ABSTRACT
This study was set to determine the effect of deposit structure on credit performance in The banking system in Nigeria. The study used a descriptive research design. This study, focused on nine (9) DMBs licensed under the central bank of Nigeria (CBN, 2013). The study used a census study whereby the entire population was studied as opposed to selecting a sample. The study used both primary and secondary data. Primary data was collected by use a structured questionnaire. The data was collected from secondary sources since the nature of the data is quantitative. The secondary data was obtained from financial reports of micro finance institutions. Secondary data from the Central Bank of Nigeria (CBN) reports and library was reviewed for completeness and consistency in order to statistical analysis. The study focused on four key variables namely the dependent variable (Credit performance which was measured using debts. The results of the regression equation revealed that the predictors that were significant contributors to the 68.9% of explained variance in credit performance were (R2=.689). The predictors that were significant were profitability since an increase in profitability by 0.224 resulted into a corresponding increase in credit performance of the banking system. This means that there was positive relationship between the variables. The study concluded that it was important for the banking system in Nigeria to maintain an appropriate balance between provision of credit and collections as a key factor, critical to the survival and ultimate success of DMB’s in Nigeria. The findings also revealed that although most the banking system implemented deposit structure, the gross loan portfolio increase steadily over the years. Also, it was observed that the amount of non-performing loans increased progressively. This rate of default could be as a result of poor investment decisions by the borrowers due to lack of professional advice by the banking system on how to choose and select viable investments that can yield profitability. The study further concluded that some microfinance institutions were a bit lenient while giving out credit facilities to their customers. Some of the credit officer had too much trust on their customers and thus failed to observe all the deposit structure while giving out credit. This however, led to an increase in the amount of nonperforming loans leading to poor loan repayment and thus poor financial performance. The limitation of this study was time constraints, limited financial resources and geographic distance between The banking system in Nigeria. Time and geographical constraints were overcome by the utilization of professionally trained research assistants without compromising the validity and reliability of the research findings, while the limited financial resources available were spent on research activities that could not be undertaken solely by the researcher.
CHAPTER ONE INTRODUCTION
1.1 Background of the Study
The process of lending is guided by deposit structure which are achieved through proper policies that define the guidelines and procedures put in place to ensure smooth lending processes in microfinance institutions. If proper risk management practices are not implemented the firm risks if the borrower is not able or willing to honor their financial obligations. In order to lend, financial institutions accept deposits from the public against which they provide loans and other form of advances since they bear the cost for carrying these deposits, banks undertake lending activities in order to generate revenue. The major sources of revenue comprise margins, interests, fees and commissions (Fiordelisi, Marques-Ibanez & Molyneux, 2010).
Beyond the urge to extend credit and generate revenue, most financial institutions have to recover the principal amount in order to ensure safety of depositors' fund and avoid capital erosion. When lending the financial institution has to consider a number of factors namely interest income, cost of funds, statutory requirements, depositor’s needs and risks associated with loan proposals (Harrison, 1996). As a result financial institutions have overtime developed deposit structure that are observed during lending. These practices include among others the credit appraisals, documentations, disbursement, monitoring and recovery processes lending. Bank lending is also based on established international standards (Day & Taylor, 1996).
Credit risk assessment models often consider the impact of changes to borrower and loan- related variables such as the probability of default, loss given default, exposure amounts, collateral values, rating migration probabilities and internal borrower ratings. As credit risk assessment models involve extensive judgment, effective model validation procedures are crucial. Financial institutions should periodically employ stress testing and back testing in evaluating the quality of their credit risk assessment models and establish internal tolerance limits for differences between expected and actual outcomes and processes for updating limits as conditions warrant (Nsereko, 1995)
1.1.1 Deposit structure
The process of managing credit is significant in improving the current credit scoring practices by the lenders. Credit management ensures inclusion of primary predictive factors that cover the full spectrum of relevant qualification criteria and both determines and reveals how they combine to produce outcomes. Credit scoring, which relies on historical data, does not have this capability, nor does it possess a feedback mechanism to adjust factor weightings over time as experience accumulates. The process of managing credit determines which risk factors that pertain to the lending decision within the context of each borrower’s situation and the loan product parameters, and then appropriately adjusts the factor weightings to produce the right outcome (Matovu & Okumu, 1996).
Deposit structure integrate judgmental components and proper context into the modeling process in a complete and transparent manner. Some credit management systems lack context because they rely purely on the available data to determine what factors are considered. Credit scoring systems lack transparency because two individuals with identical credit scores can be vastly different in their overall qualifications, the credit score itself is not readily interpretable, and industry credit scoring models are maintained as proprietary, as are their development processes (Gardner, 1996).The strategies include transferring to another party, avoiding the risk, reducing the negative effects of the risk, and accepting some or all of the consequences of a particular risk. The process of risk management is a two step process. The first is to identify the source of the risk, which is to identify the leading variables causing the risk. The second is to devise methods to quantify the risk using mathematical models, in order to understand the risk profile of the instrument (Ddumba & Sentamu, 1993),
1.1.2 Credit performance
Credit performance refers to the financial soundness of a financial institution on the performance of their disbursed loan to various sectors. It also means how the loans are scheduled to act and how they are actually performing in terms of the schedule payment compared to the actual payments. It is closely associated with timely and steady repayment of interest and principal of a loan. Default on borrowed funds could arise from unfavorable circumstances that may affect the ability of the borrower to repay as pointed out by (Stigliz and Weiss, 1981).
The most common reasons for the existence of defaults are the following: if the financial institution is not serious on loan repayment, the borrowers are not willing to repay their loan; the financial institutions staffs are not responsible to shareholders to make a profit; clients lives are often full of unpredictable crises, such as illness or death in the family; if loans are too large for the cash needs of the business, extra funds may go toward personal use; and if loans are given without the proper evaluation of the business Norell (2001).Wakuloba (2005) in her study on the causes of default in Government micro credit programs identified the main causes of default as poor business performance, diversion of funds and domestic problems.
Breth (1999) argued that there are many socio-economic and institutional factors influencing loan repayment rates. The main factors from the lender side are high- frequency of collections, tight controls, a good management of information system, loan officer incentives and good follow ups. In addition, the size and maturity of loan, interest rate charged by the lender and timing of loan disbursement have also an impact on the repayment rates (Okorie al., 2007). The main factors from the borrower side include socio economic characteristics such as, gender, educational level, marital status and household income level and peer pressure in group based schemes.
1.1.3 Deposit structure and Credit performance
Effective deposit structure and loan accounting practices should be performed in a systematic way and in accordance with established policies and procedures. To be able to prudently value loans and to determine appropriate loan provisions, it is particularly important that banks have a system in place to reliably classify loans on the basis of credit risk to facilitate repayment of loans by customers (Kagwa, 2003).Larger loans should be classified on the basis of a credit risk grading system. Other, smaller loans may be classified on the basis of either a credit risk grading system or payment delinquency status. Both accounting frameworks and Basel II recognize loan classification systems as tools in accurately assessing the full range of credit risk (Hanson & Rocha, 1986).
A well structured loan grading management system is an important tool in differentiating the degree of credit risk in the various credit exposures of a bank. This allows a more accurate determination of the overall characteristics of the loan portfolio, probability of default and ultimately the adequacy of provisions for loan losses. In describing a loan grading system, a bank should address the definitions of each loan grade and the delineation of responsibilities for the design, implementation, operation and performance of a loan grading system (Glen, 1996).
Glen (1996),credit risk grading management processes typically take into account a borrower’s current financial condition and paying capacity, the current value and reliability of collateral and other borrower and facility specific characteristics that affect the prospects for collection of principal and interest. Financial institutions should put in place policies that require remedial actions be taken when policy tolerances are exceeded. These institutions should also document their validation process and results with regular reporting of the results to the appropriate levels of management. Additionally, the validation of internal credit risk assessment models should be subject to periodic review by qualified, independent individuals for example internal and external auditors (Kagwa, 2003).
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