Effect of Asset Quality on Performance of Quoted Deposit Money Bank in Nigeria
Chapter One
Objectives of the Study
The objective of the study was to examine the effect of asset quality on financial performance of deposit banks in Nigeria.
The following are the specific objectives of the study
- To determine the impact of assets quality on bank performance.
- To Ascertain if long-run relationships do exist between the dependent and Independent variables.
- To determine if there is a Causal Relationship between the Dependent and the Independent variables.
CHAPTER TWO
LITERATURE REVIEW
Introduction
This chapter serves as the foundation for the development of the study. It seeks to assist the researcher to critically understand the problem area and what previous researchers have done. It provides a discussion on the theories related to financial services, empirical researches from the available literature on the topic under study are presented in the chapter, as well as conceptual model of the study.
Conceptual review
Concept of Asset Quality
The concept of asset quality bank management involves the process of evaluating asset of organizations which are used in facilitating the measurement of their size and level of credit risk linked to the general operation. This has relationship to banks’ left-hand side as displayed on balance sheet and its main focus is on provision of earnings through quality of loans given by banks. The meaning of asset quality and that of loan quality are essentially same and their management can be very essential as far as banking sector is concerned (Adeolu, 2014).
Swamy (2013) noted that aspect of Non-Performing Assets (NPAs) has increasingly been gaining much interest within recent past years. This argument was based on fact established that the failure of banks is caused by the consequences of raising NPAs up in the entire banking system. Some studies discovered that insolvency of an institution can be predicted by asset quality which is said to be one of the causes of failure of many banks since most of the banking institutions which have failed were linked to increase in the level of their non-performing loans (NPLs).
Based on the world financial report of International Monetary Fund (IMF) (2009), NPAs as a challenge, is believed to be one of the main causes of the economic stagnation in that it is becoming practically the same as financial intermediaries’ functionality efficiency. The report further elaborates that two among the three key priorities that relates to NPAs directly is the identification and mitigating the distressed assets while ensuring that viable weak institutions are recapitalized and that collapsed institutions are resolved and reinstated. Therefore, it can be concluded that profitability of banks can be improved by better management of asset quality.
Financial Performance of Deposit banks
In monetary terms, operations and policies of an organization are measured through financial performance. This is also used as a general measure of financial health of a firm within a specific period of time, and also in comparison of firms of the same level and in the similar industry/sector or as a comparison in aggregation of various sectors and/or industries. Mishkin (2007) stated that financial performance of an institution can also be measured in various ways including measurement based on return on investment (ROI) of a given firm, measurement based on return on assets (ROA), as well as estimation based on value addition, etcetera. The achievement of positive financial performance in any given organization can be realized through eradication of waste which may exist in the entire system and process. A “critical success factor” of organizations is based on the level at which the set objectives and mission are fulfilled in form of efficiency, effectiveness as well as economical aspect (Davies, 2005).
The Nigerian banking sector realized steady advancement in the present years which has enabled its great expansion across the region of East African. The sector also involves in automation, and outsourcing of both essential and non-essential services thus shift from old ways of banking to the current dynamic ways that enable them meet the needs of customer and challenges of globalized world. As such the Nigerian banking sector remains sound and resilient, developing and deepening faster. From the time the government introduced liberalization, the current operation of banking industry is in a business environment that is challenging and competitive as compared to olden days. It has led to flooding of financial services from many institutions providing same services/products as that of the banks, thus an increase rivalry. This most challenging and dynamic business environment has made many banks to undergo major restructuring which come along with change in the look of the entire industry (CBN, 2015).
In case of failure of a banking institution operating in Nigeria, there is provision of two as given in Banking Act; i) a statutory manager can be appointed as stipulated in section 34(2) which gives powers to safeguard the assets of that particular institution, managing the assets of the banking institution, the power of evaluating the institutions capital structure and giving recommendations to CBN on the available options which can help in reorganisation as well as restructuring in the effort to revive the bank; and ii) appointment of a liquidator as provided in section 35(1) of the insolvency of an institution (Magu & Kibati, 2016). In this regard, Euro Bank Ltd was placed under liquidation in 2003 after becoming insolvent following substantial losses emanating from huge non-performing loans and the placement of Daima Bank Ltd under Central Bank’s statutory management after a prolonged loss-making period that led to gross undercapitalization. Prudential Building Society was placed under statutory management in the same year due to its insolvency which eroded its capital base (Kinyua, 2016).
CHAPTER THREE
RESEARCH METHODOLOGY
Introduction
This chapter contains the methodology to be utilized in carrying out the research. It focuses on the research design, target population, research instruments, data collection and data analysis.
Research Design
This study relied on descriptive research design. The preference of this research design by this study was due to the fact that it had intention of establishing the causal between asset quality and performance of financial institutions. Unlike exploratory research design, descriptive research design was found to be more rigorous and helped in seeking the findings on how, who, when, and what of the issues under investigation (Cooper & Schindler, 2006).
Target Population
Population can be defined as the “entire group of individuals, events or objects that possess common characteristics” (Mugenda and Mugenda, 2012). According to Cooper and Schindler (2006) “population is the total collection of elements that the researcher wishes to examine and make observations on”. The target population for this research comprised all the 22 licensed deposit banks in Nigeria as at December 2019 (See appendix I).
RESEARCH FINDINGS AND PRESENTATION
Introduction
This chapter on research findings and presentation is comprised of descriptive statistics of the study variables. Descriptive statistics was found to be vital for this study to predict the data by presenting it into a more meaningful way which necessitated the interpretation. The chapter as well presented inferential statistics which helped in the testing of associations and hypothesis of variables under study. The inferential used in this study included correlation analysis and regression statistics. First, the study tested the effect of asset quality on financial performance of deposit banks, thereafter; the study tested the effect of the dependent variable (asset quality) in conjunction with the control variables (capital adequacy and liquidity) on the financial performance of deposit banks.
CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATIONS
Introduction
This chapter provides a brief summary of the research findings together with conclusion which are made in line with findings of the study. The recommendations are as well given in this chapter based on the study findings.
Summary of Findings
The objective of this research project was to examine the effect of asset quality on financial performance of quoted deposit banks in Nigeria. Among the variables used in analysis were asset quality, liquidity, capital adequacy as independent and control variables and financial performance as dependent variable.
From the findings provided in descriptive statistics, it was revealed that liquidity had the highest mean, followed by capital adequacy, asset quality, and thereafter financial performance. The Pearson’s correlation revealed that only liquidity and capital adequacy had significant association towards financial performance of the deposit banks in Nigeria while asset quality had an insignificant association.
In the first regression model carried between asset quality and financial performance, it was discovered that this model had a low power in explaining the variation of financial performance. However, the results of ANOVA indicated that we reject the null hypothesis that asset quality has no effect on financial performance since the significance value was less than the critical value of 0.05. The outcomes of this model further revealed that asset quality was significantly related to financial performance of banks.
When liquidity and capital adequacy were included as control variables in the relationship between asset quality and financial performance, the model’s R2 value improved slightly. The ANOVA results indicated that the null hypothesis that the asset quality of a bank, its capital adequacy as well as liquidity jointly, has no significance in predicting financial performance of a given bank should be rejected.
It was revealed that liquidity was statistically significant in determining the financial performance. Similarly, the findings gave a revelation that an increase in capital adequacy could lead to an increase in financial performance of a deposit bank. Conversely, the new predictor model showed that liquidity and capital adequacy were the only variables that found to be statistically significant on financial performance within deposit banks operating in Nigeria.
Conclusion of the Study
The conclusion of the research was made in relation to the study objective and findings. The study found out that asset quality was significantly essential to measure of financial performance of a given deposit bank since when regressed alone with financial performance it was found to be statistically significant. Therefore, it calls for banks to observe the impact of non-performing loans effectively as when not controlled well might result to negative impact on their performance.
However, upon inclusion of the control variables (liquidity and capital adequacy), asset quality was found to have an insignificant impact on the deposit banks’ financial performance. On the other hand, liquidity and capital adequacy were statistically significant in determining the financial performance of the deposit banks within the scope of ten years (2009 – 2019).
The study can also conclude that the increase in financial performance of deposit banks operating in Nigeria dependents on better management of expenditures. It can also be wrapped up that the relationship existing between capital adequacy and financial performance of deposit banks is positive. Profitability’s positive influence caused through capital cost reduction was because of higher equity levels.
Similarly, study concludes that there is a positive correlation (association) between liquidity management and financial performance of deposit banks in Nigeria. This could imply presence of sufficient liquidity level. Hence the management should ensure to maintain a liquidity level that will ensure the bank stays afloat and in long run improves on the profitability stand.
Recommendations of the Study
The study recommends the following policies which are done in relation with the findings of the study:
The deposit banks operating in Nigeria should put more emphasis on credit risk minimization and encourage diversity of revenue. This is because when credit risk is improperly managed it might lead to reduction in profitability financial institutions, and it might affect the asset quality of the entity and also raise loan losses as well as non- performing loans which could ultimately distress financial institutions.
The study also proposes that lending attitudes of deposit banks in Nigeria should be regularly assessed by the CBN. This can be done through assessment of the of credit crunch degree where isolation of the impact of supply side of loans from the demand side are taken into account. The CBN should focus on the lending cycle of the banks as most of the failed banks have had a high non-performing loan amounts prior to their failures.
Security markets should be strengthened which might lead to a positive impact on the entire growth and performance of the banking industry and therefore an increase in competitive edge among the financial institutions. The Abuja securities stock exchange should ensure they revisit their policies and procedures from time to time in order to accommodate the changing environments in the banking sectors and other industries.
Furthermore, the study recommends that more focus should be on policies of capitalization reinforcement which can be put in place by regulatory bodies in the banking sector. This will enable the deposit banks operating in Nigeria to enhance their financial performance through capital cost reduction.
Suggestions for Further Study
This research examined the effect of asset quality on financial performance of deposit banks in Nigeria and it revealed that asset quality provided low explanatory power towards financial performance. Therefore, there is a need for further studies whose data should be based on use of more variables, which should comprise of a larger sample size to help in more understanding and justification of results generalization.
Furthermore, another study can be done on factors that influence the liquidity and capital adequacy of financial institutions by doing so, it might contribute to academic literature and add value to the banks’ performance. The study clearly showed that liquidity and capital adequacy affects the financial performance of deposit banks in Nigeria in the ten year periods significantly.
It can also be proposed that related research be carried out in other financial institutions other than deposit banks to give more understanding on the aspect of asset quality and financial performance. This is because other financial institution like Saccos and microfinance institutions also lend and therefore are have non-performing loans which greatly affects the financial performance of the institutions.
Limitations of the Study
The findings of the current study are applicable only to twenty two (22) Deposit banks in Nigeria which were in operation as at December 2019 (see appendix I) and therefore it is hard to generalize these findings to all financial institutions including microfinance banks. Although all financial institutions carry out quite similar roles in the industry, the study only looked at commercials banks in Nigeria for the ten year period. Therefore a similar study can be done for other financial institutions for comparison.
The dynamism of the variables used in this study was in relation to business cycle as well as demand on market. Therefore, the results might not be true on testing the real impact of the variables that deal with performance of deposit banks putting into consideration of limited time. The demand and business cycle of the market is subject to changes and different banks are affected different by the changes.
Furthermore, due to time and resource constraints, the study could not cover enough evidence based on different categories like bank ownership and size. Different variables affect the financial performance of the deposit banks differently depending with the business cycle and the demands in the industry. More determinants of financial performance should be included as control variable in study for comparison.
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