ANALYSIS OF CREDIT RISKS AND LOAN RECOVERY STRATEGIES IN NIGERIAN BANKING INDUSTRY

SUNDAY C. NWITE Ph.D, ACII, ACIB, IRDI

SENIOR LECTURER

DEPARTMENT OF BANKING AND FINANCEEBONYI STATE UNIVERSITY – ABAKALIKI

PHONE NO: 080-37743134E-MAIL: nwitewhite2006@yahoo.com

ABSTRACT

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Credit is the extension of fund to a borrower which he/she pays interest rate for using the money. The money given out as loans are monies mobilized from individuals, households, corporate bodies etc. If the money is not paid at the due date or total failure to pay, will affect the lender. The aggregate or cumulated non payment may lead to failure. Banks have adopted various strategies of recovering their money, some orthodox, some unorthodox, mortgages, legal risks. It has been found that most borrowers are always willing to pay, but certain situation like economic recession, inflation, political instability, poor investment makes them not to pay. The implication is that if loans are not recovered, then, there will be no money to give other borrowers and also it will affect the economic growth as banking is the hub of economic development. Conclusion was drawn that banks give out loans are exposed to a lot of risks and such risks should be managed to ensure efficiency and loan payments. The work recommends that banks should always advise the borrower to take insurance policies, purpose of the loan, monitoring, capability and the means the money will arise from, will play active role in reducing loan default.KEYWORDSCredit risk, credit default, loan recovery strategies, credit risk management.

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INTRODUCTIONThe banking industry play a vital role in economic development of

any nation, they play roles like fund mobilizations, opening of

account, letters of credit business guarantees, and mostly give out

loans from the part of the money mobilized. The loan is for

economic growth and development of the nation which do have

vicious effect in employment creation.

Most cases, some of the money extended as loan are not paid, this

do have negative impact on the banks and also the money that will

be available to give to others will not be available .

Even if it from the interest rates paid from, where the banks make

profit. Most of the loans banks give out have been unguided with

the principles of given loans like CAMEL rating, CAMPARI and ICE,

Altman model, the 5cs all has contributed to given out non

performing loans which is the major problems Nigerian banks have.

Because there are a lot of risks in given out credit, this work

therefore wants to find out what causes of non credit payment and

the strategies the Nigerian banking industry use in recovering such

loans and their implications on bank performance.

THE CONCEPT OF CREDIT RISK

Credit risk management can be explained with simple meaning,

individually and jointly. Credit can be defined as an amount of

money that is given by a creditor and taken by a debtor that will be

paid for at some future date, in return for benefits received earlier

such as goods purchased or loan obtained (Coyle, 2005).

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Risk on the other hand is defined by Nwite (2006) as chances of

misharp, chances of miscalculation, chances of an event happening

or not happening. Mordi (1987) defines risk as the uncertainty of an

event, the chance that an event will happen or will not happen.

Management on one hand is the step taken for effective planning,

control, coordinating and directing to achieving a company’s

desired goal. Management with relevance to risk can be defined as

all the steps, strategies, taken to reduce the severity or the impact

of the loss. The three words now combined can mean all the

strategies taken to reduce the risks that arises in given out credit.

(Nwite, 2006).

HISTORICAL DEVELOPMENT OF CREDIT RISK

Man by nature is an investor. Any person created on earth has plan,

programme on what to do. Most of the hindrances to these plans

are lack or inadequate finance. Because of this, the banking

industry comes up to provide some categories of loan to meet up

his or her obligations ranging from building houses, marriages,

buying vehicles business, expansion etc. the banking industry may

decide to give short-term loan, medium term and sometimes with

special preference long term loans. It is through giving out these

various categories of loans that bank make their profits. It is always

said that an idle fund is a wasted fund. Banks must be very careful

not to be over liquid (having much cash) and not to hold cash-

illiquidity (not having much cash) to meet up the obligations of their

customers. Without given out loan, there could have been no

investment in the economy and one wonders how the world should

be without credit. Risk is a form of counterparty risk that arises in

giving out credit.

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Counterparty risk is the risk that the other party to a contract or

agreement will fail to perform his side of the deal. This could mean

a failure to provide promised goods or services, a refusal to provide

promised loan facilities or a failure to pay amount owned in full and

on time.

It is more natural to think of credit risk from the point of view of the

provider of credit that may be a lending bank or selling goods or

services on credit (Orji, 1991).

A company that borrows from a bank might fail to repay the loan;

the bank therefore has the risk of either incurring losses from bad

debt or the potential cost of delayed payment. Similarly, a company

that sells its goods or services on credit normally must accept the

risk that the customer will fail to pay in full or that he will take him

longer time to pay than agreed.

REASONS WHY BANKS GIVE OUT CREDIT

Banking industry is the hub of the economy. Any nation that does

not have sound financial system is in trouble, the banks are the

catalyst for economic growth. Bank give out loan for various

categories of people, corporate organizations, all facet of the

government via federal, state and local government, contractors

even the small and medium enterprise benefits from banks.

Below are some of the reasons Nigerian banking industry give out

loan (credit).

1. For Industrial Development: Odi (2007) outlines some

of the reasons for banks giving out loan as for industrial

development. Any country that is not industrially developed is

floating because they must be importing into the country like

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today, in Nigeria nobody today can say that Nigeria is an

agriculturalist nation or an industrialist nation rather every

hope is based on minerals, oil and gas and the fall in the price

of oil and gas has affected economic development in Nigeria.

2. To build Houses: People borrow money to build residential

homes or for commercial purposes. The aim is that if it is for

commercial purposes, the houses will be rented and it is a

source of investment by the borrowers of fund. (Emeka; 1992)

3. Provision of vehicles and other infrastructure:- Most

civil servants borrow money from banks to purchase vehicles,

infrastructures and to mortgage their salaries for certain time.

Infact today in Nigeria, salary is one of the major collaterals

people pledge to borrow money from the bank. (Nwite; 2004)

4. For marriages, payment of children’s school fees and other

emergency problems: Most people borrow money nowadays,

to celebrate marriages sine it requires a lot of fund and also to

pay children school fees.

5. For agricultural development, people who wants to engage in

intensive agriculture usually borrow money from the bank.

6. Those businessmen with small capitals and without collaterals

like the small and medium enterprise today can get loan from

the bank with special arrangements. Banks give out loans to

importers, offer letters of credit and also give guarantee to

contractors importers in Nigeria. Without bank loan, most of

the contractors cannot execute most of the contracts.

Financial institutions like the banking industry, insurance

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industry, pension firms, all are the main company for

economic growth of any nation. (Odi; 2005)

ANALYSIS OF VARIOUS RISKS THAT ARISES IN BANKING

ACTIVITIES

There are basic risks which are inherent in banking operations.

These forms of risk (Rose, 1999) are as identified and explained

below:

1. Credit risk: Banks make loans and take on securities that are

nothing more than promises to pay. When borrowing

customers fail to make some or all of their promised interest

and principal payments, these defaulted loan and securities

result in losses that can eventually erode the bank’s capital.

Because owners capital is usually no more than 10 percent of

the volume of bank loans and risky securities (and often much

less than that), it doesn’t take too many defaults on loans and

securities before capital become inadequate to absorb further

losses. At this point, the bank fails and will close unless the

regulatory authorities elect to keep it afloat until a buyer can

be found.

2. Liquidity risk: There is also substantial liquidity risk in

banking the danger of running out of cash when cash is

needed to cover deposit withdrawals and to meet the credit

requests of good customers. If a bank cannot raise cash in

timely fashion, it is likely to loss many of its customers and

suffers a loss in earnings for its owners. If the cash shortage

persists, this may lead to runs on the bank and ultimate

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collapse. The inability of a bank to meet its liquidity needs at

reasonable cost is often a prime signal that it is in serious

trouble.

3. Interest rate risk: Banks also encounter risk to their spread

– that is, the danger that revenues from earning assets will

decline or that interest expenses will rise significantly,

squeezing the spread between revenues and expenses,

thereby reducing net income. Changes in the spread between

bank revenues and expenses are usually related to either

portfolio management decisions (i.e changes in the

composition of banks assets and liabilities) or interest rate

risk. The probability that fluctuating interest rates will result

in significant appreciation or depreciation of the value of and

the return from the bank’s assets. In recent years, banks have

found ways to reduce their interest rate risk exposure, but

such risks have not been completely eliminated.

4. Operating risk: Bank also face significant operating risk due

to possible breakdowns in quality control, inefficiencies in

producing and delivering services, or simple errors in

judgment by management fluctuations in the economy that

impact the demand for each individual bank’s services and

shifts in competition as new suppliers of financial services

enter or leave a particular banks market area. These changes

can adversely affect a bank’s revenue flows, its operating

costs, and the value of the owners investment in the bank, e.g

its stock price.

5. Exchange risk: Larger banks face exchange risk from their

dealings in foreign currency. The world’s most tradeable

currencies float with changing market conditions today. Banks

trading in these currencies for themselves and their customers

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continually run the risk of adverse price movements on both

the buying and selling sides of this market.

6. Crime risk: Finally, banks encounter significant crime risk

fraud or embezzlement by bank employee or directors can

weaken a bank severally and in some instance, lead to its

failure. In fact, fraud and embezzlement from insiders

constitute one of the prime causes of recent bank closings.

Moreover, the large amounts of money that banks keep in

their vaults often proves to be an irresistible attraction of

outsides. The focus of ban robberies has shifted somewhat

with changes in banking technology, theft from ATMs and from

and from patrons using those money machines has becomes

one of the moist problematic aspects of bank crime risk today.

VARIOUS WAYS BANKS RECOVER FAILED CREDIT FROM

CUSTOMERS

The introduction of prudential guidelines in 1990 and promulgation

of failed bank and financial malpractices decree No. 18 of 1994 and

the inauguration of the tribunal have all helped in recovery of

already lost account. One will now fail to mention the poor quality

of loans and advances, protracted legal processes and the attitude

of some bank mangers who are not living up to their responsibilities

have contributed to the loan default.

There are two (2) methods of strategies of loan recovery namely:

Orthodox Method: Under orthodox method of loan recovery,

there are:

1. Demand Letter: This is a letter written to the borrower,

one month before the maturity of the loan to remind him

that capital loan and interest thereon is due for repayment.

It is best written by legal department of the bank, who will

insert some clause in the failed bank (Recovery of Debt and

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Financial Malpractices in Bank Decree No. 18 of 1994 could

be incorporated into the letter). The debtors who fail to

repay their debt could be sued to court.

2. Personal Visit and Telephone Calls: the bank officers

could pay personal visit to the debtors business premises or

home to discuss and see things for himself. Telephone calls

could also be used constantly as this will make the

customer restless.

3. Debt Counseling: The bank officer would be able to

discuss with customers the nature of his problem (personal

or business), especially why he has not made good his/her

debt. After the exercise, the bank officer could be able to

advice the customer as to know how to re-order his

priorities and start repaying his debt.

4. Life Assurance and Loan Insurance: it is relevant to

take up endowment or term assurance policy in respect to

repay if the loan. This insurance will undertake to repay the

capital loan, the borrower will then make the interest

payment directly to the lender. The insurance protect the

asset financed or securities mortgaged to the bank as well

as life of the borrower to guarantee the repayment of the

credit even if the borrower dies.

5. Sales of Mortgage Property: A mortgage has no power

or control over his property particularly legal mortgage of

he has defaulted the term of legal mortgage. The indenture

creating the legal mortgage could give the mortgage the

power to sell either by private treaty or public auction and if

by public auction. The provision of the Auction Act of 1979

or sale by Auction law by Abia State of Nigeria applicable in

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Ebonyi State must be strictly compiled with otherwise the

sale will be declared null and void.

6. Litigation: Litigation is the last resort to any bank in

Nigeria because of the wasted and the attitude of judiciary

to financial institutions. The courts are always in sympathy

with the debtors. However, when a debtor is unable to pay,

bank may go to court to prove the debt and attach the

assets of the debtors after obtaining judgment.

7. Local Purchase Order (LPO) Domiciliation of

Payment: Banks accept local purchase order from

reputable companies when the local purchase order is

obtained. The proceeds will be domiciled in customer

account so that part of it will be used to affect the debt,

while the balance is released to the customers after the

bank must have deducted the principal plus interest.

8. Appointment of Receiver: When receiver are made out of

court, it is the deed of debenture / mortgage which grants

the power to either the trustee of the deed of debenture

holders to make an appointment. Receiver can also be

appointed through application to law court.

9. Opening of Saving Security Account: With the problem

of credit today in Nigeria, bank managers have learnt to

device a means of immediate recovery of loans from day

one credit customers are required to open savings account

with a notation “no withdrawal without the intention of bank

manager / credit officer”. The customer will be encouraged

to be depositing a certain amount of money into the

account, the account will be yielding interest but no

withdrawal is allowed.

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10. Dividend Warrant: Stock and Shares from reputable

companies whose shares are quoted in the stock exchange

market could be as security for credit grant.

Unorthodox Method

Under the unorthodox method of loan recovery are:

1. Publication of Names of Debtors in National Dailies:

Whenever effort have been made to collect the debts from

the bank debtor customers, the bank goes out of its way by

actually publishing the names of debtors in national

newspaper, magazines, television etc. through this, debtors

will be able to repay their loan.

2. The Use of Armed Men: This is a situation whereby banks

used armed policemen and soldiers in recovery of the loan

from debtors.

3. Private Investigation: With Nigerians attitude to

repayment, it becomes more difficult to recover debt

granted to bank customers already made up their mind not

to repay such bank loans. All they do is to claim addresses

and move to a new location.

4. Use of Thugs: this is a situation whereby bank hire thugs

in other to recover their loan money from debtors when

debt are bad debts.

5. Technical Embarrassment: Bank use technical method

like all staff affairs in loan recovery. This is unconventional

means where all staff go for loan recovery from their

debtors.

6. Use of Professional Seizures: This method is common

with finance houses and leasing houses, particularly in

finance and equipment lease agreement. This arises when

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the lease defaults in making repayment as agreed in the

terms of the lease.

7. Debt Collections: Due to delay and adjournment of cases

in courts, banks resort to debt collection to help in the

recovery of their outstanding indebtedness.

THE IMPLICATIONS OF SUCH STRATEGIES ON ECONOMIC

DEVELOPMENT ON NIGERIA.

Banks play a vital role in economic development, if there is any

delay in loan payment or default, it will result to the performance of

the bank.

Again aggregate of none payment of debts may lead to bank

distress. Further to it, it may also result that there will be no funds

available to banks to enable them give more loans to other

borrowers. It will also affect the profit of the bank.

It may also lead to distress and distresses do have a danger signal;

which if not controlled; it will lead to discouraging people from

saving contagion effect and sporadic withdrawals from other banks.

It will also show the economic development, because the money

which could be used in investment will not be available.

It will also result to unemployment and above all, affect

government policies and the regulatory authorities in making their

policies and further bank control.

CONCLUSION

Banks play active and efficient roles in Nigeria and both the

banking industry, the regulating bodies all help to make the

banks strong any default in payment of loans, delay in the

payment result to a serious issues, it is therefore concluded that

the banking industry mostly the credit risk department should

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ensure that adequate assessment are given to borrowers and

monitoring of such loans to ensure banks performance.

RECOMMENDATIONS

- Bank should stop giving out personal interest loans.

- The loan guideline must be strictly complied o.

- The principles of CAMEL rating almost model and CAMPARI and

ICE to ensure adequate monitoring.

- There should also be equity among the operators and

borrowers.

- Loan recovery strategies should always be adopted.

- The best option is the legal means and strategies than

unorthodox methods, though Nigeria is a developing nation

and the only language they hear is these orthodox processes

or methods.

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