Analysis of credit risks and loan recovery strategies in nig
1ANALYSIS 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
2 PHONE NO: 080-37743134 E-MAIL: email@example.com ABSTRACTCredit is the extension of fund to a borrower which he/she pays interest ratefor using the money. The money given out as loans are monies mobilizedfrom individuals, households, corporate bodies etc. If the money is not paidat the due date or total failure to pay, will affect the lender. The aggregate orcumulated non payment may lead to failure. Banks have adopted variousstrategies of recovering their money, some orthodox, some unorthodox,mortgages, legal risks. It has been found that most borrowers are alwayswilling to pay, but certain situation like economic recession, inflation, politicalinstability, poor investment makes them not to pay. The implication is that ifloans are not recovered, then, there will be no money to give other borrowersand also it will affect the economic growth as banking is the hub of economicdevelopment. Conclusion was drawn that banks give out loans are exposedto a lot of risks and such risks should be managed to ensure efficiency andloan payments. The work recommends that banks should always advise the
3borrower to take insurance policies, purpose of the loan, monitoring,capability and the means the money will arise from, will play active role inreducing loan default.KEYWORDSCredit risk, credit default, loan recovery strategies, credit risk management. INTRODUCTION
4The banking industry play a vital role in economic development of any nation,they play roles like fund mobilizations, opening of account, letters of creditbusiness guarantees, and mostly give out loans from the part of the moneymobilized. The loan is for economic growth and development of the nationwhich do have vicious effect in employment creation.Most cases, some of the money extended as loan are not paid, this do havenegative impact on the banks and also the money that will be available togive to others will not be available .Even if it from the interest rates paid from, where the banks make profit. Mostof the loans banks give out have been unguided with the principles of givenloans like CAMEL rating, CAMPARI and ICE, Altman model, the 5cs all hascontributed to given out non performing loans which is the major problemsNigerian banks have. Because there are a lot of risks in given out credit, thiswork therefore wants to find out what causes of non credit payment and thestrategies the Nigerian banking industry use in recovering such loans andtheir implications on bank performance.THE CONCEPT OF CREDIT RISK
5Credit risk management can be explained with simple meaning, individuallyand jointly. Credit can be defined as an amount of money that is given by acreditor and taken by a debtor that will be paid for at some future date, inreturn 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 anevent will happen or will not happen. Management on one hand is the steptaken for effective planning, control, coordinating and directing to achieving acompany’s desired goal. Management with relevance to risk can be definedas all the steps, strategies, taken to reduce the severity or the impact of theloss. The three words now combined can mean all the strategies taken toreduce the risks that arises in given out credit. (Nwite, 2006).HISTORICAL DEVELOPMENT OF CREDIT RISKMan 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 orinadequate finance. Because of this, the banking industry comes up toprovide some categories of loan to meet up his or her obligations ranging
6from building houses, marriages, buying vehicles business, expansion etc.the banking industry may decide to give short-term loan, medium term andsometimes with special preference long term loans. It is through giving outthese various categories of loans that bank make their profits. It is alwayssaid that an idle fund is a wasted fund. Banks must be very careful not to beover liquid (having much cash) and not to hold cash- illiquidity (not havingmuch cash) to meet up the obligations of their customers. Without given outloan, there could have been no investment in the economy and one wondershow the world should be without credit. Risk is a form of counterparty risk thatarises in giving out credit.Counterparty risk is the risk that the other party to a contract or agreementwill fail to perform his side of the deal. This could mean a failure to providepromised goods or services, a refusal to provide promised loan facilities or afailure 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 ofcredit 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 banktherefore has the risk of either incurring losses from bad debt or the potentialcost of delayed payment. Similarly, a company that sells its goods or services
7on credit normally must accept the risk that the customer will fail to pay in fullor that he will take him longer time to pay than agreed.REASONS WHY BANKS GIVE OUT CREDITBanking industry is the hub of the economy. Any nation that does not havesound financial system is in trouble, the banks are the catalyst for economicgrowth. Bank give out loan for various categories of people, corporateorganizations, all facet of the government via federal, state and localgovernment, contractors even the small and medium enterprise benefits frombanks.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
8 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
9 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 BANKINGACTIVITIESThere are basic risks which are inherent in banking operations. These formsof 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
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 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
11 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
12 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 FROMCUSTOMERSThe introduction of prudential guidelines in 1990 and promulgation of failedbank and financial malpractices decree No. 18 of 1994 and the inaugurationof the tribunal have all helped in recovery of already lost account. One willnow fail to mention the poor quality of loans and advances, protracted legalprocesses and the attitude of some bank mangers who are not living up totheir 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
13 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.
145. 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.
15 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
16 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.
17 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 ECONOMICDEVELOPMENT ON NIGERIA.Banks play a vital role in economic development, if there is any delay in loanpayment or default, it will result to the performance of the bank.Again aggregate of none payment of debts may lead to bank distress. Furtherto it, it may also result that there will be no funds available to banks to enablethem give more loans to other borrowers. It will also affect the profit of thebank.It may also lead to distress and distresses do have a danger signal; which ifnot controlled; it will lead to discouraging people from saving contagion effectand sporadic withdrawals from other banks.It will also show the economic development, because the money which couldbe used in investment will not be available.It will also result to unemployment and above all, affect government policiesand the regulatory authorities in making their policies and further bankcontrol.
18 CONCLUSIONBanks play active and efficient roles in Nigeria and both the bankingindustry, the regulating bodies all help to make the banks strong anydefault in payment of loans, delay in the payment result to a seriousissues, it is therefore concluded that the banking industry mostly the creditrisk department should ensure that adequate assessment are given toborrowers 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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