Effect of Credit Risk on Performance of Nigerian Banks

Effect of Credit Risk on Performance of Nigerian Banks

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Abstract on Effect of Credit Risk on Performance of Nigerian Banks

Recent reports have traced bank failures across the country to rising “toxic assets” in commercial banks’ loan portfolio. Poor credit appraisal techniques that have seen credit exposures turn bad, no doubt, largely accounts for this rising level of non-performing loans. This development not only threatens the viability and sustainability of banks but also adversely affects the economic performance of the country as a whole. This paper therefore empirically investigated the effect of credit risk on performance of Nigerian Banks. An ex-post facto research design was adopted by the study and secondary data sourced from annual reports of five banks covering the period from 2008 to 2014 was used for the study. Purposive sampling technique was employed in the selection of the five banks from the existing twenty one commercial banks. Data collected was analysed using panel least square method and the result revealed that DLA_TD (-0.027), LLP/NPL (-0.011) and NPL/LA (-0.093) significantly influenced banks performance negatively. The study therefore concluded that credit risk have significant negative influence on commercial banks’ profitability. The study thus recommended amongst other things that banks in Nigeria should enhance their capacity in credit analysis and loan administration so as to reduce loss on non performing loans which raises their expenses and consequently leads to reduction in financial performance. Credit Risk, Performance, Nigeria, Banks

Chapter One of Effect of Credit Risk on Performance of Nigerian Banks

INTRODUCTION

Commercial banks play a significant role in the economic development of nations through the financial services they provide. Their intermediation role can be said to be a catalyst for economic growth (Kolapo, Ayeni and Oke, 2012). Lending is no doubt a significant part of the financial services rendered by these banks. This is why Kargi (2011) pointed out that credit creation is the main income generating activity of banks. However, commercial bank lending is guided by credit policies which are guidelines and procedures put in place to ensure smooth lending operations. Bank lending if not properly assessed, involves the risk that the borrower will not be able or willing to honour their obligations (Omara, 2007).

However, beyond the urge to extend credit and generate revenue, banks have to recover the principal amount in order to ensure safety of depositors’ fund and avoid capital erosion. Bank lending therefore has to consider interest income, cost of funds, statutory requirements, depositor’s needs and risks associated with loan proposals (Dongo, 2004). For these reasons banks have overtime developed credit policies and procedures which stipulate the lending process. This process includes among others the credit appraisals, documentations, disbursement, monitoring and recovery processes lending. Bank lending is also based on established international standards (Omara, 2007).

However, despite the credit processes and procedures put in place, the Nigerian banking industry, in the past decade, has been strained by the deteriorating quality of its credit assets as a result of the significant dip in equity market indices, global oil prices and sudden depreciation of the naira against global currencies (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. This prompted the Federal Government of Nigeria through the instrumentality of an Act of the National Assembly to establish the Asset Management Corporation of Nigeria (AMCON) in July, 2010. Similarly, the Prudential Guidelines was amended in 2010. This was with a view to provide a lasting solution to the recurring problems of non-performing loans that bedevilled Nigerian banks.

Similarly, the commercial banks on their part and in response to deteriorating quality of credit assets have almost universally embarked upon an upgrading of their risk management and control systems. This is because poor asset quality no doubt creates the problem of non-profitability and illiquidity.

Thus, there is no doubt that the success of banks largely depends on the effectiveness of their credit management systems because these institutions generate most of their income from interest earned on loans extended to their customers. The Central Bank Annual Supervision Report, 2010 indicated high incidence of credit risk reflected in the rising levels of non- performing loans by commercial banks in the last 10 years, a situation that has adversely impacted on their profitability. This trend not only threatens the viability and sustainability of banks but also adversely affects the economic performance of the country as a whole. Poor credit appraisal techniques that have seen credit exposures turn bad, no doubt, largely accounts for the rising level of non-performing loans. Hence, the report of the rising “toxic asset‟ of banks informed the need to undertake an investigation into the effect of credit risk on banks’ performance. In doing this, the ratio of non-performing loan to loan & advances, ratio of total loan & advances to total deposit and the ratio of loan loss provision to non performing loans were used as indicators of credit risk while the ratio of Profit after Tax to total asset known as return on asset (ROA) indicates performance.

Research Questions

The research questions raised from the problem identified are as follows;

• What is the influence of non-performing loan to loan & advances on bank performance?
• What is the effect of total loan & advances to total deposit on bank performance?
• What is the influence of loan loss provision to non performing loans on bank performance?

Statement of Research Objectives

The general objective of this paper is to examine the effect of credit risk on the performance of Nigerian Banks. Specifically, the study intended to;

• Examine the influence of non-performing loan to loan & advances on bank performance.
• Determine the effect of total loan & advances to total deposit on bank performance.
• Ascertain the influence of loan loss provision to non performing loans on bank performance.

Research Hypotheses

To achieve the study’s objectives, the following null postulate has been made.

H01: Non-performing loan to loan & advances has no influence on bank performance.

H02: Total loan & advances to total deposit has no effect on bank performance.

H03: Loan loss provision to non performing loans has no influence on bank performance.

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