e-sRC

CHAPTER ONE
INTRODUCTION
1.1 Background to the study
Banks and banking activities have evolved significantly through time and with the introduction
of money. Financial services like deposit taking, lending money, currency exchange and money
transfers became important due to the role being played by money, as no good financial system
can do without well-structured and efficient financial institutions, specifically the banking
industry. Banks had and still have an important role in the economy, by mediating between
supply and demand of securities, and transforming short-term deposits into medium-term and
long-term credits through credit creation. Through credit creation, deposit money banks are able
to create new money through deposit multiplier effect and formed part of the main income
generating activity of banks, though exposing them to credit risk (Kargi, 2011).
The Basel Committee on Banking Supervision (2001) defined credit risk as the possibility of
losing the outstanding loan partially or totally, due to credit events (default risk) or the likelihood
of losses when a borrower fails to repay a debt of any kind. Credit risk is an internal determinant
of bank performance and the efficiency of the bank‟s performance is a function of how they are
able to satisfy their customers at a minimum risk level and maximum profitability level. The
higher the exposure of a bank to credit risk, the higher the tendency of the bank to experience
financial crisis and vice-versa, thus necessitate its management.
According to Statement of Accounting Standards, credit risk management is the process of
managing capital assets of banks and loss of loan reserves. These necessitate the appropriate
management of the risks and serves as a key issue in reducing the earnings risk of banks and
improving its value in the capital market. Nigeria deposit money banks has experienced high
non-performing loans, low reserve for loan loss provisions, inadequate secured loans, loans and
advances and low capital adequacy.
Credit risk is a serious threat to the performance of banks, as some of the reviewed studies
showing a negative effect; therefore necessitate its management. Credit risk management
provides a leading indicator of the quality of banks credit portfolio which is because it greatly
influences or prevents the failure of a bank, as the failure of a bank is influenced to a large extent
by the quality of credit decisions and thus the quality of the risk assets, which can be deterred as
a result of poor corporate governance such as CEO duality etc. The importance of strong credit
risk management for building quality loan portfolio is of paramount important to firm
performance of deposit money banks as well as overall economy (Charles & Kenneth, 2013).
The growing stock of studies in accounting, finance and economics, underscores the failure in
credit risk management as one of the main source of banking sector crises which possibly led to
economic failure experienced in the past, including 2001 global financial crises (Fofack, 2005).
Due to increasing spate of non-performing loans and its attendant consequences, the Central
Bank authorities through its accords (Basel I and II) emphasized on the importance of capital
adequacy for mitigating credit risk. Capital adequacy in banking business provides protection
against sudden financial losses and serves as a distress prevention strategy (Greuning, 2003). The
level of capital, a cushion to absorb credit and other losses, is matched to the portfolio risk
depending on the risk characteristics of individual transactions, their concentration and
correlation. All organizations, including banks, need to optimally allocate capital in relation to
the selective investments made. Hence, efficient tools and techniques for risk measurement are a
key cornerstone of a good credit risk management.
Other measures put in place in managing the risk associated with lending include making
provisions to loans in case of loss or default in repayment, which could turn out to improve the
firm performance of deposit money banks, most especially when specific assets are set aside for
claims in terms of secured loans. In addition, when banks have adequate capital, it not only
solves insolvency but also avoid the failure of the financial system.
The Nigerian banking industry has been strained by the deteriorating quality of its credit assets
as a result of the fall in global oil prices and sudden depreciation and devaluation of the naira
against global currencies (BGL Banking Report, 2010).The poor quality of the banks‟ loan assets
hindered banks to extend more credit to the domestic economy, thereby adversely affecting the
performance of financial institutions. This prompted the Federal Government of Nigeria through
the instrumentality of an Act of the National Assembly to establish the Asset Management
Corporation of Nigeria (AMCON) in July, 2010 to provide a lasting solution to the recurring
problems of credit risk mismanagement that bedeviled Nigerian banks. In 2017, it is said that
about 1.5 per cent of the Nigeria population are said to owe banks the sum of N5trilion and that it
had been difficult to recover the debts as a result of legal technicalities deployed by debtors‟
layers (AMCON, 2017). This has motivated for this study to be carried out in order to assess the
effect of credit risk management on the market performance of deposit money banks in Nigeria.

1.2 Statement of the Problem
Empirical studies that examine the effect of credit risk management on bank‟s performance in
Nigeria centered on traditional measures of performance such as return on equity, return on asset,
earnings per share etc. with none to the best of the researchers knowledge on market (value
based) measures of performance, as the traditional measures of performance do not take into
consideration the cost of capital and moreover, they are influenced by accrual based accounting
conventions, in addition to overemphasis to achieve and maintain short-term financial results.
While market measures of performance are promoted as the measures of a company‟s real
profitability, in terms of performance. Since value creation has become of primary concern to
investors and proponents of value based measures claim that those measures are the only
performance measures tied directly to stock‟s intrinsic value (Stewart, 1991; 1999; Grant, 2003).
In addition, to examined how credit risk affects the performance of the banks under study as it
has caused the liquidation and takeover of many banks that include Intercontinental bank,
Oceanic bank, Bank PhB and Afri-Bank just to mention but a few. When loan are not repaid as
at when due (Non-performing) could affect the performance of banks, as loan interest (profit)
payment are delayed. Inadequate provisions for loans or collateral (secured loan) can also affect
the performance of banks but generally, banks are expected to absorb the losses from the normal
earnings. But there may be some unanticipated losses which cannot be absorbed by normal
earnings. Capital comes in handy on such abnormal loss situations to cushion off the losses.
Above all, combining the above variables in this study differentiated it from previous studies, as
they account for few of the variables used. In addition, sample size and period of study are not
wide which could possibly be one of the reason of having different findings and as such, this
study covered nine (9) years, five (5) credit risk variables and sample size of sixteen (16) firms.
However, in Nigeria, literature on this subject is very limited or the issues have not been
localized or well treated, like the inclusion of capital adequacy. Little or no attention is paid to
this area by academics, financial economist or corporate directors and regulators as evidenced by
little of literature and contribution to this discourse.
1.3 Research Questions
The following research questions are raised to guide the study;

What is the influence of non-performing loans on the market performance of listed
deposit money banks in Nigeria?
What is the effect of loan loss provisions on the market performance of listed deposit
money banks in Nigeria?
What is the effect of secured loans on the market performance of listed deposit money
banks in Nigeria?
To what extent do loans and advances influence the market performance of listed deposit
money banks in Nigeria?
What effect does capital adequacy have on the market performance of listed deposit
money banks in Nigeria?