Over the past 3 decades, corruption has plagued the Nigerian banking industry leading to the collapse of many banks particularly in the 1990s (Idolor, 2010). This corruption has resulted in enormous losses to customers, investors, and other stakeholders. In 1991, the number of total banks in the country grew to 120, and in 1998, the licenses of 26 banks were revoked. These failures, which were largely attributed to frauds perpetrated by the bank management and staff, arose through the granting of unsecured loans. The nonsettlement of the unsecured loans resulted in huge bad debts and consequent loss of liquidity, failure to maintain the prescribed capital base, and outright embezzlement of funds (Transparency International, 2009). Idolor (2010) described this fraudulent practice in Nigerian banks as industry-wide. This corruption in the banks during that period caused the military government to set up the Failed Banks Tribunal in 1994, before it was scrapped in 1999 at the advent of civilian rule. Transparency International (2009) further stated that during the period, 2332 civil and 132 criminal cases were brought before the tribunal. Of them, 672 civil and 44 criminal cases were disposed off, resulting in the recovery of 4.3 billion naira from the banks’ debtors. The Transparency International report added that 82.5% of the total recovered debts were in respect of the banks in liquidation, and that, by the time the tribunals were scrapped, the Nigerian Deposit Insurance Corporation had refunded 5.8 billion naira to the depositors of 35 banks that had closed.
According to Soludo (2004), by 2004, many banks in Nigeria were undercapitalized, notwithstanding that they had previously met the minimum capital requirements that ranged from 1 billion naira for existing banks and 2 billion naira for new banks. He stated further that one-third of the banks were unhealthy and operating losses were enormous, leading to negative shareholders’ funds and so promoting insolvency; and 28% of the bank loans were nonperforming (Central Bank of Nigeria [CBN], 2005-2006). Cook (2011) stated, “Weak corporate governance and substantial insider-lending that resulted in large portfolios of non-performing loans” (p. 6) were among other conditions that posed an imminent threat to bank development, efficiency, and corporate governance. In a reaction to this unhealthy situation, CBN announced a reform agenda for the Nigerian banking industry on July 6, 2004. At the top of this agenda was the requirement that each bank increase its share capital from 2 billion naira to 25 billion naira by December 31, 2005 through mergers and acquisitions (CBN, 2004). The recapitalization effort was aimed at improving the financial capacity of the banks for the execution of big projects; improving public confidence in the banks; creating a level-playing field, hence promoting healthy competition among the banks; enhancing transparency in the banks’ operations; and making them global players (CBN, 2004). The reform process, which was largely completed by the end of 2005, resulted in the emergence of 25 banks that became invigorated by the new minimum share capital and a code of corporate governance enacted for them (CBN, 2006).
In studies related to bank reforms, based on bank-level data from 2000–2005, the World Bank predicted increased efficiency of intermediation among banks in Nigeria, thus giving support for reforms (Cook, 2011). Similarly, Somoye (2008) found that bank recapitalization would cause a change in total assets, and this change would boost bank performance. Onaolapo (2008) reported a positive relationship among bank capitalization, distress management, and asset quality all of which increase expectation for improved financial performance of the recapitalized banks.
From 2006 to 2008, CBN did not report any bank distress. This situation indicated that the 2005 banking sector reforms were on the right course. However, the results of two stress tests conducted by the CBN in 2009 on the 24 banks showed significant distress and poor management in the banking system (Agbonkpolor, 2010; Cook, 2011; Olayiwola, 2010). The report disclosed that eight banks failed the tests, the system required a capital and liquidity injection of 620 billion naira, and that the distressed banks altogether held 2 trillion naira in nonperforming loans. In addition, it was reported that the absence of effective internal controls, hence, regulatory failures and weak corporate governance among other factors could have caused the crisis in the banking system (Agbonkpolor, 2010; Cook, 2011; Olayiwola, 2010). In their initial reaction, the CBN replaced and arrested the executives at eight of the 24 banks, accusing them of mismanagement (Sanusi, 2010). Among the reasons adduced by the CBN were “major failures in corporate governance, inadequate disclosure and transparency about the financial position of banks, critical gaps in the regulatory framework and regulations, and uneven supervision and enforcement” (Sanusi, 2010, p. 5). Against the backdrop of this reign of ineffective internal controls, regulatory failures, and weak corporate governance, Agbonkpolor (2010), Cook (2011) and Olayiwola (2010) recommended additional banking reforms that would emphasize more effective internal controls and bank monitoring.
Prolonged bank distress and mismanagement would result in total bank failure and resultant adverse economic consequences. Empirical results of a study on local economic effects of bank failures indicated that such failures cause a reduction in the volume of sales in local markets, and in many cases, the liquidation of failed banks aggravate unemployment (Gilbert & Kochin, 1989). Generally, bank distress deters economic growth (Ochejele, 2007; Rose & Hudgins, 2010).
However, it is theorized that a strong system of internal control will enhance the attainment of organizational objectives; it will keep a firm on the path of growth and continuity, and hence, profitability (Jamshidi-Navad & Arad, 2010). According to Jamshidi-Navad and Arad (2010), internal control is an organizational system designed to secure an efficient implementation of a policy, safeguard assets, and prevent fraud and error. It is an integral aspect of the management of an organization that assists managers to achieve set goals and objectives by effectively utilizing and accounting for resources. Absence of effective internal control would result in weak financial performance (Lu, Richardson, & Salterio, 2010). There is, therefore, a nexus between internal control and firm performance in all its ramifications.
As the CBN did not report any signs of bank distress between 2006 and 2008, it became necessary to ascertain the financial performance for the immediate period before the reported significant distress in eight of the 24 commercial banks in 2009. It was also necessary to examine the postintervention financial performance. Additionally, because a major cause of the distress was attributed to the absence of or the ineffectiveness of internal controls, it was also necessary to ascertain the ICE of the banks for the corresponding periods. Finally, against the backdrop of theory, it would have to be seen how the ICE in the banking industry related to its financial performance before and after CBN liquidity injection intervention and the extent to which ICE and financial performance respectively differed based on CBN intervention.