THE IMPACT OF RISK MANAGEMENT ON THE PROFITABILITY OF BANKS IN NIGERIA ( A CASE STUDY OF GTB)
The study examines Risk Management and Credit Administration in GT Bank Plc, Murtala Mohammed square branch Kaduna. The research questions that guided this study were: How is risk managed in GT Bank Plc? What are the constraints militating against risk management and credit administration in GTBank Plc? What are the solutions to the identified problems. The survey method was used as the research design. The entire population of 30 person from credit department of GT Bank Plc, were used as the sample size. A questionnaire design in five likert scale was used as the instrument of data collection. The mean (x) was used to analyze data. The result of findings indicates that risk is mainly managed in Gt Bank Plc, through embarking on insuring customer deposit with NDIC as well as proper evaluation and monitoring of policy as well as efficient appraisal of proposed on investment that would be finance with bank loan. However, the problems confronting risk management and credit administration are basically defective procedures of loan appraisal as well as dearth of knowledge and skills in credit administration and risk management. Commercial bank should establish sound and competent credit risk management units and recruit well motivated staff, credit officers are the cutting edge of credit administration. As such issue pertaining to their selection, training, placement, job evaluating reward and discipline need to be tackled effectively
TABLE OF CONTENTS
Title page - - - - - - - - i
Declaration - - - - - - - - ii
Certification - - - - - - - - iii
Approval - - - - - - - - iv
Dedication - - - - - - - - v
Acknowledgement - - - - - - - - vi
Table of Contents - - - - - - - - vii
Abstract - - - - - - - - - xi
CHAPTER ONE: Introduction
1.1 Background of the Study - - - - - - 1
1.2 Statement of the problem - - - - - 2
1.3 Research Question - - - - - - 3
1.4 Objective of the study - - - - - - 3
1.5 Statement of Hypothesis - - - - - - 3
1.6 Significance of the study - - - - - - 4
1.7 Scope of the study - - - - - - - 4
1.8 Definition of Terms - - - - - - 4
CHAPTER TWO – Literature Review
2.1 Introduction - - - - - - - 5
2.2 Conceptual Framework - - - - - - 5
2.3 Review of Research Literature - - - - - 17
2.4 Review of Related Empirical Literature - - - - 28
2.5 Summary of the Literature - - - - - 36
CHAPTER THREE: Research Methodology
3.1 Introduction - - - - - - - 37
3.2 Research Design - - - - - - - 37
3.3 Population of the Study------37
3.4 Sample Size - - - - - - - - 37
3.5 Sources and Method of Data Collection - - - 37
3.6 Validity of Instrument - - - - - - 38
3.7 Reliability of the Instrument - - - - - 38
3.8 Method of Data Collection - - - - - 38
3.9 Method of Data Analysis - - - - - - 39
CHAPTER FOUR: Data Presentation and Analysis
4.1 Introduction - - - - - - - - 40
4.2 Respondents Characteristics - - - - - 40
4.3 Data Presentation and Analysis - - - - - 41
4.4 Summary of Findings - - - - - - 46
4.5 Discussion of Findings - - - - - - 46
CHAPTER FIVE: Summary, Conclusion and Recommendation
5.1 Summary - - - - - - - - 48
5.2 Conclusion - - - - - - - - 39
5.3 Recommendations - - - - - - - 49
1.1 Background of the Study
Risk Management is the identification assessment and prioritization of risks. It is the effect of uncertainty on objectives, whether positive or negative followed by coordinated and economic of application of resources to monitor and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities (Okeh, 2006).
The survival of every commercial bank depends on its ability to manage its risks and loans or advance portfolio effectively. However in the recent past, commercial banks in Nigeria witnessed rising non-performing credit portfolios and these significantly contributed to the financial distress in the banking sector.
Financial organization need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credit or transaction. This is so because the survival and ability of financial institution to compete depend on their ability to profitability and manage credit risk. This is the reasons why lending is based on the two fundamental products of banking: money and information. Banks obtain these products from customers themselves by offering customer valuable services. They package money and information about their borrowers together with valuable banking services to create loan agreements and sell the loan agreements back to their customers (Hempel and Simonson, 2007).
As such, risk rating system in financial institution contains both objective and subjective elements. Objective aspect are based on financial statements and application of certain financial ratio that reflect liquidity, leverage and earnings. Despite the requirement that risk be quantified, risk rating systems always have a subjective dimension that attempts to capture intangibles such as the quality of management, the borrower’s status within the industry, and the quality of financial reporting. These subjective items may result in inconsistencies.
It is in this regard that many financial institutions have faced difficulties over the years arising from their inability to effectively manage credit risk. As such the major cause of serious banking problems continues to be directly related to tax credit standard for borrowers and counterparties, poor portfolio risk management, or lack of attention lead to a deterioration in the credit standard of a bank’s counterparties.
Hence, the need to investigate the subject matter of this research becomes imperative.
1.2 Statement of the Problem
Commercial banks in the recent past witness rising non-performing credit portfolios sequel to the inability of their management to effectively manage risk and credit administration. That problem resulted to high bad debts in commercial bank and a number of other commercial banks were classified as distressed banks by the monetary authorities.
Consequently, the need to examine the subject matter: An Assessment of risk management and credit administration in Union Bank Plc, Kaduna Main branch becomes worthy of investigation.
1.3 Research questions
In order to actualize the objectives of this research, the following research questions was formulated to guild this study:
1) What are the Methods of Risk Management in GT Bank Plc?
2) How is Credit administered in GT Bank Plc?
3) What are the constraints of Risk Management and Credit Administration in GT Bank Plc?
1.4 Objectives of the Study
The central objective of the study is to assess the impact of risk management on the profitability of GT Bank Plc, Murtala Mohammed Square Branch, Kaduna. The specific objectives are:
1. To find out the method of risk management used in GT Bank Plc.
2. To identify to how credit is administered in GT Bank Plc.
3. To identify the constraints militating against risk management and credit administration in GT Bank Plc.
1.5 Statement of Hypothesis
1. H0: Effective credit risk management is not a strong determinants of banks profitability
H1:Effective credit risk management is a strong determinants of banks profitability
2. H0 Poor credit risk management does not lead to bank distress.
H1 poor credit risk management lead to bank distress.
3. H0 risk management does not enhances the performance of banks in terms of profitability.
H01 risk management enhances the performance of banks in terms of profitability.
1.4 Significance of the Study
This study will be beneficial to financial institution especially GT Bank Plc, as they utilize the finding of this study as a basis for policy formulation regarding risk management and credit administration in Banks. The shareholders, stakeholders and the entire society will benefit from this study.
1.6 Scope of the Study
To this end, the study will examine which is the best way to manage risk in GT Bank Plc, Murtala Mohammed Square branch, Kaduna. The branch manager, other staff and customers of the branch are to be questioned in the course of the study
1.7 Definition of Terms
1. Credit Risk: This refers to delinquency and default by borrowers i.e. failure to make payment as at when due.
2. Pure Risk: This refers to reduction in business value as a result of damage to business property by theft, robbery, fire, flood or the prospect of premature death of employee due to work-related illness or accident.
3. Price Risk: This refers to variability in cash flows due to change in input and output prices.
4. Credit Administration: This is the system used in managing the exposure of financial institution to loan delinquency and default.
5. Business Risk: This refers to variability in cash flow.
6. Loan Appraisal: This is the process of determining in advance the various lending parameters and determining the overall loan limit for each borrower based on his debt capacity, loan duration.
Concept of Credit
Credit is defined by the Economist Dictionary of Economics as “the use or possession of goods or services without immediate payment” and it “enables a producer to bridge the gap between the production and sale of goods” and “virtually all exchange in manufacturing, industry and services is conducted on credit”.(Colquitt 2007) Consequently, credit generates debt that a party owes the other. The former is called a debtor or borrower. The latter is a creditor or lender. Certainly the debtor will have to pay an extra amount of money for delaying the payment. In that circle, both debtor and creditor expect a return which is worth their paying more and waiting, respectively. Debtor-Creditor: Pays the creditor extra money earned from reinvestments of the credit amount Gives the debtor time and takes back a return for supplying the credit So now it is clear why credit exists and how important it is to the economy. Firms or individuals that run short of capital need credit to continue or expand their businesses/investments. The ones that have excess money, on the other hand, never want to keep it in the safes. As a result, all are growing and making more money. Demand and supply together exist but do they meet each other? Here borne financial intermediaries who act as the bridge between credit suppliers and clients. Now in this innovative phase of the global financial-services industry, numerous types of financial institutions have joined the credit supplier group: insurance companies, mutual funds, investment finance companies, etc. (Colquitt 2007, 2) Nevertheless, banks are still the dominant source that both individuals and corporates seek credit from. In banking specifically, two primary kinds of credit services based on customer categories are offered: retail credit and wholesale credit. Lending in retail or personal banking are subject to individuals and may fall under: home mortgages, installment loans (e.g. consumer loans, educational loans, auto loans…), credit card revolving loans, revolving credits (e.g. overdrafts), etc. (Crouhy et al. 2006, 207-208). Wholesale lending, on the other hand, involves firms as the borrowers and therefore is of much higher value, more complicated and poses more threats to the banks.
Concept of Credit Risk Quite often in the previous sections of this paper, credit risk has been mentioned or even defined. However, it still needs to be repeated from a deeper point of view. Basically, it is understandable that credit risk occurs when the debtor cannot repay part or whole of the debt to the creditor as agreed in the mutual contract. More formally, “credit risk arises whenever a lender is exposed to loss from a borrower, counterparty, or an obligor who fails to honor their debt obligation as they have agreed or contracted”. This loss may derive from deterioration in the counterparty’s credit quality, which consequently leads to a loss to the value of the debt. (Colquitt 2007) Or in the worst case, the borrower defaults when he/she is unwilling or unable to fulfill the obligations (Crouhy et al. 2006).
Risks in Banks Risks are the uncertainties that can make the banks to loose and be bankrupt. According to the Basel Accords, risks the banks facing contain credit risk, market risk and operational risk. Credit risk is the risk of loss due to an obligator's non-payment of an obligation in terms of a loan or other lines of credit. The Basel Committee proposes two methodologies for calculating the capital requirements for credit risk, one is to measure the credit risk in a standardized manner and the other is subject to the explicit approval of the bank’s supervisor and allows banks to use the IRB approach. Market risk is defined as the risk of losses in on and off-balance sheet positions arising from movements in market prices. The capital treatment for market risk addresses the interest rate risk and equity risk pertaining to financial instruments, and the foreign exchange risk in the trading and banking books. The value at risk (VaR) approach is the most preferred to be used when the market risk is measured. Operational risk is defined as the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events. There are three approaches applied to the operational risk measurement: Basic Indicator Approach (BIA), Standardized Approach (SA), and Advanced Measurement Approach (AMA). The banking business, compared to other types of business, is substantially exposed to risks, especially in this ever-changing competitive environment. Banks no longer simply receive deposits and make loans. Instead, they are operating in a rapidly innovative industry with a lot of profit pressure that urges them to create more and more value-added services to offer to and better satisfy the customers. Risks are much more complex now since one single activity can involve several risks. Risks are inside risks. Risks overlap risks. Risks contain risks. Scholars and analysts in recent decades have been trying to group banking risks into categories. The Basel Accords issued by the Basel Committee on Bank Supervision mention three broadest risk types in the first pillar: credit, market and operational risks. Then the second pillar deals with all other risks. Anthony (2009) categories risks into six generic kinds: systematic or market risk (interest rate risk), credit risk, counterparty risk, liquidity risk, operational risk, and legal risks. This categorization is based on types of services offered by banks. (The Wharton Financial Institutions Center 2007) But the risks seem to be insufficient and some overlapping can be found. Counterparty risk and credit risk are quite alike or the list lacks country risks, for example. Another classification that is quite comprehensive though not particularly aims at banks only is introduced in “The Essentials of Risk Management” (2006) by Michel Crouhy, Dan Galai and Robert Mark.
Risk Management in Banks As mentioned above, “risk is always bad as a false assumption and can mislead the way people deal with risks. Eliminating each and every risk definitely is not the way because risk is an unavoidable element of life. Moreover there is a special relationship between risk and reward. If you want a higher rate of return, be willing to take risks and be tolerant of risks is a must. “The greater the risk, the greater the gain.” (Spanish Proverb). “He who does‟t risk never gets to drink champagne.” (Russian Proverb) (Book Rags 2010) The point is people know how to cope with, or in other words how to control risks properly, responsibly, and in a business context, profitably, beneficially and sustainably. That is the question risk management must answer. Ordinary people also manage risks in different ways. Nevertheless, risk management in organizations is more concerned. Like risk, risk management has been attempted to define in various ways. It may take pages to list all the definitions from the literature. But there is one definition from the International Organization for Standardization (ISO) that is typical and covers most of general issues: “Risk management is a central part of any organization’s strategic management. It is the process whereby organizations methodically address the risks attaching to their activities with the goal of achieving sustained benefit within each activity and across the portfolio of all activities.” (IRM, 2002: ) The three key phrases in the sentences above are in bold. First, risk management’s primary mission is to bring benefits to the companies and makes them sustainable. Second, risk management is at the heart of any firm’s strategy. The significance of risk management in an organization’s activities was surprisingly ignored for a long time. It used to be regarded as no more than insurance. It only started to catch attention from business top executives in the 1990s after the enormous derivatives disasters triggered in the United States that shook Barings Bank, Procter & Gamble, Gibson Greetings, government of Orange County - California, BankAmerica Corp. and many other giants with loss of billions of dollars. (Culp, 2001: ix; Markham, 2002: 198-201). Third, risk management is an ongoing and continuously developing process. The need for risk management in the banking sector is inherent in the nature of the banking business. Poor asset quality and low levels of liquidity are the two major causes of bank failures. During periods of increased uncertainty, financial institutions may decide to diversify their portfolios and/or raise their liquid holdings in order to reduce their risk. In terms of credit risk management, the goal is to maximize a bank’s risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters and the maximization of shareholder value. Banks need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credits or transactions. Banks should also consider the relationship between credit risk and other risks, for example, the relationship between credit risk, interest risk, liquidity risk, and market risk. The effective management on credit risk is a critical component of a comprehensive approach to risk management and essential to long-term success of any banking organization. Undeniably banking risk management in the modern business world takes place in such a great scale and unexpected manner. On the one hand, the creation and development of a number of risk instruments allow higher risk diversification, better prediction and more effective solutions to the potential dangers in the global financial market. On the other hand, growing interactions among financial institutions in the world make room for a possible sequential effect if something goes wrong. The consequences might be “far beyond the doors of the banks and investors themselves”. (Utrecht University 2010).