CHAPTER ONE INTRODUCTION

1.1   Background Information

A bank is a financial intermediary and money creator that creates money by lending money to a borrower, thereby creating a corresponding deposit on the bank‟s statement of financial position. Commercial Banks are profit-making organizations acting as intermediaries between borrowers and lenders attracting temporarily available resources from business and individual customers as well as granting loans for those in need of financial support (Drigă, 2012). Commercial banks can also refer to banks or a division of a bank that mostly deals with deposits and loans from corporations or large businesses.

The health of a financial system plays a very important role in the economic development of the country and it failure can have very tragic consequences for such an economy. In developing countries like Nigeria, commercial banks through their functions and activities aid the growth and development of the economy and therefore, are very important to the efficiency and success of the financial system.

Traditionally, it is the belief of every business that profit is a key indicator of success. This is very much true but most business have failed to understand that there is more to profitability than the large figure of retained earnings or reserves in the statement of financial position.

Commercial banks accept deposits from its customers and in turn, generate revenue by lending to individuals and corporate organizations. The statement of financial position of a commercial bank is constituent mostly of loans and advances and bonds as the majority of its asset and deposits as it major liability. This implies that loans make up the bulk of the bank‟s asset and this make it safe to say the life blood of a commercial bank is credit. As a result of lending, credit risk is introduced into the activities of the commercial bank and this is the most critical of all risk faced by the banking institution. If the bank makes bad loans to firms or consumers for example, the bank will be in a crisis if those loans are not repaid (Mavhiki et al., 2012).

As a matter of fact a bank cannot remain in business if it neglects the credit function (Osayeme 2000). Credit risk is of major concern to commercial banks; therefore, commercial banks need to put in place risk management measures to help avoid the risk from blooming into something

greater than they are able to handle which ultimately is illiquidity. Risk management is the human activity which integrates recognition of risk, risk assessment, developing strategies to manage it, and mitigation of risk using managerial resources, but credit risk is the risk of loss due to debtor‟s non–payment of a loan or other line of credit (either the principal or interest or both) (Campbell, 2007). There is need for commercial banks to adopt appropriate credit appraisal techniques to minimize the possibility of loan defaults since defaults on loan repayments leads to adverse effects such as the depositors losing their money, loss of confidence in the banking system, and financial instability (kithinji, 2010). Hence, credit management is made necessary for both profitability and liquidity.