THE IMPACT OF QUALITY LENDING ON BANKS PROFITABILITY

CHAPTER ONE

1.0   INTRODUCTION

1.1     Background to the Study

Realizing a good quality product in the market (whether it is a physical or service product) gives benefits to both organization as well as their customers. “Quality means a process through which a business seeks to ensure that product or service quality is maintained or improved and errors are reduced or eliminated. Quality requires the business to create an environment in which both management and employees strive for perfection. This is done by training personnel, creating benchmarks for quality, and testing products or services to check for statistically significant variations (Adewale 2013)

Bank is a financial institution that undertakes the banking activity i.e., it accepts deposits and then lends the same to earn profit. Lending or extending credit to needy persons is a major bank product.

Quality lending’ and ‘Credit Risk’ is interrelated. Credit Risk is inversely proportionate to Quality lending.  Credit Risk will decrease, if Quality lending increases and vice versa.  Due to poor quality lending, banking industry is suffering with huge Non-performing Assets (NPAs). Thereby higher provisions for NPAs, lower profits, additional capital to maintain CRAR and decrease in rating of the bank etc are the side effects of poor quality of credit or lending.

Agier and Assuncao (2009) contend that financial relations all over the world, have been deeply transformed in the last two decades. This has been characterized by new products, new markets and new regulatory systems which have radically altered the environment in which financial institutions operate, opening new profit opportunities but also creating new risks. Today’s modern and competitive financial atmosphere influence banks to improve their service quality and follow new technologies all over the world. Nigeria is no exception to these effects and almost all industries including the banking sector. Commercial banks private are providing varied services to attract the customers’ community since it is treated as assets of banks (Moya 2009). Shatto & Singer (1996) points out that for retail bankers to meet the changing preferences of the customers and to stay ahead of competitors they are bound to provide quality and efficient services. In the lending business banking has to be distinguished from transaction based on lending in particular? Both variants are reflected in the underlying credit processes. The distinguishing feature of banks with a relationship approach is the ability to gain and to use qualitative information for customer evaluations. In contrast, the granting of credit in transaction-based lending occurs based only on “hard,” quantitative information (Berger, 2002). The theory of financial intermediation suggests that lending has a bright side and a dark side (Boot 2000). Strong bank-borrower relationships help reduces asymmetric information between lenders and borrowers, the bright side. But, at the same time, these relationships can create hold-up problems whereby the lender captures the borrower to extract rents, the dark side. Hence, the overall effect of quality banking relationships is a trade-off in costs and benefits between lenders and borrowers through interactions across time, space, and financial products.

Different empirical evidences suggested that profitability of financial institutions specifically banks are affected by internal and external factors. Andreas and Gabrielle (2009) stated that Bank profitability is usually measured by the return on average assets and is expressed as a function of internal and external determinants. The internal determinants include bank-specific variables. The external variables reflect environmental variables that are expect to affect the profitability of banks. Internal factors such as capital adequacy ratio, asset size, asset quality, net-worth, liquidity, earnings quality, loan performance, business risk, management quality, people, technology and operating environment are major determinant that are used to analyzed the determinants of bank profitability. An external macroeconomic and industry-specific factor includes Effective tax rate, Real GDP growth, inflation, and regulation and Bank concentration. Banks profitability is given due attention after the great economic depression is experienced in the United States of America in 1940s. Due to United State sub-prime mortgage crisis that happened recently in 2007-2009, the banking sectors of many countries suffer huge losses, especially United State of America and European Union countries. The poor performance of the banking industry has slowed down the United State of America economy and also the growth of global economy until current period. In Asia, although the losses in banking sectors are not as serious as U.S., it is also hurting the economy. If the banking industry does not perform well, the effect to the economy could be huge and broad. Because, banks are the critical part of financial system, play a pivotal role in contributing to a country`s economic development (Rasidah and Mohd 2011).

1.2     Statement of the Problem

Increased competition among financial institutions coupled with financial distress and unpredictable economic conditions there is need for these firms to understand how well they can use the concept of quality lending to increase their profits. Petersen and Rajan (1994) find that lending affects the quantity of credit more than the price, while other studies find that customers get either lower future contract prices. Also due to poor quality lending, banking industry is suffering with huge Non-performing Assets (NPAs). Thereby higher provisions for NPAs, lower profits, additional capital to maintain CRAR and decrease in rating of the bank etc are the side effects of poor quality of credit or lending, therefor this study is aimed at investigating the impact of quality lending on banks profitability using GT Bank as a case study.

1.3     Objective of the Study

The main objective of this study is to find out the impact of quality lending on bank profitability, therefore specifically the study intends to:

1.     Find out the impact of quality lending on bank profitability

2.     Find out the factors that impede quality lending in commercial banks’

3.     Investigate other factors that impact profitability of banks

1.4     Research Questions

The following research questions were formulated from the objectives to guide this study.

1.     What is the impact of quality lending on bank profitability

2.     What are the factors that impede quality lending in commercial banks’

3.     Are there other factors that impact profitability of banks

1.5     Significance of the study

It is hoped that the findings of the study would be significant in various ways like; Banks would be able to have information that would guide it to improve on their profitability through quality lending. The findings would enable banks to champion its quality lending to all the stakeholders so that they can improve on their profits as a result of this concept. Other banking institutions would be able to understand the concept of quality lending from this study so that they can use the same to improve on the profits. The findings of this study would help institutions to be able to make relevant decisions based on the concept of quality lending. The regulators and the policy makers can use the finding as reference for policy guidelines on management and control of such organizations. They would be able to use the findings of the study to formulate viable policy documents that effectively address problems faced by the banking sector. These may relate to regulating those aspects that threaten to adversely impact on the operations and development of such organizations. This study would be important to the present theory because it would furnish those who are interested in this study area with relevant information.

1.6     Scope of the Study

This study will cover impact of quality control and bank profitability, the research will vividly discuss different factor that determine bank profitability like quality lending and some other factors, a theoretical framework will also be used to back up the research. Also the research will be conducted in GT bank.

1.7     Limitation of the Study