MAKERERE UNIVERSITY
CREDIT RISK MANAGEMENT AND PROFITABILITY OF COMMERCIAL BANKS
A CASE STUDY OF BARCLAYS BANK
BY
ARINAITWE IGNITIOUS
O7/U/6748/EXT
A RESEARCH REPORT SUBMITTED TO MAKERERE UNIVERSITY IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE AWARD OF THE DEGREE OF BACHELOR OF COMMERCE OF MAKERERE UNIVERSITY.
JULY, 2011
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DECLARATION
I ARINAITWE IGNITIOUSdo hereby declare that this is my original work and it has never before been presented elsewhere for any academic award. The pieces of work from other sources have been dully recognized.
Sign: ……………………………… date: …………………………………
APPROVAL
This research report by ARINAITWE IGNITIOUS which has been under the title the credit risk management and profitability of commercial banks a case study of BARCLAYS BANKhas been under my supervision and is now ready for submission.
Sign: …………………………………………………………
MR. KIWALA YUSSUF
Date: …………………………………………………………
DEDICATION
This work is dedicated to my father Mr. John Muhame Kikomo, my late mother the Mrs. Mary Tumuramye Prudence, relatives and friends.
Thanks, for giving me hope in despair, joy in sorrow, ease in pain No one loves me more than you do.
God bless you
ACKNOWLEDGEMENT
First of all I would like to thank the God almighty for giving me wisdom and keep healthy
I would like to express my sincere thanks to the various people who have assisted me in any way to reach the completion of this research.
My most sincere application goes to Mr. Kiwala Yussuf for his effective supervision and for his commitment, guidance and constructive advice whenever I needed him. I thank him very much for availing me time and energy to reach the end of the research.
I would like to acknowledge and thank my family members, relatives for all the great support financially, socially and spiritually.
I do also appreciate the effort of friends especially Kamuli Olive, Tukamwesiga Justus, Douglas, Ben, Lorine, Wilson, Joshua ,Innocent, and the entire discussion group for invaluable contribution extended to me in times of need and success towards my study.
Finally I thank all those persons whom I have not mentioned specifically in the acknowledgement. I will always remember you for your kindness, constant support and encouragement.
MAY GOD BLESS YOU
TABLE OF CONTENTS
DECLARATION
APPROVAL
DEDICATION
ACKNOWLEDGEMENT
TABLE OF CONTENTS
LIST OF TABLES
ABBREVIATIONS
ABBREVIATIONS
ABSTRACT
CHAPTER ONE
1.0 Background to the study
1.2 Statement of the problem
1.3 Purpose of the study
1.4 Objectives of the study
1.5 Research questions
1.6 Scope of the study
1.7 Significance of the study
CHAPTER TWO
LITERATURE REVIEW
2.0 Introduction
2.1 The concept of risk in commercial banks
2.1.1 Credit Risk Management in Commercial Banks
2.1.2 Risk management process
2.2 Credit Policy in Commercial Banks
2.2.1. Identification and prioritization of Market Targets
2.2.2 Credit Initiation/ Analysis Process
2.2.3 Credit Approval
2.2.4 Credit Documentation and Disbursement
2.3 Credit risk measurement, monitoring and control
CHAPTER THREE
3.0. Introduction
3.2. Sampling technique
3.2.1. Sampling size
3.2.1 Sample design
3.3 Data collection
3.3.1 Source of data
3.4 Methods of data collection.
3.5 Data processing and Analysis.
3.5.1 Data Analysis
3.6 Limitations Encountered in the study
CHAPTER FOUR
PRESENTATION, ANALYSIS AND DISCUSSION OF FINDINGS
4.0 INTRODUCTION
4.2 Duration
4.3 Age of respondents
CHAPTER FIVE
CONCLUSION AND RECOMMENDATIONS
5.0 Introduction
5.1 The study revealed the following:
5.1.1 Credit risk management
5.1.2 Profitability
5.1.3 Effect of credit risk management on profitability
5.2 Conclusion
QUESTIONAIRE FOR BARCLAYS BANK EMPLOYEES
LIST OF TABLES
Table 1: Showing distribution of respondents in Barclays bank.
Table 2: Showing how long the respondents have served in Barclays bank
Table 3: Showing age of respondents
Table 4: Showing identification and priotisation of markets
Table 5: Showing credit origination
Table 6: Showing banks `credit evaluation
Table 7: Showing bank’s negotiation
Table 8: Showing bank`s credit approval
Table 9: Showing credit documentation and disbursement
Table 10: Showing the banks credit monitoring
Table 11: Showing doubtful loans.
Table 12: Showing provision for bad loans
Table 13: Showing bad debts written off
Table 14: Showing return on equity
Table 15: Showing return on assets
Table 16: Showing the relationship between credit risk and profitability.
ABBREVIATIONS
BCBS - Basel Committee on Banking Supervision
CAR - Capital Adequacy Ratio
CRD -Capital Requirements Directives
NI -Net Income
NPL - Non-performing Loan
NPLR- Non-performing Loan Ratio
ROA -Return on Assets
ROE -Return on Equity
RORAC- Return on Risk Adjusted Capital
RWA -Risk Weighted Asset
IFRS -International Financial Reporting Standards
BOU -Bank of Uganda
ABSTRACT
The study was done on credit risk management and profitability of commercial banks. The study was carried out at Wandegeya Branch , Jinja Road Branch in Kampala district.
The researcher collected both primary and secondary data, using the survey method and review of the existing literature respectively. Questionnaires were used for data collection.
Data obtained from findings indicate that the bank has a credit risk management system in place that was functioning. However, the system had loopholes and was not flexible enough. The major finding is that there is of lack of good knowledge of the credit risk management among the employees was a key weakness in the system.
It was recommended that training in risk management of credit staff especially on how to screen the customers who come for l9oans is necessary and urgent for the bank. This would reduce on the number of loan portfolio written off and provisions for bad loans.
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CHAPTER ONE
1.0 Background to the study
Loans are a major source of finance to funds most businesses .Accessing loans depends on the credit worthiness or whether you comply with the credit standards of that particular bank. These include collateral security, capacity condition, character under which the business is operating(Bankers' Lending Techniques" by Nick Rouse).Credit is sought by individuals and organizations to supplement their funding since equity is often not enough and these funds are primarily allocated on the basis of price expressed in terms of salaried loans, business installment loan, mortgage loans, agricultural loans
The main objective of commercial banks is to maintain higher profitability by maintaining circular and efficient flow of amount of money deposited by the customers and lenders. Commercial banks contribute to the economic cycle by keeping the money circulation among households, government and corporate businesses. Commercial banks lend money to the economic agents through their various products and services by earning interest income on the borrowed money. Commercial banks design short term and long term loans and other products to cater to the need of customers while enhancing returns. Their objective is to attract more customers and build profitable relationships with the new and existing customers
The recent global financial crisis indicates that risk management of the financial institutions is not adequate enough. This leads to the failure of banks in highly challenging financial market.
Furthermore, the discussion of financial crisis in mass media and among scholars mentions the risk management as omissions or neglect of risk measurement signals. They state that more attentive participants could avoid the tremendous affect of the financial meltdown. Nevertheless, the financial storm teaches several key lessons which can assist to improve the risk management in future. As a result, risk has become a very challenging area of studies. While banks aim at maximizing their profits, we should appreciate their role in delivering credit to the economy.
“Credit like a honour of a female is too delicate a matter to handle with laxity ,the slightest hint may inflict an injury which no subsequent effort can repair (The journal of bankers of Ghana vol.3.2003)
The most common problem facing commercial banks in Uganda is the increasing number of non performing stocks. This in turn affects their returns and performance. In general, analysis of most commercial banks in Uganda it is found out that about 35% of their customers have outstanding bills receivable indicating that debt collection is a major problem (Owor, 2003) which means collection efforts and credit policy standards among others are weak hence influencing the level of returns as its most likely the case with Barclays Bank
The growth of various banking and micro finance institutions has largely contributed to an increase in lending to borrowers. It is vital to note that, today’s economic growth poses a big challenge to lenders to predict borrowers’ performance in recessionary conditions. Loan assessment techniques such as credit scoring which is used to evaluate whether customers should or should not be granted credit, loan screening aids such as advances in data technology, changes in regulatory environment, the firm’s future profitability, the amount of the owners equity in the business to mention but a few have often not been fully revealing and are imperfectly correlated across banks. (Lewis,1992 )
Banks and Micro Finance Institutions often rely on information to screen loan applicants and for monitoring borrowers through repeated interaction with their customers. This normally applies to the subsequent borrowers than the new entrants since it requires ample time to determine the true credit worthiness of individual borrowers.It is significant to note that a loan is depositor’s money or a type of financial aid, which must be repaid with interest. It also refers to an amount of money borrowed by a person to start or run a business.
1.2 Statement of the problem
The advent of the Financial Institutions Act, 2004 was embraced with a lot of excitement by all in the banking sector. The present possibility for banks to diversify into broader range of services and products make life really cool for banking entrepreneurs and managers. But this diversification advantage is a once in a life time opportunity that should be consumed with some caution and prudence as this involves a great deal of risk. This is in direct line with the saying that “the higher you go, the colder life becomes.” Banks use these deposits to generate credit for their borrowers, which in fact is a revenue generating activity for most banks. This credit creation process exposes the banks to high default risk which might led to financial distress including bankruptcy. All the same, beside other services, banks must create credit for their clients to make some money, grow and survive stiff competition at the market place.
"Corporate clients are the biggest loan defaulters compared to micro clients. Their defaulting rate and bounced cheque offences continue to rise. This has hampered cash flows of some commercial banks," Rashid Musisi, the corporate branch manager of Centenary Bank said last week. The New Vision 17 October 2010. The bank explained in a statement on Wednesday that the loss was due to higher operating and bad loans.The statement indicated that operating expenses jumped to sh114b last year, up from sh57b in 2007. It added that impairment on loans and advances declined to sh15b, down from sh30b recorded in 2007.
1.3 Purpose of the study
The purpose of the research is to describe the effect of credit risk management and profitability in Barclays bank in Uganda
1.4 Objectives of the study
- To establish the extent of integrating risk management processes into the credit polices of the bank
- To suggest possible solutions on improving credit risk management
- To find out the relationship between credit risk management and profitability of commercial banks
1.5 Research questions
- To what extent is risk management integrated into credit policies of the bank
- What are the possible solutions on improving the credit policy of Barclays bank?
- .What is the relationship between credit management and profitability of commercials banks
1.6 Scope of the study
Geographical scope
The study will be conducted in Barclays bank Jinja road and Wandegeya branches.
Time scope
The study will be cross sectional and will cover a period from 2008 to 2010
1.7 Significance of the study
The study will help management of different banks especially Barclays bank in formulating and designing effective credit policies that are user friendly
It will be a basis for other researchers to be used as a benchmark for further understanding of credit management of commercial
CHAPTER TWO
LITERATURE REVIEW
2.0 Introduction
This chapter comprises of both empirical and conceptual literature about credit risk management in the banking sector. It is divided into eight sections. Section one describes how risk in financial institutions should be measured managed and controlled. Section two describes how credit risk in commercial banks is measured, captured, monitored and controlled. It also explains what commercial bank credit policy is all about. The following section and subsections describe the process of credit risk management in commercial banks. The process of credit risk management is broken down into five tools or instruments. These include credit policy formulation, credit initiation and analysis, credit approval, credit documentation and disbursement, loan portfolio monitoring and administration.
Section six describes the intensity of credit default in commercial banks. Section seven attempts to highlight the relationship between credit expansion and financial instability in commercial banks. The last section give a conclusion and a critique on the performance of commercial banks in controlling the default risk.
2.1 The concept of risk in commercial banks
According to Kohn (2003), and Brealy et al (1991), commercial banks like any other financial institutions are exposed to a number of different risks. These include liquidity risk. Interest rate risk, inflation risk, financial risk and credit risk. One or a combination of these risks impact in one way or another on the performance of a commercial bank. This study is exclusively on credit risk management.
All the other risks mentioned above are not studied. Commercial bank credit risk or the loan default risk has been defined by a number of authors as that event which occurs when the borrower fails to pay bank loan. This study is on how a commercial bank predicts, measures, monitors and controls credit risk in order enhance its profitability.
The concepts of credit risk studied were the risk management process which involves the prediction of and measurement, monitoring and control. The second was credit policy of commercial banks. This was followed by credit analysis, credit approval, credit documentation and disbursement.
2.1.1 Credit Risk Management in Commercial Banks
Credit risk management can be described as a function that must be performed by a commercial bank in order to ensure that the loans it advances to its clients are orderly repaid back. The basis of a sound credit risk management is the identification of the existing and potential risks inherent in the lending activities (Froot et al 1998 and RMA 2004)
According to Mc Naughton et al (1999). Credit risk management is the support, control systems and other practices necessary to manage the outstanding risk assets, normal repayment and to monitor business risk properly. Credit risk management lies at the heart of commercial banking. It remains central to the health of the banking industry and must qualify for core status (Harrison 1996), with the majority of a banks’ assets being in the form of loans, the lending function plays a critical role in the bank risk management (BIS 1999). Credit risk management involves the following aspects.
2.1.2 Risk management process
Risk management is a process which involves an interlinked of sequence of function which should be performed in order to measure, manage and control risk. Different methodologies for identifying capture, analyzing and reporting credit market, liquidity and operational risks are at the disposal of financial institutions (Bonnevie, 2003). According to Bennevie, credit risk management process as a methodology of identifying, capturing and containing risk has eight different phases. These phases are shown on appendices 5 and 6 are also explained below:
The first phase involves position and market analysis. According to Bonnevie (2003), this phase is marked by the following: first there is need for the financial institution to understand the market environment in which it operates. In this case the financial institution should analyze its position in the market, the intensity of competition in the market, the price elasticity of demand for its product and customers’ needs having identified its position and own share in the market, the financial institution should also identify the sources of data after which an information management structure is established. Finally, there is need to understand the legal aspect of the risk to be taken.
The second phase is concerned with developing the knowledge about the risk awareness and identification of tools to be used to manage risk. In this phase, there is need to valuate the degree of risk awareness, risk incentives, risk reward, perceptions and the risk acceptance limits. In this phase, the institution should evaluate the risk in terms of volatilities and probabilities or occurrence. The institution should also priorities the risk areas in relation to organizational goals and risk appetite.
According to Bonnevie (2003) and Vanden (2004), risk appetite is the degree to which an organization links its objectives and goals to risk finally, this phase is characterized with the identification and deciding of the tools to be used in measuring monitoring and controlling risk and how to integrate them into other organizational processes.
The next phase is the decision making phase. This involves deciding and agreeing on strategies and tactics that should be used to link the risk appetite to business activities. Such strategies and tactics may include the top-down or bottom techniques of measuring, evaluating and reporting risks.
The fourth phase is concerned with the defining and deciding on the limits to steer the risk management process. There is need to define and expose the stop-loss limits for each credit risk. The institution should also decide on the corrective measure to be taken, the channels of responsibility and the decision process to be followed.