EMRIRICAL ANALYSIS OF CREDIT RISKS ON BANK PERFORMANCE IN NIGERIA- A case study of FCMB Ltd

MBA Seminar PresentationMainstreet Bank Building Annex.

January 2015.

ADELEKE ADEREMI D.Matric No: 97726

The Faculty of Social SciencesDepartment of Economics

University of Ibadan.

Introduction Background to the Study Problem Statement Objectives, Research Questions and Significance Empirical Literatures Scope and Sources of Data

Empirical Analysis and Results

Graphical Presentations and Findings

Conclusion and Recommendations2

PRESENTATION OUTLINE

The banking industry plays several roles in the economy such as fund mobilizations, opening of account, letters of credit, business guarantees, and giving out of loans.

One of the functions performed by banks which is the credit function enhances the ability of borrowers to exploit desired profitable ventures.

This function expose the banks to credit risk. And this risk is a key determinant of any bank’s performance.

The higher the bank is exposed to credit risk, the higher the tendency of the bank to experience financial crisis and vice-versa

Poor credit risk management practices has affected many economies, with Nigeria inclusive and its many attendant problems.

Global economic crisis and crash in capital markets were also contributors to increasing levels of credit risks by many banks.

To revive this trend, CBN has implemented a number of significant reforms like prudential guidelines and Basel I and II supervisory regimes etc.

A number of measures have also been institutionalized to mitigate credit risks by the government like AMCON, injection of funds by CBN, corporate governance, anti-money laundering Act, EFCC etc3

INTRODUCTION

Credit risk has exposed and led to the collapse of many banks in the economy.

Credit risk according to Basel Committee of Banking Supervision BCBS (2001) and Gostineau (1992) is the possibility of losing the outstanding loan partially or totally, due to credit events (default risk).

A number of MDs of banks have been removed due to poor management of credit portfolios of the banks.

The banking sector in Nigeria has evolved through a number of eras of developments in credit policies.

Nigerian banking has therefore revolutionized from a pre-consolidation era to a post-consolidation era.

Several measures, policies, acts and agencies have been set-up to salvage the system and to ensure a more prudent credit management by banks.

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BACKGROUND

The risks being faced in banking has now become a trending issue for the banking sector because financial services are exposed to conditions of uncertainty everyday.

Thus, there is need to effectively manage the credit risks since the deregulation of the banking industry and its subsequent consolidation by past administration of the apex bank.

The excessively high level of non-performing loans in the banks could be attributed to poor corporate governance practices, lax credit administration processes and absence or non- adherence to credit risk management practices.

Despite the formulation of different policies for managing risks by the apex bank (CBN) in collaboration with several international agencies and operators within the financial system.

The banking sector is still faced with risks that are associated with lending of funds to individuals, companies and institutions.

This has adverse effect on the performance of the banks when their non-performing loans increase drastically, because this could lead to the bankruptcy of the banks.5

PROBLEM STATEMENT

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OBJECTIVES OF STUDY

Broad Objective:•The broad objective is to assess the effect of credit risk on the performance of banks in Nigeria over a period of time.

Specific Objectives:•Examine the relationships between the non-performing loans and bank’s profitability.

•Evaluate the effect of loans and advances on bank’s profitability.

•Assess the relationship between credit risk and bank’s performance.

The study will attempt to address these questions:

• What is the relationship between non performing loans and bank’s profitability?

• What are the effects of credit risks on bank’s performance ?

• What are the effects of loans and advances on bank’s profitability?

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RESEARCH QUESTIONS

The study will highlight the areas of non-compliance to issues relating to laid down credit policies, compliance issues and the level of conformity with existing regulations.

The study will also underscore the need for concerned key stakeholders to always review and come up with relevant policies that will enthrone effective credit risk management policies in the banking sector in keeping with best global practices.

The study of credit risk management procedure in the banking sector will be very beneficial to the regulatory authorities, the operators, the depositors, shareholders and the general public. Hence, the need for this study.

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SIGNIFICANCE OF THE STUDY

Authors Objective FindingsBasel Committee of

Banking Supervision BCBS

(2006)

Koehn and Santomero (1980), Kim and Santomero

(1988) and Athanasoglou et al.

(2005)

Examined that credit risks concentration led to banks

distress

Analyzed that banks risks have effects on

profitability

Historical experience shows that

concentration of credit risk in asset portfolios has been one of the

major causes of bank distress

That bank risk taking has pervasive effects on bank profits and safety

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EMPIRICAL LITERATURE – CREDIT RISKS

Authors Objective FindingsBobakovia (2003) Observed that

profitability of a bank is dependent of good risk management .

That the profitability of a bank depends on its ability

to foresee, avoid and monitor risks, possible to

cover losses brought about by risk arisen

Sanusi (2002) Examined that a number of issues are

problems towards reducing distress in the financial system.

Bank management, adverse ownership influences and

other forms of insider abuses coupled with political

considerations and prolonged court process

especially as regards debts recovery created difficulties to reducing distress in the

financial system

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EMPIRICAL LITERATURE – CREDIT RISKS

Authors Objective FindingsBasel Committee

of Banking Supervision BCBS

(2001)

Examined the effects of

outstanding loans on credit

events.

Credit risk is the possibility of losing the outstanding loan

partially or totally, due to credit events (default risk)

Bessis (2002) Examined the impacts of a number of customers

credit default on bank’s

insolvency .

Credit risk is critical since the default of a small number of

important customers can generate large losses, which can lead to

insolvency

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EMPIRICAL LITERATURE – CREDIT RISKS

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ESTIMATION TECHNIQUES

Objectives Methodology

Comparing Credit Risk and Bank Performance

Descriptive

Analysis of the financials of the Bank over the

timeline

Trend Analysis

Analysis of the financial indices of the Bank

Graphical Analysis

• The study covers Nigerian banks with specific emphasis on FCMB Ltd. This bank was selected purely based on the unavailability of this study tailored down to this commercial bank and based on reports of loans & advances of the Bank in the market.

The study used annual financials from 2001-2012 and data was sourced from the financial statements of FCMB Ltd.

The primary indices analyzed in the financials were the profitability, non performing loans, loans & advances, comparison of bank performances etc.

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SCOPE AND SOURCES OF DATA

The pooled data was analyzed using correlation and multiple regression models which adopt Ordinary Least Square (OLS) method in estimating the parameter of the model and is expressed as;

ROA = α0 + α1NPL/LA + α2LA/TD + е Where;

ROA = Ratio of profit after tax to total assets.

α0 - α2 = CoefficientsNPL/LA = Ratio of Non-performing loan to loan & Advances).LA/TD = Ratio of Loan & Advances to Total deposit).

е = error term Regression was employed in the study to forecast

relationship between variables and estimate the influence of each explanatory variable to the dependent variable.

THEORETICAL FRAMEWORK

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Table: Ratio of Credit Risk and Bank performance

Year Credit Risk Bank performance 2001 1.56 0.912002 2.46 1.542003 3.43 0.342004 3.19 1.052005 2.66 1.552006 2.23 2.672007 3.29 2.212008 2.83 2.942009 9.43 0.752010 7.64 1.362011 5.41 1.922012 4.67 1.51

Source: Financial Statement FCMB Ltd

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EMPIRICAL ANALYSIS

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EMPIRICAL RESULTSEmpirical Test Empirical Result

Comparing Credit Risk and Bank Performance

The Correlation output shows a negative and significant

relationship between credit risk and bank performance. The correlation coefficients

are -0.296 for both indicators and 0.051 for the 2 tailed test

Graphical Comparison of Credit Risk and Bank Performance

An inverse relationship was observed in the period under

review.Graphical Comparison of NPL and

PAT Between 2001 & 2006 there was steady growth, in 2007 PAT increased with reduced

NPL but reverse was the case in 2009

Graphical Comparison of Loans & Advances and PAT

There was increase in loans over the period which does

not translate into profitability due to bad loans and remedial

assets

GRAPHICAL PRESENTATIONS

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Bank performance is inversely influenced by the levels of loans and advances & non-performing loans thereby, exposing the Bank to great risk of illiquidity and distress.

Improper credit risk management reduces the bank performance and also negatively affects the quality of its risk assets.

Increase in loan losses and non-performing loans may eventually lead to financial distress of Banks.

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RESEARCH FINDINGS

There was significant relationship between credit risks and bank performance.

Loans & advances and NPL are the major determinants of bank’s profitability.

The volume of loans grew very fast over the years. The growth of loans have been a great threat to the

liquidity of banks depending on the deposit base. It is of crucial importance for banks to practice prudent

credit risk in order to safeguard their assets and protect investors’ interests.

Better credit risk management results in better bank performance.

CBN for policy purpose needs to regularly assess the lending attitudes of financial institutions for regulatory compliance. 05/03/2319

CONCLUSION AND RECOMMENDATIONS

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