Non-Performing Loans (NPLs) are those loan facilities which banks are unable to profit from because payments are not serviced as anticipated. Non-performing loans consist of both old debt that is not performing and new loans that may become non-performing.
A critical factor that affects the poor performance of loans in the banking system is economic fluctuations viz; short term inflation, high lending rates, level of risk where the economy is not doing well etc. These NPLs affect the earning power of the banks, which in turn affects the bank’s return on capital and lead to poor performance levels.
The International Monetary Fund has raised questions over the rising non-performing loans (NPLs) in Nigerian Banks and has further noted the 3% increase in NPLs in 2017 evidenced in the Central Bank of Nigeria (CBN) Financial Stability Report of the first quarter of 2017. This worrisome development has been attributed to the mainly oil and gas dependent economy of the country as evidenced in the CBN Financial Stability Report of June 2017 which showed a disproportionate credit allocation at 29.29% of the gross loan portfolio in the banking system to the oil and gas sector by the DMBs. The CBN Financial Stability Report also showed a reasonable decline in the Capital Adequacy Ratio amongst Deposit Money Banks (DMBs) which can be attributed to the fact that some of these DMBs are kept afloat largely due to continuous recourse to CBN’s lending facilities.
It is now pertinent to take a look at some of the major causes of non-performing loans in the DMBs for better insight into the problem and proffer possible solutions;
WEAK LEGAL AND REGULATORY SYSTEMS
Illegal increase in lending rate:
DMBs emboldened by regulatory inaction and indifference (which suggest tacit approval), now engage in exploitative practices. Normally, when a customer secures a loan from a bank, the latter fixes a negotiated lending rate based on the prevailing interest rate approved by the CBN. Any change in the interest rate is expected to be brought to the notice of the borrower except otherwise agreed. In Nigeria, however, the lending rate is rarely negotiated and, when it is reviewed upwards by the Central Bank of Nigeria (CBN), the average bank automatically applies the new rate to the outstanding loan without notifying the borrower. Ironically, the same bank does not communicate the fact of any downward review of the lending rate to its mostly uninformed customer, thereby illegally subjecting the customer to a higher interest regime. This inevitably leads to a high tendency of default in repayment.
POOR CREDIT RISK MANAGEMENT
Little or no adherence to lending policies:
The banking industry has attained great prominence in the country’s economic development through the financial services they provide which serves as a catalyst for economic growth. Hence, efficient credit risk management in DMBs is germane not only because of the recurring financial distress and crises, but also because it is a central factor which determines survival, growth and profitability. Credit is conventionally made available in accordance with a borrower’s financial status, business, sustainability, reputation and liquidity, but the unhinged situation of the Nigerian financial market makes it difficult for banks to rely on the aforementioned determinants.
- Capital Inadequacy:
Yet another factor is the gross under capitalization of DMBs in the country due to low initial capital, inflation, inability to recover from non-performing assets and large NPL portfolios. It is important for banks to maintain credit risk exposure within their limit depending on the baseline credit assessment of each DMB to maximize profit.
- Poor Corporate governance Practices:
The excessively high level of non-performing loans in the DMBs can also be attributed to poor corporate governance practices, lax credit administration processes and the absence of or non-adherence to credit risk management practices. This has posed a major concern to different stakeholders including bank management which granted the loans, depositors whose funds have been misappropriated and trapped and regulatory agencies whose major responsibility is to protect the system. In order to forestall or mitigate the weaknesses in Credit risk management, the Central Bank of Nigeria (CBN) in 2006, pronounced a set of codes of corporate governance that should be mandatorily observed by Nigerian Deposit Money Banks in day to day operations of the banks. They are: Equity ownership, Organizational structure, Executive duality, quality of Board membership, Board performance appraisal, quality of Management, reporting relationship, industry transparency, due process, data integrity and disclosure requirement.
Also worthy of note, is the “name and shame” method of loan recovery introduced by the CBN which ends up exposing the DMBs to countless litigation and causing a decline in profit margins from defending such matters.
Insider lending accounts for a substantial proportion of bad debts. This clearly suggests a high incidence of moral hazards within the DMBs. Often times, these insider loans are invested in speculative projects and other long term projects with no short term turn over.
The NDIC in its reports from its off-site supervision of the DMBs on fraud and forgeries has revealed that the number of fraud cases attributed to internal abuse from bank staff rose to 320 in 2017, a 38.53% increase from the previous year.
Further, the Chief Executive of Nigeria Deposit Insurance Corporation (NDIC), Umaru Ibrahim, said three commercial banks had been identified to have in their balance sheets, 60 per cent of the N700 billion insider-related bad loans bedeviling the industry. Mr Umaru who spoke at a recent forum organised by the Financial Institutions Training Centre (FITC), Lagos, said the level of non-performing loans (NPLs) in the industry could be lower if the banks were to adhere more to sound corporate governance. The Code of Corporate governance for bank Directors was instituted to address the rising cases of insider bad loans, which not only represent a conflict of interest, but are against the prudential guidelines for the industry. The Code is signed by all bank directors at their appointment, and empowers the banks’ boards to remove any director with insider non-performing loans.
The question that arises from the above is whether a mere removal of such directors actually solves the problem and is an adequate remedy in such cases of insider loans. One would expect that such executives and directors be prosecuted to set a clear example and encourage others to refrain from engaging in such illegality that cripples the growth of the banking sector and eventually the subject DMB.
The rate at which some influential citizens obtain loans with no intention to pay through internal connivance to circumvent the Credit assessment procedures has contributed in a number of ways to the increased non-performing loan portfolio of several DMBs in the country. The tacit disregard for the corporate governance procedures for granting credit is alarming and begs the question as to whether Personal recognizance is sufficient to grant loan facilities to some individuals?
Another factor is the political interference in the operations of banks through increased interest rates by the CBN. This takes a toll on the existing loan portfolios of the bank and results in an inevitable increase in NPLs. This is because interest rates are usually subject to the prevailing market rate and at the time of liquidation, may have risen beyond what the borrower can comfortably liquidate. The Exchange regulations also adversely affect the bank loan portfolio in the sense that, where loans are disbursed in foreign currency, at the time of repayment, an unfavorable exchange rate adversely affects liquidity. The exchange rate to be used for repayment is often times stated in the instrument granting the facility and is usually fixed at the prevailing rate to boost profit and enhance revenue generation.
The continued increase in the volume of non-performing loans would reduce profitability of banks in the long run. Indeed, it has been suggested in some quarters that the ongoing merger between two top 2nd generation DMBs in Nigeria is an indirect consequence of NPLs. While regulators appear to have put measures in place to curtail the decline in Capital Adequacy Ratio amongst DMBs and subsequent reliance on injections by the CBN, the effect of NPLs are so far reaching that even where banks make profits, such profits will be exhausted in a bid to offset its attendant liabilities owing to NPLs.
The NDIC and the CBN are perhaps doing a great job but there is the need for additional prudential supervision of banking activities, especially with the rising incidence of E-banking channels to ensure strict compliance with corporate governance procedures and avoid fraud.
Furthermore, all credit reporting agencies and supervising authorities will also need to ensure compliance with internal control measures for the adequate credit risk assessment. Financial institutions should also move to consider the use of movable assets as collateral, as opposed to immovable assets where possible. This will create a world of positive impact on credit management.
Zikoraifechukwu is a commercial lawyer at a notable law firm in lagos where she practises particularly as a debt recovery and insolvency practitioner amongst other areas of law. Her understanding of the commercial landscape in the Nigerian finance sector stands her out and she is directly involved in debt recovery and non-performing loan portfolio management for finance institutions and regulators.
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