CHAPTER ONE

INTRODUCTION

1.1       BACKGROUND OF THE STUDY

In a modern economy, there is distinction between the surplus economic units and the deficit economic units and inconsequence a separation of the savings investment mechanism. This has necessitated the existence of financial institution whose jobs include the transfer of funds from savers to investors. One of such institution is the money deposits banks, the intermediating roles of the money-deposit banks places them in a position of “trustees´´ of the saving of the widely dispersed surplus economic units as well as the determinant of the rate and shape of the economic development. The techniques employed by bankers in this intermediary function should provide them with perfect knowledge of the outcomes of lending such that funds will be allocated to investments in which the probability of full payment is certain. However, in practice no such tool can be found in the decision of the lending banker. Virtually all lending decisions are made under creditors on uncertainty. The risk and uncertainty associated with lending decision, situation are so great that the concepts of risk and risk analysis need to  be employed by lending bankers in order to facilitate sound decision-making and judgment. This statement implies that if risks are to be objectively assessed, lending decisions by the money-deposit banks should be based less on quantitative data and more on principles too subjective to provide sound and unbiased judgment. Furthermore, the banks depend heavily on historical information as a basis for decision making.

Apparently aware of the inadequacies of his decisions base, the lending banker has often sought solace in tangible and marketable assets as security giving the impression that lending against such securities is an insurance against bad debts. This makes the banker complacent with his loan portfolio. The increasing trend of provisions for bad and doubtful debts in most money-deposit banks is a major source of concern not only to management but also to the shareholders who are becoming more aware of the dangers posed by these debts. Bad debts destroy part  of the earning assets of banks such as loans and advances which  have  been described as the main source of earning and also determines the liquidity  and solvency which generate two major  problems, That is profitability and liquidity, has to earn sufficient income  to meet its operating costs and to have adequate return on its investments.

The banking industry has been known for its intermediary role in providing financial assistance (credit) needed in the economy. This role of financial intermediation is carried out in so many ways. First to be mentioned is the granting of loans and advances to customers which constitutes the major part of banking lending. Apart from loans and advances, other forms of bank credits like bond issued banks for and on behalf of their customers.

In providing credits or for business venture, banks should as a matter at important take all necessary steps to ensure that advances are granted to those customers who can and will make judicious use at loans so that repayment will not become a problem. Therefore credit must be made to people who are capable for utilizing it well and repaying back the loan at its maturity data. Affairs at banks can be explained by reference to the fact that “loan and advances are the large single item in the asset structure of Nigeria commercial banks; it also constitutes the major source at the operating income at banks and also the most profitable asses for the employment of bank funds.

According to Olashore, “credit (Loan and advances) are important to the bank balance, they account for a large proportion at banks income; such operating income produced from sound investment and effective management of such funds in credits enables the bank to:

1.      Pay depositors interest

2.      Pay investors dividend

3.      Pay government tax 4. Have further investment and

5. Maintain adequate reserves.

The actual work in connection with the management and conversion of such funds into various types of credit facilities in an operating function is performed by the credit department of commercial bank instruct compliance by the “Board of Director” at the bank, lie annual credit policy guidelines and prudential guideline (1990) of the Central Bank of Nigeria (CBN) and other monetary and fiscal policy issued by the government of Nigeria. The credit department is usually headed by a loan officer manager who has acquired a high skill experience and personal judgement criteria in credit administration.

Medium – term loans and long-term loan including overdraft facilities.

Credit management in our banking sector today has taken a different dimension from what it used to be. The banking industry has adopted a lot of strategies in checking credit management in order to stay in business. Thu the banking industry in Nigeria has lost large amount of money as a result of the turning source of credit exposure and taken interest rate position. Nigerian banks are being required in the market because of their competence to provide transaction efficiency, market knowledge and funding capability. To perform these roles, the banks act as the most important participants in their Credit extension is essential function of banks and the bank management strive to satisfy the legitimate credit needs of the community it tends to serve. This credit advances by banks as a debtor to the depositor requires exercising prudence in handling the funds of depositors. The Central Bank of Nigeria established a credit act in 1990 which empowered banks to render returns to the credit risk management system in respect to its entire customers with aggregate outstanding debit balance of one million naira and above (Ijaiya G.T and Abdulraheem A (2000). This made Nigerian banks to universally embark on upgrading their control system and risk management because this coincidental activity is recognized as the industry physiological weakness to financial risk. The researcher, a New yolk-based, said that 40% of Nigerian banks that made up exchange rate value in west Africa, has reduced the operating lending as a result of bad debts which hit more than $10 billion in 2009 and this has led to a tied-up questioning asset that is holding almost half of Nigerian banks. The central bank of Nigeria fired eight chief executive officers and set aside $4.1 billion in order to bail out almost 10 of the country’s lenders. The reform which was introduced by Central Bank of Nigeria (CBN) in 2010 has made Nigerian banks resume lending supporting assets management companies and set up the requirement which will allow Nigerian banks make full provision for bad debts that will boost the market. The banks identify the existence of destructive debtors in the banking system whose method involved responding to their debt obligations in some banks and tried to have contract of new debts in other banks. Banks are trying to make the database of credit risk management system more open for them to be more functional and recognized as to enable banks to enquire or render statutory returns on borrowers. There are some banking practices which increase the risks in the bank and cannot be easily changed. This result still leads to the question: what are the possible ways that will help make Nigerian banks manage their credit risks? Credit risk management helps credit expert to know when to accept a credit risk results in encouraging rewards that give internal audit more technical support service and customized training in banks or financial institutions. This research is presented to outline, find, investigate and report different state of techniques in risk management in the banking industry.

Bank exist not only to accept deposits but also to grant credit facilities, this business activity therefore inevitably exposed banks to huge credit risk which might lead to financial distress including bankruptcy. The Basel Committee on Banking Supervision (1999) defined credit risk as the probability that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms or the possibility of losing the outstanding loan partially or totally due to credit events (BCSB 2001). Credit creation is the main income generating activity for the banks Kargi (2011). Adequate management of credit risk is critical for the survival, growth and development of banks.

However, despite the creation of Risk Management Department in all the banks, which is responsible for managing the banks risk including credit risk, available records shows that the spate of bad loans (non-performing loans) was as high as 35% in Nigeria deposit banks between 1999 and 2009, Sanusi (2010). The increasing level of non-performing loan rates in banks books, poor loan processing, undue interference in the loan granting process, inadequate or absence of loan collaterals among other things are linked with poor and ineffective credit risk management that negatively impact on banks performance. This is a very disturbing phenomenon because the high level of non-performing assets in the bank’s portfolio if not brought under control, might erode the capital base of the banks and reduce its profitability. The worst case can happen where liquidation or bankruptcy may occur due to the banks inability to manage its credit risk efficiently. Can it be concluded therefore that the current credit risk policies are ineffective in controlling credit risk in Nigeria banks, is there a lax in the implementation of credit risk policies, and to what extent their performance can be augmented by proper credit risk management policies and strategies? These are questions which previous studies have not fully answered. It is therefore the crux of this study to answer these questions by examining the credit risk indicators and performance of selected banks in Nigeria thereby attempting to make a modest contribution to literature on credit risk. The paper has five sections, section one is the introduction, section two contains the literature review and theoretical framework, section three is the methodology, section four is empirical results and discussion while section five is conclusion and recommendation.

1.2    STATEMENT OF THE PROBLEMS

The problem for this study is to appraise the lending and credit management policies of a typical Money-deposit bank (the Union Bank of Nigeria Plc) with a view of finding the causes, consequences of bad debts in banks. Year after year, banks suffer much from the part of full loan extended which has for one reason or the other proved unrecoverable. Banks lose millions of Naira in various bad debts yearly and despite efforts by bank management, committee of chief inspectors and the bankers committee on the other hand, the wave of bad debts in banks is still on alarming proportion. This is gathered from a combination of literature reviews on the topic.

On the other hand, many banks experienced a lot of bad debts when the new government abandoned the project awarded to the contractors by civilian government. These contractors borrowed to execute the project awarded to them but could not repay the loan, due to government action on revamping the economy thereby abandoning the project. Other experiences were during the time of draught or poor rainfall and pest. These however led to low harvest which did not give the farmers enough time to repay their debt.

Again, experience may arise in respect of lapses on the part of the bank’s credit officers. For instance, there may be excesses over approved facility, unformatted facilities and expired facilities not renewed on time. In each of these cases the customer may easily deny even owing the bank all or part of the amount. Money deposit banks have always borne the burden alone, but this may not continue in future as the banks may be unable to take the risk of lending more but when eventually they do, they would seek the best way they come out of the risk with a realistic reward which they are clearly failing to achieve at present.

The only way to avoid bad debt is to refuse to lend money at all. But if banks should refuse to lend money at all issue at profitability is called hence the main purpose of carrying on business which is to maximize profit will be defeated. Credit must be adequately managed so that banks could remain in business and this could be done through prudent lending.

However, irrespective of how prudent a bank may be in its lending, the fact remain that every year, provision for bad and doubtful debts should be provided for. Not all loan should be granted. A profitable loan which is not safe should not be granted. The attitude of most borrowers towards loans and advances granted to them should not be ignored. As they regard such credit facilities as their own share at the national cake.

Furthermore, failure at banks to make use of banks to make use of trained qualified and experienced personnel in their credit management is a problem that should be addressed.

Bank are merely customers of the money that depositors deposit with them, and hence interest must be paid to depositors and dividend to the investors. Credit management can be seen as an integral part of lending and as such in its absence, good loans can turn into bad one. It is expedient to note that the important of credit management cannot be over emphasized and good credit management required the establishment of Adherence to and of sound and efficient credit policies of government.

For banks to be successful their corporate credit policies must be sound procedures for monitoring and repayment, must be ensured adequately for credit appraisal disbursement. But experiences over the year have shown that inadequate credit analysis and sound judgement of loans application has resulted to outperforming loans. Provision of credits which are in the form of loans and advances are the total amount of money a given bank lends out to its customers at any given period of time. The bank usually charge the borrower interest for bank using its money. These loans and advances usually have maturity period.

Such credit facilities provided by banks are usually in the form of short term facilities.

The overall results of the above are:

(i)                It exposes the bank to various problems of debt recovery.

(ii)              Consequently expenses are incurred in form of provision made.

1.3      OBJECTIVE OF THE STUDY

(i)                To determine and appraise the lending procedure of banks using Union bank of Nigerian plc as a case study-with a view to highlighting the effectiveness and adequacy or otherwise  the credit management policy of Nigerian banks in reducing the occurrence and consequences of bad debts.

(ii)              To highlight the rate at which inadequate collateral security provision by borrowers increases the incidences of bad debt in Nigerian.

(iii)            To determine whether fund diversion has any effect on bad debt of money deposit banks in Nigerian.

(iv)             To ascertain the extent to which government intervention in lending policies of money deposit banks has influenced bad debts in Nigerian money deposit banks.

(v)               To highlight the extent to which improper project evaluation influence bad debt of money deposit banks in Nigerian.

In the history of development of the Nigerian banking industry, it can be seen that most of the failures experienced in the industry prior to the consolidation era were results of imprudent lending that finally led to bad loans and some other unethical factors (Job, A.A Ogundepo A and Olanirul (2008)). Also the problem of poor attention given to distribution of loans has its effect on the bank’s performance. Most of the people collected loan from the banks and diverted the money to unprofitable ventures. Some bankers are not actually considering the necessary criteria for disbursement of loans to the customer. This work therefore intends to outline, explain these problems identify the causes and suggests lasting solutions to the problems associated with credit management and consequently banks debts.

1.4      RESEARCH QUESTIONS

In view of the consequences of bad debt in Nigerian money deposit banks, it is necessary to formulate some research question which will enable the researcher formulate statistical tables for testing hypothesis.

1.                  Has inadequate collateral security provision by borrowers caused bad debt in Union bank of Nigeria plc?

2.                  Does fund diversion have any effect on bad debt of Union bank of Nigeria Plc?

3.                  To what extent has government intervention in lending policies of money deposit bank influenced bad debt in Union bank of Nigeria Plc?

4.                  To what extent does improper project evaluation influenced bad debt of Union bank of Nigeria plc?

1.5      RESEARCH HYPOTHESIS

The following hypothesis were drawn as follows.

1.                  Ho: inadequate collateral provisions by borrowers does not increase the incidence of bad debt in Union bank of Nigeria plc.

Hi: Inadequate collateral provisions by borrowers increases the incidence of bad debt in Union Bank of Nigeria.

2.                  Ho: Fund diversion does not affect bad debt in Union Bank of Nigeria Plc.

           Hi: Fund diversion affects bad debts in Union Bank of Nigeria Plc.

3.                  Ho: Government intervention in lending policies of money-deposit banks  has no influence on Union  Bank of Nigeria Plc bad debt.

Hi:  Government intervention in lending policies of money-deposit banks have direct influence on Union Bank of Nigeria Plc bad debt.

4.                  Ho: improper project evaluation has no significant relationship with bad debt in

Union Bank of Nigeria plc.

Hi:  improper project evaluation has direct relationship with bad debt in Union Bank of Nigeria plc.

1.6      SIGNIFICANCE OF THE STUDY

It is hardly an exaggeration that the difference between the success and the failure in the banking industry is in the effective management of the banks loans and advance. Efficient loan management is vital to the protection of assets and the achievements of adequate returns to investment. Though much work abound in the literature of the technique of lending, the methods of securing such lending and the pitfalls that await the unwary banker. By comparison it appears to be very little in point on the subject of loan management and recovery.

A study of this subject will therefore be a welcome addition to the existing volume of banking literature.

Effective loan management recognized that beyond the application of sound banking principles whenever a loan is made, there is need for urgency in appreciating the point when a loan begins to look doubtful, in arriving at a decision as to the appropriate action and in taking that action. This will enable the bank to at least obtain full payment including accrued interest or at worst to mitigate the capital loss in the face of increased competition among banks, future profits are likely to be harder to come by and since bad debts are a charge against profits, it is appropriate that we review the methods, proportions and margins of lending to bad and doubtful debts.

Hence the significance of this study to bankers will enable them to appreciate an appraisal of their lending and control mechanism now that they are expected to lend under tight monetary conditions. The economy as a whole will benefit from the study because if the level of bad debts is reduced, banks will be left with more profits to enable them make the expected contributions to the development of the economy.

1.7        THE SCOPE OF THE STUDY

In the study of credit management in Nigeria, Union Bank of Nigeria Plc was used for my analysis. All references therefore relate to Union Bank of Nigeria plc.

1.8      THE LIMITATIONS OF THE STUDY

The limitations of this study include some of unavoidable constraints and problems encountered in the process. They are as follows:

i)                   FINANCE: The problem of finance was not left out in the course of research to this study. This type of study required adequate money and time to enable the researcher visit the necessary places for collection of data. Insufficient fund hindered an in-depth study of this research since it was financed from meager pocket money of the researcher.

ii)                 NON-AVAILABILITY OF RECORDS: This is one of the most important

Limiting factors in the course of the study. This includes the problems of easily

getting the appropriate data due to bureaucracy which hinders the information flow in the country.

iii)           NON-CHALLANT ATTITUDE OF BANK OFFICIALS: The reluctance of

bank officials to reveal information on the need for this study, for fear of breach of duty of secrecy to customer’s exposure of banks administrative short-comings.

iv)     IGNORANCE OF RESPONDENT /BORROWERS: Most bank customers were

Semi-illiterates and most often it was very difficult to collect adequate data required from them.

v) TIME: Since this study is one of the many courses offered by the researcher, the researcher was constrained by time to carry out an indent research on the study.

1.9           DEFINITION OF TERMS

DEBT: This is what one owes to another person.

LOAN: A Loan is a credit arrangement, a security is pledged and must be repaid with interest over a stipulated period of time.

OVERDRAFT:  This is a credit arrangement by banks to their customer to withdraw money over and above that what he has in the account.

DEFAULT:  This means failure to pay one´s debt for credit extended which has fallen due.

HYPOTHESIS:  This is a tentative statement of conclusion. It is a statement of claim which is to be proved right or wrong having been confirmed with facts.

Ho:  Null Hypothesis: the hypothesis that is being tested.

Hi:    Alternative Hypothesis: the hypothesis that will be accepted if the null hypothesis is rejected.