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This study is motivated by the recent global financial crisis that lasted between 2007 and 2009 and affected the world at large but started partly due to the inefficiency of banks in the United States. There have been however several reforms in the financial sector to strengthen banks and improve reliability. The study analysis the determinants of bank efficiency from a CAMEL perspective. The data from the annual bank reports was used to run a panel model for 12 banks, employing the panel stochastic frontier model and the fixed effect panel model. The findings of the study suggest that capital, management and liquidity are significant determinants of bank earnings while asset is not a significant determinant. Also the results show that banks in Nigeria are efficient in their consumption of inputs in optimizing output. The results show that 10 of the banks are not significantly different from Access Bank in determining earnings, and only Guaranty Trust Bank was statistically significant. The study therefore recommends that the government should maintain the capital enhancement policies as well as other policies that strengthen the CAMEL parameters and improve bank efficiency.  



1.1 Background of the Study

The efficiency of the banking system has been one of the major issues in the new monetary and financial environment. The competitiveness of financial institutions is stirred up by their efficiency levels, since their products and services are of an intangible nature. Efficiency in banking can be distinguished between allocative and technical efficiency. Wherein, allocative efficiency is the extent to which resources are being allocated to the use with the highest expected value. A firm is technically efficient if it produces a given set of outputs using the smallest possible amount of inputs (Falkena et al, 2004). Efficiency in the banking system is important at both macro and micro levels and in order to allocate resources effectively, banks should be sound and efficient (Hussein, 2000).

One of the most important economic dimensions for ensuring the success of a company is the efficiency with which it uses its resources. An efficient banking system is a sine-qua-non for efficient functioning of a nation’s economy. Thus, for the industry to be efficient, it must be regulated and supervised in view of the failure of the market system to recognize social rationality and the tendency for market participants to take undue risks which could impair the stability and solvency of their institutions (Thatcher, 2002; Onyido, 2004; Lemo, 2005; Balogun, 2007; Alao, 2010).

Bank efficiency and its determinants are vital issues confronting the public and policy makers. The banking industry in Nigeria plays a very significant role in the economic development of the country. According to Nzotta (2004), banks as part of the Nigerian financial system channel scarce resources from surplus economic units to deficit units and they exert a lot of influence on the pattern and trend of economic development through their lending and deposit mobilization activities. This is why Abdullahi (2002), states that the banking industry in particular play a crucial role in the economic development by mobilizing savings and channeling them for investment especially in the real sector which increases the quantum of goods and services produced in the economy, thus national output increases and the level of employment improves. The banking industry in Nigeria is able to play the positive role only if it is functioning efficiently. However if it is repressed, inefficient and incapable of providing timely and quality services, the banking system could become a major hindrance to economic growth and development. Nigerian banking industry suffered a historic retrogressive trend in both profitability and capitalization. In 2009 just 3 out of 24 banks declared profit, 8 banks were said to be in “grave” situation due to capital inadequacy and risk asset depletion; the capital market slummed by about 70 percent and most banks had to recapitalize to meet the regulatory directive (CBN, 2010).

This now makes bank efficiency analysis very essential for the evaluation of banks’ performance and its efficiency. Bank efficiency is the capacity to generate sustainable profitability (European Central Bank, 2010). In recent years, the intensive and continuously increasing competition in the financial services market creates a need for an access to informa­tion that would allow the evaluation of these commer­cial banks operating in this market; therefore, it is of considerable interest to measure the efficiency of evolving institutions. Creditors and investors use such efficiency evaluations to judge past performance and current position of banks. Due to the growth of competition, management of banks is interested in enhancing efficiency. According to Baten and Kamil (2010), bank efficiency studies are of crucial importance for operational purposes and it links an organization’s goal and objectives with organization decisions.

According to Uboh (2005), financial performance failure in Nigerian banks resulted to loss of public confidence in the banking sector and that bank efficiency can be grouped into two basic types; those that relate to results, output or outcomes such as competitiveness and profit; and those that focus on determinants of results such as prices or products. The assertion above suggests that efficiency can be based on results and determinants and hence the importance of efficiency analysis. As observed by Casu et al. (2006), bank efficiency analysis is an important tool used by various agents operating either internally to the bank or who form part of the banks external operating environment, This is why investors in share and bonds issued by banks consider the investment outcome based on the performance before forming an opinion about the ability of its management.

The bank rating system referred to as CAMEL (represents Capital, Assets, Management, Earnings and Liquidity) rating according to the Central Bank of Nigeria CBN (2003), is designed to be used by bank supervisors in evaluating the performances and efficiency of banks. It serves as an “early warning device” to detect emerging problems of banks. The rating system provides a more scientific basis for supervisory actions such as preliminary management discussions and priority scheduling of on-site examinations. These on-site examinations are designed to identify  problems  in  individual  banks  and  to  ensure  banks’  compliance  with  existing laws  and regulations. It is a qualitative and a quantitative approach of evaluating the factors that materially affect the condition and development of banks. The quantitative approach is undertaken by evaluating Capital Adequacy, Asset Quality, Management, Earnings and Liquidity (CAMEL parameters). Examiners score each of  these  factors  as a  single  number from 1 to 5,  with  1  being the  strongest rating,  and develop  an  overall  CAMEL rating  from  1  to 5 from the  factor  scores.  As  a rule  of thumb,  banks  with  a  CAMEL rating  of 4  or 5  are considered  to be problem banks.  In evaluating the CAMEL parameters, weights have been allocated to each parameter. Each parameter is subdivided into components and credit points assigned based on performance of such components. A composite rating of all the parameters is worked out and a bank is rated very sound, satisfactory, marginal or unsound. A bank rating could be reduced from “sound” to “unsound” if certain judgemental factors observed so dictate. With respect to the concept of efficiency the ratio of total expenses to total income (efficiency ratio) is first of all computed. For a ratio of 100% or more, the credit point is zero. Qualitative factors that should be considered are compliance with laws and regulations and other fundamental factors. The rating of Nigerian banks between 2001 and 2009 are as illustrated below;Figure 1: Rating of Nigerian banks using the CAMEL parameters.

Source: CBN (2009) and NDIC Annual Report (2007) as cited by Ofanson et al. (2010).

Figure 1 above shows a declining trend of all the indicating parameters. The marginal indicator was almost stable until 2005, and then dropped in 2006 and remained almost 0 till 2009. On the other hand, the sound indicator remained stable around 5 banks till 2004, and then dropped in 2005, improved in 2006, only to drop again in 2007 where it remained till 2009. The unsound indicator just like others remained relatively stable until 2004, worsened in 2005, improved in 2006, and remained at zero banks only to increase again in 2009. The satisfactory and total indicators were equally stable till 2004 but relatively high as the satisfactory indicator was around 60 and total indicators were around 90 banks. However, they both dropped to about 25 and 12 banks for satisfactory and total in 2006, and remained stable there till 2009. The overall trends of all parameters suggest that the ratings of banks have kept on declining over the years with a significant drop in 2006.  Ofanson et al. (2010), opine that the number of banks in Nigeria reduced from its 2001 figure of 90 to 24 in 2009, in 2006 none of the banks was found to be unsound due to the reform that was in place then. In 2009, however 9 banks were found to be unsound by the apex bank’s rating. There is no doubt that marginal and unsound banks will not play any meaningful roles in meeting the country’s development challenges.

There existed a low banking/population density of 1: 30,432 and the payment system that encouraged cash based transactions. To resolve this problem, the CBN and NDIC used an approximation by adjusting the book value of some predetermined rules based on experience and comparative study of other economies’ banking systems. Such rules include those based on Capital Adequacy, Asset Quality, Management Competence, Earnings Strength, and Liquidity Sufficiency (CAMEL). The classification of banks based on this rating system enabled the authorities to determine those banks that were distressed and their levels of distress (Ofanson et al., 2010). Baral (2005), asserts that CAMEL framework is the most widely used model and it is recommended by Basle Committee on Bank Supervision and IMF. CAMEL represents Capital adequacy, Asset quality, Management efficiency, Earnings performance and Liquidity. Capital adequacy measures the ability of the bank to absorb shocks. This requires banks to have enough equity in their financing mix (Kosmidou, 2009).

According to Aburime (2008), the profitability of a bank depends on its ability to predict, evade and monitor risks, possibly to cover losses brought about by risks that comes about. Although it is important for banks to be liquid to avoid a run on it, Kamau (2009), argues that when banks hold high liquidity, they do so at the opportunity cost of some investment, which could generate high returns. Again, Sufian and Chong (2008), draw a very strong relationship between firm performance and the management efficiency through management of expenses. Other studies have evaluated the efficiency of banks from an input-output perspective where the CAMEL version projects the earnings of banks as the output and other dependent parameters as inputs – Capital adequacy, Asset quality, Management efficiency and Liquidity.

Before now (up until 2004), the Nigerian financial environment was in dire need of major reforms since the military era when Nigeria was still a pariah state with a regulated modus operandi and the financial standing of banks that pointed to an inevitable collapse in a system fraught with corruption and poor corporate governance issues exemplified by high turnover in the Board and Management staff, inaccurate reporting and non-compliance with regulatory requirements. Others included the late or non-publication of annual accounts that obviates the impact of market discipline in ensuring banking soundness; and gross insider abuses, resulting in huge non-performing insider related credits. Also, there was low aggregate credit to the domestic economy (20% as a percentage of GDP before the banking consolidation in 2004). This study is therefore a focus on the determinant of bank efficiency in Nigeria using panel evidence.

1.2 Statement of the Problem

The inefficiency of banks in the USA caused the world the recent global financial crisis. The efficiency of banks ought to be checkmated at all times as banks act as the reservoir of individual’s savings and the motto for investments. The modern age of technology and innovation has even made banking much more inclusive and facilitative, that calls for critical measures of ensuring and maximizing efficiency.  Bulus (2010), opine that financial markets are considered as one of the strong levers in the countries’ economies and they act in favour of accelerating the economic development specially developing countries. This, therefore, is the motivation of this study, as Nigerians banking sector has also proven to be a significant instrument of the performance of the Nigerian economy.

The health of Nigerian banks cannot be divorced from their antecedents. As could be recalled, when modern banking business  commenced  in  Nigeria  since  1892,  it  was  solely  a  business  for foreigners. Nigerian entrepreneurs who came into banking from the late 1920s to early 1950s  did  so  with  the  principal  aim  of  redressing  the  situation and  meeting  the  financial  requirements of Nigerian businesses. Many indigenous banks that were established up to 1954 failed (21 out of 25); due to problems such as inadequate capital, mismanagement, overtrading, lack of regulation and unfair competition from the foreign-owned banks. The mass bank failure was a bitter experience for the economy as  it  brought  untold  hardship  to  depositors  who  lost  their  money  and  lost  confidence  in  the  ability  of Nigerians  to manage a banking business. It was not until government started to regulate banking through the Banking Ordinance of 1952 and the establishment of the Central Bank in 1959. The failure of banks in the 1990’s and early 2000’s propelled so many policies with the most prevailing being the bank capitalization of 2004. However, the performance indicators of banks such as capital adequacy, asset base, management capability, earnings (return on capital employed) and liquidity have been adversely affected while variants of bank performance such as bank deposit, bank loan, operating expenses have also deteriorated. Crisis of confidence has affected bank deposit mobilization and loan extension to customers. Muhammed (2005), opine that most Nigerian banks were becoming personalized in ownership and management structure which made the banks incapable to finance large scale and long term projects due to limited liquidity at their disposal. The sector was characterized with import financing rather than encouraging domestic growth in the economy; there was loss of public confidence due to fear of liquidation, customer dissatisfaction on banking services as well as some obnoxious, unprofessional and other sharp practices within the industry.  The banking sector has been on frequent adjustments in the form of the reforms. Each of the reforms in this sector had its objectives and it can be noted that as each administration tries to sanitize one aspect of the banking sector, other aspects still come up with high relevance to its overall performance. Nevertheless the recent global financial crisis is said to have affected all nations with concentration on the financial sector. And with the dwindling performance of CAMEL parameter indicators it is therefore important that a more robust study of Nigerian bank’s efficiency be made.

Nigerian banks are also plagued with the challenge of ethics and professionalism in a bid to survive the stiff competition in the market, poor corporate governance practices, gross insider abuses and the magnitude of non-performing risk assets was such that it had eroded the shareholders’ funds of a number of banks. For instance, according to the 2004 NDIC Annual Report, the ratio of non-performing credit to shareholders’ funds deteriorated from 90% in 2003 to 105% in 2004. These problems and more may hamper the efficiency and performance of banks as well as the growth of the financial sector and economy at large.

Answers to the questionable efficiency of banks in Nigeria are vital for the development of effective strategies aimed at eradicating distress and enhancing stability of banks operating in the Nigerian banking industry. Many studies have been done to test the efficiency of banks in Nigeria using several other methods, as it is a necessary assessment to make. However, this study analysis a panel of 12 banks and examines efficiency from the strong holds of the banking industry that is represented in the CAMEL concept.  Against this backdrop, the broad aim of this paper is to clearly identify the determinants and measure bank efficiency in Nigeria by ascertaining to what extent capital, asset, management quality and liquidity influence’s bank earnings.

1.3 Research Questions

Based on the statement of the problem mentioned above, the following research questions are drawn;

  • What are the determinants of bank performance in Nigeria after the 2004 bank reform?
  • Are the banks in Nigeria efficient?
  • What is the individual performance of banks in Nigeria?

1.4 Objective of the Study

The general objective of this study is to examine the determinants of bank efficiency in Nigeria. However the specific objectives of the study are:

  • To investigate the determinants of bank performance in Nigeria with the advent of banking reforms.
  • To determine if banks in Nigeria are efficient
  • To examine the individual performance of banks in Nigeria

1.5 Statement of Hypothesis

The hypothesis of the study is stated in their null forms while the alternative is implied.

H01: There exists no significant determinant of bank efficiency after the banking sector reform.

H02: Banks in Nigeria are not efficient

H03: Individual banks do not significantly determine bank performance

1.6 Significance of the Study

The banking sector occupies a unique position in every economy, and that is why it attracts more than a casual regulatory attention. The recent banking sector reforms in Nigeria have created a sound and more secure banking system that depositors can trust through mergers and acquisitions which enhanced operational capital base. Thus, the efficiency of the banking system is very important, especially now that government is making effort to create a sound banking sector. In this case, in testing the efficiency of panel of banks in Nigeria, it will help policy makers to initiate and implement policies based on the findings of this study. This study would also add to the existing literature, stimulate the existing debate on the subject and suggest areas for further research.

1.7 Scope of the Study

This study intends to use most recent data to test the efficiency and efficiency determinants of panel of bank in Nigeria. It will cover the period of 2005 to 2012 (i.e. after the banking reform, using quarterly data) and will be limited to twelve commercial banks namely; Access, Diamond, Ecobank, FCMB, First bank, Fidelity, GTB, SKYE, UBA, UNION, WEMA and Zenith. These banks are chosen based on the availability of their data and their relative strengths in the banking sector.

1.8 Limitations of the study

All research works generally record a number of limitations as hindrances in the course of the research and this was not an exception. The study faced the problem of data; like many studies on African countries in general and Nigeria in particular the study was constrained to the available data. The data is sensitive and was not released easily which delayed the work for a while. The study would have wanted to use more banks but could not.  Also the study would have loved to examine these estimates before and after the 2004 bank capitalization, but the bank capitalization caused many banks to merge. Banks like UBA, Union bank, Zennith bank and GTB are not the same banks as before 2004, some of them grew 3 or 4 times more and will be biased if compared.

1.9 Organization of the study

This study is organized into five chapters; the first chapter detailed the background of the study showing the related works, policies and the existing debate. Then the statement of the problem that showed the research and economic problem of the study that translates into the research questions and problems of the study. The second chapter detailed the existing theoretical and empirical literature on the subject matter. While, chapter three showed the analytical framework and model specification of the model used and the presentation of results and evaluation of hypothesis are discussed in chapter four. The last chapter captioned as chapter five, summarizes the work, concludes and proffers recommendations from the findings and then proposes areas for further research.


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