CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

This chapter places the study in the context of prior studies. It conceptualized and reviewed the

research undertaken on credit risk management and market performance of listed deposit money

banks in Nigeria, as well as survey of the theoretical and empirical studies concerning the

variables were extensively reviewed.

2.2 Concept of Market Performance

Firm Performance can be defined as the fulfillment of an obligation in a manner that releases the

performer from all liabilities under the contract. Cheng et al (2012) defined firm performance as

the degree of measure organization put in to achieve their goals and advocated that performance

goal should be synonyms. Firm Performance should include efficiency and effectiveness.

Efficiency means doing the thing right, quantitatively determined by the ratio of output to input.

Effectiveness is “doing the right thing” a relatively vague, non-quantitative concept, mainly

concerned with achieving objectives. The function of firm performance measurement is not just

informing managers but providing a better way to examine the long-term competitive ability and

enterprise value.

Firm Performance could also be referred to a subjective measure of how well a firm can use

assets from its primary mode of business and generate revenues. This term is also used as a

general measure of a firm's overall financial health over a given period of time, and can be used

to compare similar firms across the same industry or to compare industries or sectors in

aggregation.

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1
Market performance refers to the indicator that reflects a business's effectiveness in the market,

often demonstrated by an increase in market share. It can be influenced positively by factors such

as 'guanxi', which enhances a firm's market channels and responsiveness.(China business model

2019)

2.2.1 Measurement of Market Performance

Firm performance is a determinant of an organization‟s income, profits, increase in value as

supported by the appreciation in the entity‟s worthiness (Rukayat, 2023). Measures of firm

performance fall into two broad categories: investor returns and accounting returns. The basic

idea of investor returns is that, the return should be measured from the perspective of

shareholders e.g. share price and dividend yield. Accounting returns focus on how firm earnings

respond to different managerial policies, which can be measured using different accounting

ratios (Alan, 2008).

However, (Fulbier et al, 2008) maintained that financial ratios can be divided into three broad

categories that will provide a review of the overall financial position of a company. These

categories include; ratios that indicate the structural change within a company; ratios that

indicate the profitability of a company, and ratios that have an effect on the valuation of

companies from a market perspective.

The actual usefulness of any particular ratio, however, is strictly governed by the specific

objectives of the analysis, different techniques are appropriate for different purposes. Many

different individuals and groups are interested in the success or failure of a given business. The

most important are owners (investors), management, lenders or creditors, employees, labour

organisations, government agencies, and society in general (Helfert, 2011).

Managers are responsible and accountable for operating efficiency, current and long-term

profitability, and the effective deployment of capital, human effort, and other resources. Next are

the various owners of the business, who are especially interested in the current and long-term

2
profitability of their equity investment. They expect growing earnings and dividends. Then there

are providers of other people‟s money, lenders and creditors who extend funds to the business

for different length of time. They mainly concerned about the ability of the business to repay and

the availability of specific residual asset values that give them a margin of protection against

their risk. Other groups such as government, labour, and society, have specific objectives of their

own, such as the ability of the business to pay tax, the wherewithal to meet various social and

environmental (Catherine, 2020).

Market performance has been measured differently by different researchers, but in a wider

perspective three (3) major groups of accounting ratios were used to measure market

performance. According to Radut (2008), the most argued indicators that offer an important view

and complex understanding of the market performance of a company are the following ratios:

Profitability, Liquidity, leverage and Efficiency.

Profitability ratios measure a company‟s performance and provide an indication of its ability to

generate profits. As profits are used to fund business development and pay dividends to

shareholders, a company‟s profitability and how efficient it is at generating profits isan

important consideration for shareholders. Example of profitability ratio that is commonly used is

Return on assets, commonly referred to as ROA, which measure management performance.

ROA tells the investor how well a company uses its assets to generate income. A higher ROA

denotes a higher level of management performance (D‟Amato, 2010).

Liquidity ratios indicate whether a company has the ability to pay off short-term debt obligations

(debts due to be paid within one year) as they fall due. Generally, a higher value is desired as this

indicates greater capacity to meet debt obligations. Widely used liquidity ratio is Current ratio

which measures a company‟s ability to repay short-term liabilities such as accounts payable and

current debt using short-term assets such as cash, inventory and receivables (D‟Amato, 2010).

3
Efficiency ratios measure the efficiency or effectiveness with which a firm manages its

resources. These ratios indicate the speed at which assets are converted or turned over in sales.

These ratios are expressed as „times‟, some of the important efficiency ratios are: Stock turnover

ratio, Debtors turnover ratio, Creditors turnover ratio, and Working capital turnover ratio (Radut,

2008).

For the purpose of this study, Tobin‟s Q was used as measure for bank performance as itwas

measured with elements of financial and market ratio (market value of equity plus liquidity value

of firm‟s preference stock plus net current asset to book value of total assets) and shows success

in the a way that the firm has leveraged its investment to develop the company that is valued

more in terms of its market-value compared to its book-value.

2.3 Concept of Credit Risk

According to Onyeagocha (2001), the term credit is used specifically to refer to the faith placed

by a creditor (lender) in a debtor (borrower) by extending a loan usually in the form of money,

goods or securities to debtors. Essentially, when a loan is made, the lender is said to have

extended credit to the borrower and he automatically accepts the credit of the borrower. Credit

can therefore be defined as a transaction between two parties in which the creditor or lender

supplies money, goods and services or securities in return for promised future payments by the

debtor or borrower.

While, Pandy (2006) is of the view that credit risk arises because we cannot anticipate the

occurrence of possible future events with certainty and consequently cannot make any correct

prediction about the cash flow sequence. There is risk associated with life itself as well as in

business. Despite the important role played by credit in the economy, it is associated with a

catalogue of risks.Good for the bank if it is able to grant loans to debtors who are extremely

religious in making payments. But in today‟s world where virtually everyone is suffering

numerous hits of the economic downturn, you can never be too sure about the sincerity of your

4
debtors. This is that type of risk that can very well lead to instability for any financial company;

worse, it can even lead to insolvency.

According to Chen & Pan (2012), credit risk is the degree of value fluctuations in debt

instruments and derivatives due to changes in the underlying credit quality of borrowers and

counterparties. Coyle (2000) defines credit risk as losses from the refusal or inability of credit

customers to pay what is owed in full and on time. Credit risk is the exposure faced by banks

when a borrower (customer) defaults in honouring debt obligations on due date or at maturity.

This risk interchangeably called „counterparty risk‟ is capable of putting the bank in distress if

not adequately managed. While Kargi (2011) is of the view that credit risk is the current and

prospective risk to earnings or capital arising from an obligor‟s failure to meet the terms of any

contract with the bank or otherwise to perform as agreed.

For most banks, loans are the largest and most obvious source of credit risk; however, other

sources of credit risk exist throughout the activities of a bank, including in the banking book and

in the trading book, and both on and off the balance sheet. Banks are increasingly facing credit

risk (or counterparty risk) in various financial instruments other than loans, including

acceptances, interbank transactions, trade financing, foreign exchange transactions, financial

futures, swaps, bonds, equities, options, and in the extension of commitments and guarantees,

and the settlement of transactions. For the purpose of this study, credit risk is assumed to be the

exposure faced by banks when a borrower (customer) defaults in honouring debt obligations on

due date or at maturity.

2.3.1Credit Risk Management

The goal of credit risk management is to maximize bank‟s risk-adjusted rate of return by

maintaining credit risk exposure within acceptable parameters.Banks need to manage the credit

risk inherent in the entire portfolio as well as the risk in individual credits or transactions. The

5
effective management of credit risk is a critical component of a comprehensive approach to risk

management and essential to the long-term success of any banking organization.

Credit risk management maximizes bank‟s risk adjusted rate of return by maintaining credit risk

exposure within acceptable limit in order to provide framework for understanding the effect of

credit risk management on banks‟ profitability (Kargi, 2011). Demirguc-Kunt&Huzinga (1999)

opined that credit risk management is in two-fold which includes, the realization that after losses

have occurred, the losses becomes unbearable and the developments in the field of financing

commercial paper, securitization, and other non-bank competition which pushed banks to find

viable loan borrowers. The effective management of credit risk is a critical component of a

comprehensive approach to risk management and essential to the long-term success of any

banking organization.

The active management of credit risk has risen to the top of the agenda of most financial

institutions in the last couple of years - and for good reason. Despite high-profile fears about the

risks of electronic banking, or losses from derivative positions, inadequate credit risk

management is still the biggest source of serious banking problems according to the Based

Committee - the international banking supervisory body.

The worst problems are caused by insufficiently stringent credit standards for borrowers and

counterparties, poor credit risk management of the entire portfolio (as opposed to the individual

credits or transactions) and a lack of attention to changes in economic or other circumstances that

affect a counterparty's credit standing (Helfert, 2011).

For the regulators, some of the most alarming credit events are those that affect whole classes of

credit risky transactions. Recent international credit events such as the economic crisis in Asia,

which began in 1997, and the Russian debt default in 1998, caused billions of dollars of bank

losses. Within the US, the fallout from the savings and loans industry scandals in the 1980s,

estimated to have cost at least $125 billion, continued well into the 1990s.

6
But the present wave of change in credit risk management is being driven by more than the fear

of a credit crisis. Regulators of the banking industry are making capital charges more responsive

to a bank's actual credit exposure by setting new rules for how much capital banks must set aside

to cover potential losses. The Capital Accord will give larger institutions major incentives to

reduce their regulatory capital - and save money - by improving their credit management

practices (Kargi, 2011).

Meanwhile, greater industry competition, industry consolidation, and new technology are adding

to the pressure to improve credit risk management throughout the financial industry. The current

emphasis on shareholder value and risk-adjusted return on capital is directing investment towards

business lines that manage their risks more effectively - including all types of credit risk. The

advances in measuring and managing credit risk mean that a passive absorption of credit risk by

these companies is the way of the past. Leading institutions now regularly isolate and package

portions of their credit risk by means of new tools - credit derivatives and securitizations - and

pass it to the financial markets.

These transactions, often hybrids of the "first generation" credit default or total return swaps that

appeared in the mid-1990s, are thawing out the credit risk that lies frozen in bank portfolios and

channeling it to investors. And while banks improve the way they identify measure, monitor and

control their credit risk, they are also developing techniques and systems that track the

relationship between credit risk and other risks, such as market risk, to enable full enterprise-

wide risk management.

According to Nelson & Schwedt (2006) the banking industry has also made strides in managing

credit risk. Until the early 1990s, the analysis of credit risk was generally limited to reviews of

individual loans, and banks kept most loans on their books to maturity. Today, credit risk

management encompasses both loans reviews and portfolio analysis. Moreover, the development

of new technologies for buying and selling risks has allowed many banks to move away from the

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traditional book and hold lending practice in favor of a more active strategy that seeks the best

mix of assets in light of the prevailing credit environment, market conditions, and business

opportunities.

The main source of credit risk include, limited institutional capacity, inappropriate credit

policies, volatile interest rates, poor management, inappropriate laws, low capital and liquidity

levels, direct lending, massive licensing of banks, poor loan underwriting, laxity in credit

assessment, poor lending practices, government interference and inadequate supervision by the

central bank (Kithinji, 2010).An increase in bank credit risk gradually leads to liquidity and

solvency problems. Credit risk may increase if the bank lends to borrowers it does not have

adequate knowledge about.

The CBN Credit Risk Management System [CRMS] or Credit Bureau was established in

1991.The enabling legislation empowered the CBN to obtain from all banks, returns on all

credits with a minimum outstanding balance of N100, 000.00 (now N1.m and above of principal

and interest), for compilation and dissemination by way of status report to any interested party

(i.e. operators or regulators). The Act made it mandatory for all financial institutions to render

returns to the CRMS in respect of all their customers with aggregate outstanding debit balance of

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8
N=1,000,000.00 (One million naira) and above. It also required banks to update these credits on

monthly basis as well as make status enquiry on any intending borrower to determine their

eligibility or otherwise. Banks are penalized for non-compliance with the provisions of the Act.

(www.cenbank.org).

Currently the CRMS is web-enabled, thus allowing banks and other stakeholders to dial directly

into the CRMS database for the purpose of rendering the statutory returns or conducting status

enquiry on borrowers. Also, the CBN is in the process of integrating the CRMS with other

systems operating in the bank to make it more efficient.

The primary objectives for the setting-up of the CRMS included,

Strengthening the credit appraisal procedures of banks by generating accurate and reliable credit

information on bank borrowers from a central database. Banks are now in a position to review

the credit history of customers seeking new or additional credit facilities with the available

information, thereby eliminating the granting of loans to customers who already had no capacity

to repay and/or had loans in the non-performing category and in some cases, abandoned loans

(Marsh, 2008).

Storage and dissemination of Credit Data: The Credit Bureau captures all credits of N1 million

(principal and interest) and above from banks‟ monthly returns on all their customers. Banks are

also required to provide all other relevant data on the facilities such as names of borrowers,

directors of borrower companies, credit limit, outstanding amount, status of credit, securities

pledged etc. These data are collated in the CRMS database, which are made available to banks

through credit status enquiry/report. The CBN Credit Bureau provides objective responses to

status enquiries to promote a responsive borrowing culture. The customers who meet their

obligations as contracted will consequently continue to have access to credit facilities, while

9
delinquent customers are denied access to new facilities from other banks until they make good

their outstanding delinquent credits.

Monitoring of Over-Exposure to Borrowers: The consolidated credit information generated by

the Credit Bureau enables banks identifies borrowers who have already obtained loans in excess

of their repayment capabilities. Consequently banks are better able to access the potential

benefits or otherwise of granting facilities to different companies or sectors. It will also aid banks

in the assessment of the feasibility or otherwise of proposals from individual customers.

Facilitating Consistent Classification of Credits: The Credit Bureau will facilitate regulators‟

consistent classification of credits granted to the same borrower(s) by different banks. Regulators

will be provided with first-hand information on a customer‟s global debt profile thereby

eradicating the erroneous classification of loan‟s as performing in one bank, whilst same are

doubtful or lost in another.(www.cenbank.org).

2.3.3 Credit Risk Management Strategies

The credit risk management strategies are measures employed by banks to avoid or minimize the

adverse effect of credit risk. A sound credit risk management framework is crucial for banks so

as to enhance profitability guarantee survival. According to Lindergren (1987), the key principles

in credit risk management process are sequenced as follows; establishment of a clear structure,

allocation of responsibility, processes have to be prioritized and disciplined, responsibilities

should be clearly communicated and accountability assigned. The strategies for hedging credit

risk include but not limited to these;

Credit Derivatives: This provides banks with an approach which does not require them to adjust

their loan portfolio. Credit derivatives provide banks with a new source of fee income and offer

banks the opportunity to reduce their regulatory capital (Shao and Yeager, 2007). The

commonest type of credit derivative is credit default swap whereby a seller agrees to shift the

10
credit risk of a loan to the protection buyer. They further portrayed that “credit derivatives

encourage banks to lend more than they would, at lower rates, to riskier borrowers”. New

innovations in credit derivatives markets have improved lenders‟ abilities to transfer credit risk

to other institutions while maintaining relationship with borrowers (Marsh, 2008).

Credit Securitization: It is the transfer of credit risk to a factor or insurance firm and this relieves

the bank from monitoring the borrower and fear of the hazardous effect of classified assets. This

approach insures the lending activity of banks. The growing popularity of credit risk

securitization can be put down to the fact that banks typically use the instrument of securitization

to diversify concentrated credit risk exposures and to explore an alternative source of funding by

realizing regulatory arbitrage and liquidity improvements when selling securitization transactions

(Michalak&Uhde, 2009). A cash collateralized loan obligation is a form of securitization in

which assets (bank loans) are removed from a bank‟s balance sheet and packaged (tranche) into

marketable securities that are sold on to investors via a special purpose vehicle (SPV)

(Marsh,2008).

Compliance to Basel Accord: The Basel Accord is international principles and regulations

guiding the operations of banks to ensure soundness and stability. The Accord was introduced in

1988 in Switzerland. Compliance with the Accord means being able to identify, generate, track

and report on risk-related data in an integrated manner, with full auditability and transparency

and creates the opportunity to improve the risk management processes of banks. The New Basel

Capital Accord places explicitly the onus on banks to adopt sound internal credit risk

management practices to assess their capital adequacy requirements (Chen & Pan, 2012).

Adoption of a sound internal lending policy: The lending policy guides banks in disbursing loans

to customers. Strict adherence to the lending policy is by far the cheapest and easiest method of

credit risk management. The lending policy should be in line with the overall bank strategy and

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the factors considered in designing a lending policy should include; the existing credit policy,

industry norms, general economic conditions of the country and the prevailing economic climate

(Kithinji,2010).

Credit Bureau: This is an institution which compiles information and sells this information to

banks as regards the lending profile of a borrower. The bureau awards credit score called

statistical odd to the borrower which makes it easy for banks to make instantaneous lending

decision. Example of a credit bureau is the Credit Risk Management System (CRMS) of the

Central Bank of Nigeria (CBN).

2.3.4 Non-Performing Loans in Nigeria Deposit Money Banks

Caprio and Klingebiel (1996), suggest that non-performing loans are those loans that do not

generate income for a relatively long period of time that is, the principal and or interest on these

loans have been left unpaid after due date of repayment.The non-performing loans have been a

subject of concern in the Nigerian financial system for about a decade now. The excessively high

level of non-performing loans in the banks can also be attributed to poor corporate governance

practices, lax credit administration processes and the absence or non- adherence to credit risk

management practices (Kargi 2011).

Most of the non-performing loans are caused by unprofessional ways the Nigerian bank

managements disburse loans influence by personal affiliations with the customers. Rather than

follow the standard procedure of granting loan as provided by the bank, they grant loans based

on personal relationship with the customer who have not met the banks requirements for granting

such loan. Most of these loans turnout to be non-performing loans in the future. There are also

circumstances where banks grant additional loan facilities to defaulting borrower. As a proactive

measure to avert the menace of resurgence of non-performing loan and to ensure safe and sound

financial system the CBN in June 2014 directed that no financial institutions shall without the

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prior written approval of the CBN grant a credit facility to a potential borrower who is in default

of the any existing credit facility to the tune of N500Million and above in the case of deposit

banks and N250Million and above in the case of development banks and banks in liquidation.

2.3.5 Loan in the Banking Industry

One on the primary function of the banks is the provision of loan to its customers; as such it is

almost impossible for any bank to operate without lending money to its customers. Banks are

seen as major players in economic development of a nation since the control the flow of fund in

the economy. For the banks to play their role in economic development they make funds

available to investors who do not have enough resources to fund their business ideas. The loans

are provided at a consideration called interest. To ensure that the customers stay faithful to their

obligation of repaying the loan along with the interest element the banks ask of collateral. The

collateral is a sort of security on the loan to avoid loss of fund by the banks.

Caprio and Klingebiel (1996), further buttress the relevance of collateral, by relating them to

types of loan and include;

Secured Loan: A secured loan is a promise to pay a debt, where the promise is "secured" by

granting the creditor a right on a specific property (collateral) of the debtor as leverage for

repayment in the event of default. Where the debtor fails to repay the loan, the creditor can

recoup the loan by seizing and liquidating the specific property used for collateral on the debt.

Collaterals are demanded mostly if the loans are long term loans. This is the common type of

loan that the bank grants because banks are general risk-averse.

Unsecured Loan: These are loans granted to customers of the bank without any right on the

property (collateral) of the borrower to ensure repayments. In this case the lender is relying upon

the creditworthiness and reputation of the borrower to repay the debt. This is mostly in situation

of short term debt like bank overdraft also where the amount involved is not much.

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Partly secured Loan: this is a combination of both secured and unsecured features. A secured

debt is a loan in which the borrower pledges some asset as collateral for the loan. However, a

partially secured debt is a debt that is secured by collateral that is worth less than the debt.

The best form of loan is the secured loan, because it provides a back up to that allow the bank

recoup his money if the customer defaults in paying back the fund. However, despite all this

measures (requesting for collateral) to control the loss of fund/income by the bank we still have

cases of non-performing loans.

2.3.6 CAPITAL ADEQUACY AND CREDIT RISK MANAGEMENT IN NIGERIAN

BANKS

Traditionally, operators and supervisory authorities never gave much thought to the question of

th
capital adequacy in banking. This has however changed in the 20 century. According to

Adewumi (1997), since the early seventies, great concern has been expressed over the issue of

adequate capital for banks.

Firstly, the industry has witnessed unprecedented competition in the last two decades. This has

led bankers to engage in new unknown and riskier fields that the supervisory authorities in

particular have expressed concerns over capital adequacy. In Nigeria, the concern of regulatory

authorities has been reflected in the continual increase in the capital requirement for banks

entering the industry (Kithinji, 2010).

Secondly, significantly, as a result of inflation, the volume of banking business reflected in the

total assets liabilities of banks has increased phenomenally in recent years. As the asset will

diminish in relation to liabilities if no addition are made to it. This trend has given concern to the

regulatory authorities all over the world.

Thirdly, the international business environment sectors have become increasingly intertwined as

a result of globalization. Consequently too, the bankers have become exposed to risks not

14
directly inherent in the business of the economies in which they operate. The question as to

whether existing levels of capital are considered adequate for the increasing levels of risks has

risen consequently in debates between supervisory authorities.

Fourthly, although, capital in banking did not attract undue attention in the past, nevertheless

capital were calculated and observed. With increase in the volume of banking not matched with

corresponding increases in stock, the capital and deposits and total assets have declined. This

development has given some concern to practitioners and the supervisory authorities.

According to Lewis and Stein (1997) structurally, in Nigeria the banking sector was highly

concentrated as the largest banks account for about 50 Per cent of the industry's total assets and

liabilities. Most banks in Nigeria have a capitalization of less than US$ 10 million; even the

largest bank in Nigeria has a capital base of about US$240 million compared to US$526 million

for the smallest bank in Malaysia. This is not healthy for the economy. It was this concern to

save the Nigerian Banking Sector from systematic crisis that led to regular reform of the sector

and the requirement for banks to raise their capital base to a minimum of N25 billion with

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compliance date of 31 December, 2005 in the recent reform (Kargi, 2011).

2.3.7 Regulatory and Legal Framework of Capital Adequacy

As a result of concern of monetary and regulatory authorities over capital adequacy of banks,

legal and regulatory actions are being instituted or enforced to ensure that banks within their

jurisdiction operate continuously with adequate capital. According to Soludo (2004), the

Nigerian Banking System faces enormous challenges which if not addressed urgently could

snowball into crisis in the near future. Beck et al (2005) noted that since 1952 when the first

banking legislation was enacted all the banking laws in Nigeria have specified minimum paid up

capital. Up to 1969, the legislations, for this purpose distinguished between foreign banks and

indigenous banks. The 1979 Decree section 6 states that; the minimum capital required by an

15
indigenous bank to be granted license must be N600, 000.00. A bank directly or indirectly

controlled from abroad should have paid-up capital of up to N1.5 million. In1979, different

initial capital base requirement were stipulated for commercial land merchant banks. With the

promulgation of Nigeria enterprises Promotion Decree and the advent of universal banking,

specification differentiate between foreign, indigenous, NGO's, Commercial and merchant

banking dimension was eliminated.

Lewis and Stein (1997) noted that while the statutory minimum capital requirement largely

stabilized during the pre-SAP period, four upward reviews were put in place after SAP to adjust

for the inflationary effect of the SAP induced policies. The increase in the number of operators

between 1987 and1990 actual led to the ballooning of loans and advances of banks industry wide

and a consequent deterioration in the quality of banks risk assets. The CBN introduced the new

famous prudential guidelines, which made it mandatory for banks to recognize early and provide

for not performing assets. The effort of those stringent but necessary measures was the erosion of

the capital base of quite a sizable number of operators as their accumulated reserves were not

sufficient to absorb the huge loses. The almost four time devaluation of Naira exchange rate to

the dollar between March 1992 (N10:$1 to N18: $1) and February 1995 from (N22: $1), dealt a

final total blow on the capital base of the banks particularly those that have been pronounced

terminally distresses by the CBN.

According to Lewis and Stein (1997) the new globally embraced capital adequacy measurement

places considerable emphasis on the risk element in the assets of banks. This is to ensure that

each bank carries funds that are not only commensurate with its total assets but also cater

adequately for the riskless of its operation, nationally and internationally. The joint special

examination of the 24 deposit money banks conducted by the CBN and NDIC in 2009 to

ascertain their true financial condition revealed serious weaknesses in corporate governance

16
which manifested in, poor risk management; weak board and management oversight; inaccurate

financial reporting; abuse and fraudulent use of subsidiaries; poor book keeping practices; non-

compliance with banking laws, rules and regulations; and nonperforming insider-related credits,

among others. All the observed weaknesses culminated in huge non-performing loans and

insolvency of varying degrees in many of the banks. The development led to the removal of the

executive managements of 8 out of the existing 24 banks(Oceanic bank, Intercontinental bank,

Union bank, Fin bank, Afribank, Bank PHB, Equatorial Trust Bank, and Spring Bank) and the

injection of a bail-out sum of N620 billion by the CBN as liquidity support to the problem

banks(NDIC, 2009). In August, 2011, The Federal Government through the NDIC assumed

ownership of three of the problem banks: Afribank, Bank PHB and Spring Bank via the “Bridge

Bank” mechanism following the revocation of their licenses by the Central Bank of Nigeria

(Komolafe&Kolawole, 2011).

According to Sanusi (2010), the reports further revealed that non-performing loans in ten banks

totalled N1, 696 billion, representing 44.38% of total loans while the Capital Adequacy Ratio in

the ten banks ranged between 1.01% and 7.41%, which were below the minimum ratio of 10%.

This statistics portrays fragile banking system. The weakness of the Nigerian banking system

inNigeria appears to call to question the effectiveness of the pre-operation regulations of the

system, particularly those relating to licensing requirements. Among this is ensuring that board

and management are made up of “fit and proper” persons (i.e., no bankrupts, persons of criminal

records or fraudulent people).

The way the capital of most Nigerian banks were eroded in 2008/2009 in the aftermath of the

global economic meltdown despite the 2004/2005 N25 billion recapitalization exercise led

credence to the feelings in the industry that many promoters of new banks exploited the

loopholes in bank regulation in the way they contributed bank capital. A lot of them were

17
believed to have financed their contributions using commercial papers and other similar money

market instruments, which were paid back using depositors‟ funds once the banksopened. This

made the actual bank capital rather fragile. It is no wonder thatin 1990, nine distressed banks

required as much as 2.0 billion in additionalcapital to be able to operate in a safe and sound

manner. This amountballooned by a factor of 15, to 30.5 billion for 60 distressed banks by the

endof 1995 (NDIC, 1997), and then in 2009, N620 billion had to be injected intothe banking

system by the CBN to bail out nine (9) “troubled” banks (NDIC,2009).

Besides, the issue of ensuring that only “fit and proper” persons constitute theboard and

management appears to be seriously in doubt. For example,Uchendu (1995) reported that the

CBN had to delete the name of a chiefexecutive of a merchant bank from its register of fellows

in connection withfraudulent practices, among which were false claims of qualification and

experience prior to being appointed. Similarly, current regulation does not deter people from

owning a greater share than allowed by law through theuse of fronts. Neither does it ensure that

“strange bedfellows” do not populate boardrooms of banks. Boardroom squabbles and the

resultinglitigation can lead to defective management as well as poor creditadministration policy.

These are some of the major factors adduced byfinancial institutions as causing distress

(CBN/NDIC, 1995).

To be effective in its post-operation regulation, the supervisory and regulatoryauthorities in

Nigeria require adequate human and information capital.However, the human capital capacity of

the regulatory authority appearedspread to its elastic limit with the liberalization of entry of

financial institutionsand the broadened span of supervisory control of the CBN by BOFID.

Inparticular, financial institutions identified the lack of adequate supervision andinadequacy of

professionally trained personnel as some of the major causesof distress (CBN/NDIC, 1995). To

gain maximum benefit from the informationcapital of the banking system, both regulatory

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agencies and banks must haveexperienced electronic data processing (EDP) staff. In Nigeria, not

only isthese categories of staff in the banking industry in short supply, the few thatexist are

highly inexperienced.

2.4 Review of Empirical Studies on Risk Management and Bank’s Market performance

Below are some of the studies that the researcher came across and reviewed but almost all the

studies used traditional measures for performance, which includes return on asset and return on

equity in measuring the performances of their sampled firm, as they onlyindicate what return a

company is generating on its investments/assets and are mostly used as a performance measure

for autonomous strategic business units (SBU‟s), not for the whole company.Although, the

reviewed studies wasn‟t done in line with the variables under study, as the previous studies

combined some of the variables in their respective work. In order to report a comprehensive

study reviewed, a combined variable method was adopted.

Ahmed, Takeda & Shawn (1998) in their study found that loan loss provision has a significant

positive influence on non-performing loans. Therefore, an increase in loan loss provision

indicates an increase in credit risk and deterioration in the quality of loans consequently affecting

bank performance adversely.

According to Umoh (2002) and Ferguson (2003) few banks are able to withstand a persistent run,

even in the presence of a good lender of last resort. As depositors take out their funds, the bank

hemorrhages and in the absence of liquidity support, the bank is forced eventually to close its

doors. Thus, the risks faced by banks are endogenous, associated with the nature of banking

business itself, whilst others are exogenous to the banking system.

Altunbas, (2005) assessed the effect of loan activities on bank risk using the ratio of bank loans

to assets (LTA) because bank loans are relatively illiquid and subject to higher default risk than

other bank asset, implying a positive relationship between LTA and the risk measures. In

19
contrast, relative improvements in credit risk management strategies might suggest that LTA is

negatively related to bank risk measures.

Ahmad &Ariff (2007) examined the key determinants of credit risk of commercial banks on

emerging economy banking systems compared with the developed economies. The study found

that regulation is important for banking systems that offer multi-products and services;

management quality is critical in the cases of loan-dominant banks in emerging economies. An

increase in loan loss provision is also considered to be a significant determinant of potential

credit risk. The study further highlighted that credit risk in emerging economy banks is higher

than that in developed economies.

Ben-Naceur&Omran (2008) in attempt to examine the influence of bank regulations,

concentration, financial and institutional development on commercial banks‟ margin and

profitability in Middle East and North Africa (MENA) countries from 1989-2005 found that

bank capitalization and credit risk have positive and significant effect on banks‟ net interest

margin, cost efficiency and profitability.

Felix & Claudine (2008) examined the association between the performance of banks and credit

risk management. As part of their findings, they observed that return on equity and return on

assets both measuring profitability were inversely related to the ratio of non-performing loan to

total loan of financial institutions thereby leading to a decline in profitability.

Kithinji (2010) assessed the effect of credit risk management on the profitability of commercial

banks in Kenya. Data on the amount of credit, level of non-performing loans and profits were

collected for the period 2004 to 2008. The findings revealed that the bulk of the profits of

commercial banks are not influenced by the amount of credit and non-performing loans,

therefore suggesting that other variables other than credit and non-performing loans effect on

profits.

20
Al-Khouri (2011) assessed the effect of bank‟s specific risk characteristics, and the overall

banking environment on the performance of 43 commercial banks operating in 6 of the Gulf

Cooperation Council (GCC) countries over the period 1998-2008. Using fixed effect regression

analysis, results showed that credit risk, liquidity risk and capital risk are the major factors that

affect bank performance when profitability is measured by return on assets while the only risk

that affects profitability when measured by return on equity is liquidity risk.

In a comparative study between the conventional banks and Islamic banks, Hayati&Shahrul

(2011) identified factors influencing credit risk of Islamic bank, using Malaysian as a case. The

study investigated the factors influencing credit risk of Islamic banking and identify whether

there exists any difference between credit risk determinants of Islamic banking and conventional

banks in Malaysia. The study used descriptive statistics about Islamic and selected conventional

banks risk characteristics, and regression analysis was used to determine the underlying factors

influencing risk of Islamic banking and that of the major six anchor banks on interest-based

banking system. This is done by carefully identifying and examining for each year, each risk

predictor of Bank Islam Malaysia (BIMB) and the Islamic windows of 6 anchor banks (for

Islamic banking) as well as risk predictors of the 6 anchor banks from their conventional banking

performance (for conventional banking).The study revealed that the unique nature of Islamic

banking operations provides an insightful intuition that the risk determinants of Islamic banking

ought to be different from those factors affecting conventional banking, considering that credit

risk of Islamic banking remains relatively high (which is contrary to the general understanding)

as interest is usually not charged on the principal.

Kargi (2011) evaluated the effect of credit risk on the profitability of Nigerian banks. Financial

ratios as measures of bank performance and credit risk were collected from the annual reports

and accounts of sampled banks from 2004-2008 and analyzed using descriptive, correlation and

21
regression techniques. The findings revealed that credit risk management has a significant effect

on the profitability of Nigerian banks. It concluded that banks‟ profitability is inversely

influenced by the levels of loans and advances, non-performing loans and deposits thereby

exposing them to great risk of illiquidity and distress. Although, most of the reviewed literatures

are not current as at the time of the study but the identified non-performing as having significant

effect to banks performance, which Robert & Gary (1994) also identified as increased non-

performing loans to be key evidence among failed banks and not poor operating efficiency.

In another development, Naveed, Muhammad & Muhammad (2011) aimed to determine the

firm‟s level factors which have significant influence on the risk management practices of Islamic

banks in Pakistan. The study selected credit, operational and liquidity risks as dependent

variables while size, leverage, non-performing loans ratio, capital adequacy and asset

management as explanatory variables for the period of four years from 2006 to 2009. The results

revealed that size of Islamic banks have a positive and statistically significant relationship with

financial risks (credit and liquidity risk), whereas its relation with operational risk is found to be

negative and insignificant. The asset management establishes a positive and significant

relationship with liquidity and operational risk. The debt equity ratio and NPLR have a negative

and significant relationship with liquidity and operational risk. In addition, capital adequacy has

negative and significant relationship with credit and operational risk, whereas it is found to be

positive and with liquidity risk.

Chen & Pan (2012) examined the credit risk efficiency of 34 Taiwanese commercial banks over

the period 2005-2008. Their study used financial ratio to assess the credit risk and was analyzed

using Data Envelopment Analysis (DEA). The credit risk parameters were credit risk technical

efficiency (CR-TE), credit risk allocative efficiency (CR-AE), and credit risk cost efficiency

(CR-CE). The results indicated that only one bank is efficient in all types of efficiencies over the

22
evaluated periods. Overall, the DEA results show relatively low average efficiency levels in CR-

TE, CR-AE and CR-CE in 2008.

Epure&Lafuente (2012) examined bank performance in the presence of risk for Costa-Rican

banking industry during 1998-2007. The results showed that performance improvements follow

regulatory changes and that risk explains differences in banks and non-performing loans

negatively affect efficiency and return on assets while the capital adequacy ratio has a positive

effect on the net interest margin.

The work of Funso, Kolade&Ojo (2012), empirically investigated into the quantitative effect of

credit risk on the performance of commercial banks in Nigeria over the period of 11 years (2000-

2010). Five commercial banking firms were selected on a cross sectional basis for eleven years.

The traditional profit theory was employed to formulate profit, measured by Return on Asset

(ROA), as a function of the ratio of Non-performing loan to loan & Advances (NPL/LA), ratio of

Total loan & Advances to Total deposit (LA/TD) and the ratio of loan loss provision to classified

loans (LLP/CL) as measures of credit risk. Panel model analysis was used to estimate the

determinants of the profit function. The results showed that the effect of credit risk on bank

performance measured by the Return on Assets of banks is cross-sectional invariant. That is the

effect is similar across banks in Nigeria, though the degree to which individual banks are

affected is not captured by the method of analysis employed in the study.

Adeusi, Akeke, Obawale&Oladunjoye (2013) further extended the research by not just

investigating the relationship between credit risk and market performance of Banks in Nigeria

but included market risk and liquidity risk. In essence, the study focused on the association of

risk management practices and bank market performance in Nigeria. Secondary data sourced was

based on a 4year progressive annual reports and financial statements of 10 banks and a panel

data estimation technique adopted. The study found an inverse relationship between market

23
performance of banks and doubt loans, and capital asset ratio was found to be positive and

significant, implying that the higher the managed funds by banks the higher the performance.

The study concludes a significant relationship between banks performance and risk management.

Hence, the need for banks to practice prudent risks management in order to protect the interests

of investors.

In a hybridized paradigm study, Agus&Rifki (2013) conducted their study on a review of Credit

Risk Management in Indonesian Islamic Banking. The study aimed at measuring and valuing the

credit risk management application in Islamic banks, together with valuing some credit risk

management indicators in order to have a credit risk management index as an indicator to check

the credibility and soundness of the Islamic banking industry in managing depositors‟ funds and

mitigating credit risk. Methodologically, the study employed primary data which was collected

with questionnaires to the respondents from Islamic banks. Meanwhile, the secondary data was

also taken from Bank Indonesia data based for the period thirteen years(2000-2012). The study

took into account monthly data of Islamic bank financing and none performing financing (NPF).

The study revealed that credit risk management policies and procedures in the Indonesian

Islamic banking industry have been quite good with the index value of the credit risk

management.

The work Ogboi&Unuafe (2013) empirically examined the effect of credit risk management and

capital adequacy on banks market performance in Nigeria, using a panel data model to estimate

the relationship that exists among loan loss provisions (LLP), loans and advances (LA), non-

performing loans (NPL), capital adequacy (CA) and return on asset (ROA) as a measure of

performance, which is peculiar to previous studies from 2004-2009. The study found that credit

risk management and capital adequacy effected positively on bank‟s market performance with

24
the exception of loans and advances which was found to have a negative effect on banks‟

profitability in the period under study.

Abiola&Olausi(2014) investigated the effect of credit risk management on the performance of

commercial banks in Nigeria. Financial reports of seven commercial banking firms were used to

analyze for seven years (2005 – 2011). The panel regression model was employed for the

estimation of the model. In the model, Return on Equity (ROE) and Return on Asset (ROA) were

used as the performance indicators while Non-Performing Loans (NPL) and Capital Adequacy

Ratio (CAR) as credit risk management indicators. The findings revealed that credit risk

management has a significant effect on the profitability of commercial banks‟ in Nigeria.

Affirming the work of Kargi (2011), Gizaw, Kibede, Selvaraj (2015) examined the effect of

credit risk on profitability of commercial banks in Ethiopia using two (2) traditional measure of

performance (return on asset and return on equity) in a two model, utilizing data collected from

the annual report of eight (8) sampled of the commercial banks for a period of twelve years

(2003-2014). After using a descriptive statistics and panel data regression model, the result

showed that credit risk measures in form of non-performing loan, loan loss provisions and capital

adequacy have a significant effect on the profitability of the sampled commercial banks in

Ethiopia.

Uwuigbe, Ranti, &Babajide (2015) assessed the effects of credit management on Banks‟

performance in Nigeria. In achieving the objectives identified in the study, the audited corporate

annual financial statement of listed banks covering the period 2007-2011 were analyzed. More

so, a sum total of ten (10) listed banks were selected and analyzed for the study using the

purposive sampling method. However, in an assessing the research postulations, the study

adopted the use of both descriptive statistics and econometric analysis using the panel linear

regression methodology consisting of periodic and cross sectional data in the estimation of the

25
regression equation. Findings from the study revealed that ratio of non-performing loans and bad

debt do have an inverse significant effect on Nigeria banks while secured and unsecured loans

were not significant. The sample horizon of this research is short compared to other related

studies in the literature.

26
2.5 Theoretical Framework

Below are some of the theories used by previous studies

1. The Modern Portfolio Theory (MPT)

Harry Markowitz Introduced in 1952

Assumptions

Investors are rational and aim to maximize returns for a given level of risk.

Risk can be quantified and managed through diversification.

Historical returns can be used to predict future performance.

Criticisms

It relies heavily on the assumption that markets are efficient and all investors have access to the

same information.

The theory may underestimate the impact of real-world factors, such as behavioral biases and

extreme market conditions.

It assumes that risk can be minimized through diversification without considering systemic risks.

How the Theory Explains Study

MPT helps in understanding how effective credit risk management can lead to better portfolio

selection for banks. By minimizing credit risk through rigorous management practices, banks can

enhance their overall market performance. The theory underscores the importance of balancing

risk and return, thus providing a foundation for analyzing how credit risk management practices

can lead to superior financial outcomes.

2. The Capital Asset Pricing Model (CAPM)

William Sharpe Introduced in 1964

Assumptions

Investors look for the best risk-return trade-off.

Markets are efficient, and investors can diversify their portfolios to eliminate unsystematic risk.

The risk of an asset can be quantified as its covariance with the market portfolio.

27
Criticisms

It rests on strong assumptions about market efficiency and investor behavior that may not hold

true in real-life situations.

The model's reliance on historical data may not accurately predict future market returns.

It doesn't account for market anomalies and irrational behavior among investors.

How the Theory Explains the Study

CAPM provides insights into how credit risk affects the expected returns of a bank's assets and,

consequently, its market performance. By emphasizing the relationship between risk and

expected return, this model can help explain how effective credit risk management can enhance

the perceived value of a bank in the market, thereby influencing its stock price and overall

performance.

3. The Agency Theory

Michael C. Jensen and William H. Meckling Introduced in 1976

Assumptions

There is a separation between ownership and management in firms.

Conflicts of interest exist between managers (agents) and shareholders (principals).

Effective governance mechanisms can reduce agency costs.

Criticisms

May oversimplify the nature of relationships within firms by focusing predominantly on

financial incentives.

It does not consider the impact of stakeholder interests outside of the ownership structure.

The practicality of governance mechanisms can vary widely across industries and regions.

How the Theory Explains Study

Agency theory can elucidate why effective credit risk management is critical for the market

performance of banks. Poor credit risk management can lead to higher default rates, negatively

28
impacting shareholders' wealth. The alignment of interests between managers and shareholders

through proper risk management practices can contribute to better financial outcomes, enhancing

market confidence and performance.

4. Risk-Adjusted Return on Capital (RAROC)

Initially developed by Bankers Trust in the late 1970s Gained prominence in the 1980s and

1990s

Assumptions

Returns should be assessed on a risk-adjusted basis.

Only risk-adjusted returns should be used to evaluate financial performance.

Criticisms

Implementation can be complex and resource-intensive.

It requires accurate estimation of risk, which may not always be feasible.

There are difficulties associated with comparing RAROC across different institutions or sectors.

How the Theory Explains Study

RAROC provides a framework for understanding the profitability of banks concerning the risks

taken. In the context of credit risk management, this theory is particularly relevant as it

emphasizes the need to evaluate returns while considering potential credit losses. Efficient credit

risk management contributes to a more favorable RAROC, thus enhancing market performance.

Each of these theories provides unique insights that can deepen our understanding of the

relationship between credit risk management and market performance in the Nigerian banking

sector. By synthesizing these theoretical frameworks, researchers can establish a more

comprehensive understanding of the dynamics at play and the critical importance of effective

credit risk management for listed deposit money banks in Nigeria

2.5.1Loan Pricing Theory

This theory looks at banks‟ risk in terms of interest rate. Banks always consider the problems of

adverse selection and moral hazard since it is very difficult to forecast the borrower type at the

29
start of the banking relationship. If banks set interest rates too high, they may induce adverse

selection problems because high-risk borrowers are willing to accept these high rates. Once these

borrowers receive the loans, they may develop moral hazard behaviour or so called borrower

moral hazard since they are likely to take on highly risky projects or investments.

2.5.2 Firm Characteristics Theories

These theories predict that the number of borrowing relationships will be decreasing for small,

high-quality, informationally opaque and constraint firms, all other things been equal. Kargi

(2011) stated that the most obvious characteristics of failed banks are not poor operating

efficiency, however, but an increased volume of non-performing loans. Non-performing loans in

failed banks have typically been associated with regional macroeconomic problems.

2.5.3 The Signaling Arguments

The signaling argument states that good companies should provide more collateral so that they

can signal to the banks that they are less risky type borrowers and then they are charged lower

interest rates. Meanwhile, the reverse signaling argument states that banks only require collateral

and or covenants for relatively risky firms that also pay higher interest rates.

2.5.4Credit Market Theory

A model of the neoclassical credit market postulates that the terms of credits clear the market. If

collateral and other restrictions (covenants) remain constant, the interest rate is the only price

mechanism. With an increasing demand for credit and a given customer supply, the interest rate

rises, and vice versa. It is thus believed that the higher the failure risks of the borrower, the

higher the interest premium.

2.5.5 Theory of Multiple-Lending

It is found in literatures that banks should be less inclined to share lending (loan syndication) in

the presence of well- developed equity markets. Both outside equity and mergers and

acquisitions increase banks‟ lending capacities, thus reducing their need of greater

30
diversification and monitoring through share lending. This theory has a great implication for

banks in Nigeria in the light of the 2005 consolidation exercise in the industry

A situation where a borrower is motivated to default (even though the underlying project is a

success) because of the chance of gaining debt forgiveness. The motivation to cheat, however, is

reduced if collateral is posted (secured debt). Hence, collateral in the Bester model protects

creditors against cheating by borrowers. Besides resolving the moral hazard problem, theoretical

models of secured debt have also assumed that collateral reduces potential adverse selection

problems in the presence of asymmetric information (Chen & Pan, 2012). The underlying

premise in these models is the inability of the lenders to distinguish between good and bad

borrowers. Consequently, an interest rate that reflects the average quality of borrowers in the

market results in an under-pricing of low quality firms but an over-pricing of high quality firms.

As a result, high quality firms do not have incentives to enter the market leading to an adverse

selection situation, but if banks give out more loans, it will increase cost of monitoring and

increases its performance. And if the bank gives lesser loan, it will decrease the cost of

monitoring credit risk management and subsequently decrease its performance as there won‟t be

any accruing interest. Under such conditions, secured debt, provisions for loansand adequate

capital can play a role in signaling the real worth of a firm Performance.

Also, the theory predicts a greater of multiple lending when the banks have lower equity, firms

are less profitable and the monitory cost is high.

31
32
 CHAPTER THREE
RESEARCH METHODOLOGY

3.1 Introduction

This study examined the effect of credit risk management on market performance of listed deposit

money banks in Nigeria. In accordance with this objective, this chapter discussed the research

design, methods of data collection, population and sampling, techniques of data analysis and

variables measurement as well as the model that was employed in the study.

3.2 Research Design

The research design that was employed in this study is correlation design; the choice of the design

is informed by the effectiveness of the design in revealing the effect of two or more variables and

the effect of one variable on another. It is therefore, most appropriate for this study because it

allows for testing of expected relations between variables and the making of predictions regarding

these relationships. This study involved the measurement of five independent variables to one

dependent variable, along with controlling for firm size.

3.3 Population of the study

The population of the study comprised all the thirteen (13) listed Deposit Money Banks in the

st
Nigerian Exchange Group as at 31 December, 2023 as attached in the appendix.The choice of the

banking sector is informed by the fact that the sector is one of the oldest and biggest sectors in the

Nigerian economy that are involve in lending and its management, thus provided a logical basis

for assessing the effect of credit risk management on firm market performance.

3.4 Sample Size and Sampling Technique

The sample of the study was fourteen (10) Listed Deposit Money Banks in the Nigerian

Exchange Group. The sample was arrived using convenience sampling technique. The technique

was adopted to enabled the study accessed only those banks that have complete records of all the

data required for measuring the variables of the study within the period covered, as attached in the

appendix.

33
3.5 Sources and Methods of Data Collection
The data that was used for this study was obtained from secondary sources, because it is a

quantitative study based on positivism paradigm and the core of the data needed for analysis can

be adequately and conveniently extracted from the audited financial reports of the selected firms

within the period of study. These financial reports are obtained from the Nigerian Stock of

Exchange.

3.6 Techniques of Analysis

The study used the result of Ordinary Least Square (OLS) multiple regression technique of data

analysis, as the result from the hausman was insignificant. In addition, various tests was

conducted, ranging from multicollinearity test, normality test, heteroscedasticity test and hausman

specification test. The data analysis was done using Statistics/Data Analysis Software (STATA

13).

3.7 Model Specification

To examine the effect of credit risk management on market performance of listed deposit money

banks in Nigeria. The model that was used for this study was derived from the panel regression

equation which combined both regular time-series and cross section regression with the used of

double subscript (it) attached to each variable. The study therefore specified the general form of

panel data model compactly as follows:

Yit = αit + β1X1it + β2X2it + .........βnXnit + µit

Subscript „i‟ is used to denote the cross-sectional dimension and „t‟ to represent the time-

series dimension. In this equation, Yit represent the dependent variable in the model, which is the

firm performance; Xit contained the set of explanatory variables in the regression model; and α i is

considered constant over time „t‟ and is specific to the individual cross-sectional unit i. The final
model for this study is designed with the expectation that it better explained the relationship and
prediction of the study.

The model used to test the hypothesis formulated for this study is presented below. TQit =

β0 + β1 NPLRit + β2 LLPRit + β3 SLRit + β4 LAit + β5 CARit+ β6 FSIZE it + ε it

34
Where:

β0 = intercept

β1- β6= Coefficient of the independent variables

TQ = Tobin‟s Q

NPLR = Non-Performing Loan Ratio

LLPR = Loan Loss Provisions Ratios

SLR = Secured Loan Ratio

LA= Loans and Advances

CAR=Capital Adequacy Ratio

FSIZE = Firm Size

εit = Residual or error term of firm „i‟ in period „t‟

Table 3.2 Variables Definitions and Measurement

Variable Variable Measurement Source (s)

Acronym
TQ Ratio of Capital/Shareholder‟s Fund to (Al-Matari, Al-
Weighted Risk Assets Swidi&Fadzil, 2014).
NPLR Non-performing loans to Total Loans (Non - (Gizaw, Kebede&Selvaraj

Performing Loans Ratios) 2015)

LLPR Loan Loss Provisions Ratios to Classified (Funso, Kolade&Ojo, 2012)

Loan
SLR Secured Loans to Unsecured Loans (Secured (Uwuigbe, Ranti,

Loan Ratio) &Babajide, 2015)

LA Ratio of Loan & Advances to Total deposit (Kargi, 2013)

(Loan and Advances Ratio)

CAR Ratio of Capital to Risk Assets. (Abiola&Olausi, 2014)

FSIZE Natural logarithm of total assets (Sanda, Mikailu&Garba,

2005).
Source: Computed by Author based on reviewed literature

35
53

36
 CHAPTER FOUR
DATA PRESENTATION AND ANALYSIS
4.1 Introduction

The chapter starts with the preliminary analysis of the study result, using descriptive statistics.
This was followed by the presentation of the results of the model estimations and the inferences
drawn from the tests of the hypotheses. In addition, findings were discussed and policy
implications analyzed. The chapter concluded with a discussion of the robustness of the results
for dependent and independent variables.

4.2 Descriptive Statistics

The simple descriptive statistic is first presented in Table 4.1 where minimum, maximum,
mean,

standard deviation and number of observation of the data for the variables used in the study are

described. The descriptive statistics are presented in the table below:

Table 4.1 Descriptive Statistics

Variables Min Max Mean Std. Dev. N

TQ .001 .042 .011 .008 126
NPLR .056 .310 .153 .057 126
LLPR .001 1.085 .059 .124 126
SLR .017 .632 .125 .107 126
LA .057 .671 .396 .129 126
CAR .034 .107 .070 .012 126
FSIZE 18.799 22.077 20.759 .720 126
SOURCE: Computed from Annual Reports of Sampled Banks 2019-2023 using STATA
Table 4.1 reports the descriptive statistics for the dependent and independent variables

respectively (TQ=Tobin‟s Q, NPLR=Non-Performing Loans to Total Loans, LLPR= Loan Loss

Provisions Ratios,SLR= Secured Loan Ratios, LA=Loan & Advances, CAR= Capital Adequacy
Ratios and FSIZE= Firm Size).

From the table, it can be seen that the mean performance of the banks under study earns about
1.1%market value of its equity, as measured by Tobin‟s Q and maximum of 4.2% for the period
under consideration. Non-Performing Loans has an average of 0.153 with standard deviations of
0.057. The difference between the maximum (0.310) and minimum (.056) and standard
deviations (0.057) shows a low variability with the Non-performing loans ratio.
Loan loss provisions which shows the default risk that the bank expects to sustain from lending

business has an average of 59% loan loss reserve amount with a standard deviation of .124.It

shows that banks tends to be more profitable when they are able to undertake more lending

activities, if a higher level of provision is maintained then bank‟s ability to give loan will

decrease and thus depresses banks‟ performance. Capital Adequacy Ratio has a minimum value
37
of 3.4% and maximum of 10.7% with an average (mean) of 7% equity, although this is below the

15% statutory requirement, as it is been used by the Central Bank of Nigeria as a protection of

the depositors money from credit risk and other failures.

The ratio of loans and advances to total deposit is the most commonly used measure of bank

liquidity and has a minimum of 5.67% and maximum of 67%, which shows that the deposit

money banks in Nigeria lend up to 67% of its deposit fund for lending and on average 40%. The

secured loans of the listed deposit money bank in Nigeria stood at 63% (maximum), 1.7%

(minimum) and 13%(average), with over N146 million as minimum total asset and a maximum

of N3.9 billion.

4.3 Correlation Matrix

This section presents correlation matrix to reveal the relationship between the dependent and
independent variables as well as the control variable.

Table 4.2 Correlation Matrix of Dependent and Independent Variables

Variables TQ NPLR LLPR SLR LA CAR FSIZE

TQ 1.00
NPLR -.259* 1.00
LLPR .356* -.437* 1.000
SLR -.135 -.002 -.225** 1.000
LA -.209** .163*** -.198** -.147 1.000
CAR .042 -.214** .140 .114 .195** 1.000
FSIZE .258 .173*** .121 -.074 -.154 -.062 1.000
SOURCE:Computed from Annual Reports of Sampled Banks 2019-2023 using
STATA *Correlation is significant at 1%
**Correlation is significant at 5%
***Correlation is significant at 10%

Table 4.2 shows the correlation matrix with the correlation coefficient between all pairs of

variables along with their significances. Checking the pattern of relationships between

dependent and independent variables, it is observed that Non-Performing Loans, Secured

Loans and Loans

Advances have negative associations with the market performance of the sampled banks and

are significant at 1% (NPLR) and 5% (LA) with the exclusion of Secured Loans. This

38
 signifies that, Non-Performing Loans, Secured Loans and Loans & Advances are negatively

related to the market performance of the sampled banks.

On the other hand, Loans Loss Provisions and Capital Adequacy are positively associated

with the market performance of the listed deposit money banks in Nigeria but Loan Loss

Provisions is statistically significant, as an increase in its amount will improve the market

performance of the sampled banks.

The table also revealed an insignificant relationship between the explanatory variables

themselves, as none of the coefficient of the variables exceeded 50%. However, this may not

be enough evidence to strongly justify the presence or existence of multicolinearity and

autocorrelation problems among the independent variables under study before computing the

tolerance value and VIF. Where the result obtained from the tolerance value and VIF was

above the expected limits and inconsistent with the rule of thumb of less than 1 and 10 then

the problems of multicolinearity exist among the independent variables. The tolerance value

and VIF were computed to assess the presence of multicolinearity using Stata 10, and the

result found was consistently less than 1 and 10 respectively. This evidence is indicating

complete absence of multicolinearity and the appropriateness and fitness of the model of

study comprising one dependent and five independent variables

4.4 Presentation, Analysis and Interpretation of Regression Results

This section presents the regression result of the dependent variable (Performance; TQ) and the

independent variables of the study (NPLR, LLPR, SLR, LA, CAR) and the control variable (firm

size). It follows with the analysis of the association between dependent variable and each

independent variable.

The summary of the regression result obtained from the model of the study (TQit = β0 + β1 NPLRit

+ β2 LLPRit + β3 SLRit + β4 LAit + β5 CARit+ β6 FSIZE it + εit) is presented in Table 4.4

Table 4.3: Regression Results

39
 Variables Coefficients T-Statistics T-Sig Std Error VIF Tolerance

-CONS -.032 -1.77 .080 .022

NPLR -.001 -1.30 .197 .010 1.33 .753
LLPR .016 3.09 .002 .007 1.40 .716
SLR -.007 -1.13 .260 .007 1.16 .863
LA -.009 -1.48 .143 .006 1.20 .834
CAR .026 0.35 .728 .060 1.17 .857
FSIZE .002 2.49 .014 .000 1.06 .941
R2 .2005
2
Adj R .1601
F. Statistics 14.51
Significance 0.000
SOURCE: Computed from Annual Reports of Sampled Banks 2019-2023using STATA
2
The multiple coefficient of determination (R ) gives the proportion or percentage of the total
variation in the dependent variable explained by the explanatory variable jointly. Hence, it
signifies that 20% of total variation in the market performance of listed deposit money banks in
Nigeria is caused by their non-performing loans, loan loss provisions, secured and unsecured
loan, loans and advances, capital adequacy and firm size, while 80% is caused by factors
outside the model. The F-Statistics is 14.51, which indicates that the model is fit and the
explanatory variable are properly selected, combined and used.

4.5 Robustness Test of Dependent and Independent Variables

This section presents the results of robustness tests conducted in order to improve the validity of
all statistical inferences for the study. These tests include;
multicollinearity test, heteroscedasticity test, cross-sectional dependence test and Shapiro-
wilk test.

Multicollinearity Test: This is to check whether there is a correlation between the independent

variables which will mislead the result of the study. Table 4.3 above presents the matrix of the

linear relationships among the independent variables. From observation, no variable with high

correlation above 0.50 and present no threat. Multicollinearity should not be a problem for the

sample of the study, as the magnitude of the correlations amongst the remaining independent

variables is low. Collinearity diagnostics were observed through the application of variance

inflation factors (VIF) and tolerance values and indicated the absence of multicollinearity in the

data.

Table 4.3, shows that non-performing loans, loan loss provisions, secured and unsecured loan,

loans and advances, capital adequacy and firm size has 1.33, 1.40, 1.16, 1.20, 1.17 and 1.06

40
respectively values of VIF, while the tolerance values are 0.753 (non-performing loans), 0.716

(loan loss provisions) 0.863(secured and unsecured loan), 0.834 (loans and advances), 0.857

(capital adequacy) and 0.941 (firm size). This shows the absence of multicollinearity as the

computed VIF and tolerance values with the aid of STATA are found to be consistently smaller

than one (1) and ten (10) respectively. This shows the appropriateness of fitting the model of the

study with a dependent variable to the five independent variables.

Heteroscedasticity: This check was carried out to check whether the variability of error terms is

constant or not. The present of heteroscedasticity signifies that the variation of the residuals or

term error is not constant which would affect inferences in respect of beta coefficient (that is

coefficient of determination and F-statistics) of the study. The result of the test revealed that

there is no presence of heteroscedasticity because the chi-square value was smaller than the P-

value, as depicted below.

Table 4.4Heteroscedasticity Test

VARIABLES T-Sig

Chi 2 (1) 2.35

Prob> Chi 2 0.1252

SOURCE: STATA Output Result

4.6 Hypotheses Testing and Discussions of Results

This section deals with presentation of univariate analysis conducted for testing the hypotheses

earlier stated in Chapter One. Various robustness tests were conducted to analyze the results

obtained under several conditions. The tests were made to get findings with greater level of

reliability and credibility in this study. Table 4.3 in the study presented the results used for the

hypotheses test in the study.

41
Table 4.3 shows that the independent variables loan loss provisions and capital adequacy are

positive, while non-performing loans, secured loans and loans and advancesare negative. In

addition, the statistical significance was limited only to loan loss provisions (1%). The results for

each hypothesis are presented below:

4.6.1 Non-performing loans and Market performance of listed deposit money banks in

Nigeria.

H01: Non-performing loans have no significant influence on market performance of listed

deposit money banks in Nigeria.

Non-performing loans measured by non-performing loans ratio is found to be negatively

associated with the market performance of the sampled banks, indicating that the higher the

amount of non-performing loans, the lesser the market performance of listed deposit money

banks in Nigeria will be. Therefore, this provides evidence of failing to reject hypothesis one of

the study. Thus, for Hypothesis 1, Ho is not rejected.This result is consistent with the findings of

Felix & Claudine (2008), Kargi (2011) Naveed et al (2011), Funsoet al. (2012),Ogboi&Unuafe

(2013), but contrary to the reported results of Abiola&Olausi (2014).

This shows that at every one percent (1%) increase in non-performing loans amount, the market

performance of listed deposit money banks in Nigeria declined by #1.30k. This implies that

NPLR represent how much of the bank loans and advances are becoming non-performing, which

measures the extent of credit default risk that the bank sustained. As the amount of the ratio

increases, it will show bad message for the management of the banks as it depicts high

probability of none recovering of the banks‟ major assets.

4.6.2Loan loss provisions and Market performance of listed deposit money banks in

Nigeria.

42
H02: Loan loss provisions have no significant effect on market performance of listed deposit

money banks in Nigeria.

Loan loss provisions is found to be significant and positively associated with the market

performance of listed deposit money banks at 1% level of significance, indicating that, the higher

the amount of loan loss provisions of the of listed deposit money banks in Nigeria, the better will

be its market performance. Therefore, this provides evidence for rejecting hypothesis two of the

study. Thus, for Hypothesis 2, Ho is rejected.This result is consistent with the findings of Ahmed

et al (1998) and Ogboi&Unuafe (2013), but contrary to the reported results of Funso et al (2012).

This shows that at every one percent (1%) increase in the amount ofloan loss provisions, the

market performance of listed deposit money banks in Nigeria increases by #3.09k.

4.6.3Secured loans and Market performance of listed deposit money banks in Nigeria.

H03: Secured loans have no significant effect on market performance of listed deposit money

banks in Nigeria.

Looking at the relationship between secured loans and market performance of listed deposit

money banks in Nigeria, a negative relation is observed with a coefficient of -0.007and t-value of

-1.13 but not statistically significant. This association indicates that for every increase in the

amount of secured loans, the market performance of the sampled banks will decrease by #1.13k.

The negative association between secured loans and market performance of listed deposit money

banks in Nigeria shows a decline in the benefit of providing specified asset for claim in the event

of default in payment.In line with the result reported, this provides evidence of failing to reject

hypothesis three of the study. Thus, for Hypothesis 3, Ho is not rejected.

4.6.4Loans and Advances and Market performance of listed deposit money banks in

Nigeria.

Ho: Loans and advances have no significant effect on the market performance of listed deposit

money banks in Nigeria.

43
Loans and advancesmeasured by a ratio to total deposit(loan and advances ratio)are found to be

negative but not significant with the market performance of listed deposit money banks in

Nigeria. This shows that the higher the amount of loans and advances of deposit money banks,

the performance will decrease by #1.48k. In line with the result reported, this provides evidence

of failing to reject hypothesis four of the study. Thus, for Hypothesis 4, Ho is not rejected.

Theinverse relationship is true of Nigerian banking system during the period under study when

most loans and advances were concentrated in the stock market to create what is known as

margin loans. (This is the art of granting loans to stock brokers to purchase share using the share

as security for the loan). Unfortunately, most of these loans were lost as a result of Nigerian

banks financialcrisis when foreign portfolio investors had to divest their funds. This finding is

consistent with Kargi (2011), Ogboi&Unuafe (2013) and contrary to Funso et al (2013).

4.6.5Capital Adequacy and Market performance of listed deposit money banks in Nigeria.

Ho: Capital adequacy has no significant effect on the market performance of listed deposit money

banks in Nigeria.Capital Adequacy, measured by the ratio of shareholders‟ fund to total assets, is

found to be positively associated with the performance of listed deposit money banks in Nigeria,

indicating that the larger the capital base of deposit money banks in Nigeria, the better will its

market performance.

The reported result in respect of capital adequacy provides an evidence of failing to reject

hypothesis five of the study. Thus, for hypothesis 5, H o is not rejected.In support of this result is

the work of Epure&Lafuente (2012) and Abiola&Olausi (2014), but contrary to Naveed et al

(2011).

Expectedly, the enhancement of capital base of Nigerian banks in the period under study from

N2billion to N25 billion significantly improved the profitability of banks. The lesson one draws

from this is that enhanced capital base, especially Tier one capital protected Nigerian banks

44
against financial losses from default loans, and also afforded banks opportunity to compete

internationally especially in the area of downstream oil sector.

4.7 Discussion and Policy Implication of Findings

The section discusses the findings of the study and also included its implications as a

contribution to the existing body of knowledge within the accounting research, regulators,

providers and users of accounting information.

Non-Performing Loans measured as a ratio to total loan was found to be negative but not

significantly related to market performance of the listed deposit money banks in Nigeria. The

negative relationship might be attributed to poor corporate governance practices and the absence

or non- adherence to credit risk management practices. This finding is consistent with Kolapoet

al. (2012) where they opined that an increase in non-performing loan would eventually lead to a

decrease in profitability. By implication, non-performing loans in particular, indicates how banks

manage their credit risk because it defines the proportion of loan losses amount in relation to

total loan amount.

Loan Loss Provisionwas found to be positive and statistically related to market performance of

the listed deposit money banks in Nigeria. The positive effect of loan Loss provision may signify

that the lending business in Nigeria deposit money banks as presumed by managers could be

risky and could turn out to improve its market performance, through strengthening of their credit

risk management capability and in addition to allowing high loan loss provisions to loans and

advances.

From the finding, Secured Loans was found to be negatively associated with the market

performance of listed deposit money banks in Nigeria, which could be due to ineffective

institutional measures to deal with credit risk management and might shift the cost on loan

default in form of higher interest rate on loans to other customers.Theoreticallywhen loans are

secured, it is expected to improve the market performance of listed deposit money banks,this is

because specific assets are set aside for claims in case of default in the payment of loan.

45
Loans and Advancesare relatively illiquid and subject to higher default risk than other bank

assets, butthe study found a negative association between loans and advances and market

performance of listed deposit money banks in Nigeria. This result may be explained by taking

into account the fact that the more financial institutions are exposed to high risk loans, the higher

is the accumulation of unpaid loans, implying that these loan losses have produced lower returns

to many deposit money banks in Nigeria.

Capital Adequacy is very important for the solvency and improvement in the performance of

banks. This is because of possible financial losses that could resultfrom none payment of loans,

which makes the business of banking risky. Banks are therefore required to have adequate

capital, not only to remain solvent, but to avoid the failure of the financial system. The CBN

require commercial banks maintain a 15% capital adequacy ratio.

It is theoretically acceptable that banks with good capital adequacy ratio have a good

performance. A bank with a strong capital adequacy is also able to absorb possible loan losses

and thus avoids bank „run‟, insolvency and failure. The study result indicates that, although

capital adequacy ratio is positive, it is not significant. The insignificant effect of the level of

CAR on banks‟ firm market performance seems to confirm the directive of the Central Bank of

Nigeria (CBN) to deposit money banks to increase their capital from N25 billion.

CHAPTER FIVE
SUMMARY, CONCLUSIONS AND RECOMMENDATIONS
5.1 Summary of Findings

The study examined the effect of credit risk management on the market performance of listed

deposit money banks in Nigeria. A multiple regression model was developed for the purpose

explaining and empirically predicting the market performance of listed deposit money banks in

Nigeria. The developed model of the study estimates the relationship and effect of five

46
explanatory variables – Non-Performing Loans, Loan Loss Provisions, Secured Loans, Loans

and Advances and Capital Adequacy along with controlling for firm size all on one explained

variable (performance: Tobin‟s Q) by means of ordinary least square.

The study centered on the premise on how credit risk management affects the market

performance of listed deposit money banks in Nigeria, by examining the extent to which credit

risk management could influences the market performance of listed deposit money banks in

Nigeria. The independent variables of the study were Non-performing loans, Loan Loss

Provisions, Secured loans, Loan & Advances and Capital Adequacy. These independent

variables were used in formulating our hypotheses from one to five. While the dependent

variable (Performance: Tobin‟s Q) was measured as the ratio of market value of equity plus

liquidity value of firms preference stock plus net current asset to book value of total assets.

The findings of this study are based on panel data collected for the period 2007 – 2015, and from

st
a sample of fourteen (14) listed deposit money banks, in Nigeria Stock Exchange as at 31

December, 2015. The result of the study showed that only one of the explanatory variables was

significant in explaining the market performance of the listed deposit money banks in Nigeria.

Loan loss provision was positively significant at 1%, while Capital adequacy was positive but

not significant, while non-performing loans, secured loans, and loans & advances were all

inversely associated to the market performance of listed deposit money banks in Nigeria.

These results are considered to be contribution to the accounting and finance literature and

additionally, the results could provide accounting practitioners as well as regulators with

valuable insight into the complex interactions between the variables under study.

5.2 Conclusions

The study draws its conclusions based on the empirical and statistical evidence arrived upon after

the analysis and discussions of the result from the preceding chapter as stated below.Firstly, the

study has empirically provided an evidence for selecting, combining and using five independent

variables that formed the credit risk management (non-performing, loan loss provisions, secured

47
loans, loans & advances and capital adequacy) in explaining and predicting the performance of

the sampled banks.

Secondly, non-performing loans had a negative but not significant effect on the market

performance of listed deposit money banks in Nigeria, which could be attributed to poor

corporate governance and the absence or non- adherence to credit risk management practices.

Thirdly, the association between loan loss provisions and market performance of listed deposit

money banks in Nigeria with expectation. This may portray riskiness of lending which improve

its performance, through strengthening of credit risk management capability.

Fourthly, secured loan was expected to be positively related to the market performance of listed

deposit money banks in Nigeria but the inverse was the case, as it could be ascribed to

ineffective institutional measures to deal with credit risk management.

Fifthly, loans and advances were found to be negatively related to the market performance of

listed deposit money banks in Nigeria, while capital adequacy was positively related to the

sampled banks and shows its adequacy to absorb possible loan losses and thus avoids bank

„run‟, insolvency and failure.

5.3 Limitations of the Study

Like any other research, the result of this study is subject to some limitations due to the

following factors. Firstly, the study limited itself to secondary data from the audited financial

reports, if there where alteration in the numbers of the report could affect the findings of this

study.

In addition, ordinary least square was used as technique of data analysis as the probability result

of hausman specification was not significant but if generalized least was used, the findings of the

study might change.Although listed deposit money banks was used as the domain for the study

but the individual firms have their own distinct characteristics such as age, which the study did

not recognize and formed part of its limitation.

5.4 Recommendations

48
In view of the above conclusions that were reached based on the findings of the study, the below

recommendation is proffered

It is recommended that deposit money banks in Nigeria should enhance their capacity in credit

analysis and loan administration while the regulatory authority should pay more attention to

banks‟ compliance to relevant provisions of the Bank and other Financial

Institutions Act (1999) and prudential guidelines.

Regulators should be more concern in making capital charges more responsive to a bank‟s actual

credit exposure by setting new rules for how much capital banks most set aside to cover potential

losses.

5.5 Future Research

This research work examined the effect of credit risk management on market performance of

listed deposit money banks in Nigeria and has paved the way for further research in the

following areas.

The same research can be replicated by incorporating more financial firms.

Other credit risk management determinants could be added, in view of replicating the same

research, as the overall explanatory power of the study model accounts for 20% suggesting that

there are other factors not accounted for.

The research can also be replicated but using other measures of performance such as financial

measures in order to observe the superiority of the measure using coefficient of determination.

49
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