ere very low. Owners had little of their own funds at risk should their bank fail, which created a large asymmetry in the potential risks and rewards of insider lending. Bank owners could invest the bank deposits in their own high-risk projects, knowing that they would make large profits if their projects succeeded, but would lose little of their own money if they were not profitable The third factor contributing to insider lending was the excessive concentration of ownership. In many of the failed banks, the majority of shares were held by one man or one family, while managers lacked sufficient independence from interference by owners in operational decisions. A more diversified ownership structure and a more independent management might have been expected to impose greater constraints on insider lending, because at least some of the directors would have stood to lose more than they gained from insider lending, while managers would not have wanted to risk theFinancial distress has afflicted numerous local banks IN Cameroon, many of which have been closed down by the regulatory authorities or have been restructured under their supervision. In Cameroon banks such as the B.I.C.I.C. Meridian B.I.A.O. Cameroon Bank were closed Many more local banks were distressed and subject to some form of "holding action". Failed local banks accounted for as much as 23 per cent of total commercial bank assets in Cameroon.

The cost of these bank failures is very difficult to estimate: much of the data is not in the public domain, while the eventual cost to depositors and/or taxpayers of most of the bank failures which occurred between the 1988 to 2004 period will depend upon how much of the failed banks' assets are eventually recovered by the liquidators. The costs are almost certain to be substantial.

Most of these bank failures were caused by unprofitable loans. Areas affecting more than half the loan portfolio were typical of the failed banks. Many of the bad debts were attributable to moral hazard: the adverse incentives on bank owners to adopt imprudent lending strategies, in particular insider lending and lending at high interest rates to borrowers in the most risky segments of the credit markets.

Insider lending

The single biggest contributor to the bad loans of many of the failed local banks was insider lending. In at least half of the bank failures referred to above, insider loans accounted for a substantial proportion of the bad debts. Most of the larger local bank failures in Cameroon, such as the Cameroon Bank, B.I.A.O. Bank and B.I.C.I.C. Bank, involved extensive insider lending, often to politicians. Insider loans accounted for 65 per cent of the total loans of these local banks, virtually all of which was unrecoverable.

Almost half of the loan portfolio of one of the local banks local banks had been extended to its directors and employees .The threat posed by insider lending to the soundness of the banks was exacerbated because many of the insider loans were invested in speculative projects such as real estate development, breached large-loan exposure limits, and were extended to projects which could not generate short-term returns (such as hotels and shopping centres), with the result that the maturities of the bank assets and liabilities were imprudently mismatched.

The high incidence of insider lending among failed banks suggests that problems of moral hazard were especially acute in these banks. Several factors contributed to this. First, politicians were involved as shareholders and directors of some of the local banks. Political connections were used to obtain public-sector deposits: many of the failed banks, relied heavily on wholesale deposits from a small number of firms.

Because of political pressure, the small banks which made these deposits are unlikely to have made a purely commercial judgement as to the safety of their deposits. Moreover, the availability of micro deposits reduced the need to mobilize funds from the public. Hence these banks faced little pressure from depositors to establish a reputation for safety. Political connections also facilitated access to bank licences and were used in some cases to pressure bank regulators not to take action against banks when violations of the banking laws were discovered. All these factors reduced the constraints on imprudent bank management.

In addition, the banks' reliance on political connections meant that they were exposed to pressure to lend to the politicians themselves in return for the assistance given in obtaining deposits, licences, etc. Several of the largest insider loans made by failed banks in Cameroon were to prominent politicians.

Second, most of the failed banks were not capitalized, in part because the minimum capital requirements in force when they had been set up were very low. Owners had little of their own funds at risk should their bank fail, which created a large asymmetry in the potential risks and rewards of insider lending. Bank owners could invest the bank deposits in their own high-risk projects, knowing that they would make large profits if their projects succeeded, but would lose little of their own money if they were not profitable The third factor contributing to insider lending was the excessive concentration of ownership. In many of the failed banks, the majority of shares were held by one man or one family, while managers lacked sufficient independence from interference by owners in operational decisions. A more diversified ownership structure and a more independent management might have been expected to impose greater constraints on insider lending, because at least some of the directors would have stood to lose more than they gained from insider lending, while managers would not have wanted to risk thei

al of the failed banks. Many of the bad debts were attributable to moral hazard: the adverse incentives on bank owners to adopt imprudent lending strategies, in particular insider lending and lending at high interest rates to borrowers in the most risky segments of the credit markets.

Insider lending

The single biggest contributor to the bad loans of many of the failed local banks was insider lending. In at least half of the bank failures referred to above, insider loans accounted for a substantial proportion of the bad debts. Most of the larger local bank failures in Cameroon, such as the Cameroon Bank, B.I.A.O. Bank and B.I.C.I.C. Bank, involved extensive insider lending, often to politicians. Insider loans accounted for 65 per cent of the total loans of these local banks, virtually all of which was unrecoverable.

Almost half of the loan portfolio of one of the local banks local banks had been extended to its directors and employees .The threat posed by insider lending to the soundness of the banks was exacerbated because many of the insider loans were invested in speculative projects such as real estate development, breached large-loan exposure limits, and were extended to projects which could not generate short-term returns (such as hotels and shopping centres), with the result that the maturities of the bank assets and liabilities were imprudently mismatched.

The high incidence of insider lending among failed banks suggests that problems of moral hazard were especially acute in these banks. Several factors contributed to this. First, politicians were involved as shareholders and directors of some of the local banks. Political connections were used to obtain public-sector deposits: many of the failed banks, relied heavily on wholesale deposits from a small number of firms.

Because of political pressure, the small banks which made these deposits are unlikely to have made a purely commercial judgement as to the safety of their deposits. Moreover, the availability of micro deposits reduced the need to mobilize funds from the public. Hence these banks faced little pressure from depositors to establish a reputation for safety. Political connections also facilitated access to bank licences and were used in some cases to pressure bank regulators not to take action against banks when violations of the banking laws were discovered. All these factors reduced the constraints on imprudent bank management.

In addition, the banks' reliance on political connections meant that they were exposed to pressure to lend to the politicians themselves in return for the assistance given in obtaining deposits, licences, etc. Several of the largest insider loans made by failed banks in Cameroon were to prominent politicians.

Second, most of the failed banks were not capitalized, in part because the minimum capital requirements in force when they had been set up were very low. Owners had little of their own funds at risk should their bank fail, which created a large asymmetry in the potential risks and rewards of insider lending. Bank owners could invest the bank deposits in their own high-risk projects, knowing that they would make large profits if their projects succeeded, but would lose little of their own money if they were not profitable The third factor contributing to insider lending was the excessive concentration of ownership. In many of the failed banks, the majority of shares were held by one man or one family, while managers lacked sufficient independence from interference by owners in operational decisions. A more diversified ownership structure and a more independent management might have been expected to impose greater constraints on insider lending, because at least some of the directors would have stood to lose more than they gained from insider lending, while managers would not have wanted to risk the

at posed by insider lending to the soundness of the banks was exacerbated because many of the insider loans were invested in speculative projects such as real estate development, breached large-loan exposure limits, and were extended to projects which could not generate short-term returns (such as hotels and shopping centres), with the result that the maturities of the bank assets and liabilities were imprudently mismatched.

The high incidence of insider lending among failed banks suggests that problems of moral hazard were especially acute in these banks. Several factors contributed to this. First, politicians were involved as shareholders and directors of some of the local banks. Political connections were used to obtain public-sector deposits: many of the failed banks, relied heavily on wholesale deposits from a small number of firms.

Because of political pressure, the small banks which made these deposits are unlikely to have made a purely commercial judgement as to the safety of their deposits. Moreover, the availability of micro deposits reduced the need to mobilize funds from the public. Hence these banks faced little pressure from depositors to establish a reputation for safety. Political connections also facilitated access to bank licences and were used in some cases to pressure bank regulators not to take action against banks when violations of the banking laws were discovered. All these factors reduced the constraints on imprudent bank management.

In addition, the banks' reliance on political connections meant that they were exposed to pressure to lend to the politicians themselves in return for the assistance given in obtaining deposits, licences, etc. Several of the largest insider loans made by failed banks in Cameroon were to prominent politicians.

Second, most of the failed banks were not capitalized, in part because the minimum capital requirements in force when they had been set up were very low. Owners had little of their own funds at risk should their bank fail, which created a large asymmetry in the potential risks and rewards of insider lending. Bank owners could invest the bank deposits in their own high-risk projects, knowing that they would make large profits if their projects succeeded, but would lose little of their own money if they were not profitable The third factor contributing to insider lending was the excessive concentration of ownership. In many of the failed banks, the majority of shares were held by one man or one family, while managers lacked sufficient independence from interference by owners in operational decisions. A more diversified ownership structure and a more independent management might have been expected to impose greater constraints on insider lending, because at least some of the directors would have stood to lose more than they gained from insider lending, while managers would not have wanted to risk the

judgement as to the safety of their deposits. Moreover, the availability of micro deposits reduced the need to mobilize funds from the public. Hence these banks faced little pressure from depositors to establish a reputation for safety. Political connections also facilitated access to bank licences and were used in some cases to pressure bank regulators not to take action against banks when violations of the banking laws were discovered. All these factors reduced the constraints on imprudent bank management.

In addition, the banks' reliance on political connections meant that they were exposed to pressure to lend to the politicians themselves in return for the assistance given in obtaining deposits, licences, etc. Several of the largest insider loans made by failed banks in Cameroon were to prominent politicians.

Second, most of the failed banks were not capitalized, in part because the minimum capital requirements in force when they had been set up were very low. Owners had little of their own funds at risk should their bank fail, which created a large asymmetry in the potential risks and rewards of insider lending. Bank owners could invest the bank deposits in their own high-risk projects, knowing that they would make large profits if their projects succeeded, but would lose little of their own money if they were not profitable The third factor contributing to insider lending was the excessive concentration of ownership. In many of the failed banks, the majority of shares were held by one man or one family, while managers lacked sufficient independence from interference by owners in operational decisions. A more diversified ownership structure and a more independent management might have been expected to impose greater constraints on insider lending, because at least some of the directors would have stood to lose more than they gained from insider lending, while managers would not have wanted to risk the

ere very low. Owners had little of their own funds at risk should their bank fail, which created a large asymmetry in the potential risks and rewards of insider lending. Bank owners could invest the bank deposits in their own high-risk projects, knowing that they would make large profits if their projects succeeded, but would lose little of their own money if they were not profitable The third factor contributing to insider lending was the excessive concentration of ownership. In many of the failed banks, the majority of shares were held by one man or one family, while managers lacked sufficient independence from interference by owners in operational decisions. A more diversified ownership structure and a more independent management might have been expected to impose greater constraints on insider lending, because at least some of the directors would have stood to lose more than they gained from insider lending, while managers would not have wanted to risk their reputations and careers.

The high cost of funds meant that the local banks had to generate high earnings from their assets; for example, by charging high lending rates, with consequences for the quality of their loan portfolios. The local banks almost inevitably suffered from the adverse selection of their borrowers, many of who had been rejected by the foreign banks (or would have been had they applied for a loan) because they did not meet the strict creditworthiness criteria demanded of them. Because they had to charge higher lending rates to compensate for the higher costs of funds, it was very difficult for the local banks to compete with the foreign banks for the "prime" borrowers (i.e. the most creditworthy borrowers). As a result, the credit markets were segmented, with many of the local banks operating in the most risky segment, serving borrowers prepared to pay high lending rates because they could access no alternative sources of credit. High-risk borrowers included other banks which were short of liquidity and prepared to pay above-market interest rates for inter bank deposits and loans. We all experienced in Douala and Yaounde how some of the local banks were heavily exposed to finance houses which collapsed in large numbers in the 1990s.

Consequently, bank distress had domino effects because of the extent to which local banks lent to each other.

Within the segments of the credit market served by the local banks, there were probably good quality (i.e. creditworthy) borrowers as well as poor quality risks. But serving borrowers in this section of the market requires strong loan appraisal and monitoring systems, not least because informational imperfections are acute: the quality of borrowers' financial accounts are often poor, many borrowers lack a track record of successful business, etc. The problem for many of the failed banks was that they did not have adequate expertise to screen and monitor their borrowers, and therefore distinguish between good and bad risks. In addition, credit procedures, such as the documentation of loans and loan securities and internal controls, were frequently very poor. Managers and directors of these banks often lacked the necessary expertise and experience.

Recruiting good staff was often difficult for the local banks because the established banks could usually offer the most talented bank officials better career prospects. Moreover, the rapid growth in the number of banks outstripped the supply of experienced and qualified bank officials.

Macroeconomic instability to an extent contributed to these failures;

The problems of poor loan quality faced by the local banks were compounded by macroeconomic instability. Periods of high and very volatile inflation occurred in Cameroon, just before the devaluation of the FCFA. With interest rates liberalized ,nominal lending rates were also high, with real rates fluctuating between positive and negative levels, often in an unpredictable manner, because of the volatility of inflation . Macroeconomic instability would have had two important consequences for the loan quality of the local banks. First, high inflation increases the volatility of business profits because of its unpredictability, and because it normally entails a high degree of variability in the rates of increase of the prices of the particular goods and services which make up the overall price index. The probability that firms will make losses rises, as does the probability that they will earn windfall profits .This intensifies both adverse selection and adverse incentives for borrowers to take risks, and thus the probabilities of loan default. The second consequence of high inflation is that it makes loan appraisal more difficult for the bank, because the viability of potential borrowers depends upon unpredictable developments in the overall rate of in