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MEASURES NECESSARY TO MINIMIZE THE HIGH INCIDENCE OF BAD DEBTS IN NIGERIA COMMERCIAL BANKS

Format: MS WORD  |  Chapter: 1-5  |  Pages: 76  |  1903 Users found this project useful  |  Price NGN5,000

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CHAPTER ONE

 

INTRODUCTION

 

BACKGROUND OF THE STUDY

 

Banks today are the largest financial institutions around the world, with branches and subsidiaries throughout the world. The services rendered by commercial banks in Nigerian cannot be over-emphasized. The banks basically in any economy are financial intermediaries that perform two main traditional functions which include deposit collection and lending. These banks offer different products and services to public, and because of their high liquidity, these intermediary operations are quite risky. Therefore, the banks are faced with diverse risks in the course of carrying out their operations. In view of the risks inherent in bank lending and the need to minimize or contain the risk (since they cannot be avoided entirely), and in view of the need for liquidity and profitability consistence with safety and regulatory constraints, the central issue in managing the lending portfolio is balancing the potential risk with returns. This involves credit management and credit analysis. The borrower‟s ability to repay the loan has to be determined, the borrower capacity and capital have to be assessed (Nwankwo, 1991). Credit creation is the main income generating activity of banks (Kargi, 2011) Due to the increasing spate of non-performing loans; the Basel II Accord emphasized credit risk management practices. Compliance with the Accord means a sound approach to tackling credit risk has been taken and this ultimately improves bank performance Deposit money banks are exposed to a variety of risks among them; interest rate risk, foreign exchange risk, political risk, market risk, liquidity risk, operational risk and credit risk; and what banks does is to manage these challenges especially the credit aspect. In some instances, deposit money banks and other financial institutions have approved decisions that are not vetted; there have been cases of loan defaults and non-performing loans, massive extension of credit and directed lending. Policies to minimize on the negative effects have focused on mergers in banks, better banking practices but stringent lending, review of laws to be in line with the global standards, well capitalized banks which are expected to be profitable, liquid banks that are able to meet the demands of their depositors, and maintenance of required cash levels with the central bank which means less cash is available for lending. This has led to reduced interest income for the commercial banks and other financial institutions and by extension reduction in profits. Credit risk is the possibility that the actual return on an investment or loan extended will deviate from that, which was expected. Agu, & Ogbuagu,. (2015). defines credit risk as losses from the refusal or inability of credit customers to pay what is owed in full and on time. The main sources of credit risk include, limited institutional capacity, inappropriate credit policies, volatile interest rates, poor management, inappropriate laws, low capital and liquidity levels, directed lending, massive licensing of banks, poor loan underwriting, reckless lending, poor credit assessment, laxity in credit assessment, poor lending practices, government interference and inadequate supervision by the central bank. To minimize these risks, it is necessary for the financial system to have; well-capitalized banks, exposure within acceptable limit in order to provide a framework of the understanding the impact of credit risk management on banks profitability. One of the regulations is the minimum capital commercial banks must keep absorbing loss if unexpected things happen. It strengthened the framework and made some innovations, including tightened definition of capital, requirements for leverage ratio and a countercyclical buffer, the capital for liquidity risk and counterparty credit risk as the derivatives had gained their population in 20th century. Credit risk is one of significant risks of banks by the nature of their activities. Through effective management of credit risk exposure banks not only support the viability and profitability of their own business but also contribute to systemic stability and to an efficient allocation of capital in the economy (Psillaki, Tsolas, & Margaritis, 2010). The relationship between private sector lending and growth is one that can have strong consequences for the growth of a country and the viability of many private sector businesses. Lending being the primary function of commercial banks can have strong implication for private sector growth and will probably be impeded in times of crisis by the riskiness of the business environment that often accompany economic contraction. Growth and business cycles fluctuations are a norm in the global economy, economic crises such as the 2007 sub-prime mortgage crisis have the capability of affecting lots of lives that depend on earnings from production capabilities in the private business sector for 4 a living. The relationship between commercial lending and economic growth will be one in which the private sector which is the primary driver of a nation’s economy will be affected by increased cost of access to capital dueto the riskiness of the business environment leading to the high probability of loan default. This high probability to default is likely to make many private sector businesses to be averse to borrowing forcing them to downsize on their production output which will finally be accompanied by laying-off production staffs. The question if commercial bank lending incites growth in Nigeria is one that has not been previously addressed in a sufficient manner. It is well known that commercial bank lending in Nigeria is at an all time low and has not returned to the pre 1990s lending levels, (CBN 2012 statistics) making most Nigerian banks to be failing in their role of primary responsibility which is to lend to private sector businesses. While most of the blame lies at the doorstep of commercial banks the Nigerian government also has a joint responsibility since it has failed to create enabling environment for productive commercial activities that have the capability to reduce the transaction cost associated with production making the business environment to be risky. A host of macroeconomic variables are identified in the study to be responsible for driving growth in the Nigeria economy this include the cost of access to capital, institutional quality, the country’s monetary policy, aggregate savings and finally aggregate loss of capital due to default or mismanagement in the Nigerian Banking system. Due to the shortcomings in the management of the lending portfolio of commercial banks and the inability of the decision makers, in this case, the banker to make perfect and accurate predictions and forecast of loan repayment, bad and doubtful debts become inevitable. This arises based on the fact that lending involves a certain degree of risks and there is no standard measure of a customer whose loan will go bad or whether payment will be made at the agreed period with the price of the loan. The paper is therefore set to evaluate the effects of bad debts on the investment generation among Nigerian banks.

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