THE EFFECT OF CREDIT RISK MANAGEMENT ON PROFITABILITY OF BANKS IN NIGERIA A CASE STUDY OF ECO BANK NIGERIA PLC.

TABLE OF CONTENTS

CHAPTER ONE

INTRODUCTION

1.1    Background to the Study

1.2    Statement of the Problem

1.3    Objectives of the Study

1.4    Significance of the Study

1.5    Relevant Research Questions

1.6    Statement of Hypotheses

1.7    Scope and Limitation of the Study

1.8    Operational Definition of Terms

CHAPTER TWO

LITERATURE REVIEW

2.1    Introduction

2.2    Conceptual Framework

2.3    Introduction of Basel Committee

2.4    Credit Risk Analysis Techniques in Eco Bank Pic

2.5    Risk and Uncertainty in Project Appraisal

2.6    Factors Responsible For Uncertainty

2.7   Analysis of Risk and Uncertainty in Decision- Making Process of Project Selection in Eco Bank Plc

2.8   Risk and Sensitivity Analyses

2.9    Risk Control Analysis

2.10 Types of Credit Risk

2.11 Credit Risk Process

2.12  Changing Business Model of Credit Risk in the Banking Industry

2.13 New Risks and Credit Risk Management Challenges

2.14  Practical Areas of Focus for Risk Managers and Supervisors

2.15  Sources of Risk

2.16 Key Concepts in Risk Management

2.17Risk and Return Analysis

2.18Factors Causing Credit Risk

2.19 Credit Risk Management: Policies and Procedures

2.20 Risk Management and the Banking Industry

CHAPTER THREE

RESEARCH METHODOLOGY

3.1    Introduction

3.2    Restatement of the Research Questions

3.3    Restatement of Hypotheses

3.4    Sources of Data

3.5    Population of Study

3.6    Sample and Sampling Techniques

3.7    Research Instrument

3.8    Questionnaires Administration

CHAPTER FOUR

DATA PRESENTATION AND ANALYSIS OF RESULTS

4.1      Introduction

4.2     Characteristics of the Study Population

4.3     Testing Statement of Hypotheses

CHAPTER FIVE

SUMMARY OF FINDINGS, CONCLUSIONS RECOMMENDATIONS AND SUGGESTIONS FOR FURTHER STUDIES

5.1     Summary of Findings

5.2     Conclusion

5.3     Recommendation

5.4     Suggested Areas for Further Studies

Appendix: Questionnaire

CHAPTER ONE

INTRODUCTION

1.1      BACKGROUND TO THE STUDY

This project is set investigate "the effect of Credit Risk Management on profitability of Banks in Nigeria' with special reference to Eco Bank Nigeria Plc. Risk management has become a hot issue in the financial sector. Almost without exception, institutions have rushed headlong into major effects upgrade their risk management systems and focus management attention on appropriate process for due consideration of the tradeoff between risk and return. For a long while, these systems were a patchwork of firm specific solution to risk measurement and management but recently this has all changed. The financial institution worldwide, has begun to settle on stand and approaches to risk management well as a consistent view of what is and is not possible in this domain ( Madufor, 2006).

Banking by its nature entails taking a wide variety of risk. It IS therefore important to examine credit risk within the context of overall risk frame work for a better understanding and appropriation.

In general, banking risks fall into four major risk categories: financial, operational, business and event risks (Soluda 2006). The following paragraph however elaborated on historical background of the case study (i.e. Eco Bank Plc).

1.1.1  HISTORICAL BACKGROUND OF ECO BANK PIC

Eco Bank was incorporated on March 26, 1990 as a private limited liability company with 100^% equity ownership by Nigerian citizen, and licensed April 10, 1990 to carry on commercial banking.

The Bank commenced business on June 12, 1990 at the Waterfront plaza, Plot 270, Ozumba Mbadiwe Avenue, Victoria Island, Lagos. It was listed on the Nigerian Stock Exchange on June 25, 2004. At present, it authorized capital is N32 billion.

Eco Bank International therefore is sixteen year old commercial banks with business offices located in several parts of Nigeria.

The Bank is one of the largest in Nigeria. Her financial year runs from October 1 to September 30 of the subsequent year. Eco bank's impressive performance over the years accounts for the quality of its customer portfolio which includes corporate Organizations, High Net worth Individuals, The Federal Government and some state Government. To enhance response time, relationship management units have been structured as follows:

Corporate Banking Group (CBG), Treasury and Financial Institution Group (TFIG,) Retail Banking Group (RBG), Public Sector Group (P8U).

1.1.2               ECO BANK PLC: RISK MANAGEMENT; PHILOSOPHY AND CORPORATE VALUE

Eco Bank's corporate values derive from the overall corporate vision of Nigeria's bank of first choice" and the bank's goals business objectives. The core values, that provide the premise for decision making approvals and behaviour in Eco Bank include:

Value- drive Customer Focus: Emphasis on value creating products and services that are responsive to customers' requirements. Customer intimacy and adequate knowledge of the customer and business is important in order to ensure that credit products and offerings adequately address our customer's needs

A Culture of Excellence: Differentiated service delivery and responsiveness to customers are emphasized as a core competitive advantage in Eco Bank provide industry leadership in defining service quality standards in line with global best standards and best practices. This implies excellence in the Bank's credit translating into efficient and timely credit processing

Courtesy: Polite, articulate and sterling service delivery and Customer interaction aimed at delighting all customers and the bank's public.

Integrity: Emphasis on fidelity and confidentiality geared towards winning the customer's implicit trust. Virtue and transparent honesty are emphasized in all transaction and relationships including delivering on promise made to customers.

Accountability Each Eco Bank person is personally responsible and accountable for result and outcomes of his/her work and deliverables. To create an environment of individual accountability, individual roles and responsibilities are clearly articulated and communicated.

Teamwork: Corporate objectives are bigger than any individual or group in the bank. It is therefore imperative that teamwork is emphasized and actively cultivated to create a cohesive environment for the achievement of set goals.

Innovativeness: Innovation and creativity is deliberately.

Creativity: Encouraged by Creating and Maintaining an environment that ensures freedom to express and apply one ideas and is tolerant of 'genuine' mistakes.

Entrepreneurialism: Proactive identification, development and follow up on market and business opportunities and challenges are emphasized.

Meritocracy: Merit is emphasized as the basis for decision making and approvals in the bank appraisal including peer, sub-ordinate and as may be appropriate customer feedback is incorporated into the performance appraisal process. Performance evaluations are transparent and reward decision.

Respect for the individual: An environment of respect of the dignity of each Eco Bank employee is maintained. It is imperative that each Eco Bank person treats everyone the way they would expect to be treated.

Loyalty: The quality of unwavering devotion/and sense of duty, which bind or connects the staff to the Bank.

1.1.3               ECO BANK PLC: PRIMARY RISK MANAGEMENT PRINCIPLES

These fundamental principles that underlie Eco Bank's risk management policies are derived from Eco Bank's corporate valve as outlined above as well as current best thinking and global best practices for the management of risk in financial services institutions

Accountability

The Board of Directors of the bank are responsible for articulating and reviewing on an ongoing basis the overall risk strategy and risk policies of the bank that outline clearly the risk. Appetite and return preferences that will govern the creation and management in assets in the bank.

Relationship managers In asset creating business units are responsible and accountable for prospecting and marketing customers that meet the criteria defined in the bank's target market in the line with the provision of the risk management credit exposures to reduce incidence of delinquency and maintains standards to:

·        Establish an appropriate risk environment in the bank.

·        Operate under a sound credit-originating process.

·        Maintain an appropriate credit risk asset creation, administration and monitoring process.

·        Ensure adequate control over risk assets.

At Eco Bank; responsibility is matched by appropriate authority to perform job duties and achieve desired result and outcomes. Hence individuals and group with responsibility for credit creation and approval are accordingly empowered with the appropriate level of authority to carry out their tasks.

1.1.4   ECO BANK PLC AND ITS PORTFOLIO MANAGEMENT

In line with defined risk and return preferences, the risk assets portfolio of the bank is deliberately managed to avoid excessive concentration of risk to any industry, market sector or individual customer as well as to ensure portfolio flexibility and liquidity.

The Eco Bank portfolio management process provides for upfront definition of target risk assets stratification in the bank and on an ongoing basis tracks the actual composition of the risk assets portfolio against the desired structure. The bank's management information system provides up to date, accurate and complete information on the risk assets provide informed basis for management action decision making in respect of the risk asset portfolio.

Credit Authority

The authority to approve credit is jointly exercised by the bank's risk management function as well as business managers online with the provisions of the bank policies in respect of credit approval.

1.1.5   RISK ADMINISTRATION

The Risk and Management Control function establishes and maintains appropriate structure and frameworks for administration of the bank's risk asset portfolio and individual risk exposures. The risk Management Framework enables on-going administration of credit risk- bearing portfolios, monitor the condition and performance of individual exposures.

Analytical techniques based on information systems are established to enable management measure and manage risk inherent in all on ­and off balance sheet activities.

1. 1.6 ECO BANK RISK MANAGEMENT PHILOSOPHY

Across organizations, many business leaders are recognizing that risk are no longer merely hazards to be avoided especially banks but in many cases opportunities to be embraced. "Risk is itself is not bad. What is bad is risk that is mismanaged, misunderstood, mispriced, or unintended". Risk Management is moving well beyond the tradition of risk mitigation (using controls to limit exposure to problem) toward risk portfolio optimization (determining the organization's risk appetite and capacity among a group of risk across the enterprise, seizing opportunities within those defined parameters, and capitalizing on the rewards that results). As a consequence, risk management is beginning to be perceived as a means of strategic business management linking business strategy to day risks (Diacon, 1984)

The intervention of July 6, 2004 was therefore an attempt to address the problem of distressed and technically insolvent banks without an initial resort to liquidation with all its adverse consequences for depositors.

Empirical evidence and studies have confirmed that distress In financial systems in many cases are caused by the absence of inadequate effective credit risk management process and risk management process and risk management in banks and thereby address the problem of distress in the banking system. Some of these initiatives are as follows (Obinna,2005).

Injection of fresh Capital into the Industry

In the process of complying with the minimum capital requirement, over N350 billion was raised by banks from the capital market '" As at now the total capitalization of the less than N300 billion.

The capital injection addresses the cases of weak capitalization. It equally provides investment capital for service delivery systems and risk management capabilities. It improves ability to access up ­market opportunities that are currently significant not locally banked e.g upstream oil, gas and telecommunication.

The liquidity engendered by the new investment into the banking industry induced interest rate to fall, improve overall liquidity in the system and increase in lending to the real sector.

1.2      STATEMENT OF THE PROBLEM

This research work intends to investigate the effect of credit risk management on profitability of bank in Nigeria. Empirical evidence and studies have confirmed that distress in financial system in many cases IS caused by the absence or inadequate effective credit risk management process. The saving and Loans (S&L) crisis in Nigeria took two decades plus serious regulatory ineptness and legislative cupidity, to develop into the debacle it became. This project will investigate the problem of credit risk management in Bank and similar financial institutions. The problem of risk measures to direct capital to activities with the best risk/reward ration, problem of prudent risk taking by division and individuals. Also, problem of risk reductions in firms' value due to changes in the business environment. Investigation has been extended to the problem of adverse effect of credit risk on banks profitability, growth, stability and development in post consolidation and recapitalization era.

1.3      OBJECTIVES OF THE STUDY

Any research study without clearly defined objective is baseless and irrelevant. Considering the above fact, the objective of this research is as follow.

·        To investigate both the positive and negative effects credit risk management on banks profitability growth and development.

·        To investigate Bank's credit policy frame work install for effective operation.

·        To examine bank credit policies ("Lending Guidelines") that clearly outline the banks' loan portfolio and favourable to customers.

·        To investigate the type of risk banks are exposed to in their operation.

·        To examine the various techniques banks adopted to manage credit risk.

1.4      SIGNIFICANCE OF THE STUDY

This research work is important because it discusses sensitive issues in credit risk management in the Banking operation. Besides, other key benefits are:

This research work will assist banks to identify, measure, manage and investigate various risk elements banks are exposed to or that could have adverse effect(s) on bank operations and threaten its survival. Since bank business is a growing concern involving various risk types, it is imperative to have an effective mechanism. From this research work as risk management frame work and control systems in place to check these risk.

The research study will assess the key factors and proffers solution. Also, issues regarding the borrower's position in the industry, overall industry concerns or competitive forces will be addressed and the strength and weaknesses of the borrower relative to its competition will be identified. This study will solve the incidence of bank distress that is there will be banks with no virus: the healthier will be the banking industry, which will, obviously, translate into healthier and better economy. It will serve as a source of reference to other banks for their credit risk management in the financial institution.

1.5      RELEVANT RESEARCH QUESTIONS

·        The research questions that guide this study are as follows:

·        Is there any relationship between bank effective risk management and its relative profitability?

·        Can credit risk management influence bank's performance?

·        Would effective evaluation and measurement of credit risk by bank' management enhance bank's lending ability.

1.6  STATEMENT OF HYPOTHESES

Ho: There is no relationship between bank effective credit risk management and profitability

Ha: There is relationship between bank effective credit risk management and profitability

Ho: There is no correlation between Credit risk management on bank performance and Eco bank profitability

Ha: There is correlation between Credit risk management on bank performance and Eco bank profitability

Ho: Effective evaluation and management of credit risk by Bank's management does not enhanced Bank's lending ability

Ha: Effective evaluation and management of credit risk by Bank's management has enhanced Bank's lending ability.

1.7      SCOPE AND LIMITATION OF THE STUDY

The research work, intended to investigate credit risk management on profitability of Bank in Nigeria with special reference to Eco Bank Nigeria Plc. Emphasis would be on impact of credit risk on banks and profitability in the banking industry. The study covered types of credit risk in the bank, measurement and solving problems and risk management strategy.

Most of the facts used in this study were limited to Eco Bank PIc, journals, magazines, articles on credit and risk management in banking industry as well as through the questionnaires. Based on risk management, CBN and Stock Exchange Bulletin; unpublished thesis, literature and various text books on the subject matter were also reviewed.

Limitations of this project work included financial constraint, time constraint as well as lack of access to secondary data and attitude of the respondents to the questionnaire administered to them.

1.8      OPERATIONAL DEFINITION OF TERMS

The following words are defined to enable the user to comprehend.

Credit or Loan: Used interchangeably. It refers to the cash or goods or services granted by the financial institution with a pledge to payback at a future date

Collateral Security: Is an asset pleaded against the performance of a loan.

Shareholders/Investors: These are the stakeholders of the bank who invested their money for the operation of the business.

Recapitalization: Is the minimum capital base (shareholders fund) required to float a bank in the banking industry.

Merger and Acquisition: CAMA 1990 however defines merger and acquisition to mean "any amalgamation of the undertakings of any part of the undertakings or interest of two or more companies or the undertakings or part of the undertakings of one or more companies and one or more bodies corporate.

CBN: Central Bank of Nigeria the Apex Bank and Bankers' Bank also they have the authority to issue Currency Note.

The various types of risk include business risk, investment risk, financial risk, portfolio risk and cataclysmic risk.

Business Risk is due to variability in operating earnings, which in turn may be a function of firm's normal operations. It is determined by charges in economic environment In general and by management's decision on capital intensification within the firm. Specifically, a firm is influenced by the ratio of its fixed costs to variable costs.

Investment of project risk is due to the variability in expected earnings arising from variations in both cash outflows and inflows from an investment. It is usually associated with errors in forecasting of consumer tastes and other demand related influences, changes in relevant factors costs in the investment as well as in technology.

Financial risk is the variability in operating earnings arising from the commitment of the firm to meet its fixed payment obligations due to .he use of debt capital. In other words, the use of more debt or reference share which increases the firm’s financial leverage, results 1 greater fixed obligatory payments for it and in turn increases the variability of earnings after taxes (EAT) and earnings per share (EPS).

Portfolio risk deals with the variability in operating earnings due to the level of efficient diversification in a firm's portfolio of assets. A firm's portfolio risk is reduced by choosing investments with low ore negative correlation with its existing portfolio or investments.

Cataclysmic risk relates to the variability in earnings due to events beyond managements control and anticipation. Usually included in this category are expropriation by governments, outright exhaustion of a natural resources on which a firms future operation depends serious energy and acts of God (earthquake, flooding, etc.)

Risk assessment: Those activities that enable the risk manometer to identify, evaluate, and measure risk and uncertainty and their potential impact on the organization.

Risk identification: The process of identifying the exposures to potential property, liability, and human resources losses, as well as the hazards and perils that lead to those losses."

Risk Measurements: The process of determining the likelihood of a loss from an exposure and its probable severity.

Organizational Risk Management (ORM): A general management function that seeks to identify, assess and address the causes and effects of uncertainty and risk on an organization.

Strategic, operations, and risk management model: A model of management functions that emphasizes the relationship between strategic management, operations management, risk management.

Risk and Uncertainty Assessment: All activities associated with identifying, analyzing, and measuring risk and uncertainty.

Risk Control: All activities associated with avoiding, preventing, reducing or otherwise controlling risks and uncertainties.

Risk Financing: Those activities that provide the means of reimbursing losses that occur and that fund other programmes to reduce risk and uncertainty.

Programme Administration: All those activities and strategies associated with the long-term and day-today operation of the risk management function.