The Effect Of Loan Management In Relation To Bank’s Profitability

Project and Seminar Topics with material for Banking and Finance

The Effect Of Loan Management In Relation To Bank’s Profitability


Abstract


This study analyzes “the effect of loan management in relation to banks’ profitability” A cases study of First Bank Nigeria Plc Enugu state. This study reveals why banks are into loans and how the loans granted by banks could affect the profitability of the bank and also how it is being managed.

The methodology of the study, percentage statistics was used in analyzing responses from questionnaires which was distributed to bankers, bank auditors and customers in other to know how the management of loans makes profit for the bank.


Table of Contents


Preliminary Page(s)

  • Title Page
  • Declaration
  • Approval
  • Dedication
  • Acknowledgement
  • Abstract
  • Table of Content

Chapter One

Introduction

  • 1.1 Background of study
  • 1.2 Statement of the problem
  • 1.3 Objectives of the study
  • 1.4 Research Questions
  • 1.5 Research hypothesis
  • 1.6 Scope of the study
  • 1.7 Significance of study
  • 1.8 Limitations of Study
  • 1.9 Definition of terms

Chapter Two

Conceptual Framework and Related Literature


Chapter Three

Research Methodology

  • 3.1 Introduction
  • 3.2 Research Methods
  • 3.3 Population of the Study
  • 3.4 Sampling Technique
  • 3.5 Methods of Data Collection
  • 3.6 Method of Data Analysis.

Chapter Four

Data Presentation, Analysis and Interpretation

  • 4.1 Introduction
  • 4.2 Analysis of Profitability; Loans and Advances
  • 4.2.1 Analysis of Variance (ANOVA)
  • 4.3 Analysis of the effects of credit management on Profitability among Nigerian banks

Chapter Five

Summary, Conclusion and Recommendations

  • 5.1 Summary
  • 5.2 Conclusions
  • 5.3 Recommendations
  • Bibliography

Chapter One


Introduction

1.1 Background of study

In any economy especially developing ones like Nigeria, the role of banking sub-sector, is a very crucial one. The principal economic function of banks is making loans available to fund consumption and investment spending by business, individuals and units of government. They mobilize funds of surplus economic units and then convert such funds as credit facilities to the deficit units. Proper management of loans and advances is therefore required; however due to the fact that it is the most profitable of bank operations and accounts for about 45% of banks assets; it is also the most risky of the bank business.

The process of lending begins from when the loan is granted and managed to make sure that it is judiciously used and within the framework of the agreement so that it can be repaid back with interest. Therefore, a bank needs to be very careful in taking all the necessary steps to ensure that the loan and advances are given out only when it is almost sure that repayment will not be a problem. Most banks have failed and even more are faced with distress as a result of bad and doubtful debts and loss of loans, illegal manipulations of loans misguided lending policies or an unexpected economic downturn (Rose, 1996), Loan management could be defined as the managerial ability concerned with the planning, execution and controlling of bank loans and advances (Nwankwo, 1980). It is a broad spectrum of banking activities encompassing mobilization of surplus funds from owners and lending same to borrowers or deficits on agreed terms and at a profit.

In addition, it also involves packaging and management of loans through their repayment and part repayment stages. The most widely acknowledged tool for effective management of loan is a well articulated and credible policy which serves as a guide to all those that handle the management of the loan and advances provided to the customers. If good loan management is not instituted, the good loans can turn bad (Adewunmi, 1983). One cannot generalize a measure of authenticity about lending practice because the bank’s lending practice is more variant than a replica of their banks. Moreover, lending practice depends on a number of varying factors such as the economic environment of lending, the experience and expertise of the banker, the “Tradition” and “culture” of the individual bank and the personality of the individual involved. “Two lending officers sitting side by side in the same bank may react differently to the same loan request” (Rose, 1996). Despite all these, a well formulated loan policy should have the general objective and modalities for loan management and guidelines for credit analysis. The popularly known and accepted cannons of lending are factors that are considered by banks in assessing a loan request.

Reed et al (1980) views these factors as the ingredients that determine the lending officer’s faith in the debtor’s ability and willingness to pay obligation in accordance with the terms of the loan agreement. Many authors call it the “6 c’s of lending” which are

  • Capacity
  • Collateral
  • Condition
  • Capital
  • Character.
  • Cash flow

Aside these principles, there are some factors and principles, which also affect the way and manner in which each bank manages its loans. They are called the “5p’s of lending”. These are:

  • Personal factor analysis
  • Purpose analysis
  • Payment analysis
  • Protection analysis
  • Perspective analysis

These principles are important and if lenders follow them, the incidence of bad debts could be reduced to the barest minimum. Moreover, the principles are applicable to every type of lending, from the personnel borrowing to the borrowing to buy aircraft and ship.

Personal factor analysis:

Here, the borrower’s attention should shift the human resources, who are to coordinate the various factors of production in achieving the desired purpose of the loan. Unfortunately, bankers do not give much attention to this, perhaps because human beings are the most difficult factor to predict.

Purpose analysis:

A loan purpose, which is not consistent with the borrower’s funding needs, should not be granted n matter the attraction of profitability of the proposal. Company’s funding needs should fall into any of the following categories;

  • Support or acquire assets
  • Replacement of liabilities
Payment analysis:

This is the core of the credit analysis because, it is the essence of any other analysis specifically here, and we would talk about the payment source, the direction, volume and timing. This can only be done if the banker’s understands the dynamics of the customer’s transaction flow. The lender should familiarize himself with the customer’s operating cycle. It requires the examination of the past cash flow as a basis for projecting future cash flows. If there were any significant changes in the cash flows, it would be because there were significant developments such as mergers, acquisitions or reinvestment.

Protective analysis:

A good lender would need to protect him against unforeseen events. He could not be the only to take all risks. He should ask for receive a good collateral to support his lending. Collateral should be analyzed as to its ownership, control, location and market ability. These four factors can affect the reliability or usefulness of the collateral as a source of protection.

Perspective analysis

Here the borrowers should be concerned with the future outlook of the transaction to be financed. The lending bank should evaluate the risks that have been identified and what can be done to militate them.


1.2 Statement of the problem

The bank’s ability to generate significant profit from loans and advances is constrained by the regulatory authority (CBN). In view of this, the bank must as well achieve their objective of profitability through the institution of sound credit appraisal framework in their lending operations.

The problem encountered in loan management is due to the default in the repayment of this loans, inexperience staff to manage this loan and invaluable collateral provided to cover this loans been given out, non performing credit and so on.

Hence, the problem of this study revolved around loan management and review process as it affects the profitability of first Bank of Nigeria, since poor management of loan portfolio could adversely affect bank’s profitability.


1.3 Objectives of the study

The effective performance of lending function of commercial banks has loans support and promote growth of new businesses and jobs within the bank’s trading territory and also promote economic liability (Rose, 1996). The prime objective of the study is to appraise the effects of loan management on the profitability of banks. However, the study also intends to;

  1. Examine the benefits of effective loan management on profitability of banks.
  2. Identify the relationship between an effective loan management framework and the profitability of banks.
  3. Show the extent to which the relationship in (1) favors the achievement of the profit maximization of the banks.
  4. To make the policy makers realize the importance of formulating sound loan management framework for the bank.

1.4 Research Questions

On the premises of the objective of the study with the aim of providing a solution to the problem identified earlier, the study attempts to provide answers to the following research questions.

  1. Is there any relationship between an effective loan management framework and the profitability of banks?
  2. Is there any relationship between loans and advances of the bank and its asset base?
  3. Does sound credit analysis the incidence of the bad debts in banks?

1.5 Research hypothesis

The following hypothesis are formulated and tested above:

Ho: represent the null hypothesis while Hi, represent the alternative hypothesis.

Hypothesis one
  • Ho: there is no relationship between an effective loan management framework and the profitability of banks.
  • Hi: there is a relationship between an effective loan management framework and the profitability of banks.
Hypothesis Two
  • Ho: there is no relationship between loans and advances of bank and its asset base.
  • Hi: there is a relationship between loans and advances of banks and its asset base.
Hypothesis Three
  • Ho: Sound credit analysis does not reduce the incidence of bad debts in banks.
  • Hi: Sound credit analysis reduces the incidence of bad debts in banks.

1.6 Scope of the study

This research work will cover the appraisal of customers request for loan and advances with associated requirements of First Bank of Nigeria Plc Enugu branch and how these credits have contributed to the profitability of the bank. This study will access the performance of First Bank loan portfolio between the years 2006-2009.


1.7 Significance of study

This study will assist the banks credit department to know the qualities the customer has to possess before loans and advances are granted to them. Furthermore, this study will enable credit department to understand the causes of their problems and losses of profit in the area of loan management, there by being in a position to increase their profit, since bad debts will be greatly minimized. Finally, this study will be a guide to prospective borrowers as to what the banks expect them to satisfy before any credit is given.


1.8 Limitations Of Study

There is no situation without its own limitations and this research work is not an exception. The major problem encountered by the researcher is the limited time given within which to gather and analyze data because this topic is based on what is happening presently in the banking system today. Also the researcher was also faced with the problem of finance as well as the unpreparedness of the respondent to disclose some information to the researcher. Also there is the problem of transportation from one place to another and also the study area. Other problems include physical problem such as the energy used in carrying out this work and because it was carried out when normal school activities were on, the researcher had to devote more time in order to meet up with the time limit for the submission of this work.


1.9 Definition of terms

Loan and advances

It refers to primary earning of the bank which is created when banks lend funds to a customer and in return gets a promissory note from the customer promising to repay the interest and the principal outstanding.

Loan management

It is the art of managing loan portfolio with a view to identify non- performing facilities and reduces its exposure.

Credit policy

This will contain all the relevant issues relating to the credit administration of the bank.

External constraint

It refers to the general, social and economic environment in which a bank operates, that imposes restrictions on loan expansion.

Internal constraint

These are the internal constraints that are internal to the bank and which limits their operation in the industry.

Profitability

It refers to the ability of the bank to generate regulate a sustainable returns on its assets in the form of interest income, service income and investment income.


Chapter Five


Summary, Conclusion And Recommendations

5.1 Summary

The most recent development in the banking industry came up when a new method of banking popularly known as Universal System of Banking. The Universal banking system is a system of banking that permits any bank to determine its portfolio offerings, which may involve non – financial services. Merchants bank are already converting to Commercial banks to be able to access the relatively cheaper and stable deposits, also giving the diminishing investment banking business in the weak economy. Banking as a service industry is organized to make “PROFIT” for the shareholders vide provision of banking services and supply of financial needs of individuals and cooperate bodies. Banks as a sub-system of national economy is not immune and is having its own share of the economic downturn in form of increasing loan defaults because of the inability of borrowers to redeem their loans, which resulted in banks failure and subsequently banks distress.

One of the major problems confronting the Nigerian banking industry today is the increasing incidence of loan defaults and consequent loan losses which manifested on the profitability of the banks, huge uncollectible loans and advances.

Many banks even after the liquidation of several banks in 1998, still paraded inexperience and “glaucoma” visionary managers. There is a growing concern in these quarters of increased potential for bank failures and bank distress if the problem is not urgently addressed. Between the years 2001 and 2002, the CBN and NDIC closed the gates of Savannah

Bank and peak Merchant Bank for problem of liquidity. In August, 2003 the Central Bank of Nigeria took over control of Bank of the North Limited, one of the oldest indigenous bank in Nigeria which was established by the default Northern Region and incorporated on 9th September, 1959 as a private limited liability company engaged, in commercial banking business.

This study therefore, examines the impact of loans and advances on the profitability of Nigerian banks. The study found out that at 5 percent level of significant, the calculated value of the z value is greater than the tabulated value in most of the banks considered in the study. Therefore, this leads to the results that there is significant relationship between loans and advances and its profitability. In order words this means that there is a significant relationship between the way the banks manage their credits and the profitability of the banks.

To assess the strength of the relationship, we employ the Pearson’s Product Moment Coefficient Correlation and we found that the value of r from the SPSS output indicated that the value of r in most of the banks show a value more than 50 percent. This reflects strong positive relationship between the amount of loans granted by the banks and the bank’s profitability.

Similarly the value of r2 indicated a value greater than 50 percent which, this implies that more than 50% of the
variation in the bank’s profitability is as a result of loans and
advances management.


5.2 Conclusions

Based on the findings of the study the following conclusions were made:

First, the variations in the bank’s profitability are as a result of the problems of the management of the loans and advances of the banks. This can be observed as most of the banks have more than 50 percent of their profitability being determined by the fluctuations in the way the loans and advances were handled.

Furthermore the study established that the effects of credit management on the profitability of the banks studied cut across all the banks, the Kruscal Wallis statistical tests suggests that the z value calculated is less than the tabulated z value in most cases. This means that the effect of the credit management on the profitability of the banks is almost on all the banks. This leads to the conclusion that the way credit is being managed in the bank affects its profitability.

Finally, the study established that the management of the loans and advances (credit) by the banks is ineffective.
This is as a result of the increase in the amount lost to the loans and advances by the banks over the years considered in the study.


5.3 Recommendations

The following recommendations have been made based on the findings of the study:

There is the need for a strong policy on the management of banks’ credit facility. This involves the need for control at the various stages of collecting loans and advances in the banks.

Furthermore, banks must ensure strict tradeoff between the liquidity and the profitability of the banks. This will ensure strict compliance with the money being kept by the bank and the amount granted for loans and advances.
There is the need for an immediate change in the banks’ management style and internal control system of the banks. This will help to enhance the debt recovery method in operation. There should also be close watch of the laonable funds portfolio by the regulatory authorities (CBN, NDIC etc).

Furthermore, the formulation and implementation of appropriate economic policies by the government as well as maintaining a stable economic environment will enhance the development of a secured loan and advances portfolio to both the customers and the banks.

There is also the need for a proper and well articulated analyses over all collaterals presented for loans and advances. This will help the banks in ensuring that the assets serving as collaterals have the economic value that will cover the loans and advances collected. It will further help the recovery effort in case of any default.


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