ABSTRACT
This study examined the determinants of non-performing loans in emerging economies with evidence from the Nigerian banking industry. The study adopted the ex-post facto design. Time series data for the period 1993-2014 were collated from the Central Bank of Nigeria Statistical Bulletin and Financial Statement of banks for the period. The Ordinary least square regression was used to test the five hypotheses stated. Non-performing loans measured by the natural logarithm of aggregate non-performing loans of banks represented the dependent variable while gross domestic product, inflation rate, total loans and advances, total assets and bank’s lending rate were adopted as the independent variables for the five hypotheses of the study. Macroeconomic variables such as exchange rate, and interest rate were also included as control variables. Descriptive statistics on the dependent, independent and control variables were also computed and graphed to complement the regression results. The result emanating from this study revealed that gross domestic product had negative effect on non-performing loans; Inflation rate had positive effect on non-performing loans but was insignificant; total loans and advances had positive effect on non-performing loans and was statistically significant at the 0.05 level; total Assets exerted negative effect on non-performing loans and was statistically significant at the 0.05 level and Bank lending rate had positive and insignificant effect on non- performing loans. The study therefore concludes that bank-specific factors drive changes in or determine Non-performing loans more than macroeconomic factors in Nigeria. This should affect the direction of economic policies in the country. It is recommended, among others, that macroeconomic policy should be directed at sustaining economic growth as it curbs non- performing loans in the banking industry.
1.1 Background to the Study
CHAPTER ONE
INTRODUCTION
Emerging economies as defined by Center for Knowledge Societies (2008), are those regions of the World that are experiencing rapid informationalization under conditions of limited or partial industrialization. The emerging economies often referred to as “Emerging Markets” (Bloomberg,
2006) are Countries that have the characteristics of developed markets but are not yet developed markets. These include countries that may become developed markets in the future or were in the past. It may be a nation with social or business activity in the process of rapid growth and industrialization. Kveint (2009:3) explains that “emerging market country is a society transitioning from a dictatorship to a free-market-oriented-economy, with increasing economic freedom, gradual integration with the Global Marketplace and with other members of the Global Emerging Market (GEM), an expanding middle class, improving standards of living, social stability and tolerance, as well as increase in cooperation with multilateral institutions”.
According to Robert (2000:1), the emerging economies are low-income, rapid-growth countries using economic liberalization as their primary engine of growth. He explained that the major government policy tool is the capital account liberalization, which is a parameter used in measuring the degree of openness of an economy, signaling the rate of inflow and outflow of capital from one country to another without undermining its territorial integrity and independence. The extremes of the continuum are strict controls, which come in some variety, and liberalized markets, where economic agents freely interact under commonly applicable rules to clear the markets.
In the early 1980s, the term, newly industrialized countries, was applied to a few fast-growing and liberalizing Asian and Latin American countries. Because of the wide spread liberalization and adoption of market-based policies by most developing countries, the term “newly industrializing countries” has now been replaced by the broader term emerging market economies (Adedipe, 2006). Thus, an emerging economy has further been explained as a country that satisfies two criteria: a rapid pace of economic development, and government policies favouring economic liberalization and the adoption of a free-market system (Anold & Quelch, 1998).
The International Finance Corporation (IFC, 1999) identified 51 rapid-growth economies in Asia, Latin America, Africa and the Middle East in addition to the 13 transitional economies following the collapse of Communism in Eastern and Central Europe in 1989. Over time, the Emerging Economies countries became classified as regional economic blocks which are identified as follows:
The BRICS Countries (Brazil, Russia, India, China, and South Africa).
The CIVETS Countries (Columbia, Indonesia, Vietnam, Egypt, Turkey and South Africa).
MINT (Mexico, Indonesia, Nigeria and Turkey).
Others include (Bangladesh, Iran, Pakistan, Philippines, Poland, and South Korea, etc).
Miller (1998) summarizes the most common characteristics of emerging markets using the following parameters, and comparing emerging markets with developed economies in the table below as follows:
1) Physical characteristics- in terms of an inadequate commercial infrastructure as well as inadequacy of all other aspects of physical infrastructure (communication, transport, power generation);
2) Sociopolitical characteristics- which include, political instability, inadequate legal framework, weak social discipline, and reduced technological levels, besides (unique) cultural characteristics; and
3) Economic characteristics- in terms of limited personal income centrally controlled currencies with an influential role of government in economic life, in managing the process of transition to market economy.
Comparing emerging markets (and emerging economies) with developing countries, it is necessary to understand why emerging economies are so important for world economic growth. Differences between emerging economies and developed economies are presented in Table 1 below.
Table 1.1(a): Comparison between Developed and Emerging Markets
S/N | Dimensions | Developed markets | Emerging markets |
1 | Level of economic development | High | Low/ Medium |
2 | State of economy (and society) | Developed/ Stable | Transitional/ Unstable (Economic/Political reforms) |
2.1. | Macroeconomic framework | Developed/ Stable | Undeveloped (being created) |
2.2. | Market institutions | Developed | Undeveloped (being built) |
2.3. | Market conditions | Stable | (Un)stable |
2.4. | Market infrastructure | Developed | Undeveloped (being built) |
2.5. | Governmental involvement | Not so high | Relatively high |
2.6. | Cultural resistance to market Economy | Low | Higher |
3. | Rate of growth | Low | High |
4. | Room for growth | Narrow (matured markets) | Huge (undeveloped markets) |
Source: Adapted from Emerging Markets: a Review of Conceptual Framework by Sunje, et al.
The growth of emerging economies, resulting from economic liberalization, led to the proliferation of private and State-owned banks in the developing countries, and competing aggressively with government owned banks and among themselves in order to survive. The pressure of demand for goods and services and the large capital inflows from International markets caused the local banks to continue to expand their total loans and advances portfolio. Most of these loans could not be repaid following the cyclical nature of the individual emerging economies which result into banking crises.
The various governments, having liberalized their economies started experiencing large capital inflows with increasing demand for goods and services. The channels for these huge International banking transactions were the local banks. The resulting economic boom led the banks to develop high appetite for profitability through the expansion of their loans and advances portfolio despite their inadequate preparation for financial liberalization. This led to the deterioration of average bank asset quality across the emerging economies (Beck, 2013). The fact that loan performance is still linked to the economic cycle is well known. During economic crash, most of these loans could not be repaid as at when due. The implication was NPLs for the banks and often banking failure.
The emerging economies promise huge potential for growth but also pose significant political, monetary, and social risks. The framework for the emerging economies explains how the non- industrialized nations of the world are achieving unprecedented economic growth using new energy, telecommunications and information technologies. The emerging economies are
becoming the potential business leaders in the world in providing products and services at low cost and in quick time to consumers.
The implication of the framework of the emerging economies for the banking industries is such that large capital inflows are in principle desirable for relatively low income countries; they also pose the potential risk of sudden stops leading to large economic and financial imbalances. To control this potential risks facing the emerging economies, the country’s financial system need to be strengthened.
The financial system plays a fundamental role in the growth and development of an economy, particularly by serving as the fulcrum for financial intermediation between the surplus and the deficit units in the economy. A robust financial system that imbibes the smooth and efficient flow of investment process, lays foundation for financial stability and sustainable economic development of a country.
The economic growth in any country is not possible without a sound financial sector that is made up of financial institutions (Rajaraman and Visishtha, 2002). These financial institutions not only ease the credit flow in the economy but also enhance the productivity by revitalizing investments (Richard, 2011). Good performance of these financial institutions is the symbol of prosperity and economic growth in any country or region and their poor performance will not only damage the economic growth and structure of the particular region but also impact on other economies (Khan and Senhadji, 2001).
The role of banking industry is versatile; Banks utilize the depositor’s funds in an efficient manner, share risk, play a significant role in the growth of economy, are always critical to the whole financial system and remain at the centre of financial crisis (Franklin and Elena 2008).One of the main causes of financial instability or crisis is the percentage of non-performing loans(NPLs) to the total assets of the banks both in developed and emerging economies.
In the last few decades, there have been many banking failures all over the world (Brownbridge and Harvey, 1998), following which many banks have been closed by regulatory authorities (Barr and Siems, 1994; Chijoriga, 1997; Brownbridge, 1998; and Brownbridge and Harvey,
1998). Non-performing loans are one of the main reasons that cause insolvency of the financial institutions and ultimately hurt the whole economy (Hou, 2007). By considering these facts it is necessary to control non-performing loans for the economic growth in the country by identifying
and sensitively managing those variables that are causing loan defaults, and are capable of damaging the financial stability and also the economic growth. In order to control the non- performing loans it is necessary to understand the root causes of these non-performing loans in the particular financial sector (Rajaraman and Visishtha, 2002).
It is important to understand the phenomena and nature of non-performing loans; it has many implications, as fewer loan losses is indicator of comparatively more firm financial system, on the other hand high level of non-performing loans is an indicator of unsecure financial system and a worrying signal for bank management and regulatory authorities. If we look into the causes of the 2007-2009 global financial crises which damaged not only economy of USA but also economies of many countries of the world we find that non-performing loans were one of the main causes (Adebola, Wan Yusoff, & Dahalan, 2011). During economic booms, high risk loans were found to be granted to unqualified borrowers and were secured against overestimated collateral values or against nothing. When this economic boom went burst, those high risk loans turned into Non-Performing Loans (Chijoriga, 1997).
Chang (1999) explains that the role of banks in credit creation process is considered very relevant in sustaining financial stability. But strong financial foundation is often shaken by impaired credits referred to as non-performing loans (NPLs). He argued that the success of any business enterprise especially banks, is to add value to their shareholders wealth by remaining in profit at the end of their financial year; and where this profit or surplus is impaired by high default rate in loan repayment, the degree of success of the bank become greatly challenged such that the health of the bank will become doubtful. Loans are the major output provided by banks, but loan is a risk output. There is always a foreseen (ex ant) risk of non-repayment of a loan before the loan will finally become non-performing which can be treated as undesirable output or costs to a bank and impacts negatively on the bank. High non-performing loans results into credit crunch which causes a bank to start to avoid further lending despite high demand from borrowers.
In Nigeria, Somoye (2010) reviewed the performance of banks within the context of non- performing loans. The results showed that variations in non-performing loans impacted on the banks earnings followed by the risk of fluctuating interest rates resulting from monetary policy rate adjustments by the monetary policy authorities. The results largely supported the findings from the study on non-performing loans conducted on Sub-Saharan Africa countries by Fofack (2005) who maintained that a loan is non-performing where earnings due are no longer available
to profit because full repayment of principal or interest is 90 days or more delinquent, and, or, the maturity date has passed and repayment in full has not been made.
Evidence from literature shows that the studies on non-performing loans have focused on advanced economies like the United States of America (USA), Spain, and United Kingdom (UK), and emerging economies like China, Taiwan, India, Brazil, Egypt, Indonesia, Turkey, Malaysia, Bangladesh, Pakistan, South Korea etc., but with very scanty literature on the Nigerian economy which has been grouped as one of the emerging economies.
The studies in the Nigerian economy have concentrated on bank failures with non-performing loans as one of the major factors but without corresponding studies on non-performing loans itself. This suggests that the study on the determinants/causes of non-performing loans as a major factor for bank failures have been ignored. This is a knowledge gap that needs to be filled. Therefore, the aim of this study is to analyze the sensitivity of the “Determinants of non- performing loans in emerging economies with evidence from Nigerian Banking Industry”. The objective based on existing International evidence is to explain the determinants of non- performing loans by identifying the macroeconomic and the bank specific factors.
1.2 Statement of the Research Problem
Gross Domestic Product (GDP) has remained one of the macroeconomic factors that determines Non-Performing Loans. From literature, Nigerian GDP has shown robust growth trend throughout the period of this study. It was expected (all things being equal) that borrowers’ cash flow would have improved to ease their repayment capabilities, but NPLs increased to all time high of N2, 992.80 billion in 2009. My interest lies on the fact that I did not see result-oriented efforts being put in place by the Federal Government through the Central Bank of Nigeria and other regulatory bodies to cause the positive GDP to reflect in loan repayments so as to close the gap created. Okonjo-Iweala (2010) position that the Country’s GDP has shown positive growth, but worrisome was the lack of corresponding improvement on the welfare of the people, supported the researcher’s problem statement.
The researcher identified Inflation Rate (INFR) as one of the Non-Bank-Specific variable determinants of NPLs in the Nigerian Banking Industry. Higher inflation can enhance the loan repayment of borrowers by reducing the real value of outstanding debt. It can also weaken the loan repayment capability of the borrowers by reducing the real income when Salaries/Wages are sticky. The researcher’s computation has shown that inflation trend in Nigeria has been fluctuating widely. It rose to 72.80% in 1993 and dropped to 3.29% in the year 2,000. It made
loan repayment plans difficult, thus, increasing NPLs. There was no strong economic blue-print by the government to close the wide inflation gap to lower level as in most economies. Previous studies supporting the researcher’s position include Nkusu, (2011); Khemraj and Pasha, (2009); Fofack, (2005); and Adebola et, al (2011).
The study identified Total Loans and Advances (TLADV) as one of the Bank-Specific factors that determines NPLs. A positive relationship exists between TLADV and NPLs such that as banks increase their loan portfolios, the rate of default in loan repayment increases. Within the period of this study, Nigerian Banks were found lending in excess of their deposit/lending threshold or ratio in order to satisfy their high appetite for profitability. The implication was increase in NPLs. The Central Bank of Nigeria (CBN) did not close the gap that led to reckless lending by the banks. I did not see the CBN effectively applying the relevant provisions of the Prudential Guidelines and BOFIA to control the banks lax lending habit. In order to check indiscriminate lending, banks in Nigeria could have taken a cue from the experience of the USA. MaGovern (1993) examined the case of the USA and noted that ‘Character’ has historically been a paramount factor of credit and a major determinant in the decision to lend money.
When loans are repaid, they add to the Total Assets (TA) base of the bank and the overall NPLs is reduced. Banks face insolvency due to declining total assets values when bank borrowers are unable to repay their debts as a result of adverse shock to economic activities. It is a sign of stability when banks increase their asset base significantly such that it can afford to raise provisions for doubtful debts and eventually write them off. Between 1993 and 2009, the Nigerian Banking Industry reflected a substantial rise in the general quality of assets and NPLs, suggesting that the quality of total assets had influenced the level of NPLs. The researcher will like to know why there was a gap resulting in the less effective reform policies prior to 1993 which could not address the issues of credit expansion emanating from the growth in the asset qualities of banks whereas the Prudential guidelines remains an available tool to restrain the banks from injurious credit expansion.. The situation escalated and eventually culminated in failure of most banks in 2005. Earlier studies such as Dimirguc-Kent and Detriagiache, (1995); Arellano, (2006); and Hue et, al (2006) lay credence to this problem.
A rise in Bank Lending Rate (BLR) weakens loan repayment capacity of the borrower. This goes to show that interest rate policy plays very crucial role in growth or decline of NPLs in Nigeria. The highest BLR in 1993 was averaged 36.09% – this was considered very high. Although the interest rate policy makers reduced it to average 18.70% in 2008, it rose again to 25.74% average in 2014. Why didn’t the Central Bank of Nigeria remain consistent towards maintaining a lower and stable BLR? Previous studies that support lower BLR in order to reduce NPLs include Nkusu, (2011); Dash and Kabra, (2010); and Farhan et, al (2012).
In consideration of the above stated problems, the researcher is tempted to ask; why were the financial system stability managers in Nigeria and the external regulatory bodies not proactive and disciplined enough to manage this situation? This question and others will form the basis of this research.
1.3 Research Objectives
The main objective of this study is to examine the bank specific and nonbank specific (macroeconomic) factors (or determinants) affecting non-performing loans in the Nigerian Banking Industry. Specifically, the study examines as follows:
1. The effect of gross domestic product on non-performing loans in Nigerian Banking
Industry.
2. The effect of inflation on non-performing loans in Nigerian Banking Industry.
3. The effect of total loans and advances of Banks on non-performing loans in Nigerian
Banking Industry.
4. The effect of total assets of Banks on non-performing loans in Nigerian Banking
Industry.
5. The effect of banks’ lending Rates on non-performing loans in Nigerian Banking
Industry.
1.4 Research Questions
The research questions for this study are as follows:
1. To what extent is the effect of gross domestic product on non-performing loans in
Nigerian Banking Industry?
2. To what extent is the effect of Inflation rate on non-performing loans in Nigerian
Banking Industry?
3. How far is the effect of total loans and advances of Banks on non-performing loans in
Nigerian Banking Industry?
4. To what extent is the effect of total assets of Banks on non-performing loans in Nigerian
Banking Industry?
5. How far does the bank’s lending rate affect non-performing loans in Nigerian Banking
Industry?
1.5 Research Hypotheses
The Hypotheses for this study are stated in their null form as follows:
1. Gross domestic product does not have a positive and significant effect on non-performing loans in Nigerian Banking Industry.
2. Inflation rate does not have a positive and significant effect on non-performing loans in
Nigerian Banking Industry.
3. Total loans and advances of Banks do not have a positive and significant effect on non- performing loans in Nigerian Banking Industry.
4. Total assets of Banks do not have a positive and significant effect on non-performing
loans in Nigerian Banking Industry.
5. Bank’s lending does not have a positive and significant impact on non-performing loans in Nigerian Banking Industry.
1.6 The Scope of the Study
The period of study covered Twenty One years starting from the year 1993 – 2014. The nature of this empirical research work demands the coverage of all licensed Commercial banks in Nigeria. The choice of the base year was because this period witnessed major landmarks in the banking terrain towards the end of the last century, and the government transition from Military government to usher in the third republic democracy era in 1999. It was in 1999 also that the Universal Banking Policy was introduced in the Nigerian banking history.
The merchant banks and the commercial banks were merged to a common level business playing ground. The reform marked the beginning of bigger banks and also competition. Another justification considered for the choice of this period is that it covered a period from pre- consolidation (1993-2004) to post-consolidation (2005-2014) and clearly showed the trend of activities in the industry. For example, the pre-consolidation shows 89 licensed banks in Nigeria that were consolidated into 24 banks and by the end of 2014, the number of banks had reduced further to 22 banks.
The period of study witnessed the global financial crisis which started from late 2007 and reached its peak in 2008 with negative impacts recorded most in 2009. This study will give emphasis of how the banks reacted to the shocks of the crisis. Previous study showed that strong global economies gradually was drifting into recession especially the United States of America and Europe, emerging economies like Nigeria was near collapse but it survived.
1.7 The Significance of the Study a) Academia
I have known that in every risk asset created by a bank, there is a foreseen risk of non-repayment
before the loan will finally become non-performing and impact negatively on the bank. A bank that has a very high appetite for profit usually relaxes her risk management policies to increase its risk asset portfolio. Therefore, to overcome the risk of non-performing loans, every borrowing must be supported with adequately and acceptable collateral values. The causes of Non-Performing Loans have been attributed to many factors by researchers who have applied various methodologies both descriptive and quantitative to arrive at their conclusions which have shown conflicting results. This study is very significant because the dynamic nature of the global economies justifies the need for constant research.
b) Policy Makers/Regulators
The study of Non-Performing Loans determinants which considers other macroeconomic indicators and banks-specific variables give credence to greater significance for all Policy makers and regulators within the Financial System to take appropriate actions that will mitigate the rising level of non-performing loans in the banks. The study will be significant to the regulatory bodies like the Central Bank of Nigeria (CBN), Nigeria Deposit Insurance Corporation (NDIC), Securities and Exchange Commission (SEC), Nigerian Stock Exchange (NSE), National Board for Micro finance Bank (NBMFB), the Chartered Institute of Bankers of Nigeria, the Institute of Chartered Accountants of Nigeria (ICAN), the Association of National Accountants of Nigeria (ANAN), the Nigerian Institute of Management (NIM) and other Professional bodies, according to the guidelines establishing them.
c) Private Sector Borrowers
Lending and borrowing is the core business of any Money Deposit Bank. This function is extended to all the sectors of the economy. Most often, banks become averse to further lending despite high demand from borrowers and expected high interest income. The borrowers may not understand the rationale for such adverse reactions from their bankers, which have been due largely to very high non-performing loans. Therefore, the findings from this thesis will be useful to the various private sector borrowers such as the Manufacturers, Traders, Transporters, players in the Oil & gas sub-sector, Airlines and Aviation operators, Multinationals, Importers, Exporters, Agriculture, Maritime Agencies, Private investors in real estates and, Capital Markets in terms of understanding how their inability to repay borrowed funds from banks will affect the entire financial system stability.
d) Bank Risk Asset Management Executives
In Nigeria, studies have shown that Risk Management Practices which is one of the major tools to hedge against asset quality depletion is still at its rudimentary stage (Moghalu, 2013). This is evidenced by the lax implementations of Basel 1, and 11, while Basel 111 is already being implemented by other global economies. Thus the findings will be significant to the formulation of Banks Risk Asset Management Policies, and enforce best International Practices. Advanced Loans treatments such as Loan negotiations, Loan sales, Loan derivatives and securitization will be better understood and implemented. The compliance to various statutory laws like the Bank and Other Financial Institutions Act (BOFIA), the Company and Allied Matters Act (CAMA), and Banks Code of Corporate Governance, will be strictly adhered to in considerations of their systematic implications to the balance sheets of the banks and the economy whenever the laws are breached. The study is significant as it will identify, analyze and show how to mitigate the various risk types (Credit, Operational, Reputational, Liquidity, Market and Human Resources) risks. Other risk types are customer satisfaction risk, leadership risk, information technology risk, regulatory risk, industry risk, government policies risk, sovereign risk, competition risk, and fraud risk.
The study is significant as it will expose the major challenges facing the banks in her loan administrations and control. Such challenges identified is the dearth of professionals and the absence of strategic partnerships and alliances with local and global professional bodies like Credit Risk Management Association of Nigeria (CRIMAN), Global Association of Risk Professionals (GARP); the Institute of Risk Management (IRM) in the United Kingdom, and “The International Association of Risk and Compliance Professionals (IARCP)” in the United States which creates skill and capacity gaps.
e) Policy Enforcement Authorities
The post consolidation era witnessed a restructuring and reclassification of most non-performing loans into performing status for a period within the next financial year. The Asset Management Corporation of Nigeria (AMCON) was established among other objectives, to manage the Non- Performing Loans. The delay in the implementation of the functions of the Asset Management Corporation of Nigeria caused the already restructured and reclassified Loans that were for a short period to deteriorate again. The effect impacted negatively on the balance sheet of the banks and it threatened the financial stability of the economy. The global financial crises that coincided with this development stood as a lesson to all. The significance of this study will ensure that future occurrence will be held under control.
f) Government
The study will be significant at this period of globalization where the United States of America, Canada, Europe, World Bank, International Monetary Fund (IMF), and other world financial blocs like the BRICS (Brazil, Russia, India, China and South Africa) battles with regional and global financial crises, the various levels of government might intervene to rescue the financial system by considering packaging economic financial stimulus to the citizenry through lowering lending rates, releasing more public sector funds to the banks for onward lending to borrowers, buying over the ‘toxic assets’ of the banks, thus, releasing much needed liquidity to the banks and moderating the impact of the harsh global economic and financial crises, or injecting much needed Capital to the ailing bank.
This material content is developed to serve as a GUIDE for students to conduct academic research
DETERMINANTS OF NON-PERFORMING LOANS (NPLS) IN EMERGING ECONOMIES EVIDENCE FROM NIGERIAN BANKING INDUSTRY>
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