THE IMPACT OF CREDIT RISK ON BANK PERFORMANCE IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.0       BACKGROUND OF THE STUDY

Adequately managing credit risk in financial institutions is critical for the survival and growth of the financial institutions. In the case of banks, the issue of credit risk is of even  greater concern because of the higher level of perceived risks resulting from some of the characteristics of clients and business conditions that they find themselves in. According to Dwayne (2004) banks originates for the main purpose of providing a safe storage of customer’s cash. He argued that since this money received from the customers was always available to the bank, they later put it to use by investing in assets that are profit earning. Thus, the practice of advancing credits.

             Banks are in the business of safeguarding money and other valuables for their clients. They also provide loans, credit and payment services such as checking accounts, money orders and cashier’s checks. Banks also may offer investment and insurance products and a wide whole range of other financial services (in accordance with the 1999. Financial services Modernization Act by the US congress) which they were once prohibited from selling (by the Glass-Steagall or Banking Act of 1933 in the USA). According to Ayo (2002), in modern economy, there is distinction between the surplus unit and the deficit unit in economy and inconsequence a separation of the saving investment mechanism. This has necessitated the existence of financial institutions whose job includes the transfer of finds from savers to investors. One of such institution is the money deposits banks, the intermediating roles of the money-deposit banks places them in a position of “trustee” of the saving of the widely dispersed surplus economic units as well as the determinant of the rate and the shape of economic development. The techniques employed by banks in this intermediary function should provide them with perfect knowledge of the outcomes of lending, such that funds will be allocated to investments in which the probability of full payment is certain. But unarguably, financial institutions have faced difficulties over the years for a multitude of reasons, the major cause of serious banking problems continues to be directly related to lax credit standards for borrowers and counter parties, poor portfolio risk management, or a lack of attention to changes in economic or other circumstances that can lead to a deterioration in the credit standing of a bank’s counter parties.

            Credit risk is one of great concern to most authorities and banking regulators. This is because credit risk is those risks that can easily and most likely prompts bank failure. Therefore, credit risk management needs to be a robust process that enables financial institutions to proactively manage facility portfolios in order to minimize losses and earn an acceptable level of return for shareholders Dandago (2006). Credit risk management is a structured approach to managing uncertainties through risk assessment, developing strategies to manage it, and mitigation of risk using managerial resources (Nnanna, 2004). The strategies include transferring to another party, avoiding the risk, reducing the consequences of a particular risk. The objective of risk management is to reduce the effects of different kinds of risks.

            The role of commercial banks is alike blood arteries of human body in developing economies as it accounts for more than 90 percent of their financial assets (ADB, 2013) due to less borrowers’ access to capital market (Felix Ayadi et al., 2008). Therefore, efficient intermediation of commercial banks is vital for developing economies in order to achieve high economic growth, while insolvency of them leads to economic crisis. However, intermediation function of commercial banks gives rise to different types of risks with different magnitudes and level of causes on bank performance such as credit risk, liquidity risk, market risk, operational risk etc. credit risk management are the main reasons of recent global financial crisis. The problem starts in the application stage and increases in the approval, monitoring and controlling stage if credit risk management guideline is weak or incomplete (Richard et al. 2008). Recognizing the effect of credit risk and providing an extensive approach for managing this risk, the Basel Committee on Banking Supervision adopted the Basel I Accord in 1988, followed by the Basel II Accord in 2004 and in recently the Basel III accord by experiencing the loopholes of previous accords to deal credit risk during financial crisis (Jayadev, 2013; Ouamar, 2013).

            Banks are germane to economic development through the financial services they provide. Their intermediation role can be said to be a catalyst for economic growth. The efficient and effective performance of the banking industry over time is an index of financial stability in any nation. The extent to which a bank extends their operation to the public for productive activities accelerates the pace of a nation’s economic growth and its long-term sustainability (Kolapo, Ayeni & Oke, 2012). In the 21st century business environment is added multifaceted and intricate than ever. The majority of businesses have to trade with uncertainties and qualms in every dimension of their operations. Without a doubt, in the present-day’s unpredictable and explosive atmosphere all the banks are in front of a hefty risks like: credit risk, liquidity risk, operational risk, market risk, foreign exchange risk, and interest rate risk, along with others risks, which may possibly intimidate the survival and success of the bank’s Corporate Performance. The Nigerian banking industry has been strained by the deteriorating quality of its risk related assets as a result of the significant dip in equity market indices, global oil prices and sudden depreciation of the naira against global currencies (BGL Banking Report, 2010).The poor quality of the banks’ loan assets hindered banks to extend more credit to the domestic economy, thereby adversely affecting economic performance. This prompted the Federal Government of Nigeria through the instrumentality of an Act of the National Assembly to establish the Asset Management Corporation of Nigeria (AMCON) in July, 2010 to provide a lasting solution to the recurring problems of non-performing loans that bedevilled Nigerian banks (Kolapo, et al, 2012).

1.1`      STATEMENT OF THE PROBLEM

            The present possibility for banks to diversify into broader range of services and products make life really cool for banking entrepreneurs and managers. But this diversification advantage is a once in a life time opportunity that should be consumed with some cautions and prudence as this involves a great deal of risk. The very nature of the banking business is so sensitive because more than 85% of their liability is deposits from depositors (Saunders, Cornett, 2005). Banks use these deposits to generate credit for their borrowers, which in fact is a revenue generating activity for most banks. This credit creation process exposes the banks to high default risk which might lead to financial distress including bankruptcy. Starting from 1990, the Nigeria financial system has utilized various reforms such as, the Universal Banking, Bank Consolidation Reserve, Bank Credit Reforms, Interest Rate Reforms and so on. In spite of all those measures, the CBN has found some banks to be distressed in poor credit risk management which explains a high level of nonperforming loans in most Nigeria commercial banks. The pervasive incidence of non-performing loan is one of the prime causes of failure in the banking system. The internal exams to ascertain if loans are with collateralized and self-liquidating could not be held accountable. Another serious problem is the customer’s default in repayment of credits which causes a reduction in the bank’s earnings for the period. Hence, this in turn reduces the amount of credits which the bank can grant to prospective loan applicants. All the same, beside other services, bank must create credit for their clients to make money, grow and survive stiff competition at the market place. The question is what is the impact of credit risk on bank performance in Nigerian? How does Loan and advances affect banks performance in Nigeria?

1.2       OBJECTIVE OF THE STUDY

            The overall objective of the study is to investigate the impact of credit risk and bank performance in Nigeria. However, the study will certify the following objectives:

·         To investigate the nature of credit risk in Nigeria.

·         To examine if credit risk affect the profit of commercial banks in Nigeria

1.3       RESEARCH QUESTIONS

·         What is the nature of credit risk in Nigeria?

·         What is the nature of commercial banks loan and advances in Nigeria?

·         what is the impact of credit risk on bank performance in Nigeria?.

1.4       RESEARCH HYPOTHESIS

The hypothesis will be tested below:

·         H0: There is no significant relationship between credit risk and bank performance in Nigeria.

·         H1: There is significant relationship between credit risk and bank performance in Nigeria.

1.5       SIGNIFICANCE OF THE STUDY

            The paper aimed at investigating credit risk and bank performance in Nigeria by awakening the federal authorities in revisiting its policy and operational guides to counter the challenges faced by the commercial banks in its credit creation to investors i.e., customers so as to ensure a rigid attitude in controlling its credit management so as not to run into losses. And also more researchers' will also find the research work useful in their various study related to the topic.

1.6       METHODOLOGY

            The methodology that would be adopted in this study will be a secondary data, however, time series data for ten years (2004-2014) will be use in this study. Data will be sourced for from secondary sources and the ordinary least square (OLS) multiple regression analysis will be used to estimate the hypothesis formulated. Sources of the secondary data will includes central bank of Nigeria (CBN) statistical bulletin, journals on the research topic and annual report.

1.7       SCOPE OF THE STUDY

            This research will concentrate on the credit risk and bank performance in Nigeria. This study will cover the period from (2004-2014) to enable us to establish the a negative and positive of the impact of credit risk and bank performance in Nigeria.

1.8       PLAN OF THE STUDY

            The project research will be structured into chapters as describe below:

Chapter one; it deals with the background of the study, statement of the problem, objective of the study, research questions, research hypothesis, scope of the study, justification of the study, methodology, and plan of the study. Chapter two is the literature review, theoretical framework and empirical review. Chapter three is about the methodology that will be used for the research study. Chapter four is strictly about data presentation and analysis. Chapter five is about summary, and conclusion.

1.9   LIMITATIONS OF THE STUDY        

The limitations of the study is based on the short period of time available in making the research and errors that could be encountered in gathering data from our sources of research.