ANALYSIS OF BANKING RISKS AND THE ROLE OF INSURANCE INDUSTRY FOR NATIONAL DEVELOPMENT

SUNDAY C. NWITE Ph.D, ACII, ACIB, IRDI

SENIOR LECTURER

DEPARTMENT OF BANKING AND FINANCEEBONYI STATE UNIVERSITY – ABAKALIKI

PHONE NO: 080-37743134E-MAIL: nwitewhite2006@yahoo.com

ABSTRACT

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Banks are among the financial institutions that exist in our economy. The banking industry mobiles funds from individuals, households and corporate organizations. The money mobilized, part of it are always extended to borrowers with interest. This is the major ways banks make their profit. There are various activities of banks like giving out loans, leasing, ownership of property, vehicles, project financing etc. there are a lot of risks that are exposed to their activities like interest rate risk, volatility risk, inflation risk, risk of failure to pay debt, delay in payment of debt and sometimes government makes some policies against the bank which is a risk. These risks affects the performance of banks. The insurance industry on its own acts as a shock absorber by providing covers/polices to ensure adequate protection. It has been found that banks activities involves a lot of risks both systematic and unsystematic risks and that insurance industry provides some policies like fire insurance, theft insurance, legal expenses insurance, credit insurance, fidelity guarantee insurance. It is concluded that the banking risks need to be managed through insurance policy mechanisms. The implication is that banks are very volatile and if these risks are not property managed, may cause problems to these banks which can result to distress and distress may lead to total failure. Recommendations were made that banks should use the insurance industry to manage their risks and also receive insurance advise to help reduce the risks exposed to them by taking adequate insurance policies.KEYWORDSHazards, perils, risks, volatility, interest risk, credit risk.

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INTRODUCTIONThe banking industry is the hub of any economic development of

any nation. The banking practice started with Gold Smith, but the

modern banking industry practice started in 1890s. The introduction

of banking industry has helped in economic development in various

ways such as giving out loans, financing foreign business among

business men, given out money for agricultural development,

infrastructural provision and also in marriages, even buying vehicles.

Most of these activities of banks involve a lot of risks. These risks

includes credit risk, delay in payment risk, legal expenses risk,

fidelity. These risks arises from the banking transactions. The

insurance industry plays active role in providing some services to

the banking industry like advisory role, risk management, training

staff, training on risk management and also insuring some of their

risks. This work therefore wants to look at the risks involved in

banking activities and how such risks can be managed through

insurance process for national development.

THE CONCEPT OF BANKING

The concept of banking can be traced to Gold Smith, when he

started collecting money for deposit and realized that some of the

depositors do not collect them at the same time, he decided to give

out some as loan with interest (Cyole, 2000). Interest rate sends

signals to lenders, borrowers, savers and investors. Banking in its

own has no particular definition. This is because banking can be

seen as a profession, and institution, keeping deposit and other

important documents. Rather, a banker was defined in bill of

exchange Act 1958 that a banker includes a body of persons

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whether incorporated or not who carry out the business of banking.

Pagets (1972) Doyle, 1972 Hart (1931) all were given various

definitions of a banker not banking.

Today, the banking industry mobilizes savings from households,

individuals and pay them interest and then give out part of the

savings to investors at higher interest rate. Efficient financial

intermediation is an important factor in economic development

process as it has implication for effective mobilization of investible

resources (Nwite, 2009).

HISTORICAL DEVELOPMENT OF BANKING INDUSTRY

Banking is an institution for keeping, lending and exchanging

etcetera of money. It is a moneybox for savings, a stock of money,

fund or capital in game of hazard, (Odo, 2004)

The history of banking development in Nigeria can be traced back to

1890s. The African Banking Corporation was the first commercial

bank that opened its first branch in Lagos in 1892, whose founder

was Messrs Elder Dempsters and Co. a shipping firm based in

Liverpool.

This bank encountered different initial difficulties and eventually

decided to transfer its interest to elder Dempster and Co in 1893;

this led to the formation of new bank known as British Bank of West

Africa (BBWA) in 1893 with the initial capital of £10,000 which was

later increased to £100,000 the same year.

The British Bank of West Africa (BBWA) was the first surviving bank

in Nigeria and registered in London as a Limited Liability Company in

March 1894, and the same year other branches started springing up.

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The Barclay Bank Dominion Colonial and overseas (BBDC) was

established in Lagos in 1971 now Union Bank of Nigeria PLC.

Another bank, the British and French Bank in 1949, now called

United Bank of Africa PLC was established in 1949 making it the

third expatriate banks to dominate early Nigerian Commercial

Banks. The foreign banks came principally to render services in

connection with international trade, so their relation as at that time

was with company and with the government. These three banks

control closed up to 90% aggregate bank deposits from 1914 to

early 1930s, several abortive attempts were made to establish

locally owned foreign monopoly.

In Paton (1949), the indigenous sectors in 1929, industrial and

commercial banks were set up by a handful of patriotic Nigerians. It

folded up in 1930s due to their under capitalization, poor

management, aggressive competition from expatriate banks

(Emeka, 1999).

According to CBN (1970) many in indigenous banks were opened

and later dissolved or collapsed between 1947 and 1952, a total of

22 banks were registered in Nigeria. However a figure as high as

185 banks were quoted from government records in 2000, but from

2005 till date after banking reform, 22 banks was left for operation

and was licensed as commercial banks in Nigeria.

Today, banking business or industry are licensed to operate as

follows;

Merchant bank, Commercial bank, Specialized banks.

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The central bank of Nigeria repealed the universal banking

operations in September 2010 therefore, directed all commercial

banks to divert from non-banking business (Alawiye, 2011).

This reform measure effectively signaled the reversal of the

universal banking operations in the banking industry and making

banks to choose International, National or Regional banking licenses.

VARIOUS ACTIVITIES BANKS ENGAGE IN NIGERIA

Banking is the heart of economic development of any nation. The

following are the activities banks engage in Nigeria.

1. Granting consumer loans: Early in this century, bankers

began to rely more heavily on consumers for deposit to help

fund their large corporate loans. By the year 1920s and 1930s

several major banks led by one of the forerunners of New

York’s Citibank and by the bank of America, had established

strong consumer loan departments. This means consumer

loans were among the fastest growing forms of bank credit.

2. Financial advisory: This is a situation where banks engage in

many financial advisory services, from helping to prepare tax

returns and financial plans for individuals to consulting firms

about marketing opportunities at home and abroad for business

customers. They also provide financial advisory when it comes

to the use of credit and the saving or investing of funds. (Nwite,

2004)

3. Managing cash: This means that over the years, financial

institutions have found that some of the services they provide

for themselves are also valuable for their customers. And one

of the most prominent is cash management services in which a

financial intermediary agrees to handle cash collections and

disbursement for a business firm and to invest any temporary

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cash surpluses in interest bearing assets until cash is needed to

pay bills.

4. Offering equipment leasing: This means that many banks

and finance companies have moved aggressively to offer their

business customers the option to purchase equipment through

a lease arrangement in which the lending institution buys the

equipments and rents it to the customer. These equipment

leasing services benefit leasing institutions as well as their

customers because as the real owner of the leased equipment,

the lessor can depreciate it for additional tax benefits.

5. Making venture capital loans: This means that banks,

security dealers and other financial conglomerates have

become active in financing the start-up cost of new companies.

This is because of the risk involved in such loans, it is generally

done through a separate venture capital firm, that raises

money from investors to support young businesses in the hope

of turning a profit when those firms are sold or go public.

6. Selling insurance policies: For many years bankers have

sold credit life insurance to their customers receiving loans,

guaranteeing repayment if borrowers die or become disabled.

Moreover, during the 19th and early 20th centuries, many

bankers sold insurance and provided financial advice to their

customers, though they do that through organized insurance

companies.

VARIOUS RISKS THAT ARISES IN BANKING ACTIVITIES

There are basic risks which are inherent in banking operations.

These forms of risk (Rose, 1999) are as identified and explained

below:

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1. Credit risk: Banks make loans and take on securities that are

nothing more than promises to pay. When borrowing customers

fail to make some or all of their promised interest and principal

payments, these defaulted loan and securities result in losses

that can eventually erode the bank’s capital. Because owners

capital is usually no more than 10 percent of the volume of

bank loans and risky securities (and often much less than that),

it doesn’t take too many defaults on loans and securities before

capital become inadequate to absorb further losses. At this

point, the bank fails and will close unless the regulatory

authorities elect to keep it afloat until a buyer can be found.

2. Liquidity risk: There is also substantial liquidity risk in

banking the danger of running out of cash when cash is needed

to cover deposit withdrawals and to meet the credit requests of

good customers. If a bank cannot raise cash in timely fashion, it

is likely to loss many of its customers and suffers a loss in

earnings for its owners. If the cash shortage persists, this may

lead to runs on the bank and ultimate collapse. The inability of

a bank to meet its liquidity needs at reasonable cost is often a

prime signal that it is in serious trouble.

3. Interest rate risk: Banks also encounter risk to their spread –

that is, the danger that revenues from earning assets will

decline or that interest expenses will rise significantly,

squeezing the spread between revenues and expenses, thereby

reducing net income. Changes in the spread between bank

revenues and expenses are usually related to either portfolio

management decisions (i.e changes in the composition of

banks assets and liabilities) or interest rate risk. The

probability that fluctuating interest rates will result in

significant appreciation or depreciation of the value of and the

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return from the bank’s assets. In recent years, banks have

found ways to reduce their interest rate risk exposure, but such

risks have not been completely eliminated.

4. Operating risk: Bank also face significant operating risk due

to possible breakdowns in quality control, inefficiencies in

producing and delivering services, or simple errors in judgment

by management fluctuations in the economy that impact the

demand for each individual bank’s services and shifts in

competition as new suppliers of financial services enter or

leave a particular banks market area. These changes can

adversely affect a bank’s revenue flows, its operating costs,

and the value of the owners investment in the bank, e.g its

stock price.

5. Exchange risk: Larger banks face exchange risk from their

dealings in foreign currency. The world’s most tradeable

currencies float with changing market conditions today. Banks

trading in these currencies for themselves and their customers

continually run the risk of adverse price movements on both

the buying and selling sides of this market.

6. Crime risk: Finally, banks encounter significant crime risk

fraud or embezzlement by bank employee or directors can

weaken a bank severally and in some instance, lead to its

failure. In fact, fraud and embezzlement from insiders

constitute one of the prime causes of recent bank closings.

Moreover, the large amounts of money that banks keep in their

vaults often proves to be an irresistible attraction of outsides.

The focus of ban robberies has shifted somewhat with changes

in banking technology, theft from ATMs and from and from

patrons using those money machines has becomes one of the

moist problematic aspects of bank crime risk today.

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THE ROLE OF INSURANCE INDUSTRY IN THE MANAGEMENT OF

BANKING RISK

The insurance industry from its creation, formation and operation

are expert in risk management.

The insurance industry usually conduct survey, to identify the

operational risks that arises from the environment and other risks.

First risks are first identified by the experts and if they are identified

they will be evaluated or measured to know the magnitude, to find

out if such risks can be retained by the organization or insured by

the insurance company. Then the final stage is the risk control

popularly called risk treatment will come in.

Nwite (2004) opines that the risk treatment can be financial or

physical organizations employ staff, train them organize seminars,

conferences, workshop all on the aim of training their staff.

They also provide safety gadgets for staff and ensure compliance.

The flow chart and the operations are always monitored. Sometimes,

tags, fences are used to protect places that are not meant for

visitors. In most cases depending on the type of organizations,

customers are trained that come to the banking premises.

In the banking industry, they own property, rent or build houses for

office use, electrical appliances are used staff of various categories

are employed. They own vehicles, have keyman, interact with the

general public, lend out money and also participate in some projects

jointly.

All these activities are the ways risks arises in insurance practice.

These various categories of risks are managed through avoidance,

reduction, retention, transfer, combination, research diversification

and hedging. These will be discussed in the course of the work.

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DEFENSIVE MEASURES AGAINST RISK BEING HANDLED BY

OTHER INSTITUTIONS

There are other risks of banks which are being handled by other

institutions, these involves the use of the following measures;

1. Deposit with central bank of Nigeria: The deposit funds

with the apex bank is also a measure against the risks involved

in banking business. These deposits are funded through

liquidity reserve and cash reserve which are in many cases

compulsory as normally adjusted in terms of their ratios on

period basis. Such funds constitute safety reserve against a run

on the banks.

2. Deposit insurance with NDIC: In Nigeria, it is compulsory for

the banks to insure their deposits with the Nigeria Deposit

Insurance Corporation (NDIC). Hence, the commercial banks

and microfinance banks do insure their depositors funds with

NDIC so that in the event of failure, such customers can be

compensated the scheme is designed by the government to

prevent runs on other banks when any particular bank fails. The

scheme therefore promotes the public confidence in the

banking system. The NDIC in conjunction with the apex bank

does guarantee loans for other banks in the event of illiquidity

or insolvency.

3. Risk transfer: The banks do insure their operational assets

with the insurance for future compensation in the events of loss

occurring from their inherent perils. It implies that commercial

and microfinance banks do normally insure their physical

assets against operational hazards as well as environmental

hazards. Hence, the banks transfer some of the risks in banking

business to insurance companies with the payment of

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premium. The payment is to guarantee reinstatement where

the risks insured against eventually occur.

VARIOUS POLICIES INSURANCE INDUSTRY OFFER TO BANKS

Insurance industry offer a lot of services to the banking industry.

Such services ranges from advisory role, credit management role,

risk management role and acceptance of risk role.

Mordi (1987) outlines such insurance services provided to the

banking industry, such are;

1. Theft insurance policy: Theft according to theft act of 1968

was defined as taking something which does not belong to you

without the intention of bringing it back. This type of risk is

exposed to the banks

2. Fidelity insurance policy: The Nigerian banking industry

engage in employment of staff. Most of the frauds that occur in

the banking industry do arise do to insider abuse among the

staff, hence, these evil practices need to be protected, because

of bad moral hazard infidelity to a keyman’s knowledge is

dishonesty.

3. Legal expenses insurance: Banks can be taken to court by

their customers and the fire, the bank may not pay or if they

pay it, it will have serious effect in the financial statement.

4. Professional indemnity insurance policies. Insurance

companies usually advise people on some financial

transactions because they are held for professional negligence.

5. Keyman insurance: Some staff are very important in any

operation, and that of banking is not exception. So if such

happens, the company will be idle for the period until they

employ another capable staff which is not always very easy.

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6. Motor insurance: The banks have motor vehicles and these

vehicles has to be insured on any of the classes of motor

insurance like third party only, theft and fire and

comprehensive.

7. Accident insurance policy: The staff of the bank are also

exposed to accident; so they also need to protect the staff

against accident.

8. Life assurance policies like group life assurance and workmen

compensation are now made compulsory to enable efficient

operation and safeguard against any unexpected happening.

9. Credit insurance policies: Banks give out loans to

customers. There in any probabilities that such loan may not

be paid or delayed in payment. Aggregate of such loans may

also result to distress in the banks; hence it needs to be seen.

10. Health insurance scheme, contributory pension scheme. All

these are insurance practices and need to be appreciated by

banks to enhance efficient practice.

11. Cash in transit, money in safe insurance. Every time banks

carry money from one place to the other. They are also

exposed to risk and need to be insured. Even the police or

military following the money and the drivers need to be insured

because in most times, categories of people of this nature have

lost their lives.

PROBLEMS OF MANAGEMENT OF BANKING RISKS

Risk is one of the difficult things to manage. There are some

problems that rise on the process of managing risk. They are as

follows:

1. Problem of owner’s capital: The owner’s capital or share

capital funds constitute the first line of problem in managing

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risk in bank business. This is because capital fund of the bank

is normally used to provide a hedge against the risk of failure.

Hence, it is used to absorb financial and operating losses until

management can address the bank’s problems.

2. Problem of quality management: Recruitment of quality,

seasoned and experienced bank managers is one of the major

problems in managing risk in banking industry. Such quality

management of banks has to be proactive as well as reactive

in their posture so that they can deal with banks problems.

Managing of banking risks involves the ability of the top

managers to move shiftily to deal with a bank’s problems

before they overwhelm the institution.

3. Problem of diversification: The management of a bank can

use the bank can use the bank’s sources and uses of funds to

reduce operation risk. Generally, banks strive to achieve two

types problems in risk diversification, portfolio and

geographical diversification.

4. Problem of risk retention: This means that banks normally

do not take insurance policies on minutes items of operations

and ill experience in risk management.

5. Problem of mismatch of assets and liabilities: This is the

problem or the risk banking industry encounter when using

short term finance to finance long term investment. It will

connote serious problems.

CONCLUSION

The management of banking risk has been discovered as an

instrument for effective operation of banking industry. Though it is

being handled by both the banks and other institutions through

appropriate measures, which involve the apex bank (CBN), Nigeria

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Deposit Insurance Corporation (NDIC) and insurance companies.

Adequate risk management is the best way of handling risk in the

banking industry.

RECOMMENDATIONS

The recommendations of this work are as follows;

1. There is the need for banks to employ insurance professionals

in their corporate affairs departments to handle the insurance

of their physical facilities. Such professionals would pre-occupy

themselves with risk identification and treatment. They will also

liaise with insurance companies handling their banks insurance

policies. They will also be useful in credit risk analysis and

prediction.

2. There is the need for banks to engage in risk research in order

to reduce baking hazards. This is where the employment of

insurance professionals becomes very relevant.

3. The staff of banks should be appropriately remunerated to

eliminate human attitudes that can aggravate the occurrence

of some risks in bank business.

4. All banks should strive o make use of bullet proof billion vans in

order to eliminate hazards that can lead to attack on cash in

transit.

5. All banks should strive to install security doors in their premises

to checkmate the activities of hood hems on their banking

halls.

6. Insurance and risk management awareness seminars and

conferences.

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