The Impact Of Risk Management In Financial Institutions

Project and Seminar Material for Accountancy / Accounting

Abstract

Customers of the banks expect their bankers to provide them with loans and advances to make up any short fall in their funds requirement for transactional motive. This project is sub-divided into five chapters, which focuses on risk management in Nigeria Banking Sector. Questionnaires were distributed to collect the relevant information from the respondents, percentage and chi-square method were employed and hypotheses testing was carried out, it was discovered that there is risk in the bank sector which enabled the researcher to conclude that there is risk in bank lending and because the rules of lending are not often followed when granting credit facilities to their customers. It was however recommended that there is need to employ more competent staff to the risk management department.

Chapter One

Introduction

1.1 Background to the Study

Banks are germane to economic development through the financial services they provide. Their intermediation role can be said to be a catalyst for economic growth. The efficient and effective performance of the banking industry over time is an index of financial stability in any nation. The extent to which a bank extends their operation to the public for productive activities accelerates the pace of a nation’s economic growth and its long-term sustainability (Kolapo, Ayeni & Oke, 2012). In the 21st century business environment is added multifaceted and intricate than ever. The majority of businesses have to trade with uncertainties and qualms in every dimension of their operations. Without a doubt, in the present-day’s unpredictable and explosive atmosphere all the banks are in front of a hefty risks like: credit risk, liquidity risk, operational risk, market risk, foreign exchange risk, and interest rate risk, along with others risks, which may possibly intimidate the survival and success of the bank’s Corporate Performance. The Nigerian banking industry has been strained by the deteriorating quality of its risk related assets as a result of the significant dip in equity market indices, global oil prices and sudden depreciation of the naira against global currencies.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 to provide a lasting solution to the recurring problems of non-performing loans that bedeviled Nigerian banks (Kolapo, Ayeni & Oke, 2012).

In the last few years, Nigerian banking industry suffered an historic retrogressive trend in both profitability and capitalization. Just 3 out of 24 banks declared profit, 8 banks were said to be in ‘grave’ situation due to capital inadequacy and risk asset depletion; the capital market slummed by about 70 percent and most banks had to recapitalize to meet the regulatory directive. This drama in the banking sector eroded public confidence in banking and depositors funds aggregately dropped by 41% in the period. Possibly due to financial liberalization and globalization, the fact is there has been a reckless abandonment of the essentials of managing risk in times of economic boom and recession; the volatility of bank earnings has been under-rated by bank managements. The central monetary authorities also impacted negatively on stability of the sector. The auditing exercise was a very good one but the sanctity and policy implementation mode was bad considering the nature of the Nigerian economy. Basically, bank objectives revolve around 3 directions: profitability, growth in asset and customer base. Aremu, Suberu and Oke (2010) pointed out that the major problem of bank management is the mis-prioritization of short term goals over its long term objectives. While the profitability centres on the quality of short term reprievable assets and liabilities, net worth expansion which is the equity capital, is a function of total asset and liability. In Nigeria, it has been observed that most bank managers have focused more on profitability (which usually is a short term objective), with little attention on risk managing the quality of assets which has better impact on the long term sustainability of a financial institution. The risks that are faced by businesses can be categorized into financial and non-financial risks. Both of these types of risks are very vital in order to safely run any business.

Sadaqat, Akhtar and Ali (2011) also scrutinizes credit risk having its financial nature and operational risk with its non-financial nature in context to Nigerian Commercial Banks, as financial market of Nigeria is among volatile markets of the world which is filled with anonymity and escapade performances. The recent economic crisis has focused attention on risk management, but managing risk is all about achieving objectives (Woods, Kajüter, and Linsley, 2008; Van der Stede, 2009). Senior managers in particular, are expected to build sustainable performances: create value at acceptable risk levels over time (Calandro & Lane, 2006). To this end, they should be clearly aware of the multiple sources and types of risks (CIMA, 2007). A stronger focus on risk in performance reports addressed to senior managers can address such expectation. Incorporating risk into performance management processes can foster a better understanding of the overall organisational risk exposure and improve business results. The way in which senior managers are made aware of risks via top management reporting is however an open ground where different professions and processes may find a role. On the one hand, the reporting of high level risk information is considered a constituent element of enterprise-wide risk management (ERM) frameworks. These attempts to provide an overview of crucial business risks, integrating traditional, function-specific risk management efforts, for example labour safety and information system security. This reporting can include a range of different information (Lam, 2006): qualitative information such as objectives at risk, audit findings and escalation of particular events or quantitative data such as early warning indicators, key risk indicators (KRIs) and financial risk measures, for example value at risk (VaR). On the other hand, it is argued that innovative performance management frameworks may contribute to foster senior managers’ ability to oversee business risks (CIMA, 2007). In fact, frameworks such as the Balanced Scorecard (BSC) try to overcome the shortcomings of traditional accounting indicators by means of a balanced set of non-financial performance measures. These allow an early detection of weak signals from the environment and provide a more timely and long-term oriented view of the business (Kaplan & Norton, 2001). The use of such frameworks can help signal that some risks related to an item exist and will eventually cause poor financial performances.

1.2 Statement of Problems

The Nigerian Commercial Banking industry has experienced series of problems right from the early 30s down to the middle of the first decade of the new millennium. In 1930 for instance, 21 banks failed. In 1958 when the Central Bank of Nigeria was founded, about 9 banks failed. Still in 1989, about 7 banks failed. In 2006, the numbers of banks were reduced to 24 from 87. As if it is not enough, the number continued to fluctuate from 25 to 24 and so on. The most recent record of banks failure in Nigeria was 2011 when 3 banks were acquired by the Asset Management Corporation of Nigeria (AMCON). Perhaps this problem is subject to recurrence. The question is: does it mean that these banks are not managing their risks at all; or is it that they are managing them poorly?

It is bewildering indeed when one begins to examine the Nigerian scenario of the financial crises; it is incomparable and sometimes very strange! Another question that comes to mind is why it is difficult for these Banks to find a lasting solution to this seeming customary problem in the industry. The study therefore attempts to assess the risk management strategies obtainable in the commercial Banks in Nigeria. The consequences of bank failures are numerous and very unpalatable, not only to the depositors but also the investors, the general banking public and indeed, the entire economy. The regulators and operators have also not had it easy when financial institutions collapse. Bank failures, in general, impair financial intermediation and efficient allocation of resources. They retard individual well-being and economic progress.

1.3 Objectives of the Study

To determine and appraise of banking industry has being in distressed state due to poor management risk firms that has huge profit in response to these commercial banks in Nigeria have seen the need to embark on the risk management and ways in which risk can be reduced or stopped.
To investigate the extent to which government has intervened in financial institution in order reduces risk in banks.
To highlight the rate at which inadequate collateral security increase the risk management.
To determine whether risk management has any effect in financial organization.

1.4 Research Questions

The following are the research question for the study:

To what extent has government intervened in the financial institution in order to stop or reduced risk?
Has inadequate collateral security causes financial risk?
Does fund diversion have any effect on financial institution?

1.5 Statement of Hypotheses

The following hypotheses formulate:

Hypothesis One

HO: Government intervention in financial institution does not influence risk.
HI: Government intervention in financial institution influence risk.

Hypothesis Two

HO: Inadequate collateral security does not cause risk in the banks.
HI: Inadequate collateral security causes risk in the bank.

Hypothesis Three

HO: Risk management does not have effect in financial organization.
HI: Risk management has effect in financial organization.

1.6 Significance of the Study

It is hardly an exaggeration that the difference between the success and the failure in the banking industry is in the effective management of banks loan and advance. Efficient loan management is vital to the protection of asset and achievement of adequate return to the investment. Though much work abound in the literature of the technique of risk management the methods of reducing risk. Hence the significance of this study to banks will enable them to appreciate an appraisal of the risk and control mechanism. The economy as a whole will benefit from the study.

1.7 Scope of the Study

The study of risk management in Nigeria listed bank is used in my analysis all references therefore relate to United Bank for Africa Plc.

1.8 Limitation of Study

The limitation of this study includes some problem or constraint encountered.

Time to get all the information is not there.
Some of the respondents are not willing to response to the questionnaires, because some are afraid.
Financial limitation which led to the inability to provide all the material that is needed in this study.

1.9 Definitions of Terms

Risk:

Is defined as a possible event or circumstance that can have negative influence on the enterprise in question. Its impact can be on the very existence of the resources (human and capital).

Risk Management:

Risk management according to Raghaven (2003) is the proactive action in the present future.

Financial Risk Management:

Is the process of creating economic value in the firm by using financial instrument to manage the exposure of this risk. Financial risk management can be quantitative and qualitative.

Market Risk:

Is the method of assessing the market using the standard statistical techniques.

Credit Risk Rate:

It is the risk where by an investor supply money goods securities return from a promised future payment.

Money:

This can be defined as anything which passes freely from one hand to another. And it is generally acceptable in settlement.

Collateral:

The property pledge as a guarantee of payment or obligation on loan.

Operational Risk:

Is the risk continual circle process which result from loss of inadequate internal procedures or organization internal activities such as market credit risk.

Basis Risk:

It is the risk, where interest rate of different asset/liabilities and off balance sheet item may change in different magnitude.

Chapter Five

Summary, Conclusion and Recommendation

5.1 Introduction

It is important to reiterate that the objective of this study was to examine the impact of risk management in financial institutions.

In the preceding chapter, the relevant data collected for this study were presented, critically analyzed and appropriate interpretation given.

In this chapter, certain recommendations are made which in the opinion of the researcher are drawn from the findings of the study.

5.2 Summary

This study was undertaken to examine the impact of risk management in financial institutions. The study opened with chapter one where the statement of the problem was clearly defined. The study objectives and research hypotheses were defined and formulated respectively. The study reviewed related and relevant literatures. The chapter two gave the conceptual framework, empirical and theoretical studies. The third chapter described the methodology employed by the researcher in collecting both the primary and the secondary data. The research method employed here is the descriptive survey method. The study analyzed and presented the data collected in tables and tested the hypotheses using the chi-square statistical tool. While the fifth chapter gives the study summary and conclusion.

5.3 Conclusion

This study has therefore concluded that adequate risk management practices in Nigerian banks will lead to positive performance financially. This has been concluded from the result in the study.

The study also concluded that risk measurement, Risk management environment and adequate internal controls have the highest impact on financial performance of banks in Nigeria. Thus, as each shilling invested in risk measurement techniques and risk management environment techniques and internal control increases revenues generation and the financial performance of commercial banks increases. Therefore commercial banks need to put more efforts in risk management practices in order to improve financial performance of the banks.

The study established that the study variables i.e. risk management practices and financial performance of the banks had significant positive correlation coefficient. We can therefore conclude that the study variables i.e. risk management and financial performances of commercial banks were highly correlated.

5.4 Recommendation

From the findings in the study which were based on factual information from the bank Manager, we recommend the following; Nigerian banks should expound their risk measurements techniques and adopt more technical and reliable measures so as to adequately manage the financial risks resulting from the increased financial innovations in the banking sector The financial innovations have been made a reality by use of advanced information techniques.

Commercial banks should also check their risk management policy, Procedures and practices and streamline them with global standards. This standards are adopted by all financial institutions hence it will be very practical to compare risk mitigation procedures and practices of different financial institutions globally. On budget allocation the banks should ensure risk management sections have a stand-alone budget to ensure resources are availed for the ever changing risk environment. By this they would efficiently manage the financial risk and consequently increase their financial performance.

On the risk management practices, the mentioned above risks are not only the risk management practices influencing financial performance of commercial banks in Nigeria. Capital adequacy and investment guidelines were added to the study due to wake of commercial banks going bankrupt due to the inability to meet the financial requirements. In light to this, other risk management practices should be put in to consideration by commercial banks. Capital adequacy and investment guidelines and strategies had a very low mean scores and low beta factor meaning that they were perceived as having less impact in financial performance of commercial banks in Nigeria.

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