Anthony O. Garuba

Department of Accounting and Finance, Western  Delta University,Oghara




Loans and advances still account for a sizeable proportion of banks’ assets in Nigeria. Therefore, credit risks remain the major source of risk  the banking industry.Poor credit risk management has been the bane of the Nigerian banking industry. The recent crash ofthe Nigerian Stock Exchange market again brought to the fore that most Nigerian banks’ do not have a framework for managing risk effectively. Out of the total loan portfolio of N2 .801 trillion of the five banks’ whose managing directors were sacked by the Central Bank of Nigeria on the 14th August, 2009,exposure to margin loans and oil and gas stood at N456.28billion and N487.02billion respectively.This will definitely have adverse effect on the economy and liquidity of the banks.It is therefore, the intention of this paper to critically examine how best banks can effectively manage their credit risks in order to ensure that quality assets are booked.


Keywords: Risk, credit, management, loans, assets



The deregulation of the banking industry in 1986 and the introduction of the universal banking in 2001 brought about intense competition amongst banks. Thus, signifying the end of ‘’armchair’’ banking.The intense competition in the banking industry have tended to narrow the spread between earnings on assets and the cost of raising funds. The resultant fall in banks’ margin has put pressure on banks to expand their lending activity. This has resulted in an increase in credit risk with a lot of banks recording quite unpleasant experiences.


The major objective of the deregulation of the banking industry in the late 1980s was to enhance efficiency and effective resource allocation through service driven competition. In order to strengthen the massive processes put in place in the post Structural Adjustment Programme(SAP) era, the regulatory bodies devoted much of their efforts to tracking and controlling the risks of banks.


Such controls usually revolve round capital requirements, cash reserves, liquidity ratio, single obligor limit, stabilization securities, foreign exchange operations, etc.

The irony of it all is that in spite of the regulatory requirements and controls, banks have been known to fail due largely to excessive risk taking. This happened not only in environments in which supervision is weak but also in strong supervision environments such as the United States of America.


However, the fact remains that regulatory restrictions do not and will never substitute for risk

 management function that has to be unique to each bank.  Therefore, the importance of credit risk management in the Nigerian banking industry cannot be over-emphasized. 


Credit risk management in the banking industry

Shim and Siegel (2007) state that companies often use the following steps in managing their risks:

(1)   Identify the risks faced by the company.

(2)   Gauge the potential impact of each risk.

(3)   Decide how each relevant risk should be handled.

It is very important to note that credit, for it to meet the requirements of safety and soundness should be extended only to honest, capable and responsible individuals and organizations having adequate capability to repay the loan from normal sources of business income. It is also important to highlight the fact that whoever borrows money from the bank should know that the money borrowed does not belong to the bank but the depositors/shareholders and therefore must be re-paid.


Therefore, the Risk Manager must ensure the safety of such funds. Hence the following questions should readily come to the mind of the Credit Officer while analyzing a commercial risk:

(1)   What are the risks inherent in the operations of the business being considered for a grant or a loan? Here, he is expected to identify the sources of risk relating to the business e.g. it could be change in government policies, youth restiveness, change in technology, source of raw materials, etc.

(2)   What has management done or failed to do in mitigating those identified risks? The analysis here will help to show what has been done to prevent the risk or what has not been done which could have adverse effect.

(3)   How can a lender structure and control its own risk in supplying funds? There has to be a framework for identifying the type of risk to be faced, how to measure the risk and how to control them.

(4)   What is the loan going to be used for? There is the need to ask searching questions so as to ascertain how the money is to be spent.

(5)    How much does the customer really need to borrow? The adequacy of the amount to be borrowed must be determined because this will enable the bank to avoid lending too little or too much. The customer must show a good appraisal of what his borrowing requirement is, preferably backed by a cash-flow forecast.

(6)   What are the primary sources of repayment and when will the loan be repaid? The customer must show clearly the source and timing of repayment.

(7)   What collateral is available? It is the security the bank falls back on as a last resort.

The above questions, which are by no means exhaustive address the critical elements that can

 significantly affect the safety, soundness and workability of a loan.

The basic credit risk management problem in the Nigerian banking industry is the drive to grow its risk assets by taking excessive risk at the expense of assets quality. The drive for excessive risk-taking by banks according to Onalo (2009) is traceable to two factors:

(a)    High corporate profit appetite resulting to unhealthy competition.

(b)   Extreme culture of disregard to or absence of professionalism and best practices.



Table 1- Loans & Leases and Growth Rate







Total loans& leases of banks(N’Billions)






Source: Bank Returns to NDIC and the CBN


From table 1 above, it was only in 2004 that there was a drop in total loans and leases of 4.9% when compared with the previous year. Between 2004 and 2005 there was an increase of 59.9%. While there was an increase of 55% in 2006, although there was slight decrease of 4.9% when compared with 2005.


However,  there was a significant increase of 84.9% in 2007.

The above trend analysis showed that there was a steady growth of loans and leases from 2004 when the CBN banks’ reforms were introduced and it was also an indication of a  deliberate policy by banks’to grow their risk assets.


 Indicators of credit risk

 Ratios when computed can be used to measure credit risk. Ratio is the quantitative relation

 between two similar magnitude e.g. between two numbers or values, often expressed in mathematical form(e.g. 2:1) or as a percentage(e.g. 50%) or as a number of days, number of times or in Naira value.


It provides a means by which the various significant items in the financial statements are inter-related for the purpose of assessing the financial position and commercial soundness of the business to which those items relate.


The most widely used indicators of credit risk are:

-the ratio of total loan and leases to total deposits.

-the ratio of non-performing assets to total loans and leases

-the ratio of net charge-off of loan to total loans and leases

-the ratio of the annual provision for loan losses to total loans and leases or to equity capital

-the ratio of non-performing assets to equity.

In this paper, the following ratios were used to analyze the data obtained from Nigeria Deposit

Insurance Corporation( NDIC) and the Central Bank of Nigeria( CBN) reports based on the returns from banks:

(a)    Total loans and leases to total deposits

(b)   Non-performing assets to total loans and leases

Table 2- Ratio of total loans & leases to total deposits.

Macro economic indicator






Total loan & leases of Banks(NBillion)






Total deposits of Banks(NBillion)












Source: Bank returns to NDIC and the CBN  


The most popular and long standing credit risk measure is the ratio of total loans and leases to total deposits. From table 2 above one would observe that there was a steady rise in the ratio from 2004 to 2007. The year 2007 witnessed a very high ratio of 0.98:1.   As this ratio rises, exposure to credit risk grows, and failure of a lending institution may just be around the corner. As the ratio grows, examiners  representing the regulatory bodies should be more concerned because loans are usually among the riskiest of all assets for depository institutions, and therefore, deposits must be carefully protected.


This analysis revealed that as at 2007 with a ratio as high as 0.98:1, the regulatory bodies(the CBN and NDIC) should have known that some of the banks were heading towards failure and their excessive lending activities would have been curtailed. Hence some financial analysts asked the apex bank to look inward with a view to ascertaining what really went wrong on their own part. This is because the same apex bank that passed the financial status to be vibrant few months to the assumption of office of the new CBN Governor, later came up with a report that revealed the rot in the banking system. Does it mean if the Governor had not set up a special audit to examine the banks, the true position would not have been known?  Therefore, it is also important for the CBN to overhaul its Banking Supervision Department.Going forward, the health of the banking system  would largely be determined by what extent any perceived regulatory lapse identified is adequately addressed.


Fig- 1.1 Ratio of non-performing credit to total credit.











Source: CBN 2008 annual report


Non-performing credits are facilities that are past due for 90 days or more. Based on the 1990

 Prudential guidelines, non-performing credits are categorized into three: Sub-standard(past due for 90days or more but below 180 days), doubtful(past due for 180 days or more but below 360 days) and lost(past due for 360 days or more). Banks are expected to make specific provisions as follows:

sub-standard-10% of outstanding principal amount, doubtful-50% of outstanding principal amount and lost-100% of outstanding principal amount. While a general provision of at least 1% should be made for all performing credits because of the recognition of the fact that even performing facilities harbor some risk of loss no matter how small.


From fig1.1 above one would observed that the asset quality of banks as measured by the ratio of non-performing loans to industry total loans improved in 2008 at 6.3 percent, reflecting a 2% points decline from the preceding year’s level. This portrayed a good asset quality for the banking industry during the period under review. But the question of “full disclosure” readily comes to mind. In August 2009, the current Central Bank of Nigeria (CBN) Governor, Mallam Sanusi Lamido Sanusi  made it known to the public when he sacked 5 managing directors/directors that the 5 troubled banks were guilty of lack of full disclosure and adequate provisioning among others,  based on the report of the examination conducted by a joint team of CBN and NDIC Officials. In fact, he attributed the excessively high level of non-performing loans in the said banks to “ poor corporate governance practices, lax credit administration processes and absence or non-adherence to the banks credit risk management practices”. According to the CBN Governor, “ the huge provisioning requirements have led to significant

 capital impairment. Consequently all the banks are undercapitalized for the current levels of operations and are required to increase their provisions for loans losses, which impacted negatively on their capital.”

Ighomwenghion (2009) highlighted the huge loss made by banks after making a provision of N2.216trillion. He clearly stated in his words “ As a result of the huge provisions made by banks, following the bank audit and additional discoveries by the CBN appointed management, all banks in Nigeria provided N2.216 trillion for loan loss so far.” It again showed that most of the banks were declaring ‘paper profits’because after provisioning at the instance of the CBN, most of the banks that were declaring jumbo profits over the years, declared losses.



From the analysis above the following findings can been deduced:

(1)   The banks’ indulged in excessive risk taking resulting in non-performing loans. To have given out 98% of the total deposits as loan was excessive. Most of the banks wanted to outwit each other in terms of profitability but failed to take cognizance of their risks exposure.

(2)   There was poor Corporate Governance in the banking industry because there was no transparency in doing banking business hence there was no full disclosure and inadequate provisioning.

(3)   The banks in giving out loans did not ensure that their capitals meet the risks they were exposed to. Hence after making provisions for non-performing loans, their capitals were impaired.

(4)   There was weak supervision by the regulatory bodies(CBN and NDIC). If there was proper supervision, the authorities would have known that the banks’ did not make adequate provisions. Fig.1.1 above based on the CBN latest annual report, indicated that there was a drop of 2% points in non-performing loans to total loans in 2008 compared to 2007. The ratio was as low as 6.3%. But within one year after the report, banks’ had to make a provision of N2.216 trillion. This is clear indication of weak supervision.

Based on the findings above, it is imperative that banks should put in place a framework to manage their risks. There must be a business/strategic plan, a clear vision of what to do over time, based on certain assumptions and how to survive in times of difficulties.

According to Hussey(1994), “there can only be one justification for the introduction of a system of corporate planning into a company-a belief that it can lead to improved results…” Therefore, if banks are to expect improved results, they must have a plan on how to drive their businesses and hedge risks.


Risk may be positively reduced in three ways:

-choice of strategies with lower adverse effects if assumptions are wrong.

-contingency plans.

Hedging actions.



The recommendations are from two perspectives, that is, from the regulatory and banks perspectives.

(a)    Regulatory bodies

To ensure sounding banking system in the Nigerian economy the following recommendations are proffered:

(i)                 The regulatory bodies should train their staff in order to cope with changes especially in areas of Information and Communication Technology(ICT) and overhaul their supervision departments to ensure proper supervision.

(ii)               They should ensure that the code of Corporate Governance introduced in banks in 2006 is fully implemented. Any infraction by banks should be sanctioned.

(iii)             They should ensure that banks’ capital base meet their risks exposure. 



(b)    Banks

      To effectively manage credit risks in the Nigerian banking industry, the following recommendations are proffered. Each bank should :

(1)   Have in place, sound and tested credit policy/procedures. A bank’s credit policy is a broad statement of its basic philosophy and concept of lending, which include guidelines, standards and limitations to guide the decision making process.

There should be a credit manual, which should be strictly adhered to at every stage of the credit process. When credits are administered and managed in accordance with laid down policies and procedures, the occurrence of reckless, un-sustainable credits and poor loan administration will be drastically reduced or eliminated. It must be emphasized that credit policies should be reviewed periodically in line with changes in the economy and environment.


(2)   Have risk acceptance criteria to determine the kind of risk it is prepared to face and the kind of business to be done. A well focused and defined bank has certain transactions it will not go into and there are certain customers it will not touch no matter the story. Therefore, any loan request that does not meet the risk acceptance criteria should not be approved.


(3)   Have exposure limit, in which case it will not allow its services to be concentrated on only one aspect of the economy where it is believed that easy profits can be made. That was what happened in the case of margin loans. Most of the banks developed margin loan products over night and with the aid of stock brokers launched out in search of customers in top management positions in blue chip companies, business ventures and government agencies. It is now obvious that the banks and investors did not understand the workings of the margin loan accounts. In fact, the banks were carried away with the easy profits they would make and ignored the risk involved. It is now glaring that the banks only succeeded in given out loans for speculative business. A good Risk Manager knows that it is very risky to give out loans for speculative purposes. On the other hand some of the customers (investors) who are top management staffers of blue chip companies and government agencies claimed that they were lured into operating such accounts by banks and stock brokers, not knowing the implication of such transactions.


(4)     Engage knowledgeable credit Risk Managers who are versed in the understanding of the market and economic dynamics. In order to ensure that quality loans are booked, banks should ensure that experienced staff are engaged who would be in a better position to thoroughly and painstakingly analyze and evaluate credit proposals.


(5)   Guard against insider abuse by top management and risk managers. Insider abuse includes failure to disclose the interest of the borrower or customer in his business dealings with the financial institution, diverting assets and income for the insiders own use; misuse of position by approving questionable transactions for relatives, friends and business associates; abuse of expense accounts; acceptance of bribes and gratification; and other questionable dealings related to their positions at the institutions. Indulging in such abuses in the banking industry, usually undermine the laid down guidelines and regulation, resulting in non-performing loans and ultimately lead to bank failure.


(6)   Ensure that the chief executive avoids “approval in principle” in the credit process. Approval in principle is anticipatory approval given by the chairman of the board of directors in time of exigency and it is expected to be ratified by the board of directors. However, experience has shown that such” approval in principle” is never approved or ratified by the board when the outcome of the transaction is known and unfavourable. This has caused some banks’ chief executives their jobs in the past. It is advisable to adhere to laid down credit process/procedure.


(7)   Institutionalized relationship management. This is after-sales-service which is the marketer’s strong selling point. It shows that the marketer cares about the maintenance of the equipment when the buyer starts using it. Bankers are advised to imbibe the spirit of “ after-sales-service”. They should monitor the credit process. For instance where the credit is ‘transaction-tied’ or ‘operation-tied’, it is important to monitor its utilization to prevent possible diversion of funds. There is a great danger in not monitoring a customer for it can lead to a bad loan.


(8)   Have in place credit administration department charged with the responsibilities of formulating risk management policies, strengthening of the internal control and risk management procedures. Such departments are likened to the quality assurance/control personnel in a manufacturing concern. However, the focus here is on the bank’s assets portfolio.


(9)   Put in place checks and balances in credit administration. Grant of credit facilities should not be the exclusive preserve of the credit department rather key officers outside the credit department should be brought in, to criticize and make meaningful contribution to the presentations of the credit department. Such key officers can be a committee to take a critical look at the loan proposals and vet before approval. Such a committee is known as the Asset and Liability Committee (ALCO). The committee is expected to meet on a regularly basis to examine the assets and liabilities of the bank and to find solutions to any problems confronting the bank. Policies, procedures and regulations that appear inimical or portend danger to the bank are promptly reviewed, fined-tuned or replaced as deemed appropriate. This helps to strengthen the bank’s asset portfolio.


Put in place proper credit documentation. Documentation refers to official documents that are used to prove that something exist, true or correct. Credit documentation therefore, serves as the official documents verifying the existence of a credit facility and contains information germane to the credit. Adequate information about a credit aids the bank in recovery when the loan goes bad. Lack or absence of vital documents can give rise to controversial credit facilities which is detrimental to the bank because such facilities could not be recovered for want of proof.



 Manage its credit risk by spreading risk to other banks through loan syndication. Loan syndication is the process where by a group of financial institutions pool their resources together to provide credit facility for a borrower under a common agreement, terms and conditions and single loan documentation. This type of lending may be borne out of wisdom, that is, the need to spread risk.


(10)                        Diversify its credit risk exposure by pooling loans through securitization. It reduces the need to monitor each individual loan’s payment stream. Securitization creates liquid assets out of what are often illiquid, expensive to sell assets and transforms these assets into new sources of funds for bankers and attractive investments for investors in the money and capital market.


(11)                        Ensure at all times that lending is adequately collateralized/secured. Banks should avoid clean lending( without collateral), for it gives rise to loan default.


(12)                        Train its workforce to ensure effective and efficient service delivery in its operations. Most of the banks overstress their employees so much so that these employees no longer think of self development and skills competence. A functional emerging financial services market like ours must pay attention; provide strong support and motivation to its workforce in terms of continuous knowledge acquisition and capacity building. Except this is done there will be dearth of skilled manpower in the banking industry. 


(13)                        Carry out routine audit and credit inspection. When such inspection is carried out in branches of the banks nationwide, it helps to beam search light on the bank’s risk assets; to ascertain approval and compliance with the terms and conditions of various facilities. It also help to highlight overdrawn accounts, unauthorized credits and other related sharp and unwholesome practices.


(14)                        Have a monitoring and control units or department. Such units carry out a sort of post-mortem exercise by way of controlling and monitoring credit facilities and also ensuring completeness of all conditions precedent to draw down. The unit also ensures that all credits granted to customers are in line with the bank’s credit policy.


(15)                         Adhere to the code of Corporate Governance. The code of Corporate Governance was introduced to ensure soundness and transparency in the conduct of banking business in Nigeria. The recent CBN bailing out of weak banks underlined the severity of combined risk management and corporate governance failures. The positions of weak banks were most severe where corporate governance issues in addition to risk management failures were uncovered by the CBN.


(16)                        Avail itself of the “Independent Company Credit Report” prepared by expert firms of credit services, to support or complement its own internal credit analysis. Independent Company Credit Report contains every detail about a prospective or existing borrower, including well analyzed audited accounts, profile of its registered directors/shareholders, scrutiny of its management team, market and business viability analysis, collateral verification and value grading, owners’ personal asset identification, among others.


(17)                        Embrace the Internal Capital Adequacy Assessment Process (ICAAP). ICAAP is a system whereby a bank ensures that its capital meets the risks it is exposed to. ICAAP is one of the ways of avoiding the recent embarrassment of over-exposure to margin lending and lending to oil and gas marketers, which gave rise to huge non-performing loans.


(18)                        Ensure it operates in line with statutory and regulatory requirements to avoid been sanctioned.


(19)                       Avail itself of insurance cover. Banks can also hedge their risks by obtaining insurance policies from reputable insurance companies.          




The riskiness of banks’ assets and the strength of risk management practices would determine whether depositors would be protected or not.

Cases of bank failures in Nigeria are rooted in bad loans. Undue credit expansion without ensuring that quality assets are booked does not augur well for a bank. It should be noted that banks do not succeed by booking the biggest loan but quality loan. The regulatory bodies especially (CBN and NDIC) have a great role to play by ensuring sound banking system. The recent sanitization of the banking industry is a step in the right direction.


It is hoped that if the recommendations proffered are implemented, banks would be able to manage their credit risks and book quality loans. 






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