STRATEGIC MANAGEMENT AND



CORPORATE FAILURE AND TURNAROUND STRATEGIES IN BANKING INDUSTRY

By

Dr. M.M.Maishanu[1]

mmmaishanu@

ABSTRACT

This paper is a theoretical exposition into the causes of bank failure and different strategies to turn ailing banks around. It is quite timely considering the recent removal of five chief executives of banks followed by a N400 billion bailout by the Central Bank of Nigeria (CBN). Since the banking industry is the engine growth of any economy, failure in banks should not be allowed due to contagious nature of bank failures. Thus, this paper investigates into these causes and examines the different turnaround strategies that can be put in place to address such problems early enough for the purpose of taking remedial actions. This paper concludes that since turnaround strategy involves the reallocation of resources, the most commonly reallocated resource in the implementation of a turnaround strategy is management and therefore gives credence to the recent action of the CBN.

1.1 INTRODUCTION - This paper is a theoretical exposition intended to provide critical as well as analytic review of the existing literature on corporate failure and survival in the banking industry. It is set against the background of recent failures in banking institutions across the globe. The paper unravels the causes of these failures and gives insights on how to address such problems. To achieve this, the paper is structured in four sections. While section one is this introduction, section two thoroughly examines the issue of failure in banks. Section three presents a brief on survival strategies and dwells in details on turnaround strategies in the banking industry. The last section concludes the paper.

1.2 FAILURE IN BANKS

1.2.1 Meaning of failure

The subject of failure is not pleasant, but it is a fact that companies are collapsing, failing, or busting. Despite the critical importance of corporate health to economic and social progress, the subject had received practically little attention in literature. A large number of people feel that business failure is anathema: something that happens to someone else but hopefully never touches their own lives. They place a premium on survival and, when failing, "assert that no error has occurred, or that if it did it was unimportant, or that if it was important, it was somebody else's fault" (Michael, 1973:133). However Bibeault (1982:07) observes that there are very few instances where the phenomenal success of an entrepreneur or manager did not follow on the heals of earlier failure. Again, some failures have led to advancements in organisation change (Fleishman: 1953, Lawler, Hackmanm and Kaufman: 1973) and much can be learned from studying failures in organisations (Mirvis and Berg: 1977).

Bibeault (1982:09-10) defines business failure from four standpoints: social; economic; legal; and managerial. From the social standpoint, he argues in terms of its impact. That is, the human suffering that such a phenomenon usually brings. It affects almost everyone: the owners; employees; government; customers; investors; suppliers; creditors; and the society in general. However, not everyone agrees that the longer-range social impact of corporate failure is negative. Grisati as cited in Bibeault (1982:09) points that:

Some companies never have a reason to exist in the first place. In a lot of markets there is room for two or three companies and no more. Usually the last guy in beyond that point barely makes a living in good times and is extremely vulnerable in bad times, and for good reason, because he shouldn’t exist in the first place. Any good turnaround man will spot that situation right away and avoid it like the plague.

From the economic standpoint, Bibeault (1982:10) further viewed failure as a situation whereby the realised rate of return on investment capital is significantly and continually lower than prevailing rates on similar investments. In fact, a company could be an economic failure for years and yet, in the absence of legally enforceable debt, be able to meet its current obligations. This view of failure is however subjective, and there are very few data available on industry or company incidence of economic failure.

Legally, a company/firm is declared as a failure if it is not able to meet its current obligations and settling its outstanding debts. Thus, failure is synonymous with insolvency (Benston et’al:1986) and bankruptcy (CFMRIMT: 1985). Glaessner and Mas (1995) on the contrary, opine that insolvency needs not be synonymous with failure. Failure occurs only when insolvency is officially recognised and the organisation is closed.

A business can also be a failure from a managerial standpoint before it is an economic failure and certainly long before a legal failure. Managerial failure is measured by a long period of decline leading to large write-offs and to losses at the bottom line, which culminate, into intense pressure for a change in management.

Argenti (1976) identifies twelve elements that cause failure and links them together thus:

If the management of a company is poor then two things will be neglected: the system of accounting information will be deficient and the company will not respond to change (some companies, even well managed ones, may be damaged because powerful constraints prevent the managers making responses they wish to make). Poor managers will also make at least one of three other mistakes: they will overtrade; or they will launch a big project that goes wrong: or they will allow the company’s gearing to rise so that even normal business hazards become constant threats. These are the chief causes, neither fraud nor bad luck deserve more than a passing mention. The following symptoms will appear: certain financial ratios will deteriorate but, as soon as they do, the managers will start creative accounting, which reduces the predictive value of these ratios and so lends greater importance to non-financial symptoms. Finally, the company enters a characteristic period in its last few months

It is pertinent to note that though these mechanisms operate logically, not all organisations need to go the whole stretch. Besides, Argenti was silent about the nature of the organisation, size, and even ownership structure. Yet, they at least buttress the symptoms and possible causes of failure in organisations.

Specifically narrowing down to a banking business, one discovers that the meaning of terms such as bankruptcy and insolvency in Corporation Law and Finance do not carry over in precisely the same way to banking (Benston et’al: 1986:91). Most firms face the danger of insolvency only as obligations become due. Insolvency or bankruptcy is a potentially greater threat to a bank than most firms are, because the bulk of the banks’ liabilities are payable on demand or on short notice. Economic insolvency is not fatal to the business firm because most creditors must wait until their obligations come due to take any action, regardless of the condition of the firm. Economic insolvency is a potentially serious situation for a bank, because knowledge of that condition might well provoke a run on the bank.

In economic terms, banks become insolvent when the market (present) value of their net worth (capital) becomes zero. At this point, the present value of a bank’s total assets is equal to the present value of its deposit and non-deposit liabilities other than equity capital (Benston et’al: 1986, 37). At least economically, the bank no longer belongs to the shareholders, but to its creditors (including depositors and deposit insurance agencies, if any). When declared insolvent, the bank is considered to have failed, with penalties accruing to shareholders and possibly also managers, depositors and other creditors. A bank fails, if there is a regulatory induced cessation in its operations as an independent entity free of direct intervention and oversight by a regulatory agency (Benston et’al, 1986:38). Banks are not subject to the bankruptcy laws that apply to other firms as Benston et’al (1986) further argue. Their analogous legal framework is the power of the Chartering Authority (e.g. CBN) to declare it `insolvent' and close it and the subsequent appointment of a receiver. The receiver closes the bank by liquidating its assets or keeps the doors of the bank open (under a different name and/or ownership). In literature however, experts have debated the merits and demerits of both options under different conditions.

Bank failure may differ from failures in other organisations because of its contagious nature. As Nadler and Bogen (1933: 21-2) state, "a bank failure is an economic, a financial and a social disaster... a series of bank failures is very aptly called as epidemic. Failures are contagious ...The collapse of one bank of itself tends to undermine the confidence of the community and start runs on others". Benston et’al (1986:47) add that financial problems in one bank may be contagious and ignite runs on other banks. Bradford (1932:239-340) in addition argues that if bank failures continue on a wide scale, business concerns, as well as individuals will be increasingly likely to withdraw their accounts and hold liquid cash. This will have system-wide domino or ripple effect (Benston et’al 1986:68). In support of this, Thornton (1802) and Humphrey (1983) as cited by Benston et’al (1986) note that:

If one bank fails, a general run on the neighbouring ones is apt to take place, which if not checked at the beginning by a pouring into the circulation a large quantity of gold, leads to very expensive mischief.

Benston et’al 1986) also cite Bagehst (1894) who concludes that

If any large fraction of (money held by bankers) really was demanded, our banking system and our industrial system too, would be in great danger...In wild periods of alarm, one failure makes many

1.2.2 Causes of Bank Failure

Many factors cause bank failure just as there are many possible causes of death of a human being (Afolabi, 1994:07-08). In most cases however, it is a case of one factor precipitating others. The following are causes of bank failure discussed in literature.

(a) Bad management - There is a considerable degree of consensus that the quality of management makes the difference between sound and unsound banks (de-Juan: 1991, Sheng: 1990, and Bibeault: 1982). This singular factor bears a high share of the causes of failure in banks. As Thomas (1935: 36) argues, “faulty management rather than external circumstance is the major cause for bank failures... During periods of prolonged depression, weak and inefficient management, unable to meet the rigorous requirements of the time, contributes heavily to failure”. On the contrary, with poor supervision, even good bank managers became bad managers, engaging in speculative, excessive spending, and ultimately fraud (de-Juan: 1987). In the researcher’s opinion, poor supervision can encourage bad management by encouraging excessive risk taking and increased fraudulent activities. Moreover, as he further asserts, mismanagement is more likely to occur if banking supervision is ineffective. de-Juan (1991:01) also points out that contrary to the theory that financial crises (bank failures) are only due to macroeconomic factors, the bank management is a major element and is a potential originator or a multiplier of losses and economic distortions.

(b) Inadequate Capital Base – Banks maintain capital by banks to support their fixed assets, to ensure the financial commitment of the shareholders, and to cushion depositors against unexpected losses faced by the bank (Sheng: 1990:16). For banks to enjoy confidence of depositors, they must have strong capital base as evidence of strength. It is also important that banks operate profitably for the shareholders fund to increase through accretion to statutory and general reserve. However, where depositors’ funds finance fixed assets it signals for the worst to come.

(c) Inadequate Supervision - Poor supervision has also been cited as a decisive element in bank failure and insolvency. Borish et’al (1995:32) attribute poor supervision to insufficient number of trained supervisors, poor information systems, lack of enforcement powers on the part of supervisors, and bank supervisors focus on liquidity without a longer-term approach to risk management. Bank supervisory agencies are required by law to conduct periodic on-site examinations of institutions within their jurisdictions (Graddy and Spencer: 1990:621). They further argued that although banks are required to submit quarterly financial statements (report of condition and income) to the bank regulations, the best way to determine the quality of a bank's assets and management is still an on-site examination and appraisal of its books and operations. But probably insufficient number of trained supervisors has hampered this (Borish et al, 1995). However, banks fail when they deteriorate over a long period, accumulating large losses.

(d) Unbalanced Risk Assets Portfolio and Poor Asset Quality - This is no doubt a reflection of poor management. Some banks do not have clear investment or credit policy and there is absolutely no control on credit (Afolabi, 1994:08). In a study conducted by the Comptroller of the Currency (OCC), Graddy and Spencer (1990:607) reported that though OCC knew that poor asset quality was the immediate cause of failure, it found that asset quality was directly traceable to the quality of the management. Connected lending, lending without due assessment and control, form part of the major problems that lead to failure (de Juan, 1991).

(e) In-ability to Adapt to Changes - Where banks refuse to adapt in an atmosphere of growing competition and immeasurably increasing sophistication, they will surely be edged out of business. Technological environment as an example is highly dynamic. Unfortunately, the problem of poor profitability in failing banks do not put them in competitiveness and lead to failure (Afolabi, 1994).

(f) Fraud - Bank fraud and embezzlement are a major cause of bank failure (Graddy and Spencer: 1990:606). The high incidence of bank fraud as McCoy (1987:25) observes is related to the ethics that says that it is important to be rich regardless of how one achieves the goal; the fast process of the deregulation process, which has overwhelmed both internal and external bank supervision; and the poor financial condition of many institutions, which has made it difficult to hide fraud. As Afolabi (1994) posits, these frauds range from outright theft, and in more than a few cases of bank failure (Long, 1981), forgery or account manipulation to constructive theft by way of credits that the manager or approving authority knows will fail.

(g) Political Interference - In a number of countries, bank’s (especially state-owned banks) lending is strongly influenced by pressure to achieve social, political, or developmental objectives. Pressure for non-recovery or tolerance for non-repayment is not infrequent either. Political factors influence the appointment of management. In certain cases banks are forced into opening rural branches to support certain government policies which ultimately create losses and hence failure (Sheng: 1996 and Afolabi: 1994).

(h) Inappropriate Macroeconomic Policies - Many governments have allowed banking laws to become outdated, neglected enforcement of existing laws and regulations, or worse still, engaged in perverse or financial repressive policies that use the banking system to finance large fiscal deficits. Sundararajan`s (1988) study of banking crises in six countries shows that banking crises were typically associated with large internal and external imbalances due mainly to the pursuit of inappropriate macroeconomic policies. The pioneering work of Long (1987) and Hinds (1988) has cogently argued that macroeconomic imbalances such as large fiscal and balance of payments deficits, sharp changes in relative prices, external shocks, and policy errors can lead to weak financial structures, large portfolio losses, and weak bank management and supervision. These as Sheng (1996) observes will in turn reduce the efficiency of reallocation, causing distress borrowing, bank runs, capital flight, and monetary and price instability. Sheng (1991:06) also cites a number of instances where the bank failures were the result of financial liberalisation having been done without first putting into place appropriate regulatory and monitoring systems. For example, the banking crises in Argentina and Chile in the early 1980s followed the extensive financial sector liberalisation in the 1970s without creating a strong supervisory regime.

(i) Inadequate planning - Inadequate planning as a cause of bank failure is closely related to bad management. As Afolabi 1994) argues, bank without avowed objectives and targets make their performance difficult to be judged. The nature, type, and timing of strategy change are quite relevant. As Graddy and Spencer (1990) observe, shift in strategy had led to bank failure in the late 1960s through the middle 1970s. Sinkey (1979) particularly characterises the strategy change as one where banks moved from a go-slow to a go-go philosophy.

The list of causes of failure in banks is not exhaustive. The causes are at all levels - institutional, sectoral, and national. However, Sheng (1996:14) concludes that while fraud and bank mismanagement were responsible for many individual bank failures and losses, macroeconomic factors such as external shocks, policy mistake, and inadequate risk management at all levels created the conditions of financial imbalance that led to widespread bank failure. He adds that no unique set of factors, macroeconomic or microeconomic, created the failure, nor did bank failures happen overnight.

The failure of a bank has multi-dimensional consequences (Afolabi, 1994) and can be observed at micro and macro levels. In addition, Benston et’al (1986) argue that bank financial difficulties and failures are both affected by and affect economic activity in their communities. Benston et’al (1986) also point that when a bank is declared insolvent, it is considered to have failed, with penalties accruing to shareholders and possibly managers and/or uninsured depositors and other creditors. Customers suffer indirect losses since they must search for and/or adjust to new banking associations. Bank employees also lose their positions or work for a new organisation and face possible changes in their rank or seniority status.

Bank runs and contagion are also by-products of problem banking system. Sheng (1990) notes that contagion is a disaster and it happens when the lack of transparency triggers the domino effect... the failure of one bank is associated in the public’s mind with the failure of all banks, and the whole process, if not promptly stopped, result in a systemic failure. This collapses the payment system and leads to failure of the enterprises and the economic system. Again, as depositors panicly withdraw their deposits, this adversely affects other banks by leading investors to question their viability (Stigliz, 1993:27). de-Juan (1991) concurs that bank failure might trigger off a confidence crisis resulting in deposit runs, which affect stability, contribute to demonetisation, and prompt capital flight. The implications he opines, is distortions in resource allocation, upward pressure on interest rates, a corporate culture with no sense of risk or disclosure and losses in the system (1991:07). However, as Benston et’al (1986) caution, the stability of the banking system and economic activity in a community is affected only to the extent of the type of bank run, the financial condition of the bank, and the reaction of the regulatory authorities.

1.3 TURNAROUND STRATEGIES IN BANKING INDUSTRY

Survival and prosperity of organisations rest primarily on their ability to achieve legitimacy (Ifechukwu, 1974:06). This simply means acceptability of output and methods of operation by their environment. Wining this acceptance however, brings organisations face to face with the desires and needs of their environment. Organisations therefore should have a sound mechanism for monitoring their environment and the capacity to adapt to changes in their environment.

Change according to Bennis et’al (1969:315), is an alteration of an existing field of forces. This means that there is an array of forces, not one, or two, counterpoised in dynamic tension. It further means we have choice in change, since we can control some forces. Following the above therefore, no institution or organisation is exempt from change (Benne and Birmbaum, 1969:328). For organisations to survive, they must recognise the dynamism of their environment that can create or destroy relevance and value (Allsopp: 1977).

As a survival strategy, recognising change is one thing and appropriately responding to it is another. Allsopp (1977) illustrates the response to change that is commonly encountered in business and how they affect the success or failure of organisations. The first he calls negative response, which is total opposition to change and relying strongly on maintaining the status quo. The weathervane response is characterised by the belief that if you ignore change it will go away or somehow accommodated if it does not. The opportunist response suggests reacting to changing situations only because short-term opportunities will avail. A response where people interpret circumstances subjectively is termed `self centred'. Finally, there is the response of leadership. The latter are people who can make positive change. Thus, they see change and opportunity on the horizons and make careful plans to decide the optimum reaction and introduce it at the right time. These people will move their organisation to greater heights. The response of leadership is perhaps the ideal response that requires the ability to identify forces or variables surrounding a problem and to develop consensus about the relevant forces and a strategy of manipulating these forces (Bennis et’al:1969).

Banks are like living organisms. They evolve in cycles and in certain period of their development undergo phases of rupture, which improve changes of direction and make survival their central preoccupation (de-Carmoy, 1990:200). To remain relevant and maintain their identity, they need to improve their competitive standing and operational efficiency. The right strategies are the turnaround strategies (Wheelen and Hunger: 1992, Colin and Keith: 1993), also referred to as strategies of change (de-Carmoy: 1990).

According to Rue and Holland (1989: 51), a turnaround strategy in banking industry is designed to reverse a negative trend and to get the industry back on the track to profitability. Turnaround strategies usually try to reduce operating costs, either by cutting excess fat and operating more efficiently or by reducing the size of operations. It thus involves the adoption of a new strategic direction, the activation of which almost by definition involves retrenchment as a first step. A turnaround strategy therefore involves a reallocation of resources from one strategic thrust to another and focuses attention on the transitional issues involved (John and Richard: 1987).

A turnaround strategy involves many changes and the most primary is management change. Apart from management change, other turnaround elements involve revenue generation, product market refocusing, liquidation of assets, divestment of parts of the business, and costs reduction. At any rate attempting a turnaround necessarily, depends on the root of poor profitability and the urgency of any crisis.

Turnaround effort is one sure way of reversing a declining fortune and improving the competitive standing of a distress bank. In the banking sector, turnaround efforts could be observed from three angles, based on source: internal when induced by management of the troubled bank; external when restructuring and reorganisation of a bank is done by the regulatory or other bodies set-up to address the issue; or a combination of the first two options (Ndekwu:1997). The goal of internal turnaround is to arrest and reverse the source of competitive and financial weakness as quickly as possible (Thompson and Strickland, 1987: 120). Hofer (1980) theorised that before a turnaround is attempted, the magnitude of the problem should be assessed.

John and Richard (1987) argue further that since turnaround strategy involves the reallocation of resources, the most commonly reallocated resource in the implementation of a turnaround strategy is management. Schendel et’al (1976) add that usually a turnaround lead to top management changes. Thus if a sleepy complacent management is replaced by new and eager management, the declining trend is reversed dramatically. Losses are stopped, employee morale rebuilt, customer confidence regained, and the company returns to robust and healthy growth (Bibeault: 1982). However, it is not as easy as depicted. This is because most banks that find themselves in trouble fail to take the right actions in time and impair or eliminate their future forever. The earlier the recognition of the problem, the higher the probability of survival. This therefore justifies the current action of the Central Bank of Nigeria (CBN) in removing the chief executives of five troubled banks and intensification of efforts at investigating the activities of other banks.

In case of distress in the system and the fear of contagion and wide-ranging consequences of failure, governments frequently intervene to ensure the stability of the financial system (Glaessner and Mas, 1995:57). According to Sheng (1996:37), there are good reasons for government intervention in bank restructuring. First, bank failure involves thousands of deposit and loan contracts, which involve extremely high transaction costs through the normal process of liquidation or court resolution. Second, since banks are both custodians of private savings and operators of the payments system, bank failures carry the systematic risk of causing economic disruption and loss of confidence in the system itself. The externalities of bank failures are very large. Thirdly, the fact that banks are closely regulated compared with other enterprises gives depositors an implicit/explicit public guarantee that the government will safeguard the value of deposits.

Government intervention is echoed through the desirability for either restructuring or liquidation of financially distressed banks. Bank restructuring according to Sheng (1996:01) is “a package of macroeconomic, microeconomic, institutional, and regulatory measures taken to restore problem banking systems to financial solvency and health”. Popiel (1988:12) adds that the restructuring of financial institutions generally involves a government entity, such as the superintendence of banks, or the Central Bank as monetary authority and lender of last resort, or an FDIC equivalent.

Restructuring may be simultaneous with change of ownership and management, through mergers or acquisitions or otherwise. In some cases, it may require interim management by a specialised institution. Thus, modalities vary, but experience has shown that some work better than others (de Juan, 1991:20).

Sheng (1996:40) observes that, government intervention in ailing banking system involves one of two key approaches - flow or stock solutions. Intervention can also involve a variety of these approaches, including a combination of flow and stock solutions depending on the degree of bank distress. Flow techniques have worked well in most mild cases of banking distress. The most common flow technique is Central Bank liquidity support at subsidised rates. The Central Bank could extend credit to the ailing institution in the form of soft loans, revolving lines of credit, and rediscount facilities, primarily for working capital purpose (as the CBN just did in August 2009) (Popiel, 1988:13). The stock solution involves techniques that address the balance sheet and capital adequacy of the bank.

However, the adoption of either flow or stock solution depends on the severity of the problem. If banking problems are detected early with a reasonable stable macro-economic environment and effective administrative and supervisory machinery, flow solutions will be adequate to deal with banking system that still has 0 - 2 percent capital-asset ratio (Sheng: 1996:46). However, if the problems deteriorate beyond the level, a combination of stock and flow solutions will have to be implemented, depending on the size of the distress.

1.5 CONCLUSIONS

This paper reviews literature on corporate failure and turnaround strategies in the banking industry and attempts to synthesize the views of experts in the area. The paper believes that the struggle to survive through a turnaround strategy starts with the knowledge of failure and the causes of failure. Although failure is common with all organizations whether big or small, manufacturing or service industries etc., the concept of failure or ‘insolvency’ slightly differs in banking industry because of its contagious nature. Thus, a good turnaround strategies must consider changing the status quo by injecting new and vibrant management and it should be swift, prompt, and decisive to negate the spill over effect such neglect could cause.

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[1] Dr M.M.Maishanu is a senior lecturer and Head of Department of Business Administration, Usmanu Danfodiyo University, Sokoto

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