CREDIT RISK MANAGEMENT IN COMMERCIAL BANKS

(A CASE STUDY OF UBA PLC)

 ABSTRACT

The aim of this study is to examine the pattern of credit risk management and the consequential effect of bad, doubtful and uncollectible debts. In most banks, colossal debt burden has continued to mount pressure on their ability to balance liquidity in value asset and liabilities. Accordingly, a survey of 40 respondents made up of CBN regulator, NDIC supervisor and UBA operator was carried out, simple percentage frequency tabulated were used as the statistical test of analysis. The study revealed that while CBN and NDIC rated the risk management of asset and mounting debt profile low, UBA Plc rated itself effectively high. The study recommends periodic review of credit profile and monitoring the debt portfolio to prevent banks distress.

TABLE OF CONTENTS

CHAPTER ONE: INTRODUCTION

1.1     Background of Study

1.2     Statement of Problem

1.3     Objectives of the Study

1.4     Research Questions      

1.5     Research Hypothesis     

1.6     Scope and Limitation of the Study

1.7     Significance of the Study        

1.8     Definition of Terms       

1.9     Study Outlines    

CHAPTER TWO: LITERATURE REVIEW

2.1        Origin of Banking

2.2        Evolution and Structure of the Nigeria Banking System

2.2.1     Non Regulated Banking Period

2.2        Commercial Bank Credits and the Economy    

2.3        The Role of Financial Institution in the Saving Investment Process

2.4        The Role in Capital Formation

2.5        Credits and Credit Risk Management

2.5.1     What is Credit?

2.5.2     What are Credit Risks

2.5.3     Sources of Credit Risk

2.5.4     Handling of Credit Risk

2.5.5     Credit Risk Management

2.6        Application of 1988 Basle Standard by Nigerian Banks      

2.7        Application of Guidelines to Bank Capital Requirement

2.8        Risk Asset Management Process

2.9        Target Market/Risk Asset Acceptance Criteria

2.9.1     General

2.9.2     Survey

2.9.3     Industry Studies/Externally Induced Risks

2.9.4     Business Risk-Internally Induced Risk

2.9.5     Risk Asset Acceptance Criteria (RAAC)

2.9.6     Product Risk Asset Acceptance Criteria(PRAAC)

2.9.7     Prospect Lines

2.9.8     Reporting         

2.9.9     Target Market Update

2.10.10       Housekeeping Controls

2.10      Credit Initiation and Analysis

2.10.1   Credit Initiation

2.10.2   Customer Solicitation

2.10.3   Negotiation

2.11      Credit Committee Review Approval

2.11.1   Control and Reporting Requirements

2.12      Documentation and Disbursement

2.13      Conceptual Issues in Distress Management

2.14      Extent and Implications of Distress

2.14.1   Extent of Distress

2.14.2   Implications of Distress for an Economy

2.1.5     Causes of Bank Distress

2.15.1   Adverse Economic Conditions

2.15.2   Capital Inadequacy    

2.15.3   Inept Management     

2.16      Ownership Structure Interference in the Management of Banks

2.17      Distress Management in the Nigerian Banking Industry

2.18      Moral Suasion 

2.19      Imposition of Holding Actions

CHAPTER THREE: RESEARCH METHODOLOGY

3.0     Introduction        

3.1     Research Design

3.2     Restatement of Hypothesis

3.3     Population of Study      

3.4     Sample and Sampling Technique

3.5     Determination of Sample Size

3.6     Research Instrument

3.7     Method of Data Collection

3.8     Validity and Reliability of Instrument

3.9     Method of Data Analysis

CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS

4.0     Introduction

4.1     Testing of Hypothesis

4.2     Definition of Variables

CHAPTER FIVE: SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATIONS

5.1     Summary of Findings

5.2     Conclusion

5.3        Recommendations

Bibliography

Appendix

CHAPTER ONE

INTRODUCTION

1.1    Background of Study

The recent upsurge of concern by retail and wholesale bankers for the enthronement of credit risk management into their operational process had been adjudged by credit analysis as timely and relevant. Financial institutions are exposed to risk taking of which credit risk is probably the most important. The risk problem usually emanates from undue delays in. collection or from a signal of a potential loss which cause a lot of complications in management. Banks in developing economies like Nigeria face intense challenges in the management of credit risk management. Government controls frequent instability in the business environment and most importantly the legal environment undermine the financial condition of the borrower.

It thus becomes clear that risk management as a disciple should pursue the goal of protecting the assets and profit of an organization. This can only be achieved by arresting the potential for loss before it occurs. In a financial world where there is dearth of information which interestingly is fragile in nature, both the allocation of and the use of credit are more vulnerable to disturbances. The Nigerian financial industry has suffered from the adverse effects of these disturbances resulting in distress of some institutions. Despite the fact that borrowers themselves absorb a disproportionate share of risk, the failure of the financial sector to manage their risk reduces not only the financial systems ability to allocate capital effectively but also erodes public confidence in the financial sector.

In other to bridge the risk profit gap, a macroeconomic framework for meditation is therefore required for depositors and lenders. Although lending is an integral and fascinating aspect of banking business, its complexity underlines its importance as the highest most profitable aspect of a bank’s operation. Lending is therefore something that must be done with minimum loss. The quality of bank loan portfolio will ultimately improve profitability and corporate survival.

Banks today continually face the problem of how to maintain asset quality in an asset generating environment. It has therefore become imperative for financial institution to sustain the discipline attain these past few years and stay focused on the fundamentals of credit as standard measure to improve the quality of loan portfolio. Lenders need to assess lending risk and device an effective way to hedge against risk related to the borrowers’ industry management and operation.

1.2    Statement of Problem

The changes that have taken place in the Nigerian financial system over the past two decades have been traumatic and revolutionary with disturbing news of shrinking spread on loans, erosion of demand deposits, disintermediation of banks or in most cases by the capital market and the concentration of oligopolistic practices in few core banks with series of threats to the Nigerian money market.

Credit risk management system incorporates the processing of credit transactions from the receipt of credit facility request from customers, through credit risk analysis and approval, monitoring of credit exposures to credit payoff or delinquency management in event of decline in credit quality. The management of loans and advances does not require any special skill, although, technical knowledge is essential. Previous experiences can also assist but the ability to think objectively to deal and communicate with a broad range of accounts and customers of different back experience, approach and ability is more important. As the challenges posed by the difficult economic environment increases, financial institutions are subsequently exposed to increasing risk. The most important of these is credit risk, that is the possibility that a borrower will not repay the loan when if falls due or that he may even fail outright to repay. This credit risk has the effect of exposing banks to problem loans when they crystallize. Advance problems arise immediately customer makes his request for the manager to take a decision. This is further compounded when repayment by customer is not met and debt irrecoverable, except through realization of security (where possible). Where a large chunk of banking system credit is unpaid, the process of intermediation is impeded, fresh funds are unavailable to deserving new projects and the consequences of this for national productivity and employment can be serious. Because of these problems, loans which are increasingly becoming a threat to the financial stability of the banking industry, the Regulatory/Supervisory Authority (CBN and NDIC) introduced the prudential guidelines in November 1990 and always release credit policy guidelines annually for financial institutions comply with so as to minimize this credit risk. But the question is, are these banks really complying with the guidelines so as to safeguard customers’ deposit and owners’ funds? This question is what the research seeks to answer using UBA Plc as a case study.

1.3    Objectives of the Study

The objectives of the study are:

-        To show the extent of compliance of UBA Plc with the prudential and credit guidelines so as to minimize credit risk

-        To establish the pattern of relationship between loans and advances in UBA Plc and bad loans (i.e. non performing loans)

-        To make appropriate recommendations for control of advances and minimizing bad debt arising from bad lending.

1.4    Research Questions

-        To what extend has UBA Plc been managing its credit?

-        Has UBA Plc been complying with the CBN prescribed guidelines?

-        What are some of the problems and challenges militating against the enthronement of efficient credit risk management in UBA Plc?

-        What are your recommendations for the removal?

1.5    Research Hypothesis

For this study, one research hypothesis is considered. This is:

H0:     There is no significant relationship between loans and advances (credit) and bad loans (non-performing loans)

H1:     There is significant relationship between loans and advances (credit) and bad loans (non-performing loans).

1.6    Scope and Limitation of the Study

The scope of the study shall be limited to credit risk management in commercial banks. it shall be within the frame of population size which comprises of all commercial banks in Nigeria.

However, the sample size of the study is restricted to. UBA Plc. Focus will be on the risk management department of UBA Plc coupled with information from CBN and NDIC.

A research work of this nature is fraught with many limitations. An obvious limitation of this study is non-availability of textbooks on credit. Most of the materials available are in form of seminar papers, workshop papers and credit review extracts etc. Time constraint is  another limitation since the researcher is a part time student who has to combine this project with regular office work. In spite of all these limitations, justice is done with the available information and materials collected.

1.7    Significance of the Study

This study becomes important because of the volume of bad debts, which has mounted in banks over the years. The magnitude of non performing credits in the banking system is a cause for concern to different stakeholders including bank management which granted the credit, bank director some of whom took the credit, depositors whose funds have been misappropriated, bank supervisors, government responsible for protecting the banking system and the society at large. These concerns arise not only because of the potential losses to depositors but because of the likely loss of confidence in the banking system arising from a systematic distress. When credit is not paid, the banking system would be unable to play its intermediating role. It thus becomes obvious that this is a problem that everyone has a role to pay in finding solution.

1.8    Definition of Terms

Risk: Is a state in which losses are possible.

Loss: Consists of disappearance or reduction in value.

Risk Management: Is an organized method for dealing with the pure risks (and sometimes speculative risks) to which an individual, family, firm or other organization is exposed.

Employees: Are those who work in an organization.

Loss Prevention: An effort that reduces the probability of a loss.

Loss Reduction: An effort that reduces the severity of loss.

Risk Transfer:    A technique such as insurance or a hold-harmless agreement whereby financial aspects of a potential loss are shifted to another party.

1.9    Study Outlines

This study shall be divided into five chapters. Chapter one shall contain the study background, statement of problem, objectives of the study, research questions and hypothesis, scope and limitation of study, significance of study, definition of terms and study outlines.

Chapter Two shall contain literature review. My emphasis is to review relevant literature on the study using UBA Plc as my case study.

Chapter Three discusses the various techniques and procedures used in collecting data and the analytical treatment of the data collected in the study. It, among other things, discussed the research design; population; sample and sampling procedure; research instrument; method of data collection and data analysis.

Chapter four is devoted to explain how the data collected and arranged in tables to facilitate clear and proper analysis.

Chapter five presents a summary of this study and the conclusions that could be drawn from it. Following this conclusion, some recommendations are made.