EFFICACY OF BAD LOAN DEBT IN NIGERIAN COMMERCIAL BANKS FROM

EFFICACY OF BAD LOAN DEBT IN NIGERIAN COMMERCIAL BANKS FROM 2010- 2014. ADEKUNLE ABIODUN God’s Heritage Academy Management Department, Project Management Professional And ARASHI AMINAT ATOKE Department Of Accounting, Banking and Finance, Faculty of Management Sciences, Osun State University, Osogbo, Nigeria. ABSTRACT The study investigated “the efficacy of bad loan debt in Nigerian commercial banks from 20102014” was undertaken to examine the effect of bad loans on banks on the basis of their net profit and to assess the relationship between non-performing loans and bad debt. The research work made use of a secondary data for a period of five years (2010 to 2014). The data collected through reports from the various banks was analyzed using statistical method. Correlation coefficient was used to test the efficacy of bad loan debt indicators. The findings indicated that there is a strong positive relationship between bad loan debt and Nigerian commercial banks’ profitability. The study recommends that banks should ensure that loans given out to customers should be adequately reviewed from time to time to assess the level of its risk and such loan should be backed by collateral security. Keywords: Bad debt, Commercial Banks, Non-performing loans, credit risk, loans and advances

Background to the Study Commercial Banks have been globally acknowledged for their unique role as an engine of growth and development in any economy. Their intermediation role can be said to be a catalyst for economic growth and development as investment funds are mobilized from the surplus units in the economy and made available to the deficit units (Adegbaju & Olokoyo, 2008; Kolapo, Ayeni & Oke, 2012; Mohammed, 2012). Bad loans result from the inability of debtors to repay their loans and their interest within the specified time (Aballey, 2009) resulting in adverse effects on the financial condition of the creditor (Aballey, 2009; Agu & Okoli, 2013). Debt is asserted to be a two-edged sword. On one hand, when employed wisely and in moderation, it enhances people’s welfare. On the other hand, when used imprudently and in excess, the result can be disastrous. Commercial banks are major players in the financial sector of every country’s economy. Bad loan debts are said to be dependent more on the industry performance than other sectors of the economy. It is posited that when debt ratios reach certain levels, financial crises become inevitable and more severe. Bad and doubtful debts make the banking industry unstable and at loss have eaten deep into the banking industry. Loans and advances posed a number of risks to the commercial banks and the banking sector in general, if not properly managed could lead to bank distress thereby affecting customers and stakeholders. Statement of the Problem Starting from 1990, the Nigerian financial system has utilized various reforms such as; the Universal Banking 1992, Bank Consolidation Reserve 2005, Bank Credit Reforms, Interest Rate Reforms and so on. The present challenges in the financial sector are primarily linked to

poor debt management which has over time, eaten into the shareholder’s funds of banks and adversely hampered their liquidity. Bad debts do not only affect commercial banks who are the principal lenders of loans but also the shareholders, stakeholders and the employees at large. Negative incentives on bank owners to adopt imprudent lending strategies such as lending at high interest rates to borrowers in the most risky segments of the credit market could be blamed for bad debts. As a result therefore, the management of provision for bad and doubtful debt constitutes a major issue in commercial bank lending and therefore deserves research attention. Objectives of the Study The general objective of this study is to examine the effect of bad loan debt; this broad objective is broken down to the following specific objectives which are to: i.

Assess the relationship between bad loan debt and Nigerian commercial Banks profitability.

Research Question Given that final states can be reached from different starting points along various perspectives in research studies, we have drawn our research question frame of reference from the objectives of the study. The major research questions are: i.

What is the relationship between bad loan debt and Nigerian commercial Banks profitability?

Research Hypothesis The following hypotheses were formulated from the objectives which will be verified in the course of this research work and will guide us in finding the solution to the problem that is induced in this research work:

Hypothesis One; H0:

There is no significant relationship between bad loan debt and Nigerian Commercial Banks profitability.

H1:

There is significant relationship between bad loan debt and Nigerian Commercial Banks profitability.

Significance of the Study The significance of this study is that, it will enable banks to appreciate the appraisal of their lending mechanism which will assist the management and other regulatory authorities in ensuring a safe banking. It is therefore pertinent to investigate the effect of bad debts and recommend possible measures to address them and make banks’ balance sheet free of bad debts. Scope of the Study The study will be conducted using five banks which are the top most in Nigerian Commercial banks which are First bank of Nigeria Plc., United Bank for Africa Plc. and Union Bank Plc. Literature Review and Theoretical Framework Concept of Bad debt The health of a bank’s loan portfolio can be affected by the variation in the credit risk affecting the overall performance of the bank (Sufian, 2009). This argument was further supported by Duca and Mclaughlin (1990) as cited in Owojori, Akintoye and Adidu (2011) that a large scale variation in bank’s profitability can be ascribed to variations in credit risk management. Banks that are largely exposed to credit risk resulting to reduction in their profitability. Miller and Noulas (1997) are of the view that so long as the banks has exposure in

risk loans, bad or doubtful debts (otherwise referred to as non-performing loans) tend to rise which ultimately reduces the profitability of the bank. The main effect of bad loan is the fact that increasing bad loans limit the financial growth of banks (Karim, Chan & Hassan, 2010; Kuo et al; 2010). The consequence of this is as a result of the fact that bad loans deprive banks of the needed liquidity and limit their capability to fund other potentially viable businesses and make credit facilities available to individuals. Ajani (1992; 5) posits that one of the most serious lapses that can make a high flyer manager lose everything overnight is the mismanagement or maladministration of his credit portfolio. Usually money lost by a bank in this way is not easy to recover. Karim et al., 2010 posited that another basic effect of bad loans on the bank is a reduction in the bank’s lending potential. As a result when banks lose much of their lending capital to bad loans, it is likely that a greater part of their revenue is lost. Graham (2007) described nonperforming loans as those credit / loans that are not well serviced by the customers as at when due i.e. they delay/default in loan repayment. He identified the types of such non-performing loans as follows: Doubtful debts, Bad debts and Loss. Theoretical Framework Credit Risk Theory: Credit is the provision of goods and services to a person or entity on agreed terms and conditions where the payments are to be made later with or without interest. During the contract period, not all debtors will repay their dues as and when they fall due. When the debtor does not pay their dues on the due date, the lender is exposed to credit risks which may in turn lead to default. Credit risk is therefore the investor’s risk of loss, financial or otherwise, arising from a borrower who does no pay his or her dues as agreed in the contractual terms (Nyunja, 2011).

Loan Pricing Theory: Banks cannot always set high interest rates. E.g. trying to earn maximum interest income Banks should consider the problems of adverse selection and moral hazards since it is very difficult to forecast the borrower type at the start of the banking relationship (Stiglitz and Weiss, 1981). If banks set interest rates too high, they may induce adverse selection problems because high risk borrowers are willing to accept these high rates. Once these borrowers receive the loans, they may develop moral hazard Behaviour or so called borrower moral hazards since they are likely to take a highly risky projects or investments (Chodecal 2004). Theory of multiple lending: it is found in literature that banks should be less inclined to share lending (loan syndicate in the presence of well-developed equity markets and after a process of consolidation. Both outside equity; and mergers and acquisition increases banks’ lending capacity, thus reducing that need of greater diversification and monitoring through share lending. (Carletti et al 2006; Ongene & Smith, 2000; Karet et al, (2004); Dgreyse et al, (2004). This theory has a great implication for banks in Nigeria in the 2005 consolidation exercise and the recent 2009 reformation exercise in the industry. Methodology The bane of the study is to empirically examine the quantitative effect of credit risk on the performance of banks in Nigeria over the period of 5 years (2010-2014). As earlier stated in section one, 3 banks were chosen from the twenty- one existing commercial banks. The banks are First bank of Nigeria Plc., United Bank for Africa Plc., and Union Bank Plc. Data were sourced from the Annual Reports and Accounts of the banks in the sample. The data include time-series and cross-sectional data, therefore pooled into a panel data set and estimated using correlation coefficient.

BANKS

YEARS

NON

LOAN

LOANS AND AVERAGE

TOTAL

PERFORMING

PROVISION\

ADVANCES

INTEREST

ASSETS

LOAN (Nm)

COLLATERAL

(N’m)

RATE

(Nm)

(N’000) UBA

2010 2011

36,566 127,400

(N’000)

557,224

11,226

15.6

1,440,724

552,526

41,564

15.8

1,666,053

2012

111,737

570,714

27,878

16.2

1,933,065

2013

48,685

796,942

26,251

16.0

2,217,417

2014

110,724

884,587

48,991

15.8

2,338,858

FIRST

2010

5,748,717

529,830,021

4,517.41

14.9

497,432,304

BANK

2011

7,517,000

503,114,362

6,813.49

18.2

682.248,558

2012

13,796,000

890,313,606

7,229.30

20.3

722,949,132

2013

17,451,000

131,482,189

8,111,53

10.1

783,691,443

2014

20,924,000

131,570,290

8,885. 59

14.9

935,872,543

UNION

2010

9,342.88

34,860,000

2,517.41

15.5

529,830,021

BANK

2011

1,570,290

42,506,793

4,813.49

15.5

503,114,362

2012

2,482,189

50,313,606

5,229.30

15.2

601,616,494

2013

2,534,000

58,522,867

6,111,53

15.5

839,350,050

2014

3,307,000

63,158,000

6,885. 59

15.5

908,545,756

Correlations

Years

Years

NPL

LPC

LD

AIR

TOA

1

.339

-.202

.293

-.176

.277

.216

.470

.290

.531

.318

15

15

15

15

15

15

Pearson Correlation

.339

1

.486

.331

-.184

.658(**)

Sig. (2-tailed)

.216

.066

.229

.513

.008

Pearson Correlation Sig. (2-tailed) N

NPL

N LPC

15

15

15

15

15

15

-.202

.486

1

-.117

.532(*)

.379

.470

.066

.678

.041

.163

15

15

15

15

15

15

Pearson Correlation

.293

.331

-.117

1

-.628(*)

.333

Sig. (2-tailed)

.290

.229

.678

.012

.225

15

15

15

15

15

15

-.176

-.184

.532(*)

-.628(*)

1

-.105

.531

.513

.041

.012

15

15

15

15

15

15

Pearson Correlation

.277

.658(**)

.379

.333

-.105

1

Sig. (2-tailed)

.318

.008

.163

.225

.708

15

15

15

15

15

Pearson Correlation Sig. (2-tailed) N

LD

N AIR

Pearson Correlation Sig. (2-tailed) N

TOA

N

** Correlation is significant at the 0.01 level (2-tailed). * Correlation is significant at the 0.05 level (2-tailed).

.708

15

Test of Hypothesis One; The test of hypothesis being tested here is stated in its null (H0) and alternative (H1) as shown below: Research Objective one Assess the relationship between bad loan debt and Nigerian commercial Banks profitability. Research Question one What is the relationship between bad loan debt and Nigerian commercial Banks profitability? Hypothesis One; H0:

There is no significant relationship between bad loan debt and Nigerian Commercial Banks profitability.

H1:

There is significant relationship between bad loan debt and Nigerian Commercial Banks profitability.

Correlation TOA

NPL

Pearson Correlation

.277

.658(**)

Sig. (2-tailed)

.318

.008

N

15

15

The table above shows the spss result for the correlation analysis to assess the relationship between bad loan debt and Nigeria commercial banks’ profitability. It shows that a strong positive correlation exits between two variables (NPL and TOA). Total assets measure a concrete relationship and correlates with the Independent variable (Non-performing loans) at 65.8% having confidential limit (0.01) showing the significant ratio. Therefore, there is a strong positive relationship between bad loan debt and Nigerian commercial banks profitability.

Summary of Findings The aim of this study was examine the efficacy of bad loan debt on Nigerian commercial banks. The study identified some of the most significant causes of bank debt through the use of annual reports of banks. This is summarized as follows: 

The findings revealed that bad loan debt has a significant effect on the profitability of Nigerian banks. It concluded that banks’ profitability is inversely influenced by the levels of loans and advances, non-performing loans and deposits thereby exposing them to great risk of illiquidity and distress. Therefore, a significant relationship exists between bad loan debt and banks’ profitability. Bad debts destroy loan which are the essential determinants of the liquidity and ultimate solvency of the bank. They are the source of earning as well and it is these earnings that translate into cash for banks primary motive which is profitability.

Conclusion Commercial banks remain dominant in the banking system in terms of their shares of total assets and deposit liabilities. From the discussion presented in the preceding section of this study and also from the summary of our findings, the following conclusions were made: 

The study was carried out with a view to assessing the efficacy of bad loan debt on Nigerian commercial banks. In contrast to early studies, the study main focus is on United Bank for Africa plc, First bank plc and Union bank. The study analyzed whether the effect of bad loan debt as posited by various authors have significant relationship with banks’ profitability. As a result of these research findings, it was found that a significant relationship exists between non-performing loans and total assets of the banks.

Recommendations This study has investigated many issues both empirically and in literature and based on the findings, certain conclusion have been drawn. This section further extends frontiers of the study by putting up some recommendations generally intended towards improving the efficacy of bad loan debt in Nigerian banks. The following specific recommendations are deemed appropriate: a. Banks should ensure that loans given out to customers should be adequately reviewed from time to time to assess the level of its risk and such loan should be backed by collateral security. b. The regulatory authority should pay more attention to banks’ compliance to relevant provisions of the Bank and other Financial Institutions Act (1999) and prudential guidelines. c. Reduction of interest rates on lending. d. Banks should enhance their capacity in credit analysis, policies and loan administration. e. Setting systems to identify significant portfolio indicators, problem credits and level of provisioning required. f. Assessment and the continuous monitoring of counterparty and portfolio to know when loan is becoming non-performing.

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