The Effect Of Credit Policy On Bad Debt Management In Nigerian Banks (A Case Study Of Union Bank Of Nigeria)
The principal task of bank management is to generate sufficient return on their shareholders investment. However, of recent, there have been criticisms and allegations of bad and doubtful debts reported by banks annually.
This raise the question as to whether banks accomplish the task of maximizing shareholders’ returns on their investment and whether the banking system is still one of the most enviable and profitable investment options in Nigeria.
In the study, an attempt was made to identify the causes of bad and doubtful debts, effects on banks’ profits and investment and how they can be ameliorated with the use of appropriate securities and management teams put in place.
The study made use of secondary data collected from fifteen-year annual reports of Union Bank of Nigeria,, a sample selected purposively from Nigerian commercial banks. Regression analysis was used to determine the effect of credit policy on bad debt management. And it was discovered that bad and doubtful debts has an inverse relationship with credit policy of banks.
And, loan losses and credit risk if not checked will lead to low investment growth rate thereby jeopardizing shareholders’ returns.
It is therefore suggested that both commercial banks and monetary authorities should put necessary machineries in place to safeguard any impending loan losses in the banking sector in order to instill confidence among depositors and boost the Nigerian economy as a whole.
Table Of Contents
- Title page
- Approval page
- 1.1 Background of the study
- 1.2 Statement of problem
- 1.3 Objectives of the study
- 1.4 Research question
- 1.5 Statement of hypothesis
- 1.6 Significance of the study
- 1.7 Scope of the study
- 1.8 Limitation of study
- 1.9 Definitions of term
2.0 literature Review
- 2.1 Introduction
- 2.2 Meaning Of Credit Management
- 2.3 Factors Responsible For Customer Default
- 2.4 Interest Rate And Private Investment In Nigeria
- 2.5 Types Of Bank Credit
- 2.6 Credit Policy Of Banks
- 2.7 The Cannons Of Lending
- 2.8 Credit Administration And Control
- 2.9 Measures To Avoid Bad And Doubtful Debts
3.0 Research Design and Methodology
- 3.1 Introduction
- 3.2 Research designed
- 3.3 Sources/method of data collection
- 3.4 Population and sample size
- 3.5 Sample techniques
- 3.6 Validity and reliability of measuring instrument
- 3.7 Method of data analysis
4.0 Presentation and Analysis of Data
- 4.1 Introduction
- 4.2 Presentation of data
- 4.3 Analysis of data
- 4.4 Test of hypothesis
- 4.5 Interpretation of results
5.0 Summary, Conclusion and Recommendation
- 5.1 Summary of finding
- 5.2 Conclusion
- 5.3 Recommendations
This is the introductory chapter of the chapters. is briefly explains the background of the study, statement of the problem, objectives of the study, research questions, statement of hypothesis, significance of the study, scope of the study, limitations of the study and definition of terms.
1.1 Background Of The Study
Credit Policy can be viewed as written guidelines that set the terms and conditions for supplying goods on credit, customer qualification criteria, procedure for making collections, and steps to be taken in case of customer delinquency.
This term can also be refers to as collection policy. It‟s also the guidelines that spell out how to decide which customers are sold on open account, the exact payment terms, the limits set on outstanding balances and how to deal with delinquent accounts. Business organizations in their attempts to make profit adopt several strategies and one of which is allowing credit to customers. Pandey, (2004) submitted that credit is a marketing tool for expanding sales. Credit sales to customers however, must be well monitored because regardless of an organization‟s share of the market and demand for its products, if there are no measures put in place to regulate sales made to customers on credit, there could be problems especially those related to liquidity.
The importance of credit policy therefore to any business organization cannot be over emphasized because it is a factor that has a strong influence on the cash inflow of an organization from its sales activities which is very critical to any business organization. Every credit policy set by an organization seeks to achieve adequate profitability and flow of cash (liquidity) which are the two basic factors that sustain a business in the present and determines its position in the long run. A company‟s credit policy refers to the actions taken by a business to grant, monitor, and collect the cash for outstanding accounts receivable (Maysami, n.d).
The credit policy of a typical organization contains the following variables: collection policy, cash discount, credit period and credit standard, while Entrepreneur Media, (2011) classified it as credit limits, credit term, deposits, customer information and documentation. And each of the components of a company‟s credit policy is used as a tool for monitoring account receivables which is the outcome of credit sales; it covers from the kind of customers that credit may be extended to when actual collections would be made.
There is however no particular universal credit policy that should be adopted by every organization. The credit policy of an organization should therefore be based on its particular business and cash-flow circumstances, industry standards, current economic conditions, and the degree of risk involved. For a manufacturing business organization to achieve its critical objectives of liquidity as it allows credit to customers, concern should be given to its credit
policy, it should be adequately planned and its adherence must be strictly emphasized.
The reason for this paper however stemmed from the fact that in manufacturing organizations, it is usual to present, a policy that regulates credit sales to customers. Nowadays companies operate basically on credit rather than cash, both from their suppliers to their customers.
The existence of a credit policy itself is however not an issue, the main problem lies in the fact that every manufacturing organization exists in a dynamic and complex environment especially in current times where information technology is the order of the day; trends emerge on a daily basis and the behaviour of customers keep changing.
This constantly changing environment affects organizations as well as their decisions and all their policies. A credit policy that is therefore written without an understanding of the market and ample room for change in it, and one that is not frequently revisited could become obsolete in a matter of weeks, it is therefore not enough for these policies to be established but there should exist, flexibility, provisions for review and adjustments, this is necessary to help the organization move with the constantly emerging trends in the world of business.
There’s no one-size-fits-all credit policy–your policy will be based on your particular business and cash-flow circumstances, industry standards, current economic conditions, and the degree of risk involved.
1.2 Statement Of Problems
One of the ways to totally avoid bad debts is to refuse to lend money at all. If banks should then refuse to lend at all, then issue of profitability is cancelled and hence the main purpose of carrying on a business, which is to maximize profit, is then defeated.
Credit must be adequately managed so that banks could remain in business and prudent lending could do this. The provision for bad and doubtful debts rises steadily in banks annual reports which send bad signals to the investors within the economy. The cases of failed banks in the economy over the years have made the investors lose confidence in the banks. Hence, the existing evidence in Nigeria, points to a decline or stagnation of private investment during the immediate past reform years.
The industries usually make short term planning as opposed to long term planning which tends to hamper their forecast and projection into the future activities and earnings. The success of any programme in bringing about a sustainable recovery in economic activity in an economy depends crucially on the behavior of investment in the aftermath of the reform process.
In Nigeria, many reform programmes have been undertaken in the banking industry with little or no impact on the investment behaviour. The behaviour of private investment has been identified as a factor for assessing the reform outcome.
The existing evidence in Nigeria, points to a decline or stagnation of private investment during the immediate past reform years (World Bank 1988, Harriggen and Mosley 1991, Green Way and Morrissey 1992; Gunning; 1994; Coller 1995, dehn, 2000; Lomi and Sisay,2001).
1.3 Objectives Of The Study
To be able to proffer adequate answers to the problem identified above, this paper will look at the following objectives:
- To determine if an organization’s credit policy affects its liquidity.
- To determine whether an organization’s collection period affects its liquidity
- To determine whether an organization’s collection policy determines its cash flow.
- To investigate the causes of bad and doubtful debts in Nigeria Commercial Banks
- To examine the effects of bad and doubtful debts in banks profitability, investors, the public and the economy.
1.4 Research Question
- What effects has the credit policy had on the organizations obligations to its own creditors?
- Does production cycle considered when setting the credit standards & collection period?
- Is it true that the credit terms are reasonable enough to induce prompt payment?
- Does credit policy has a negative effect on the liquidity position of banks in Nig?
- Does the bank collection period affect its liquidity?
- To what extent does feasibility study affect loan repayment in the banking industry
- To what extent does diversion of bank loans to unprofitable venture affect loan repayment?
- Does distribution of loans have effect on banks performance if given proper attention?
1.5 Statement Of Hypothesis
- H0: production cycle is not considered when setting the credit standards & collection period?
H1: : production cycle is considered when setting the credit standards & collection period.
- H0: credit policy does not have a negative effect on the liquidity position of banks in Nig?
H1: credit policy has a negative effect on the liquidity position of banks in Nig.
1.6 Significance Of The Study
This study will be useful to the executive and managers in the banking industry and other financial institutions. This is because it provides guidance which will enhance effect and efficient credit policy and management of bad debt which aimed at attaining and boosting maximum profitability and liquidity in their banks.
The depositor (public) on the other hand will be more enlightened on the need to be honest and fulfill the responsibilities in credit transaction with the banks so that they can look up to improve service from the banks. Finally to the researcher, this is an eye opener because as a potential manager it will guide one in future on how to manage loan facilities.
1.7 Scope Of The Study
This study is aimed at analyzing the loan administration management in the banking industry in Nigeria with a particular reference to Diamond bank Nigeria plc from the period of 2010-2015. The study intends to analyze the loan facilities in banking industry. It also reviews the various concepts procedures for efficient and effective credit management. It examines the success and failure (if any) as well as recommending corrective measure.
1.8 Limitation Of The Study
In this study, they course of carrying out this research encounters a lot of difficulties and was constrained in many areas among which are:
Data from banks:
The problem of getting the managers, staff and customers of the two banks to answer questions in the proposed questionnaire, in many cases, information given by both banks and the ones from internet were not simplified. That is, they are very difficult to understand.
In the aspect of theoretical and practical of this work, the researcher being a student had to apportion her time so as to carry out concurrently with other academic assignment.
The research was constrained by cavity of materials and other expenses. However, in spite of the limitations, effort were made by the researcher to utilize the limited resources at her disposal to ensure that the work is successfully completed.
1.9 Definition Of Terms
Below are the major terms used in the course of this research work?
A state where a person or firm is unable to meet their financial obligations.
Management is the study of decision-makers from the supervisor and line managers at lower levels to the Board of Directors.
3) Loans And Advances:
These are credit facilities granted by banks to their customers. They could be short, medium or long term depending on the length of period of repayment
A credit facility (usually short term) granted by banks to current account holders and it carries interest charges on daily basis
Section 61 of BOFIA 1991 Act defines a banking business as business of receiving deposits on current account or other similar account paying or collecting cheques drawn by or paid in by customers.
A person is a customer if he or she has account with the bank.
7) Financial Ratio:
These are ratios usually expressed in mathematical terms to test the financial obligations.
8) Financial Statement:
They are firm balance sheets, profit and loss account and classified statement which show the financial state of affairs of the firm.
A person or group of persons who stand for bank customers for credit facilities.
10) Collateral / Securities:
Is an asset presented by a customer to his bank to secure a credit facility granted to him by the bank.
5.0 Summary, Conclusion And Conclusion
This chapter is divided into three distinct parts. The first part is concerned with the summary of the whole study from the beginning to the end. The second part deals with the conclusion where inferences and generalization were made or drawn from. Findings in the analysis of the study formed the recommendation section which brought the research to an end.
The survey confirmed the increasing existence in the amount of bad and doubtful debts in Nigeria Commercial Banks of which the major causes are:-
- Inadequate close monitoring of the borrowers to ensure proper utilization of fund (i.e on site visit to factory or project site).
- Incessant increase in interest rate (lending rate)
- Lack of adequate knowledge of the loan seeker
- Failure by Commercial Banks to give their loan immediate follow-up to avoid diversion.
- Poor credit policy administration.
The summary also reveals inefficient credit management, which results in high bad debts portfolio, which is the principal cause that drives banks to their untimely grave. The effects of these bad debts as revealed by the survey were.
Effects On Banks
- Bad debts destroy loan which are banks earning assets. They are the source of earning as well as the essential determinants of the liquidity and ultimate solvency of the bank. It is these earnings that translate into cash, which of course is the life and blood of any business. Eating them up therefore, amounts to slamming death certificates on banks.
- Due to the fact that the higher the bad debts written off from the profit of the bank, the lower the net profit and, therefore, the amount available for distribution as dividends to shareholders and, in fact, the amount ploughed back into the business to enhance its future revenue earning capacity.
Effects On The Society
- Since credits (loans and advances) are funds availed the deficit unit for investment purpose, the amount available for future credit is lowered. Because the loan is lost, it becomes impossible to re-cycle that particular fund (as demonstrated above), which may have enabled new projects, take off or existing ones expand.
- Social services to communities by government are covered because lowered taxes result from reduced profits occasioned by bad debts.
Effects On The Banking Public
- Loss of substantial portion of deposit
- The banking culture is threatened due to lack of confidence in the financial system.
Effects on Shareholders
- Reduction on the amount available for shareholders as dividends due to reduction on profits occasioned by bad debts.
- Lose future earning because of stunted growth arising from paucity of reserve.
From the findings of this study, the researcher draws the following conclusions:
- The consideration of the credit period allowed to organizations by their own suppliers when setting the credit standards and collection period will minimize the problem of cash flow and liquidity.
- Companies have a better chance of maintaining a desirable level of liquidity if their credit policy is regularly revisited and adjusted.
There is no particular recommended credit policy for organizations (Brigham, 1999); credit policy should therefore be established considering factors as: the nature of the organization’s business, its share of the market, its immediate external environment and the level of competition.
Also, From the analysis so far it can be concluded that bad and doubtful debts impacts negatively on bank’s performance, though the bank still makes huge profit from its operations and hence considerable increase in its investment rate over the years considered. This was due to the recapitalization exercise which has really increased its capital based to finance more investments. However, there is the need for banks to monitor their loans so as not to incure huge bad debts as this will reduce the strength of the bank in the period of post consolidation. Effective lending therefore requires the banker to be proactive in dealing with financial proposals of would-be borrowers because the banker controls an essential commodity-money- which if not carefully handled can impact negatively on the banking sector and at large can trigger the economy.
The prescription for bad and doubtful debts in Nigeria Commercial Banks could be resolved through the following recommendations:-
- Banks Management should establish sound lending policies, adequate credit administration procedure and an effective and efficient machinery to monitor lending function with established guidelines.
- Reduction of interest rates on lending.
- The character and financial statement of the borrower must be properly studied.
- The Central Bank of Nigeria should re-introduce interest rate regulation on banks.
- Banks should be making public the names of bad and doubtful debtors (by compilation of bad debtors‟ black book in banks).
- For agricultural lending, the rate should be pegged; say 5% while banks that extended such credits to farmers should be allowed to recoup their loss margin through fax rebate among other incentives.
- Giving business advisory services to customers and further extension of credit to alleviate a promising problem loans.
- Finally, the financial institutions should all together, set up credit bureau system which is a form of data bank where every bank will submit the names of its defaulting customers for references by others. This will equally frustrate multiple borrowing from banks for the same purpose by the dubious customers.
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