Abstract

Credit risk management is of paramount importance to business men and the business world as whole. The study made use of UBA Bank as case study. Data for the period 2009 to 2015 was used. We have employed the regression model to do the analysis. In this model, we have defined profit as a performance indicator while non-performing loans, performing loans, cost per loan, loan provision, total loans, total deposit and capitals credit risk management indicators. The findings and analysis show that credit risk management has a significant effect on the performance of commercial banks in Cameroon.

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study          

The health of a financial system has an important role in the country as its failure can disrupt economic development of the country. (Das and Ghosh, 2007) . Company’s financial performance is ability to generate new resources, from day – to – day operation over a given period of time and being gauged by net income and cash from operation. The strength of a banking system in every economy is an essential requirement to ensure economic stability and growth (Halling and Hayden, 2006).Banks are the main part of the financial sector in every economy performing valuable activities on both sides of the balance sheet. The asset side enhances the flow of funds by lending to the cash starved users of funds, while they provide liquidity to savers on the liability side (Diamond and Rajan, 2001).

Banks also facilitate the payment, settlement and support the smooth transfer of goods and services. They ensure productive investments on capital to stimulate economic growth and help develop new industries thereby increasing employment and facilitating growth. The bank performance measure can be divided into traditional measures and market based measures (Aktan and Bulut, 2008).  New banking risk management techniques emerged in early 1990’s. To be able to manage the different types of risk one has to define them. Credit risk, interest rate risk, liquidity risk, market risk, foreign exchange risk, operations risk and solvency risk are the most applicable risk to the banks institutions.

Risks are natural elements of business and the community life as a whole. It is a condition that raises the chance of losses/gains and the uncertain potential events which could manipulate the success of financial institutions. Risk management is the human activity which integrates recognition of risk, risk assessment, developing strategies to manage it, and mitigation of risk using managerial resources. Effective risk management is accepted as a major corner stone of bank management by academic, practitioners and regulators. By acknowledging this reality and the need for a comprehensive approach to deal with the Bank Risk Management. The BASEL committee a banking supervision adopted the Basel 1 Accord followed by the Basel 2 Accord and recently by the Basel 3 Accord to deal with the matters (Sensarma and Jayadev, 2009).

Risk management is found to be one of the determinants of the returns of bank stocks. Holland (2010) observed that a risk management failure is considered as one of the main causes of the crisis. Determinants of bank performance are divided into both internal and external factors. The internal factors focus on the special characteristics of banks such as bank size, bank capital, credit risk and liquidity risk while the external factors include the macro economic variables that’s is Gross Domestic Product (GDP) and inflation.

A number of commercial banks in the world have collapsed or experienced financial problems due to inefficient risk Management systems. The study seeks to examine the relationship between risk management and banks’ profitability. The past decade has seen dramatic losses in the banking industry. Firms that had been performing well suddenly announced large losses due to credit exposures that turned sour, the Reserve Bank of Zimbabwe (RBZ) pointed out what it terms “imprudent credit risk management practices” as being one of the major causes of the banking crisis of 2004. In response to this, commercial banks have almost universally embarked upon an upgrading of their risk management.

Banks are exposed to different types of risks, which affect the performance and activity of these banks, since the primary goal of the banking management is to maximize the shareholders’ wealth, so in achieving this goal banks’ manager should assess the cash flows and the assumed risks as a result of directing its financial resources in different areas of utilization. Credit risk is one of the most significant risks that banks face, considering that granting credit is one of the main sources of income in commercial banks. Therefore, the management of the risk related to that credit affects the profitability of the banks (Li and Zou, 2014). The importance of credit risk management in banks is due to its ability in affecting the banks’ financial performance, existence and growth.

Banks today are the largest financial institutions around the world, with branches and subsidiaries. There are plenty of differentiations between types of banks. And much of this differentiation rests in the products and services that banks offer (Howells & Bain, 2008,). For instance, commercial banks hold deposits, bundling them together as loans.

Credit risk management is very important to banks as it is an integral part of the loan process. It minimizes bank risk, adjusted risk rate of return by maintaining credit risk exposure with view to shielding the bank from the adverse effects of credit risk. Banks are investing a lot of funds in credit risk management modeling. Banks need to manage the credit risk inherent in the entire portfolio as well as the risk in individual credits or transactions. Banks should also consider the relationships between credit risk and other risks. The effective management of credit risk is a critical component of a comprehensive approach to risk management and essential to the long-term success of any banking organization.  Credit risk can be accessed through analyzing the financial performance of commercial banks in an attempt to mitigate impacts arising from credit defaults. The future of these banks depends on the possession of good credit risk management dynamics. Since exposure to credit risk continues to be the leading source of problems in banks world-wide, banks and their supervisors should be able to draw useful lessons from past experiences. Banks should now have a keen awareness of the need to identify, measure, monitor and control credit risk as well as to determine that they hold adequate capital against these risks and that they are adequately compensated for risks incurred. The existing procedures for credit risk management are not adequate to compete with the existing financial and economic challenges thus the need for continued study and analysis on the matter of credit risk and managing it.

1.2 Problem Statement

Banks consciously take risk as they perform their role of financial intermediation in the economy. Consequently, they assume various risks, which include credit risk, interest rate risk, liquidity risk, foreign exchange risk and operational risk. Managing these risks is essential for their survival and prosperity. Losses from a single loan or a material breakdown in controls can eliminate the gain on many other transactions.

In many countries Commercial banks   have registered an unsatisfactory financial performance as reflected from increasing loss ratios such as: current ratios, quick ratio, net profit ratio, and return on capital employed ratio. This poor performance has been attributed to combination of many factors including, low net interest margins, inflation, exchange rates, Good managerial ideas, credit risk management etc. Herrero (2003), in his paper, the determinants of the Venezuela banking crisis argued that among the reasons for bank failure was inappropriate lending practices which exposed banks to different risks and losses. Risk management has emerged as a distinctive subject and as an arm of practical management of risk. It brings ideas and techniques drawn from many disciplines in order to provide a sound conceptual foundation and a set of tools for analysis and control of risks.

Our Cameroonian banking industry has continue to grow both in terms of new local and foreign entrants, customers, and deposit base, regionisation and increase in scrutiny from the regulation specifically the Bank of Central African States (BEAC).The banking sector in Cameroon has liberalized increase in the adoption of information technology and improve business environment due to reforms being undertaken  in the political ,economic, social and cultural fields(IMF country report 2009).Due to these changes ,the level of competition has reached its optimum level coupled with the enlightened customers and increase in scrutiny from the regulators has led banks to introduce effective risk management practices.

The different nature and functions performed by banks expose them to all the various kinds of risk most especially the credit and liquidity risk are the risk that the bank and the customer may not be able to meet up with their obligations as they fall due. Credit risk deals more the customers who take credits in the bank where as liquidity risk deals with the bank itself.

The way credit risk is managed greatly determines the performance of such a bank. Many banks that failed to manage their credit risk very well have performed poorly while those ones that managed them properly have had good profits. UBA has credit policy set to reduce risk and NPL as critical role in financial performance. However, the extent to which risk management contributes to profitability of UBA is not clear. It is against this issue that the researcher wants to carry out this research and find the relationship between risk management and profitability of commercial banks.

In Oder to be successful in managing credit risk is to clearly understand about risk involved in lending quantification of risk within each item of the portfolio and reaching a conclusion as to the likely composite credit risk profile of the bank

As a result of all this management of risk problems, the principal concern of this research is to access the relationship between Risk management and financial performance of commercial Banks in Cameroon.

Thus our main problem statement will be finding out the relationship between credit risk management and financial performance of commercial banks in Cameroon.  Based on the above statement, we have the following research questions which we hope will contribute in providing solutions to the main research questions.

1.3 Research Questions

1. What is the effect of cost of funds on the financial performance in UBA?
2. What is the effect of total deposits on the financial performance in UBA?
3. What is the effect of Performing loans and Non-Performing on the profitability of UBA?
4. What is the effect of capital on the financial performance in UBA?