UHOMOIBHI TONI ABURIME1

Keywords: Banks; Consolidation; Concentration; Implications; Nigeria

1
Department of Banking and Finance, Faculty of Business Administration, University of Nigeria,
Enugu Campus, Nigeria.

Postal Address:- P. O. Box 10555, Ugbowo - Benin City, Edo State, Nigeria.

Tel. No.:- +234 - 803 - 4526897.

E-mail:- pastor_toni@yahoo.com.

ABSTRACT
The consolidation of banks around the globe has fuelled an active policy debate on the impact

of consolidation on financial stability. In Nigeria, there is a banks consolidation exercise that has

recently been completed. This paper theoretically outlines, on the basis of existing bank concentration

theories, the term effects the banks consolidation exercise will likely have on the Nigerian banking

system via concentration and suggests solutions to associated problems. Based on the findings,

it is recommended that the CBN should tighten its watchdog role over the Nigerian banking

industry and make it clear that none of the twenty-five surviving banks is “too big to fail”.

1
I – INTRODUCTION

The consolidation of banks around the globe has fuelled an active policy debate on the

impact of consolidation on financial stability (Beck, Demirguc-Kunt and Levine, 2003 and

Boyd and Graham, 1998 and 1991).

The objective of this paper is to outline, on the basis of existing bank concentration

theories, the extensive impacts the recently concluded banks consolidation exercise in Nigeria

could have on the Nigerian banking system via concentration and suggest plausible solutions

to associated problems.

The motivation for this paper comes firstly, from the fact that the concluded

banks consolidation exercise is intended to improve Nigerian banking system efficiency through

the enhancement of the efficiency of the composite units; and several international researchers

have proved concentration levels to be a major determinant of banking system efficiency.

Secondly, there is no study in the literature to my knowledge that has examined this very

important issue in the Nigerian context. The present study thus improves the understanding

of bank concentration in Nigeria and addresses an important gap in the literature. Finally,

this study has important policy implications, as it could help regulatory authorities determine

the future course of action to be pursued in the matter of banks’ activities in Nigeria as also

in the context of establishing a level playing field among banks operating in the Nigerian

banking industry.

The remainder of this paper is organised as follows: the next section gives an overview

of the Nigerian banks consolidation exercise, Section 3 is a review of bank concentration

theories, Section 4 is a theoretical analysis of the concentration implications of the Nigerian

banks consolidation exercise, and Section 5 concludes the paper.

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II – AN OVERVIEW OF THE NIGERIAN BANKS CONSOLIDATION

EXERCISE

On Tuesday, 6th of July 2004, the Governor of the Central Bank of Nigeria (CBN) made

pronouncements on Nigerian banking sector reforms. The main objective of the reforms is to

move the Nigerian economy forward and to strengthen the banking system in order to facilitate

development. The first phase of the reforms is designed to ensure a diversified, strong and

reliable banking sector, which will ensure the safety of depositors’ money, play active

developmental roles in the Nigerian economy and become competent and competitive players

both in the African and global financial systems; while the second phase will involve

encouraging the emergence of regional and specialized banks (Okagbue and Aliko, 2005: 1).

The just concluded banks consolidation exercise, mainly through bank mergers and

acquisitions (M & As) in order to attain a minimum capital base of N25 billion (approx $250

million), is an aspect of the first phase of the reforms. It resulted in the compression of 74 banks,

which accounted for about 93 per cent of the industry’s total deposit liabilities, into 25 new banks

(Komolafe and Ujah, 2006: 1). Now that the exercise has been concluded, attention has clearly

shifted to its term effects on the Nigerian banking system (Omoh, 2006: 5). Hence, in this study,

we are concerned about the concentration impacts of this exercise on the Nigerian banking system.

III – A REVIEW OF BANK CONCENTRATION THEORIES

Concentration refers to the degree of control of economic activity by large firms

(Sathye, 2002: 10). Increase in concentration levels could be due to considerable size

enlargement of the dominant firm(s) and / or considerable size reduction of the non-dominant

firm(s). Conversely, reduction in concentration levels could be due to considerable size reduction

of the dominant firm(s) and / or considerable size enlargement of the non-dominant firm(s)

(Athanasoglou et al., 2005: 25).

3
 The degree to which banking market structure matters for competition and performance

has been a “hotly debated topic”. The outcomes of numerous researches have resulted in the

existence of numerous bank concentration theories in the literature. In the main, these theories

could be classified into pro-concentration theories and pro-deconcentration theories.

The theoretical analysis of the concentration implications of the Nigerian banks consolidation

exercise shall be based on these theories.

Pro-Concentration Theories

Proponents of banking sector concentration argue that economies of scale drive bank

mergers and acquisitions (increasing concentration), so that increased concentration goes

hand-in-hand with efficiency improvements (Demirguc-Kunt and Levine, 2000: 1). To buttress

this point, Boyd and Runkle (1993) examined 122 U.S. bank holding companies and found an

inverse relationship between size and the volatility of asset returns. However, these findings are

based on situations in which the consolidations were voluntary, unlike the case with the

concluded banks consolidation exercise in Nigeria.

Some theoretical arguments and country comparisons suggest that a less concentrated

banking sector with many small banks is more prone to financial crises than a concentrated

banking sector with a few large banks (Allen and Gale, 2000; and Beck, Demirgüç-Kunt and

Levine, 2004). This is partly because reduced concentration in a banking market results in

increased competition among banks and vice-versa. Proponents of this ‘concentration-stability’

view argue that larger banks can diversify better so that banking systems characterized by a few

large banks will be tend to be less fragile than banking systems with many small banks

(Allen and Gale, 2003). Concentrated banking systems may also enhance profits and therefore

lower bank fragility. High profits provide a buffer against adverse shocks and increase the

franchise value of the bank, reducing incentives for bankers to take excessive risk. Furthermore,

a few large banks are easier to monitor than many small banks, so that corporate control of banks

4
will be more effective and the risks of contagion less pronounced in a concentrated banking

system (Beck, Demirguc-Kunt and Levine, 2003: 1).

Pro-Deconcentration Theories

Findings from a study carried out by Chong (1991) indicate that bank consolidation tends

to increase the risk of bank portfolios. Proponents of banking sector deconcentration also argue

that concentration will intensify market power and political influence of financial conglomerates,

stymie competition in and access to financial services, reduce efficiency, and destabilize financial

systems as banks become too big to discipline and use their influence to shape banking

regulations and policies (Demirguc-Kunt and Levine, 2000; Beck, Demirgüç-Kunt and Levine,

2004; and Bank for International Settlements, 2001). While excessive competition may create an

unstable banking environment, insufficient competition – and contestability – in the banking

sector may breed inefficiencies.

In concentrated banking systems, bigger, politically connected banks may become more

leveraged and take on greater risk since they can rely on policymakers to help when adverse

shocks hurt their solvency or profitability. Similarly, large, politically influential banks may help

shape the policies and regulations influencing banks’ activities in ways that help banks, but not

necessarily in ways that help the overall economy. For instance, concentrated, powerful banks

may argue against granting generous deposit insurance since that levels the playing field for

smaller banks that do not enjoy the too-big-to-fail policy of most governments in economies

where concentration levels are high. Concentrated banks may also seek to stymie stock market

development by pushing for higher taxes on capital gains and by discouraging regulations that

protect the rights of small investors and promote accounting transparency. To boost the

profitability of large clients, powerful banks may also seek to control “unruly” markets by

weakening anti-trust laws and other policies designed to promote competition. Furthermore,

5
if concentrated powerful banks unduly influence the formation of policies and regulations,

this may hinder political integrity and reduce tax compliance (Demirguc-Kunt and Levine, 2000: 3).

Pro deconcentration, there is evidence linking increase in banking concentration to

reductions in credit supply. In the United States, Berger et al (1995) find evidence that the

increase in the proportion of banking industry assets controlled by the largest banking

organizations in the 1990s, due to the liberalization of geographic restrictions on banking in the

United States, may have been responsible for part of the credit crunch observed in

1989-92. There is also growing evidence linking increased concentration in a banking market to

reduced lending to small and medium scale enterprises. Peek and Rosengren (1996), combining a

single cross-section data on lending businesses in the New England states for 1994 with some

information on mergers and de novo entry, find that after banking organizations merged with

smaller organizations, the consolidated organization typically reduced the amount of small

business lending that was conducted earlier by the acquired institution. Berger and Udell (1996)

find that large banks not only tend to have a smaller proportion of their loans made to small

borrowers, but also tend to charge lower average prices than other banks to small borrowers,

indicating that large banks only issue business loans to higher-quality credits (Cañonero, 1997: 5).

It has also been argued that the higher the concentration in the local banking market,

the higher prices are for financial services, and consequently the higher the banks’ profits. This is

because banks in less competitive environments charge higher interest rates to firms.

If concentration is positively associated with banks having market power, then concentration will

increase both the expected rate of return on bank assets and the standard deviation

of those returns (Beck, Demirgüç-Kunt and Levine, 2004: 2). The policy implication is that

higher market concentration is associated with lower socio-economic welfare and, therefore,

higher concentration is undesirable. Hence, a country like the UK (Monopolies and Mergers

Commission, 1996) is wary of a concentration ratio that is 25 per cent or more of the banking

market in terms of total assets or deposits (Holden and El-Bannany, 2006).

6
 Another pro-deconcentration position is that a more concentrated banking structure

enhances bank fragility. Advocates of this ‘concentration-fragility’ view note that larger banks

frequently receive subsidies through implicit ‘too big to fail’ policies that small banks do not

enjoy. This occurs when regulators fear potential macroeconomic consequences of large bank

failures. The greater subsidy for larger banks may in turn intensify risk-taking incentives beyond

any diversification advantages enjoyed by them, thereby increasing the fragility of concentrated

banking systems (Boyd and Runkle, 1993). Proponents of the concentration-fragility view

disagree with the proposition that a few large banks are easier to monitor than many small banks.

If size is positively correlated with complexity, then large banks may be more opaque than small

banks, and therefore more difficult to monitor. This would tend to produce a positive relationship

between concentration and fragility.

IV – ANALYSIS OF THE CONCENTRATION IMPLICATIONS OF THE

NIGERIAN BANKS CONSOLIDATION EXERCISE

There are numerous ways of measuring bank concentration. While Rose (1999: 687)

states: “the degree of concentration in a market is measured by the proportion of assets or

deposits controlled by the largest banks serving that market”, Demirguc-Kunt and Levine

(2000) measure banking system concentration via the fraction of bank loans controlled by the

three largest banks in a banking system.

Following Rose (1999) and Demirguc-Kunt and Levine (2000), we have measured bank

concentration in Nigeria from 1995-2003 using three indices- the fractions of system assets,

system deposits and system credits controlled by the three largest banks in Nigeria. We assume

these banks to be First Bank of Nigeria Plc., Union Bank of Nigeria Plc., and United Bank

of Africa Plc. In the Nigerian banking industry, these banks have been popularly called ‘the big

three’. Based on the results of our computations, it is clear that bank concentration in Nigeria,

7
before the consolidation directive was issued, was on a downward trend. Tables 1-3 and Figs. 1-3

present bank concentration levels in Nigeria from 1995 -2004.

Table 1- Bank Concentration in Nigeria from 1995-2004 (Assets)

Year 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Max Min

Concentration 0.44 0.34 0.29 0.35 0.32 0.26 0.25 0.25 0.25 0.22 0.44 0.25

Source:- Researcher’s Computations from NDIC Annual Reports and Individual Bank Annual Reports, Various Years

Fig. 1- Graph Illustrating Bank Concentration Levels in Nigeria from 1995-2004 (Assets)

0.5
Concentration

0.4
Bank Asset

0.3
Series1
0.2
0.1
0
1990 1995 2000 2005
Year

Table 2- Bank Concentration in Nigeria from 1995-2004 (Deposits)

Year 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Max Min

Concentration 0.60 0.57 0.47 0.51 0.44 0.36 0.44 0.41 0.40 0.33 0.60 0.36

Source:- Researcher’s Computations from NDIC Annual Reports and Individual Bank Annual Reports, Various Years

Fig. 2- Graph Illustrating Bank Concentration Levels in Nigeria from 1995-2004 (Deposits)

0.8
Concentration
Bank Deposit

0.6
0.4 Series1
0.2
0
1990 1995 2000 2005
Year

8
Table 3- Bank Concentration in Nigeria from 1995-2004 (Credits)

Year 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Max Min

Concentration 0.17 0.20 0.22 0.21 0.23 0.15 0.13 0.16 0.13 0.14 0.23 0.13

Source:- Researcher’s Computations from NDIC Annual Reports and Individual Bank Annual Reports, Various Years

Fig. 3- Graph Illustrating Bank Concentration Levels in Nigeria from 1995-2004 (Credits)

0.25
Concentration
Bank Credit

0.2
0.15
Series1
0.1
0.05
0
1990 1995 2000 2005
Year

Earlier on in Section 2 of this paper, we stated that the ongoing Nigerian banking sector

reforms is planned out in phases. The first phase is the concluded banks consolidation exercise

mainly through M & As. Empirical evidence shows that a series of M & As usually result in

increased concentration levels (Athanasoglou et al., 2005: 16). Hence, if the twenty-five mega

(colossal) banks that have been established are the only set of banks that would remain after the

completion of the entire Nigerian banking sector reforms, we would have been right to conclude

that the Nigerian banks consolidation exercise will only result in reversing deconcentration trends

in the Nigerian banking industry. But, the second phase of the reforms is designed to produce

another set of banks that will not be as colossal as the mega banks produced by the first phase.

These shall be regional and specialized banks (Okagbue and Aliko, 2005: 1). With the

establishment of these set of banks, bank concentration levels in Nigeria shall gradually decrease

again. Hence, it is appropriate to forecast concentration of the Nigerian banking industry in the

short term and deconcentration of the industry in the long term. Based on this forecast and

the knowledge acquired from the review of bank concentration theories, there are some plausible

implications of the Nigerian banks consolidation exercise that need to be highlighted.

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 Firstly, though the Nigerian banks consolidation exercise has produced few banks that are

easier for the regulatory authorities to effectively monitor, reducing contagion risks,

pro-deconcentration theories show that these banks may be generally termed “too big to fail”

—as monetary authorities may fear that the failure of a single large bank could seriously disrupt

financial markets and result in grave macroeconomic consequences. This may lead to an

undesirable extension of the scope and cost of the official safety net. A too-big-to-fail problem

may, in turn, increase moral hazard problems: knowing the existence of an (implicit) safety net,

banks may be less careful in allocating credit and screening potential borrowers. This may result

in an increase in the proportion of non-performing loans and advances.

Secondly, efficiency improvements as a result of the consolidation exercise are unlikely to

be experienced in the short term. Though the twenty-five megabanks are large banks having the

capital to generate jumbo returns, these returns are not likely to match the capital and asset

strength of the banks. Boyd and Runkle (1993) find that larger banks are more highly leveraged

and less profitable in terms of asset returns (Beck, Demirguc-Kunt and Levine, 2003: 2).

Hence, short-run concentration of the Nigerian banking market will only result in thinning

margins and increased competition among banks (Athanasoglou et al., 2005: 16), as already

being observed (Ahiuma-Young, 2006: 19). Excessive competition is likely to create an unstable

banking environment. The situation will compel bank managers to undertake higher levels of risk

in order to fully utilize the funds at their disposal. The bank would take the place of the servant;

while the customer would take the place of the king (as it is meant to be). But, in the corrupt and

fraudulent Nigerian scene (e.g. Uche, 1996: 438), this may result in higher loan default rates,

all amounting to inefficiencies in the short term. One can only hope that, as time unfolds,

the situation would gradually change for the better as the banks start developing new ways

of doing business.

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 Thirdly, pro-deconcentration theories point to the possibility that, in anticipation of the

implementation of the second phase of the banking sector reforms, mega banks may move to

intensify their market power and political influence of financial conglomerates, and attempt to

stymie competition. The overall effect would be to reduce efficiency and destabilize the financial

system as the mega banks may become too big to discipline and may use their influence to shape

banking regulations and policies, especially if they are allowed to attain the status of “too big to

fail” banks (Demirguc-Kunt and Levine, 2000; Beck, Demirgüç-Kunt and Levine, 2004; and

Bank for International Settlements, 2001).

Fourthly, in the long-run, deconcentration resulting from the implementation of the

second phase of the banking sector reforms will result in increased competition among banks;

and this could make the banking sector prone to financial crises (Allen and Gale, 2000; and Beck,

Demirgüç-Kunt and Levine, 2004).

Finally, the long-term deconcentration of the Nigerian banking industry could pose

advantageous through a likely increase in foreign investment in Nigerian banks. Already,

Njoku (2005) and Komolafe (2005) report that several foreign banks have indicated interest in

investing in Nigerian banks. As regards the implications of increased foreign participation,

Agénor (2001:31) argues that the competitive pressures (between foreign and local banks)

usually created leads to improvements in the efficiency of domestic banks and financial

intermediation in general in terms of lower operating costs and reduced net interest margins.

This could enhance overall banking sector efficiency and stability.

V – CONCLUSION

In order to avert negative consequences of the Nigerian banks consolidation exercise and

to realize the benefits derivable from the exercise, it is pertinent for the CBN to make it clear that

none of the twenty-five megabanks existing today is “too big to fail”. The CBN should also

11
tighten its watchdog role over the banking industry, in order to ensure that the intended gains

of the exercise are truly realized.

The Economic and Financial Crimes Commission (EFCC) should turn its searchlight

on the Nigerian banking industry, so that the megabanks wouldn’t begin to perpetuate

financial crimes to generate jumbo returns from the enormous funds available to them. There is

an urgent need, now more than ever before, for the Federal Government to tighten the noose on

the activities of money launderers and banks that collaborate with them (Adesina, 2006: 26).

Greater transparency and accountability should be firmly embedded as the hallmark of the

Nigerian banking system.

Since concentration theories have linked bank consolidation to reduction in credit supply

(Berger et al, 1995) to small and medium scale enterprises (SMEs) (Peek and Rosengren, 1996;

Berger and Udell, 1996; and Cañonero, 1997), the CBN owes a duty to the Nigerian economy to

ensure that this does not happen during this post-consolidation era. Already, the Small and

Medium Industries Equity Investment Scheme (SMIEIS) is in place; but banks should be given

further encouragement to lend to SMEs. The development of SMEs is a prerequisite for Nigeria’s

economic development. Banks in Nigeria should find suitable investment outlets in them.

Most of these enterprises have the necessary expertise and acumen but only lack the finance to

actualize their potentials (Jobis, 2006: 39).

Finally, as soon as the empirical data begin to stream in, researchers should conduct

econometric empirical analyses to ascertain the true empirical implications of the Nigerian banks

consolidation exercise on the Nigerian banking system via concentration. This will help bank

regulatory authorities deal with concentration-related problems as they arise; and will also help

build a platform for domestic bank concentration theories.

12
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