ABSTRACT
The study examined the effect of credit risk management on the financial performance of commercial banks in Nigeria, the specific objectives were to ascertain the effect of capital adequacy ratio, loan loss provision ratio and non-performing loan ratio on return on asset, return on equity and return on investment, the study adopted ex-post facto research design and extracted data from cross section of commercial banks over a period of 6 years. Capital adequacy ratio, loan loss provision ratio and non-performing loan ratio were jointly used as proxies for credit risk management and served as joint in dependent variable while return on asset, return on equity and return on investment were each employed as dependent variable. Based on the nature of data extracted, the panel least squares method of data analysis was used to investigate the relationship of the variables. It was found that credit risk management have significant effect on both return on asset, return on equity and return on investment. The study therefore concludes that credit risk management significantly affects performance of commercial banks and recommends that banks need to place and devise strategies that will not only limit the banks exposition to credit risk but will develop performance and competitiveness of the banks, and banks should establish a proper credit risk management strategy by conducting sound credit evaluation before granting loans to customers. There is need to strengthened bank lending policy through effective and efficient regulatory supervision and monitoring when facility is given out especially during utilization of the facility by the borrower.
TABLES OF CONTENTS
Title page i
Certification ii
Approval page iii
Dedication iv
Acknowledgement v
Table of content vi
List of Tables ix
Abstract
x
CHAPTER ONE: INTRODUCTION
1.1 Background to the Study 1
1.2 Statement of Problem 2
1.3
Objective of the Study 3
1.4 Research Question 4
1.5 Research Hypotheses 4
1.6 Significance of the Study 4
1.7 Scope of the Study 5
1.8 Definition of Terms 6
CHAPTER
TWO: REVIEW OF RELATED LITERATURE
2.1 Conceptual Framework 7
2.1.1
Credit Risk 8
2.1.2 Credit Risk Management Strategies 9
2.1.3 Credit Evaluation 11
2.1.4 Non-Performing Loans 11
2.1.5 Loan Loss Provision 12
2.1.6 Performance of Commercial Bank 12
2.1.7 Loan Review, Monitoring and Evaluation 13
2.1.8 Policy on Loans Classification (bad and
doubtful debt) and
Recovery Procedure 15
2.1.9 Management of Problem Loans 15
2.1.10 Causes of Problem Loans 16
2.1.11
Basis for Classification 16
2.1.12 Recovery of Bad Debt 18
2.2 Theoretical Framework 18
2.2.1 Loan Pricing Theory 19
2.2.2 Firm Characteristics Theory 19
2.2.3 Theory of Multiple-Lending 20
2.2.4 The Signaling Arguments 20
2.2.5
Credit Market Theory 20
2.3 Empirical Reviews 21
CHAPTER THREE: RESEARCH METHOD
3.1 Research Design 26
3.2 Area of the Study 26
3.3 Population of the Study 26
3.4 Sample sampling Technique 26
3.5 Instrument for Data Collection 27
3.6 Data Analysis Technique 27
3.7 Model
Specification 27
3.8 Method of Data Analysis 28
3.9 Decision Rule 28
CHAPTER FOUR: PRESENTATION OF RESULTS
4.1 Data Presentation 29
4.2 Analysis and Discussion Descriptive
Statistics
31
4.3 Result and Discussion 33
4.4 Hypotheses Testing 38
CHAPTER FIVE: SUMMARY, CONCLUSION AND
RECOMMENDATIONS
5.1
Summary of Findings 41
5.2 Conclusion 41
5.3 Recommendations 42
LIST OF TABLES
Table 4.1 Descriptive
Statistics 31
Table 4.2: OLS
Test of Credit Risk Management and Return on Asset 33
Table 4.3:
OLS Test of Credit Risk Management and Return on Equity 35
Table 4.4: OLS
Test of Credit Risk Management and Return on Investment 37
CHAPTER ONE
INTRODUCTION
l.1
Background of the Study
Banks are an integral part of a country's
development. Their major role in any economy is the ability to mobilize funds
from surplus unit to the deficit unit through lending activities. When loans
and advances granted are paid promptly, this serves as an impetus for
additional credits to be provided to existing and future customers. However, in
every imperfect market there exist some risks that affect the repayment of the
credit facility by banks' customers. Basel (2001) identified credit risks as
the major form of risks that affect financial institutions. Credit risk can
occur from two major sources- the bank management (through lack of thorough
investigation of loan requests of the customer) and the customer (having hidden
agenda, unknown to the bank, on the credit facility requested for). These
combined activities of banks' management and customers lead to non-payment of
both the principal sum and interest as and when due. The loans that are not
paid at the agreed date are known as non-performing loans. The non-performing
loan, especially when it is deemed lost, is the greatest threat to the
profitability and survival of banks. When it is lost, it will hinder banks from
achieving their set target and can also lead to organisational failures
(Greuning & Bratanovic, 2003, Kolapo, Ayeni, &Oke, 2012 and Poudel. 2012).
Banks' management recognises the fact that mitigating the occurrence of the
risk of non-performing loans can only come from the institution of pragmatic
credit administration policy and the policy must incorporate risk assessment
and follow up mechanism. Capital adequacy as an ingredient of credit risk
measure depicts the extent to which shareholders' funds cover non-performing
loans. It helps to prevent bank failure if it is properly controlled and
managed. The prescribed ratio is usually provided by the regulatory
institution, such as the Central Bank of Nigeria (CBN). Profitability is
essential for the survival of any firm that is in business and banks do rely on
interest income generated from loans and advances extended to their customers.
Thus, non-performing loans, advances and bad debt can erode the profitability
of banks. The financial services provided by banks is essential to economic and
financial development. Their role as financial intermediaries facilitates rapid
economic growth. Financial stability is vital for any nation so therefore the
financial institutions need to be properly managed. The velocity of loan
creation in an economy significantly influences the productive activities in a
nation. The main motive of a bank is to redirect funds from the surplus sector
to the deficit sector in a profitable and sustainable manner. Interest on loans
and advances are the main sources of income for a commercial bank, by given out
loans, banks are exposed to different forms of risks e.g. liquidity risk,
credit risk. etc. (Kargi. 2011). Our main focus is the credit risk a bank
incurs by virtue of loan creation. The Basel Committee on Banking Supervision
(BCBS) defined credit risk as the probability that a bank borrower will fail to
meet its obligations in accordance with agreed terms or the possibility of
losing the outstanding loan partially or totally due to credit events (IwedL
& Onuegbu. (2014). Poor credit administration reduces bank profitability
and leads to bank distress and/or failure (Osuka, & Amako, (2015). The aim
of credit risk management is to maximize a bank's risk adjusted rate of return.
This can be achieved by maintaining credit risk exposure within acceptable
parameters. Efficient loan portfolio diversification can ensure that credit risk
is minimized but it is imperative for banks to be wary of credit risk in
administering each individual loans.
1.2 Statement of the Problem
Adequate management of credit risk is
critical for the survival, growth and development of banks. However, despite
the creation of Risk Management Department in all the banks, which is
responsible for managing the banks risk including credit risk, available
records shows that the spate of bad loans (non-performing loans) was as high as
35% in Nigeria deposit banks between 1999 and 2009,Sanusi (2010). The
increasing level of non-performing loan rates in banks books, poor loan
processing, undue interference in the loan granting process, inadequate or
absence of loan collaterals among other things are linked with poor and
ineffective credit risk management that negatively impact on banks performance.
This is a very disturbing phenomenon because the high level of non-performing
assets in the bank's portfolio if not brought under control, might erode the
capital base of the banks and reduce its profitability. The worst case can
happen where liquidation or bankruptcy may occur due to the banks inability to
manage its credit risk efficiently. Can it be concluded therefore that the
current credit risk policies are ineffective in controlling credit risk in
Nigeria banks, is there a laxin the implementation of credit risk policies, and
to what extent their performance can be augmented by proper credit risk
management policies and strategies? These are questions which previous studies
have not fully answered. It is therefore the crux of this study to answer these
questions by examining effect of credit risk management on the performance of
money deposit banks in Nigeria thereby attempting to make a modest contribution
to literature on credit risk management.
1.3
Objective of the study
The main objective of the study is to
determine the effect of credit risk management on the financial performance of
commercial banks in Nigeria. The specific objectives of the study includes the
following,
1.
To ascertain the effect of capital adequacy, loan loss provision and
non-performing loan ratio on the return on assets of commercial banks of
commercial banks in Nigeria.
2.
To determine the effect of capital adequacy, loan loss provision and
non-performing loan ratio on the return on equity of commercial banks of
commercial banks in Nigeria.
3.
To examine the effect of capital adequacy, loan loss provision and
non-performing loan ratio on the return on investment of commercial banks of
commercial banks in Nigeria.
1.4 Research
Questions
The research questions of the study are as
follows:
1.
What is the effect of capital adequacy, loan loss provision and
non-performing loan ratio on the return on assets of commercial banks of
commercial banks in Nigeria?
2.
What is the effect of capital adequacy, loan loss provision and
non-performing loan ratio on the return on equity of commercial banks of
commercial banks in Nigeria?
3.
What is the effect of capital adequacy, loan loss provision and
non-performing loan ratio on the return on investment of commercial banks of
commercial banks in Nigeria?
1.5 Research hypotheses
The research hypotheses of the study are as
follows:
H0I: Capital adequacy, loan loss provision and
non-performing loan ratio has no significant effect on the return on assets of
commercial banks of commercial banks in Nigeria
H02: Capital adequacy, loan loss provision and
non-performing loan ratio has no significant effect on the return on equity of
commercial banks of commercial banks in Nigeria
Capital adequacy, loan loss provision and
non-performing loan ratio has no significant effect on the return on investment
of commercial banks of commercial banks in Nigeria
1.6
Significance of the Study
The significance of this study is to make contribution
on the ongoing study of problem loans in the Nigerian commercial banks. To the
bank's management and managers of other banks, this study draws their attention
to the importance of this asset (loans and advances) are to the overall success
and growth of their organizations. As the largest component of a bank's total
assets, there is the need for its effective and efficient credit management.
Besides, loans and advances are also the most profitable and risky assets,
hence the need for proper management for maximum profitability while minimizing
the risk element. The study is also significant to the shareholders, both
existing and potential ones. This springs from the fact that the proper
management of this resource will enhance reasonable returns on shareholder's
investment.
As pointed out earlier, banks performance of
intermediation activity involves accepting deposits from surplus unit of the
economy and channeling it to the deficit units. This role ensures proper
allocation of scarce financial resources to the various sectors of the economy
thereby enhancing the overall growth and development of the national economy.
One of the reasons adduced for bank failure is that of indiscriminate granting
of loans that makes collectibles virtually impossible. A study of this nature will
draw attention of bank's management to the need for proper management of
loans and advance obviates failure and its negative consequence on the profitability
and economic growth. The study, therefore is timely current and relevant not
only for the continued visibility of the financial system but the overall
growth and development of the economy. The findings of this study are duly and
adequately incorporated by all operators of the banking industry and financial
system in general will enhance profitability
and efficiency in the provision of banking services in the country.
1.7. Scope
of the study
The study looks at the effect of credit risk
management on the performance of listed commercial banks in Nigeria, using
Access bank Nigeria Pic, Guarantee trust bank Nigeria Pic & Zenith bank
Nigeria pic Umuahia as a case of study. The study period is 10 years spanning
from 2009 to 2018.
1.8 Definition of terms
A.
CREDIT: This is financial assistance in form of
loans and advances granted by banks to their customers
B.
LOANS: A borrowed sums of money at an agreed rate
at interest, usually for a specified period of time and payable in the line
with the terms of a loan agreement.
C.
CBN; Central of Nigeria, this is the apex regulator) of financial
system.
D.
BAD AND
DOUBTFUL DEBTS: This offers to all
the non-performing credit facility to reflect such specification in
the CBX prudential guidelines.
E.
OVERDRAFT: This is a less formal credit facility by
which a current account, customer is allowed by a bank to write cheques in
excess of existing balance in his or her account.
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