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IMPACT OF CREDIT RISK MANAGEMENT ON THE PROFITABILITY OF LISTED MONEY BANKS IN NIGERIA
Abstract
This study examines the impact of credit risk management on the profitability of listed money banks in Nigeria. The banking sector is pivotal to the economic stability and growth of a nation, and effective credit risk management is essential for maintaining the financial health of these institutions. The study employs a quantitative approach, utilizing financial data from selected listed money banks over a period of years to analyze key indicators such as non-performing loans, capital adequacy, and return on assets. By exploring the relationship between credit risk management practices and bank profitability, the study provides insights into how Nigerian banks can optimize their risk management strategies to enhance their financial performance. The findings reveal a significant correlation between sound credit risk management and improved profitability, emphasizing the need for robust risk assessment and mitigation frameworks in the Nigerian banking industry. The study concludes with recommendations for policy makers and bank management to strengthen credit risk management practices, which are crucial for sustaining profitability and contributing to the broader economic stability of the country.
Table of Contents
Chapter One: Introduction
1.1 Background of the Study
1.2 Statement of the Problem
1.3 Research Objectives
1.4 Research Questions
1.5 Research Hypotheses
1.6 Significance of the Study
1.7 Scope of the Study
1.8 Limitations of the Study
1.9 Definition of Key Terms
Chapter Two: Literature Review
2.1 Conceptual Framework
2.1.1 Credit Risk Management
2.1.2 Profitability in Banking
2.1.3 Listed Money Banks in Nigeria
2.2 Theoretical Framework
2.2.1 Credit Risk Theories
2.2.2 Risk-Return Tradeoff Theory
2.2.3 Agency Theory
2.3 Empirical Review
2.3.1 Global Perspectives on Credit Risk Management and Profitability
2.3.2 Credit Risk Management in Nigerian Banks
2.3.3 Comparative Studies on Credit Risk Management and Profitability
2.4 Summary of Literature Review
Chapter Three: Research Methodology
3.1 Research Design
3.2 Population and Sample Size
3.3 Sampling Technique
3.4 Data Collection Methods
3.4.1 Primary Data
3.4.2 Secondary Data
3.5 Data Analysis Techniques
3.6 Model Specification
3.7 Reliability and Validity of Instruments
3.8 Ethical Considerations
Chapter Four: Data Presentation, Analysis, and Interpretation
4.1 Data Presentation
4.1.1 Descriptive Statistics
4.1.2 Trend Analysis of Credit Risk Indicators
4.2 Data Analysis
4.2.1 Correlation Analysis
4.2.2 Regression Analysis
4.3 Interpretation of Results
4.3.1 Impact of Non-Performing Loans on Profitability
4.3.2 Impact of Capital Adequacy on Profitability
4.3.3 Other Key Findings
4.4 Discussion of Findings
Chapter Five: Summary, Conclusion, and Recommendations
5.1 Summary of Findings
5.2 Conclusion
5.3 Recommendations
5.3.1 Recommendations for Bank Management
5.3.2 Recommendations for Policy Makers
5.4 Contribution to Knowledge
5.5 Suggestions for Further Research
References
1.1 Background to the study
The financial services provided by quoted deposit money banks are essential to economic and financial development in an economy. The role of deposit money banks as financial intermediaries enhances rapid economic growth and financial stability in a nation by providing support especially to the real sector of the economy. Financial stability is vital for any nation so therefore the deposit money banks need to be properly managed. Stephen and Joseph (2020) posited that the volume of loans and advances disbursed in an economy significantly influences the productive activities in a nation. The main goal of deposit money banks is to redirect funds from the surplus sector to the deficit sector in a most profitable and sustainable manner. The extent to which deposit money banks extend loans and advances otherwise called credit facilities to members of the public for productive activities accelerates the pace of a nation’s economic growth, financial stability and its long-term sustainability.
Egide and Paul (2017) posited that efficient management of credit risk in deposit money banks is crucial for the survival and growth in the economic globalization waves. He also posited that the Swedish Banking Crisis in the 1990s; the credit losses for the Swedish banks were extremely high. The Swedish banks managed to get through the global mortgage crisis relatively well compared to banks in other countries due to help from the Swedish Government and “Riksbanken” (Central Bank of Sweden, 2009) still they were faced with large losses because of their operations in the Baltic states (FI, 2009). These crises show that the banking industry is exposed to high degrees of risks. He then concluded that efficient management of credit risk in deposit money banks is critical for the survival and growth in the economic globalization waves.
Ravi (2012) posited that credit risk management is best practice in banks and above 90% of the banks in country have adopted the best practice. Inadequate credit policies are still the main source of serious problem in the banking industry and hence effective credit risk management has gained an increased focus in recent years. The main role of an effective credit risk management policy must be to maximize a bank’s risk adjusted rate of return by maintaining credit exposure within acceptable limits. Moreover, banks need to manage credit risk in the entire portfolio as well as the risk in individual credits transactions.
In the study of Kolapo, Ayeni and Oke (2012), deposit money banks in some economies of the world such as Thailand, Indonesia, Malaysia, Japan and Mexico experienced high nonperforming loans and significant increase in credit risk during financial and banking crises, which resulted in the closing down of several banks in Indonesia and Thailand. Financial crisis has not only shaken big economies of the world but developing economies have also been severely affected. Many financial institutions in Africa have either collapsed and or are facing near collapse because of improper functioned subprime mortgage lending to firms and people with bad and unreliable credit. Green (2008) posited that since the late 1950s when Ghana became the first Sub-Saharan African country to gain independence, which has been regarded across the world as a “torchbearer for African aspirations” also faced financial crisis because of real estate losses in early 2000. Sheng (1996) posited that deposit money banks in Ghana experienced several liquidations which affected Meridian BIAO Bank, Bank for
Housing and Construction, National Savings and Credit Bank, Ghana Co-operative Bank and Bank for Credit and Commerce (Amidu, 2010; Appiah, 2011). These high-profile failures, in turn, raise questions on the credit risk management practices of banks in Ghana. Deposit money banks in developing economies like Nigeria also face problems in the management of credit risk as a result of banking crisis in the past. Banking crises in Nigeria have shown that not only do banks often take excessive risks but the risks differ across banks leading to collapse of some banks. Most banks quality of assets have deteriorated as a result of significant dip in equity market indices (BGL, 2010). The lessons learnt from financial crisis are to open awareness of the government and business people on the important role of implementing good risk management in Nigeria. Thus, as a way out of the tide, the Central Bank of Nigeria (CBN) on July 6, 2004 introduced measures to make the entire banking system a safe, sound and stable environment that could sustain public confidence and promote financial stability in Nigeria quoted deposit money banks (Owojori, Akintoye, & Adidu, 2011).
Ikpefan and Ochei (2012) posited that several factors led to the failure of some banks between 1977 and earlier 2000. Some of the reasons advanced are; poor asset quality, under capitalization, inexperienced personnel, illiquidity, inconsistent regulatory policies and supervision. Sanusi (2012) opined that in Nigeria, the economy faltered and was hit by the second round effect of the crisis as the stock market collapsed by 70 per cent in 2008–2009 and many Nigerian banks sustained huge losses, particularly as result of their exposure to the capital market and downstream oil and gas sector. The real economic crisis, which began in 2008 is still producing its harmful impact on the financial stability of deposit money banks as a result of continuous deterioration in the credit leading to increase in bad debts and of the other types of deteriorated receivables. The increase in non-performing exposure impacts in turn on the cost of the risk which keeps growing due to the need of the banks to increase provisions and impairment losses on loans. Therefore, the CBN had to rescue eight of the banks through capital and liquidity injections, as well as removal of their top executives and consequent prosecution of those who committed some infractions. These actions became necessary to restore confidence and sanity in the banking system.
Banks and banking activities have evolved significantly through time and with the introduction of money. Financial services like deposit taking, lending money, currency exchange and money transfers became important due to the role being played by money, as no good financial system can do without well-structured and efficient financial institutions, specifically the banking industry. Banks had and still have an important role in the economy, by mediating between supply and demand of securities, and transforming short-term deposits into medium-term and long-term credits through credit creation. Through credit creation, deposit money banks are able to create new money through deposit multiplier effect and formed part of the main income generating activity of banks, though exposing them to credit risk (Kargi, 2011).
The Basel Committee on Banking Supervision (2001) defined credit risk as the possibility of losing the outstanding loan partially or totally, due to credit events (default risk) or the likelihood of losses when a borrower fails to repay a debt of any kind. Credit risk is an internal determinant of bank performance and the efficiency of the bank‟s performance is a function of how they are able to satisfy their customers at a minimum risk level and maximum profitability level. The higher the exposure of a bank to credit risk, the higher the tendency of the bank to experience financial crisis and vice-versa, thus necessitate its management.
According to Statement of Accounting Standards, credit risk management is the process of managing capital assets of banks and loss of loan reserves. These necessitate the appropriate management of the risks and serves as a key issue in reducing the earnings risk of banks and improving its value in the capital market. Nigeria deposit money banks has experienced high non-performing loans, low reserve for loan loss provisions, inadequate secured loans, loans and advances and low capital adequacy.
Credit risk is a serious threat to the performance of banks, as some of the reviewed studies showing a negative effect; therefore necessitate its management. Credit risk management provides a leading indicator of the quality of banks credit portfolio which is because it greatly influences or prevents the failure of a bank, as the failure of a bank is influenced to a large extent by the quality of credit decisions and thus the quality of the risk assets, which can be deterred as a result of poor corporate governance such as CEO duality etc. The importance of strong credit risk management for building quality loan portfolio is of paramount important to firm performance of deposit money banks as well as overall economy (Charles & Kenneth, 2013).
The growing stock of studies in accounting, finance and economics, underscores the failure in credit risk management as one of the main source of banking sector crises which possibly led to economic failure experienced in the past, including 2001 global financial crises (Fofack, 2005).
Due to increasing spate of non-performing loans and its attendant consequences, the Central Bank authorities through its accords (Basel I and II) emphasized on the importance of capital adequacy for mitigating credit risk. Capital adequacy in banking business provides protection against sudden financial losses and serves as a distress prevention strategy (Greuning, 2003). The level of capital, a cushion to absorb credit and other losses, is matched to the portfolio risk depending on the risk characteristics of individual transactions, their concentration and correlation. All organizations, including banks, need to optimally allocate capital in relation to the selective investments made. Hence, efficient tools and techniques for risk measurement are a key cornerstone of a good credit risk management.
Other measures put in place in managing the risk associated with lending include making provisions to loans in case of loss or default in repayment, which could turn out to improve the firm performance of deposit money banks, most especially when specific assets are set aside for claims in terms of secured loans. In addition, when banks have adequate capital, it not only solves insolvency but also avoid the failure of the financial system.
The Nigerian banking industry has been strained by the deteriorating quality of its credit assets as a result of the fall in global oil prices and sudden depreciation and devaluation 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 the performance of financial institutions. 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 credit risk mismanagement that bedeviled Nigerian banks. In 2017, it is said that about 1.5 per cent of the Nigeria population are said to owe banks the sum of N5trilion and that it had been difficult to recover the debts as a result of legal technicalities deployed by debtors‟ layers (AMCON, 2017). This has motivated for this study to be carried out in order to assess the effect of credit risk management on the market performance of deposit money banks in Nigeria.
1.2 Statement of the Problem
Empirical studies that examine the effect of credit risk management on bank‟s performance in Nigeria centered on traditional measures of performance such as return on equity, return on asset, earnings per share etc. with none to the best of the researchers knowledge on market (valuebased) measures of performance, as the traditional measures of performance do not take into consideration the cost of capital and moreover, they are influenced by accrual based accounting conventions, in addition to overemphasis to achieve and maintain short-term financial results.
While market measures of performance are promoted as the measures of a company‟s real profitability, in terms of performance. Since value creation has become of primary concern to investors and proponents of value based measures claim that those measures are the only performance measures tied directly to stock‟s intrinsic value (Stewart, 1991; 1999; Grant, 2003).
In addition, to examined how credit risk affects the performance of the banks under study as it has caused the liquidation and takeover of many banks that include Intercontinental bank, Oceanic bank, Bank PhB and Afri-Bank just to mention but a few. When loan are not repaid as at when due (Non-performing) could affect the performance of banks, as loan interest (profit) payment are delayed. Inadequate provisions for loans or collateral (secured loan) can also affect the performance of banks but generally, banks are expected to absorb the losses from the normal earnings. But there may be some unanticipated losses which cannot be absorbed by normal earnings. Capital comes in handy on such abnormal loss situations to cushion off the losses.
Above all, combining the above variables in this study differentiated it from previous studies, as they account for few of the variables used. In addition, sample size and period of study are not wide which could possibly be one of the reason of having different findings and as such, this study covered nine (9) years, five (5) credit risk variables and sample size of sixteen (16) firms. However, in Nigeria, literature on this subject is very limited or the issues have not been localized or well treated, like the inclusion of capital adequacy. Little or no attention is paid to this area by academics, financial economist or corporate directors and regulators as evidenced by little of literature and contribution to this discourse.
1.3 Research Questions
The following research questions are raised to guide the study;
i. What is the influence of non-performing loans on the market performance of listed deposit money banks in Nigeria?
ii. What is the effect of loan loss provisions on the market performance of listed deposit money banks in Nigeria?
iii. What is the effect of secured loans on the market performance of listed deposit money banks in Nigeria?
iv. To what extent do loans and advances influence the market performance of listed deposit money banks in Nigeria?
v. What effect does capital adequacy have on the market performance of listed deposit money banks in Nigeria?
1.4 Objectives of the Study
The main objective of this study is to examine the effect of credit risk management on the market performance of listed deposit money banks in Nigeria. While the specific objectives are to assess the:
1.5 Objectives of the Study
The following objectives were set for the research:
1. To determine the measure of relationship between credit risk and profitability of deposit money banks
2. To determine the extent to which non-performing loans affect the performance of banks in Nigeria
3. To ascertain the effects of loan loss provision on the performance of banks in Nigeria.
4. To ascertain the effects of loans and advances on the performance of banks in Nigeria.
5. To ascertain the nature of the relationship between loanable funds ration and bank performance in Nigeria
1.6 Research Questions
1. What is the measure of relationship between credit risk and profitability of deposit money banks
2. What is the extent to which non-performing loans affect the performance of banks in Nigeria
3. What are the effects of loan loss provision on the performance of banks in Nigeria.
4. What are the effects of loans and advances on the performance of banks in Nigeria.
5. What is the nature the nature of the relationship between loanable funds ration and bank performance in Nigeria
1.7 Statement of Hypotheses
In line with the objectives of the study, the following hypotheses have been formulated in null form:
H01: Non-performing loans have no significant influence on the market performance of listed deposit money banks in Nigeria.
H02: Loan loss provisions have no significant effect on the market performance of listed deposit money banks in Nigeria.
H03: Secured loans have no significant effect on the market performance of listed deposit money banks in Nigeria.
H04: Loans and advances have no significant influence on the market performance of listed deposit money banks in Nigeria.
H05: Capital adequacy has no significant effect on the market performance of listed deposit money banks in Nigeria.
1.8 Scope of the Study
The study was limited to the listed deposit money banks in the Nigerian stock exchange as at 31st December, 2020 as the needed data are readily available and are involve in deposit taking and money lending. The study covered a period of nine years (2010-2020). The period was considered because the deposit money banks were strengthening their corporate governance mechanisms and capital base. Market performance of listed deposit money banks was the dependent variable of the study, while non-performing loans, loan loss provisions, secured and unsecured loans, loans and advances and capital adequacy served as the independent variable for the study and provision was made to control for firm specific variable (firm size).
1.9 Significance of the Study
The research will be relevant to several groups of individuals and organizations. First of all, the result or empirical evidence of the study will enable the management of the listed deposit money banks in Nigeria, on how to assess the viability of loan collector in terms of repayment, in order to avoid default. Also, a standard needs to be set on the minimum value of collateral in relation to the amount of money being loaned to a customer.
Secondly, regulatory authorities like Central Bank of Nigeria (CBN) and Securities and Exchange Commission (SEC) to examine whether the listed deposit money banks in Nigeria are complying to relevant provisions, as in the Bank and other Financial Institutions Act (1999) and Prudential Guidelines in terms of capital adequacy, provisions against loan loss etc. with a view to recognizing any deterioration in credit quality.
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