Predicting Bank Distress in Nigerian Banking Industry: A New

Discriminant Analysis Model

Malami Muhammad Maishanu PhD
Department of Business Administration
Usmanu Danfodiyo University, Sokoto
ABSTRACT
The Nigerian banking industry has for over two decades suffered from turmoil of distress on one hand and wave of
regulatory and supervisory activities to stem the tide on the other. These activities were aimed at strengthening the
industry in order to enhance economic efficiency and effective resource allocation through service-driven competition
and improvement in quality and spread of banking service. Consequently, many banks had to be liquidated in the
process particularly when their net worth was in negative bringing untold hardships to depositors and other
stakeholders. There is therefore the need for an early warning model for the industry with the hope that prompt but
appropriate as well as effective strategies could be put in place in order to resolve crises in banks before they precipitate
into failure. Data were collected for this purpose from thirty-two commercial banks using their 1996 and 1997 financial
reports. The banks were divided into two groups: distressed and healthy. The study relied on a variety of accounting
ratios in developing a discriminant model that distinguish distressed and healthy banks. The study shows that distressed
banks differ significantly from healthy banks with respect to capader3, capader5, asequal1, and ownership performance
variables. To study concludes that an early warning model developed in this study could be used by various
stakeholders to monitor distress-proneness, direct attention to laggard areas for remedial action, and adjust their
relationships where necessary.

KEY
WORDS:
RESOLUTION

DISTRESS,

BANKING,

FAILURE,

LIQUIDATION,

INTRODUCTION
Despite the potentials of the Nigerian economic and financial system to be one of the
most dynamic and diversified in sub-Saharan Africa, the financial system particularly the
banking industry, suffered from inefficiency, obsolescence and lack of competitiveness
because of what had been documented partly in the literature as government policies and
regulations, which encouraged a culture of complacency and armchair banking in the
1980s and 1990s. Banking reforms particularly recapitalisation which led to banking
consolidation in 2005 largely contributed but not a sustainable level of stability in the
industry. Between 2005 and 2011 many issues came up still signalling dangers within the
system. For example closure of a bank bringing the number of consolidated banks to 24
1

from 25, sacking of chief executive of four banks in 2010 and nationalisation of yet
another three banks in 2011. This therefore justifies the need to revisit the need for an
early warning model for the industry. This paper modestly contributes to the literature on
bank failure and resolution with the hope that appropriate and effective strategies would
be adopted to resolve crises in banks promptly before they precipitate into failure.

To do this, the paper is divided into five sections. Section one is this brief introduction.
Section two reviews literature while section three presents the methodology. Section four
presents data analysis and findings while section five concludes the paper.
1.2

LITERATURE REVIEW

The rate of bank failure in Nigeria has risen sharply since the early episode of late 1980s.
The rapid increase in the incidence and magnitude of distress has reached an alarming
proportion that confidence and credibility are steadily being eroded. Prior to 1989, the
scale of distress in the banking system was generally modest. Serious cases of distress
were relatively few, and quite amenable to control by the monetary authorities. However,
from 1990 to 1995 the situation has changed dramatically. In 1990, eight (8) banks were
identified as distressed while two years later, in 1992, the figure jumped by 100% to
sixteen banks (16). By 1994, the situation had become so serious with fifty-five (55)
distressed banks compared with thirty-eight (38) as at the end of 1993. The number rose
to an unsurpassed level of sixty- (60) at year-end of 1995. This implies that at the end of
that year an average of one (1) out of every two (2) banks was distressed. Beyond 1998,
many banks had to be liquidated by the regulatory authorities and more recently in 2011,

three banks had to be nationalised to avoid the consequences of liquidating them and the
negative but ripple effect on the economy.

A number of studies reveal that causes of distress and failure in the banking system are a
manifestation of a complex set of inter-related problems. Although there seems to be an
emerging worldwide consensus that the quality of management makes the difference
between sound and unsound banks (de-Juan: 1991, Sheng: 1996 and Bibeault: 1982),
other factors are also known to be potent. In Nigeria, these factors include economic
downturn, inhibitive policy environment, inadequate capital, impact of deregulation, the
rapid increase in the number of licensed banks between 1986 and 1991, and boardroom
crisis. Other factors are inability to adapt to changes, fraud, ownership structure, or
political interference in the management of banks, embezzlement, or financial
manipulation, high gearing/leverage, mismatch of maturities between assets and
liabilities, and ineffective supervision (Adeniyi, 1998; Ebhodaghe, 1993; Afolabi, 1994;
Alashi, 1993).
Early warning system is desirable to prevent sudden occurrence of a financial crisis and
applied internally by management and externally by the supervisory authority. At the
internal level, management analyses the assets and liabilities structure on a continuous
basis disregarding whether a problem emerges or not. Externally, bank supervisors
should look at early warning signs of illiquidity, including a pattern of poor-quality loans;
rapid expansion in lending activity without a healthy, stable deposit base; mismatch in
maturity structure; drop in dividend, and poor management.

The identification of problem banks allows the bank supervisors to allocate examination
resources more efficiently between problem and emerging problem institutions. The
monitoring system(s) also helps to identify problem areas, thus aiding off-site analysis
and helping focus examinations toward major areas of concern.
Ratio analysis is one screening technique used to identify how healthy or weak a bank is.
According to Graddy and Spencer (1990: 622), one or more of the following screening
techniques can be employed.
(i)
(ii)
(iii)
(iv)

Screening individual ratios and identifying those institutions falling in the bottom
percentile of a peer group.
Screening individual ratios and comparing them to critical values
Combining ratios into a composite score and ranking the institutions from best to
worst based on the composite score.
Some combination of the preceding.

Once institutions are classified as weak or potentially weak, an analysis is performed to

determine the extent of the financial problems and their possible causes. Once the
analytical effort confirms that a serious financial problem exists, regulatory intervention
occurs.
In many parts of the world the popular model for supervision of financial institutions is
the uniform inter-agency Bank Rating System (CAMEL), which provides examiners with
a framework for evaluating an institutions financial condition.
In addition to this, over the last thirty-five years, a number of empirical studies and
failure prediction models have been developed by different experts (Scapens etal: 1981)
to serve as early warning system. Essentially, the purpose has been to find a means of
discriminating between those firms, which seem likely to fail and those, which do not.

According to Scapens etal (1981:5), univariate and multivariate statistical techniques

have been used by writers who have attempted to identify a relationship between
accounting ratios and corporate failure. Beaver (1966) and Deakin (1972) for instance
used univariate model to develop their predictive models. However, a major limitation of
the univariate approach is that different ratios can suggest different conclusions for the
same company (Scapens etal: 1981)
The most common statistical tool used in the multivariate models is linear discriminant
analysis. This technique, similar to regression analysis, uses a variety of financial ratios
to detect any significant deterioration in profitability and liquidity. It is a statistical
procedure aimed at classifying an observation into one of several distinct groups based
upon the observations individual characteristics (Scapens etal, 1981:6) and it estimates
discriminant functions, which are linear combinations of the predictor variables that best
discriminate between a priori defined groups (Sinclair etal., 1990:33). On a systematic
basis as Popiel (1988:11) argues bank supervisors can apply predictive models, such as
discriminate analysis to detect the onset of financial problems.
However, it should be noted that since management of a weak institution may engage in
creative accounting to improve their financial statements, this will affect the value of
early warning systems especially aspects relating to off-site analysis and ratio analysis.
1.3

METHODOLOGY

The specific choice of commercial banking sub-sector for this study is purposive. As at
the end of 1994, there were sixty-five (65) commercial banks in operation with a total of
two thousand two hundred and fifty nine (2259) branches (NDIC Annual Report,
5

1994:71). This sampling decision is motivated by the fact that commercial banks have
the largest number of banks and branches, meaning that they are widely spread in all
states of the federation and the Federal Capital Territory, Abuja. In addition, commercial
banks have the largest resources in the industry. For example in 1994, Commercial banks
accounted for 83.5% and 89.2% of the total assets and deposits of the banking system in
Nigeria. Thus, if a large proportion of these banks fail, the whole industry and the
economy will suffer.
The data collected from the financial statements, statutory reports were used in
developing multivariate (discriminant analysis) model in order to explain the causes of
distress and whether any difference exists between distressed and healthy banks. Data
were collected for this purpose from thirty-two commercial banks for 1996 and 1997.
One of the observations was incomplete, and therefore excluded from analysis.
Consequently, sixty-three observations were used for the analysis. The selection of the
period is justified on the grounds that it provides us the opportunity to comfortably
identify the two groups since discriminant analysis can only be applied when two
discernable groups can be identified: distressed; and healthy.
The banks are divided into two groups: distressed and healthy. The distressed group
consists of twelve banks. This is because all the banks (except one in 1997) were within
that period considered as distressed by the regulatory authorities.

Twenty healthy

commercial banks were also randomly selected using data collected from the regulatory
authorities (whose names did not appear in the distressed banks list and have all satisfied
the minimum paid-up capital requirement) and the Nigerian Banking Index 1998 (Pharez:
1999).

The purpose is to use their financial reports and returns to the regulatory

authorities for the purpose of computing the relevant ratios

Fifteen (15) different financial ratios (see appendix) were computed based on available
data from the statutory returns of selected banks and their financial statements. The ratios
are further divided into the following five (5) broad categories: capital adequacy,
profitability, liquidity, risk, and asset quality. There are six capital adequacy, three
liquidity and three profitability ratios. In addition, there is one ratio measuring risk and
two measuring asset quality. Ownership variable was also considered because of the role
it has played as reported in various works such as Nyong (1994), and Jimoh (1993).
These fifteen ratios and ownership variables represent the performance variables referred
to in hypothesis two of this study. The researcher utilises them in developing the early
warning model from multivariate analysis in order to test the hypotheses there is no
significant difference between distressed and healthy banks with respect to
performance variables in the Nigerian commercial banking sub-sector.

This study uses the linear discriminant model since it is most appropriate for research
problems similar to this, where the dependent variable, the status of the bank (distressed
or healthy), is a two group categorical variable and the independent variables are metric
(performance variables).

Discriminant analysis, which is a multivariate statistical

technique, classifies observations into two or more groups based on specified predictor
variables. These groups may be distressed and healthy banks, problem and non-problems
banks, or insolvent and solvent banks. In this study the grouping that applies is distressed
and healthy.

The analysis estimates discriminant functions, which are linear combinations of the
predictor variables that best discriminate between a priori defined groups (Sinclair etal.,
1990:33).

The analysis examines whether significant differences exist among the

7

distressed and healthy banks, determines which predictor contributes to most of the intergroup differences and evaluates the accuracy of classification of groups. The linear
combination for a discriminant analysis, also known as the discriminant function, is
derived from an equation that takes the following form:
Z = W1X1 + W2X2 + W3X3 . WnXn
Z = Discriminant Score
Wi = Discriminant weight for variable i
Xi = Independent variable i

The analysis was used in testing the hypothesis that the group mean of a set of
independent variables (performance variables) for distressed and healthy bank group are
equal. The test for the statistical significance of the discriminant function is a generalised
measure of the distance between the group centroid. The group centroid is arrived at by
comparing the distribution of the discriminant scores for the two groups. If the overlap in
the distribution is small, the discriminant function separates the groups well. If the
overlap is large, the function is a poor discriminator between the groups (Joseph F. H Jnr.
etal, 1995:182).
Since the objective of this analysis was to determine which financial ratios are the most
efficient in discriminating between distressed and healthy banks, the analysis employs
stepwise procedure against methods like ENTER. The ENTER method uses all the
variables in building a model without attempting to determine whether all of the variables
contribute in the ability to classify the banks. In fact, some of the variables may not
contribute any new information to the problem and eliminating such variable through
stepwise selection procedures is desirable. The stepwise selection procedure identifies
ratios that appear to be important in distinguishing the groups (healthy and distressed
banks) based on how much they lower Wilks Lambda. The stepwise procedure begins
8

with all of the ratios excluded from the model and selects the ratios that lower the Wilks
Lambda. A minimum F value of 1.00 (the default value) is required for entry. Following
this procedure, those ratios based on their Wilks Lambda that appear as significant
discriminators are selected by the model.
Classification matrices, which assess the predictive accuracy of the discriminant function,
are calculated for both the analysis and the holdout samples. However, before developing
the classification matrices, the cutting score which is the criterion for judging each
individuals discriminant Z score to determine into which group the individual is
classified is determined
In calculating the cutting score since the groups are unequal in size, a weighted average
accounts for the difference in variance. The formula applied is expressed below:
NAZA + NBZB
Zcn =
NA + NB
Where:
Zcn = Critical cutting score for unequal group sizes
NA = Number in group A (healthy banks)
NB = Number in group B (distressed banks)
ZA = Centroid group A
NA = Centroid group B

Since the dependent variable consists of two groups; 23 distressed banks (representing
37% of the sample) and the remaining 40 healthy banks(representing 63%), we substitute
the appropriate values in the formula to obtain the critical cutting score (assuming costs
of misclassification):
Zcn = ((40) * (-1.60457)) + ((23) * (2.79056))
63
Zcn = -64.1828 + 64.1828
63
Zcn = 0.0

The cutting score is zero if the data are standardised. Since the critical score is zero, the
procedure for classifying banks is as follows:
1. Classify a bank as healthy if its discriminant score is negative
2. Classify a bank as distressed if its discriminant score is positive
The Statistical Package for Social Sciences (SPSS) was used in data entry and
computation.
1.4

DATA ANALYSIS

Discriminant analysis is a multivariate statistical technique employed in this study.

Typical discriminant analysis is suitable for use in classification of observations into two
or more groups based on specified predictor variables. It involves deriving a variate, the
linear combination of the two (or more) independent variables that will discriminate best
between a priori defined groups.

Discriminant sets the variates weights for each

variable to maximise the between-group variance relative to the within-group variance.

As used in this study, the following equation derives the linear combination for a
discriminant analysis otherwise known as the discriminant function.
Z = W1X1 + W2X2 + W3X3 + .. WnXn
Where: Z = Discriminant Score
W1 = Discriminant Weight for Variable 1
X1 = Independent Variable 1

To begin this analysis, Table 1.1 presents the unweighted group means for each of the
independent variables, based on the 63 observations constituting the analysis sample.

Table 1.1
Group Descriptive Statistics for the Discriminant Analysis Sample

10

Dependent
Variables
Group
means
Healthy
Banks
Distressed
Banks
Total

Independent Variables
Status

Capader1

Capader2

Capader3

Capader4

Capader5

Capader6

ROA

ROE

1.701

0.232

0.284

0.547

0.156

0.558

0.179

0.174

1.288

-0.125

-0.495

-0.875

-0.274

-0.882

-0.298

-0.317

1.550

0.102

-0.000

0.028

-0.001

0.032

0.005

-0.005

Group
means
Healthy
Banks
Distressed
Banks
Total

Status

Npfixass

Liquidr1

Liquidr2

Liquidr3

Trwatoa

Asequal1

Asequal2

0.289

-0.174

-0.119

-0.290

-0.237

-0.636

-0.315

Owner
ship
0.150

-0.508

0.331

0.214

0.494

0.148

0.957

0.546

0.826

-0.002

0.010

0.003

-0.004

-0.097

-0.055

0.001

0.397

Group
Standard
Deviation
Healthy
Banks
Distressed
Banks
Total

Status

Capader1

Capader2

Capader3

Capader4

Capader5

Capader6

ROA

ROE

0.358

0.024

0.093

0.223

0.003

0.392

0.033

0.328

1.579

0.929

1.548

1.123

1.656

0.958

1.645

1.577

1.003

0.580

0.999

0.978

1.008

0.954

1.007

1.003

Group
Standard
Deviation
Healthy
Banks

Status

Npfixass

Liquidr1

Liquidr2

Liquidr3

Trwatoa

Asequal1

Asequal2

Owner
ship

0.165

0.454

0.941

0.193

0.068

0.186

0.029

0.362

Distressed
Banks
Total

1.547

1.522

1.074

1.540

1.007

0.798

1.524

0.388

1.008

1.006

0.996

1.005

0.631

0.920

0.999

0.493

Source: SPSS Output

Discriminant analysis begins with an analysis of variance to assess the difference

between means of the financial ratios of banks classified as distressed and those classified
as healthy. Table 1.2 below shows the results from the univariate analysis.

Table 1.2
Test for Equality of Group Means between Healthy and Distressed Banks
Independent
Variables

Wilks
Lambda

Univariate
F-ratio

Signifi
cance

Independent
Variables

11

Wilks
Lambda

Univariate
F-ratio

Signifi
cance

Capader1

0.96

2.54

0.13

Capader2

0.91

5.95

0.02

10.22
60.67
2.72
70.51
3.41
3.64

0.00
0.00
0.10
0.00
0.07
0.06

Capader3
0.86
Capader4
0.50
Capader5
0.96
Capader6
0.46
ROA
0.95
ROE
0.94
Source: SPSS Output

Npfixass
Liquidr1
Liquidr2
Liquidr3
Trwatoa
Asequal1
Asequal2
Ownership

0.85
0.94
0.97
0.86
0.91
0.30
0.83
0.56

10.57
3.85
1.65
10.20
5.87
147.34
12.93
48.45

0.00
0.05
0.20
0.00
0.02
0.00
0.00
0.00

It is evident from Table 1.2 that the distressed and healthy banks significantly differ with
respect to eleven ratios: capader2, capader3, capader4, capader6, Npfixass, Liquidr1,
Liquidr2, Liquidr3, trwatoa, asequal1, asequal2, and ownership.
Since the procedure is to exclude all the ratios from the model except those that lower the
Wilks Lambda, and satisfy the requirement of a minimum F value of 1.00 (the default
value) for entry, all the ratios are therefore considered for possible entry into the
discriminant functions (see Table 1.2). From the table, the lowest Wilks Lambda is
associated with Asequal1. After Asequal1 entered the model and the associated variance
removed, the model evaluated the remaining variables based on distance between their
means. The model eliminates ratios with F values less than 1.00 (i.e. capader1, ROE, and
Npfixass) from consideration for entry at the next step (see Table 1.3).
Table 1.3
Results from Step 1 of Stepwise Discriminant Analysis Model
STEP 1: Asequal1 included in the Analysis
Summary Statistics
Degrees of Freedom

Significance

Wilks
.29280
1
1
61.0
Lambda
Equivalent F
147.33674
1
61.0
.000
Variables in the Analysis after Step 1
Variables
Tolerance
F
to Wilks lambda
Remove
Asequal1
1.000
147.3367
Variables not in the Analysis after Step 1
Variable
Tolerance
Minimum Tolerance
F to Enter

12

Between
Groups

Wilks
Lambda

Capader1
Capader2
Capader3
Capader4
Capader5
Capader6
ROA
ROE
Npfixass
Liquidr1
Liquidr2
Liquidr3
Trwatoa
Asequal2
Ownership

.9879
.7523
.5269
.8808
.9883
.7853
.7555
.9649
.9523
.9963
.9925
.9878
.7651
.5039
.9991

.9879
.7523
.5269
.8808
.9883
.7853
.7555
.9649
.9523
.9963
.9925
.9878
.7651
.5039
.9991

.0196
4.954
14.51
4.233
5.123
2.819
6.586
.0397
.1086
2.103
1.583
1.003
4.507
14.03
12.53

.2927
.2705
.2358
.2735
.2698
.2797
.2638
.2926
.2923
.2829
.2853
.2880
.2723
.2373
.2422

Source: SPSS Output

Variable capader3 was the next variable to enter the model because it had the lowest
Wilks Lambda (.2358) and the highest F value (14.507). Given Asequal2s large F value
(14.023), it is likely that it will enter the model at a later step if it is not highly correlated
with variables previously selected. After removing the effect of the variable in the model,
the procedure requires the F value to be calculated. For instance, high multicollinearity
of Asequal2 with variables in the model could substantially reduce the F value.
Table 1.4:
Results from Step 2 of Stepwise Discriminant Analysis Model
STEP 2: Capader3 included in the Analysis
Summary Statistics
Degrees of Freedom
Significance
Wilks
.23579
2
1
61.0
Lambda
Equivalent F
97.23347
2
60.0
.000
Variables in the Analysis after Step 1
Variables
Tolerance
F
to Wilks
Remove
lambda
Capader3
.5269
14.5067
.2928
Asequal1
.5269
157.9581 .8565
Variables not in the Analysis after Step 1
Variable
Tolerance
Minimum Tolerance
F to Enter
Capader1
.9739
.5195
.2827
Capader2
.7170
.4904
1.623
Capader4
.8707
.4716
2.179

13

Between Groups

Wilks Lambda
.2347
.2295
.2274

Capader5
.9250
Capader6
.7169
ROA
.7099
ROE
.8493
Npfixass
.9245
Liquidr1
.9434
Liquidr2
.9798
Liquidr3
.9129
Trwatoa
.7461
Asequal2
.0408
Ownership
.9822
Source: SPSS Output

.4875
.4811
.4952
.4538
.5116
.4990
.5166
.4870
.4841
.0408
.5181

7.253
6.809
2.244
2.073
.7842
.2743
2.287
.0019
1.884
.0864
13.116

.2099
.2114
.2271
.2278
.2327
.2347
.2270
.2358
.2285
.2354
.1929

In step 2 (see Table 1.4), Capader3 enters the model as expected. As in step 1, the overall
model is significant (F=97.23), as is the discriminating power of both ratios included to
this point (Asequal1 and Capader3). As noted earlier, Asequal2 is the next candidate for
inclusion, but the F-to-enter value reduced substantially because of the multicollinearity
of Asequal2 with Asequal1 and Capader3. In step 3 (see Table 1.5), ownership enters the
model with the highest F value of 13.116.
Table 1.5
Results from Step 3 of Stepwise Discriminant Analysis Model
STEP 3: Ownership included in the Analysis
Summary Statistics
Degrees of Freedom
Wilks Lambda .19290
3
Equivalent F
82.28389
Variables in the Analysis after Step 1
Variables
Tolerance
F to Remove
Capader3
Asequal1
Ownership
Variable
Capader1
Capader2
Capader4
Capader5
Capader6
ROA
ROE
Npfixass
Liquidr1

1
3

Significance
61.0
59.0

.000

Wilks
lambda
.5180
15.0771
.2422
.5245
102.8614
.5292
.9822
13.1159
.2358
Variables not in the Analysis after Step 1
Tolerance
Minimum Tolerance
F to Enter
.8468
.5150
.5580
.7138
.4869
1.891
.7969
.4589
.1567
.9215
.4863
4.929
.7003
.4780
3.487
.7087
.4886
2.198
.8326
.4538
.7138
.9156
.5051
.2212
.9299
.4871
.0065

14

Between
Groups

Wilks Lambda
.1911
.1868
.1924
.1778
.1820
.1859
.1906
.1922
.1929

Liquidr2
Liquidr3
Trwatoa
Asequal2
Source: SPSS Output

.9795
.8923
.7429
.0401

.5113
.4734
.4807
.0401

2.003
.2842
2.095
.0250

.1865
.1920
.1862
.1928

Based on the result in Table 1.5, the overall model is significant (F=82.28) as is the
discriminatory power of all the variables included to this point (Capader3, Asequal1, and
ownership). Other ratios eliminated from consideration for entry at the next step include
capader1, ROE, Npfixass, Liquidr1, Liquidr3, and Asequal2 with F values less than 1.00.
In step 4, (see Table 1.6) capader5 enters the model with the highest F value of 4.929.
Table 1.6
Results from Step 4 of Stepwise Discriminant Analysis Model
STEP 4: Capader5 included in the Analysis
Summary Statistics
Degrees of Freedom

Significance

Wilks
.17779
4
1
61.0
Lambda
Equivalen 67.05491
4
58.0 .000
tF
Variables in the Analysis after Step 1
Variables
Tolerance
F to Remove
Wilks
lambda
Capader3
.5017
16.9841
.2299
Capader5
.9215
4.9291
.1929
Asequal1
.4863
112.6282
.5230
Ownershi
.9785
10.4978
.2099
p
Variables not in the Analysis after Step 1
Variable
Tolerance
Minimum
F to Enter
Tolerance
Capader1
.8385
.4851
.8554
Capader2
.7100
.4493
2.124
Capader4
.7954
.4261
.0816
Capader6
.6979
.4664
2.742
ROA
.7061
.4551
2.376
ROE
.8221
.4154
1.098
Npfixass
.9114
.4858
.3416
Liquidr1
.9147
.4669
.0378
Liquidr2
.9770
.4754
2.119
Liquidr3
.8886
.4459
.4176
Trwatoa
.7384
.4429
2.393
Asequal2
.0396
.0396
.1494
Source: SPSS Output

15

Between
Groups

Wilks
Lambda
.1752
.1714
.1775
.1696
.1707
.1744
.1767
.1777
.1714
.1765
.1706
.1773

From Table 1.6, the overall model is significant with Equivalent F of 67.05. However,
Table 1.7 provides the overall stepwise discriminant analysis results after all the
significant discriminators have been included in the estimation of the discriminant
function.
Table 1.7
Summary of Stepwise Discriminant Analysis Result
Summary Table
Step

Action
Variables in
Wilks
Lambda
Entered Removed
1
Asequal1
1
.29280
2
Capader3
2
.23579
3
Ownership
3
.19290
4
Capader5
4
.17779
Classification function coefficients
(Fishers linear discriminant functions)
Status
0
1
Healthy
Distressed
Capader3
-1.2500929
2.2430912
Capader5
0.6312290
-0.7900554
Asequal1
-4.4037638
6.8502526
Ownership
1.0356914
6.2036684
(Constant)
-2.0435068
-6.0872809
Canonical Discriminant Functions
Function

Eigenvalue

%
of
variance

Cumulative

1*

4.6245

100.00

100.00

Significance

Label

.0000
.0000
.0000
.0000

Canonical
Correlation

After
Functi
on

Wilks
Lambda

Chi
Square

DOF
F

:
.9068:

.177794

101.901

Sign

.
000
0

* Marks the 1 canonical discriminant functions remaining in the analysis

Standardised canonical discriminant function coefficients
Independent variables
Discriminant Function Coefficient: Function 1
Capader3
.74099
Capader5
-.32152
Asequal1
1.28483
Ownership
.43645
Structure Matrix: Pooled within-groups correlations between discriminant variables and canonical discriminant
functions (variables ordered by size of correlation within function
Independent variables
Discriminant Function Loadings: Function 1
Asequal1
.72270
Capader4
-.42655
Ownership
.41442
Trwatoa
.33846

16

Capader2
ROA
Capader6
Liquidr3
ROE
Capader1
Asequal2
Capader3
Liquidr1
Liquidr2
Npfixass
Capader5

-.32464
-.29912
-.29787
.27909
-.25241
-.21860
.20283
-.19032

.14398
-.13376
.11202
-.09827
Unstandardised canonical discriminant function coefficients: Function 1
Capader3
.794786
Capader5
-.3233765
Asequal1
2.5605600
Ownership
1.1758393
Constant
-.3270612
Canonical discriminant functions evaluated at group means (Group Centroids)
Group
Group Centroids function 1
0
-1.60457
1
2.79056
Source: SPSS output

The summary table indicates that four ratios (Capader3, Asequal1, Capader5, and
ownership) entered the model and based on their Wilks Lambda appear significant
discriminators. The heading Canonical Discriminant Function reports the multivariate
aspects of the model. The discriminant function is highly significant (.000) and displays
a canonical correlation of 0.9068.
To interpret this correlation it is squared ((0.9068)2 = 0.8223) and this means that the
model, which include only four independent variables accounts for and explains 82.23 %
of the variance in the dependent variable.

The standardised canonical discriminant

function coefficients are the weights used in the validation of this model. The loadings
(which the model employs during the interpretation stage) appear under the heading
structure matrix, in ordered manner from highest to lowest by the size of the loading.
The table also shows the group centroids, which represent the mean of the individual
discriminant function scores for both the healthy and distressed banks group. The group
17

centroids suggest that there is a substantial separation between group 1 (distressed banks)
and groups 2 (healthy banks).

Using cutting score criterion, the SPSS developed classification matrices for the
observations in both the analysis and the holdout samples. In the analysis sample, Table
1.8 shows 95.24 % accuracy, which is slightly higher than the 94.83 % accuracy of the
holdout sample.
Table 1.8
Classification Matrices for Both Analysis and Holdout samples
Classification Results: Analysis Sample*
Actual Group

Group
0
Healthy
Group
1
Distressed

No of Banks

Predicted Group Membership

40
23

0
39
(97.5%)

1
1
(2.5%)

2
(8.7%)

21
(91.24%)

Classification Results: Holdout Sample**

Actual Group

No of Banks

Predicted Group Membership

0
1
Group
37
36
1
0
(97.3%)
(2.7%)
Healthy
Group
21
2
21
1
(9.5%)
(90.5%)
Distressed
* % of grouped cases correctly classified: 95.24% ((40+21)/63 = 95.24%)
** % of grouped cases correctly classified: 94.83% ((36+19)/58 = 94.87%)

The 94.83% classification accuracy is quite high especially when compared with the a
priori chance of classifying individuals correctly without the discriminant function.

18

In order to interpret the result, it is important to examine the function to determine the
relative importance of each independent variable in discriminating between the groups.
Table 1.9 contains among the interpretive measures, the discriminant weights, and
loadings for the function. The stepwise procedure screens the independent variables and
four were significant enough to be included in the function Asequal1, Capader3,
Ownership, and Capader5.

For the interpretation purpose, the model ranks the

independent variables in terms of both their weight and loadings.

However, the

respective signs do not affect the rankings; they indicate a positive or negative
relationship with the dependent variable.
Table1.9
Summary of Interpretive Measures for Group Discriminant Analysis
Variable
Capader1
Capader2
Capader3
Capader4
Capader5
Capader6
ROA
ROE
Npfixass
Liquidr1
Liquidr2
Liquidr3
Trwatoa
Asequal1
Asequal2
Ownership

Standardised weight
Value
Nil
Nil
0.74099
Nil
-0.32152
Nil
Nil
Nil
Nil
Nil
Nil
Nil
Nil
1.28483
Nil
0.43645
Source: SPSS Output

Discriminant Loadings
Value
Rank
-0.21860
10
-0.32464
5
-0.19032
12
-0.42655
2
-0.09827
16
0.29787
7
-0.29912
6
-0.25241
9
0.11202
15
0.14398
13
0.13376
14
0.27909
8
0.33846
4
0.72270
1
0.20283
11
0.41442
3

Univariate F Ratio
Value
Rank
2.54
15
5.95
9
10.22
7
60.67
3
2.72
14
70.51
2
3.41
13
3.64
12
10.57
6
3.85
11
1.65
16
10.20
8
5.87
10
147.34
1
12.93
5
48.45
4

Out of the four ratios in the function, Asequal1 discriminates the most and Capader5
discriminates the least. It is true though that several ratios not included in the model have
higher loadings than Capader3 and Capader5, they were not included in the model
because their collinearity with the ratios included in the model reduced the additional

19

discriminating power they could provide. Thus, although Capader3 and Capader5 are
lower, they provide a unique and statistically significant source of discrimination not
found in the other ratios.
To corroborate this analysis, it can be recalled that in Table 1.1 the means of healthy
banks are higher in respect of capader3 and capader5. For capader3, it means that
healthy bank group has enough capital base to provide cushion against non-performing
loans since it shows the relationship between total shareholders funds and total net loans.
This equally implies that distressed banks generally have lower capader3 ratio, which
indicate poor capitalisation and hence system fragility. Poor loan administration in the
latter group is also evidenced since the loans were given under mysterious conditions and
without perfecting collaterals. This played a major role in eating up the shareholders
funds and setting the stage for deepening distress phobia. Capader5, which is defined as
total shareholders funds by contingency liabilities also stand between the distressed and
healthy groups. The former group it implies carries off-balance sheet risks without
providing backup funds (in form of adequate capital) in case if counter parties default.
However, the healthy bank group has adequate capital, which provides cover against
potential losses from off-balance sheet transactions.
On the other hand, the mean for distressed banks was higher in terms of asequal1 and
ownership. Asequal1 implies the relationship between loan loss provision and gross
loans. It measures the adequacy of loan loss provision to meet future losses on gross
portfolio. Distressed banks on the average have higher provision for future losses due to
poor quality loan portfolio and general poor administration of credit. In fact, the law

20

requires depending on the level of risks involved to make provision in various degrees
(100%, 50% 20% or 0%) on different assets. This shows distressed bank group has poor
asset portfolio and this eventually erodes its capital base. On the issue of ownership
variable, majority of the distressed banks fall under government ownership and this is
more associated with ownership interference. The result in fact validates the a priori
assumption that the higher the value of ownership variable, the greater the level of
ownership interference, and the more the probability of distress.
1.5

CONCLUSIONS

The linear discriminant analysis model developed in this study suggests we assign a
weight of 0.74099 to capader3 (shareholders funds by total net loans), -0.32152 to
capader5 (shareholders funds by contingency liabilities), 1.28483 to asequal5 (loan loss
provision by gross loans) and, 0.43645 to ownership.
Hence Z = 0.74099 (capader3) 0.32152 (capader5) + 1.28483 (asequal5) + 0.43654
(ownership)
The sum of these weighted variables should be used to compute a banks probability of
failure. Against a cutting score of zero a bank is classified as healthy if its discriminant
score is negative and distressed if positive. To this end, the predictive power of the model
was 95.24 percent accurate for the analysis sample and 94.83 percent accurate for the
holdout sample. In fact, one of the banks categorised in distressed banks group in 1997,
the model re-classifies it as healthy, and just a year later, the regulatory authorities CBN
and NDIC adjudged it as healthy.
To sum up, this analysis clearly shows that distressed banks differ significantly from
healthy banks with respect to capader3, capader5, asequal1, and ownership performance
21

variables. A further insight revealed that inadequate capital, poor management, and
ownership interference played a major role in causing distress in Nigerian commercial
banking sector.
The regulatory authorities should take this more seriously considering the fact that even
the three banks nationalised in 2011 had poor management and could not recapitalise to
25 billion Naira which is the minimum capital requirement. Though recently the CBN
had done well in taking over banks (take-over of eight banks in 2009 and three in 2011)
and injecting funds instead of outright liquidation, insists on the enforcement of the CBN
Code of Conduct to stem the tide of poor management, and issuance of Loan-loss
Provisioning, this early warning model becomes handy before the situation deteriorates.

22

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(1996). The Impact of Failed Banks on the Nigerian Economy. NDIC

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25

APPENDIX: MEANING OF THE PERFORMANCE VARIABLES USED IN

THE STUDY
CAPADER1

This is defined as total assets by total shareholders funds. This shows the extent
to which total assets are supported by shareholders funds. The higher the value
of this ratio the better the financial health, hence a positive relationship is
expected.

CAPADER2

This is defined as total shareholders funds by total assets. This is a measure of

leverage and it reveals how much each Naira of equity has been stretched to
create assets. It tells us how much equity cushions the asset base of the bank
rest on. The higher the value of this ratio the better the financial health, hence a
positive relationship is expected.

CAPADER3

This is defined as total shareholders funds by total net loans. This reveals the
extent to which shareholders funds have been used in granting loans to
customers. The higher the value of this ratio, the stronger the financial position
of the bank. Thus, a Positive relationship is expected.

CAPADER4

This is defined as total shareholders funds by total deposits. It gives a measure

of the capacity of shareholders funds to withstand sudden withdrawals; the use
of a banks capital as a bridge between demand and supply of funds. If banks
capital cannot serve as a bridgehead in this respect, the stability of the bank will
depend on the degree and extent of withdrawal by depositors. The higher the
value of this ratio, the better for the financial health of the company. Thus, a
positive relationship is expected.

CAPADER5

This is defined as total shareholders funds by contingency liabilities. This

measures the extent to which banks carry off-balance sheet risks, which may
crystallize if the counter parties default. It also reveals the adequacy of the
banks capital against potential losses from off-balance sheet transactions. One
would expect a positive relationship as the greater the value of this ratio, the
better the financial health.

CAPADER6

This is defined as total shareholders fund by total risk weighted assets. It is a

measure of shareholders funds in absorbing losses arising from risk assets. A
positive relationship is expected because the higher values of this ratio tend to
be associated with stronger financial positions.

ROA

This is defined as net profit by total assets. This reveals the relationship
between after tax profit and total assets. A positive relationship is expected, as
higher values of this ratio tend to be associated with stronger financial positions.

ROE

This is defined as net profit by total shareholders funds . It is a function of the

profitability of the asset base and leverage, such that the higher leverage the
more the return to shareholders. Thus, a positive relationship is expected
because the higher the value of this ratio the better for the bank.

NPFIXASS

This is defined as net profit by fixed assets. This measures the return of the
banks fixed assets and it is expected to have a positive relationship to the
probability of distress.

26

LIQUIDR1

This is defined as total net loans by total deposit. It measures the extent to
which a bank has tied up its deposits in less liquid assets. The greater the value
of this ratio, the weaker the financial health, implying a negative relationship is
expected. In fact, a level below 75% suggests that the bank is liquid and it has
not tied up its deposits in less liquid banking assets.

LIQUIDR2

This is defined as demand liabilities by total deposits. Demand liabilities refer

to core deposits (savings and demand liabilities). The ratio tells us what portion
of the total deposits is less vulnerable to sudden withdrawals. The greater the
value of this ratio, the weaker the financial health of a bank.

LIQUIDR3

This is defined as gross loans by total deposits. It measures the extent to which
banks have tied up their deposits in less liquid assets. A negative relationship is
expected since the greater the value of this ratio, the weaker the financial health
of a bank.

TRWATOA

This is defined as total risk weighted assets by total assets. This measures the
risk profile of a bank. This ratio is both a measure of how risky the bank asset
portfolio is and for a given level of return, how efficient the bank management is
in selecting its portfolio. A higher value of this ratio tend to be associated with
bank distress

ASEQUAL1

This is defined as loan loss provision by gross loans. It measures the adequacy
of loan loss provision to meet future losses on gross portfolio. The higher the
value of this ratio, the more the probability of bank distress. Thus, a negative
relationship is expected.

ASEQUAL2

This is defined as loan loss provision by total net loans. This ratio measures the
adequacy of loan loss provision and the ability of the bank to meet further losses
on total net loans. A negative relationship is expected, as higher values of this
ratio tend to be associated with bank distress.

OWNERSHIP

The ownership category was simplified to a dummy variable, which takes the
value of one for government owned banks and zero for private owned banks.
The higher the value of this ratio, the greater the level of ownership interference,
and the more the probability of distress.

LIST OF ABBREVIATIONS
CBN

CENTRAL BANK OF NIGERIA

NDIC

NIGERIA DEPOSIT INSURANCE CORPORATION

CAMEL

CAPITAL
ADEQUACY,
MANAGEMENT COMPETENCE,
AND LIQUIDITY SUFFICIENCY.

27

ASSET
QUALITY,
EARNING STRENGTH