Chapter One 1.1 Background To The Study

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CHAPTER ONE

INTRODUCTION
1.1 Background to the study
It is commonly known that the banking sector contributes significantly to the economic growth

of any nation, but particularly that of developing nations like Nigeria. This is because, in addition

to offering a means of saving money, the banking sector also helps to provide financial services

to investors, customers, and the general public (Adeusi, Akosile & Ogunsanwo, 2023) and makes

credit available for the creation of new businesses as well as the expansion of existing ones

(Bhattarai, 2019). Thus, they receive deposits, make loans, handle transactions, and create and

manage money.

Despite the various macroeconomic challenges that Nigeria has faced, including the financial

crisis in 2008, the oil crisis coupled with the Covid-19 outbreak in 2019, and others, the banking

industry has persevered as one of the country's most stable sectors, significantly contributing to

the expansion of the Nigerian economy (adding approximately 168.4 trillion dollars to Nigeria's

GDP) (Adeusi et al., 2023). However, due of the role of commercial banks in providing credit

(inform of loan and advances) to the enterprises, companies and the general public, commercial

banks are vulnerable to credit risk (Taiwo, Ucheaga, Achugamonus, Adetiloye, Okoye and

Agwu, 2017).

Even though the credit provision is a source of revenue/income for commercial banks, it may

involves huge risks to both lender and the borrower (Taiwo et al., 2019). That is, the risk of

trading partners not fulfilling their obligation as per the contract as at when due which can

hugely hinder the smooth running of the banks business. Conversely, as a bank's credit risk

increases, the bank runs the risk of failing, endangering its depositors (Taiwo et al., 2019).

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Due to their dynamic structure and the complexity of the economic environment in which they

operate, commercial banks in Nigeria face a variety of risks, including market, political,

liquidity, and other risks. However, credit risk is the most common and severe risk because it can

expose banks to a high risk of illiquidity and distress (Catherine, 2020). It covers losses that

happen to banks as a result of loan collectors defaulting on loan or borrower’s inabilities or

reluctance to pay back debt, loan or any other kind of credit in full and at the correct time

(Serwadda, 2018; Catherine, 2020). It is the likelihood of covering losses brought on by loan

default (Folajimi & Dare, 2020). Put another way, credit risk is the result of customers' refusal or

incapacity to pay their debts on time, which results in loss and impacts the bank's original asset

and profitability (Bhattarai, 2019; Yimkaa, Taofeekb, Abimbolaa, & Olusegun, 2015).

Occurrence of credit risk in commercial banks could be as a result of macroeconomic problems

and other problems such as poor lending practices, insufficient credit assessment, poor credit

policies and assessment, management deficiency (internal weakness), inadequate government

policy, ineffective and poor supervision and regulation of CBN, fluctuating interest rate, etc

(Adeusi et al., 2023; CBN, 2021; Ofosu-Hene and Amoh, 2016). Abisola and Philips (2019)

assert that credit provision is a significant source of revenue for commercial banks since it

generates enormous profits from interest on loans that are extended, but it also exposes them to

credit risk in the event of inadequate management, which will have detrimental effect on the

banks' performance. According to Serwadda (2018), depositors are put at risk of losing when

banks has a high credit risk because a bank with high credit risk is on the verge of bankruptcy.

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Accordingly, credit risk is the risk that commercial banks need to be aware of, take aggressive

action on, and effectively manage in order to survive (Abisola and Philips, 2019).

Credit risk management is highly valued by all banks, but especially by commercial banks, since

it is critical to the financial stability of these institutions and plays a major role in improving their

overall performance and competitiveness (Naceur, Marton, K. & Roulet, 2019; Chhetri, 2021).

Evidence have proven that that with effective credit risk management, commercial banks are able

to survive, manage and avoid risks associated with credit creation, as well as minimise the

negative effects of credit risk which may hinder their development, success and overall

performance as a firm in the field (Catherine, 2020; Chhetri, 2021). According to Taiwo et al.

(2019), commercial banks can lower their default risk by assessing borrowers' creditworthiness

appropriately through effective credit risk management. Consequently, this helps to reduce non-

performing loans and maintain banks' profitability. According to Nwude and Okeke (2018),

credit risk management helps prevent loans from becoming non-performing assets by detecting

and mitigating possible credit concerns early on. This maintains a high-quality loan portfolio and

improves the bank's overall asset quality.

Inadequate management and regulation of credit risk can result in increased harm and

disillusionment, as well as detrimental effects on bank performance (Ndubuisi & Amedu, 2018).

In fact, according to Bhattarai (2019), inadequate credit risk management is the main cause of

poor bank performance and the main reason most commercial banks in Nigeria fail because it

causes banks to lose money rather than make money from the credit given to customers or

borrowers and prevents banks from giving more credit to the domestic economy, which has a

negative impact on economic performance (Adeusi et al., 2023; CBN, 2021). In addition to

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increasing profitability, banks that manage credit risk well also help to maintain systemic

stability and allocate capital in the economy efficiently (Oduro, Asiedu, and Gadzo, 2019).

Credit risk management is still a crucial concept in the current financial crisis that the Nigerian

banking industry is experiencing, along with a weak economy. This is because credit risk

management acts as a preventive measure to lower the defaulter rate and non-performing loan

(loans that are subject to late repayment or are unlikely to be repaid by the collector/borrower)

which may result in bank failure (Chhetri, 2021; Bhattarai, 2019; Alsati, 2015). For banks,

defaulted loans may cause liquidity issues. Effective credit risk management lowers the

likelihood of significant defaults and guarantees the bank has enough cash on hand to fulfil its

commitments.

Strong capital adequacy guarantees that financial institutions have an adequate capital cushion to

deal with unforeseen losses and to keep stakeholders, including depositors, satisfied and ensures

that banks are able to absorb potential loan losses and, as a result, prevents banks from entering

insolvency (a state of financial distress) and failure. This is why banks that exhibit sound credit

risk management are more likely to have strong capital adequacy and improved profitability

(Bhattarai, 2019; Alshati, 2015). Thus, competent and efficient management of credit risk is

critical to the survival and expansion of commercial banks. Nonetheless, commercial banks are

heavily investing in credit risk management due to its many advantages. Thus, it is necessary to

look into the viability of this investment in credit risk management in relation to the performance

of Nigeria's commercial banks.

1.2 Statement of the Problem

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It is evident that commercial banks rely heavily on loans and other forms of credit provision for

their revenue, which exposes them to a number of significant hazards, including credit risk. A

number of commercial banks have offered advances and loans that they were unable to recover

because of inadequate management, all in an attempt to increase profits and solidify their market

position, thereby increasing the amount of non-performing loans in their accounts as a result. It's

becoming a major issues for commercial banks and other parties involved. However,

management credit risk effectively has often been a challenge to many commercial banks in

Nigeria, because, despite best practices measures in credit risk management put in place by the

management of these commercial banks, loan collectors, borrower still have strong tendencies to

delay or completely stop repayment of their loan, which often lead to problem of non-performing

loans. Therefore, it is imperative to look for ways to control credit risk, which negatively impacts

bank profitability, without jeopardising the integrity of the financial system.

Numerous studies (Adeusi et al., 2023; Chhetri, 20221; Catherine, 2020; Oduro et al., 2019;

Abisola and Philips, 2019; Bhattarai, 2019; Nwude and Okeke, 2018; Taiwo et al, 2017; Alshati,

2015) have made various attempts to investigate the how credit risk management influence the

financial performance of commercial banks in Nigeria but the researcher decide to replicate this

topic of discussion due wide gap left uncovered by the prior studies. One of the research gaps

that has been identified is the fact that, out of the various variables available to measure financial

performance, Return on Equity (ROE) and Return on Asset (ROA) were the most commonly

utilised metrics of bank performance in earlier studies. This study aims to close this research

vacuum by incorporating other metrics for bank performance, such as return on capital

employed, profit after tax and earning per share, which have not been examined in previous

studies. The need to bridge the above research gaps identified, address inconsistent findings in

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the literature, and extend the study period from 2018 to 2023 which none of the previous studies

have fully adopted justifies the significance of this research.

1.3 Research Questions

i. How does capital adequacy ratio influence the earnings per share (EPS) of commercial

banks in Nigeria?

ii. To what extent does loan loss provision ratio affect return on capital employed (ROCE)

of commercial banks in Nigeria?

iii. What is the effect of non-performing loan ratio on profit after tax (PAT) of commercial

banks in Nigeria?

1.4 Objectives of the study

The broad objective of this study is to examine the impact of credit risk management on financial

performance of commercial banks in Nigeria. The objected are to:

i. examine the influence of capital adequacy ratio on earnings per share (EPS) of

commercial banks in Nigeria?

ii. investigate the effect loan loss provision ratio affect return on capital employed (ROCE)

of commercial banks in Nigeria?

iii. ascertain the effect of non-performing loan ratio on profit after tax (PAT) of commercial

banks in Nigeria?

1.5 Research Hypotheses

H01: Capital adequacy ratio has no significant influence on earnings per share (EPS) of

commercial banks in Nigeria?

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H02: Loan loss provision ratio has no significant effect on return on capital employed (ROCE) of

commercial banks in Nigeria?

H03: Non-performing loan ratio has no significant effect on profit after tax (PAT) of commercial

banks in Nigeria?

1.6 Scope of the study

This study is interested in examining the impact of credit risk management on commercial banks

performance in Nigeria. However, the scope of the study covers five Nigerian Commercial banks

out of the total commercial banks in Nigeria. These Commercial banks includes, United Bank for

Africa, First Bank, Access banks, WEMA bank and Guarantee Trust Bank. Again, the study is

limited to three variables of credit risk management (capital adequacy ratio, non-performing loan

ratio, and loan loss provision ratio) and three measure of performance (return on capital

employed, earnings per share and profit after tax) from 2018 - 2023

I.7 Significance of the study

The management of other banks as well as the chosen commercial banks will greatly benefit

from this study's observation of the influence credit risk management has on the chosen bank

performance metrics. They will probably be motivated by this to critically examine their

approaches to credit risk management. By examining the amount of non-performing loans in the

banks, total asset value, and profit after taxes, investors and the banking public will be able to

assess the bank management's leadership abilities. In essence, the study's findings might serve as

a reference document for additional research on risk management evaluation. It also gives

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decision-makers in policymaking and implementation monitoring further understanding of risk

management..

1.8 Operational Definition of Terms

Earnings Per Share: It is one important financial metric that shows an organization's

profitability It is calculated by dividing net income by the total number of outstanding shares of

the corporation.

Return on capital employed: It is a financial indicator ROCE that assesses how well a business

uses its capital to generate profits. The term "capital employed" describes the overall amount of

money used in a business, including debt and equity.

Profit after Tax: This refers to a company's earnings after all income taxes have been

deducted

Loan loss provision: A loan loss provision is an accounting item made by financial institutions

to account for probable losses on loans and advances. It stands for an estimate of the sum of

money put aside by a bank or lender to cover possible losses on loans that might not be fully

repaid.

Non-performing loan: Any loan for which the borrower has not made scheduled payments for a

predetermined amount of time—typically 90 days or more—is considered non-performing.

Stated differently, a non-performing loan is one on which the borrower's ability to repay the loan

in full is questioned and interest and principal payments are not being made as scheduled.

Capital adequacy: It is a bank’s capacity to withstand possible losses without endangering its

operations or the security of depositors' money.

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References

Abisola, A. T. & Philip, A. O. (2019) Impact of credit risk management on profitability of


selected deposit money banks in Nigeria. International Journal of Economics, Commerce
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Adeusi, S.O., Akosile, M.O. & Ogunsanwo, O.F. (2023). The effects of credit risk management
on the deposit money bank’s performance in Nigeria. Nigerian Journal of Banking and
Financial Issues, 9 (1), 9-19
Alshatti, A. S. (2015). The effect of credit risk management on financial performance of the
Jordanian commercial banks. Investment Management and Financial Innovations, 12(1),
338-345
Bhattarai, B. P. (2019) Effect of credit risk management on financial performance of commercial
banks in Nepal. European Journal of Accounting, Auditing and Finance, 7(5), 87-103.
Catherine, N. (2020) Credit Risk Management and Financial Performance: A Case of Bank of
Africa (U) Limited. Open Journal of Business and Management, 8, 30-38
Central Bank of Nigeria, (2021). Guidelines for developing risk management: Framework for

individual risk element in banks retrieved. Available from www.cenbank.org.

Chhetri, G. R. (2021) Effect of credit risk management on financial performance of Nepalese


commercial banks. Journal of Balkumari College, 10 (1), 19-30

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Folajimi, A. F., & Dare, O. E. (2020). Credit risk and financial performance: An empirical study

of deposit money banks in Nigeria. European Journal of Accounting, Auditing and

Finance Research, 8(2), 38-58.

Naceur, S. B., Marton, K., & Roulet, C. (2019). Basel III and bank lending: Evidence from the

United States and Europe. Journal of Financial Stability, 42, 47-59.

Ndubuisi C. J., & Amedu,J. M (2018). An analysis of the relationship between credit risk

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Nwude, E.C. & Okeke, C. (2018). Impact of Credit Risk Management on the Performance of
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Oduro,R., Asiedu, M.A. & Gadzo, S.G. (2019). Impact of credit risk on corporate financial
performance: Evidence from listed banks on the Ghana stock exchange. Journal of
Economics and International Finance, 11(1), 1-14.
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commercial banks in Uganda. Acta Universitatis Agriculturae et Silviculturae
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