwide deposit insurance
  scheme in 1924, principally as a measure to
  revitalise the banking system after the ravages
  of the First World War. In addition, the scheme
  was meant to encourage savings, by increasing the
  safety of deposits and ensuring the best possible
  development of banking practice in that country.

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• However, the United States FDIC, which was
  established in 1933 in response to the banking
  collapse and panic of that year, provides the
  abiding lessons and model for most countries
  which subsequently introduced formal deposit
  insurance schemes. Between 1930 and 1933 over
  one-third of commercial banks (mostly small, unit
  banks) failed. Some intrinsically sound
  institutions also failed because of contagion.

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• Today, extensive deregulation has taken place in
  the United States, but the FDICs mission has
  remained the same to maintain stability in the
  nations financial system by insuring bank
  depositors and reducing the economic disruptions
  caused by bank failures. Notwithstanding the
  fact that bank failures are still rife in the
  U.S., the FDIC has made it painless on the
  American financial system and has thus engendered
  public confidence in the banking system.

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2.3 Bank Deregulation and Bank Competition

• In 1986, the Federal Government of Nigeria
  introduced and implemented an economic Structural
  Adjustment Programme (SAP) which was aimed at
  deregulating the economy in the direction of
  market-determined pricing.
• Banking competition increased as is evident in
  the growth of banking offices (see Table I) in
  the range of banking services offered.

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Table IGrowth in Bank Offices in Nigeria (1980 -
1988)

• Year Banking Offices Annual Growth Rate ()
• ---------- ------------------
  ---------------
• 1980 752 10.6
• 1981 884 17.5
• 1982 1,010 14.3
• 1983 1,132 12.1
• 1984 1,267 12.1
• 1985 1,323 4.4
• 1986 1,394 5.4
• 1987 1,545 10.8
• 1988 1,711 10.7
• Source Computed from CBN Annual Reports (various
  issues).

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• Another evidence of increasing bank competition
  can be adduced from the yearly fall in bank
  density as shown in Table II.
• Table II
• Bank Density in Nigeria (1980 - 1987)
• Year Population No. Of
• (Estimated)
  Persons Per
• 
  Bank Office
• -------- -------------- ---------------
• 1980 84,445,728
  114,116
• 1981 86,583,482
  97,945
• 1982 88,775,353
  88,775
• 1983 91,022,712
  80,409
• 1984 93,326,962
  73,718
• 1985 95,689,546
  72,328
• 1986 98,168,079
  70,422
• 1987 101,407,626
  66,891
• Sources National Population Commission, and

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• The increasing bank competition manifested in
  sharp practices by some bankers. Such practices
  would increase the risk to which the banks and
  consequently bank depositors would be exposed. A
  DIS was therefore necessary to protect bank
  depositors who would be exposed to the greater
  risks undertaken by bank managers.

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• 2.4 Change in Government Bank Support Policy
• Prior to the establishment of NDIC, government
  had been unwilling to let any bank fail, no
  matter the banks financial condition and/or
  quality of management. Government feared the
  potential adverse effects on confidence in the
  banking system and in the economy following a
  bank failure. Consequently, government
  deliberately propped up a number of inefficient
  state-owned banks over the years.

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• Evidence in support of the change in government
  support policy could be seen from the skewness in
  shareholders fund in total liabilities in favour
  of depositors as shown in Table III below.

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Table III Proportion of Deposits and
Shareholders Fund in Total Liabilitiesof Banks
in Nigeria

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• In the new economic policy of government,
  emphasis has shifted from direct support of bank
  owners to prevent failure to one of protecting
  the deposits of customers, especially the small
  depositors. The depositors fund accounted for an
  average of 47 of the total liabilities of banks
  during the period. That preponderance of risks
  by the depositors was clearly a ground for the
  shift of protection by the Government in their
  favour.

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• Also, the economic reforms have imposed
  challenges and enormous responsibilities on the
  financial system, especially on banks.
• These responsibilities imply increased use of
  depositors funds in the pursuit of bank
  profitability at a time bank capital ratios have
  been falling. This scenario calls for an
  insurance scheme to protect the funds of banks
  depositors.

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3.0 CRITICAL ISSUES RELATING TO DIS PRACTICE IN
NIGERIA

• The practice of the DIS in Nigeria in these areas
  is reviewed in the ensuing sub-parts.

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• 3.1 Ownership and Administration
• There are three types of ownership structures
  identified among the countries that have
  established the scheme
• Jointly held by the private and public sectors. -
  Japan, Argentina, Denmark, Belgium, Greece and
  Hungary.
• Private ownership being practised by countries
  like France, Brazil, Italy, Spain and United
  Kingdom.

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• Ownership is held purely by the public as in
  India, United States of America, Sweden, Uganda,
  Taiwan, Kenya, Canada and Nigeria. The Nigerian
  DIS is owned 100 by the Federal Government of
  Nigeria through the Central Bank of Nigeria and
  the Federal Ministry of Finance which held 60
  and 40 equity capital of the Nigeria Deposit
  Insurance Corporation, respectively.

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• It is pertinent to note however that the best
  practice in ownership type is one that would
  effectively salvage the system by providing
  mitigants for the depositors in case of bank
  distress. As the Japanese experience has shown,
  the Government had to intervene whenever bank
  failure occurred through provision of financial
  support despite private ownership of the scheme
  in that country.

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• 3.2 Membership
• The major issues associated with membership are
  the types of institutions that should be included
  in the scheme, and whether or not participation
  by eligible members should be compulsory or
  voluntary. An observable set back associated
  with voluntary membership is what is known as
  adverse selection.

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• This is a situation whereby only banks with great
  potential for failures join the system, while
  financially sound banks opt out, since they see
  no need to spend their money on deposit insurance
  premiums. With membership of only weak and sick
  banks, the DIS becomes endangered.

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• Membership is compulsory in most countries
  operating DIS. Section 15 (1) of the NDIC Act No
  . 22 of 1988 (as amended), makes it mandatory for
  all licensed banks and deposit-taking financial
  institutions to be members of the scheme.

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• 3.3 Funding
• Adequate financial resources are required to meet
  the schemes obligations and operational costs. I
  want to emphasize that the operations of NDIC is
  being funded from the income earned on the
  investment of the Deposit Insurance Fund (DIF) in
  accordance with Section 11(3) of NDIC Act, 1988
  as amended.

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• The DIF can only be used to pay depositors in
  banks under liquidation and to resolve the
  problems of a distressed bank as provided for in
  Section 12 of NDIC Act, 1988 as amended. This
  clarification is necessary to correct the
  misconception in some quarters that NDIC can
  spend part of the DIF to fund its operations.

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• (a) Initial Capitalisation
• The owners of a DIS usually provide initial
  capital either as paid-up capital as is the case
  with a public sector/joint ownership scheme or as
  an initial levy contributed by members as obtains
  in a privately-owned scheme.

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• (b) Subsequent Funding
• (i) Periodic Premium Contribution by Insured
  Institutions
• This option is usually adopted in order to build
  up a fund necessary to tackle the schemes
  obligations. Under that option insured banks in
  Nigeria pay 15/16 of 1 of their total deposit
  liabilities as at 31st of December of the
  preceding year as premium for the current year.

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• Rates charged in 13 countries surveyed show that
  Venezuela has the highest rate of 2 followed by
  Chile with 1.2. The NDICs rate of 0.94 ranks
  fifth highest among the 13 countries.
• The fairly high premium rate in Nigeria had been
  influenced by the prevailing level of distress
  among the insured banks at inception of the
  scheme and the need to quickly build up adequate
  reserve fund to meet possible calls on the DIF.

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• (ii) Ex-post Surcharge
• A DIS can also be financed through ex-post
  assessments levied after a bank failure. In such
  a case, when a bank fails, amount equal to what
  is required to settle depositors and other sundry
  creditors is levied on insured financial
  institutions.

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• In our own case Section 21 (3) of the NDIC Act
  empowered the Corporation to charge a special
  levy in the sum equal to the amount of an annual
  premium where the DIF is not enough to settle
  obligations arising from its deposit insurance
  liabilities.

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• (iii) Periodic Recapitalisation
• the owners may decide to inject more equity into
  the DIS to meet the required capital standards.
  The capital base of the NDIC which was ?100
  million at inception in 1988 has since been
  increased to ?2.3 billion.

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• (iv) Back-up Funding Arrangements
• It is usual for some publicly-owned DIS to be
  granted provision for supplementary funding
  through the national treasury.
• At the peak of its bank distress, the Philippines
  DIS was lent P19.1 billion in 1986 (about 936.9
  million then) by the Central Bank of that country
  to provide financial assistance to problem
  institutions alone.
• The USA government in its own case provided about
  160 billion from the treasury to resolve the
  savings and loans institutions debacle between
  1989 and 1995.

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• 3.4 Coverage
• Coverage is of great significance in a DIS
  because it determines not only the potential
  liabilities of the scheme but also depositors
  level of confidence in the banking system. The
  key factors that are central to the issue of
  coverage are the deposits to be insured and the
  insurance limit. Coverage may be limited or
  unlimited. Unlimited insurance coverage has been
  widely criticised due to the fact that it leads
  to moral hazard and tendency to imprudent
  management of financial institutions.
• When deposits are 100 percent insured, bankers
  tend to engage in highly risky business
  activities with a view to maintain high returns.
  

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• All depositors in Nigerian banks are covered as
  provided for in Section 20 of NDIC Act, 1988 as
  amended with the exception of insider deposits,
  counter-claims from a person who maintains both a
  deposit and loan account and such other deposits
  as may be specified from time to time by the
  Board.

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• At the commencement of the Corporation in 1988
  the maximum insurance coverage per depositor was
  set at ?50,000.00 and is still in use as of this
  moment. However based on its perceived
  inadequacy, in the light of Naira depreciation
  and inflation among other reasons, the Board of
  Directors of the Corporation approved an upward
  review of the limit to ?100,00.00 during the last
  quarter of 2000. The review would become
  operational once the necessary amendment is made
  to the NDIC Act by the National Assembly and
  signed into law by the President.

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• 3.5 Investment Policy
• A policy regarding how the deposit insurance fund
  is to be invested is usually contained in the
  enabling legal instrument establishing a DIS.
  Major points of emphasis are usually liquidity
  and safety of fund. By the provision of Section
  11 (1) of the NDIC Act, 1988 as amended the
  Corporation is required to invest its fund in
  government securities.

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• 3.6 Power to Supervise Insured Institutions
• Under a DIS, the supervision of insured
  institutions is a major burden that falls
  squarely on the insurer. This arises from the
  fact that it is of paramount importance that the
  administrator of the scheme knows the extent of
  risk it is assuming and to monitor the changes in
  the composition and extent of such risks through
  close supervision of the insured institutions.
• The NDIC Act, 1988 as amended empowered the
  Corporation to supervise insured institutions in
  Nigeria.

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4.0 STRUCTURE OF THE NDIC

• At the apex is the Board of Directors responsible
  mainly for policy formulation and they are
  appointed by the President. Among them are the
  Managing Director/Chief Executive Officer
  (MD/CEO) who is in charge of the day-to-day
  management of the Corporation and two Executive
  Directors (EDs) who assist him.
• Administratively, NDIC is structured into three
  divisions comprising of various Departments and
  Units. The MD/CEO Office has Corporate
  Development Department (CDD), Internal Audit
  Department (IAD), Legal Department (LD) and
  Public Affairs Unit (PAU).

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• The Operations Division being supervised by the
  ED (Operations) has Off-Site Supervision, Field
  Examination, Receivership Liquidation, Research
  and Special Insured Institutions Departments.
  The Finance and Administration Division under the
  supervision of ED (FA) comprises Administration,
  Human Resources, Finance, and Computer Services
  Departments. The Coordinator of Lagos Office
  (CLO) also report to the ED (FA) while the Zonal
  Controllers in Benin, Enugu and Kano reports to
  the Director, Field Examination Department (FED)
  on operational matters.

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5.0 OPERATIONAL ACTIVITIES OF NDIC

• 5.1 Banking Supervision
• Largely involves on-site examination and
  off-site surveillance of banks. The primary
  objectives are to determine the financial
  condition of banks and to ascertain their
  compliance with banking laws, rules and
  regulations.
• (i) On-Site Examination
• Entails on-site verification and assessment of
  a banks records and operations. It focuses
  mainly on
• Competence of management and adequacy of
  corporate governance
• Adequacy of accounting and internal control
  systems
• Information technology (IT) general controls
• Adequacy of risk management systems
• Quality of loan portfolio
• Operational performance in the area of earnings,
  deposits and liquidity and
• Adequacy of capital.

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• The types of examinations usually carried out are
  routine, special, target and investigation. The
  basis for selection of banks to be examined by
  NDIC include annual programme mutually agreed
  with CBN and banks identified through early
  warning system (EWS) or market information.
• The examination report is presented to the Board
  of examined bank at a meeting convened for that
  purpose. The External Auditors of the examined
  bank are invited to such a presentation.
• Given the poor quality of returns by many banks,
  on-site examination has continued to serve as the
  most effective means of supervising banks.

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(ii) Off-Site Supervision

• Analysis of periodic returns from banks to
  determine their financial condition has been
  largely computerised. Jointly with CBN, NDIC is
  enhancing the electronic financial analysis
  surveillance system (eFASS) to make it
  web-enabled and robust in analysing data from
  insured financial institutions.
• Compilation and analysis of reported cases of
  frauds and forgeries which is regularly
  published. The information is also useful in
  conducting fit and proper test for those
  wanting to be involved in the management of
  banks.

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5.2 Managing of Distress

• Resolution of distress is of primary concern to
  NDIC because of its mandate and the adverse
  consequences of poorly managed bank distress.
  Such consequences include
• loss of confidence, leading to deposit runs
• Dis -intermediation and de-monetisation
• crowding-out of the real sector from credit
  extension and
• Increase in cost of resolution.
• Resolution measures include
• Open bank assistance
• Purchase and assumption
• Insured deposit transfer
• Bridge bank and
• Pay-off

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• NDIC has used open bank assistance and pay-off to
  manage banking distress over the years. In 1989,
  jointly with CBN, ten banks were given
  accommodation facilities which totaled N2.31
  billion to address their liquidity problems.
• Several distressed banks were taken over and
  passed to NDIC to superintend over their affairs
  before they are acquired by new investors.
  Pay-off had been used to resolve 35 out of the 36
  banks whose licenses were revoked by CBN since
  the inception of NDIC.
• Also, jointly with the CBN the Framework for
  Contingency Planning for Banking Systemic Crisis
  was developed and became effective from 1st July,
  2002 as a measure for managing distressed banks.

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5.3 Activities as Deposit Insurer and
Liquidator

• (i) Payment of Insured Deposits
• Deposit of ?5000 and below are held by 88.27 of
  the insured depositors who had only 4.57 of the
  total insured deposits.
• 98.2 of total depositors held ?50,000 and below
  and are fully covered in the 35 closed banks.
• Only 1.8 of total depositors have above ?50,000
  deposits in the closed 35 banks.

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Table IVANALYSIS OF DEPOSIT RANGE FOR 35 BANKS
IN LIQUIDATIONAS AT 31 05 2004
51
Table VANALYSIS OF DEPOSIT CLAIMS SETTLEMENT AS
AT 31-05-2004
52

• PAYMENT OF LIQUIDATION DIVIDEND
• 32 closed banks declared liquidation dividend of
  ?10,750.5 million
• 10 out of the 32 banks declared 100 dividend to
  their depositors
• 4 out of the 10 banks declared dividend to
  general creditors
• 1 of them paid dividend to its shareholders.

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(ii) Liquidation

• Orderly and efficient closure of failed banks
• Cost effective realisation of assets of closed
  banks
• Distribution of proceeds of asset realised to
  depositors and other creditors as per rules of
  priority of claim
• Separate and distinct roles, accounts, audit and
  reporting requirements from NDIC corporate

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Table VIASSET REALISATION AS AT 31-05-2004
55
5.4 Other Activities of NDIC

• Capacity building through FITC, CIBN, NASB and
  endowment funds in several universities.
• Provision of detailed and qualitative information
  to the banking and non-banking public through its
  publications
• Annual Report Accounts
• NDIC Quarterly
• Various Books on Deposit Insurance
• Pocket Guide for Bank Directors
• Facts About Deposit Insurance
• Papers and Lectures by MD/CEO, EDs, and Staff

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6.0 BENEFITS OF DEPOSIT INSURANCE IN NIGERIA

• Without benefits, there should be no need for the
  scheme at all.
• These benefits are both direct and indirect.
  However, while the public and government have
  willingly embraced deposit insurance scheme in
  all countries where it exists, the banks have
  always initially shown resentment mainly because
  of cost considerations. The bankers resistant
  notwithstanding, governments have always gone
  ahead with the scheme because of its tremendous
  benefits to the banking system.

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6.1 Protection of Depositors

• The most basic reason for prudential regulation
  on banking is depositor protection. This is
  particularly so for small depositors as they are
  unable or unlikely to have access to sufficient
  information to permit them to evaluate the
  solvency of banks in which they deposit their
  money. It is for this reason that most deposit
  insurance schemes including our own have had
  relatively low cut off points.

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6.2 Development of Banking Habit

• The protection which a deposit insurance scheme
  gives is helpful in developing banking habit
  which contributes to the growth of the banking
  industry. As a consequence, bank deposits would
  grow since customers fear of loss of deposits
  through bank failures would have been allayed.
  Equally important is that a bank DIS protects
  individuals wealth held as deposits to the level
  of the guarantee. It thus increases the
  proportion of insured wealth of the public.

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6.3 Monetary Stability

• Deposit insurance acts as a stabilizer by
  preventing dangerous reductions in the nations
  money stock through bank failures.
• There is a general agreement among economists
  (whether monetarists or fiscalists) that changes
  in money supply are an important determinant of
  the level of economic activities. When a bank or
  banks fail, in the absence of a deposit
  insurance, the money supply drops by the amount
  of lost deposits and the ability of banks to
  create more money is lowered. Deposit insurance
  scheme, by replacing the potentially lost amount,
  stabilizes the money stock at the pre-failure
  level.

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6.4 Protection From Bank Runs

• One of the major benefits of deposit insurance,
  according to Robert E. Barnett (a former Chairman
  of FDIC) is that it protects the banking system
  against destructive runs on deposits. This view
  is supported by the Deposit Insurance and Credit
  Guarantee Corporation of India which claims such
  runs can lead to a complete breakdown of a
  countrys financial system and the collapse of
  its economy (Deposit Insurance and Credit
  Guarantee Corporation, India, 1984).

61

• The scheme is thus seen as engendering public
  confidence in the financial system and reducing
  external diseconomies resulting from frequent
  bank failures. It also has the potential of
  lessening capital flight that may arise from a
  country with bank failures.

62
6.5 Promotion of Competitive Efficiency

• One aspect of a good banking system is that
  customers are provided quality services at
  competitive prices. All the banks should have the
  same competitive advantage as the scheme imposes
  a flat-rate of premium on them. Competition is a
  vehicle for achieving efficiency since, in a
  competitive banking system, banks are forced to
  operate efficiently if they are to keep their
  customers and remain in business.

63
7.0 CONCLUSION

• Going by our recent experience with bank distress
  it is only trite to admit that the Nigerian
  banking environment, like every other system
  worldwide, is not immune from bank distress. What
  is important, therefore, is the reinforcement of
  regulatory structures to prevent systemic failure
  in case of bank failures.

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• The wisdom in the establishment of a deposit
  insurance scheme in the country cannot be
  over-emphasized given the efficient and orderly
  manner with which depositors of 35 banks under
  liquidation (excluding Savannah Bank) are being
  paid and its efforts in the sanitisation of the
  banking industry. The smooth resolution of failed
  banks has continued to sustain public confidence
  in the system.
• Deposit Insurance in Nigeria is not only total
  embracing deposit insurer, liquidator and banking
  supervisor, it is done in accordance with
  international best practice.

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• Thank you for your kind attention.