CREDIT RISK MANAGEMENT AND BANKS PROFITABILITY IN NIGERIA

ABSTRACT

The purpose of this study is to examine credit risk management and bank profitability in Nigeria.  The study employs secondary data collected from some selected quoted banks in the Nigerian Stock Exchange for the periods of 2008 to 2012 for the empirical analyses. The empirical analysis revealed that that non-performing loan as a credit risk variable has a negative significant impact on bank profitability (ROE) at 5% level of significance. This indicates that we should reject the null hypothesis (H1) that there is no significant relationship between non-performing loans and bank profitability in Nigeria. The variable, loan and advances have a positive and insignificant impact on bank profitability in Nigeria. It is therefore suggested that we should accept the null hypothesis (H2) that there is no significant relationship between loans and advances and bank profitability in Nigeria. Total deposits have a positive and insignificant impact on bank profitability in Nigeria. It is therefore suggested that we should accept the null hypothesis (H3) that there is no significant relationship between total deposits and bank profitability in Nigeria. Therefore, this study recommended that loan managers should implement a sound credit risk policy to minimize the incidence of non-performing loans as a default credit risk. Also, the study suggests that bank managers should create a credit rating scale for bank loan customers in order to guarantee the performance of the loans given out to customers.

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

Banks are important to economic development through the financial services they offer. Their intermediation role can be said to be a catalyst for economic growth. The recent failure of banks has been a concern for the Central bank of Nigeria and shareholders of these banks. Loans and advances are a major source of earnings for banks. Banks are exposed to high risk as a result of lending to customers. Banks face the risks of borrowers not being able to repay principal and interest as they fall due. Experience shows that poor credit risk management typified by a high level of insider loans, speculative lending and high concentration of credit in certain sectors among other issues impede the stability and profitability of banks. Over the years banks in Nigeria have been carrying huge non-performing loans that rose progressively from year to year without being reported through sound credit risk management. In the past several banks failed as a result of high non-performing loans running into several billions of naira. Attractive interest rates on deposits and loans in the 1990s led to indiscriminate granting of loans without credit risk appraisal and management. This led to bad and irrecoverable loans. Despite measures put in place to check the trend, the rising profile of non-performing loans continued unabated into the 2000’s. The study is motivated by the negative effect of nonperforming assets on shareholders’ funds and would be relevant as it addresses how credit risk affects bank profitability. Greening and Bratanovic (2003) posit, that because of the potentially dire effect of credit risk, it is important to perform a comprehensive evaluation of banks’ capacity to evaluate, monitor and manage loans and advances granted to customers. The study evaluates the extent to which failure in credit risk management impedes the profitability of banks in Nigeria.

1.2  STATEMENT OF THE PROBLEM

It is generally accepted that credit risk is the most prominent risk in terms of the level to which it impacts on the quality of risk assets as well as bank profitability and eventually bank failure. Banks grant a large portion of their deposits as loans to customers which account for a large portion of their income. Provisions made on nonperforming loans will have a negative impact on the profitability of the banks. Inadequate information about borrowers made the Central Bank of Nigeria set up a Credit Risk Management system. This system ensures that loans granted by banks are captured and made available to all the banks in Nigeria. The objectives of the CBN Credit Risk Management System are to provide information, monitor the level of borrowings, and facilitating consistent classification of credit. As part of the effort to stem the problem of credit risk Asset Management Corporation of Nigeria was established in 2010 to buy off the non-performing loan of banks in Nigeria and take over eight weak banks. Central Bank of Nigeria periodically issues prudential guidelines that address the quality of loan assets, provisions on non-performing loans, capital adequacy and stability of the banking industry. The code of corporate governance for banks was issued after consolidation to check corporate governance and risk management failures. This requires that the bank should adequately disclose its risk management in its annual reports. Despite the efforts made by regulatory authorities to stem the tides of credit risk problems, banks still have a high level of non-performing loans attributed to noncompliance to corporate governance and credit risk management practices. Credit quality is considered a primary indicator of financial soundness and health of the bank. Credit risk management is very important in evaluating and determining bank profitability. Considering the public loss of confidence as a result of banks’ distress which has bedeviled the financial sector in the last decade, it is very important for banks to be profitable. It is against this background that the study seeks to find out the impact of credit risk management on bank profitability in Nigeria.

1.3   RESEARCH QUESTIONS

This study is intended to answer the following questions:

i.   What is the relationship between return on equity and non-performing loans?

ii.  Do loans and advances affect bank profitability?

iii. Do total deposits determine profitability bank?

1.4   OBJECTIVES OF THE STUDY

The objectives of the study are to

i.  Find out the relationship between return on equity and nonperforming loans

ii.  Find out if loan and advances has an impact on return on equity.

iii.  Examine the relationship between total deposits and return on equity.

1.5   RESEARCH HYPOTHESES

The following hypotheses were formulated and tested:

1.  HO: There is no significant relationship between return on equity and non- performing loan

H1: There is a significant relationship between return on equity and non-performing loan

2.  HO: There is no significant relationship between loan and advances and return on equity

H1:  There is a significant relationship between loan and advances and return on equity

3.  H0:   There is no significant relationship between total deposits and return on equity

H1: There is a significant relationship between the total deposit and return on equity

1.6 SCOPE OF THE STUDY

This study seeks to examine credit risk management and profitability of banks in Nigeria. The study is limited to the top five banks out of the twenty Banks in Nigeria. These banks are First Bank of Nigeria Limited, Guaranty Trust Bank Plc, Zenith Bank Plc, United Bank for Africa Plc and Access Bank Plc. The annual report for 2012 shows that these banks ranked as the top five banks in Nigeria. The time frame of work is restricted to 5years (2008 to 2012).

1.7  Relevance of the study

One of the objectives of every organization is to make a profit. Profit enables an organization to invest in assets, and enhance its capital base. Various groups are interested in the profitability of banks. Suppliers and vendors are interested in the profitability of a bank as this will motivate them to transact business with the bank on a credit basis. Employees also have an interest in the profitability of the bank. Employees are interested in knowing if the bank will be able to continue to pay salaries and other benefits. Shareholders want to be sure that they will continue to get returns from their investment. The government is interested in profitability because taxes are paid from profit. Managers of banks, researchers, financial analysts, and potential investors would also benefit from the result of this study as it will serve as reference material. The evidence from this study will complement the existing international studies regarding credit risk management and profitability of banks.

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