RISK MANAGEMENT IN BANK LENDING:
A CASE STUDY OF EQUITORIAL TRUST BANK.
The emergence of Banks owned by the local private sector began in the mid-1970s. Financial markets in the period since independence have been dominated by foreign and government owned commercial banks. But deficiencies in financial intermediation provided an opportunity for local private investors to enter financial markets. Between the late 1970s and the mid-1980s, 13 local Banks were set up in Nigeria. The growth of local banks accelerated dramatically in the second half of the 1980s, with 70 Commercial and Merchant Banks established between 1986 and 1991 when the Central Bank of Nigeria suspended issuing new licenses: almost all of these were wholly owned by local investors.
In Nigeria, the rising cases of bank distress have also become a major source of concern for policy makers. As a result of attractive interest rate on deposits and loans, credits were given out indiscriminately without proper credit appraisal. The resultant effects were that many of these loans turn out to be bad. It is in realization of the consequence of deteriorating loan quality on the banking sector and the economy at large that this paper is motivated. This paper, therefore, attempts to evaluate the effect of risk management in bank lending, using Equitorial Trust Bank as a case study.
- BACKGROUND OF THE STUDY
The Nigerian financial institutions have faced difficulties over the years for a multitude of reasons but the major cause of serious banking problems in recent times continues to be directly related to lax credit standards for borrowers and counterparties, poor portfolio risk management or a lack of attention to changes in economic or other circumstances that can lead to a deterioration in the credit standing of a bank’s counterparties. Credit risk is most simply defined as the potential that a bank borrower will fail to meet the obligations in accordance with agreed terms. The goal of risk management in bank lending is to maximize a bank’s risk adjusted rate of return, maintaining risk exposure with acceptable parameters.
The problem of Bank distress in the Nigerian Banking Sector has been observed since 1930s. In fact, between 1930 and 1958, over 21 Bank failures were recorded. The Bank failures during the time were attributed to the domination of foreign Banks in terms of the exclusive patronage by British firms. Other factors that led to mass failure of the indigenous banks were low capital base, lack of managerial expertise and untrained personnel.
The deregulation of the financial system was embarked upon by the military administration in 1986 as part of the Structural Adjustment Programme (SAP). The deregulation witnessed sharp changes in banks’ operations, regulatory environment and the distress syndrome resurfaced again in Nigeria. The changes brought about by SAP included the liberalization of the foreign exchange and money markets, the introduction of prudential guidelines and accounting standards, increase in minimum paid-up capital, establishment of Nigerian Deposit Insurance Corporation (NDIC), relaxation of mandatory sectoral allocation of credits, etc.
The Late 1980s and early 1990s were years of financial boom, as the number of players increased substantially in the system? For instance, between 1986 and 1989, about 38 new commercial and merchant banks were created. The increase in the number of banks over-stretched the existing human resources capacity of banks which resulted to many problems such as poor credit appraisal system, financial crimes, accumulation of poor asset quality, among others. The consequence was increase in the number of distress banks. During 1994 alone, two banks had their licenses suspended (Republic Bank Ltd and Broad Bank of Nigeria Ltd). Another four banks has their licenses revoked. Also in 1994, the number of banks adjudged distressed by the Central Bank rose by 10 to 42, excluding the four banks that were closed during the year. By the end of year in 1994, non-performing loans and advances constituted about 60.33 percent of the total deposits of the entire banking industry. Furthermore, the ratio of non-performing loans and advances to the total loans and advances in the entire banking industry was 43.03 percent while that for the distressed banks was 64.5 percent according to CBN Annual Report 1994. By the year 1998, up to 31 banks were being liquidated.
The Global Financial crisis is yet to run its full course, but is already one of the largest crises ever experienced according to the existing literature. With its roots in banking, the sub-prime mortgage crisis that commenced in the United States in 2007 soon resonated in other sectors of its financial system, and the economy at large. The crisis later spread to Europe and now has become a global phenomenon. The emerging economies were not isolated. In the wake of the United State Government bid to boost housing was a policy error that permitted sub-prime clientele unrestricted access to mortgage finance. Combined with the thriving derivative market, the horizon for credit expansion widened to unprecedented levels. The result was private over-borrowing accompanied by an internal debt crisis. As long as capital flows and credit expansion grew unchecked, lending expectedly spilt over from financing safe and productive investments to risky and speculative assets. Housing prices had trended upwards for ten consecutive years up to 2004, enticing speculators. Mortgages perfected imprudent lending practices.
The cannons of basic lending were never followed in credit creation. Credits were generally not collaterized in the mortgage sub-sector.
Credits, especially in mortgage finance and commercial real estates were excessive to the repayment ability of the borrower. The housing market was overpriced. Investors borrowed to enter the booming overpriced market without a thought that the market could ever crash. It crashed unexpectedly and commercial loan defaults became widespread. Financial institutions gradually became illiquid. Available stocks were dumped on the capital market to shore up liquidity. Banks became unwilling to lend to one another. The financial system was weakened by runs, bankruptcy, takeovers, job losses and bail-outs. United State financial institutions failed to honour maturing investments, especially placed by foreign investors.
The Nigerian economic recession of 1982 could not have dragged the rest of the world into a global recession because the quantum of foreign investments in the Nigerian economy was minimal. Although there were defaults in the return of deposits, it was an internal affair. Nigeria was in it alone and had to steer to good financial health on its own accord. There is hardly any bank anywhere in the world that does not have correspondence arrangement with a bank in the USA, at least for the confirmation and settlement of letters of credit as well as for the transfer of funds. By arrangement, all such idle funds are invested in the American financial system, especially on high-yielding derivatives.
According to October 2008 IMF World Economic Outlook, the global financial crisis did not have any direct and serious consequences on sub-Saharan African, of which Nigeria is one. However, Nigeria feels the pinch in various ways such as difficulty in sourcing new credit lines by banks and real-sector operators from abroad, possibility of non-renewal of expiring credit lines to banks sourced from abroad, withdrawal of liquid assets and other investment portfolio by foreigners, reduced inflow of foreign direct investments etc.
As at third quarter of 2009, there was a shift in the Nigerian banking system as a result of audit carried out by the central bank of Nigeria, the apex regulatory body, on Nigerian banks. Consequent upon their findings, the CBN replaced the leadership of Eight (8) Nigerian banks and injected N620 billion of liquidity into the sector for a rescue. This was a natural consequence of bad lending decisions by banks leading to huge provisions and erosion in their capital. A bulk of depositor’s money was lent for speculative purposes in the capital market. The attitude of some borrowers who are unwilling to repay even when they are known to have the means to service their debts. Such borrowers seek refuge under the inadequate legal framework and cumbersome loan recovery processes which make it difficult for the lending bank to foreclose collaterals. Obtaining judgment when a loan defaulter is sued is often lengthy, thereby increasing the cost of banking business in Nigeria. In the case of some small borrowers particularly in priority sector of agriculture and small and medium scale enterprise, they willfully defaulted on the wrong notion that the bank loans are part of their share of the “national cake”. There are also borrowers who through connivance with some banks’ staff take bank loans with no intention to repay such loans. These problems greatly impaired the quality of banks’ assets as non-performing loans and advances become unbearable and turn out to be a high burden on many of them.
Insider abuse by bank owners, directors and management staff is another factor which exacerbated loan defaults in some weak banks. Insider in those banks obtained loans and advances without adequate collaterals in contravention of banking regulations. Sometimes, the loan applications were poorly appraisal with inadequate documentation. Poor lending and borrowing culture was contributory to distress in the system.