Full Project – BANKS AND THE CHALLENGES OF MANAGING RISK IN THE NIGERIAN ECONOMY: A STUDY OF SELECTED BANKS

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CHAPTER ONE

INTRODUCTION

1.1         BACKGROUND OF THE STUDY

Commercial banks are in the risk business. In the process of providing financial services, they assume various kinds of financial risks. Over the decade our understanding of the place of commercial banks within the financial sector has improved substantially. Over this time, much has been written on the role of commercial banks in the financial sector both in the academic literature (Santomero, 1997).

The Nigerian Banking Industry for the past decades has witnessed series of Banking distress and subsequent failures. Banks that had been doing well suddenly announced large losses due to credit exposures that turned sour, interest rate position taken or derivate exposures that may or may not have been assumed to hedge balance sheet risk. In response to this, there is indeed urgent need for banks in Nigeria to devote enough attention to the management of financial risks in the Nigerian Banking Industry. The 1989 annual report and statement of account of NDIC revealed that classified loans and advances or bad debts amounted to 9.4 billion which contributed 40.8 percent of total loans and advances and 280 percent of shareholders funds” (Hall, 1991:8). It is the development of his nature that have led to the introduction of the CBN prudential guidelines for banks.

Cooker (1989:115), observes that “the main function of a bank is the collection of deposits from those with surplus cash resources and the lending of these cash resources to those with an immediate need for them” in fulfilling this:

• It must be easily understood
•  It must be permanent
•  It must be able to absorb losses

These three features are expected to guide member countries, including Nigeria, in assessing instruments to be used in raising bank capital. The bottom line in the debt capital is a risk instrument for financing bank operations and should be discourage as much as possible. The Basel Committee on banking supervision also introduced the “New Capital Accord” which was implemented in 2007. The New Capital Accord required capital charges to be made for credit, market and operational risks. This is aimed at protecting depositors, consumers, and the general public against losses arising from bank fragility and failure (Umoh: 2005). Ever since 1988, captains of the Nigerian Banking industry have shown keen interest in improving the risk analysis, measurement and management capacity of firms in the banking sector. Recently risk managers of major banks came together in Lagos to form an organization named Credit Risk Association of Nigeria (CRAN). It is hoped that CRAN will offer them opportunities for networking on issues of bank risk management. Concerted efforts are also being made by captains of banking industry to reduce the risk exposure of banks in lending to borrowers generally but especially to commercial bank, which is traditionally prone to market and credit risk.

Coincidentally to this activity, and in part because of our recognition of the industry‟s vulnerability to financial risk, the Wharton Financial Institutions center with the support of the Slon Foundation, has been involved in an analysis of financial risk management processes in the banking sector.

In the banking sector, system evaluation was conducted covering many of North America‟s super regional and quasi money center commercial banks as well as a number of major investment banking firms.

The Nigerian economy is increasing begin globalized by the deliberate government actions since July 1986 when the federal government began the implementation of the Structural Adjustment Programme (SAP). The SAP sought to deregulate and free the economy from government control with a view to allowing market forces determine the production and consumption decisions of economic agent within the country. The deregulation process which was accompanied by privatization and commercialization government enterprises, had far-reaching impacts on the entire economy. In particular, deregulation of interest rates affected bank lending to the real sectors of the economy. In more recent times, government adopted business consolidation strategies viz: merges, acquisitions and taken over as part of its efforts to facilitate the ability of firms in financial services industry to become global market Players.

According to the governor of the Central Bank of Niger (CBN), business consolidation in the banking sector was to, among other things; make Nigeria banks complete favourably in the global financial market” and to generate a high capital base that “will provide banks with the resources to met the cost of compliance in the areas of credit and market risk management” (Soludo, 2005:98-99).

1.2         STATEMENT OF PROBLEM

Risk management is at the core of lending in the banking industry. Many Nigerian banks had failed in the past due to inadequate risk management exposure. This problem has continued to affect the industry with serious adverse consequences. Banks are generally subject to wide array of risks in the course of their business operations. Nwankwo (1990:15) observes that „the subject of risks today occupies a central position in the business decisions of bank management and it is not surprising that every institution is assessed an approached by customers, investors and the general public to a large extent by the way or manner it presents itself with respect to volume and allocation of risks as well as decision against them‟. Other risks include insider abuse, poor corporate governance, liquidity risk, inadequate strategic direction, among others. These risks have increased, „especially in recent times as banks diversity their assets in the changing market. In particular, with the globalization of financial markets over the years, the activities and operations of banks have expanded rapidly including their exposure to risks.

1.3         OBJECTIVES OF THE STUDY

Basically; the main objective of this is to determine banks and the challenges of managing market Risk in the Nigerian Economy.

Others are:

• To determine how asset quality can be efficiently and effectively monitored.

• To examine the effects of credit risk exposure on growth and profitability of Nigeria commercial banks.

1.4         RESEARCH QUESTIONS

The study will seek to answer the following questions:

• How does deposit of banks affect the portfolio of credit by banks?

• How does the quality of banks assets in terms of risks exposures affect banks profitability?

• What are the effect of credit risk exposures on growth and profitability of banks?

1.5         RESEARCH HYPOTHESIS

The following alternative and null hypotheses will be formulated such as to uphold or reject the preposition of the “risk management in two Nigerian commercial banks”.

• H^o:Deposit does not have a significant positive impact on bank loans

• H^o:Asset quality does not have a significant positive impact on profitability of a bank

• H^o:Credit risk exposures do not have a significant positive impact on profitability of banks.

1.6         SCOPE OF THE STUDY

This study covers risk management in First Bank Nigeria PLC and Fidelity Bank Nigeria PLC. Pre and Post banking consolidation in Nigeria, specifically between 2003 and 2008.

1.7         SIGNIFICANCE OF THE STUDY

This study has a number of significant dimensions.

• The result of this study should provide information to the

commercial banks risk management department on the progress so far made in identifying and evaluating risks as to enhance growth and profitability of the financial institutions.

• The result of this study should also reveal how much such progress has impacted on the growth of the entire commercial banks in Nigeria.

• Essentially, this work is a step in a right direction to assist and enlighten the general public on what risk management in commercial banks is all about and hence guide them in their immediate decision of handling risks.

• Furthermore, there is need to provide a reference document for further researchers and evaluation of risk management conducted by other Nigerians/other Nations. This research work will go a long way to increase the availability of literature in the field of risk management in the banks and other related business associates that involve risk in the day-to-day running of the businesses.

• Finally, the study is of immense benefit to policy makers, investors, financial managers lecturers and the general public.

1.8         DEFINITION OF THE TERMS

Risk management: Risk management is the identification, evaluation, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability or impact of unfortunate events or to maximize the realization of opportunities.

Portfolio Management:           The process of making and carrying out a decision to

invest in securities (Anyafo, 2001 : 93).

Portfolio – Akinsulire (2002:357). Defined portfolio “as the combination or collection of several securities on behalf of an investor.

Hedging: According to (Ebhalaghe, 1995 : 161) defined hedging as a system employed to smoothen out unpredictable fluctuations in financial variables so as to aid planning and avoid embarrassment induced by cash shortfalls.

Forward Contracts: This is a contract usually between a bank and customer to buy or sell a specified quantity of foreign currency at an agreed future data (Akinsulire, 2002: 467).

Tenor Mismatch: Involves matching the tenor of an investment with the tenor of the borrowed funds, so invested or a mismatch is said to occur when the tenor of investments in aggregative exceeds the contractual tenor of the borrowed funds (Ebhalaghe, 1995:144).

Currency Swap: This is a simultaneous borrowing and lending operation whereby two parties exchange specific amount of two currencies on the outset at the sport rate (Akinsulire, 2002:474).

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