1.1 Background to the Study
money may be done for a variety of reasons. Traditional areas of need may be
for capital asset acquirement - new machinery or the construction of a new
building or plant. The development of new products can be enormously costly and
here again capital may be required. Normally, such developments are financed
internally, whereas where internal source in not enough the firm may result to
external sourcing. In this day and age of tight liquidity, many organisations
have to look for short term capital in the way of overdraft or loans in order
to provide a cash flow cushion.
the financial system is more than just institutions that facilitate payments
and extend credit. It encompasses all functions that direct real resources to
their ultimate user. It is the central nervous system of a market economy and
contains a number of separate, yet dependent, components all of which are
essential to its effective and efficient functioning (Sanusi, 2012). According
to Aruwa (2011), commercial banks remain the formal source of finance
for enterprises. He states that banks have
three social and economic functions: to collect and secure savings and other
deposits; to finance the economy by handing out credits; and to facilitate
payments and to transfer funds. Their role
is to reduce the gap between supply and demand that exists between idle
money and productive investment.
Bank lending is guided
by credit policies which are guidelines and procedures put in place to ensure
smooth lending operations. Bank lending if not properly assessed, involves the
risk that the borrower will not be able or willing to honour their obligations
(Feder& Just, 1980). Beyond the urge to extend credit and generate revenue,
banks have to recover the principal' amount in order to ensure safety of
depositors' fund and avoid capital erosion. Bank lending therefore has to
consider interest income, cost of funds, statutory requirements, depositor's
needs and risks associated with loan proposals. For these reasons banks have
overtime developed credit policies and procedures which stipulate the lending
process. This process includes among others the credit appraisals,
documentations, disbursement, monitoring and recovery processes of lending.
to Roy and Lewis (1971), giving credit to worthy borrowers is one of the most
significant functions of commercial banks that are directly related to the
development of the economy. If those loans or credit where not grow, the
expansion of our production facilities and operations would almost be
impossible or take a longer time.
Lending criteria are
basic principles of lending which are Character, Capacity, Capital, Collateral
and Conditions. Adeyemi (1994) describes using lending criteria as credit analysis
as the 'heart' of a high quality portfolio. This involves gathering, processing
and analyzing of quality information as way of discerning the client's
creditworthiness and reducing the incentive problems between the lenders as
principals and the borrowers as agents. The bank's credit policy, procedures
and directives guide the credit assessment process.
Matovu and Okumu (1996)
state that, banks should base their credit analysis on the basic principles of
lending which are Character, Capacity, Capital, Collateral and Conditions, this
Matovu and Okumu (1996) aver that, it is designed to ensure lenders take
actions which facilitate repayment or reduce repayment likely problems. This
information about the riskiness of the borrower has necessitated banks to beam
their search lights on thorough scrutiny through measurement of debtor’s
capacity and capital structure as lending criteria; they also take remedial
actions like asking for collateral, shorter duration of payment, high interest
rates and other forms of payments (Stiglitz& Karla, 1990). When these steps
are not adhered to, loan performance is highly affected. Edminster (1980)
stresses the importance of credit analysis, when he observed that its
abandonment often resulted into several banks witnessing non-performing loans
and bad debts. The variable we have, according to Hunte (1996) includes the
scrutiny of debtors’ Capacity and Capital structure, credit experience,
proportion of collateral security to the loan approved. It was found out that
capital structure reflected in inability to repay larger credit facilities
accessed, while Capacity reflected on shortage of credible performance
information required to make informed credit decisions.
loan is a non income earning loan, full payment of principal and interest is no
longer anticipated, principal or interest is 90 days or more delinquent, the
maturity date has passed and payment in full has not been made. The issue of
non-performing loans (NPLs) has gained increasing attentions in the last few
decades. The multiple consequence of large amount of NPLs in the banking system
is liquidity problems and eventual distress. However, many researches on the
causes of bank distress find that asset quality is a statistically significant
predictor of insolvencyand that failing banking institutions always have high
level of non-performing loans prior to failure (Barr &Siems, 1994). There is no global standard to define non-performing
loans at the practical level. Variations exist in terms of the classification
system, the scope, and contents. Such problem potentially adds to disorder and
uncertainty in the NPL issues.
1.2 Statement of the Problem
banking industry has achieved great prominence in the Nigerian economic
environment and its influence play predominant role in granting credit
facilities. The probability of incurring losses resulting from non-payment of
loans or other forms of credit by debtors known as credit risks are mostly
encountered in the financial sector particularly by institutions such as banks.
The biggest credit risk facing banking and financial intermediaries is the risk
of customers or counter party default.
the 1990s, as the number of players in banking sector increased substantially,
Nigerian economy and banks witnessed rising non-performing credit portfolios.
This significantly contributed to financial distress in the banking sector
(Hamisu, 2011). Also identified were the existences of predatory debtors in the
banking system whose modus operandi involves the abandonment of their debt
obligations in some banks only to contract new debts in other banks.
major cause of serious banking problems continues to be directly related to low
credit standards for borrowers and counterparties, poor portfolio management,
and lack of attention to changes in economic or other circumstances that can
lead to deterioration in the credit standing of bank’s counter parties (Treacy& Carey, 2000). Ojo
(2011) avers that, it is also clear that banks use high leverage to generate an
acceptable level of profit.
The discovery of the imminent collapse of five banks
by the Central Bank as a result of high non-performing loans which the banks
were exposed to, necessitated subsequent auditing of other banks, which led to
more discovery of high liquidity risk, poor risk management, insider dealings,
by these banks (Sanusi, 2012). This can be pinned on the lending criteria used
by the banks.
surprisingly (especially given all of this activity) there has been relatively
little research into whether the lending criteria has worked well in terms of
its implementation and its usefulness to banks. In fact this criticism can be
leveled at the field of loan granted more generally, which has seen much
prescription, but relatively little empirical research (Ojo, 2003). Molondu
have made some efforts to demonstrate the extent of reliance on lending
criteria, but his approach has been to use largely anecdotal cases (Molondu,
2000). Others have sought to undertake studies on Credit risk management, but
have tended to concentrate on non-performing loan rather than lending criteria.
However, it is interesting to know that financial providers
often depend too much on credit risk management, to the detriment of lending
criteria, for increasing the loan performance level which may be misleading
and other financial intermediaries are at the heart of the world’s recent
financial crisis. The deterioration of their asset portfolios, largely due to reliance
on lending criteria, was one of the main structural sources of the crisis
(Fries, Neven&Seabright, 2002; Kashif, 2008; Sanusi, 2010). To a large
extent, this problem was the result of inappropriate lending criteria. More so,
realizing the need to focus on measurability of extent of reliance on Capacity,
Capital structure, collateral, character and condition as lending criteria is a
challenge to banks providing the funds.
This research therefore seeks to fill in the existing
vacuum between assessment and non-assessment in respect of the extent of
reliance on lending criteria by Deposit Money Banks Nigeria. This
study therefore aims at assessing lending criteria of Deposit Money Banks in
1.3 Research Questions
In order to achieve the set
objectives of this study, the following research questions are addressed by
what extent do Deposit Money Banks rely on borrower’s Capacity as a
what extent doDeposit Money Banks rely on borrower’s Capital Structure as a lending
what extent doDeposit Money Banks rely on borrower’s Collateral as a lending criterion?
what extent doDeposit Money Banks rely on borrower’s Characteras a lending criterion?
what extent doDeposit Money Banks rely on borrower’s Condition as a lending criterion?
1.4 Objectives of the Study
The main objective of this study is
to assess the lending criteria used by Deposit Money Banks in granting loan.
The specific objectives are to:
the extent of reliance on borrower’sCapacity as a lending criterion by Deposit
the extent of reliance on borrower’sCapital Structure as a lending criterion by
the extent of reliance on borrower’s Collateral as a lending criterion by Deposit
Establish the extent of reliance on borrower’sCharacteras a lending criterion byDeposit
the extent of reliance on borrower’sCondition as a lending criterion by Deposit
In order to pursue the objectives of
the study which is focused on the effect of lending criteria on corporate loan
performance, the following hypotheses were formulated in there null form:
do not significantly rely on borrower’sCapacity as a lending criterion.
do not significantly rely on borrower’s Capital Structure as a lending
H03: DMBs do not significantly rely on borrower’sCollateral as a
H04: DMBs do not significantly rely on borrower’s Character as a
H05: DMBs do not significantly rely on borrower’sCondition as a
1.6 Significance of the Study
role of bank remains central in financing economic activity and its
effectiveness could exert positive impact on overall economy as a sound and
profitable banking sector is better able to withstand .negative shocks and
contribute to the stability of the financial system (Athanasoglou,
Brissimis& Delis, 2005). Therefore, lending criteria as a determinant of
loan performance in banks have attracted the interest of academic research as
well as of bank management.
The findings of this study will help
banks and other financial institutions in formulating effective lending
criteria that will reduce bad debts and non-performing loan.It will enable
Nigerian government and other regulatory authorities like Central Bank of
Nigeria (CBN) formulate policies and institute reforms that will enhance
performing loans.By examining the reliance on lending criteria, it will assist
business owners in the preparation of necessary lending criteria in other for
them to have access to quick loan.Finally, academics and researchers will find
this study useful as it shall increases the body of knowledge on lending
criteria and lending of DMBs in Nigeria.
1.7 Scope and Limitations of the Study
The scope of this research covers the
assessment of capacity, capital structure, collateral, character and condition
in First Bank Plc., Guaranty Trust Bank Plc., Zenith Bank Plc. and United Bank
for Africa Plc. The period under review covered 1994 to 2013; being a period
that witnessed series of turbulence and subsequent reforms in the banking
is no research carried out which would not encounter difficulties in one way or
the other. Just as many other research works, this study too faced the
following constraints: Funding; the study needs to be properly financed so as
to gather enough information.Another militating factor will be time. As it is
known that the study would be combined with course work, which will make the
time available too limited.
1.8 Definition of Terms
The research would attempt here to
define in the process of this study some expressions and technical term used in
order to eliminate some misinterpretation or misunderstanding at the research
work and objectives. These terms include;
Capacity:Itrefers to the
customer’s ability to fulfill his/her financial obligations.
financial strength, more so in respect of net worth and working capital.
It refers to the
client’s willingness to or commitment to meeting loan obligations and the
client’s past repayment record.
the property, fixed assets or chattels, pledged as security by clients.
Condition: It relates to the general economic climate
and its influence on the client’s ability
situation without widespread bank runs, but in which banks are reluctant to
lend, because they worry that they have insufficient funds available.