DETERMINANTS OF NON-PERFORMING LOANS (NPLS) IN EMERGING ECONOMIES: EVIDENCE FROM NIGERIAN BANKING INDUSTRY
ABSTRACT
This study examined the determinants
of non-performing loans in emerging economies with evidence from the
Nigerian banking industry. The study adopted the ex-post facto design.
Time series data for the period 1993-2014 were collated from the Central
Bank of Nigeria Statistical Bulletin and Financial Statement of banks
for the period. The Ordinary least square regression was used to test
the five hypotheses stated. Non-performing loans measured by the natural
logarithm of aggregate non-performing loans of banks represented the
dependent variable while gross domestic product, inflation rate, total
loans and advances, total assets and bank’s lending
rate were adopted as the independent variables for the five hypotheses
of the study. Macroeconomic variables such as exchange rate, and
interest rate were also included as control variables. Descriptive
statistics on the dependent, independent and control variables were also
computed and graphed to complement the regression results. The result
emanating from this study revealed that gross domestic product had
negative effect on non-performing loans; Inflation rate had positive
effect on non-performing loans but was insignificant; total loans and
advances had positive effect on non-performing loans and was
statistically significant at the 0.05 level; total Assets exerted
negative effect on non-performing loans and was statistically
significant at the 0.05 level and Bank lending rate had positive and
insignificant effect on nonperforming loans. The study therefore
concludes that bank-specific factors drive changes in or determine
Non-performing loans more than macroeconomic factors in Nigeria. This
should affect the direction of economic policies in the country. It is
recommended, among others, that macroeconomic policy should be directed
at sustaining economic growth as it curbs nonperforming loans in the
banking industry.
CHAPTER ONE
1.0 INTRODUCTION
1.1 Background to the Study
Emerging economies as defined by Center
for Knowledge Societies (2008), are those regions of the World that are
experiencing rapid informationalization under conditions of limited or
partial industrialization. The emerging economies often referred to as
“Emerging Markets” (Bloomberg, 2006) are Countries that have the
characteristics of developed markets but are not yet developed markets.
These include countries that may become developed markets in the future
or were in the past. It may be a nation with social or business activity
in the process of rapid growth and industrialization. Kveint (2009:3)
explains that “emerging market country is a society transitioning from a
dictatorship to a free-market-oriented-economy, with increasing
economic freedom, gradual integration with the Global Marketplace and
with other members of the Global emerging Market (GEM), an expanding
middle class, improving standards of living, social stability and
tolerance, as well as increase in cooperation with multilateral
institutions”.
According to Robert (2000:1), the
emerging economies are low-income, rapid-growth countries using economic
liberalization as their primary engine of growth. He explained that the
major government policy tool is the capital account liberalization,
which is a parameter used in measuring the degree of openness of an
economy, signaling the rate of inflow and outflow of capital from one
country to another without undermining its territorial integrity and
independence. The extremes of the continuum are strict controls, which
come in some variety, and liberalized markets, where economic agents
freely interact under commonly applicable rules to clear the markets.
In the early 1980s, the term, newly
industrialized countries, was applied to a few fast-growing and
liberalizing Asian and Latin American countries. Because of the wide
spread liberalization and adoption of market-based policies by most
developing countries, the term “newly industrializing countries” has now
been replaced by the broader term emerging market economies (Adedipe,
2006). Thus, an emerging economy has further been explained as a country
that satisfies two criteria: a rapid pace of economic development, and
government policies favouring economic liberalization and the adoption
of a free-market system (Anold & Quelch, 1998).
The International Finance Corporation
(IFC, 1999) identified 51 rapid-growth economies in Asia, Latin America,
Africa and the Middle East in addition to the 13 transitional economies
following the collapse of Communism in Eastern and Central Europe in
1989. Over time, the Emerging Economies countries became classified as
regional economic blocks which are identified as follows:
- The BRICS Countries (Brazil, Russia, India, China, and South Africa).
- The CIVETS Countries (Columbia, Indonesia, Vietnam, Egypt, Turkey and SouthAfrica).
- MINT (Mexico, Indonesia, Nigeria and Turkey).
- Others include (Bangladesh, Iran, Pakistan, Philippines, Poland, and South Korea, etc).
Miller (1998) summarizes the most common
characteristics of emerging markets using the following parameters, and
comparing emerging markets with developed economies in the table below
as follows:
- Physical characteristics- in terms of an inadequate commercial
infrastructure as well as inadequacy of all other aspects of physical
infrastructure (communication, transport, power generation);
- Sociopolitical characteristics- which include, political
instability, inadequate legal framework, weak social discipline, and
reduced technological levels, besides (unique) cultural characteristics;
and
- Economic characteristics- in terms of limited personal income
centrally controlled currencies with an influential role of government
in economic life, in managing the process of transition to market
economy.
Comparing emerging markets (and emerging
economies) with developing countries, it is necessary to understand why
emerging economies are so important for world economic growth.
Differences between emerging economies and developed economies are presented in Table 1 below.
Table 1.1(a): Comparison between Developed and Emerging Markets
| S/N |
Dimensions |
Developed markets |
Emerging market |
| 1 |
Level of economic development |
High |
Low/ Medium |
| 2 |
State of economy (and society) |
Developed/ Stable |
Transitional/ Unstable
(Economic/Political reforms) |
| 2.1. |
Macroeconomic framework |
Developed/ Stable |
Undeveloped (being created) |
| 2.2 |
Market institutions |
Developed |
Undeveloped (being built) |
| 2.3. |
Market conditions |
Stable |
Unstable |
| 2.4. |
Market infrastructure |
Developed |
Undeveloped (being built) |
| 2.5. |
Governmental involvement |
Not so high |
Relatively high |
| 2.6. |
Cultural resistance to market
Economy |
Low |
Higher |
| 3. |
Rate of growth |
Low |
high |
| 4. |
Room for growth |
Narrow
(matured markets) |
Huge (undeveloped markets) |
Source: Adapted from Emerging Markets: a Review of Conceptual Framework by Sunje, et al.
The growth of emerging economies,
resulting from economic liberalization, led to the proliferation of
private and State-owned banks in the developing countries, and competing
aggressively with government owned banks and among themselves in order
to survive. The pressure of demand for goods and services and the large
capital inflows from International markets caused the local banks to
continue to expand their total loans and advances portfolio.
Most of these loans could not be repaid
following the cyclical nature of the individual emerging economies which
result into banking crises. The various governments, having liberalized
their economies started experiencing large capital inflows with
increasing demand for goods and services. The channels for these huge
International banking transactions were the local banks. The resulting
economic boom led the banks to develop high appetite for profitability
through the expansion of their loans and advances portfolio despite
their inadequate preparation for financial liberalization. This led to
the deterioration of average bank asset quality across the emerging
economies (Beck, 2013). The fact that loan performance is still linked
to the economic cycle is well known. During economic crash, most of
these loans could not be repaid as at when due. The implication was NPLs
for the banks and often banking failure.
The emerging economies promise huge
potential for growth but also pose significant political, monetary, and
social risks. The framework for the emerging economies explains how the
non-industrialized nations of the world are achieving unprecedented
economic growth using new energy, telecommunications and information
technologies. The emerging economies are becoming the potential business
leaders in the world in providing products and services at low cost and
in quick time to consumers.
The implication of the framework of the
emerging economies for the banking industries is such that large capital
inflows are in principle desirable for relatively low income countries;
they also pose the potential risk of sudden stops leading to large
economic and financial imbalances. To control this potential risks
facing the emerging economies, the country’s financial system need to be
strengthened.
The financial system plays a fundamental
role in the growth and development of an economy, particularly by
serving as the fulcrum for financial intermediation between the surplus
and the deficit units in the economy. A robust financial system that
imbibes the smooth and efficient flow of investment process, lays
foundation for financial stability and sustainable economic development
of a country.
The economic growth in any country is not
possible without a sound financial sector that is made up of financial
institutions (Rajaraman and Visishtha, 2002). These financial
institutions not only ease the credit flow in the economy but also
enhance the productivity by revitalizing investments (Richard, 2011).
Good performance of these financial institutions is the symbol of
prosperity and economic growth in any country or region and their poor
performance will not only damage the economic growth and structure of
the particular region but also impact on other economies (Khan and
Senhadji, 2001).
The role of banking industry is
versatile; Banks utilize the depositor’s funds in an efficient manner,
share risk, play a significant role in the growth of economy, are always
critical to the whole financial system and remain at the centre of
financial crisis (Franklin and Elena 2008).One of the main causes of
financial instability or crisis is the percentage of non-performing
loans (NPLs) to the total assets of the banks both in developed and
emerging economies.
In the last few decades, there have been
many banking failures all over the world (Brownbridge and Harvey, 1998),
following which many banks have been closed by regulatory authorities
(Barr and Siems, 1994; Chijoriga, 1997; Brownbridge, 1998; and
Brownbridge and Harvey, 1998). Non-performing loans are one of the main
reasons that cause insolvency of the financial institutions and
ultimately hurt the whole economy (Hou, 2007). By considering these
facts it is necessary to control non-performing loans for the economic
growth in the country by identifying and sensitively managing those
variables that are causing loan defaults, and are capable of damaging
the financial stability and also the economic growth. In order to
control the nonperforming loans it is necessary to understand the root
causes of these non-performing loans in the particular financial sector
(Rajaraman and Visishtha, 2002).
It is important to understand the
phenomena and nature of non-performing loans; it has many implications,
as fewer loan losses is indicator of comparatively more firm financial
system, on the other hand high level of non-performing loans is an
indicator of unsecure financial system and a worrying signal for bank
management and regulatory authorities. If we look into the causes of the
2007-2009 global financial crises which damaged not only economy of USA
but also economies of many countries of the world we find that
non-performing loans were one of the main causes (Adebola, Wan Yusoff,
& Dahalan, 2011). During economic booms, high risk loans were found
to be granted to unqualified borrowers and were secured against
overestimated collateral values or against nothing. When this economic
boom went burst, those high risk loans turned into Non-Performing Loans
(Chijoriga, 1997).
Chang (1999) explains that the role of
banks in credit creation process is considered very relevant in
sustaining financial stability. But strong financial foundation is often
shaken by impaired credits referred to as non-performing loans (NPLs).
He argued that the success of any business enterprise especially banks,
is to add value to their shareholders wealth by remaining in profit at
the end of their financial year; and where this profit or surplus is
impaired by high default rate in loan repayment, the degree of success
of the bank become greatly challenged such that the health of the bank
will become doubtful. Loans are the major output provided by banks, but
loan is a risk output. There is always a foreseen (ex ant) risk
of non-repayment of a loan before the loan will finally become
non-performing which can be treated as undesirable output or costs to a
bank and impacts negatively on the bank. High non-performing loans
results into credit crunch which causes a bank to start to avoid further
lending despite high demand from borrowers.
In Nigeria, Somoye (2010) reviewed the
performance of banks within the context of nonperforming loans. The
results showed that variations in non-performing loans impacted on the
banks earnings followed by the risk of fluctuating interest rates
resulting from monetary policy rate adjustments by the monetary policy
authorities. The results largely supported the findings from the study
on non-performing loans conducted on Sub-Saharan Africa countries by
Fofack (2005) who maintained that a loan is non-performing where
earnings due are no longer available to profit because full repayment of
principal or interest is 90 days or more delinquent, and, or, the
maturity date has passed and repayment in full has not been made.
Evidence from literature shows that the
studies on non-performing loans have focused on advanced economies like
the United States of America (USA), Spain, and United Kingdom (UK), and
emerging economies like China, Taiwan, India, Brazil, Egypt, Indonesia,
Turkey, Malaysia, Bangladesh, Pakistan, South Korea etc., but with very
scanty literature on the Nigerian economy which has been grouped as one
of the emerging economies.
The studies in the Nigerian economy have
concentrated on bank failures with non-performing loans as one of the
major factors but without corresponding studies on non-performing loans
itself. This suggests that the study on the determinants/causes of
non-performing loans as a major factor for bank failures have been
ignored. This is a knowledge gap that needs to be filled.
Therefore, the aim of this study is to
analyze the sensitivity of the “Determinants of nonperforming loans in
emerging economies with evidence from Nigerian Banking Industry”. The
objective based on existing International evidence is to explain the
determinants of nonperforming loans by identifying the macroeconomic and
the bank specific factors.
1.2 Statement of the Research Problem
Gross Domestic Product (GDP) has remained
one of the macroeconomic factors that determines Non-Performing Loans.
From literature, Nigerian GDP has shown robust growth trend throughout
the period of this study. It was expected (all things being equal) that
borrowers’ cash flow would have improved to ease their repayment
capabilities, but NPLs increased to all time high of N2, 992.80 billion
in 2009. My interest lies on the fact that I did not see result-oriented
efforts being put in place by the Federal Government through the
Central Bank of Nigeria and other regulatory bodies to cause the
positive GDP to reflect in loan repayments so as to close the gap
created. Okonjo-Iweala (2010) position that the Country’s GDP has shown
positive growth, but worrisome was the lack of corresponding improvement
on the welfare of the people, supported the researcher’s problem
statement.
The researcher identified Inflation Rate
(INFR) as one of the Non-Bank-Specific variable determinants of NPLs in
the Nigerian Banking Industry. Higher inflation can enhance the loan
repayment of borrowers by reducing the real value of outstanding debt.
It can also weaken the loan repayment capability of the borrowers by
reducing the real income when Salaries/Wages are sticky. The
researcher’s computation has shown that inflation trend in Nigeria has
been fluctuating widely. It rose to 72.80% in 1993 and dropped to 3.29%
in the year 2,000. It made loan repayment plans difficult, thus,
increasing NPLs. There was no strong economic blue-print by the
government to close the wide inflation gap to lower level as in most
economies. Previous studies supporting the researcher’s position include
Nkusu, (2011); Khemraj and Pasha, (2009); Fofack, (2005); and Adebola
et, al (2011). The study identified Total Loans and Advances (TLADV) as
one of the Bank-Specific factors that determines NPLs. A positive
relationship exists between TLADV and NPLs such that as banks increase
their loan portfolios, the rate of default in loan repayment increases.
Within the period of this study, Nigerian Banks were found lending in
excess of their deposit/lending threshold or ratio in order to satisfy
their high appetite for profitability. The implication was increase in
NPLs. The Central Bank of Nigeria (CBN) did not close the gap that led
to reckless lending by the banks. I did not see the CBN effectively
applying the relevant provisions of the Prudential Guidelines and BOFIA
to control the banks lax lending habit. In order to check indiscriminate
lending, banks in Nigeria could have taken a cue from the experience of
the USA. MaGovern (1993) examined the case of the USA and noted that
‘Character’ has historically been a paramount factor of credit and a
major determinant in the decision to lend money.
When loans are repaid, they add to the
Total Assets (TA) base of the bank and the overall NPLs are reduced.
Banks face insolvency due to declining total assets values when bank
borrowers are unable to repay their debts as a result of adverse shock
to economic activities. It is a sign of stability when banks increase
their asset base significantly such that it can afford to raise
provisions for doubtful debts and eventually write them off. Between
1993 and 2009, the Nigerian Banking Industry reflected a substantial
rise in the general quality of assets and NPLs, suggesting that the
quality of total assets had influenced the level of NPLs. The researcher
will like to know why there was a gap resulting in the less effective
reform policies prior to 1993 which could not address the issues of
credit expansion emanating from the growth in the asset qualities of
banks whereas the Prudential guidelines remains an available tool to
restrain the banks from injurious credit expansion.. The situation
escalated and eventually culminated in failure of most banks in 2005.
Earlier studies such as Dimirguc-Kent and Detriagiache, (1995);
Arellano, (2006); and Hue et, al (2006) lay credence to this problem.
A rise in Bank Lending Rate (BLR) weakens
loan repayment capacity of the borrower. This goes to show that
interest rate policy plays very crucial role in growth or decline of
NPLs in Nigeria. The highest BLR in 1993 was averaged 36.09% – this was
considered very high. Although the interest rate policy makers reduced
it to average 18.70% in 2008, it rose again to 25.74% average in 2014.
Why didn’t the Central Bank of Nigeria remain consistent towards
maintaining a lower and stable BLR? Previous studies that support lower
BLR in order to reduce NPLs include Nkusu, (2011); Dash and Kabra,
(2010); and Farhan et, al (2012).
In consideration of the above stated
problems, the researcher is tempted to ask; why were the financial
system stability managers in Nigeria and the external regulatory bodies
not proactive and disciplined enough to manage this situation? This
question and others will form the basis of this research.
1.3 Research Objectives
The main objective of this study is to
examine the bank specific and nonbank specific (macroeconomic) factors
(or determinants) affecting non-performing loans in the Nigerian Banking
Industry. Specifically, the study examines as follows:
- The effect of gross domestic product on non-performing loans in Nigerian Banking Industry.
- The effect of inflation on non-performing loans in Nigerian Banking Industry.
- The effect of total loans and advances of Banks on non-performing loans in Nigerian Banking Industry.
- The effect of total assets of Banks on non-performing loans in Nigerian Banking Industry.
- The effect of banks’ lending Rates on non-performing loans in Nigerian Banking Industry.
1.4 Research Questions
The research questions for this study are as follows:
- To what extent is the effect of gross domestic product on non-performing loans in Nigerian Banking Industry?
- To what extent is the effect of Inflation rate on non-performing loans in Nigerian Banking Industry?
- How far is the effect of total loans and advances of Banks on non-performing loans in Nigerian Banking Industry?
- To what extent is the effect of total assets of Banks on non-performing loans in Nigerian Banking Industry?
- How far does the bank’s lending rate affect non-performing loans in Nigerian Banking Industry?
1.5 Research Hypotheses
The Hypotheses for this study are stated in their null form as follows:
- Gross domestic product does not have a positive and significant effect on non-performing loans in Nigerian Banking Industry.
- Inflation rate does not have a positive and significant effect on non-performing loans in Nigerian Banking Industry.
- Total loans and advances of Banks do not have a positive and
significant effect on nonperforming loans in Nigerian Banking Industry.
- Total assets of Banks do not have a positive and significant effect on non-performing loans in Nigerian Banking Industry.
- Bank’s lending does not have a positive and significant impact on non-performing loans in Nigerian Banking Industry.
1.6 The Scope of the Study
The period of study covered Twenty One
years starting from the year 1993 – 2014. The nature of this empirical
research work demands the coverage of all licensed Commercial banks in
Nigeria.
The choice of the base year was because
this period witnessed major landmarks in the banking terrain towards the
end of the last century, and the government transition from Military
government to usher in the third republic democracy era in 1999. It was
in 1999 also that the Universal Banking Policy was introduced in the
Nigerian banking history. The merchant banks and the commercial banks
were merged to a common level business playing ground. The reform marked
the beginning of bigger banks and also competition. Another
justification considered for the choice of this period is that it
covered a period from pre-consolidation
(1993-2004) to post-consolidation
(2005-2014) and clearly showed the trend of activities in the industry.
For example, the pre-consolidation shows 89 licensed banks in Nigeria
that were consolidated into 24 banks and by the end of 2014, the number
of banks had reduced further to 22 banks.
The period of study witnessed the global
financial crisis which started from late 2007 and reached its peak in
2008 with negative impacts recorded most in 2009. This study will give
emphasis of how the banks reacted to the shocks of the crisis. Previous
study showed that strong global economies gradually was drifting into
recession especially the United States of America and Europe, emerging
economies like Nigeria was near collapse but it survived.
1.7 The Significance of the Study
- Academia
I have known that in every risk asset
created by a bank, there is a foreseen risk of non-repayment before the
loan will finally become non-performing and impact negatively on the
bank. A bank that has a very high appetite for profit usually relaxes
her risk management policies to increase its risk asset portfolio.
Therefore, to overcome the risk of non-performing loans, every borrowing
must be supported with adequately and acceptable collateral values. The
causes of Non-Performing Loans have been attributed to many factors by
researchers who have applied various methodologies both descriptive and
quantitative to arrive at their conclusions which have shown conflicting
results. This study is very significant because the dynamic nature of
the global economies justifies the need for constant research.
- Policy Makers/Regulators
The study of Non-Performing Loans
determinants which considers other macroeconomic indicators and
banks-specific variables give credence to greater significance for all
Policy makers and regulators within the Financial System to take
appropriate actions that will mitigate the rising level of
non-performing loans in the banks. The study will be significant to the
regulatory bodies like the Central Bank of Nigeria (CBN), Nigeria
Deposit Insurance Corporation (NDIC), Securities and Exchange Commission
(SEC), Nigerian Stock Exchange (NSE), National Board for Micro finance
Bank (NBMFB), the Chartered Institute of Bankers of Nigeria, the
Institute of Chartered Accountants of Nigeria (ICAN), the Association of
National Accountants of Nigeria (ANAN), the Nigerian Institute of
Management (NIM) and other Professional bodies, according to the
guidelines establishing them.
- Private Sector Borrowers
Lending and borrowing is the core
business of any Money Deposit Bank. This function is extended to all the
sectors of the economy. Most often, banks become averse to further
lending despite high demand from borrowers and expected high interest
income. The borrowers may not understand the rationale for such adverse
reactions from their bankers, which have been due largely to very high
non-performing loans. Therefore, the findings from this thesis will be
useful to the various private sector borrowers such as the
Manufacturers, Traders, Transporters, players in the Oil & gas
sub-sector, Airlines and Aviation operators, Multinationals, Importers,
Exporters, Agriculture, Maritime Agencies, Private investors in real
estates and, Capital Markets in terms of understanding how their
inability to repay borrowed funds from banks will affect the entire
financial system stability.
4. Bank Risk Asset Management Executives
In Nigeria, studies have shown that Risk
Management Practices which is one of the major tools to hedge against
asset quality depletion is still at its rudimentary stage (Moghalu,
2013). This is evidenced by the lax implementations of Basel 1, and 11,
while Basel 111 is already being implemented by other global economies.
Thus the findings will be significant to the formulation of Banks Risk
Asset Management Policies, and enforce best International Practices.
Advanced Loans treatments such as Loan negotiations, Loan sales, Loan
derivatives and securitization will be better understood and
implemented. The compliance to various statutory laws like the Bank and
Other Financial Institutions Act (BOFIA), the Company and Allied Matters
Act (CAMA), and Banks Code of Corporate Governance, will be strictly
adhered to in considerations of their systematic implications to the
balance sheets of the banks and the economy whenever the lawsare
breached. The study is significant as it will identify, analyze and show
how to mitigate the various risk types (Credit, Operational,
Reputational, Liquidity, Market and Human Resources) risks. Other risk
types are customer satisfaction risk, leadership risk, information
technology risk, regulatory risk, industry risk, government policies
risk, sovereign risk, competition risk, and fraud risk.
The study is significant as it will
expose the major challenges facing the banks in her loan administrations
and control. Such challenges identified is the dearth of professionals
and the absence of strategic partnerships and alliances with local and
global professional bodies like Credit Risk Management Association of
Nigeria (CRIMAN), Global Association of Risk Professionals (GARP); the
Institute of Risk Management (IRM) in the United Kingdom, and “The
International Association of Risk and Compliance Professionals (IARCP)”
in the United States which creates skill and capacity gaps.
- Policy Enforcement Authorities
The post consolidation era witnessed a
restructuring and reclassification of most non-performing loans into
performing status for a period within the next financial year. The Asset
Management Corporation of Nigeria (AMCON) was established among other
objectives, to manage the Non-Performing Loans. The delay in the
implementation of the functions of the Asset Management Corporation of
Nigeria caused the already restructured and reclassified Loans that were
for a short period to deteriorate again. The effect impacted negatively
on the balance sheet of the banks and it threatened the financial
stability of the economy. The global financial crises that coincided
with this development stood as a lesson to all. The significance of this
study will ensure that future occurrence will be held under control.
6. Government
The study will be significant at this
period of globalization where the United States of America, Canada,
Europe, World Bank, International Monetary Fund (IMF), and other world
financial blocs like the BRICS (Brazil, Russia, India, China and South
Africa) battles with regional and global financial crises, the various
levels of government might intervene to rescue the financial system by
considering packaging economic financial stimulus to the citizenry
through lowering lending rates, releasing more public sector funds to
the banks for onward lending to borrowers, buying over the ‘toxic
assets’ of the banks, thus, releasing much needed liquidity to the banks
and moderating the impact of the harsh global economic and financial
crises, or injecting much needed Capital to the ailing bank.
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