Causative Factors for Non-Performing
Loans of Deposit Money Banks in Nigeria: A Critical Examination
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.
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 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 wellbeing 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
lossmaking 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 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 nonperforming 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 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 nonperforming 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 have 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.
Causative Factors for Non-Performing Loans of Deposit Money Banks in Nigeria: A Critical Examination
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