CHAPTER ONE

1.1 Background of the Study

This study investigates the determinants of banking stability in Nigeria. Banking stability is crucial
for the stability of any financial system in the world. Financial system regulators understand that a
loss of confidence in the banking system can have devastating consequences for the entire
financial system. For this reason, banking stability has always been a top regulatory and
supervisory policy objective for regulators. Nigeria has an emerging banking sector which is
ranked ‘third’ in Africa after South Africa and Egypt. Nigeria has experienced many episodes of
financial and economic recession within the last two decades, and this has brought the fragility of
Nigerian banking and finance onto the front burner of discourse by academics and policy makers.
Many studies have identified some determinants of banking stability such as financial development
levels, bank efficiency and systemic interconnectedness, among others. But much of these studies
have focused on developed economies. One major issue that is not clearly understood in the
literature is the determinants of banking stability in emerging economies, given that their financial
structure is less sophisticated than that of developed economies.

So far, the literature on bank stability determinants in Africa is rather scanty, and the studies that
examine the Nigerian context are quite few. Therefore, there is need to identify the determinants of
banking stability in Nigeria. In theory, bank capital and abnormal credit cuts are the two biggest
predictors of bank failure (Diamond and Rajan, 2009; Mendoza and Terrones, 2012). Focusing on
bank capital, bank regulators in Nigeria want banks to keep sufficient capital for the risks they take
and to mitigate unexpected losses (CBN, 2010). However, some experts believe that capital
resources alone are not sufficient to achieve banking stability in emerging economies due to
debates about what constitutes bank capital (Farag et al, 2013, Ozili, 2017a). Considering these
arguments, it is needful to identify the determinants of banking stability in Nigeria.

This study differs from prior studies in that it is primarily interested in aggregate outcomes rather
than in individual bank performance. Using aggregate outcomes allows us to focus on the changes
occurring in the Nigerian banking industry. The study uses the z-score as the measure of banking
stability. The explanatory variables include bank performance variables, macroeconomic variables
and financial structure variables. The findings indicate that nonperforming loans, regulatory
capital, bank efficiency, financial depth and banking concentration have a significant effect on
banking stability in Nigeria depending on how banking stability is measured. The findings are
robust to alternative estimation techniques.
This study contributes to the literature in two ways. Firstly, it aligns with studies that explore bank
stability and regulation (e.g. Ozili 2017a; Allen and Gale, 2004; Brunnermeier et al., 2009;
Segoviano and Goodhart, 2009; Ozili, 2019). These studies attempt to identify the sources of
fragility or potential factors that influence financial stability. This study adds to this literature by
examining the case of Nigeria since studies on banking stability determinants in Nigeria are scanty.
Secondly, from a policy standpoint, insights gained from this study would help bank supervisors
understand the importance of assessing how bank-factors, macroeconomic factors and financial
structure could affect the stability of the banking system in the Nigeria.

1.2 Statement of Problem

In recent years, the Nigerian economy has encountered domestic and external shocks. The
economy has continued to grow to roughly 6.7 percent annual estimate since 2009. Efficiency in
financial institutions has continued to improve, although there are still some anti-crisis emergency
measures that need to be in place. The need for sustaining financial stability in spite of the crisis
and in the face of significant internal and external threats are drivers of the Central Bank (CBN)'s
crucial and broad-based policy response.

The CBN has taken an extensive range of remedial measures after the crisis. Substantial liquidity
has been injected; a full guarantee has been given to depositors as well as to banks interbank and
foreign loan lines. The Asset Management Company of Nigeria (AMCON) was set up to buy
banks’ Non-Performing Loans (NPLs) in return for zero-coupon bonds and injection funds to take
assets to zero. Other measures taken were the strengthening of financial laws, regulations to
enhance corporate governance and other oversight functions while also abandoning the Universal
Banking Model and also instructing banks to set up holding companies (Kaminsky and Carmen,
1999; Laeven and Levine, 2009).
In spite of the procedure towards a favourable macroeconomic outlook, a significant risk in the
financial system persists. There have been bank and other financial service failures such as a
substantial decline in the value of asset prices, liquidity shortages, the inability of these institutions
to meet their financial obligations and finally stock market crashes. These kinds of financial crises.

Also, an overview of the non-banking financial institutions in the country shows the need for
additional regulations. For instance, the insurance sector requires the better implementation of
compulsory insurance; improvements in requirements of product disclosure; and the resolution of
unviable businesses.
Given the different regulatory frameworks instituted to forestall crises in the financial sector in
Nigeria such as the CBN’s emergency liquidity assistance (ELA), the Nigeria Deposit Insurance
Corporation (NDIC) and AMCON’ indemnity of banks’ nonperforming loans (NPLs); in addition
to current security situation and legal and political laxities, the questions remain: how stable is the
financial sector in Nigeria? How diverse is the financial sector in Nigeria? What is the effect of the
financial sector on economic growth in Nigeria? This study, therefore, examines the stability and
diversity of the Nigerian financial sector.

1.3 Objectives of the Study

The main objective of this study is to assess the stability and diversity of the Nigerian Financial
sector. The specific objectives include to empirically:
i. Examine the stability of the financial sector in Nigeria.
ii. Analyze the level of diversity in the Nigerian financial sector using their concentration index.
iii. Investigate the effect of the financial sector on economic growth in Nigeria.

1.4 Research Questions

i. To what extent is the stability of the financial sector in Nigeria?
ii. How can we analyze the level of diversity in the Nigerian financial sector using their
concentration index?
iii. What is the effect of the financial sector on economic growth in Nigeria?

1.5 Research Hypothesis

Ho: There exist no significant positive stability to the financial sector in Nigeria
Ho: There exists no significant positive effect of diversity in the Nigerian financial sector using
their concentration index
Ho: Financial sector does not have any positive effect on the economic growth in Nigeria

1.6 Significance of the Study

This study's will highlight the problems that militate against the realization of the monetary policy
objectives and focus attention on the prospects of minimizing the effect of the problems
outstanding in terms of financial instability. These problems should be eliminated to have the
advantages of a stable and efficient financial system's monetary policy objectives.
1.7 Scope and Limitation of the Study

The study therein considered banking system and the stability of financial institutions. The study
can be expanded and the study can be expanded to different safety and soundness of the banking
system conditions. There is a great need on the part of the researcher to reveal certain problems
encountered in the course of writing this project. There were some constraints which as limiting
factors are worth mentioning first, the issues of time there was not enough time for the researcher
to adequately carry on indent worth. This was due to the high schedule of the school political
impasses in this study.

Secondly, it was certainly not easy for the researchers to get vital information from the company
understudy as they were termed confidentially. Most of the workers too declined to accept
questionnaires. In depth analysis could not be carried out because of shorter time period.
Finally, despite these difficulties, justifiable and acceptable work has been done to this research
work. However, there were some constraints that impinged on the research, these are;
Financial constraint: The cost of sourcing information and administering questions was quite on
the high side, which included issuing out questionnaires to students.
Time Constraint: The limited time frame given to achieve the research was also a constraint to
the study.

1.7 Definition of Terms

Monetary base: This is also known as high-powered money or reserve money and comprises
certain CBN liabilities, including currency with the non-bank public and total bank reserves.
Money stock or money supply: This refers to the total value of money in the economy, and this
consists of currencies (note and coins) and deposits with the commercial and commercial banks.
Macro-economic: This is the study of aggregate, average or whole covering the entire economy.
Interest Rate: The interest rate provides a link between the change in a monetary variable
(instrument) and the level of output, income and employment.
Financial stability: This is the financial system's resilience to unanticipated adverse shocks while
enabling the financial system's intermediation process is continuing smooth functioning.
Open Market Operations (OMO): This involves sales or purchasing government securities in the
open market, whether the economy is inflationary or deflationary.
Inflation: Means a sustained rise in the average price of goods and services in the country, without
a corresponding increase in the quantity.
Liquidity: This is the excess of the money supply over money demand.
 CHAPTER TWO

LITERATURE REVIEW

2.1 Conceptual Review

2.1.1 An Overview of Nigeria’s Financial Sector

In Nigeria, the financial service sector comprises of financial institutions, financial markets,
specialized development finance institutions and other various institutions. Under the financial
institutions, we have both bank and non-bank institutions. Bank involves commercial banks,
mortgage banks, merchant banks, etc., while non-bank involves insurance companies, pension
firms, finance firms, and exchange offices. The financial markets are both the money and capital
markets where loans are secured for various reasons. The specialized development finance
institutions are set up to support economic development particularly in developing countries such
as the Bank of Industry (BOI) and Nigerian Export Import Bank (NEXIM).
The Nigeria financial service sector also includes the supervisory authorities charged with the
responsibility of regulations. They are the Central Bank of Nigeria (CBN), Nigerian Deposit
Insurance Corporation (NDIC), Securities and Exchange Commission (SEC), National Insurance
Commission (NAICOM), Nigerian Stock Exchange (NSE) and the Federal Ministry of Finance
(FMF). The financial sector in Nigeria has experienced several reforms to improve its efficacy.

2.1.2 Concept of Financial Stability

Financial stability refers to the absence of systemic financial shocks or crises. It is merely the
avoidance of a financial crisis in an economy (Macfarlane, 1999). The emphasis on systemic
shocks or crisis is essential in this definition, as financial instability does not only connote
financial Ill-health of a particular bank, firm or household but extended to cover the entire
financial system in an economy.
According to foot (2003), financial stability is attained if:
i. Monetary stability is achieved.
ii. The employment level in an economy is close to its natural rate.
iii. The public reposes complete confidence in the operations of critical financial institutions and
markets and there is relative stability in the price movement of both real and financial assets. By
inference, financial stability cannot be achieved in an economy characterized by rapid inflation or
high unemployment rate. Similarly, high incidences of bank failures or financial institutions'
inability to perform their intermediary financial role either for individuals or corporate customers
are symptoms of financial instability, leading to a gradual erosion of public confidence in the
financial system. The implication is a slowdown in economic growth due to credit's nonavailability
or high financial intermediation cost. Simply put, "financial stability is a state of affairs in which
an episode of financial crisis unlikely to occur, so that fear of financial instability is not a material
factor in an economic decision taken by household or businesses" (Allen & Wood, 2005). It is
important to emphasize that financial instability could have occurred if the financial shock or stress
is significant enough to cause substantial damage to a large group of customers and counterparties.
2.1.3 Banking System Stability

The Basel Committee on banking supervision established an initial set of guidelines (Basel I) to
complement banking regulations to improve the stability of the banking system and to fill the
synchronization gap that led to prior financial crises. It was, however, discovered that Basel I was
ineffective owing to rapid financial development caused by innovation and risk management.
Basel II was subsequently developed in 2004, which was based on three pillars: supervisory
review, market discipline and minimum capital requirement. The implementation of the Basel II
framework was both slow and difficult. Then, the 2007–2010 global financial crises had a massive
impact on global banking system stability. The unpredictable business environment characterized
by increased financial distresses and bank failures required that immediate attention be paid to the
banking system in particular and other financial institution in general. Many issues were raised,
and due to the impact that they had on the economies the desire to solve the problems became top
priority for financial experts, academics, policy makers and researchers. (Neem, 2019).

2.2 Theoretical Review

2.2.1 Micro-Prudential Approach

The micro prudential regulation assumes a partial-equilibrium condition and is aimed at averting
the failure of individual financial institutions. According to Sere-Ejembi, Udom, Salihu, Atoi and
Yaaba (2014), the paradigm of micro-prudential supervision views that risks arise from individual
malfeasance.
Therefore, micro-prudential regulation focuses on the stability of the components of a financial
system. The regulation seeks to enhance the safety and soundness of individual financial
institutions by supervising and limiting the risk of distress. The principal focus is to protect the
clients of the institutions and mitigate the risk of contagion and the subsequent negative
externalities in terms of confidence in the overall financial system.
2.2.2 Macro-Prudential Approach

The macro prudential approach, on the other hand, adopts the general-equilibrium condition and is
aimed at safeguarding the entire financial system (Charles, 2015). Macro prudential policies aim to
increase the overall resilience of the financial system, contain the build-up of systemic risk over
time. It is also reputed to address vulnerabilities stemming from structural relationships between
financial intermediaries. (Ananthakrishnan, Heba & Pilar, 2016) The macro-prudential approach
argues that safety and soundness of the entire financial system is not necessarily guaranteed by the
safety and soundness of the individual financial institutions. In fact, there are times when
individual actions of the financial institutions aimed at keeping such institutions safe and sound
may pose dangers to the stability of the entire system. (Charles, 2015) According to
Ananthakrishnan, Heba and Pilar, (2016), a macro prudential policy framework should ideally
encompass:
(i) A system of early warning indicators that signal increased vulnerabilities to financial stability;
(ii) A set of policy tools that can help contain risks ex ante and address the increased
vulnerabilities at an early stage, as well as help build buffers to absorb shocks ex post; and
(iii) An institutional framework that ensures the effective identification of systemic risks and
implementation of macro prudential policies.
Micro and macro-prudential supervisions are interlinked. Macro-prudential supervision cannot
achieve its objective except it has some level of impact on supervision at the micro-level.

2.2.3 Benign Neglect’ Theory

The ‘Benign neglect’ theory was developed by Bernanke and Gertler (1999 & 2001) and further
elaborated by Greenspan (2002). The theory states that monetary policy should focus primarily on
price stability rather than on financial stability because achievement of price stability would
automatically lead to financial sector stability. In this regard, the theory states that monetary policy
should play a reactive role in the event of financial crisis. This means that monetary authorities
should activate monetary policy actions only when there is crisis in the financial system but not to
adjust monetary policy in a pre-emptive manner (Bordo & Jeanne, 2002; Gameiro et al. 2011).
Thus, central banks need not take actions directly when there is financial instability such as asset
boom-bust or credit boom but should adopt a laissez-faire approach and work indirectly in
addressing financial instability through the primary goal of price stability (Greenspan, 2002).
The leaning against the wind theory was developed by Cecchetti et al., (2002) and states that
monetary policy should play a proactive rather than a reactive role in curtailing financial
instability. According to the theory, monetary authorities should implement monetary policy that
would mitigate financial crisis proactively rather than instituting policy actions that will clean up
the mess after financial crisis might have occurred (IMF, 2015). The proponents of this theory
argued that leaning is not only about preventing financial crisis but promoting financial stability,
even when there is a possibility of financial instability occurring at the remote level (Borio &
Lowe, 2002; Bank of International Settlement [BIS, 2016]; and Juselius et al., 2016). The theory
further contends that a more proactive monetary policy action through an active interest rate policy
has the capability to mitigate bust and prevent crisis in the financial system. Thus, monetary policy
tightening even in the face of market bubbling could limit the build-up of significant price
misalignment, which results in financial instability (Borio & White, 2004).

2.3 Empirical Review

Monnin and Jokipii (2010), studied the relationship between the degree of banking sector stability
and the subsequent evolution of real output growth and inflation. Adopting a panel VAR
methodology for a sample of 18 OECD countries, they found a positive link between banking
sector stability and real output growth. This finding is predominantly driven by periods of
instability rather than by very stable periods. Laeven and Valencia (2012) presented descriptive
statistics on the frequency of banking crises, their resolution, and their real effects. They identified
147 banking crises, over the period of 1970 to 2011.
Results showed that advanced economies tend to experience larger output losses and increases in
public debt than emerging and developing countries. These larger output losses in advanced
economies were to some extent driven by deeper banking systems, which makes a banking crisis
more disruptive.
Dell’Ariccia, Detragiache and Rajan (2008) studied the effects of banking crises on growth in
industrial sectors and found that while adverse shocks cause both poor economic performance and
bank distress, bank distress has an additional, adverse effect on growth, as banks must cut back
their lending, and that the differential effect is stronger in developing countries (where alternatives
to bank financing are more limited), in countries with less access to foreign finance, and where
bank distress is more severe.
Demirguc-Kunt and Detragiache (1998) developed a model which identified a group of
macroeconomic variables that consist of high interest rate, inflation, output downturns, decline in
asset prices, adverse terms of trade, credit expansion, foreign exchange reserve’s losses and market
pressure. These were reported to have affected the financial system as a whole, using a
multivariate logit framework and considering both industrial and emerging market economies. It
was discovered that the characteristics of the banking sector and structural characteristics of the
country were robustly correlated with the emergence of banking sector crisis.
Sere-Ejembi (2014) constructed a Banking System Stability Index (BSSI) for Nigeria, using a
combination of financial soundness indicators and macro-fundamentals. It applied statistical and
Conference Board Methodology normalization processes on Nigeria’s banking and
macroeconomic data from the first quarter of 2007 to the second quarter of 2012. They discovered
that the resulting index traced fairly well the episodes of crisis in the system over the study period
and thus concluded that the BSSI is capable of acting as an early warning mechanism of signaling
fragility and could be used as a complimentary regulatory policy tool to detect potential threats to
enable monetary authorities take timely pre-emptive policy measures to avert crisis. Barro (2001)
examined the impact of a banking crisis on growth. They employed data from 67 industrialized
and emerging countries (five-year averages) and the panel data approach was adopted. Results
showed that a banking crisis reduced GDP per capita growth rate of GDP of 0.6% per annum and
the investment rate of 0.9%.
Kupiec and Ramirez (2010) investigated the effect of bank failures on economic growth using data
on bank failures ranging from 1900 to 1930. The sample period predated active government
stabilization policies and included several severe banking crises. The VAR and difference-in-
difference methods were applied to estimate the impact of bank failures on economic activity.
VAR results show bank failures have negative and long-lasting effects on economic growth. While
the difference-indifference results suggest that bank failures trigger an increase in non-bank
failures. The evidence showed that bank failures reduce economic growth and provides a lower
bound estimate of the cost of banking sector systemic risk. Soundness (i.e. reserve for money bank
deposits and ratio of net foreign assets to GDP) are the factors most likely to influence its stability.
Jide (2003) designed an early-warning bank failure model that captured the dynamic process
underlying the banking sector slide from soundness to closure, by employing a transition
probability matrix. The study used “Instrumental Variables-Generalized Maximum Entropy
formalism” to assess the likelihood of the banking sector experiencing distress via the evaluation
of banking crisis probabilities.
 CHAPTER THREE

METHODOLOGY

3.1 Research Design

The research design to be used for this study is a quantitative description survey research design.
Survey is a research method which involved the researcher using it to get information about certain
groups of people who are representative of some larger group of people of interest to them.

3.2 Population of the Study

Population here refers to the total number of workers targeted to form the focus of this study. The
objective of the data collection process is draw conclusions about the population. It is therefore
imperative to have a clear picture of what constitutes the research population. The total number of
customers of financial institutions in Abeokuta South Local Government is over hundred after
taking census of the various industries (Adeyanju, 2018).

3.3 Sample Technique

According to Egbu (2010), sampling involves the section of a number of study units from a
defined study population. The technique to be used for this research study is the simple random
technique. A sample is therefore, a small representative of a large population. In drawing a small
sample for the study, the researcher considered how many people that are needed in the sample and
their categories first to be selected.

3.4 Sample Size

A total number of one hundred (100) questionnaires were distributed among respondents and sixty
(60) were fully filled and returned.

3.5 Sources of Data

A source of data includes primary data which will assist the researchers to make a thorough
analysis of the problem at hand. Primary data were obtained through the use of questionnaire to
gather accurate information.
3.6 Method of Data Collection

The method of collection for this study will be questionnaire. Questionnaire was used for
collection of data needed for this study. The reliability of the information of this study depends
largely on the ability of the selected sample size to provide accurate and measureable answers to
questions on the questionnaire.

3.7 Method of Data Analysis

Quantitative method will be used for data analysis in the research work. Data collection through
questionnaire will be presented in tables and analyzed using sample percentage.

3.8 Validity and Reliability of Data Instrument

Research instrument that will be used for this study will be questionnaire. To ensure the validity of
the study, the questionnaire will be shown to the supervisor before final administration to avoid
misunderstanding of any questions drawn.

This research work will be accorded with a close supervision as the supervisor will read, made all
necessary corrections in the areas where lapses occurred and after which the corrections has been
made, he approves validation of the work.

The research instrument to be used is reliable because the information obtained has been tested
over and over again and yet same result was gotten hence, reliable.

3.9 Model Specification

The following multiple linear regression model has been formulated to guide the research in the
investigation:
Y = f (x)
X = independent variable
Y = Dependent variable
Y = Tool for decision Making
Y = a+b(x)
Financial analysis = a +b (Tool for Decision making)
X1 = Investment
X2 = Decision making
X3 = Competitive environment
Y = f(x1+x)