THE EFFECT OF RISK MANAGEMERNT ON PORTFOLIO PERFORMANCE IN NIGERIA
ABSTRACT
The study examined the effect risk management on portfolio performance in Nigeria. Risk management plays a crucial role in ensuring the sustainability and resilience of industries in Nigeria amidst dynamic and uncertain operating environments. The study found that credit risk management has significant influence on deposit money banks’ net assets per share, thus, the study recommends that DMBs should determine the optimum level for their loan-deposit mix up to when marginal cost (MC) is equal to marginal revenue (MR). Thus would help to bring the nonperforming loans to a minimal level.This research work examines the effect of risk management practices on the Nigerian industry, focusing on the strategies employed to identify, assess, mitigate, and monitor risks. Through an analysis of existing literature and empirical evidence, the paper explores the impact of effective risk management in enhancing organizational performance, mitigating financial losses, and fostering a culture of proactive decision making. Additionally, the paper discusses the challenges and opportunities associated with risk management implementation in the Nigerian context and proposes recommendations for stakeholders to optimize risk management practices for sustainable industry development.
TABLE OF CONTENTS
TITLE PAGE - - - - - - - ii
DECLARATION - - - - - - - - iii
CERTIFICATION - - - - - - - - iv
DEDICATION - - - - - - - - v
ACKNOWLEDGEMENTS - - - - - - vi
CHAPTER ONE: INTRODUCTION
1.1 Background to the Study - - - - - - 1
1.2 Statement of Problem - - - - - - 8
1.3 Objective of the Study - - - - - - 10
1.4 Research Questions- - - - - - - - 11
1.5 Statement of the Hypothesis - - - - - 12
1.6 Significance of Study - - - - - - 13
1.7 Scope of the Study - - - - - - - 14
1.8 Definition of Key Terms - - - - - - 15
CHAPTER TWO: LITERATURE REVIEW
2.1 Introduction - - - - - - - - 18
2.2 Conceptual Framework - - - - - - - 33
2.3 Theoretical Framework - - - - - - - 45
2.4 Empirical Review - - - - - - - 50
CHAPTER THREE: RESEARCH METHODOLOGY
3.1 Research Design - - - - - - - 56
3.2 Population of the Study - - - - - - - 57
3.3 Sample Size - - - - - - - - 57
3.4 Sampling Technique - - - - - - - 58
3.5 Method of Data Collection - - - - - - 58
3.6 Technique for Data Analysis - - - - - - 59
3.7 Model Specification and Variable Definition - - - - 59
3.8 Measurement of Variables - - - - - - 59
CHAPTER FOUR: PRESENTATION AND ANALYSIS OF DATA
4.1 Presentation of Data - - - - - - 60
4.2 Discussion of Findings - - - - - - 79
CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS
5.1 Summary - - - - - - - - 80
5.2 Conclusion - - - - - - - 80
5.3 Recommendations - - - - - - - 93
References - - - - - - - - 95
Appendix - - - - - - - - 98
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND TO THE STUDY
The Nigerian industry operates within a complex and dynamic environment characterized by various internal and external risks, including economic volatility, regulatory changes, geopolitical uncertainties, and technological disruptions (Odulaja, Oke, Eleogu,Abdul, Daraojimba, (2023) & Aroge,(2019) Effective risk management practices are essential for organizations to navigate these challenges and capitalize on opportunities while safeguarding their assets and stakeholders' interests. This paper examines the effect of risk management in the Nigerian industry, addressing the importance of identifying, assessing, mitigating, and monitoring risks to enhance organizational resilience and competitiveness [Ngwu, Nwuke,Agu,& Igudia, (2023). By analyzing the role of risk management in mitigating financial losses, improving operational efficiency, and fostering strategic decision making, this study aims to provide insights into the benefits and challenges of risk management implementation in Nigeria (Alfaqiri, Hossain, Jaradat, Abutabenjeh, Keating, Khasawneh, & Pinto, (2019),Settembre-Blundo, González-Sánchez, Medina-Salgado, & García-Muiña,2021). Despite the importance of risk management, many organizations in Nigeria face significant challenges in implementing robust risk management practices (Isa, 2021). These challenges include limited awareness and understanding of risk management concepts, inadequate resources and expertise for risk assessment and mitigation, resistance to change, and a lack of integration of risk management into strategic planning processes (Belhadi, Kamble, Subramanian, Singh, & Venkatesh, 2024).
In recent years, business organizations have experienced numerous obstacles in their operations and investment strategies, significantly impacting their profit margins (Sufian & Habibullah, 2009). When considering the risks that they cover, which are on the high side, insurance companies are not immune to the fall in profit margin. This tendency necessitates the creation of a new strategy or plans to address the current economic crisis confronting the business world. Environmental instability, strong competition, and the challenges of market liberalization, along with the occurrence of repeated financial crises, have prompted businesses to rethink their strategy in order to maximize profit and outperform other industry competitors (Njuguna, kwasira & Orwa, 2018). As a result, current tactics including the careful selection of securities to be included in an investment portfolio in order to successfully minimize risk exposure and maximize the portfolio's expected return are required (Kanini, Patrick & Muhanji, 2019). The current economic crisis, banditry, kidnapping, high rate of unemployment, cyber-crime, and the recent COVID-19 pandemic all pose hurdles to the implementation of a modern plan. As a result of these issues, risk management has become a necessity for insurance firms, whose major mission is to limit risk faced by individuals and businesses.
Furthermore, the Nigerian industry is particularly vulnerable to external risks such as political instability, security threats, and fluctuations in global commodity prices, which can have profound impacts on organizational performance and sustainability (Venkatesh, 2024). Addressing these challenges is imperative to enhance the effectiveness of risk management in the Nigerian industry and ensure the resilience and sustainability of organizations operating within it. This research work will therefore examine the effect risk management on prtfolio performance in Nigeria (Subramanian, 2024).
Knowing fully well that risks in the Nigeria industrial cannot be eliminated or avoided as stated by Soyemi, Ogunleye & Ashogbon (2024) but can only be managed to control the degree and direction of their impact on performance. Risk management therefore is the identification, assessment and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor and control the probability and/or impact of unfortunate event as stated by Njogo (2012).
Risk management requires developing an atmosphere that safeguards financial institutions against poor outcomes or risk exposure. It aims at assess the risks that individuals, corporations, financial institutions (both banking and non-banking), and public entities face in order to make recommendations on how to mitigate those risks (including risk transfer). This can be accomplished by categorizing events into one or more broad categories, such as market risks, credit risks, and operational risks; assessing risks using data and risk models; monitoring and reporting risk assessments on a timely basis; and employing risk management techniques to mitigate the risks' impact (Ebenezer & Omar, 2016). Documents and guidelines recommend that established risk management approaches should be employed on a continuous basis to increase performance and business profits because risk management is a never-ending process that comprises several steps (Kokobe & Gemechu, 2016).
Insurance firms are a bit of a riddle in that they handle both internal and external risks for individuals and businesses, and also have their own risks to manage (Olaiya, Arikewuyo, Sogunro, & Yunusa 2021). As a result, risk management and risk management approaches are critical to a company's ability to make sound decisions and perform successfully. Most risk management solutions deal with several types of hazards based on their severity which necessitates risk ranking and prioritization. Risks that may cause minor inconveniences are rated low, but risks that can cause catastrophic losses are rated high. As a result, it is critical to rank risks in order for the company to make informed decisions.
The profit that insurer derived from providing insurance or reinsurance coverage, exclusive of the income it derives from investment (Underwriting profitability), is a critical component that keeps a company running and gives it a competitive advantage over its competitors, since it is crucial to all stakeholders, investors, shareholders, and the economy as a whole. So far, investors are only concerned with the returns on their investments. Profitable businesses are economically and socially responsible because they create value, employ people, innovative, and also pay taxes (Odusanya, Yinusa & Ilo, 2018 as cited by Olaiya et al, 2021). An insurer faces numerous sorts of risk when carrying out their operations, which must be controlled by incorporating a robust risk management strategy into their system so that they can perform better.
The banking industry has experienced huge and dramatic losses in the past decades occasioned by risk management failures. Banks that had been performing well suddenly announced large losses due to credit risk exposures that turned sour, interest rate positions taken, or derivative exposures that may or may not have been assumed to hedge balance sheet risk. According to Santomero (1997), commercial banks have in response to risk management, almost universally embarked upon an upgrading of their risk management approaches and control systems in order to ensure that investors’ return and safety of their investment is assured.
By definition, risk is the chance of an asset (financial) suffering a loss. It could also be defined as the potential that a given threat will exploit vulnerabilities of an asset or group of assets to cause loss or damage to the asset. In this sense, Dipo (2008), defined banking risk as those threats that may impact the assets (loan) or processes of banks. According to Dipo (2008), risk management is the process of identifying vulnerabilities and threats to an organization’s assets in achieving business objectives and deciding what counter – measures if any, to take in reducing the risk to an acceptance level. Risk can be accepted, rejected, reduced or transferred.
Modern banks provide liquidity on demand to depositors and supply funds to borrowers through loans and lines of credit (Kashyap, 2002). Accordingly, banks’ risk (liquidity) management involves maintaining a store of liquid assets and access to various borrowing to guard against unexpected cash shortfalls (Loutskina 2011, Loutskina & Strahan 2009). According to Adrian and Shin (2010), recent financial innovations such as securitization as well as changes in liability structure, notably, an increased dependence on short term wholesale funding have had a profound impact on modern banks’ liquidity management.
Coincidental to this activity, and in part because of our recognition of the industry's vulnerability to financial risk, the central bank of Nigeria (CBN), with the support of other regulatory authorities has been involved in an analysis of financial risk management processes in the financial sector. Through the past financial year, on-site visits were conducted to review and evaluate the risk management systems and the process of risk evaluation that is in place. In the banking sector, system evaluation was conducted covering many of Nigeria's mega banks and quasi-money center of deposit money banks (DMBs), as well as a number of major investment banking firms. These results were then presented to a much wider array of banking firms for reaction and verification.
Credit risk is one of the significant risks of banks by the nature of their activities. Through the effective management of credit risk exposure, organisation does not only support the viability and profitability of their own business but also contribute to the systematic stability and to an efficient allocation of capital in the economy as stated by Psillaki, Tsolas, and Margaritis (2010). The default of a small number of customers may result in a very large loss for the organisation, which can have a negative effect of the financial performance of the organisation; therefore, a good credit risk management tries to avoid high exposure on risk.
In order to appraise and weigh up the soundness and reliability of banking industry, the information on connection between fluctuations in banking industry and the risk which is faced by banking sector is important. Appalling financial conditions can deteriorate the value of the bank’s portfolio, engendering liquidity and credit losses, which ultimately reduce profits of the banks. Therefore, a sound and reliable banking system dishes up as a significant feed for accomplishing economic growth all the way through the mobilization of monetary resources, placing them to dynamic use and transforming various risks.
The lessons leant from financial crisis are to open awareness of the government and business people on the important role of implementing good risk management in Nigeria. Thus, as a way out of the tide, the CBN on July 6, 2004 introduced measures to make the entire banking system a safe, sound and stable environment that could sustain public confidence in it (Owojori, Akintoye & Adidu., 2011). According to the then CBN Governor, it is now time to set up a structure that creates a strong base relative to the kind of economy we are operating where banks become channels to do proper intermediation (The Obasanjo Economic Reforms on the Banking sector, 2005). Hence, in order to adhere partly to the Basel II 2004 regulations, a 13-point agenda to stabilize the base of the banking sector was put in place from which a compulsory recapitalization requirement of N25billion for a commercial bank operating in Nigeria is required to possess.
In any nation, banks play vital role in the economic development; they provide loan advancement to private enterprise for development purposes. Most commercial banks known as the Deposit Money Banks (DMBs) plays important role in the economic resources distribution of various countries. In terms of survival and growth therefore, it is expedient that Deposit Money Banks (DMBs) needs to be profitable, because the profitability of banks will have positive effects on economic goals. Also good financial performance of Deposit Money Banks (DMBs) can lead to high shareholders’ return which will promote investment and economic growth. On the other hand, poor financial performance of Deposit Money Banks (DMBs) can lead to failure which will have a negative impact on economic growth of a nation as stated in Ongore & Kusa (2013). Beside these “the safety of banking system is depending on the profitability and capital adequacy of banks profitability as a parameter which shows management approach and competitive position of banks in market-based banking. This parameter helps the banks to tolerate some level of risk and support them against short-term problems” as stated by Tabari, Ahmadi & Emami (2003).
There are many factors that affects and determine the performance of banking system, these factors includes liquidity, capital adequacy, interest rate, inflation, exchange rate, etc. high liquidity and capital adequacy ratio lead to more money being held back in the bank, creating low profitability but boost confidence on investors and other stakeholders. On the other hand, giving loans and advances out leads to high profit but might result in low liquidity and capital adequacy ratio, reducing confidence. Banks are expected to turn in high performance and at the same reassure investors. The process of pressing for high performance, problem of liquidity and risk set in. This create problem for management of banks on how to balance the two sides of the coin. This problem can be solved by adopting compromise principle which means graduating loanable fund into various short term maturity period loans and advances increase profitability thereby resulting to economic growth and development. Based on the information we have studied so far, we have realized that it is of great necessity to study the relationship between credit risk management and financial performance in Nigeria. In understanding the effect of credit risk management on financial performance of banks, the following variables should be considered critically in evaluating bank performance; they are loans and advances, non-performing loan, capital adequacy, loan loss from vision, loan to total assets, etc.
Another major area that has led to the unsuccessful curtailing of the banking risk that has also affected the efficiency and credit risk of the Nigerian banking institutions is the increased competition associated with the process of capitalization, liberalization and globalization and the attempt of Nigerian banks to increase their presence in other markets.
Deposit Money Banks (DMBs) employs different risk management policies majorly determined by ownership of the banks. These are: Credit policies of banks, credit scoring systems, banks regulatory environment, and the caliber of management of the banks as stated by Nworji, Olagunju & Adeyanju (2011). Banks may however have the best Credit management policies but might not necessarily record high profit. In addition, the main source of credit risk include, limited institutional capacity, inappropriate credit policies, volatile interest rates, poor management, inappropriate laws, low capital and liquidity levels, directed lending, massive licensing of banks, poor loan under writing, reckless lending, poor credit assessment, no non-executive directors, poor lending practices, laxity in credit assessment, government intolerance and inadequate supervision by central bank. Looking at the emphasis that is laid on credit risk management and the financial performance of banks in Nigeria, we find out that the level of contribution of these factors to profit has not been analysed.
In July 2010, the federal government of Nigeria provides a lasting solution to the recurring problem of banks failure in Nigeria. From the year 1994 - 2016, forty eight (48) Deposit Money Banks were liquidated, Nigeria Deposit Insurance company (NDIC) (2011), Non-performing loan (NPL) reduce the liquidity of banks credit expansion and it slow down the growth of the real sector built direct consequences on the performance of banks, other efforts by the Central Bank of Nigeria (CBN) to ensure sound and efficient financial institution performance are the recapitulation policy of July 2004, Issuance of prudential guidelines establishment of Nigeria Deposit Insurance Corporation (NDIC), etc. The reasons why CBN supervised and examined banking operations are: To minimize the risk of bank of failure; to provide a mechanism for the enforcement of monetary policy thrusts of the government, which is essentially geared towards the achievement of aggregate economic performance; to provide basis for establishing warning signals about an impending distress or failure. This assists the monetary authorities to take timely measure to improve the situation and hence restore sound banking practices, and provide proper evaluation of a bank's loan portfolio to determine the performing and non-performing Credits and assets. In summary to the conclusion of the background or the study there is need to follow proper guidelines and exhibit good credit risk management in order to reduce the burden faced by Nigeria Banks and without doubt a proper credit risk management will have a significant and a positive effect on banks performance, therefore this study examines the credit risk management and financial performance of banks in Nigeria.
1.2 STATEMENT OF THE PROBLEM
It will assess the effectiveness of risk identification, assessment, mitigation, and monitoring strategies employed by organizations in Nigeria, and analyze the challenges and barriers hindering the implementation of robust risk management practices in the Nigerian context. This problem was caused by poor credit management as this cannot be eliminated or avoided as stated by Soyemi, Ogunleye & Ashogbon (2014). They can only manage to control the degree and direction of the impact on bank performance. Due to this problem, banks are now working hard to attract customers that are not banking with them. This has led to increase in the bank's surplus units as well as deficit unit with the aim of increasing profitability and this has made banks to give loans and advances that cannot be recovered, leading to a massive growth of non-performing loans resulting to bad debt that now reduce banks profitability.
1.3 OBJECTIVES OF THE STUDY
The broad objective of this study is to examined the effect risk management on prtfolio performance in Nigeria, the specific objectives are:
i. To examine the effect of Non-Performing Loan ratio on the DMBs performance in Nigeria.
ii. To access the effect of loan loss provision ratio on the DMBs bank performance in Nigeria.
iii. To determine the effect of capital adequacy ratio on the DMBs performance in Nigeria.
iv. To determine the effect of loan to total asset ratio on the DMBs performance in Nigeria.
1.4 RESEARCH QUESTIONS
From the objectives of the study, the following research questions were formulated:
i. Does Non-Performing Loan Ratio (NPLR) have significant effect on the DMBs performance in Nigeria?
ii. Does Loan Loss Provision Ratio (NPLR) have significant effect on the DMBs performance in Nigeria?
iii. Does Capital Adequacy Ratio (CAR) have significant effect on the DMBs performance in Nigeria?
iv. Does Loan to Total Asset Ratio (LTAR) have significant effect on the DMBs performance in Nigeria?
1.5 STATEMENT OF HYPOTHESES
For the purpose of this study, the following hypotheses have been formulated.
i. HO1: There is no significant effect between Non-Performing Loan Ratio (NPLR) and the DMBs performance in Nigeria.
ii. HO2: There is no significant effect between Loan Loss Provision Ratio (LLPR) and the DMBs performance in Nigeria.
iii. HO3: There is no significant effect between Capital Adequacy Ratio (CAR) and the DMBs performance in Nigeria.
iv. HO4: There is no significant effect between Loan to Total Asset Ratio (LTAR) and the DMBs performance in Nigeria.
1.6 SCOPE OF THE STUDY
This study focuses on examined the effect risk management on prtfolio performance in Nigeria: a case study of DMBs in Nigeria. It evaluates the practices of all the Deposit Money Banks, i.e. the thirty three (33) Deposit Money Banks listed in the Nigeria stock exchange as at 2020 as released by the Central Bank of Nigeria (CBN), i.e. geographical scope. This study make use of Secondary data that are collected from annual report of the Central Bank of Nigeria Statistical Bulletin and the Federal Reserve Economic for a period of ten (10) years, i.e. time scope. The credit risk management measured by Non-Performing Loan (NPL), Loan Loss Provision (LLP), Capital Adequacy Ratio (CAR) and Loan to Total Asset (LTA) independent variables and bank performance is Proxy by Return on Asset (POA) and Return on Equity (ROE) as dependent variable, i.e. variables scope.
1.7 SIGNIFICANCE OF THE STUDY
The following are the significant of this study:
i. Deposit Money Banks: It will help credit managers in Deposit Money Banks on how to grant loans to their customers.
ii. Credit Managers: It will help credit managers on how to avoid default risk which is the major risk in the banking system. Also, it will help them in the area of knowing the actual amount needed by the customer and know if customer is credit worthy or not.
iii. Researchers: Finally, this study has added to the existing findings and knowledge on credit risk management as it relates to banks in Nigeria as such, it can pave way for other research and develop their works.
1.8 LIMITATIONS OF THE STUDY
The limitation of this study is the geographical scope of the study. This is so because what the study arrives at will only be applicable to Nigeria. Window dressing of figures from the Nigerian deposit money banks is another limitation. This is done to avoid the issue of insolvency. Availability of data can be mentioned as another limitation. This has been a recalling decimal in research of this kind. Most trusted sources of data are to be subscribed for, sometimes in foreign currency, i.e. dollars. This makes it somewhat cumbersome. However, these limitations were surmounted with the help of the Central Bank of Nigeria Statistical Bulletin and the Federal Reserve Economic, were data can be collected with easy and without payment or subscription made.
1.9 DEFINITION OF TERMS
i. risk management: this are the processes a bank engage in trying to curb or avoid high exposure on risk.
ii. Deposit Money Banks: this are financial institutions in the banking system that grants credit facilities to their customers in form of loan advances and overdraft and in return accept deposit from their customers.
iii. Profitability: this is the efficiency of a firm at generating profit from each unit of shareholders' equity.
iv. Return on assets: this is an example of the profitability ratio. It is used to measure the company return from all assets.
v. Risk: the uncertainty of losing.
1.10 ORGANISATION OF THE STUDY
The organizational frame work of this study is divided into five chapters as following:
Chapter one, this is the introductory part of the study. It also highlighted the following key sub-headings; the background to the study, the research problem, the undertaking objectives, scope and significance of the study and also the expected limitation and definition of terms.
Chapter two, this chapter showcases the review of literatures both conceptual, theoretical and empirical frame work that has been done by different scholars on credit risk management and financial performance of banks in Nigeria.
Chapter three, here, the methodology of the study, research design and population of the study, sample size and sampling technique, method of data collection, technique for data analysis, model specifications, operational definition of variables, were all discussed and also prior expectation was employed for analyzing the survey results gathered for the study.
Chapter four, this chapter dwells on the data presentation and analysis while the final chapter, chapter five, delves into the summary of findings, conclusion and recommendations.
1.11 SUMMARY
This study examined the effect risk management on prtfolio performance in Nigeria for a specific period or number of years. The background to this study is well explained with much details pertaining to risk management, following the background is the statement of the problems, objectives and research questions that may arouse from the study. Research hypotheses were also formulated. Also, the scope, significance, limitations and gaps in the literature of the study are well explained in this chapter. Finally was the definition of terms, summary of the chapter and references to the citations in the chapter.
Login To Comment