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Full Project – RISK MANAGEMENT A CRITICAL TOOL IN NIGERIA BANKING INSTITUTION

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RISK MANAGEMENT A CRITICAL TOOL IN NIGERIA BANKING INSTITUTION

CHAPTER ONE

INTRODUCTION

1.1. BACKGROUND TO THE STUDY

The banking industries are susceptible to all forms of risk. It has an ageing long history in the overall operation of all banks. The Nigerian Banking Industry for the past decades has witnessed series of Banking distress and subsequent failures. Banks that had been doing well suddenlyannounced 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 balancesheetrisk

Risk is a commonly used word. The Webster comprehensive dictionary defines it as a chance of encountering harm or loss, hazard, danger or to expose to chance of injury or loss”. Thus something that has potential to cause harm or loss to one or more planned objectives. 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 has 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 fragilityand 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.

All human and corporate under taking have certain element of risk to avert risk, forward looking in management must show sufficient interest in the management and control of these Operations in the bank and monitor the possible impact these may have on the banking performance.

1.2. STATEMENT OF PROBLEM

The Basel II norms cameasan attempt to reduce the gap in point of viewsbetween conflict practices; 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 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 asdecision 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 diversify 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. therefore the implementations of those resolutions emerged by the banks, this Research work is carried out to investigate into some areas that need more attention, which has not been focused or where there has been work or ideals put forward in the areas. To this end, this work attempts to find out a certain problems that affect the bank and try to suggest solution in areas of pitfalls some of these problems included the followings:

1.3 OBJECTIVES OF THE STUDY

In view of the risks prevalent in the credit risks management in Nigerian banks, the major aim of the study is to assess risk management as a critical tool in the Nigerian banking sector. Other aims of the study include;

To identify the risks faced by commercial banks in Nigeria
To find out the effects of those risks on the profitability of commercial banks.
To find out risk management techniques used to treat risk exposures in banks.
To examine the effects of credit risk exposure on growth and profitability of Nigeria commercial banks.
To recommend ways of improving commercial banks profitability through adequate risk management techniques.

1.4 RESEARCH QUESTIONS

The study will seek to answer the following questions:

What are the risks faced by commercial banks in Nigeria?
What are the effects of those risks on the profitability of commercial banks?
What is the risk management techniques used to treat risk exposures in banks?
What are the effects of credit risk exposure on growth and profitability of Nigeria commercial banks?
What are the ways of improving commercial banks profitability through adequate risk management techniques?

1.5 RESEARCH HYPOTHESES

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

H0: Asset quality does not have a significant positive impact on profitability of commercial banks in Nigeria

H1: Asset quality has a significant positive impact on profitability of commercial banks in Nigeria

H0: Credit risk exposures do not have a significant positive impact on profitability of commercial banks in Nigeria.

H1: Credit risk exposures have a significant positive impact on profitability of commercial banks in Nigeria.

1.6 SIGNIFICANCE OF STUDY

Sequel to the enormous challenges before the banking institution in Nigeria in the management of their credit portfolio in ensuring minimal loan loss through maintenance of high quality risk assets while optimizing returns, this study is focusing on the potential financial loss resulting from the failure of customers to honour fully the terms of a loan. The paper will also examine the role played by the regulatory authorities in enhancing bank’s overall risk management through checks on compliance to credit policies in the system.

This research, however, will help the bank constitute an effective risk management program with an oversight from the board and senior management. Managing risk requires a top down approach. The quality of bank management and especially, the risk management process are key in ensuring the safety and stability in the banking system. It is the aim of this research work to encourage the strict adherence to the rules and policies by the operators and regulatory authorities alike.

1.7 SCOPE AND LIMITATION OF THE STUDY

This study is set to analyze the credit risk that is inherent in Nigerian banking system. This is prompted by the need to have an efficient and effective risk management program to stem the tide of distress in Nigerian banking industry. Data from both qualitative and quantitative sources will be used to gain an insight and knowledge of the Nigerian banking industry.

However, a structured questionnaire and interviews will be used to get relevant information on areas that requires further clarification.

Limitation of the study

Financial constraint: Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview)

Time constraint: The researcher will simultaneously engage in this study with other academic work. This consequently will cut down on the time devoted for the research work.

1.8 OPERATIONAL DEFINITIONS OF TERMS

It is the intention of this portion of the study to define some of the terms used in the work:

Credit: This involves the transfer of money or other property on promise of repayment, usually at a fixed future date.

Risk: Uncertainty of future outcome or the possibility of loss

Portfolio Management: The process of making and carrying out a decision to invest in securities.

Portfolio – Defined portfolio “as the combination or collection of several securities on behalf of an investor.

Hedging: 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.

Risk Assets: These relate basically to loans or facilities granted to customers

Credit Analysis: A systematic examination or an inquiry that can enhance the decision to lend.

Performing Credit: These are facilities having the payments of both principal and interest repayments as at when due.

Non-Performing Credit: These are facilities that re not serviced according to the terms of the agreement.

Doubtful Credit: A situation where the principal and/or interest remained unpaid for more than 180 days but less than 360 day

Lost Credit: Facilities with unpaid principal and/or interest remaining outstanding for 360 days or more and are not secured by realizable collateral.

Substandard Credit: Those with unpaid principal and/or interest remaining outstanding for more than 90 days but less than 180 days.

Profitability Ratio: This ratio measures the firm’s ability to earn a fair return from its investment

Efficiency Ratio: Used to calculate a bank’s efficiency

Liquidity Ratio: Measures the firm’s ability to meet its short-term financial obligations as at maturity

Debt Management: This consist of all the activities involved in obtaining funds from depositors and other creditors and determining the appropriate mix of funds for a particular bank.

Asset Management: This comprises the allocation of funds among various investment alternatives.

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.

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.

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.

Prudential Guideline: The guidelines were issued on November 7th, 1990 by the CBN as an offshoot of the statement of accounting standard No 10 on banks and other financial institutions. The guidelines were to be strictly adhered to by all banks in reviewing and reporting the performance.

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