Chris. O. Itsede


Attempts to restructure the banking sector in many countries have led to the realization that for any meaningful bank restructuring to take place, there must be successful macroeconomic reforms. In the same vein, restructuring a distressed banking sector has been recognized as a significant variable in any macroeconomic reform model. Here lies the dilemma faced by policy-makers: should macroeconomic reforms be launched before restructuring a distressed banking sector or vice versa? Or should the two be implemented simultaneously?

This knotty issue requires a resolution as the possibility of implementing macroeconomic reforms against the backdrop of a distressed banking sector may be illusory. The same can be said of restructuring a distressed banking sector in a depressed and unstable economy.

The uniqueness of the banking sector arises from the strategic role bank play in the process of economic development. By their very nature, banks play a catalytic role in the economy, pool financial resources which are held in atomistic sizes from individual economic agents and energize them to into productive assets through the granting of credit to borrowers. They provide a sound and efficient payments mechanism for domestic and international transactions. In addition to these traditional functions, banks also play what has been described as developmental roles especially in sub-saharan African (SSA) countries.

Capital is widely recognized in development theory as necessary, though not sufficient, condition for economic growth. this is particularly so in a developing economy where it is believed that the provision of adequate financial resources is a pre-requisite for economic transformation. Many economists have shown that finance is critical for real economic development. Adelman and Morris (1967) found that financial development is associated fairly closely with observed differences in the level and the rate of growth of real national product per head when compared with other 13 variables examined. For Goldsmith (1969), financial superstructure in the form of both primary and secondary securities, accelerates economic performance to the extent that it facilitates the migration of funds to the best user. That is to say, the sectors of the economy where the funds would yield the highest rate of social return. This has been corroborate by the finding of Gurley and Shaw (1976) that as countries rise along the scale of wealth and income, they become increasingly rich in financial assets, institutions and markets. The banking sector is central and is in fact, the hub of the financial system particularly in developing countries where the capital market is shallow and narrow.

The rest of the paper discusses these issues under six major sections. Part 1 discusses the implications of bank distress and macroeconomic instability. Part 2 examines the consequences of macroeconomic instability for bank instability. Some experiences with structural reforms are discussed in Part 3. Key elements of macroeconomic reforms and sequencing of policy measures are examined in Part 4 and 5. In the last par are presented a number of recommendations and conclusion.


For different reasons, various interest groups, including governments, regulators, and bank operators, and the banking public have cause for worry or concern over bank failures. Governments are particularly concerned in view of the social, political and economic ramifications of bank distress. The diseconomies associated with a failing bank makes it particularly distasteful and of serious macroeconomic implications unlike what obtains when a non-bank institution crumbles. For example, if a brewery company goes under, its demise would not adversely affect other brewery firms. From a competitive point of view, the surviving firms should benefit by way of increased patronage and sale volume. However, when a bank fails, the initial sound and echo are heard loud and clear beyond the precincts of the banking system.

According to Glaessner and Mas (1995), there are three characteristics which distinguish banks from non-bank institutions and create or reinforce the incentives to handle their failure more promptly and effectively. These include (a) a liability structure characterized by deposits withdrawable on demand, (b) substantial leverage as measured by total liabilities, (c) substantial leverage as measured by total liabilities (including debts and deposit contracts) relative to the value of the institution’s own capital; and (d) a smaller proportion of non-marketable assets than most non-bank companies.

In addition, there is the real or perceived threat of contagion effects across banks and the potential for high macroeconomic costs resulting bank distress which have often led governments to adopt a safety net to prevent or minimize these outcomes (Glaessner and Mas, 1995).

Erosion of Public Confidence in the Banking System

About the greatest havoc which bank distress wreaks on the public psyche is the erosion of confidence in the system, especially if urgent steps are not taken to find lasting remedies to the problem. Banking is built on trust and confidence. Once trust and confidence are compromised, the basis for the relationship between the bank and its customers is impaired. It easily leads to panic and runs on other healthy banks. In the absence of a deposit insurance scheme or other safety net, the stage is set for a systematic collapse.

A major manifestation of the loss of public confidence and consequent bank runs is massive demonetization of the economy. This takes the form of massive portfolio shifts as sophisticated depositors seek relatively safer assets such as government securities and non-monetary assets, foreign currencies, as well as capital flight. The bulk of the banking public that would not be able to participate in the “flight to safety” would have no place to hide. As it is the government’s responsibility to protect the vulnerable segment of the banking public, political pressure builds up for government to tackle the crisis.

Demonetization in itself is deleterious to the development of a sound banking culture. In an economic environment characterized by low saving ratio, this could aggravate the problem of mobilization of resources for development programmes. This is particularly true of sub-saharan African countries with poor banking culture. For instance, in Nigeria, currency outside banks, as a ratio of narrow money supply, rose sharply from 42.3 percent in 1987 before the official identification of distressed banks to 57.4 percent in 1995, when 60 out of the 115 banks, were identified to be at various stages of distress by the monetary authorities.

On the supply side, widespread distress in the banking sector is a signal to new investors to look for safer havens for their investible funds. Depending on the gravity of the crisis, existing investors may actually divest from the sector. This state of affairs is compounded by low profitability for the remaining banks as loss of public confidence in them jeopardize their patronage and earnings.

Economic Effect

Banks are the link between the money and product markets and form the hub of an efficient and effective payments system in any economy. Generalized distress in the industry renders the payments system perilous, risky and greatly undermines the role of the financial services industry.

The inability of banks to perform their main role of financial intermediation has serious adverse, even if unintended repercussions on the real sector of the economy. Banks are main artery through which monetary policy is transmitted through the economy. Widespread bank failures do compromise the efficacy of sudden contraction in money supply. This usually has serious adverse implications for macroeconomic stability. Economists, whether of the monetarist or fiscalist school of thought, agree that the level of money supply has a positive correlation with the volume of activities in the economy.

The credit rating of an economy afflicted with generalized bank distress, takes a beating from the perception of the international financial community. In most cases, the international financial community, with the exception of the high risk lovers and those who may be engaged in fraudulent transactions, would shy away from a country with a distress banking system. This also discourages the inflow of foreign investments and capital while encouraging capital flight from the country.

Failed banks in a country suffering from systematic distress in the financial sector would be disabled from extending new credit. The healthy banks would equally be constrained from granting credit for the fear of such facilities becoming delinquent. If phenomenon dubbed by Onimode (1996) as a “casino” economy. The effect of these would be to crowd out the real sector of the economy from the credit market. Yet the productive sectors must be galvanized for macroeconomic stability to materialize.

For banks to successfully play their role in the economy, the macroeconomic framework has to be right. In the same vein, a distressed banking sector must be revived and made healthy for it to be able to contribute to macroeconomic stability.


An economy characterized by high inflation and in some cases stagflation, low and unstable value of the domestic currency, large fiscal deficits mostly financed by the central bank, heavy external debt overhang, high unemployment and slow growth is certainly not a credible candidate for a safe and sound banking system. Empirical evidence has shown that the economic environment in which a bank operates impacts on its health or ill-health. In a volatile economic environment, the assumptions on which loans and investments are made may be invalidated and this may pose serious problems for repayment.

Such macroeconomic instability has been known to cause portfolio problems for banks, thus leading to their collapse. This situation can be aggravated due to asymmetric information (Mishkin 1996) a situation whereby a borrower taking out the investment project than the bank lending the money. This problem of asymmetric information is often rampant in an unstable economy as loans are likely to be extended for risky projects and borrowers may have incentives to misallocate borrowed funds for personal use or invest them in unprofitable projects. In some cases, borrowers have been known to contract loans with the intention of not repaying from the outset.

Government economic policy inconsistency and unpredictability can tell seriously on the health of a bank especially if the policy shifts have adverse impact on the prosperity of bank customers, and impair their ability to service their loans. A prolonged recession or depression could severely curtail the ability of borrowers to repay their loans owing to a fall in income and output. The collapse in economic activity and the deterioration in the cash flow and balance sheets of firms and households automatically result in an exacerbate of the banking crisis (Mishkin 1996). Such scenario is often characterized by low effective demand, burgeoning inventory and non-performing assets or loans. In the circumstance, banks come under severe financial distress arising from classified loans.

Many sub-saharan African (SSA) countries that embarked on macroeconomic adjustment have found the value of their currency, transiting from a state of overvaluation to that of under-valuation is some cases. As the dependence ration of most SSA countries is very high, a depreciation of their currency invariably leads to high costs of production and reduced capacity utilization. In the absence of countervailing measures, the pervasive effects of the exchange rate depreciation would tend to adversely affect many economic units which may find it difficult to service their loans. This has led many banks to go under. Private savings are stimulated by stable and predictable macroeconomic policies, especially in relation to interest rate policies. In strengthening domestic financial institutions, the significant influence of appropriate macroeconomic policies cannot be over looked. As the World Bank (1988) has stressed, it is virtually impossible to have a good project in bad policy environment.


The transition from economic repression to liberalization usually calls for the adoption of an economic reform package. In Nigeria, the Structural Adjustment Programme (SAP) was introduced in July, 1986 to restructure and diversify the productive base of the economy in order to lessen dependence on the oil sector and on imports. Other objectives of SAP were to reduce the dominance of unproductive investments in the public sector; to improve the sectors’ efficiency and to intensify the growth potential of the private sector. The main elements of the programme included evolving a realistic exchange rate policy for the naira; further rationalization and restructuring of the tariff regime, liberalization of the trade and payment system and reduction of complex administrative controls.

Also See:  Bank Distress in Gambia

By and large, the contents of the SAP embarked upon by SSA countries have not differed markedly as they were all virtually packaged by the Bretton Woods Institutions. For example, the Economic Recovery Programme (ERP) of Ghana which commenced in 1983 had identical policies and objectives as those adopted under SAP in Nigeria some three years after. One notable difference between the two programmes, however, was the absence of bank restructuring in the Nigerian programme whereas it was an important element of ERP in Ghana. This was perhaps due to the fact that bank distress was not an issue when SAP was put in place in Nigeria in contradistinction to the situation in Ghana where most of the banks were distressed prior to the introduction of macroeconomic reforms.

At the inception of ERP in Ghana, all the eleven (11) commercial banks (9 owned by government and 2 foreign-owned) in the country were distressed. The healthy bank in operation was the only merchant bank in the country with 70 percent and 30 percent government and foreign ownership respectively. As part of the bank restructuring embodied in the financial liberalization programme, holding actions were imposed and the accounting standards improved upon. Foreign management was sourced for the distressed banks and the Non-Performing Assets Recovery Trust (NPART) which has a legal status too over the bad assets for recovery. The banks issued bonds up to the amount of bad loans taken over and it was financed by facility provided by the World Bank and other foreign donors. The bank restructuring measure in Ghana was successful to the extent that there were no bank runs and public confidence was sustained. A good degree of success was also recorded in macroeconomic reforms. For example, inflation rate plummeted from over 100 percent before the reforms to about 15 percent two years into the economic recovery programme.

Attention has been drawn to this here to show the distinction in liberalization and restructuring of the banking industry. Liberalization can commence without restructuring as witnessed in several countries which embarked on the two simultaneously.

In Nigeria, a major drawback to financial deregulation in the phenomenon of high interest rates which posed solvency problems both for the private sector borrowers and the banks themselves due to growing incidence of classified assets. In a situation of high interest rate, microenterprises often suffer because banks doubt their ability to sell enough to service their loans (Steel and Webster, 1992).


Since the mid-1980s, many countries in SSA including Cote d’Ivoire, Ghana, Guinea, Madagascar, Mozambique, Nigeria, Tanzania and Uganda have launched macroeconomic reforms principally to stimulate the private sector and yield greater space to market forces in the national economic arena. The overall objective is to promote structural changes that support sustainable long-term growth.

After almost two decades of adjustment efforts in SSA, experience has shown that a successful adjustment programme should encompass some basic ingredients.

First, the need for ownership of an adjustment programme has been recognized as vital to successful implementation of an economic reform program. A “home-grown” economic reform programme is more likely to reflect local conditions and reality than an “off-the-shelf” programme designed off-shore and usually for general application by different countries. Furthermore, building a political consensus around an endogenously determined reform programme would be relatively easier since various interest groups would have been consulted.

Second, adjustment with growth would be difficult to achieve in an economy buffeted by high inflation and balance of payment crisis. Yet, a successful adjustment programme must of necessity encompass a stabilization effort if fiscal viability must be restored. The bottom line is to ensure that the reduction in public expenditure does not include investment that are growth enhancing and projects that benefit the vulnerable segment of the population.

Third, to be successful, an adjustment programme must achieve appropriate macroeconomic balance and also raise the level of output of existing factors of production. Empirical evidence has shown that distortions in factor and commodity prices, insufficient public sector enterprises and inappropriate incentives often cripple output and thwart the sprouting of a vibrant export sector. Eliminating these growth unfriendly conditions is a sine qua non of an adjustment effort.

Fourth, financing the higher level of investment needed to achieve durable growth calls for both increased domestic savings and inflow of additional resources from the external sector. This is where the role of direct foreign investment is thrust into bold belief. Even the most heroic adjustment efforts of the developing countries will not achieve the desired result without the crucial support of the international community. in addition to providing additional finance for sustainable growth, the international community needs to lower international interest rates, establish stable exchange arrangements and roll-back the frontiers for protectionism. Market access would facilitate large scale production which in turn permits the enjoyment of economies of scale which have been shown to be significant in the growth process (Rostow, 1960). It is also in this context that access to export markets can be an important determinant of growth.


Since resource allocation depends on expectations about prices, the credibility of any reform programme is of vital importance. This throws up the question of how quickly the particular reforms should be implemented? For instance, should interest rates be uncapped at once or gradually? Should price control in agriculture be dismantled in one fell swoop or progressively? What is the optimum time frame for liberalizing interest rate on current account? There are no clear-cut questions. Yet it is pertinent to bear in mind that economic reform is not an end in itself. Rather, it is a means to launching the economy into a trajectory of sustainable growth through a more judicious use of existing resources. The larger the original disequilibrium and the faster the intended speed of adjustment, the greater the transitional costs and the higher the risk of public resentment of the reform effort. A reform effort that ignores the pace at which adjustment to the reforms can reasonably be expected to take place stands a good chance of failure and is also capable of undermining the credibility of future reforms efforts. Whatever the initial conditions, it is advantageous to undertake a reform package within a reasonably paced time frame, bearing in mind that the desired resource reallocation will not take place if the signal is neither strong enough nor gives a clear direction to make the reform credible. For instance, an unduly slow pace of reforms will discourage the development of export activities and alienate interest groups whose support for the reforms would be necessary in order to counter the antagonism of vested interests (Papageorgiou, et al 1986).

In the specific case of financial sector reform, the speed of deregulation of financial markets also needs to take cognizance of initial conditions. For instance, if deregulation has led banks to build up a portfolio largely made up of assets held at below market rates, and if real lending rates are substantially negative, deregulation of interest rates will pose problems for the banking sector (Michalopoulos, 1987). If deposit and lending rates are deregulated simultaneously even as new entrants come into the market, existing financial intermediaries will be forced to pay market rates and this may cause them substantial capital losses. Such a development could jeopardize the smooth functioning of the financial system. This therefore supports case for a phased programme in which lending and interest rates would be deregulated one after another.

On the external sector, an economic reform programme must seek to accomplish a number of tasks including an appropriate and stable exchange rate, and a sustainable balance of payments positions. Fiscal policy must also be designed to restore fiscal viability, ensuring that fiscal deficit is compatible with the domestic credit expansion and the quantum of available external financing. At the same time, there should be adequate safeguards to ensure that the proportion of the deficit that is financed from the domestic capital market does not crowd out the private sector.


In the light of the foregoing, effective macro-economic reforms and bank distress resolution call for the following:

  • A strong political will,
  • The need to popularize the reforms,
  • Elimination of unsustainable level of fiscal deficits,
  • Executive capacity building
  • Provision of appropriate legal framework, and
  • Bank restructuring

It is human nature to resist any major change from the status quo. This particularly so in the case of macroeconomic reforms and bank restructuring where the response can be painful and slow. Since most reform efforts are dogged by high level of inflation, at least in the short run, the tendency is for the public to mount pressure on government to discontinue them. This underscores the need for a strong political will and commitment on the part of the government of any country that wants to implement a successful economic reform programme.

The government should also demonstrate sincere and active efforts to sell reforms to the public and economic agents in the country. the benefits of a reform programme should be made known well in advance and plans for mitigating its adverse effects especially on the vulnerable majority should be made explicit to curry public support for it. Most importantly, the government should have the will to persist with a reform programme long enough for its fruits to ripen.

With regards to fiscal operations, the government must refrain from financing its fiscal deficits at negative real interest rates. This is because for a successful macroeconomic adjustment where healthy banking would be the order of the day, there should be a healthy competition between the public and private sector in the acquisition of scarce resources for investment. This calls for the widening and deepening of the financial markets.

Following from the above, institutional development is imperative for meaningful economic reform which also entails bank restructuring. Ideally, this should precede policy development.

The importance of high quality personnel in the government, regulatory institutions and banks cannot be over-emphasized. The programmes for economic recovery and bank restructuring require the services of capable and knowledgeable administrators and managers. The regulatory agencies are sometimes handicapped be paucity of trained manpower to cope with the growth and complexity of the financial system. One of the first towards a sustainable effective economic management is the development of critical mass of trained personnel to man core areas of macroeconomic and financial policy formulation and implementation.

Relevant legislation should be reviewed with the view to creating an investment friendly environment which would intra alia, facilitate the free entry and exit of enterprises. Nevertheless, the regulatory framework should be strengthened to deal with “professional borrowers” and streamline the process of foreclosures on loan collaterals.

If for sound economic or public reasons some ailing banks have to be bailed out, their management should be changed as leaving them would amount to what the World Bank (1989) described as asking monkeys to watch over bananas. Government should resist the temptation of throwing good money after bad money while providing financial assistance to revive ailing institutions.

On a strong and final note, bank restructuring needs to be undertaken alongside macroeconomic reforms. Experience of some countries that attempted bank restructuring in an unstable economy showed that they suffered destabilizing capital flight, high interest rates and corporate distress (World Bank, 1989). In the same vein, macroeconomic reform cannot succeed unless it is accomplished by the restructuring of insolvent banks and firms. In order to ensure the success of these measures, there is need for strong political will and commitment on the part of government.

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