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RISK MANAGEMENT IN TWO NIGERIAN BANKS
BY
OKOYE IFEOMA
PG/M.SC/06/45978
BEING A RESEARCH DISSERTATION PRESENTED IN PARTIAL
FULFILLMENT OF THE REQUIREMENTS FOR THE AWARD OF MASTERS OF
SCIENCE (M.SC) DEGREE IN BANKING AND FINANCE
DEPARTMENT OF BANKING AND FINANCE
FACULTY OF BUSINESS ADMINISTRATION
UNIVERSITY OF NIGERIA
ENUGU CAMPUS
SUPERVISOR: DR. B. E. CHIKELEZE
SEPTEMBER, 2010.
APPROVAL
This dissertation has been approved for the department of Banking and Finance, faculty of
Business Administration, University of Nigeria, Enugu Campus by
__________________________________ ________________
DR. B. E. CHIKELEZE Date
_______________________________ ____________
DR. J.U.J. ONWUMERE Date
CERTIFICATION
I, Okoye Ifeoma, a post graduate student of the department of Banking and Finance with
Registration Number PG/MSc/45978, has satisfactorily completed the requirements of
research work for the masters‟ degree in Finance.
This work embodied in this dissertation is original and has not to the best of my knowledge,
been submitted in part or in full for any other diploma or degree of this or any other
university.
__________________________________ ________________
Okoye, Ifeoma Date
(Student)
DEDICATION
This work is dedicated to God Almighty, who made this work a reality. I also dedicate this
research work to my husband and my sons.
ACKNOWLEDGEMENT
My gratitude goes to my supervisor, Dr. B. E. Chikeleze for his commitment in this work.
My appreciation also goes to Dr. J. U. J. Onwumere who was the source of my inspiration
and motivator that made this work a reality. I also thank him in a most special way for his
support and concern for this work. My appreciation also goes to all members of my family
for their support, financially, morally and above all their prayers for me.
My regards goes to friends like Afamefuna Joseph, Gibson Eze and others for their
contributions in various degrees towards ensuring the success of this dissertation. I pray that
the good Lord reward you all abundantly.
ABSTRACT
This study examines the impact of risk management in two Nigerian Banks. Data were
obtained from the annual accounts and reports of the two banks (AfriBank Nigeria PLC and
Fidelity Bank Nigeria PLC). An event study methodology was employed to examine the
effects of deposit, asset quality and credit risk exposures on the growth and profitability of
Nigeria commercial banks.
Similarly, results shows the significant impact of asset on profit. On a whole, the study finds
the need for banks in Nigeria to devote enough attention to the management of financial risks
in the banking industry.
TABLE OF CONTENTS
Title Page----------------------------------------------------------------- i
Approval------------------------------------------------------------------- ii
Certification--------------------------------------------------------------- iii
Acknowledgment--------------------------------------------------------- iv
Abstract-------------------------------------------------------------------- v
Table of Content---------------------------------------------------------- vi
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study---------------------------------------- 1
1.2 Statement of Problem---------------------------------------------- 3
1.3 Objectives of the Study----------------------------------------------- 3
1.4 Research Questions-------------------------------------------------- 3
1.5 Research Hypotheses------------------------------------------------ 4
1.6 The Scope and Limitations of the Study------------------------ -- 4
1.7 Significance of the Study----------------------------------------- -- 4
1.8 Definition of the Terms --------------------------------------- 6
References----------------------------------------------------------------- 9
CHAPTER TWO
REVIEW OF RELATED LITERATURE
2.1 Introduction-------------------------------------------------------- 9
2.2 Business Risks and Economic Globalization-------------------- 7
2.3 Meaning and Concept o risk Management--------------------- 8
2.4 Types of Risks Providing Banking Services-------------------- 10
2.5 Classification of risks---------------------------------------------- 13
2.6 Financial Risks Facing Nigerian Commercial Banks------------- 14
2.7 Design and Selection of Risk Management Strategic---------- 16
2.8 Portfolio Risk Analysis Management------------------------------ 17
2.9 Implication of Banking Risks on the Stability and
Soundness of the Financial System and the economy in General------ 18
2.10 Procedures for Adequate Bank Risk Management-------------- 20
2.11 Method of Monitoring Bank Risk--------------------------------- 13
2.12 Risk Control and Financing in Commercial Bank---------------- 24
2.13 Regulatory and Supervisory Frameworks------------------------ 28
2.14 Overview of the 1988 Accord------------------------------------- 29
2.15 Causes of Credit Risks to Commercial Banks------------------ 31
2.16 The Role of Liquidity in Commercial Bank Portfolio Management 33
2.17 Lending Polices of Commercial Banks----------------------------- 34
2.18 Summary of Literature Review------------------------------------- 36
References
CHAPTER THREE
RESEARCH DESIGN AND METHODOLOGY
3.1 Introduction----------------------------------------------------------- 40
3.2 Research Design----------------------------------------------------- 40
3.3 Population and Sample Size--------------------------------------- 40
3.4 Models of the Study------------------------------------------------ 41
3.5 Sources of Data----------------------------------------------------- 41
3.6 Techniques of Data Collections----------------------------------- 42
3.7 Data Analysis Techniques----------------------------------------- 42
References------------------------------------------------------------------ 44
CHAPTER FOUR
DATA PRESENTATION AND ANALYSIS
4.0 Introduction--------------------------------------------------------- 45
4.1 Data Presentation--------------------------------------------------- 45
4.2 Analysis of Data----------------------------------------------------- 45
CHAPTER FIVE
CONCLUSION AND RECOMMENDATIONS
5.1 Conclusion and Recommendations------------------------------ 48
5.2 Recommendations------------------------------------------------- 48
References----------------------------------------------------------------- 50
Bibliography---------------------------------------------------------------- 51
Appendix-------------------------------------------------------------------- 53
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
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 the effect of deposit on banks
lending and risk management.
Others are:
(i) To determine how asset quality can be efficiently and effectively monitored.
(ii) 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:
(i) How does deposit of banks affect the portfolio of credit by banks?
(ii) How does the quality of banks assets in terms of risks exposures affect banks
profitability?
(iii) 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”.
(i) Ho: Deposit does not have a significant positive impact on
bank loans
(ii) Ho: Asset quality does not have a significant positive impact
on profitability of a bank
(iii) Ho: 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 AfriBank 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.
(i) 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.
(ii) The result of this study should also reveal how much such progress has impacted on
the growth of the entire commercial banks in Nigeria.
(iii) 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.
(v) 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.
(vi) Finally, the study is of immense benefit to policy makers, investors, financial
managers lecturers and the general public.
1.8 DEFINITION OF THE TERMS
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).
REFERENCES
Anyafo, A. M. O. (2001), Investment Risk Evaluation: The State of the Art in Investment
and Project Analysis, Enugu: Banking and Financial Publication.
Akinsulure, O. (2002), Financial Management, Second Edition, Lagos, El-Toda Ventures
Limited.
Ebhalaghe, J. U. (1995), Corporate Financial Risk exposure Management, Lagos, Ronald
Printing Company Limited.
Hall J. A. (1999), “Banking Prudential Guidelines and their Impact on the Banking
Industry, being paper presented at the Bankers forum organized by CBN, June 5.
Nwankwo, G. O. (1990) “Prudential Regulation of Nigerian Banking” Institute of
European Finance, Lagos: University of Lagos publication.
Nigerian Deposit Insurance Corporation (1988), Annual Report and Statement of Accounts.
Soludo, C. (2005), Opening Remarks to Conference Participants, in CBN (ed), Consolidation
of Nigerian’s Banking Industry: Proceeding of Fourth Annual Monetary Policy
Conferences, Abuja, FCT.
CHAPTER TWO
REVIEW OF RELATED LITERATURE
2.1 INTRODUCTION
The review of related literature in this chapter will be reviewed under various sections
covering meaning and concept of risks, business risk and globalization, types of risks
managed by financial institutions (commercial banks), overview of the 1988 Accord
concerning risks, management, causes of credit risk to commercial banks, the role of liquidity
in commercial banks portfolio management, financial risk implication of securities, lending
policies of commercial banks. The regulatory and supervisory framework of CBN
concerning risk management in banks, risk control and financing in commercial banks,
financial risks facing commercial banks as a corporate body and techniques for monitoring
and managing financial risks exposure.
2.2 BUSINESS RISKS AND ECONOMIC GLOBALIZATION
In its general form, risk refers to variability around an expected value. The
probabilities of occurrence of the different outcomes are known, some of which are less
desirable than others and may entails a loss. Expected value is the outcome that would occur
on average over time if an individual or firm were repeatedly exposure to identifiable
conditions, decision or scenarios. Economists make a distinction between risk, in which a
random set of out comes can occur for which one known the probabilities, and uncertainty, in
which a random set of outcomes can occur for which one does not know the probabilities.
For a business enterprise, risk implies any thing that can cause variability in business value
such as unexpected increase in cash outflows or unexpected reduction in cash inflows. In
effect, business risk refers to variability in cash flow. The major business risks that give rise
to variability in cash flow. They are: price risk, credit risk. In recent times, these risks have
greatly increased as a result of economic globalization.
Globalization is the process by which national economics increasingly integrated and
dependent on one another. It is rooted in three technological revolutions.
In transportation, communication and information technology. Globalization has
drastically reduced economic transaction costs from afar and has tended to swallow up
inefficient production systems in developing countries with cheap imports from
industrialized nations (Shah, 2002).
Globalization ahs created huge concerns among government officials especially in
low-income countries as they lose sovereignty over their national economic policies. Also,
the combination of huge financial markets and flexible exchange rates makes it possible for
national economies to receive large shocks from abroad, some of which tend to be
destabilizing as demonstrated by the shocks in Indonesia and Argentina in the late 1990s. for
instance, the 1997 Asian currency crisis precipitated by hyper inflation and a 12% decline in
Indonesia GDP the following year (Friendman and Livensolhm 2002). This globalization
has capacity to greatly, increase the incidence of business risks, are sometimes classified in
economic literature as financial risks (Trieschamann et al, 2001).
2.3 MEANING AND CONCEPT OF RISK MANAGEMENT
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).
Suffice it to say that market participants seek the services of these financial
institutions because of the ability to provide market knowledge, transaction efficiency and
funding capacity. In performing these roles they generally act as a principal in the
transaction.
As such they use their own balance sheet to facilitate the transaction and to absorb the
risks associated with it.
To be sure, there are activities performed by banking firms which do not have direct
balance sheet implications. These services include agency and advisory activities such as:
Trust and investment management, “efforts” or facilitating contracts, standard underwriting
through sector 20 subsidiaries of the holding company or the packaging, securitizing,
distributing and servicing of loans in the areas of consumer and real estate debt primarily.
According to the Longman Dictionary of the English Language (1984 : 1284), risk is
the possibility of loss, injury, damage or peril. Defined in this way, risk is an inevitability of
life. No aspect of human endeavour is devoid of or can escape it. It is inherent in every day
lie and more so in the life of a banker because his business has business has been and
continues to be taking risks (Nwankwo; 1990:62). Managing risks like managing capital and
liquidity has therefore been the centre peace of banking (Nwankwo, 1990:63).
Umoh (1998:69), defined financial risk as the chance or probability that some
ufnavourable event will occur such that the financial position or cash flow stream of an
organization is adversely affected. One way of identifying the financial risks of an
organization is to recognize the sources of such risks. Another way is to see the risks as
either those the corporation can control and those that cannot.
Once a risk has been identified, the next stage is to estimate these frequency and
sovereignty of potential losses. In this way, risk managers obtain information for
determining the risks and selecting particular methods for managing them. In some cases, no
particular problems would arise if losses were incurred regularly (example, delay repayment
on small loans) because the potential size of each loss is small. But loses that occur
imprudently, yet are relatively large when they occur, need to be treated differently. It might
be a prudent policy to refuse loan application of the borrowers collateral of sufficient high
value that can be disposed without any legal entanglement. A good risk evolution system
should produce data on the following estimate: A good risk evaluation system should
produce data on the following estimate: Frequency of loss, maximum problem loss,
maximum possible loss expected loss, probability distribution of loss and standard deviation
of loss.
Risks in technical definitive terms to a situation where a project or investment
decision has a number of alternative possible outcomes and the probability of each occurring
is known. What is not known is which of the alternative outcomes will actually materialized
(Brown, 1988: 45 – 58).
the banking industries recognizes that an institution need not engage business in a
manner that unnecessarily imposes risk upon nor should it absorb risk that can be efficiently
transferred to other participants (Santomero, et all 1997).
2.4 TYPES OF RISKS PROVIDING BANKING SERVICES
In view of Nnanna (2003 : 30) observed that the risks associated with banking sector
can be grouped into the following types: Credit risk, Liquidity risk, interest rate risk, market
risk, currency risk, balance sheet structure, income structure and capital adequacy country
and transfer risk, legal risk. He further restated that the above type of risk, captures almost
all the risks arising from the normal day-to-day activities of a bank and are applicable to bank
that operate both internationally and locally. The based committee, however, noted that the
fundamental requirement for a good management of the above risks is the ability of banks to
identify and measure them accurately.
The risks associated with the provision of banking service differ by the types of
services rendered (Santomero; 1984:60). For the sector as a whole, however the risk
can be broken into five generic types: systematic/market risk, credit risk, counter part
risk, liquidity risk, and legal risks.
a. SYSTEMATIC RISK: This type of risk is referred as the risk arising
from asset value change associated with systematic factors (Old field et al,
1997: 61). It sometimes referred to as market risk, which is infact a some
what imprecise term. According to (Nnanna 2003:1) observed that market
risks is the risk arising from capital loss resulting from adverse market price
movement. By its nature, this risk can be hedged but cannot be diversified
complete away. Infact, systematic risk can be thought of an
undiverasifiable risk. All investors assume this type of risks, whenever
assets owned or claims issued can change in value as a result of broad
economic factors. Because of the bank‟s dependence on these systematic
factors, most try to estimate the impact of these particular risks on
performance.
b. CREDIT RISK: Credit risk refers to delinquency and default by
borrowers, that is, failure to make payment as at when due or make
payment by those owing the firm. The need to include delinquency derives
from the importance usually attached to the time of money in financial
analysis: one naira received today is worth more than one naira received in
the future. While delinquencies indicate delay in payment, default, denotes
non payment and the former is unchecked, leads to the latter
(Padmanaghan, 1988:14). The exposure to credit risk is particularly large
for financial institutions such as commercial and merchant banks. When
firms borrow money, they in turn, exposes under the credit risk.
However, credit risk arises from non-performance by a borrower. It may
arise from either an inability of unwillingness to perform in the pre-
committed contracted manner. This can affect the under holding the loan
contract as well as other lenders to the creditors. As a consequence,
borrowing exposes the firm‟s owners to the risk that the firm will be unable
to pay its debt and thus be forced into bankruptcy, and the firm generally
will have to pay more to borrow money because of credit risk (Harrington
and Niehaus, 1999:45).
It reduces the business value of the bank that granted the loan and
destabilizes the credit system.
Cost of administration of overdue local tends to the very sundry and
defaults push up lending costs without any corresponding increase in
loan turnover.
Default reduces the resources base for further lending, weaken staff
morale, and affect the borrower‟s confidence (Padmanabhan, 1998: 16)
The identification of credit risks and exposure to loss is perhaps the most
important element of the credit risk management process. Unless the
sources of possible losses delinquencies and defaults are recognized, it is
impossible to consciously choose appropriate, efficient methods for dealing
with those losses when they occur. The credit risk management unit of the
bank will need to draw a checklist of causes of delinquencies and default in
commercial bank financing.
c. COUNTER PARTY
Nnanna (2003:31) referred this type of risk arising from the economic, social
and political environment in the borrower‟s home country (Country risk) and
the risk present in loans that are not denominated in the borrower‟s local
currency (Transfer risk).
Moreover, counterparty risk comes from non performance of a trading
partner. The non performance may arise from a counter party‟s refusal to
perform due to an adverse price movement caused by systematic factor or from
some other political or legal constraint that was not anticipated by the principal
(Smith, 1990:59). Diversification is the major tool for controlling non
systematic counterparty risk. Counterparty risk is like credit risk, but generally
viewed as a more transient financial risk associated with trading than standard
creditor default risk.
d. LIQUIDITY RISK.
Nnanna (2003:31) defined liquidity risk as the risk arising form bank having
insufficient funds on hand to meet its current obligation. In view of Santomero
(1984:10) described liquidity risk as the risk of funding crisis. While some
would include the need to plan for growth and unexpected expansion of credit,
the credit here is seen more correctly as the potential for a funding crisis. Such
a situation would inevitably be associated with an unexpected event, such as a
large chares off, loss of confidence or a crisis of national proportion such as a
currency crisis.
One of management‟s fundamental responsibilities is to maintain sufficient
resources to meet liquidity requirements, as when cheque are presented for
payment, deposits mature and loan request are funded. Managing liquidity risk
forces a bank to estimate potential deposit losses and renew loan demanded.
e. LEGAL RISK:
Legal risks are endemic in financial contracting and are separate from the legal
ramification of credit, counter party and operational risk. Risk that a bank‟s
contract or claims will be enforceable or that court will impose judgment
against them. It covers the risk of legal uncertainty due to the lack of clarity of
laws in localities in which the bank does business (Nnanna, 2003:31);
examples of legal risk is fraud violation of regulation or laws and other actions
that can lead to catastrophic loss.
2.5 CLASSIFICATION OF RISKS
Generally, banking risks can be classified broadly into four categories: These are
financial risks, operational and event risks. Business risk and event risk.
a. Financial Risks:
Financial risks are further disaggregated into pure and speculative risks. Pure
risks which include liquidity, credit and solvency risks can result in a loss for bank, if
they are not properly managed. Speculative risks, based on financial arbitrage, can
result in a profit if the arbitrage is positive or a loss, if it is negative. The main
categories of speculative risks are interest rate, currency and market price (or
position) risks.
b. Operational risks:
Operational risks are related to a bank‟s overall organization and functioning of
internal systems, including: computer related and other technologies, compliance with
bank policies and procedure and measures against management and fraud.
c. Business risks
Business risk are associated with a bank business environment including:
macroeconomic and policy concern, legal and regulatory factors and the overall
financial sector infrastructure and payment system.
d. Event risks:
Event risks includes all type of exogenous risk which, if they are to materialize could
jeopardize a bank‟s operations or undermine its financial condition and capital
adequacy.
2.6 FINANCIAL RISKS FACING NIGERIA COMMERCIAL BANKS
Umoh (1988: 95) stated that one way of identifying the financial risks of an
organization/corporate body such as commercial bank is to categorize the sources of
such risks. He further observed that another way is to see the risks as either those the
corporation can control and those they cannot control consistent with these methods
one can classify financial risks into following sources: credit, interest rate, inflation,
exchange rate, investment, capital adequacy, liquidity, management and concentration
of asset risks: here the writer will examine sources of these financial risks briefly as
followings:
a. EXCHANGE RATE RISK
Exchange rate risk arises from the potential loss emanating from the inherent
fluctuation nature of exchange rates, particularly, since the Naira started
depreciating steadily against the major international currencies, cooperate
bodies that require foreign productive inputs have been exposed to loss arising
from changes in the relative value of the Naira vis-à-vis foreign currencies.
For the banking industry, exchange rate risks would arise if the naira rises in
value before a bank sell off its stock of foreign exchange. Conversely,
exchange gains are realized as the naira depreciates.
b. INFLATION/PURCHASING POWER RISK:
This risk arises from the changes in the price level. Since the Udeoji awards or
early 1970s the Nigerian economy, for the most part has lived with double
digit inflation. The inflation in the country has been linked mainly to excess
demand pressures, monetary and fiscal factors. One implication of purchasing
power risk for banks is that more funds must be raised to replace assets
resulting replacement.
c. INTEREST RATE RISKS:
Interest rate risk arises from changes in the prevailing rates of interest. For
example, if a merchant bank buy funds from a commercial bank at 27% and
before the merchant bank can place the funds, the market rate of interest falls
and the merchant bank can only get 25% of the funds placement, then a
financial loss will be sustained by a merchant. Bank‟s interest rate risk are
common in times of tight liquidity to financial market.
d. CAPITAL ADEQUACY RISKS:
This risk is particularly relevant in the banking business, where supervisory
authorities (CBN & NDIC) are demanding certain levels and types of capital
in order to maintain stability in the banking system and ensure the confidence
of depositors.
e. CONCENTRATION OF ASSETS RISK:
This is the probability that a corporate entity especially a financial house
would sustain financial losses if its funds are concentrated in one or only a
few asset portfolios. An example is that of a bank giving primarily real estate
loans and advances. If the market for real estate suffers a downturn, the bank
takes losses on the loans and advances portfolio. This kind of risk was
responsible for the much published savings and loan crisis in the Untied States
of America.
f. MANAGEMENT RISK:
This type of financial risk usually occur where the key management staff are
either incompetent or are pursuing goals other than those set for them by the
owners (shareholders) of the bank. Business literature has identified other
goals management may pursue to include market share, expense preference
and satisfying behaviour.
g. INVESTMENT RISK:
This is the change that the cash inflow from a given investment project when
put on a present value basis and aggregated may not be sufficient to cover the
cost of the project. Investment risk may arise from a number of factors most
of them may be outside the control of the investing bank (systematic risk).
For example, a down turn in the national economy may turn an otherwise
proof investment opportunity into a very risky one unpredictable government
policy such as ban on raw materials, importation can mar an otherwise
profitable investment opportunity. However, credit and liquidity risks have
been highlighted in our early discussions.
2.7 DESIGN AND SELECTION OF RISK MANAGEMENT STRATEGIES
This is the critical stage of fusion of risk management process and strategy. Three
basic strategies commonly employed in dealing with risks are: loss control, loss
financing and internal risk reduction. Loss control and internal risk reduction involve
decisions by firm to invest (or forego investing) resources in order to increase
business value. They are other conceptually equivalent to other decisions made by
firms. For instance, under loss control there are two basic methods loss prevention
and loss reduction. A commercial bank involved in Agriculture financing can only
bring its loss exposure to zero by refusing to grant loans to farmers. This is called
risk avoidance, the main cost being foregone benefits form agriculture financing. But
this is a non option in an environment where government insists that banks must grant
credit to their borrowers and provides the banks with incentives to do so. The
plausible option, therefore is one of loss reduction, whereby banks seek to reduce the
magnitude of losses from financing risks. The goal here is to make a safer and thus
reduce the frequency and severity of losses from delinquencies and defaults.
Investment in information on loan applicants, market research and diversification of
loan portfolio by funding different enterprises are internal risk reduction strategies
available to banks increased precaution in credit administration is very important and
can be achieved through two means:
- Demand for appropriate collateral security by banks before granting loan, and
- Effective loan supervision ad monitoring by credit officers of lending
agencies.
Loss financing refers to methods used to obtain funds to offset or pay for risks
related losses: retention, hedging and insurance.
With retention, the bank assumes obligation to pay for part or all of the credit
risk losses from available bank funds.
Hedging is employed to smoothen out unpredictable fluctuations in financial
variables so as to aid planning ad avoid embarrassment induced by cash shortfalls.
Unlike in diversification where securities/projects which are not closely correlated in
returns are sought. In hedging efforts should be made to find securities which are
perfectly correlated in returns. When one security is bought and other security with
perfectly correlated returns is sold so that the net position is safe. Hedging is used to
minimize interest rate risk and exchange rate risks.
Insurance is the third method for financing credit losses, and which tends to
spread out risk and consequently minimize the burden an individual lender/investor
has to bear.
2.8 PORTFOLIO RISK ANALYSIS MANAGEMENT
A portfolio is defined as a combination of assets and portfolio. A portfolio is
not merely a collection of unrelated assets but a carefully blended asset combination within a
unified framework. When investors make decisions with reference to their wealth positions,
they rationally should make them in a portfolio context. What constitutes a portfolio would
depend on whose perspective from which you are looking at it for an investor in the stock
market, the portfolio will be a collection of shareholdings in different companies. For a real
estate investor, his portfolio will be a collection of buildings. To a financial manager from
the industrial sector, his portfolio will be a collection of real capital projects.
The process of making and carrying out a decision to invest in securities is called
portfolio management. Proper portfolio management reduces investment risks. Portfolio
management has become a profession for delivery of investment counseling and
management services. Management of a portfolio of significant size is a time-consuming
and painstaking job. Historically, portfolio management progressed form traditional
to modern approach.
Traditional portfolio management expressed investment risk and its
relationship to returns in qualitative rather than in quantitative terms. Under the
approach, past returns could not be compared through the use of generally accepted
common denominator of risk. The uncertainty of expected return could not be
expressed with any degree of quantitative assurance.
Modern portfolio theory treats risk in quantitative terms. It focuses attention
beyond the tradition exhaustive analysis and evaluation of individual securities to the
problems of overall portfolio composition predicated on explicit risk return
parameters and on the identification and quantification of client objective.
Institutional investment polices are often a combination of the traditional and modern
approaches to portfolio management.
The basic elements of modern portfolio theory emanates form a series of
propositions concerning relational investor behaviour set forth in 1952 by Dr. Harry
Marketwise of the Rand Corporation and later in a more complete monograph
sponsored by the Cowls Foundation of the United States of America. Whether the
investor is an individual or an institution, the following factors influence investment
behaviour:
Security of capital invested: How secure is the investment given the state of
the economy?
Liquidity: the ease of convertibility of the capital invested into cash at short
notice
Return: The reward potentials of the investment
Risk: The risk content of the investment and the extent of its diversificability.
Growth prospects: The growth potentials of investment companies wishing to
attract investor‟s funds must ensure sufficient securities, liquidity, return and
growth prospects in order to enhance the marketability of the securities in the
capital market.
2.9 IMPLICATION OF BANKING RISKS ON THE STABILITY
AND SOUNDNESS OF THE FINANCIAL SYSTEM AND THE ECONOMY IN
GENERAL
Risks could result to bank distress, failure and financial crisis in an economy.
The worst problem associated with a bank crisis is that of contagion in which the
problems in one bank result to a run on the entire banking system. (Hilbers et al, 200:
52) depositors and other creditors who are worried about the safety of their money are
worried compelled to move their funds form those banks which are perceived to be
unhealthy, to the banks that are solvent. The panic withdrawal may not only be from
one bank to another, it could lead to total withdrawal of funds from the banking
system. Consequently, the loss of confidence of banks depositors on the banks can
establish the banking system and hence the economy as a whole.
2.10 PROCEDURES FOR ADEQUATE BANK RISK MANAGEMENT
It seems appropriate for an discussion or risk management procedures to
being with why these firms manage risk. According to standard economic
theory, managers of value maximizing firms ought to maximize expected profit
without regard to the variability around its expected value. However, there is
growing literature on the reasons for active risk management including in the
work of Stulz (1984), Smith, Smithson and Wolford (1990). Infact, the recent
review of risk management reposted in Santomero (1995) list dozen of
contributions to the area and at least four distinct rationals offered for active
risk management. These include managerial self interest, the non linearity of
the tax structure, the costs of financial distress and the existence of capital
market imperfections.
In the light of the above, what are the necessary procedures that must be
in place to carry out adequate risk management? And how they are
implemented in each area of risk control? The management of the banking
firm relies on a sequence of steps to implement a risk management system.
These can be seen as containing the following four parts:
- standards and reports
- position limit or rules
- investment guidelines or strategies
- incentives contracts and composition
In general, these tools are established to measure exposure, define procedures
to manage these exposures, limit individual positions to acceptable levels, and
encourage decision makers to manage risk in a manner that is consistent with the
firm‟s goals and objectives. To see how each of these four parastatals arts of basic
risk management techniques achieves these ends, we elaborate on each part of the
process below:
a. STANDARD AND REPORTS:
This involves two different conceptual activities, that is, standard setting and
financial reporting. They are list together because they are the sine qua non of
my risk system. Underwriting standards, risk categorizations, and standards of
review are all traditional tools of risk management and example is the great
depression of the 1930s, which originated in USA and affected many countries
across the world. The origin of the great depression is said to be traceable to
the initial crisis that began in the U.S. financial industry.
Empirical studies have shown that bank distress could affect the
economic growth of a country through the savings investment channel. For
instance, it has been proved that the mismanagement of contingent risks could
lead to panic withdrawals in the ailing bank, which could further deteriorate
into a run on the banking sector. The withdrawal of funds from the financial
sector implies a leakage in the system.
According to (Haynes, 2003:45) stated that in the process of managing
financial risks, and to safe-guard the banking industry in their business there is
need for banks to maintain and guide against risks losses as to ensure sound
and stable financial system in the following manners:
a. THE PURPOSE OF PRUDENTIAL REGULATIONS AND
SUPERVISION
The basic objectives of prudential regulation and supervision of banks
are to prevent systematic banking distress, protection of depositors,
savings and the encouragement of financial intimidation, specifically,
the objectives of prudential regulation as to:
enhance prudent portfolio management
ensure optimal risk diversification
prevent adverse selection and risk aversion
promote sound and stable financial system
b. REGULATORY AND SUPERVISORY FRAME WORKS
The international financial crisis of the second half of the 1990s
provoked much reflection on ways to strengthen the global financial system.
The international community identified a number of priorities including the
need to enhance its own ability to monitor the health of the financial system.
The ability to monitor the financial sector soundness presupposes the existence
of valid indicators which can measure the health and stability of the financial
systems. The general macro-prudential indicators as developed by the IMF for
assessing and supervising banks is embedded in the CAMELS frame control.
Consistent evaluating and rating of exposures of various types are essential to
understand the risk in the portfolio and the extent to which these risks must be
mitigated or absorbed.
Obviously, outside audits, regulatory reports and rating agency evaluations are
essential for investor to gauge asset quality and firm level or risk.
b. POSITION LIMITS AND RULES
A second technique for internal control of active management is the use of
position limits, and minimum standards for participation. In term of the latter,
the domain of risk taking is restricted to only those assets or counterparties that
pass some pre-specified quality standard. Then even for those investment that
are eligible limits are imposed to cover exposures to counterparties, credits and
overall position concentration relative to various types of risks.
c. INVESTMENT GUIDELINES AND STRATEGIES
Investment guidelines and recommended positions for the immediate future are the
third technique commonly in use. Here the strategies are outlined in term of
concentration and commitments to particular areas of the market, the extent of desired
asset/liability mismatching or exposure and the need to hedge against systematic risk
of a particular type.
The limit described above lead to passive risk avoidance and/or diversification,
because managers generally operate within position limits and prescribe rules.
d. INCENTIVE SCHEMES
To The extent that management can enter incentive compatible contracts with
the line managers and make companion related to the risk born by these
individuals, then the need for elaborate and costly control is lessened.
However, such incentive contracts require accurate position valuation and
proper internal control system (Santomero, 1995:4). Such tools which include
posting, risk analysis, the allocation of costs and setting of required returns to
various parts of the organization are not trivial. Notwithstanding the difficulty,
well designed system aligns the goals for managers with other stakeholders in a
most desirable way (Babble, et al, 1996:10). Infact, most financial decades can
be traced to the absence of incentive compatibility as the cases of deposit
insurance and maverick traders.
2.11 METHODS OF MONITORING BANK RISK
The banking industry has long viewed the problem of risk management as the
need to control four of the above risks mentioned earlier which make up most, if not all, of
their risk exposure, credit, interest rate, foreign exchange and liquidity risk. While they
recognize the counterparty, and legal risks, they view them as less central to their concerns
(Trester et al, 1997:45). Where counterparty risk is significant. It is evaluated using standard
credit risk procedures, and often within the credit department itself. Likewise, most bankers
would view legal risks as arising from their credit decisions, or more likely, proper process
and not employed in financial contraction. Accordingly, the study of bank risk management
process is essentially an investigation of how they manage these four risks. To illustrate how
this is achieved, this review of firm level risk management begins with a discussion of risk
management controls in each area as follows:
a. We begin with standards and reports. As noted earlier, each bank must
apply a consistent evaluation and rating scheme to all its investment
opportunities in order for credit decisions to be made in a consistent manner
and for the resultant aggregate reporting of credit risk exposure to be
meaningful. To facilitate this, a substantial degree of standardization of
process and documentation is required. The form reported here is a single
rating system where a single value is given to each loan, which relates to the
borrowers underlying credit quality. At some institution, a dual system is in
place where both the borrower and the credit facilities are rated.
There are various ways of trying to keep bad debts on loan to a tolerable
low level including:
avoiding loan to risky customers
monitoring loan repayment and
renegotiating loan when customers get unto difficulties.
Loans should be made only to borrowers who are likely to be able to
repay and who are unlikely to become insolvent. Credit analysis of
potential customers is carried out in order to judge the credit risk with
the borrower and to rich a lending decision. Loan payments are
monitored and action taken when a customer defaults.
There is some credit for customers in their dealing with bank more
commonly, borrowers are at some risk from the lending decisions of
their banks. The risk arises from taking credit rather than form giving it.
The borrower‟s risks can be listed briefly.
The interest rate charged by the bank will be dependent on the
bank‟s view of the borrower‟s credit worthiness
A bank might decide to reduce a customer‟s borrowing facility by
reducing an overdraft facilities
Lending covenants on an existing loan could restrict the ability of
the borrower to obtain further loans
A bank might refuse to extend a loan to support a company with
temporary cash flows.
Generally, accepted accounting principles require this monitoring. The
credit portfolio is subject to far value accounting standards, which have
recently be tightened by the financial Accounting shares board (FASB).
Commercial banks are required to have a loan loss reserve account (A
contra asset) which accurately represents the diminution in market value
from known or estimated credit losses. Bank loans have three sources
for repayment and these must be evaluated by the credit department of
the bank and they include:
The cash flow of the borrower
Security, in the form of a fixed or floating charge the borrower‟s
assets or a mortgage on property.
A guarantee from a third party, such as holding company
Credit management is concerned primary with managing debtors and
financing debts. The objectives of credit management can be stated as
safeguarding the company‟s investment in debtors and optimizing
operational cash flows. The objectives of credit management are
achieved primarily by means of health monitoring functions.
Assessing the credit risks and other risks such as currency risks
Negotiating and arranging credit terms appropriate to those risks.
Collecting payment in accordance with the agreed terms.
b. Interest Rate Monitoring Procedures
The area of interest rate risk is the second area of major concern and on-
going risk monitoring and management. However, the tradition has
been for the banking industry to diverge somewhat from other part of
the financial sector in their treatment of interest rate risk. Most
commercial bank make a clear distinction between their trading activity
and their balance sheet interest rate exposure. For large commercial
banks that have an active trading business, such systems have a required
part of the infrastructure. But, infact, these trading risk management
system vary substantially form bank to bank and generally are less real
than imagined.
For balance sheet exposure to interest rate risk, commercial banking
firms follow a different drummer or is it accountant? Given the
generally accepted accounting procedure (GAAP) established for bank
assets as well as the close correspondence of asset and liability
structures, commercial banks tend not to see market value reports
guidelines or limits. Rather, their approach relies on cash flow and
book value at the expense of market values.
Currently, many commercial banks are using balance sheet simulation
models to investigate the effect of interest rate variation on reported
earning over one, three and five years horizons.
c. Exchange Rate Monitoring Procedures
In this area, there is considerable difference in current practice. This can be
explained by the different franchise that co-exists in the banking industry.
Most banking institutions view activity in the foreign exchange market
beyond their frameless, while others are active participants; the former will
take virtually no principal risk, no forward open oppositions, and have
expectation of trade volume. Limits are the key elements of the risk
management systems in foreign trading as thy are for all trading business.
Incentive systems for foreign exchange traders are another area of significant
differences between the average commercial bank and its investment banking
counterpart.
d. Liquidity Risk Management Procedures
Two different nations of liquidity risk have evolved in the banking sector.
Each has some validity. The first and the easiest in most regards is a notion
of liquidity risk as a need for continued founding. The counterpart of standard
cash management, this liquidity need is forecast able and easily analysed.
Accordingly, attempt to analyze liquidity risk as a need for resources for
facilitate growth or honor outstanding credit lines are f little relevance to the
goal of risk management pursued here.
The liquidity risk that does present a real challenge is the need for funding
when and if a sudden crisis arises. In this review of literature we are
concerned with liquidity needs associated with a bank specific shock, which,
such as a severe loss, and a crisis that is system wide. The management of
risk in this aspect of our review tries to examine the extent to which it can be
self supporting in the event of a crisis and tries to estimate the speed with
which the shock will result in a funding crisis.
The regulatory authorities have increasingly mandated that a liquidity risk
plan be developed by members of the industries.
e. Risk Aggregation Procedures:
This method of risk management procedures measure, report, limit and
manage the risks of various types which have been earlier explained. A
process has been developed to measure particular risk considered and
techniques have been deployed to control each of them. In this procedure,
credit risk process is a quantitative review of the performance potential of
various borrowers. It result in rating, periodic re-evaluation at reasonable
intervals through time and on-going monitoring of various types of measures
of exposure interest rate risk rate is usually measured weekly, using on and off
balance sheet exposure. Limits are established and synthetic hedges are taken
on the basis of this cash flow earnings forecasts. Foreign exchange or general
trading risk is monitored in real time with strict limits and accountability.
As the organizational level, overall risk management is being centralized into
Risk management committee, headed by some one designated as the senior
risk manager. The purpose is to empower one individual or group with the
responsibility to evaluate overall firm level risk and determine the best interest
of the bank as a whole. At the analytical level, aggregate risk exposure is
receiving increase scrutiny. To do so, however, requires the summation of the
different types of risk outlined above. This is achieved in two district but
related ways: the first of these, pioneered by Bankers trust, is the RAROC
system of risk analysis (Wee et al, 1995:25). In this approach, risk is
measured in terms of variability of outcome, where possible, a frequency
distribution of returns is estimated, from the historical data and the standard
deviation of this distribution is estimated. Capital is allocated to activities as a
function of this credit or volatility measure.
A second approach is similar to the RAROC, but depends less on capital
allocation scheme and more on cash flow or earning effects of the implied
risky position. This was referred to as earnings. This method can be used to
analyze total firm level risk in a similar manner to the PAROC system.
2.12 RISK CONTROL AND FINANCING IN COMMERCIAL BANK
Identifying and measuring financial risks are only the preliminary steps in managing
and controlling financial risks. The next essential step is the strategy for controlling and
financing the risks. Control encompasses measures aimed at avoiding, eliminating or
reducing chances of loss, i.e. preventing events occurring or limiting the severity of the loses
when they occur (Naiyeju, 1989:15). Financing aims at spreading more evenly the costs of
the risks in order to reduce strains, financial and otherwise, and possible insolvency which
random occurrence of large losses may cause include three measures: risk avoidance and
minimization, risk transfer and risk retention (Naiyeju, 1989:25).
a. RISK AVOIDANCE AND MINIMIZATION
Banks make considerable use of this strategy which is inherent in the following areas:
Balance sheet strategy asset based and liability base approaches, particularly the
strong preference for short term self liquidating lending strategy.
Reinforced by regulator prohibitions through moral suasions and other limitations
that limit the scale of particular operations or contraction of risks in particular
areas.
Through off balance sheet activities such as currency and interest rate swaps and
other hedging devices
Internal control systems, efficiency in credit analysis and in assessing credit
worthiness and exposure limits.
Regulatory intervention by monetary authorities to keep the financial system upon
an even keel.
Overall improvements in quality of management.
Discount window and lender of last resort borrowing.
b. RISK TRANSFER STRATEGY
The management of banks especial the risk mangers in controlling and financing risks
should involve the following strategy in transferring risk.
Through an insurance system e.g. deposit insurance.
Collective guarantees of governments and their agencies e.g. international
lending.
Third party guarantees of government, wealth individuals.
c. RISK RETENTION
Assumption of risk that cannot be avoided or transferred a form of self insurance.
This is usually achieved through;
Charging losses as they occur against operations.
Adequate capital backing
Financing losses as they occur by obtaining loans from financial houses.
Providing for the loss through insurance, risk fund, contingency fund.
Interest margins on operations to cover operating expenses and some losses.
2.13 REGULATORY AND SUPERVISORY FRAMEWORKS
The international financial crisis of the second half of 1990s provided much reflection
on ways to strengthen the global financial system. The International community
identified a number of priorities, including the need to enhance its own ability to
monitor the health of the financial system. The ability to monitor the financial
system/sector soundness presupposes the existence of valid indicators which can
measure the health and stability of financial systems. The general macro-prudential
indicators as developed by the IMF for assessing and supervising bank embedded in
the CAMELS framework. CAMELS is acronym for capital (adequacy), Assets
quality, Management, Earrings, Liquidity and Sensitivity to market risks. The essence
of the CAMELS framework is explained as follows:
i. Capital: Capital adequacy ultimately determines how all financial
institutions can cope with shocks to their balance sheets, thus, it is
useful to track capital adequacy ratios that take into account the most
important financial risks, foreign exchange, credit, interest rate risks by
assigning risk weighting to the institution‟s assets.
ii. Assets Quality: The solvency of a bank is typically at risk when its
assets become impaired, so, it is important to monitor the indictor which
measures the quality of a bank‟s assets in terms of over exposure to
specific risks and the trends in non performing loans.
iii. Management: Sound management is the key to bank‟s performance,
though it could be difficult to measure. It is primarily a quantitative
factor applicable to individual institutions. Several indicators, however,
can serve for instance, efficiency measures can be applied as an indictor
of management soundness.
iv. Earnings: Chronically unprofitable financial institutions risk insolvency,
compared with other most indictors trends in profitability can be more
difficult to interpret of instance, usually; high profitability can reflect
excessive risk taking.
v. Liquidity: Initially, solvent institutions may be driven towards by poor
management of short-term liquidity indictors should cover funding
sources and capture large maturity mismatch.
vi. Sensitivity to market risk: Banks are increasingly involved in diversified
operations, all of which are subject to market risk, particularly in setting
of interest rates and the carrying out of foreign exchange transactions. In
countries that allow banks to trade in stock market or commodity
exchanges, there is also a need to monitor indictors, of equity and
commodity price risk.
2.14 OVERVIEW OF THE 1988 ACCORD
The 1988 capital accord, was a major development in bank‟s capital regulation. It
explicitly linked capital requirements to a bank quantum and degree of risks. It is also
established minimum capital requirements that were internationally comparable. It
required that banks should hold as capital, at least 80 percent of their weighted assets.
Four risk weights were introduced namely, claim on government (10 percent), claims
on banks (20 percent), residential mortgage claim (50 percent). The accord thus
provided a benchmark for the assessment of the banks by market participants.
The 1988 Accord however, has some weaknesses, some o which, at least, was a crude
measure of economic risk exposure were not sufficiently segmented to adequately
differentiate between true economic risk and the measured under the Accord.
The accord covered only credit risk.
While the 1988 Accord provided essentiality, only an option for
measuring, managing and mitigating risk, the new framework, on the other
hand provides a spectrum of approaches for the measurement of both
credit and operational risks in determining the capital requirement. It also
introduced the element of flexibility of the choice of measure, subject to
supervisory view.
Consequently, the new capital accord consists of three mutually
reinforcing pillars namely, the minimum capital requirement, supervisory
review and market discipline.
PILLAR 1: Minimum Capital Requirement:
The minimum capital requirements comprise three fundamental elements, viz
a definition of eligible regulatory capital, which remains the same as outlined
in the 1988 Accord, the risk weighted assets and the minimum capital to risk
weighted assets the fundamental; elements of 1988 Accord remain in change.
It is the measurement of risks embodied in the risk-weighted assets that the
new Accord addresses,
PILLAR 2: Supervisory Review Process
The supervisory review process is intended to ensure that the banks home
adequate capital to support all the risk in their business and also to encourage
them to develop and use better risk management techniques in monitoring and
managing risks.
PILLAR 3: Market Discipline:
This third pillar dealt with disclosure equipments and recommendations for
the market banks. The principle states that banks should have a formal
disclosure policy by the boards of directors. This policy should describe the
banks objective and strategy for the public disclosure of information on his
financial condition and performance. In addition, banks should implement a
process assessing the appropriateness of their disclosure including the
frequency of disclosure.
2.15 CAUSES OF CREDIT RISKS TO COMMERCIAL BANKS
Credit risk delinquency and fault is the main risk that commercial bank face in lending to
firms, individual, and corporate body. Empirical studies have produce a verity of reasons for
loan default,. Adeyemo (1984) identified the principal cause of loan default in Kwara state
as loss of production due to calamities. He found the educated borrowers and landlords or
landowners repaid loans more promptly than uneducated and tenant borrowers. Okorie
(1998) identified poor project supervision evaluation and management, ultimate loan
disbursements, diversion of funds, and dishonesty of loan beneficiaries as the cause of loan
default. A study in India found that default were by and large, willful and mostly large
borrowers were responsible (World Bank, 1975, Padmanabhan 1988). Given the variety of
reasons for credit risk in bank lending, it may be necessary to classify them into three broad
sources: Causes at borrower level, at financial institution level and at economy level. Such a
classification offers a quick checklist and guide to credit risk managers of bank in
management of commercial bank risks:
a. CAUSES OF LOAN DEFAULT AT BORROWERS LEVEL;
The causes of loan default the borrowers level include the following.
Failure of investment to generate sufficient income due to improper technical
advice, inadequate support services, marketing risks or natural disasters.
Diversion of loan business operations to non essential consumption which makes
it difficult to meet repayment commitment on time.
Existence of liabilities towards informal lenders, leading to delinquency and
default.
Contingencies at borrowers household, such as sickness, accident or death (pure
risk).
Absence of incentives for prompt repayment or penalties for delayed repayment.
Prevalence of low real rate of interest or pegging of interest rate far below the
market rate.
b. CAUSES OF LOAN DEFAULT AT FINANCIAL INSTITUTION
LEVEL:
At the financial institution level, loan default may be due to any or
combination of the following:
Inability or reluctance of lenders to ensure sanctions against conspicuous
defaulters.
Absence of a sound accounting and management information systems.
Defective procedures for loan appraisal which could lead to financing of
bad projects, thereby giving rise to delinquencies and default.
Quality of loan officers, their mobility in the field and their capacity to
judge borrowers as well as the incentive package available to them affect
repayment. When loan officers are assessed on the baisi of compliance
with lending targets than with recovery performance, it could lead to bad
loans, when targets than with recovery tends to decline.
Ultimate loan disbursement and inappropriate repayment schedules. In
addition, when the procedure for repayment is cumbersome, borrowers
tend to default.
c. CAUSES OF LOAN DEFAULT AT ECONOMY LEVEL
At the level of the economy, the causes of loan default include the following:
Excessive government regulations in the day to day administration of
financial institutions could result in difficult and bad debts.
Government indemnity or guarantee of banks against losses arising from
poor loan repayment, which could weaken the efforts of the banks in loan
collection.
Low real interest rate which makes borrowing and consumption more
profitable at the expense of savings and loan repayment.
Inappropriate monetary and fiscal policies that could induce inflation and
encourage borrowers to delay repayment in order to take advantage of the
fall in the value of monetary and
Poor planning and execution of development programmes by government
agencies, which could result in lack coordination between credit supported
activities and other support services.
2.16 THE ROLE OF LIQUIDITY IN COMMERCIAL BANK PORTFOLIO
MANAGEMENT
Liquidity is often measured in terms of balance sheet aggregate (Emekekwue,
1994:155) cash and government securities have continued to decline while loan
have been on the increase. The reason for decline in cash holding is because of
the sterility of cash, as for the government securities the income in the form of
interest rate is very negligible. On the other hand loan which are largely liquid
have been on the increase because of the huge profit potential from expending
prudent loans.
The loan deposit ratio measures, that extent to which the banks have used up
its resources in the extension of loans to its customers and as the ratio
continues to increase, the banks becomes very cautious and restrictive in their
lending activities. This is because their resources are tied up in liquid assets
and should assets and should there be serve pressure on the resources by
depositors.
The issue of liquidity is very crucial in the discussion of a bank to extent loans.
Liquid assets help to protect the bank against unexpected gyrations in the
amount of deposit held as some of those deposit could have been used in the
process of extending loans. When bank experience on unexpected loss of fund
through excessive with drawls of funds by depositors, part of this loss can be
met from liquid assets, (James, 1988:23). The ownership of liquid assets
reduces the profitability of a bank selling its loan under pressure at
unfavourable terms. In this way, when there is an unexpected flow of funds
into the bank, either because of depositors increasing the volume of deposit
they lodge at the bank, or through the repayment of loans on maturity, the
banker should exercise a lot of cautious in viewing such funds (George,
1973:133).
However, the amount of deposits held by bank can be influenced by
endogenous and exogenously influenced because the volume of loan demands
and deposit withdrawals cannot be predicted and the result is a diminution in
the amount of deposit in the bank. Similarly, the volume of deposits can be
enhanced by the sale of some assets of the bank and the sale of the certificate
of deposits (CDs) and the purchase of federal funds in the market.
2.17 LENDING POLICIES OF COMMERCIAL BANKS
The main preoccupation of banks is to extend loans to their customers.
Thus, the formulation and implementation of sound lending policies are
some important responsibilities of the directors and management of a
bank. If a bank is to execute its credit creation function properly, there
must be well articulated lending policy by the bank. The lending policy
of a bank must be specific on how much of loans will be made to whom,
when, for what period and for what purpose. Against this background,
lending policies should be well documents so that lending officers will be
able to know the area of prohibition and the areas where they can operate.
Even when the policies are established and documented, such policies
must be subject to periodic review to enabling the bank keep abreast with
the dynamic nature of the economy and complete effectively with other
banks in the system.
A bank‟s lending policy is simply a screening device that enables a bank
screen out poor loan applications and respond favourable tot eh good
ones, keeping in view its resources. We must emphasis that the character
of the loan is more important than its form. That is, it is more important
that a loan is sound and that the project can through of periodic incomes
large enough to service and extinguish the loan, than the mere fact that it
is a secured loan such as mortgage loan collateral loans consumer loans,
business loans etc.
Establishing policy guidelines for extending credits involves determining
well in advance how loans are to be made, how such loans will be
service, reviewed, and collected. In order to achieve this, the policy
makers must determine the organizational structure of the lending
function, delegate authority tot hose that will have to execute the polices
and to establish guidelines on how to review loan applications and
outstanding loans.
Most of the time, it is not proper to allow the directors to extend or
review loans to customers of the bank. This is because they not specialist
except executive directors) since they are not specialist they might over
emphasis the magnitude of the collaterals pledged as the sole basis of
extending credit. At times their social relationships might weigh heavily
in their decision making process. Against thus background the
responsibility for lending should be delegated to loan officers or credit
analyst.
Credit review is another guidelines for which commercial banks must be
put into consideration in making of lending to their customers. In order to
make sounding lending decisions, it is proper that the lending officer
should have all the relevant information about potential borrower. The
information is analyzed in the lending department which is made up of
officer to analyze all the information about a loan applicant. It often lends
to faulty decisions because in their bid to impress, they often become
over enthusiastic about the prospects of a customer. That is why this job
of lending is assigned to department that is why the importance of
establishing a credit department in commercial bank cannot be
overemphasized. The job of the credit department is to analyze all the
information avoidable about a borrower and the use that as a basic for
judging the desirability.
The performance of the credit reviews function is not the end o the matter
a container all relevant information about the borrower such as his loan
application, the comments of the credit analyst or loan officer,
recommend actions about the loan application, the material pledged if
any, the history of the business, the amount of loan granted and for what
and the earning of the business.
Another essential ingredient to successful lending is a various collection
policy. At the inception of the loan, the repayment and method of
payment must loan proposal that does not contain these ingredients must
be dropped in the process of the bank or borrower relationship, some
borrowers will honour their obligations, leaving others unpaid, while
other my not even pay back a single kobo.
Moreso, the final important issue on lending policies is that of loan
development. Many bank officials hid under the façade of some
predetermined ratio to decide on the desirability or otherwise of
extending loan. Others on the other hand maintain an aggressive policy in
their quest for loans. The essence of loan development is to search for
potentiality new users of credit, encourage then to apply for financial
assistance and help make such application meet the required standards.
2.18 SUMMARY OF LITERATURE REVIEW
The review of literature for this project work identified risk categories that can
potentially cause financial loss to commercial banks businesses. The risk
categories can be group into two: those that are direly within the control of the
bank industry (Commercial banks) and those that arises from macroeconomic
factors beyond the direct control of the corporation (Systematic risks)
The various control measures available for the control of these risks have been
identified and discussed. It has been noted that elimination of risk is difficult
and in many instance impossible. It follows therefore that some risk can be
minimized and some other can be transferred.
Interestingly, all the authors cite in the course of the review like Naiyeju
(1989), Okerie 1998, Padmanabhan (1988), Emekekwue (1994) Wee, et al
(1995), James (1988), Brown (1988), Harrington (1999), Nwankwo (1990)
Schuh (2002), and Santomero et al (1997) among others whose work were
reviewed have all written on a number of areas concerning the topic especially
the need for adequate risk management and control measures, but more has
written on the impact of risk management in the Nigeria Banking Industry and
that is what this study is set to achieve.
REFERENCES
Brown, K.C. and D.J. Smith (1988) “Recent Innovation in Interest Rate Risk
Management and the Reintermediation of Commercial Banking” Financial
Management Writer.
Ebhalaghe, J.U. (1995), Corporate Financial Risk Exposure Management, Lagos,
Ronald Enterprising Publishing Company Limited.
Emekekwue, P.E. (1994), Commercial Banking, Kinshasa – Zaire, Africa Bureau of
Educational Sciences.
Friedman, J and Levision. J. (2002), The Distribution Impacts of Indonesia’s
Financial Crisis on Household Welfare. A Rapid Response Methodology, the World
Bank Economic Review.
Harrington, S.E. and Nichaus, G.R. (1999), Risk Management and Insurance, USA
Irwin McGraw. Hill, Boston.
James, L.P. (1988), Commercial Bank Liquidity Innovation in Bank Management:
Selected Readings, U.S.A: Paul – Jessup Publishing Company Limited.
Okorie, A. (1998) Management of Risk and Default in Agricultural Lending in
Ijere, M and A. and A Okorie (ed) Reading in Agricultural finance, Lagos, Longman
Nigeria Plc.
Nwankwo, G.O. (1980) “International Risk based Capital Standard: History and
Explanation.
Oldfield, G. and Santomero, A, (1997), “The Place of Risk Management in
Financial Institutions,” Slona Management Review, summer – Forthcoming.
Santomero, A. and Babble, D. (1996), Financial Markets Instruments and
Institutions, Illinois, Irwin Publishers.
Smith, C.C. et al (1990), Strategic Risk Management: Institutional Investors Series
in Finance, New York, Harper and Row Publishing Company Limited.
Padmanabhan, K.P. (1988), Rural Credit: Lessons for Rural Credit: Lessons for
Rural Bankers and Policy Makers, London, Intermediate Technology Publication Ltd.
Trieschmann, J.S.et al (2001), Risk Management and Insurance, Eleventh Edition,
Georgia, South-Western College Publishing Company Limited.
Umoh, P.N. (2005), Capital Restructuring of Banks: A conceptual Framework, in
CBN (ed) consolidation of Nigeria‟s Banking Industry: Process of fourth Annual
Monetary Policy Conference, Abuja, FCT.
Nnanna O.J., (2003), Today’s Banking risks and Current Regulatory and
Supervisor Framework, CBN Bullion Publication Vo. 27 No 23, July – Sept. P. 30-
44.
World Bank (1975), Agricultural Credit Sector Policy Paper, World Bank
Washington DC, United States of America.
Wee, L.Et al (1995) RAROC and Risk Management – Quantifying the Risk of
Business, New York, Bankers Trust.
Macaver, O.J. et al (2006), Credit Risk Management in Bank Lending to
Agriculture: An Economic and Business Publication of Union Bank of Nigeria Plc,
Vol. 10 No. 1 and 2, June.
Chartered Institute of Bankers, (200), Credit Risk Management: Framework for
Credit Risk Management, WBC Book Manufacturing Bridgends.
CHAPTER THREE
RESEARCH METHODOLOGY
3.1 INTRODUCTION
This Chapter deals with the methodology used by the researcher in the course of the
study. It shows the design of the study as well as the techniques of data collection as
contained in this chapter, and also are the data sources: primary and secondary,
sample size, models of the study and data analysis techniques.
3.2 RESEARCH DESIGN
Planning is essential in research: Planning is an academic or scientific method of
designing a research work. This planning in research generally is a research design.
According to Okeke (2005:64) defined design as it is used in purely research context
“as the total constructional plan or structure of the research framework”. He further
observed that research design therefore means the structure and planning of the entire
approach to the problem that generated the research.
Both quantitative and historical research design will be adopted for this study. The
choice of these methods of research design was informed by the fact that extensive
use of raw data was made on risk correlated variables as will be analyzed in chapter
four of this project work. Historical research on the other is a “Systematic collation of
data related to past occurrences in order to test hypotheses or research questions
concerning causes, impact/effect or tends of those events anticipate future trends
(Gay: 1989).
3.3 POPULATION AND SAMPLE SIZE
The population of this study is the commercial banks in Nigeria and the study
essentially examined the risk management in some commercial Banks. However,
considering the size of the commercial banks and time, constrained this work was
narrowed down to two banks: “AfriBank Nigeria Plc and Fidelity Bank Nigeria Plc”.
3.4 MODELS OF THE STUDY
In this research work the functional relationships are specified as follows:
QD (LB) = 0……………………………………. (1)
Where QD = Depot
LB = Bank Loans and advances.
This (ie. Model 1) states that there is a positive relationship between deposit structure
and bank loans and advances.
Our model 2 is:-
AQ = F(R)…………………………………………..
Where AQ = Asset quality
R – profitability
OR
AQ = xo + xi R + U
xi > 0
Where ∞1 Coefficient or R and is expected to be positive
U = Disturbance of Error term
Model 3 is:-
LB = ……………………………………………… (3)
Where LB = Credit loans and advances
R = profitability
Model (3) can be further specified as
LB = ao + ai R
Ai > o
Thus the expectation is the coefficient of R is positive.
These models will aid our hypotheses testing.
3.5 SOURCE OF DATA
In the course of this research, the researcher will employ only the use of secondary
source of data. The use of only secondary data was informed by the fact that
quantitative data analysis will be employ by the researcher in chapter four of this
research work. However, primary data will be unnecessary since a good number of
people are not familiar with commercial banks related risk exposures.
3.6 TECHNIQUES OF DATA COLLECTIONS
The data for this research work will be from the official records, precisely published
and unpublished materials which include: textbooks, CBN Billon publications,
journals, magazines, internet- web and seminars.
3.7 DATA ANALYSIS TECHNIQUES
The techniques of data analysis will be purely quantitative method of data analysis.
In this method, the writer will use of correlation/ regression analysis techniques. This
method(s) of data is chosen because it establishes the impact of relationship between
risk associated variables and creditability of growth and profitability in the banking
industry. The formular is mathematically calculated thus:
r = n ∑ XY – (∑ X) (∑ Y)
n∑X2 – (∑x)
2 n Y2 – (∑Y)
2
r = Correlation and coefficient
n = Number of paired value
x = Independent variable
y = Dependent variable
That is,
r = +1 indicates positive correlation
= -1 indicates negative correlation
= 0 it indicates neutral correlation
For Simple regression technique
For a simple model of type 1 show below
Y = F(X) …………………. (1), the regression equation
Is shown in 2 below as
Y = a + bx…………………….. (2)
Where Y = Dependent variable
X = Independent variable
a = Constant indicating the point of interception with the Y
axis
b = parameter that defines the specific relationship between Y and X
The constant a and b can be calculated using:
b = ∑xy ………………………………………………….. (4)
∑x2
A = Y – bx ……………………………………………………………(5)
However, for this research, all calculations will be move via the computer using
relevant regression packages.
REFERENCES
Gay, I.R. (1989), Educational Research: Competences for Analysis and
Application, Columber, Ohia Meill Publishing Company.
Okeke, T.C. (2005) Research Methods: a guide to success in project
writing, Bauchi, Multi- System Nigeria publishing Company Limited.
Olakunori, O.K. (1997) Successful Research: Theory and Practice,
Enugu, Computer Edge Publishing Company Limited.
CHAPTER FOUR
DATA PRESENTATION AND ANALYSIS
4.0 INTRODUCTION
This chapter analyzes the model specifications which aided our hypotheses testing.
Three formulated hypotheses will be tested from the four objectives stated earlier.
4.1 DATA PRESENTATION
The data presented are results from regression model of the two banks. The computer
print out of the result are included as Appendix.
4.2 ANALYSIS OF DATA
TEST OF HYPOTHESES
HYPOTHESES 1
Ho: Deposit does not have a significant impact on bank loans
Model specification:
The statistical tool employed as the simple regression Analysis model. The relationship
between the dependent variable (Y) and the independent variable (X) is given by the liner
function re presented by the equation below:
QD (LB) = 0
The relationship between the deposit and bank loan. In mathematical notation as
stated above is presented below for empirical verification. In the specification above, bank
loan is the dependent variable while deposit is independent variable.
Model Representation
The model is hereby stated below:
Y = Bank loan and advances is the dependent variable represented as LB
X = Deposit which is the independent variable represented as QD
Thus, deposit has a significant positive impact on bank loans.
HYPOTHESIS 11
Ho: Asset quality does not have a significant positive impact on profitability of a bank.
Model Specification:
The specific tool employed is the regression Analysis model. The relationship between the
dependant variable (Y) and the independent variable (x) is given by the liner function
represented by the equation by the equation below
AQ = o + 1 R + U
The relationship between the asset quality and bank profitability is represented below in
mathematical nortation stated above for empirical verification. In the specification above,
asset quality is the dependent variable while the bank profitability is the independent
variable.
Model Representation:
The model is hereby stated below:
Y = Asset quality is the dependent variable, represented as AQ
X = Profitability which is the independent variable, represented as R
U = Error term
= Coefficient of the independent variable.
Thus, asset quality has a significant positive impact on profitability of a bank.
HYPOTHESIS III
Ho: Credit risks exposures do not have a significant positive impact on profitability of
bank
Model Specification:
The statistical tool employed is the simple regression analysis model. The relationship
between the dependent variable (Y) and the independent variable (X) is given by the linear
function represented by the equation below:
LB = ao + a1R
In the specification above, credit risk exposures is the dependent variable while bank
profitability is the independent variable.
Model Representation
The model is hereby stated below:
Y = Credit loans and advances is the dependent variable,
represented as LB
X = Profitability which is the independent variable, represented as
R
ai = Coefficient of the independent variable.
Thus, credit risk exposures have a significant positive impact on profitability of banks.
DISCUSSION OF FINDINGS
The decision criterion set for this test requires us to reject the null hypothesis if the impact of
asset on profit is significant as the table value is greater than two, otherwise do not reject it.
Through the analysis of regression and correlation of the two banks (Fidelity Bank Nigeria
PLC and AfriBank Nigeria PLC).
Similarly, the result is significant at R2 = 0.993 or 99.3% of variation in profit which
indicates that impact of assets is significant since table value of 20.925 > 2.0. Thus asset
quality has a significant shows positive impact on profitability. R2 = 0.916 or 91.6% of
variation in profit which shows that impact of asset is significant since table value of 32.664
> 2.0. Thus, credit risk exposure have a significant positive impact on profitability.
Based on this statistical results therefore, the null hypothesis is hereby rejected and the
alternative hypothesis accepted, therefore concluded that deposits, asset quality and credit
risk exposures have significant positive impact on profitability and bank loans respectively.
CHAPTER FIVE
CONCLUSION AND RECOMMENDATION
5.1 CONCLUSION
This research work examines the impact of risk management in Nigerian banks and
the effect of deposit, asset quality and credit risk exposures on the growth and
profitability of Nigeria commercial banks. This study covers risk management in
Afribank Nigeria PLC and Fidelity Bank PLC within the period of 2003 and 2008.
An event study methodology was employed to examine the effects of deposit, asset
quality and credit risk exposures on the growth and profitability of Nigeria
commercial banks. Based on the analysis of regression and correlation of the two
banks (AfriBank Nigeria PLC and Fidelity Bank Nigeria PLC). The study concluded
that deposit, asset quality and credit risk exposures have significant positive impact
on the growth and profitability of Nigeria commercial banks.
5.2 RECOMMENDATIONS
Based on our research findings on the impact of risk management in Nigeria banking
industries, were hereby make the following suggestions to banks:
1. Commercial banks risk management departments should be more prudent in
identifying and evaluating risks so as to enhance growth and profitability of
financial institutions.
2. Banks should be careful in their lending habit by making proper channeling of
their funds to the supposed sectors of the economy.
3. Adequate measures should be taken by the bank managers to avoid bank
fragility or distress.
4. Effective control measures should be taken also by the risk management
department of the banking sector to avoid bankruptcy.
5. Banks are to analyze the credit portfolio of a customer before giving loan a
customer.
6. The policy makers must determine the organizational structure of the lending
functions and establish guide lines on how to review loan applications and
outstanding loans.
7. Most times, the directors of the bank are not advised to extent or review loans
to customers of the bank due to their social relationships with the customer
which might weigh heavily in their decision making process.
8. Credit review is another guidelines which commercial banks must put into
consideration in making decision of lending to their customer. In order to
make sound lending decision, it is proper that the lending officer should have
all the relevant information about the potential borrower.
9. Lending policies should be well documented so that lending officers will be
able to know the area of prohibition and the areas where they can operate.
10. It is recommended that both the internal control and risk management
departments should report directly to the highest authority within the bank to
avoid manipulation of the bank‟s credit policies.
11. The supervisory authorities and regulatory bodies should endeavour to
monitor the risk in portfolio of loans granted to either private, government and
co-operate agencies.
REFERENCES
Asika, N. (2006), “Research Methodology in the Behavioural Science”, Lagos: Longman
Publishers.
Nnanna, O. J. (2004), Financial markets in Nigeria, Abuja: Central Bank of Nigeria
Publication.
Onwumere, J. U. J. (2005), “Business and Economic Research methods”,
Lagos: Don Vinton Press Ltd.
BIBLIOGRAPHY
Akinsulire, O. (2002), Financial Management, Second Edition, Lagos, El-Toda Ventures
Limited.
Anyafo, A. M. O. (2001) Investment Risk Evaluation: The State of the Art
in Investment and Project Analysis, Enugu: Banking and Financial Publication.
Asika, N. (2006), “Research Methodology in the Behavioural Science”,
Lagos: Longman Publishers
Brown, K. C. and D. I. Smith, (1988) “Recent Innovation in Interest Rate
Risk Management and The Reintermediation of Commercial Banking” Financial
Management Writer.
Chartered Institute of Bankers, (2000), Credit Risk Management:
Framework for Credit Risk Management, WBC Book Manufacturing Bridgends.
Ebhalaghe, J. U. (1995), Corporate Financial Risk exposure Management,
Lagos, Ronald Printing Company Limited
Emekekwue, P. E. (1994), Commercial Banking, Kinshasa – Zaire, Africa
Bureau of Educational Sciences.
Friedman, J and Levision, J. (2002), The Distribution Impacts of
Indonesia’s Financial Crisis on Household Welfare. A Rapid Response
Methodology, the World Bank Economic Review.
Gay, I. R. (1989), Educational Research: Competences for analysis and
Application, Columber, Ohia Meill Publishing Company.
Hall J. A. (1999), “Banking Prudential Guidelines and Their Impact on the
Banking Industry, being paper presented at the Bankers‟ Forum organized by CBN,
June 5.
Harrington, S. E. and Nichaus, G.R. (1990), Risk Management and
Insurance. U.S.A Irwin McGraw, Hill, Boston.
James, L. P. (1988), Commercial Bank Liquidity Innovation in Bank
Management: Selected Readings, U.S.A: Paul-Jessup Publishing Company Limited.
Macaver, O. J. et al (2006), Credit Risk Management in bank Lending to
Agriculture: an Economic and Business Publication of Union bank of Nigeria PLC.
Nigeria Deposit Insurance Corporation, (1988), Annual rEportand
Statement of Accounts
Nnanna, O. J., (2003), Today’s Banking Risks and Current Regulatory and
Supervisory Framework, CBN Bullion Publication.
Nnanna, O. J. (2004), Financial markets in Nigeria, Abuja: central Bank
of Nigeria Publication.
Nwankwo, G. O. (1980) “International Risk Based Capital Standard:
History and Explanation.
Nwankwo, G. O. (1990) “Prudential Regulation of Nigerian Banking”
Institute of European Finance, Lagos: University of Lagos Publication.
Okeke, T. C. (2005) Research Methods: A Guide to success in Project
Writing, Bauchi, Multi-system Nigeria Publishing Company Limited.
Okorie, A. (1998) Management of Risk and Default in Agricultural Lending
in Ijere, M and A. an Okorie (ed) Reading in Agricultural Finance, Lagos, Longman
Nigeria PLC.
Olakunori, O. K. (1997) Successful Research: Theory and Practice,
Enugu: Computer Edge Publishing Company Limited.
Oldfield G. and Santomero, A, (1997), “The Place of Risk Management in
Financial Institution, Sloan Management Review, Summer – Forthcoming.
Onwumere J. U. J. (2005), “Business and Economic Research Methods”,
Lagos: Don-Vinton Press Ltd.
Padmanabhan, K. P. (1988), Rural Credit: Lessions for Rural Bankers and
Policy Makers, London, Intermediate Technology Publication Ltd.
Santomero, A., and Babble, D. (1996), Financial Markets Instruments and
Institutions, Irwin Publishers.
Smith, C. C. et al (1990), Strategic Risk Management: Institutional
Investors Series in Finance, New York, Harper and Row Publishing Company
Limited.
Soludo, C. (2005), Opening Remarks to Conference Participants, in CBN
(ed), Consolidation of Nigerian’s Banking Industry: Proceeding of Fourth Annual
Monetary Policy of Conferences, Abuja, FCT.
Trieschmann, J. s. et al (2001), Risk Management and Insurance,
Eleventh Edition, Georgia, South-Western College Publishing Company Limited.
Umoh, P. N. (2005), Capital Restructuring of Banks: A Conceptual
Framework in CBN (ed) consolidation of Nigeria‟s Banking Industry: Process of
Fourth Annual Monetary Policy Conference, Abuja, FCT.
Wee, L. Et. Al (1995) RAROC and Risk Management: Quantifying the Risk
of Business, New York, Bankers Trust.
World Bank (1975), Agricultural Credit Sector Policy paper, World Bank
Washington DC, United States of America.
APPENDIX 1
HYPOTHESIS ONE
REGRESSION (FIDELITY)
Descriptive Statistics
Mean Stad. Deviation N
Loans
deposit
27940362.000 26757912.21085 5
63014777.2000 69104627.27482 5
Correlations
Mean Loan Deposit
Pearson Correlation Loan
Deposit
Sig. (1-tailed) Loans
Deposit
N Loans
Deposit
1.000 .995
.995 1,000
. .000
.000 .
5 5
5 5
Model Summary (b)
Model R R. Square Adjusted R. Square Std. Error of the Estimate Durbin-Watson
1 .995(a) .989 .989 3219914.03820 1.389
a. Predictors: (Constant). Deposit
b. Dependent variable: loans.
ANOVA (b) Model Sum of Squares Df Means square F Sig.
1 Regression
Residual
Total
2832839923423093.000
31103540109520.630
2863943463532614.00
1
3
4
2832839923423093.00
1036784703173.540
273.233 .000(a)
a. Predictors: (Constant). Deposit
b. Dependent Variable: loans.
Coefficient (a)
Model Unstandardized coefficients Standardized coefficients t F
1 B Std. Error Beta 1 273.233 (Constant
Deposit
3673350.403
.385
2056411.111
023 .995 1.786
16.530 .172
.000
A dependent Variable: loans Loans = 3673350.403 + .385 deposit
(t = 16.530)
R2 = 0.989 R
2 = 0.986 F =273.233 DV = 1.389
From the above equation, 98.9% of variations in profit are explained by assets. The impact of asset is
significant (as the t-value of 16.580 > 2.0). Again, the equation is significant given by the high f-
value of 273.233. Other independent variables, excluded form the current equation may be
contributory factors. Nevertheless, the significant impact of asset on profit is not in doubt as shown
by the equation above.
Based on the above, the null hypothesis is hereby rejected and the alternative hypothesis accepted.
Thus deposit has a significant positive impact on bank loans.
REGRESSION (AFRIBANK)
Descriptive Statistics
Mean Stad. Deviation N
Loans
deposit
34321.800 21888.99737
81513.800 37073.85724
5
Correlations
Mean Loan Deposit
Pearson Correlation Loan
Deposit
Sig. (1-tailed) Loans
Deposit
N Loans
Deposit
1.000 .997
.997 1,000
. .000
.000 .
5 5
5 5
Model Summary (b)
Model R R. Square Adjusted R. Square Std. Error of the Estimate Durbin-Watson
1 .997(a) .993 .991 2085.00815 2.609
a. Predictors: (Constant). Deposit
b. Dependent variable: loans.
ANOVA (b)
Model Sum of Squares Df Means square F Sig.
1 Regression
Residual
Total
1903471045.864
13041776.936
1916512822.800
1
3
4
1903471045.864
4347258.979
437.855 .000(a)
a. Predictors: (Constant). Deposit
b. Dependent Variable: loans.
Coefficient (a)
Model Unstandardized coefficients Standardized coefficients t F
1 B Std. Error Beta 1 273.233 (Constant
Deposit
-13641.219
.588
2474.542
.028 .997 1.786
16.530
20.925
.012
.000
A dependent Variable: loans
Loans = 13641.219 + .588 Deposit
(t = 20.925)
R2 = 0.989 R
2 = 0.991 F =437.855 DV = 2.609
From the above equation, 99.3% of variations in profit are explained by assets. The impact of asset is
significant (as the t-value of 20.925 > 2.0). Again, the equation is significant given by the high f-
value of 273.233. Other independent variables, excluded form the current equation may be
contributory factors. Nevertheless, the significant impact of asset on profit is not in doubt as shown
by the equation above.
Based on the above, the null hypothesis is hereby rejected and the alternative hypothesis accepted.
Thus deposit has a significant positive impact on bank loans.
HYPOTHESIS TWO
CORRELATIONS (AFRIBANK)
Descriptive Statistics
Mean Stad. Deviation N
Loans
deposit
113160.20 44859.19079
00
1594.2000 1335.57392
5
5
Correlations
Mean Loan Deposit
Asset Pearson Correlation
Sig. (2-tailed)
N
Profit Pearson Correlation
Sig. (2-tailed)
N
1 .913(*)
.030
5 5
.9313(*) 1
030
5 5
*Correlation is significant at the 0.05 level (2-tailed).
REGRESSION (AFRIBANK)
Descriptive Statistics
Mean Stad. Deviation N
Profit
deposit
1594.2000
113160.2000
1335.57392
44859.19079
5
5
Model Summary (b)
Model R R. Square Adjusted R. Square Std. Error of the Estimate Durbin-Watson
1 .913(a) .834 .778 629.05752 3.402
a. Predictors: (Constant). asset
b. Dependent variable: profit
ANOVA (b)
Model Sum of Squares Df Means square F Sig.
1 Regression
Residual
Total
5947890.696
1187140.104
7135030.800
1
3
4
5947890.696
395713.368
15.031 .030(a)
a. Predictors: (Constant). Deposit
b. Dependent Variable: loans.
Coefficient (a)
Model Unstandardized coefficients Standardized coefficients t F
1 B Std. Error Beta 5.513 273.233 (Constant)
asset -1481.853
.027
841.817
.007 .913 -1.760
3.877 .177
.030
A dependent Variable: profit
Profit = -1481.853 + .027 Asset
(t = -1.760)
R2 = 0.834 R
2 = 0.778 F = 15.031 DV = 3.402
From the above equation, 83.4% of variations in profit are explained by assets. The impact of asset is
significant (as the t-value of -1.760 > -2.0). Again, the equation is significant given by the high f-value of
273.233. Other independent variables, excluded form the current equation may be contributory factors.
Nevertheless, the significant impact of asset on profit is not in doubt as shown by the equation above.
Based on the above, the null hypothesis is hereby rejected and the alternative hypothesis accepted.
Thus deposit has a significant positive impact on bank profitability.
CORRELATIONS (FIDELITY)
Descriptive Statistics
Mean Stad. Deviation N
asset
profit
84430551.800 84251992.06100
2065926.6000 1505357.67192
5
5 Correlations
Mean Asset Profit
Asset Pearson Correlation
Sig. (2-tailed)
N
Profit Pearson Correlation
Sig. (2-tailed)
N
1 .982(**)
.003
5 5
.982(**) 1
003
5 5
*Correlation is significant at the 0.01 level (2-tailed).
REGRESSION (FIDELITY)
Descriptive Statistics
Mean Stad. Deviation N
Profit
deposit
2065926.600
84430551.8000
1505357.67192
84251992.06100
5
5
Model Summary (b)
Model R R. Square Adjusted R. Square Std. Error of the Estimate Durbin-Watson
1 .982(a) .965 .953 325942.04664 2.280
a. Predictors: (Constant). asset
b. Dependent variable: profit
ANOVA (b)
Model Sum of Squares Df Means square F Sig.
1 Regression
Residual
Total
8745692228364.610
318714653296.584
9064406881661.200
1
3
4
8745692228364.610
106238217765.528
82.322 .003(a)
a. Predictors: (Constant). Deposit
b. Dependent Variable: loans.
Coefficient (a)
Model Unstandardized coefficients Standardized coefficients t Sig
1 B Std. Error Beta (Constant)
asset 584136.978
.018
218906.134
.002 .982 2.668
9.073 .076
.003
A Dependent Variable: profit
Profit = 584136.978 + 018 Asset
(t = -2.668)
R2 = 0.965 R
2 = 0.953 F = 82.322 DV = 2.280
From the above equation, 95.5% of variations in profit are explained by assets. The impact of asset is
significant (as the t-value of 2.668 > 2.0). Again, the equation is significant given by the high f-value of 82.322.
Other independent variables, excluded form the current equation may be contributory factors. Nevertheless, the
significant impact of asset on profit is not in doubt as shown by the equation above.
Based on the above, the null hypothesis is hereby rejected and the alternative hypothesis accepted.
Thus deposit has a significant positive impact on bank profitability.
HYPOTHESIS THREE
REGRESSION (FIDELITY)
Descriptive Statistics
Mean Stad. Deviation N Generalreserve
profit 1033106.2000 1305717.74578
2065926.6000 1505357.67192
5
5
Correlations
Mean Generalreserve Profit
Pearson Correlation generalreserve
profit
Sig. (1-tailed) generalreserve
profit
N generalreserve
profit
1.000 .769
.769 1.000
. .064
.064 .
5 5
5 5
Model Summary (b)
Model R R. Square Adjusted R. Square Std. Error of the Estimate Durbin-Watson
1 .769(a) .592 .456 963217.77877 2.813
a. Predictors: (Constant). Profit
b. Dependent variable: generalreserve
ANOVA (b)
Model Sum of Squares Df Means square F Sig.
1 Regression
Residual
Total
4036229858570.420
27833654682020.382
6819595326590.800
1
3
4
4036229858570.420
927788489340.128
4.350 .128(a)
a. Predictors: (Constant). Profit
b. Dependent Variable: generalreserve
Coefficients(a)
Model Unstandardized coefficients Standardized coefficients t Sig
1 B Std. Error Beta (Constant)
Deposit -345477.493
.667
788932.673
.320 .769 -438
2.086 .076
.003
a Dependent Variable: profit
Profit = -345477 + .667 generalreserve
(t = 2.086)
R2 = 0.592 R
2 = 0.456 F = 4.350 DV = 2.813
From the above equation, 59.2% of variations in profit are explained by assets. The impact of asset is
significant (as the t-value of 2.086 > 2.0). Again, the equation is significant given by the high f-value
of 4.350. Other independent variables, excluded form the current equation may be contributory
factors. Nevertheless, the significant impact of asset on profit is not in doubt as shown by the
equation above.
Based on the above, the null hypothesis is hereby rejected and the alternative hypothesis accepted.
Thus deposit has a significant positive impact on bank profitability.
REGRESSION (AFRIBANK)
Descriptive Statistics
Mean Std. Deviation N generalreserve
profit 6194.000
1594.2000
3102.028387
1335.57392
5
5
Correlations
Mean Generalreserve Profit
Pearson Correlation generalreserve
profit
Sig. (1-tailed) generalreserve
profit
N generalreserve
profit
1.000 .957
.957 1.000
. .005
.005 .
5 5
5 5
Model Summary (b)
Model R R. Square Adjusted R. Square Std. Error of the Estimate Durbin-Watson
1 .957(a) .916 .888 1038.86797 2.609
a. Predictors: (Constant). Profit
b. Dependent variable: generalreserve
ANOVA (b)
Model Sum of Squares Df Means square F Sig.
1 Regression
Residual
Total
35252580.040
3237739.960
38490320.000
1
3
4
35252580.040
1079246.653
32.664 .011(a)
a. Predictors: (Constant). Profit
b. Dependent Variable: generalreserve
Coefficients(a)
Model Unstandardized coefficients Standardized coefficients t Sig
1 B Std. Error Beta (Constant)
Deposit 2650.436
.2.223
774.773
.389 .957 3.421
5.715 .042
.011
a Dependent Variable: profit
Profit = 2650.436+ 2.223 generalreserve
(t = 2.086)
R2 = 0.916 R
2 = 0.888 F = 32.664 DV = 2.609
From the above equation, 59.2% of variations in profit are explained by assets. The impact of asset is
significant (as the t-value of 32.664 > 2.0). Again, the equation is significant given by the high f-
value of 32.664. Other independent variables, excluded form the current equation may be
contributory factors. Nevertheless, the significant impact of asset on profit is not in doubt as shown
by the equation above.
Based on the above, the null hypothesis is hereby rejected and the alternative hypothesis accepted.
Thus deposit has a significant positive impact on bank profitability