GTA-AP6 Okpalaobieri.pdf - Global Trade Alert

Financial Crisis and BankingSectors’ Coping Mechanisms:Evidence from Ghana andNigeriaPhilip Cobbinah and Dozie OkpalaobieriGTA Analytical Paper No.6bcdeGLOB LTR DELERT

It is considered by many economists to be the worst financial crisis since the Great Depression of the1930s. It contributed to the failure of key businesses, declines in consumer wealth estimated in thehundreds of billions of US dollars, substantial financial commitments incurred by governments, and asignificant decline in economic activity. Many causes have been suggested, with varying weightassigned by experts. Both market‐based and regulatory solutions have been implemented or areunder consideration, while significant risks remain for the world economy over the 2010–11 period.Possible research questions under considerationThis paper seeks to address the following questions:1 How the financial crisis has affected the banking sector’s performance in the two leading WestAfrican English‐speaking countries?2 How the measures (from outright bailouts to structural reforms) taken in each of these twocountries mitigated or worsened the impact of the financial crisis?3 How effective have the measures been?The private financial sector in Ghana is described as booming and over the last five years, the CentralBank of Ghana’s prime rate has moved in lock‐step with the inflation rate, but cautiously to preventthe crowding out of the private sector. While Nigeria is described as the largest economy, a fastdeveloping country and one of the largest financial services sector in sub‐Saharan Africa with thepotential to become a regional financial services centre (Becker et al, 2008 ‐ Nigeria Financial Servicecluster; Analysis and Recommendations. The microeconomics of competitiveness, firms, cluster andeconomic development). Ghana has 1.2 million bank account holders out of a population of 23million (a ratio of about 5%), compared to Nigeria’s 23 million bank account holders among apopulation of 140 million (more than 16%). With 27 banks, Ghana has three more than Nigeria —where further consolidation is expected (source; the Ghanaian journal & Oxford Analytica). Yet theperformances of the banking sector in these two countries have not been investigated in the light ofthe global financial crisis to assess the effectiveness of their coping mechanisms. This paper intendstherefore to fill this gap.Stylised FactsThe financial crisis and response from governments and central banks worldwideThe global financial crisis had major impacts on developed and developing countries alike. Thedeveloped and richer developing countries began to address the consequences of the crisis andannounced various fiscal stimuli. The G‐20 countries announced fiscal stimuli worth around 1.5% ofGDP, or some US$2 trillion, to cushion the consequences of the global financial crisis.Questions regarding bank solvency, declines in credit availability, and damaged investor confidencehad an impact on global stock markets, where securities suffered large losses during late 2008 andearly 2009. Economies worldwide slowed during this period as credit tightened and internationaltrade declined. Critics argued that credit rating agencies and investors failed to accurately price therisk involved with mortgage‐related financial products, and that governments did not adjust theirregulatory practices to address 21st‐century financial markets.Governments and central banks responded with unprecedented fiscal stimulus, monetary policyexpansion and institutional bailouts. The responses included were direct (Treasury) or indirect(Central Banks) or both measures were taken by countries worldwide; however, the actions can besummarised under several categories as follows:• Interest rate cuts and liquidity injections by central banks• Capital injections into banks/companies by governments (eg UK and USA)• Lending guarantees by governments to restore liquidity, and

• Reviving the ailing banking system through recapitalisation and strengthening of supervision• Bank deposit guarantees• Minimising market disruptions – crackdown on short selling• Fiscal stimulus packages to shore the economy out of recession – stimulating aggregate demand• Subsidies to ailing sectors.Outcomes of measures (from outright bailouts to structural reforms) taken on the bankingsector around the world (selected countries only)The financial sector crisis that broke out in the summer of 2007 disrupted the structure andfunctioning of the industry around the world. In order to preserve investors’ confidence and restoreviability, public policy responded to the crisis with liquidity and capital injections, implicit and explicitguarantee schemes as well as direct rescues and asset purchases. Public support backed majormergers aimed at rescuing distressed institutions. While many small banks, especially in the UnitedStates, went into liquidation, some medium and large‐sized financial institutions have not beenallowed to fail. The scope and cost of these crisis management measures are unprecedented.The numerous mergers occurred during the crisis have led to a significant increase of theconcentration levels of the banking industry in several countries. Between 2005, before the crisisbroke out, and 2009, the market share in deposits of the top five domestic institutions has increasedfrom 29.3% to 37.3% in the United States and from 58.3% to 61.3% in France. Similar patterns can beseen in the loan markets.In Europe, for example, several of the banks that have been bailed out or have been involved inorchestrated mergers have been subject to severe measures in terms of size reduction and limits onactivities. For example, Commerzbank, Hypo Real Estate, Landesbank Baden Württemberg andNorthern Rock have been required by the European Commission, among others, to cut their balancesheet by half. Similarly, ING, RBS and Lloyds have had measures imposed, ranging from theseparation of the insurance and banking businesses to restrictions on aggressive behaviours and onpotential acquisition activities or branches to be dismissed.In Australia, two significant banking mergers took place during the crisis, each involving a major bankand a significant mid‐tier institution – Westpac’s acquisition of St George in 2008 andCommonwealth Bank of Australia’s acquisition of BankWest in 2008. In addition, there wassignificant merger activity among smaller institutions and the number of credit unions declined from213 in 2001 to 143 in 2008. The Australian government provided timely fiscal stimulus measures,including the $42 billion Nation Building and Jobs Plan. Treasury estimates that, in the absence offiscal stimulus, growth would have contracted approximately 2.0% until September 2009. In October2008, the government announced a commitment to guarantee all retail deposits up to $1 millionunder the newly created Financial Claims Scheme. The guarantees supported confidence in thedeposit system, and also allowed ADIs to continue to raise funds in wholesale markets, both onshoreand offshore and despite the financial market turmoil, Australian banking customers continued tohave access to a significant number of providers evidenced by competitive pressures on interestrates, especially for mortgages. For example, a significant number of smaller lenders are offeringmortgages at rates of up to 1% lower than the four major banks.In Chili, the recent systemic crisis of 2008 brought about no significant consequences on the Chileanbanking industry. Indeed, the crisis came to be quite surmountable on the economy as a whole,cushioned as it was by a fiscal structural rule, a sound monetary policy and a favourable andsustained international price of copper – the country’s chief tradable good. The Chilean bankingsector is, and has been for a while, a quite concentrated one, where two large banks of all 25incumbent ones hold an indisputable dominant position, encompassing nearly 45% of the system’sloans. There have been a number of M&A in the Chilean banking system both before and throughoutthe 2008 systemic crisis. Neither of the two latest M&A is to be, nevertheless, mainly linked orascribed to it. It is frequently said that consolidation in the Chilean banking sector has taken placeroughly for the same reasons M&A happen.

In Finland, the banking market is heavily concentrated and the banks have not faced seriousdifficulties. There are a number of alternative explanations for the banks’ relatively goodperformance during the crisis. First, the crisis in the early 1990s with large‐scale bank failuresprovided a lesson that may still have affected the propensity to be excessively exposed to risks.Secondly, although Finnish banks expected that lending will decrease in 2009, this decrease has tobe viewed against the fact that from the outbreak of the global financial crisis, Finnish banks actedincreasingly as substitutes to drained foreign lending channels, thus increasing their lending. Thirdly,it is possible that the financial crisis had not yet had its full effect and that the effect for Finland islagging. On 12 December 2008, the parliament authorised the government to grant state guaranteesfor the refunding of Finnish banks to a maximum value of €50 billion. However, the surveys of theConfederation of Finnish Industry (CFI) in early 2009 indicated that access to credit has notconstituted bottlenecks in production. The concentration of the Finnish banking markets wasaffected by the exit of two Icelandic banks in 2008. These banks grew quite swiftly, partly due tofierce competition in deposit interest rates. Lack of investor confidence and liquidity problemscontributed to their exit.In Italy the financial system has proved quite resilient to the effects of the financial crisis. However,the issues of corporate governance highlighted in the Competition Authority’s inquiry need to beaddressed in order to improve the performance and the stability of the system. Specifically, strongermarket disclosure, combined with a more transparent governance that increases autonomy andindependence of administrators, can contribute significantly to strengthen furthermore the system’sreputation and its level of competition.In Iceland, where the economy was very dependent on the finance sector, economic problems havehit them hard. The banking system virtually collapsed and the government had to borrow from theIMF and other neighbours to try and rescue the economy. However, Iceland has raised its interestrates to some 18%, partly on advice from the IMF. It would appear to be an example where highinterest rates may be inappropriate. The economic problems have led to political challengesincluding protests and clashes. But as Krugman notes, capital controls may have also helped Icelandas well as having its own currency and making the banks pay for the problems rather than makingthe public pay, which is what has since happened in Ireland which now faces a massive bailout andvery severe austerity measures. It may be that this time round a more fundamental set of measuresneeds to be considered, possibly global in scope. The very core of the global financial system issomething many are now turning their attention to.Africa and the Financial CrisisWhile it is true that the advanced economies were the hardest hit by the crisis, with growth rateprojections declining from 2.7% in 2007 to about 1.0% in 2008, developing economies were notspared. As the global financial crisis continued to deepen, world output growth prospects,particularly for 2009 and 2010, had been downgraded at least a few times. Growth in developingeconomies, including emerging economies, was estimated at 6.3% for 2008, down from the realisedgrowth rate of 8.3% in 2007. Africa was initially believed by many pundits to be somehow insulatedfrom the global financial crisis, because of the relatively limited level of integration of most Africanfinancial markets with global financial markets. However, the continent witnessed some adverseeffects, evidenced in a slowdown in the rate of growth from 6.2% in 2007 to 5% in 2008.The impact of the crisis on Africa came from both direct and indirect channels. The direct effects hadbeen felt mostly through the financial sector. For example, stock market volatility had increasedsince the onset of the crisis and wealth losses had been observed in the major stock exchanges. InEgypt and Nigeria, the stock market indices declined by about 67% between March 2008 and March2009. The turmoil in African stock markets had had significant negative effects on the financialsector, and on aggregate demand. For example, there was growing evidence that it had a negativeeffect on bank balance sheets and a continued trend was likely to increase non‐performing loans inthe banking sector, with dire consequences for financial stability in the region.

In Ghana, the ratio of non‐performing loans to gross loans increased from 7.9% to 8.7% between2006 and the third quarter of 2008. So far, bank failures have been rare in the region, largelybecause most African banks do not have any significant exposure to the sub‐prime mortgage marketand asset‐backed securities. They were, however, vulnerable to contagion effects arising from thehigh rate of foreign ownership of banks in several countries in the region. To the extent that ifforeign‐owned banks reduced their support of local banks or sold their assets, it was going to haveserious negative consequences for the financial sector in Africa. The foreign exchange markets ofAfrican countries had been under enormous pressure since the onset of the crisis. In the first quarterof 2009, the Ghanaian cedi depreciated against the US dollar by 14% and the Nigerian naira declinedby 10%.The financial crisis had also increased the risk premiums that African countries had to pay ininternational capital markets. There is evidence that several countries in the region had difficultyobtaining funds from international capital markets. For example, Nigeria, Kenya and Uganda hadcancelled plans to raise funds in these markets. The drying‐up of this source of external finance wasa serious setback for development in the region because the money raised would have been used tofinance infrastructure development and boost growth. The private sector also faced challenges inraising funds in international capital markets.Country‐specific responsesAfrican countries took several steps to mitigate the impact of the financial crisis on their economies,including interest rate reductions, recapitalisation of financial institutions, increasing liquidity tobanks and firms, fiscal stimulus packages, regulatory reforms, etc. The measures adopted differ fromcountry to country, depending on available fiscal space as well as the degree of vulnerability to thecrisis.Since the onset of the crisis, 18 countries in the region made interest rate changes in response to thecrisis. For example, in Botswana, the central bank reduced interest rates by 50 basis points inDecember 2008. This was followed by a percentage point reduction on 27 February 2009. In Egypt,the central bank cut its overnight and lending rates by 50 basis points on 26 March 2009. The CentralBank of Nigeria also cut its interest rate from 10.25% to 9.25%.Liquidity injectionsSome countries took actions to increase liquidity in the banking system and to domestic firms. Forexample, in Benin, Burkina Faso, Côte d’Ivoire, Guinea‐Bissau, Mali, the Niger and Togo, the commoncentral bank (BCEAO) injected liquidity on a weekly basis in the regional money market. In Cameroonand Liberia, a support or guarantee fund was created for firms. In Tunisia, the central bank had setup new deposit and credit facilities to improve flow of credit and increase liquidity in the bankingsystem.Recapitalisation of banks and regulatory changesSome countries took specific measures to recapitalise domestic banks. In Mali, the governmentdecided to recapitalise the Banque de l’Habitat du Mali in order to increase and improve finance forhousing. In Tunisia, the central bank doubled the capital for the financing of small and medium‐sizedenterprises in order to boost domestic investments. The Algerian Credit and Monetary Council alsoissued instructions to commercial banks to increase their capital from 2.5 billion Algerian dinars to aminimum of 10 billion Algerian dinars ($142 million) within 12 months.

Sub‐Saharan Africa andthe Financial CrisisSub‐Saharan Africa’s(SSA’s) growth droppedd from 6.9% in 2007 to 5.5% in 2008; ; in January 2009, theInternational Monetary Fund ( IMF) once more cut its forecast for f growth for this year by 1.6percentage points to 3.5%. In April 2009, , the IMF revised againn its forecast leading toa newprojection for SSA growth in 2009, equal to 1.7%. Private capital inflows to SSA were relatively rrobust up to the first half of 2008, but dropped sharplyfrom the third quarterr of 2008, owing to areducedd capability and propensity to invest on the partof foreign investors. However, the financialturmoil originating in the developed world in August 2007 had sincee spread to developing countries,and SSAwas not left out. The direct impact of the financial turmoil on SSA had so far been lesssevere than in advanced economies, since SSA countries are less integrated inn the global financialsystem and their financial institutions are relatively inactive in the derivatives market, relying mainlyon domestic marketresource mobilisation rather than on foreign borrowings too finance operations.Nevertheless, SSA was not immune to the global financial crisis and was already feeling thesecondary effects, like the dryingup of financial inflows (see Figure 1). 1Figure 1: Financial inflows to SSA, 2000–20099 (US$ billions)Note: 2009 expected values. Source: (IMF 2009a, International Monetary Fund (2009a) Regional Economic Outlook Sub‐Saharan Africa (April), Washington, DC: IMF.).Private capital inflows to SSA were relativelyy robust up to the first half h of 2008, but droppedd sharplyfrom the third quarter of that year. Two main factorswere responsible for the fall in direct andportfolioo investment: first, a reduced capability to invest; second, a reduced propensity to invest.Credit conditions became tighter, makingg it more difficult and expensive to invest inforeignoperations. At the same time, the gloomy growth prospects worldwide andd the increased riskaversionreduced investors’ appetite for risk. Many bond issuance plans were put on hold incountries such as Ghana, Kenya, Tanzania and Uganda.FDI inflows continued to grow, but at a lower rate. Portfolio equity e flowss slowed down andsometimes reversed, consistentt with sharpp falls in stock markets in Nigeria, South Africa, Kenya,Mauritius and Côte d’Ivoire. The first signss of contraction of international bank lending began toemerge:banks’ total foreign claims declined in June 2008 and in September 2008, and Ghanaexperienced a similar drop over the same period.

While SSA countriesare not highly dependent on credit from foreign banks, some countries hadalready seen the signs of a drop in foreign claims from the third quarter of 2008 (see Figure 2).Source: BIS Consolidatedd Banking Statistics, March 2009.Figure 2: Banks’ total foreign claims on selected SSA countries, September 2000–September 2008(US$ million). The countries most exposed to a fall in international bank lending were likely thosewith a high share of foreign‐owned banks (egg Ghana, Tanzania, Zambia, Uganda and Swaziland).The IMF(2009b); International Monetary Fund ‐ Impact of the Global Financial Crisis on Sub‐SaharanAfrica. Washington, DC: IMF.) reckoned that, as the crisis continued, there might be an ncreasingrisk of contagion from distressed foreign parent banks to local subsidiariess in SSA. There aredifferent mechanisms through which this could happen. Parent banks could call in loans or withdrawcapital from their SSA subsidiaries. They could stop nvesting local profits in local subsidiaries orrequire the closure of their subsidiaries (IMF, 2009c International Monetary M Fund ‐ The Implicationsof the Global Financial Crisis for Low‐Income Countries. Washington, DC: IMF.). However, theexistence of tight prudential capital controls in many SSA banking systems helped to minimise thiscontagion effect. In Tanzania, for example, profit repatriationhad been regulated and localsubsidiaries were not allowed to t transfer funds automatically to compensate c for losses in parentbanks (AfDB, 2009b ‐ African DevelopmentBank (2009b) Impact of the Crisis onn African Economies:Sustaining Growth and Poverty Reduction, African Perspectives andd Recommendations to the G20.Report to the British Prime Minister from the Committee of African Finance Ministers andCentralBank Governors, 17 March.).GhanaaImpacton Ghana’sfinancial sector sAfter about a decade of relatively strong economic performance with w real gross domesticc product(GDP) growing at an average of about 6% % annually over the last five years, there wass greateruncertainty about Ghana’s economic growth prospects at the beginning b off 2009. Thelimitedtransmission of the global economic and financial crisis to Ghana contributed to a relatively smallimpact on the macroeconomic performancee. The GDP growth rate declined to a mere 4.7% in i 2009 –the lowest since 2002 – after rising r to a two‐decade high of 7.3% % in 2008 but remained positive,even in per capita terms – in contrast to many other developing countries. Afterr declining inthe firsthalf of 2009, economic activity as measured by the Composite Index of Economicc Activity of the Bank

of Ghana picked up during the second half of 2009 (Bank of Ghana, 2010a ‐ ‘Financial Stability Report5(4/2010)’. Accra, Ghana).Even though the effects of the challenging global meltdown had severe consequences on lowincome economies, the impact through the financial sector in Ghana was quite slow, because of theperceived weak integration with the global financial market, the Central Bank of Ghana observed.According to the Bank of Ghana, the slow reaction in these economies of the region was largely dueto the fact that low income economies have limited exposure of their economies to toxic assets thathave precipitated and also spread the crisis in the international financial systems. ‘This limitedexposure of the banking sector of the region, has enjoyed a relatively strong performance, which issupported by improved macroeconomic stability and legislative reforms, while resulting in theimplementation of revised prudent guidelines and risk management frameworks’ – Finance Minsterin his presentation of the 2009 budget statement to Parliament in March 2009).In spite of the global financial crisis, the Ghanaian banking industry remained stable. Industry returnon equity (ROE) and return on assets (ROA) remained at around 22% and 2% respectively. Thegrowth of the industry in 2008 suggested that the global financial crisis did not have a severe impacton the Ghana banking industry in 2008. However, the effects of the crisis for Ghana were significantin 2009 and the timing and quantum was uncertain.Specific impact on Ghana’s banking sectorThe direct impact of the crisis on the banking system has remained rather modest. The reason forthis is evident in the banking system’s little exposure to complex financial instruments and itsreliance on abundant low‐cost domestic deposits and liquidity. However, the industry’s financialsoundness indicators are beginning to show signs of contagion. The Bank of Ghana’s creditconditions survey, conducted in December 2008, showed a further general tightening of creditconditions for enterprises in the fourth quarter of 2008 (Bank of Ghana, 2009 ‐ ‘Financial StabilityReport 5(1/2009)’. Accra, Ghana). Banks had a favourable but more selective credit stance towardshouseholds. Credit to households for mortgages was much tighter because of rising cost of fundsand preference for shorter maturities. Lenders reported that they had reduced the availability ofcredit to households for house purchases in the three months to December 2008. As in the thirdquarter survey, concerns about the economic outlook and cost of funds were reported to have beenfactors contributing to this tightening. Also contributing to the net tightening of credit to householdsfor consumer credit and other lending are expectations regarding general economic activity and riskrelated to the current performance of banks’ 50 largest borrowers.According to the Bank of Ghana, the possible direct links to the global financial crisis for Ghanaianbanks remain their exposure to counterparties in the form of nostro balances and placements withsome of the affected banks abroad. Deposit money banks’ (DMBs’) nostro balances at the end ofDecember 2008 were 55.46% of the net worth of banks, an increase on the 48.12% in 2007.Similarly, placements constituted 26.0% of net worth of banks compared with 23.9% in September2008, but the central bank is of the view that these exposures are not a cause for worry, since theyare within the internationally acceptable prudential limits, the only concern being that theseplacements, nostro balances and borrowings are overly concentrated with a few international banksand thus require close monitoring.Other key performance indicators showing some erosion of the banking system in the face of theglobal financial crisis include the growth of total assets, loan quality, capital adequacy andprofitability. According to the Bank of Ghana, growth of total assets of the banking industry was37.2% as of December 2008, down from 50.4% for the same period in 2007. Loans and advancesrecorded a 42.7% growth over 2008, a slowdown from the 67.9% growth recorded a year earlier. Thequality of the banks’ aggregated loan book deteriorated marginally. Impaired assets increased overthe year on account of some increase in substandard and doubtful loans. The loan loss provisions togross loans ratio and the non‐performing loans (NPL) net of provisions to capital ratio alsodeteriorated over the quarter, from 7.6% in September 2008 to 7.7% in December 2008. The

industry’s capital adequacy ratio, as measured by the ratio of regulatory capital to risk‐weightedassets, edged down to 13.8% as of December 2008, from 14.8% in December 2007, albeit remainingabove the required minimum of 10.0%. Lastly, earning indicators continue to weaken, as return onassets (RoA) and equity (RoE) worsened from the December 2007 positions of 3.7% and 25.8%,respectively, to 3.2% and 23.7% in December 2008.With huge current account and fiscal deficits, rising inflation and a weakening currency, the Bank ofGhana’s Monetary Policy Committee was forced to maintain a tight monetary policy stance to steerinflationary expectations towards the now elusive single‐digit path. In its July 2008 sitting, the MPCraised the prime rate from 16% to 17%, before increasing it further in February 2009 to 18.5%, mostlikely in an attempt to keep offering high yields to investors.Response from the government and central bank of GhanaIn the course of the year 2008, the central bank raised the prime rate on three different occasions –from 13.5% in January to 14.25% in March to 16% in May and finally 17% in July – all in an attemptto reduce inflation. The government of Ghana said it would start cutting interest rates as soon as itsaw a clear signal of inflation easing. The prime rate had been on hold at 18.5% since it was raised inFebruary 2009, while the appreciation of the Ghanaian cedi to around 1.45 to the dollar had helpedease price pressures.The inflation rate fell, from 20.7% in June 2009 to 14% in February 2010 (Bank of Ghana, 2010a;Monetary Policy Report; 2010). The lower inflation rate and lower public sector borrowingrequirement prompted the Bank of Ghana to lower its policy rate first from 18.5% to 18.0% inNovember 2009 and then to 16.0% in February 2010. The banking sector gross loans and advancesgrew by 47% from 2007 to 2008 with a significant chunk going into the commerce and financesector.The financial system remained stable with strong supervision. Generally, the financial soundnessindicators of the banking industry, measured in terms of earnings, portfolio quality, liquidity andcapital adequacy were strong (Bank of Ghana, 2010c; Financial Stability Report – Sept, 2010). Yet,the banking sector faced a doubling in the share of non‐performing loans, rising from 6.9% inDecember 2007 to 14.9% in December 2009 (Bank of Ghana, 2010c).Profitability was declining and a few banks were financially strained (IMF, 2009b). The Central Bankof Ghana introduced measures that should re‐enforce the ability of banks in Ghana to withstandshocks and protect the soundness of the financial system. These include strengthening theregulatory and supervisory framework with the passage of the Borrowers and Lenders Act 2008 (Act773), the Non‐Bank Financial Institution Act 2008 (Act 774), Home Mortgage Finance Act 2008 (Act770) and the Anti‐Money Laundering Act 2008 (Act 749). In February 2008, the Bank of Ghana raisedthe minimum capital requirements to GH¢60 million. All foreign controlled banks, except one, metthe requirement by the deadline of end of December 2009 and the remaining bank met it in January2010 (Bank of Ghana, 2010c).Outcome of responseData on the banking industry for the 12‐month period to July 2010 suggests that the industry’sbalance sheet expanded by 28.2% to GH¢15.1 billion. Unlike a year ago where the expansion in thebalance sheet size of the banking sector was significantly driven by expansion in foreign assets,current performance is largely driven by the expansion in domestic assets, with a contraction inforeign assets.The size of the banking system’s foreign assets base shrunk by 2.3% to GH¢1.32 billion by the end ofJuly 2010 significantly slower than the growth of 76.2%. By the end of July 2010, total deposits in thebanking system grew by 25.7 %to GH¢ 9.98 billion in year‐on‐year terms. Paid‐up capital, on theother hand, increased significantly by 97.6% to GH ¢1.24 billion over the 12 months to July 2009,compared with 78.9% growth in the corresponding period earlier.

The share of shareholders’ funds in overall liabilities increased to 13.5% by the end of July 2010, upfrom 11.2% in the corresponding period inn 2009. Thissuggests that 13.5% off the banking sectorassets are backed by equity. However, the share of total borrowings in total liabilities declined to11.1% from 12.4% registered forr the same periods under consideration.The credit portfolio of the banking sector (measured bydevelopments in gross loans and advances)continueto expand at a slow pace. Year‐on‐year growth stood at 5.9% by the end of July 2010, lowerthan a growth of 20.4% recordedd a year earlier, but better than 3.2% % growth registered in May 2010.In real terms, there was a contraction of 3. .3% compared with a growth of 10. 1% in July 2009, butbetter than a contraction of 6.7%recorded in May 2010.The quality of the loan portfolioo of the banking industry as measured by the non‐performing loans(NPL) ratio increased to 18.2% by the end of July 2010 from 11.4% by the end of July 2009, thoughlower than the 18. 7% recorded at the last MPC meeting in May 2010. Similarly, the loan l lossprovisions to gross loans ratio increased to 10.2% by the end of July 2010 fromm 7.4% by the end ofJuly 2009 and the NPL net of provisions to capital ratioincreased to 28.5% by the end of July 2010from 20.3% by the end of July 2009.The composition of banks’ credit portfolio by economic sectors shows Private enterprises accountedfor 72.1 percent of gross loans in July 2010, up from 67.8 percent recorded in July 2009. However,the share of household loans declined to 14.4 percent in July 2010 from 16.6 per cent in July 2009.Also, credit to Government, public enterprises and public institutions decreased to 1.7 percent inJuly 2010 from 3.6 percent in July 2009. (seee Figure 3 below).Figure 3: Sectoral allocation of credit c (stock)Source: Bank of Ghana, Financial Stability Report, September 2010.The industry’s Capital Adequacy Ratio (CAR) as measured by the ratio of risk‐weighted capital to riskperiodinweighted assets increased significantly to 19.1% in July 2010 fromm 14.7% for r the same2009. However, the ratio of risk‐weighted assets to total assets declined to 68.5% in July from 78.3%in July 2009.The banking sector’s profit before tax improved by 15.1% to GH¢240.6 million as of July 2010compared with a growth of 52.0% recorded in the same period inn 2009. The industry’s net profitafter taxof GH¢190.8 million representedd an annual growth of 13.9% by the end of July 2010compared with a growth of 56.7% registered in the same period in 2009. The decline in thelevel ofprofitability relativee to a year earlier could be largely attributed too compressed operatingincomeand increase in stafff cost.

The general outlook of the Ghanaian banking sector after the coping measures aimed at the financialcrisis were introduced is characterised by the following:• High levels of NPLs, especially the increase in the loss component of impaired assets, continue topose some threat to the stability of the financial system, undermining efforts to reduce lendingrates significantly.• The current developments in money market rates (ie declining rates) and their impact on the repricingof the product of banks pose challenges for the profitability of the industry and riskmanagement.• Market and liquidity risks are well contained in the short to medium term.• Developments in the banking sector through July 2010 show strong asset growth, increasedcompetition in the mobilisation of deposits and a generally strong banking system.• The financial soundness indicators of the banking industry, measured in terms of earnings,liquidity and capital adequacy are strong except for the quality of the bank’s loan portfolio.• The period recorded some incipient recovery in credit delivery.• Investments, largely in the long dated instruments saw a significant boost.• The solvency of the banking industry remained very strong to the extent that most banks havemet the new minimum capital requirement. All the banks, except two, remained withinprudential limit for capital adequacy.NigeriaImpact on Nigeria’s financial sectorThe following pointers summarise the impact of the financial crisis on Nigeria:• Commodity prices collapse (especially oil price)• Revenue contraction (possible burst syndrome)• Declining capital inflows in the economy• De‐accumulation of foreign reserves and pressure on exchange rate• Limited foreign trade finances for banks – possible drying‐up of credit lines for some banks• Capital market downturn, divestment by foreign investors with attendant tightness and possiblesecond‐round effects on the balance sheet of banks by increasing provisioning for bad debt anddecrease in profitability.The financial system is dominated by the banking sector (about 90% of the assets) and about 65% ofmarket capitalization of the NSE. It is the key driver of the economy ‐ supplier of oxygen ‐ with newcredit to private sector expected to exceed the combined spending by three tiers of government.Nigeria cannot afford a banking crisis: The non‐deficit part of the Federal Government of Nigeria(FGN) budget in 2009 is less than banks’ capital; hence the totality of FGN budget cannot recapitalizethe banks if the system should collapse. With the drying up of global finance, and non‐bank investingpublic still nascent, the scope for funding any bank bailout in Nigeria is slim ‐ except by printingmoney (see figure below)Figure 5: Banks: financial deepening

Source: A presentation by Professor Chukwuma C. Soludo (2009a), Governor, CBN.Counterparty risks vis‐à‐vis external reserves but Central Bank of Nigeria (CBN) had taken measuresto safeguard the reserves and this led to a situation thatt enabled Nigerian bankss to remain robust r towithstand the shocks. The impact of the crisis on the Nigerian economy had different ramificationsfor the capital market, the banking sector, foreign exchange and thee balance of payments, as well asthe real sector. Market capitalisation fell byy 45.8% in 2008, a sharp reversal of growth from 2007,when the market grew by 74.7%(Okereke‐Onyiuke, 2009‐A Revieww of Market Performancee in 2008and the Outlook in 2009: The Nigerian Stock Exchange). The Nigerian currency, the naira, has alsodepreciated against the US dollar, and this has implications for foreign reserves, which dropped from$67 billion in June 2008 to $53 billion in December 2008.Nigerianmarkets, although nott well integrated into the world market, faced serious destabilisingeffects since the emergence of the global financial crisis in July 2008. The capital market began toshrink, major international hedge funds were being withdrawn, and the international credit line wasfading out of loadable funds for the domestic industry. This resulted in the decline of banks’ credit tothe real sector of theeconomy as shown in the figure below.Figure 6: Banks: credit to the real sectorSource: A presentation by Prof. Chukwuma C. Soludo (2009a), Governor, CBN.The gravity and depth of the crisis in the financial sector was not yet fully evident, but the following findicators pointed toits direction:

• Prudential indicators, whichh show declining levelsof qualityy of risk assets with the maincomponent considered as non‐performing loans (NPLs) as a percentage of total commercial bankloans; this ratio increased in 2009 as the maturity of loans granted in 2008 falls due.• Capitalised valueof quoted banks had been seriouslyeroded since the crisis, owing to thedeclinein the quoted values of these institutions at the stock exchangee and was seriously endangeringtheir tier one andtwo capital.• Activity indicators, captured by the ratio of security investment too total commercial banks’ assets,showed a continued decline in i the ratio from its peakin 2007.Specificc impact onNigeria’s banking sectorIn a globalised world, transactions are carried out in different countries in integrated markets. Theworld has over the past two decades headed towards liberalisationand deregulation, with the goalof integrating world markets.Prudential indicators: Some of these t are consequent to the activities of the stockbrokers inthe useof margin loans in funding their capital market activities, as well as those who received loans tofinance share purchases when their pricess were still high. These became problems when pricestumbled. Margin lending allows money to bee borrowed using existing shares, managed funds or cashas security. The main component consideredd is non‐performing loans (NPLs) as a percentagee of totalcommercial bank loans. This ratio is likely to increase in 2009 see figure 7 below; ;Figure 7: NPLs, 2003–2008 (% off commerciall bank loans)* Indicates estimated value based on the amount of margin loan swept by the crashh in the capital market. The total marginloan (₦1 trillion), represents 20% of total credit. If the crisis continues, most of the loans will enterr the NPL profile.Source: (Central Bank of Nigeria (2008; Annual Reportt and Statement of Accounts’ . Year ended 31 December 2007. Abuja,Nigeria).Activity indicators: The activity indicator iss captured by the ratio of security investment to totalcommercial banks’ assets. Available data show a continued decline inn the ratio from its peak in 2007.

Figure 8: Securities investment to t total bankk assets of commercial banks, 2004–2010 (%)Source: www.cenbank.org.Figure 8 indicates that such a decline could continue for the rest of 20092and extend until 2010.According to the Central Bank of Nigeria, initially banklending witnessed growth of about 60.9%,which was an indication that Nigerian bankss were doingwell first off all in the face of financial crisis.However, the situation on the inter‐bank market had since indicatedd otherwise, and that banks wereexperiencing reduced liquidity.For instance, as of 31 December 2008, thee Nigerian Inter‐bank Offer Rate (NIBOR) went up from13.8% to14.6% on all segmentss of the lending market, with the seven‐day NIBOR rising from 14.8%to 15.3% %, 30‐day NIBOR from 16.7% to 17.0% and 60‐day NIBOR up from 16.7% to 17.0%. . The 90‐day NIBOR rate alsorose, from 16.7% to 17.2%, the 180‐day NIBOR from 16.7% to 17.4%and the360‐dayNIBOR from16.9% to itss 17.8% level.The rising interest rate was an indication off fewer funds to lend out, which mayy have occurred as aresult of the exposure of banks to the margin loan and other capital c market funding activitiesdiscussed above.Response from thegovernment and Central Bank of NigeriaThe government andthe Central Bank of Nigeria – the regulatory body put forward the under listedresponse mechanisms to seriously monitor operations of banks. The CBN further deployed residentauditorsto all the banks, and all figures presented by banks were met withh increased scrutiny.Hence, the level of monitoring of banks wass intensified and will continue to increase. The following fpoints demonstratethe response from the Nigerian government andd the Centrall Bank of Nigeria:• Implementationof the 7‐Point Agenda off Mr. President• Stimulus Budgeting: FGN and State Government were expectedd to borrow ₦1.6 trillion(deficitspending as in many other countries)• Presidential Steering Committee on the Global Economic crisis• Proactive measures to conserve the foreign reserves and alsoo allowing the exchangee rate todepreciate as a shock absorber• Injection of liquidity into the banking system• Tightening of regulation and supervision• Stimulating the dormant growth reserve – agriculture– through the t Special Agricultural Fund.

Liquidity management• Reduction of the MPR from 10.25% to 9.75% (below inflation rate)• Reduction in CRR from 4.0% to 2.0%• Reduction of liquidity ratio from 40.0% to 30%• Directive to banks that they have the option to restructure margin loans (if necessary) untilDecember 2009• Expanded discount window, which allows banks to borrow for up to 360 days (currently atinterest rate not exceeding 500 basis points above the MPR)• Suspended aggressive mop‐up of liquidity since September 2008.Foreign exchange/exchange rate management• Exchange rate adjustment to preserve foreign reserves• Reversion from Whole Sale Dutch Auction System (WDAS) to Retail Dutch Auction System (RDAS)to check speculative demand for forex• Introduction of a band of plus or minus 3% to ensure stability• Temporary suspension of inter‐bank forex transactions• Restructuring of the bureaux de change operations – two classes ‘A’ and ‘B’• Reduction in net open position of banks from 20% to 1%• Sale of cash forex only through bank bureaux de change• Revision and enlargement of transactions that are eligible under the RDAS window.Tightening of regulation and supervision• Greater emphasis on enforcement of Code of Corporate Governance• Resident examiners have been deployed to banks since January 2009• Standby teams of target examiners being deployed to any bank at any time to ensure timelyregulatory actions if necessary• Review of Contingency Planning Framework for Systemic Distress in Banks• Introduction of credit bureau• Advice to banks on risk management – extra conservatism during time of crisis – capitalconservation, cost minimisation, de‐emphasis on size, salaries/bonuses, etc• Strengthening of institutional coordination through the Financial Sector Regulatory CoordinatingCommittee (FSRCC). Greater emphasis on the electronic Financial Analysis and SurveillanceSystem e‐FASS as a tool for banks’ returns analysis for speedy identification of early warningsignals• Consolidated Supervision and Risk Based Supervision has been adopted and arrangements arebeing made to migrate from the current fragmented sub‐sectoral supervision to all‐inclusivefinancial sector supervision• All banks are to be examined in 2009 by consolidated teams• Adoption of common accounting year end for all banks with effect from end of December 2009,aimed at improving data integrity and comparability• Adoption of the International Financial Reporting Standards (IFRS)• Review of Banks and Other Financial Institutions Act (BOFIA )to strengthen regulatory capacity.Interest rate regime:• To reduce pressure on interbank rates, CBN reduced rates on Expanded Discount Window (EDW)to maximum of 500 basis points above MPR effective from 16 March 2009.• Also as a temporary measure, and to ensure that the liquidity pressures and run‐up to commonyear end do not drive banks to ‘race to the bottom’, the Bankers’ Committee decided to peg themaximum deposit and lending rates at 15% and 22% respectively from 1 April 2009 until the endof 2009 to have salutary effects on the real economy.

Confidence building:• Assurances about the state of the banks and that government /CBN would not allow anybank tofail• Advice to banks to ensure greater disclosure to the public• Bankers’ Committee increasing emphasiss on maintaining high ethical standards in the operationsof banks: using service delivery as key instrument of competition.Outcomes so far and prospectsThe following were the direct outcomes and prospectss of the response from the government andthe Central Bank ofNigeria aimed at mitigating the impact of thee financial crisis on the Nigerianbanking sector.• GDP growth rateincreased from 6.2% in 2007 to an estimated 6.8% in 2008 the National Bureauof Statistics (NBS) despite the global crisis (with non‐oil growth at 9.5%, while the oil sectordeclined by 4.5% %)• End period HEADLINE inflation in December 2008 was 14.6%, while CORE (non‐food) inflation was9.2%• Credit to private sector grew by over 50% % by the end of December 2008• GROSS liquidity injections by the Central Bank of Nigeria through expanded discount window andrepayment of maturing OpenMarket Operation (OMO) bills from September 2008 to 7 January2009stood at about ₦2.2 trillion. This had moderated interest rates in thee money market andcurrently interbank rates below the MPR.• The Expanded Discount Window facilityy to banks now stands at ₦275 billion (down from ₦1trillion as banks repay the temporary loans)• Repayment of maturing OMOO bills since September 2008 is ₦1.2 trillion• Stockof External Reserves stood at US$52.9 billion as at the end of December 2008, with ‘ExcessCrude’ balances at about $20billion (relative sharp decline in the inflow of forex relative to thedemand pressure).• Exchange rate allowed adjusting to reflect the demand pressuress relative to supply: the exchangerate depreciated from ₦117 to t ₦135 per r US dollar asat the end of o Decemberr 2008• As atMay, 2009, exchange rate depreciation is approximatelyy 20%, effectively translating toabout ₦2.5 billion extra revenue per day to the Federation Account• Stockmarket remained depressed as at end of December 2008• Outlook for oil price in 2009 is i about $51 (optimistic range) and below b $51 (pessimistic range)• Growth rate of GDP between 7 and 9% % still possible – despite the economic crisis and thisindicates that Nigeria will nott experience economic recession after the financial crisis• Totaloutstandingborrowing on Expanded Discount Window as at a 24 March 2009: ₦68.93 billionas shown in table2 below;Table 2: Outcomes: interbank interest rates and borrowingSource: A presentation by Professor Chukwuma C. Soludo (2009 a), Governor, CBN.

• Banks’ total risk assets as at end of February 2009 were ₦12.78 trillion.• Non‐performing risk assets as at end of February 2009 was 4.74%• Banks’ total loans as at end of February 2009 was ₦7.8 trillion• Total non‐performing loans as a percentage of total asset as at 28 February 2009 was 6.2%• Estimated non‐performing loans as at end of December 2009 was about 7.4%• Amount banks are prepared to turn over to an asset management company (AMCON) if suchwere set up by end of the year was ₦350–₦400 billion or approximately 4–5% of loans as atFebruary 2009• About 15 banks would have no need for AMCON• Of those that indicated interest in AMCON, there is hardly any for which it would threaten theirsolvency• CAMELS rating of the banks as at end December 2008, showed an average composite score of62% and average industry rating is satisfactory• Total shareholders’ fund as at end of December 2008 was ₦2.8 trillion• Average capital adequacy ratio of 22%, among the highest in the world• No bank has failed or gone out of clearing.LITERATURE REVIEWIntroductionThe term ‘financial crisis’ is applied broadly to a variety of situations in which some financialinstitutions or assets suddenly lose a large part of their value. In the 19th and early 20th centuries,many financial crises were associated with banking panics, and many recessions coincided withthese panics. Other situations that are often called financial crises include stock market crashes andthe bursting of other financial bubbles, currency crises and sovereign defaults. Financial crisesdirectly result in a loss of paper wealth; they do not directly result in changes in the real economyunless a recession or depression follows. Many economists have offered theories about howfinancial crises develop and how they could be prevented. There is little consensus, however, andfinancial crises are still a regular occurrence around the world.When a bank suffers a sudden rush of withdrawals by depositors, this is called a bank run. Sincebanks lend out most of the cash they receive in deposits, it is difficult for them to quickly pay back alldeposits if these are suddenly demanded, so a run may leave the bank in bankruptcy, causing manydepositors to lose their savings unless they are covered by deposit insurance. A situation in whichbank runs are widespread is called a systemic banking crisis or just a banking panic. A situationwithout widespread bank runs, but in which banks are reluctant to lend, because they worry thatthey have insufficient funds available, is often called a credit crunch. In this way, the banks becomean accelerator of a financial crisis. Examples of bank runs include the run on the Bank of the UnitedStates in 1931 and the run on Northern Rock in 2007. The collapse of Bear Stearns in 2008 has alsosometimes been called a bank run, even though Bear Stearns was an investment bank rather than acommercial bank. The US savings and loan crisis of the 1980s led to a credit crunch which is seen as amajor factor in the US recession of 1990–1.Economists say that a financial asset (stock, for example) exhibits a bubble when its price exceedsthe present value of the future income (such as interest or dividends) that would be received byowning it to maturity. If most market participants buy the asset primarily in hopes of selling it laterat a higher price, instead of buying it for the income it will generate, this could be evidence that a

ubble is present. If there is a bubble, there is also a risk of a crash in asset prices: marketparticipants will go on buying only as long as they expect others to buy, and when many decide tosell the price will fall. However, it is difficult to tell in practice whether an asset’s price actuallyequals its fundamental value, so it is hard to detect bubbles reliably. Some economists insist thatbubbles never or almost never occur. Well‐known examples of bubbles (or purported bubbles) andcrashes in stock prices and other asset prices include the Dutch tulip mania, the Wall Street Crash of1929, the Japanese property bubble of the 1980s, the crash of the dot‐com bubble in 2000–2001,and the recent – deflating – United States housing bubble.International financial crisesWhen a country that maintains a fixed exchange rate is suddenly forced to devalue its currencybecause of a speculative attack, this is called a currency crisis or balance of payments crisis. When acountry fails to pay back its sovereign debt, this is called a sovereign default. While devaluation anddefault could both be voluntary decisions of the government, they are often perceived to be theinvoluntary results of a change in investor sentiment that leads to a sudden stop in capital inflows ora sudden increase in capital flight. Several currencies that formed part of the European ExchangeRate Mechanism suffered crises in 1992–3 and were forced to devalue or withdraw from themechanism. Another round of currency crises took place in Asia in 1997–8. Many Latin Americancountries defaulted on their debt in the early 1980s. The 1998 Russian financial crisis resulted in adevaluation of the ruble and default on Russian government bonds.Wider economic crisesNegative GDP growth lasting two or more quarters is called a recession. An especially prolongedrecession may be called a depression, while a long period of slow but not necessarily negativegrowth is sometimes called economic stagnation. Since these phenomena affect much more thanthe financial system, they are not usually considered financial crises per se. But some economistshave argued that many recessions have been caused in large part by financial crises. One importantexample is the Great Depression, which was preceded in many countries by bank runs and stockmarket crashes. The subprime mortgage crisis and the bursting of other real estate bubbles aroundthe world led to the recession in the US and a number of other countries in late 2008 and 2009.Nonetheless, some economists argue that financial crises are caused by recessions instead of theother way around. Also, even if a financial crisis is the initial shock that sets off a recession, otherfactors may be more important in prolonging the recession. In particular, Milton Friedman and AnnaSchwartz argued that the initial economic decline associated with the crash of 1929 and the bankpanics of the 1930s would not have turned into a prolonged depression if it had not been reinforcedby monetary policy mistakes on the part of the Federal Reserve, and Ben Bernanke acknowledgedthat he agrees.Strategic Complementarities in Financial MarketsIt is often observed that successful investment requires each investor in a financial market to guesswhat other investors will do. George Soros has called this need to guess the intentions of others‘reflexivity’. Similarly, John Maynard Keynes compared financial markets to a beauty contest game inwhich each participant tries to predict which model other participants will consider most beautiful.Furthermore, in many cases investors have incentives to coordinate their choices. For example,someone who thinks other investors want to buy lots of Japanese yen may expect the yen to rise invalue, and therefore has an incentive to buy yen too. Likewise, a depositor in IndyMac Bank whoexpects other depositors to withdraw their funds may expect the bank to fail, and therefore has anincentive to withdraw too. Economists call an incentive to mimic the strategies of others strategiccomplementarity. It has been argued that if people or firms have a sufficiently strong incentive to dothe same thing they expect others to do, then self‐fulfilling prophecies may occur. For example, ifinvestors expect the value of the yen to rise, this may cause its value to rise; if depositors expect a

ank to fail this may cause it to fail. Therefore, financial crises are sometimes viewed as a viciouscircle in which investors shun some institution or asset because they expect others to do so.LeverageLeverage, which means borrowing to finance investments, is frequently cited as a contributor tofinancial crises. When a financial institution (or an individual) only invests its own money, it can, inthe very worst case, lose its own money. But when it borrows in order to invest more, it canpotentially earn more from its investment, but it can also lose more than it has. Therefore leveragemagnifies the potential returns from investment, but also creates a risk of bankruptcy. Sincebankruptcy means that a firm fails to honour all its promised payments to other firms, it may spreadfinancial troubles from one firm to another The average degree of leverage in the economy oftenrises prior to a financial crisis For example, borrowing to finance investment in the stock market(‘margin buying’) became increasingly common prior to the Wall Street Crash of 1929.Asset‐liability mismatchAnother factor believed to contribute to financial crises is asset‐liability mismatch, a situation inwhich the risks associated with an institution’s debts and assets are not appropriately aligned. Forexample, commercial banks offer deposit accounts which can be withdrawn at any time and they usethe proceeds to make long‐term loans to businesses and homeowners. The mismatch between thebanks’ short‐term liabilities (its deposits) and its long‐term assets (its loans) is seen as one of thereasons bank runs occur (when depositors panic and decide to withdraw their funds more quicklythan the bank can get back the proceeds of its loans). Likewise, Bear Stearns failed in 2007–8because it was unable to renew the short‐term debt it used to finance long‐term investments inmortgage securities.In an international context, many emerging market governments are unable to sell bondsdenominated in their own currencies, and therefore sell bonds denominated in US dollars instead.This generates a mismatch between the currency denomination of their liabilities (their bonds) andtheir assets (their local tax revenues), so that they run a risk of sovereign default due to fluctuationsin exchange rates.Uncertainty and herd behaviourMany analyses of financial crises emphasise the role of investment mistakes caused by lack ofknowledge or the imperfections of human reasoning. Behavioural finance studies errors in economicand quantitative reasoning. Psychologist Torbjorn K A Eliazon has also analysed failures of economicreasoning in his concept of ‘œcopathy’. Historians, notably Charles P Kindleberger, have pointed outthat crises often follow soon after major financial or technical innovations that present investorswith new types of financial opportunities, which he called ‘displacements’ of investors’ expectations.Early examples include the South Sea Bubble and Mississippi Bubble of 1720, which occurred whenthe notion of investment in shares of company stock was itself new and unfamiliar, and the Crash of1929, which followed the introduction of new electrical and transportation technologies.More recently, many financial crises followed changes in the investment environment brought aboutby financial deregulation, and the crash of the dot com bubble in 2001 arguably began with‘irrational exuberance’ about Internet technology. Unfamiliarity with recent technical and financialinnovations may help explain how investors sometimes grossly overestimate asset values. Also, ifthe first investors in a new class of assets (for example, stock in ‘dot com’ companies) profit fromrising asset values as other investors learn about the innovation (in our example, as others learnabout the potential of the Internet), then still more others may follow their example, driving theprice even higher as they rush to buy in hopes of similar profits.If such ‘herd behaviour’ causes prices to spiral up far above the true value of the assets, a crash maybecome inevitable. If for any reason the price briefly falls, so that investors realise that further gains

are not assured, then the spiral may go into reverse, with price decreases causing a rush of sales,reinforcing the decrease in prices.Regulatory failuresGovernments have attempted to eliminate or mitigate financial crises by regulating the financialsector. One major goal of regulation is transparency: making institutions’ financial situations publiclyknown by requiring regular reporting under standardised accounting procedures. Another goal ofregulation is making sure institutions have sufficient assets to meet their contractual obligations,through reserve requirements, capital requirements, and other limits on leverage. Some financialcrises have been blamed on insufficient regulation, and have led to changes in regulation in order toavoid a repeat. For example, the Managing Director of the IMF, Dominique Strauss‐Kahn, has blamedthe financial crisis of 2008 on ‘regulatory failure to guard against excessive risk‐taking in the financialsystem, especially in the US’. Likewise, the New York Times(http://topics.nytimes.com/top/reference/timestopics/subjects/c/credit_crisis/index.html) singled out thederegulation of credit default swaps as a cause of the crisis. However, excessive regulation has alsobeen cited as a possible cause of financial crises. In particular, the Basel II Accord has been criticisedfor requiring banks to increase their capital when risks rise, which might cause them to decreaselending precisely when capital is scarce, potentially aggravating a financial crisis.FraudFraud has played a role in the collapse of some financial institutions, when companies have attracteddepositors with misleading claims about their investment strategies, or have embezzled the resultingincome. Examples include Charles Ponzi’s scam in early 20th‐century Boston, the collapse of theMMM investment fund in Russia in 1994, the scams that led to the Albanian Lottery Uprising of1997, and the collapse of Madoff Investment Securities in 2008. Many rogue traders that havecaused large losses at financial institutions have been accused of acting fraudulently in order to hidetheir trades. Fraud in mortgage financing has also been cited as one possible cause of the 2008subprime mortgage crisis; government officials(http://money.cnn.com/2008/09/23/news/companies/fbi_finance/) stated on 23 September 2008 that theFBI was looking into possible fraud by mortgage financing companies Fannie Mae and Freddie Mac,Lehman Brothers, and insurer American International Group.ContagionContagion refers to the idea that financial crises may spread from one institution to another, aswhen a bank run spreads from a few banks to many others, or from one country to another, as whencurrency crises, sovereign defaults, or stock market crashes spread across countries. When thefailure of one particular financial institution threatens the stability of many other institutions, this iscalled systemic risk. One widely cited example of contagion was the spread of the Thai crisis in 1997to other countries like South Korea. However, economists often debate whether observing crises inmany countries around the same time is truly caused by contagion from one market to another, orwhether it is instead caused by similar underlying problems that would have affected each countryindividually even in the absence of international linkages.Recessionary effectsSome financial crises have little effect outside of the financial sector, like the Wall Street crash of1987, but other crises are believed to have played a role in decreasing growth in the rest of theeconomy. There are many theories why a financial crisis could have a recessionary effect on the restof the economy. These theoretical ideas include the ‘financial accelerator’, ‘flight to quality’ and‘flight to liquidity’, and the Kiyotaki‐Moore model. Some ‘third generation’ models of currency crisesexplore how currency crises and banking crises together can cause recessions.

The Recent Financial CrisisDuring the 20th century, the world experienced two major financial crises. The first global financialcrisis was seen during 1929–30, which affected the developed nations, Europe and America, whilethe second crisis came in 1997 and remained until 1999 and was experienced by emergingeconomies of Asia Pacific. The recent financial crisis has taken the attention of the world; it was seenwith serious anxiety as it falls outwards from the regions originally affected. Alan Greenspan recentlycalled it a ‘once‐in‐a‐century credit tsunami’, born of a collapse deep inside the US housing sector.On the other hand the discussions from the other previous or recent disaster come to mind too, as itwas seen that the great wave of the financial crisis overtop one economic levee 1 after another.Instability rushed forward from sector to sector, firstly from housing into banking and other financialmarkets, and then into all parts of the real economy. The recent financial crisis has also been rushed 2across the public private boundary, which has hit the private firms and the financial statements hasforced the new heavy demands 3 on the public sector’s finances. The crisis has surged across nationalborders within the developed world, and which swamp other developing countries, affecting thesignificant economic progress of recent years (Yifu Lin, 2008).As Nikolson (2008) recognised, the financial crisis which initiated in the United States has nowbecome a global phenomenon. This crisis apart from affecting the capitalist economies hasdistressed the socialist economy like Russia as well; in May 2008 the Russian stock market had fallenby 50% and the Russian central bank had to buy rouble in massive amounts to prevent the severedrop against the US dollar and euro (Erkkilä, 2008). About the cause of current crisis Bartlett (2008)said that it started with the downfall of the US sub‐prime mortgage industry, the intensity of thiscollapse was significant: ‘Mark‐to‐market losses on mortgage backed securities, collateralized debtobligations, and related assets through March 2008 were approximate $945 billion.’ He furtherstated that it is ‘The largest financial loss in history’, as compared to Japan’s banking crisis in 1990 ofabout $780 billion, losses stemming from the Asian crisis in 1997–8 of approximately $420 billionand the $380 billion savings and loan crisis of the US itself in 1986–95. Yılmaz (2008) charged the USsubprime mortgage industry to be the major reason of current global financial crisis; he also statedthat the total loses estimated initially up to $300 to $600 billion are now considered to be around $1trillion.While highlighting the factors why this US sub‐prime mortgage crisis turn into global banking crisis,Khatiwada and McGirr (2008) stated ‘Many of these sub‐prime mortgages actually never made it onthe balance sheets of the lending institutions that originated them’; and they were made attractiveto foreign banks by high investment grading, ‘when sub‐prime borrowers failed to repay theirmortgages, the originating institution needed to finance the foreclosure with their own money,bringing the asset back on its balance sheet. This left many banks in a financially unviable situation,in a rather short, unmanageable timeframe’. However Hyun‐Soo (2008) argues that it was the ‘TrustCrisis’ which caused this global predicament. DeBoer (2008) believes that it was a series of eventswhich caused the crisis; it begins with the collapse of currencies in East Asia in 1997 and becameedgy due to the financial crisis of Russia in 1998. Next, in USA was the ‘dot‐com’ stock collapse in2001, and the final stroke was again in USA, when after a swift decline in housing prices and rapidcontraction in credit, it fell into recession.Rasmus (2008) has the same thoughts; he, while discussing the reasons for the economic recessionof the US said:The ‘real’ ailments afflicting the US economy for more than a quarter‐century nowinclude sharply rising income inequality, a decades‐long real pay freeze for 91 millionnon‐supervisory workers, the accelerating collapse of the US postwar retirement andhealthcare systems, the export of the US economy’s manufacturing base, the neardemiseof its labor unions, the lack of full time permanent employment for 40 per centof the workforce, the diversion of massive amounts of tax revenues to offshore shelters,the growing ineffectiveness of traditional monetary and fiscal policy, and the progressivedecline of the US dollar in international markets.

Marxist theoriesRecurrent major depressions in the world economy at the pace of 20 and 50 years (often referred toas the business cycle) have been the subject of studies since Jean Charles Léonard de Sismondi(1773–1842) provided the first theory of crisis in a critique of classical political economy’sassumption of equilibrium between supply and demand.Developing an economic crisis theory becomes the central recurring concept throughout Karl Marx’smature work. Marx’s law of the tendency for the rate of profit to fall borrowed many features of thepresentation of John Stuart Mill’s discussion Of the Tendency of Profits to a Minimum (Principles ofPolitical Economy, Book IV, Chapter IV). The theory is a corollary of the Tendency towards theCentralization of Profits.The viability of this theory depends upon two main factors: first, the degree to which profit is taxedby government and returned to the mass of people in the form of welfare, family benefits and healthand education spending; and secondly, the proportion of the population who are workers ratherthan investors/business owners.Empirical and econometric research continues especially in the world systems theory and in thedebate about Nikolai Kondratiev and the so‐called 50 years Kondratiev waves. Major figures of worldsystems theory, like Andre Gunder Frank and Immanuel Wallerstein, consistently warned about thecrash that the world economy is now facing. World systems scholars and Kondratiev cycleresearchers always implied that Washington Consensus oriented economists never understood thedangers and perils that leading industrial nations will be facing and are now facing at the end of thelong economic cycle which began after the oil crisis of 1973.Minsky’s theoryHyman Minsky has proposed a post‐Keynesian explanation that is most applicable to a closedeconomy. He theorised that financial fragility is a typical feature of any capitalist economy. Highfragility leads to a higher risk of a financial crisis. To facilitate his analysis, Minsky defines threeapproaches to financing that firms may choose, according to their tolerance of risk. They are hedgefinance, speculative finance and Ponzi finance. Ponzi finance leads to the most fragility.• For hedge finance, income flows are expected to meet financial obligations in every period,including both the principal and the interest on loans.• For speculative finance, a firm must roll over debt because income flows are expected to onlycover interest costs. None of the principal is paid off.• For Ponzi finance, expected income flows will not even cover interest cost, so the firm mustborrow more or sell off assets simply to service its debt. The hope is that either the market valueof assets or income will rise enough to pay off interest and principal.Financial fragility levels move together with the business cycle. After a recession, firms have lostmuch financing and choose only hedge, the safest. As the economy grows and expected profits rise,firms tend to believe that they can allow themselves to take on speculative financing. In this case,they know that profits will not cover all the interest all the time. Firms, however, believe that profitswill rise and the loans will eventually be repaid without much trouble. More loans lead to moreinvestment, and the economy grows further. Then lenders also start believing that they will get backall the money they lend. Therefore, they are ready to lend to firms without full guarantees ofsuccess.Coordination gamesMathematical approaches to modelling financial crises have emphasised that there is often positivefeedback between market participants’ decisions. Positive feedback implies that there may be

dramatic changes in asset values in response to small changes in economic fundamentals. Forexample, some models of currency crises (including that of Paul Krugman) imply that a fixedexchange rate may be stable for a long period of time, but will collapse suddenly in an avalanche ofcurrency sales in response to a sufficient deterioration of government finances or underlyingeconomic conditions. According to some theories, positive feedback implies that the economy canhave more than one equilibrium. There may be an equilibrium in which market participants investheavily in asset markets because they expect assets to be valuable, but there may be anotherequilibrium where participants flee asset markets because they expect others to flee too This is thetype of argument underlying Diamond and Dybvig’s model of bank runs, in which savers withdrawtheir assets from the bank because they expect others to withdraw too.Herding models and learning modelsA variety of models have been developed in which asset values may spiral excessively up or down asinvestors learn from each other. In these models, asset purchases by a few agents encourage othersto buy too, not because the true value of the asset increases when many buy (which is called‘strategic complementarity’), but because investors come to believe the true asset value is highwhen they observe others buying.In ‘herding’ models, it is assumed that investors are fully rational, but only have partial informationabout the economy. In these models, when a few investors buy some type of asset, this reveals thatthey have some positive information about that asset, which increases the rational incentive ofothers to buy the asset too. Even though this is a fully rational decision, it may sometimes lead tomistakenly high asset values (implying, eventually, a crash) since the first investors may, by chance,have been mistaken.In ‘adaptive learning’ or ‘adaptive expectations’ models, investors are assumed to be imperfectlyrational, basing their reasoning only on recent experience. In such models, if the price of a givenasset rises for some period of time, investors may begin to believe that its price always rises, whichincreases their tendency to buy and thus drives the price up further. Likewise, observing a few pricedecreases may give rise to a downward price spiral, so in models of this type large fluctuations inasset prices may occur. Agent‐based models of financial markets often assume investors act on thebasis of adaptive learning or adaptive expectations.ConclusionThis study confirms that the global financial crisis has a significant effect on the financial institutionsof developing countries. Banks in the developing economies will see their credit lines from foreignbanks squeezed and the increasing financial flows that these economies have been experiencing aregoing to dry up. The perception that they had broken the links with the larger economies has beenpainfully refuted by the hard facts since the advent of the crisis. The Governments and Central Banksof Ghana and Nigeria introduced programs to recapitalize banks, guarantee bank liabilities, andprovide liquidity to banks by funding markets and in some cases support troubled asset markets.These measures have somewhat proved efficient in managing the negatives effects that the crisiscould have brought on these economies. As Global problems may require global multilateralsolutions. If the crisis will continue for long period, state and local governments may becomerestrictive as they try to shore up new financing arrangements for their operations.1‐ Levees and floodwalls are flood control structures meant to keep flood waters out of a floodplain area. These structureshave upper limits beyond which larger floods cannot be controlled. This limit is often referred to as the level of protectionthat the structure provides to the floodplain area. Since the structure will experience bigger floods that will overtop andflood the interior, overtopping becomes a design concern.2 & 3 ‐ the situation where the financial crisis demands that the public sector would have to bail out some private sectorfirms in order to prevent them from going bankrupt. This places a demand on the financial statements of the public sector.

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Soludo, C C (2009a), ‘Global Financial and Economic Crisis: How Vulnerable Is Nigeria?’, apresentation by the Governor of the Central Bank of Nigeria; January.Soludo, C C (2009b), ‘Banking in Nigeria at a Time of Global Financial Crisis’, a presentation by theGovernor of the Central Bank of Nigeria at the Special Interactive Session on the Banking System, 30March.World Bank (2008), Global Development Finance. Washington, DC: World Bank.Yifu Lin (2008), The impact of the financial crisis on developing countriesYilmaz (2008), ‐ Global Financial Crisis and the Volatility Spillovers across Stock MarketsWebsiteshttp://en.wikipedia.org;/wiki/financial_crisi_of_2007 ‐ Wikipediahttp://www.internationalviewpoint.org/spip.php?article1581 – International View Pointhttp://www.globalissues.org/article/768/global‐financial‐crisis ‐ Global Issueshttp://www.rba.gov.au/publications/fsr/2007/ mar/html/box‐c.html.http://www.bog.gov.gh – Central Bank of Ghanahttp://www.cbn.gov.ng – Central Bank of Nigeriahttp://www. Africa‐union.org – African Union (AU)

Anecdotal evidence suggests that the success of government policies tostabilise the banking systems of West Africa has varied. This paper will examineprecisely what steps governments took, whether discrimination against foreigncommercial interests was a necessary part of a successful formula for stabilisation,and in general assess the effectiveness of measures taken in Nigeria and Ghana.Centre for Economic Policy Research77 Bastwick Street, London EC1V 3PZTel: +44 (0)20 7183 8809 Fax: +44 (0)20 7183 8820 Email: cepr@cepr.org www.cepr.org