CHAPTER ONE

INTRODUCTION

1.1       INTRODUCTION

Finance is the bedrock for every business organization whereas the growth of businesses precipitates the general growth and development of a nation. As a result, the banking sector has become the central interest of the entire populace, both individual and corporate body as banks are the custodian of finance (money) – the most sought after commodity on earth. According to Agu (2010), availability of financial capital is obviously a condition for the rapid development and transformation of any national economy. Because the provision and efficient management of finance is best facilitated by the existence and appropriate functioning of financial institutions of the nation, the state and activities of the bank is of public interest. Banks play this unique role through granting of loans which constitute a vital function in banking operation, and has direct effect on economic growth and business development. As financial intermediaries, banks assist in channeling funds from surplus economic units to deficit ones so as to facilitate business transactions and economic development generally.

1.2       BACKGROUND TO THE STUDY

Loans are the most important asset held by banks; but loan has its own cost and risk. In other words, the granting of credit, though beneficial for business as a whole, is not without cost, either to the supplier or to the buyer, or to both. It follows therefore that the process of granting credit to customers, and the tasks of risk assessment and risk analysis, amount to no more than weighing the benefits of granting credit against the cost to the supplier of doing so. Furthermore, that cost element is not restricted to non-payment, or bad debt losses, but applies to cost of the credit period itself and the cost incurred in late payment. Therefore, although, lending which is a primary function of commercial banks, and the single most important source of   gross   income   for   commercial   banks as well as contributes to the larger part of a bank’s profits; it has its own risks if not well managed. In other words, the degree of risk associated with lending is proportionate to its contribution to profit. Since these funds are owned by third parties called depositors, prudence demands that such funds should be efficiently managed to sustain the confidence of depositors in the banking system and ensure the continued soundness of the system itself and to minimizing risk of banks failure. This is necessary because bad debts destroy part of the earning assets of banks such as loans and advances which have been described as the main source of earning and also determines the liquidity and solvency which generate two major problems (Institute of Credit Management – ICM, 2012). That is profitability and liquidity, has to earn sufficient income to meet its operating costs and to have adequate return on its investments.

For this reason, the present study examined the effectiveness of credit management in Nigerian banking sector. Credit management is defined as the process of controlling and collecting payments from customers. This is the function within a bank or company to control credit policies that will improve revenues and reduce financial risks ICM, (2012). The function of Credit Management is the protection of the investment in the debtors of the company as well as maintaining the lowest levels of receivables, balancing risks inherent in achieving sales objectives. The main objectives of credit management according to ICM (2012) include ensuring that – credit terms are used to maximize sales with the minimum of risk; high risk or marginal accounts, especially those likely to get into financial difficulties, are identified and to take whatever action is necessary to safeguard sales to those customers; all amounts due are collected according to the agreed payment terms; monthly cash collection targets are achieved; a high quality of accounts receivable is maintained; an accurate and responsible database of customers is operated and maintained. Achieving these objectives lies on the effectiveness of the financial institutions that manage the credit. The reason being that credit management is associated with risk. If not properly management may result to great loss.

Brown and Moles (2012) define credit risk as the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms. Therefore, the goal of credit risk management is to maximize a 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. Banks should also consider the relationships between credit risk and other risks. 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 organisation.

According to Brown and Moles (2012), 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. Drawing from the premise of Adeniyi (2002), who stated that effective supervision and monitoring of loans ensure that these loans do not turn bad forms, this study investigates the effectiveness of credit management in Nigerian banking sector. This study is working on the assumption that when banks managed their credit effectively, they overcome credit risk associated in credit management. In other words, banks, may through proper credit management, have a keen awareness of the need to identify, measure, monitor and control credit risk as well as to determine that they hold adequate capital against these risks and that they are adequately compensated for risks incurred. The question therefore is: how effective are the Nigerian banking sector is in credit management?

1.3       STATEMENT OF PROBLEMS

One of the ways to totally avoid bad debts is to refuse to lend money at all. If banks should then refuse to lend at all, then issue of profitability is cancelled and hence the main purpose of carrying on a business which is to maximize profit, is then defeated. Credit must be adequately managed so that banks could remain in business and prudent lending could do this. Egwuatu (2004) has pointed out that many banks in Nigeria experienced a lot of bad debts. He explained that when a new government abandoned the project awarded to their predecessor, the credit loan borrowed from the bank by either the government or the contractor who manages the project is at stake. This is because most contractors borrowed to execute the project awarded to them but could not repay the loan, due to government action. Furness (2005) also illustrated that during the time of draught or poor rainfall and pest which led to low harvest, farmers who took loans from the bank may delay the repayment.

Again, experience may arise in respect of lapses on the part of the banks’ credit officers. For instance, there may be excesses over approved facility, unformatted facilities and expired facilities not renewed on time. In each of these cases the customer may easily deny even owing the bank all or part of the amount. Money deposit banks have always borne the burden alone, but this may not continue in future as the banks may be unable to take the risk of lending more which may result to loses to both the bank (whose part of its profit is from the interest from loans) as well as the borrower (whose business may collapse as a result of insufficient finance to run the business). Consequently, there may be stagnation or drop in the nation’s economy. For this reason, this study investigates the effectiveness of credit management in Nigerian banking sectors.

1.4       RESEARCH QUESTION

The following are research questions formulated to guide the study

i.        How effective is the credit policy in curbing bad debt in Nigerian banking sector?

ii.       How effective is the credit administration in meeting customers’ demand in Nigerian banking sector?

iii.      How effective is the procedures put in place by the Nigerian banking sector for the recovery of bad debt?

iv.      What are the constraints associated with loan management in Nigerian banking sector?

1.5       OBJECTIVE OF STUDY

The primary objective of this study is to investigate the effectiveness of credit management in Nigerian banking sector. Specifically, this study seeks to:

i.        Examine the effectiveness of credit policy in curbing bad debt in Nigerian banking sector

ii.       Examine the effectiveness of credit administration in meeting customers’ demand in Nigerian banking sector.

iii.      Examine the effectiveness of the procedures put in place by the Nigerian banking sector for the recovery of bad debt

iv.      Determine the constraints associated with loan management in Nigerian banking sector.

1.6       SIGNIFICANCE OF THE STUDY

The significance of this study is that, it will enable banker to appreciate the appraisal of their lending and control mechanism now that they are expected to lend under tight monetary conditions. In essence, finding from the study will assist management and regulatory authorities in ensuring a safe banking since development of country’s economy is tired to performance of financial institutions in Nigeria. It is hardly an exaggeration that the difference between the success and the failure in the banking industry is in the effective management of the banks loans and advance. Effectiveness of credit management is vital to the protection of assets and the achievements of adequate returns to investment. Though many works abound in the literature of the technique of lending, the methods of securing such lending and the pitfalls that await the unwary banker. By comparison it appears to be very little in point on the subject of loan management and recovery.

A study of this subject will therefore be a welcome addition to the existing volume of banking literatures.

1.7       STATEMENT OF THE HYPOTHESIS

i.        H0: The credit policy will not be effective in curbing bad debt in Nigerian banking sector

          H1:  The credit policy will be effective in curbing bad debt in Nigerian banking sector

ii.       H0: The credit administration will not be effective in meeting customers’ demand in Nigerian banking sector

H1:  The credit administration will be effective in meeting customer’s demand in the Nigerian banking sector

iii.      H0:  The procedures put in place by the Nigerian banking sector will not be effective for the recovery of bad debt

          H1:  The procedures put in place by the Nigerian banking sector will be effective for the recovery of bad debt

1.8       JUSTIFICATION OF THE STUDY

          Apart from the financial and time constraints that justified the scope of the a bank selected some out of the banks operating in the sector could not said to be good representation or sample of bank required to generalize the lending policies and practices in the Nigerian Banking Industry. Hence, it should be noted that the officers of some the Banks were wary of disclosing certain information often tagged as confidential because of the oath of secrecy sworn to by them. This equally limited the extent to which useful data were available.

1.9       SCOPE OF THE STUDY

The study covers three commercial banks within Surulere local government area which have currently scaled through the twenty five billion (N25, 000,000,000) capital base. Specifically, the bank under study include: Fidelity Bank, Zenith Bank and First banks of Nigeria and the frame of time to be considered shall be between 2008 and 2012.          The effectiveness of credit management in Nigerian banking sector in the area of credit policy in curbing bad debt; credit administration in meeting customers’ demand; the procedures put in place by the Nigerian banking sector for the recovery of bad debt; and the constraints associated with loan management in Nigerian banking sector.

1.10     DEFINITION OF TERMS

Credit cards – This is a plastic cards which provide a payment system and access to credit facilities apparently dominate Banks customer spending.

Debit cards – The direct debiting of cheque accounts with special ATM card point of sale terminal cards are expected to become increasingly important when cost of providing equipment and networks are finally agreed.

Credit Administration

This involves advising and monitoring of all aspect of credit on day to day basis to ensure that it is fully repaid. It commences with the approval of facility. The term and offer should be clearly documented in the letter of commitment to the customer.

Credit Control

This involves monitoring of facilities to ensure that each credit is and remains satisfactory. It encompasses disbursement according to descendible schedule of repayment agreed with the customer within the approved limit and monitoring of customer credit turnover.

Bad Debt: Debt is defined as payment which must be paid but has not been paid. Therefore this obligation becomes bad when the possibility of its recovery becomes remote. That is, when it becomes difficult to recover such debt.

Long term loans – Long term loans are those granted for periods of between 15 and 30 years.

NET – Payment due on delivery

C.N.D. – Cash next delivery

Weekly credit – Payment of all supplies Monday to Sunday (unless otherwise stated) by specified day in the next week.

Half month credit – Payment of all supplies made in the period 1st to 15th of the month by a specified date in the 2nd half month.

Liquidity – This can be defined as the ease and speed by which a company’s assets can be turned into cash sufficient to meet its current liabilities.