IMPACT OF CREDIT RISK MANAGEMENT ON PROFITABILITY OF

DEPOSIT MONEY BANKS IN NIGERIA

Abstract
Banks today are the largest financial institutions around the world, with branches and
subsidiaries throughout everyone’s life. However, deposit money banks in Nigeria are facing
risks when they are operating. Credit risk is one of the most significant risks that banks face,
considering that granting credit is one of the main sources of income in commercial banks.
Therefore, the management of the risk related to that credit affects the profitability of the banks.
The aim of the research is to provide stakeholders with accurate information regarding the
credit risk management of commercial banks with its impact on profitability. The main purpose
of the research is to investigate if there is a relationship between credit risk management and
profitability of deposit money in Nigeria. We also aim to investigate if the relationship between
the research model Net profit margin (NPM) as dependent variable defined as proxies of
profitability while capital adequacy ratio (CAR), Non-performing loan ratio (NPLR), Loan loss
provision (LLP) and firm size (FZ) are defined as proxies of credit risk management as
independent variable. The research collects data from the largest 15 deposit money banks in
Nigeria 2006 to 2015 and formulates three hypotheses which are related to the research
question. A series of statistical tests are performed in order to test if the relationship exists.
Other statistical tests are performed toinvestigate if the relationship is stable or not. The findings
reveal that credit risk management hasa positively, strongly and significant effects on
profitability of deposit money banks in Nigeria. By the proxies of credit risk management, CRA,
NPLR, LLP and FZ has a significant effect on the NPM while CAR has a weak effect on
profitability on deposit money banks in
Key words: Credit risk management, Net profit margin, Capital adequacy ratio, loan loss
provision and firm size

i
1.0 INTRODUCTION
In every system world over there are major components that feature prominently and are critical
to its survival and development. A critical success factor of any system is the ability ensure
balance of its various components to ensure potential maximization which would lead to
efficiency. Similarly, the operation of any economy depends to a great extent, on the balance
created in its financial component. Therefore, it would be safe to posit that the critical aspects of
a financial system must be identified and harnessed in such a way as to ensure that they
complement each other.

Banks are a major arm of any economy’s financial system and have arisen over the years from
being just a bridge between the deficit and surplus poles, metamorphosing into the complex
system requiring technical approaches to enhancing and oiling its machinery. There is a constant
need to channel funds from savers to investors basically because people who save are more often
than not different from those who have the ability to exploit the profitable investment
opportunities with the deficit arm of the economy. This technical function is performed through a
careful and shrewd process of financial intermediation which is aimed at enhancing the
efficiency of the saving and investment processes by eliminating the mismatches inherent in the
needs of surplus and deficit units of an economy.

There is no doubt to the great extent to which banks have contributed to the effectiveness of the
financial system, as they offer an efficient institutional mechanism through which resources can
be mobilized and directed from less essential uses to more productive investment purposes
ensuring the overall growth of an economy. Banks have overtime become very important
institutions in the financial system as they function in all strata of the economy, facilitating the
transfer of financial assets that are less urgently desirable from some part of the public (fund
lender) into other financial assets which are more widely preferred by greater part of the public
(fund seekers). The financial intermediation role of banks has grown to become the bedrock of
the two major functions namely deposit mobilization and credit extension. The role and functions
of banks outlined above are indeed highly useful and socially desirable. It is in this recognition
that components which determines this functionality are of paramount importance.

Credit has assumed a wide significance and an important instrument for promoting and
sustaining economic growth in modern economies. It is the major foundation upon which real
investment in the economy are determined. According to Opanocha (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 debtor. Essentially, when a
loan is made, the lender is said to have extended credit to the borrower and he automatically
accepts the credit of the borrower. Credit can therefore be seen as a transaction between two
parties in which the creditor or lender supplies money, goods and services or securities in return
for promised future payments by the debtor or borrower.

The issues pertaining credit risk management is the oldest and biggest risk that bank, by virtue of
its very nature of business are faced with. Risks are inherent in everyday activities of humans.
Private, institutional, organizational and communal undertakings comprise a level risk. In the
financial world, risks are major elements of the day to day running of organizations. Risk
exposures are critical for the survival and growth of financial institutions. Credits are major ways
through which players (especially deposit money banks DMB’s) in the financial sector of any
1
economy make revenue and subsequently profit. When banks grant loans they expect customers
to repay the principal and interest on an agreed date.

It was also observed that banks have faced many challenges over the years for a plethora of
reasons ranging from lax credit standards for both borrowers and their counter parties poor
portfolio management, lack of attention to vital economic indices that may lead to deterioration
which affects credit standings of a banks counter parties.

A credit facility is said to be performing if payment of both principal and interest are up to date
in accordance with agreed repayment terms. The Non-Performing Loans (NPLs) represent
credits which the banks perceive as possible loss of funds due to defaults. They are further
classified into substandard, doubtful or bad (lost). Bank credits in lost category hinder banks
from achieving their set target (Kolapo, Ayeni, and Oke, 2012) also different banks employee
different risk management.

Risk management is a major concern to banks and its regulators. Its perfection leads to healthier
banking and economic operating environment, while a shoddy implementation can lead to
catastrophic consequences on such bank and the economy at large. Therefore, credit risk
management management needs to be a robust process that enables financial institutions to
proactively manage its portfolio in order to minimize losses and earn acceptable level of return
for shareholders (Dandago, 2006), Credit risk management management is a structural approach
to managing uncertainties through risk assessment developing strategies to manage it and
mitigation of risk using managerial resources (Nnanna, 2004). The strategy includes; transferring
to another party, avoiding the risk reducing the consequences of a particular risk all these aimed
at reducing the effects of different kinds of risks. This study shall investigate the effect of risk
exposure on the profitability of Deposited Money Banks in Nigeria.
The problem of the study focus, on the management of the risk related to that credit affects the
profitability of the banks. The aim of the research is to provide stakeholders with accurate
information regarding the credit risk management of commercial banks with its impact on
profitabilityAlso to examining the credit risk indicators and performance of selected banks in
Nigeria thereby attempting to make a modest contribution to literature on credit risk.This study
aim at provide a clear understanding of the concepts of credit risk and bank performance, so as
to generate reliable information which the bank management could use to appraise their
strategies, plans and designs, and underscores areas for improvement

The major objective of this study is to assess the impact of credit risk management on the
performance of Nigeria banks over a period of 10 years (2006-2015). The specific objectives
are:
i. To determine the relationship between capital adequacy ratio of banks profitability.
ii. To determine the relationship between non-performing loan ratio (NPLR) and bank
profitability.
iii. To determine the relationship between ratio loan loss provision to core Capital (LLP) and
bank profitability.

H01: There is no significant relationship between capital adequacy ratio(CAR) on deposit money
bank profitability.

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H02: There is no significant relationship between non-performing loan ratio (NPLR) on deposit
money bank profitability.
H03: There is no significant relationship between ratio of loan loss provision (LLP) on deposit
money and bank profitability.
Significance, credit risk management are one of the key factors that influence the profitability of
a banks. The relevance of credit risk management on depositmoney banks in Nigeria is amatter
of considerable importance to the management who sets the policy, to the investors who invest in
shares, and to the financialeconomists who endeavor to understand and appraise the functions of
the credit risk management. The results of this study are important in that it may enlighten banks
management on the efficiency and effectiveness of credit risk management and recommend
measures for improvement. The study will help banks in planning and controlling in the
implementation of credit management and ensure efficient investments of resources.
Academicians and scholars; the study will provide useful basis upon which further studies of
credit risk management The study will also add to the body of knowledge in finance credit
management. Through the study, credit risk management in making sound financing and
investment decisions. Through the research one can have better understanding of the factors that
should systematically affect firms’ credit risk management decisions. It also gives insight into
what kind of credit management will operate is beneficial for the shareholders. The findings may
also be useful to deposit money banks in Nigeria.

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2.0 LITERATURE REVIEW
Credit risk management is found in all financial activities in which one or more parties are
critical to the success of the endeavor. Where success depends on counterparties issues or
borrowers’ performance, a level of uncertainty exists. A bank exists not only to accept deposits
but also to grant credit facilities, therefore it inevitably, is exposed to credit risk management.

Credit is by far, the most significant risk faced by banks and the success of the business depends
on accurate measurement on accurate measurement and efficient management of this risk to a
greater extent than any other risk (Gieseche, 2004).Credit risk management is the exposure faced
by banks when a borrower (customer) defaults in honouring debt obligations on due date or at
maturity. This risk, interchangeable called “counterparty risk” is capable of putting the bank in
distress if not adequately managed.

According to Chen and Pan (2012), credit risk management is the degree of value fluctuations in
debt instruments and derivatives due to changes in the underlying credit quality of borrowers and
counterparties. Coyle (2008) defined credit risk management as losses arising from the refusal or
inability of credit customers to pay what is owed in full and on time.

Credit risk management maximizes bank’s risk adjusted rate of return by understanding the
impact of credit risk management on banks profitability (Kargi 2011). Demirgue-kunt and
Huzinya (1999), opined that credit risk management is in two fold which includes, the realization
that after losses have occurred, they become unbearable and the developments in the field of
financing commercial paper, securitization and other non-bank competition which pushed bank
to find viable loan borrowers. The main source of credit risk management include: limited
institutional capacity, inappropriate laws, low capital and liquidity levels, direct writing, laxity in
credit assessment, poor lending practices, government interference and inadequate supervision
by the central bank (Kitchinji, 2010).

An increase in a bank’s credit risk management gradually leads to liquidity and solvency
problems. Credit risk management may increase if the bank lends to borrowers it does not have
adequate knowledge of. When bank funds are extended, committed or invested, whether on or
off balance sheet or exposed through actual or implied contractual agreements, risk arises.
Therefore, it is safe to posit that risks are largely determined by factors extraneous to a bank such
as unemployment levels, changing socio-economic conditions, debtors, attitudes, political,
environmental and cultural issues.

Anthony (1997) asserted that credit risk managements arise from non-performance by a borrower
and may arise either from the inability or an unwillingness to perform in the pre-committed
contracted manner. Brownbridge (1998) claimed that the single biggest contributor to bad loans
of many of the failed banks was insider lending. He further observed that the second major factor
contributing to bank failure were the high interest rate charged to borrowers. The most profound
impact of high non-performing loans in banks portfolio is reduction in the bank profitability
especially when it comes to disposals.

The Basel committee (1982) stated that lending involves a number of risks such as; funding
risks, interest rate risks, clearing risks and foreign exchange risks. According to Robert and Gary

4
(1994), the most obvious characteristic of failed banks is not poor operational efficiency
however, but an increased volume of non-performing loans.
Koehn and Santomero (1980), Kim and Santomero (1988) and Athanasoglou (2005), suggested
that bank risk taking has pervasive effect on bank profits and safety. Bovakovia (2003) asserted
that the profitability of a bank depends on its ability to foresee, avoid and monitor risk, possible
to cover loses brought by risk arisen and it also has the net effect of increasing the ratio of
standard credit in the bank’s profitability. The Basel committee (2006) observed that historical
experiences shows that concentration of credit risk management in asset portfolios has been one
of the major causes of bank distress.

Concept of risk Management

Credit risk management management consists of procedures and policies of credit risk
management mitigation, identification of risk, measurement of risk and, monitoring and
controlling risks (Bank Indonesia, 2011a; Rivai and Arvyan, 2010). It indeed determines the
quality of credit management because bad credit risk management may downgrade bank
financing and vice versa (Abadi et al., 2011). Rekha (2005), Opined that preventive measures
and curative measures are two distinct dimensions of credit risk management. The preventive
measures include risk assessment, risk measurement and risk pricing, early warning system to
pick early signals of future defaults and better credit portfolio diversification. The curative
measures, on the other hand, aim at minimizing post-sanction loan losses through such steps as
securitization, derivative trading, risk sharing, legal enforcement etc. It is widely believed that an
ounce of prevention is worth a pound of cure. One of the most important and profitable business
of commercial banks is lending and advancing credits to boost economic activities. Banks
optimizes utilization of deposits by deploying funds for developmental activities and productive
purposes through credit creation process Dandago (2009). Deposit mobilization and credit
deployment constitute the core of banking activities and substantial portion of the expenditure
and income are associated with them.

According to Dwayne (1961), banks originate for the main purpose of providing a safe storage of
customer’s cash. He argued that since this money received from the customer was always
available to the bank, they later put it to use by investing in assets that are profit earning, thus the
practice of advancing credits. Banks have grown from being financial intermediaries, in the past,
to risk intermediaries. In credit management, risks are correlated and exposure to one risk may
lead to another having deeper ramification and hence, the real mantra for prudent banking lies in
successfully managing the risks in an integrated and pro-active manner to optimize the exposure
already taken or to be assumed by the bank.

Adherence to standard of quick decision and providing adequate and need based financial
assistance on attractive but safe terms, without losing the sight of associated risks involved
therein appears to be a difficult proposition. There is an implicit understanding on the part of the
planners that in the post nationalism era, banks will meet social obligations through client
lending, Mandel (1974). Pitcher (1970), stressed that it is very much essential to conduct credit
investigation before taking up a proposal for consideration.

The preliminary study should lead to valuable information on the customers (borrowers)
integrity, honesty, reliability, credit worthiness, management competency, expertise, association
concern and guarantor. A due diligence report shall invariably accompany the credit proposal
5
evaluation. Banks have a strictly adhere to KYC (Know Your Customer) norms to ensure
bonafide identification borrowers and should also follow the fair practice code on lenders,
liability, by evolving their own best practices to be followed by the field functionaries, so as to
avoid complaint from customers where at a later date Raghaan (2005), whenever those cautions
are not observed, it is always normal that the bank records a high rate of default (debts), delay in
repayment of borrowed funds and experience high operational costs.

These problems have frustrated most banks efforts to encourage growth through lending. Failure
of some of the banks have placed the entire system under great distress resulting to defaults in
transaction. Thus, the 1990’s and also periods between 2008 and 2011 can be classified as a
period of upheaval for the banking industry. The December, 2005 deadline for commercial banks
to recapitalize their minimum shareholders’ funds, was met with many banks which were unable
to and thus had to merge or be acquired. Banks were gone to either liquidation or marginalization
by December (Osayameh, 1986). Similarly, studies have shown that the numerous government
controls have contributed to the problems.

Nwanko (2000) stressed that credit evaluation should bother on safety of the loan, suitability of
the loan and profitability incidental or booking of the loan. The inadequacies of the traditional
approaches to loan processing with its attendant problems arising from repayment and recovery
have been the concern of banking professionals over time. This then calls for an approach that
can take care of the inadequacies in the credit processing and administration procedures. The
CBN (2005) maintained that the credit framework of banks should be designed to serve as a tool
for monitoring and controlling risk inherent in individual credits. The concept has been referred
to as ‘credit scoring’ in some quarters.

Credit scoring is a statistical method used to predict the probability that a loan or an existing
borrower will default or become delinquent (Loretta, 2000). This model assigns scores for
potential borrower by estimating the probability of default of their loans based on borrowers and
loan characteristic data (Myra, 2000). Information on borrowers to be used are applicant’s
monthly home, outstanding debt, financial assets, duration on the job, lending history of the
customer, collateral owned, type of bank accounts, amongst others.

Adekanye (2010) emphasized that managers must obtain satisfactory answers to those questions
before agreeing to a loan request. This proposition also has its flaws as comprehensive credit
ratings, management and recovery procedure which are the essential requirements of modern
lending were not emphasized. Konoshi and Yasuda (2004) opined that credit evaluation should
be based on the following areas:
i Character: This refers to the applicant’s willingness or desire to meet credit obligations.
ii. Capacity: This refers to the applicant’s ability to enter into or make valid contract.
The following, which as: lunatics, drunkards, infant, etc are disqualified by law from
becoming a party to valid contract.
iii. Capital: This constitutes the applicant’s financial requirement to meet the needed
obligation.
iv. Collateral: This represents assets that the borrower may pledge as security. Though
security is considered secondary in credit but banks look for something to fall back to in
case of default.

6
v. Conditions: This refers to the general economic climates and it effects on the applicant’s
ability to pay such as period of recession.
iv. Contribution: This refers to the level of commitment projected or purposed by the
borrower of the loan. According to Adeusi, Akeke, Obwale and Oladunjoye (2013), risk
management issues in the banking sector do not only have greater impact on bank
performance but also on national economic growth and general business development.

The bank’s motivation for risk management comes from those risks which can lead to under-
performance. Their study focused on the association of risk management practices and bank
financial performance in Nigeria. Secondary data sourced was used on a 4year progressive
annual reports and financial statements of 15 banks. A panel data estimation technique was
adopted. The result populated an inverse relationship between financial performance of banks
and doubt loans. Capital asset ratio was discovered to be positive and significant. Similarly, the
study suggested that the higher the managed funds by banks, the higher the financial
performance. The study concluded that a significant relationship between banks performance and
risk management exist. Hence, the need for banks to practice prudent risks management in order
to protect the interests of investors.

Similarly, the United States Government announced a whopping USD700 Billion financial sector
intervention in the officially tagged ‘Emergency Economic Stabilization Act 2008. This
represented the 4th time that government interceded to prevent a ruin of private enterprise or the
entire financial sector. The major aim of this was to authorize the United States treasury to buy
up non performing debts from various lending institutions including mortgages, auto loans,
college loans and other ambiguous loans allowed for broad interpretations. This consequently
restored liquidity and confidence in the banking system.
Risk Management and Profitability
Though one of the major causes of serious banking problems continues to be ineffective credit
risk management management, the provision of credit remains the primary business of every
bank worldwide. For this reason, credit quality is considered a primary indicator of financial
soundness and health of banks. Interests are charged on loans and advances from sizeable parts
of banks assets. However, default on loans and advances poses serious setbacks, not only for
borrowers and lenders but also to the entire economy of a country. Studies of banking crises
worldwide have shown that adverse credit exposures (poor loan/poor quality assets) are key to
banks declining profitability. Stuart (2005), stressed that the spate of bad loans (non-performing
loans) was as high as 35% in Nigerian commercial banks between 1999 and 2000. Umoh (1994)
also pointed out that increasing levels of non-performing loan rates in banks books, poor loan
processing, undue interference in the loan granting process, inadequate or absences of loan
collaterals among other things are linked with poor and ineffective credit risk management that
negatively impact on banks profitability. In order to minimize loan losses as well as credit risk
management, it is crucial for banks to have an effective credit risk management system in place
(Santomera 1997, Basel 1999). As a result of asymmetric information that exist between banks
and borrowers, banks must have a system in place to ensure that they can do analysis and
evaluate levels of not so obvious default risk inherent in a transaction.

Information asymmetry may make it impossible to differentiate good borrowers from bad ones
(which may culminate in adverse selection and moral hazards) have led to huge accumulation of
non-performing accounts and profit reduction in banks (Baster, 1994, Gobbi 2003).
7
Credit risk management is vital to determining profitability. The long term success of any
banking institution depend on effective system that ensures repayments of loans by borrowers
which was critical in dealing with asymmetric information problems, thus, reduced the level of
loan losses (Basel, 1999). An effective management system involves establishing a suitable
credit risk management environment, operating under a sound credit granting process,
maintaining an appropriate credit administration that involves monitoring, processing as well as
enough controls over it (Greuniny and Bratanovic 2003). Top management must ensure, in
managing this, all guidelines are properly communicated throughout the organization and that
everybody is involved in credit risk management.

United States. According to the results of a survey made with respondents being senior
Management staff of banks, the three risk factors that most contributed to the financial crisis
were; inappropriate risk governance, weak risk culture and ineffective incentive and
remuneration policies (Hashagen, Harman, Conover and Sharma 2009).
Risk governance is necessary for limiting excessive risk taking, while banks should develop a
strong risk culture through the encouragement of an assessment, measurement and mitigation
mindset of bank employees, at all levels, in the organizational hierarchy. In addition, incentive
and remuneration policies should reward managers with strong performance. If proper behavior
is rewarded, it will be in the manager’s best interest not to make decisions leading to a rise of
bank risks to intolerable levels, therefore resulting in decreased share values and lacking high
enough returns (Junarsin & Ismiyanti, 2009). Diminished shareholder value would be an adverse
effect of the separation of ownership (shareholders) and control (managers) that may give rise to
agency problem (Gong, 2011).
Bobakovia (2003) asserts that the profitability of a bank depends on its ability to foresee, avoid,
monitor risks, and cover losses brought about by risk arisen. This has the net effect of increasing
the ratio of substandard credit in the bank’s portfolio and decreasing the bank’s profitability
(Mamman & Oluyemi, 1994). The bank supervisor are well aware of these problems, it is
however very difficult to persuade bank managers to follow more prudent credit policies during
an economic upturn, especially in a highly competitive environment. They claim that even
conservative managers might find market pressure for higher profits very difficult to overcome.

According to the CBN journal (2006), the early 1990’s witnessed rising non-performing credit
portfolios in banks and these significantly contributed to the financial distress in the banking
sector. Also identified was the existence of predatory debtor in the banking system whose modus
operandi involved the abandonment of their debt obligation in some banks only to contract new
debts in other banks. Furthermore, the use of status enquiries on bilateral basis between banks
was characterized by some weaknesses. Status enquires regarded as some courtesies to which
some banks neither did not respond to or gave vague replies. In spite of these systemic
weaknesses, many banks continued to extend fresh facilities to customers who already had core
and unserviced debts with other banks and financial institutions. On the part of regulators, the
paucity of credit information had inhibited consistent classification of credits granted to certain
borrowers and their associated companies (BN, 2006).The Credit Risk Management Bureau
(CRMB) was established against this background, (CBN,2006).

The enabling legislation (CBN Act No.24 of 1991 {Sections 28 and 52}) as amended,
empowered the CBN to obtain from all banks, return on all credits with a minimum outstanding
8
balance of N100,000 (now N1,000,000 and above of principal and interest) for compilation and
dissemination by way of status report to any interested party. The Act made it mandatory for all
financial institutions to render returns to the Credit Risk Management System (CRMS) in respect
of all customers with aggregate outstanding debit balance of N1,000,000 (One Million Naira)
and above. It also required banks update and credit analysis on monthly basis as well as making
status enquiry on any intending borrower to determine their eligibility or otherwise. Banks are
penalized for non-compliance with the provision of the Act.

Credit risk management is by far the most significant risk faced by banks and the success of their
business depends on accurate measurement and efficient management of this risk to a great
extent than any other risk (Gieseche, 2004). According to Chen and Pan (2012) credit risk
management is the degree of value fluctuations in debt instrument and derivatives due to changes
in the underlying credit quality of borrowers and counterparties. Coyle (2000), defines credit risk
management as losses from the refusal or inability of credit customers to pay what is owed in full
and on time. Credit risk management is the exposure faced by banks when a borrower
(customers) defaults in honouring debt obligations on due date or at maturity. This risk, often
referred to as counterparty risk is capable of putting the bank in distress if not adequately
managed. Credit risk Management Operations maximizes bank risk adjusted rate of return by
maintaining credit risk management within acceptable limit in order to provide frame work for
understanding the impacts of credit risk management on bank’s profitability (Kargi, 2001).

Credit risk management is all about identification of and mitigation against dangerous situations
or obstacles (risks) likely to stand against the ability of someone that has being trusted to borrow
money today and pay tomorrow. Most banks in Nigeria do not have clearly defined or adherent
implemented credit lending policies (Onalo, 2007). He further explains that a good credit report
resolves a great deal of the problems that might be credit related, a good report has the potential
to aid debt recovery in the future if an account run to default category

Komolafe (2010), explains that the CBN has tried to fully implement the Basel Accord into the
Nigerian banking sector but to a large extent, bank remain unbothered.. Tracey and Carey
(2002), suggests that in designing a credit system, a bank should consider various factors,
including cost, efficiency of information gathering, consistency of rating produced, staff
incentives, nature of bank’s business and asses to be made of the internal rating.

NET PROFIT MARGIN

Net profit divided by net revenues, often expressed as a percentage. This number is an indication
of how effective a company is at cost control. The higher the net profit margin is, the more
effective the company is at converting revenue into actual profit. The net profit margin is a good
way of comparing companies in the same industry, since such companies are generally subject to
similar business conditions. However, the net profit margins are also a good way to compare
companies in different industries in order to gauge which industries are relatively more profitable

McDonald study provided new evidence on the determinants of the profitability of Australian
manufacturing firms by analyzing a unique firm-level data set of firm performance over the
period 1984-1993. The panel nature of the data permitted the author to estimate the dynamic
profitability models over the business cycle, to test both the persistence and cyclically of firm
profitability. Econometric results suggest that lagged profitability is a significant determinant of
9
current profit margins, and that industry concentration is positively related to firm profit margins.
Also, profit margins are found to be procyclical in concentrated industries but counter-cyclical in
less concentrated industries.

The paper by Kambhampati and Parikh analyzed the effects of increased trade exposure on the
profitability of firms in Indian industry. The authors revealed that while trade reforms are often
expected to decrease profit margins as firms struggle to compete in international markets, there is
the possibility that increased competition may improve firm efficiency and provide a positive
impetus to firm profitability. The authors indicated that their paper is different from many others
in this area because it considered both possibilities. The authors developed an efficiency index to
directly analyze the impact of changing efficiency levels on firm profit margins. Results
indicated that liberalization significantly influenced profit margins. Results from this analysis
further indicated that liberalization main effect was through the impact that it had on the other
firm variables: market shares, advertising, R&D and exports-all that changed after 1991. The
authors of the paper indicated that neither capital nor managerial capabilities (as proxied by
remuneration) were particularly effective in increasing profit margins.

NET PROFIT MARGIN AND CAPITAL ADEQUACY RATIO

Earlier studies on capital adequacy as a determinant of profitability of banks revealed that a high
capital adequacy ratio should signify a bank that is operating over-cautiously and ignoring
potentially profitable trading opportunities (Goddard, Molyneux, and Wilson 2004), which
implies a negative relationship between equity to asset ratio and bank performance. At the same
time, banks with higher equity to asset ratio will normally have lower needs of external funding
and therefore higher profitability (Pasiouras and Kosmidou, 2007). Yu Min-The (2006), defined
the adequate capital for banks as the level at which the deposit insuring agency would breakeven
in guaranteeing the deposits of individual banks with premium the banks pay. An option of
theoretical framework was employed in his study for measuring fair capital adequacy holdings
for a sample of depository institutions in Taiwan, during 1985-1992. Except for the 1989, most
banks in their sample proved to be inadequately capitalized so that capital infusion is required.
George and Dimitrios (2004) applied non-parametric analytic technique (data envelopment
analysis, DEAGeorge and Dimitrios (2004) applied non-parametric analytic technique (data
envelopment analysis, DEA) in measuring the performances of the Greek banking sector with
respect to capital adequacy. He proved that data envelopment analysis can be used as either an
alternative or complement to ratio analysis for the evaluation of an organization's performance
with attention to macroeconomics indicators. Various studies suggest that banks with higher
levels of capital perform better than their undercapitalized peers.

Staikouras and Wood (2003) claimed that there exists a positive link between a greater equity
and profitability among EU banks. Abreu and Mendes (2001) also trace a positive impact of
equity level on profitability. Goddard et al. (2004) supports the prior finding of positive
relationship between capital/asset ratio and bank’s earnings. Again the direction of the
relationship between bank capital and bank profitability cannot be unanimously predicted in
advance. 14 In 1997, a sixth component, a bank’s sensitivity to market risk was added to the
CAMEL model; hence, the acronym was changed to CAMELS. The main objective of this
measure is to test the impact of changing market conditions on bank profitability and the value of
its assets and liabilities.

10
Bank equity capital, the first element, provides a buffer against unexpected losses and thus
assists banks to survive, thereby overcoming the risk of insolvency. That is, a bank’s equity
capital acts as the last resort or defence against failure because any losses suffered by a bank are
potentially written off against capital. In the case of unavoidable bankruptcy, Bras and Andrews
(2003) stated that bank equity capital protects depositors, creditors and investors against
expected losses that should be borne by them. It is worth mentioning that the size of a bank’s
equity capital and its capital adequacy (i.e., the proportion of the bank’s capital relative to its
risk) are considered by RAs to be the most important factors in the analysis of bank
creditworthiness. Rawcliffe and Andrews (2003) pointed out that bigger banks (in terms of
absolute size of equity) are more likely to be significant to their domestic economies as the
probability of receiving external support exists strongly, if needed, and thus decreases the risk
that the bank will default. Many studies in the literature have stated that high capital strength
ratios result in better bank ratings (Laruccia and Revoltella, 2000; Pasiouras et al., 2006, 26 In
1990, the CBN issued the circular on capital adequacy which relate bank’s capital requirements
to risk-weighted assets. It directed the banks to maintain a minimum of 7.25 percent of risk-
weighted assets as capital; to hold at least 50 percent of total components of capital and reserves;
and to maintain the ratio of capital to total risk-weighted assets as a minimum of 8 percent from
January, 1992. Despite these measure and reforms embodied in such legal documents as CBN
Act No. 24 of 1991 and Banks and other financial institutions (BOFIA) Act No.25 of 1991 as
amended, the number of technically insolvent banks increased significantly during the 1990s.

NET PROFIT MARGIN AND LOSS LOAN PROVISION

Ahmed, Takeda and Shawn (2013) in their study found that loan loss provision has a significant
Positive influence on non-performing loans. Therefore, an increase in loan loss provision
indicates an increase in credit risk and deterioration in the quality of loans consequently affecting
bank performance adversely. The risks in lending stem from the various factors that can lead to
non-payment of the loan obligation when it falls due. Losses sometimes result from “acts of god”
such as storm, drought, fires, earthquakes and floods. Changes in consumer demand or in
technology of an industry may alter drastically the fortunes of a business firm and place a once
profitable borrower to a loss position. A prolonged strike, competitive price cutting, or loss of
key management personnel, can seriously impair a borrowers’ ability to make loan repayments.
The swings of the business cycle affect the profits of many who borrow from banks and
influence the optimism and pessimism of business people as well as consumers.

To measure credit risk, there are a number of ratios employed by researchers. The ratio of Loan
Loss Reserves to Gross Loans (LOSRES) is a measure of bank’s asset quality that indicates how
much of the total portfolio has been provided for but not charged off. Indicator shows that the
higher the ratio the poorer the quality and therefore the higher the risk of the loan portfolio will
be. In addition, Loan loss provisioning as a share of net interest income (LOSRENI) is another
measure of credit quality, which indicates high credit quality by showing low figures. In the
studies of cross countries analysis, it also could reflect the difference in provisioning regulations
(Demirgiic-Kunt, 1999). Assessing the impact of loan activities on bank risk, Brewer (1989) uses
the ratio of bank loans to assetsassessing the impact of loan activities on bank risk; Brewer
(1989) uses the ratio of bank loans to assets (LTA). The reason to do so is because bank loans are
relatively illiquid and subject to higher default risk than other bank assets, implying a positive
relationship between LTA and the risk measures. In contrast, relative improvements in credit risk
management strategies might suggest that LTA is negatively related to bank risk measures
11
(Altunbas, 2005). Bourke (1989) reports the effect of credit risk on profitability appears clearly
negative This result may be explained by taking into account the fact that the more financial
institutions are exposed to high risk loans, the higher is the accumulation of unpaid loans,
implying that these loan losses have produced lower returns to many commercial banks (Miller
and Noulas, 1997). The findings of Felix and Claudine (2008) also shows that return on equity
ROE and return on asset ROA all indicating profitability were negatively related to the ratio of
non-performing loanKolapo, Ayeni and Oke (2012) carried out an empirical investigation into
the quantitative effect of credit risk on the performance of commercial banks in Nigeria over the
period from 2000 to 2010. In their panel model approach, profitability is proxied by return on
assets and credit risk by; the ratio of non-performing loan to total loans and advances, ratio of
total loans and advances to total deposit and the ratio of loan loss provision to classified loans.
Their findings show that the effect of credit risk is similar across banks in Nigeria and that an
increase in non-performing loan and loan loss provision reduce profitability. The results further
shows that an increase in total loans and advances increase profitability.

NET PROFIT MARGIN AND NON PERFORMING LOAN

Kargi (2011) investigated the impact of credit risk on the profitability of Nigerian banks, using
data on six selected banks for the periods of 2004 to 2008. The ratio of non-performing loans to
total loans and advances and the ratio of total loans and advances to total deposit were used as
indicators of credit risk while return on asset indicates performance. From their findings, it is
established that banks profitability is inversely influenced by the levels of loans and advances,
non-performing loans and deposits, thereby exposing the banks to great risk of illiquidity and
distress. Also, Dietrich and Wanzenried (2011) in their study approximating credit risk by the
loan loss provisions over total loans ratio, suggest a negative relationship between credit risk and
banks’ profitability. Kithinji (2010) assessed the effect of credit risk management on the
profitability of commercial banks in Kenya. Data on the amount of credit, level of non-
performing loans and profits were collected for the period 2004 to2008. The findings revealed
that the bulk of the profits of commercial banks are not influenced by the amount of credit and
non-performing loans, therefore suggesting that other variables other than credit and non-
performing loans impact on profits. Non-performing loans are increasing due to lack of risk
management, which threatens the profitability of banks. This study provides suggestion that
banking sector can avoid their non-performing loans by adopting methods suggested by the
central bank of perspective country (Haneef and Riaz, 2012).

All the selected independent variables (Real GDP per Capita, Inflation, and Total Loans as
independent variables) have significant impact on the depended variable(Non-Performing Loan
Ratio), however, values of coefficients are not much high. Banks should control and amend their
credit advancement policy with respect to mentioned variables to have lower non-performing
loan ratio (Saba, Kouser and Azeem, 2012); (Dash, 2010). To bit simultaneous equation
regression results clearly indicate that higher non-performing loan reduces cost efficiency and
lower cost efficiency increases non-performing loans. The result also support the hypothesis of
bad management proposed by Berger and De Young (1992) that poor management in the
banking institutions results in bad quality loans, and therefore, escalates the level of non-
performing loans (Calice, 2012).

The purpose of the study is to identify the actual situation in the banks depending on the net
interest margin and non-performing loan. The analysis of the banks is depending on the banking
12
sector in Dhaka Stock Exchange. The limitations for the study are not consideration of all banks
operating in Bangladesh or all schedule banks. Further study will be evaluating under the time
series and overall industry based analysis
Agency theory. Despite the enactment of corporate governance whose aim is ideally to control
the behavior of top corporate executives and also to protect the interest of company owners
(shareholders), problem still arise as result of the separation between ownership and banks
management. The authority to use corporate resources is entirely at the disposal of the executive
because the supplier of the capital has delegated their authority of the management of the banks
to professional manager. Therefore shareholder expects management to act in a professional
manner to manage the company such that any decision take by management should be centered
on the interest of shareholders. However most often than not decisions taken by management are
not solely for the benefit other company but the interest of the executives themselves.

13
3. 1 RESEARCH METHODOLOGY
Research design is the structure of investigation that Researchers want to investigate. It’s a
strategy about how the researcher goes about investigation in a particular problem. For the
purpose of this research, the researcher uses quantitative research design using multiple
regression models. The choice of this design is warranted by the fact that, it seeks to establish the
existence and nature or relationships associations and interdependence between variable (Kumar
2005). The choice of this design is also necessary in view of the fact that the objective of the
study is to establish the relationship between net profit margin (NPM) as the indicator of
profitability capital adequacy ratio, (CAR) non-performing loan ratio (NPLR), loan loss
provision (LLP) independent variable as proxy indicator of risk exposure which might affects
profitability of DMB’s in Nigeria. All the variables are extracted from notes to financial
statements of the selected banks. The use of ratio in measuring credit risk and profitability
performance is common in the literatures of finance and accounting practices which is evident
from the previous studies such as among the others Athanasoglou et al. (2008); Francis (2013);
Heffernan and Fu (2008); Kargi (2011); Perera et al. (2013). The greatest advantage for using
ratio for measuring banks' performance is that it compensates bank disparities created by bank
size (Samad, 2004).
Population and Sampling Technique
The population of this study consists of the twenty one (15) DMB’s listed under the banking
sector of the Nigeria Stock Exchange (NSE) as at 31st December, 2013 (NSE, 2013). Thus,
considering the quantum of new and existing credits and its metamorphosis in the last five years,
the need for conducting an empirical study on the resulting effects of this phenomenon on banks
financial performance becomes more crucial. It is against this back drop that the study chose the
listed DMB’s as its population. There are several compelling reasons for sampling, including:
lower cost, greater accuracy of result, greater speed of data collection and availability of
population selection (Cooper & Schindler, 2003).
The model for this study functionally becomes;
Model Specification
NPMit = o + 1CARit + 2NPLRit + 3LLPit +4FSiteit.
NPM = Net profit margin
CAR = capital adequacy ratio
NPLR = Non performing loan ratio
LLP = Loan loss provision
F-SIZE = Firm size
Variable measurement
B0 = Constant Parameter/Intercept
B1:Non-performing loan ratio (NPLR) and bank profitability.
B2: ratio of bank loans to assets (LTA) and bank profitability.
B3: ratio of Net Interest Income to Total Asset (NITA) and bank profitability.
B4: ratio non-performing loan to core Capital (NPLC) and bank profitability.
B5 : ratio of Net Interest Income to Total Income (NIITI) and bank profitability?
e= Error terms
The ‘a priori expectation’ in the model is that all independent variables are expected to some to
have negative relationship on bank performance measured by return on Asset (ROA). The
mathematical expression is represented as: B and B implying that a unit increase in the
independent variable will lead to a decreased in ROA by a unit.

14
DATA PRESENTATION ANALYSIS
4.1 Result and Discussion
This section provides descriptive statistics of variable covering a period of ten (10) years. It
described the dependent variable and independent variable using the mean, standard deviation,
min and max. It contains the ROE which is the dependent variable. The independent variables
include the credit risk, liquidity risk, inflation rate and exchange rate. The table also describe the
control variable
Table 4.1 Descriptive Statistics
Variables OBS Mean Std. dev Min Max
NPM 150 29.9732 15.85985 3.73 74.39
CAR 150 45.09727 37.35631 1.54 119.95
LLP 150 9.649533 18.211 13.07 68.29
NPL 150 22.54247 14.80171 3.73 72.07
FSIZE 150 23.04327 14.59441 3.07 72.07
SOURCE: STATA OUTPUT
Table 4.1 present the descriptive statistics of dependent and independent variable of the study
consisting of the mean and standard deviation, minimum and maximum. The average of the
dependent variable Net profit margin (NPM) is 29.9732 with standard deviation of 15.859. This
indicates that credit risk managementhas 29% of profitability. However the other independent
variable in the table shows different level of result. Which capital adequacy ratio has a mean of
45.09 with standard deviation of 37.35this indicate that it contribute more to the credit risk
management and the profitability of deposit money banks in Nigeria than the other independent
variable of the study. Also Loan loss provision (LLP) mean value at 9.64 with the standard
deviation of 18.2111 which show weak impacts of credit risk management and profitability of
deposit money banks in Nigeria. Non-performing loan (NPL) has a mean of 22.54247 and the
standard deviation of 14.59441 implies that the variable was mention in the annual report which
has average impacts on credit risk management. Firm size on the other hand has a mean of
23.04327 and the standard deviation of 14.59441 which indicate that firm size 23% contribution
on the deposit money banks in Nigeria credit risk management and profitability.
Table. 4.2 Correlation Matrix
Correlation Coefficient between Variable Matrixe

VARIABLES NPM CAR LLP NPL FSIZE

NPM 1.0000
CAR 0.3182 1.0000
LLP 0.8649 0.2294 1.0000
NPL 0.8762 0.2264 0.7364 1.0000
FSIZE 0.8696 0.2107 0.7316 0.9988 1.0000
15
The correlation matrix as shown in table 4.2the relationship between dependent variable and all
the independent variables used in the regression model. It shows that all the independent variable
has a positive relationship with net profit margin (NPM). Indicate that capital adequacy ratio
(CAR) positively, weak and statistically correlated with NPM. Loan loss provision (LLP) have a
positively and strong relationship with the NPM which indicate strong contribution to credit risk
management and profitability of deposit money banks in Nigeria. Also non-performing loan is
positively and strongly related with the NPM which show that it contribute more to the
profitability of deposit money banks Nigeria on credit risk management. However firm size also
positively related to the profitability of deposit money banks in Nigeria which indicate that firm
size also contribute more impact on the credit risk management and profitability of banks in
Nigeria. However there were absence of muliticolinarity among the independent variable of the
study variance inflation factor and tolerance value are within the limit expected. Therefore the
tolerance value and the variance inflation factor (VIF). The variance inflation factor and
tolerance are computed using stata and were found to be consistently smaller than ten and one
respectively

Table 4.2 this consist of the summary of the multiple regression result obtained from the model
of the study. This result contained the individual regression result used in the study.

TABLE 4.2 Summary of Regression Result

VARIABLES BETA COEFFICIENTS T.VALUE SIG.

CAR 0. 33211 2.54 0.012

LLP 0.4004735 10.90 0.000
NPL 1.717605 2.54 0.012
FSIZE -1.178465 -1.73 0.085
CONST 13.04773 10.80 0.000

R2 0.8841
AdjR2 0.8809
F.STATISTICAL 276.54
SIGN 0.000
SOURCE: STATA 13 OUTPUT
From the table 4.2 shows that the independent variables peroxide by credit risk management has
a positive and significant impact on the profitability of Nigeria deposit money banks in Nigeria.
The cumulative correlation between dependent variable and independent variable is indicating
that the relationship between credit risk management and profitability used in this study which is
positively, strongly and statistical significant at 1% level of significant. This indicates that for
any changes in credit risk management of deposit money banks in Nigeria their profitability will
be directly affected. The cumulative R2 0.8841% which is the multiple coefficient of
determination gives the proportion of percentage of the total variation in the dependent variable
explained variation in the dependent variable explained by variable jointly. Hence it signifies at
88% of total variation in profitability of deposit money banks in Nigeria is by the level of capital
adequacy, loan loss provision, non performing loan and firm size This indicates that the model
is fit and the explanatory variable are properly selected, combined and used. This can be
confirmed by the value of F statistics of 276.54. At 1% level of significant.

16
Table 4.2indicatecapital adequacy ratio has t- value of 2.54 and beta value of 0.33 which is
significant at 1%. This signifies that capital adequacy ratio has positively, strongly and
significant impact on the profitability of deposit money banks in Nigeria. It therefore implies that
for every 1% increase in the number of capital adequacy profitability of deposit money in
Nigeria will increase by 0.33%

From the table also shows that loan loss provision has a t-value of 10.90 and the beta value of -
0.40 which is significant at 1% level of significant. This implied that loan loss provision
positively, strongly and significant influencing the profitability of deposit money banks in
Nigeria. This implies that for every 1% increase in loan loss provision the profitability of deposit
money will increase by40%.
Also from the table 4.2 non-performing loan indicate has the t- value of 2.54 and the beta value
of 1,71 which is significant at 1% this shows that has positive impacts on the profitability of
deposit money banks in Nigeria. However for every 1% increase in non-performing loan the
profitability of Nigeria deposit money banks will increase 1.71%

17
5.0 Conclusion and Recommendation
The study aimed at to investigate the impact of credit risk management and profitability of
deposit money in Nigeria also to determining the relationship between credit risk management
and profitability of 15 deposit money banks in Nigeria. This was done by collecting data from
the 15 banks’ audited annual reports from 2006 to 2015. In order to test the relationship for the
study the proxies used as dependent variable net profit margin (NPM) also independent
variables as follows as the proxies for profitability are capital adequacy ratio, non-performing
loan, loan loss provision and firm size proxies for credit risk management. The data collection,
were used statistic program STATA to test for our research question. Hence made three
hypotheses and one regression tests for the independent variables based on the 10-years data.
However the findings of the study indicate that capital adequacy ratio has a weak relationship
with the credit risk management and profitability among the independent variables of the study.
Also regression result shows that firm size negative impacts on credit risk management and the
bank’s profitability of deposit money banks in Nigeria. While loan loss provision and non-
performing loan has great impacts on the profitability of deposit money banks in Nigeria

The study has concluded with this recommendations to deposit money banks in Nigeria.
Considering the positive relationship between capital adequacy ratio, loan loss provision and
non-performing loan profitability, the study recommend the bank managers, shareholders and all
others concern they should take note level of their capital adequacy and firm size is very
important in other to manage their credit risk proper so, that will not leads to the bank’s failure
since base on the findings of this study

18
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Athanasoglou, P., Brissimis, S.N., and Delis, M. D. (2005).Bank-specific, industry specific and
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European text. 4. ed. Harlow: Prentice Hall

Hull, John (2012). Risk Management and Financial Institutions, + Web Site, 3rd Edition

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John Wiley & SonsHyun, J. and Rhee, B. (2011).Bank capital regulation and credit supply.
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Jones, R. A., & Pérignon, C. (2013). Derivatives Clearing, Default Risk, and Insurance. Journal
Of Risk & Insurance, 80(2), 373-400.

Josef F. Hair, CelsiM.W., Arthur H. M., Samuel P. and Page M.J. (2011). Essentials 78of
Business Research Methods.2nd edition.

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Kargi, H.S. (2011). Credit Risk and the Performance of Nigerian Banks. Ahmadu Bello
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Chichester institute for Research in Economic History, Stockholm Economies, Stockholm.

20
 ___ ____ ____ ____ ____ (R)
/__ / ____/ / ____/
___/ / /___/ / /___/ 13.0 Copyright 1985-2013 StataCorp LP
Statistics/Data Analysis StataCorp
4905 Lakeway Drive
College Station, Texas 77845 USA
800-STATA-PC http://www.stata.com
979-696-4600 stata@stata.com
979-696-4601 (fax)

118-student Stata lab perpetual license:

Serial number: 301306212234
Licensed to: University of California, LA
Social Sciences Computing

Notes:
1. You are running Small Stata.

. *(7 variables, 150 observations pasted into data editor)

. swilk netprofitmargin capitaladequacyratio loanlossprovision nonperformingloan fsize

Shapiro-Wilk W test for normal data

Variable Obs W V z Prob>z

netprofitm~n 150 0.89808 11.859 5.607 0.00000

capitalade~o 150 0.86803 15.356 6.192 0.00000
loanlosspr~n 150 0.57291 49.695 8.855 0.00000
nonperform~n 150 0.83173 19.579 6.743 0.00000
fsize 150 0.84035 18.577 6.624 0.00000

. summarize netprofitmargin capitaladequacyratio loanlossprovision nonperformingloan fsize

Variable Obs Mean Std. Dev. Min Max

netprofitm~n 150 29.9732 15.85985 3.73 74.39

capitalade~o 150 45.09727 37.35631 1.54 119.95
loanlosspr~n 150 9.649533 18.21113 .07 68.29
nonperform~n 150 22.54247 14.80171 3.73 72.07
fsize 150 23.04327 14.59441 3.07 72.07

. correlate netprofitmargin capitaladequacyratio loanlossprovision nonperformingloan fsize

(obs=150)

netpro~n capita~o loanlo~n nonper~n fsize

netprofitm~n 1.0000
capitalade~o 0.3182 1.0000
loanlosspr~n 0.8649 0.2294 1.0000
nonperform~n 0.8762 0.2264 0.7364 1.0000
fsize 0.8696 0.2107 0.7316 0.9988 1.0000

. xtset id year, yearly

panel variable: id (strongly balanced)
time variable: year, 2006 to 2015
delta: 1 year

21
.
. regress netprofitmargin capitaladequacyratio loanlossprovision nonperformingloan fsize

Source SS df MS Number of obs = 150

F( 4, 145) = 276.54
Model 33135.1638 4 8283.79094 Prob > F = 0.0000
Residual 4343.51381 145 29.9552677 R-squared = 0.8841
Adj R-squared = 0.8809
Total 37478.6776 149 251.534749 Root MSE = 5.4731

netprofitmargin Coef. Std. Err. t P>|t| [95% Conf. Interval]

capitaladequacyratio .033211 .0130776 2.54 0.012 .0073637 .0590582

loanlossprovision .4004735 .0367322 10.90 0.000 .3278738 .4730731
nonperformingloan 1.717605 .6769099 2.54 0.012 .3797197 3.05549
fsize -1.178465 .6800777 -1.73 0.085 -2.522611 .1656811
_cons 13.04773 1.208016 10.80 0.000 10.66013 15.43532

. estat hettest

Breusch-Pagan / Cook-Weisberg test for heteroskedasticity

Ho: Constant variance
Variables: fitted values of netprofitmargin

chi2(1) = 5.92
Prob > chi2 = 0.0150

. estat vif

Variable VIF 1/VIF

nonperform~n 499.34 0.002003

fsize 490.01 0.002041
loanlosspr~n 2.23 0.449283
capitalade~o 1.19 0.842376

Mean VIF 248.19

22
. xtreg netprofitmargin capitaladequacyratio loanlossprovision nonperformingloan fsize, re

Random-effects GLS regression Number of obs = 150

Group variable: id Number of groups = 15

R-sq: within = 0.7016 Obs per group: min = 10

between = 0.9197 avg = 10.0
overall = 0.8726 max = 10

Wald chi2(4) = 620.15

corr(u_i, X) = 0 (assumed) Prob > chi2 = 0.0000

netprofitmargin Coef. Std. Err. z P>|z| [95% Conf. Interval]

capitaladequacyratio .0660449 .0155623 4.24 0.000 .0355434 .0965464

loanlossprovision .3875543 .044226 8.76 0.000 .3008729 .4742357
nonperformingloan -.5855964 .6970878 -0.84 0.401 -1.951863 .7806705
fsize 1.124405 .6931696 1.62 0.105 -.2341821 2.482993
_cons 10.54585 1.389611 7.59 0.000 7.822265 13.26944

sigma_u 2.1045131
sigma_e 4.1012478
rho .20843014 (fraction of variance due to u_i)

. xtreg netprofitmargin capitaladequacyratio loanlossprovision nonperformingloan fsize, fe

Fixed-effects (within) regression Number of obs = 150

Group variable: id Number of groups = 15

R-sq: within = 0.7238 Obs per group: min = 10

between = 0.8640 avg = 10.0
overall = 0.8322 max = 10

F(4,131) = 85.82
corr(u_i, Xb) = 0.2446 Prob > F = 0.0000

netprofitmargin Coef. Std. Err. t P>|t| [95% Conf. Interval]

capitaladequacyratio .1001668 .0179656 5.58 0.000 .0646266 .135707

loanlossprovision .3241086 .0546174 5.93 0.000 .2160623 .432155
nonperformingloan -2.555598 .7213818 -3.54 0.001 -3.982663 -1.128533
fsize 3.060344 .7105202 4.31 0.000 1.654766 4.465923
_cons 9.417603 1.34169 7.02 0.000 6.76342 12.07178

sigma_u 5.5719454
sigma_e 4.1012478
rho .64860341 (fraction of variance due to u_i)

F test that all u_i=0: F(14, 131) = 9.09 Prob > F = 0.0000

. est store fe

. est store re

. hausman fe re

Note: the rank of the differenced variance matrix (0) does not equal the number of coefficients being tested (4); be sure this is what you
expect, or there may be problems computing the test. Examine the output of your estimators for anything unexpected and possibly
consider scaling your variables so that the coefficients are on a similar scale.

Coefficients
(b) (B) (b-B) sqrt(diag(V_b-V_B))
fe re Difference S.E.

capitalade~o .1001668 .1001668 0 0

loanlosspr~n .3241086 .3241086 0 0
nonperform~n -2.555598 -2.555598 0 0
fsize 3.060344 3.060344 0 0

b = consistent under Ho and Ha; obtained from xtreg

B = inconsistent under Ha, efficient under Ho; obtained from xtreg

Test: Ho: difference in coefficients not systematic

chi2(0) = (b-B)'[(V_b-V_B)^(-1)](b-B)
= 0.00
Prob>chi2 = .
(V_b-V_B is not positive definite)

23
24