LOAN DEFAULT, CREDIT RECOVERY AND BANKING SYSTEM STABILITY AMONG DEPOSIT MONEY BANKS IN NIGERIA
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Date
2022
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Abstract
The banking system is essential in driving business growth and macroeconomic
effectiveness. Evidence, however, revealed that the Nigerian banking system had suffered
various degrees of instability from shocks arising from both endogenous and exogenous
sources, leading to default in repayment of bank loans. This has made deposit money banks
(DMBs) in Nigeria ineffective at meeting set targets for sustainable banking and stable
performance. The constant growth of loan default rate that gradually develops into hardcore
bad debt continues to trend amongst DMBs. These issues necessitate the basis to empirically
examine the effects of loan default and credit recovery on banking system stability among
the DMBs in Nigeria. The study adopted the techniques of Partial Least Squares Structural
Equations Modelling (PLS-SEM) and the dynamic panel of the system of the Generalised
Method of Moments (SYS-GMM) to analyse data from primary and secondary sources. The
result of the PLS-SEM indicated that there are various idiosyncratic factors among DMBs
that encourage loan default and its increase. Scholars discovered that borrowers' nonadherence to loan agreement terms is mainly responsible for bank loan loss. The effect of
loan default on banking system stability indicates that loan default has a negative impact on
banking system stability in Nigeria both in the short and long run. The result further reveals
that credit recovery has a positive and significant influence on banking system stability both
in the short and long term. The findings of the combined causal effect of loan default and
credit recovery on banking system stability reveal that the result is negative in the short run.
However, in the long run, the negative effect is neutralised when credit recovery is achieved.
The individual impact of the three categories of non-performing loans on banking system
stability showed that each category negatively impacts banking system stability in the short
and long run, except sub-standard loans, which have a positive effect in the short run. The
findings showed that the vulnerability index is more pronounced than the banking soundness
index. This is because the independent variables have higher and more significant
relationships with the Banking Vulnerability Index (BVI) than with the banking soundness
index, which means that the impact of loan default and credit recovery on the banking system
stability is more significant on the Banking Vulnerability Index. The finding implies that
exogenous factors rather than endogenous factors mainly cause the instability of DMBs in
Nigeria. The study thus recommends that bank borrowers adhere strictly to loan agreement
terms and conditions while lending officers should be penalised for defaulting on loans they
booked. Therefore, bank management should ensure that inexperienced and non-risk
professionals are not saddled with assignments in the risk directorate of banks to avoid
causing unnecessary losses. In addition, banks should not wait as long as 90 days of default
before activating prompt credit collection/recovery activities while maintaining favourable
minimal recovery expenses, particularly with their Debt Recovery Agents (DRA). This is to
ensure recovery expense does not outstrip the actual amount recovered.