ABSTRACT
Commercial
banks engage primarily in the business of intermediation, which is, mobilizing
funds from surplus units of the economy and lending same to the deficit
units. In rendering these services, a
large percentage of the loans granted are not repaid or serviced as at when
due, leading to bank distress. Defective credit risk management practices,
laxity of the supervisory and regulatory authorities have been identified as
the problems. This study examined the effect of the credit risk management
techniques on the loan portfolio quality of Nigerian commercial banks.
The
study employed ex-post facto and
cross sectional designs. Target population comprised 3097 credit risk managers
drawn from 21 commercial banks in Nigeria and a sample of 425 was selected
using the stratified random sampling technique. A structured questionnaire was
validated for the study. Secondary data were
also obtained from the audited accounts of the selected banks over the period
covered by the study (2006 - 2015). The Cronbach’s alpha coefficient for the
construct ranged between 0.782 and 0.941. The response rate from 425 copies of
the questionnaire administered was 95.5%. The data collected were analyzed
using descriptive and inferential (simple and multiple regression) statistics.
Findings
revealed that credit risk management techniques had significant effects on
loan portfolio quality (R2 = 0.675, p<0.05), credit risk
environment had significant effect on loan portfolio quality (R2 =
0.577, p<0.05), credit analysis had positive significant influence on loan portfolio
quality (R2 = 0.656, p<0.05), credit administration had
significant effect on loan portfolio quality (R2 =
0.638, p<0.05), credit control had negative and significant relationship
with loan portfolio quality (r = -.615,
p<0.05), supervisory and regulatory roles had significant effect on loan
portfolio quality of Nigerian commercial banks (R2 =
0.487, p<0.05).
The
study concluded that credit risk management techniques were capable of
impacting loan portfolio quality of Nigerian commercial banks. It recommended
that the management of lending institutions should establish and maintain sound
credit risk management structures that match best practices and global
standard. The banks should automate their credit-risk process in line with
Basel Accord and local regulatory requirements. Credit control functions should
be strengthened to ensure strict compliance with policies and minimization of
unauthorized lending.
CHAPTER
ONE
INTRODUCTION
1.1 Background to the Study
This study is based on the effect of various credit
risk management techniques deployed by Nigerian commercial banks on the quality
of their loan portfolio. Banks are very
important to economic growth and development all over the world, in view of the
financial services they render. They act as financial inter-mediators,
mobilizing deposits from surplus units of the economy and channeling the funds
to deficit units by way of loans to finance projects and transactions that
drive economic growth. According to
Kithinji (2010), the role of commercial banks is very critical to the success
of every economy, commercial banks play an intermediation role between the
surplus and deficit units of the economy. They constitute the foundation upon
which the payment system is built. They also stimulate the financial system by
engendering stability and effective delivery of financial transactions
Credit plays a prominent role in the financing of
economic activities all over the world.
Credits are granted to finance various production, investment and
consumption activities, across various sectors of the economy. Credits therefore constitute critical tools
for economic growth (Ugoani 2013). However, once credits are created, credit
risk exposure has commenced and if not carefully handled, it could spiral into
monumental global financial crisis, such as was witnessed in year 2006, arising
from concentration of financial institutions’ loan portfolio on overvalued
sub-prime mortgage-related assets which were built up over time. By mid-2007, most of the underlying assets in
the sub-prime mortgage crisis had suffered default (CBN 2015). North America and Europe instantly felt the
impact as it manifested in form of a drastic reduction in available credit and
the consequential slump in aggregate demand.
The crisis spread like wild fire, cutting across one economy after
another, in both developed and developing nations. The Nigerian economy, being a mono-product
economy in foreign exchange earnings, was touched through the oil slump,
erosion of foreign direct investment, pressure on foreign reserves and a sharp
decline in the performance of the stock market.
The global economic melt-down affected the Nigerian banking industry,
particularly, those that had large portfolio exposure to the oil and gas industry,
the capital market and through paucity of off-shore credit lines
Global economic growth, according to WEO (2016) and
CBN (2016), was marginal over the years of this study, dropping from 5.2% in
2007 to 3.1% in 2015 due to the sub-prime mortgage crisis, low energy and
commodity prices, weak demand, bearish capital markets in America and Africa,
capital reversal from emerging markets and high volatility in currencies of
developing economies. Chimkono, Muturi and
Njeru (2016); Llaudes, Salman and Chivakul (2010) posited that, evidence of
questionable credit risk management practices manifested world over
particularly, during and after the sub-prime mortgage crisis and the global
economic melt-down of 2006 and 2007. Klein (2013); Chimkono et al (2016) agreed that, Central,
Eastern and South Eastern Europe (CESEE) suffered growth in non-performing loan
ratio from 3 percent in 2007 to 11 percent in 2011 and this caused a
devastating effect on bank performance, bank lending and the economy as a
whole.
A review of the American economy over the period
showed growth in non-performing loan ratio from 3 percent in 2008 to 7.5
percent in 2010 (WEO, 2016). Major South
American economies comprising of Argentina and Brazil enjoyed low
non-performing loan ratio of 3 percent, while Columbia and Mexico witnessed
marginal non-performing loan growth rate from 1.9 percent in 2012 to 2.1
percent in 2013 and 2.5 percent in 2012 to 3.4 percent in 2013 respectively. In
2009, during the Asian banking crisis, Asia witnessed a huge NPL growth rate of
75% leading to the collapse of over 60 banks, while in Singapore and Malaysia,
economic growth was constrained by accumulated NPLs which eroded the capital
base of the banks. Chimkono et al
(2016). According to Kolapo, Ayeni and
Oke (2012), the development, growth and sustained stability of the economy of
any country is substantially a function of the volume of credit availed by
banks to fund production and commercial activities that add value to the
economy. Abdulraheem, Yahaya and Aliu (2011); Bashir and Kadir (2007); Yanfei
(2013) aligned with these views, stressing that, the role of commercial banks
in an economy is indispensable. Commercial banks facilitate the development,
expansion and growth of a nation’s economy by making funds available for
investment in the economy through the use of various financial instruments to
mobilize surplus funds from those that forego current consumption for the
future and they make same funds available to the deficit unit, by way of
lending, for production, investment and consumption purposes.
Beck, Dewatripont, Freixas, Seabright and Coyle
(2010) asserted that the financial intermediation role of banks involves three
basic functions and these include, making means of payment available to
economic agents, this makes transfer of property rights more efficient and
transactions become more cost effective. Casu, Girardone and Molyneux (2006);
Pyle (1971) shared same opinion. Banks
handle asset transformation to match short-term supply of funds in little
volume (from their depositors) as well as the long-term demand in large amounts
from their borrowers. Banks also handle
screening of potential borrowers, monitoring of their activity and enforcement
of repayments. Beck et al (2010) established the relationship between these three
functions, arguing that efficient linkage of deposits to the payment system and
careful lending of the funds collected through deposit, brings about economies
of scale.
The history of banking is traceable to the Italian
merchants. Adekanye (1986) traced the
origin of the term “bank” to Italian language that simply means: ‘Bench or
Benco’; the study argued that the process emanated from the ingenuity of the
then blacksmith of Italy whose job specialization was building of boxes for
safe keeping of ornaments and jewelries, the safe keeping of money and other
valuables was later added to the process.
Banking operation in Nigeria has come a long way. Somoye (2008) traced the commencement of
banking operation in Nigeria to 1892 when it was under the control of the
expatriates and banks owned by some Nigerians and Africans did not come on
stream until the year 1945. In the
opinion of Akinyooye (2008), the use of silver coins in Nigeria was introduced
by the British and this came on the platform of African Banking Corporation in
1892, the company was founded by Elder Dempster Company and it was exclusively
saddled with the responsibility to issue legal tender, which was the British
silver coins, then, the only money in circulation. In 1893, the then newly established British
Bank for West Africa took over its business operations and that culminated in
the birth of present day First Bank of Nigeria Plc. The monopoly remained intact until the West
African Currency Board was created in 1912, in order to stimulate the
British-West African trade. It was saddled with the responsibility to issue and
it did issue a West African currency convertible to British Pound Sterling.
Literatures revealed that before the Central Bank of
Nigeria (CBN) was established in 1959, the banking system was relatively
unorganized as the system rode through the rough tide of uncoordinated markets,
paucity of financial instruments, manual processes and all attributes of an
underdeveloped financial system. This
view was corroborated by Somoye (2008), who asserted that the financial system
was not well organized and it was bereft of sufficient financial instruments to
trade or invest in, as a result, banks only focused on investing in real assets
which were not liquid and could not be quickly converted to cash when needed,
without a drop in value.
Promulgation of the Ordinance of 1958 which
established the CBN was an outcome of the Loynes commission instituted by the
Nigerian Federal Government in September 1958. This was followed by enactment of the Treasury
Bill Ordinance in 1959, the first Treasury Bill was issued in April 1960,
formal money and capital markets were established and the Companies Act was
enacted in 1968. These marked the
commencement of serious banking regulations in Nigeria. The financial system then began to witness
series of reforms following the Structural Adjustment Programme (SAP) of
1986. Iganiga (2010) posited that the
Structural Adjustment Programme (SAP) which kicked off in 1986 was an offshoot
of the financial sector reforms. The components of the reforms included, fixing
of the minimum paid up capital for banks at N400,000
(USD480,000). In January 2001, the
banking sector came under full deregulation with the adoption of universal banking
system in Nigeria which led to merger of merchant and commercial banking
operations and prepared the grounds for the consolidation programme of 2004.
On September 7, 2010, the CBN repealed the Universal
Banking regime and licensed banks to perform commercial banking (regional,
national and international authorization), merchant banking and specialized
banking (Microfinance Banking, Mortgage Banking, Non-Interest Banking and
Development Finance Institutions). The
same circular also prohibited banks from undertaking non-banking activities
(CBN 2010). Following multiple licensing and influx of banks in Nigeria between
years 1986 and 1989, when about 38 new commercial and merchant banks were
created, there was mass bank failure and this preceded another round of
recapitalization exercise that saw bank capital increased to N500Million in 2002, followed by another
increase to N2Billion in January 2004
and subsequently to N25Billion in July
2006. The deregulation and
recapitalization exercises culminated in change in number of banks from time to
time, the number had earlier increased from 66 to 107 in 1990, it further
increased to 112 in 1996. The number of banks reduced to 110 in 2002, 89 in
2003 and 25 in July 2004.
According to
Iganiga (2010), the Nigerian nation witnessed arrival of the mother of reforms
in July 2004, during which 89 banks were forced to merge and this culminated in
25 universal banks which was further reduced to 24 at the end of December 2007.
Altunbas and Marques-Ibanez (2008); Donli (2003) noted that, on the average
such mergers result in improved performance.
This position was also supported by Amel, Barnes, Panetta and Salleto
(2002); Goldstein & Turner (1996). Ojo (2008). Adam (2009) reviewed the deregulation process
and noted that it brought about an array of sharp changes in the operations of
banks and the regulatory environment while Nigeria once again witnessed another
round of distress syndrome. The changes
witnessed in banking operations included; liberalization of the foreign
exchange regime and money market, the CBN Prudential Guidelines were
introduced, the minimum paid-up capital was increased, the Nigerian Deposit
Insurance Corporation (NDIC) was established, the mandatory sector allocation
of credits was relaxed to boost credit growth, a new legal framework was
adopted to enrich the legal process while the autonomy and supervisory
responsibilities of the CBN was enhanced to impact the health of the financial
system.
Adam (2009) examined the factors responsible for the
substantial increase in number of players in the industry in the late 1980s and
1990s and attributed it to the economic boom of that period, which expanded
business scope and financial capacity across the industries, leading to wider
business opportunities, wider margins and resultant increase in number of
financial institutions across board.
These views were shared by Onaolapo (2007); Sanni (2009); Subaru, Nafiu,
Omankhanlen (2011); Udom (2011). Sanusi
(2002) however, was of the opinion that many of the problems that befell the
financial system then, such as, financial crimes, poor credit analysis system,
accumulation of poor risk asset quality, were attributable to the increase in
number of banks, as this caused an over-stretching of the existing human resource capacity of
banks.
A good number of eminent scholars have examined the
concept and theory of credit risk management in banks in various
jurisdictions. Mavhiki, Mapetere and
Mhonde (2012) described credit risk as
risk that emanates from uncertainty of a given counter party meeting his/her obligation. It can also be described as the risk of loss
occasioned by a debtor defaulting on a loan obligation or credit line. Mavhiki et
al (2012) dwelled further on the possibility of losses occurring from
reduction in value of portfolio due to actual or perceived deterioration in
quality of credit. Due to increasing spate of non-performing loans, the Basle
II Capital Accord emphasized on the importance of entrenching sound credit risk
management practices. This position was buttressed by Kolapo, Ayeni and Oke
(2012), who also emphasized on the need for dynamic credit risk management
structures, policies and procedures in the lending value chain. Kithinji (2010) reviewed the scope of credit
risk management and asserted that it involves the processes of identification,
monitoring, measurement, control and reporting of risk arising from possibility
of default in loan repayment obligations.
This study has
reviewed a good number of definitions of credit risk management as provided in
existing literatures. The study has chosen to take it a step further by
describing credit risk as the risk of loss occasioned by a debtor or borrower
defaulting on a loan obligation, either in part or whole, as at when due,
resulting or capable of resulting in a reduction in the bank’s earnings,
margins, capital, asset base and asset quality.
In the course of this study, a number of gaps were
identified in the literatures reviewed which mostly pointed in the direction of
a need for further research into various credit risk management techniques that
have the ingredients and capacity to impact the loan portfolio quality of
commercial banks, with focus on the Nigerian financial institutions sector and
this constitutes the primary objective of this study. Further studies in the
area of credit risk management, including that of Awojobi, Amel and Norouzi
(2011) questioned and expressed doubt on the adequacy of Basel Accord
principles for risk management, because of volatility of asset quality with
business cycles. In view of this, there is need for further research in the
area of effective and sufficient credit risk management principles that have
capacity to address variations in asset quality with business cycles.
Commenting on the impact of the business and risk environment on credit
risk management, Kolapo, Ayeni and Oke (2012) were of the opinion that a number
of factors constitute triggers of credit risk and these include, limitation in
the capacity of the institutions, irregularities in promulgation and
implementation of credit policies, interest rate volatility weak management,
weak legal system, weak capital base, weak liquidity base, insider lending, excessive licensing of banks, poor credit
analysis, laxity in credit administration, poor lending culture, government
interference and weakness of supervisory system. All these informed the call for further
studies into; identification of sound credit risk framework and strategies, as
measures for avoiding or minimizing the adverse impact of credit risk.
In relation to credit risk management, existing literatures have also
examined how banks are managing credit and by extension, risk in a hostile
operating environment. Aremu, Suberu and
Oke (2010) argued that credit risk may arise from various forms of risk events
such as management risk, business risk, financial risk and industrial risk. The
probable occurrence of partial or total default requires a thorough risk
assessment prior to granting of loans.
Further stressing the importance of a conducive environment for credit
risk management to thrive, Waweru and Kalani (2009) asserted that, at present,
banking crisis is being experienced by several developed countries including
the USA. For example more than
$39billion has been written off by the Citibank Group in losses. However,
despite the myriad of problems confronting the global financial market,
Canadian banks have been witnessing relative stability. Chimkono et al (2016) attributed the stability to
a combination of key factors such as regulatory diligence and disciplined
cultural mindset among Canadian banks.
In the Credit Risk Management value chain, the process of credit analysis
takes the pride of place because, this is the process that leads to a final
decision as to whether to lend or not.
According to Awojobi et al (2011), the structure of a credit is akin to
the structure of a building, the architect designs, the quantity surveyor
quantifies how much it will cost to put the building in place in Naira terms
and the civil engineer constructs. In all, there must be a meeting of minds
among all the parties. The right materials, ingredients and workforce are found
in what is popularly referred to as 7 Cs of credit namely; Capital, Capacity,
Character, Collateral, Condition, Connection and Consideration. Olokoyo (2011)
called for a high level of care and caution in bank lending decisions, as
these generally involve a great deal of risk taking, a wrong lending
decision may invariably portend a creation of bad asset, right from the
beginning. Thus, for every lending activity to be a success, the process of
credit analysis, presentation, structuring and reporting must be skillfully and
diligently handled.
Credit Administration is another crucial function in
the credit risk management process
cycle. It has to do with establishment and implementation of
infrastructures and resources for early detection of warning signals in the
credit portfolio, through effective loan monitoring, review, management
reporting, limit setting, portfolio administration and credit referencing
system. kithinji (2010) went a step
further by identifying weak credit administration as a major problem militating
against the development of banks in Nigeria and resulting in abuse of the
system by borrowers.. The concluded that an effective credit administration
system can add value to the entire credit risk management process through
adequacy in scope, content and capacity to detect and report early warning
signals.
Credit control is another fundamental credit risk management technique
that has a far reaching effect on loan portfolio quality of commercial banks
all over the world. Credit Control entails entrenchment of checks and balances
by way of policies and procedures to ensure prevention and early detection of
fraud, error, unauthorized lending and other credit abuses or credit breaches.
It involves having in place, control systems that are proactive enough to
prevent or detect violations of credit policies, risk acceptance criteria, bank
risk appetite, target market and regulatory measures. Kithinji (2010) observed that, financial
institutions are being forced to rely on managerial competencies and other
intra-organizational factors for survival and success rather than effective
risk analysis and control techniques.
The impact of regulatory and supervisory intervention on loan portfolio
quality of banks cannot be overemphasized. Lending credence to this assertion,
Etale, Ayunku and Etale (2016) observed that the Nigerian banking regulators
namely, the Central Bank of Nigeria and Nigeria Deposit Insurance Corporation must also begin to direct more resources in terms
of human, material and technological resources, to ensure that banking
supervision in the new dispensation, is more dynamic, more preventive in terms
of proactivity and increased transparency.
The foregoing analysis show that a remarkable body of research exists on
various components of credit risk management processes and procedures in the banking
industry. However, a good number of the studies have either focused on one or
two credit risk management techniques or strategies. This study aims to examine all the major
credit risk management techniques in totality, with the objectives of determining
how they affect the loan portfolio quality of Nigerian commercial banks.....
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