Analysis of credit risks and loan recovery strategies in nig
description
Transcript of Analysis of credit risks and loan recovery strategies in nig
ANALYSIS OF CREDIT RISKS AND LOAN RECOVERY STRATEGIES IN NIGERIAN BANKING INDUSTRY
SUNDAY C. NWITE Ph.D, ACII, ACIB, IRDI
SENIOR LECTURER
DEPARTMENT OF BANKING AND FINANCEEBONYI STATE UNIVERSITY – ABAKALIKI
PHONE NO: 080-37743134E-MAIL: [email protected]
ABSTRACT
1
Credit is the extension of fund to a borrower which he/she pays interest rate for using the money. The money given out as loans are monies mobilized from individuals, households, corporate bodies etc. If the money is not paid at the due date or total failure to pay, will affect the lender. The aggregate or cumulated non payment may lead to failure. Banks have adopted various strategies of recovering their money, some orthodox, some unorthodox, mortgages, legal risks. It has been found that most borrowers are always willing to pay, but certain situation like economic recession, inflation, political instability, poor investment makes them not to pay. The implication is that if loans are not recovered, then, there will be no money to give other borrowers and also it will affect the economic growth as banking is the hub of economic development. Conclusion was drawn that banks give out loans are exposed to a lot of risks and such risks should be managed to ensure efficiency and loan payments. The work recommends that banks should always advise the borrower to take insurance policies, purpose of the loan, monitoring, capability and the means the money will arise from, will play active role in reducing loan default.KEYWORDSCredit risk, credit default, loan recovery strategies, credit risk management.
2
INTRODUCTIONThe banking industry play a vital role in economic development of
any nation, they play roles like fund mobilizations, opening of
account, letters of credit business guarantees, and mostly give out
loans from the part of the money mobilized. The loan is for
economic growth and development of the nation which do have
vicious effect in employment creation.
Most cases, some of the money extended as loan are not paid, this
do have negative impact on the banks and also the money that will
be available to give to others will not be available .
Even if it from the interest rates paid from, where the banks make
profit. Most of the loans banks give out have been unguided with
the principles of given loans like CAMEL rating, CAMPARI and ICE,
Altman model, the 5cs all has contributed to given out non
performing loans which is the major problems Nigerian banks have.
Because there are a lot of risks in given out credit, this work
therefore wants to find out what causes of non credit payment and
the strategies the Nigerian banking industry use in recovering such
loans and their implications on bank performance.
THE CONCEPT OF CREDIT RISK
Credit risk management can be explained with simple meaning,
individually and jointly. Credit can be defined as an amount of
money that is given by a creditor and taken by a debtor that will be
paid for at some future date, in return for benefits received earlier
such as goods purchased or loan obtained (Coyle, 2005).
3
Risk on the other hand is defined by Nwite (2006) as chances of
misharp, chances of miscalculation, chances of an event happening
or not happening. Mordi (1987) defines risk as the uncertainty of an
event, the chance that an event will happen or will not happen.
Management on one hand is the step taken for effective planning,
control, coordinating and directing to achieving a company’s
desired goal. Management with relevance to risk can be defined as
all the steps, strategies, taken to reduce the severity or the impact
of the loss. The three words now combined can mean all the
strategies taken to reduce the risks that arises in given out credit.
(Nwite, 2006).
HISTORICAL DEVELOPMENT OF CREDIT RISK
Man by nature is an investor. Any person created on earth has plan,
programme on what to do. Most of the hindrances to these plans
are lack or inadequate finance. Because of this, the banking
industry comes up to provide some categories of loan to meet up
his or her obligations ranging from building houses, marriages,
buying vehicles business, expansion etc. the banking industry may
decide to give short-term loan, medium term and sometimes with
special preference long term loans. It is through giving out these
various categories of loans that bank make their profits. It is always
said that an idle fund is a wasted fund. Banks must be very careful
not to be over liquid (having much cash) and not to hold cash-
illiquidity (not having much cash) to meet up the obligations of their
customers. Without given out loan, there could have been no
investment in the economy and one wonders how the world should
be without credit. Risk is a form of counterparty risk that arises in
giving out credit.
4
Counterparty risk is the risk that the other party to a contract or
agreement will fail to perform his side of the deal. This could mean
a failure to provide promised goods or services, a refusal to provide
promised loan facilities or a failure to pay amount owned in full and
on time.
It is more natural to think of credit risk from the point of view of the
provider of credit that may be a lending bank or selling goods or
services on credit (Orji, 1991).
A company that borrows from a bank might fail to repay the loan;
the bank therefore has the risk of either incurring losses from bad
debt or the potential cost of delayed payment. Similarly, a company
that sells its goods or services on credit normally must accept the
risk that the customer will fail to pay in full or that he will take him
longer time to pay than agreed.
REASONS WHY BANKS GIVE OUT CREDIT
Banking industry is the hub of the economy. Any nation that does
not have sound financial system is in trouble, the banks are the
catalyst for economic growth. Bank give out loan for various
categories of people, corporate organizations, all facet of the
government via federal, state and local government, contractors
even the small and medium enterprise benefits from banks.
Below are some of the reasons Nigerian banking industry give out
loan (credit).
1. For Industrial Development: Odi (2007) outlines some
of the reasons for banks giving out loan as for industrial
development. Any country that is not industrially developed is
floating because they must be importing into the country like
5
today, in Nigeria nobody today can say that Nigeria is an
agriculturalist nation or an industrialist nation rather every
hope is based on minerals, oil and gas and the fall in the price
of oil and gas has affected economic development in Nigeria.
2. To build Houses: People borrow money to build residential
homes or for commercial purposes. The aim is that if it is for
commercial purposes, the houses will be rented and it is a
source of investment by the borrowers of fund. (Emeka; 1992)
3. Provision of vehicles and other infrastructure:- Most
civil servants borrow money from banks to purchase vehicles,
infrastructures and to mortgage their salaries for certain time.
Infact today in Nigeria, salary is one of the major collaterals
people pledge to borrow money from the bank. (Nwite; 2004)
4. For marriages, payment of children’s school fees and other
emergency problems: Most people borrow money nowadays,
to celebrate marriages sine it requires a lot of fund and also to
pay children school fees.
5. For agricultural development, people who wants to engage in
intensive agriculture usually borrow money from the bank.
6. Those businessmen with small capitals and without collaterals
like the small and medium enterprise today can get loan from
the bank with special arrangements. Banks give out loans to
importers, offer letters of credit and also give guarantee to
contractors importers in Nigeria. Without bank loan, most of
the contractors cannot execute most of the contracts.
Financial institutions like the banking industry, insurance
6
industry, pension firms, all are the main company for
economic growth of any nation. (Odi; 2005)
ANALYSIS OF VARIOUS RISKS THAT ARISES IN BANKING
ACTIVITIES
There are basic risks which are inherent in banking operations.
These forms of risk (Rose, 1999) are as identified and explained
below:
1. Credit risk: Banks make loans and take on securities that are
nothing more than promises to pay. When borrowing
customers fail to make some or all of their promised interest
and principal payments, these defaulted loan and securities
result in losses that can eventually erode the bank’s capital.
Because owners capital is usually no more than 10 percent of
the volume of bank loans and risky securities (and often much
less than that), it doesn’t take too many defaults on loans and
securities before capital become inadequate to absorb further
losses. At this point, the bank fails and will close unless the
regulatory authorities elect to keep it afloat until a buyer can
be found.
2. Liquidity risk: There is also substantial liquidity risk in
banking the danger of running out of cash when cash is
needed to cover deposit withdrawals and to meet the credit
requests of good customers. If a bank cannot raise cash in
timely fashion, it is likely to loss many of its customers and
suffers a loss in earnings for its owners. If the cash shortage
persists, this may lead to runs on the bank and ultimate
7
collapse. The inability of a bank to meet its liquidity needs at
reasonable cost is often a prime signal that it is in serious
trouble.
3. Interest rate risk: Banks also encounter risk to their spread
– that is, the danger that revenues from earning assets will
decline or that interest expenses will rise significantly,
squeezing the spread between revenues and expenses,
thereby reducing net income. Changes in the spread between
bank revenues and expenses are usually related to either
portfolio management decisions (i.e changes in the
composition of banks assets and liabilities) or interest rate
risk. The probability that fluctuating interest rates will result
in significant appreciation or depreciation of the value of and
the return from the bank’s assets. In recent years, banks have
found ways to reduce their interest rate risk exposure, but
such risks have not been completely eliminated.
4. Operating risk: Bank also face significant operating risk due
to possible breakdowns in quality control, inefficiencies in
producing and delivering services, or simple errors in
judgment by management fluctuations in the economy that
impact the demand for each individual bank’s services and
shifts in competition as new suppliers of financial services
enter or leave a particular banks market area. These changes
can adversely affect a bank’s revenue flows, its operating
costs, and the value of the owners investment in the bank, e.g
its stock price.
5. Exchange risk: Larger banks face exchange risk from their
dealings in foreign currency. The world’s most tradeable
currencies float with changing market conditions today. Banks
trading in these currencies for themselves and their customers
8
continually run the risk of adverse price movements on both
the buying and selling sides of this market.
6. Crime risk: Finally, banks encounter significant crime risk
fraud or embezzlement by bank employee or directors can
weaken a bank severally and in some instance, lead to its
failure. In fact, fraud and embezzlement from insiders
constitute one of the prime causes of recent bank closings.
Moreover, the large amounts of money that banks keep in
their vaults often proves to be an irresistible attraction of
outsides. The focus of ban robberies has shifted somewhat
with changes in banking technology, theft from ATMs and from
and from patrons using those money machines has becomes
one of the moist problematic aspects of bank crime risk today.
VARIOUS WAYS BANKS RECOVER FAILED CREDIT FROM
CUSTOMERS
The introduction of prudential guidelines in 1990 and promulgation
of failed bank and financial malpractices decree No. 18 of 1994 and
the inauguration of the tribunal have all helped in recovery of
already lost account. One will now fail to mention the poor quality
of loans and advances, protracted legal processes and the attitude
of some bank mangers who are not living up to their responsibilities
have contributed to the loan default.
There are two (2) methods of strategies of loan recovery namely:
Orthodox Method: Under orthodox method of loan recovery,
there are:
1. Demand Letter: This is a letter written to the borrower,
one month before the maturity of the loan to remind him
that capital loan and interest thereon is due for repayment.
It is best written by legal department of the bank, who will
insert some clause in the failed bank (Recovery of Debt and
9
Financial Malpractices in Bank Decree No. 18 of 1994 could
be incorporated into the letter). The debtors who fail to
repay their debt could be sued to court.
2. Personal Visit and Telephone Calls: the bank officers
could pay personal visit to the debtors business premises or
home to discuss and see things for himself. Telephone calls
could also be used constantly as this will make the
customer restless.
3. Debt Counseling: The bank officer would be able to
discuss with customers the nature of his problem (personal
or business), especially why he has not made good his/her
debt. After the exercise, the bank officer could be able to
advice the customer as to know how to re-order his
priorities and start repaying his debt.
4. Life Assurance and Loan Insurance: it is relevant to
take up endowment or term assurance policy in respect to
repay if the loan. This insurance will undertake to repay the
capital loan, the borrower will then make the interest
payment directly to the lender. The insurance protect the
asset financed or securities mortgaged to the bank as well
as life of the borrower to guarantee the repayment of the
credit even if the borrower dies.
5. Sales of Mortgage Property: A mortgage has no power
or control over his property particularly legal mortgage of
he has defaulted the term of legal mortgage. The indenture
creating the legal mortgage could give the mortgage the
power to sell either by private treaty or public auction and if
by public auction. The provision of the Auction Act of 1979
or sale by Auction law by Abia State of Nigeria applicable in
10
Ebonyi State must be strictly compiled with otherwise the
sale will be declared null and void.
6. Litigation: Litigation is the last resort to any bank in
Nigeria because of the wasted and the attitude of judiciary
to financial institutions. The courts are always in sympathy
with the debtors. However, when a debtor is unable to pay,
bank may go to court to prove the debt and attach the
assets of the debtors after obtaining judgment.
7. Local Purchase Order (LPO) Domiciliation of
Payment: Banks accept local purchase order from
reputable companies when the local purchase order is
obtained. The proceeds will be domiciled in customer
account so that part of it will be used to affect the debt,
while the balance is released to the customers after the
bank must have deducted the principal plus interest.
8. Appointment of Receiver: When receiver are made out of
court, it is the deed of debenture / mortgage which grants
the power to either the trustee of the deed of debenture
holders to make an appointment. Receiver can also be
appointed through application to law court.
9. Opening of Saving Security Account: With the problem
of credit today in Nigeria, bank managers have learnt to
device a means of immediate recovery of loans from day
one credit customers are required to open savings account
with a notation “no withdrawal without the intention of bank
manager / credit officer”. The customer will be encouraged
to be depositing a certain amount of money into the
account, the account will be yielding interest but no
withdrawal is allowed.
11
10. Dividend Warrant: Stock and Shares from reputable
companies whose shares are quoted in the stock exchange
market could be as security for credit grant.
Unorthodox Method
Under the unorthodox method of loan recovery are:
1. Publication of Names of Debtors in National Dailies:
Whenever effort have been made to collect the debts from
the bank debtor customers, the bank goes out of its way by
actually publishing the names of debtors in national
newspaper, magazines, television etc. through this, debtors
will be able to repay their loan.
2. The Use of Armed Men: This is a situation whereby banks
used armed policemen and soldiers in recovery of the loan
from debtors.
3. Private Investigation: With Nigerians attitude to
repayment, it becomes more difficult to recover debt
granted to bank customers already made up their mind not
to repay such bank loans. All they do is to claim addresses
and move to a new location.
4. Use of Thugs: this is a situation whereby bank hire thugs
in other to recover their loan money from debtors when
debt are bad debts.
5. Technical Embarrassment: Bank use technical method
like all staff affairs in loan recovery. This is unconventional
means where all staff go for loan recovery from their
debtors.
6. Use of Professional Seizures: This method is common
with finance houses and leasing houses, particularly in
finance and equipment lease agreement. This arises when
12
the lease defaults in making repayment as agreed in the
terms of the lease.
7. Debt Collections: Due to delay and adjournment of cases
in courts, banks resort to debt collection to help in the
recovery of their outstanding indebtedness.
THE IMPLICATIONS OF SUCH STRATEGIES ON ECONOMIC
DEVELOPMENT ON NIGERIA.
Banks play a vital role in economic development, if there is any
delay in loan payment or default, it will result to the performance of
the bank.
Again aggregate of none payment of debts may lead to bank
distress. Further to it, it may also result that there will be no funds
available to banks to enable them give more loans to other
borrowers. It will also affect the profit of the bank.
It may also lead to distress and distresses do have a danger signal;
which if not controlled; it will lead to discouraging people from
saving contagion effect and sporadic withdrawals from other banks.
It will also show the economic development, because the money
which could be used in investment will not be available.
It will also result to unemployment and above all, affect
government policies and the regulatory authorities in making their
policies and further bank control.
CONCLUSION
Banks play active and efficient roles in Nigeria and both the
banking industry, the regulating bodies all help to make the
banks strong any default in payment of loans, delay in the
payment result to a serious issues, it is therefore concluded that
the banking industry mostly the credit risk department should
13
ensure that adequate assessment are given to borrowers and
monitoring of such loans to ensure banks performance.
RECOMMENDATIONS
- Bank should stop giving out personal interest loans.
- The loan guideline must be strictly complied o.
- The principles of CAMEL rating almost model and CAMPARI and
ICE to ensure adequate monitoring.
- There should also be equity among the operators and
borrowers.
- Loan recovery strategies should always be adopted.
- The best option is the legal means and strategies than
unorthodox methods, though Nigeria is a developing nation
and the only language they hear is these orthodox processes
or methods.
REFERENCES
Adekanye, F. (1983), The Element of Banking in Nigeria, Lagos and Publishers Ltd.
Ahmed and Alashi (1992), Bank prudential Regulations in Nigeria NDIC Quarterly,
Lagos, Vol 2 N0.3.
14
Amadi,A.C (1990): Effects of petroleum Hydrocarbon on the ecology of soil Microbial
species and performance of maize and cassava university of Ibadan unpublished
Ph.D dissertation.
Ayomike, J.O.S (1995) Optimization of the survey (NDES). What the survey should and
could achieve Port Harcourt.
Chief and people of Rivers state (1992) Conference: the Endangered. Environment of
Niger Delta. Constraints and strategies for Development at BIODE Janeiro,
BRAZIL.
Chilekezi, O.C. (2006): Risk Management for Insurance Practices Lagos, Inte Training and
Education Services.
Freeman B. (1998): Environmental Ecology: The impacts of pollution and other
stresses on ecosystem structure and function. United State of America, Academic
Press, Inc.
Francis, M. (2007): Customer Relationship Management, Concepts and Tools Burlington M.A.
Gordon, W., Cheese J, Sherril K., & Rushton A. (1984): Introducing Marketing by MCB University
Press Ltd Bradford.
Grosse D.H and Hempel, E.A (1973), Management policies for commercial banks, New
jersey, prentice Hall Inc; Englewood Cliffs. Central Bank of Nigeria, Annual Report
and Account, various years.
Harrington, N. (1999): Risk Management and Insurance (4th edition) JohnWilly and son
publication, New York Chichester Brishare-Toronto-Singapore.
Jhingan, M.L. (2002) Money, Banking International Trade and Public Finance, Vrinda Publication
(p) Ltd 3-5 Ashish Complex Delhi-10091 John Willy and Son publication, New York.
Chichester Brishare Toronto – Singapore.
Khan, S.A. (1994): The political Economy of oil, Oxford. Oxford University press.
Mordi, O. (1989): Concept and definition of risk, lecture note for ASUTech.
Niehaus, R. and Harrington S.E. (1999): Risk Management and Insurance, Irwin/Mc Graw Hill
Nwite, S.C. (2003) Element of insurance Enugu Immaculate publication.
Nwite (1998) “Principal and practice of insurance” lecture Note in IMT unpublished.
Ogunleye, G.A (2000)The regulating imperative implementing the universe banking in Nigeria Quarterly Vol. 11 No. 1 and 2Sinkey, J.F. (1973) “Failure of US Natural Bank of San Oiego or portfolio and Performances
Analysis”. Journal of Bank Research P42
Uche, C.U. (1996) “The Nigeria failed Bank Decree Critiques burnal of International Banking
Laws” Vol.11, Issue Lo.
15