Credit Risk Management And Banks Profitability In Nigeria

Project and Seminar Material for Accountancy / Accounting

Abstract

The purpose of this study is to examine credit risk management and bank profitability in Nigeria. The study employ secondary data collected from some selected quoted banks in the Nigerian Stock Exchange for the periods of 2008 to 2012 for the empirical analyses. The empirical analysis revealed that that non-performing loan as a credit risk variable has a negative significant impact on bank profitability (ROE) at 5% level of significance. This indicates that we should reject the null hypothesis (H1) that there is no significant relationship between non-performing loan and bank profitability in Nigeria. The variable, loan and advances have a positive and insignificant impact on bank profitability in Nigeria. It is therefore suggested that we should accept the null hypothesis (H2) that there is no significant relationship between loan and advances and bank profitability in Nigeria. Total deposits have a positive and insignificant impact on bank profitability in Nigeria. It is therefore suggested that we should accept the null hypothesis (H3) that there is no significant relationship between total deposits and bank profitability in Nigeria. Therefore, this study recommended that loan mangers should implement a sound credit risk policy to minimize the incidence of non-performing loans as a default credit risk. Also, the study suggests that bank managers should create a credit rating scale for bank loan customers in order to guarantee the performance of the loans given out to customers.

Chapter One

Introduction

1.1 Background of the Study

Banks are important to economic development through the financial services they offer. Their intermediation role can be said to be a catalyst for economic growth. The recent failure of banks has been a concern for Central bank of Nigeria and shareholder of these banks. Loans and advances is a major source of earnings for banks. Banks are exposed to high risk as a result of lending to customers. Banks face the risks of borrowers not being able to repay principal and interest as they fall due. Experience shows that poor credit risk management typified by high level of insider loans, speculative lending and high concentration of credit in certain sector among other issues impede the stability and profitability of banks. Over the years banks in Nigeria have been carrying huge non-performing loans that rose progressively from year to year without being reported through sound credit risk management.

In the past several banks failed as a result of high non performing loans running into several billions of naira. Attractive interest rate on deposits and loans in the 1990’s led to indiscriminate granting of loans without credit risk appraisal and management. This led to bad and irrecoverable loans. Despite measures put in place to check the trend, the rising profile of non-performing loans, continued unabated into 2000’s. The study is motivated by the negative effect of non performing assets on shareholders fund and would be relevant as it addresses how credit risk affects bank profitability.

Greening and Bratanovic (2003) posits, that because of the potentially dire effect of credit risk, it is important to perform comprehensive evaluation of banks capacity to evaluate,monitor and manage loans and advances granted to customers. The study evaluates the extent to which failure in credit risk management impede profitability of banks in Nigeria.

1.2 Statement of the Problem

It is generally accepted that credit risk is the most prominent risk in terms of the level to which it impacts on the quality of risk assets as well as bank profitability and eventually bank failure. Banks grant large portion of their deposits as loans to customers which account for a large portion their income. Provisions made on non performing loans will have negative impact on the profitability of the banks. Inadequate information about borrowers made the Central Bank of Nigeria to set up Credit Risk Management system. This system ensures that loans granted by banks are captured and made available to all the banks in Nigeria. The objectives of CBN Credit Risk Management System is to provide information, monitor the level of borrowings, and facilitating consistent classification of credit. As part of effort to stem the problem of credit risk Asset Management Corporation of Nigeria was established in 2010 to buy off the non-performing loan of banks in Nigeria and take over eight weak banks.

Central Bank of Nigeria periodically issues prudential guidelines that address quality of loan assets, provisions on non-performing loans, capital adequacy and stability of the banking industry. The code of corporate governance for banks was issued after consolidation to check corporate governance and risk management failures. This requires that bank should adequately disclose it risk management in its annual reports. Despite the efforts made by regulatory authorities to stem the tides of credit risks problems, banks still have high level of non-performing loans attributed non compliance to corporate governance and credit risk management practices. Credit quality is considered a primary indicator of financial soundness and health of bank. Credit risk management is very important evaluating and determining bank profitability. Considering the public loss of confidence as a result of banks distress which has be deviled the financial sector in the last decade, it is very important for banks to be profitable. It is against this background that the study seeks to find out the impact of credit risk management on bank profitability in Nigeria.

1.3 Research Questions

This study is intended to answer the following questions:

What is the relationship between return on equity and non-performing loans?
Do loan and advances affect bank profitability?
Does total deposits determine profitability bank?

1.4 Objectives of the study

The objectives of the study are to

Find out the relationship between return on equity and non performing loans
Find out if loan and advances has impact on return on equity.
Examine the relationship between total deposits and return on equity.

1.5 Research Hypotheses

The following hypotheses was formulated and tested:

HO: There is no significant relationship between return on equity and non- performing loan
H1: There is significant relationship between return on equity and non-performing loan
HO: There is no significant relationship between loan and advances and return on equity
H1: There is significant relationship between loan and advances and return on equity
H0: There is no significant relationship between total deposits and return on equity
H1: There is significant relationship between total deposit and return on equity

1.6 Scope of the study

This study seeks to examine credit risk management and profitability of banks in Nigeria. The study is limited to the top five banks out of the twenty Banks in Nigeria. These banks are First Bank of Nigeria Limited, Guaranty Trust Bank Plc, Zenith Bank Plc, United Bank for Africa Plc and Access Bank Plc. The annual report for 2012 show that these banks ranked as top five banks in Nigeria. The time frame of work is restricted to 5years (2008 to 2012).

1.7 Relevance of the study

One of the objectives of every organization is to make profit. Profit enables organization to invest in assets, and enhance its capital base. Various groups are interested in the profitability of banks. Suppliers and vendors are interested in the profitability of a bank as this will motivate them to transaction business with the bank on credit basis. Employees also have interest in the profitability of the bank. Employees are interested in knowing if the bank will be able to continue to pay salaries and other benefits. Shareholders want to be sure that they will continue to get returns from their investment. Government is interested in profitability because taxes are paid from profit. Managers of banks, researchers, financial analyst and potential investors would also benefit from the result of this study as it will serve as a reference material. The evidence from this study will complement the existing international studies regarding credit risk management and profitability of banks.

Chapter Five

Summary of Findings, Conclusion and Recommendation

The purpose of this study is to examine credit risk management and bank profitability in Nigeria. The dependent variable for this study is bank profitability (ROE) while the independent variables are non-performing loans (NPL), loans and advances (LADVS) and total deposits (TDEPS). To investigate the impact of credit risk management on bank profitability in Nigeria, the study employ secondary data collected from some selected quoted banks in the Nigerian Stock Exchange for the periods 2008 to 2012 for the empirical analyses. To this end, the study uses multiple least squares regression techniques for the empirical testing.

5.1 Summary of Findings

In this study, we examine credit risk management and bank profitability in Nigeria. The study makes use of secondary sources of data for the empirical analysis. It would be observed from the descriptive statistics that on the average bank profitability in Nigeria is 12%. Though the profit of the banks increased during the period 2008 to 2012. The level of non-performing loans among the banks decreased in 2011 and 2012. The takeover of NPL’s by AMCON in 2010 was responsible for the decrease. However loan and advances as a proportion of total asset of the banks fluctuated during the period 2008 to 2012. Loan and advances as a proportion of total deposit a credit risk variable of the banks fluctuated during the period 2008 to 2012. The proportion of total loan and advances to total deposit was higher in 2009 and 2010; these periods also experienced high non-performing loans. Banks gave out a higher proportion of their deposit to cushion the effect of high non-performing loan ratios. The correlation coefficients result revealed that a weak positive correlation relationship exists between the variables. The R-Square indicates that only 15.3% of the profit is explained by the independent variables. The finding reveals that there is a relationship between profit of the banks and non-performing loans. The empirical findings reveal that;

Non-performing loan (NPL) a credit risk variable has a negative significant impact on bank profitability (ROE) at 5% level of significance. It therefore means that increase in non-performing loans of banks will have negative impact on the profit of banks in Nigeria.
Loan and advances (LADVS) as a credit risk has a positive and insignificant impact on bank profitability in Nigeria. It therefore means that loan and advance does not have impact on the profits of the banks
Total deposits, a credit risk variable has a positive and insignificant impact on bank profitability in Nigeria.

The level of total profit may be eroded by cost of bank fund and interest that are paid to depositors. The finding show that the bulk of the profits of banks is not influence by credit risk suggesting that other variable other that credit risk impacts on profits. Banks that are interested in making high profits should focus on other factors other than focusing more on credit risk.

5.2 Conclusion

The purpose of this study is to examine credit risk management and bank profitability in Nigeria.

Credit risk is the risk that a borrower will not meet its loan obligations as the fall due.it also known as default risk. Credit risk is a major risk faced banks,hence the management of this risk is very important to banks.The profitability of banks drive the economy of a country. Therefore, the sector’s profitability is of the major concern for those who are responsible for policy making and operating day to day with it. Banks profitability can be measured by using the ROE which shows the extent shareholder equity is used to generate profits. The reduction of foreign exchange losses, cash flows fluctuations, increase profitability and survival of the firm are the objectives of risk management.
ROE is a very important measure of profit because it represents how much earnings a company can get on the equity capital.

Furthermore, Lending in form of loan and advances involves the creation and management of risk assets and is an important task of bank management. As in liquidity and portfolio management, effective management of the lending portfolio requires an articulated lending policy. The policy should set out the bank’s lending philosophy and objectives including the modalities for implementation, monitoring appraisal and review.

From the findings it is concluded that banks profitability is inversely influenced by the levels of non-performing loans thereby exposing them to great risk of illiquidity and distress and loans and advances as well as total deposits are not a credit risk factors that affect bank profitability in Nigeria. Therefore, management need to be careful drafting credit policy that will not negatively affects profitability and also they need to know how credit policy affects the operation of their banks to ensure judicious utilization of deposits and maximization of profit.

5.3 Recommendation

Based on the empirical findings the researcher would recommend that the banks should establish a credit risk management team that should be responsible for the following actions that will help in minimizing credit risk;

It is therefore recommended that loan mangers should implement a sound credit policy to minimize the incidence of non-performing loans (credit risk).
The study also suggests that bank managers should create a credit rating scale for bank loan customers in order to guarantee the performance of the loans given out to customers.
It is also recommended that bank managers should place less emphasis on total deposits as a credit risk variable because is not a determinants of bank profitability in Nigeria.
It is also recommended that banks should place less emphasis on loan and advances as a credit risk variable because it is not a determinant of bank profitability in Nigeria
Developing database management to manage portfolio data and Setting an information technology system to enhance communication and obtaining accurate data in timely manner.
Presents information about the bank’s exposure to and its management and control credit risks, in time.
Improve the collateral registration process and obtain cash equivalent collateral for each loan made to the customers.
Banks that are interested in making high profits should focus on other factors other than focusing more on credit risk.

5.4 Contribution to Knowledge

The study provide valuable compact of ideas, facts and figures that can be used by academics, management practitioners, bank managers and consultants in understanding the dynamics of relationships and resultant effects between credit risk management and profitability.
This study therefore, provides research opportunities for further researchers on the field to expand the horizon of knowledge on these variables thus identified as credit risk variables. A lot of limitations were identified during the study such as the concentration of the study on the five banks alone.. Thus, the study can be improved on by conducting research using all the banks operating in Nigeria.
This research will make a contribution to literature about credit risk management and the importance of sound credit policies in developing country as Nigeria. This study is paramount as the Central Bank of Nigeria will know to what extent the banks are complying with credit risk management framework.

5.5 Limitation of the Study

The limitations of this study are identified so that the findings can be interpreted correctly within the context of the study. The limitation of the study covers areas such as the population, sample, methodology and data. The sample of study was drawn from the twenty-one banks in Nigeria. Because this study sample was limited to five banks, it implies that other sixteen banks were not included. Hence, one reason the researcher may not be able to generalize the results to all the banks within the country.

5.6 Suggestion for Future Studies

This study could be further developed by including more independent variables to the regression model and increasing the sample size. The variables would help improve the results of the study since it would include all the other factors that affect the profitability of the banks. The increased sample size would give a better representation of the banking sector. Profitability indicator could be developed by adding other relevant dependent variable to grasp the whole variations in profitability. Future researchers should look at the relationships between the variables considered in the study in all the banks (i.e. both commercial and merchant banks).