CREDIT RISK MANAGEMENT AND BANKS PROFITABILITY IN NIGERIA

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CHAPTER ONE

INTRODUCTION

1.1 Background of the study

Banks are important to economic development through the financial services they offer. Their intermediation role can be said to be a catalyst for economic growth. The recent failure of banks has been a concern for Central bank of Nigeria and shareholder of these banks. Loans and advances is a major source of earnings for banks. Banks are exposed to high risk as a result of lending to customers. Banks face the risks of borrowers not being able to repay principal and interest as they fall due. Experience shows that poor credit risk management typified by high level of insider loans, speculative lending and high concentration of credit in certain sector among other issues impede the stability and profitability of banks. Over the years banks in Nigeria have been carrying huge non-performing loans that rose progressively from year to year without being reported through sound credit risk management. In the past several banks failed as a result of high non performing loans running into several billions of naira.

Attractive interest rate on deposits and loans in the 1990’s led to indiscriminate granting of loans without credit risk appraisal and management. This led to bad and irrecoverable loans. Despite measures put in place to check the trend, the rising profile of non-performing loans, continued unabated into 2000’s. The study is motivated by the negative effect of non performing assets on shareholders fund and would be relevant as it addresses how credit risk affects bank profitability. Greening and Bratanovic (2003) posits, that because of the potentially dire effect of credit risk, it is important to perform comprehensive evaluation of banks capacity to evaluate,monitor and manage loans and advances granted to customers. The study evaluates the extent to which failure in credit risk management impede profitability of banks in Nigeria.

1.2 Statement of the Problem

It is generally accepted that credit risk is the most prominent risk in terms of the level to which it impacts on the quality of risk assets as well as bank profitability and eventually bank failure. Banks grant large portion of their deposits as loans to customers which account for a large portion their income. Provisions made on non performing loans will have negative impact on the profitability of the banks. Inadequate information about borrowers made the Central Bank of Nigeria to set up Credit Risk Management system. This system ensures that loans granted by banks are captured and made available to all the banks in Nigeria. The objectives of CBN Credit Risk Management System is to provide information, monitor the level of borrowings, and facilitating consistent classification of credit. As part of effort to stem the problem of credit risk Asset Management Corporation of Nigeria was established in 2010 to buy off the non-performing loan of banks in Nigeria and take over eight weak banks.

Central Bank of Nigeria periodically issues prudential guidelines that address quality of loan assets, provisions on nonperforming loans, capital adequacy and stability of the banking industry. The code of corporate governance for banks was issued after consolidation to check corporate governance and risk management failures. This requires that bank should adequately disclose it risk management in its annual reports. Despite the efforts made by regulatory authorities to stem the tides of credit risks problems, banks still have high level of non-performing loans attributed non compliance to corporate governance and credit risk management practices. Credit quality is considered a primary indicator of financial soundness and health of bank. Credit risk management is very important evaluating and determining bank profitability. Considering the public loss of confidence as a result of banks distress which has be deviled the financial sector in the last decade, it is very important for banks to be profitable. It is against this background that the study seeks to find out the impact of credit risk management on bank profitability in Nigeria.

1.3 Research Questions

This study is intended to answer the following questions: i. What is the relationship between return on equity and non-performing loans? ii. Do loan and advances affect bank profitability? iii. Does total deposits determine profitability bank?

1.4 Objectives of the study

The objectives of the study are to i. Find out the relationship between return on equity and non performing loans ii. Find out if loan and advances has impact on return on equity. iii. Examine the relationship between total deposits and return on equity.

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