Chapter One 1.1 Background To The Study
Chapter One 1.1 Background To The Study
Chapter One 1.1 Background To The Study
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
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).
and other problems such as poor lending practices, insufficient credit assessment, poor credit
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
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
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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
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
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)
iii. What is the effect of non-performing loan ratio on profit after tax (PAT) of commercial
banks in Nigeria?
The broad objective of this study is to examine the impact of credit risk management on financial
i. examine the influence of capital adequacy ratio on earnings per share (EPS) of
ii. investigate the effect loan loss provision ratio affect return on capital employed (ROCE)
iii. ascertain the effect of non-performing loan ratio on profit after tax (PAT) of commercial
banks in Nigeria?
H01: Capital adequacy ratio has no significant influence on earnings per share (EPS) of
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H02: Loan loss provision ratio has no significant effect on return on capital employed (ROCE) of
H03: Non-performing loan ratio has no significant effect on profit after tax (PAT) of commercial
banks in Nigeria?
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
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..
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
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
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
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References
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Folajimi, A. F., & Dare, O. E. (2020). Credit risk and financial performance: An empirical study
Naceur, S. B., Marton, K., & Roulet, C. (2019). Basel III and bank lending: Evidence from the
Ndubuisi C. J., & Amedu,J. M (2018). An analysis of the relationship between credit risk
management and bank performance in Nigeria: A case study of fidelity bank Nigeria
Nwude, E.C. & Okeke, C. (2018). Impact of Credit Risk Management on the Performance of
Selected Nigerian Banks. International Journal of Economics and Financial Issues, 8(2),
287-297. Retrieved from file:///C:/Users/user/Downloads/6001-15787-1-PB.pdf
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.
Ofosu-Hene, E. D. & Amoh P. (2016) Risk management and performance of listed banks in
Ghana. European Journal of Business Science and Technology, 2 (2), 107–121.
Serwadda, I. (2018) Impact of credit risk management systems on the financial performance of
commercial banks in Uganda. Acta Universitatis Agriculturae et Silviculturae
Mendelianae Brunensis, 66(6), 1627–1635.
Yimkaa, A. S., Taofeekb, A., Abimbolaa, C. & Olusegun, A. (2015) Credit risk management and
financial performance of selected commercial banks in Nigeria. Journal of Economic &
Financial Studies, 3 (1), 1-9.
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