DELINQUENT LOANS AND FINANCIAL PERFORMANCE OF SELECTED COMMERCIAL BANKS IN NIGERIA

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DELINQUENT LOANS AND FINANCIAL PERFORMANCE OF SELECTED COMMERCIAL BANKS IN NIGERIA

ABSTRACT

The loan portfolios of the lending institutions are major assets that generate a significant amount of interest income. The loan portfolios play a critical role in determining the financial performance of these institutions and it can therefore be said that the healthier the loan portfolio of the banks, the better their financial performance. The rising volume of nonperforming loans was identified as one of the threats to financial system stability in Nigeria and thus the non-performing loan ratio has become a very important index for measuring the performance of bank. This study is an attempt to empirically examine the relationship between non-performing loan and financial performance of Banks in Nigeria. Two proxies was used to represent the independent variables. These variables are non-performing loan ratio and Loan Loss Provision ratio. Fifteen (15) banks were sampled from the population of twenty-one (21) banks in the Nigerian banking industry as at December, 2014. Secondary data were collected from the financial statements of the banks for a period of five years, from 2009 – 2013. The regression analysis result revealed that non-performing loan has a negative effect on financial performance of Nigerian Banks. The findings revealed that there is significant relationship between the variables used in this study. The overall result is that non-performing loan has negative significant relationship with financial performance of Nigerian Banks. The model is fitted as there is absence of serial correlation and multicollinearity based on the Durbin Watson result of approximately 2, tolerance values of less than 1 for the coefficients of the model. Changes in financial performance are explained by changes in the independent variables. It was therefore, observed that there is a significant negative relationship between non-performing loans and financial performance, which implies that the higher the non-performing loan in the books of the bank the lower the Profit before Tax and Earnings per Shares of these banks. In line with these findings, the study recommends that management of Nigerian banks should adopt a strong credit risk and loan granting service process management to keep the level of non- performing loan as low as possible in order to record a good financial performance as there is significant negative relationship between non-performing loans and financial performance.

CHAPTER ONE

INTRODUCTION

Background of the study

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.

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 basis 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 (Damankah, Anku-Tsede & Amankwaa, 2015).

Essentially, commercial banks are deposit taking entities. They are financial intermediaries through which funds are transferred from the surplus sectors to the deficit sectors and thereby started assuming credit risk. Credit, thus, became the primary business of banking, and the primary basis on which a bank‟s quality and performance are judged (Aremu, Suberu & Oke, 2010). Empirical studies on banking crises all over the world have shown that poor assets quality (predominantly loan) has been the most frequent factor in bank failures. Stuart (2005) emphasized that the spate of non-performing loans, is as high as 35% in the United State. According to Umoh (1994), the rising trend of non-performing loans‟ ratio in banks‟ books is due to poor loan processing, undue interference in the loan granting process, inadequacy or absence of loan security, among other things, which are all linked with poor and ineffective credit administration.

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 (Anolue, 2010).

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 load. 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 from 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 provide acceptable security which will serve as something to fall back on if the expected source of repayment should fail (Anolue, 2010).

All these safeguards are built into the lending activities 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.

The performance of these banks is affected by the amount of loans and advances they grant, the quality of the loans and the provision made for the loans losses. Banks need to ensure they maintain adequate amount of liquidity, so as to be able to meet their customers‟ deposit withdrawal. Nevertheless, excess liquidity should not be kept idle in the banks‟ vault, so the banks need to deploy these resources into profitable venture mostly granting them out in form of loans and advances which form the bulk of their profit. The bail out of eight banks in Nigeria by the Sanusi led Central Bank of Nigeria in 2009 can be traced to a large extent to be as a result of substantial volume of unsecured and non-performing loans in the books of these banks. The rising volume of non-performing loans and unsecured loans was identified by Sanusi as one of the threats to financial system stability in Nigeria. He further argued that the inability to manage non-performing loans well, has caused most banks distress in the world (Sanusi, 2012).

Statement of the problem

Banking problems majorly are caused by low credit standards for borrowers and counterparties, poor portfolio management, and lack of attention to changes in economic or other circumstances that can lead to deterioration in the credit standing of bank‟s counter parties. The major issue addressed by this study was, „how has a delinquent loan in Nigeria banking industry influence financial performance of selected commercial banks. The key objective of the study was to examine the impact of delinquent loans of commercial banks in Nigeria on their financial performance.

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