ABSTRACT
The study broadly investigated the effect of credit risk on the performance of commercial banks in Nigeria. To achieve this objective, the study specifically investigated the effect of loan-to-total assets ratio, non-performing loans and interest rate on return on assets of commercial banks in Nigeria. Aggregate loan-to-total assets ratio, non-performing loans ratio and interest rate of the commercial banks in Nigeria were used as the independent variables and measures of credit risk while return on assets was used as the proxy for performance and the dependent variable. The study covered the period 1996 to 2016. A trend analysis of the return on assets, credit risk ratios and interest rate was carried out to ascertain the movement of the variables over time. Thereafter, the study employed the Ordinary Least Squares (OLS) method to determine the effect of the independent variables on the dependent variable. From the empirical outcomes, it was shown that loan-to-total assets ratio and interest rate had positive and insignificant effect on the performance (proxied by return on assets) of commercial banks in Nigeria. On the other hand, the study revealed that non-performing loans had a negative and significant effect on the performance of commercial banks in Nigeria. The study recommended that managers of commercial banks in Nigeria should desist from granting illegal and sentiment-backed loans to their family members and cronies in order to eliminate the non-performing loans syndrome plaguing the banking industry in Nigeria.
TABLE
OF CONTENTS
Title
Page i
Declaration ii
Certification iii
Dedication iv
Acknowledgement v
Table
of Contents vi
Lists
of Tables vii
Abstract viii
CHAPTER ONE
1.0
Introduction 1
1.1 Background
to the Study 1
1.2 Statement
of the Problem 3
1.3 Objectives
of the Study 4
1.4 Research
Questions 4
1.5 Research
Hypotheses 5
1.6 Significance of the Study 5
1.7 Scope of the Study 6
1.8 Limitation of the Study 6
1.9 Definition
of Terms 7
CHAPTER TWO
2.0
Review of Related Literature 8
2.1 Conceptual Framework 8
2.1.1 What is Risk? 8
2.1.2 What is Credit Risk? 8
2.1.3 Banks Performance and its
Determinants 11
2.1.4 Internal Determinants 13
2.1.5 External Determinants 17
2.2 Theoretical Framework 18
2.2.1 Commercial Loan Theory 18
2.2.2 The Shiftability Theory 19
2.2.3 The Anticipated Income Theory 20
2.2.4 The Credit Risk Theory 20
2.2.5 The Liability Management Theory 21
2.3 Empirical Review 21
CHAPTER THREE
3.0
Research Methodology 27
3.1 Research Design 27
3.2 Area of the Study 27
3.3 Nature and Sources of Data 27
3.4 Technique of data analysis 28
3.5 Model Specification 28
3.6
Description of Research Variables 29
CHAPTER FOUR
4.0
Data Presentation, Data Analysis and Discussion of Findings 31
4.1
Data Presentation 31
4.1.1 Return on Assets (ROA) 32
4.1.2 Loan-to-Total Assets Ratio (LTA) 33
4.1.3 Non-Performing Loans (NPLs) 33
4.1.4 Interest Rate 34
4.2 Data Analysis 34
4.3 Test of Hypotheses 37
4.3.1 Hypothesis One 38
4.3.2 Hypothesis
Two 38
4.3.3 Hypothesis
Three 38
4.4 Discussion of
Findings 39
CHAPTER FIVE
5.0
Summary of findings, conclusion and recommendations 42
5.1 Summary of Findings 42
5.2 Conclusion 42
5.3 Recommendations 43
Reference 44
Appendix
51
LIST OF
TABLES
Table
4.1: Data on Return on Assets (ROA), Loan-to-Assets Ratio (LTA), Non-performing
Loans (NPL) and Interest Rate (INTR) in Nigeria. 31
Table 4.2: Ordinary Least Squares (OLS)
Regression Method 34
CHAPTER ONE
INTRODUCTION
1.1 Background
to the Study
The
role of banks remain 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 (Athansoglou, Brissimis, and Delis
(2005). Consequently, the determinants of banking performance have attracted
the interest of academic research as well as bank management. Studies dealing
with internal determinants employ variables such as size, capital, credit risk
management and expenses management. Credit risk is one of the most significant
risks that banks face, considering that granting credit is one of the main
sources of income in commercial banks. Therefore, the management of the risk
related to that credit affects the profitability of the banks (Li and Zou,
2014). The importance of credit risk management in banks is due to its ability
in affecting the banks’ financial performance, existence and growth.
Credit
risk is by far the most significant risk faced by banks and the success of
their business depends on accurate measurement and efficient management of this
risk to a greater extent than any other risk (Gieseche, 2004). Increase in
credit risk will raise the marginal cost of debt and equity, which in turn
increases the cost of funds for the bank (Basel Committee, 2001).
It
is the potential that a contractual party will fail to meet its obligations in
accordance with the agreed terms (Brown and Moles, 2012). The Basel Committee
on Banking Supervision (2001) also defined it as the possibility of losing the
outstanding loan partially or totally, due to credit events (default risk). It
is true that, the credit function of banks enhances the ability of investors to
exploit desired profitable ventures. Credit creation is the main income
generating activity for the banks. But this activity involves huge risk to both
the lender and the borrower. The risk of the trading partner not fulfilling his
or her obligation as per the contract on due date or anytime thereafter can
greatly jeopardize the smooth functioning of banks business. On the other hand,
a bank with high credit risk has high bankruptcy risk that puts the depositors
in jeopardy. In a bid to survive and maintain adequate profit level in this
highly competitive environment, banks have exposure to credit risk the higher
the tendency of the banks to experience financial crisis and vice-versa.
In
Nigeria, as at 2017 there are twenty-four commercial banks operating under the
direct supervision of the Central Bank of Nigeria .Looking at the financial
statements of these commercial banks (1990-2016), most of them are maintaining
significant amount of provisions for loans and advance that strengthen the Basel
Committee’s on Banking Supervision (2001) asserts that loans are the largest
and most obvious source of credit risk.
Therefore,
it is a requirement for every bank worldwide to be aware of the need to
identify measures to monitor and control credit risk while also determining how
credit risk could be lowered. This means that a bank should hold adequate
capital against these risks and that are adequately compensated for risks
taken.
It
is realization of the high provision expense to the loan and advance made by
the banks that this research work is inspired to see in detail the factors that
are contributing to same and recommend solutions to mitigate the negative
consequences on the profitability of the Nigerian Commercial Bank.
1.2 Statement
of the Problem
Banks
consciously take risk as they perform their role of financial intermediation in
the economy. Consequently, they assume various risks, which include credit
risk, interest rate risk, liquidity risk, foreign exchange risk and operational
risk. Managing these risks is essential for their survival and prosperity.
Losses from a single loan or a material breakdown in controls can eliminate the
gain on many other transactions (CBN, 2010).
Majority
of Nigerian Commercial Banks recorded a huge amount of provision for their
loans and advance. All commercial banks financial statement for years 2012 is
taken as a data point to look at their provision for loans and advance status.
These banks have recorded average of 3.7% provision for loan and advance for
the period from 2008 to 2012 for the loan and advances made (Author Compilation
from Banks’ financial statement). For loans and advances under pass (Normal) status,
as per Central Bank of Nigeria directive No. SBB43/2007, one percent of the
total loan and advance has to be recorded as provision; however, the provision
is almost more than double from the standard.
Recently
there are attempts being made to see in commercial banks of Ethiopia the impact
of credit risk on profitability, as there is high loan provision expenses
though declining, which is above the standard,. However, there are no in-depth
studies that have been conducted to investigate the impact of credit risk management
in the commercial banks’ performance in Nigeria. The research made by Girma (2011)
focuses on the credit risk part and the models considered are loan provisions
to total asset, loan provision to total loan, NPL to total loan, and loan
provisions to Non-performing loan. And Tseganesh’ (2012) investigated some of
bank specific and macroeconomic factors affecting liquidity and their impact on
financial performance.
Local
studies so far however did not consider some variables like age or size of
banks (Economies of Scale), and cost per loan asset (Credit Administration Cost)
in relation to performance of banks. These variables were among the factors
considered in studies made in different countries Pasiouras and Kosmidou (2007),
Appa (1996), Guru, Staunton and Balashanmugam. (2002) and Ben Naceur (2003). This
study therefore fills the gap in respect of the variables considered in the
study and it is further believed that such a study with complete recognition of
all factors would contribute to policy making and devise risk mitigating
mechanism.
1.3 Objectives
of the Study
The
main objective of the study is to measure the effect of credit risk on the
performance of banks.
The
specific objectives are:
1. To
assess the impact of loan to total asset on the performance of commercial
banks.
2. To
assess the non-performing loan on the performance of commercial banks.
3. To
assess the impact of interest rate on the performance of commercial banks.
1.4 Research
Questions
Given
the various issues relating to the impact of credit risk on banks performance
in Nigeria, a number of research questions can be raised as follows:
1. How
does loan to total asset affects the performance of banks?
2. How
does non-performing loan affects the performance of banks?
3. How
does interest rate affects the performance of commercial banks?
1.5 Research Hypotheses
H01:
Loan to total asset has no significant impact on banks performance.
H02:
Non-performing loan has no significant impact on banks performance.
H03: Interest rate has
no significant impact on banks performance.
1.6 Significance of the
Study
The
aim of this paper is to assess the impact of credit risk on the performance of
Nigerian commercial banks over a period of twenty six (26) years (1990-2016).
The study is made because of the damaging effect of credit risk on banks’
performance and would be of utmost relevance as it addresses how credit risk
affects banks profitability using a judgmental sampling and the finding would serve
as the basis for possible recommendations.
This
study will be beneficial to the following:
1. Government: the
study will benefit the government of Nigeria by providing empirical evidence on the contribution of impact
of credit risk management on the performance of banks.
2. Investors: the
study will serve as an information tool to both stake and share holders on the
role of credit risk management policies in the country. This will enable them
to strategically hedge on their investments.
3. Researchers: the work will serve as an empirical literature to
support existing studies on the impact of credit risk management on the
performance of banks. It will also encourage further studies on the subject
matter.
1.7 Scope of the Study
A
total of twenty-four commercial banks operate presently in Nigeria, out of
which a sample of eight is drawn. The eight are selected primarily since the
banks account for over eight percent of the total loan and advance in the
industry. Besides the compositions is both from the government owned and
private company with varied capital basis and hence risk exposure.
Due
to confidentiality of data, credit risk exposure assessed by loan loss provision
which is proxy to same and twenty six years data from 1990 – 2016 is used to
see the effect of both dependent and independent variable like the trends of
loan and advances with respective provisions, operation cost, asset positions
and return on asset. The data is collected from secondary sources which are
obtained directly from banks audited financial statements that are prone to
variation in accounting years. In addition, this study is quantitative
primarily because both the dependent and independent variable are quantifiable
hence measurable over the time period to see the trend.
Determinants
of banks performance closely tied with profitability measure like ROA than then
pricing measures which only focuses on interest rates and stock pricing which needs
stock market which is not the case in the local banking industry context.
Therefore, in the research performance is measured through return on asset.
1.8 Limitation of the
Study
The
independent variables are few as other variables like interest income/total
loan, total asset have high multi-colinearity relationship and hence excluded
recently established banks so to avoid bias, related to limited observations.
1.9 Definition of Terms
Credit Risk
means possibility of losing the outstanding loan partially or totally due to
credit events (default risk) (BCBS, 2001).
Credit Risk Exposure
means the total amount of credit extended to a borrower by a lender (Croatian
National Bank, 2010). This definition is adopted for the purpose of this paper.
Credit Risk Management
means the process of risk identification, measurement monitoring and control
(CBN, 2010).
Loan and Advances
means any financial assets of bank arising from a commitment to advance funds
by a bank to a person that is conditioned on the obligation of the person to
repay the funds, either on a specified date or on demand, usually with interest
(CBN, 2010).
Provision for Loan and
Advances means a balance sheet valuation account
established through charges to provision expense in the income statement in
respect of possible losses in the loans or advance portfolio (CBN, 2010).
Bank Performance
means profitability. Gilbert (2004) in a survey of literatures argued that
banks profit is an appropriate measure of bank performance
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