Effect Of Credit Risk Management On Firm Financial Performance: A Case Study Of Gt Bank Asaba Delta State

Project and Seminar Topics with material for Banking and Finance

Effect Of Credit Risk Management On Firm Financial Performance: A Case Study Of Gt Bank Asaba Delta State


Abstract


The study sought to analyze the effect of credit risk management on financial performance of GT Bank, Asaba, Delta state. A descriptive research design was used for the study. Qualitative data was gathered in order to establish the relationship between credit risk and performance of GT Bank, Asaba, Delta state. The study collected data from GT Bank staff from the period 2012 to 2016. The target population was the bank financial bankers, branch bankers and credit/loan officers in Asaba, Delta State. The study was based mainly on both primary and secondary data which was collected from questionnaires sent to the bank mangers and from the annual reports of bank and it was presented using tables and charts. The study findings concluded that the credit risk had an inverse effect on performance in GT Bank, Asaba, Delta state. It was recommended that commercial banks should put consideration on non-performing loans which increases credit risks thus decreasing the bank’s performance, they should have effective techniques of measuring and intimidating credit risk such as the use of ratios like non-performing loans ratios, liquidity and operational cost efficiency ratios, they should have effective and efficient strategies to manage credit risks which might increase the performance in commercial banks.


Chapter One


Introduction

1.1 Background of the Study

The banking industry today plays a very important and significant role in the economic development of the country due to the variety of services and opportunities it provides for the populace and nation at large. Banks are distinguished from other types of financial firms because, they accept deposits and provide credit facilities to its clients. Thus Bossone, (2001) suggests that banks are special intermediaries since they have unique capacity to finance production by lending their own debt to agents that are willing to accept it. Banks manage liabilities, also lend money and thereby create bank assets.

Credit risk is the risk that promised cash flows from loans and securities and financial institutions may not be paid in full (Cornett (2003). Credit risk is recognized in today’s business as an integral part of good management practice. In its broadest sense, it entails the systematic application of management policies, procedures and practices to the tasks of identifying, analysing, assessing, treating and monitoring credit risks, (Bikker and Metzmakers, 2005; Buttimer,2001). Credit risk is important for the success of banks since they determine its performance, liquidity, solvency and quality of the loan portfolio. When commercial bank bankers are aware of the effect credit risk towards performance, then they are bound to take care of their credit decision and adopt best credit risk mechanisms which will be good for the bank. The importance of credit risk is increasing with time because of some reasons like; economic crises and stagnation, company bankruptcies, infraction of rules in company accounting and audits, growth of off-balance sheet derivatives, declining and volatile values of collateral, borrowing more easily of micro finance institutions.

According to commercial-loan theory, also known as real bills doctrine, argues that commercial banks have a problem described as liquidity-earnings dilemma. It states that if a commercial bank wants to be a safe haven for all its depositors’ funds, it would simply hold all those funds in its safe as perfectly liquid assets; then whenever a depositor requested cash from the commercial bank, the banker would simply open the safe and give the money back to the customer. This would ensure that there is no credit risk. However, this presents the problem that no earnings would be generated for the commercial bank (Woolcock, 1999). On the other hand, agency theory developed by Jensen and Mackling, (1976) states that conflicts of interest resulting from principal agent relationships between commercial bank’s owners and management, and between bank’s creditors and owners, are incurring agency costs to the bank’s as the credit risk of these agency conflicts is transferred to performance. While loan pricing theory states that if commercial banks set interest rates too high, they may induce adverse selection problems because high-risk borrowers are willing to accept these high rates.

Nigeria’s banking sector involves 43 registered and licensed commercial banks providing banking and financial services to customers (CBN, 2014). The bank had assets worth KES: 223 billion as at June 2014 (CBN, 2014). Commercial banks in Nigeria play an important role in mobilizing financial resources for investment by extending credit to various businesses and investors, and are the oldest and most diversified of all financial intermediaries. Commercial banks have in the past 10 years made tremendous growth profits and asset growth. Commercial banks like other business enterprises aim to earn profits and grow their balance sheet. They earn profits principally by obtaining funds at relatively low interest rates and then lending the funds or investing in securities at higher interest rates. The balance sheet of the bank means that sits assets indicates what the bank owns or claims that the bank has on external entities (individuals, firms, governments and other banks). A commercial bank’s liabilities indicate what the bank owes, or claims that external entities have on the bank (Onkoba 2014).


1.2 Statement of the Problem

Good credit management systems result into increased performance due to reduced loan defaults. Thus management should adopt and practice prudent credit risk management so as to safeguard the assets of the bank. This suggests that better credit risk management generates income that is partly channeled to bank profits. On the other hand, if credit risk bankers put in place stringent measure which will bar many from borrowing the bank will be denied one of its main streams of income hence negatively affect performance (Mille, 1997).

The Central Bank Supervision Report (2005) on the Nigerian banking system indicted that most banks that collapsed in the late 1990s were as a result of poor management of credit risks which were portrayed in the high levels of nonperforming loans. The liberalization of the Nigeria banking industry in 1992 marked the beginning of intense competition among commercial banks in Nigeria, which saw banks extend huge amounts of credit with the main objective of increasing performance. Due to extending huge amounts of credit, many of the bank have failed, this is because there have been many loan defaulters, poor management techniques and high competition in banking industry. Commercial banks have been offering high quality loans, medium quality loans and low quality loans. The qualitiness of loans is in terms of their returns generation to the bank. Thelow quality loansled to high level of non-performing loans and subsequently eroded profits of banks leading to some commercial banks failing to meet their objectives. Despite the efforts made to address poor credit risk management, commercial banks still have difficulties resulting from the credit risk management processes undertaken and changes in customer base leading to decreasing performance. The banking industry recognizes that commercial banks need not engage in business in a manner that unnecessarily imposes risk upon it; nor should it absorb risk that can be efficiently transferred to other participants. Li yuqi (2007) examined the determinants of banks performance and its implications on credit risk in the United Kingdom. The study employed regression analysis and found that liquidity and credit risk have negative impact on bank’s performance.

Buttit (2010) carried out a study with the aim of establishing the relationship between credit risk and performance of micro finance institutions in Nigeria. Data was analysed using simple linear regression analysis. The ranking of each MFI based on credit risk it adopts was then compared with its financial performance using the simple linear regression model. The findings of the study showed that credit risk was extremely important since it gives assurance about the reliability of the operations and procedures being followed.

Oretha (2012) did a study on the relationship between credit risk and financial performance of bank in Liberia. The researcher found that there was a positive relationship between credit risk and the financial performance of bank in Liberia. All of the above studies did not include management strategies of managing credit risk of bank as an explanatory variable to measure commercial banks’ financial performance(performance). This study therefore sought to fill this gap by including management strategies of managing credit risk among other measures such as operational cost efficiency ratio, liquidity ratios and nonperforming ratios to establish the relationship between credit risk and performance of GT Bank, Asaba, Delta state. In addition, no convincing study has been done on the credit risk identification, monitoring and evaluation relating to financial performance in GT Bank, Asaba, Delta state. Taking into consideration of this evaluation, there comes a gap in literature that warrants a research to be conducted in this industry. Therefore, this research tends to cover the gap.


1.3 Objectives of the Study

The aim of the study is to establish the effect of credit risk on the financial performance of GT Bank, Asaba, Delta state.

1.3.1 Specific Objectives

The following strategically designed objectives guided the study:

  1. To find out the effectiveness of bank bankers in managing and identifying credit risk.
  2. To establish whether the strategies of managing credit risk have an effect on the financial performance.
  3. To analyse how the management challenges of credit risk management affect the financial performance.
  4. To find out the perception of bank bankers towards controlling and managing credit risk.

1.4 Research Questions

The study aimed at answering the following questions:

  1. What is the effectiveness of bank bankers in managing and identifying credit risk?
  2. Are the strategies used by bankers in managing credit risk have an effect on the financial performance?
  3. How are the management challenges of credit risk management affect the financial performance of bank?
  4. What kind of perception does the bank bankers have towards controlling and management of credit risk?

1.5 Justification of the Study

1.5.1 Bankers

The study stands to be of benefit to the bankers of bank as it provides an insight on the relationship between credit risk and financial performance of bank. It also helps the bankers of bank in formulating the best strategies of dealing with credit risks.

1.5.2 Government

The research study is of great importance to the government especially the Ministry of Finance which is involved in making policy decisions whereby credit analysts are employed to determine credit worthiness of their customers.

1.5.3 Researchers and Students

This study is beneficial to the researchers and the students since it enables them gain more understanding about credit risk and its effect to financial performance of bank. It also suggests areas for further research and it acts as a source of reference in future. The study stands to improve not only researcher’s scope of understanding risk management but also the entire public, hence gain exposure to the banking industry.

1.5.4 Commercial Banks and Other Financial Institutions.

Commercial Banks and other non-bank financial institutions also gain from this study as it helps them to determine the likely impact of credit risks management practices on their performance.


1.6 Scope of the Study

The study was carried out on the effect of credit risk management on firm financial performance. The study focused on GT Bank Asaba Delta State.


1.7 Limitations

Uncooperative staffs, there was a challenge of some staffs not willing to give out some information which was beneficial to this research study. To resolve this, I promised them about the confidentiality of their information.
Limited time, there being a limited time to conduct this research I prepared a work plan which I strictly followed.
There was a financial constraint which I resolved by giving priority to the most important activities related to the research study.


1.8 Definition of Terms

Credit

According to Myers and Brealey (2003), credit is a process whereby possession of goods or services is allowed without spot payment upon a contractual agreement for later payment.

Credit Management

According to Nelson (2002), credit management is the means by which an entity manages its credit sales.

Risk

This is deviation from the desired outcome (Brigham et al., 1999).

Credit Risk

According to Mwirigi (2006), credit risk is the potential that a counterparty will fail to meet his/her obligations in accordance to agreed terms.

Micro-credit

According to Muhammad Yunus (1970), micro credit is an extremely small loan given to impoverished people to help them become self-employed.

Portfolio

It is any collection of financial assets such as cash which may be held by individual investors and/or managed by financial professionals, hedge funds, banks and other financial institutions (Glasserman, 2009).

Diversification

According to Maubi, A. M &Jagongo, A. (2014), diversification is a risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.


Chapter Five


Summary of the Findings, Conclusions and Recommendations

5.1 Introduction

This chapter presents the summary of the findings, the conclusions and the recommendations to the study. From the recommendation the study will present the areas for further studies.


5.2 Summary

The study indicated that commercial banks have to ensure that credit risk management is effective to prevent it from failing in its obligation and meeting its objectives. The study indicated that it is crucial for commercial banks to manage credit risk so as to maximize on its return on assets (performance). The study indicated that commercial banks need effective credit risk management techniques to minimize loan defaulters, cash loss and ensures the organization performs better increasing the returns thereby portraying a stable financial performance.

The study established that there are approaches that are used by the bank in screening and risk analysis before awarding credit to clients to minimize on loan loss. From the findings, the competition and conditions are the approaches mostly used in screening and in risk analysis before awarding credit to clients.

It was also found that most of the respondent agreed to a moderate extent that collateral and character of borrower were used in screening and risk analysis. Credit risk management is important since it leads to optimizing the financial performance and that sound credit risk management practices were built on good quality portfolio management, credit union adopted credit documentation as a ways of managing credit risk and the use of collateral enhances risk management in commercial banks.

The study also reached to a conclusion that commercial banks adopt various strategies in analyzing and screening of risk before awarding credit to clients to minimize on loan loss. This included establishing competition and conditions and use of collateral and character of borrower were used in screening and risk analysis in attempt to reduce credit risk.


5.3 Conclusion

From the findings, the study concludes that there is a relationship between credit risk management and performance such that credit risk management affects performance. When asked about the application of the credit management principles in the banking institutions, the secondary data indicated that credit management principles were widely used in the banking and even microfinance institutions. Credit management principles were applicable in their banking institutions. They gave examples of credit management principles used as creating value, explicitly addressing uncertainty, basing on the best available information and taking into account human factors. They also cited on the six Cs of credit management which include character, capability, context, credibility, collateral and conditions. In conclusion, there was an inverse relationship between credit risk and performance (return on assets) in commercial banks.


5.4 Recommendations to the Study

The study recommends that commercial banks should put consideration on non-performing loans which increases credit risks thus decreasing the bank’s performance, they should have effective techniques of measuring and intimidating credit risk such as the use of ratios like non-performing loans ratios, liquidity and operational cost efficiency ratios, they should have effective and efficient strategies to manage credit risks which might increase the performance in commercial banks.


5.5 Suggestions for Further Research

Since this study focuses on credit risk, the researcher recommends further research on other risks such as financial risks, interest rate risks and market risks. The researcher also suggests that the study could further be developed by including more independent variables to the study 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 performance of the banks. The increased sample size would give a better representation of the banking sector.


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