Credit Risk and Profitability of Deposit Money Banks in Nigeria

UDDIN, GODWIN ENAHOLO

JANUARY 2021

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 Credit Risk and Profitability of Deposit Money Banks in Nigeria

Deposit Money Banks (DMBs), even in Nigeria, are reputed to extend credits (or loans) to different types
of borrowers and for many different purposes. By example, for many customers, bank credit remains the
primary source of available debt financing; and for banks, good loans are the most profitable risk assets.
Thus, the role of a (bank) financial institution to channel funds from the surplus sector to the deficit
sector of the economy, and to even the distribution of scarce resources for the development of the
economy is duly noteworthy, however such feat is not without a profit objective (or profit orientation).

More so, the events of the last few years suggest the financial sector – banking sector in particular – is a
crucial determinant of business cycle fluctuations, i.e. the financial crisis in Europe and in the United
States of America attests to this. A key monetary policy transmission mechanism (or channel) notably
through which banks affect the economy is the provision of credit to fund private investment and
consumption. To this end, the banking sector firms are required to comply strictly to the tenets of
proper administration of funds and efficient credit creation process.

In the history of development of the Nigerian banking industry, it is evident that most of the failures
(low capital adequacy, low profit before / after tax (PBT or PAT), low earning per share (EPS), low return
on equity (ROE), low return on asset (ROA), unfavourable debt-equity ratio, unfavourable loan-deposit
ratio, among others) experienced within the industry (and which partly led to the eventual merger /
buy-off or acquisition / non-existence of some of the (bank) financial institutions) were results of
improper lending, rising bad loans / non-performing loans (NPLs), inside-bank ‘sharp-practices’/ insider-
abuses / unethical corporate governance conducts, asset-maturity and liquidity mismatch, etc., and such
shows how critical credit risk management (CRM) is to the growth, profitability and continued existence
of DMBs. Besides, credit policy refers to a set of guidelines designed to minimize costs associated with
credit while maximizing benefits from it, and profitability is noted as associated with performance and
productivity.

Furthermore, the proper implementation of processes such as (i) establishing an appropriate credit risk
environment, (ii) operating under a sound credit-granting process, (iii) maintaining an appropriate credit
administration, measurement and monitoring process, and (iv) ensuring adequate controls over credit
risk, is attested to serve greatly for the management and or mitigation of credit risk exposure of (bank)
financial institutions due to lending activities. In other words, the processes of risk identification,
measurement, assessment, monitoring and control, of which involves identification of potential risk
factors, estimation of their consequences, monitoring activities exposed to the identified risk factors and
putting in place control measures to prevent or reduce the undesirable effects, are expectations to be
part of the management of credit risk in banking industry and thus to be applied within the strategic and
operational framework of a bank in order to ensure its health, profitability and continued existence.
More so, considerations to appropriate human resource deployment and other allied matters are well
attested of also as necessary (or fundamental) in the process of credit risk management.

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But then, the (potential) rise in levels of NPLs, the (possible) prevalence of unethical corporate
governance conducts, amidst others in some of the (bank) financial institutions in the Nigerian financial
system, most especially during the years 2007 and 2009 (before the establishment of Asset
Management Corporation of Nigeria – AMCON), and now (in times after the establishment of AMCON
since year 2010) still raises concern, since the obvious inability of (bank) financial institution to mitigate
their credit risk exposure could go a long way to undermine their health and or profitability and
ultimately their continued existence as a going concern. Whereas, poor credit risk management in
(bank) financial institutions blown out of proportion could be endemic or a precursor for an economy-
wide (or system-wide) panic or bank runs. Hence, the focus of this piece on credit risk and profitability of
DMBs in Nigeria.

A case here made reference to is the thorough Stress Test for all DMBs in Nigeria ordered by the then
Central Bank of Nigeria (CBN) Governor in 2009, and consequent to the findings had to inject N620
billion to rescue eight (8) troubled banks while five (5) others were given ultimatum to recapitalize.
Moreover, the discovery from the Stress Test include that most of the bad loans were used to finance
private businesses of the Directors, their friends, and family; and a large proportion of the loan of the
DMBs became classified as non-performing assets. The foregoing assertions thereof are pointers to the
notion that low-quality credit analysis and evaluation system leads to poor lending decisions, which
invariably in relation could affect the profitability of DMBs. Nevertheless, it is argued that credit risk
management in (bank) financial institutions have now become crucial for the survival and growth of
these institutions.

Thus, in these times of increased real sector credit lending mandated to be complied to by DMBs,
thereby fostering lending to private sector (or real sector) investment initiatives as pioneered by the
CBN, the significant impact of credit risk variables on selected DMBs’ profitability measures in a recent
study1 notably calls for re-orientation of Credit Officers in Nigerian DMBs, besides the need to address
other board-room / managerial politics, on the basic techniques of identifying credible customers,
possibly by ways of credit analysis, ratio analysis, balance sheet projection, and future performance
forecasting as tools for evaluating customers performance, though not neglecting the possibility of loan
losses due to adverse economic environment which still could be provided for during loan request
evaluation and hence not tenable as an excuse in event of increasing NPLs.

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Ogundajo, G. O., Oyedokun, G. E.& Okwuosa, I. (2020). Credit risk management and profitability of listed deposit
money banks in Nigeria. African Journal of Corporate Governance Research 1(1): 86–105