Full Project - EFFECT OF LOAN LOSS PROVISION ON FINANCIAL PERFORMANCE OF LISTED DEPOSIT MONEY BANKS IN NIGERIA

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Full Project – EFFECT OF LOAN LOSS PROVISION ON FINANCIAL PERFORMANCE OF LISTED DEPOSIT MONEY BANKS IN NIGERIA

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CHAPTER ONE

INTRODUCTION

1.1 Background to the study

Loan loss is a serious threat to the performance of banks, as some of the reviewed studies showing a negative effect; therefore necessitate its management. Loan Loss Provision 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 Loan Loss Provision for building quality loan portfolio is of paramount important to firm performance of deposit money banks as well as overall economy (Charles & Kenneth, 2013).

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 Loan loss (Kargi, 2011).

The Basel Committee on Banking Supervision (2001) defined Loan loss 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. Loan loss 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 Loan loss, the higher the tendency of the bank to experience financial crisis and vice-versa, thus necessitate its management.

According to Statement of Accounting Standards, Loan Loss Provision 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.

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.

1.2 Statement of the Problem

Empirical studies that examine the effect of Loan Loss Provision 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 Loan loss 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 unanticipatedlosses 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) Loan loss 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 Financial Performance of listed deposit money banks in Nigeria?
What is the effect of loan loss provisions on the Financial Performance of listed deposit money banks in Nigeria?
What is the effect of secured loans on the Financial Performance of listed deposit money banks in Nigeria?
To what extent do loans and advances influence the Financial Performance of listed deposit money banks in Nigeria?
What effect does capital adequacy have on the Financial Performance of listed deposit money banks in Nigeria?

1.4 Objectives of the Study

The main objective of this study is to examine the effect of Loan Loss Provision on the Financial Performance of listed deposit money banks in Nigeria. While the specific objectives are to assess the:

Influence of non-performing loans on the Financial Performance of listed deposit money banks in Nigeria.
Effect of loan loss provisions on the Financial Performance of listed deposit money banks in Nigeria.
Effect of secured and unsecured loans on the Financial Performance of listed deposit money banks in Nigeria.
Effect of loans and advances on the Financial Performance of listed deposit money banks in Nigeria.
Effect of capital adequacy on the Financial Performance of listed deposit money banks in Nigeria.

1.5 Statement of Hypotheses

In line with the objectives of the study, the following hypotheses have been formulated in null form:

H0_1: Non-performing loans have no significant influence on the Financial Performance of listed deposit money banks in Nigeria.

H0₂: Loan loss provisions have no significant effecton the Financial Performance of listed deposit money banks in Nigeria.

H0_3: Secured loans have no significant effect on the Financial Performance of listed deposit money banks in Nigeria.

H0_4: Loans and advances have no significant influence on the Financial Performance of listed deposit money banks in Nigeria.

H0_5: Capital adequacy has no significant effect on the Financial Performance of listed deposit money banks in Nigeria.

1.6 Significance of the Study

The research will be relevant to several groups of individuals and organizations. First of all, the result or empirical evidence of the study will enable the management of the listed deposit money banks in Nigeria, on how to assess the viability of loan collector in terms of repayment, in order to avoid default. Also, a standard needs to be set on the minimum value of collateral in relation to the amount of money being loaned to a customer.

1.7 Scope of the Study

The study examines the effect of Loan Loss Provision on the Financial Performance of listed deposit money banks in Nigeria. The study covered a period of nine years (2007-2015).

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Full Project – EFFECT OF LOAN LOSS PROVISION ON FINANCIAL PERFORMANCE OF LISTED DEPOSIT MONEY BANKS IN NIGERIA

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Full Project – EFFECT OF LOAN LOSS PROVISION ON FINANCIAL PERFORMANCE OF LISTED DEPOSIT MONEY BANKS IN NIGERIA

Full Project – EFFECT OF LOAN LOSS PROVISION ON FINANCIAL PERFORMANCE OF LISTED DEPOSIT MONEY BANKS IN NIGERIA

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