Overview of Deposit Insurance
System & Banking Supervision
(Onsite & Offsite)
By
S. A. Oluyemi, PhD, FCA
Director,
Research Policy and International Relations
Department (NDIC)
Presented at The NDIC Onsite Examination Training
for Ghana Deposit Protection Corporation (GDPC)
Outline
Introduction
Rationale for establishing a DIS
DIS Public Policy Objective
Objectives of Banking Supervision and Prudential
Regulation
Banking Supervision Methodology
(Onsite & Offsite)
Summary
INTRODUCTION
 One of the interventions of Government in managing the
antecedent effects of bank failures to the economy of any country
in the world is through Deposit Insurance.
 Deposit insurance has been defined as a financial guarantee to
protect depositors in the event of a bank failure and also to offer a
measure of safety for the banking system
 Countries face a choice between explicit (defined with specific
mandate) and implicit (at government discretion) deposit
insurance systems.
 On of such mandates of the explicit DIS is Bank supervision.
 Bank Supervision is a statutory function, performed by a
specialised agency, that entails monitoring of commercial banks
and other banking institutions for compliance with applicable rules,
seeks to reduce the potential risk of failure and ensures that
unsafe and unsound banking practices do not go unchecked.
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RATIONALE FOR ESTABLISHING DIS IN
NIGERIA
The decision by the Federal government of Nigeria to
establish the NDIC was informed by a number of
factors.
These included:
–the country’s past bitter experience of bank failures
–the lessons of other countries’ experiences with deposit
insurance schemes, banking competition
–the need for effective supervision/prudential regulation
–change in government bank support policy.
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RATIONALE FOR ESTABLISHING DIS IN
NIGERIA
Lessons of History: Bank Failures in Nigeria
 The period between 1947 and 1952 witnessed a rapid growth of
indigenous banks in Nigeria.
 This was before the establishment of the Central Bank of Nigeria in
1958, which commenced operations in 1959.
 The increase in the number of indigenous banks was followed also
by a high rate of failures of such banks.
 By 1954, twenty-one (21) out of twenty-five (25) indigenous banks
operating in Nigeria had failed.
 The Federal Government of Nigeria did not want Nigerians to
relive those experiences, it was considered that the establishment
of a Deposit Insurance Scheme was urgently needed.
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RATIONALE FOR ESTABLISHING DIS IN
NIGERIA
Lessons from Other Countries
 the former Czechoslovakia which established a nationwide deposit
insurance scheme in 1924 and the USA in 1933, to revamp their
banking systems and by extension their respective economies, many
countries, including Nigeria, joined the league of nations with DISs.
 Notwithstanding the fact that bank failures are still rife in the U.S., the
FDIC has made it painless on the American financial system and has
thus engendered public confidence in the banking system.
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RATIONALE FOR ESTABLISHING DIS IN
NIGERIA
Anticipated Consequences of Economic Reforms on Banking
Supervision.
 The Structural Adjustment Programme (SAP) embarked upon by
government in 1986 was aimed at deregulating the economy and
removing all distortions created by the hitherto administrative
policies of government.
 It was envisaged that since the reform involved the liberalisation of
the bank licensing process, there would be a substantial increase in
the number of licensed banks to be supervised by the CBN.
 The establishment of an explicit deposit insurance scheme with
supervisory powers over insured institutions was expected to
complement the supervisory efforts of the CBN.
 Indeed, since the establishment of the Corporation in 1989, it has
been possible for both institutions (the CBN and NDIC) to carry out
routine and special examinations of licensed banks.
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RATIONALE FOR ESTABLISHING DIS IN
NIGERIA
Increased Competition Among Banks
 It was envisaged that with the rapid growth in the number of newly
licensed banks, there would be increased competition.
 Whereas, competition is good for individual banks, the customers,
and the banking system, increased competition could encourage,
excessive risk-taking with depositors’ funds.
 It was therefore necessary to protect the depositors, especially the
small ones, against loss of the their deposits from excessive risks
undertaken by their banks.
8
RATIONALE FOR ESTABLISHING DIS IN
NIGERIA
Change in Government Bank Support Policy
 Prior to the establishment of the Corporation, government had
been unwilling to let any bank fail, no matter the bank’s financial
condition and/or quality of management.
 Government was apprehensive of the potential adverse effects on
confidence in the banking system and in the economy generally
following a bank failure.
 Consequently, government deliberately propped up a number of
inefficient banks over the years, especially those banks in which
state governments were the majority shareholders.
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IADI CORE Principle 1: Public Policy
Objectives
The principal public policy objectives for DISs are to
protect depositors and contribute to financial stability.
These objectives should be formally specified and
publicly disclosed.
The design of the DISs should reflect the system’s
public policy objectives.
PUBLIC POLICY OBJECTIVES OF NDIC
The public policy objectives of the NDIC are as follows:
Protecting depositors by providing an orderly medium
for reimbursement to depositors in the case of
imminent or actual failure of a licensed deposit-taking
financial institution;
Contributing to financial system stability by making
incidence of bank runs less likely; and
Enhancing public confidence by providing a framework
for the resolution and orderly exit of failing and failed
insured institutions.
The NDIC Act establishes the Corporation as a risk
minimiser as opposed to a pay box by conferring on it
powers to supervise all insured institutions
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MANDATE OF THE DIS IN NIGERIA
 Deposit Guarantee
 The key and distinct function of the Corporation is the guarantee to pay up
to maximum of N500,000.00 to depositors of failed licensed banks
[International, National and Regional] and N100,000.00 to depositors of
failed MFBs and PMIs. S 20[1] NDIC Act as amended by powers conferred
on the Board of the Corporation in that regard.
 Banking Supervision
 As a risk minimiser, the Corporation carries out supervision of insured
institutions in order to reduce the potential risk of failure and to ensure that
unsafe and unsound banking practices do not go unchecked.
 Supervision is carried out through off site surveillance and on site
examination.
 Failure Resolution
 The Corporation is charged with the responsibility of ensuring that failing
and failed insured institutions are resolved in a timely manner.
 Bank liquidation
 The Corporation is conferred with the office of Provisional Liquidator of
Failed Banks pursuant to its enabling Act in order to ensure the orderly
and efficient closure of failed institutions with minimum disruption to the
banking system, utilizing cost effective realization of assets and facilitating
prompt settlement of claims of depositors, creditors and shareholders,
where possible.
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Objectives of Banking Supervision and
Prudential Regulation
 Banking supervision and prudential regulation generally seeks to reduce the
potential risk of failure and ensures that unsafe and unsound banking
practices do not go unchecked.
Specifically, it aims to:
• Safeguard the financial system against risk of disruption and mass failure of
banks
• Reduce the level of risk to which bank, depositor, creditors and other
stakeholders are exposed to
• Minimize Money Laundering activities in the financial system
• Enhance the efficiency of the financial system
• Supporting productive and social activities by channeling resources to priority
sectors of the economy
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Banking Supervision and Prudential
Regulation
• Books and affairs of every licensed insured institution are
examined as a means of meeting its supervisory mandate.
• This function is performed through the off-site surveillance
and on-site examination of the books and affairs of the
banks.
– Exceptions are reported,
– Recommendations made on how the observed lapses can be
corrected, and
– The implementation of such recommendations is monitored
through scheduled post examination visits to the affected banks.
SUPERVISORY ACTIVITIES OF THE NDIC
• Forms of Bank supervision
–
Off-site surveillance
–
On-site examination
• On site examination
– This entails examination of a bank’s reports, document and
other materials within the premises of the bank, and the
reconciliation of the information derived from the examined
documents with physical realities/assets such as cash and other
inventories to determine whether
– the bank complies with the bank regulation
– the returns sent by the bank are congruent to physical realities
in the bank
– the results/findings of the off-site analysis of the bank’s return
describe the bank’s financial risk performance
SUPERVISORY ACTIVITIES OF THE NDIC
• Off-site Surveillance
– Off-site supervision involves the receipt and analysis of
returns from insured banks on a periodic basis to ascertain the
banks’ compliance with prudential regulations.
– Returns, basically, are requirements of the
regulatory/supervisory authorities from the banking
institutions which are made on determined periodic basis to
assist in ensuring that the banks conform to desired operating
rules.
SUPERVISORY ACTIVITIES OF THE NDIC
– Two categories of regulatory returns can be identified: statutory
and non-statutory returns.
– Statutory returns are the returns that must be made by financial
institutions as provided for in various acts governing the banking
business.
– Non-statutory returns on the other hand are those returns
which the regulatory/supervisory authorities can require from
banks in their day to day operations. These non-statutory
returns are usually called for by means of circulars or
questionnaires.
SUPERVISORY ACTIVITIES OF THE NDICMethodology of Supervision
• Compliance/Transaction Based Supervision
• Risk Based Supervision
• Compliance-based examination
– also known as rule or principle-based.
– A method of examination which involves checking for
and enforcing compliance with rules – legislation,
regulations or policies – that apply to a bank or a
given banking industry.
– However, it is a reactive, and not proactive, form of
supervision. It is static and less useful in a dynamic,
constantly-evolving world
SUPERVISORY ACTIVITIES OF THE NDICMethodology of Supervision (Contd.)
• Risk Based Supervision (RBS)
– A structured process aimed at identifying the most critical
risks that face each bank and through a focused review by
the supervisor to assess the bank’s management of those
risks and the bank’s financial vulnerability to potential
adverse experience.
– Risk Based Supervision is a comprehensive, formally
structured system that assesses risks within the Risk Based
Supervision financial system, giving priority to the resolution
of those risks.
– Special effort is made to understand the environment in
which the deposit taking financial institution operates.
SUPERVISORY ACTIVITIES OF THE NDIC
RBS (Contd.)
– The inherent risks are identified, the Risk Management Control
Functions are appraised to the extent used to mitigate the risks.
– RBS is gradually becoming the dominant approach to regulatory
supervision of financial institutions around the world.
– Emphasis is placed on the RMCFs (Board, Senior Management,
Risk Management, Internal Audit, Compliance and Financial
Analysis) capacity to manage the inherent risks i.e. Credit,
Operational, Liquidity, Market etc.
SUPERVISORY ACTIVITIES OF THE NDIC
- RBS (Contd.)
– It is a robust, proactive and sophisticated supervisory
process, essentially based on the risk profiling of a bank;
– It enables a better evaluation of risks through the separate
assessment of inherent risks and risk management
processes;
– It is a dynamic, forward looking process, placing greater
emphasis on the early identification of emerging risks and
system-wide issues
– It allows the supervisor to prioritize efforts and focus on
significant risks by channeling resources to banks that have
higher risk profiles.
SUPERVISORY ACTIVITIES OF THE NDIC –
Scope of Bank Supervision
Scope of Bank Supervision
• Solo Based Supervision
• Consolidated Supervision
• Cross Border Supervision
• Solo Based Supervision
– Solo examination focuses on a single bank, its distinct
individual operations, risk profile and management.
– This supervisory approach focuses on individual group
entities. Individual entities are supervised on a solo basis
according to the capital requirements of their respective
regulators.
SUPERVISORY ACTIVITIES OF THE NDICConsolidated Supervision
• Consolidated Supervision
– This is a general qualitative assessment of the group as a whole
and, usually, by a quantitative group-wide assessment of the
adequacy of capital.
– A qualitative and quantitative assessment of the strength of
those business groups which contain banks (and other regulated
financial institutions) in order to identify and evaluate all the
risks to which the banks are exposed.
•
Supervisory Activities of the NDICConsolidated Supervision
Rationale
– Some banks are themselves subsidiaries and exposed to risks arising
from the influence exercised over them by their parents.
– Many banks and subsidiaries are exposed to risks arising from the
influence of parent companies.
– The impact of the global melt down showed that some events could
have been projected if regulators/supervisors had adopted a holistic
approach rather than resolving issues from a ‘’solo’’ perspective.
– Consolidated supervision is an essential element of risk based
supervision.
– The adoption of Universal Banking in Nigeria in 2001 brought
additional challenges to the Regulatory Authorities. As such, many
banks carried on activities through subsidiaries/affiliates.
SUPERVISORY ACTIVITIES OF THE NDIC–
Consolidated Supervision (Contd.)
• Objectives of Consolidated Supervision
– Supports principle that no business segment risk escapes.
– Supervision prevents over leveraging of Capital (Double Gearing)
control.
– Evaluates strength of the Group Consolidated Financial
Resources.
Conclusion
• The foregoing has touched key issues in supervision
of financial institutions in the banking industries in
Nigeria.
• Understanding these issues will help in appreciating
the tools, strategies and policies of DIS and by
extension bank supervision as employed by the
NDIC.