CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

The banking industry has achieved great prominence in the Nigerian

economic environment and its influence play a predominant role in granting credit

facilities. The probability of incurring losses resulting from nonpayment of loans

or other forms of credit by debtors known as “credit risks”, are mostly encountered

in the financial sector particularly by institutions such as banks (Hamisu, 2011).

Banks are essential to economic development through the financial services

they provide. Their intermediary role can be said to be a catalyst for economic

growth. The efficient and effective performance of the banking industry over time

is an index of financial stability in any nation. The extent to which a bank extends

credit to the public for productive activities accelerates the pace of a nation’s

economic growth and its long-term sustainability (Kolapo, Ayeni & Oke, 2012).

The biggest credit risk facing banking and financial intermediaries is the risk

of customers or counter party default. During the 1990s, the number of players in

banking sector increased substantially in the Nigerian economy and banks

witnessed rising non-performing credit portfolios. This significantly contributed to

financial distress in the banking sector. Also identified was the existence of

1
predatory debtors in the banking system whose modus operandi involves the

abandonment of their debt obligations in some banks only to contract new debts in

other banks (Hamisu, 2011).

Credit creation is the main income generating activity for the banks. But this

activity involves huge risks to both the lender and the borrower. The risk of a

trading partner not fulfilling his or her obligation as per the contract on due date or

anytime thereafter can greatly jeopardize the smooth functioning of a bank’s

business. On the other hand, a bank with high credit risk has high bankruptcy risk

that puts the depositors in jeopardy. In a bid to survive and maintain adequate

profit level in this highly competitive environment, banks have tended to take

excessive risks. But then the increasing tendency for greater risk taking has

resulted in insolvency and failure of a large number of the banks (Hamisu, 2011).

The credit function of banks enhances the ability of investors to exploit

desired profitable ventures (Kargi, 2011 cited in Kolapo et al., 2012). However, it

exposes the banks to credit risk. The Basel Committee on Banking Supervision

(2001) defined credit risk as the possibility of losing the outstanding loan partially

or totally, due to credit events (default risk). Credit risk is an internal determinant

of bank performance. The higher the exposure of a bank to credit risk, the higher

the tendency of the banks to experience financial crisis and vice-versa. Among

other risks faced by banks, credit risk plays an important role on banks’
2
profitability since a large chunk of banks’ revenue accrues from loans from which

interest is derived. However, interest rate risk is directly linked to credit risk

implying that high or increment in interest rate increases the chances of loan

default. Credit risk and interest rate risk are intrinsically related to each other and

not separable (Drehman, Sorensen, & Stringa, 2008 cited in Kolapo et al., 2012).

Increasing amount of non-performing loans in the credit portfolio is inimical to

banks in achieving their objectives. Non-performing loan is the percentage of loan

values that are not serviced for three months and above (Ahmad & Ariff, 2007

cited in Kolapo et al., 2012). Due to the increasing spate of non-performing loans,

the Basel II Accord emphasized on credit risk management practices. Compliance

with the Accord means a sound approach to tackling credit risk has been taken and

this ultimately improves bank performance. Through the effective management of

credit risk exposure, banks not only support the viability and profitability of their

own business, they also contribute to systemic stability and to an efficient

allocation of capital in the economy (Psillaki, Tsolas, and Margaritis, 2010 cited in

Kolapo et al, 2012).

Financial performance is company’s ability to generate new resources, from

day- to- day operations, over a given period of time. Performance is gauged by net

income and cash from operations. A portfolio is a collection of investments held by

an institution or a private individual (Apps, 1996 cited in Danson, 2012). Risk

3
management is the human activity which integrates recognition of risk, risk

assessment, developing strategies to manage it, and mitigation of risk using

managerial resources (Apps, 1996 cited in Danson, 2012).

Whereas Credit risk is the risk of loss due to a debtor’s nonpayment of a

loan or other line of credit (either the principal or interest (coupon) or both)

(Campel, et al., 1993 cited in Danson, 2012). Default rate is the possibility that a

borrower will default, by failing to repay principal and interest in a timely manner

(Campel, et al., 1993 cited in Danson, 2012). A bank is a commercial or state

institution that provides financial services, including issuing money in various

forms, receiving deposits of money, lending money and processing transactions

and the creating of credit (Campel, et. al., 1993 cited in Danson, 2012).

The major cause of serious banking problems continues to be directly related

to low credit standards for borrowers and counterparties, poor portfolio

management, and lack of attention to changes in economic or other circumstances

that can lead to deterioration in the credit standing of bank’s counter parties. And it

is clear that banks use high leverage to generate an acceptable level of profit.

Credit risk management comes to maximize a bank’s risk adjusted rate of return by

maintaining credit risk exposure within acceptable limit in order to provide a

framework of the understanding the impact of credit risk management on banks

profitability.
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 The excessively high level of non-performing loans in the banks can also be

attributed to poor corporate governance practices, lax credit administration

processes and the absence or non- adherence to credit risk management practices.

1.2 Statement of the Problem

It has been observed that most commercial banks are faced with the

following challenges as related to credit risk;

i. The problem of debtors avoiding or abandoning of the previous banks they

involved in credit transaction to go into new debts in other banks.

ii. Increment in interest rate increases the chances of loan frauds.

iii. The major cause of serious banking problems is as a result of low credit

standard for borrowers and counterparts, poor portfolio management and

lack of attention to changes in the economy or other circumstances that can

determine the credit standings of commercial banks and their counterparts.

1.3 Objective of the Study

The major objective of this study is to determine the relationship between

credit risk management and financial performance of commercial banks in Nigeria.

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1.4 Research Questions

What is the relationship between credit risk management and financial

performance of commercial banks in Nigeria?

1.5 Research Hypothesis

To achieve the purpose of the study, the following hypothesis was

formulated:

H0: There is no significant relationship between credit management and the

financial performance of commercial banks.

1.6 Significance of the Study

This study became important because of the volume of bad debts which has

mounted in banks over the years. These concern arose not only because of the

potential losses to depositors but also because of the likely loss of confidence in

the banking system arising from a systematic distress. When credit is not paid, the

banking system would be unable to play its intermediating role. It thus becomes

obvious that this is a problem that everyone has a role to play in finding solution.

1.7 Scope of the Study

The scope of the study shall be limited to credit risk management in

commercial banks in Nigeria.

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1.8 Limitations of the Study

However, during the course of this study the researcher encountered some

constraints in the area of time, distance, finance and insufficient reference

materials.

1.9 Definition of Terms

These are some of the credit risk term which are basically associated with

commercial banks. These operational terms are briefly as follows:

Business Risk: can be defined as anything that threatens a company’s ability to

achieve its financial goal.

Financial Risk: Can be defined as the possibility of losing money on an

investment or business venture. It include credit risk, liquidity risk and operational

risk.

Management Risk: is associated with ineffective, destructive, or underperforming

management.

Purchasing Power Risk: is the chance that the cash flows from an investment

won’t be worth as much in the future because of changes in purchasing power due

to inflation

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Risk: can be defined as a situation involving exposure to danger. It is also a change

to bad consequences or unwanted events.

Financial performance: is a subjective measure of how well firm can use assets

from its primary mode of business and generate revenue.

9
 CHAPTER TWO

LITERATURE REVIEW

2.1 Conceptual Framework

2.1.1 Credit Risk

Donald et al. (1996) defines Credit risk simply as the potential that a bank

borrower or counterpart will fail to meet its obligations in accordance with agrees

terms. The goal of credit risk management is to maximize a bank’s risk- adjusted

rate of return by maintaining credit risk exposure within acceptable parameters.

Banks need to manage the credit risk inherent in the entire portfolio as well as the

risk in individual credits or transactions. Banks should also consider the

relationships between credit risk and other risks. The effective management of

credit risk is a critical component of a comprehensive approach to risk

management and essential to the long-term success of any banking organization.

According to Nelson and Schwedt (2006) the banking industry has also made

strides in managing credit risk. Until the early 1990s, the analysis of credit risk was

generally limited to reviews of individual loans, and banks kept most loans on their

books to maturity. Today, credit risk management encompasses both loans reviews

and portfolio analysis. Moreover, the development of new technologies for buying

and selling risks has allowed many banks to move away from the traditional book

10
and hold lending practice in favor of a more active strategy that seeks the best mix

of assets in light of the prevailing credit environment, market conditions, and

business opportunities. Much more so than in the past, banks today are able to

manage and control obligor and portfolio concentrations, maturities, and loan sizes,

and to address and even eliminate problem assets before they create losses. Many

banks also stress test their portfolios on a business line basis to help inform their

overall management. There are three stages in the credit process:

 The first is the simple risk control of the business avoiding being over

concentrated in any one sector, estimating the probability of defaulting and

assessing recovery.

 The second phase is the link between economic capital and return.

Clearly banks would like to set minimum rates of return they expect to earn on

their portfolios after provisioning. The link between economic profit and risk is the

next stage in advancing the practice of credit risk management.

 Finally, the third stage is when risk management is used as a strategic

management tool to align RAROC (Risk Adjustment Returns on Capital) with

ROE (Return on Equity). Each bank must understand what drives the share price of

the bank and thus must understand the link between economic capital, intellectual

property owners IPOs (Intellectual Property Owners) and ROE. Once this

11
paradigm is understood, banks will be in a better competitive position to compete

more aggressively and likely service in the next decade (Lawrence, 2006). Success

in credit risk management has a highly visible impact on the results of the firm. For

the management of credit risk a profit and return focused activity within our broad

base of businesses.

According to Cuthbertson and Nitzsche (2003), risk management technology

has been transformed over the last decade. The speed of information flow and the

sophistication of the international financial markets enable banks to identify,

assess, manage and mitigate risk in a way that was just not possible ten years ago.

The most current credit modeling software in place is Basel 11 Accord. This

accord has certainly been a catalyst in spearheading the drive towards building

appropriate credit risk modeling and capital adequacy requirements. However, it is

no substitute whatsoever for designing a business risk strategy. Banks will have to

decide what their risk appetite is, how to allocate their resources optimally and in

what markets to compete. The dramatic increase in loan velocity and secondary

market activity, such as in credit derivatives, implies that the old paradim has been

turned upside down. A bank will not necessarily have to hold onto the loans until

maturity, but can sell off the risk. This allows much more efficient risk transfer and

portfolio optimization.

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 However, to do this effectively, banks must have a deep understanding of

risk management, knowing how to price their loans on a market to market basis,

knowing what the marginal risks adjusted contribution of each loan is and being

able to allocate measure and monitor economic capital (Cuthbertson and Nitzsche,

2003).

As observed by RBI (2005), Credit Risk is the major component of risk

management system and this should receive special attention of the Top

Management of a bank. Credit risk is the important dimension of various risks

inherent in a credit proposal, as it involves default of the principal itself.

{According to (Raghavan, 2005) Credit risk consists of primarily two components,

viz. Quantity of risk, which is nothing but the outstanding loan balance as on the

date of default and the Quality of risk, which is the severity of loss defined by

Probability of Default as reduced by the recoveries that could be made in the event

of default. Thus credit risk is a combined outcome of Default Risk and Exposure

Risk}. The elements of Credit Risk are Portfolio risk comprising Concentration

Risk as well as Intrinsic Risk and Transaction Risk comprising migration/down

gradation risk as well as Default Risk. At the transaction level, credit ratings are

useful measures of evaluating credit risk that is prevalent across the entire

organization where treasury and credit functions are handled.

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2.1.2 Bank Credits/Credit Facilities

Traditionally, bank lending could in broad term be categorized into two:

overdraft and loan but according to Osayemeh (1981) he described credit facilities

as the types of loans portfolio that are available to customers in the banking

industry especially in commercial banks. He further classified these credit facilities

into four major categories; Short term credit, Medium term credit, Long term

credit, Secured and unsecured credits.

i. Short Term Credit: This type of credit facility is due for repayment after

one year. It is used to meet working capital requirement i.e expansion of current

business operation. Examples are: Commercial credits, Overdraft, and

Demand/call credit.

ii. Medium Term Credit: Osayemeh (1986) described medium term credit as

bank credit whose maturity is over one year, but not more than five years. It is

required to finance or acquire capital assets which yield a commensurate return

within the credit period. Examples are: Consumption credit and Letter of Credit.

iii. Long Term Credit: According to Onouha (2007), this is a credit facility

that is used to finance the expansion of fixed assets. It is usually a large sum of

money which is due for repayment after five years of grant. Examples are;

Industrial Credit, Equipment leasing credit, Stock replacement credit.

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iv. Secured and Unsecured Credits: Banks grant credits against the securities

of tangible pledges by the borrower in favour of the lending bank. The assets so

pledge are known as collateral securities‟. Therefore credits granted with respect to

provision of such collateral securities are known as ‟SECURED CREDITS.” On

the other hand, “UNSECURED CREDITS” are those credits granted to customers

without any requirement of collateral securities. In addition to these Ajayi (1997)

submits that at the long-run, these credit classifications would be in two categories

i.e performing loans and Non-performing loans. He described performing loans as

those loans/credits that are well serviced by the customers as at when due i.e they

do not default in loan repayment.

Graham (2007) described non-performing loans as those loans/credits that

are not well serviced by the customers as at when due i.e they delay/default in loan

repayment. He identified the types of such nonperforming loans as follows;

Doubtful Debts, Bad Debts and Loss.

15
2.1.3 Factors Responsible for Credit Risk

According to Taxxman, (2006) some of the important factors which cause

credit risk and have adverse impact on credit quality highlighted in various studies

conducted by expert communities/groups are: Deficiencies in appraisal of loan

proposals and in the assessment of credit worthiness of financial strength of

borrowers, Inadequately defined lending policies and procedures High prudential

exposure limits for individuals and group of borrowers, Absence of credit

concentration limits for various industries/business segments, Inadequate values of

collaterals obtained by the banks to secure the loan facilities, Liberal loan

sanctioning powers for bank executives without checks and balance, Lack of

knowledge and skills of officials processing loan proposals, Lack of information

on functioning of various industries and performance of economy, Lack of proper

coordination between various departments of banks looking into credit functions,

Lack of well defined organizational structure and clarity with respect to

responsibilities, authorities and communication channels, Lack of proper system of

credit risk rating, quantifying and managing across geographical and product lines,

Lack of reliability of data being used for managing credit and risks associated with

lending.

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2.1.4 Risk Based Audit System

Risk-based internal audit system (RBI) has advised banks to put in place

system which should play an important role in bringing effectiveness in credit risk

management and control system as also to help in ensuring regulatory compliances

by providing high quality counsel to bank’s management. The banks internal audit

systems have been concentrating on transaction testing, ensuring accuracy and

reliability of accounting records and timely submission of control returns.

According to Taxxman, (2006) for effectiveness of risk-based credit audit, it

is suggested that banks should formulate risk based audit policy and establish a

proper set-up clearly indicating their role/responsibilities‟ and communication

channels between risk-based internal audit staff and to management which

encourages reporting of negative and sensitive findings so that it help in initiating

corrective actions to remedy the ills. Banks should consider merging credit

inspection and auditing functions to avoid duplicity.

2.1.5 Managing Credit Risk Using Ratios

An analysis of the financial statement of the customer is always helpful,

financial statement constitute an important source of information for appraising the

financial health of a business venture. For purpose of compassion, the audited

figures are expressed as ratios computed from audited figures of two consolidated

17
years immediately preceding the request for loan will help to determine the credit

worthiness of the customer and his ability to repay the loan. In short the ratio helps

the banker to assess the degree of risk being taken-emphasis being placed on

earning capacity and operating efficiency (Dandago 2010).

Mather (1979) grouped financial ratios into five categories are as follows:-

Liquidity ratio, Leverage ratios, Efficiency ratios, Profitability ratios and Equity

related ratios.

2.1.6 Credit Risk Management Strategies

The credit risk management strategies are measures employed by banks to

avoid or minimize the adverse effect of credit risk. A sound credit risk

management framework is crucial for banks so as to enhance profitability

guarantee survival. According to Lindergren (1987) cited in Kolapo et al (2012),

the key principles in credit risk management process are sequenced as follows;

establishment of a clear structure, allocation of responsibility, processes have to be

prioritized and disciplined, responsibilities should be clearly communicated and

accountability assigned. The strategies for hedging credit risk include but not

limited to these;

i. Credit Derivatives: This provides banks with an approach which does not

require them to adjust their loan portfolio. Credit derivatives provide banks with a

18
new source of fee income and offer banks the opportunity to reduce their

regulatory capital (Shao and Yeager, 2007 cited in Kolapo et al (2012)). The

commonest type of credit derivative is credit default swap whereby a seller agrees

to shift the credit risk of a loan to the protection buyer. Frank Partnoy and David

Skeel in Financial Times of 17 July, 2006 said that “credit derivatives encourage

banks to lend more than they would, at lower rates, to riskier borrowers”. Recent

innovations in credit derivatives markets have improved lenders‟ abilities to

transfer credit risk to other institutions while maintaining relationship with

borrowers (Marsh, 2008 cited in Kolapo et al (2012)).

ii. Credit Securitization: It is the transfer of credit risk to a factor or insurance

firm and this relieves the bank from monitoring the borrower and fear of the

hazardous effect of classified assets. This approach insures the lending activity of

banks. The growing popularity of credit risk securitization can be put down to the

fact that banks typically use the instrument of securitization to diversify

concentrated credit risk exposures and to explore an alternative source of funding

by realizing regulatory arbitrage and liquidity improvements when selling

securitization transactions (Michalak and Uhde,2009 cited in Kolapo et al (2012)).

A cash collateralized loan obligation is a form of securitization in which assets

(bank loans) are removed from a bank’s balance sheet and packaged (tranched)

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into marketable securities that are sold on to investors via a special purpose vehicle

(SPV) (Marsh,2008 cited in Kolapo et al (2012)).

iii. Compliance to Basel Accord: The Basel Accord are international principles

and regulations guiding the operations of banks to ensure soundness and stability.

The Accord was introduced in 1988 in Switzerland. Compliance with the Accord

means being able to identify, generate, track and report on risk-related data in an

integrated manner, with full auditability and transparency and creates the

opportunity to improve the risk management processes of banks. The New Basel

Capital Accord places explicitly the onus on banks to adopt sound internal credit

risk management practices to assess their capital adequacy requirements (Chen and

Pan,2012 cited in Kolapo et al (2012)).

iv. Adoption of a sound internal lending policy: The lending policy guides

banks in disbursing loans to customers. Strict adherence to the lending policy is by

far the cheapest and easiest method of credit risk management. The lending policy

should be in line with the overall bank strategy and the factors considered in

designing a lending policy should include; the existing credit policy, industry

norms, general economic conditions of the country and the prevailing economic

climate (Kithinji,2010 cited in Kolapo et al (2012)).

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v. Credit Bureau: This is an institution which compiles information and sells

this information to banks as regards the lending profile of a borrower. The bureau

awards credit score called statistical odd to the borrower which makes it easy for

banks to make instantaneous lending decision. Example of a credit bureau is the

Credit Risk Management System (CRMS) of the Central Bank of Nigeria (CBN).

vi. Policy Strategy: Banks and other financial institutions should endeavour to

have a credit policy manual which should be updated regularly to meet the

changing business environment. Such credit manuals should provide rules and

regulations guiding the important aspect of work being performed within their

credit department. The reason for the manual is to understand and recognize

important issues and to ensure consistent thinking and action on these issues by

people inside the department. One of the fundamental things to remember is that

the work being done by the credit department affects many people and departments

within the organization.

Because of this, it is therefore vital that the manual be agreement of written

off after mutual agreement of policies from the management, sales and other

departments have been affected.

Graham suggested that the credit manual policy should be details; guidelines

give in respect of the following: Documentation required; department of credit

21
analysis and format to be used; statutory requirements; approval process; credit

procedure; Communication channels between headquarter, the branches and

customers; Penalties for defaulters, e.t.c.

2.1.7 Interest Rate Charged on Borrowers.

There are daily reports of how Nigerian banks rip off their customers

through various charges and practices. Often times, customers complain and cry

out for appropriate regulatory intervention. Unfortunately, their complaints seem to

fall on deaf ears, because they are unaware of any positive regulatory action in

response thereto. Emboldened by regulatory inaction and indifference (which

suggest tacit approval), many Nigeria banks now engage in more exploitative

practices. The categories of such predatory bank practices are unfolded daily.

Normally, when a customer secures loan from a bank, the latter fixes a

negotiated lending rate based on the prevailing interest rate approved by the apex

bank. Any change in the interest rate should be brought to the notice of the

borrower except otherwise agreed. In Nigeria, however, the lending rate is rarely

negotiated and, when it is reviewed upwards by the Central Bank of Nigeria

(CBN), the average bank automatically applies the new rate to the outstanding loan

without notifying the borrower (Okafor, 2011). Ironically, the same bank hides the

22
fact of any downward review of the lending rate from its mostly uninformed

customer, thereby illegally subjecting the customer to a higher interest regime.

23
2.1.8 Securities for Bank Lending

Securities for bank lending are property pledged as collaterals for loans by

borrowers. Securities are the general name for stocks, mortgages, bonds, and

certificates showing ownership of property. From the foregoing, the preview of

securities for bank lending shall be limited to such properties held as securities by

banks in Nigeria. Shegolar and Thomas (1999), Mandel (2000) From the diagnosis

of the Nigerian Banking system, some of the securities held by banks before any

lending is made to any individual, corporation or government and those securities

often demanded by banks for loans and advances in the country have been shown

to be quite unsatisfactory. One of such is the requirement of bank that prospective

borrower should pledge any real estate holding for loans given to them. Such estate

includes heavy plants and machinery, landed properties and other physical assets.

Real estate properties must be immovable properties. The advantage it has to the

bank is that due to the fact that it is stationary, the banks lay confidence on it to

recover its debts in case of default. This category of security constitutes a major

singular security in Nigeria banking industry) Mandel (2000) According to

Olayinka (1999) other securities pledged by customers wishing to borrow from the

bank is their money in either saving, current or time deposits, especially if the

account has a regular cash flow usually from any salaries or wages or even other

private sources.

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2.2 Theoretical Framework

2.2.1 Loan Pricing Theory

Banks cannot always set high interest rates. Banks should consider the

problems of adverse selection and moral hazard since it is very difficult to forecast

the borrower type at the start of the banking relationship (Olokoyo, 2011). If banks

set interest rates too high, they may induce adverse selection problems because

high-risk borrowers are willing to accept these high rates. Once these borrowers

receive the loans, they may develop moral hazard behaviour or so called borrower

moral hazard since they are likely to take on highly risky projects or investments

(Olokoyo, 2011). From the reasoning of Stiglitz and Weiss, it is usual that in some

cases we may not find that the interest rate set by banks is commensurate with the

risk of the borrowers.

2.2.2 Firm Characteristics Theories

These theories predict that the number of borrowing relationships will be

decreasing for small, highquality, informationally opaque and constraint firms, all

other things been equal (Godlewski and Ziane, 2008). Hamisu (2011) state that the

most obvious characteristics of failed banks is not poor operating efficiency,

however, but an increased volume of non-performing loans. Non-performing loans

in failed banks have typically been associated with regional macroeconomic

26
problems. DeYoung and Whalen (1994 cited in Hamisu, 2011) observed that the

US Office of the Controller of the Currency found the difference between the

failed banks and those that remained healthy or recovered from problems was the

caliber of management. Superior mangers not only run their banks in a cost

efficient fashion, and thus generate large profits relative to their peers, but also

impose better loan underwriting and monitoring standards than their peers which

result to better credit quality, Hamisu (2011).

2.2.3 Theory of Multiple-Lending

It is found in literature that banks should be less inclined to share lending

(loan syndication) in the presence of welldeveloped equity markets. Both outside

equity and mergers and acquisitions increase banks‟ lending capacities, thus

reducing their need of greater diversification and monitoring through share lending

(Carletti, 2006; Ongene and Smith, 2000; Karceski, 2004; Degryse, 2004). This

theory has a great implication for banks in Nigeria in the light of the recent 2005

consolidation exercise in the industry.

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2.2.4 The Signaling Arguments

The signaling argument states that good companies should provide more

collateral so that they can signal to the banks that they are less risky type borrowers

and then they are charged lower interest rates. Meanwhile, the reverse signaling

argument states that banks only require collateral and or covenants for relatively

risky firms that also pay higher interest rates (Chodechai, 2004).

2.2.5 Credit Market Theory

A model of the neoclassical credit market postulates that the terms of credits

clear the market.

If collateral and other restrictions (covenants) remain constant, the interest

rate is the only price mechanism. With an increasing demand for credit and a given

customer supply, the interest rate rises, and vice versa. It is thus believed that the

higher the failure risk of the borrower, the higher the interest premium (Olokoyo,

2011).

The theoretical framework for this study is adapted from (Patnaik and

Vasudevan, 1998), which tries to factor the degree of openness of an economy in

the analysis of the influence of both internal and external factors on interest rate

movements in a semi-open economy like Nigeria. Suppose we have a closed

economy, in which there is no inflow or outflow of capital and the demand for

28
money is the demand for real money. In such an economy, money is held by the

economic units purely to finance transactions and increase the demand for money

with real output. However, it is worthy of note, that holding money has an

opportunity cost that is measured by the nominal rate of interest, with higher

interest rates discouraging the holding of wealth in the form of money. If M is

assumed to be the nominal stock of money and P is the price level, real money

demand is defined as M/P, which is a function of the interest rate, i and the output,

Y. Short run equilibrium in the money market exists, when the demand for money

is equal to the supply of money.

2.2.6 Obstacles toward Effective Performance

As should be expected in most business enterprises in developing economies

the banking industry has certain factors that are militating against the effective

performance of their lending function. Most of the people operating various

businesses in Nigeria are illiterates. They do not easily understand nor do they

appreciate reasons a lot of difficulties are encountered if loans are mismanaged.

Explaining to such business men and women ways and means of improving their

account with the bank before asking for loan is usually a mere waste of time. They

would prefer to offer kickbacks than to understand the simple operation of the

system. (Okoh 1997). The credit departments of some banks do not have the

29
required level of man power and the will needed to perform difficult and technical

transactions involved in lending.

2.3 Empirical Framework

Credit risk is the current and prospective risk to earnings or capital arising

from an obligor’s failure to meet the terms of any contract with the bank or

otherwise to perform as agreed. Credit risk is found in all activities in which

success depends on counterparty, issuers, or borrower performance. It arises any

time bank funds are extended, committed, invested, or otherwise exposed through

actual or implied contractual agreements, whether reflected on or off the balance

sheet. Thus risk is determined by factor extraneous to the bank such as general

unemployment levels, changing socio-economic conditions, debtors‟ attitudes and

political issues, Hamisu (2011).

2.3.1 Extant studies from Developed economics

Credit risk according to Basel Committee of Banking Supervision BCBS

(2001) and Gostineau (1992 cited in Hamisu, 2011) is the possibility of losing the

outstanding loan partially or totally, due to credit events (default risk). Credit

events usually include events such as bankruptcy, failure to pay a due obligation,

repudiation/moratorium or credit rating change and restructure. Basel Committee

on Banking Supervision- BCBS (1999) defined credit risk as the potential that a

30
bank borrower or counterparty will fail to meet its obligations in accordance with

agreed terms. Heffernan (1996 cited in Hamisu, 2011) observe that credit risk as

the risk that an asset or a loan becomes irrecoverable in the case of outright default,

or the risk of delay in the servicing of the loan. In either case, the present value of

the asset declines, thereby undermining the solvency of a bank. Credit risk is

critical since the default of a small number of important customers can generate

large losses, which can lead to insolvency (Bessis, 2002 cited in Hamisu, 2011).

BCBS (1999) observed that banks are increasingly facing credit risk (or

counterparty risk) in various financial instruments other than loans, including

acceptances, interbank transactions, trade financing foreign exchange transactions,

financial futures, swaps, bonds, equities, options, and in the extension of

commitments and guarantees, and the settlement of transaction. Anthony (1997

cited in Hamisu (2011).) asserts that credit risk arises from non-performance by a

borrower. It may arise from either an inability or an unwillingness to perform in

the precommitted contracted manner. Brownbridge (1998 cited in Hamisu (2011).)

claimed that the single biggest contributor to the bad loans of many of the failed

local banks was insider lending. He further observed that the second major factor

contributing to bank failure were the high interest rates charged to borrowers

operating in the high-risk. The most profound impact of high non-performing loans

31
in banks portfolio is reduction in the bank profitability especially when it comes to

disposals.

BCBS (1982) stated that lending involves a number of risks. In addition to

risk related to the creditworthiness of the borrower, there are others including

funding risk, interest rate risk, clearing risk and foreign exchange risk.

International lending also involves country risk. BCBS (2006) observed that

historical experience shows that concentration of credit risk in asset portfolios has

been one of the major causes of bank distress. This is true both for individual

institutions as well as banking systems at large.

Assessing the impact of loan activities on bank risk, Brewer (1989) uses the

ratio of bank loans to assets (LTA). The reason to do so is because bank loans are

relatively illiquid and subject to higher default risk than other bank assets,

implying a positive relationship between LTA and the risk measures. In contrast,

relative improvements in credit risk management strategies might suggest that

LTA is negatively related to bank risk measures (Altunbas, 2005). Bourke (1989)

reports the effect of credit risk on profitability appears clearly negative This result

may be explained by taking into account the fact that the more financial institutions

are exposed to high risk loans, the higher is the accumulation of unpaid loans,

implying that these loan losses have produced lower returns to many commercial

banks (Miller and Noulas, 1997 cietd in Hamisu (2011).). The findings of Felix
32
and Claudine (2008) also shows that return on equity ROE and return on asset

ROA all indicating profitability were negatively related to the ratio of non-

performing loan to total loan NPL/TL of financial institutions therefore decreases

profitability.

2.3.2 Extant studies from Developing/emerging markets

Al-Khouri (2011) cited in Kolapo et al (2012) assessed the impact of bank’s

specific risk characteristics, and the overall banking environment on the

performance of 43 commercial banks operating in 6 of the Gulf Cooperation

Council (GCC) countries over the period 1998-2008. Using fixed effect regression

analysis, results showed that credit risk, liquidity risk and capital risk are the major

factors that affect bank performance when profitability is measured by return on

assets while the only risk that affects profitability when measured by return on

equity is liquidity risk. Ben-Naceur and Omran (2008) in attempt to examine the

influence of bank regulations, concentration, financial and institutional

development on commercial banks‟ margin and profitability in Middle East and

North Africa (MENA) countries from 1989-2005 found that bank capitalization

and credit risk have positive and significant impact on banks‟ net interest margin,

cost efficiency and profitability.

33
 Ahmed, Takeda and Shawn (1998) in their study found that loan loss

provision has a significant positive influence on non-performing loans. Therefore,

an increase in loan loss provision indicates an increase in credit risk and

deterioration in the quality of loans consequently affecting bank performance

adversely.

Koehn and Santomero (1980), Kim and Santomero (1988) and Athanasoglou

et al. (2005) cited in Hamisu (2011), suggest that bank risk taking has pervasive

effects on bank profits and safety. Bobakovia (2003) cited in Hamisu (2011)

asserts that the profitability of a bank depends on its ability to foresee, avoid and

monitor risks, possible to cover losses brought about by risk arisen. This has the

net effect of increasing the ratio of substandard credits in the bank’s credit

portfolio and decreasing the bank’s profitability (Mamman and Oluyemi, 1994

cited in Hamisu, 2011). The banks supervisors are well aware of this problem, it is

however very difficult to persuade bank mangers to follow more prudent credit

policies during an economic upturn, especially in a highly competitive

environment. They claim that even conservative mangers might find market

pressure for higher profits very difficult to overcome.

The Basel Committee on Banking Supervision (1999) asserts that loans are

the largest and most obvious source of credit risk, while others are found on the

various activities that the bank involved itself with. Therefore, it is a requirement
34
for every bank worldwide to be aware of the need to identify measure, monitor and

control credit risk while also determining how credit risks could be lowered. This

means that a bank should hold adequate capital against these risks and that they are

adequately compensated for risks incurred. This is stipulated in Basel II, which

regulates banks about how much capital they need to put aside to guide against

these types of financial and operational risks they face (Hamisu, 2011).

In response to this, commercial banks have almost universally embarked

upon an upgrading of their risk management and control systems. Also, it is in the

realization of the consequence of deteriorating loan quality on profitability of the

banking sector and the economy at larger that this research work is motivated,

(Hamisu, 2011).

The main source of credit risk include, limited institutional capacity,

inappropriate credit policies, volatile interest rates, poor management,

inappropriate laws, low capital and liquidity levels, direct lending, massive

licensing of banks, poor loan underwriting, laxity in credit assessment, poor

lending practices, government interference and inadequate supervision by the

central bank (Kithinji, 2010 cited in Kolapo et al, 2012). An increase in bank credit

risk gradually leads to liquidity and solvency problems.

35
 Credit risk is a serious threat to the performance of banks; therefore various

researchers have examined the impact of credit risk on banks in varying

dimensions.

Kargi (2011) cited in Kolapo et al (2012) evaluated the impact of credit risk

on the profitability of Nigerian banks. Financial ratios as measures of bank

performance and credit risk were collected from the annual reports and accounts of

sampled banks from 2004-2008 and analyzed using descriptive, correlation and

regression techniques. The findings revealed that credit risk management has a

significant impact on the profitability of Nigerian banks. It concluded that banks‟

profitability is inversely influenced by the levels of loans and advances, non-

performing loans and deposits thereby exposing them to great risk of illiquidity

and distress.

Kithinji (2010) cited in Kolapo et al (2012) assessed the effect of credit risk

management on the profitability of commercial banks in Kenya. Data on the

amount of credit, level of non-performing loans and profits were collected for the

period 2004 to 2008. The findings revealed that the bulk of the profits of

commercial banks are not influenced by the amount of credit and non-performing

loans, therefore suggesting that other variables other than credit and non-

performing loans impact on profits. Chen and Pan (2012) cited in Kolapo et al

(2012) examined the credit risk efficiency of 34 Taiwanese commercial banks over
36
the period 2005-2008. Their study used financial ratio to assess the credit risk and

was analyzed using Data Envelopment Analysis (DEA). The credit risk parameters

were credit risk technical efficiency (CR-TE), credit risk allocative efficiency (CR-

AE), and credit risk cost efficiency (CR-CE). The results indicated that only one

bank is efficient in all types of efficiencies over the evaluated periods. Overall, the

DEA results show relatively low average efficiency levels in CR-TE, CR-AE and

CR-CE in 2008. Felix and Claudine (2008) investigated the relationship between

bank performance and credit risk management. It could be inferred from their

findings that return on equity (ROE) and return on assets (ROA) both measuring

profitability were inversely related to the ratio of non-performing loan to total loan

of financial institutions thereby leading to a decline in profitability. Kolapo (2012)

examined the key determinants of credit risk of commercial banks on emerging

economy banking systems compared with the developed economies. The study

found that regulation is important for banking systems that offer multi-products

and services; management quality is critical in the cases of loan-dominant banks in

emerging economies. An increase in loan loss provision is also considered to be a

significant determinant of potential credit risk. The study further highlighted that

credit risk in emerging economy banks is higher than that in developed economies.

2.3.3 Extant studies from Nigeria.

37
 The deregulation of the financial system in Nigeria embarked upon from

1986 allowed the influx of banks into the banking industry. As a result of

alternative interest rate on deposits and loans, credits were given out indiscrimately

without proper credit appraisal (Philip, 1994 cited in Hamisu, 2011). The resultant

effects were that many of these loans turn out to be bad. It is therefore not

surprising to find banks to have non-performing loans that exceed 50 per cent of

the bank’s loan portfolio. The increased number of banks over-stretched their

existing human resources capacity which resulted into many problems such as poor

credit appraisal system, financial crimes, accumulation of poor asset quality among

others (Sanusi, 2002 cited in Hamisu, 2011). The consequence was increased in the

number of distressed banks.

However, bank management, adverse ownership influences and other forms

of insider abuses coupled with political considerations and prolonged court process

especially as regards debts recovery created difficulties to reducing distress in the

financial system (Sanusi, 2002 cited in Hamisu, 2011). Since the banking crisis

started, the Central Bank of Nigeria (CBN) has had to revoke the licenses of many

distressed bank particularly in the 1990’s and recently some banks has to be

bailout. This calls for efficient management of risk involving loan and other

advances to prevent reoccurrences.

38
 A high level of financial leverage is usually associated with high risk. This

can easily be seen in a situation where adverse rumours, whether founded or

precipitated financial panic and by extension a run on a bank. According to Umoh

(2002) and Ferguson (2003) few banks are able to withstand a persistent run, even

in the presence of a good lender of last resort. As depositors take out their funds,

the bank hemorrhages and in the absence of liquidity support, the bank is forced

eventually to close its doors. Thus, the risks faced by banks are endogenous,

associated with the nature of banking business itself, whilst others are exogenous

to the banking system (Hamisu, 2011).

Owojori et al (2011) highlighted that available statistics from the liquidated

banks clearly showed that inability to collect loans and advances extended to

customers and directors or companies related to directors/managers was a major

contributor to the distress of the liquidated banks. At the height of the distress in

1995, when 60 out of the 115 operating banks were distressed, the ratio of the

distressed banks‟ non-performing loans and leases to their total loans and leases

was 67%. The ratio deteriorated to 79% in 1996; to 82% in 1997; and by

December 2002, the licences of 35 of the distressed banks had been revoked. In

2003, only one bank (Peak Merchant Bank) was closed. No bank was closed in the

year 2004. Therefore, the number of banking licences revoked by the CBN since

1994 remained at 36 until January 2006, when licences of 14 more banks were

39
revoked, following their failure to meet the minimum re-capitalization directive of

the CBN. At the time, the banking licences were revoked, some of the banks had

ratios of performing credits that were less than 10% of loan portfolios. In 2000 for

instance, the ratio of non-performing loans to total loans of the industry had

improved to 21.5% and as at the end of 2001, the ratio stood at 16.9%. In 2002, it

deteriorated to 21.27%, 21.59% in 2003, and in 2004, the ratio was 23.08% (NDIC

Annual Reports- various years).

In a collaborative study by the CBN and the Nigeria Deposit Insurance

Corporation {NDIC} in 1995, operators of financial institutions confirmed that bad

loans and advances contributed most to the distress. In their assessment of factors

responsible for the distress, the operators ranked bad loans and advances first, with

a contribution of 19.5%.

In 1990, the CBN issued the circular on capital adequacy which relate

bank’s capital requirements to riskweighted assets. It directed the banks to

maintain a minimum of 7.25 percent of risk-weighted assets as capital; to hold at

least 50 percent of total components of capital and reserves; and to maintain the

ratio of capital to total riskweighted assets as a minimum of 8 percent from

January, 1992. Despite these measure and reforms embodied in such legal

documents as CBN Act No. 24 of 1991 and Banks and other financial institutions

40
(BOFI) Act No.25 of 1991 as amended, the number of technically insolvent banks

increased significantly during the 1990s.

The role of bank remains central in financing economic activity and its

effectiveness could exert positive impact on overall economy as a sound and

profitable banking sector is better able to withstand negative shocks and contribute

to the stability of the financial system (Athanasoglou et al, 2005). Therefore, the

determinants of bank performance have attracted the interest of academic research

as well as of bank management. Studies dealing with internal determinants employ

variables such as size, capital, credit risk management and expenses management.

The need for risk management in the banking sector is inherent in the nature of the

banking business. Poor asset quality and low levels of liquidity are the two major

causes of bank failures and represented as the key risk sources in terms of credit

and liquidity risk and attracted great attention from researchers to examine the their

impact on bank profitability (Hamisu, 2011).

A bank exists not only to accept deposits but also to grant credit facilities,

therefore inevitably exposed to credit risk. Credit risk is by far the most significant

risk faced by banks and the success of their business depends on accurate

measurement and efficient management of this risk to a greater extent than any

other risks (Gieseche, 2004 cited in Kolapo et al., 2012). According to Chen and

Pan (2012) cited in Kolapo et al (2012), credit risk is the degree of value
41
fluctuations in debt instruments and derivatives due to changes in the underlying

credit quality of borrowers and counterparties. 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. Credit risk is the exposure faced by banks when a borrower

(customer) defaults in honouring debt obligations on due date or at maturity. This

risk interchangeably called „counterparty risk‟ is capable of putting the bank in

distress if not adequately managed. Credit risk management maximizes bank’s risk

adjusted rate of return by maintaining credit risk exposure within acceptable limit

in order to provide framework for understanding the impact of credit risk

management on banks‟ profitability (Kargi, 2011 cited in Kolapo et al, 2012).

Demirguc-Kunt and Huzinga (1999) cited in Kolapo et al (2012) opined that credit

risk management is in two-fold which includes, the realization that after losses

have occurred, the losses becomes unbearable and the developments in the field of

financing commercial paper, securitization, and other non-bank competition which

pushed banks to find viable loan borrowers.

Credit risk is by far the most significant risk faced by banks and the success

of their business depends on accurate measurement and efficient management of

this risk to a greater extent than any other risk (Gieseche, 2004). Increases in credit

risk will raise the marginal cost of debt and equity, which in turn increases the cost

of funds for the bank (Basel Committee, 1999).

42
 To measure credit risk, there are a number of ratios employed by

researchers. The ratio of Loan Loss Reserves to Gross Loans (LOSRES) is a

measure of bank’s asset quality that indicates how much of the total portfolio has

been provided for but not charged off. Indicator shows that the higher the ratio the

poorer the quality and therefore the higher the risk of the loan portfolio will be. In

addition, Loan loss provisioning as a share of net interest income (LOSRENI) is

another measure of credit quality, which indicates high credit quality by showing

low figures. In the studies of cross countries analysis, it also could reflect the

difference in provisioning regulations (Demirgiic-Kunt, 1999 cited in Hamisu,

2011).

43
 CHAPTER THREE

RESEARCH METHODOLOGY

3.1 Research Design

The basic research design employed in this study was descriptive design.

The choice of this design was chosen due to the fact that it enriches the data

collection. The research design adopted on this study was carefully planned, so as

to be able to obtain accurate and complete information about the research project

being used.

3.2 Sources of Data

The major source of data used in this work was mainly the secondary data

which are simple data obtained on a second hand base from CBN statistical

bulletin, textbooks, seminar papers, journals, newspapers, internet and magazines.

3.3 Population of the Study

The population of the study covers all commercial banks in Nigeria

3.4 Specification of the Models

In carrying out this research paper on the effect of credit risk management on the

performance of commercial banks, we developed a compact form of our model as

follows:

44
Y = b0 + b1 x 1…………….. + Ci

Where y = Dependent variables of banks

x = Independent variables of banks

b0 =Intercept for x variables of i banks

b1 = coefficient for the independent variable x banks, denoting the nature of

the relationship with dependent variable y (or parameter)

Ci = The error term specifically when researcher converts the above general

least squares model into our specified variable, it becomes:

TA = b0 + b1LA

Where TA = Total Assets of banks

LA = Total loan and advance

Ci = Error term

3.6 Methods of Data Analysis

Hypothesis formulated for the study will be tested with the paired t-test with

the aid of statistical package for social sciences (SPSS) version 20:0 software

package. Using SPSS, 5% is considered a normal significance level. The

accept/reject criterion will be based on the computed t-value. If t-value is equal or

45
greater than “sig” value, there is significant effect, it means reject null and accept

alternate hypothesis.

CHAPTER FOUR

DATA PRESENTATION AND ANALYSIS

4.1 Data Presentation

Table 1 presents the data from annual reports and statement of accounts of selected

deposit money banks namely Diamond, First bank, GTBank, UBA and Zenith

bank while Table 2 contains the descriptive statistics of the variables.

4.2 Preliminary Tests

4.2.1 Test for normality

To confirm if the data set assume a pattern of standard normal distribution we

utilized the Jarque-Bera (JB) statistic. Table 2 showed that all the variables are

normally distributed as the p-values are greater than the critical value of 0.05 and

all right

46
Table 4.1: Computed data of Diamond bank

Bank Year Total Assets Total loan and Productivity

advance (N’million)
Diamond 2000 (0.0092) (0.7484) 0.0199 110,994,950
2001 (0.0260) (1.2162) 0.2003 115,047,860
2002 (0.0261) (1.0854) 0.1046 118,249,720
2003 (0.0269) (0.9340) 0.2133 120,326,540
2004 (0.2630) (0.9365) 0.1266 122,004,950
2005 (0.0281) (0.8482) 0.3173 124,994,957
2006 (0.2370) (1.0125) 0.2702 223,047,862
2007 (0.0281) (1.4746) 0.382 312,249,721
2008 (0.2490) (1.7967) 0.2761 603,326,540
2009 (−0.0149) (−0.6747) 0.3074 604,000,914
2010 (0.0172) (0.9011) 0.4833 548,402,560
2011 (−0.0380) (−3.1596) 0.5005 714,063,959
2012 0.0267 0.1275 1,059,173,257
2013 0.0245 0.1275 1,354,930,871
2014 0.0139 0.1275 1,750,270,423

Table 4.2: Computed data of First bank

Bank Year Total Assets Total loan and Productivity

advance (N’million)
First 2000 0.0293 0.1427 256,500,000
2001 0.0330 0.2457 275,450,000
47
 2002 0.0387 0.312 284,650,000
2003 0.0395 0.255 302,456,000
2004 0.0451 0.0514 312,490,000
2005 0.0401 0.3038 377,496,000
2006 0.0367 0.3252 540,129,000
2007 0.0289 0.2873 762,881,000
2008 0.0326 0.321 1 ,165,461,000,
2009 0.0276 0.3451 1,667,422,000
2010 0.0170 0.5184 1,962,444,000
2011 0.0213 0.4582 2,463,543,000
2012 0.0300 0.1188 2,770,675,000
2013 0.0236 0.1132 3,246,577,000
2014 0.0197 0.144 3,586,433,000

Table 4.3: Computed data of GT bank

Bank Year Total Assets Total loan and Productivity

advance (N’million)
GTB 2000 0.0195 0.2001 102,500,080
2001 0.0264 0.2309 110,865,000
2002 0.0251 0.1331 125,400,000
2003 0.0324 0.2441 132,500,000
2004 0.0394 0.1503 154,800,000
2005 0.0417 0.2874 167,897,704
2006 0.0328 0.306 305,080,565
2007 0.0320 0.2643 478,369,179

48
2008 0.0390 0.2896 963,118,828
2009 0.0324 0.3645 1,078,177,585
2010 0.0407 0.4963 1,168,052,897
2011 0.0402 0.5001 1,608,652,646
2012 0.0618 0.1254 1,620,317,223
2013 0.0527 0.1097 1,904,365,795
2014 0.0518 0.217 2,126,608,312

49
Table 4.4: Computed data of UBA bank

Bank Year Total Assets Total loan and Productivity

advance (N’million)
UBA 2000 0.0053 0.2561 178,500,000
2001 0.0074 0.2433 195,580,000
2002 0.0092 0.1772 201,305,000
2003 0.0115 0.1009 201,150,000
2004 0.0142 0.2441 225,000,000
2005 0.0253 0.3306 248,928,000
2006 0.0147 0.2642 851,241,000
2007 0.0259 0.2497 1,102,348,000
2008 0.0359 0.2861 1,520,093,000
2009 0.0113 0.3222 1,400,879000
2010 0.0060 0.4638 1,432,632000
2011 −0.0002 0.3895 1,655,465,000
2012 0.0238 0.1773 1,933,065,000
2013 0.0233 0.1241 2,217,714,000
2014 0.0181 0.1339 2,338,858,000

Table 4.5: Computed data of Zenith bank

Bank Year Total Assets Total loan and Productivity

advance (N’million)
Zenith 2000 0.0100 0.1335 186,500,000
2001 0.0122 0.2633 205,896,000

50
 2002 0.0170 0.2447 225,980,000
2003 0.0211 0.3115 265,800,000
2004 0.0255 0.1993 296,500,000
2005 0.0277 0.2909 329,716,511
2006 0.0249 0.2541 608,505,175
2007 0.0263 0.3136 883,940,926
2008 0.0291 0.288 1,680,302,005
2009 0.0177 0.3325 1,789,458,000
2010 0.0273 0.4407 1,573,196,000
2011 0.0263 0.3891 2,169,073,000
2012 0.0385 0.1452 2,436,886,000
2013 0.0326 0.1067 2,878,693,000
2014 0.0355 0.2331 2,987,600,000
Source: Computations from annual reports and statement of accounts of selected

deposit money banks by CBN (2016).

51
 Table 4.6: Regression result

Dependent variable:
Profitability Method:
Least squares
Sample: 2000 2014
Included observations: 15
Variable Coefficient Standard error t-statistic Prob.
C 0.074144 0.263357 0.281534 0.7831
NPLR 0.062433 0.344571 0.471408 0.0658
NLTA 0.013345 0.018945 0.704397 0.4946
R-squared 0.523424 Mean dependent var 0.263080
Adjusted R-squared 0.466005 S.D. dependent var 0.092222
S.E. of regression 0.097424 Akaike info criterion −1.642634
Sum squared resid 0.113897 Schwarz criterion −1.501024
Log likelihood 15.31976 Hannan-Quinn −1.644143
criter.
F-statistic 0.272371 Durbin-Watson stat 2.390369
Prob (F-statistic) 0.026155

52
Following a detailed cross sectional data analysis, the findings As revealed from

the finding of this study, credit risk revealed plausible results on the economic

growth parameter.

This implies that on the average about 6% of the total loans and advances

constituted irrecoverable loans which is bad and considered as losses. Several

reasons may have been behind the dismal performance. Top among these reasons

is high incidence of business failures. Bobakovia (2003) asserts that the

profitability of a bank depends on its ability to foresee, avoid and monitor risks,

possible to cover losses brought about by risk when arisen. This has the net effect

of increasing the ratio of substandard credits in the bank’s credit portfolio and

decreasing the bank’s profitability (Mamman and Oluyemi, 1994). The bank

supervisors are well aware of this problem, it is however very difficult to persuade

bank managers to follow more prudent credit policies during an economic upturn,

especially in a highly competitive environment. They claim that even conservative

managers might find market pressure for higher profits very difficult to overcome.

53
4.2 Discussion

As revealed from the Tables, credit risk management has a positive and significant

impact on profitability of the selected deposit money banks in Nigeria. Also a

cursory examination revealed that the rate of penetration of credit risk management

by the selected financial institutions within the region contributes to 2% of returns

generated from the assets of these banks within the period (2000–2014). This

implies that on the average about 2% of the total returns on investment was

generated through the assets. Although, the result from the hypothesis tested

indicates that Credit risk management had positive and significant impact on

profitability, compared to other regions several reasons may have been behind the

dismal returns on assets. Top among these reasons is high incidence of NPLs.

However, according to IMF (2013), the banking sector time series (including that

for the NPLs) have recent and fundamental structural breaks due to the major

consolidation since 2005–06, and the significant changes in the structures of the

banks’ balance sheets following their surrender of bad assets.

54
 CHAPTER FIVE

SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATION

5.1 Summary of Findings

In this study, the researcher analyzed the effect of credit risk management on the

profitability performance of commercial banks in Nigeria. Five commercial banks

were used as study. The findings in the research is summarized as thus a well

analyzed credit risk before granting credit has a significant impact on the reduced

risk associated with credit.

A reduced credit risk will impact much on the margin of the bank. Since increase

in their asset base guarantee them continently in the business, credit management is

therefore of high necessity to the banks.

Environment where facilities from banks are used to contribute to a large extent to

increase risk the better the operating environment, the less the credit risk. If there is

effective credit risk analysis and control in any bank, the banks’ profitability will

be increased by a well-managed policy of credit since it influences liquidity

position of the bank.

55
5.2 Conclusion

In view of the findings and recommendations, the researcher ascertained that the

profitability of banks are affected by bad and doubtful debts loan. Losses and

substandard loans. This credit risk has been identified, analyzed and

recommendation made so as to control them. Some of the control measures

includes:

1. Certifying the character of the customers

2. Ensuring that customers have reasonable equity participation in any project

finance to get them committed.

3. Obtaining enough collateral securities from the customer.

4. Preparing a repayment schedule that will coincide the customer’s cash flows

5. Banks credit officers should make prompt visitation to their customers to

remind them of nearing maturity of their facilities and project so as not to be

taken unawares.

5.3 Recommendations

Based on the findings by the researcher, the following were made; since one of the

ways of ensuring repayments of loans is well arranged schedule, banks should

consider the customer, analyzed the profitability ensure that the repayment

56
coincides with the customers cash flow before extending credit to any customer

and should consider the security they involve as otherwise.

Furthermore, since the operating environment is a since-quo-non, the success of

this project and the adverse environment situation includes unstable government,

they should always make effort to stabilize their regulations and credit conducive

environment for the investors.

Also banks should extend the service to project advice consultancies so that the

investors will help to avoid business failures.

Neutral approach adherence to ethical codes of the bank will go a long way to

reducing the incidence of substandard loan. Irregularities that characterized

banking practice that led to the distress of many banks in the recent years should be

avoided. Such irregularities among other things include payment and collection of

up front interest to or from customers respectively management flow-play etc.

More so, for financing, credit given to importer in this respect should be followed

until the banks receive its money, this will help to avoid diversion of funds and

eventually default of customer.

57