Home Project-material CAUSATIVE FACTORS FOR NON-PERFORMING LOANS OF DEPOSIT MONEY BANKS IN NIGERIA: A CRTICICAL EXAMINATION (1997-2007)

CAUSATIVE FACTORS FOR NON-PERFORMING LOANS OF DEPOSIT MONEY BANKS IN NIGERIA: A CRTICICAL EXAMINATION (1997-2007)

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Abstract

The study was principally made to appraise the loan portfolio of DMBs in Nigeria with the aim of finding the magnitude and trend of non-peforming loans (NPLs) and the factor responsible fo that. The problem x-rayed here stems from the high magnitude NPLs in the loan portfolio of DMBs as evidenced in recent joint examination of banks carried out by CBN and NDIC. NPLs put bank in a position of under capitalization which will in turn lead to crises and distress. In order to tackled the above problem, six specific objectives and five research questions were designed to guide the study. Four hypothesis were formulated and tested in the course of the study. The study, which is a survey design, used six DMBs in Onitsha metropolies. Both primary and secondary data from these banks were used in achieving the set objectives. Though the population of the study comprised 410 staff of the six banks selected, the study however limited target population to only 111 senior bank officials who take par

CHAPTER ONE

INTRODUCTION

Background of the Study

The relevance of banking to the Nigerian financial system and

indeed the entire economy cannot be over emphasized. Without banks

economic activities would grind to a halt. Undoubtedly banks serve as

catalysts to the growth and development of any nation, Nigeria inclusive.

The primary function of banking in an economy is to provide

financial intermediation. Financial intermediation means the mobilization

of funds from the surplus units at a cost for on-lending to deficit spending

unit at a price, (Oboh, 2005). Through this process, deposits collected

from surplus economic units are channeled to deficit unit in the form of

loans and advances. Thus banks as financial intermediaries have two

basic traditional functions: deposit mobilization and lending. But by far

the most important function as far as banks are concerned is the lending

function.

Lending has become a vital function in banking because of its

direct effect on economic growth and development. This is being

pursued in most countries particularly the developing ones where banks

and lending activities have been usefully integrated into government

policy formulation in the national economic development process. Thus

the lending activity of banks as it affects economic growth and

development has continued to gain prominence in the light of modern

economy.

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As agents of development, banks provide loans and advances

including a variety of contingent facilities. The bulk of the funds

deposited with banks constitute the bases for loans and advances to

personal and business customers to facilitate their individual economic

activities. Like any other business entity, banks are in business to make

profit and as such they charge interest on credit extended and pay

interest on funds deposited with them. The difference between the

interest received and that paid is the gross margin which constitutes the

profit of the banks (Rose, 2003).

Lending is said to be the most profitable activity of banks.

However, if lending decisions are not handled with care, it could turn out

to be the most loss-making activity of a bank. The safety of any loan and

advance is therefore of paramount importance to bank.

Banks therefore ensure that there is a reasonable certainty that the

loans granted are likely to be repaid by the borrower. In order to keep

these risk factors under control, the bank lending function is closely

regulated to ensure prudent policies and practices. Banks also control

risk in the lending function by setting up written policies and procedures

for processing each loan request.

The bulk of loans and advances made by banks follow some basic

principles which help to minimize the adverse effects of lending

especially the incidence of bad debt. Banks lay great emphasis on the

character, integrity and reliability of borrowers. There must be a

reasonable certainty that the amount granted can be repaid form the

operations of the firm. If the loan is granted to a personal borrower, the

source of repayment must not be doubtful. The borrower must be able to

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provide acceptable security which will serve as something to fall back on

if the expected source of repayment should fail

All these safeguards are built into the lending programme to help

reduce credit risk. Credit risk is the risk that the principal or the interest,

or both or part thereof of the credit extended to a customer will not be

repaid by him in accordance with the loan agreement, (Anyanwaokoro,

1996). When this happens, the bank will end up classifying the credit as

bad debt, and in due course it will be written off. The long-run effect of

this on the bank can be very detrimental with its attendant effect on the

entire economy. This is what has happened to many Nigerian banks that

were classified in the past as distressed by the Central Bank of Nigeria.

It is therefore expected that a high degree of efficiency and

effectiveness be maintained in the operations of banks especially in the

area of loan-making considering its implication on the profitability,

liquidity and safety objective of banks and the well being of the economy

at large.Statement of Problem

There is consensus among banking experts that the greatest

source of bank profitability is credit delivery. However if lending

decisions are not handled with care, it can turn out to be the most loss

making activity of a bank. The safety of any loan and advances is of

paramount importance to banks.

The expectation of every banker is that customer to whom the credit is

extended will repay both the principal and the interest as agreed. But this

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expectation does not always materialize. Banks may incur risks and

experience some losses if certain borrowers fail to repay their loans.

In order to keep risk factors associated with lending function under

control, a lot of caution is applied by both banks and regulatory/

supervisory authorities. The bulk of loans and advanced given by banks

follow some basic principles so that certain adverse effects of lending

will not occur especially the incidence of bad debt. Moreover, the bank

lending function is closely regulated to ensure the safety of bank and the

safety of customers’ deposit. The responsibilities of monitoring the

lending activities of banks in Nigeria are vested with Central Bank of

Nigeria (CBN) and Nigerian Deposit Insurance Corporation (NDIC) to

ensure strict compliance with the laid down rules and regulations. All

these precautions are built into the lending programme of banks to help

minimize credit risk associated with lending.

With all the precautions highlighted above, one expects the

problem of credit risk to be very minimal in the Nigerian banking system.

It is however disheartening to observe that the magnitude of non

performing loans in the loan portfolio of Deposit Money Banks (DMBs) in

Nigeria is on the increase. This trend is generating a lot of concern

among stakeholders in the banking industry. Umeaba (2009) observed

that bank loans classified as non-performing in 2008 amounted to 40%

of total bank loans. Infact the magnitude of non-performing loan in the

loan portfolio of deposit money banks in Nigeria has questioned the

professional credibility of banks management and integrity of

regulatory/supervisory authorities who are responsible for protecting the

banking system. Uzor (2009) noted that the increasing share of loans

5

classified as non-performing is evidence that something was wrong with

the system of credit delivery of the banking sector.

It is obvious that a bank that has the bulk of its assets as non

performing debts stand very little or no chance of surviving in the

industry, especially in the face of the present global financial crises.

Classified debts put banks in a position of under capitalization which will

in turn lead to crisis and distress. Recently, the joint examination of

banks carried out by CBN and NDIC revealed that ten banks were in

grave danger of collapse because of burden of non-performing loan. The CBN, in order to prevent systemic crises, had to extend a life-line of

620 billion to these banks in a bid to breathe life into them, (Business

Day, 2009).

Although there has been several attempts by the relevant

authorizes to check the ugly incidence of non-performing loans, all

efforts made by these authorities seem not to have yielded the desired

result as the problem has continued to persist as evidenced in the

current credit crises in the system. This means that the major factors

which have fostered the issue of classified debts among deposit money

banks in Nigeria have not been properly scanned and diagnosed. The

need therefore arises for further studies on the problem which is the

issue of the research.Objectives of the Study

Based on the problems highlighted above, the broad objective of

this study is to examine the performance of the loan portfolio of Deposit

6

Money Banks (DMBs) in Nigeria. Specifically, the study will achieve the

following objectives:

1. To determine the extent and trend of non-performing loans among

banks in Nigeria.

2. To ascertain the extent poor credit administration is responsible for

the high incidence of non-performing loans in the banking sector.

3. To examine if poor supervision by supervisory/regulatory

authorities is responsible for high incidence of non-performing

loans in the banking system.

4. To identify if the level of non-performing loans among banks is as

a result of poor corporate governance by the operators.

5. To find out if economic performance of the country is responsible

for non-performing loans in the banking sector.

6. To suggest various ways through which the problem of non

performing credit in the banking system will be minimized.Research Questions

The study is guided by the following questions:

1. What is the magnitude and growth rate of non-performing loans

in the banking sector?

2. To what extent has poor credit administration contributed to the

high incidence of non-performing loans in the banking system?

3. To what extent has poor supervision by supervisory/regulatory

authority impacted on high incidence of non-performing loans in

the banking system?

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4. To what extent has poor corporate governance by bank

management contributed to non-performing credit in the banking

system?

5. To what extent does the economic situation in the country

contribute to credit crises in the banking system?Significance of the Study

This study is coming up at a time when the banking industry is

passing through a serious problem of non-performing loans with its

negative consequences in the sector. The study will therefore be of

immense importance to various stakeholders in the banking sector

particularly the operators of banks, borrowers, depositors, regulatory

bodies and even the general public.

The outcome of the study will help managers of banks to identify

the causes of bad debts and its effects on the activities of banks so that

they can take the necessary steps to check the ugly trend.

The study would be of significance to the investing public who

obtains loans from banks. They would be educated on the need to make

efficient use of credit extended to them as the reverse often leads to

inability to honour their obligations. The study will show them that by

defaulting in loan repayment they make it impossible for banks to

address their function of credit provision in the economy.

Unprofessional and unethical practices among bank operators

constitute the greatest threat to banking industry. It is hoped that the

findings and recommendations of this study will help to expose some of

the unethical and unprofessional practices carried out by both bank

8

management and staff. With this exposure, it will position the supervisory

and regulatory authorities to tackle the problem in order to minimize it.

To bank management, the study will enlighten them on the

importance of efficient risk management techniques in the management

of loan portfolio.

To the academia, the research work would be significant because

salient issues in loan portfolio management will be highlighted to

enhance their knowledge of the topic, and this will increase the pool of

knowledge from which reference can be made in future.Scope of the Study

The researcher would have liked to extend the scope of this work

to cover both development banks, specialized banks and other

categories of banking institutions in the banking system, so as to get to

the root of the problem identified in this study. However in order to carry

out more accurate and detailed study, the scope of this work is strictly

narrowed to loan portfolio of Deposit Money Banks (DMBs) in Nigeria.

The study covered a period of eleven (11) years (1997 to 2007).Hypothesis

The following hypotheses were tested in the course of the study.

All the hypothesis are in the null.

Ho1: There is no significant difference in the mean responses of

Accountants and Managers on the extent poor credit administration

contributed to the problem of non-performing loans in DMBs.

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Ho2: There is no significant difference in the mean responses of

Managers and Accountants on the extent the supervisory/regulatory

authorities contributed to the problems of non-performing loans in the

banking system.

H03: There is no significant difference in the mean responses of

Managers and Accountants on the extent poor corporate governance

contributed to the problem of non-performing loans in DMBs.

Ho4: There is no significant relationship between the level of banks’ non

performing loans and GDP of Nigeria.Plan of the study

In order to present detailed account of what the researcher has done

and found in the course of this study, the work is presented in five

chapters.

The first chapter is introductory chapter. The chapter presents the

background of the study, the problem to be studied, objective of the work

and the significance of the study. The chapter also specifies the

research questions that guided the study, the hypothesis and the scope

of the work.

Chapter two reviews related literature. In this chapter the opinions

of eminent scholars and commentators are reviewed. The review is

divided into eight sub-topics.

Chapter three presents the methods and procedures adopted in

data collection and analysis. The presentation is made under the

following sub-headings: research design, area of study, sources of data

collection, population and sampling procedure, instrument for data

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collection and how it is pre-tested and validated, techniques adopted in

data analysis, and problems encountered in data collection.

Chapter four is the presentation and analysis of data gathered.

Here the data collected are presented in tables and analyzed.The four

hypothesis formulated in the work are tested here. Summary of findings

are presented at the tail-end of the chapter. All the tables used in this

chapter are assembled in appendix.

The fifth chapter which is the last chapter contains the discussion

of findings, its implications, recommendations and conclusion of the

work.


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