A comparative study of the relationship between stock price
Analysis of credit risks and loan recovery strategies in nig
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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 FINANCE
EBONYI STATE UNIVERSITY – ABAKALIKI
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PHONE NO: 080-37743134
E-MAIL: nwitewhite2006@yahoo.com
ABSTRACT
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
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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.
KEYWORDS
Credit risk, credit default, loan recovery strategies, credit risk management.
INTRODUCTION
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The 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
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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).
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
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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.
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
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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 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
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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
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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
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
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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
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
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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 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
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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
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department of the bank, who will insert some clause in the failed
bank (Recovery of Debt and 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.
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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 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.
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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.
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
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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 the lease defaults in
making repayment as agreed in the terms of the lease.
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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.
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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 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.
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