Reconciling banking regulation and the ‘systemically important banks’ syndrome : deconstructing the legal constraints from a Nigerian perspective

• Author: Patrick Osode,Nelson Ojukwu-Ogba
• DOI: 10.10520/EJC-c6c288969
• Published date: 01 January 2016
• Date: 01 January 2016
• Record Number: sapr1_v31_n2_a3
• Pages: 1-29

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ARTICLE

RECONCILING BANKING REGULATION AND

THE ‘SYSTEMICALLY IMPORTANT BANKS’

SYNDROME: DECONSTRUCTING THE

LEGAL CONSTRAINTS FROM A NIGERIAN

PERSPECTIVE

Nelson Ojukwu-Ogba

Post-Doctoral Fellow, University of Fort Hare

Senior Lecturer, University of Benin

Patrick C Osode

University of Fort Hare

Email: POsode@ufh.ac.za

ABSTRACT

Banks occupy a central position in the nancial architecture of any economy due to

their nancial intermediation roles and as facilitators of the national payments system.

However, because of the peculiarly risky nature of their business, banks do fail. Among

other outcomes, this can have grave repercussions for various stakeholders, especially

depositors. To overcome these challenges and ensure that the banking system remains

efcient, transparent, strong and stable, banking regulators apply various administrative and

statutory measures. A major inuential factor in seeking to keep distressed banks aoat

is the ‘systemically important banks’ syndrome that nudges regulators to expend public

funds in bailing out large insolvent banks because of their strategic position in the nancial

system and the potentially traumatic systemic implications of their failure and liquidation.

The foremost tool in the pursuit of this objective is the now globally acknowledged failure-

resolution policy of bank bailout. Here, regulators are unduly inuenced by the ‘too big to

fail’ phenomenon; they therefore reason that some banks are too big and are therefore too

systematically important to be allowed to fail, hence the deployment of public funds to bail

them out when they are in distress. This article considers the dilemma of banking regulators

in pursuing the protection of depositors, on the one hand, and seeking to keep big distressed

banks aoat at the expense of public resources, on the other. This objective is particularly

pursued from the perspectives of the Nigerian jurisdiction. The article advances the view that

the ‘systemically important banks’ syndrome may not be the most effective means of driving

banking regulation because of the question of moral hazard involved. It proffers alternative

measures for attaining the crucial outcome of effective banking regulation.

https://doi.org/10.25159/2522-6800/2956

ISSN 2219-6412 (Print) ISSN 2522-6800 (Online)

© Unisa Press 2017

Southern African Public Law

https://upjournals.co.za/index.php/SAPL/index

Volume 31 | Number 2 | 2016 | #2956 | 29 pages

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Ojukwu-Ogba and Osode Deconstructing the Legal Constraints from a Nigerian Perspective

INTRODUCTION

Banking institutions are usually prone to failure because they take business risks that

sometimes go awry.1 This may result from faulty credit risk management, insider abuse,

fraud and such related problems.2 When these challenges become endemic, the affected

banks suffer illiquidity and, subsequently, insolvency.3 An insolvent bank becomes

distressed and in such a dire state faces certain challenges often associated with critically

ill nancial institutions, including bank runs and liquidation.4 Banking regulation aims

to prevent or contain these challenges that plague banks. Apart from the insolvency-

resolution and safety-net objectives, other purposes of regulation are to maintain

nancial stability in the economy and sustain depositors’ condence in the banking

system.5 However, in carrying out their statutory functions, banking regulators are

faced with some challenges that militate against effective monitoring and supervision.

Regulatory measures seek to tame these challenges in order to ensure that the banking

system is not only effective but also strong. A banking system that is strong, efcient

and transparent becomes attractive to a greater number of the members of the populace

and encourages the cultivation of the banking habit. This is apart from the fact that

banks become resilient to the identied challenges that lead to failure. Such a desirable

1 In the past decade, a number of banks in several countries have failed for many reasons, including

excessively risky transactions and poor management of toxic assets. The problem climaxed in the

global nancial crisis (GFC) of 2007–2008. This had devastating consequences for many economies.

See NE Ojukwu-Ogba, ‘Banking Regulation in Nigeria and the Lessons of the Global Financial

Crisis’ (2013) Nigerian Institute of Advanced Legal Studies Journal of Business Law 38 at 39.

2 A banking crisis can have a ripple effect on all other sectors of an economy. See DM Driesen, ‘Legal

Theory Lessons from the Financial Crisis’ (2014) The Journal of Corporation Law 55 at 68. See also

R Baxter, ‘The Global Economic Crisis and Its Impact on South Africa and the Country’s Mining

Industry’ <https://wwww.resbank.co.za/Lists/News%20Publications/Attachments/51/Roger+Baxter.

pdf> accessed 8 December 2016.

3 For example, in Nigeria, between January 1994 and January 2006, the Nigeria Deposit Insurance

Corporation (NDIC) liquidated forty-ve banks. These do not include the seven banks whose

operating licences were revoked but whose owners challenged the action of the NDIC in court. Bank

failure is an event that cannot be completely prevented as long as banks take business risks. See

‘Nigeria Deposit Insurance Corporation – Closed Financial Institutions’ <http://www.ndic.org.ng/

closed-nancial-institutions.html> accessed 8 December 2016. In the United States, 547 banks were

liquidated between 2000 and 2015 (see Table 1). Most of them were absorbed by stronger, more

resilient banks in arrangements often overseen by the regulator in order to prevent systemic nancial

crisis. See ‘Federal Deposit Insurance Corporation – Analysis of Failed Banks’ <http://www.fdic.gov/

bank/individual/failedbanklist> accessed 7 December 2016.

4 When a bank faces persistent illiquidity, it becomes incapable of fullling one of the most basic

obligations to its customers: honouring their mandates validly drawn. At this point, a crisis of

condence develops which precipitates spontaneous panic by the bank’s depositors. When the

depositors of a bank simultaneously converge on their bank to withdraw money, it could result in

bank runs, which may push the bank into more serious illiquidity, even when it may ordinarily have

been able to navigate its way through the initial illiquidity in the absence of a run. This development

worsens its solvency state and may lead in quick succession to distress.

5 GA Ogunleye, Perspectives on the Nigerian Financial Safety-net (NDIC Press, 2010) 19.