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THE EFFECT OF INTEREST RATE ON LOAN RECOVERY OF DEPOSIT MONEY BANK

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND TO STUDY

Greater prominence have been said to be associated with banking industry in Nigeria because of the role it plays in her economic environment. The banking industry plays a great influence and in the provision of credit facilities in Nigeria. However the tendency to incur financial losses due to failure to repay loans or credit facilities by borrowers which is regarded as credit risks are most often faced by banking institutions in the financial sector (Muhammad & Shahid, 2012). The bank’s credit function enables investor’s exploits ventures that are considered profitable (Kargi, 2011). This function however, exposes the banks to the risk of credit default. Credit risk as defined in 2001 by the Banking Supervision of the Basel Committee as the possibility of an outstanding credit going absolutely or partially lost due to default effect (credit risk). Default effect or credit risk is assumed an internal measurement factor of the performance of banks. The higher the level of bank’s exposure to credit risk, the higher the possibility of the bank to likely experience financial crisis and so on. Credit risk is the most formidable amongst the numerous risks faced by banks and the profitability of the banks is highly affected since a greater aspect of banks’ income accrues from granting credit facilities from which interest is generated. However, credit risk is found to be linked with interest rate risk by implying that interest rate increment enhances loan default possibilities.

Interest rate risk and credit risk are related intrinsically to one another and not separately (Drehman, Sorensen &Stringa, 2008). According to Ahmad and Ariff (2007), the credit portfolio with greater non- performing assets limits the banks’ ability in achieving its stated objectives. Therefore, loans that are non-performing are expressed as the percentage of loan values which has not been service for 90 days and above. Consequence upon the huge rate of non- performing loans, credit risk management practices is highly emphasized by Basel II Accord Working in tune with the recommendations of the Accord is a sure approach to handling the risk of credit and generally the enhancement of bank performance. Through the effective management of the exposure of credit risk by banks, they end up facilitating the viability and profitability of their businesses and ultimately enhancing the systemic stability and smooth allocation of capital in the economy (Psillaki, Tsolas & Margaritis, 2010). Banks have adopted various strategies of recovering their money, some orthodox, some unorthodox. It has been found that most borrowers are always willing to pay, but certain situation like economic recession, inflation, political instability, poor investment makes them not able to pay. According to Ojiegbe (2002), there are also the existences of bad borrowers in the banking industry whose primary assignment is to abandon their loan obligations in most banks and enter into new loan contracts with another bank. This low credit standard of borrowers along with poor management of portfolio and changes insensitivity in the economic environment by the bankers led to the banks witnessing rising non-performing credit portfolio. This ultimately causes many banks to fail and become insolvent. It is quite unfortunate that in spite the degree of carefulness, skillful, experience or tact of a loan officer, most of the loan facilities granted to borrowers sometimes go bad. The introduction of the Prudential Guideline in 1990 for banks licensed in Nigeria enable banks to properly classify bad and doubtful debt. These guidelines made it compulsory for licensed banks to at least in a quarter, have their credit portfolios reviewed and credit classified (into non-performing loans and performing loans) appropriately (Mora, 2011).

The introduction of these guidelines has assisted the banks to promptly identify the deterioration of loans held by banks. For a credit facility to be considered as non- performing, both the principal and accrued interest is unpaid for three months and more; or this interest payment must have been interest of 90 days or more may have been rescheduled, rolled-over or capitalized into a new credit facility (unless these facilities have reclassified and the borrower have made cash payment to the effect that interest payment outstanding does not exceed three months). Over the years, bank loans and advances to the Nigerian economy has been on the increase. According to the CBN annual report in 2007, commercial banks’ credit to the core private sector grew by 98 per cent which has been the highest ever. However, this incremental trend could not be sustained due to the prevailing harsh economic situation and its effects on the business sector thus leading to increased default on loan repayment. Furthermore, some bank customers misconstrue the loans and advances received from banks as national cake, hence, they deliberately shy away from repayment.

1.2   STATEMENT OF THE PROBLEM

Interest rate is a very important factor to consider in measuring the performance of banks in Nigeria; however the variation in interest rate tends to affect loan and advances in the bank. Increase in interest rate on loan collected could delay the recovery processes of loans by the bank. Most borrowers might stop collecting loans from banks due to high interest rate. Secondly there have been series of research on loan and interest rate but not even a single study has been carried out the effect of interest rate on loan recovery of deposit money bank; hence a need for the study.

1.3   AIM AND OBJECTIVES OF THE STUDY

The main aim of the research work is to determine the effect of interest rate on loan recovery of deposit money bank. Other specific objectives of the study are:

1.  to determine the relationship between interest rate and loan repayment in first bank Nigeria plc

2.  to determine the extent to which interest rate affect loan recovery of deposit money banks in Nigeria

3.  to determine the causes of variations in interest rate in deposit money banks in Nigeria plc

4.  to investigate on the factors affecting interest rate in deposit money banks in Nigeria

1.4 RESEARCH QUESTIONS

The study came up with research questions so as to ascertain the above stated objectives of the study. The research questions for the study are:

1.  What is the relationship between interest rate and loan repayment in first bank Nigeria plc?

2.  To what extent does interest rate affect loan recovery of deposit money banks in Nigeria?

3.  What are the causes of variations in interest rate in deposit money banks in Nigeria?

4.  What are the factors affecting interest rate in deposit money banks in Nigeria?

1.5 STATEMENT OF RESEARCH HYPOTHESIS

H0: there is no significant relationship between interest rate and loan repayment in first bank Nigeria plc

H1: there is significant relationship between interest rate and loan repayment in first bank Nigeria plc

1.6 SIGNIFICANCE OF STUDY

The study on the effect of interest rate on loan recovery of deposit money bank will be of immense benefit to first bank Nigeria plc in the sense that the study will educate the banking sector on various methods of recovering loan from debtors; the study will also determine the relationship between interest rate and loan repayment in first bank Nigeria plc. The study will serve as a repository of information to other researchers that desire to carry out similar research on the above topic. Finally the study will contribute to the body of the existing literature on interest rate and loan recovery of deposit money bank

1.7 SCOPE OF THE STUDY

The study on the effect of interest rate on loan recovery of deposit money bank will focus on first bank Nigeria plc from the year 2000-2017.

1.8 LIMITATION OF STUDY

Financial constraint- Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview). Time constraint- The researcher will simultaneously engage in this study with other academic work. This consequently will cut down on the time devoted for the research work.

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