A PROJECT PROPOSAL ON CREDIT OPERATIONS: ITS PROBLEMS

AND CHALLENGES FOR THE NIGERIAN FINANCIAL SECTOR

INTRODUCTION
This research aims to analyze the effect of granting Credit facilities
operations of financial institutions to sectors of the economy and the inherent
threat it poses to these financial institutions. The financial sector plays a significant
role in mobilizing funds to fuel investment and growth. The effectiveness and
efficiency in performing its role, particularly intermediation between the surplus
and deficit units of the economy, depends largely on the level of development of
the financial system. The more developed and stable financial sectors tend to be
associated with the mature economies while the under-developed financial systems
feature in developing countries. As a process the financial system adjusts to
changes in the real economy just as the economy responds to developments in the
financial sector.
This role is particularly significant in Nigeria where Banks continue to
dominate the Financial markets, other units in the Financial sector/lending system
include the CBN, NDIC, Securities and exchange commission (SEC),National
insurance commission (NAICOM), National pension commission (PENCOM),
Deposit money banks, Discount houses(DH), Microfinance banks, Primary
Mortgage Institutions (PMIs), Development banks, other lenders- leasing
companies, and the informal sector (CBN Annual Report, 2008). In 2004, the
banks accounted for about 80% of the total resources of the financial system.
Expansionary economic activities by corporations and the government are mostly
financed by the banking sector. The domestic-owned banking sector constitutes the
largest component of the financial sector and lends primarily to the oil and gas
(25.5% of total credit to the private sector in 2008), and telecoms sectors (16.7%).
Bank credit remains the main source of external formal financing for Nigeria as
development of corporate debt and equity market are still in its early stages.
According to Onyeagocha (2001) the term “Credit” is used specifically to refer to
the faith placed by a creditor (lender) in a debtor (borrower) by extending a loan
usually in the form of money, goods or securities to the debtor. Credit is the largest
element of risk in the books of most financial institutions as well as failures in the
management of credit risk, by weakening individual institutions and in some cases,
the lending system as a whole which have contributed to episodes of financial
instability. Empirical studies on challenges faced by the financial sector have
shown that poor assets quality (predominantly credit loans) has been the most
frequent factor in Bank failure. Stuart (2005) emphasized that the spate of Non-
performing loans (NPL) is as high as 35%. This implies the reason for distresses
and crises in the financial sector as the interest charged on these loans and
advances constitute the major source of income to these lending institutions.
However the giant steps taken since 1958 and especially the said innovations of the
CBN in 1986 has not been able to provide enough backbone for the financial
industry as reflected by the down turn in the events of late 1980s which were
characterized by the unprecedented level of distress as reflected in large volume of
non-performing loans, insolvency, liquidity problem and default in meeting
depositors and inter-bank obligations. This poor state of the banking system was
exposed in 1989 with the government directive to withdraw the deposits of
governments and other public sector institutions from banks to CBN. Thus, the
number of distressed banks increased at an increasing rate from 7 in 1989 to 60 in
1995 and decreased to 7 in 2000 while the banking system non performing loan
started with N2.9billion in 1989 and peaked at N44.5 billion in 1995, came down
to N17.3 billion in 2000 but picked up from 19.23 in 2001 to N49.60 billion in
2004. (Okpara, 2009). In light of this, where the sizeable part of the finance sector
earnings is cut off, it creates friction in the performance of its operations, that is, it
poses a threat to the profitability of the sector and thus its performance. Umoh
1994, traced the rising problem of banks to challenges from its credit operations
i.e. poor loans processing, undue interference in loan granting process, inadequate
or absence of loans collateral, among other things.

Challenges of Credit Operations in the Financial sector

According to Obalemo (2004) credit risk is an assumed risk that a borrower won’t
pay back the lender as agreed. Where this occurs, the financial sector will be
impaired in playing its role (i) to intermediate further funds, (ii) generate funds to
sustain its operations. Since profitability is the guiding force to any operation of
the bank, including credit extension their facilities should yield a certain level of
profit to sustain its capital.
The various types of credit risk faced by financial institutions may be categorized
into, management risk, geographical risk, business risk, financial risk, and
industrial risks. Under these are other factors such as:
Increasing Interest rates
High levels of NPLs exacerbate the risk-averse lending behavior of banks, limiting
their ability to increase their interest income. This becomes a particular concern
when earnings from interests on loans lack the potential to generate strong earnings
to cover for the probable losses. The vulnerability of banks’ profitability to the rise
and fall of interest rates is further worsened by the fact that pre-tax profitability is
only 1% of average assets if trading gains are excluded.
High operating expenses
The high operating expenses contribute to the inability of the banking system to
generate profits. On average, operating expenses have eaten up 89% of the
operating income for the last five years. As of the third quarter of 2004, operating
expenses have grown by 5% from the same period in 2003. This problem reflects
the inefficiencies in the banking system that threatens its operating fundamentals.
Corporate Governance Problems
Corporate governance problems in the banking sector are evidenced by the
prominence of a few bank auditors, absence of domestic credit rating agencies, and
lack of proper disclosure and reporting of information, and compliance with
international accounting standards. The presence of family and conglomerate
ownership coupled with the lack of stringent regulations poses risks of distorting
bank decisions to favor certain vested interests. In fact, some even see the lingering
NPL problem as a reflection of lax corporate governance standards.
It must be noted however, that efforts to strengthen corporate governance in banks
have been initiated. On top of the existing corporate governance code set by the
SEC, banks have started to institutionalize the framework for a corporate scorecard
that aims to apply “peer pressure” in raising the standards in professional and
ethical practice and improving the competencies of bank directors, audit
committees, and risk management committees.

Conclusion and Recommendations

The recent upgrade by the CBN on the credit ratings of the bigger commercial
banks in the country from ‘negative’ to ‘stable’ is a welcome development for the
financial sector. Banks must still however, contend with their inherent problems.
Banks have to clean up their balance sheets and find ways to best facilitate the
absorption of losses involved in NPL sales. The key is for banks to manage the
risks properly while still being able to serve the credit needs of the economy. Weak
bank lending has undesirable consequences for the economy. If financing will be
limited to only a few large corporations, this would negatively affect investment
growth, thereby limiting output growth and employment. The following reforms
are therefore necessary to ensure that the banking system is profitable, stable and is
growing at a sustainable rate.
Address NPL Problem
Successful financial reform efforts in other countries usually involved an influx of
investments in an NPL market and an accompanying prudential regulatory effort
on the part of the government to ensure that banks will be rid of their bad loans.
The success of Taiwan in lowering its NPLs was due to the creation of an investor-
friendly environment which involved instituting a simple system for disposing of
bad assets, protecting creditor rights, and lowering transaction costs. Thus, policies
that aim to establish an attractive NPL market for investors will be most helpful to
address the NPL problem of the finance sector. A common policy in other
countries was to set a targeted NPL ratio that should be strictly met by the banks or
to impose a higher ROE to promote diligence among banks to improve its
profitability. The regulatory/supervisory efforts of the central banks and the
Nigerian deposit insurance corporation should be articulated more on the undue
interference from bad credit policies, political crises, undercapitalization and
fraudulent practices of the insiders. These factors are the most critical factors
inhibiting efficient performance of the Nigerian financial institutions and where
they can be simultaneously arrested; the problem of bank failure will be put to a
halt.
This research will be written in 5 chapters which will deliberate on all that
has been briefly discussed above. Chapter one will introduce the research as a
whole dwelling on the definitions of key points, like Credit, financial system etc
and the objectives of the study, background to the study, scope and problem
statement of the study. Chapter two contains the literature review and its
theoretical framework. Chapter three will contain background information on the
Nigerian economy in relation to the financial institutions operations over a period
of time. Chapter four of the research will contain the research methodology using
the most appropriate model choices, empirical analysis with the implication of
findings discussed in relation to the study. And lastly will be chapter five in which
will be summary of findings and policy recommendations and will help solve the
problem of credit operation in financial institutions in the country.

References
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Backgound and Issues, Working Paper, November 2004.
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