TABLE OF CONTENTS
Title Page i
CHAPTER ONE: INTRODUCTION
1.1 Background to the
Study 1
1.2 Statement of the Problem 2
1.3
Objectives of the Study 3
1.4 Research Questions 3
1.5
Research hypothesis 4
1.6 Significance of the Study 4
1.7 Scope of the Study 5
1.8 Limitation of the Study 5
1.9
Definition of Terms 5
CHAPTER TWO: REVIEW
OF RELATED LITERTURE
2.1 Conceptual Framework 7
2.1.1 The Concept of Credit 7
2.1.2 Credit
Evaluation 8
2.1.2.1 Character
8
2.1.2.2 Capacity 9
2.1.2.3 Capital 9
2.1.2.4 Condition
9
2.1.2.5
Collateral 9
2.1.3 The Concept
of Risk 10
2.1.4 Credit Risk
11
2.1.5 Credit Risk
Management 12
2.1.6 Credit Risk
Management Strategies 14
2.1.6.1 Selection
14
2.1.6.2
Limitation 14
2.1.6.3
Diversification 15
2.1.6.4 Credit
Enhancement 15
2.1.6.5
Compliance to Basel Accord 15
2.1.7 Credit Risk
Measurement 15
2.1.7.1 Default
Ratio (DR) 16
2.1.7.2 Cost Per
Loan Advance Ratio (CLA) 16
2.1.8
Profitability 16
2.1.9 Internal
Determinants of Banks’ Profitability 17
2.1.9.1 Loan
Quality 18
2.1.9.2 Income 19
2.1.9.3 Deposits 19
2.1.9.4 Capital
Ratio 20
2.1.9.5 Liquidity
Ratio 21
2.1.10 External
Determinants of Profitability of Bank 22
2.1.10.1 GDP 22
2.1.10.2 Interest
Rate 23
2.1.10.3 Exchange
Rate 24
2.2 Theoretical Review 24
2.2.1
Govermentality Theory 24
2.2.2
Cultural Theory 26
2.2.3
Risk Society 27
2.3 Empirical Review 28
CHAPTER
THREE: RESEARCH METHODOLOGY
3.1 Research Design 34
3.2 Area of the Study 34
3.3 Nature and Sources of Data 34
3.4 Method of Data Analysis 35
3.5 Model Specification 35
3.6 Technique for Analysis 36
3.7 Description of Research Variables 36
3.7.1 Dependent Variable 36
3.7.2 Independent Variables 37
CHAPTER FOUR: PRESENTATION OF DATA, ANALYSIS AND
DISCUSSION
4.1 Presentation
of Data 38
4.2 Data Analysis
and Discussion of Findings 39
4.2.1 Descriptive
Statistics 39
4.2.2 Regression
Analysis 40
4.2.3 Test of
Hypothesis 41
CHAPTER FIVE: SUMMARY OF FINDINGS, CONCLUSION AND
RECOMMENDATIONS
5.1 Summary of
Findings 43
5.2 Conclusion 43
5.3
Recommendations 43
REFERENCES 45
APPENDIX 48
LIST OF TABLES
Table 4.1: Time Series data for the variables 38
Table 4.2: Descriptive Statistics 39
Table 4.3 Regression result (dependent variable: ROA) 40
CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
Banks
are firms that efficiently provide a wide range of financial services for
profit. Not surprising, banks have an important role in the economy and the
society as a whole. Their central role is to make the community’s surplus of
deposits and investments useful by lending it to people for various investment
purposes: company growth, education, houses etc. Baesens and Gestel, (2010).
The provision of deposit and loan products normally distinguishes banks’ from
other types of financial firms. Deposits are liabilities for banks, which must
be managed if the bank is to maximise profit. Likewise, they manage the assets
created by lending. Thus, the core activity is to act as intermediaries between
depositors and borrowers. Other financial institutions, such as stockbrokers
are also intermediaries between buyers and sellers of shares but it is the
taking of deposits and the granting of loans that singles out a bank, though
many offer other financial services Heffernan (2015). Like any other firm, banks are exposed to classical operational
risks like infrastructure breakdown, supply problems, environmental risks etc.
More typical and important for a bank are the financial risks it takes by its
transformation and brokerage function. A bank raises funds by attracting
deposits, borrowing on the interbank market or issuing debt instruments on the
financial market. Essentially, the bank’s main activity is to buy and sell
financial products with different profit and risk characteristics. This
transformation from supply to demand side is not without risk. Banks are
exposed to credit, market, operational, interest rate and liquidity risk. The
appropriate management of these risks is a key issue to reduce the earnings risk
of the bank and to reduce the risk that the bank becomes insolvent and that
depositors cannot be refunded Baesens and Gestel (2009). The institute of company secretary of
India states that a risk arises on account of an uncertain event, which might
result in a loss or gain to the parties associated with such risk. Even though
the risk is an independent event, invariably risks are interlinked in the
sense; one risk may lead to other risks as well. On account of default in
payment by borrower a bank faces credit risk. On account of the non-receipt of
the funds a bank would face another risk called liquidity risk. Not only that,
it would lead to a situation of asset liability mismatch (gap risk) for bank.
In view of the shortage of funds and also to manage the mismatch in its
asset-liability, bank should arrange for funds from accepting new deposits
and/or approach the market to borrow at the markets interest rate. Hence bank
would be facing the market risk (and needs to pay the market interest rate). Risk-based
policies and practices have a common goal; enhancing the risk–return profile of
the bank portfolio. The innovation in this area is the gradual extension of new
quantified risk measures to all categories of risks, providing new views on
risks, in addition to qualitative indicators of risks Joel Bessis (2012). Because of the nature of their
business, commercial banks are by default susceptible to the default risk by
the counter party to settle its obligations as agreed. Lending is a business
for commercial banks and it is the main source of risk-credit risk as well.
Thus prudent credit risk assessment and instituting proper credit risk
management techniques suitable with the environment in which a bank operates
worth’s to caution the bank’s risk.
1.2 Statement of
the Problem
Risk
management is at the core of lending in the banking industry. Many Nigerian
banks had failed in the past due to inadequate risk management exposure. This
problem has continued to affect the industry with serious adverse consequences.
Banks are generally subject to wide array of risks in the course of their business
operations. Nwankwo (2011) observes that the subject of risks today occupies a
central position in the business decisions of bank management and it is not
surprising that every institution is assessed an approached by customers,
investors and the general public to a large extent by the way or manner it
presents itself with respect to volume and allocation of risks as well as
decision against them‟. Other risks include insider abuse, poor corporate
governance, liquidity risk, inadequate strategic direction, among others. These
risks have increased, „especially in recent times as banks diversity their
assets in the changing market. In particular, with the globalization of financial
markets over the years, the activities and operations of banks have expanded
rapidly including their exposure to risks.
1.3 Objectives of the
Study
The
main objective of this research work is to investigate the effect of Risk
Management on the Profitability of Commercial Banks. The specific objectives
are:
1. To examine the effect of Non-Performing
loans on the Return on Assets of Commercial Banks.
2.
To determine the influence of Loan and Advances on the Return on Assets of
Commercial Banks.
3.
4. To investigate the effect of interest rate on Return on Assets of Commercial
Banks.
1.4 Research Questions
The
following research question guides the study:
1. What effect do Non-Performing
loans have on Return on Assets of Commercial Banks?
2.
What influence do Loan and Advances Ratio have on Return on Assets of
Commercial Banks?
3.
What effect does interest rate have on Return on Assets of Commercial Banks?
1.5 Research hypotheses
Based
on the research questions the following research hypotheses are formulated by
the research.
H01:
Non-Performing loans do not have positive
significant effect on the Return on Assets.
H02:
Loan and Advances does not have positive significant effect on the Return on
Assets.
H03:
Interest Rate does not have significant effect on the Return on Assets.
1.6 Significance of the Study
This
study has a number of significant dimensions.
(i)
Commercial Banks: The result of this study should provide information to the
commercial banks risk management department on the progress so far made in
identifying and evaluating risks as to enhance growth and profitability of the
financial institutions.
The
result of this study should also reveal how much such progress has impacted on
the growth of the entire commercial banks in Nigeria.
(ii)
General Public: this work is a step in a right direction to assist and
enlighten the general public on what risk management in commercial banks is all
about and hence guide them in their immediate decision of handling risks.
(iii)
Researchers: There is need to provide a reference document for further
researchers and evaluation of risk management conducted by other
Nigerians/other Nations. This research work will go a long way to increase the
availability of literature in the field of risk management in the banks and
other related business associates that involve risk in the day-to-day running
of the businesses.
(vi)
Finally, the study is of immense benefit to policy makers, investors, financial
managers lecturers and the general public.
1.6 Scope of the Study
This
study covers the Impact of risk management on the profitability of banks between
the periods of 2000 to 2017. The period was chosen based on the availability of
data that would enable us investigate the said effect. Instruments selected
were Return on Asset, Interest Rate, Loan and Advances and Non-performing Loan.
1.8 Limitation of the
Study
This
study is limited to the Impact of risk
management on the profitability of Commercial banks between the periods of 2000
to 2017 and therefore the findings, analyses and recommendations cannot be
linked to the whole banking industry in the Nigeria. Perhaps researching into
other banks will yield dissimilar outcome. Cross border study can bring a
different dimension as a result of difference in supervisory guidelines.
1.9 Definition of Terms
It is the intention of this portion of the study to define some of
the terms used in the work:
Credit: This involves
the transfer of money or other property on promise of repayment, usually at a
fixed future date.
Risk: Uncertainty
of future outcome or the possibility of loss
Risk Assets: These relate
basically to loans or facilities granted to customers
Non-Performing Credit: These are facilities that are not serviced according to the terms
of the agreement.
Asset Management: This comprises the
allocation of funds among various investment alternatives.
Return on asset: The return on assets
(ROA) is a ratio that measures company earnings before interest & taxes
(EBIT) against its total assets. The ratio is considered an indicator of how
efficient a company is using its assets to generate before contractual
obligation must be paid. It is calculated as: ROA= EBIT to total Assets.
Earning: Earnings in terms of credit
facilities can be measured by the ratio of net interest income to total
operating income. Net interest income is good measure of banks earnings.
Liquidity:
Liquidity refers to a situation where
institutions can obtain sufficient funds, either by increasing liabilities or
by converting its assets quickly to cash at a reasonable cost. It is computed
by the ratio of credit facility to total deposit. The loans and advances to
deposit ratio helps assess a bank's liquidity and by extension the
aggressiveness of the bank's management.
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