Effect Of Credit Risk On The Performance Of Nigerian Banks

Project and Seminar Material for Accountancy / Accounting

Effect Of Credit Risk On The Performance Of Nigerian Banks


Recent reports have traced bank failures across the country to rising “toxic assets” in commercial banks’ loan portfolio. Poor credit appraisal techniques that have seen credit exposures turn bad, no doubt, largely accounts for this rising level of non-performing loans. This development not only threatens the viability and sustainability of banks but also adversely affects the economic performance of the country as a whole. The aim of this study is to examine the pattern of credit risk and the consequential effect of bad, doubtful and uncollectible debts. In most banks, colossal debt burden has continued to mount pressure on their ability to balance liquidity in value asset and liabilities. Accordingly, a survey of 40 respondents made up of CBN regulator, NDIC supervisor and UBA operator was carried out, simple percentage frequency tabulated were used as the statistical test of analysis. The study revealed that while CBN and NDIC rated the risk management of asset and mounting debt profile low, UBA Plc rated itself effectively high. The study recommends periodic review of credit profile and monitoring the debt portfolio to prevent banks distress.

Chapter One


1.1 Background of the Study

Commercial banks play a significant role in the economic development of nations through the financial services they provide. Their intermediation role can be said to be a catalyst for economic growth (Kolapo, Ayeni and Oke, 2012). Lending is no doubt a significant part of the financial services rendered by these banks. This is why Kargi (2011) pointed out that credit creation is the main income generating activity of banks. However, commercial bank lending is guided by credit policies which are guidelines and procedures put in place to ensure smooth lending operations. Bank lending if not properly assessed, involves the risk that the borrower will not be able or willing to honour their obligations (Omara, 2007).

However, beyond the urge to extend credit and generate revenue, banks have to recover the principal amount in order to ensure safety of depositors’ fund and avoid capital erosion. Bank lending therefore has to consider interest income, cost of funds, statutory requirements, depositor’s needs and risks associated with loan proposals (Dongo, 2004). For these reasons banks have overtime developed credit policies and procedures which stipulate the lending process. This process includes among others the credit appraisals, documentations, disbursement, monitoring and recovery processes lending. Bank lending is also based on established international standards (Omara, 2007).

However, despite the credit processes and procedures put in place, the Nigerian banking industry, in the past decade, has been strained by the deteriorating quality of its credit assets as a result of the significant dip in equity market indices, global oil prices and sudden depreciation 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 economic performance. 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. Similarly, the Prudential Guidelines was amended in 2010. This was with a view to provide a lasting solution to the recurring problems of non-performing loans that be devilled Nigerian banks.
Similarly, the commercial banks on their part and in response to deteriorating quality of credit assets have almost universally embarked upon an upgrading of their risk management and control systems. This is because poor asset quality no doubt creates the problem of non-profitability and illiquidity.

Thus, there is no doubt that the success of banks largely depends on the effectiveness of their credit management systems because these institutions generate most of their income from interest earned on loans extended to their customers. The Central Bank Annual Supervision Report, 2010 indicated high incidence of credit risk reflected in the rising levels of non- performing loans by commercial banks in the last 10 years, a situation that has adversely impacted on their profitability. This trend not only threatens the viability and sustainability of banks but also adversely affects the economic performance of the country as a whole. Poor credit appraisal techniques that have seen credit exposures turn bad, no doubt, largely accounts for the rising level of non-performing loans. Hence, the report of the rising “toxic asset‟ of banks informed the need to undertake an investigation into the effect of credit risk on banks’ performance. In doing this, the ratio of non-performing loan to loan & advances, ratio of total loan & advances to total deposit and the ratio of loan loss provision to non performing loans were used as indicators of credit risk while the ratio of Profit after Tax to total asset known as return on asset (ROA) indicates performance.

1.2 Statement of Problem

The changes that have taken place in the Nigerian financial system over the past two decades have been traumatic and revolutionary with disturbing news of shrinking spread on loans, erosion of demand deposits, disintermediation of banks or in most cases by the capital market and the concentration of oligopolistic practices in few core banks with series of threats to the Nigerian money market.

Credit risk management system incorporates the processing of credit transactions from the receipt of credit facility request from customers, through credit risk analysis and approval, monitoring of credit exposures to credit payoff or delinquency management in event of decline in credit quality. The management of loans and advances does not require any special skill, although, technical knowledge is essential. Previous experiences can also assist but the ability to think objectively to deal and communicate with a broad range of accounts and customers of different back experience, approach and ability is more important. As the challenges posed by the difficult economic environment increases, financial institutions are subsequently exposed to increasing risk. The most important of these is credit risk, that is the possibility that a borrower will not repay the loan when if falls due or that he may even fail outright to repay. This credit risk has the effect of exposing banks to problem loans when they crystallize. Advance problems arise immediately customer makes his request for the manager to take a decision. This is further compounded when repayment by customer is not met and debt irrecoverable, except through realization of security (where possible).

Where a large chunk of banking system credit is unpaid, the process of intermediation is impeded, fresh funds are unavailable to deserving new projects and the consequences of this for national productivity and employment can be serious. Because of these problems, loans which are increasingly becoming a threat to the financial stability of the banking industry, the Regulatory/Supervisory Authority (CBN and NDIC) introduced the prudential guidelines in November 1990 and always release credit policy guidelines annually for financial institutions comply with so as to minimize this credit risk. But the question is, are these banks really complying with the guidelines so as to safeguard customers’ deposit and owners’ funds? This question is what the research seeks to answer using UBA Plc as a case study.

1.3 Research Questions

The research questions raised from the problem identified are as follows;

  1. What is the influence of non-performing loan to loan & advances on bank performance?
  2. What is the effect of total loan & advances to total deposit on bank performance?
  3. What is the influence of loan loss provision to non performing loans on bank performance?

1.4 Statement of Research Objectives

The general objective of this paper is to examine the effect of credit risk on the performance of Nigerian Banks.

Specifically, the study intended to;

  1. Examine the influence of non-performing loan to loan & advances on bank performance.
  2. Determine the effect of total loan & advances to total deposit on bank performance.
  3. Ascertain the influence of loan loss provision to non performing loans on bank performance.

1.5 Research Hypotheses

To achieve the study’s objectives, the following null postulate has been made.

  • H0: There is no significant relationship between loans and advances (credit) and bad loans (non-performing loans)
  • H1: There is significant relationship between loans and advances (credit) and bad loans (non-performing loans).

1.6 Scope and Limitation of the Study

The scope of the study shall be limited to credit risk management in commercial banks. it shall be within the frame of population size which comprises of all commercial banks in Nigeria.

However, the sample size of the study is restricted to. UBA Plc. Focus will be on the risk management department of UBA Plc coupled with information from CBN and NDIC.

A research work of this nature is fraught with many limitations. An obvious limitation of this study is non-availability of textbooks on credit. Most of the materials available are in form of seminar papers, workshop papers and credit review extracts etc. Time constraint is another limitation since the researcher is a part time student who has to combine this project with regular office work. In spite of all these limitations, justice is done with the available information and materials collected.

1.7 Significance of the Study

This study becomes important because of the volume of bad debts, which has mounted in banks over the years. The magnitude of non performing credits in the banking system is a cause for concern to different stakeholders including bank management which granted the credit, bank director some of whom took the credit, depositors whose funds have been misappropriated, bank supervisors, government responsible for protecting the banking system and the society at large. These concerns arise not only because of the potential losses to depositors but because of the likely loss of confidence in the banking system arising from a systematic distress. When credit is not paid, the banking system would be unable to play its intermediating role. It thus becomes obvious that this is a problem that everyone has a role to pay in finding solution.

1.8 Definition of Terms


Is a state in which losses are possible.


Consists of disappearance or reduction in value.

Risk Management:

Is an organized method for dealing with the pure risks (and sometimes speculative risks) to which an individual, family, firm or other organization is exposed.


Are those who work in an organization.

Loss Prevention:

An effort that reduces the probability of a loss.

Loss Reduction:

An effort that reduces the severity of loss.

Risk Transfer:

A technique such as insurance or a hold-harmless agreement whereby financial aspects of a potential loss are shifted to another party.

1.9 Study Outlines

This study shall be divided into five chapters.

  • Chapter one shall contain the study background, statement of problem, objectives of the study, research questions and hypothesis, scope and limitation of study, significance of study, definition of terms and study outlines.
  • Chapter Two shall contain literature review. My emphasis is to review relevant literature on the study using UBA Plc as my case study.
  • Chapter Three discusses the various techniques and procedures used in collecting data and the analytical treatment of the data collected in the study. It, among other things, discussed the research design; population; sample and sampling procedure; research instrument; method of data collection and data analysis.
  • Chapter four is devoted to explain how the data collected and arranged in tables to facilitate clear and proper analysis.
  • Chapter five presents a summary of this study and the conclusions that could be drawn from it. Following this conclusion, some recommendations are made.

Chapter Five

Summary of Findings, Conclusion and Recommendations

5.1 Summary of Findings

From the analysis in chapter four, a number of findings emerge:

  1. Responses from department of loans and advances, credit risk and asset department of UBA rated UBA high in managing its credit risk with 10 or 25% respectively. CBN rated it low with 6 or 15% while NDIC rated it lowest with 4 or 10%. This signifies that the public seems to have confidence in the bank, this may be as a result of the reputation and image and goodwill the bank has built for itself over many years of banking operations. The increase in the deposits over the years has helped to increase the loan-able funds available to the bank. As a result, the loans and advances which the bank wants to customers have also been on the increase over the years. However, this is being mismatched with the resultant bad loans and advances.
  2. As evidence from the earlier analysis, the liquidity position, cash ratio and loan to deposit ratio show that UBA Plc complied with the prescription of the supervisory/regulatory authorities for the period of study, where a minimum given to the bank did not go below the minimum and where also maximum given it has not been exceeded. Table 4.2 attest to this.
  3. Lack of enthronement of efficient credit risk management to insider abuses, reckless appraisal of loans, faulty conceptualization of feasibility reports and inability to factor in the un-predictable has been attributed to problems and challenges militating against the enthronement of efficient credit risk management in UBA Plc. Table 4.3 attest to this
  4. The study revealed that UBA Plc places more emphasis on short-term loans and the bank has been operating in such a way as to comply with relevant guidelines of the CBN and NDIC. This is evidence from the comparison of ratios earlier computed for the bank with the prescribed standard.
  5. Finally, the study reveals that there is a significant relationship between loans and advances (credit) and bad loans (non- performing loans).

5.2 Conclusion

In reaching conclusion, it is good at this junction to note that the essence of prescribing the prudential ratios and credit policy guidelines are to reduce the risk attached to credit, to ensure proper credit management is practiced by banks and most importantly to meet cash withdrawals of depositors.

In giving credit, a bank benefits by way of profit from interest received. As it is in other professions, a banker also has his type of professional hazards among them is bad debts/loans i.e. the failure of borrowers to pay interest or the principal. There is need for banks therefore to manage their credit well so as to reduce the risk of non payment of interest and. principal.

The distress in the banking sector has been widely acknowledged as arising primarily from non performing loans (bad loans) which have been traced to the poor macroeconomic environment, poor loan processing, inept management, undue interference in the loan granting process, inadequate or absence of loan collaterals, self serving interest of managers and directors etc. As a result of the deterioration of banks credit portfolio especially of 1990, the monetary authority were directed by government to act and put a halt to the side and reverse the trends.

This brought about the introduction of the prudential guidelines in November 1990. The guidelines were issued to ease the identification of problem loans and ensure prudence in recognizing income from such loans.

5.4 Recommendations

In view of the urgent need to sanitize the banking industry and bring the incessant occurrence of loans turning bad to a halt, the following recommendations are made with consideration given to the present economic climate and the growing number of banks in the system.

  1. It had been observed that some banks would rather pay the prescribed penalties than meet some of the guidelines strictly. Therefore, penalties for default should be more drastic.
  2. In order to be able to make loans that can be repaid while minimizing the bank’s exposure to high credit risk, profitability and cash flow of the company using trend analysis and industry comparison should be encouraged.

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