e-sRC

CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
The financial sector plays crucial roles in economic growth and development by virtue of its
financial intermediation roles which includes savings mobilization, risk management, project
evaluation among others. Channeling of funds from depositors (surplus units) to investors
(deficit units) is a key role played by banks(Negera,2012). Toensure sustainability and
profitability, banks procure cheaper loanable funds from customers‟ deposits, and lend these
funds to borrowing customers at a relatively higher rate of interest (lending rates) than that paid
to the depositors (deposit interest rates) (Warue, 2013). One of the difficulties in lending is the
precise prediction of whether a loan and interest will be paid back in full. This implies that
lending involves credit risk especially default risk. Banks use diverse internal techniques such as
client screening to minimize their level of loan default(Warue, 2013).
The causes for loan default vary in different countries and have a multidimensional aspectboth in
developing and developed countries. Theoretically, there are so many reasons as to why loans
fail to perform which maybe in terms of internal factors (some of this include Capital Adequacy
Ratio, Loan Loss Provision and Loan to Total Asset Ratio among others) or external factors
(such as Exchange Rate and Crude oil Prices among others)(Negera, 2012).Bank-specific factors
involve those factors that are peculiar to the operation of the bank and it can be manipulated by
the bank while the macroeconomic variables are those variables that are beyond the control of
any individual bank and affect all bank in the system.
It is quite natural that banks try to lend in safe ventures at one hand and to increase the
profitability on the other hand. Therefore, the banks are usually extremely vigilant when it comes
to giving loans at a riskier avenue because the situation can be financially inviable if a large
amount of loans default is involved, which can ultimately lead to the insolvency of the banks as a
result of the failure of their borrower to pay back the principal and interest as at when due and
increase the level of non-performing loans in the industry. Nigerian banking sector has
experienced a number of bank failures with non-performing loans becoming the precursor to
eventual bank failures in Nigeria(CBN, 2014).
Basel committee (2001), defines Non-performing Loans asthe total amount of money borrowed
and which the borrower has been unable to fulfill his or her debt obligations within 90 days after
the maturity date for repaying the principal or interest due on the loans. Assets quality of the
bank, measured in terms of the ratio of non-performing loans (NPLs) to gross loans, weakened in
the first half of 2016 deteriorating by 6.4 percentage to 11.7 per cent at end-June 2016(CBN
financial report 2016). Researchers such as Warue, (2013),Zhang and Daly (2013) and
Etale,Ayunku andEtale (2016), among others explain NPLs as bad debts whose recovery is
highly doubtful as they are not being serviced as required. In the banking system, bad loan
problems consist of a stock component (old debt) that is not performing and a flow component
(new lending) that may become non-performing (Clementina & Isu 2014).
Extracts of the bank financial statements show that the NPLs grew from N363.31 billion in 2014
to N649.63 billion in 2015 and N 1.678 trillion at end-June 2016 (CBN, 2016).The Total banks
loans as at the end of 2015 was N13.1 trillion, up by a miserable 1.5 per cent against N12.9
trillion in 2014 and rose to 16.372 trillion in 2016.
Giving a breakdown of the figures, the Central Bank of Nigeria (CBN) observes that in the
industrial segment, oil and gas firms‟ aggregate credit stood at N2.153 trillion as at March 2015,
compared to N2.3 trillion in February 2015 and N2.047 trillion as at December 2014 and 3.307
at end of 2015. Nigeria oil and gas sector accounted for the largest percentage of bank loans and
advances which may be as a result of the over dependence of Nigeria government on oil and gas
sector and banks usually direct their credit to the economy main source of revenue(CBN, 2016).
The increase in the NPL ratio maybe attributed largely to either bank-specifics (Loan to total
asset ratio, loan loss provision and capital adequacy ratio) or macroeconomics variables
(exchange rate and crude oil prices) (Amugo, 2015). For instance, the price of Nigeria‟s crude oil
fell by about 60 per cent to US$38.22 at end-December 2015 from US$62.01 at end-June 2015,
and this reduced Government revenue and strained fiscal positions. Also, at end-December 2015,
loans to the oil and gas sector constituted 25 per cent of the gross loan portfolio of the banking
system while credit to the sector rose marginally by 2.8 per cent to N3,307.87 billion at endDecember 2015 compared to the position at end-June 2015 (Amugo,2015).
The result of the CBN Financial Stability Report 2015, shows that some deposit money banks
have capital adequacy ratios below the regulatory requirement of 15% and also the overall
industry liquidity ratio decline from 45% to 38%, although it is still within the minimum
regulatory requirement of 30% but post strong indication to the sector which may be attributed to
the internal factors causing NPLs in the sector.
The June 2016 CBN Financial Stability Report indicators of capital adequacy shows marginal
declines in the Nigerian banking sector, compared with the positions in the preceding and
corresponding periods of 2015. The ratio of regulatory capital to risk weighted assets stood at
15.6 per cent at end-June 2016, showing a decrease of 0.5 percentage point below the level at
end-December 2015. Similarly, the ratio of tier 1 capital to risk weighted assets which stood at
15.9 per cent at end-June 2016, was 1.2 and 1.5 percentage points below the levels achieved at
end-December 2015 and end-June 2015, respectively.This has impacted the asset quality of the
banks, which resultsin rising in the nonperforming loans in the sector.Furthermore, rising in
nonperforming loans may be direct consequences of depreciation in the exchange rate of Nigeria
Naira ofother countries‟ currencies.
The exchange rateis the rate at which one country’s currency is beingexchanged for other
currencies.The prevailing inflationary trend and the liberalization of the foreign exchange
market, which witnessed significant depreciation of the Naira/dollar exchange rate, during the
second quarter of2015, contribute to the rise in nonperforming loans in the Nigeria banking
industry.Specifically, the report also shows that Nigeria naira depreciated from N196.95/$ at
end-June 2015 to N197/$ at end-December 2015 representing a fall of 0.03 per cent in value of
the naira currency against US dollar.The current instability in the exchanges rate has post
significant effect on the performance of hard currencies loans and advance (CBN,2015).Hence,
the falling in value of Naira has made very difficult forthose loans borrowed in foreign not to be
repaid back and this forced banks to make loans loss provision on the loans.
The loan loss provision is an indicator of how the bank is secured against unexpected future
losses and it can be divided into two (specific provision and general provision). Specific
provisions are made on the basis of perceived risk of default on specific credit facilities while
general provisions are made in recognition of the fact that even performing credit facility having
some risk of loss no matter how small (CBN Prudential guideline, 2010).The industry ratio of
non-performing loans net of provision to capital increased significantly to 30.9 per cent at endJune 2016 from 5.9 per cent at end-December 2015, depicting weak capacity of the sector to
withstand the adverse impact of non-performing loans (CBN,2016).
The loans to assets ratio measures the total loans outstanding as a percentage of total assets. The
higher this ratio indicates a bank is loaned up and its liquidity is low. The higher the ratio, the
riskier a bank may be to higher defaults (http://activemedia-guide.com).Sinkey and Greenwalt
(1991) are of the view that banks that value profitability more than the cost of high risk that is
represented by a high loan to asset ratio are likely to incur higher levels of Nonperforming
Loans.
The recent growth of NPLs in Nigerian banking sector can be imputed to thelow purchasing
power of the borrowers, unproductive use of loans, exchange rate volatility and lenient credit
terms of the banking sector(Ibrahim, 2012).This study empirically examines the impact of banksspecific factors (CAR, LLP & LOAS) and macroeconomic variables (COILP & EXCH) on
nonperforming loans of Listed Deposit Money Bank in Nigeria.
1.2 Statement of the Problem
The issues of non-performing loans have been one of the major concerns in Nigeria banking
industry. One of the primary issues that face banks is the risk that loans may not be paid
back(Clementina& Isu 2014).The Central Bank of Nigeria financial stability report reveals that
NPL was about 9.3% in 2006 and reached maximum of 37.3% in 2009, which called for urgent
and proper measured to compact it adverse impact on asset quality of the banks (CBN, 2010).
For instance, CBN, 2009 financial stress test reveals that banks distress are mainly caused by
poor corporate governance, capital adequacy, risk management and liquidity. The result showed
that about ten (10) banks was wallowing in financial distress during the period before the
intervention of Central Banks of Nigeria (CBN). This has a serious issues on the asset quality
and increase the level of nonperforming loans of the banks.Saba, Kouser, and Azeem (2012) are
of the view that Non-Performing Loans are so significant to study as these are responsible for
various financial and economic problems of developed and developing countries. The Total
banks loans as at the end of 2015 was N13.1 trillion, up by a miserable 1.5 per cent against
N12.9 trillion in 2014 andloans to the oil and gas sector constituted 28.77 per cent of the gross
loan portfolio of the banking system as credit to that sector grew to N4, 511.34 billion,
compared with N3, 307.87 billion at end-December 2015 (CBN, Financial Stability Report,
2016).
Despite government and regulatory agency effort to keep NPLs within the regulatory
requirements of 5 per cent maximum, the industry NPLs ratio rose from 2.88% in 2013 to 4.48%
in 2014 and 5.3% in the 2015, while the aggregate NPLs rose from N363.31b at close of 2014 to
N649.63b in 2015(CBN, 2015).The Report of CBN 2016, further states that NPLs grew by 158
per cent from N649.63 billion at end-December 2015, to N1, 678.59 trillion at end-June 2016
and the industry NPLs ratio rose to 11.7 per cent from 5.3 per cent in 2015 which is far away
above the maximum regulatory requirement of 5 percent.The challenging economic situation in
the country made the banking industry‟s non-performing loans ratio to rise from N1.678bn in
June to N2.084tn in December 2016 (Oyetunji&Onuba, 2017).This called for urgent and
serious attentions to provide lasting solution.
Essentially, if the issue of non-performing loans is left unresolved, it can compound into
financial crisis, where the loans exceed bank capital in a relatively large number of banks and
this requires innovative and urgent solution as the unresolved can lead to economic and financial
crises (Akinlo & Emmanuel, 2014).Nevertheless, in that respect are several studies in both
developed and developing countries that have sought to analyze the impact of banks-specific
factors and macroeconomic variables on Non-performing loans,but no consensus has been
reached. Some of these studies focused on the banks specific factors, while some focused on
macroeconomic variable. For instance, studies like Dimitrios, Angelos and Vasilios (2010);
Miyajima (2015); Akinlo and Emmanuel (2014) documented that banks attributes and
macroeconomic factors has positive and significant impact on the nonperforming loans. On the
other hand, Chimkono and Maturi (2016); Haniifiah (2015); Massia and Jouini (2013) concluded
that banks attributes and macroeconomic factors has insignificant impact on nonperforming
loans.
Some bank-specific factors and macroeconomic variables (such as volume of deposit, lending
rate, bank size, return on asset, management efficiency, bank branches, bank liquidity, gross
domestic product, capital adequacy ratio, inflation rate, exchange rate, money supply among
others) on nonperforming loans have been documented in the previous studies in developed and
developing countries.Badar&Javid, 2013;Adeyefa, 2014; Guzu 2014; Owokuti 2015; Sheefeni,
2015; Abrebrese 2015; Waure, 2016; Abebrese, Pickson&Opare 2016.Some of these studies
found a negative relationship between nonperforming loans and banks specific and
macroeconomic variables, while some documented negative impact of banks-specific factors and
macrocosmic variables on nonperforming loans of the countries in which those studies were
conducted.
For example Owokuti and Adeyefa (2014) found positive and significant impact of internal
factors on NPLs while Guzu (2014), Abebrese, Pickson&Opare (2016), found that bank‟s loan
interest rate, loan to asset ratio and bank‟s loan loss provision for reserve are bank specificfactors that influenced loan performance, while Badar and Javid (2013) found negative
andinsignificant effect of banks-specifics factors on NPLs.Miyajima, (2015), found that Lower
growth of oil prices and non-oil private sector output leads to slower credit and deposit growth
and higher nonperforming loan ratios. Sheefeni, (2015) documents that loans to total asset ratio
is the main determinants of nonperforming loans.
Other variables such as loan loss provision ratio and loan to total asset ratio are not being
considered by most of the studies in Nigeria context.According to CBN prudential guideline
2010, asset quality of the banks is usually determined by the amount of provision made on the
loans and advance given out by the bank to their customers (Prudential Guideline, 2010). It has
been found to be a better asset quality (loans) measure than some of the variables considered in
the previous studies (CBN, 2010).
In addition, there has not been much research which is conducted to date on the determinants of
NPLs in Nigeria using Crude Oil Prices as one of the macroeconomic variable determinant of
NPLs in Nigeria. Extraction from Central Bank of Nigeria Financial Stability Report (2015)
revealed oil and gas sector accounted for that about 28.7% of gross loans and advances given out
by the banks (CBN, 2015). However, falling in the price of crude oil in international market
made it difficult for the oil marketers to repay back their debt because the actual revenue would
be less than the projected revenue from the sale of the product. On this note, it is very crucial to
check the impact of crude oil on the nonperforming loans in Nigeria.
The subject matter of this study is for the fact that their results differ and have divergence
conclusions. Hence, it appears hard to extrapolate the effects of previous studies to the content of
Nigeria for the fact that findings are mixed, unclear and very difficult to generalize their
findings.Given that the Nigerian banking industry has been experiencing a continued growth in
the NPLs, the study examines the impact of bank-specifics factors (i.e. Loan Loss Provision,
Capital Adequacy Ratio and Loan to Total Asset Ratio) and macroeconomic variables (i.e. Crude
Oil Price and Exchange Rate Volatility) on nonperforming loans of Listed Deposit Money Bank
in Nigeria.
1.3 Research Questions
The following are some of the research questions that guide the study:
(i) Does Loan Loss Provision Ratio has impact on non-performing loans of Listed
Deposit Money Banks in Nigeria?
(ii) Does Loans to Asset Ratio has impact on non-performing loans of Listed Deposit
Money Banks in Nigeria?
(iii) Does Capital Adequacy Ratio has impact on non-performing loans of Listed Deposit
Money Banks in Nigeria?
(iv) Does Crude Oil Prices has impact on non-performing loans of Listed Deposit Money
Banks in Nigeria?
(v) Does Exchange Rate Volatility hasimpact on non-performing loans of Listed Deposit
Money Banks in Nigeria?