Impact Of Regulation And Supervision

Published Date: 02 Nov 2017

ABSTRACT

The study is an empirical analysis of the impact of regulation and supervision on the activities of financial institutions in Ghana with emphasis on the roles of the central bank (Bank of Ghana) and other regulatory bodies in the financial system. It evaluates the impact of government regulation of the banking industry in Ghana over the years in order to provide a framework for improvement in the process. Extensive field survey and library research was carried out and data collected were subjected to thorough analysis.

The analysis shows that the supervisory and regulatory framework of the Bank of Ghana and other regulatory bodies are not sufficient to guarantee effective banking practices in Ghana.

Other findings from the study include the need to increase the maximum insurance coverage due to the effect of inflation and the persistent fall in the value of the Cedi, the need to disclose transactions continuously to ensure financial prudence through regular supervision and monitoring of the financial health of local banks with the aid of the ‘CAMEL’ ratings and other supervisory framework.

There is need to also increase the awareness of banking activities within the general populace through a deliberate integration process aimed at demystifying certain inherent perceptions of the public with respect to the role of Bank of Ghana (BoG). Moreover, the public, investors and depositors were not fully aware of the activities of the central bank in liquidating and revocation of banks’ licenses due to the ineffectiveness of the enlightenment programmes used in carrying out the awareness.

A questionnaire and telephone based research was adopted for the study and the data collated was tested using the chi-square analysis and supported by fundamental evidence from the database of the regulatory authorities.

Finally, the study offered suggestions as to how the problems so identified could be ameliorated.

CHAPTER 1

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

Poorly functioning banking systems impede economic progress, exacerbate poverty, and destabilize economies. Specifically, a substantial literature documents that well-functioning banks accelerate economic growth, which in turn alleviates poverty. The banking sector in Ghana presents compelling opportunities for growth and development, fuelled by key reforms to rules and regulations which have in turn, encouraged new entrants to the sector and fuelled intense competition within the industry. The depth of importance of the sector to the economy cannot be underestimated – in 2000 the Asset to GDP ratio stood at 43.6 percent and by the end of 2008, the ratio had scaled upwards to 65.6 percent. Over the same period (2000‐2008), credit availability to the Private Sector saw a considerable expansion to 30 percent of GDP from 13 percent in 2000. Increasing banking competition has led to an extraordinary growth in branch network, leading to growths in deposits, which increased by 41% in 2008, albeit, down from the 45% recorded in 2007.

Bank of Ghana (BoG) is responsible for monetary policy of the country and also assists the Ministry of Finance to ensure economic stability. To this end it manages interest rates, inflation as well as exchange rates. The central bank, BoG is also responsible for the regulation and supervision of the Ghanaian banking system as well as other non banking financial institutions.

In Ghana, the financial service industry is categorized into three main sectors;

Banking and finance (including Non-Bank financial services and Forex Bureau)

Insurance

Financial market/ Capital markets

The operating institutions include both foreign and local major banks, Rural and Community Banks (RCB’s), savings and Loans Companies (SLC’s) and other finance and leasing companies.

This study provides a detailed and comprehensive analysis of how the central bank and other regulatory bodies in the financial system have fared in discharging their roles of supervision and regulation. Given the overall importance of banks in the economy, their supervision and regulation become imperative in order to ensure a stable and healthy financial system. Supervision entails, not only the enforcement of rules and regulations, but also some judgment regarding the quality of financial institutions’ assets, capital adequacy and management, while regulation involves the body of specific rules governing expected behaviors that limit or control the activities and business operations of financial institutions. The resultant close linkage between financial markets has in turn necessitated, among others, the development of financial derivatives, strong support for reducing counter party credit risk and a growing need to clarify laws and regulations regarding cross-border financial contracts. Banking Supervisors worldwide have consequently realized and recognized the need to harmonize laws, regulations, codes and standards in order to promote economic growth and international financial stability.

1.2 STATEMENT OF THE PROBLEM OF THE STUDY

The dynamic environment of today has made the banking industry in Ghana more robust. Considering the developments in information technology and the proliferation of financial markets, the fading distinction between banking and non-banking financial institutions and the competitive nature of the banks through product innovations, have fundamentally changed the landscape of financial services. Moreover, this competitive and dynamic environment may lead to an unstable financial system. Against this backdrop we need to evaluate what the government through the central bank and other regulators can do about financial instability. The key question is how to adapt the regulatory framework to this increasingly competitive environment of banking. In other words how do we regulate this identified target?

1.3 OBJECTIVES OF THE STUDY

The objective of this research work is to evaluate the impact of government regulation of the banking industry in Ghana over the years in order to provide a framework for improvement in the process. In view of this, the study intends to:

Analyze the banking system of Ghana

Evaluate the impact of the financial sector reform policies on banking in Ghana

Evaluate the effectiveness of the risk regulation in the banking industry

Investigate the comprehensiveness of bank regulation and supervision in Ghana

Provide pragmatic approach to improving banking supervision and regulation in Ghana.

1.4 SCOPE AND LIMITATION OF THE STUDY

The study will cover the operation of the regulatory authorities as it relates to the banking industry. Secondary, it provides an overview of government regulation of the banking industry with the analysis of the financial reforms of the industry basically being on banking system in Ghana, risk regulations and its effect on the performance of the banking industry with data support from 2008 to 2010.

The study is limited to the regulation and supervision of the banking sector. There would not be distribution and collection of questionnaires concerning the area of study for the research. Again few restricted protocol for interviews will limit the study.

1.5 SIGNIFICANCE OF THE STUDY

The regulation that characterizes banking determines that banks are considered different from other firms. Obviously, regulation has made them special. What makes bank different and special is that their failure posses a major threat to the economy.

Moreover, particular concerns are the linkages or networking between banks and not to mention the interbank balances (direct exposure). A crisis in one bank may lead to confident crisis in the banking sector as a whole emphasizing the importance of system risk.

The direct source of instability in banking is often associated with the banks’ role in providing liquidity to depositors, particularly the vulnerability to runs rooted in the withdrawal-upon-demand and sequential-service-constraint features of the deposit contract. The fear is that excessive withdrawals would force a bank to liquidate assets and thereby incur substantial liquidation costs that undermine the bank’s ability to honor its remaining deposits. The excessive withdrawals could be triggered by concern about the bank’s well being.

The potential vulnerability of deposit-funded banks to runs and the banking system’s vulnerability to panics are often used as motivation for regulation. Then, government regulation of the industry has not proved to be effective in safeguarding the depositors who bear the ultimate loss in a financial crisis. This necessitates for an evaluation of the regulation in order to suggest ways for improving it.

1.6 RESEARCH QUESTIONS AND HYPOTHESIS

1.6.1 Research Questions

The study would examine the following questions:

What are the justifications for banking industry regulation?

Have the regulatory authorities helped in controlling the monetary and fiscal inefficiencies of government policies?

Has the Ghanaian banking industry become safe, stable and command the confidence of the general public since the Banking Act 2004 (Act 673) replaced Act 2002 (Act 612) to strengthen the regulatory and supervisory functions of BoG?

Have the activities of banking supervisions brought about normal banking practice, professionalism and ethical conduct in the Ghanaian banking system?

As a liquidator, how effectively did BoG ensure orderly and efficient closure of failed banks with minimum disruption to the banking system?

Was proper screening of person(s) allowed to own and manage banks carried out by the regulators and if so how far has it fared in minimizing the incidence of abusive ownership and management?

Have banks and other financial institution brought about high standard of financial practice in Ghanaian banks?

What is the performance rating of regulatory authorities in preventing financial distress in Ghana?

Is the CAMEL framework useful in assessing performance of financial institutions in Ghana?

Is Universal banking the key to Ghanaian economic development and evolution of sound and healthy financial system?

1.6.2 Research Hypothesis

The supervisory and regulatory authorities play a significant role in the financial system of any economy through the promulgation of policies aimed at ensuring the prudent management of banks’ assets and liabilities and thereby guarantee the safety of depositors’ funds. They also promote compliance to safe and sound banking practices, encourage the institution of an efficient internal control system in individual money deposit banks in order to prevent the incidence of frauds, forgeries and other financial malpractices as well as ensure the stability and engendering of public confidence in the system.

This study will therefore test the following three hypotheses.

1.

H0. The supervisory and regulatory functions of the Central Bank (BoG) have been effective in curtailing distress in the Ghana banking system.

H1. The supervisory and regulatory functions of the Central Bank (BoG) have not been effective in curtailing distress in the Ghana banking system.

2.

H0. The Regulatory and Supervisory activities of the Central Bank (BoG) have boosted depositors’ confidence in the Banking System.

H1. The Regulatory and Supervisory activities of the Central Bank (BoG) have not boosted depositors’ confidence in the Banking System.

3.

H0. The supervisory and Regulatory activities of the Central Bank (BoG) have impacted positively on the pricing of banks’ products to their external customers.

H1. The supervisory and Regulatory activities of the Central Bank (BoG) have not impacted positively on the pricing of banks’ products to their external customers.

1.7 RESEARCH METHODOLOGY

The research work will make use of a case study research which is going to give an in-depth study of the research. The case study will also explore and give descriptive issues both in the present and in the past as they affect the banking industry and in which to look for the future by means of the recommendations made by the study. The estimation period for the analysis will cover 2008 through to 2010.

The collection of data for this study would be obtained mainly from secondary sources, particularly from Bank of Ghana (BoG) and the Ministry of Finance and Economic Planning publications. Literature review of published articles, relevant journals and financial newspapers as well as textbooks on financial market indicators in Ghana will also be obtained.

There will also be interview conductions of some key personalities in the financial sector concerning the study.

CHAPTER 2

LITERATUR REVIEW

2.1 INTRODUCTION

The banking system in any economy plays the important role of promoting economic growth and development through the process of financial intermediation. Development economists argue that the existence and evolution of financial institutions and markets constitute an important element in the process of economic growth. The banking system, in promoting economic growth, plays the following roles among many others:-

Improving the efficiency of resource mobilization by pooling individual savings;

Increasing the proportion of societal resources devoted to interest-yielding assets and long-term investments, which in turn facilitate economic growth. This relates to the savings function of banks and the pivotal role of savings is demonstrated by the fact that when it is in short supply in any nation, investment and the standard of living decline.

Providing a more efficient allocation of savings into investment than the individual savers can accomplish on their own. This flow of savings into investment ensures that more goods and services can be produced, thus increasing productivity and the nation’s standard of living.

Reducing the risks faced by firms in their production processes by providing liquidity and capital;

Enables investors to improve their portfolio diversification by providing insurance and project monitoring. Apart from providing insurance services as part of the practice of universal banking, banks have developed a number of products linked to specific insurance policies which are designed to offer protection against life, health, property and income risks. In addition to these, the banks have been used by businesses and private consumers to "self- insure" against risk; that is holdings of cash and other similar products are built up as protection against future losses.

Provides a veritable platform for an effective monetary policy implementation thereby enhancing the effective management of the economy. The banking system has been one of the channels through which government carries out its policy of stabilizing the economy and controlling inflation. Through the manipulation of certain key variables such as interest rates and the quantum of credit, government is able to influence borrowing and spending within the economy. These in turn affect employment, production and prices.

Facilitates a reliable payments system which provides support for the economy. In this regard, certain financial assets such as current accounts, deposit / savings accounts, domiciliary accounts etc, which serve as media of exchange for payments readily come to mind. Cheques, credit cards and electronic transfers are the principal means of payment today.

Provides credit. The banking system provides credit to finance investment and consumption.

2.2 INTRODUCTION TO BANKING SUPERVISION AND REGULATION

Regulation of banks has been defined by Llwellyn (1986) as a body of specific rules or agreed behaviour either imposed by government or other external agency or self imposed by explicit or implicit agreement within the industry that limits the activities and business operations of banks. In a nutshell, it is the codification of public policy towards banks to achieve a defined objective and/or act prudently. Banking regulation has two major components:

(i) the rules or agreed behaviours; and

(ii) the monitoring and scrutiny to determine safety and soundness and ensure compliance.

Supervision on the other hand, is the process of monitoring banks to ensure that they are carrying out their activities in a safe and sound manner and in accordance with laws, rules and regulations. It is a means of determining the financial condition and of ensuring compliance with laid down rules and regulations at any given time. Bench (1993) asserts that effective supervision of banks leads to a healthy banking industry.

Dimitri Vitas (1990) also believes that good regulation and supervision will minimise the negative impact of moral hazard and price shocks on the banking system, thereby leading to a reduction in bank failures and banking system distress. Traditionally, the role of banks whether in a developed or developing economy, consists of financial intermediation, provision of an efficient payments system and serving as a conduit for the implementation of monetary policies. It has been postulated that if these functions are efficiently carried out, the economy would be able to mobilize meaningful level of savings and channel these funds in an efficient and effective manner to ensure that no viable project is frustrated due to lack of funds.

In view of the importance of the banking sector in economic development and the imperfection of the market mechanism to mobilize and allocate financial resources to socially desirable economic activities of any nation, governments the world over, do regulate them more than any other sector in an economy.

This underscores the need for banking sector regulation. However, in addition, the nature of banking business (being highly geared and conducted with greater secrecy when compared with other real sector businesses) provides added reason for strict supervision. This is to constantly beam a search-light on the sector’s activities with a view to ensuring that operators play by the rules of the game and imbibe sound and safe banking practices.

Furthermore, such an oversight is intended to assist supervisory authorities in timely identification of deterioration in banks’ financial conditions before it degenerates to threaten the stability of the banking system or even the economy. This was the view of Donli J.G. (2003)

2.3 FINANCIAL SECTOR POLICIES ON BANKING IN GHANA

Extensive government intervention characterised financial sector policies in the post independence period. Public ownership dominated the banking system: all of the banks set up between the early 1950s and the late 1980s were wholly or majority owned by the public sector, while the government also acquired minority shares in the two already established foreign banks in the mid 1970s. Interest rates were administratively controlled by the Bank of Ghana (BoG) and a variety of controls were also imposed on the asset allocations of the banks, such as sectoral credit directives. The motivation for these policies was the belief that, because of market imperfections and the nature of the financial system inherited from the colonial period, the desired pattern of investment could not be supported without extensive government intervention in financial markets. Policies were motivated by three objectives: to raise the level of investment, to change the sectoral pattern of investment, and to keep interest rates both low and stable (Gockel, 1995, p117). Financial sector policies were characterised by severe financial repression, real interest rates were steeply negative and most of the credit was channelled to the public sector.

2.3.1 Establishment of public sector banks

The government established its own commercial and development banks for two reasons: the belief that the operational focus of the foreign commercial banks, in particular their lending policies, was too narrow, thus depriving large sections of the economy of access to credit, and, second, the contention that sectors important for development, such as industry and agriculture, required specialised financial institutions (FIs) to supply their financing needs. Dissatisfaction with the foreign banks focused on their conservative lending policies, modelled on those employed in the UK, and in particular their demands for the types of security (life insurance policies, stock certificates, bills, etc) which were uncommon in Ghana (Newlyn and Rowan, 1954, p82). The Ghana Commercial Bank (GCB) was set up in 1953 to improve the access to credit of indigenous businesses and farmers.2 It was also instructed to extend a branch network into rural areas, so that people in the rural areas would have access to banking facilities, and was heavily involved in lending to agriculture. GCB became the largest bank in Ghana: it had 36% of total bank deposits in the late 1980s.

The Social Security Bank (SSB), was set up in 1977. It grew rapidly to become the second largest bank in Ghana, with 18% of deposits in the late 1980s, providing credit, including longer term loans, for businesses and consumers. It also invested in the equity of several large businesses. Two smaller commercial banks began operations in 1975. The National Savings and Credit Bank (NSCB) - formerly the Post Office Savings Bank - and the Cooperative Bank: these were expected to provide consumer loans, credit for small industries and cooperatives. A merchant bank, Merchant Bank Ghana (MBG), was set up in 1972 as a joint venture between ANZ Grindlays, the government and public sector FIs, with the former having a 30% stake. To fill the perceived gaps not served by the commercial banks, especially for long term finance, three development finance institutions (DFIs) were set up: the National Investment Bank (NIB), in 1963, to provide long term finance for industry; the Agricultural Development Bank (ADB) in 1965;4 and the Bank for Housing and Construction (BHC), in 1974, to provide loans for housing, industrial construction and companies producing building materials. The DFIs mobilised funds from deposits as well as from government and foreign loans and undertook commercial banking activities as well as development banking. The government did not nationalise the two foreign owned banks - Barclays Bank and Standard Chartered Bank (SCB) - which had been established in Ghana during the colonial period, but it did acquire 40% equity stakes in the banks following an indigenisation decree enacted in 1975 (which was applied to all large scale industries).

2.3.2 Interest Rate Policy

The BoG determined the structure of bank interest rates, including minimum interest rates for deposits and maximum lending rates. Priority sectors, such as agriculture, received preferential lending rates: in some cases these were lower than the minimum savings deposit rates. The structure of interest rates set by the BoG made no allowance for loan maturity or risk; indeed incentives for banks to extend credit were often perverse because riskier sectors such as agriculture were accorded a preferential rate. Nominal interest rates were held below prevailing inflation rates in most years and, when inflation accelerated in the second half of the 1970s and early 1980s, real interest rates were highly negative (see table 1).

2.3. 3 Credit Controls

Sectoral credit guidelines, based on an annual credit plan drawn up by the BoG, were imposed on the banks to channel credit towards the priority sectors of agriculture, manufacturing and exports: these usually took the form of maximum permitted percentage increases in the stock of loans to each sector, with priority sectors accorded larger increases than non priority sectors. The sectoral credit directives appear not to have been strictly enforced. Since 1981 an additional regulation stipulated that lending to agriculture should comprise a minimum of 20% of total loans, with shortfalls to be transferred to the ADB. Foreign companies were required to obtain BoG permission to access loans from domestic banks.

2.3.4 Demonetization exercises and anti fraud measures

A series of measures taken by the government during the late 1970s and early 1980s further eroded public confidence in the holding of currency and bank deposits. The most drastic were two currency appropriations in 1979 and 1982, initiated in an attempt to reduce the money supply and therefore inflation, but the public were also discouraged from holding bank deposits by a number of measures aimed at countering fraud. Banks were ordered in 1979 to furnish information to the authorities about customers at the authorities’ request. In 1982 accounts in excess of C50,000 were frozen pending investigation for fraud or tax liabilities, bank loans for the financing of trade inventories were recalled and compulsory payment by cheque was introduced for business transactions in excess of C1000.

2.3.5 Prudential Regulation and Supervision

The 1970 Banking Act provided the regulatory framework for the banking industry. This imposed minimum paid up capital requirements for foreign and locally owned banks of C2 million and C0.5 million respectively (the latter was subsequently raised to C0.75 million). The minimum capital requirements were worth very little by the early 1980s because of inflation. At the end of 1983, the minimum paid up capital for a local bank was equivalent to only $16,000.

Banks were also required to maintain capital and reserves of at least 5% of their total deposits (rather than risk assets which would be more relevant as an insurance against insolvency).

The capital adequacy requirements were in any case largely meaningless because of the absence of clear accounting rules regarding the recognition of loan losses, provisioning for non performing assets and the accrual of unpaid interest. The true state of banks’ balance sheets, including the erosion of their capital as a result of loan losses, could therefore be concealed. Although the Banking Act did provide some rules to constrain imprudent behaviour by banks, penalties for infractions were minimal. There were also important regulatory omissions, such as limits on single borrower loan exposures. A Bank Examination Department (BED) was established in the BoG in 1964 but its activities were largely confined to ensuring that banks complied with allocative and monetary policy directives, such as sectoral credit directives, and reserve requirements, rather than prudential regulations. The BED also lacked adequate resources to monitor and inspect the banks. In the early 1980s it had only five professional staff, of which only two had any training in bank supervision. On site examinations were infrequent and off site supervision was impeded because of deficiencies in bank reporting (ie the submission of financial data by the banks to the BoG). Hence the BED lacked the information necessary to evaluate the condition of banks’ asset portfolios, their profitability and solvency (World Bank, 1986, p65).

2.4 THE OBJECTIVES FOR BANKING SUPERVISION AND REGULATION

Banks worldwide are more regulated than other institutions because of their roles as financial intermediaries. As financial intermediaries, banks mobilise funds from the surplus spending units at a cost for on lending of such funds to the deficit spending units at a price both within and outside the shores of a country. In discharging their financial intermediating role, it is the responsibility of banks to ensure that the funds mobilised could be accessed by the depositors as when needed. While in their care, the mobilized funds are advanced as loans and advances at a price to be repaid along with the principal loan. The spread between the cost of funds and the price of the loans granted in this manner is the singular most important source of income for banks. Banks also provide an efficient payment mechanism in the economy. They provide mooth and efficient system for making payment to settle both business and personal transactions, and international financial obligations on behalf of their customers. Thus, savings are stimulated for investment in the economy by banks. The weight of evidence is that banks in the process of intermediation contribute significantly to real economic development. According to Schumpeter (1934), banks are necessary condition for economic development. This proposition has been supported by several later scholars including Goldsmith (1969) and Cameron et al (1972). Empirical evidence also suggests that there is a positive correlation between real growth of output, investment, bank assets and money supply. Growth in the banking sector when well transmitted would result in the growth of the real sector. The opposite is also possible if the banking sector is repressed and inefficient. It is in recognition of this that John B.Heimann, founding Chairman of Financial Stability Institute (FSI) in June 2001 asserted that "the prosperity and strength of any economy relies heavily upon the proper and prudent functioning of the country’s system of financial intermediation. If the financial system is strong, the economy has the ability to grow and the strength to absorb shocks. But if the financial system is weak, it acts as a magnifier of problems, rather than a shock absorber.

In performing their various functions, banks are expected to ensure prudent management of assets and guarantee the safety of depositors’ funds. They are expected to adhere strictly to safe and sound banking practices, maintain adequate internal control measures to prevent incidences of fraud, forgery and other financial malpractices, to ensure stability and engender public confidence in the system. The proper management of banks is therefore a pre-requisite for economic prosperity in any country as the vehicle for the implementation of monetary policy. Indeed, the contributions of banks to the development of the economy depend on the quantity and quality of their services and the efficiency with which these services are provided. Here lies the concern of the Regulatory Authorities and hence the "raison detre" for intensive banking regulation and supervision.

The objectives of banking regulation and supervision were advanced by Giddy (1984) as for monetary policy, i.e. the ability of banks to create money through the extension of credit; credit allocation function of banks; the need to ensure competition and innovation by the prevention of cartels; and because banks are depositories of public savings and managers of payments mechanism, they are very vulnerable to collapse. The protection of depositors has come to be generally accepted as the most basic reason for banking regulation and supervision. This objective is hinged on the fact that bank depositors have difficulty protecting their interests when compared to other bank creditors and investors. On his part, Sheng (1990) stated the objectives of supervision as: promotion and development of sound and wide range of financial services to meet the needs of the economy; ensuring efficiency, security and responsiveness of banks to the needs and complaints of customers; ensuring compliance with laid-down rules and regulations which are germane to ensuring high standards of banking; and to achieve important developmental and social goals through their compliance with monetary and credit allocation policies. Sinkey J. R. (1989) states the goals of regulation as:

The protection of depositors;

The protection of the economy from the vagaries of the banking system; and

The protection of banks’ customers from the monopolistic power of banks.

Dale (1986) had classified prudential regulation of banks into three: preventive, protective and supportive. While preventive regulation is designed to limit the risk undertaken, the protective regulation offers protection in the event of failure. The supportive regulation is in form of a lender of last resort. In both developed and developing economies, the banking industry determines the financial services available to the economies. Hence, regulation is necessary to break this monopolistic power and prevent abuse. Moreover, in developing economies, banks play their traditional intermediation roles as well as being used as a vehicle for achieving developmental and social goals. Banks in third world countries have to develop indigenous entrepreneurs by channelling credits for their use. As a result of this, the World Bank (1989) noted that banks in these economies have to be regulated to ensure that they play their proper role in economic development. In a nutshell, the rationale for bank regulation and supervision can be summarised as follows:

Efficiency,

Diversity of choice,

Competition,

Stability of banking system,

Macroeconomic stability, and

Developmental and social objectives.

2.5 APPROACHES TO BANKING REGULATION AND SUPERVISION

The four approaches to banking regulation are standard and are applicable in all jurisdictions although with some variations here and there. A highlight of each of them is given below.

The first approach relates to information disclosure which is of two types. The disclosure to the general public through the announcement of operating results and full disclosure to bank supervisors where public disclosure may not be necessary in order to protect the clients’ secrecy. Information disclosure by banks is basically designed to ensure that supervisors, depositors, investors and the general public are adequately informed of bank’s performance/condition. The enforcement of adequate disclosure is paramount. The level of disclosure and timing of information to the various stakeholders should be articulated for banks to comply as a routine. This is an issue in Pillar III (Market Discipline) of the New Capital Accord.

The second approach is self regulation through the use of internal audit and controls, external audit and board audit committee. Self regulation involves the various independent checks and reviews put in place by the bank itself to ensure that its sound procedures do not deteriorate. Self regulation and self discipline are supposed to be more effective than regulation by a government agency because it is based on the conviction of self. It is also developed from industry norms; hence the stigma of non-compliance with peers and competitors are enough to encourage compliance. Basically in all banks, the primary responsibilities for safety and soundness, and prevention and detection of frauds and errors rest with the bank management. Self regulation which is yet to be imbibed in emerging markets works in developed countries where market leaders impose market discipline. Self regulation normally fails due to competition or when market leaders themselves are weak. At such periods, self regulation becomes ineffective; indecision and self interest become a determinant.

The third approach is through banking supervision which is in two forms. The on-site examination is to ascertain the financial condition of a bank. It also aims at verifying the accuracy of the periodic reports of the banks sent to the Regulatory Authorities, analysing those aspects of a bank that cannot be adequately monitored through off-site surveillance and confirming and ensuring compliance with laid down laws, rules and regulations. On-site examiners assess the quality of assets, management, earnings, capital and funds management as well as accounting and internal control systems. The second form is off-site surveillance. The returns of banks to the Regulatory Authorities are analysed by off-site supervisors for completeness, accuracy and consistency as well as compliance with prudential ratios and regulations. Regulatory Authorities, mainly in emerging markets, which do not have adequate resources rely more on off-site supervision to monitor the financial condition and performance of banks and to identify those banks that may need closer scrutiny. It is an irony of fate that where on-site examination should be emphasized due to low integrity of information from banks, resource constraints make such Regulatory Authorities to rely on off-site supervision. It is useful to add that on-site examination has been found to be more effective than off-site supervision in many jurisdictions due mainly to unreliable information that many banks do send to the Regulatory Authorities.

Finally, deposit insurance scheme is a financial guarantee scheme which seeks to protect depositors’ fund against losses associated with bank failures. The scheme promotes a safe, sound and stable banking system. As a means to curtail moral hazard that deposit insurance could engender, the insured limit is always set at a low amount to ensure adequate protection of small savers for which the scheme is primarily designed. It is therefore, necessary for Regulatory Authorities to set up effective monitoring systems and increase punitive measures against the abuses in the system.

2.6 BANKING SUPERVISION AND REGULATORY STRUCTURES

It has been said that there is no theoretically optimal system or standard blueprint of what constitutes the best structure of banking system regulation and supervision (Bank for International Settlement, 2000). Factors like differences in political structures, general complexity and state of development of the financial systems; the nature and extent of public disclosure of banks’ financial positions; level of market discipline; the availability and robustness of information technology; and the capacities of the regulator(s) dictate(s) regulatory and supervisory approaches world-wide.

The Basel Committee on Banking Supervision in 1997 came out with an implicit framework for the regulation and supervision of banks code-named, The Core Principles for Effective Banking Supervision. The framework can be interpreted as comprising four distinct yet complementary sets of arrangements:

Legal and institutional arrangements for the formulation and implementation of public policy with respect to the financial sector, and the banking system in particular;

Regulatory arrangements regarding the formulation of laws, policies, prescriptions, guidelines or directives applicable to banking institutions (e.g. entry requirements, capital requirements, accounting and disclosure provisions, risk management guidelines);

Supervisory arrangements with respect to the implementation of the banking regulations and the monitoring and policing of their application; and

Safety net arrangements providing a framework for the handling of liquidity and solvency difficulties that can affect individual banking institutions or the banking system as a whole and for the sharing of financial losses that can occur (e.g. deposit insurance scheme or winding-up procedures).

With respect to the supervisory arrangements, the Core Principles describe what could be termed a "cradle to grave" approach covering the licensing of individual banks, the process of ongoing supervision and mechanisms for taking prompt corrective actions in case institutions do not meet regulatory or supervisory requirements (the latter would also include exit arrangements for institutions facing serious losses or default and possibly resulting in the activation of safety net arrangements). The overall objective of this comprehensive process of supervision is to guarantee that banks can be established, operated and restructured in a safe, transparent and efficient manner.

Interestingly the Basel Committee has continued to facilitate collegial approach to cross border supervision through co-operation and resource input in response to the increasing globalization of the financial systems, which raised concerns for standards and competence of regulators worldwide. Such concerns have often been met by agreement on conduct, codes or principles. Consequently, regulatory standards by the Basel Committee on such thresholds like capital adequacy are often adopted at the minimum.

2.7 DEFINITION OF TERMS

Financial Intermediation: Financial Intermediation is the mobilization of funds from the surplus spending units at a cost or lending of such funds to the deficit spending units at a price both within and outside the shore of a country.

Bank regulation: A body of specific rules or agreed behaviour either imposed by some government or other external agency, or self-imposed by explicit or implicit agreement within the industry that limits the activities and business operations of financial institutions e.g. BoG.

Bank supervision: Is the process of monitoring banks to ensure that they are carrying out their activities in accordance with laws, rules and regulations, and in a safe and sound manner.

Stable banking system: A stable banking system means that banks have the ability and capacity to meet maturing obligations as they fall due, and are making adequate profits from authorized banking business to justify their investment while at the same time keeping banking failures at a minimum within the country.

Prudential guidelines: Is a body of specific rules imposed by government through the Central bank aimed at ensuring prudent management and administration of banks’ funds so that reports of financial institutions are correct and reflective of their true portfolio.

Deposit insurance scheme: Is primarily intended to promote stability of the financial system and to protect the less financially sophisticated depositor by minimizing the risk that depositors will suffer, lender of last resort, effective bank regulation and supervision and efficient payment system.

Financial stability form (FSF): This states that a deposit insurance system needs to be supported by strong prudential regulation and supervision, sound accounting and the enforcement of effective law.