When Banks Fail: Understanding the Causes and How Your Money Is Protected.

Bank failures are an all-too-frequent headline in recent years. As far as Nigeria is concerned, the Central Bank has revoked the licenses of more than 130 microfinance banks in 2023, in addition to the revocation of the license of the more popularly known Heritage Bank. For every person who deposits money into a bank, every time they hear about another bank's failure, they ask themselves, “What will happen to my money?”

For anyone seeking to protect their earned savings, it's important to know the reasons why banks fail and how depositors are protected. This is not an economist's story; it's a story to every Nigerian who has a bank account.

Why Do Banks Fail? The Root Causes

There are not many instances of bank failures due to one incident. However, they are the product of a mix of high-risk behavior, inadequate controls, and external events. If you know what causes them to happen, you are the first step to being protected.

The first is poor corporate governance and weak management. The first is poor corporate governance and weak management.

The lack of leadership is at the core of many banking crises. Bank failures have consistently been examined, and the behavior of bank managers and bank shareholders is invariably cited as the main driver of bank failures. For instance, in the Ghanaian banking crisis, failures were associated with interrelated lending, loans granted without proper procedures in place and lending to high-risk borrowers without appropriate checks.

A more detailed picture is provided by the Nigerian banking crisis which occurred in 2009. After a few years of expansion and a transition to a Universal Banking model, underlying weaknesses emerged. CBN singled out corporate governance inadequacies, lack of transparency regarding financial positions, and enforcement and supervision double standards as contributors. This is an example of banks being too exposed to risk without the means of managing that risk.

3. Lack of motivation

The 2009 Nigerian crisis was not an ordinary case of global recession spillover but was "homegrown". The crisis worsened with large capital inflows from high prices for crude oil that prompted banks to lend recklessly, sometimes to non-priority uses, such as the stock market, and treat the proprietary trading as loans.

This suggests a process of "lending concentration" by powerful borrowers which affects the lending policy. The blame has been placed on "elite borrowers in the financial market" and the regulatory reaction that ensued, as one analysis put it, "often [was] geared to the 'elite customers' while harming lower-end consumers.

 3. Systemic Vulnerabilities and Regulatory Gaps

Regulators have the responsibility of keeping the system safe but can be caught off-guard. One important oversight committee, the Financial Services Regulation Coordinating Committee, failed to meet for two years prior to the crisis in 2009. This important regulatory lacuna enabled dangerous behavior to flourish.

There are other environmental factors that have a role as well. The banking sector is fragile due to poor business infrastructure, weak legal processes which make debt recovery difficult and lack of credible rating agencies for the assessment of credit worthiness. Banks have to contend with a wide range of risks, all of which are continually changing, ranging from credit and liquidity risks to emerging ones such as cyber risks, climate change risks and geopolitical risks.

The NDIC's role in protecting your money

A bank failure can cause quite a bit of panic. But the Nigeria Deposit Insurance Corporation (NDIC) has a safety mechanism in place to keep you safe. The NDIC is a government body that guarantees your bank deposits as a protection in case your bank fails.

What is the NDIC?

The NDIC insures deposits, supervises insured banks, liquidates failed banks and ensures stability and public confidence in the financial system. This is one of the elements of the “financial safety net”, which also includes the Central Bank's role as “lender of last resort” and the various policies regarding the regulation and supervision of banks.

The question that arises is, “How Much is Insured?”

This depends on the financial institution type, and the amount of insurance you can have depends on the type of financial institution. As of May 2024, the NDIC increased the deposit insurance coverage. The current coverage levels are:

Deposit Money Banks (DMBs): ₦5,000,000 per depositor.

Microfinance Banks (MFBs): ₦2,000,000 per depositor.

Primary Mortgage Banks (PMBs): ₦2,000,000 per depositor.

Payment Service Banks (PSBs): ₦2,000,000 per depositor.

Mobile Money Operators (MMOs): ₦5,000,000 per depositor.

The hike in coverage for DMBs this time from N200k to N5m was to spur on savings and trust in the financial system in the face of economic pressures and rising prices.

 What If Your Bank Goes Out of Business?

The process should be as seamless as possible for the depositors. In case of bank failure or a bank is revoked, the NDIC intervenes.

Individuals whose deposits are insured up to ₦5 million or less will be entitled to a full refund of their deposits.

For deposits exceeding ₦5 million, the insured amount of ₦5 million will be paid and the balance may be paid to the depositors as and when proceeds of bank's assets are realized from sales and the loans recovered. This means that you may recoup some of your money over time, but you have no guarantee that you'll get back the amount that you haven't been insured for.

The NDIC is doing all it can to speed up payouts. The corporation, for instance, are adopting depositors' Bank Verification Numbers (BVN) for credit to alternative accounts in the event of failure of the bank for a more streamlined process. This is because all deposits are automatically protected up to the amount of your deposit, without having to opt in for protection.

Caution: The bounds of protection,

The NDIC system is a great safety device but not a complete safeguard for everything you have. The ₦5 million is a ceiling; not a floor. When a bank fails, if you have over ₦5 million in one bank, then you are an unsecured creditor of the bank for the amount over ₦5 million. The amount that you can get back will depend on the amount that the NDIC can recover from the bank assets.

That's why the diversification strategy is a good one to use. For those with substantial savings, having accounts in several banks can help ensure that savings fall within limits for each bank and that risk is reduced. While the NDIC is taking the right steps to enhance the protection of deposits, it is important to note that individuals' personal financial safety comes first, and that starts with the rules of the game.

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