This study sought to investigate the impact of credit risk management on the performance of deposit money banks in Nigeria using five banks that have highest asset base. We adopted ex-post facto and analytical design. Time series data for the period (2000 to 2014) were collated from the annual reports and financial statement of selected deposit money banks in Nigeria. The base year, 2000, is justified based on the adoption of universal banking system. Three hypotheses were proposed and tested using ordinary least square (OLS) regression model. Non-performing loan ratio was used as the independent variable, while the dependent variables were total loans and advances ratio (TLAR), return on assets (ROA), and return on equity (ROE). Descriptive statistics and regression technique were used to analyze the behavior of both dependent and independent variables. Other tests were done at 5% probability level of significance. The findings reveal that credit risk management had a positive and significant impact on total loans and advances, credit risk management had a positive and non- significant impact on the return on asset, credit risk management had a positive and non- significant impact on the return on equity of deposit money banks in Nigeria.It is recommended that bank managers need to put more efforts to credit risk management, especially to control the NPL. Evaluate critically borrowers’ ability to pay back. There is need to strengthen bank lending rate through effective and efficient regulation and supervisory framework. Banks should try as much as possible to strike a balance in their loan pricing decisions.
TABLE OF CONTENTS
Title Page i
Approval Page ii
Declaration Page iii
Table of Contents vii
CHAPTER ONE: INTRODUCTION
- Background to the Study 1
- Statement of the Problem 3
- Objectives of the Study 4
- Research Questions 5
- Research Hypotheses 5
- Scope of the Study 5
- Significance of the Study 6
CHAPTER TWO: REVIEW OF RELATED LITERATURE
2.1 Conceptual framework 9
2.1.1 Concept of Credit risk management in the banking industry 9
2.1.2 Benefits of effective credit risk management 11
2.1.3 Concept of Bank Performance 12
2.2 Theoretical Review 12
2.2.1 Credit risk management practices and financial performance 12
2.2.2 Soft wares used in Risk management in banks 14
2.2.3 Capital adequacy and bank profitability 16
2.2.4 Causes of credit risk to commercial banks 19
2.2.5 The role of liquidity to commercial banks portfolio management 21
2.2.6 Lending policies of commercial banks 22
2.2.7 Methods of monitoring bank risk 24
2.2.8 Overview of bank distress and regulatory stance in Nigeria 28
2.3 Empirical Review 30
2.4 Review Summary 34
CHAPTER THREE: METHODOLOGY
3.1 Research Design 43
3.2 Nature and Sources of Data 43
3.3 Model Specification 44
3.4 Description of Model Variables 45
3.4.1 Dependent Variables 45
3.4.2 Independent Variable and Proxy for Credit Risk Management 45
3.4.3 Control Variables 45
3.5 Techniques of Analysis 46
CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS
4.1 Presentation of Data 48
4.2 Descriptive Analysis and Stationarity Test 52
4.2.1 Testing for Normality 52
4.2.2 Unit Root Test 54
4.3 Test of Hypotheses 55
4.3.1 Test of Hypothesis one 55
4.3.2 Test of Hypothesis two 57
4.3.3 Test of Hypothesis three 59
4.4 Implications of Results 60
CHAPTER FIVE: FINDINGS, RECOMMENDATION AND CONCLUSION
5.1 Summary of findings 63
5.2 Conclusion 63
5.3 Recommendations 64
5.3.1 Contribution to knowledge 64
5.3.2 Recommendation for further studies 64
- BACKGROUND OF THE STUDY
Risk is the possibility of loss or the chances of loss resulting from unfortunate occurrence or event. Risk is always at the center of our life. This means that for every human endeavor, there is risk as a result of our different economic pursuit. Risk management is the process of identifying risks, assessing their implications, deciding on a course of action, and evaluating the results. It is at the core of lending in the banking industry. Risk management introduces the idea that the likelihood of an event happening can be reduced, or its consequences minimized. Effective risk management seeks to maximize the benefits of a risky situation while minimizing the negative effect of the risk. According to Njogo (2012), risk management is the identification, assessment, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events. Risks can come from uncertainty in financial markets, project failures, legal liabilities, credit risk, accidents, natural causes and disasters as well as deliberate attacks from an adversary. Risk management ensures that an organization identifies and understands the risks to which it is exposed.
In one of his speeches, the former CBN Governor, Soludo (2004) made it known that Nigerian banking system today is fragile and marginal. Deposit money banks are in the risk business. In the process of providing financial services, they assume various kinds of financial risks, (Anthony ,2010). Adequately managing credit risk in financial institutions is critical for the survival and growth of the financial institutions. Abdullahi (2013) posits that, in the case of banks, the issue of credit risk is even of greater concern because of the higher level of perceived risks resulting from some of the characteristics of clients and business conditions that they find themselves in.
According to Dwayne (2004), banks originate for the main purpose of providing a safe storage of customer’s cash. He argued that since this money received from the customers was always available to the bank, they later put it to use by investing in assets that are profit earning. Thus, the practice of advancing credits. Banks are in the business of safeguarding money and other valuables for their clients. They also provide loans, credit and payment services such as checking accounts. The intermediating roles of the money-deposit banks places them in a position of “trustee” of the savings of the widely dispersed surplus economic units as well as the determinant of the rate and the shape of economic development. The techniques employed by banks in this intermediary function should provide them with perfect knowledge of the outcomes of lending such that funds will be allocated to investments in which the probability of full payment is certain.
Unarguably, financial institutions have faced difficulties over the years for a multitude of reasons, the major cause of serious banking problems continues to be directly related to lax credit standards for borrowers and counter parties, poor portfolio risk management, or a lack of attention to changes in economic or other circumstances that can lead to a deterioration in the credit standing of a bank’s counter parties. Therefore, credit risk management needs to be a robust process that enables Financial Institutions to proactively manage facility portfolios in order to minimize losses and earn an acceptable level of return for shareholders Dandago (2006).
Lending is the principal business activity for most deposit money banks. The loan portfolio is typically the largest asset and the predominate sources of revenue. As such, it is one of the greatest source of risk to a bank’s safety and soundness. Effective management of the loan portfolio’s credit risk requires that the board and management understand and control the bank’s risk profile and its credit culture. To accomplish this, they must have a thorough knowledge of the portfolio’s composition and its inherent risks. They must understand the portfolio’s product mix, industry and geographic concentrations, average risk ratings, and other aggregate characteristics. They must be sure that the policies, processes, and practices implemented to control the risks of individual loans and portfolio segments are sound and that lending personnel adhere to them (Imeokpararia, 2013).
Risk is an essential part of business because firms cannot operate without taking risks. Risk is commonly associated with uncertainty, as the event may or may not occur. Risk implies exposure to uncertainty or threat (Kannan and Thangavel, 2008). Olajide, (2013) explains that recent economic volatility gives risk management a new focus and eminence. Successful firms are able and willing to effectively integrate risk management at all levels of management process.
Traditionally, risk has been viewed as negative consequences and unfavorable events. The consideration of risk from the negative perspective is restrictive and misleading for two main reasons. First, uncertainty may manifest in either negative (threat) or positive (opportunity) form, or both; and second, the way a risk is perceived influences the manner in which it is handled (Hillson, 2002). Managing risks from negative perspective may result to complete omission of opportunities (benefits/gains) in the event being considered. However, perspectives on risk differ, as the risk definition depends on and is affected by the risk observer (Kelman, 2003). Moreover, risk sometimes entails some economic benefits, as firms may derive considerable gains by taking risk. Business grows through greater risk taking (Drucker, 1977). Risk is, therefore, integral to opportunities and threats which may adversely affect an action or expected outcome (Kaye, 2009; Lowe, 2010). Getting rid of risk undermines the source of value creation; which truncates potential opportunities. Hillson and Murray-Webster, (2011) write that, in essence, to business enterprise, risks are ‘uncertainty that matter’.