African
Develop
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The Colonial Origins of Banking Crisis in Africa
Working
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Lisa D. Cook, Linguère Mously Mbaye, Janet Gerson and Anthony Simpasa
Indus
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n° 358
Octobe
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Working Paper No. 358
Abstract
Could initial – colonial and early post-colonial –
conditions explain episodes of systemic crisis in
banking systems today? We exploit differences in
ethnic concentration of initial ownership and
management structure of Nigerian banks
established during the colonial era to examine
banking crisis and vulnerability of the financial
system in contemporary Nigeria. Although
banking institutions emerged from or were a
reaction to British colonial banking structure,
they pursued different practices with respect to
ownership and management structure. To
measure these initial conditions, we use historical
data from the Nigerian banking system to
construct an index of diversity in the initial
ownership and management structure of each
bank, where more diversity corresponds to a
lower concentration of insiders, including family
members, tribal affiliates, and political partners.
We collected data from the “Blue Books”, British
colonial banking records from 1887 to 1940, data
on indigenous banks established during the
colonial period from 1929 to 1960, and data on
banks from 1960 to 2016. These data allow us to
track the first Nigerian families, ethnic groups,
and their associates who were part of the
formation of the formal banking institutions in
the country. We also collect individual and
aggregate bank data from 2001 to 2016 collected
from bank balance sheets, financial statements,
annual reports, statistical bulletins, banking
supervision reports, and other reports of the
Central Bank of Nigeria and the Nigeria Deposit
Insurance Corporation. Our estimates suggest
that lower levels of diversity are associated with
higher levels of risk for a bank. That is, lack of
initial diversity in ownership and management of
Nigerian banks may have played a role in the
performance and fragility of the Nigerian banking
system that lent itself to systemic crisis. Our
findings are consistent with the broader recent
literature that shows higher profit and stronger
performance of more diverse firms relative to less
diverse firms due to, for example, diversity-
driven innovation and product development.
This paper is the product of the Vice-Presidency for Economic Governance and Knowledge Management. It is part of
a larger effort by the African Development Bank to promote knowledge and learning, share ideas, provide open access
to its research, and make a contribution to development policy. The papers featured in the Working Paper Series
(WPS) are considered to have a bearing on the mission of AfDB, its strategic objectives of Inclusive and Green
Growth, and its High-5 priority areas: Power Africa, Feed Africa, Industrialize Africa, Integrate Africa, and
Improve Living Conditions of Africans. The authors may be contacted at [email protected].
Citation: Cook, L. D., L.M. Mbaye, J. Gerson and A. Simpasa. (2021), The Colonial Origins of Banking Crisis in
Africa, Working Paper Series N° 358, African Development Bank, Abidjan, Côte d’Ivoire.
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1
The Colonial Origins of Banking Crisis in Africa*
Lisa D. Cook,† Linguère Mously Mbaye,‡ Janet Gerson,§ and Anthony Simpasa**
JEL Classification: G21, G32, N47, N27, O16
Key words: Banks, financial institutions, banking crisis, financial crisis, colonial economic history, African
economic history, social networks, Africa
*Acknowledgements: Earlier versions of this paper were presented at the 7th Annual Meeting of the African Economic
History Network and The African Development Bank Research Seminar Series. We are grateful to conference and
seminar participants, Koffi Boateng and an anonymous reviewer for their comments. We thank Chuku Chuku and
Adeleke Salami for help with the assignment of ethnicity in Nigeria. We also thank Zackary Seogo and Assi Okara
for excellent research assistance. We are responsible for any errors that may remain. The findings, interpretations, and
conclusions expressed in this paper are entirely those of the authors and do not necessarily represent the view of the
African Development Bank, its Board of Directors, or the countries they represent. † Michigan State University. E-mail address: [email protected] ‡ African Development Bank Group . E-mail address: [email protected] § University of Michigan. E-mail address: [email protected] ** African Development Bank Group. E-mail address: [email protected]
2
1. Introduction
The economic and financial crisis of 2007–2009 and the following global economic downturn
caused financial instability with negative effects on economic growth and development. Banking
crises are expensive anywhere and the associated fiscal costs tend to be high relative to GDP. For
instance, in the 1990s, in Norway the cost was equivalent to 4% of GDP; Sweden, 6.4%; and
Finland, 8%. For developing countries, the cost is even higher. For Mauritania, it represented 15%
of GDP, for Côte d’Ivoire it was estimated at 17%, and for Senegal it was 25% (Cook, 2014).
Consequently, being able to deal with such consequences requires a deep understanding of the
genesis and nature of the banking crisis, especially in developing countries, which tend to be more
vulnerable (Demirgüç-Kunt and Detragiache, 2005). Moreover, the origin of the crisis matters in
explaining the relationship between financial crisis and subsequent reforms to be implemented
(Waelti, 2015).
In this study, we analyze the extent to which the diversity of the initial ownership and
management structure can explain the banking crisis and the vulnerability of the financial system
in contemporary Nigeria. We are interested in Nigeria for several reasons. Nigerian banks have
been expanding across the continent, and their increased footprint could propagate shocks from
one of the largest banking systems in Africa to other countries (with weaker banks or supervision,
for instance) without an overarching regulatory authority for the continent, which highlights the
need for more robust cross-border supervisory cooperation. At the same time, Nigeria has had
regular banking crises dating back to the pre-colonial era. However, little is known about the
origins of these crises. It is therefore crucial that we understand the genesis of these crises in order
to prevent future ones from occurring, especially given that most countries, such as the United
States and some in the eurozone, are implementing policy measures to lessen the frequency,
amplitude, and cost of banking crises. The banking sector reforms conducted in 2004 in Nigeria
were aimed at enhancing the capacity of banks to withstand external shocks and therefore improve
the financial system stability. Since then, the performance of the banking system has improved but
global and other exogenous shocks could still pose potential risks to the system.
Understanding the genesis of banking crises by examining the dynamics established before
and during the colonial era is embedded in a broader literature that focuses on colonial economic
history and the role of initial conditions and institutional architecture that shaped those conditions.
3
There is an increasing focus among economists on economic outcomes arising from historical
foundations. It has been demonstrated that initial conditions are important determinants of
contemporary economic outcomes. For instance, European colonization from the 16th century
shaped economic growth and development through its effect on institutions or cultural norms
(Acemoglu et al., 2001; Engerman and Sokoloff, 1997, 2002; La Porta, et al., 1998; Nunn, 2008;
Nunn and Wantchekon, 2011).
The relationship between the diversity of ownership and management structures and the
occurrence of banking crisis has not been well documented in developing countries, particularly in
Africa. This study aims to fill this gap by focusing on Nigeria, the largest economy in Africa with
one of the largest banking systems on the continent. We measure initial conditions using a diversity
index, constructed as a concentration index of insiders such as family members, affiliates, and
political partners in the founding ownership or management structure of indigenous banks
established during the colonial era. More diversity corresponds to a lower concentration of insiders.
In this context, we assume that the relationship between historical social networks and financial
crisis will be highly influenced by the level of trust exhibited by different segments of the banking
population.
The literature on the centrality of trust in well-functioning financial systems to collect and
produce information is extensive. Trust is an important element of economic development that can
be transmitted across generations. Algan and Cahuc (2014) use data from 86 countries for the years
1980–2010 to show the positive relationship between trust and the development of financial
markets, measured as credit granted by banks and financial institutions as a percentage of GDP.
Gould and Hijzen (2017) mention growing empirical evidence that trust contributes to financial
development and economic growth, pointing out that people who do not trust the financial system
might not invest in the stock market. More specifically, in Africa, Nunn and Wantchekon (2011)
found that levels of trust could be traced back to the period of the trans-Atlantic slave trade. People
whose ancestors were heavily traded were more likely to have lower levels of trust, a relationship
that helps understand why banking crises have strong negative effects (Mishkin, 1996). For
instance, Ajayi (2016) demonstrates that trust is the main reason why unbanked people do not hold
bank accounts in Nigeria. and trust shaped consumer perceptions and savings behavior after the
4
financial crisis. This is particularly true when, from prior experience with banking crises, people
prefer keeping their money from banks that are found presenting a higher risk.
Another argument is that on the supply side, lenders may be more likely to minimize
information asymmetry by giving loans to borrowers when they can check their socio-economic
background through their family name or ethnicity, for instance. On the demand side, customers
will make formal banking services only if they have strong confidence in such an institution. Social
networks will thus be at play. Indeed, the reputation of a bank is very likely related to its owner. If
that reputation has been historically established, this will positively affect the confidence of
potential clients. Moreover, there is evidence showing that people who do not have access to formal
banks or credit institutions rely on their close relatives to finance their consumption, saving, and
investment needs, as well as to deal with shocks that may occur (e.g., Rosenzweig, 1988;
Fafchamps and Lund, 2003). Thus, social networks affect access to credit and financial institutions
and help people finance their consumption, saving, and investment needs (Banerjee et al., 2013;
Okten and Osili, 2004; Wydick et al., 2011). Indeed, ethnicity-based networks can lead to more
trust and insurance, above all in imperfect credit markets (Fafchamps, 2000), and allow access to
group resources in the form of cheap loans, for instance (La Ferrara, 2002).
This paper also relates to the literature on the role of diversity in performance. The effect
of diversity on productivity is rather complex and depends on various factors6. On the one hand, it
is argued that diversity matters a great deal for a firm’s performance. There can be positive
complementarities between different ethnic groups that could foster productivity, and some studies
find that diversity has a positive effect on production, consumption, and productivity in the United
States (Ottaviano and Peri, 2005, 2006). Racial and gender diversity can thus have a positive effect
on creativity and task completion (Richard et al., 2002; Jackson and Ruderman, 1995). This
positive effect on productivity is also valid in the context of a developing country such as Kenya
(Bigsten et al., 2000). In the literature grounded in signaling theory and theory of the behavior of
the firm, the common view is that board diversity leads to higher firm performance. Directors with
different origins introduce heterogeneity of ideas, experiences, and points of view (Ezat and El-
Masry, 2008; Samaha et al., 2012). In this line of research, diversity is found to be key for creativity
6 See Alesina and La Ferrara (2005) for a comprehensive literature review of ethnic diversity and
economic performance.
5
and innovation (Hillman, 2014). Experimental studies have also provided evidence of the positive
linkage between diversity and performance. Using a lab study setting, Cox et al. (1991) and Watson
et al. (1993) have shown that diversity within work groups increases their effectiveness.
Nevertheless, another strand of this literature argues that there is no direct relationship
between diversity and team performance (Kochan et al., 2002)7 or that diversity can even have a
detrimental effect on a firm’s performance. This is particularly the case for relations-oriented
diversity, where heterogeneity within the board can foster social categorization, lead to
misunderstandings, slow decision making, and generate conflict of interest with different board
members pursuing different agendas (Veltrop et al., 2015; Ferreira, 2011). Social identity plays a
major role in explaining this negative association between diversity and performance, as evidenced
by Pelled et al. (1999) and Tsui et al. (1992).8
These two strands of literature suggest research on diversity should examine the trade-off
between positive complementarities and communication costs. Recent research on team diversity
and team performance (Marx et al., 2021) explores the consequences of diversity in Kenyan non-
profit organizations using a field experiment and door-to-door canvassers. Incorporating both
strands of literature, they conclude ethnic diversity between teammates and their supervisor
improves team effort and performance, while diversity within a team may instead create
communication costs and other frictions, hurting team performance. An experimental study on the
role of diversity in the performance of entrepreneurial teams (Calder-Wang et al., 2021) adds
another insight on this dichotomy. In the experiment, some of the teams were assigned randomly,
while in other teams, people choose their teammates. In randomly assigned teams, diversity was
forced and greater ethnic diversity reduced team performance. This negative effect was eliminated
if a diverse team instead formed by choice.
The link between diversity and performance has been of special interest in the banking
sector in the aftermath of the global financial crisis. Among the identified shortcomings in the
7 Unless organizational context and policies are controlled for. 8 The evidence seems to point to a trade-off between the benefits of diversity and the costs that may arise
due to difficult communication between people with different cultures, for instance (Lazear, 1999). Some
evidence on the link between ethnic diversity and performance finds that more diversity could lead to
more conflict and less communication, but after controlling for the effects of conflict on performance it
could also increase productivity (O’Reilly et al., 1997)
6
banking sector that led to the crisis are the functioning of corporate governance mechanisms (de
Larosiere Group, 2009). In the case of the European Union (EU), the European Commission (2010)
highlighted the need for strong and legally binding action to ensure heterogeneity in corporate
boards. Investigating the effect of board diversity on performance in banks, García-Meca et al.
(2015) show that gender diversity increases bank performance, while national diversity inhibits it,
based on a banks’ sample from selected OECD countries. More recently, Arnaboldi et al. (2020)
analyze the EU board diversity-related reforms and also found a positive effect of diversity on bank
performance.
Birken and Cigna (2019) make the case for gender diversity on corporate boards. They
point out that greater female representation enhances the variety of skills and experiences boards
draw on, which improves performance while reducing the risk of bribery, fraud, and scandals.
Reviewing corporate governance of financial institutions in Europe, they mention new 2013
directives mandating sufficient diversity in management, resulting in a variety of views and
experiences when crucial decisions are made. Ironically, several dimensions of diversity are
included in these directives, including gender, but not race or ethnicity. More recently, a Wall Street
Journal article9 covered the European Central Bank’s goal of including gender diversity in its
approval process for new bank board members and executives, quoting the claim by the Bank’s
banking supervisor that diversity in leadership is crucial for effective governance of banks.
There is little evidence however on the relationship between diversity – in particular, ethnic
diversity – and banks’ performance in Africa. Elsewhere, and particularly in some Asian countries
(e.g., Japan, South Korea, and Indonesia), where the shareholding of banks is concentrated in a few
connected people and firms, often with links to the ruling political elites, the breach of lending
limits to such people was found central to growing credit risks and the Asian financial crisis of
1997 (Lemieux, 1999). Lending to politically exposed people and the attendant moral hazard and
potential regulatory capture are a real concern in countries with weak institutional and governance
structures. This further highlights the importance of robust governance systems within banks and
9 Source: https://www.wsj.com/articles/big-banks-required-to-fill-board-seats-with-women-under-ecb-
proposal-11623752981
7
the need to have a bank regulatory framework where different supervisors hold power, rather than
having all power concentrated in a single supervisor (Boyer and Ponce, 2012).
It is helpful to link the role of diversity in performance to the literature on related party
transactions and corporate governance, which is another aspect that we tackle in this paper. Related
party transactions are defined as transactions between a company and its managers, directors, and
owners. As in the case of diversity, there can be conflicting views on the role of related party
transactions. On the one hand, the related party transactions could lead to abuse and conflict of
interest by undermining management agency to shareholders or executives. On the other hand, they
could lead to efficient transactions for firms by allowing third parties to build trust and share
relevant information (Gordon et al., 2004).
In addition to the literature on the role of initial conditions, trust, diversity, and corporate
governance on performance, this paper also draws on the literature that attempts to identify the
causes of banking crisis.10 The existing evidence shows that banking crises are likely to appear in
weak macroeconomic environments with low GDP growth, high inflation, high real interest rates,
a high share of credit to the private sector, high past credit growth, weak institutions, and an explicit
deposit insurance scheme, all of which can trigger risk-taking behavior from managers (e.g.,
Demirgüç-Kunt and Detragiache, 1997). Claessens et al. (2014) summarized extensive research
on the causes of financial crises, citing unsustainable macroeconomic policies, excessive credit
booms, large capital inflows, and balance sheet fragilities as common indicators foreshadowing
financial crises.
Moretti et al. (2020) summarize and update the IMF’s work on preparing more specifically
for banking crises, finding that common causes of banking crises include high leverage, booming
credit, an erosion of underwriting standards, exposure to rapidly rising property prices and other
asset bubbles, excessive exposure to the government, inadequate supervision, and – often – a high
external current account deficit. It has also been demonstrated that financial liberalization could
increase vulnerability of the banking system (Kaminski and Reinhart, 1999; Mishkin, 1996; Noy,
2004). Moreover, it has been shown that some countries are more vulnerable to banking crises
10 See Reinhart and Rogoff (2009) and Kaminski and Reinhart (1999) for a detailed review of the origins
and correlates of financial crisis.
8
because of the role of different interest groups that form coalitions to influence the functioning of
the banking system, which in turn will affect the stability of the financial system, although such
pressure is less present in liberal regimes than in autocratic ones (Calomiris and Haber, 2014). This
practice can also be associated with the chaebols in South Korea and kieretsu in Japan (Lemieux,
1999). This is all the more important given evidence that firms in countries facing strong official
supervisory bodies face greater financial obstacles due to more reliance on connections and
corruption to acquire external finance while independent supervisory agencies would mitigate the
negative effects of strong supervisory bodies (Beck et al., 2006). Moreover, living wills, whereby
large financial institutions file resolution plans, are very helpful in dealing with bankruptcy costs
(Jarque and Athreya, 2015).
However, the historical causes and, in particular, the effect of social networks formed in
early times on contemporary banking crisis remains largely unexplored, especially in the context
of the most vulnerable African economies and developing countries more generally. Moreover, the
paucity of empirical evidence in developing countries and especially in Africa provides a
compelling case for our paper to fill the gap and, more importantly, provides another dimension to
understanding the effect of diversity or lack thereof on banking performance. Therefore, the
contribution of this paper is important and novel in many aspects.
First, the paper provides new insights related to the aforementioned literature on initial
conditions and economic development by focusing on the financial system. Second, although
various causes of banking crisis have been explored in the literature, to the best of our knowledge
this study is the first to examine crisis related to diversity of initial ownership and management
structure. Third, this paper goes beyond the issue of diversity and performance by looking at
corporate governance–related party transactions, the bank regulatory framework, the importance
of cross-border regulatory supervisory cooperation, and insider lending and asset quality. Fourth,
it focuses on Nigeria, an interesting country in the context of sub-Saharan African banking.
Although Nigeria is the largest economy and the most populous country in Africa, it has a large
share of individuals and entrepreneurs excluded from the formal financial system and has
previously faced regular banking crisis (Cook, 2014). Our findings can therefore be used more
generally to inform policies of banking regulators at all levels, as well as those of multilateral
financial and development organizations, concerning mechanisms that could help foster financial
9
stability along with the implementation of policies to address negative initial conditions settled in
social norms and cultural values. They will also help determine how social networks combined
with efficient policies can be used to better reinforce financial stability in Africa and in developing
countries more generally.
Did early banks set in motion an institutional environment that could increase the
probability of banking crises in the future? We use historical data on these banks and on the
environment they created to investigate the features of that environment that are relevant and could
persist over time. Historical data are available from the “Blue Books” colonial banking records
from 1887 to 1940 in Nigeria11 and from information on the indigenous banks established during
colonial times from 1929 to 1960 (Brown, 1966; Uche, 1997). We identify the first Nigerian
families and their associates who were integral to the formation of the formal banking institutions
in Nigeria at the time of independence. We also collect data on Nigerian banks from 1960 to 2016.
We use both individual and aggregate bank data from 2001 to 2016 and collect information from
financial statements of individual banks, statistical bulletins, banking supervision reports from the
Nigeria Deposit Insurance Corporation (NDIC), and annual reports and other publications of the
Central Bank of Nigeria (CBN). Our results from pooled ordinary least squares (OLS) estimates
suggest that high ethnic concentration, or lack of diversity in the original ownership and
management structure of banks, is associated with a higher level of risk for a bank. This highlights
the importance of diversity of ownership and management structure in mitigating risks to banks
and strengthening banks and the banking system, generally.
Section 2 discusses the Nigerian banking system from colonial times to date. Section 3
describes the data and descriptive statistics, while Section 4 presents the empirical strategy and
results. Section 5 offers concluding remarks and policy implications.
11 The British Colonial Blue Books statistics for Lagos started in 1863.
10
2. Background on Nigerian Banking System
2.1 The colonial banking system and the emergence of indigenous banks12
In the Protectorate of Southern Nigeria, formal banking started with the Treasury Savings Bank,
which was established in Lagos in 1886 and operated from 1887. It started with 45 depositors and
just over £1,400 in deposits at the beginning of the period. By 1940, it had merged with the Postal
Service and had 49,542 depositors and nearly £143,000 in deposits. Two British banks, the Bank
of British West Africa, founded in 1893, and the Barclays Bank DCO (Dominion Colonies and
Overseas), which opened its branch in Lagos in 1917 (IBRD, 1955; Uche, 1997), dominated the
initial formal banking system in Nigeria prior to its independence. Between 1916 and 1960, these
two banks colluded to restrict competition (Austin and Uche, 2007). In 1948 the British and French
bank, United Bank for Africa Limited (UBA), was established to break the monopoly of the two
British-owned banks. Overall, these three banks controlled over 90 percent of aggregate bank
deposits. Consequently, the lack of competition remained, illustrating the fact that the colonial
government in pre-independence Nigeria was more interested in protecting British interests than
African ones (Uche, 1997).13
In addition to the lack of competition between existing colonial banks, they had little
incentive to lend directly to Africans (Austin and Uche, 2007; Uche, 1997), making the colonial
banking system less favorable to Africans compared to European and other non-indigenous African
communities. Among the discriminatory practices cited during the colonial era was the systematic
way Africans were deemed not creditworthy, which reinforced the lack of interest and trust of
colonial banks and translated into higher interest rates charged on loans to Africans (Uche, 1997,
2010). On this issue of trust, Uche (1997, p. 56) writes, “...the belief, among Africans, that the
colonial banks and indeed the entire colonial structures discriminated against them led to
widespread mistrust of colonial initiatives, thus further reducing the chances of success for any
informal kind of regulation either from London or from any kind of colonial structure within the
12 Banking system in pre-independence Nigeria has been documented in the seminal work of Newlyn and
Rowan (1954) as well as Brown (1966). Later, Uche (1997) provided an interesting economic history
study on the Nigeria banking system relying on archive materials.
13 It is worth noting that the British interests were not homogeneous and led to intense competition and
favoritism by the Colonial Office toward one British faction over another. This led to the entrenchment
of monopoly power and contributed to the delay in the evolution of the monetary system in West Africa
(see, e.g., Hopkins, 1970; Fry, 1976).
11
colonies.” The belief that colonial banks discriminated against them was widespread and Africans
therefore created the indigenous banks in protest.
The first indigenous bank in Nigeria, the Industrial and Commercial Bank, was created in
1929 by some African businessmen (Ayida, 1960). However, this bank was liquidated only one
year later. The National Bank of Nigeria (NBN), created in 1933, was the first successful
indigenous bank,14 and indigenous banks created later were less successful (Uche, 1997; IBRD,
1955). In general, indigenous banks did not have the same power as the colonial ones, because they
were poorly capitalized, poorly managed, and poorly staffed (Uche, 1997, 2010). In 1952, the
colonial government implemented a new ordinance to regulate the banking system, giving banks
three years to meet the conditions of the ordinance or face liquidation. The direct consequence of
this ordinance was the failure of most indigenous banks, making people even less likely to trust the
remaining unlicensed indigenous banks (IBRD, 1955; Uche, 1997). In addition, bank requirements
became more demanding with a 1958 banking ordinance that increased the capital requirement
from N200,000 to N400,000. Of the 24 banks established between 1929 and 1952, only four
survived until 1960, and that primarily due to government aid rather than their success in the
banking sector (Uche, 1997; 2010).
2.2 Nigerian banking crisis
In an effort to better control banking activities, the CBN was created in 1958 and became fully
operational in 1959. Bank capital requirements increased to N1.5 million in 1969, the first major
capital requirement increase since the CBN’s inception. The same year, the Banking Decree was
promulgated and marked out the distinction between commercial and merchant banks.
The Nigerian government implemented successive reforms from 1970 to date. Cook (2014)
documents these reforms as well as their effects on the financial system in Nigeria. A wave of
nationalization occurred in 1970s and in the early 1980s resulting in 29 commercial banks and 12
merchant banks for a population of 84 million. Additional structural adjustment plans, begun in
1986, liberalized the financial sector via more privatization, leading to an increase in the number
14 While British bank lending was primarily used to facilitate international trade, African banks invested
a large part of their assets in loans and advances (IBRD, 1955).
12
of banks (Cook, 2014). By 1991, despite the existence 120 commercial and merchant banks,
lending to the private sector remained flat. Much of the banks’ activity involved arbitrating between
opportunities in foreign exchange operations and money market interest rate spreads (Lewis and
Stein, 1997). Minimum capital requirements were increased in 1988 and 1989 to deal with shocks;
and more regulations were put into place to ensure safety of the banking industry and depositors.
For instance, non-bank financial intermediaries were put under the supervision of the CBN
following the promulgation of the Banks and Other Financial Institutions Act (BOFIA) to replace
the CBN Act of 1958 and the Banking Decree of 1969.
These measures were, however, insufficient. The combination of rising non-performing
loans and high interest rates rendered many banks insolvent and the crisis continued until 1994. In
1998, 26 banks’ licenses were withdrawn. In 2001, a new policy established universal banking,
removing the distinction between commercial and merchant banks to enhance the stability of the
financial system. But this did not prevent many banks from being undercapitalized. In 2004, with
contagion spreading financial instability throughout the community and microfinance banking
sectors, the CBN implemented far-reaching reforms, further increasing the minimum capital
requirement from N2 billion to N25 billion (Cook, 2014). These reforms led to bank consolidation,
reducing the number of banks from 89 to 25 licensed banks operating in Nigeria (Marshal, 2017).
In 2008–2009, a new banking crisis emerged in Nigeria, precipitated by the global financial and
economic crisis, as well as a decline in oil prices, reversal of capital inflows and foreign exchange
reserves, a fall in foreign trade finance and investment by foreign investors, and downward pressure
on the exchange rate (Egboro, 2016). In 2009, the Nigerian government asked for an audit, which
revealed that 9 out of 24 banks were insolvent (Sanusi, 2010).
In 2010, the CBN revised the universal banking model toward separated banking licenses
to commercial, merchant, and specialized or development banks. Reforms were continued in 2014
under the 2010 banking model. In 2016, at the height of the economic recession, Nigeria took
various measures to reduce macroeconomic vulnerabilities by strengthening banking supervision,
deregulating fuel prices, and depreciating the Naira (IMF, 2017). The overall history of the
Nigerian banking system between 1887 and 2016 is summarized in Table 1.
13
3. Data and Descriptive Statistics
3.1 Data
Computation of Ethnic Diversity Index
Since this paper is interested in how initial conditions of diversity of ownership and management
structure relate to contemporary banking crises, we use historical data to inform our analysis. We
first refer to the British Colonial Office’s annual Blue Book, which provides data on withdrawals,
loans, interest rates, investments, revenues, expenditures, capital, deposits, and depositors of the
government and private banks operating in Nigeria from 1887 to 1940.
To capture diversity or ethnic concentration within the senior management or ownership of
a bank, we compute a Herfindahl-Hirschman index (HHI). Our index follows previous literature
incorporating ethnic concentration into its analysis (e.g., Guerra et al., 2012). While there are more
than 250 ethnic groups in Nigeria, the three most populous ones are Hausa, Ibo, and Yoruba. We
code the names of the directors and senior management according to their ethnic group, which
corroborates the dominance of the three ethnic groups in the banking system. In addition to groups
for the three primary ethnicities, for completeness we include a group for other ethnicities and a
group for foreigners. Our classification of people in the Hausa group includes all Hausa and
associated ethnic groups, such as the Fulani; the Ibo group includes all Ibo and associated ethnic
groups, such as people from the Niger Delta, Ijaw, Ibibio, and Kalabari; and people in the “other”
ethnicity group include those who could not be clearly identified in an ethnic group resident in
Nigeria. This yields five broad categories of ethnicity: Hausa, Igbo, Yoruba, other ethnicities, and
foreigners.
14
Table 1: Nigerian banking system (1887–2016): From genesis to recent developments
Year Event
1887 Treasury Savings Bank begins operations in Lagos
1893 Advent of the Bank of British West Africa
1917 Opening of a branch in Lagos of the Barclays Bank Dominion Colonies and Overseas
1929 Establishment of the first indigenous bank, the Industrial and Commercial Bank
1930 Liquidation of the first indigenous Bank
1933 Creation of the National Bank of Nigeria
1948 Establishment of the British and French bank, the United Bank for Africa Limited (UBA)
1952 Colonial government issued ordinance to regulate the banking system
1958 Creation of the CBN; banking ordinance increased the capital requirement from N200,000 to N400,000
1959 CBN fully operational
1960 Independence of Nigeria; 4 of 24 banks established between 1929 and 1952 survived
1969 CBN increased the capital requirement to N1.5 million; banking decree delimitating between commercial and merchant banks
1970s–1980s Attempts to nationalize the banking system; 29 commercial banks and 12 merchant banks for a population of 84 million people
1986 Structural adjustment program adopted: liberalization of the financial sector led to an increase in the number of banks
1988–1989 Regulatory reforms to address rising problems in the banking sector due to liberalization and economic stagnation
1991 Peak of 120 commercial and merchant banks; Banks and Other Financial Institutions Act (BOFIA) promulgated
1991–1995 Crisis due to rising non-performing loans, bank insolvency and bank distress; share of distressed banks doubled in 4 years
1998 Major rounds of bank reforms; CBN withdrew the licenses of 26 banks
2001 Adoption of the universal banking removed the distinction between commercial and merchant banks
2004 89 commercial banks; undercapitalized banks; contagion throughout the community and microfinance banking sectors
Reform increasing the minimum capital requirement from N2 billion to N25 billion
2008–2009 Nigerian banking crisis precipitated by the global financial and economic crisis
2009 25 commercial banks operating after some merger and acquisitions and the failure of 13 banks
2010 Creation of the Asset Management Corporation of Nigeria (AMCON); CBN revised the universal banking model
2011 Failure of 6 banks
2014 Continued banking reforms under the 2010 banking model
2016 Measures to reduce vulnerabilities: strengthening banking supervision; deregulation of fuel prices; depreciation of Naira
Source: Authors’ desk research; British Colonial Blue Books (1887–1940); Cook (2014); IMF (2017); Marshal (2017); Uche (1997, 2010).
15
Information on directors and senior management of indigenous banks beginning in 1893–
1894 was collected using information in Uche (1997; 2010) and Brown (1966), which list all
indigenous banks created before 1960. More information, including a bank’s date of failure, if
applicable, was collected from other sources (Austin, 2012; 2016; Chukwu, 2010; Ejamah, 2014;
Mann, 2007; Olukoju, 2003)15.
For more recent years, we relied on various sources such as the CBN Annual Reports, as
well as extensive online searches from Google Scholar and other search engines to find the names
of the owners and managing directors of existing banks. By matching the names of the founders
and directors to data on ethnic names, we were able to identify the ethnicity of founders and
directors. More precisely, after collecting information on names of directors and senior
management, we determined their ethnicity by relating each name with the corresponding ethnicity
mainly using references in the anthropology literature (e.g., Wieschhoff, 1941) and online searches
documenting names and their meaning in each ethnic groups. We also relied on Nigerian
colleagues, who helped identify both ethnicity and regions of origin according to both first and last
names. This information allowed us to build a database of social networks. Then, we were able to
construct an HHI using the concentration of insiders – family members, tribal affiliates, and
political partners in the founding ownership and/or management structure of a bank.
Thus, for each bank 𝑖, we compute 𝐻𝐻𝐼 = ∑ 𝑠𝑖,𝑘25
𝑘=1 , where 𝑠𝑖 is the share of a particular
ethnic group among directors and senior management of a bank over the five ethnic groups. Based
on the proportion of each ethnic group among directors and in senior management, the index was
calculated as: (share of Yoruba)2 + (share of Hausa)2 + (share of Ibo)2 + (share of other ethnicity)2
+ (share of foreigners)2.
The HHI ranges from 0 to 1. Consistent with the literature (e.g., Guerra et al., 2012), an
index below 0.15 indicates low concentration. An index ranging from 0.15 to 0.25 indicates
moderate concentration, while an index above 0.25 indicates high concentration and thus low
ethnic diversity. A HHI of 0 means that there is no concentration (and thus a high level of diversity)
15 Some desk research was also carried out to complete this information.
16
while an index of 1 means that there is only a single ethnic group among directors and senior
management of the bank.
The HHI was calculated, to the extent the data were available, the year the bank was
founded, in 2005, one year, after of an important reform of the banking system, and in 2016 as the
cut-off period for the most recent years of data availability. Following Cook (2014), we also
collected data on bank failures from 1990 to 2016 from financial statements of individual banks
and statistical bulletins, banking supervision annual reports and annual reports of the CBN. In the
econometric analysis, we included all banks for which there was sufficient data for the sample
period.
Other variables
1. For other variables, including the individual bank z-score, liquidity ratio, foreign bank
presence, and cost of contravention, we use data reported in statistical bulletins, banking
supervision annual reports, and annual reports of CBN for various years. We computed an
individual bank’s z-score capturing the probability of default of the bank, defined for each bank
as return on assets (ROA), or ((profit before taxes/total assets) – mean ROA)/standard deviation
of ROA. A high z-score corresponds to a low level of risk, while a low z-score suggests a high
level of risk. The liquidity ratio is a good measure of the financial credibility of the bank. It is
calculated as the ratio between a bank’s assets and its deposit liabilities. The foreign bank
variable is a dummy equal to 1 if the bank is foreign owned and zero otherwise. The cost of
contravention (in millions of naira) capturing penalties imposed to banks for non-compliance
with regulations is used as a proxy for the state of corporate governance.
2. We also collected a measure of bank concentration from system-level data from Cook (2014),
updating this information using CBN sources. The bank concentration variable is the ratio of
the three largest banks’ assets to total assets, and loans/liabilities measures, indicating the
competitiveness of the banking system. It is important to note that alternative measures of bank
competition such as the Panzar-Rosse (1987) H-Statistic have also been used in the literature,
but broadly, results obtained using various measures are not materially different. Real GDP per
capita (USD), which is the gross domestic product at constant prices from the IMF’s World
Economic Outlook, captures general economic conditions. We include the bonny light oil price
17
(Nigeria’s reference oil price) as an another indicator of local economic activity, since oil
accounts for roughly two-thirds of government revenue and 9 percent of GDP and movements
in the oil price affect other sectors of the economy almost contemporaneously (see, e.g.,
Omitogun et al., 2018). Appendix 1 gives variable definitions and sources.
3.2 Descriptive statistics
Figure 1 compares banks’ survival in years by type of bank. The data come from information
related in Uche (1997) and completed by Eboreime (2009) and from desk research. Colonial banks
have the longest survival rates, with an average of 109 years of existence and maximum of 120
years; the British Bank of West Africa, acquired by Standard Bank in 1965, is the longest-surviving
of them all.16 Indigenous banks have the shortest survival rates, averaging 12 years of existence,
ranging from one year to 81 years of survival, with a median of 3 years. Overall, non-indigenous
banks have survived an average of 58 years, with the median estimated at 55 years. Mixed banks,
owned by both foreigners and nationals, have a survival rate of 22 years, with a minimum survival
estimated at 4 years and a maximum survival estimated at 55 years.
Figure 1: Banks’ survival in years, 1887–2014
16 In 1969, Standard Bank merged with Chartered Bank to form Standard Chartered Bank.
18
Source: Authors’ computation using data from Uche (1997), Eboreime (2009) and desk research
Note: Figure line for foreign banks lies on the x-axis
Figure 2, using data from the Blue Books, shows the evolution of deposits, withdrawals,
and loans from 1887 to 1940 and gives an indication of the development of the banking system in
Nigeria. From 1887 to 1915, banks’ loans, deposits, and withdrawals increased steadily. They
started to decline around 1915, coinciding with the period of the World War I. They subsequently
increased more slowly until about 1932, after which they increased exponentially including
throughout the period of World War II.
Figure 2: Deposits, withdrawals, and loans (1887–1940)
Source: Authors’ computation using data from the Blue Books.
Note: In nominal pounds.
Figure 3 illustrates the difference between indigenous (Nigerian Mercantile Bank and
National Bank of Nigeria) and colonial banks (Bank of British West Africa and Barclays Bank),
with the number of establishments and branches much higher for colonial banks than indigenous
banks, which record only a few.
19
Figure 3: Private banks’ establishments and branches (1887–1940)
Source: Authors’ computation using data from the Blue Books.
The National Bank of Nigeria (Figure 4) was smaller than colonial banks but had a long
survival rate, until it merged with Wema Bank in 2005. This has not been the case for all indigenous
banks, as most of them closed shortly after opening, with some even closing in the same year they
were established, as shown in Figure 5.
20
Figure 4: Private banks’ deposits (1932–1940)
Source: Authors’ computation using data from the Blue Books.
Figure 5: Bank entry and exit (1887–2014)
Source: Authors’ computation using data from Uche (1997), Eboreime (2009). and desk research.
21
Examining the banks’ performance, computations using data from CBN reports show that
years of banking crisis are associated with weak performance, characterized by a higher ratio of
non-performing loans to gross loans and lower bank credits to bank deposits (Figure 6 and 7),
perhaps due to credit rationing as credit risk heightens. Banks did not have the credit assessment
systems necessary to expand their portfolios beyond lending to the small group of related connected
parties. This may explain the rapid growth of microfinance institutions, which often lend to a small
group of insiders. This pattern replicates itself, leading to more institutions being established
creating a vicious cycle. This factor underscores the systemic risk that results from a financial
system built on insider lending. A higher proportion of credit delinquency reduces banks’ appetite
to extend more loans, resulting in a significantly lower share of financial intermediation, as
measured by the ratio of loans to deposits. This reflects a much more fragile situation during those
years, weakening both the solvency and liquidity of banks.
The summary statistics in Table 2 reveal that between 2001 and 2016, the average
individual bank’s z-score was very low, estimated at –0.06, signaling a high level of bank risk. This
included the peak years of the 2009–2011 financial crisis in Nigeria. The HHI is on average 0.53,
highlighting high ethnic concentration and little diversity within the ownership and management
structure of the banks.
Figure 6: Bank deposits and liabilities (1960–2014)
Source: Authors’ computation using data from Central Bank of Nigeria
22
Figure 7: Bank deposits and liabilities during years of banking crisis (1960-2014)
Source: Authors’ computations using data from Central Bank of Nigeria.
Table 2: Summary statistics: Banking system 2001–2016
Variables Mean
Std.
Dev. Min Max Obs.
Individual bank z score -0.06 0.2 -0.22 0.93 84
HHI 0.53 0.22 0.2 1 84
Liquidity ratio 1.97 3.13 0.91 30.08 84
Foreign bank 0.14 0.35 0 1 78
Bank concentration 59.96 7.97 23.76 88.93 69
Cost of contravention (million
Naira) 139.76 1065.61 0 8925 70
Oil prices ($/barrel) 51.25 10.91 23.12 107.46 69
Real GDP per capita (USD) 803.28 54.7 562.23 1015.82 69
4. Empirical Framework and Results
4.1 Econometric model
With individual bank level data, we use the following pooled OLS specification:
z − score2001−2016 = β0 + β1 HHI2 0 0 1 - 2 0 1 6+ β2X2001-2016 + k 2005 + ε 2001-2016 (1),
where the dependent variable is the individual bank’s z-score. The variable of interest is the HHI,
measuring the level of diversity or ethnic concentration in the individual bank, and X is the vector
23
of control variables to condition for internal bank level effects as well as environmental factors
likely to affect banks’ z-score. Through k 2005 , we control for a dummy equal to 1 for the year 2005
and 0 otherwise to take into account the context around the 2004 banking sector reforms. Finally,
εt, is the residual, picking up effects of unexplained factors.
4.2 Results
Our main results are presented in Table 3. They show a negative association between the index of
diversity and individual bank z-scores in all regressions. This relationship is significant in all
estimates except for the plain correlation between the index of diversity and individual bank’s score
(Column 1). Once we control for bank characteristics such as liquidity ratio, whether the bank is
foreign owned, and bank concentration (Column 2), the relationship is still negative and becomes
significant, highlighting the necessity to factor in important control variables. This is robust to the
inclusion of the year dummy 2005, capturing ongoing changes that occurred in the context of the
2004 reforms of the banking system (Column 3), or when we control for the cost of contravention
(Column 4).
Table 3: Main results
Dependent variable: individual bank z-score
VARIABLES (1) (2) (3) (4) (5)
Variable of interest: HHI -0.047 -0.166** -0.220** -0.263** -0.229**
(0.13) (0.08) (0.09) (0.12) (0.11)
Controls
Liquidity ratio 0.059 0.026 -0.005 -0.049
(0.08) (0.08) (0.08) (0.09)
Foreign bank 0.062 0.076 0.084 0.069
(0.07) (0.07) (0.09) (0.09)
Bank concentration -0.010 -0.008 -0.016*** -0.091***
(0.01) (0.01) (0.00) (0.02)
Cost of contravention (million
Naira)
-0.001 -0.002
(0.00) (0.00)
Average oil price ($/ barrel) 0.034***
(0.01)
Log real GDP per capita (USD) 3.242**
(1.38)
Year 2005 No No Yes Yes No
Observations 84 64 64 52 52
R-squared 0.00 0.17 0.21 0.41 0.48
Notes: Robust standard errors in parentheses. *** p<0.01, ** p<0.05, * p<0.1.
24
Results are also robust to the inclusion of controls for the macroeconomic conditions
(Column 5). Consistently, the coefficient on the HHI remains negative and statistically significant.
These findings consistently show that a high ethnic concentration is correlated with a lower
individual bank z-score. Put differently, less ethnic diversity within the ownership and management
of a bank is associated with a higher level of risk, while more ethnic diversity is associated with a
lower risk. This result can be interpreted in several ways. Diversity can increase the possibility of
social interaction, and provide an open and favorable environment, resulting in more creativity and
productivity. This would be reflected in a bank’s performance, reducing its risk of failure. Diversity
also imposes controls on vested interests that might propagate risky lending to those affiliated with
members of the board or management without prudent credit history.
Our findings are in line with the strand of literature showing that more diversity improves
performance. Whether it relates to differences in gender, social, cultural, or educational
background, diversity matters for a firm’s performance. However, even in the presence of diversity,
flawed corporate governance structures could trigger risk and systemic banking crises due to
unregulated or related party lending. The skills that constitute the quality of firm management are
more likely to flourish with board heterogeneity. Firms can benefit from a wider pool of talent, a
broader range of perspectives, resources, and access opportunities and wider connections. The
results therefore seem to confirm this hypothesis, especially in the case of Africa. Additionally, in
the case of Nigeria, since our analysis included years when there was a financial crisis, our results
suggest that a lack of diversity may have played a role in exacerbating the fragility of the banking
system.
Estimated results for other significant variables show that bank concentration, a measure of
bank competitiveness, is negatively associated with the individual z-score and thus corresponds to
a higher probability of insolvency (see Columns 4 and 5 where the result is significant).17 A higher
oil price reduces the possibility of bank insolvency. Banks’ lending to the oil sector exposes them
to oil price shocks, and in boom times, oil windfall gains bolster banks’ balance sheet buffers,
17 The literature has found mixed empirical evidence regarding the effect of bank’s competition on the
stability of the banking system (Beck et al., 2011).
25
reducing risk, while a downturn in oil market manifests in weakening performance. We obtain
similar results with the logarithm of the real GDP per capita, with an associated large and
statistically significant coefficient (Column 5). This implies that higher real GDP per capita,
highlighting a healthy economy, bolsters bank performance.
5. Conclusion
This paper uses historical data to investigate the relationship between ethnic diversity in the
ownership and management structure of Nigerian banks and banks’ performance. Our descriptive
statistics show a higher level of risk for indigenous banks at creation. We find a negative association
between an index of ethnic diversity of the ownership and management structure of a bank and the
individual bank’s z-score. This result suggests the importance of diversity in banks’ ownership and
senior management in strengthening the financial system. Strong economic conditions – a higher
oil price and real per capita GDP – bode well for stability of the banking system.
Overall, this study has established that diversity influences lending and capital allocation
and thus directly affects asset quality. A lack of diversity could weaken the importance of skills
and capability in influencing banks’ performance decisions. If not mitigated by robust external
regulatory safeguards, such weakness can contribute to fragility of an individual bank and, to the
extent that such banks are systemic in nature, they can propagate a systemic financial crisis.
Monetary integration in (West) Africa is imminent. As was the case for the ECB following the
global financial crisis, greater supervision and coordination among banking and monetary
authorities are key to ensure safety and soundness of the banking system. This highlights the
importance of adopting a continental or regional bank regulatory framework with independent
cross-border supervisory authority or mandate. These are ways in which banks and banking
systems will need to be monitored and supervised, following international standards of best
corporate governance, which we show can be tied to ethnic diversity.
The findings of this paper call for further research in determining the relative importance
of various measures of asset quality on performance as well as the linkages between those assets
and the effect of diversity on bank’s performance.
26
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Appendix 1: Definition variables
Variables Definition Data source
Individual bank
z-score
This variable captures the probability of default of a bank. It is estimated for
each bank as return on assets (ROA)
((profit before taxes/total assets) – mean ROA)/standard deviation of ROA
Compiled by authors based on Statistical Bulletins,
Banking Supervision Annual Reports, and Annual
Reports of CBN for various years
HHI
This variable is the Herfindhal-Hirschman
index, capturing the ethnic diversity within the senior management of a bank
Compiled by authors based on Uche (2010, 1997),
Blue Books, Central Bank of Nigeria annual reports,
and desk research
Liquidity ratio Ratio of assets to deposit liabilities
Compiled by authors based on Statistical Bulletins,
Banking Supervision Annual Reports, and Annual
Reports of CBN for various years
Foreign bank Dummy equal 1 for foreign banks and 0 otherwise
Compiled by authors based on Statistical Bulletins,
Banking Supervision Annual Reports, and Annual
Reports of CBN for various years
Bank concentration
Ratio of the three largest banks’ assets to total assets, and loans/
liabilities
System level data compiled by Cook (2014) and
updated using CBN sources
Cost of contravention
(million Naira) Proxy for the state of corporate governance
Compiled by authors based on Statistical Bulletins,
Banking Supervision Annual Reports, and Annual
Reports of CBN for various years
Real GDP per capita
(USD) Gross domestic product at constant prices World Economic Outlook (IMF)
Bonny Light crude oil
price (USD/barrel)
Price of high-grade Nigerian crude oil produced in the Niger Delta Basin and
named after the prolific region around the city of Bonny. Central Bank of Nigeria
34
Appendix 2: Matrix correlation variables
Individual
Bank z
score HHI
Liquidity
ratio
Foreign
bank
Bank
concentration
Cost of
contravention Oil prices
Real
GDP per
capita
Individual bank z
score 1.0000
HHI -0.0538 1.0000
Liquidity ratio 0.0143 -0.0172 1.0000
Foreign bank 0.0298 -0.0020 0.0002 1.0000
Bank concentration -0.1016* -0.2875* -0.0526 0.0171 1.0000
Cost of contravention -0.0156 -0.0155 -0.0190 0.0093 0.1509* 1.0000
Oil prices -0.0828 -0.1927 -0.0479 0.0276 0.9096* 0.1599* 1.0000
Real GDP per capita -0.1044* -0.2811* -0.0567 0.0154 0.9641* 0.1163* 0.8911* 1.0000
Note: * significant at the 5% level.
