THE IMPACT OF RISK MANAGEMENT ON PROFITABILITY OF BANKS

CHAPTER ONE

INTRODUCTION

1.1       Background of the Study

Risk Management is the identification assessment and prioritization of risks. It is the effect of uncertainty on objectives, whether positive or negative followed by coordinated and economic of application of resources to monitor and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities (Okeh, 2006).

The survival of every commercial bank depends on its ability to manage its risks and loans or advance portfolio effectively. However in the recent past, commercial banks in Nigeria witnessed rising non-performing credit portfolios and these significantly contributed to the financial distress in the banking sector.

Financial organization need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credit or transaction. This is so because the survival and ability of financial institution to compete depend on their ability to profitability and manage credit risk. This is the reasons why lending is based on the two fundamental products of banking: money and information. Banks obtain these products from customers themselves by offering customer valuable services. They package money and information about their borrowers together with valuable banking services to create loan agreements and sell the loan agreements back to their customers (Hempel and Simonson, 2007).

As such, risk rating system in financial institution contains both objective and subjective elements. Objective aspect are based on financial statements and application of certain financial ratio that reflect liquidity, leverage and earnings. Despite the requirement that risk be quantified, risk rating systems always have a subjective dimension that attempts to capture intangibles such as the quality of management, the borrower’s status within the industry, and the quality of financial reporting. These subjective items may result in inconsistencies.

It is in this regard that many financial institutions have faced difficulties over the years arising from their inability to effectively manage credit risk. As such the major cause of serious banking problems continues to be directly related to tax credit standard for borrowers and counterparties, poor portfolio risk management, or lack of attention lead to a deterioration in the credit standard of a bank’s counterparties.

 Hence, the need to investigate the subject matter of this research becomes imperative.

1.2       Statement of the Problem

Commercial banks in the recent past witness rising non-performing credit portfolios sequel to the inability of their management to effectively manage risk and credit administration. That problem resulted to high bad debts in commercial bank and a number of other commercial banks were classified as distressed banks by the monetary authorities.

Consequently, the need to examine the subject matter: An Assessment of risk management and credit administration in Union Bank Plc, Kaduna Main branch becomes worthy of investigation. 

1.3       Research questions

In order to actualize the objectives of this research, the following research questions was formulated to guild this study:

1. What are the Methods of Risk Management in GT Bank Plc?
2. How is Credit administered in GT Bank Plc?
3. What are the constraints of Risk Management and Credit Administration in GT Bank Plc?

1.4       Objectives of the Study

The central objective of the study is to assess the impact of risk management on the profitability of GT Bank Plc, Murtala Mohammed Square Branch, Kaduna. The specific objectives are:

1.         To find out the method of risk management used in GT Bank Plc.

2.         To identify to how credit is administered in GT Bank Plc.

3.         To identify the constraints militating against risk management and credit    administration in GT Bank Plc.

1.5       Statement of Hypothesis

1.         H0:         Effective credit risk management is not a strong determinants of banks       profitability

            H1:Effective credit risk management is a strong determinants of banks        profitability

2.         H0 Poor credit risk management does not lead to bank distress.

            H1 poor credit risk management lead to bank distress.

3.         H0 risk management does not enhances the performance of banks in terms of          profitability.

            H01 risk management enhances the performance of banks in terms of           profitability.

1.4       Significance of the Study

This study will be beneficial to financial institution especially GT Bank Plc, as they utilize the finding of this study as a basis for policy formulation regarding risk management and credit administration in Banks. The shareholders, stakeholders and the entire society will benefit from this study.

1.6       Scope of the Study

To this end, the study will examine which is the best way to manage risk in GT Bank Plc, Murtala Mohammed Square branch, Kaduna. The branch manager, other staff and customers of the branch are to be questioned in the course of the study

1.7       Definition of Terms

1.         Credit Risk: This refers to delinquency and default by borrowers i.e. failure to make payment as at when due.

2.         Pure Risk: This refers to reduction in business value as a result of damage to business property by theft, robbery, fire, flood or the prospect of premature death of employee due to work-related illness or accident.

3.         Price Risk: This refers to variability in cash flows due to change in input and output prices.

4.         Credit Administration: This is the system used in managing the exposure of financial institution to loan delinquency and default.

5.         Business Risk: This refers to variability in cash flow.

6.         Loan Appraisal: This is the process of determining in advance the various lending parameters and determining the overall loan limit for each borrower based on his debt capacity, loan duration.