THE EFFECT OF RISK MANAGEMENT IN THE NIGERIAN BANKING INDUSTRY

ABSTRACT

The global phenomenon in the financial service industry is the consolidation of the financial activities towards ensuring financial stability. It is occurring at a rapid pace due to changes in economic environment, which often alter the constraints faced by financial service firms. At the same time, the changes is battling to combat poor risk asset management which has been established by some studies to be the basic cause of bad debt, a major distress syndrome in the banking industry. The scenario has been argued to be a factor that downsizes banks’ profitability within any fiscal year and often times destroys customers’ confidence in banking. The present study attempted an evaluation of the effect of risk management in the Nigerian Banking industry in this era of consolidation. The major objectives were to determine the relationship between the income of banks and the volume of their risk assets; evaluate the effect of loan repayment on the profitability of banks; and lastly, to determine the impact of loan repayment on loanable funds available in the Nigerian banks. By employing the survey research method, the study used questionnaire instrument to generate the primary data needed  for  the  study.  The  generated  data  were  further  subjected  to  chi-square inferential statistical test to determine if the null hypotheses formulated in chapter one were either validated or nullified. Testing at 95% confidence level with 8 degree of freedom, the null form for hypothesis one was not rejected. This implies that there is a negative relationship between banks income and the volume of their risk assets. But the null form for hypothesis two was rejected. The result showed that Loan Repayment has Positive effect on the bank’s profitability. Lastly, the null for the third hypothesis was not again rejected. The implication was that Loan Repayment negatively affects the availability of loanable funds in banks. The findings of this study justify the fact that loan is the engine that drives money creation in the economy.  Due to this crucial role, the study recommends among other things that banks should develop effective mechanism to overcome default risks and other information asymmetries.

CHAPTER ONE

INTRODUCTION

1.1       Background of the Study

The traditional theory of banking is rooted in the concept of intermediation between depositors and borrowers. Banks act as intermediaries by accepting deposits from customers and offering loans as well as advances to others that variously need fund for investments. In other words, one of the basic functions of banks is granting of loans and advances to customers who utilize these facilities for investment in expectation of profitable results (Idam, 2002).

The driving motive for lending proposition is the expectation that borrowing customer will profitably utilize the facility when granted such that returns from the investment will cover both the principal

and interest on the loan as well as contribute to the growth of the business. Successful lending is therefore one that is mutually beneficial to both the lending bank and the customer. Bad lending create problem both for the customer and the bank. When the proposed venture fails, a bank loan is lost and customers’ businesses may eventually end in liquidation. Beside, the success or failure of bank lending does not only affect the two parties involved. There are numerous multipliers effects and macro economic implications. When bank loans are successfully and profitably invested, the resulting growth in micro industrial units leads to overall macro economic growth and development. Hence, what credit polices and management techniques the bank adopt have far reaching effects on the economic well being of the nation (Doyle, 1972).

Credit risk is the measure of possible loss to the bank due to failure of any third party to meet its repayment obligation as they fall due (Ahmed and Alashi, 1992). It has great effect on the safety and soundness of the individual bank and the financial system as a whole. Since risk and return have been established to  be positively correlated (Tracy,  2002), it  becomes prudent that  risk exposure be adequately diversified in such a way that delinquency of any individual facility will not have material effect on the whole portfolio. This fit is believed in this study to be achievable through effective risk minimization and management techniques.

Recently, credit risk management has come to the fore in the banking industry and has become one of the  basic  functions  of  the  banker.  Grace  (1983)  has  defined  credit  risk  management  as  the management of investment obligations of a banker in respect of its assets. It involves the use of ratios, canons of good lending, feasibility studies etc to make informed decisions.

In  the  1980s  and  early  part  of  1990s,  the  Central  Bank  of  Nigeria  established  Credit  Risk

Management System (CRMS) to  deal with the  distresses in the Nigeria banking industry then.

CRMS’ inability to achieve the desired result called for a total restructuring and redesigning of the Nigeria banking system. By 2001, Universal banking system was introduced to blur the line of demarcation among  banking  institutions.  Further  reformation occurred  in  2004  when  the  CBN increased banks capital adequacy from N2 billion to 25 billion; an effect targeted at instituting Mega banks capable of competing favourably with other banks across the globe. While capital adequacy may,  produce viable and strong banking sector, strong enough to  support the real sector, clear evidence reveals the need for more risk management measures to adequately protect depositors’ funds. This study is therefore to investigate on the current measures of risk management and risk minimization in the Nigeria banking industry.

1.2      Statement of Problem

Poor risk asset management has been established to be the basic cause of bad debt, a major distress syndrome in the banking industry. The scenario downsizes the banks’ profitability within any fiscal year and by extension destroys customers’ confidence in banking. The issue of bad debt arises because bank customers either voluntarily refuses to pay back their loan or are unable to pay back due to short of fund. The uncertainty arising from customers’ ability to payback is often a problem to banks especially when it is impossible to have sufficient information concerning the credit worthiness of the  prospective  borrower.  Some  studies  have  argued  that  the  rate  of customers’ repayment determine the banks’ ability to provide more fund for the advancement of loans to borrowers. Others argue that information asymmetries can lead to problems of adverse selection. However, even though considerable information asymmetries exist in the banking industry, banks must continue to make loans. This is because loans are the engine that drives money creation in the economy. As a result of this crucial role, banks have to develop several effective mechanisms to overcome default risks and other information asymmetries.

The  current  study  evaluates  the  effect  of  banks  risk  minimization  strategies  and  banks  risk management techniques.

1.3      Objective of the Study

Consistent with the research problem, this study was intended to achieve the following three major objectives:

i           To determine the relationship between the income of banks and the volume of their risk assets.

ii         To evaluate the effect of loan repayment on the profitability of banks.

iii        To determine the impact of loan repayment on loanable funds available in the Nigerian banks.

1.4      Research Questions

In line with the statement of problems and the objectives of the study, this research shall sort answers to the following questions:

i          What is the relationship between the banks’ income and the volume of their risk assets?

ii         Is there any relationship between loan repayment and banks profitability?

iii        What is relationship between the available loanable funds and loan repayment?

The above challenging questions constituted the underlying foundation for this investigation. The research explore the issues to enable him establish the possible relationship between effective risk management and improvement in gross income and profitability of banks in Nigeria.

1.5       Research Hypotheses

Based on the research questions and the objectives of the study, the following null hypotheses were formulated:

(A)      There is a negative relationship between banks income and the volume of their risk assets.

(B)       Loan repayment has negative effect on the banks profitability

(C)      Loan repayment negatively affects the availability of loanable funds in banks.

1.6      Significance of the Study

Banks are trustees and safe keepers of wealth materials as well as purveyor of depositors’ funds. Being licensed by the apex financial regulator to receive deposits from savers and to provide credits to users of such depositors’ funds, they perform intermediatory role which forms the core of their Operations. Banks in the process come in contact with several persons and institution to which this study is deemed beneficial to:

Bank customers: Fixed, saving, and currents account holders of banks as well as other person who have dealings other then those above will find renewed hope in banking once they are guaranteed of the security of their transactions through effective risk minimization and management.

Bank shareholders: The owners of banks through the findings of this research will have greater understanding of the risk management strategy employed by management of their banks.

Private and public investors: A good knowledge of risk management in a given bank serves as attraction for investors. This is in consonance with the normal risk averse behaviour of average investor.

Policy Makers: This study will equally provide a platform that will assist policy makers enunciate policies capable of impacting positively on business risk management.

Financial Market Regulators: The study will provide required empirical and theoretical foundation on the workings of the banking institution in area of risk minimization and management.

Research Students and other Researchers: It will contribute to the enrichment of literature on bank risk management. Such will serve as a guide to future researchers and the reading public.

1.7       Scope of the Study

This research into the techniques of risk management and risk minimization in Nigeria Banking Industries will be limited to Oceanic Bank Plc in Rumobochi area of Lagos. The time frame will cover the period 2000-2006. This study would have been more appreciated if it were based on all the

25 capitalized banks in Nigeria. This is not possible due to myriads of constraints.

1.8      Limitation of the Study

One basic limitation of this study was finance. Fund which were required for travels to the area of study to gather data and other logistic were limited. This actually affected the quality of this work.

The second limitation was data generation. Getting statistical data from the bank slated for the investigation for the time covered posed some difficulties. This is due to the poor attitude of Nigerian towards data preservation.

Finally, the insufficiency of local literature on risk management was another factor that affected the quality of this work. The implication is that even though this research is meant to cover local gap, most of the literature that were reviewed in chapter two were foreign literature.

1.9       Definition of Terms

•          Asset Management: This is the allocation of funds among various investment alternatives

(Idam, 2002).

•           Credit: Odi, (2002) defines credit to include all commitments by a bank which has risk exposure and may result in financial loss.

•          Credit  Analysis:  The  process  of  inquiry  to  determine  the  worthiness of  making  credit

(Pandey, 2006).

•          Doubtful Debt: Where the principal and/ or interest on debt remained unpaid for more than

90 days but less than 180 days (Nkechukwu, 2004).

•           Feasibility  Studies:  This  is  a  careful  financial  study  and  examination  of  a  particular project to show the favorability of such investment to the bank concerned (Tuckman, 1978).

•           Liability  Management:  This  consist  of  all  activities  involved  in  obtaining  fund  from depositors and other creditors and determining the appropriate mix of funds for a particular bank (Okafor, 1983).

•           Liquidity: When a banker is financially strong and buoyant to meet  its immediate cash obligation to its customers on daily basis (Dimson, B and Paul, M. 1990).

•          Liquidity Ratio: Measures the firms’ ability to meet  its short term financial obligations

(Pandey, 2006).

•           Loss Credit: A situation where the principal and/or interest and remained unpaid for 360 days or more (Okoro, 2000).

•           Performing Credit: Credit on which payment of both interest and principal is redeemed as at when due (Idam, 2002).

•          Risks: An investment obligation of a banker. It is the possibility of loss (Eleje, 2009).

References

Ahmed, M.K, and Alashi, S. 0 (1992) “Bank Prudential Regulation in Nigerian”, A Central bank of

Nigeria Publication

Dimson, E. and paul, M. (1990), Cases in Corporate Finance, John Wiley Publishers, 1St Edition, London

Doyle, E.P (1972), Practice of Banking, Macdonald and Evans Ltd, London.

Eleje, E. O. (2009), “Risk Asset Market and Derivatives: Some Lessons for Emerging Markets like

Nigeria” Journal of Oil and Gas Management, Vol. 10:3-09

Grace, O. B (1983), Financial Management, Harvard Business Review, London

Heffeman, S. (1996), Modem Banking in Theory and Practice John Wiley and Sons, New York

Idam L.E  (2002), Bank  Management  in Nigerian Concepts, Methods and  processes,  Nwamazi, Printing and Publishing Co. Ltd, Abakaliki.

Nkechukwu, G. C. (2004) Business Finance Volume One, Onitsha, Akunesses Press and Publisher

Ltd

Odi, N. (2002) Bank Credit Analysis and Loan Administration, Abakaliki, Glajoh Publisher Okafor, F. O. (1983) Investment Decision: Evaluation of Projects and Securities, London, Cassel Okoro, S. W. (2000) Money and Banking Volume One, Abakaliki, Glajoh Publisher

Pandey, I. M. (2006), Financial Management, Ninth Edition, India, NewDelhi

Tracy  Brain  (2002),  The  100  Absolutely  Unbreakable  Laws  of  Business  Success,  Joint  Hier

Publication, Benin, Nigeria

Tuckman, B. W. (1978), Conducting Educational Research, Second Edition, New York, Harcourt

Brace Jovanovich, Inc

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