The banking industry has continued to play a crucial role in the economic development of economies such as Nigeria. This is because banks are able to simultaneously satisfy the needs and preferences of both surplus and deficit units [1]. They therefore contribute to the real productivity of the economy and to the overall standard of living. It is universally acknowledged that the banking industry plays a catalytic role in the process of economic growth and development [2]. 

Functions of Deposit Money Banks are to serve in creation of money, payment mechanism, pooling of savings, extension of credits, financing of foreign trade, trust service, safekeeping of valuables and brokerage services. The main function of banks is to receive deposits from individuals who have savings; these deposits are kept in various types of accounts opened in the bank. They lend from those deposits to those in need and charge interest. The Nigerian banking industry has been strained by the deteriorating quality of its credit assets as a result of the significant dip in equity market indices, global oil prices and sudden depreciation of the naira against global currencies [3].  These have worsened recently as Nigerian banks are contending with the effects of earnings from weak oil prices, shortages of US dollars, devaluation of the naira and slowing economic growth. 

The drop in oil prices and the concomitant decline in the value of the naira against the dollar are severely testing the resilience of the recently reformed banking sector, according to a report entitled, “Cheap oil will test Nigerian banks resilience,” by British researcher Oxford Analytica published on Nov. 25, 2015. After oil companies and the public sector, banks are the next most vulnerable to falling oil prices. This is raising fresh concerns about the prospects of a repeat of the 2008-09 banking crisis. The low price of oil has led to a sharp increase in non-performing loans in Nigerian banks because many banks are heavily exposed to the oil sector.

Growth-wise, FBN Quest Limited, a research and investment banking arm of FBN Holdings Plc revealed that Nigerian banks are experiencing their slowest year since the last crisis (2009).

The industry ratio of non-performing loans net of provision to capital increased significantly to 30.9 per cent at end-June 2016 from 5.9 per cent at end-December 2015, depicting weak capacity of the sector to withstand the adverse impact of non-performing loans. “Non-performing loans in the period under review grew by 158 per cent from N649.63 billion at end-December 2015, to N1.679 trillion at end-June 2016” [4]. It is however noted that only a few large banks showed resilience to the rising credit risk, even at the point of a very high per cent increase in the NPLs, while the others showed vulnerabilities. Amidst the economic situation facing financial institutions  in  Nigeria, it  is  important  to know the current shape of loan management (credit risk management) in banks vis-à-vis the performance of Deposit  Money  bank.  It is therefore imperative to lift the veils behind sustainable performance of banks even in a stressed financial system such as being experienced now in Nigeria. It is these problems that this research work aims at examining with a view to finding reasonable solutions.

Credit Risk Theory

Credit risk, as defined by the Basel Committee on Banking Supervision, is also the possibility of losing the outstanding loan partially or totally, due to credit events (default risk). It can also be defined as the potential that a contractual party will fail to meet its obligations in accordance with the agreed terms. Credit risk is also variously referred to as default risk, performance risk or counterparty risk. Credit risk is by far the most significant risk faced by banks and the success of their business depends on accurate measurement and efficient management of this risk to a greater extent than any other risks. Credit risk is critical since the default of a small number of important customers can cause large losses, which can lead to insolvency.

Although people have been facing credit risk ever since early ages, credit risk has not been widely studied until recent 30 years. Early literature (before 1974) on credit uses traditional actuarial methods of credit risk, whose major difficulty lies in their complete dependence on historical data. Up till now, there are three quantitative approaches of analyzing credit risk structural approach, reduced form appraisal and incomplete information approach.

Empirical Review

Kargi [5] evaluated the impact of credit risk on the profitability of Nigerian banks. Financial ratios as measures of bank performance and credit risk were sourced from the annual reports and accounts of sampled banks from 2004-2008 and analyzed using descriptive, correlation and regression techniques. The findings revealed that credit risk management has a significant impact on the profitability of Nigerian banks. It concluded that banks’ profitability is inversely influenced by the levels of loans and advances, non-performing loans and deposits thereby exposing them to great risk of illiquidity and distress.

Owojori et al. [1] highlighted that available statistics from the liquidated banks clearly showed that inability to collect loans and advances extended to customers and directors of companies, relatives to directors/managers was a major contributor to the distress of the liquidated banks. At the height of the distress in 1995, when 60 out of the 115 operating banks were distressed, the ratio of the distressed banks’ non-performing loans and leases to their total loans and leases was 67%. This deteriorated to 79% in 1996, to 82% in 1997 and by December 2002, the licenses of 35 of the distressed banks had been revoked. 

On studies that found a direct relationship between credit risk and bank performance, Kosmidou et al. examined the determinants of profitability of Domestic UK Deposit Money banks from the period of 1995 to 2012. The findings of their study provide the evidence that credit risk affect positively the bank profitability. The study carried out by Ben-Naceur and Omran [6] to examine the impact of bank concentration, regulations, financial and institutional development on bank profitability in middle East and North Africa countries from 1989 to 2005, found that credit risk has positive and significant effect on bank profitability and cost efficiency.

Mekasha investigated credit risk management and its impact performance on Ethiopian Commercial Banks. The researcher used 10 years panel data from the selected commercial banks for the study, to examine the relationship between ROA and loan provision, non-performing loans and total assets. The study revealed that there is a significant relationship between bank performance and credit risk management.

Charles, Okaro Kenneth examined the impact of credit risk management on capital adequacy and banks financial performance in Nigeria. For this purpose six banks were selected by using positive sampling technique. Data were obtained from the published financial statements from 2004 to 2009. Panel data model was used to estimate the relationship that exists among Loan Loss Provisions (LLP), Loans and Advances (LA), Non-performing Loans (NPL), Capital Adequacy (CA), and Return on Assets (ROA). Results showed that sound credit risk management and capital adequacy related positively on banks’ financial performance with the exception of loans and advances which was found to have a negative impact on banks’ profitability in the period under studiedBased on the findings, they recommended that Nigerian banks establish appropriate credit risk management strategies by conducting rigorous credit appraisal before loan disbursement and drawdown. It is also recommended that adequate attention be paid for Tier-one capital of Nigerian banks.

Kolapo et al. [7] using panel data regression for the period 2000 to 2010 found that the effect of credit risk on bank’s performance measured by the Return on Asset (ROA) of banks is cross-sectionally invariant. They concluded that the nature and managerial pattern of individual firms do not determine the impact. Also, Hosna et al. reemphasized the effect of credit risk management on profitability level of banks. They concluded that higher capital requirement contributes positively to bank’s profitability. 

Muhammed et al. used descriptive, correlation and regression techniques to study whether credit risk affect banks performance in Nigeria from 2004 to 2008. They also found that credit risk management has a significant impact on profitability of Nigerian banks.

Poudel appraised the impact of the credit risk management in bank’s financial performance in Nepal using time series data from 2001 to 2011. The result of the study indicates that credit risk management is an important predictor of bank’s financial performance. 

Meanwhile, Jackson towed the line of Fredrick by using CAMEL indicators as independent variables and return on Equity as a proxy for banks performance. His findings were also in line with that of Fredrick who also concluded that CAMEL model can be used as proxy for credit risk management. Musyoki and Kadubo also found that credit risk management is an important predictor of bank’s financial performance; they concluded that banks success depends on credit risk management [8].

The functional model of the study becomes

ROA = f (NPL, LA)

(1) 

where,

ROA    :   Return on Assets (which is obtained as a ratio of Profit after Tax to Total Assets) 

NPL    :   Non-Performing Loan 

LA       :   Loans and Advances to Total Assets. 

ROA = β₀ + β₁ (NPL) + β₂(LA)+ µ_t

(2) 

Where, β₁ and β₂ are the partial slope coefficients or parameters of the independent variables, NPL and LA respectively, β₀ is the intercept term or constant variable in each of the models, and µt is the disturbance term (error term). 

Data Sources

For this study, secondary data was collected. The data was obtained from Banks annual financial reports (2000-2019). The population of study comprises of (3) three quoted banks namely: First Bank of Nigeria Plc, United Bank for Africa Plc, and Access Bank Plc. The choice of the quoted Banks is due to their perceived stability, network of branches, and size of workforce, public perception and profitability. The data used are aggregates for each variable obtained for the period 2000-2019. The period was chosen to cover to a reasonable extent the period of various reforms in the banking sector and because of the availability of data.

This paper carried out stationarity test of the variables using Augmented Dickey-Fuller (ADF).

The Augmented Dickey-Fuller (ADF) test for unit roots was  conducted  for  all the time series employed for the study. A variable is stationary when ADF values exceed the critical values.

The result of unit root test, in relation to FBN, Access Bank and UBA is summarized in table 4.1, 4.2 and 4.3 below. It shows that ROA, NPL and LA are stationary at levels and as indicated. 

The result shows that the variables NPL has inverse relationship with ROA, showing that NPL has a negative effect on bank performance. This relationship is statistically significant at 95% confidence level and meets the a priori expectation. The result also shows that a unit increase in NPL will lead to 0.007 unit decrease in bank performance respectively ceteris paribus. On the other hand, the relationship between LA and ROA is opposite that of other variables. The result shows that a positive insignificant relationship exists between them.

The result shows that the variables NPL has inverse relationship with ROA, showing that NPL has a negative effect on bank performance. This relationship is statistically significant at 95% confidence level and meets the a priori expectation. The result also shows that a unit increase in NPL will lead to 0.004 unit decrease bank performance respectively ceteris paribus. On the other hand, the relationship  between  LA  and  ROA  is opposite that of other variables. The result shows that a positive non-significant relationship exists between them. 

Table 1: FBN

Source: Extracts from Result of Stationarity Test

Table 2: ACCESS BANK

Source: Extracts from Result of Stationarity Test

Table 3: UBA

Source: Extracts from Result of Stationarity Test

Table 4: FBN

Dependent Variable: ROA, Method: Least Squares, Sample: 2000 2019, Included observations: 19

Table 5: Access Bank

Dependent Variable: ROA, Method: Least Squares, Sample: 2000 2019, Included observations: 19

Table 6: UBA

Dependent Variable: ROA, Method: Least Squares, Sample: 2000 2019, Included observations: 19

Just as the cases of FBN (Table 4) and Access Bank (Table 5), This result also shows that NPL has inverse relationship with ROA, showing that NPL has a negative effect on bank performance. A unit increase in NPL will lead to 0.02 unit decrease in bank performance respectively ceteris paribus. On the other hand, the relationship between LA and ROA is opposite that of other variables. The result shows that a positive non-significant relationship exists between them.

The relationship between the variables of the different banks can be stated as follows:

• FBN: ROA = -2.370609-0.006575*NPL + 0.016563*LA

• ACCESS BANK: ROA = -2.434757-0.004045*NPL + 0.016440*LA

• UBA: ROA = -3.342914-0.020731*NPL + 0.075197*LA

Recommendations

From the findings, the followings policy recommendations are imperative to loan management and performance of Deposit Money Banks in Nigeria.

• Deposit Money Banks in Nigeria should not only be concerned about profit maximizing in a complex and competitive market as we have now. While taking out loans and advances, due diligence should be done in their loan management.

• Credit risk management should have a wider coverage (integrating other forms of risk as defined in Enterprise Risk Management) to bring about more efficient loan management in Deposit Money Banks.

• The researcher recommends the need to strengthen supervision of banks by the Central Bank of Nigeria (CBN) and the Nigeria Deposit Insurance Corporation (NDIC) to prevent buildup and accumulations of NPLs in the future. The Central Bank of Nigeria (CBN) should regularly assess the lending attitudes of financial institutions. There is therefore need to strengthened bank lending rate policy through effective and efficient regulation and supervisory framework.

• Training and retraining to enable employees of Deposit Money Banks acquire the latest skills on loan management. 

1. Owojori, A.A., et al. “The challenge of risk management in Nigerian banks in the post-consolidation era.” Journal of Accounting and Taxation, vol. 3, no. 2, 2011, pp. 21–23.

2. Uwuigbe, U., et al. “Corporate governance and capital structure: Evidence from listed firms in Nigeria stock exchange.” Advances in Management, vol. 7, no. 2, 2014, pp. 44–49.

3. Central Bank of Nigeria. Banking Supervision Annual Report. Abuja: CBN Publications, 2010.

4. Adedipe, B. “Post-consolidation challenges.” CBN Bullion, vol. 29, no. 2, 2005, pp. 37–41.

5. Kargi, H.S. Credit Risk and the Performance of Nigerian Banks. Ahmadu Bello University, Zaria, 2011.

6. Ben-Naceur, S., and M. Omran. “The effects of bank regulations, competition, and financial reforms on MENA banks’ profitability.” Economic Research Forum Working Paper, no. 44, 2008.

7. Kolapo, T.F., et al. “Credit risk and commercial banks’ performances in Nigeria: A panel model approach.” Australian Journal of Business and Management Research, vol. 2, no. 2, 2012, pp. 31–38.

8. Abhiman, D., and G. Saibal. Determinants of Credit Risk in Indian State-Owned Banks: An Empirical Investigation. Munich, Personal RePEc Archive (MPRA). Accessed 19 April 2013. http://mpra-ub.unimerichen.de/17301.