FINANCIAL RISK MANAGEMENT AND FINANCIAL PERFORMANCE OF LISTED NIGERIAN DEPOSIT MONEY BANKS

FINANCIAL RISK MANAGEMENT AND FINANCIAL PERFORMANCE OF LISTED NIGERIAN DEPOSIT MONEY BANKS

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CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

In recent times, the banking sector has witnessed a major transformation in its environment due to improvement in the requirement of financial risk and high tech facilities, resulting in significant impact on its performance (Soliman & Adam, 2017).

Banks as a financial institution has the major role of lubricating the gears facilitating the economic operations of a nation. The banking sector plays one of the most important roles in the economic life of a country. It is the major mechanism of moving funds from the saving units to the spending units. If a financial system is efficient, it indicate improvements in performance. The banking sector facilitate the production, distribution, exchange and consumption process in an economic system thereby making it the most essential component of a country’s sustainability development ( Davydenko, 2011).

Risk can be characterized as a hazard, a chance of bad consequences, loss or exposure to mischance. Risk is an integral part of financial services. (Defaul in Charles, Jane & Cheruiyot, 2014). When banks collect deposits and lend them to other clients (i.e. conduct financial intermediation), they put clients’ savings at risk. Any institution that conducts cash transactions or makes investments risks can led to loss of funds which hitherto is financial risk.                                      

The efficiency of financial risk management could be verified by measuring banks profitability whereby any financial institution has set profitability as its essential objective to be achieved and thus “Superior risk management practices are really good for the assessment of financial risk” (Bird and Skinner as cited in Ariffin & Tafri, 2014). Financial risk is inherent in every institution, but deposit money banks that embed the right financial risk management strategies into business planning and financial performance management are more likely to achieve their strategic and operational objectives. Taking financial risk management is core to the Bank’s financial performance. The bank’s aim is therefore to achieve an appropriate balance between risk and return and minimize potential adverse effects on its financial performance. This requires more dynamic and sound Financial Risk Management methods to perform well in an ever dynamic and highly competitive banking industry, which will translate into having a competitive advantage and thus generate growth in profits. Financial risk management present opportunities through which firms can have a competitive edge over others and contribute to improvement of financial performance (Ashby, Palermo & Power (2013)).

The recent financial crisis and the failure of banking system even in the developed countries like the USA have forced the policy makers and researchers to look into the details of these failures and in doing so, financial risk has come out as one factor that need to be addressed by banks to guarantee their sustenance. Therefore a bank must determine what its level of financial risk is and then implement a financial risk management requirement that would cover that risk (Ashby et. al. 2013). A study by consultancy firm of Central Bank of Nigeria (2018), asserts that banks, having moved to enhance the structure of risk management post-crisis, are still working to fully operationalize those policies with most banks still finding it difficult to embed risk appetite. Banks are reviewing their cultures across legal entities and business

The Nigerian Financial Sector is considered as one of the key segments of the economy. According to CBN, the banking sector employs more than 60,000 employees and the volume of transactions in terms of monetary value has been growing at an average of 10.5% pa since 2011. The Nigerian vision 2020 blue print identifies financial sector stability as one of the attainment of the objectives of the strategy and point out that the sector should grow by 20% to help the country achieve its objective. This can only be achieved if there is growth in and stability in the financial sector and cases of the institutions insolvency or financial crisis happening should be prevented at all cost. Financial risk management helps lessen the chances that a bank may become insolvent if sudden shocks occur. Apart from that, the impact of financial risks namely interest rate risk, credit risk, liquidity risk and inflation is a vital agenda for all financial institutions. Indeed, facts have showed that banks are exposed to a wide array of risks whereby there are stand outs and normally related to each other. To quote (Ariffin and Tafri, 2014) “An increase in inflation rate would trigger credit risk as it leads to an increase in the number of loan defaults, the increase in inflation rate could also lead to liquidity problems.” Hence, the management of the banks could focus on the positive effects and mitigate the negative effects. So, the wealth of the bank owners and depositors can be maximized.

Performance is the crucial test of the effectiveness of risk management. It is the bottom-line of any financial institutions and thus “Superior risk management practices are really good for the bottom line” (Bird and Skinner as cited in Tafri, Hamid, Meera, & Omar 2009). Thus, knowing the impact that the financial risks have on the performance of bank is a vital agenda for all financial institutions as it would enable the bank to manage those risks effectively. Moreover, a strong and profitable banking system promotes broader financial stability and increases the economy’s resilience to adverse macroeconomic shocks. The tradeoff between risk and return is well acknowledged - the higher return comes with higher risk. Therefore in order to increase the return, banks should know which risk factors have greater effect on performance. Furthermore, it is also a well-known fact that the amount of risk faced by banks is of substantial nature and is of great concern to the policymakers. Therefore, information about key sources of major financial risks and the impact that the risks may have on profitability of the Deposit Money Banks could be analyzed. Hence, this study would contribute information to the current literature, body of knowledge and regulators.

1.2 Statement of the Problem

The motivation for this study stem from the fact that the banking sector is still facing a down turn in its activities there by leading to the de-listing of banks from Nigerian stock exchange. Existing known studies in this direction in Nigeria are: (Olamide, Uwalomwa & Ranti (2015), Oluwafemi, Israel, Simeon & Olawale (2014), Dabari & Saidin (2014). Those that have focused on other African countries are Muteti (2014), Mutuku (2016), Wanjohi, Wanjohi, & Ndambiri (2017), Ofosu-Hene & Amoh (2015) and those that have focused on a panel of countries ( Imane (2014), Nair, Purohit & Choudhary (2014), Athansasoglou, Delis & Staikouras (2018)). As such, this study tries to integrate both the bank specific variable: credit risk management, Liquidity risk management, capital adequacy ratio and the industry related variable: inflation risk management to measure financial risk management while return on asset is used for performance for the period 2009 – 2016. To the researches Knowledge, no study used the same combination of variables to measure financial risk management and assess them on performance.

More so, the researcher practically noticed from the financial statements of listed banks in Nigeria that in-between 2009 to 2016, over 25.6% was a loss on performance, and for the year 2016 alone, 32% of the firms made loss out of the 16 firms under study. Also, according to National Bureau of Statistics (November 2016). The banking Sector is the major subsector which account for 87.09% in real terms. As a whole the sector grew at –3.88% in nominal terms (year on year), with the growth rate of –4.47% recorded for the banking sector. The overall rate was lower than that in third quarter of 2016 by -24.53% points, and lower by -21.56 % points than the preceding years. Again driven by the financial institutions activity, growth of the sector in real terms totaled –5.96%, lower by –8.61% points from the rate recorded in 2016 and down by –16.42% points from the rate recorded in the preceding years. Year on Year growth in real terms stood at –11.67%. The contribution of Finance and banks to real GDP totaled 2.69%, lower than the contribution of 2.90% recorded in 2016, yet lower than 3.32% recorded in the preceding year. This shocking revelation prompt the researcher to emphasize on the importance of financial risk management on the Listed Nigerian deposit money banks and their financial performance which is aimed at addressing the challenge of ever emerging risks within the sector. It is an attempt to critically examine the various practices through which the banking sector, manage the various types of risks that they face, and determine if there was any relationship between the practices and the financial performance of these companies. The study, therefore, sought to fill the gap in knowledge about the possible existence of a relationship between financial risk management and financial performance of listed deposit money banks in Nigeria.

 Also, because of the variability of the size of the banking sector, a control variable is introduce to control the size difference of the Nigerian Banks, so that a moderated result can be determine by the researcher. Also, This study will also fill in a period gap by extending the use of data to present times in order to breach the gap between now and previous studies which might have been overtaken by changes in time, standardization and improvement in technology/software application considering the fact that operations in most sectors of the Nigerian and other world economies has gone technological.

1.3 Objectives of the Study

The main objective of this study is to examine the impact of financial risk management on the performance of the Nigerian deposit money banks. Other specific objective is to:

1.       Assess the impact of credit risk on profitability of listed deposit money banks in Nigeria

2.      Determine the impact of liquidity risk on profitability of listed deposit money banks in Nigeria

3.      Investigate the impact of capital adequacy ratio on profitability of listed deposit money banks in Nigeria

4.      Ascertain the impact of inflation rate on profitability of listed deposit money banks in Nigeria.

1.4 Research Hypothesis

Based on the stated objectives, the following hypotheses are formulated in null form:

H01:      Credit risk has no significant impact on profitability of listed deposit money banks in Nigeria.

H02:      Liquidity risk has no significant impact on profitability of listed deposit money banks in Nigeria.

H03:      Capital adequacy ratio has no significant impact on profitability of listed deposit money banks in Nigeria.

H04:      Inflation rate has no significant impact on profitability of listed deposit money banks in Nigeria.

1.5       SCOPE OF THE STUDY

This study duals on financial risk management and financial performance of listed Nigerian deposit money banks. It covers a period of eight years (2009-2016). The study is limited to only listed firm that are quoted on the floor of the Nigerian stock exchange as at Dec 2017 which are fully engage in banking activities. The independent variables are credit risk, liquidity risk, capital adequacy ratio and inflation risk while the dependent variable is profitability representing performance of the firm’s proxy by ROA

1.6       Significant of the Study

The significance of this study goes a long way in ensuring that financial regulators like Nigerian Deposit Insurance Corporation (NDIC), Securities and Exchange Commission (SEC), Central Bank of Nigeria (CBN) and other regulatory bodies/agencies in the financial sector will employ the study findings as encapsulated in the recommendations to formulate appropriate policies and measures that will help boost the financial performance of the banking sector in Nigeria. The board and management of firms in the sector are also expected to make use of the results/recommendation for internal control and policy formulation with regards to appropriate financial risk management in consideration of the cost of investment.

Investors and other relevant stakeholders including the general public will also benefit from the findings of this study as it will help them in assessing firms and making informed decisions.

The academic citadel will also not be left out as researchers and students may use the study as reference materials. It is expected to add value to Researchers and Scholars as it will contribute to the literature on the relationship between financial risk management and performance of the listed Nigerian deposit money banks. It is hoped that the findings will be of benefit to the academicians, who may find useful research gaps that will stimulate interest in further research in future. Recommendations will be made on possible areas of future studies.





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