THE EFFECT OF BANK LENDING ON THE PROFITABILITY OF COMMERCIAL BANKS IN NIGERIA (A CASE STUDY OF SELECTED COMMERCIAL BANKS IN BORNO STATE)

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND TO THE STUDY

Banks today are the largest financial institutions around the world, with branches and subsidiaries throughout the world. They offer different products and services to public, and because of their high liquidity, these intermediary operations are quite risky. commercial banks are exposed to a variety of risks among them; interest rate risk, foreign exchange risk, political risk, market risk, liquidity risk, operational risk and bank lending; and what banks does is to manage these challenges especially the credit aspect. In some instances, commercial banks and other financial institutions have approved decisions that are not vetted; there have been cases of loan defaults and non-performing loans, massive extension of credit and directed lending. Policies to minimize on the negative effects have focused on mergers in banks, better banking practices but stringent lending, review of laws to be in line with the global standards, well capitalized banks which are expected to be profitable, liquid banks that are able to meet the demands of their depositors, and maintenance of required cash levels with the central bank which means less cash is available for lending. This has led to reduced interest income for the commercial banks and other financial institutions and by extension reduction in profits. Lending of funds is the main business of a bank. The major portion of bank fund is employed by way of lending. The lending banker is the banker who lends funds to trade, commerce and industry etc to meet their financial requirements. Bank lending is the possibility that the actual return on an investment or loan extended will deviate from that, which was expected. One of the regulations is the minimum capital commercial banks must keep absorbing loss if unexpected things happen. This kind of capital requirement is, in particular, conducted by Basel Committee which aims to enhance the key supervisory issue and improve the quality of banking supervision. The banking sector had entered the crisis with too much leverage and inadequate liquidity buffers (Bis.org, 2014). These defects were accompanied by poor governance and risk management, as well as inappropriate incentive structures. The combination of these factors was manifest in the mispricing of credit and liquidity risk, and excess credit growth (Bis.org, 2014). Bank lending is one of significant risks of banks by the nature of their activities. Through effective management of bank lending exposure banks not only support the viability and profitability of their own business but also contribute to systemic stability and to an efficient allocation of capital in the economy (Psillaki, Tsolas, & Margaritis, 2010). The regulations have been evolutionarily developed; the three Basel Accords all have placed explicitly the onus on banks to adopt sound internal bank lending management practices to assess their capital adequacy requirement. The strength of the banking industry is an important prerequisite to ensure the stability and growth of economy (Halling & Hayden, 2014). The safety of banking system is depending on the profitability and capital adequacy of banks. Profitability is a parameter which shows management approach and competitive position of bank in market-based banking. This parameter helps the banks to tolerate some level of risk and support them against short-term problems. It is of great interest to see how the profitability is affected by the risks faced by commercial banks. Profitability in the form of retained earnings is typically one of the key sources of capital generation. A sound banking system is built on profitable and adequately capitalized banks. Profitability is a revealing indicator of a bank’s competitive position in banking markets and of the quality of its management. It allows a bank to maintain a certain risk profile and provides a cushion against short-term problems. Interest income is a major source of bank profitability and is dependent on performing loans. Interest income originates from loans and all advances extended by a bank such as working capital overdrafts, among others. It also includes interest received on bank’s deposits kept with other financial institutions. Interest income is often eroded when a bank accumulates a large stock of nonperforming loans that do not yield income. Ara, Bakaeva & Sun (2009) have found the positive relationship between bank lending management and profitability of commercial banks in Sweden. Saeed & Zahid (2016) showed that bank lending indicators had a positive association with profitability of the banks. Ogboi & Unuafe (2013) found that sound bank lending management and capital adequacy impacted positively on the banks financial performance with the expectation of loan and advances which was found to have a negative impact on bank’s profitability in Nigeria. Taiwo & Abayomi (2013) found that bank lending management has a significant impact on the profitability of Nigerian banks. Agu & Basil (2013) confirmed that increasing existence in the amount of bad doubtful debts in Nigeria commercial banks. And inefficient credit management which results in high bad debts portfolio, which is the principal cause of bank collapse. Kolapo, Ayeni & Oke (2012) showed that bank lending management is positively related to profitability of banks in Nigeria. Kithinji (2010) assessed the effect of bank lending management on the profitability of commercial banks in Kenya and found that banks‟ profitability is not affected by bank lending management. When it comes to both bank lending and liquidity risk, Ruziqa (2013) has tested the impact of bank lending and liquidity risk on the financial performance of conventional banks in Indonesia. The results illustrated that bank lending was negatively related to profitability while liquidity risk demonstrated a positive effect. Olalere & Ahmad (2015) have empirically tested the effects of bank lending on profitability of commercial banks in Nigeria. The result revealed that there is a negative and significant relationship between Non-performing loan ratio and profitability; negative and significant relationship between debts to equity ratio and profitability of banks during the period of study. These kinds of researches show that no exact final conclusion could be drawn until now and thus make this area worth studying.

1.2 STATEMENT OF THE PROBLEM

Commercial banks create loans from deposits from customers and these loans are major income generating source for majority of the banks. However this intermediation function of commercial banks is associated with enormous risks to both the banks and the deficit units. Banks are now working so hard to attract the massive number of people who are not banking with them. The Effect of Bank lending on the Banking Profitability: A case on Bangladesh, 2015 finds a robust negative and significant effect of Non-Performing Loan to Gross Loan (NPLGL), Loan Loss Reserve to Gross Loan (LLRGL) on all profitability indicators. The analysis also finds a negative and significant effect of Capital Adequacy Ratio (CAR) on Return on Average Equity (ROAE). It also reveals that the effect of the implementation of Basel II is significantly positive on Net Interest Margin (NIM) but significantly negative on ROAE (Abu, Sajeda & Mustafa, 2015). With respect to the issues raised, it can be said that the effect credit management has on a bank’s financial strength (profitability) cannot be undermined. This has led to an increase in banks‟ surplus units and deficit units as well. With the aim of increasing revenue and gaining a large portion of the market share, many banks have given out loans and advances which could not be recovered leading to a massive growth in Non-Performing Loans (NPLs) in their accounts. This has become a worrisome situation for banks and other stakeholders.). This implies that, banks in Nigeria experience high profit irrespective of the huge bank lending exposure, conflicting with views shared by other researchers. The Prime concern of this study is to determine whether bank lending has an effect on the profitability of Nigerian banks.

1.3 AIMS OF THE STUDY

The major purpose of this study is to examine        the effect of bank lending on the profitability of commercial banks in Nigeria. Other general objectives of the study are:

1. To assess the effect of credit appraisal on the profitability of commercial banks
2. To assess the effect of collection policy on the profitability of commercial banks
3. To assess the effect of loan repayment on the profitability of commercial banks
4.  To examine the relationship between bank lending and profitability of commercial banks.
5. To make recommendations on proper credit risk management in commercial banks in Nigeria.

1.4 RESEARCH QUESTIONS

1. What are the effects of credit appraisal on the profitability of commercial banks?
2. What are the effects of collection policy on the profitability of commercial banks?
3. What are the effects of loan repayment on the profitability of commercial banks?
4.  What is the relationship between bank lending and profitability of commercial banks?
5. What are the suggested recommendations on proper credit risk management in commercial banks in Nigeria?

1.5 RESEARCH HYPOTHESES

Hypothesis 1

H0: There is no significant effect of credit appraisal on the profitability of commercial banks.

H1: There is a significant effect of credit appraisal on the profitability of commercial banks.

Hypothesis 2

H0: There is no significant relationship between bank lending and profitability of commercial banks

H1: There is a significant relationship between bank lending and profitability of commercial banks

1.6 SIGNIFICANCE OF THE STUDY

Bank Lending of commercial banks or lending institutions is major assets that generate a significant amount of interest income. It plays critical role in determining the financial performance of commercial banks and can therefore be said that the healthier the bank lending of commercial banks, the better their financial performance and profitability. In the light of the importance of bank lending, it essential that a study be conducted to assess the effect of bank lending on profitability of commercial banks in Nigeria.

The outcome of this study will enable commercial banks in Nigeria to adopt workable strategies to control the problem of growing non-performing loans and thereby improve its financial performance and profitability.

Secondly, the findings of this study will serve as a tool to guide credit staff about the implications of their credit decisions in creating quality for their banks. This will indirectly enhance the performance of credit staff in loan appraisals.

Again, academicians and researchers will benefit from this study in that they will be furnished with relevant information regarding loan default and its effect on profitability of commercial banks. The findings will stimulate other researchers to venture into loan default management and proper credit appraisals. This will also contribute to the general body of knowledge and form a basis for further research.

1.7    SCOPE OF THE STUDY 

The study is based on the effect of bank lending on the profitability of commercial banks in Nigeria, case study of selected commercial banks in Borno state.

1.8 LIMITATION OF STUDY

Financial constraint- Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview).

Time constraint- The researcher will simultaneously engage in this study with other academic work. This consequently will cut down on the time devoted for the research work.

1.8 DEFINITION OF TERMS

Credit Policy: Is a guideline on overall credit operations within a banking institution to ensure the establishment and maintenance of proper credit standards within the bank.

Commercial Bank: Is a banking institution involved in taking depositors‟ funds and investing them and also issues out loans to corporate and individual borrowers.

Credit Appraisal Techniques: Are methods that are employed by commercial banks when assessing the credit worthiness of a prospective borrower. These techniques usually vary, depending on determinants such as the size and maturity of the loan, the operating record of the business, security offered and previous relations with the borrower.

Credit Risk: Is the current or prospective risk to earnings and capital arising from an obligator’s failure to meet the terms of any contract with the bank or if an obligatory otherwise fails to perform as agreed. An institution is exposed to credit risk from diverse financial instruments such as loans, acceptances, inter-bank transactions, trade financing, foreign exchange transactions, financial derivatives and other off-balance sheet activities.