CHAPTER ONE

1.1 Introduction Background to the Study

The study of risk management started from the post second war II. Several

sources (Crockford, 1982, Harrington and Niehaus, 2003; Williams and Heins

1995) date the origin of modern risk management to 1955 – 1964. Snider (1956)

observed that there were no books on risk management at the time, and no

universities offered courses in the subject. The first two academic books were

published by Mehr and Hedges (1963) and Williams and Hems (1964).

Their content

covered pure risk management, which excluded corporate financial risk. In

parallel, engineers developed technological losses; today operational risk has to

be managed by firms and is regulated for banks and insurance companies.

Engineers also consider the political risk of projects. Risk management has long

been associated with the use of market insurance to protect individuals and

companies from various losses associated with accidents (Harrington and

Niehaus, 2003). In 1982, Crockford wrote: “Operational convenience continues to

dictate that pure and speculative risks should be handled by different functions

within a company, even though theory may argue for them being managed as

one. For practical, therefore, the emphasis of risk management continues to be

on pure risks.

1
 “In this remark, speculative risks were more related to financial risks than

to be current definition of speculative risks.

The concept of risk management in the financial sector was revolutionised

in the 1970s, when financial risk management became a priority for many

companies including banks, insurers, and non-financial enterprises exposed to

various price fluctuations such as risk related to interest rates, stock market

returns, exchange rates, and the prices of raw materials or commodities.

This revolution was sparked by the major increase in the price fluctuations

mentioned above. In particular, fixed currency prices disappeared, and prices of

commodities became much more volatile. The risk of natural catastrophe also

magnified considerable. Historically, to protect themselves from these financial

risks, companies used balance sheets or real activities (liquidity reserves). To

increase flexibility and to reduce the cost of traditional hedging activities,

derivatives were then increasingly used.

Derivatives are contracts that protect the holder from certain risk. Their

value depends on the value and volatility of the underlie, or of the assets or value

indices on which the contracts are based. The best-known derivatives are forward

contracts, options, futures, and swaps. Derivatives were first viewed as forms of

insurance to protect individuals and companies from major fluctuations in risks.

However, speculation quickly arose in various markets, creating other risk that are

2
increasing difficult to control or manage. In addition, the proliferation of

derivatives made it difficult for it to assess companies’ global risk (specially

aggregating and identifying functional form of distribution of prices or returns).

At the same time, the definition of risk management became more general.

Risk management decisions are now financial decisions that must be evaluated

based on their effect on firm or portfolio value, rather than on how well they

cover certain risks. This change in the definition applies particularly to large public

corporations, which, ironically, may be the companies that least need risk

protection (apart from speculation risk), because they are able to naturally

diversify much more easily than small companies. In particular, shareholders can

diversify their portfolios on financial markets at a much lower cost than the

companies whose shares they hold.

However, risk management became a corporate affair in the late 1990s.

The major orientation decision in the firms’ management policy and monitoring

are now made by the board of directors. Most often, the audit committee

monitors these decisions, although some large financial institutions have put risk

management committees in place.

The position of Chief Risk Officer, or CEO, emerged. Adequate capital

reserves became a major concern in the early 2000s following major defaults in

the late 1990s and the Enron bankruptcy in 2001. Basel II introduced more rigours

3
rules for banks. In addition to modifying the credit risk management rules, the

Accord introduced new rules for operational risk. However, the legislators have

said little about managing the risk of various management and hedge funds,

especially pension funds.

In today’s world, managing risk has become a necessity, not an option. In

the words of the outgone Central Bank Governor, Lamido Sanusi Lamido, in 2010

pointed out that recent year excessive credit and financial asset growth went

unchecked. Risk, in insurance terms, is the possibility of a loss or other adverse

event that has the potential to interfere with an organization’s ability to fulfil its

mandate, and for which an insurance claim may be submitted. The Former CBN

Governor Sanusi sanitization in the banking industry revealed the holes in

Nigerian banking industry, especially on the recklessness of the bank chief

executives. But before that, another former CBN

Governor Soludo (2004) made it known in one of his speeches that Nigerian

banking system today is fragile and marginal.

Commercial banks are in the risk business; the process of providing

financial services. They assume various kinds of financial risks Anthony (2009). On

22nd July, 2008, the Basel Committee on Building Supervision issued for public

comment Guidelines for Computing Capital for incremental risk in the trading

book as well as Proposed Revisions to the Basel II market risk framework. In Basel

4
II, risk management is divided into credit, market and operational risk

management. In many cases, credit and market risk are handled through a

company’s financial department, whereas operational risk management is

through a company’s coordinated centrally but most commonly implemented in

different operational units.

Banking crisis in Nigeria has shown that not only do Banks often take

excessive risks but the risk differs across banks. Some banks engage in more risk

than they could bear. Other banks are more prudent and would be able to contain

a banking crisis. As a way to stem the tide, the Central Bank of Nigeria (CBN) on

July 6, 2004, introduced measures to make the entire banking system a safe,

sound and stable environment that could sustain public confidence in it.

According to the bank’s Governor at

the time, Charles Chukuwuma Soludo “it is now time to set up a structure that

creates a strong base relative to the kind of economy we are operating where

bank become channels to do proper intermediation (The Obasanjo Economic

Reforms on the Banking Sector, 2005).”

Nigeria in 2005, the industry players and other stakeholders have been

faced with how to best manage the post-consolidation challenges that confront

Nigeria banking industry in the economy. This perhaps is the compelling reason

operator of the banking system in Nigeria are challenged to take more seriously

5
the important issue of risk acceptance/rejection which is often the point at which

bankers fall into or escape the trap of greed (Adedipe, 2005). The end of risk

management for operators is risk mitigation, which emphasis the protection of

the bank’s assets and by extension depositors’ fund and capital.

Risk control and risk financing are at the heart of iterative process aimed at

reducing the likely hood and severity of loss.

1.2 Statement of Research Problem

The general problem that has faced the world financial system is the

recently introduced on risk management called the enterprise risk management;

it has failed to produce the desired result and disasters continue to occur on a

regular basis. Some scholars have then identified the silos approach or segmented

view to risk management which they say will cause a drastic and effectual in the

financial system (Lam, 2000).

The specific problem arises from the growing importance of risk

management; which is not really evident in its implementation in the banking

sector particularly in Nigeria. Lamentably, very few firms have implemented risk

management in Nigeria. Furthermore, the study on risk management is scarce as

there are only few studies on risk management in Nigeria. Examples are (Donwa

& Garuba, 2011; Owojori, Akintoye & Adidu, 2011; Njogo, 2012; Ugwuanyi & Ibe,

6
2012; Fadun, 2013). The Central bank of Nigeria (CBN, 2012) asserts that risk

management is still at a rudimentary stage and is bedevil by a number of

challenges. These challenges include poor

knowledge of risk management by members of the board of many banks, lack of

professionals. Others are lack of risk training and education and lack of a

framework that supports the development of skilled and capable workers in the

industry (CBN, 2011 & 2012).

Therefore, the main objective of this study is to examine the level of risk

management implementation in the Nigerian banking sector. It will also

determine the antecedents (board characteristics, external audit quality, internal

audit effectiveness, human resources competency & regulatory influence) of risk

management implementation. It will further investigate the moderating effect of

top management support on the relationship between the independent variables

and the depended variable. The study is the first known research to the

researcher's knowledge with the same combination of variables.

1.3 Purpose Statement

This study will identify what kind of risk are being absorbed in the banking

sector and will identify some institutional response to risk management and also

what kind of software are being used to contain risk in the banking sector. This

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study used a random sampling techniques focusing on the Commercials in the

country as case study to effectively ascertain the role risk plays in racking up

investment. The research is qualitative in nature because it possesses real life

experiences from the managers, investors and the other respondents. The

banking sector was appropriate for the study because it has investment in the

banking has grown over the last decade including spreading its tentacle to the

African continent.

This research study will employ Durbin Watson techniques to present the

data and chi-square statistical tool will be used in the analysing of the data.

1.4 Significance of the Study

The significance of the study lies in the fact that the myriads of evidence

accumulated in the process of the study will be used in assessing the overall

performance of Nigeria banking sector in the post consolidation and also to know

that effort are being made to shape up the Nigeria banking sector and the part it

plays for investors.

1.5 Nature of the Study

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 The nature of this research is to empirical which is to help analyse the risk

management of banks and investors. The research will employ qualitative means

through the use of questionnaires and interviews.

1.6 Research Questions

 The type of risk banks are prone to?

 Whether attitude of borrowers towards loan repayment constitute a risk

factor in bank?

 Methods used by banks to hedge against risk?

 Whether the risk management techniques put in place have curbed the

various operational risks in the bank and for investors?

1.7 Conceptual and Theoretical Framework

The conceptual and theoretical framework of this work will be sourced

from past literatures from authors derived from journals, articles, textbooks and

online materials. The conceptual review will critically analyse the concept of risk,

the types, the various terms associated with risk. The theoretical framework will

outline the theory that postulated by risk managers to effectively ascertain risk

for investors. The historical background to risk management will also be outlined.

1.8 Statement of Hypothesis

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H0: Risk management techniques put in place have not been able to curb

operational risks in the bank and with investors.

H1: Risk management techniques put in place have been able to curb operational

risks in the bank and with investors.

1.9 Scope of the Study

The research will involve a careful study of how risk in any financial

organizations particularly the banking sector is being managed globally and

locally.

The study will also involve a thorough evaluation of the risk management

play and the possible advantage if it is being managed properly and a

comprehensive study of risk management for investors.

1.10 Limitation of the Study

The study shall be hindered by some facts as which the researcher intend

to limit their effects as much as possible. Another limitation to this research is

time and financial constraints. The researcher would try as much as possible to

ensure that these limiting factor do not affect the outcome of this research work

adversely.

1.11 Plan of the Study

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 Chapter one of the research work highlights the introduction to the topic

on head. Background information of the study, its evolution as well as the

definition of the statement of problems highlighted. This chapter will also state

the major purpose of conducting this study, the important research questions and

subsequently the research hypothesis to be tested. It also explains the

significance of the study, the area and scope of the study including the limitation

faced.

Chapter two will contain all various literature reviewed that are revealed to

the project work. Information specifically and generally related to the study will

be extracted; information form journals, websites, textbooks, gazettes, e.t.c.

Chapter three consist of mainly the methods used in conducting the

research. The research methodology, sampling technique, research instruments,

methods of data collection and analysis will be stated. The data collected will

guide in making valuable and reliable conclusions about the research study.

Chapter four of this project is basically the presentation and analysis of

data collected in chapter three of this project work.

Chapter five of this research work is the final chapter. It is a review of the

information gathered in summary as well as the conclusions drawn from the

findings. The research will also make recommendation based on the conclusions

as well as suggestions.

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Summary

This chapter focused on the background of the study, the problem

statement and the statement of the hypothesis. The scope of the study in this was

clearly stated and the limitation of the study.

CHAPTER TWO

LITERTURE REVIEW

2.1 INTRODUCTION

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 Risk management applies to all institution of day to day living. It is

generated a whole lot of meaning different perspective of individual’s view.

Merriam Webster dictionary defines risk as the chance of loss or the perils to the

subject matter of an insurance contract; the degree of probability of a loss.

Effective risk management seeks to maximize the benefits of a risk (usually

a reduction of time or cost) while minimizing the risk itself.

Risk management is the process of identifying risks, assessing their implications,

deciding on a course of action, and evaluating the results {Wikipedia}. Risk

management is the identification, assessment, and prioritization of risks followed

by coordinated and economical application of resources to minimize, monitor,

and control the probability and/or impact unfortunate events.

Risks can come from uncertainty in financial markets, project failures,

legal liabilities, credit risk, accidents, natural causes and disasters as well as

deliberate attacks from an adversary. Risk management ensures that an

organization identifies and understands the risks to which it is exposed.

Risk management is very significant to the operations of any business entity

due to serious consequences that the occurrence of risk portends. It implies that

for a business organization to be rest assured of the achievement of its objectives

besides survival and growth, risk management becomes imperative. Risk

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management as commonly perceived does not mean minimizing risk to tally;

rather the goal of risk management is to optimize risk-reward trade off. Risk

management is also viewed as a multi-disciplinary function.

Hence, it is all embracing in the implicit actions taken by housewives,

farmers and artisans to the corporate managers. Such actions involve, consciously

putting a risk management process in place to mitigate disasters such as injuries,

incapacitation, and even death. It involves a management process aimed at “the

effective reduction of the adverse effects of risk”. According to Soludo (2007),

approaches to risk have apparently changed across organizations and the whole

globe in recent times. This involves the recognition by many business leaders that

risk re no longer mere hazard to be avoided but they also in many cases,

constitute opportunities to be embraced.

Soludo (2007) further cited the risk officer of Royal Bank Canada who

observed that “risk itself is not bad, what are bad are risks that is mismanaged,

misunderstand, mispriced or chief unintended”.

He therefore described risk management as a discipline at the core of every

financial institution and encompasses all the activities that affect its risk profile. It

involves identification, measurement, monitoring and controlling risks. To ensure

that:

i. The individuals who take or manage risks clearly understand it.

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 ii. The organization’s risk expo sure is within the limits established by Board of

Directors.

iii. Risk taking decisions are in line with the business strategy and objectives,

set by Board of Directors.

iv. The expected pay offs compensate for the risk taken

v. Risk taking decisions are explicit and clear

vi. Sufficient capital as a buffer is available to take risk

vii. The expected pay offs compensates for the risk taken

2.2 WHAT TYPE OF RISK IS BEING CONSIDERED?

Commercial banks are in the risk business. In the process of providing financial

services, they assume various kinds of financial risks. Over the last decade our

understanding of the place of commercial banks within the financial sector has

improved substantially. Over this time, much has been written on the role of

commercial banks in the financial sector, both in the academic literature and in

the financial press. These arguments will be neither reviewed nor enumerated

here. Suffice it to say that market participants seek the services of these

transactions efficiency and funding capability.

In performing these roles they generally act as a principal in the

transaction. As such, they use their own balance sheet to facilitate the transaction

15
and to absorb the risk associated with it. To be sure, there are activities

performed by banking firms which do not have direct balance sheet implications.

These services include agency and advisory activities such as

(i) trust and investment management,

(ii) private and public placements through “best efforts” or facilitating

contract,

(iii) standard underwriting through section 20 subsidiaries of the holding

company, or

(iv) The packaging, securitizing, distributing and servicing because the latter

rely in generally accepted accounting procedures rather than a true

economic balance sheet. Nonetheless, the overwhelming majority of the

risks facing the banking firm are in on-balance-sheet businesses. It is in

this area that the discussion of risk management and the necessary

procedures for risk management and controls is centred.

2.3 What Kind of Risk is being absorbed?

The risks contained in the bank’s principal activities, i.e., those involving its

own balance sheet and its basic business of lending and borrowing, are not all

borne by the bank itself. In many instances the institution will eliminate or

mitigate the financial risk associated with a transaction by proper business

16
 practices; in other, it will shift the risk to other parties through a combination of

pricing and product design.

The banking industry recognizes that an institution need not engage in

business in a manner that unnecessarily imposes risk upon it; nor should it absorb

risk that can be effectively transferred to other participant. Rather, it should only

manage risks at the firm level that are more efficiently managed there than by the

market itself or by their owners in their own portfolios. In short, it should accept

only those risks that are uniquely a part of the bank’s array of services. Elsewhere,

Oldfield and Santomero (1997), it has been argued that risks facing all financial

institutions can be segmented into three separable types, from a management

perspective. These are

I. Risk that can be eliminated or avoided by simple businesses practices

II. Risk that can be transferred to other participants and,

III. Risk that must be actively managed at the firm level.

In the first of these cases, the practice of risk avoidance involves actions to

reduce the chances of idiosyncratic losses from standard banking activity by

eliminating risks that are superfluous to the institution’s business purpose.

Common risk avoidance practices here include at least three types of actions.

17
 The standardization of process, contracts and procedures to prevent

inefficient or incorrect financial decisions is the first of these. The construction of

portfolios that benefit from diversification across borrowers and that reduce the

effects of any one loss experience is another. Finally, the implementation of

incentive-compatible with the institution’s management to require that

employees be held accountable is the third. In each case the goal is to rid

the firm of risks that are not essential to the financial service provided, or to

absorb only an optimal quantity of a particular kind of risk that can eliminate, or

at least substantially reduce through the technique of risk transfer. Markets exist

for many of the risk borne by the banking firm. Interest rate risk can be

transferred by interest rate products such as swaps or other derivatives.

Borrowing term can be altered to effect a change in their duration.

Finally, the bank can buy or sell financial claims to

diversify or concentrate the risk that results in from servicing its client base. To

the extent that the financial risks of the assets created by the firm are understood

by the market, these assets can be sold at their fair value. Unless the institution

has a comparative advantage in managing for the and/or a desire for the

embedded risk they contain, there is no reason for the bank to absorb such risks,

rather than transfer them. However, there are two classes of assets or activities

where the risk inherent in the activity must ant should be absorbed at the bank

18
level risk. In these cases, good reasons exist for using firm resources to manage

bank level risk. The first of these includes financial assets or activities where

the nature of the embedded risk may be complex and difficult to communicate to

third parties. This is the case when the bank holds complex and proprietary assets

that have thin, if not non-existent, secondary markets. Communication in such

cases may be more difficult or expensive than hedging the underlying risk.

Moreover, revealing information about the customer may give competitors an

undue advantage. The second case included proprietary positions that are

accepted because of their risk, and their expected return that are central to the

bank’s business purposes are absorbed because they are the raison d’etre to the

firm. Credit risk inherent in the lending activity is a clear case in point, as is market

risk for the trading desk of banks active in certain markets. In all such

circumstances, risk is absorbed and needs to be monitored and managed

efficiently by the institution. Only then will the firm systematically achieve its

financial performance goal.

2.4 SOURCES OF RISK

2.4.1 GLOBALIZATION AS A SOURCE OF RISK

No country is an island of itself; there are a lot of happenings in the world

around us that shapes the nature and type of decisions that are taken by

19
government institute as well as private enterprise. The facts that none of this

institution can own itself direct the course of these global events underscore the

uncertainty surrounding the impact on such an enterprise.

Globalization affects the risk return matrix of the Nigeria banks in the following

ways;

 Nigeria banks have to restructure in order to meet global challenges and

competition especially in terms of providing efficient and cost services.

 Need for adequate capitalization to meet funding requirements of major

international business partners or investors in local economy.

 Also need to advance more in technologizing the banking services provided

in order to remain relevant. Employment of well trained and competent

personnel that meets the challenges of globalization.

In effect, globalising or rather internationalizing the Nigeria banking industry

allows more room for foreign participation in the equity share of the banking

industry and thus constituting a threat to the survival of inefficient and poorly

capitalized domestic banks.

2.4.2 INTERNATIONAL CONFLICT

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 Noting that banking is a business that cut across many international

boundaries. Any serious threat to international peace will undoubtedly have

serious consequence on the industry because international settlement or

movements of good become impaired. The crisis and incident in the Middle East

between Israel and Palestine is a trouble spot in the world which has the potential

of affecting the free flow of trade and business between nations.

International banks that provide to a broad spectrum of business in

different nations with the aim of reducing their risk tend to have more risk than

anticipated. Risk also arises from external shocks resulting from world recession

and falling commodity prices. Although, the impact of external shocks vary from

one country to the other and such effect may be put to check through

appropriate domestic policies.

2.4.3 FINANCIAL GLOBALIZATION AND BANKING SECTOR

The issue of globalization of finance has been on the front burner in recent

years due to the most recent global financial crises which started in 2008 and

traceable to cooperate irresponsibility on the part of some financial sector players

in developed countries especially united states of America in the housing and

21
credit market. It became imperative for managers of the banking sector to be

alert and competent in responding to signals of crises in other banking system

their immediate domain so as to be able to manage the possible effects to

contagion i.e. the transfer of financial crises from one country to another.

Financial globalization is the integration of financial systems of different

countries of the world through linkages and interconnectivity that is facilitated by

information, communication technology and global trade. If financial globalization

is not probably managed, it will have plenty of negative effect on the economy

such:

I. Complication of financial sector policy formulation and implementation.

II. Volatility of financial systems operations.

III. Transfer of financial crisis from one country to the other.

IV. Loss of policy making independence.

V. High inequality in growth rate among countries.

Some of the positives financial globalization can bring to any country if

probably managed are:

 The opportunity for people in different countries to own financial assets

denominated in foreign currency home and abroad. Consequently,

developing countries like Nigeria and the rest are often characterised by

low total bank deposit and sometime unorganized stock exchange can with

22
 the embrace of financial globalization expand their access to capital and

developing their financial system.

 Enhancement of international trade and by extension global economic

growth.

 Possible reduction in global poverty especially on the poverty index in less

developed countries due to the preposition that opening the capital

account will tend to equalize the rate of return leading to more investment

and higher growth.

 Possibility of increased labour mobility.

2.5 RISKS IN PROVIDING BANKING SERVICES

We will elucidate properly on various risk in providing services in the

banking environment irrespective of any country. There various types of risk

include: credit risk, liquidity risk, operational risk, interest rate, foreign exchange

risk.

2.5.1 CREDIT RISK

This is also known as default risk. It is associated with the repayment of a

credit advances made by a bank. Credit risk is the potential that a bank borrower

fails to meet the obligations on agreed terms. Credit risk to inherent to the

23
business of lending funds and to the operations linked closely to market risk

variables. The objectives of credit risk management is to minimize the risk and

maximize bank’s risk adjusted rates by return assuming and maintaining credit

exposure within the acceptable parameters.

Credit risk arises from non-performance by a borrower. {pg.3, risk

management in banking industry}. It also may arise from either inability or an

unwillingness to perform in the pre-committed contracted manner. This can affect

the lender holding the loan, contract of the borrower ad well as other lenders to

the creditor. Therefore, the financial condition of the borrower as well as current

value of any underlying collateral is of considerable interest to its bank. The

real risk form credit is the deviation of portfolio performance from its expected

value. Accordingly, credit risk is diversifiable, but difficult to eliminate completely.

This is because a portion of the default risk may, in fact result from a systematic

risk. In addition, the idiosyncratic nature of some portion of these losses remains

a problem for creditors in spite of the beneficial effect of diversification on total

uncertainty. This is particularly true for banks that lend in local markets and ones

that take on highly illiquid assets. In such cases, the credit risk is not easily

transferred, and accurate estimates of loss are difficult to obtain.

2.5.2 LIQUIDITY RISK

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 This is the probability that there will be a sudden call upon the resources of

the bank that will strain its financial capacity (Pandey, 2004). It is the type of risk

which may arise from the fact may find it difficult to generate enough quantum of

funds with which short-term financial obligations can be met. Liquidity risk is the

most often thought of as a sudden liability short fall that is associated with a

deposit withdrawal or with a decline in borrowing capacity.

However, liquidity risk can best be described as the risk of a funding crisis.

While some would include the need to plan for growth and unexpected expansion

of credit, the risk here is seen more correctly as the potential for a funding crisis.

Such a situation would inevitably be associated with an unexpected event, such as

large charge off, loss of confidence, or a crisis of national production such as a

currency crisis.

In any case, risk management here centre on liquidity facilitates and

portfolio structure. Recognizing liquidity risk leads the bank to recognize liquidity

itself as an asset, and portfolio design in the face of liquidity concerns as a

challenge.

2.5.3 OPERATIONAL RISK

The concern here is that system failure or human error will result in losses

to the bank that could substantially affect its viability. The operational risk is

25
conceptualized as the risk of loss arising from failed processes, people and

systems as well as external events. In other words, operational risk refers to the

possibility that transactions or processes can fail as a result of poor design,

inadequately trained personnel and external disruptions. These failures could be

sudden, such as a computer breakdown, it could be cumulative, such as the

inability to bring on line a new computer application.

Also inability to balance ledger accounts including dormant and

special ledger accounts could lead to losses that could weaken the ability of a

bank to continue in operations. {pg.3, risk management in banking industry}. As

such, individual operating problems are small probability event for well-run

organization but they expose a firm to outcomes that may be quite costly.

However, this is the risk of direct and indirect loss resulting from

inadequate or failed internal processes people and systems or external threats

generate. Operational risk may include frauds. By this we mean a situation where

customers and/or bank staff intentionally falsify information or present forged

documents. It may also include technology risk which refers to the risk of

inadequate or ineffective operating and information technology infrastructure it

support the business of the bank. Other examples are system failures, losses due

to natural disasters, and accidents involving key management staff of the bank.

But the question may arise as to how well banks prepared to meet the challenges

26
of operational risk in the post-consolidation era, especially now that master

forgers present and obtain value on cheques with the same characters like

genuine ones issued to customers?

2.5.4 Post Consolidation Experience

Operational risk became more pronounced in the pose – consolidation era as

losses are now running into about three billion naira in each case (Table 5). These

losses arise principally from weak internal controls and the retention of staff with

high propensity for fraudulent practices. Invariably, banks with high volume of

losses from frauds tends to have these two factors and often the weak internal

control manifest in such ways as preponderance of un-reconciled items, non-

segregation of active from dormant balances, lack of dual control of strong room,

lack of online auditing for banks that are online, etc. An analysis of the types of

frauds and forgeries perpetrated showed that the commonest types were the

following:

a. Presentation of forged cheques

b. Granting of unauthorised credits

c. Posting of fictitious credits;

d. Fraudulent transfer/withdrawals

e. Cheque and cash defalcation.

27
f. Loss of money to armed robbers; and

g. Outright theft of money.

2.5.5 INTEREST RATE AND FOREIGN EXCHANGE RISK:

This refers to the change in value of a financial asset or liability occasioned

by a change in the general level of interest rates. Interest rate risk also entails

reinvestment risk which is the probability that the bank will not be able to

reinvest its interim cash flows at interest rates that are required to meet its

liabilities. Foreign exchange risk is analogous to interest rate risk. It measures the

change in equity value due to variations in the level of the exchange rate. Interest

rate risk is also said to be the risk (variability in value) borne by an interest –

bearing asset, such as a loan or a bond, due to variability of interest rates. In

general, as rates rise, the price of a fixed rate bond will fall, and vice versa.

However, interest risk faced by banks is

classified into the following:

2.5.5.1 Basic Risk

The risk presented when yield on asset and costs on liability are based on

different bases. In some, circumstance different bases will move at different rates

28
or in different directions, which can cause erratic change in revenues and

expenses.

2.5.5.2 Yield Curve Risk:

The risk presented by different between short-term and long-term interest

rates. Short-term rates are normally lower than long-term, and bank earns profits

by borrowing shot-term money (at lower rates) and investing in long-term assets

(at higher rates). But relationship between short-term and long-term rates can

shift quickly and dramatically, which can cause erratic changes in revenues and

expenses.

2.5.3 Reprising Risk:

The risk presented by assets and liabilities that reprise at different times

and rates. For instance, a loan with variable rates will generate more income

when rates rise and less interest income when rates fall. If the loan is funded with

fixed rated deposits, the bank’s interest margin will fluctuate.

2.5.4 Option Risk:

29
 It is presented by optionally that is embedded in some assets and liabilities.

For instance, mortgage loans present significant option risk due to prepayment

speeds that change dramatically when interest rates and fall.

2.5.5 Hedging Interest Rate Risk:

Interest rate risk can be hedging using fixing income instruments or interest

rates swaps. Interest rate risk can be reduced by buying bonds with shorter

duration, or by entering into a fixed-for floating interest rate swap.

Other types of risk include the following:

2.5.6 Legal Risk

Legal risks are endemic in financial contracting and are separate from the

legal ramification of credit, counterpart, and operational risks. New statutes, tax

legislature, court opinions and regulations can put formerly well-established

transactions into collection even when all parties have previously performed

adequately and are fully able to perform in the future. For example, environment

regulations have radically affected real estate values for older properties and

imposed serious risk to lending institutions in this area.

A second type of legal risk arises from the activities of an institution’s

management or employees. Fraud, violations of regulations or laws, and other

30
actions can lead to catastrophic loss, as recent examples in the thrift industry

have demonstrated.

All financial institutions face all these risks to some extent. Non-principal or

agency activity involves operational risk primarily. Since institutions in this case do

not own the underlying assets in which they trade, systematic, credit and

counterparty risk accurse directly to the asset holder. If the latter experience a

financial loss, however, legal recourse against an agent is often attempted.

Therefore, institutions engage in only agency transactions bear some legal risk, if

only indirectly.

2.5.7 Counterparty Risk

This kind of risk comes from non-performance of a trading partner. The

non-performance may arise from a counter party’s refusal to perform due to an

adverse price movement caused by systematic factors, or form some other

political or legal constraint that was not anticipated by the principals.

Diversification is the major tool for controlling non systematic counterparty risk.

Counterparty risk is like credit risk, but it is generally viewed as a more

transient financial risk associated with trading than standard creditor default risk.

In addition, a counter party’s failure to settle a trade can arise from other factor

beyond a credit problem.

31
 2.5.8 Reputational Risk

Reputational risk is any risk to a Bank’s reputation that is likely to destroy

shareholder value. Reputational risk leads to negative publicity, loss of revenue,

litigation, loss of clients and partners, exit of key employees, share price decline,

difficulty in recruiting talent. A comprehensive reputational risk assessment is

necessary as an important part of a risk assessment.

2.6 GENERAL STEPS IN RISK MANAGEMENT

The management of the banking firm relies on a sequence of steps to

implement a risk management system. These can be seen as containing the

following four parts:

I. Standards and reports,

II. Position limits or rules,

III. Investment guidelines or strategies,

IV. Incentive contracts and compensation.

In general, these tools are established to measure exposure, define

procedures to manage these exposures, limit individual positions to acceptable

levels and encourage decision makers to manage risk in a manner that is

consistent with the firm’s goals and objectives. To see how each of these four

32
parts of basic risk management techniques ach9ieve these ends, we elaborate on

each part of the process below. We illustrate how these techniques are applied to

manage each of the specific risks facing the banking community.

2.6.1 Standards and Reports

The first of these risk management techniques involves two different

conceptual activities, i.e. standard setting and financial reporting.

They are listed together because they are the integral part of any risk

system. Underwriting standards, risk categorizations, and standards of review are

all traditional tools of risk management and control. Consistent evaluation and

rating of exposures of various types are essential to understand the risks in the

portfolio, and the extent to which these risks must be mitigated or absorbed. The

standardization of financial reporting is the next ingredient. Obviously outside

audits, regulatory reports, and rating agency evaluations are essential for

investors to gauge asset quality and firm level risk.

These reports have long been standardization, for better or worse.

However, the need here goes beyond public report and audited statements to the

need for management information on asset quality and risk posture. Such internal

reports need similar standardization and much more frequent reporting intervals,

with daily or weekly reports substituting for the quarterly GAAP periodicity.

33
2.6.2 Position Limits and Rules

A second technique for internal control of active management is the use of

position limits, and/or minimum standard for participation. In terms of the latter,

the domain of risk taking is restricting to only those assets or counterparties that

pass some pre-specified quality standard. Then, even for those investments that

are eligible, limits are imposed to cover exposures to counterparties, credits, and

overall position concentrations relative to various types of risks. While such limits

are costly to establish and administer, their imposition restricts the risk that can

be assumed by any one individual, and therefore, by the organization as a whole.

In general, each person who can commit capital will

have a well-defined limit. This applies to traders, lenders, and portfolio managers.

In large organizations with thousands of positions maintained, accurate and

timely reporting is difficult, but even more essential.

2.6.3 Investment Guidelines and Strategies

Investment guidelines and recommended positions for the immediate

future are the third technique commonly in use. Here, strategies are outlined in

terms of concentrations and commitments to particular areas of the market, the

34
extent of desired asset-liability mismatching or exposure, and the need to hedge

against systematic risk of a particular type.

The limits described above lead to passive risk avoidance and/or

diversification, because managers generally operate within position limits and

prescribed rules. Beyond this, guidelines offer firm level advice as to the

appropriate level of active management, given the state of the market and the

willingness of senior management to absorb the risk implied by the aggregate

portfolio. Such guideline lead to firm level hedging and asset-liability matching.

In addition, securitization and even derivative activity are rapidly growing

techniques of position management open to participants looking to reduce their

exposure to be in line with management’s guidelines

2.6.4 Incentive Schemes

Management can enter into incentive compatible contracts with line

managers and make compensation related to the risk borne by these individuals,

and then the need for elaborate and costly controls is lessened. Notwithstanding

the difficulty, well-designed systems align the goals of managers with other

stakeholders in a most desirable way. In fact, most financial debacles can be

traced to the absence of incentive compatibility.

35
2.7 IMPACT OF RISK ON BANKING ENVIRONMENT

Having considered the various myths surrounding risk in banking and all

other financial institutions, it is prudent to access the impact of risks on banking

and financial operation.

Any risk has the capacity of throwing the bank earnings into the wind. This is

possible through changes in interest rate, asset prices, operating expenses and

pace of inflation.

 Risks generally are capable of eroding the bank’s capital base

 Closure of business

 Downsizing the scale of operation

Above is some of the havoc risk cause if not properly managed.

2.8 RECENT DEVELOPMENT IN THE NIGERIA BANKING INDUSTRY

The government is totally committed to sanitize the Nigerian Banking

Industry, protects all depositors and ensure that no bank id allowed to fail. I n his

effort of strengthen the financial system and engender financial stability, the

central Bank of Nigeria has effected some changes in the executive management

of the under listed banks: Afribank, Intercontinental Bank, Union Bank, Oceanic

Bank, Fin Bank, Bank PHB, Spring Bank and Equatorial Trust Bank. Chukwuma

36
(2010) commended that firing of the CEOs of the above Banks by the former CBN

Governor must have been a surprised to many Nigerians, but to some in the

financial sector, it was a day of reckoning that has been long awaited incentive for

risky lending and wider use of capital arbitrage contributed to the deteriorating

quality of bank loan portfolios in recent years Julius (2008). The central Bank of

Nigeria injected fresh capital into the banks up to the tune of more than

N700billion to ensure that the banking system but also to protect all depositors

and creditors.

The central bank of Nigeria on Wednesday, 19 August 2009, made the list

of debtors known to the public. On the list are the names of prominent

businessmen, bankers and politicians. It was discovered that these people own

the first five banks discovered to be shaking after auditing by the CBN to the tune

of N747billion.

The loans are non-performing and that led to the sack of the Bank MDs

because they failed to apply the risk management rules especially their exposures

to margin loans and the Oil and Gas. The former CBN GOV. Sanusi (2010) also

made it known that there is a general failure in recognizing the limitations of the

banking system when it comes to delivery economic development. The reform by

the former CBN Governor is to put the Nigeria bank to shape.

37
2.9 SOFTWARES USEF IN MANAGING RISK IN THE BANKS

The on-going development of contemporary risk management methods

and the increased use of innovative financial products such as securitization and

credit derivatives have brought about substantial changes in the business

environment faced by credit institutions today. Especially in the field of lending,

these changes and innovation are now forcing banks to adapt their in houses

software systems and the relevant business process to meet these new

requirements. The following are the software used in the banking:

2.9.1 SAS SOFTWARES:

With the global economy ailing, banks needs to actively manage risk,

accurately track regulatory compliance and precisely measure forecast economic

capital to support business strategies. To avoid potential disaster but also uncover

opportunities for growth, effective governance, risk compliance (GRC) program is

necessary. SAS, the leader business analytics, assists with this business needs. SAS

helps banks proactively manage enterprise-wide risk, while complying with

regulations and tracking and enhancing overall corporate performance. SAS offers

existing and new software solution to tackle the three parts of GRC. All build on a

flexible and integrated business analytics framework.

38
 In October 2008, SAS ranked first in operational risk and GRC categories in

Chartis Research’s Risk Tech 100 report. “SAS brings together best-in-class

qualitative and quantitative risk assessment and reporting. SAS provides a firm-

wide platform to automate the collection, analysis and monitoring of risk related

information.

2.9.2 NUCLEUS SOFTWARE

Nucleus software is a leading software power house providing innovative

and pioneering software solutions for Banks Financial Organizations globally.

Nucleus software offers a host of competitive IT solutions and consultancy

services designed to support the whole spectrum of business offerings spanning

retail and corporate banking, cash management, credit card relationship banking,

financial CRM, credit risk & appraisal, internet banking data warehousing and

analytical.

Nucleus Risk Management for banking helps organizations achieve

comprehensive risk governance by incorporating a performance management

approach into all areas risk. Adekun, Owojori, Ishola and Felix (2011) in their

study, stated that the moral view of risk taking in business assumes that

shareholders make the lending and investment decisions and therefore take a risk

to maximize the value of insurance if they so desire. In this case this

39
solution addresses key requirement for financial institutions, including a quality

integrated risk data infrastructure with timely access, the ability to measure

exposure and risk across all risk type and books of business; and the ability to

distribute incentives for consistence optimization of risk adjusted returns

throughout the organization. Nucleus has expedited and enhanced customer

service by automating the credit to organization, effectively tracking applications,

timely disbursement, faster collections, untimely income accruals and swift

decision making.

2.10 Capital Asset Pricing Model (CAPM )

This is another model which measures investment risk and the expected

return on same investment. According to Davis (2001), three Economists worked

independently by building on the framework of Markowitz – Sharpe (1964),

Lintner (1965), and Mossin (1966), to develop what has come to be known as

capital Asset Pricing Model (CAPM).

He stated further that the model assumes that investors use the logic of

Markowitz in forming portfolios,(The risk-free asset) that has a certain return.

Also, the Capital Asset Pricing Model stated that the expected risk premium on

each investment is proportional to its beta. This means

that each investment should lie on the sloping security market line. The difference

40
between the return on the market and the interest rate is termed the risk

premium Therefore, expected risk premium on stock equals beta multiply by

expected risk premium on market (i. e. r – rf )= B (rm – rf) The CAPM Equation is E

(Rj) = Rf + βj {E (Rm) – Rf} Where: E (Rj) and E (RM) are the expected returns to

asset j and the market portfolio, respectively, Rfis the risk free rate, and βjis the

beta coefficient for asset J, βj measures the tendency of asset j to co-vary with the

market portfolio. It represents the part of the asset’s risk that cannot be

diversified away, and this is the risk that investors are compensated for bearing.

The models assumed efficient portfolio in which risk is well

diversified and no added diversification can lower the portfolio risk for a given

return expectation. However, studies in the recent times have shown that

diversification of investment portfolio may not reduce risk for higher returns.

2.11 INSTITUTIONAL RESPONSE TO RISK

Looking carefully into the past and present occurrence in the Nigeria banking

industry, institutions have titled towards providing stricter rules and regulations.

Some of the developments are:

 Strengthen of CBN through enrichment of CBN decrees

41
 Increase in the capital vase as well as harmonizing the capital requirement of

both commercial and merchant banks.

 Substitution of banking decree of 1969 with BOFID 1991 with more

innovations and provision

 The enhancement of more decrees that have generous implications on the

industry e.g money laundering decree of 1995, NDIC decree of 1990, failed

banks decree etc.

 Liquidation of some banks

 Introduction of advanced technology

 Arresting and detaining of bank official including the executives if found guilty

of fraudulent activity

 Globalization and financialization of the economy.

2.12 Empirical Review

2.12.1 Impact of Credit Risk Exposure on the Market Value of Nigerian Banks

According to Kallestrap (2012),the dynamics of sovereign credit risk

depends critically on fragility in the banking sector and this added additional

insights to the conclusions in Long staff, Pan, Pedersen and Singleton (2011), who

argued that, sovereign credit risk is primarily driven by global risk premium

factors. This view is consistent with that expressed by Lehmann and Manz (2006),

42
on the exposure of Swiss Banks to macroeconomic shocks – an empirical

investigation. They said that credit risk is considered to be a key contributor to

fluctuations in bank earnings which is likely to depend on the macroeconomic

environment. Also, Reinhart and Rogoff (2009), presented the evidence from his

work that systemic banking crises often result in recessions which in turn result in

lower government revenues, large fiscal deficits and potentially sovereign credit

defaulters. There is a close link between banks’ shares and capital market.

Kulathunga (2012), buttress this fact by documenting that, the development of

capital market is a powerful indicator of the depth of the financial sector.

He also concluded that, in an environment of

great interest volatility and increased bank failures, the market values of the

stocks of banks are depleted in reaction to the performance of the banks and

other public information about the institution and economy. Philippatos and

Viswanalthan (1994), emphasized in their study, on the Mexican debt Moratorium

and its effect upon US bank stock values: empirical tests on major event windows

that, the primary objective of the creditor banks, like any other publicly held firm,

is to maximize the wealth of their shareholders. Hence, creditor banks should be

concerned about events that affect them adversely.

Their conclusion among others

were, the announcement of the debt moratorium conveyed a negative signal to

43
the market and forced bank stock prices downward – both Mexican loan -

exposed and non – exposed banks. The market reacted by adjusting quickly the

share prices of banks. However, the adverse reaction was not limited to banks

with loans outstanding in Mexico. Non - exposed banks experienced a similar

decline in equity prices, suggesting a contagion effect in the market for bank

equities.

Similarly, when the global economic meltdown hit Nigerian economy in

2008 and the report of the audit jointly conducted by the CBN and NDIC revealed

that certain banks were carrying toxic assets in their balance sheets, the stock

market reacted negatively to this information and banks’ stock prices started

tumbling. The effect did not only manifest on the banks with toxic assets, it

rubbed on other ones that were even declared healthy which confirmed the

contagious effect as documented by Spiegel and Yamori (2004), in their study on

the evolution of Bank resolution policies in Japan: evidence from market equity

values. Their results supported the

information based contagion hypothesis, demonstrating that news concerning the

failure of a bank of a certain regulatory class was treated in equity markets as

representing a change in regulatory policy, even before these changes in

regulatory policy were officially announced. Philippatos and Viswanalthan (1994),

further said that the empirical evidence on the efficiency of the markets for bank

44
equities is mixed. If the market for the share of banks (or bank holding

companies) is efficient, information about events that have adverse effects on

creditor banks, such as the Moratorium announcements by major Third world

borrowers, should immediately translate into lower market prices. But if

the relevant market has some inefficiency due to asymmetric information

between the affected institutions and the market participants, the adjustment to

the market prices of the securities will not reflect the information conveyed by

the event. Also, Brewer, Genay, Hunter and Kaufman (1999), examine the effect

of Japanese bank failure announcements on surviving bank equity values.

Their results demonstrate that shareholders interpreted these failures as

adverse changes in the banking system. They also found that, sensitivity of bank

to news concerning bank failures was systematically related to bank financial

health. In sum, bank failed because of the impact of their exposure to credit risk

and with the level of capital market efficiency their stock prices react in line with

the information announced in the market or sneaked in. This theoretical

frame work will therefore review portfolio selection theory and capital asset

pricing model (CAPM) to show how investors react to risks while expecting high

returns. Of course, the foundation of this work is laid on these theories.

2.13 CREDIT RISK MANAGEMENT AND BANK PERFORMANCE IN NIGERIA

45
 Agency theory suggests that the firm can be viewed as a nexus of contracts

between resource holders. An agency relationship arises whenever one or more

individuals, called principals, hire one or more other individuals, called agents, to

perform some service and then delegate decision-making authority to the agents.

The primary agency relationships in business are those between

stockholders and managers; and between debt holders and stockholders. These

relationships are not necessarily harmonious; indeed, agency theory is concerned

with agency conflicts, or conflicts of interest between agents and principals

(Kieiman, 2011).

One particularly important agency issue is the conflict between the interests of

shareholders and debt holders. In particular, following a more risky but higher

return strategy benefits the shareholders to the detriment of the debt holders. It

can easily be seen why debt holders lose out: a more risky strategy increases the

risk of default on debt, but debt holders, being entitled to a fixed return, will not

benefit from higher returns. Shareholders will benefit from the higher returns (if

they do improve), however if the risk goes bad, shareholders will, thanks to

limited liability, share a sufficiently bad loss with debt holders. This conflict can be

addressed by the use of debt covenants, or by providing debt holders with a

hedge against such action by the shareholders by issuing convertible debt or debt

bundled with warrants (Pietersez, 2005).

46
 However, management decisions of a bank should be in line with the

Principal-agent relationships and should reflect efficient organization of

information and risk-bearing costs (Eisenhardt,vHarvey (2011) explained Return

on Equity (ROE) as an Indicator of profitability determined by dividing net income

for the past 12 months by common stockholder equity (adjusted for stock splits).

Result is shown as a percentage. Investors use ROE as a measure of how a

company is using its money. ROE may be decomposed into return on assets (ROA)

multiplied by financial leverage (total assets/total equity). ROE encompasses the

three pillars of corporate management: profitability, asset management, and

financial leverage. By seeing how well the executive team balances these

components, investors can not only get an excellent sense of whether they will

receive a decent return on equity but can also access management's ability to get

the job done. Return on equity is calculated by taking a year's worth of earnings

and dividing them by the average shareholder equity for that year. The earnings

number can come directly from the Consolidated Statement of Earnings in the

company's most recent annual filing with the SEC.

It can also be figured as the sum of the past four quarters' worth of

earnings, or as the average of the past five or 10 years' earnings, or it can even be

an annualized figure based on the previous quarter's results.

However, investors should be careful not to annualize the results of a seasonal

47
business, in which all of the profit is booked in one or two quarters. The

shareholder-equity number is located on the balance sheet. Simply the difference

between total assets and total liabilities, shareholder equity is an accounting

convention that represents the assets that the business has generated. It's

assumed that assets without corresponding liabilities are the direct creation of

the shareholder capital that got the business started in the first place.

Many analysts consider ROE the single most important financial ratio

applying to stockholders and the best measure of performance by a firm's

management. Return on equity is calculated by dividing net income after taxes by

owners' equity (Scott, 2003). Economic and financial literature pays a great deal

of attention to the performance of banks, expressed in terms of competition,

concentration, efficiency, productivity and profitability (Bikker & Bos, 2009).

Takang & Ntui (2008) examined the relationship between banks’ profitability

(ROE, ROA) and loan losses (Non-Performing Loans/ Total Loans).

Their results showed that non-performing loan of the financial

institutions is significantly negatively related to (ROE) by 1,506 percent. They also

found out that the banks with higher interest income (net interest/Average total

assets, interest net /total income) also have lower bad loans (NPL); how that non-

performing loan of the financial institutions is significantly negatively related to

48
profitability. The parameter value shows that 1 percent increase in non-

performing loans decreases profitability (ROA) by 0, 4168 percent. Cebenoyan et.

al. (2004) found evidence that banks which have advanced in risk management

have greater credit availability, rather than reduced risk in the banking system.

The greater credit availability leads to the opportunity to increase the productive

assets and bank’s profit.

This implies a high rate of loans to total deposit. Eduardus et. al.

(2007) studied the inter-relationship between risk management and bank

performance after relating both to corporate governance using triangle gap

model. They had non-performing loans and business risk as proxy variables for

risk management, to which it was explained that non-performing loans specifically

relates to credit risk. The proxy for bank performance was return on equity and

value at risk. VAR describes the quintile of the projected distribution of gains and

losses over the target horizon. Their result showed that nonperforming loan (NPL)

and business risk (BR) have significant effect on Value at Risk (VAR) at 1% level of

alpha. Both NPL and BR have positive effect on VAR. Furthermore, ROE has

significant effect on VAR at 1% level of alpha.

ROE has negative effect on VAR. This result

confirms risk management has significant effect on bank performance. He further

listed some advantages that are available to banks which better implement the

49
risk management and includes: increase in bank reputation and opportunity to

attract more wide customers in building their portfolio of fund resources;

increases in bank efficiency and profitability.

Neely and Wheelock (1997) examined whether loan loss provisions taken

by money centre banks and other large banks in the 1980s contributed to the

increased dispersion of state-level bank earnings in those years and concluded

that these factors had some effect on dispersion of state-level bank earnings.

Further analysis led to the conclusion that the nine money centre banks with

significant foreign loan exposure dramatically influenced average ROA in their

states in 1987 and 1989. Without its six money centre banks, New York would

have posted state-level ROA of – 0.05 percent in 1987, instead of its actual – 0.66

percent. Hays, Lurgio & Gilbert (2010) used measure of bank performance, the

efficiency ratio, as a basis for identifying low versus high efficiency banks.

It utilizes a linear multivariate discriminant model to identify variables that

differentiate between these two groups. In addition to profitability as measured

by return on average assets, other important variables included charge-offs to

loans. They concluded that community banks that desire to survive and thrive

should pay attention to these variables. Most of these are strategic variables over

which management and the board of directors have considerable control. Staffing

issues, decisions about deposit mix, credit standards, and quality and branching

50
decisions are within the scope of managerial decision making. While the liquidity

ratio is partly determined by exogenous factors such as market loan demand,

competition and the stage of the business cycle, it is controllable within limits.

The future for community banks favours those that are sufficiently

adept at understanding operating efficiency. The ability to compete with larger

institutions with greater resources depends on it. As the banking industry

recovers from the current economic and financial crisis, attention must be paid to

efficiency as a potential strategic advantage.

Credit risk is a serious threat to the performance of banks; therefore

various researchers have examined the impact of credit risk on banks in varying

dimensions.

Kargi (2011) evaluated the impact of credit risk on the profitability of

Nigerian banks. Financial ratios as measures of bank performance and credit risk

were collected from the annual reports and accounts of sampled banks from

2004-2008 and analyzed using descriptive, correlation and regression techniques.

The findings revealed that credit risk management has a significant impact on the

profitability of Nigerian banks. It concluded that banks’ profitability is inversely

influenced by the levels of loans and advances, non-performing loans and

deposits thereby exposing them to great risk of illiquidity and distress.

Epure and Lafuente (2012) examined bank performance in the

51
presence of risk for Costa-Rican banking industry during 1998-2007. The results

showed that performance improvements follow regulatory changes and that risk

explains differences in banks and non-performing loans negatively affect

efficiency and return on assets while the capital adequacy ratio has a positive

impact on the net interest margin.

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 to 2008. 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. Chen and Pan (2012) examined the credit risk efficiency of 34

Taiwanese commercial banks over the period 2005-2008.

Their study used financial ratio to assess the credit risk and was analyzed

using Data Envelopment Analysis (DEA). The credit risk parameters were credit

risk technical efficiency (CR-TE), credit risk allocative efficiency (CR-AE), and credit

risk cost efficiency (CR-CE). The results indicated that only one bank is efficient in

all types of efficiencies over the evaluated periods. Overall, the DEA results show

relatively low average efficiency levels in CR-TE, CR-AE and CR-CE in 2008.

52
 Felix and Claudine (2008) investigated the relationship between bank

performance and credit risk management. It could be inferred from their findings

that return on equity (ROE) and return on assets (ROA) both measuring

profitability were inversely related to the ratio of non-performing loan to total

loan of financial institutions thereby leading to a decline in profitability. Ahmad

and Ariff (2007) examined the key determinants of credit risk of commercial

banks on emerging economy banking systems compared with the developed

economies.

The study found that regulation is important for banking systems that offer

multi-products and services; management quality is critical in the cases of loan-

dominant banks in emerging economies. An

increase in loan loss provision is also considered to be a significant determinant of

potential credit risk. The study further highlighted that credit risk in emerging

economy banks is higher than that in developed economies.

Al-Khouri (2011) assessed the impact of bank’s specific risk characteristics, and

the overall banking environment on the performance of 43 commercial banks

operating in 6 of the Gulf Cooperation Council (GCC) countries over the period

1998-2008. Using fixed effect regression analysis, results showed that credit risk,

liquidity risk and capital risk are the major factors that affect bank performance

when profitability is measured by return on assets while the only risk that affects

53
profitability when measured by return on equity is liquidity risk. Ben-Naceur and

Omran (2008) in attempt to examine the influence of bank regulations,

concentration, financial and institutional development on commercial banks’

margin and profitability in Middle East and North Africa (MENA) countries from

1989-2005 found that bank capitalization and credit risk have positive and

significant impact on banks’ net interest margin, cost efficiency and profitability.

Ahmed, Takeda and Shawn (1998) 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. A bank exists not only to accept deposits but also to grant

credit facilities, therefore inevitably exposed to credit risk. Credit risk 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 greater extent

than any other risks (Gieseche, 2004). According to Chen and Pan (2012), credit

risk is the degree of value fluctuations in debt instruments and derivatives due to

changes in the underlying credit quality of borrowers and counterparties.

Coyle (2000) defines credit risk as losses from the refusal or

inability of credit customers to pay what is owed in full and on time. Credit risk is

the exposure faced by banks when a borrower (customer) defaults in honouring

54
debt obligations on due date or at maturity. This risk interchangeably called

‘counterparty risk’ is capable of putting the bank in distress if not adequately

managed. Credit risk management maximizes bank’s risk adjusted rate of return

by maintaining credit risk exposure within acceptable limit in order to provide

framework for understanding the impact of credit risk management on banks’

profitability (Kargi, 2011). Demirguc-Kunt and Huzinga (1999) opined that credit

risk management is in two-fold which includes, the realization that after losses

have occurred, the losses becomes unbearable and the developments in the field

of financing commercial paper, securitization, and other non-bank competition

which pushed banks to find viable loan borrowers.

The main source of credit risk include, limited institutional capacity,

inappropriate credit policies, volatile interest rates, poor management,

inappropriate laws, low capital and liquidity levels, direct lending, massive

licensing of banks, poor loan underwriting, laxity in credit assessment, poor

lending practices, government interference and inadequate supervision by the

central bank (Kithinji, 2010).An increase in bank credit risk gradually leads to

liquidity and solvency problems.

Credit risk may increase if the bank lends to borrowers it does not have adequate

knowledge about. The Nigerian banking industry has been strained by the

deteriorating quality of its credit assets as a result of the significant dip in equity

55
market indices, global oil prices and sudden depreciation of the naira against

global currencies (BGL Banking Report, 2010).The poor quality of the banks’ loan

assets hindered banks to extend more credit to the domestic economy, thereby

adversely affecting economic performance. This prompted the Federal

Government of Nigeria through the instrumentality of an Act of the National

Assembly to establish the Asset Management Corporation of Nigeria (AMCON) in

July, 2010 to provide a lasting solution to the recurring problems of non-

performing loans that bedeviled Nigerian banks.

According to Ahmad and Ariff (2007), most banks in economies such as

Thailand, Indonesia, Malaysia, Japan and Mexico experienced high non-

performing loans and significant increase in credit risk during financial and

banking crises, which resulted in the closing down of several banks in Indonesia

and Thailand. The aim of this paper is to assess the impact of credit risk on the

performance of Nigerian banks over a period of eleven years (2000-2010). The

study is motivated by the damaging effect of classified assets on bank

capitalization and would be of utmost relevance as it addresses how credit risk

affects banks’ profitability using a robust sample and the findings would serve as

the basis to provide policy measures to the various stakeholders on how to tackle

the effect of credit risk in order to enhance the quality of banks’ risk assets. A

56
total of twenty commercial banks operate presently in Nigeria, out of which

cluster sample of five was drawn.

The banks in no particular order include First Bank Plc., United Bank

for Africa Plc., Guaranty Trust Bank Plc., Zenith Bank Plc., andAccess Bank Plc. The

basis for the selection rests on the fact that these banks have been rated as the

topmost five Nigerian banks by Fitch rating and Bankers’ magazine as at January

2012 and they account for over fifty percent of deposit liabilities in the Nigerian

banking sector.

2.14 Risk Management and Risk Management Failure

Risk permeates firms’ economic activities, because risk is the lifeblood of

every organisation (Shimpi, 2001). Successful firms manage risk effectively, while

those that do not suffer. Risk has no universal definition; hence, variability of

outcomes is a common way of expressing risk (Skipper, 1997). Although

definitions risk varies; risk has two dimensions or components: uncertainty and

consequences. Consequently, risk can be described in terms of its effect (positive

or negative) on objective (Hillson and Murray-Webster, 2004; Damodaran, 2008;

Kannan and Thangavel, 2008).

The recent global events (from the global financial crisis to the

ensuing market volatility, decline in consumer confidence, and extreme

57
fluctuations in energy prices) have demonstrated that uncertainty permeates

firms’ operations. Likewise, financial failures observed during global financial crisis

also highlight the importance of ERM (Coşkun, 2012). Notwithstanding the

presence of risk and uncertainty in firms’ operations; uncertainty and risk have

not been effectively managed by many firms’ in Nigeria. Performance and risk are

inextricably linked. By establishing a consistent and disciplined process for

managing risks, firms’ can improve the predictability of their results. ERM can

earn firms’ better ratings and allows them to take advantage of lower costs of

capital.

Furthermore, the recent economic volatility has given risk management a

new focus and eminence. Successful firms’ are able and willing to effectively

integrate risk management at all levels of management process from strategy to

success. Risk management is an invaluable tool for managing uncertainty

associated with business. Business enterprises have always practice some forms

of risk management, implicitly or explicitly (Meulbroek, 2002). The concept of risk

management is, therefore, not so new because risk management techniques like:

risk reduction through safety; quality control and hazard education; alternative

risk financing; and insurance, including self-insurance and captive insurance, have

been in existence for a long time (Doherty, 2000).

Regrettably, organisations in Nigeria have been hampered by pitfalls in

58
traditional approaches to risk management, as risk management is rarely

undertaken in a systematic and integrated manner across firms. Traditional risk

management views risk as a series of single and unrelated elements where

individual risk are categorised and managed separately (Wolf, 2008; Hoyt and

Liebenberg, 2011). The major deficiency of traditional approach to risk

management is the narrow focus on threats, rather than focusing on both

opportunities and threats.

The holistic approach to managing a firm’s risks differs substantially from

historical practice, as typical firm’s tends to aggregate risk (effective risk

management), rather than isolating them (traditional risk management) (Wolf,

2008; Hoyt and Liebenberg, 2011). ERM engages risks across a variety of levels in

the organisation; thus focusing on both opportunity and threat.

However, in the literature, ERM has similar meaning with Enterprise Risk

Management (ERM), Corporate Risk Management (CRM), Holistic Risk

Management (HRM), Integrated Risk Management (IRM), Strategic Risk

Management (SRM), Enterprise-Wide Risk Management (EWRM) and Business

Risk Management (BRM) (D’Arcy, 2001; Liebenberg and Hoyt, 2003; Kleffner et

al., 2003; Gupta, 2004; Hoyt and Liebenberg, 2006; Manab et al., 2007; and Yazid

et al., 2009). Risk management is not a process for avoiding risks. Risk

management does not eliminate risks, but manages risks associated with firms’

59
operations, thereby maximises opportunities and minimises threats. Several

processes and frameworks have been developed in recent years to promote ERM

in both developed and developing economics.

Generally, the main stages of ERM, as shown in Figure 1, are: context

analysis; risk identification; risk analysis; risk evaluation; risk Firms’ focus varies,

as they are subject to different types of risks. Similarly, the degree of risk

management actions varies among business enterprises, subject to corporate risk

culture and risk appetite. The fundamental difference is that corporate risk

culture is a chosen response; while, corporate risk appetite exists as a tendency

independent of human choice (Hillson and Murray-Webster, 2011). The success of

a firm depends upon ERM (Jorion, 2001; 2009). ERM can align with the business

assumptions and proactively help in overcoming the possibilities of the business

failures (Gupta, 2011). Likewise, ERM reduces earning volatility, maximises value

for shareholders, and promotes job security and financial security in the

organisation (Lam, 2001). Meanwhile, Oracle (2009) identifies four factors

which have contributed to the relative immaturity of risk management in most

organisations: lack of executive commitment to risk management; fragmented

risk management activities; viewing risk management from historical, not

predictive, perspective; and lack of alignment among corporate strategy, strategic

planning, and risk management.

60
2.15 Why Business Enterprises Should Manage Risks?

Business enterprises in Nigeria should manage risks by implementing and

maintaining ERM because:

Evolution of several risks from events around the world. It is necessary that firms’

should effectively manage these risks in order to survive in the global dynamic

business environment;

 People are more aware of the level of service to expect, and the recourse

they can take if they have been wronged;

 People are now more likely to sue firms for damages. Taking the steps to

reduce injuries could help in defending against a claim;

 Courts are often sympathetic to injured claimants and give them the

benefit of the doubt. Thus, organisations are held to very high standards of

care;

 Organisations are perceived as having a lot of assets and/or high insurance

policy limits to take care of damages and liability towards customers and

third party; and

 Organisations are vicariously liable, i.e. being held liable for the actions of

their employees, volunteers and contractors (Gupta, 2011; Lam, 2001;

Coşkun, 2012).

61
2.16 Benefits of ERM to Business Enterprises

Risk management provides a clear and structured approach to identifying,

measuring and prioritising risks in order to take appropriate actions to minimise

losses. An ERM practice does not eliminate risks, but minimise risks. However,

implementation and maintenance of ERM indicates that a firm is committed to

improved business processes efficiency. The benefits of ERM to organisation

include:

 Saving resources: time, assets, income, property and personnel;

 Protection of an organisation reputation and public image;

 Prevention or reduction of legal liabilities;

 Increasing the stability of operations and promoting continuous

improvement;

 Protecting people and environment from harm;

 Avoiding fines for corporate non-compliance with regulations and

legislation;

 Enhancing the ability to prepare for unforeseen and unexpected

circumstances;

62
  Enhancing competitive advantage through improved decision support and

market intelligence based on more accurate risk-adjusted management

information;

 Improved shareholder value and confidence, which is especially valuable in

times of crisis when shareholder trust is stressed to its maximum limits;

and

 Assisting in clearly defining suitable risk management techniques, including

insurance needs (Meulbroek, 2002; Hillson, 2006; Protiviti, 2006).

2.17 Risk Management Failure

ERM is a proactive approach to minimise threats, maximise opportunities,

and optimise achievement of objectives (Pearce and Robinson, 2000; Hillson and

Murray-Webster, 2004; Gray and Larson, 2006; Rejda, 2011). Basically, managing

a business successful entails minimising bad risks and taking advantage of good

ones. Consequently, organisational threats cannot be completely eliminated;

hence, the best managed business may still experience losses due to unaccounted

threats. Three examples of otherwise successful companies that fell victim to

some unmitigated risks are: JPMorgan, Merrill Lynch and MF Global. The financial

institution's London branch made a bet on illiquid corporate credit-derivative

63
indices to help manage overall exposure to markets. The trades ended up costing

JPMorgan nearly $6 billion and resulted in a severe hit to its public reputation.

The

backlash was so severe that the company’s chief information officer left the

company (Lundgren, 2012). Similarly, in 2007 and 2008 Merrill Lynch lost

approximately $30 billion on the back of soured mortgage investments due to risk

management failure. Consequently, the company was sold Bank of America. In

addition, In 2009 Bank of America Chief Officer was forced to step down because

he was not transparent with investors as to the severity of Merrill Lynch's

financial situation (Lundgren, 2012). Likewise, MF Global was accused in 2011 of

misappropriating $1.6 billion of customer money as it filed for bankruptcy.

This was after revelations of large exposures to troubled European

bonds (spurred) credit-rating agencies to slash its rating (Lundgren, 2012). This

further emphases the importance of ERM, and firms’ need to engage tools at their

disposal to prevent threats from damaging their business.

In practice, risk management often fails to meet expectations, as demonstrated

by repeated business and project failures. Business enterprises in Nigeria are not

exempted from such failure.

Foreseeable threats can result to problems and crises; while, achievable

opportunities can mislead to loss of benefits (Hillson and Murray-Webster, 2007).

64
ERM addresses risk across a variety of levels in the organisation, including

strategy and tactics, covering both opportunities and threats (Hillson, 2006).

However, the best risk management framework does not protect firms from

consequences of risk (Landier et al., 2009; Bozek and Tworek, 2011). The growing

interest in risk management is the result of a number concurrent secular trend.

The recent tumult in credits and financial markets has drawn attention to the risk

management function. The number, type, and extent of both financial and non-

financial firms’ exposures have also increased significantly. Consequently, risk

management has failed to play its roles in the period that led to the current crisis

(Missal and Richman, 2008; Landier et al., 2009; Golub and Crum, 2010). Hillson

and Murray-Webster (2004:1) argue that the most significant critical success

factor for ERM is ‘an appropriate and mature risk culture’.

Risk management, even if flawlessly executed, does not guarantee that

large losses will not occur (Kimball, 2000; Stulz, 2008; Hubbard, 2009; Jorion,

2009). In spite of all risk management measures, a number of firms (e.g.

JPMorgan, Merrill Lynch and MF Global) incurred large losses during the credit

and financial crises. Can we then conclude that the firms risk management system

was flawed? Matei et al. (2012) assert that companies fail due to unexpected

losses generated by three categories of causes: insufficient capital (due to the

huge dimension of losses which exceed the socially acceptable hurdle for

65
insolvency); model errors (i.e. misestimating of outcomes distribution due to

errors occurred in risk measurement); and risk ignorance (i.e. firms’ ability of

managing their equity capital and measure their exposures is directly linked to

their capacity of acting as buffers against errors in risk management).

Similarly, Kimball (2000) states that risk mitigation and management

system can fail for more subtle and indirect reasons. He identifies three major

reasons why risk management fails: agency risk; shift or changes in the form or

risk; and incremental failure (Kimball, 2000). Firstly, according to him, perhaps the

best known reason for failure of risk management system is agency risk.

Agency risk refers to the risk that a manager or employee, inadvertently or

purposefully, fails to follow policies or procedures designed to mitigate and

manage risks (Kimball, 2000). Secondly, there is tendency for risk to shift or

change form. While a firm may mitigate its risk by hedging or purchasing

insurance, these actions do not reduce systematic risk in the economy. Systematic

risks (sometimes identified as uncontrollable or unavoidable risks) are risks

associated with the overall market or the economy. Such risks are outside the

control of the firms operating in the market or the economy. Thus, hedging or

purchasing insurance does not really eliminate risk, but simply transforms the

nature of the risk (Kimball, 2000). Thirdly, there is tendency for risk management

process to fail incrementally over a long period of time.

66
 The incremental failure is often caused by a long incubator period arising

from a gradual degradation of the risk management processes, which accumulate

over a long period of time (Kimball, 2000). However, risk management

incremental failure can be avoided through regular review of risk exposures and

the risk management framework (Grabowski and Roberts, 1997; Kimball, 2000;

Charette, 2002; Bozek and Tworek, 2011).

Whilst examining lessons from credit crisis, Jorion (2009:5) classifies risks

into three categories: ‘‘known knowns’’, ‘‘known unknowns’’, and ‘‘unknown

unknowns’’. First, according to him, ‘‘known knowns’’ refer to a flawless risk

measurement system, where all the risks are perfectly measured (Jorion, 2009:6).

This implies that the risk manager adequately identifies and measures all the firm

risk factors and exposures. Second, the ‘‘known unknowns’’ categories of risk are

the numerous blind spots, broadly categorised as model risk (Jorion, 2009:6).

Model risk can arise in three major ways, where: (1) the risk manager could have

ignored important risk factors; (2) the distribution of risk factors could be

measured inaccurately; and (3) the mapping process, which consists of replacing

positions with exposures on the risk factor, could be incorrect (Jorion, 2009).

Third, ‘‘unknown unknowns’’ are the categories of risks or events that are

totally outside the scope of most scenarios; thus constitute different levels of

67
uncertainty (Jorion, 2009:6). In essence, the unknown unknowns are highly

volatile risks, such as regulatory risks or structural risks, which affect the entire

industry. Likewise, Hubbard (2009) states that when risk management has failed,

this implies that one of the following ten general causes occurred:

(1) confusion regarding the concept of risk;

(2) completely avoidable human errors in subjective judgments of risk;

(3) entirely ineffectual but popular subjective scoring methods;

(4) misconceptions that block the use of better, existing methods;

(5) recurring errors, in even the most sophisticated models;

(6) institutional factors due to unnecessary isolation of risk analysts from each

other - both within the same organisation and among organisations;

(7) Unproductive incentive structures;

(8) except for certain quantitative methods in certain industries, the effectiveness

of risk management is almost never measured; (9) some parts that have been

measured do not work; and (10) some parts that do work are not used. Similarly,

while discussing the typology of risk management failures, Stulz (2008)

emphasises that two types of mistakes can be made in measuring risk: known

risks can be mismeasured; and some risks can be ignored, either because they are

unknown or viewed as not material. Moreover, ignored risks can take three

forms, which have different implications for a firm. First, a firm may ignore a risk

68
even though that risk is known; second, somebody in the firm may know about a

risk but fail to disclose such risk, thus the risk is not captured by the firm’s risk

models; and third, there is a realization of a truly unknown risk (Stulz, 2008). Once

risks have been identified and measured, they should be communicated to the

firm’s managers.

Failure to communicate risk to the management can result to failure of risk

management. In essence, these failures suggest that we still take unnecessary

risks within risk management itself. Consequently, risk management failure can be

classify into six. According to Stulz (2008), these include:

 Mismeasurement of known risks;

 Failure to take risks into account, i.e. mismeasurement due to ignored risk;

 Failure in communicating the risks to top management;

 Failure in monitoring risks;

 Failure in managing risks; and

 Failure to use appropriate risk metrics or measurement system.

Having considered factors which may be responsible for failure of risk

management (Kimball, 2000; Stulz, 2008; Hubbard, 2009; Jorion, 2009); it is

therefore relevant to state that the causes of risk management failure can be

categorised into two: operational failure and operators’ failure.

69
Operational Failure

Operational failure arises from development and execution of risk

management framework or system. To minimize operational failure, the adopted

risk management framework must be realistic, workable and clearing describe:

what is and what is not a part of the framework, what to be done, those

responsible for actions, and the manner it should be done. Operational failures

can further be classified into two:

(i) faulty system, i.e. inadequate or defective framework, and

(ii) inadequate modus operandi (mode of operation) – arising from

ineffective and inefficient mode of operation. Modus operandi here means

a method of procedure that indicates the manner and methods of

operating the risk management framework.

A firm risk management will surely fail if an inappropriate risk

management model is adopted, or a defective risk management model is

developed for use in the firm. Moreover, an effective and efficient modus

operandi facilitates proactive risk management and attainment of a firm’s

objectives. The best risk management system can be marred by ineffective

and inefficient modus operandi. Also, to ensure that risk management

expectations are achieved, its modus operandi must be adequately

70
 documented, executed, and reviewed regularly. Finally, risk management

system must be tailored to adequately manage individual firms peculiar risk

exposures.

2.17.2 Operators’ Failure

Operators’ failure arises from a firm’s managers’ errors or misconducts. Risk

management is a proactive approach to minimise threats, maximise

opportunities, and optimise achievement of objectives (Pearce and Robinson,

2000; Hillson and Murray-Webster, 2004; Gray and Larson, 2006; Rejda, 2011).

Hence, a firm’s risk management operators’ (managers) can contribute to failure

of risk management. However, risk perception is responsible for the

disagreements about the best way of managing risk (Finucane et al., 2000; Coyle,

2002; Slovic and Weber, 2002; Weber et al., 2002). Consequently, operators

failure can be influenced by three basic, individual and corporate, factors: risk

attitude, risk culture, and risk appetite. One of the reasons responsible for the

failure of operators’ failure is the attitude that individuals or groups of people

hold towards the perception of threats and opportunities (Hillson and Murray-

Webster, 2007; Damodaran, 2008). Risk attitude is a chosen state of mind

regarding uncertainties which could impact, positively or negatively, on objectives

71
(Hillson and Murray-Webster, 2007). Risk attitude to a particular situation vary

from person to person, team to team, organization to organization, and nation to

nation. Hence, a firm’s attitude towards risk determines its management

perspective on taking risks in achieving the corporate objective (Coyle, 2002). Risk

culture also affects how humans perceive risks, as it serves as interpretive filters

which influences how human understand and describe the world (Arnoldi, 2009).

Culture is a set of values and meanings which shape our perception of what

constitute the biggest potential dangers; and it forms the basis for our reasoning

about the solution (Arnoldi, 2009).

Risk culture entails the prevalent attitudes and beliefs of organizations’ staff;

i.e. the shared beliefs, values and knowledge of a group about risk (Levy et al.,

2010; Hindson, 2011; Yates, 2011). Similarly, risk appetite is governed by how risk

taking is perceived, communicated and rewarded (Hillson and Murray-Weber,

2007; Hindson, 2011). Consequently, to minimize risk management failure, firms

operators (managers) must develop and articulate good corporate risk attitude,

risk culture and risk appetite.

This is necessary as good risk attitude, strong risk culture and clearer risk

appetite play critical role in determining a firm’s health and performance (Levy et

al., 2010; Hillson and Murray-Webster; 2011).

72
Summary

The literature review focused on the meaning of risk management as an

occurrence or possibility of loss. It was clearly stated that risk is undertaken by

every business and the commercial banks are not left out. Empirical studies were

also considered in the literature review.

CHAPTER THREE

RESEARCH DESIGN AND METHODOLOGY

Research methodology in project work involves the acquisition of relevant

data and analysing it by using the appropriate statistical techniques.

3.1 RE-STATEMENT OF RESEARCH QUESTIONS

 The type of risk banks are prone to?

 Whether attitude of borrowers towards loan repayment constitute a risk

factor in bank?

 Methods used by banks to hedge against risk?

 Whether the risk management techniques put in place have curbed the

various operational risks in the bank and for investors?

The population of the study comprises the total number of commercial

banks in Nigeria. However, first bank holdings was taken as the sample to be used

being the oldest and the biggest bank and an investment firm.

73
 3.2 SOURCES OF DATA

Data used in this study are mainly from primary and secondary source

respectively. Each of these sources was adopted where the information being

sought for was adequately met sources. The major source of data used for this

study was primary source, though supported with secondary source. The data

were sought through the use of questionnaire served on 55 workers and investors

of first bank holdings. Only 50 were received from the served respondents and

the analysis was based on the 50 questionnaires.

Secondary data includes the data sourced from textbooks, magazines,

journals and newspapers. These sources have been immense help to the research

more especially in the literature review.

3.3 DESCRIPTION OF DATA ANALYSIS

The data collected through the questionnaire were analysed through the

uses of simple percentages. The hypothesis of the study was tested with the use

of chi –square test method using the significance level of 5%. Analysis of variance

statistical techniques (ANOVA) was also used to test the hypothesis formulated.

The presentations are all in tabular form.

74
3.4 ADMINISTRATION OF THE DATA COLLECTION INSTRUMENT

In tendering these research questions to the respondents, the researcher

took appropriate measures to avoid possible loss of the research questions in

transit. He also tenders the research by hand to avoid being unduly influenced by

contemporary opinion. Questionnaires were given to 50 respondents to help in

the analysis of the data to be analysed.

3.5 LIMITATION

Time, as in all human endeavours placed the most severe limitation on the

collection of data. Hardly is there any human endeavour without its dose of

challenging.

Another limitation to this research is financial constraint. This hindered the

progress of the research; however, the outcome of the research was not

hindered.

Summary

This research focused on the research design, the collection instrument and

the data analysis. This research will use chi-square as the method of data analysis

through the use of questionnaire as the data collection method.

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 CHAPTER FOUR

DATA PRESENTATION AND ANALYSIS

4.1 INTRODUCTION

This chapter deals with data presentation, analysis, testing of hypothesis and

interpretation. There is a need for a data collected to be critically and accurately

analysed as inaccurate data give rise to a faulty interpretation which invariably

causes misleading conclusions.

The data presented in this chapter for analysed are those collected from

primary source with aid of questionnaires administered to the relevant

institutions and individual alike.

The data collected through the questionnaire were analysed through the use

if simple percentages. The hypothesis of the study was tested with the use chi-

square test (x2) method using the significance level of 5%. Analysis of variance

statistical technique (ANOVA) was also used to test the hypothesis formulated.

76
4.2 ANALYSIS OF DATA

Table 1.1: The type of risk the first bank is prone to

Response Frequency Percentage Cum, percentage

Valid credit risk 20 40.0 40.00

Interest rate risk 02 04.0 44.00

Liquidity risk 02 04.0 48.00

Operations risk 14 28.0 76.00

Reputation risk 12 24.0 100.00

Total 50 100

From the table above, 20 respondents ranked credit risk as the major risk

confronting the bank’s activities. This is followed by operations risk and

reputation risk having 28% and 24% of the respondents respectively. The interest

rate risk and liquidity risk have low effect on the banks because banks benefit

77
more during high interest rate regime and may decide to reduce loan and

advances during low liquidity level. Hence, the percentages of respondents who

believe is prone to them is very low.

Table 1.2: Whether Fraud and forgeries contribute to risk exposures in banks.

SD= strongly disagree, D=Disagree, I=Indifferent, A=Agree, SA= strongly agree

Response Frequency Percentage Cum.percentage

SD 03 6.0 6.00

D 11 22.0 28.0

I 07 14.0 42.0

A 17 34.0 76.0

SA 12 24.0 100.0

TOTAL 50 100

The information above shows that 24% of the respondents strongly agree

that fraud and forgeries contribute to risk exposures in the banking industry while

34% also backed the preposition. Only 22% and 6% of the respondents disagreed

and strongly disagreed with the notion respectively and 14% of the respondents

were neutral. Hence, we can conclude that fraud and forgeries contribute to risk

exposure in Nigeria banking industry.

78
Table 4.2: Whether attitude of borrowers towards loan repayment constitute a

risk factor in the bank.

Response Frequency Percentage Cum. Percentage

SD 0 0 0

D 13 26.0 26.0

I 06 12.0 38.0

A 19 38.0 76.0

SA 12 24.0 100.0

TOTAL 50 100

The table above revealed that 24% of the respondents strongly agreed with

the statement that attitude of borrowers towards loan repayment constitute a

risk factor in the banks and 38% of the respondents disagreed with the statement

while 12% of the respondents remained indifferent.

Table 4.2: Various Methods used by banks to hedge against risk.

79
Response Frequency Percentage Cum. Percentage

Risk avoidance 22 44.0 44.0

Risk retention 07 14.0 58.0

Loss prevention 17 34.0 92.0

Loss reduction 02 04.0 96.0

Indifferent 02 04.0 100.0

TOTAL 50 100

Based on the exposition above, 44% of the respondents chose risk avoidance

method, 14% chose risk retention method and 34% chose loss prevention method

as the various methods used in hedging against risk in the bank. Only 4% of the

respondents chose loss reduction method for hedging against risk. Therefore, risk

avoidance method is the most popular method used in hedging against risk in the

banking industry followed by loss prevention method.

Table 4.5: Whether the risk management techniques put in place have curbed the

various operational risks in the bank.

Response Frequency Percentage Cum. Percentage

Very effectively 30 60.0 62.50

80
Effectively 17 34.0 97.90

Ineffectively 01 02.0 100.0

Total 48 96.0

Missing system 02 0.40

TOTAL 50 100

The above revealed how effectively the various risk management techniques

used by the bank have been able to curb the various operational risks confronting

the bank. 60% chose very effectively, 34% chose effectively and only 2% chose

ineffectively. This shows that the various risk management techniques put in

place by the management of first bank have been helping to curb the operational

risks confronting the bank.

4.3 HYPOTHESIS TESTING

The hypothesis tested in the study as stated below was tested using the chi-

square (x2) and F statistic.

Ho: Risk management techniques put in place have not been able to curb the

various operational risks in the bank.

H1: Risk management techniques put in place have been able to curb the various

operational risks in the bank.

81
Table 4.5 replicated: Whether the risk management techniques put in place have

curbed the various operational risk in the bank.

Response Observed N Expected N Residual

Very effectively 30 16.0 14.0

Effectively 17 16.0 1.0

Ineffectively 01 16.0 15.0

TOTAL 48

TEST STATISTIC: whether the risk management techniques put in place have

curbed the various operational risk in the bank.

CHI SQUARE: 26.375

D.F [DEGREE OF FREEDEOM]:2

SIGNIFICANCE: 00

Decision rule

82
 Where the computed value of chi-square (x2) is less than the tabulated value

at 5% level of significance, we accept the null hypothesis (Ho) while we reject the

alternative (H1) and vice versa. From the calculation above through the use of

statistical packages for social science (SPSS), the calculated chi-square ( ) value of

26.375 is greater than the tabulated chi-square ( ) which is 4.61. Therefore we

reject the null hypothesis and conclude that risk management techniques put in

place have been able to curb the various operational risks in the bank.

ANOVA TABLE

Sum of DF Mean F Significance

square square

Between 2.935 3 0.978 0.012

groups

Within 10.545 44 0.240 4.082

groups

TOTAL 13.479 47

Summary

83
 This chapter focused on the data presentation, and the data analysis; this

showed the data collected from questionnaire and the analysis of the data

collected through the use of the chi-square and the ANOVA table. The data

concluded that risk management techniques put in place to curb operational risks

in the banks and investors.

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 CHAPTER FIVE

SUMMARY OF FINDINGS, RECOMMENDATION AND CONCLUSION

5.1 SUMMARY OF FINDINGS

Despite the important role played by credits in economic growth and

development of a country, it is associated with catalogue of risk. If risk are

improperly assessed and prioritized, time can be wasted in dealing with it. And

also spending too much time assessing and unlikely risks can divert resources that

could be used more profitably. It is important to know that prioritizing too highly

the risk management process and could keep banks form ever completing a

project or even getting started. In this case, banks should be careful in their risk

management.

The former CBN Governor started by positioning the Nigerian banks into

entering the global financial market and it is important that certain domestic

issues be handled. It is important that such entry be combined with a

commitment to open markets, adequate infrastructure, including good

information, a proper framework for selected lending and sufficient transparency.

From the finding of this research work, it can be deduced that fraud and forgeries

85
in banks constitute a risk factor to bank’s performance and is therefore playing an

adverse role in its activities.

It was also discovered that among the various types of risk confronting

banks’ performance, operations risk and credit risk are the commonest. These

risks revolve around the activities of the management and the workers in the

banking industry.

However, the study showed that some risk management techniques put in

place have been able to check or curb the various operational risks in the bank.

This can be observed as there is a peaceful atmosphere currently surrounding the

Nigeria banking industry unlike few years ago which can be called liquidation

period in the banking system, though the management of various banks have not

risen to the task of avoiding totally the avoidable risks inherent in the system.

5.2 RECOMMENDATION

It is the contention of this research to also recommend that so grow nearly

into having a perfect banking industry in Nigeria; it is also therefore

recommended that apart from the operational risks as a result of human error or

inefficiency in the banking hall, there are still other types of risk that should be

paid attention to. The one that stood out is the credit risk which is still having

adverse effect on banks’ performance.

86
 Nigerian government should strengthen the legal frame work for the

enforcement of loan repayments form borrowers to banks.

Every bank should update its infrastructure so as to curb the system risk

confronting the Nigeria banks. This would also prevent system failure.

The financial market regular should adopt a risk based management

approach that is incomplete compliance with international standards focusing to

the financial and operation risk faced by banks.

Banks should also set up inspection departments to perform internal

checking functions to guide against operational problems.

The Nigerian government should create conducive environment for the

smooth operations of the banks. This comprises regular power supply and safe

distribution of funds in the economy.

5.3 CONCLUSION

The study have been able state out to get in-depth analysis on risk

management in banking industry thus highlighting the Nigeria banking industry at

some point. If the recommended solutions are properly used, risk in the industry

will be minimal and thus create a nearly perfect banking industry.

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 Also, the central bank together with the government and all financial

organization should also strive to make the banking industry a better place for

possible investors.

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 APPENDIX A

Department of Banking and Finance,

Faculty of Management Sciences,

University of Abuja,

P.M.B 114,

F.C.T

Abuja,

Dear Sir/Madam,

REQUEST TO ANSWER A QUESTIONNAIRE

I Omiwale Tunde of the above mentioned Department in University of Abuja,

Abuja am a final year student and presently carrying out a research project on the

“empirical studies on risk management for banks and investors” with reference to

your institution.

Please kindly assist in answering the questionnaire. The information provided in

the questionnaire is surely for academic purpose and shall be treated with utmost

confidence.

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Thanks for your co-operation

Yours faithfully,

Omiwale Tunde

APPENDIX B

Dear Respondent,

This questionnaire is designed to collect data from the officials and investors of

first bank holdings that will help the researcher about “the empirical studies on

risk management on investors and banks. Please help the researcher by giving

honest opinions. Confidentiality will be highly regarded. Thanks for your

anticipated cooperation.

SECTION A: BACKGROUND

a. Sex: Male _________ Female __________

b. Marital Status: Married _____ Single _____ Divorced _____

Widow/Widower

c. Educational Qualifications: SSCE/GCE/NECO_____ OND/NCE/AL _____

HND/B.SC/BA/ACCA _______ M.SC/MBA/MA _________

d. Years of service: 1-5 years

6-10 years

95
 11-15 years

16-20years

20 and above years

Please tick the gap of your choice of answer

SECTION B: Empirical Analysis of Risk

1. What kind of risk is first bank prone to?

Valid credit risk ______

Interest rate risk _______

Liquidity Risk ________

Operations Risk _______

Reputation Risk ________

2. Does fraud and forgeries contribute to risk exposures in banks?

Strongly disagree ______

disagree ________

Indifferent ______

Agree _______

Strongly Agree _______

96
3. Does the attitude of borrowers towards loan repayment constitute a risk

factor in the bank?

Strongly disagree ______

disagree ________

Indifferent ______

Agree _______

Strongly Agree _______

4. What is the method used by the bank to hedge risk?

Risk avoidance ________

Risk retention _________

Loss prevention ________

Loss reduction ________

Indifferent ___________

5. Has the risk management techniques put in place have curbed the

operational risk in the bank.

Very effectively _______

Effectively ________

ineffectively ________

97
Total __________

Missing system_________

98
99