THE EFFECTS OF CREDIT MANAGEMENT ON PROFITABILITY OF NIGERIAN BANKS
THE EFFECTS OF CREDIT MANAGEMENT ON PROFITABILITY OF NIGERIAN BANKSABSTRACTOne of the major problems confronting the Nigerian banking industry today is the increasing incidence of loan defaults and consequent loan losses which manifested on the profitability of the banks, with huge uncollectible loans and advances. This study therefore, examines the effects of loans and advances on the profitability of Nigerian banks.The methodology used in the research includes secondary sources and primary sources of data collection. The data collected were analyzed using Correlation Coefficient, Pearson Product Moment Correlation and other statistical tools to establish trends and relationship between the variables. Furthermore, graphs were used in the interpretation of the data collected.The study found out that at 5 percent level of significant; the calculated value of z is grater than the tabulated value in most of the banks considered in the study. Therefore, this leads to the results that there is significant effect between loans and advances and its profitability. In order words this means that there is a significant effect between the way the banks manage their credits portfolio and the profitability of the banks.It is the recommendation of the study that there is the need for a strong internal control system to strengthen the credit policy on the management of the banks’ credit facility. This involves the need for thorough checking of loan applications at various stages of granting loans and advances in the banks. Furthermore, banks must ensure strict tradeoff between their liquidity and profitability. This will ensure strict compliance with the money being kept by the banks and the amount granted for loans and advances.vi.TABLE OF CONTENTTitle pageDeclarationCertificationDedicationAcknowledgmentAbstractTable of Contentsiiiiiiivvviviii, ix, x, xiChapter 1 GENERAL INTRODUCTION1.1 Background of the Study—————————- 11.2 Statement of Problem——————————– 71.3 Objectives of the Study—————————— 131.4 Statement of Hypotheses—————————- 151.5 Scope of the Study———————————— 151.6 Significance of the Study—————————- 18viii.Chapter II CONCEPTUAL FRAMWORK AND RELATED LITRRTURE 2.1 Introduction——————————————- 202.2 Types of Credit facilities—————————- 212.3 Credit Maturity profile —————————— 242.4 Credit Management Concepts———————- 252.4.1 Commercial Loan theory 2.4.2 Shiftability Doctrine 2.4.3 Anticipated Income theory 2.4.4 Liability Management 2.4.5 Profitability 2.5 Credit Policy Formulation————————— 322.6 Criteria for loan/Loan Decisions and its effect onprofitability——————————————– 402.7 Ratios—————————————————- 472.8 Securities for Bank Loans and Advances———– 582.9 Loans Review monitoring and Evaluation———- 612.10 Policy on Loans Classification and Recovery Procedure -652.11 Summary————————————————- 71 Chapter III RESEARCH METHODOLOGY 3.1 Introduction———————————————- 72 3.2 Research Methods————————————— 73 3.2.1 Historical Research Method 3.2.2 Descriptive Research Method 3.2.3 Experimental Research Method 3.2.4 Survey Research Method 3.3 Methods of Data Collection—————————- 84 3.4 Methods Data Analysis——————————— 90 3.4.1Correlation Coefficient Analysis 3.4.2 Linear Regression Analysis 3.4.3 Ratios Analysis 3.4.4 Time series Analysis 3.5 Justification of Methods and Techniques———– 90 3.6 Summary————————————————- 90 Chapter IV DATA PRESENTATION, ANALYSIS4.1 Introduction ——————————————– 914.2 Analysis of Profitability; Loans and Advances—– 914.3 Analysis of the effects of Credit Management onProfitability among Nigerian Banks—————— 1174.4 Analysis of the effects of Classified Loans and the Qualityof Loan Assets.——————————— 120 Chapter V. SUMMARY, CONCLUSIONS &RECOMMENDATION 5.1 Summary————————————————– 123 5.2 Conclusion———————————————— 126 5.3 Recommendation—————————————– 127 5.4 Frontier for Further Research————————– 128 CHAPTER ONE:GENERAL INTRODUCTION1.1 Background of the Study.In every economy, there exist facilities for the creation, custodianship and distribution of financial assets and liabilities (Mohammed, 2002). These facilities make up the financial system in any economy of which banking is a sub-sector. Banks are global phenomena, a universal institution. In fact, banks intermediate between surplus and deficit economic units, thereby, acting as machinery for the allocation for the allocation of scarce financial resources. (Mohammed, 2002). Consequently, banks occupy a primary position in the economy as it is the fulcrum of the money market and the central nervous system of the economy. The banking industry world wide, and in Nigeria particularly, had been witnessing a lot of structural changes. These changes are meant for the improvement of services for the betterment of it operators and for the benefit of the customers, shareholders as well as the economy at large.In Nigeria, the business of banking has not been Stagnant, the advent of the British political and economic influence brought about the evolution of banking in Nigeria. This is as far back as the last decade of 19th Century, precisely in 1892. The first Commercial bank in Nigeria “the British African Banking Corporation(BABC)” was formed in that year (Onanuga, 1998.) Ever since the first bank was formed, the banking industry had witnessed a lot of changes. In July 1958 for instance, in recognition of its importance at that time, the Central Bank of Nigeria was formed as the apex bank in Nigeria under the Central Bank of Nigeria Ordinance cap 30 of portfolio olio 1958, (Agom, 2000). The bank is saddled with the responsibility of supervising and monitoring banking activities in Nigeria. Another boost of the industry came up in 1961 when another history was recorded in the banking arena with the establishment of the first Merchant Bank – PHILIP HILL LTD. Though the bank was more or less like the branch of a UK Merchant Bank – HILL SAMUEL & CO. It paved the way for the establishment of the JOHN HOLT LTD’S finance firm – NIGERIAN ACCEPTANCES. These two firms later merged under the name NIGERIAN ACCEPTANCES LTD in 1969.The Nigerian banking arena witnessed yet another change in 1990 when the Community and Peoples banking systems (a form of unit banking) were introduced to further promote and instill the habit of banking in the Nigerian populace (Mohammed , 2002). The most recent of the development in the banking industry came up when a new method of banking was introduced, the Universal System of Banking. Otherwise referred to as “The Universal Banking System” It is the latest of all banking practices globally, although in some economies they do not use the term Universal Banking, but practice it through a partial or complete removal of the differences among the various banks which hitherto specialized in a narrow range of banking. Iyari, (2001:1) opined that “The whole idea of Universal Banking was spurred by the forces of globalizations, deregulation of financial markets, trade liberalization, internationalization of economic activities and the phenomenal impact of information technology on business process and decision – making”The Universal banking system is a system of banking that permits any bank to determine its portfolio offerings, which may involve non – financial services. The approval in principle given by the Central Bank of Nigeria for the practice of Universal banking in Nigeria in January, 2000 was well appreciated in the industry. Merchant banks are already converting to Commercial banks to be able to access the relatively cheaper and stable deposits, also given the diminishing investment banking business in the weak economy. Considerable prospects for the re-alignment of activities and forces will be explored to achieve economics of scale and to enhance profitability.Generally, banks render a number of services to the economy, foremost of which is the provision of finance which has been described as a lubricant for economic growth (Carmero et al, 1967). A critical factor in this growth process is adequate supply of credit to the various sectors of the economy to carry on their activities. The role of the banking system in this regard is that of financial intermediation which entails moving funds from the surplus unit to deficit unit of the economy, to facilitate trade and capital formation.Banking as a service industry is organized to make profit for the shareholders vide provision of banking services and supply of financial needs to individuals and cooperate bodies. In order to achieve this, banks accept deposits from customers and lend to others. According to Sayer, (1970:175), banks seek to make themselves as attractive as debtors and as efficient as creditors that they can earn a substantial gross income from the difference between the interest they charge as creditors and the interest they pay as debtors”.Statutorily, Banks and Other Financial Institutions Act (BOFIA, 1991), Section 61, defines Banking Business as business of receiving deposits on current account, savings account, or similar accounts, paying or collecting cheques, drawn by or paid in by customers, provision of finance or such other business as the Governor of Central Bank of Nigeria (CBN), by order published in the Gazette, designate as banking business. Through credit, banks promote investments and sale of a wide range of goods and services. Banks in Nigeria have been performing this financial intermediation role in the economy. Thus, loans and advances today constitute a major asset of the total asset structure of banks in the country. (Banks’ Annual Report and Accounts)An asset constituting a significant proportion of total assets deserves nothing less prudent and efficient management if the economy impacts of banks on the economy are to be optimally realized. In addition, banks are expected to derive their income principally from lending/credits (loans and advances) and investing, and to a lesser extent, from fees and charges received from services rendered. According to Crosse (1962:66), Income from loans and advances should constitute more than 60 percent of the total income of the banks”.Developments in the Nigerian economy in the last decade, specifically, from 1992 to date have had considerable impact on the functioning of the banks and other non financial institutions. The decade witnessed a down – hill trend in the Nigerian economy, occasional dwindling oil revenue and the global economic recession. Banks as a sub-system of national economy is not immune and is having its own share in the form of increasing loan defaults because of the inability of borrowers to redeem their loans, which resulted in banks failure and subsequently banks distress.1.2 Statement of the Problem:One of the major problems confronting the banking industry today is the increasing incidence of loan defaults and consequent loan losses which manifested on the profitability of the banks. Sequel to increasing incidence of huge bad debts in the Nigerian banking industry, insider’s abuses, management’s competence have been called to question. Bad debts, it must be noted occur due to the inability of the bank’s management to recover loans granted to customers.It is reported in the NDIC 1989 Annual Report and Accounts that the deteriorating health of the banking industry is on the increase. With reasons adduced for this development in the report to include the following amongst others:-huge uncollectible loans and advances;the financing of long-term assets with short-term funds;over trading;unsound management practices;reliance on volatile deposits;non-standardization of accounting practices and financial reportage.These prompted the issuance of CBN Prudential Guideline in 1990, to sanitize the banking system. Many banks even after the liquidation of several banks in 1998, still paraded inexperience and “glaucoma” visionary managers. Also many banks lack well articulated credit policies, efficient and effective internal control, and high quality professional and motivated staff.In 1996 and 1997, the number of frauds reported by Nigerian banks were 127 cases involving about N1006 million and 587 cases involving N1543 million respectively (NDIC, 1997). There are also several cases of insider abuses and even board tussles. Many of these cases bordered on corrupt tendencies, which led to the failure of many banks a few years ago.As earlier pointed out, loans and advances constitute the largest proportion of the banks’ earning asset hence loan defaults which results in bad debts, destroy this asset and subsequently reduce banks profitability as bad debt or provision for bad debt are charged to profit and loss account. Thomas (1964), described loans as being vital both to the banks and to the general public in that it is the source of earnings as well as the essential items that determines the liquidity and ultimate solvency of the banks. Bank credits in form of loans and advances are funds transferred to the deficit unit of the economy for investment purposes and any lowering of banks asset (loans and advances) due to bad debts will affect the amount available for future credits. Consequently, this will affect production, employment, taxes due to the government and funds available for social services, and also affect the bank growth.The incidence of huge bad debts resulting in non-profitability and subsequent bank failure/distress in the banking industry has not only attracted the attention of the monetary authorities but the public at large. Igwesi, (2005) observed that, “The issue of distressed bank is a very great concern to the entire people of the country and indeed some of us in the House of Representatives. We feel so bad about the so-called liquidation squeeze and other things attached to it based on the fact that we are representatives of the people and most of the people who are worst hit in this matter are the electorate, the masses”. He went further to say; “The problem to me really borders on whose responsibility it is to regulate the sector and check the liquidity rate in our banking sector and also the issue of re-capitalization. This problem is really causing untold hardship on our people, it is certainly not in the interest of the nation’s economy and it is capable of sounding a very bad signal to potential investors and the private sector too.”There is a growing concern of increased bank failures and bank distress if the problem is not urgently addressed. This fear may not be out of place when viewed against recent developments in the industry. Between the years 2001 and 2002, the CBN and NDIC closed the gates of Savannah Bank and peak Merchant Bank for problem of liquidity. Others, SGBN and AIB were suspended from the clearing House. In August, 2003 the Central Bank of Nigeria took over control of Bank of the North Limited, one of the oldest indigenous bank in Nigeria which was established by the default Northern Region and incorporated on 9th September, 1959 as a private limited liability company engaged, in commercial banking business. These take over and suspension from clearing House were attributable to their distressful situation and liquidity ratio of less than 20 percent, occasioned amongst others by poor management resulting in huge uncollectible debts and consequently affecting the banks profitability.Thus, it is within this setting that growing concern emerged regarding increased potential of bank failures. As Marshall (1980:113) observed that “a commercial bank failure implies a loss of stockholders investment in the bank; however, the general public may loss the insured portion of its deposit as well as other bank debt owed to the public. Further-more, a banks’ failure may seriously shake the public confidence in other banks”.In a report by a World Bank staff who noted that, banks as an institution will remain dominant in the Nigerian financial system for sometime and can be made more efficient by improving their management system. According to the report, better management requires new lending /credit policies and better loan recovery procedures. (UBA, Monthly Business Economic digest, June, 1990). The task before this study is to make an empirical analysis of the management of loans and advances and its effect (positive, negative or both) on the profitability of Nigerian banks and the causes of the problem if any, so as to be in a position to proffer solution to aid management performance towards better profitability.1.3 Objective of the StudyThe basic objective of the study is to assess the performance of Nigerian banks in managing loans and advances in their asset structure and how the management or mismanagement affects the profitability of the banks.The specific/objectives of the study included the following:-to examine the structure put in place by Nigerian banks for the management of loans and advances and to determine its adequacy or otherwise.to examine the regulatory and institutional frame work within which the banks perform their financial intermediation role.to examine the Bank’s practices in granting loans and advances and their recovery procedure.to examine the extent of loan losses and the quality of this asset (loans and advances).to identify the problem that impairs the banks’ effective and efficient management of loans and advances portfolio and proffer solution.1.4 Statement of Hypotheses:In order to assess the effect of Credit Management on profitability of Nigerian Banks; the following hypotheses are to be tested;H01: That there is no significant effect between the management of loans and advances portfolio and the profitability of banks.H02: That the effects (positive, negative or both) of loans and advances portfolio management on the profitability of Nigerian banks do not cut across most banks.H03: That classified (performing and non-performing) loans and advances are on the increasing direction over the period (as covered in the study) resulting in deterioration of loans asset quality.1.5 Scope of the StudyThe Study looks at management of credit facility (Loans and advances) and its effect on profitability of Nigerian Banks using some selected banks as case study.These banks include; Bank of North Limited (BON), First Bank of Nigeria Plc. (FBN), Union Bank of Nigeria Plc. (UBN), Standard Trust Bank Plc. (STB) Habib Nigeria Bank Limited (HNB) Chartered Bank (CB) FSB and United Bank for Africa (UBA). The study period is 10 years spanning from 1993 to 2002. This period witnessed the most dramatic changes in the economic landscape of Nigerian banks in recent past, occasioned by the downturn in the national economy, political era and the consequent introduction of various policies by government to pull the economy out of the doldrums. These changes have had considerable impact on the functioning of the financial system. For instance, the introduction of stabilization security in 1992, the withdrawal of government funds from banks of CBN in 1989 and the return of government funds to banks in 1991 etc. These changes have had considerable impact on the functioning of the financial system. The period chosen, therefore, will be of immense value in establishing trends in loan management over the period and will aid in predicting the likely future trend. Knowledge of the likely future trend will be of help to the bank management in bringing the future under control for effective and efficient management of credit (Loans and advance) portfolio.1.6 Significance of the StudyA study of this nature is in valuable not only to the bank’s management, other banks, share-holders, potential investors and depositors but to the economy as a whole.To the bank’s management and managers of other banks, the study draws their attention to the importance of this asset (loans and advances) to the overall success and growth of their organizations. As the largest component of a bank’s total assets, there is the need for its effective and efficient management. Besides, loans and advances are also the most profitable and risky assets, hence the need for proper management for maximum profitability while minimizing the risk element.The study is also significant to the share holders, both existing and potential ones. This springs from the fact that the proper management of this resource will enhance reasonable returns on shareholders investment.As pointed out earlier, banks performance of intermediation activity involves accepting deposits from surplus unit of the economy and channeling it to the deficit units. This role ensures proper allocation of scarce financial resources to the various sectors of the economy thereby enhancing the overall growth and development of the national economy.One of the reasons adduced for bank failure is that of indiscriminate granting of loans that make collectibles virtually impossible. A study of this nature will draw the attention of bank’s management to the need for proper management of loans and advance to obviate failure and its negative consequence on profitability and economy growth. Bank’s failure erodes depositor confidence in the financial system, thus resulting in dearth of loanable funds to the economy. To enhance depositor confidencein the system, there must be proper management of the loans and advances portfolio to enhance growth of the bank. Students as well as other researchers would find this study worthwhile.The study, therefore, is timely, current and relevant not only for the continued visibility of the financial system but the overall growth and development of the economy.The findings of this study if duly and adequately incorporated by all the operators of the banking industry and the financial system in general will enhance profitability and efficiency in the provision of banking services in the country.
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