EFFECTS OF FINANCIAL RISKS ON THE ORGANIZATIONAL PERFORMANCE IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

          Numerous elements that impact a company's operational and financial performance surround its business environment. Thus, a variety of factors influence an organization's business decision-making, but managers and investors continue to place a higher priority on financial and operational risks.Firms encounter risk difficulties as a result of, among other things, changing technology, a complicated environment, intense competition, regulatory obstacles, and other factors (Jafari, Chadegani, and Biglari, 2011; White and Frame, 2004).

In the realm of corporate finance and financial management, risk—which is defined as the potential for variations in expected returns or outcomes—has gained attention recently (Holton, 2004). Risks are thought to influence an organization's investment choices and prospects for the future, thus managers are always coming up with ways to lower the likelihood of suffering financial losses and the company closing down.

Financial risk, as defined by Arif and Showket (2015) and Fali, Terzungwe, and Mustapha (2020), is the likelihood of a corporation collapsing when its capital structure has a large debt load and a low cash balance.With the current global financial crisis, credit crunch, and unanticipated company swings, the topic of financial risk and other hazards has garnered a lot of attention. Therefore, managers use a variety of strategies to reduce financial risks while attempting to maximise profit (Fang, 2016). Risk management, including financial risk management, has proven to be challenging in light of the previous financial crises and the world's accelerating changes (Carlson, 2006; Lewis, 2010). In this sense, the absence of appropriate strategies may make it impossible to attain improved performance in the face of financial and operational risks (Stanley, 2013). One of the main industries thought to support economic growth in the contemporary period is manufacturing. Industrial development and change have been facilitated by the manufacturing sector in both established and developing nations, including South Africa, Japan, Malaysia, China, Germany, and Malaysia. The industry has made significant contributions to employment and income distribution in an economy and is crucial to its success.

          Due to current economic difficulties, Nigeria has had to determine what variables lead to the dismal performance of the nation. However, while macroeconomic issues like growing inflation, unstable exchange values, and insecurity rates are investigated, financial and operational concerns have not gotten as much attention at the corporate level (Offiong, Udoka & Bassey, 2019).The Nigerian manufacturing sector has encountered many obstacles in recent years, and in order to revive the industry as a development engine, it is necessary to look at the elements that affect the performance of the manufacturing sector.

Risk management is crucial. Rather than attempting to protect against risk, a strategic approach should identify which risks to avoid, which to minimise or eliminate, and which to take advantage of in order to maximise opportunities and meet organisational goals. Growing exposure to some risk is essential for economic success, and any organisation hoping to reap significant benefits must be willing to assume a significant degree of risk (Damodaran, 2017). For any business venture of which the DMBs are part of, Audu (2014) submitted that it is difficult to ignore risk altogether because without taking some level of risk, the returns from operations will no doubt be compromised and therefore Audu advocated avoidance of risks as much as it is feasible saying that the rational approach to risk, is at the very least to restrict exposure to it. Financial risks are subset to the overall firm risk. Reducing the volatility of earnings and cash flow brought on by exposure to financial risk is one of the primary goals of financial risk management (Dhanini, 2007). The decrease makes it possible for the business to make more accurate projections, which would ensure that there are enough resources for investments and dividend payments (Said, 2014; Wachiya, 2011).

Avoiding financial hardship and the associated expenses is another motivation to manage financial risks (Drogt & Goldberg, 2008). Finally, management's interest in risk management may be focused on maintaining a steady tax rate or stabilising earnings (Dhanini, 2007). It is possible to organise risk management such that it focuses on preventing significant losses or reducing volatility (Said, 2014). Better planning of liquidity demands is made possible by less volatility in cash flows or earnings and the avoidance of losses (Eichhorn, 2004). The primary goal of company management is to maximise predicted earnings while accounting for unpredictability. Organisations want to prevent poor earnings, which compel them to look for outside investment options, which is why risk management is crucial. When this occurs, the capital market flaws cause the cost of such external money to be greater than the internal funds, which leads to suboptimal investments and ultimately reduce shareholders' value.

 However, few studies focused on the effect of financial risks on manufacturing sector performance in Nigeria. Most of these studies focused on the effect of risk management on performance. This study, therefore, investigates the effect of financial risks on the performance of manufacturing firms in Nigeria.

1.2 Statement of the Problem

          Organisations have faced risks over the years, including capital management risk, which is related to the cost of investment financing, foreign exchange risk, which arises when a firm engages in international business transactions and causes cash flows to be influenced by exchange rates, interest rate risk, which is based on variations in interest rates, and liquidity risk, which is related to the inability of a firm to efficiently accommodate the redemption of deposits and other liabilities and to cover funding increases in loan and investment portfolio)(Obalolo et al., 2014). Therefore, reducing these risks in business might put the company on the path to increased performance. However, there are other ways to evaluate an organization's financial success, including how well it manages its assets to produce revenue (Richard, 2009). Operating income, earnings before interest and taxes, and net asset value make up financial performance. It is crucial to remember that determining the extent to which risk influences performance cannot be done using a single financial performance metric.Instead, a comprehensive assessment of a business's performance together with several other performance indicators. Return on equity (ROE) and return on assets (ROA) are the two most often used metrics to assess financial performance. Whereas ROA measures the return on each naira invested in assets, ROE measures accounting earnings over a period per naira of shareholders' equity. Therefore, risk management may be consistent with the company's increasing financial standing. Thus, this study seeks to investigate the effect of financial risk on the organizational performance of deposit money banks (DMBs) in Nigeria, considering their susceptibility to risks as a result of the lending nature of the industry, which could amount to huge losses.

1.3 Research Questions

          The following questions guided the direction of the study;

1. Does credit risk has a significant negative effect on the financial performance of commercial banks in Nigeria

2. Does market risk has a significant negative effect on the financial performance of commercial banks in Nigeria

3. Does liquidity risk has a significant negative effect on the financial performance of commercial banks in Nigeria

4. Does operational risk has a significant negative effect on the financial performance of commercial banks in Nigeria

1.4 Objectives of the Study

          The main objective of this study is to examine the effect of financial risk on organizational performance in Nigeria. Other objectives of the study include;

1.  To determine the extent to which the credit risk affects the financial performance of commercial banks in Nigeria

2. To ascertain the extent to which the market risk affects the financial performance of commercial banks in Nigeria

3. To examine the effect of liquidity risk on the financial performance of commercial banks in Nigeria

4. To determine the effect of operational risk on the financial performance of commercial banks in Nigeria

1.5 Research hypotheses

          The following were hypothesized;

Hypothesis 1

H0: Credit risk has no significant negative effect on the financial performance of commercial banks in Nigeria

H1: Credit risk has a significant negative effect on the financial performance of commercial banks in Nigeria

Hypothesis 2

H0: Market risk has no significant negative effect on the financial performance of commercial banks in Nigeria

H1:Market risk has no significant negative effect on the financial performance of commercial banks in Nigeria

Hypothesis 3

H0: Liquidity risk has no significant negative effect on the financial performance of commercial banks in Nigeria

H1: Liquidity risk has a significant negative effect on the financial performance of commercial banks in Nigeria

Hypothesis 4

H0: Operational risk has no significant negative effect on the financial performance of commercial banks in Nigeria

H1: Operational risk has a significant negative effect on the financial performance of commercial banks in Nigeria

1.6 Significance of the Study

          There have been controversies among researchers on the effect of financial risk on the financial performance. Good selection strategy for risk monitoring is adopted by the credit unions implies good pricing of the products in line with the estimated risk which greatly affect their profitability.

The principal concern of this study is to ascertain the effect of various financial risks on the balance sheets. While the previous research outcomes provide valuable insights in various risk management techniques. This study therefore sought to fill this gap by investigating the effect of financial risk on the financial performance of commercial banks in Nigeria. The question of financial risk and common exposures are clearly of enormous importance for regulators, industry participants and investors. The study will have great benefit to the government and regulatory bodies.

It will help the regulators to understand the scope to financial risks and how to strengthen the systems in the financial industry in terms of policies to determine the adequacy of the risk management provided for by the regulator

1.7 Scope and limitation of the Study

          The conceptual scope of this study lies on the effect of financial risk on the organiational performance of commercial banks. The specific context of the study was the commercial banks institutions in Nigeria. This study was limited to commercial banks in Nigeria where special focus was on the commercial banks and information provided to Central Bank. The study population constituted of all the commercial banks registered and operational in year 2023. The census study was employed. Secondary data analysed is time series and cross-sectional which was obtained from financial annual reports of commercial banks and CBK publications. Data collection was carried out in a period of three months starting Aprilto September 2023.

          The limitation of the study is that the results of this study largely depend on secondary information analyses. Therefore the study results are subjected to the limitations of the bank’s financial statements as reported to the general public which were under custody of Central Bank of Nigeria Supervision Department. The data available was only for the period year 2015 to 2023. The study had limitation of not having access to data as targeted and hence the unbalanced panel data was obtained.

1.7 Summary of the Chapter

          This chapter provide an overview on the background of the study, provided statement of the problem, research questions, objectives of the study, research hypotheses, significabce of the study, scope and limitation of the study and summary of the chapter.