CHAPTER ONE
1.1 Background of the Study
The changing environment in which banks finds themselves present major opportunities for banks, but also entails complex, variable risk that challenge traditional approaches to bank management.
Recently, there was increase in non-performing credit portfolios in banks and other financial institutions and these significantly contributed to the financial distress in the banking sector.
Consequently, banks must quickly gain financial risk management capabilities in order to survive in a market oriented environment, withstand competition by foreign banks, and support private sector-led economic growth. An external evaluation of the capacity of a bank to operate safely and productively in its business through effective credit risk management is normally performed once each year. All animal assessment is similar in nature, but has slightly different focuses depending on the purpose of the assessment.
Risks faced by banks are numerous but this study is essentially concerned with credit risk management in Nigeria commercial banks with First Bank Nigeria Plc and Union Bank Nigeria Plc. as case studies.
The credit risk management in commercial banks should be adequately attended to by banks that want to succeed in its over-all business operation.
For most banks, loans are the largest and most obvious source of credit risk, loans and advances constitute almost sixty to seventy percent of the assets side of the balance sheet of any bank. As long as the borrower pays the interest and the principal through proper amortization of loan on the due dates, a loan will be a performing asset.
The problem however arises once the payment are delayed or defaulted and such situations are very common occurrences in any bank. Delay or defaults in payment of bank loan affects the cash forecast made by banks and further result in a changed risk profile, as the bank will now have to face an enhanced interest rate risk, liquidity risk and credit risk.
Bank are increasingly facing credit risk in various financial instruments other than loans, which includes inter bank 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.
The late 1980s and early 1990s witnessed a great rising non performing credit portfolio in commercial banks especially in First Bank Nigeria Plc. and Union Bank Nigeria Plc. The use of status enquiries on bilateral basis between banks was characterized by some weaknesses. Status enquiries is regarded as business courtesies to which some banks either did not respond to or gave vague replies.
In spite of the systematic weakness, many banks continued to extend fresh facilities to customers who already had hard core and un-serviced debt with other banks and financial institutions. Although, it is difficult to evaluate credit risk, an argument can be made that the loan default disclosures proxy for credit risk may also provide and indication of operational risk related to management decision making.
However, it has been noted that managerial weakness for failed banks includes inadequate supervision of loan portfolio and over-all aggressive strategies for growth in loans and deposits.
Between 1994 and 2003, thirty-seven (37) banks were closed in Nigeria as against twenty-one (21) banks closed between 1930 through 1966. An assessment of the banking distress era of 1993 through 1997 reveals that lending defaults were essentially responsible for over seventy-five (75) percent of the casualties suffered by the Nigerian banking sector through this period.
So 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 organization. Banks should also consider the relationship between credit risk and other risk.