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CHAPTER ONE
INTRODUCTION
Background Of The Study
Lending has become a significant role in banking because of its direct effect on economic growth and development. This is being followed in most nations, particularly the developing ones, where banks and lending activities have been usefully incorporated into government policy making in the national economic development process (Badar & Yasmin, (2013). Thus, the lending activity of banks as it influences economic growth and development has continued to gain prominence in the light of the modern economy. As agents of development, banks issue loans and advances, including a variety of contingent facilities. The bulk of the cash deposited with banks constitute the basis for loans and advances to personal and business customers to enable their own economic activity. Like any other business entity, banks are in business to generate a profit and, as such, they charge interest on credit issued and pay interest on funds deposited with them. The difference between the interest earned and that paid is the gross margin, which constitutes the profit of the banks (Damankah, Anku-Tsede & Amankwaa, 2015). Essentially, commercial banks are deposit-taking businesses. They are financial intermediaries through which funds are transferred from the surplus sectors to the deficit sectors, thereby taking credit risk. Credit has, thus, become the major business of banking, and the primary basis on which a bank’s quality and performance are rated (Aremu, Suberu & Oke, 2010). Empirical studies on banking crises all around the world have indicated that poor asset quality (predominantly loans) has been the most prevalent reason in bank collapses. Stuart (2005) emphasized that the spate of non-performing loans is as high as 35 percent in the United States. According to Umoh (2012), the rising trend in non-performing loans ratio in banks’ accounts is attributable to inadequate loan processing, undue involvement in the loan giving process, insufficiency or absence of loan security, among other problems, which are all associated with poor and ineffective credit administration. Lending is regarded to be the most profitable operation for banks. However, if lending decisions are not handled with care, it could turn out to be the most loss-making activity for a bank. The safety of any loan and advance is consequently of paramount importance to the bank. Banks therefore guarantee that there is a reasonable assurance that the loans granted are likely to be repaid by the borrower. In order to keep these risk variables under control, the bank lending function is rigorously controlled to ensure appropriate policies and practices (Anolue, 2010). Banks also limit risk in the lending function by building up documented policies and processes for processing each loan request. The bulk of loans and advances provided by banks follow some basic criteria, which help to limit the detrimental effects of lending, especially the prevalence of bad loans. Banks lay tremendous importance on the character, integrity, and reliability of borrowers. There must be a reasonable certainty that the sum granted can be repaid through the operations of the firm. If the loan is granted to a personal borrower, the source of repayment must not be dubious. The borrower must be able to provide appropriate security which will serve as something to fall back on if the projected source of repayment fails (Anolue, 2010). All these measures are embedded into the lending activity to assist reduce credit risk. Credit risk is the danger that the principle or the interest, or both or portion thereof, of the credit granted to a client will not be repaid by him in line with the loan arrangement (Anyanwaokoro, 1996). When this happens, the bank will end up designating the credit as bad debt, and in due course, it will be written off. The long-run consequence of this on the bank might be quite negative with its attendant influence on the entire economy. This is what has occurred to several Nigerian banks that were designated in the past as distressed by the Central Bank of Nigeria. It is consequently required that a high degree of efficiency and effectiveness be maintained in the operations of banks, especially in the field of loan-making, given the implications for the profitability, liquidity, and safety objectives of banks and the well-being of the economy at large. The success of these banks is determined by the amount of loans and advances they grant, the quality of the loans and the provision made for loan losses. Banks need to ensure they maintain an acceptable amount of liquidity, so as to be able to satisfy their clients’ deposit withdrawals. Nevertheless, surplus liquidity should not be left idle in the banks’ vaults, so the banks need to deploy these resources into successful operations, usually lending them out in the form of loans and advances, which represent the bulk of their profit. The bail out of eight banks in Nigeria by the Sanusi led Central Bank of Nigeria in 2009 may be attributed to a significant extent as a result of the substantial number of unsecured and non-performing loans on the books of these banks. The rising volume of non-performing loans and unsecured loans was cited by Sanusi as one of the challenges to financial system stability in Nigeria. He also asserted that the inability to manage non-performing loans well has caused most banks difficulties around the world (Sanusi, 2012).
Statement Of Problems
Interest rates are generally the drivers of commercial banks’ performance. They are the ones that define the size of the profit margin for every transaction between a commercial bank and its customers. Yet, there are several recorded examples of defaults on loan repayments by commercial banks. Interest rate laws may contribute to non-performing loans. When borrowers default on their loan repayment, the involved banks are financially damaged. There will be limited finance to run its activities and also to loan out to other potential borrowers. In the case that the challenge of nonpayment remains for a long time, the banks will have significant bad debts. The circumstance will lead to a contraction of their employees, a stall in their market expansion, and finally collapse (Kariuki, 2013). (Kariuki, 2013).
The sustainability of commercial banks in Nigeria hinges significantly on their capacity to collect loans as efficiently and effectively as feasible. In other terms, to be financially feasible or sustainable. Commercial banks must maintain high portfolio quality based on 100 percent repayment, or at worst, loan default recovery and efficient lending.
However, there have been complaints by commercial banks regarding the high rate of default by their clients, which presupposes that most commercial banks are not achieving the internationally accepted standard portfolio at risk of 3 percent , which is a cause for concern because of its consequences for businesses, individuals, and the economy of Nigeria at large. Loan defaults have started seeping profoundly into the operations of commercial banks in Nigeria. Hence, the study tries to analyze the factors behind defaulted loans and how this might be controlled or mitigated.
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Objectives Of The Study
The main objective of the study is to The topic of interest addressed by this study was how a delinquent loan in the Nigeria banking industry affects the financial performance of commercial banks. Thereby examining the influence of delinquent loans on the financial performance of commercial banks in Nigeria. Below are the precise objectives.
1. Identify the causes of loan defaults among commercial banks in Aba.
2. Identify the challenges management of commercial banks encounters in recovery of delinquent loans.
3. Determine the impact of loan delinquency on the performance of commercial banks in Aba.
Research Question
1) What are the causes of loan defaults among commercial banks in Aba?
2) What are the challenges management of commercial banks encounters in recovering delinquent loans?
3) Does loan delinquency have any negative impact on the performance of commercial banks in Aba?
Significance Of the study
The findings of this study will be of great usefulness to commercial banks in Nigeria and even micro-finance banks will find this study invaluable as this study will unveil the major challenges encountered in the process of lending and recovering loans from individuals and businesses. In spite of that, this study will proffer applicable recommendations that will aid banks in developing strategies for handling loan delinquencies. Also, this study will be relevant to the research community as it will add to the body of existing literature.
Scope Of The Study
This study on the impact of loan delinquency on the financial performance of commercial banks is limited to identifying the causes of loan default among commercial banks in Aba, the challenges management of commercial banks encounter in recovering delinquent loans, and determining the impact of loan delinquency on the performance of commercial banks in Cameroon. Based on the nature of this study, it shall be limited to selected banks in Aba main pack.
Limitation Of The Study
In the course of the study, the researcher encountered some constraints which limited the scope of the study;
a) AVAILABILITY OF RESEARCH MATERIAL: The research material available to the researcher is insufficient, thereby limiting the study.
b) TIME: The time frame allocated to the study does not enhance wider coverage as the researcher has to combine other academic activities and examinations with the study.
c) FINANCE: The finance available for the research work does not allow for wider coverage as resources are very limited as the researcher has other academic bills to cover.
Definition Of Terms
Loan: This is a sum of money that is expected to be paid back with interest.
Delinquency: Delinquency means being behind on a payment which is due.
Commercial Bank: The term commercial bank refers to a financial institution that accepts deposits, offers checking account services, makes various loans, and offers basic financial products like certificates of deposit (CDs) and savings accounts to individuals and small businesses. A commercial bank is where most people do their banking.
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