TOPIC: UNDERSTANDING THE REGULATORY
FRAMEWORK UNDERLYING AUDIT & INSPECTION.
INTRODUCTION
For effective and equitable operation of most human activities and
organizations, a body of laws, rules and regulations are usually put in place
to regulate them. Banking operations, being one of such important human
engagements in modem world economy, are firmly regulated with adequate
legal framework which undergoes constant reviews as new developments emerge in
the industry and the general economy, rendering some of the existing laws and
regulations either inadequate or obsolete.In the Nigeria experience, the period
between 1894 and 1952 was referred to as the “Free Banking Era” as the banking
industry was an “all comers game” and functioned with minimal controls or
regulations by the Government of the day.
The Bank of British West Africa which
later metamorphosed into the First Bank of Nigeria Plc was established in 1894.
This Bank exercised virtually monopoly over banking activities in the country
until 1916 when the colonial bank, now Union Bank appeared on the scene. A few
other expatriate banks were also in existence before the emergence of some
indigenous banks following the alleged discrimination suffered by the Nigeria
businessmen in securing credits from the colonial banks. The first indigenous
bank to be established in 1929 was the Industrial and Commercial Bank which
went into liquidation in 1930. Many others were quickly established. According
to the late Prof. W. 0. Uzoaga: “Nigeria experienced a rapid expansion in
indigenous banks between the period 1947 and 1952. The rapid expansion was accompanied
by a high rate of bank failures which by 1954 has claimed 21 out of 25
indigenous banks with 16 of r them collapsing in 1954 alone” Indeed some
authorities had held that as many as 50 banks failed during the period.
Generally the failure of those banks was due largely to inadequate capital,
inexperience of the operators in banks’ accounting and management as well as
the depressed economic conditions prevailing at the time. The high failure rate
of those banks during that period and the problem faced by the young banking
institution in the absence of a regulating central bank attracted public
criticism.
It has been stated by some authorities that the 1952 Banking Ordinance was
prompted by the colossal banks’ failure of 1947-1952. Thereafter a myriad of
banking legislation, acts, decrees and other manners of controls seem to have
been unleashed on the banking sector and induced some commentators to declare
that the banking industry in the country has become over — regulated.
It is for the enforcement of those regulations, within the industry, that Banks inspection and audit outfits became a compelling necessity. Hence it must be clearly appreciated that Bank inspection and auditing operate essentially, within the same legal framework under which the Banks themselves operate.
2. DEFINITION OF KEY WORDS
Before our further discussion on this
topic — Legal Framework of Bank Inspection and Auditing — let us attempt brief
definitions of its key words.
Inspection and Auditing
According to the advanced Learners
Dictionary, to inspect means: to examine carefully; to visit officially to see
that rules are obeyed, that work is done properly etc
With this definition, let us now determine who has the responsibility of the
inspection and auditing of licensed Banks in Nigeria.
3. RESPONSIBILITY FOR BANKS
INSPECTION AND AUDITING
The responsibility of Banks inspection
and audit rests on the Central Bank of Nigeria. Section 30(1) of the Bank &
Other Financial Institutions Decree, 1991 stipulates that there shall be an officer
of the Bank who shall be appointed by the Governor to be known as the Director
of Banking Supervision or by such other title as the Governor may specify.
Sub-Section 2 of the Decree states that the Director of Banking Supervision
shall have power to carry out supervisory duties in respect of banks for a
number of specified purposes.
Sub-Section 3 of the Decree states that the Governor shall appoint to assist
the Director of Banking Supervision such other officers of the Bank as the
Governor may, from time to time, decide. Sub-Section 4 provides that the
Officers may be designated examiners or have such other titles as the Governor
may specify. Sub-Section 5 of the Decree provides that references to examiners
are references to the Director of Banking Supervision and other officers of the
Bank appointed pursuant to Sub-Section (3) of this Decree.
However, despite the exclusive powers
reserved to the CBN under this Decree for the supervision (in other words,
inspection and auditing) of banks in the country, other regulatory institutions
Such as the Nigeria Deposit insurance Corporation (NDIC), the CTBN and the FMBN
carry out some specific bank-related supervisory and examination functions over
banks or related institutions. In addition to the supervisory roles of the Apex
Bank and the NDIC. individual licensed banks are expected to have strong and
effective Inspection Department which inspect the activities of their
respective banks and enforce compliance with the statutory regulations (by the
operators) in their banks, with the strong support of and authority from their
Banks’ Boards of Directors and Executive Managements.
Furthermore, the External Auditors, by their audit functions, provide some form
of statutory examination of the books of the Banks. The combined activities of
these bodies assist the Apex institution in the actualization of its supervisor
responsibility over the Banking System.
It is under this enlarged scope (based on the background of the participants)
that
we shall conceptualize our discussions in this paper.
4. LEGAL FRAMEWORK OF BANK INSPECTION AND AUDITING
To check the colossal failure and
institutional instability that became the lot of
many banking companies in the 1950s, several ordinances, Legislations, Acts,
Decree and other forms of Controls have been instituted by the succeeding
governing authorities in Nigeria over the years. The constituents of the legal
framework have continued to grow with several amendments in conformity with the
shift in our social, political and economic environments which render the
existing controls and regulations either irrelevant, obsolete or inadequate.
Among the barrage of the Legal framework of the Banks inspection and auditing are the following:
· The 1952 Banking Ordinance
· The Banking Act, 1958
· The CBN Act, 1958
· The Exchange Control Act, 1962
· The 1969 Banking Act
· The Indigenization Decree, 1972 & 1978
· The Companies & Allied Matters Decree (CAMD), 1990
· The Banks & other Financial Institution Decree (BOFID), 1991
· The NDIC Decree (1988)
· CBN Autonomy Decree, 1994
· The Failed Banks Decree, No. 18 of 1994
· The Yearly CBN Monetary, Fiscal & Credit Policies
· Community Banks Decree, 1992 (As Amended, 1993)
· Chartered institute of Bankers Decree, No. 12, 1990.
· The Federal Mortgage Bank of Nigeria Decree.
· CBN Prudential Guidelines for Banks, etc. Owing to constraint of time and space, we shall limit our discussion on a few of these elements of legal framework
THE BANKING ORDINANCE 1952
The Colonial Administration in 1948
appointed 0. D. Paton of the Bank of
England to enquire into the Problem of Banking in Nigeria. Paton recommended
the introduction of banking legislation to regulate banking generally and
protect
depositors. His recommendation gave rise to the Banking Ordinance of 1952 which
was the first attempt at banking legislation in Nigeria... The Ordinance
stipulated a minimum capital requirement for all banks, defined a system of
licensing, liquidity requirement and maintenance of reserve, and provided for
bank supervision. Existing banks which fell short of the minimum capital
requirement were given three years to make good their deficiency. Most of the
indigenous banks could not meet the capital requirement when the Ordinance came
into effect in March, 1952 and that led to their collapse. There was no central
bank to perform as “lender of last resort” to them before 1958 and no organized
securities market before 1960 to enable them raise further outside capital.
Owing to these constraints, only the colonial banks waxed stronger.
Act. 19 The CBN was established in 1958 afterthe enactment of the Central Bank of Nigeria Act of 1958. The main objective of the Bank is to issue legal tender in Nigeria, to maintain external reserve, to safeguard international value of the local currency, to promote monetary stability and sound financial structure in Nigeria, to act as banker and financial adviser to the Federal Government and serve as a lender of last resort to the banks.
One of the major reasons for which the
CBN was established was to provide for a
sound management of the Banking System. This requires close regulation and
supervision of the banks by the CBN. Accordingly, the Bank’s Act requires any
company which desires to carry on banking business in Nigeria to apply and
obtain a license through the CBN to the Minister of Finance. On receipt of such
application the CBN would conduct a preliminary examination of the books and
affairs of the company and make recommendations to the Minister. No licensed
bank is permitted to open or close branch offices in and outside Nigeria except
with the approval of CBN. The CBN is therefore in a position to regulate the
entry and exit into banking in Nigeria and to control branch expansion of banks
licensed in Nigeria.
With the commencement, of operations by CBN on July l, 1959 a Bank Examiners
Unit was set up at the Federal Ministry of Finance in 1960. The Bank’s
examination function was subsequently transferred to the CBN in 1966. in 1969
the Banking Decree was promulgated and amended in 1979. This Decree remained
the statute governing the formation, administration, powers and duties of
licensed banks and supervisory and regulatory role of CBN over licensed banks
until the promulgation of the Central Bank of Nigeria Decree, No. 24 of 1991.
BANKS AND OTHER FINANCIAL
INSTITUTIONS DECREE (BOFID NO. 25 OF 1991.
This Landmark Decree was designed to ensure safety of depositors’ funds and to maintain the confidence of the banking public in the system. The decree aims to regulate and ,control the operations of banks and non-banks financial institutions in Nigeria.
The major stipulations of the Decree are as follows:
· The powers, functions and duties of CBN Licensing, opening and closing of Banks and other Financial Institutions and their branches.
· Minimum capital ratios or capital adequacy requirement.
· Minimum cash reserve and other liquidity requirements including restriction on dividends
· Power to deal with failing or ailing banks including revocation of licenses.
· Employment and disclosure of interest as it relates to management and directors of banks and other financial institutions.
· Restrictions on certain banking activities and operations of merchants.
· The licensing and control of other financial institutions as defined and provided for under section 56-59 of the Decree.
· Definition as to books of accounts and returns.
· General and specific powers of supervision, control, etc.
· By this Decree the Banking Act of 1969 and subsequent amendments were repealed.
CBN YEARLY MONETARY FISCAL AND
CREDIT GUIDELINES
For the purpose of regulating the cash
reserve of banks, the CBN is empowered, under the Act, to issue directives
requiring each bank to maintain , at all times, with it, an amount of cash
reserve equal to a specified ration of the Bank’s deposit liabilities. The Bank
also reserves the power to require Commercial Banks to hold a minimum amount of
specifies liquid assets which shall be expressed as a ration of their deposit
liabilities. For the purpose of maintaining monetary stability the CBN reserves
the power to issue stabilization securities at such a rate of interest and
conditions of maturity and amortization as it may determine and to sell or re-purchase
such securities from any licensed banks.
The Bank has the power to issue directives, from time to time, requiring all
commercial banks to maintain with it as “Special Deposits” an amount equal to a
percentage of the Bank’s deposit liabilities over an amount outstanding at a
certain date.
The CBN also prescribe the credit guideline to regulate the distribution of
loans and advances by Commercial and Merchant Banks to the various sectors of
the economy.
The CBN also regulates the interest and exchange rates structure for the
economy.
RURAL BANKING PROGRAM
The introduction of Rural Banking Program in 1977 added another dimension to the desire of the government to make the banking system more relevant to the realities of Nigeria’s economic development. The scheme which sought to encourage all operating commercial banks to pay more attention to the rural economy of the country have recorded a good level of success. By the end of 1989 a total of 765 branches had been established as against 766 allocated under the First, Second and Third Phases of the Scheme.
To further demonstrate the commitment
of the authorities in the stimulation of the rural economy the Federal
Government further directed that participating banks must ensure that at least
40% (later increased to 50%) of the total deposits mobilized from these areas
are granted as loans and advances to enterprises and businesses in these areas.
Such loans and advances were excluded from components making up the aggregate
loans and advances of each bank for the purpose of calculating aggregate credit
ceiling.
However, with the introduction of the Peoples and. Community Banks the
Commercial Banks were no longer compelled to establish further rural branches.
THE NIGERIA DEPOSIT INSURANCE
CORPORATION (NDIC) DECREE NO. 22 OF 1988.
a)
Section 5 of the Decree stipulates the responsibilities
of the NDIC as follows:
Insuring all deposit liabilities of licensed banks and such other financial
institution operating in Nigeria within the meaning of Section 20 and 26,
so as to engender confidence in the Nigerian Banking system.
b) Giving assistance in the interest of depositors, in case of imminent or actual financial difficulties of banks particularly where suspension of payments is threatened; and avoiding damage to public confidence in the banking system.
c)
Guaranteeing payments to depositors in case of imminent
or actual suspension of payments by insured banks or financial institutions up
to the
maximum amount as provided in Section 26 of this Decree.
d)
Assisting monetary authorities in the formulation and
implementation of banking policies so as to ensure a sound banking practice and
a fair
competition among banks in the country.
e)
Pursuing any other measures necessary to achieve the
functions of the Corporation provided such measures and actions are not
repugnant to the
function of the Cooperation.
The Decree allows far-reaching powers
to the Corporation to enable it realize its
set objectives. Such powers include collection of premiums on insurable
deposits of banks, appointment of examiners, special and routine examination,
take overs
and management, to close ailing banks.
However most of these powers are
exercised subject to presidential control or confirmation.
Between February 1994 and September 1994 three chronically distressed
commercial banks and one merchant bank had collapsed. The process of their
liquidation was immediately put in motion. In May 1993 the CBN took over the
management of five states-owned banks adjudged technically insolvent. As the affairs
of these banks seem to have failed to respond favorably to rescue measures
applied by CBN the Apex Bank recently bought them over for further management
which may include restructuring, mergers or even outright liquidation in which
NDIC will be involved.
The Prudential Guidelines for
Licensed Banks (1990)
These guidelines, issued in November
1990 are aimed at ensuring a stable, safe and sound banking system. The
guidelines are meant to serve as a guide to banks
in
(a)
Ensuring a more prudent approach in their credit
portfolio classification,
provisioning for non-performing facilities, credit portfolio disclosure and
accrual of interest on non-performing assets, and
(b)
Ensuring uniformity and reliability of their published
accounting
information and operations.
-
Bhodaghe rationalized
the need for the prudential guidelines
in these words and I
quote: - “The ultimate justification for prudential guidelines is the failure
of the
market not only to reflect a depositor’s risk exposure but more importantly to
control such exposures. The objectives of prudential regulations are therefore
to
protect the interest of depositors and the financial system as a whole. The
“public
interest” theory of regulation, for instance, identifies off-setting or market
failures
ast he major role of regulation. Furthermore, the efficiency consideration
comes up as another justification for prudential regulations”.
The international acceptance of the Basle Committee on the need for common
accounting standard for banks makes the prudential guideline imperative due to
the international nature of banking.
- The major provisions of the Prudential Guideline are the following: Classifications of credit portfolio
- Provisioning
- Treatment of accrued interest and
- Disclosure and treatment of off-balance sheet items.
CLASSIFICATIONS OF CREDIT PORTFOLIO
In addition to compelling licensed banks to ensure regular and continuous review of their credit portfolio so as to detect early enough, the deteriorating assets, the prudential guidelines also broadened the base of the items considered as credit facilities, for the purpose of the classification. Accordingly, some items that were usually treated as of balance sheet items such as commercial papers, bankers acceptances, bills discounts, leases, guarantees and other risk-laden contingencies were included as credit facilities in addition to the conventional loans and advances. Credit facilities are classified either as “performing” or non — “performing” assets depending on whether or not the repayment of principal and interest are regular and up-to-date in line with the agreed terms of the credits. The guidelines classify credit facilities as performing when both the repayments of the principal and interest are up to date and in accordance with the agreed terms.
Also, the guidelines define credit facilities as non-performing when any of the following conditions exist.
i. Interest or principal is due and unpaid for 90 days or more; and
ii. Interest payments equal to 90 interest or more have been capitalized, re-scheduled or rolled-over into a new loan except where, as specified, the facility has been re-classified.
Non-performing credit facilities are further classified into three namely:Substandard, doubtful and lost. In view of our limitations (in this paper) of time and space, details of the objective and subjective criteria employed to arrive at these classifications will not be discussed but could be found in paragraph 2.4 (a-c) of the CBN circular on the subject.
PROVISIONING FACILITIES
The guideline introduced the following types of provision for licensed banks: -
i. A general provision of 1% of risk assets is to be made for those credits considered performing.
ii. For facilities classified as sub-standard, doubtful or lost, interest overdue by more than 90 days should be suspended and recognized on cash bases only. Principal repayments that are overdue by more than 90 days should be fully provided for andrecognized on cash bases only.
iii. For Principal repayments not yet due — non performing activities provisions should be made as follows:
a. Sub-standard credit facilities: 10% of outstanding balance;
b. Doubtful credit facilities: 50% of outstanding balance; and Lost credit facilities: 100% of the outstanding balance.
c. For off-balance sheet item, the guidelines require full provisions to be made in respect of losses arising from such transactions. Their disclosure should be in note form as it should not form part of the balance sheet totals and should be distinguished between direct credit substitutes, transaction related contingencies and other contingencies.
d. As regards securities held for the credit facilities, provisioning should only take cognizance of releasable tangible facilities with perfected legal mortgages that are in the course of realization. Accordingly, securities values should be recognized on the following bases:
i. For credit exposure where the principal repayment is in arrears by more than six months, the outstanding unprovided principal should not exceed 50% of the estimated net realizable value of the collateral securities.
ii.
For credit exposure where the principal repayment is in
arrears by more than one year, there should be no outstanding unprovided
portion of the
credit facility irrespective of the estimated net realizable value of the
security held and for the credit exposure secured by abating charge or by an
unperfected or equitable charged over tangible security, it should be treated
as an unsecured credit and no account should be taken of such security held in
determining the provision for the loss to be made.
Essentially, the guideline requires the Ranks to recognizes revenues only when they are earned or realized and to make provision for losses as soon as they can be reasonably estimated. in addition, the guidelines demand that the licensed banks should automatically place all categories of non-performing credit facilities on the accrual status, that is to say, interest due on them should not be recognized while all interest previously accrued and uncollected but taken into revenue should be reversed and credited into suspense account. Before a non-performing facility can be reclassifies as performing, unpaid interest outstanding should not exceed 90 days.
THE COMPANIES AND ALLIED MATTERS DECREE (CAMDI 1990)
In Nigeria the Financial statements of Banks must comply with the requirements of the Companies and Allied Matters Decree under which Banks are incorporated. The statute specifies a number of information which are of interest to, and considerable importance for an understanding and interpretation of accounts by shareholders, lenders, depositors and other providers of funds, regulatory authorities, financial analysts and other users. Indeed, the need to provide users of accounts with additional information over and above the traditional balance sheet and profit and loss account is recognized under Section 334 of the Companies and Allied Matters Decree, 1990. The contents and form of balance sheet and profit and loss account to be published by every licensed bank shall comply with the provisions of section 28 of the CAMD, 1990 while the contents of the Auditors’ Report are contained in Section 29 of the Decree.
CONCLUSION
As we said earlier, the Legal Framework listed and discussed in this paper
is by no means definitive. In addition to the Acts and Decrees we have
considered, there are still a number of enactments which impact strongly on the
subject of banks inspection and auditing in the country. They include (inter
alia), the Securities & Exchange Commissions Acts, No. 29 of 1988, the
Cheques Act, Bill of Exchange Act, 1964. 1 urge you to find time to read
through this acts & decrees for better understanding of your work and to
enhance your knowledge generally.
It is obvious from our discussion that the Nigeria Banking Industry is
adequately provided with relevant enactment for the purpose of control and
stability of the system. Most existing sub-sectors of the Financial System are
provided with Apex Regulatory Institutions linked (as it were) to the Central
Bank of Nigeria which has superior statutory mandate for Banks’ supervision in
the country.
In recent years frequent reviews of our legal
framework have tended to narrow
down areas of subjectivity. It is therefore pertinent to say that, discounting
some gaps in the legal system, the observed instability in the system is
attributable largely to lack of will by the authorities to firmly enforce
penalties against the defaulters as provided by the Decrees/Acts rather than
inadequacy of such enactments. As Bank Inspectors/Auditors it behooves on you
to see the barrage of Laws, policies and guidelines set by Government for Banks
in positive ‘lights and to strive to ensure that the operators in your
institution comply strictly with those enactments in order to guarantee sanity
in the industry and stability to the general economy.
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