Home Accounting Project Topics BOARD CHARACTERISTICS AND RISK MANAGEMENT OF LISTED DEPOSIT MONEY BANKS IN NIGERIA

BOARD CHARACTERISTICS AND RISK MANAGEMENT OF LISTED DEPOSIT MONEY BANKS IN NIGERIA

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ABSTRACT

This study has been undertaken with the objective of examining the impact of Board of Directors
Characteristics on the Risk management Capacity of listed deposit money banks in Nigeria.
Using a sample of eight (8) too big to fail banks for a period of 8 years (2005-2012), the study
employs correlation research design and Generalized least squares method of analysis. The
study found that board characteristics of the listed deposit money banks in Nigeria have
significant impact on the risk management of the banks. Specifically, the study found that, board
of directors’ size and independence, board risk governance and board financial expertise have
significantly improved the risk management (measured by Value at risk and non-performing
loans ratio) of the deposit money banks in Nigeria. The study recommends among others that the
regulators of deposit money banks in Nigeria should increase surveillance, and supervision to
ensure proper overall risk management that could safeguard the interest of all stakeholders and
the reputations of the banks. They should also emphasize the optimal size of the board.

 

 

TABLE OF CONTENTS

Title Page – – – – – – – – – – -i
Declaration- – – – – – – – – – – -ii
Certification- – – – – – – – – – – -iii
Dedication- – – – – – – – – – – -iv
Acknowledgements- – – – – – – – – – -v
Abstract- – – – – – – – – – – -vi
Table of Contents- – – – – – – – – – -vii
CHAPTER ONE: INTRODUCTION
1.1 Background to the Study- – – – – – – – -1
1.2 Statement of the Problem- – – – – – – – -7
1.3 Objectives of the Study- – – – – – – – -9
1.4 Hypotheses of the Study- – – – – – – – -9
1.5 Significance of the study – – – – – – – – -10
1.6 Scope of the study- – – – – – – – – -11
CHAPTER TWO: LITERATURE REVIEW
2.1 Introduction- – – – – – – – – – -13
2.2 Concept of risk and risk management- – – – – – -13
2.3 Concept of corporate governance – – – – – – – -20
2.4 Board Characteristics and bank risk management – – – – – -29
2.5 Review of Empirical studies on Board characteristics – – – – -33
2.6 Theoretical Framework- – – – – – – – -38
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CHAPTERTHREE: RESEARCH METHODOLOGY
3.1 Introduction- – – – – – – – – – -42
3.2 Research Design- – – – – – – – – -42
3.3 Population and Sample of the Study- – – – – – – -43
3.4 Sources and Method of Data Collection – – – – – – -43
3.5 Technique of Data Analysis- – – – – – – – -44
3.6 Variables Measurement and Model Specification- – – – – -44
CHAPTER FOUR: RESULTS, ANALYSIS AND DISCUSSIONS
4.1 Introduction- – – – – – – – – – -48
4.2 Descriptive Statistics- – – – – – – – – -48
4.3 Correlation Result- – – – – – – – – -51
4.4 Presentation of regression result and hypothesis tested – – – -53
4.5 Discussion of Major Result – – – – – – – -59
4.6 Policy Implication of major findings– – – – – – -61
CHAPTER FIVE: SUMMARY, CONCLUSIONS AND RECOMMENDATIONS
5.1 Summary- – – – – – – – – – -62
5.2 Conclusions- – – – – – – – – – -63
5.3 Recommendations- – – – – – – – – -64
5.4 Limitations of the study – – – – – – – -64
5.5 Area for Further Research- – – – – – – – -65
References- – – – – – – – – – -66
Appendices – – – – – – – – – -74

 

 

CHAPTER ONE

INTRODUCTION
1.1 Background to the Study
The strategic role of banks in economic growth and development of any country makes them
attract stringent operational and prudential regulations. Banks mobilize funds from surplus units of
the economy, and channel them to the needy sectors of the economy; they provide the payment and
settlement system and implement monetary policy. It is in this regard that banks are regarded as the
central nervous system of any economy (Sunusi, 2012). The sole aim of stringent banking regulations is
to have a sound and efficient financial system that can foster economic growth and development.
However, to achieve the aim of banking system, a sustained banking public confidence is
necessary; confidence in this regard refers to peoples’ faith in the banks, that is, the extent to which
people generally believe that their money is safe and that the possibility of loss is remote (Emeka,
1997).According to Cranston (1995), Banks face risk in a variety of situations. He adds that the most
serious risk is that of going out of business and that a more frequent risk for banks is that of default by
a borrower. In order for regulators and banks management to safeguard the banking public
confidence and improve performance, risk as a concept has been of great concern and enterprise risk
management has been established in all jurisdictions around the world, including Nigeria.
The term Risk is usually associated with downside or bad outcomes, but when trying to
understand financial risk, limiting the analysis to just the downside would be a mistake. In the words
of Dorfman & Cathher, (2013), “the term Risk refers to the variation in possible outcomes that can
result from an uncertain event based on chance”. Enterprise Risk Management or Corporate Risk
Management creates business value through an integrated process of identification, estimation,
assessment, handling, and controlling of risk (Roggi, Garvey, & Damodaran, 2012). Risk management
allows an enterprise to create value by managing risks; it takes a much broader perspective on risk.
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Lam (2003) adds that risk management connotes a comprehensive and integrated framework for
managing credit risk, market risk, operational risk and economic capital and risk transfer in order to
maximize firm value.
Risk management is an essential activity in all business organizations, particularly financial
institutions, because taking risks and dealing with uncertainty are essential parts of doing business.
Moreover, risk management in recent times is beyond a mere mitigation activity, rather a valuecreating activity (Roggi et al., 2012). It is based on this philosophy that, Tandelilin, Kaaro, Anom, &
Supriyatna (2007) stated the interrelationship between Bank Performance and Risk Management.
According to them, the interrelationship between the risk management and performance represents
the risk and return trade-off; that is, when banks manage their risk better, they will get advantage to
increase their performance (return).
Therefore, better risk management indicates that banks operate their activities at lower relative risk
and at lower conflict of interests between parties. These advantages of implementing better risk
management lead to better banks performance. On the other hand, better bank performance
increases their reputation and image from the public or market point of view. The banks will get lower
cost of risky capital and other sources of funds. Cebenoyan & Strahan (2004) add that the banks also
get more opportunities to increase their productive assets, leading to higher bank profitability.
However, credit and liquidity crises have threatened the banking industry globally, both before
and after the global financial crises, the event that left depositors, bankers and customers in crises of
deposits recovery and crises of confidence. For instance, in the United State of America (USA), the
banking system suffered distress between 1930 and 1933 which went with about one third of
commercial banks (mostly small units), similarly, between 1987 and 1993 about 150 banks were
reported to have failed annually (Emeka 1997). This necessitated the establishment of Federal
Deposits Insurance Corporation (FDIC) in the USA to restore confidence in the system.
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In the same vein, credit and liquidity problem as well as failures of banks in Nigeria was first
reported in 1930, and with the establishment of Central Bank of Nigeria (CBN) in 1958, over 21 banks
failures were recorded between 1930 and 1958 (Emeka,1997). The Nigerian banking crises of 1990s
that caused the transfer of government’s deposits from licensed banks to the CBN necessitated the
bail-out of 13 banks by the Nigerian Deposits Insurance Corporation (NDIC) and CBN. According to
Bello (2013), Nigerian banks have recently suffered wide spread of financial malfeasances which led to
declaration of many banks as distress, and takeovers and mergers have left a historical landmark in the
history of financial service sector of the country. This necessitated the CBN to embark on second
turnaround since 1998 banking crises, which include the rescue of 8 banks through capital and
liquidity injections, as well as prosecution of the banks’ Chief Executives (Sunusi, 2012). He further
states that such actions became necessary to restore confidence in the banking public and bring sanity
in the Nigerian banking system.
Consequently, the CBN focused its policies on minimizing exposure to risk by banks operating
in Nigeria, and different measures –regulatory, cyclical, financial and operational standards and
modification of Corporate Governance code were done to sanitize the financial sector particularly the
banking industry (Bello, 2013). Thus, existing literature on corporate governance stressed that both
bank performance and risk management are dependent on implementing good corporate governance
(Tandelilin et al., 2007). According to them, a better implementation of good corporate governance is
not only concerned about better expected return but is also concerned about better risk management.
Risk management is therefore determined by mechanisms of corporate governance in the
banking sector through different points of view, for instance, markets have no adequate power to
control the operations of banks (Tandelilin et al., 2007). Hence, the need for government intervention
to overcome market failure, the main role of regulators and regulation is to serve the public interest.
In essence, regulation as external corporate governance controls managerial behavior in making
decisions relevant to improving risk management.
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Therefore, the regulatory agencies SEC and CBN generally agree that weak corporate
governance has been responsible for some recent corporate failures in Nigeria, which prompted them
to establish tight regulatory supervision and enforcement of new corporate governance codes. That is,
the SEC Code of Corporate Governance for public companies in Nigeria 2003 (which was reviewed in
2008 and took effect in April 2011) and the CBN Code of Corporate Governance for Banks in Nigeria
Post-Consolidation, 2006 (the Code hereafter).
The Code considers Corporate Governance as a system by which corporations are governed and
controlled with a view to increasing shareholder value and meeting the expectation of other
stakeholders. It therefore, emphasizes the need for the practice of good corporate governance to
corporations particularly financial institutions (banks), the need is for the retention of public
confidence through the enthronement of good corporate governance considering the utmost
importance given to the banking industry. According to the Code, the primary responsibility for
ensuring good corporate governance in banks lies with the board of directors. And, the principal
objective of the board is to ensure that banks are properly managed and management performance is
effectively overseen to protect and enhance the interest of all the banks stakeholders.
Some of the major characteristics of the board of directors of banks in Nigeria which are
meant for the effectiveness of the board in piloting their operations properly include the board
structure (Size and Independence), board risk governance, and board financial expertise. In terms of
the board structure, the board should be of a sufficient size relative to the scale and complexity of the
bank operations and should contain individuals in such a way as to ensure diversity of experience
without compromising independence, compatibility, and integrity in carrying out their role. Based on
this, board of directors is assumed to monitor and control the financial intermediation of banks as
effectively as possible to avoid credit and liquidity problems of the banking system. On the other hand,
independent/non-executive or outside directors should be the key members of the board capable of
bringing independent judgment as well as necessary scrutiny to the proposals and actions of the
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Management and executive directors especially on issues of strategy, performance evaluation and key
appointments. They are therefore critical in the proper operations of the banks particularly with
respect to financial intermediation. The code requires that, the number of non-executive directors
should be more than that of executive directors subject to a maximum board size of 20 directors; and,
at least 2 non-executive board members should be independent directors. Board risk governance is
another critical feature of the board of directors. The Board is responsible for the risk management of
banks; as such it should form its own opinion on the effectiveness of the risk management process and
should appoint its members who will serve as risk officers to oversee the Board risk committees. On
the other hand, management is accountable to the board for implementing and monitoring the
process of risk management and integrating it into the day-to-day activities of the company. In
addition to the approval of risk management framework of the bank, the board is to oversee the
establishment of a management framework. Other issues in the board risk governance of the banks
include board risk officers that are designated to oversee the banks risks profile through membership
of board credit committee, board audit commtee and board risk management committee. However,
despite all these risk governance frameworks of the board, credit and liquidity risks are synonymous
with the Nigerian banking industry and is seriously undermining the extent of the financial
intermediation of banks.
Vassileios (2011) argues that board of directors has an impact on risk management of
banks, because of the failure of many large financial institutions around the world and some
take overs resulting from the neglect of the basic rules of risk management and control.
Therefore, he concludes that risk failure in banks is usually as a result of the inability of the
board of directors to exercise effective control over senior management and to challenge the
measures and strategic guidelines that were submitted to them for approval. Moreover, the code
requires that all directors should be knowledgeable in business and financial matters and also
possess the requisite experience. The expertise of board members is a critical component in
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assuring that the monitoring role of the board is effectively discharged. Therefore, due to the
uniqueness of banking operations which is generally financial services, board members
expertise in financial matters is necessary and is at the heart of effective discharge of the board
monitoring functions.
This study is motivated by the recent crises and default in the Nigerian banking industry which
threatened public confidence in the banking system and is likely to affect the decision of customers to
deposit their money in the banks despite the governance mechanisms and strict regulations of the
industry. The study is further motivated by the designation of eight deposit money banks by the CBN
as too big to fail, in light of the lingering credit and liquidity risks crises in the sector. Moreover, the
near absence of empirical studies that logically examined the relation as well as the impact of board
characteristics (board structure, board risk governance and board financial expertise) on the risk
management of deposit money banks in Nigeria also motivated this study.
It is therefore against this background that this research sets to find out whether or not,
Board of directors as a major control mechanism is effective in enhancing and enforcing sound
risk management of deposit money banks in Nigeria.
1.2 Statement of the Problem
In order to keep banks in focus and ensure effective monitoring and control of banking operations,
banks in Nigeria are mandated to comply with, in addition to SEC code of Corporate Governance for
public companies 2008 (as amended), the CBN Code of Corporate Governance for Banks PostConsolidation 2006. The codes provide thatthe board of directors is primarily responsible for ensuring
good corporate governance in banks. The board is also to ensure that the banks are properly managed
and management performance is effectively overseen to protect and enhance the interest of all the
stakeholders. According to Dorfman & Cather, (2013), “two years after the US congress passed the
Sarbanes Oxley Act, a law that brought sweeping changes to corporate governance and financial
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accounting standards, the accounting profession also proposed a model for ERM that elevated the
responsibility for risk management to the level of the corporate board of directors”.
However, despite the explicit role of the board, banks have recently been facing default and
distress in Nigeria. For instance, Sanusi (2010) posits that, in Nigeria, the economy faltered and the
banking system experienced a crisis in 2009, triggered by global events. The stock market collapsed by
70% in 2008-2009 and many Nigerian banks had to be rescued. In order to stabilize the system and
return confidence to the markets and investors, the CBN injected 620bn Naira of liquidity into the
banking sector and replaced the leadership at 8 Nigerian banks. Furthermore, a joint examination of
Nigerian banks by NDIC and the CBN in 2011 revealed that, there is an extreme weakness in corporate
Governance of banks and weak credit administration. Thus, these prompted the research problem
which this study sets to investigate. That is, whether or not the board of director’s structure (size and
independence) and other attributes that are peculiar to core banking operations such as board risk
governance and board financial expertise, are ineffective in risk management of deposit money banks
in Nigeria.
In light of the forgoing paragraph, Roggi et al., (2012) opined that in the 2008 economic crisis, several
firms in emerging markets suffered major losses due to failed risk management and governance. They
cited an example of Societe Generale Bank whose board, managers, the risk management systems,
and internal controls failed to detect the risks and its subsequent demise. And this costs the bank
money, and reputation.
Therefore, while the board of directors is required by law to be of a sufficient size relative to
the scale and complexity of banking operations and be composed of competent and diverse
experienced members, the size of the board does not seem to be effective in Nigeria with reference to
frequent crises on the ground. Another board structure that is expected to provide objective decisions
in carrying out the monitoring of banks operations is the installation of independent or outside
directors within the board. The rationale behind composing independent directors in the board is that
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they are more likely to defend the interests of outside stakeholders effectively. However, this also
seems not to be the case in light of the frequent credit and liquidity risk crises in the Nigerian banking
industry. Also, deposit money banks in Nigeria are required to comprise individuals of diverse
experience, competence and entrepreneurial spirit with financial knowledge in the board. This is with
the goal of enabling the board to carry out its’ over sight function in an effective manner; however,
the recent crises in the banks suggests otherwise. Hence, the need for studying the effects of these
board characteristics (size and independence, presence of board risk officers and board financial
expertise) that are more pertinent to the primary role of deposit money banks in Nigeria.
Although several researches have investigated the role of board of directors in relation to
corporate goals and objectives in Nigeria, most of the studies did not use specific board attributes in
specific context like this study. Therefore, this study is unique in testing the relationship between
banks’ risk management and those board features that are directly linked with the effective
monitoring and control of banking risks.
In view of the foregoing paragraphs, the following research questions are put forward:
1. What is the impact of board size on the risk management capacity of deposit money banks in
Nigeria?
2. Does board independence have any impact on the risk management capacity of deposit
money banks in Nigeria?
3. What is the impact of board risk officers on the risk management capacity of deposit money
banks in Nigeria?
4. How does board financial expertise impact on the risk management capacity of deposit money
banks in Nigeria?
1.3 Objectives of the Study
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The main objective of the study is to examine the impact of Board of Directors Characteristics on
the Risk management of listed deposit money banks in Nigeria. However, to facilitate the achievement
of the main objective, the following specific objectives are set to achieve:
i. To examine the impact of board size on the risk management capacity of deposit money
banks in Nigeria.
ii. To evaluate the impact of board independence on the risk management capacity of
deposit money banks in Nigeria.
iii. To assess the impact of board risk governance on the risk management capacity of deposit
money banks in Nigeria.
iv. To investigate the impact of board financial expertise on the risk management capacity of
deposit money banks in Nigeria.
1.4 Hypotheses of the Study
In line with the objectives of this study, the following hypotheses are formulated in null form;
H01: Board size has no significant effect on the risk management capacity of deposit money
banks in Nigeria.
H02: Board independence has no significant effect on the risk management capacity of deposit
money banks in Nigeria.
H03: Board risk governance has no significant effect on the risk management capacity of
deposit money banks in Nigeria.
H04: Board financial expertise has no significant effect on the risk management capacity of
deposit money banks in Nigeria.
1.5 Significance of the study
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The critical role of the banking system in mobilizing funds from surplus units, lending credits to the
real sector (productive sector) and governments at all levels to finance developmental projects, makes
this study a necessity. Therefore, banks as financial intermediaries are very important not only
because they are in the business of risk acceptance but also due to their special role within the
economy in the mobilization and transfer of financial resources.
In addition, this study is significant in investigating the effectiveness of the major governance
mechanism of banks (Board of Directors) responsible for the monitoring and control of banking
operations. This is also relevant in view of the competitive business environment of banks and higher
threats from the market for corporate control in Nigeria which is the main function of the Board of
Directors. The finding from this study is expected to benefit the banking public, management,
regulators such as SEC and CBN, shareholders and researchers.
The major asset of banks that to a large extent determine the profitability and the survival of
banks are the deposits collected from the banking public. Thus, banking failures usually leave the
banking public in the crises of the recovery of their deposits, inaccessibility to credit, and loss of
confidence in the system. Therefore, the findings of this study will be of significant importance to the
banking public, in that, the study will examine the effectiveness of the main control and monitoring
mechanism in relation to the banks’ risk management. That is, it could reveal how the impact as well
as the ability of board of directors to preserve deposits or liquidity and recover loans, which in turn
implies the safety of the banking public and influence their confidence in the banks. Similarly,
regulators such as SEC and CBN could also find this study useful as the study will analyze some
mechanisms of the code of best practices enshrined in the code of corporate governance issued by
them. That is, the results of this study will provide them with empirical evidence on the effectiveness
or otherwise of the board of directors attributes as required, in order to take necessary actions.
Shareholders as owners, who are usually concerned with maximization of their wealth, could also
find this study useful. This is because the success of the banks is largely dependent upon an effective
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board on one hand, and sound risk management on the other. Hence, this study is aimed at providing
information on the impact of board characteristics on risk management, and offering logical
recommendations from the findings, which could be relevant to the shareholders as owners.
Researchers and students on corporate governance and risk management are also part of the
beneficiaries of this study, because they are usually interested in understanding how mechanisms of
corporate governance affects corporate operations, activities and performance, this makes them the
secondary consumers of the findings of this research. Hence, it will serve as a source of knowledge and
point of reference to students and researchers.
1.6 Scope of the Study
Board of Directors possesses many characteristics particularly in banks. This study is however
restricted to those board attributes that are expected to influence the risk management activities.
These include the structure of the board (size and independence), the risk officers of the board and
the board financial expertise.
The rationales for restricting the scope to these three attributes of the board are:
i. Their critical role in ensuring effective and efficient risk management.
ii. Their regulatory requirements, in view of the banking crises and failures that are linked to
poor risk management and shattered banking public confidence.
The study focuses on all the deposit money banks quoted on the floor of Nigeria Stock Exchange
(NSE) market for a period of eight years i.e. (2005 to 2012). This period is considered for two reasons:
i. It is the period after banking consolidation and major reforms in the industry with the sole
aim of enhancing and improving risk management.
ii. Second, it is the period that witnessed an unprecedented credit and liquidity crises that
affected the governance of many banks including the arrest of many chief executives. In
essence, it is the period that necessitated the CBN to come up with the distinct Code of
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Corporate Governance for Banks in Nigeria, Post-Consolidation in 2006, and a
correspondent review of SEC 2003 Code of Corporate Governance for Public Companies in
2008 which became effective as at April 2011.

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