CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Risk is commonly understood as the possibility of loss, or the chance of loss arising from an unfortunate occurrence or event. Risk is always at the centre of our lives: every human endeavour, whatever the economic pursuit, carries some risk. International standards define it more broadly as the effect of uncertainty on objectives, an effect that may be positive, negative or both (International Organization for Standardization [ISO], 2018). Risk management is the process of identifying risks, assessing their implications, deciding on a course of action and evaluating the results, and in the banking industry it lies at the core of lending. Risk management rests on the idea that the likelihood of an event can be reduced, or its consequences minimized. Effective risk management seeks to maximize the benefits of a risky situation while limiting its negative effects. In practice it involves the identification, assessment and prioritization of risks, followed by the coordinated and economical application of resources to minimize, monitor and control the probability and/or impact of unfortunate events (ISO, 2018). Risks can arise from uncertainty in financial markets, project failures, legal liabilities, credit risk, accidents, natural causes and disasters, as well as from deliberate attacks by an adversary. Risk management ensures that an organization identifies and understands the risks to which it is exposed.

Before the banking consolidation of 2004 and 2005, the Nigerian banking system was widely regarded as fragile and marginal (see Dogarawa, 2011). Deposit money banks are in the risk business: in the process of providing financial services they assume various kinds of financial risk. Managing credit risk adequately is critical for the survival and growth of financial institutions. In the case of banks, credit risk is of even greater concern because of the higher level of perceived risk arising from the characteristics of clients and the business conditions in which they operate. Recent Nigerian evidence notes that, despite comprehensive regulatory frameworks and risk management strategies, rising ratios of non-performing loans continue to raise serious concerns about the resilience of listed deposit money banks (Bello-Olatunji, Adegbola, Abdulazeez & Bello, 2025). The scale of the problem is current: the Central Bank of Nigeria's 2025 annual report shows the industry's non-performing loan ratio at 7.51 per cent in December 2025, above the regulator's prudential benchmark of 5 per cent, compared with 4.5 per cent in 2024 and 4.07 per cent in 2023 (Chima, 2026).

Banks originated mainly to provide safe storage for customers' cash. Because the money received from customers was always available to the bank, banks later put it to use by investing in profit-earning assets, which gave rise to the practice of advancing credit. Banks are in the business of safeguarding money and other valuables for their clients. They also provide loans, credit and payment services such as current accounts. Their intermediating role places deposit money banks in the position of "trustee" of the savings of widely dispersed surplus economic units, and makes them a determinant of the rate and shape of economic development (Ogundajo, Onakoya, Enyi & Siyanbola, 2019). Ideally, the techniques that banks use in this intermediary function should give them perfect knowledge of the outcomes of lending, so that funds are allocated only to investments whose full repayment is certain.

It cannot be disputed that financial institutions have faced difficulties over the years for a multitude of reasons. The major cause of serious banking problems continues to be directly related to lax credit standards for borrowers and counterparties, poor portfolio risk management, or a lack of attention to changes in economic or other circumstances that can erode the credit standing of a bank's counterparties (Basel Committee on Banking Supervision [BCBS], n.d.). Credit risk management therefore needs to be a robust process that enables financial institutions to manage their facility portfolios proactively, so as to minimize losses and earn an acceptable level of return for shareholders. The Basel principles frame the objective in the same way: to maximize a bank's risk-adjusted rate of return by keeping credit risk exposure within acceptable parameters (BCBS, n.d.).

Lending is the principal business activity of most deposit money banks. The loan portfolio is typically the largest asset and the predominant source of revenue, and for that reason it is also one of the greatest sources of risk to a bank's safety and soundness (BCBS, n.d.). Effective management of the credit risk of the loan portfolio requires the board and management to understand and control the bank's risk profile and its credit culture. To do this, they must have a thorough knowledge of the composition of the portfolio and its inherent risks, including its product mix, industry and geographic concentrations, average risk ratings and other aggregate characteristics. They must also be sure that the policies, processes and practices used to control the risks of individual loans and portfolio segments are sound and that lending personnel adhere to them. The Basel principles place responsibility for approving credit risk strategy on the board of directors and for implementing it on senior management (BCBS, n.d.).

Risk is an essential part of business, because firms cannot operate without taking risks. It is commonly associated with uncertainty, since an event may or may not occur, and it implies exposure to uncertainty or threat. Recent economic volatility has given risk management a new focus and prominence, and successful firms are able and willing to integrate risk management into every level of the management process (ISO, 2018).

Traditionally, risk has been viewed in terms of negative consequences and unfavourable events. Considering risk only from the negative perspective is restrictive and misleading for two main reasons. First, uncertainty may take a negative form (threat), a positive form (opportunity), or both. Second, the way a risk is perceived influences the way in which it is handled (ISO, 2018). Managing risk from a purely negative perspective can lead to the complete omission of opportunities (benefits and gains) in the event being considered. Perspectives on risk also differ, since the definition of risk depends on, and is affected by, the person observing it. Moreover, risk sometimes carries economic benefits, because firms may derive considerable gains from taking risk, and business grows through greater risk taking. Risk is therefore integral to both the opportunities and the threats that may affect an action or expected outcome. Eliminating risk altogether undermines the source of value creation and cuts off potential opportunities. In essence, for a business enterprise, risks are uncertainties that matter.

1.2 Statement of the Problem

The subject of risk occupies a central position in the business decisions of bank management, and it is not surprising that banks are approached by customers, investors and the general public alike. Banks are approached for loans and advances in large volumes. These constitute the risk assets of banks and make provisioning against them necessary, a practice that recent Nigerian studies continue to test through loan loss provisioning and non-performing loan ratios (Abubakar, Dadum & Ibrahim, 2025).

One of the most important decision problems that demands serious attention is the granting of loans by a financial institution, which is why sound credit-granting criteria are central to the Basel principles (BCBS, n.d.). In the case of banks, credit risk is of even greater concern because of the higher level of perceived risk arising from the characteristics of clients and the business conditions in which they operate, and this calls for thorough empirical examination.

Banks are expected to absorb losses from their normal earnings, but there may be unanticipated losses that normal earnings cannot absorb, and few studies exist to bridge the knowledge gap on these. The literature on the effect of risk exposures on bank performance has been described as scanty, and excessive or poorly managed risk can undoubtedly lead to losses and so endanger the safety of depositors' funds. Recent studies of Nigerian deposit money banks have begun to address this gap, but their results are not uniform. Bello-Olatunji et al. (2025), for example, found that the ratio of loans to total assets had a positive and significant effect on return on assets, whereas capital adequacy and non-performing loans showed no relationship with it. Abubakar et al. (2025) found a positive and significant relationship between loan loss provisioning and return on equity. Gana, Tijjani and Abubakar (2022) examined the effect of non-performing loans, loan loss provisions, capital adequacy and loans-to-deposits on return on equity in listed banks. Studies on risk exposure and bank performance (Gwamna, Miko & Abdullahi, 2022) likewise remain few relative to the size of the problem.

The pervasive incidence of non-performing loans is one of the prime causes of failure in the banking system. The very nature of the banking business makes it sensitive, because deposits from depositors account for more than 85 per cent of the liabilities of a typical deposit money bank. While banks engage in lending as their main source of income, they are at the same time exposed to various risks which, if not properly analysed and managed, could threaten their continued existence.

Even though the survival of any bank depends largely on its effective risk management strategies, some bank executives neglect this aspect of the job purely for selfish motives. Banks use customers' deposits to generate credit for borrowers, which is a revenue-generating activity for most banks. This credit creation process, however, exposes banks to a high risk of default, which may lead to financial distress, including bankruptcy.

Many Nigerian banks have failed in the past because of inadequate management of their risk exposure. The problem has continued to affect the industry with serious adverse consequences. Banks are generally subject to a wide array of risks in their business operations.

Against this background, there is a need to carry out this research in order to examine empirically and objectively the impact of credit risk management on the performance of Nigerian deposit money banks.

1.3 Objectives of the Study

The main objective of this study is to evaluate critically the effect of credit risk management on the performance of Nigerian commercial banks. In line with this, the specific objectives of the study are:

(i) To examine the impact of credit risk management on the total loans and advances of deposit money banks in Nigeria.

(ii) To assess the impact of credit risk management on the return on assets of deposit money banks in Nigeria.

(iii) To ascertain the impact of credit risk management on the return on equity of deposit money banks in Nigeria.

1.4 Research Questions

In line with the specific objectives stated above, the study seeks to consider and respond to the following research questions:

(i) To what extent has credit risk management affected the total loans and advances of deposit money banks in Nigeria?

(ii) How does return on assets (ROA) relate to the credit risk management of deposit money banks in Nigeria?

(iii) How does return on equity (ROE) relate to the credit risk management of deposit money banks in Nigeria?

1.5 Research Hypotheses

As a follow-up to the research questions raised above, the following hypotheses, stated in null form, will be tested in this study:

(i) Ho1: Credit risk management has no positive and significant impact on the total loans and advances of Nigerian deposit money banks.

(ii) Ho2: Credit risk management has no positive and significant impact on the return on assets of deposit money banks in Nigeria.

(iii) Ho3: Credit risk management has no positive and significant impact on the return on equity of deposit money banks in Nigeria.

1.6 Scope and Limitations of the Study

The study focuses on the impact of effective credit risk management on the profitability of selected deposit money banks in Nigeria and covers the period 2000 to 2014. The five banks with the highest asset base were selected: First Bank of Nigeria Plc, United Bank for Africa, Diamond Bank Plc, Zenith Bank Plc and Guaranty Trust Bank Plc. The year 2000 was chosen as the base year because of the adoption of the universal banking system, which was expected to affect the performance of the banking system.

The limited funds available for printing all the downloaded materials, and the difficulty of gaining access to the Central Bank of Nigeria library, influenced the research work.

1.7 Significance of the Study

This study will be of immense benefit to the following groups:

1. Banks

The results of this study should provide deposit money banks with information on their level of performance in the light of the credit risk management arrangements they have in place. This is likely to spur them to review critically their credit risk management styles.

2. Investors

The study will give investors the knowledge they need about risk management in banks. They will then be able to study the extent to which a bank is exposed to risk and make wise decisions about where to invest.

3. The General Public

The study can create awareness of the extent of credit risk and its management in banks. This can serve as an eye-opener for the banking public regarding the safety of their deposits in banks.

4. Researchers

The results of this study can serve as a reference document for further research and for the evaluation of risk management by other researchers. The research will also increase the available literature on risk management in banks.

5. Policy Makers

Finally, the study will be of immense benefit to policy makers, because it will give more insight into risk management and guide them in policy making and implementation.

REFERENCES

Abubakar, N., Dadum, H. H., & Ibrahim, U. Y. (2025). Effect of credit risk management on financial performance of listed deposit money banks in Nigeria. Kashere Journal of Management Sciences, 8(2), 82–95.

Basel Committee on Banking Supervision. (n.d.). Principles for the management of credit risk. In Basel Framework (Chapter 10). Bank for International Settlements. https://www.bis.org/committees/bcbs/basel-consolidated-guidelines/module/cri/10

Bello-Olatunji, O. M., Adegbola, M. M., Abdulazeez, F. O., & Bello, F. (2025). Credit risk management and financial performance of listed deposit money banks in Nigeria. KASU Journal of Accounting Research and Practice, 10(2), 454–467.

Chima, M. (2026, July 29). Banks' bad loans rise above CBN limit as consumer credit debt falls to N3.7trn. TheCable. https://www.thecable.ng/banks-bad-loans-rise-above-cbn-limit-as-consumer-credit-debt-falls-to-n3-7trn/

Dogarawa, A. B. (2011). Chronology of banking reforms in Nigeria. Journal of Financial Regulation and Compliance, 19(4), 370–382.

Gana, U., Tijjani, M. S., & Abubakar, S. (2022). Effect of credit risk on financial performance of listed deposit money banks in Nigeria. Gusau International Journal of Management and Social Sciences, 5(1).

Gwamna, Y. J., Miko, N. U., & Abdullahi, M. (2022). Risk and financial performance of listed deposit money banks in Nigeria. Polac International Journal of Economics and Management Science, 8(1).

International Organization for Standardization. (2018). ISO 31000:2018 Risk management — Guidelines (2nd ed.). ISO.

Ogundajo, G. O., Onakoya, A. B., Enyi, P. E., & Siyanbola, T. T. (2019). Financial institutions' intermediation and economic development in Nigeria. Journal of Accounting and Finance in Emerging Economies, 5(1), 33–46. https://doi.org/10.26710/jafee.v5i1.723