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CREDIT RISK MANAGEMENT TECHNIQUES AND LOAN PORTFOLIO QUALITY OF NIGERIAN COMMERCIAL BANKS (2006 – 2015)
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.
Keywords: Credit risk management, Loan portfolio, Credit administration, Credit control,
Word Count: 362
- 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-and-finance-project-materials/">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-and-finance-project-materials/">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-and-finance-project-materials/">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-and-finance-project-materials/">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.
- Statement of the Problem
The Asset Management Corporation of Nigeria (AMCON) was established on July 19 2010 to revive the financial system by efficiently resolving the non-performing loans of the banks in the Nigerian Economy. According to Onaolapo (2012), the managing director of AMCON, Chike-Obi submitted that the Corporation lost about N226Billion in three (3) nationalized banks between 2009 and 2011. These problems are, without doubt, substantially attributable to defective credit risk management techniques which adversely impact the loan portfolio quality of Nigerian banks. Onaolapo (2012) emphasized on the prominence of the issue of inadequate credit risk management technique in the Nigerian Deposit Insurance Corporation (NDIC)’s annual reports for year 2012, which reported that, total loans of the 20 Deposit Money Banks in Nigeria was N8.15Trillion out of which N286.09Billion was non-performing. This problem of huge non-performing loans (NPL) in Nigerian banking is attributable to defective credit risk management techniques.
Un-conducive internal and external environments constitute a huge challenge to credit risk management practices. Njanike (2009) asserted that, apart from ineffective credit risk systems of banks, there are many other factors that contributed to the collapse of banks, such as hostile macro-economic environments and weak risk management system. Fadare (2011) is also of the opinion that many other factors impede the viability of credit system in Nigeria and these include, dearth of adequate laws and legislations, weak asset recovery rate, poor ICT and support infrastructures such as power supply and lack of a standard national identification system. These views were supported by Honohan (2000). It has been firmly established that an unfriendly, un-conducive and difficult environment is a major cause of sub-quality lending process and poor loan portfolio quality in the Nigerian banking system.
A compromise of any of the principles of lending and credit analysis will invariably render the integrity of a credit facility highly undermined from the outset and it will be a great surprise if eventually, such facility does not end up in bad loan portfolio, these were the views of Onyukwu, (2005). Stressing the problem of poor credit analysis further, Awojobi and Amel (2011); CBN (2010) observed that, at the end of a comprehensive stress test for all commercial banks, ordered by CBN Governor, Mallam Lamido Sanusi in 2009, the CBN was constrained to inject N620Billion to rescue 8 troubled banks while ultimatum was given to 5 others to recapitalize. Further to this, the sector became highly unstable, many bank workers lost their jobs, investors lost their funds, some of the Executive Directors had to be arrested and charged to court for giving loans without due process. These researchers concluded that, following the intervention of the Economic and Financial Crime Commission (EFCC). A large proportion of insider related loans were uncovered. It was discovered that most of the bad loans were used to finance private businesses of the directors, their relatives, friends and family; a large proportion of the loans became bad and was classified as non-performing assets. All these scholarly assertions are pointers to the fact that, a low quality credit analysis and evaluation system may lead to poor lending decisions and low portfolio quality.
Declaring weak credit administration as another problem bedeviling Nigerian banks, Onyukwu (2005) and CBN (2010) affirmed that, even though the cases of bank failure and distress in Nigeria are traceable to political, macro-economic and institutional factors, the primary causes are institutional factors such as; poor credit administration, poor loan recovery, insider abuses, fraud and shareholder interference.. Owojori, Akintoye and Adidu (2011) aligned with these views, stating that; a review of statistics extracted from the liquidated banks revealed that the distress of 1995, when 60 out of 115 operating banks were distressed with non-performing loan (NPL) ratio of 67%, was attributable to poor loan collection and recovery machineries, that is, inability to collect loans and advances extended to customers and directors or companies related to directors and management. The NPL ratio further deteriorated to 79% in 1996 and to 82% in 1997 and by December 2002, the licenses of 35 distressed banks had been revoked, while in 2006, licenses of 14 more banks where revoked.
Further corroborating this assertions, Sanni, Adereti and Ebo (2012) noted that since March 2008, the Nigerian Stock Exchange (NSE) had lost over 65% of its value and an estimated N8Trillion ($54Billion), which translates to two-thirds of total market capitalization, had been wiped off bank stocks, Owojori et al (2011) stressed further that during the boom cycle, most banks in Nigeria had over-leveraged their balance sheets and were struck with trillions of Naira worth of bad loans, without disclosing it to shareholders and investors.. These problems are, to a large extent, traceable to weak credit administration and inability to detect early warning signals. Owojori et al (2011) alluded to the confirmation of financial institutions operators that their distress is mostly traceable to a huge portfolio of bad loans and advances.
According to Kargi (2011), the Nigerian banking sector has passed through a Tsunami which sent 13,272 Nigerians back to the labour market from the banking sector alone between December 2009 and March 2010 and which has also affected other sectors of the Nigerian economy like; Manufacturing, Telecommunications etc. To drive his point home, he made reference to a company in the manufacturing sector that sacked 400 of its work force spanning all cadres, on the 30th of April 2010. Onaolapo (2012) concluded that, painfully enough, this could have been avoided if only we were transparent and proactive and could hold on to the principles of best practices in our credit administration and control. Where a bank’s credit administration structure, process and procedure is weak, as is the case with many commercial banks in Nigeria, the system will always lack the mechanism and ability to detect early warning signals in loan facilities and this will always lead to declining loan portfolio quality.
Failure to install and operate an effective credit control system with capacity to drive pro-activeness in credit risk management is another problem confronting Nigerian commercial banks. Pro-activeness, according to Olokoyo (2011), refers to, acting in advance to deal with an expected difficulty or challenge. This is all about being anticipatory, putting measures in place to take care of both foreseen and unforeseen future challenges. Owojori et al, (2011) took the problem of credit control a step further by asserting that in the Nigerian banking sector, many loans are granted without collecting collateral and when collected, the collaterals are not adequate and when adequate they are not perfected. Owojori et al (2011) stressed further that, in many instances, loans are disbursed even before conditions precedent to drawdown are met, while some banks are reckless in disbursing facilities before formal loan applications and/or acceptance letters are received from intended borrowers. These are indications of weak credit control systems. The strength of the control mechanisms of some Nigerian commercial banks is questionable as a result of which, it is difficult for them to pro-actively identify credit related risk events inherent in their lending systems and deploy appropriate strategies to prevent or mitigate such risk events, thus creating room for loss-inducing vices such as fraud and unauthorized lending.
The role of supervisory and regulatory authorities in bank lending cannot be overemphasized. According to Iganiga (2010), there is a need to ensure that the strategies and processes adopted by our banking watch dogs are in tune with reality. The study stressed further that the regulatory authorities should adopt systems that match those of the financial institutions they are obliged to regulate, this will enable them carry out their functions of monitoring and supervising compliance with regulatory requirements effectively. Okonji and Okolie (2010) asserted that following the CBN examiners’ credit review exercise conducted in 2009, it was discovered among other loans that had gone bad and eroded the shareholders funds of the ailing banks, five of the banks had garnered margin loans loss of over N500Billion. The problems were attributed to laxity of control and supervisory responsibilities by the regulatory authorities, endemic corruptions, weak board and greed on the part of the executive management. Okonji et al (2010) further argued that, to say the least, the CBN has not lived up to its regulatory responsibilities and this may be due to inadequacy of qualified personnels, who are highly experienced in the art of bank examination and supervision. Okonji et al (2010) concluded that, alternatively, it is a possibility that the bank supervisors may have been compromised to issue clean bills of health for the bleeding banks over the years. Onaolapo (2012), and Saunders and Cornett (2003) observed that, all over the world, stakeholders in the financial systems of both developed and developing countries face the problems of failure of various regulatory frameworks designed by the supervisory authorities and inability of technological innovations to stem the rising toxic assets in many banks These identified weaknesses in supervisory and regulatory system lend credence to perceived compliance issues, regulatory skill gap, regulatory incompetence and ineptitude and the situation is worrisome as it seemingly contributes to incidence of low portfolio quality in the Nigerian banking sector. Therefore, this research sought to find solutions to the identified problems of weak credit risk management techniques confronting the loan portfolio quality of Nigerian commercial banks.
- Objective of the Study
The main objective of this research is to determine the effects of credit risk management techniques on loan portfolio quality of Nigerian commercial banks. The specific objectives are to:
- evaluate the effect of credit risk environment on loan portfolio quality of Nigerian commercial banks;
- examine the influence of credit analysis on loan portfolio quality of Nigerian commercial banks;
- determine the effect of credit administration on loan portfolio quality of Nigerian commercial banks;
- find out the relationship between credit control process and loan portfolio quality of Nigerian commercial banks and
- investigate the effect of supervisory and regulatory roles on loan portfolio quality of Nigerian commercial banks.
- Research Questions
The study will attempt to proffer answers to the following research questions:
- What is the effect of credit risk environment on loan portfolio quality of Nigerian commercial banks?
- To what extent does credit analysis influence the loan portfolio quality of Nigerian commercial banks?
- What is the effect of credit administration on loan portfolio quality of Nigerian commercial banks?
- What is the relationship between credit control process and loan portfolio quality of Nigerian commercial banks?
- What is the effect of supervisory and regulatory roles on loan portfolio quality of Nigerian commercial banks?
H01: Credit risk environment has no significant effect on loan portfolio quality of Nigerian commercial banks.
H02: Credit analysis has no significant influence on loan portfolio quality of Nigerian commercial banks.
H03: Credit administration has no significant effect on loan portfolio quality of Nigerian commercial banks.
H04: There is no significant relationship between credit control process and loan portfolio quality of Nigerian commercial banks.
H05: Supervisory and regulatory roles have no significant effect on loan portfolio quality of Nigerian commercial banks.
- Rationale for Hypotheses
H01: Credit risk environment has no significant effect on loan portfolio quality of Nigerian commercial banks.
The effect of the credit risk environment, both internal and external on lending decision and loan portfolio quality of commercial banks is significant based on the fact that the environment such as the information technology, the monetary policies and the macro-economy must be right and conducive for the lending process to run smoothly and add value to the loan portfolio. These are the views of existing literatures which argued that there is a significant relationship between credit risk environment and loan portfolio quality of commercial banks. According to Lata (2014), the work environment should be healthy and conducive for the employee because the relationship and interaction between the employees and their work environment has a significant impact on their sense of judgment, thus, a professional and friendly environment ensures that the employees work with sound mind and body. Onyukwu (2005) asserted that factors responsible for the bad loan portfolio and distress syndrome ravaging the banking industry include, weak macro-economic environment, inept management, conflict of interest on the part of managers and directors, poor loan processing, undue interference in the loan granting process and inadequate or absence of loan collateral. However, other studies are of the opinion that credit risk environment has no effect on loan portfolio quality as long as appropriate structures, frameworks and policies are in place to drive implementation of the lending process. In view of the foregoing, this study hypothecates that credit risk environment has no significant effect on loan portfolio quality of Nigerian commercial banks. This hypothesis was supported by Glen (2011); Gavalas & Syriopoulo (2014) and Reinhart & Rogoff (2011)
H02: Credit analysis has no significant influence on loan portfolio quality of Nigerian commercial banks.
The influence of credit analysis process on loan portfolio quality of banks is significant owing to the fact that credit analysis process will lead to lending decision and creation of loans, which could end up performing or non-performing, thus determining the ultimate quality of the loan portfolio (Onoh 2014; Onyukwu 2005; Ugoani 2016). However, this study is based on the hypothesis that credit analysis process has no significant influence on loan portfolio quality of Nigerian commercial banks and this position is supported by Owojori, Akintoye & Adidu (2011); Sanni, Adereti & Ebo (2012); Waweru & Kalani (2009);
H03: Credit administration has no significant effect on loan portfolio quality of Nigerian commercial banks.
Lending is a major component and is very critical to the heart of banking business, its administration therefore requires great technical skill and dexterity on part of lending officers and bank management in view of its effect on loan portfolio quality of commercial banks (Olokoyo 2011 and Haneef, Riaz, Ramman, Rana, Ishaq and Karim 2012). Based on the past findings of Oladele, Sulaimon & Akeke 2012; Omisore, Yusuf & Nwufo 2012 and Longstaff, Pan, Pedersen & Singleton 2011, this study hypothecates that credit administration system has no significant effect on loan portfolio quality of Nigerian commercial banks.
H04: There is no significant relationship between credit control process and loan portfolio quality of Nigeriancommercial banks.
It is desirable to have a good appreciation of credit control process as it relates to loan portfolio quality of banks as a strong credit control process will deter case of unauthorized lending and drive a sound loan portfolio quality. These views were shared by Owojori, Akintoye & Adidu (2011); Olokoyo (2011) and Ugoani (2016). Other existing literatures, including Sanni (2010); Fadare (2011) and Chen & Pan (2012) argued against existence of a relationship between credit control process and loan portfolio quality of commercial banks. It is therefore hypothecated in this study that there is no significant relationship between credit control process and loan portfolio quality of Nigerian commercial banks.
H05: Supervisory and regulatory roles have no significant effect on loan portfolio quality of Nigerian commercial banks.
The main regulatory and supervisory authorities in the Nigerian banking system namely, the Central Bank of Nigeria (CBN) and the Nigeria Deposit Insurance Corporation (NDIC) have designed various regulatory measures that are capable of improving loan portfolio quality of Nigerian commercial banks, subject to strict enforcement and compliance. (Abdulraheem, Yahaya & Aliu 2011, Aremu, Suberu & Oke 2010 and Chiejine 2010). Diverse opinions of Espinoza & Ananthakrishnana (2010); Glen (2011) and Lata (2014) suggested that supervisory and regulatory roles have no effect on loan portfolio quality of commercial banks and this informed the hypothesis of this study that supervisory and regulatory roles have no significant effect on loan portfolio quality of Nigerian commercial banks.
- Justification for the Study
Credit risk management is very sensitive to the business of banking just as credit economy is very vital to the success and survival of modern economies all over the world. According to Kithinji (2010), deposit mobilization will amount to nothing, if the funds so mobilized are channeled through wrong outlets, the beauty of financial intermediation lies in ability to ensure that the deposit mobilized from the surplus units of the economy are judiciously, professionally and prudently applied to support the production units of the economy. Onaolapo (2012) corroborated these views by taking a look at the crucial role of credit in the economy of a nation, the study asserted that, credit remains an indispensable lubricant and a tool of convenience for economic progress in every country.
However, various studies of eminent authors including, Awojobi and Amel (2011); Feridun (2008); Onaolapo (2012); Owojori, Akintoye and Adidu (2011) have shown that the level of non-performing loans contained in the credit portfolio of most banks, has always been on the high side and this translates to low level of loan portfolio quality, high level of loan provisioning, reduced profitability, reduced liquidity, declining earnings capacity, threat to capital and ultimately bank insolvency in some cases. Other factors responsible for the low credit portfolio quality of banks include, poor credit analysis, un-conducive credit environment, weak credit administration, inadequate control measures and reactive rather than proactive regulatory intervention. This view was supported by Flamini, Mcdonald & Schumacher (2009). Further review of existing literatures shows that each researcher concentrated on one or two identified portfolio quality determinants, thus, creating a gap by way of other crucial variables that equally constitute significant threat to bank loan portfolio quality. This study has therefore been structured to fill these gaps by conducting an in-depth research into the numerous identified factors attributable to effective credit risk management techniques that are capable of driving loan portfolio quality of Nigerian commercial banks.
1.7 Significance of the Study
Unfolding events in the Nigerian banking sector over the last two decades have shown that operators of the sector have a lot to do in the areas of entrenching and inculcating robust credit risk management culture in their credit process, in order to attain the desired goal of low non-performing loan (NPL) ratio and high loan portfolio quality. The research work of Aremu, Suberu and Oke (2010) has shown that, an effective credit risk management system is the foundation upon which the super structure of sound banking and lending systems are built. This derives mainly from the significant impact of credit risk management system on loan portfolio of banks, which is the main focus of this study. The study would therefore aid credit risk managers, lenders, bank management and Board of Directors in setting up efficient credit risk management structures, policies, processes and procedures, with capacity to manage their credit risk exposures optimally and maintain a decent loan portfolio quality at all time.
According to Awojobi et al (2011), the Nigerian credit market is not insulated from the global economic and financial environment. This study examined how the credit risk environment affects the lending process of Nigerian commercial banks and their portfolio quality. The findings would help lenders in deploying strategies to manage their internal and external credit risk environment in order to engender a positive effect on loan portfolio quality. Lending decision is a function of quality of credit analysis and evaluation of the individual lending bank. This study shed some light on processes and procedures of sound credit analysis that could significantly lead to quality lending decisions and improve portfolio quality. This would be of significant interest to credit analysts and approving authorities, as credit analysis process would be more thorough and lending decisions would be more accurate, while emergence of toxic assets would be reduced to the barest possible.
The study also examined how an effective credit administration system could quickly throw up early warning signals, thus significantly nipping loan delinquency.in the bud, improving collections, minimizing growth of non-performing loans to the barest possible and improving loan portfolio quality. An effective credit control mechanism must have capacity to prevent unauthorized lending. As part of the components of this study, it shows various credit control measures that are capable of preventing unauthorized lending and impacting portfolio quality positively. The credit administration and control mechanisms discussed in this study would be of great significance to bank Chief Risk Officers, executive directors and shareholders, given the prospect of capacity to detect early warning signals, minimize unauthorized lending and positively impact loan portfolio quality.
The role of supervisory and regulatory authorities is very crucial in the credit risk value chain. This study deeply examined how well these roles are played as well as various regulatory measures that drive the process and their efficacy in charting the course of loan portfolio quality of Nigerian commercial banks. This study would trigger deployment of pro-active regulatory measures rather than reactive measures. This would boost loan portfolio quality of the banks and also improve bank liquidity and capacity to create more loans to help macro-economic growth.
1.8 Scope of the Study
This study covered credit risk management structures, practices, procedures and processes of Nigerian commercial banks over a ten-year period of 2006 – 2015, with emphasis on how these contribute to the banks’ loan portfolio quality. The scope of study extends to the credit risk environment, both internal and external, with particular focus on how these impact the lending process of Nigerian commercial banks and their loan portfolio quality. The study examines the process and tools of credit analysis, the risk asset acceptance criteria, risk rating matrix, the 5-c’s of lending, credit documentations, the authorization limits, the policies and guidelines and how all these are tied together, leading to an informed lending decision and improved loan portfolio quality.
The structure, process and approach to credit administration, loan monitoring and review as well as its capacity to identify early warning signals is another area covered in this study. Credit control measures and policies put in place by the commercial banks and their adequacy to prevent unauthorized lending is within the scope of this study. Finally, the study covers supervisory roles, efficacy of regulatory intervention and their competence in solving compliance issues and impacting loan portfolio quality of Nigerian commercial banks.
- Operational Definition of Terms
Credit Risk: The risk that a borrower will default on any type of debt by failing to make required repayment as at when due. Credit risk can also be defined as the potential for loss due to failure of a borrower to meet his contractual obligations to repay a debt in accordance with the agreed terms.
Loan Portfolio: Total loans held by a bank or finance company on any given day.
Financial Market: Markets for sale and purchase of stocks (Shares), bonds, bills of exchange, commodities, futures and options, foreign currency etc, which works as exchange for capital and credit.
Credit Analysis: The method by which one calculates the credit worthiness of a business or organization. In other words, it is the evaluation of the ability of a borrower to honour its financial obligations.
Credit Administration: The establishment of credit policy and planning, organizing, directing and controlling all aspects of the credit function.
Credit Control: A system of credit checks designed to ensure that customers pay on time and do not owe more than their credit limit.
Non-performing Loan: A loan that is in default or close to default. Many loans become non performing after being in default for 90 days, but this can depend on contract terms. A loan is non-performing when payment of interest and principal are past due by 90days or more or at least 90days of interest payment have been capitalized, refinanced or delayed by agreement or payments are less than 90days overdue, but there are other good reasons to doubt that payments will be made in full.
Stress Test: A simulation technique used on asset and liability portfolio to determine their reactions to different financial situations. Stress testing is a useful method for determining how a portfolio will fare during a period of financial crisis.
Toxic Asset: A popular term for certain financial assets whose value has fallen significantly and for which there is no longer a functioning market so that such assets cannot be sold at a price satisfactory to the holder.
Market Capitalization: The total value of the issued shares of a publicly traded company. It is equal to the share price times the numbers of shares outstanding.
Financial Intermediation: The process performed by banks of taking in funds from a depositor and then lending them out to a borrower. The banking business thrives on the financial intermediation abilities of financial institutions that allow them to lend out money at relatively high rates of interest while receiving money on deposit at relatively low rates of interest.
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