1.0 Introduction
1.1 Background of Study
Banks are an integral part of a country's development. Their major role in any economy is the ability to mobilize funds from surplus unit to the deficit unit through lending activities. When loans and advances granted are paid promptly, this serves as an impetus for additional credits to be provided to existing and future customers. However, in every imperfect market there exist some risks that affect the repayment of the credit facility by banks' customers. Basel (2001) identified credit risks as the major form of risks that affect financial institutions.
Credit risk can occur from two major sources- the bank management (through lack of thorough investigation of loan requests of the customer) and the customer (having hidden agenda, unknown to the bank, on the credit facility requested for). These combined activities of banks' management and customers lead to non-payment of both the principal sum and interest as and when due. The loans that are not paid at the agreed date are known as non-performing loans. The non-performing loan, especially when it is deemed lost, is the greatest threat to the profitability and survival of banks. When it is lost, it will hinder banks from achieving their set target and can also lead to organizational failures (Greuning & Bratanovic, 2003, Kolapo, Ayeni, &Oke, 2012 and Poudel, 2012).
The global financial meltdown of 2008 accelerated a fundamental change in the banking industry the world over. It led to the diversification of banking services in order to become more competitive and also allowed for mergers and acquisitions in the industry. The impact of the meltdown was so much that almost all sectors of global business was affected; with the banking sector most affected. Because of the intermediation functions of deposit money banks, which include credit creation, they are exposed to a lot of risks including default and credit risks. These risks if not properly handled most times lead to financial distress and ultimately bankruptcy. Deposit money banks generate credit to their customers with the major objective of making profit in the process. The non-payment of loans or other forms of credit by debtors plays an important role in banks profitability because a large part of banks revenue is interest generated from loans.
Banks' management recognizes the fact that mitigating the occurrence of the risk of non-performing loans can only come from the institution of pragmatic credit administration policy and the policy must incorporate risk assessment and follow up mechanism. Capital adequacy as an ingredient of credit risk measure depicts the extent to which shareholders funds cover non-performing loans. It helps to prevent bank failure if it is properly controlled and managed. The prescribed ratio is usually provided by the regulatory institution, such as the Central Bank of Nigeria (CBN). Profitability is essential for the survival of any firm that is in business and banks do rely on interest income generated from loans and advances extended to their customers. Thus, non-performing loans, advances and bad debt can erode the profitability of banks.
1.2 Statement of Problems
Risk management is at the core of lending in the banking industry. Many Nigerian banks had failed in the past due to inadequate risk management exposure. This problem has continued to affect the industry with serious adverse consequences. Banks are generally subject to wide array of risks in the course of their business operations. Nwankwo (1990:15) observes that ‘the subject of risks today occupies a central position in the business decisions of bank management and it is not surprising that every institution is assessed an approached by customers, investors and the general public to a large extent by the way or manner it presents itself with respect to volume and allocation of risks as well as decision against them'. Other risks include insider abuse, poor corporate governance, liquidity risk, inadequate strategic direction, among others. These risks have increased, ‘especially in recent times as banks diversity their assets in the changing market. In particular, with the globalization of financial markets over the years, the activities and operations of banks have expanded rapidly including their exposure to risks.
1.3 Objectives of the study
The primary objective of the current work is to empirically explore the relationship between credit risk management practices of Nigerian listed deposit money banks and financial performance.
The following are the specific objectives of the study:
- To examine the effects of credit risk exposure on growth and profitability of Nigeria commercial banks.
- To examine the causes of credit risk in Nigeria commercial banks.
- To examine the impact of credit risk management on total loans and advances of deposit money banks in Nigeria.
- To assess the impact of credit risk management on return on assets of deposit money banks in Nigeria.
1.4 Significance of Study
This study will be of immense benefit to the following groups:
- Banks: The result of this study should provide information to the deposit money banks on the level of performance in the face of their credit risk management in place. This is likely to spur them to critical review of their credit risk management styles,
- Investors: The study will provide investor with the knowledge they need about risk management in banks. They will then be able to study the extent to which a bank is exposed to risk and be able to take wise decisions regarding where to invest.
- The General Public: The product of this study can create the awareness on the extent of credit risk and its management in banks. This can serve as eye-opener to the general banking public visa-vis the safety of their deposits in banks.
- Researchers: Essentially, the results of this study can provide a reference document for further researches and evaluation of risk management by other researchers. This research will increase the availability of literature in the field of risk management in banks.
- Policy Makers: Finally, the study will be of immense benefit to the policy makers as it will provide more insight into risk management and guide them in policy making and implementation.
1.5 Limitations of Study
In carrying out this research there are possible constraints which may occur which pose little hindrance to the effective and successful completion of the project work by the researcher. Such constraints are highlighted as follows; financial constraint i.e, there is limited finance available in harnessing research materials such as foreign journals, publications, e.t.c. because the cost of getting research journals were quite enormous to be used in the research work. Time was also a constraint as time frame that was given in carrying out this seminar was limited.
