ABSTRACT
The study sought to find the effect of non-performing loans on the performance of commercial banks in Nigeria. Hence, the study used time series data spanning from 1990 to 2017. The study employed ordinary least square (OLS) multiple regression model to analyzed data on return on asset (ROA) used to measure the performance of commercial banks, bad loans, substandard loans and doubtful loans generated from Zenith Bank and Eco bank annual reports covering the time frame reviewed. Following the results of the data analysis, it was found that bad loans has a significant effect on return on asset (proxy for bank performance). Sub-standard loans have a positive and insignificant effect on the performance of commercial banks in Nigeria. Also, it was evident that doubtful loans had a negative and insignificant effect on commercial banks’ performance. Hence, the need for a strong policy on the management of banks’ credit facility was recommended, need for an immediate change in the banks’ management style and internal control system of the banks was also recommended. And lastly, need for a proper and well-articulated analyses over all collaterals presented for loans and advances was also suggested.
TABLE OF CONTENTS
Contents
Page
Title i
Declaration ii
Certification iii
Dedication iv
Acknowledgments v
Table of contents vi
List of tables viii
Abstract ix
CHAPTER ONE
INTRODUCTION 1
1.1 Background to the Study 1
1.2 Statement of the Problem 3
1.3 Objectives of the Study 5
1.4 Research Questions 5
1.5 Research Hypotheses 6
1.6 Significance of the Study 6
1.7 Scope of Study 8
CHAPTER TWO
REVIEW OF RELATED
LITERATURE 9
2.1 Conceptual Framework 9
2.1.1 Concept
of non-performing loans 9
2.1.2 Concept
of financial performance 10
2.1.3 Essence
of Non-Performing Loans (NPL) 11
2.1.4 NPLs and
financial performance of Banks in Nigeria 12
2.1.5 Intermediation Function of Banks 12
2.1.6 Loan in the Banking Industry 13
2.1.7 Non-Performing Loans in Nigeria 14
2.1.8 Causes of Non-Performing Loans in Nigeria 15
2.1.9 Reducing
levels of non-performing loans 17
2.2 Theoretical Framework 18
2.2.1 Theory of
Asymmetric Information 18
2.2.2 Theory of
life-cycle consumption 19
2.2.3 The
Moral Hazard Theory 19
2.2.4 Adverse
Selection Theory 20
2.2.5. The Stewardship Theory 20
2.3 Empirical Review 21
2.4 Summary of Literature Review 28
CHAPTER THREE
RESEARCH
METHODOLOGY 29
3.1 Research Design 29
3.2 Sampling
Technique 29
3.3 Nature and Sources of Data 29
3.4 Model Specification 29
3.4.1 Description
of Research Variables 30
3.5 Analytical
Technique 31
3.5.1
Ordinary Least Squares (OLS) Technique 31
3.5.2 Coefficient
of Multiple Determination 32
3.5.3 F-statistic
32
3.5.4 t-Statistic 32
CHAPTER
FOUR
4.1 Presentation of Data 33
4.2 Data Analysis and Discussion of Results 34
4.2.1 Regression Analysis 34
4.3 Testing of Hypotheses 36
4.3.1 Testing of Hypotheses One 36
4.3.2 Testing of Hypotheses Two 37
4.3.3 Testing of Hypotheses Three 38
CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATIONS 39
5.1 Summary
of Findings 39
5.2 Conclusion 40
5.3 Recommendations 40
REFERENCES 41
APPENDIX 47
LIST OF TABLES
Table
4.1: Aggregate Data for the Analysis
(1990 to 2017) 33
CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
No
country can attain rapid financial growth and development without the
establishment and effective operation of well-functioning commercial banks.
Commercial banks are special financial intermediaries because of their unique
capacity to finance production by lending their own debt to agents willing to
accept it and use it as money (Ayo, 2012). In Nigeria, the traditional role of
a commercial banks is saving and lending, and loans constitute the bulk of
their assets for the lending proces. Eighty-five percent of income generated by
commercial banks in Nigeria is contributed by interest generated on loans (Adebisi
and Matthew, 2015). Therefore, loans represent the major aspect of commercial
banks assets.
On
the other hand, Chimpa (2012) opined that lending or the giving of loans is not
an easy task for commercial banks, because of the associated problems of
non-performing loans. Due to the nature of their business, commercial banks
expose themselves to the risks of default in contractual obligations from
borrowers. According to Alton and Hazen (2012), non-performing loans are those
loans which are ninety days or more and are no longer accruing interest to the
lender. Hennie (2013) argued that non-performing loans are those loans which
are not generating income to the lender. This is further supported by Fofack
(2015), who defined non-performing loans as those loans which for a relatively
long period of time do not generate income, that is, the principal and or
interest on these loans have been left unpaid for at least ninety days.
Non-performing loans are also commonly described as loans in arrears for at
least ninety days (Guy, 2011).
Non-performing loan are those loans that are not paid up as at when due.
Caprio and Klingebiel (2016), suggested that non-performing loans are those
loans that do not generate income for a relatively long period of time, that
is, the principal and or interest on these loans have been left unpaid after
the due dates of repayments.
Owing
to the effect of non-performing loans on the performance of commercial banks in
Nigeria, non-performing loans have been an issue among banking organizations
and academicians. At the most general level, a non-performing loan (NPL) is a
loan where a borrower is not making repayments in accordance with contractual
obligations (Bloem and Gorter, 2012). In many jurisdictions and for many firms,
NPL is defined as a sum of borrowed money upon which the debtor has not made
his or her scheduled payments for at least 90 days (Bholat, Lastra, Markose, Miglionica and Sen, 2016). NPLs are important because they affect the financial
intermediation role of commercial banks which constitutes the banks’ main
source of income, and ultimately, the financial stability of an economy (Klein,
2013). The immediate consequence of large amount of NPLs in the banking system
is bank failure and wind up in the lomgun. Non-performing loans are usually attributed
to lack of effective monitoring and supervision on the part of banks, lack of
effective lenders’ recourse, weaknesses of legal infrastructure and lack of
effective debt recovery strategies (Adhikary, 2017).
In
Nigeria, due to the rising increase of non-performing loans, the CBN (2010)
through its prudential guideline, required licensed banks to periodically
review their credit portfolios, at least once a quarter with a view to
recognizing any deterioration in credit quality and that a credit facility
should be deemed to be non-performing once any of the following conditions
exist: where interest or principal is due and unpaid for 90 days or more and
interest payments equal to 90 days, interest or more have been capitalized or rescheduled,
or rolled over into a new loan. Thus, they classified non-performing credit
facilities into three categories namely, substandard, doubtful or lost (CBN,
2010). The banking industry, according to NDIC (2013) annual statement and
account show that the total loans and advances stood at N10.043 trillion in 2013, showing an increase of 23.22 percent over
N8.150 trillion granted in 2012, and
that the non-performing loans to total loans ratio improved from 3.51 percent
in 2012 to 3.23 percent in 2013, this according to the report was within the
regulatory threshold of 5 percent. However, in spite of this improvement, the
volume of non-performing loans increased by 13.30 percent in 2013 (NDIC, 2013).
1.2 Statement
of the Problem
In
recent time, different studies have been conducted on factors affecting
non-performing loans, problems and prospects of banking sectors, causes and
effects of non-performing loans. But unfortunately, limited study has been
conducted on the effects of non-performing loans on the performance of
commercial banks in Nigeria, despite the increasing rate of fraud, embezzlement
and loan default for almost a decade. This continuous inadequacy has put the
entire banking sector in an embarrassing situation. Thus, making it difficult
for banks’ executives to comprehensive likely causes of non-performing loans
and mechanisms that can be implemented to address the increasing rate of
doubtful loans and sub-standard loans amongst financial institutions.
It
is averred that all over the world, financial institutions face enormous risks
of non-performing loans (NPLs). Financial
institutions particularly commercial banks are very important in not only
banking the low income earners in the society, but also in advancing credit
facilities to them. However, just like other financial institutions, they
experience many cases of NPLs. Nonperforming loans are not only argued to
adversely affect the financial performance of financial institutions, but they
also have other far reaching implications. This is due to the fact that potential
borrowers may fail to access credit facilities since part of the funds that
could be extended as loans to
potentials borrowers by financial institutions are still tied to NPLs.
Furthermore,
non-performing loans are increasing due to lack of proper risk management,
which has threatened the performance of banks. Most commercial banks in Nigeria
are found to approve the loans that are not well appraised. This may further
lead to increase in loan defaults and non-performing loans. Thus, the existing
procedures for loan management are not adequate to match the existing financial
and economic challenges in Nigeria.
Moreso,
Bloem and Gorter (2011) opined that bank credit officers do not properly assess
the effect of granting credit to their customers and that they do not adhere to
the good lending principles. All the affected banks display similar symptoms
such as insider abuse, poor monitoring of loan accounts, lack of qualified
staff, little or no cash flow appraisal of loan requests. This no doubt has
affected negatively the functionality of most financial institutions operating
in Nigeria.
Though,
most commercial banks’ have clear and sound lending policies, the reality is
that they have been quite reckless in their lending activities. Coupled with
this, is the immense pressure particularly on government controlled banks to
lend to politically connected individuals and institutions regardless of their
credit status or worthiness. This shows that the greatest precipitator of the
banking crisis in the early 1990s and the 2000s were bad corporate governance
and poor quality of loan assets.
NPLs
involve a lot of time, efforts and other related resources of bank management. This is an indirect cost
which the bank has to bear due to poor asset quality. The NPLs do not only
block the interest on loans, but they entail a missed chance of investing in
some return-earning investment, thereby affecting future stream of profits
accruable to commercial banks. NPLs imply blocked income obtainable from loans which
constrains the bank of cash at hand. Banks are, therefore, forced to borrow
more and this results in additional cost to the bank. Thus, affecting
negatively their performance. Moreso, NPLs entail a reputational risk to the
bank. If a bank is facing problem of NPLs, then it adversely affects its credit
rating and would limit its opportunities of co-financing and syndication with
other banks. Thus, huge amount of NPLs affect the performance of commercial
banks and can threaten the survival and growth of commercial banks.
1.3 Objectives
of the Study
The
broad of the study was to examine the impact of non-performing loans in the performance
of commercial banks in Nigeria. Specifically, the study:
i.
ascertained the effect of doubtful loans
on the performance of commercial banks in Nigeria;
ii.
assessed the effect of sub-standard loans
on the performance of commercial banks in Nigeria;
iii.
examined the effect of bad loans on the
performance of commercial banks in Nigeria.
1.4 Research Questions:
The study was poised to address the following research
questions. Namely:
i.
what effect does
doubtful loans have on the performance of commercial banks operating in
Nigeria?
ii.
what effect does sub-standard loans have
on the performance of commercial banks?
iii.
what is the effect of bad debt on the
performance of commercial banks in Nigeria?
1.5 Research
Hypotheses
The
hypotheses of the study, formulated in null form were itemized below:
Ho1: doubtful
loans do not have any significant effect on the performance of commercial banks operating in Nigeria;
Ho2: sub-standard loans
do not have any significant effect on the performance of commercial banks in Nigeria;
Ho3: bad
loans do not have any significant impact on the performance of commercial banks in Nigeria
1.6 Significance
of the Study
The
study provided detailed information to creditors that will enable them to
assess the credit worthiness of Commercial Banks based on both financial losses
and operational losses reports without ignoring the later as it equally affects
profitability of financial institutions.
The
study made the investors recognize that the overall level of non-performing
loans equally affects their return on investment and hence not ignore the NPLs
element when making investment decisions.
The
study made the commercial banks managers and other top executives appreciate
the need to monitor and control non-performing loans as it equally affects the
performance though provisions made by the commercial banks.
The
staff involved in the day-to-day operating activities of commercial banks drew
inference to the study in appreciating the need for controlling operational
losses as it affects profitability and their future benefits in the bank.
With
this study, the management consultants advised on the best investment decisions
based on not only the financial losses position but equally considering the
inherent non-performing loans as they also impact on the profitability of
commercial banks.
The
academicians found the study useful as it highlighted areas for further
research and also it contributed to new knowledge. Also the study gave an
insight of how the operational losses affect various stakeholders in the
banking sector. The academicians saddled with responsibility of disseminating
vital knowledge to various stakeholders on the effect of non-performing loans
on commercial banks will hence find this study useful when doing so.
The outcome of this study enabled commercial banks
operating in Nigeria Banking industry to adopt feasible mechanisms to control
the problem of a growing non-performing loan portfolio in the institutions and
thereby improve its financial performance and profitability. The study also
benefited Nigerian banking and non-banking financial sectors as a whole since
the financial and lending institutions in the country operate within the same
environment and deal with customers of similar characteristics.
And lastly, the project could serve as a source of
reference for other related research works in the future. Thus, providing the
basis for further research to be carried out by potential researchers, who may
desire to identify other effects of non-performing loans on the performance of
commercial banks that the study was unable to identify due to limited time
allotted to the study. Therefore, the study contributed immensely to the development
and growth of commercial banks which play a significant role in the economy.
1.7 Scope of
Study
The study was on the impact of non-performing loans on
commercial banks performance in Nigeria. Thus, the subjective scope of the
study was streamline to the impact of non-performing loans on commercial banks
performance in Nigeria focusing on two commercial banks in Nigeria “Zenith bank
Plc and Eco bank Plc”. The study time frame was from 1990 – 2017. This choice of
the time frame is necessitated because of the recession experienced in the
economy last few decades which affected the ability of loan users to repay
sought loans to commercial banks, thereby, increasing the rate of substandard
and doubtful of these financial institutions.
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