Global financial meltdown and the reforms in the Nigerian banking sector

Being the full text of a Public Lecture delivered by Sanusi Lamido Sanusi (Governor, Central Bank of Nigeria) at the Convocation Square, Abubakar Tafawa Balewa University, Bauchi, December 10, 2010

Protocol

1. I am very delighted to be invited to present a key-note address at this important forum. I wish to commend the organizers, the Canadian High Commission, the Chartered Institute of Bankers of Nigeria and the Royal Bank of Canada for gathering top policy makers and operators in the banking and finance industry here today for this all important seminar which is focusing on the banking sector in Nigeria. The theme of this seminar “Transformational Banking for Economic Development” is indeed topical, and couldn’t have come at a better time, considering that the banking sector in Nigeria is passing through a critical and decisive path in reforms to reposition it to effectively impact on other sectors of the economy, especially the real sector.

2. Economic development is about enhancing the productive capacity of an economy by using available resources to reduce risks, remove impediments which otherwise could lower costs and hinder investment. The banking system plays the important role of promoting economic growth and development through the process of financial intermediation. Many economists have acknowledged that the financial system, with banks as its major component, provide linkages for the different sectors of the economy and encourage high level of specialization, expertise, economies of scale and a conducive environment for the implementation of various economic policies of government intended to achieve non-inflationary growth, exchange rate stability, balance of payments equilibrium and high levels of employment.

3. The role of finance in economic development is widely acknowledged in the literature. In particular, Schumpeter (1911) put the role of financial intermediation at the center of economic development. He argued that financial intermediation through the banking system played a pivotal role in economic development by affecting the allocation of savings, thereby improving productivity, technical change and the rate of economic growth. He believed that efficient allocation of savings through identification and funding of entrepreneurs with the best chances of successfully implementing innovative products and production processes are tools to achieve this objective.

4. The endogenous growth literature also supports the argument that financial development has a positive impact on growth. Well functioning financial systems are able to mobilize household savings, allocate resources efficiently, diversify risk, and enhance the flow of liquidity, reduce information asymmetry and transaction cost and provide an alternative to raising funds through individual savings and retained earnings. These functions suggest that financial development has a positive impact on growth.

5. Ladies and Gentlemen, for many of you here, I may be stating the obvious, by highlighting the central role that banks play in the development of every economy by mobilizing resources for productive investments and being the conduit for the implementation of monetary policy. Yet, I have given this the emphasis it requires. Due to the critical nature of these roles, and the fact that the ability of banks to effectively impact on economic development hinges largely on their soundness and efficiency, governments across the world continue to take variety of measures to safeguard the banking sector through reforms. Such reforms often focus on increased risk management procedures and enhanced corporate governance in order to strengthen and reposition the banking industry to enable it contribute effectively to the development of the real sector through its intermediation process. In addition, such reforms may involve a comprehensive process of substantially improving the regulatory and surveillance framework; fostering healthy competition in banking operations, ensuring an efficient framework for monetary management, expansion of savings mobilization base, enforcement of capital adequacy, and the promotion of investment and growth through market-based interest rates. The need for reforms on an on-going basis has become more imperative with the increasing sophistication of the global financial products. The recent experience from the global financial crisis has further underscored the imperatives for countries to embark on banking reforms on a regular basis.

6. Ladies and Gentlemen, the process of reforming a financial sector usually involves the movement from an initial situation of controlled interest rates, poorly developed money and securities market and under-developed banking system, towards a situation of flexible interest rates, an expanded role for market forces in resource allocation, increased autonomy for the central bank and a deepening of the money and capital markets. It would indeed be difficult to define the components of ‘good’ banking sector reform in absolute terms. Generally speaking, good reforms would engender clear market entry and exit conditions; ensure the ability of banks to function according to market principles without state intervention in their decision-making; guarantee central bank independence and establish independent banking oversight. This means that reform in the domestic financial system will comprise of three key policy actions. The first is removal of price restrictions; that is, the removal of ceilings on deposit interest rates and restrictions on lending interest rates. The second component is…..

Sanusi Lamido Sanusi, CON

Governor Central Bank of Nigeria