EFFECT OF CREDIT RISK ON PERFORMANCE OF NIGERIAN BANKS

posted on August 3, 2018

EFFECT OF CREDIT RISK ON PERFORMANCE OF NIGERIAN BANKS

CHAPTER ONE

INTRODUCTION

Background of Study

The increased competition associated with the process of capitalization, liberalization and globalization and the attempts of Nigerian banks to increase their presence in other markets may have affected the efficiency and credit risk of the Nigerian banking institutions. The first of these aspects, already analyzed in other studies, is based on the incentive to the banks to reduce costs and to improve the management of their resources in order to gain competitiveness. The second aspect, which has not yet been analysed, is explained by the poorer knowledge of the new markets by the newly entered banks and/or the greater permissiveness in the acceptance of risk with a view to increasing the market share in certain sectors and/or regions. Despite the importance of these two aspects, banking literature has usually analysed banking efficiency without considering them together.

The risk focused examination process has been adopted to direct the inspection process to the more risk areas of both operations and business. Skills in risk-focused supervision are continually being developed by exposing examiners to relevant training. By adopting this approach, the banking industry, and specifically the commercial banks are sensitized on the need to have formal and documented risk management frameworks. Notably, the more complex a risk type is, the more specialized, concentrated and controlled its management must be (Seppala, 2000; Matz&Neu, 1998; Ramos, 2000). Financial institutions are exposed to a variety of risks among them; interest rate risk, foreign exchange risk, political risk, market risk, liquidity risk, operational risk and credit risk. In some instances, commercial banks and other financial institutions have approved decisions that are not vetted; there have been cases of loan defaults and nonperforming loans, massive extension of credit and directed lending.

Credit risk is the possibility that the actual return on an investment or loan extended will deviate from that, which was expected (Conford, 2000). Coyle (2000) defines credit risk as losses from the refusal or inability of credit customers to pay what is owed in full and on time. The main sources of credit risk include, limited institutional capacity, inappropriate credit policies, volatile interest rates, poor management, inappropriate laws, low capital and liquidity levels, directed lending, massive licensing of banks, poor loan underwriting, reckless lending, poor credit assessment, no non-executive directors, poor loan underwriting, laxity in credit assessment, poor lending practices, government interference and inadequate supervision by the central bank. To minimize these risks, it is necessary for the financial system to have; well-capitalized banks, service to a wide range of customers, sharing of information about borrowers, stabilization of interest rates, reduction in non-performing loans, increased bank deposits and increased credit extended to borrowers. Loan defaults and non-performing loans need to be reduced (Basel Committee on Banking Supervision, 2006).