THE IMPACT OF CREDIT RISK ON BANK PERFORMANCE IN NIGERIA

ABSTRACT

The purpose of this study is to look at the influence of credit risk on bank performance in Nigeria from 2004 to 2014. Non-performing loans are a common occurrence in the banking industry, and they are one of the leading causes of failure. Internal examinations to determine whether loans are collateralized and self-liquidating may not be held liable.

The study will use econometrics procedures of Panel Least Square (OLS) techniques in estimating all the functional relationships from the annual reports of United Bank of Africa (UBA), Guarantee Trust Bank (GTB), Assess Bank plc, WEMA Bank, First Bank, Diamond Bank, Fidelity Bank, Skye Bank, First City Monument Bank, and Zenith Bank from 2004 to 2014.

In order to estimate all of the functional relationships in the system as well as obtain numerical estimates for the coefficients of different equations, the study will apply econometrics procedures using Panel Least Square (OLS) methodologies.

Only bank size has a favorable and significant impact on bank performance, according to the data.

The study suggests that there is a positive association between credit risk and bank performance in Nigeria. The study advises banks to follow the credit risk principle before extending loans because it may affect their performance.

CHAPTER ONE

INTRODUCTION

BACKGROUND OF THE STUDY

The ability of financial organizations to effectively manage credit risk is vital to their existence and expansion. Because of the larger level of perceived risks coming from some of the characteristics of clients and the business settings in which they find themselves, credit risk is of even greater concern to banks. According to Dwayne (2004), banks were established to provide a secure storage facility for customers’ cash. He claimed that because the money obtained from clients was always available to the bank, it was later invested in profit-generating assets. As a result, credit advances have become commonplace. Banks are in the business of keeping their customers’ money and other valuables safe. Loans, credit, and payment services such as checking accounts, money orders, and cashier’s checks are also available. Banks may also provide investment and insurance products, as well as a wide range of other financial services, which they were previously forbidden from providing (according to the US Congress’s Financial Services Modernization Act of 1999). (by the Glass-Steagall or Banking Act of 1933 in the USA). According to Ayo (2002), there is a differentiation between the surplus and deficit units in the modern economy, as well as a separation of the saving and investing mechanisms. This forced the creation of financial organizations whose mission it is to move funds from savers to investors. Money-deposit banks’ intermediating roles put them in the role of “trustee” for the savings of widely dispersed excess economic units, as well as a determinant of the rate and shape of economic development. Banks’ approaches for performing this intermediary duty should provide them with precise knowledge of lending outcomes, allowing funds to be directed to investments with a high possibility of full payment. However, while financial institutions have had difficulties over the years for a variety of reasons, the most significant cause of serious banking problems remains directly related to lax credit standards for borrowers and counterparties, poor portfolio risk management, or a failure to pay attention to changes in the economy. Credit risk is one of major concern to most authorities and banking regulators. This is due to the fact that credit risk is one of the most common causes of bank failure. Credit risk management, as a result, must be a strong procedure that enables financial institutions to proactively manage facility portfolios in order to limit losses and achieve a satisfactory return for shareholders. Dandago Dandago Dandago Danda (2006). Credit risk management is a systematic strategy to managing uncertainties that includes risk assessment, risk management strategies, and risk mitigation employing managerial resources (Nnanna, 2004). Transferring to another party, avoiding the risk, and limiting the repercussions of a certain risk are some of the ways. The goal of risk management is to lessen the impact of various types of risks. Commercial banks play a similar role to blood vessels in the human body in emerging economies, accounting for more than 90% of their financial assets (ADB, 2013) due to borrowers’ limited access to capital markets (Felix Ayadi et al., 2008). As a result, commercial banks’ efficient intermediation is critical for developing nations to attain significant economic growth, whereas their insolvency leads to economic crises. However, commercial banks’ intermediation function generates a variety of hazards, each with a different degree and impact on bank performance, such as credit risk, liquidity risk, market risk, operational risk, and so on. The key causes of the recent global financial crisis include credit risk management. If credit risk management guidelines are poor or incomplete, the problem begins during the application stage and worsens during the approval, monitoring, and controlling stages (Richard et al. 2008). Recognizing the impact of credit risk and offering a comprehensive approach to managing it, the Basel Committee on Banking Supervision adopted the Basel I Accord in 1988, followed by the Basel II Accord in 2004 and, most recently, the Basel III Accord after learning about the flaws in previous credit risk agreements during the financial crisis (Jayadev, 2013; Ouamar, 2013). Through the financial services they provide, banks play an important role in economic development. Their job as an intermediary might be described as a catalyst for economic progress. The banking industry’s efficiency and effectiveness throughout time is a barometer of a country’s financial stability. The extent to which a bank makes its operations available to the general people for productive purposes accelerates a country’s economic growth and long-term viability (Kolapo, Ayeni & Oke, 2012). The corporate climate in the twenty-first century is more complex and varied than ever before. In every aspect of their operations, the majority of firms must deal with uncertainties and concerns. Without a doubt, in today’s volatile and volatile environment, all banks face significant risks such as credit risk, liquidity risk, operational risk, market risk, foreign exchange risk, and interest rate risk, among others, which could jeopardize the bank’s survival and success. As a result of the significant drop in equity market indices, global oil prices, and the sudden depreciation of the naira against global currencies, the Nigerian banking industry has been strained (BGL Banking Report, 2010). The poor quality of the banks’ loan assets hindered banks to extend more credit to the domestic economy, thereby adversely affecting economic performance.

STATEMENT OF THE PROBLEM

For banking entrepreneurs and managers, the current ability for banks to diversify into a wider range of services and products makes life a lot easier. However, this diversification advantage is a once-in-a-lifetime opportunity that should be approached with caution and prudence because it entails a significant amount of risk. Because deposits account for more than 85 percent of a bank’s liability, the banking industry is extremely sensitive (Saunders, Cornett, 2005). Banks use these deposits to extend credit to their customers, which is a revenue-generating activity for most institutions. The banks are exposed to a high default risk as a result of this credit creation process, which could result in financial distress, including bankruptcy. Since 1990, many changes have been implemented in the Nigerian financial system, including Universal Banking, Bank Consolidation Reserve, Bank Credit Reforms, Interest Rate Reforms, and so on. Despite these steps, the CBN has discovered that some banks are distressed due to poor credit risk management, which explains why most Nigerian commercial banks have a high proportion of nonperforming loans. Non-performing loans are a common occurrence in the banking industry, and they are one of the leading causes of failure. Internal examinations to determine whether loans are collateralized and self-liquidating may not be held liable. Another serious issue is customer default on credit repayment, which results in a decrease in the bank’s earnings for the period.

  OBJECTIVE OF THE STUDY

The study’s overall goal is to look into the relationship between credit risk and bank performance in Nigeria. The study will, however, guarantee the following objectives:

To learn more about the nature of credit risk in Nigeria.

To see if credit risk has an impact on commercial banks’ profits in Nigeria.

  RESEARCH QUESTIONS

What are the characteristics of credit risk in Nigeria?

What are the characteristics of commercial bank loans and advances in Nigeria?

What effect does credit risk have on bank performance in Nigeria?

 RESEARCH HYPOTHESIS

The following hypothesis will be tested:

H0: In Nigeria, there is no substantial correlation between credit risk and bank performance.

H1: In Nigeria, there is a strong correlation between credit risk and bank performance.

  SIGNIFICANCE OF THE STUDY

The purpose of the paper was to investigate credit risk and bank performance in Nigeria by encouraging the federal government to revisit its policy and operational guidelines in order to address the challenges faced by commercial banks in extending credit to investors, i.e., customers, and to maintain a strict attitude in credit management in order to avoid losses. Furthermore, more scholars will find the research beneficial in their varied studies on the subject.

 METHODOLOGY

This study’s technique will use secondary data; nevertheless, time series data for ten years (2004-2014) will be used. Data will be gathered from secondary sources, and the hypothesis will be estimated using ordinary least square (OLS) multiple regression analysis. The central bank of Nigeria’s (CBN) statistical bulletin, journals on the research topic, and yearly reports will all be used as secondary data sources.

 SCOPE OF THE STUDY

The focus of this study will be on credit risk and bank performance in Nigeria. This research will span the years 2004-2014, allowing us to determine the negative and positive effects of credit risk on bank performance in Nigeria.

  PLAN OF THE STUDY

The research for the project will be divided into chapters as follows:

The first chapter covers the backdrop of the study, the statement of the problem, the study’s aim, the research questions, the research hypothesis, the scope of the investigation, the justification of the study, the methodology, and the study’s plan. The literature review, theoretical framework, and empirical review are all covered in Chapter 2. The approach for the research study is discussed in Chapter three. The fourth chapter focuses solely on data display and analysis. The fifth chapter is about summarizing and concluding.

  LIMITATIONS OF THE STUDY        

The study’s limitations are based on the short amount of time available for doing the research and the potential for errors in acquiring data from our research sources.