CREDIT RISK MANAGEMENT ON BANKING PERFORMANCE IN NIGERIA

CREDIT RISK MANAGEMENT ON BANKING PERFORMANCE IN NIGERIA

This research work aims to examine the effects of credit risk management on banking performance in Nigeria.

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CHAPTER ONE

INTRODUCTION

• Background to the Study

Financial institutions are being exposed to a variety of risks, among them are interest rate risk, foreign exchange risk, political risk, liquidity risk, market risk, and credit risk. Credit risk is the possibility that the actual return on an investment or loan extended will deviate from that which was expected (Conford, 2000). Coyle (2000) defines credit risk as losses from the refusal or inability of credit customers to pay what is owed in full and on time. Credit risk includes:

Credit Default Risk: The risk that the borrower will not repay the debt in full.

Concentration Risk: The risk in a bank’s credit portfolio arising from concentration to a single counterparty, sector or country.

Country Risk: The risk of lending in a country, arising from possible political and/or economical changes in the business environment that may adversely affect operating profits or the value of assets in the country.

Some of the main sources of credit risk are; limited institutional capacity, inappropriate credit policies, volatile interest rate, poor management, inappropriate law, low capital, and liquidity levels, directed lending, massive licensing of banks, poor loan underwriting, reckless lending, poor credit assessment, no non-executive directors, laxity in credit assessment, poor lending practices, government interference and inadequate supervision by central banks (Chen et al, 2006; Ayayi, 2012).

To minimize credit risks, the financial system must have, well-capitalized banks services to a wide range of customers, sharing of information about borrowers, stabilization of interest rate, reduction in non-performing loans, increased bank deposit and increased credit extended to borrowers. Loan defaults and non-performing loans need to be reduced (Basel committee on banking supervision 2006).

The Basel committee paved the way for the creation of ‘New capital accord’ which was implemented in 2007. The new capital accord required capital charges to be accrued for credit, market and operational risks. This is in line to protect depositors, consumers and the citizens against losses emerging from bank failure (Umoh, 2005). According to Soludo (2005), business combination in the financial sector was to make Nigeria money deposit banks compete positively in the global stock market and to spawn a large capital base that will make available for the bank to settle compliance costs in the region of credit and market risk management.

Poor financial performance of deposit banks can lead to failure and financial crunch which have undesirable impacts on economic growth, (Ongore & Kusa, 2013). Credit and liquidity problems may adversely affect the financial performance of a bank as well as its solvency if not properly managed.

Banking institutions and specifically, commercial banks are sensitized on the need to have formal and documented risk management framework. Notably, the more complex a risk type is, the more specialized, concreted and controlled its management must be (Seppala, 2000; Matz & Neu, 1998; Ramos, 2000).

Commercial banks employed different credit risk management policies majorly determined by; ownership of the banks, credit policies of banks, credit scoring system, bank’s regulatory environment and the caliber of management of banks (Nworji, Olagunju, & Adeyanju 2011). Banks may be forced to adjust their credit policy in line with other banks in the market where herding behavior is practiced by banks (Altman, 2008). Banks may, however, have the best credit management policies but might not necessarily record-high profit, although there are industry standards on good credit, and banks have different characteristics.

• Statement of the Problem

Granting of credit is one of the most important sources of income for banks. Deposit banks are being exposed to the greatest level of risk via loans which lead to the winding up in the 1990’s up-to-the recent structuring of banks as a result of poor credit management which is seen in the high level of non-performing loans. Notwithstanding, lending is being seen as the financial heart of banking industry and loans and advances are the dominant assets as they generate the largest share of operating income and knowing that commercial banks in Nigeria play an important role in mobilizing financial resources for investment by extending credit to various business and investors. Looking at the emphasis that is laid on credit risk management by commercial banks in recent times, the level of contribution of this factor to financial performance has not been analyzed. When credit is allocated poorly, it reduces the lending capacity of a bank, (Osuka & Amako, 2015). It also denies new applicants’ access to credit facilities. Therefore, the justification for this study is the need to establish the importance of balancing the lending preferences of deposit money banks among the common categories of credit facilities without jeopardizing regulatory requirements and the bank’s objective of profitability, liquidity, and return on assets of banks.

• Aim and Objectives of the Study

This research work aims to examine the effects of credit risk management on banking performance in Nigeria. The study primarily aims to achieve the following specific objectives:

1. To determine the relationship between capital adequacy ratio and return on equity of banks in Nigeria.
2. To determine the relationship between non-performing loans ratio and return on equity of banks in Nigeria.
3. To determine the relationship between loan to deposits ratio and return on equity of banks in Nigeria.
4. To determine the relationship between total debt ratio and return on equity of banks in Nigeria.

• Research Question

This study sought to provide answers to the following questions;

1. To what extent has capital adequacy ratio affected return on equity of banks in Nigeria?
2. To what extent has non-performing loans ratio affected return on equity of banks in Nigeria?
3. To what extent has loan to deposits ratio affected return on equity of banks in Nigeria?
4. To what extent has the total debt ratio affected the return on equity of banks in Nigeria?

• Research Hypothesis

In line with the research purpose and questions, the following hypotheses were formulated for the study;

H₀₁:  There is no significant relationship between capital adequacy ratio and return on equity of banks in Nigeria.

H₀₂: There is no significant relationship between Non-performing loans ratio and return on equity of banks in Nigeria.

H₀₃: There is no significant between loan to deposits ratio and return on equity of banks in Nigeria.

H₀₄: There is no significant relationship between total debt ratio and return on equity of banks in Nigeria

• Significance of the Study

This study is to examine the significance of credit risk management on the financial performance of commercial banks in Nigeria. At the end of this study, it is expected and hopes that the study will bring immense benefit and act as a guideline to credit management to a lot of people especially those in the banking industry, these include, bankers, financial analysts, the bank managers, internal auditors, the top management of deposit banks.

• Scope of the Study

The study is being limited to all credit facilities of six (6) selected commercial banks in Nigeria, which covered the period of twelve (12) years (2007 – 2018).

Emphasis will be placed on the effective credit control of loans and advances, the control measures employed and the recovery of such loans and advances.

• Limitations of the Study

Time and financial constraints have always been the main problems confronting research findings and relatively affected this work. The major problem was the fact that most cooperate executives did not readily provide the required data because of cooperate privacy. Most private based data were prone to falsehood.

Secondly, the subject matter credit risk management, which is regarded as the mainstay of banking business, has witnessed varying and conflicting ideas and perceptions, due to the proliferation of literature.

• Organization of the Study

The study was systematically organized into five chapters. Chapter one which forms the introductory section of the study, creates an insightful expression of the study, statement of the problem, the purpose of the study, research questions, research proposition, significance of the study, the scope of the study, limitation of the study, and the definition of terms. Chapter two is the review of related literature. Here, a critical examination/ analysis and review of the relevant literature of the study were adequately carried out. Chapter three describes the source of data, the process of gathering relevant data, and analyzing them, using appropriate standard techniques, to arrive at the findings of the studies. Chapter four contains an in-depth presentation and analysis of data, which provides answers to the research questions in the study. Chapter five contains a summary, conclusions, and recommendations.

• Definition of Terms

For this study, the following words should be taken to mean;

1. Credit Management: Credit management is defined as the efficient control and co-ordination of loanable funds to keep credit and the investment in credit at an optimal level.
2. Financial performance: Financial performance is the company’s ability to generate new resources from day to day operations over a given period.
3. Credit Risk: Is the risk of loss due to a debtor’s non-payment of a loan or other line of credit (either the principal or interest).
4. Non-Performing Loan: Non-performing loans are loans and advances that are not earning income, full payment can no longer be expected and total credits to the accounts are insufficient to cover the interest charged and payment that has not been made.
5. Liquidity: This relates to the cash level of the organization which describes the organization to settle indebtedness and satisfying its working capital structure.
6. Credit: This is a contractual agreement in which a borrower receives something of value and now agrees to repay the lender at a later date, generally with interest.
7. Equity: This is defined as the difference between the value of assets, and the value of liabilities of something owned.
8. Commercial Banks Are banks that provide services such as accepting deposits, making business loans, and offering basic investment products, that’s is operated as a business for profit.