Author: Akindele, R I
Date published: March 1, 2012
(ProQuest: ... denotes formulae omitted.)
Risk management is the process by which managers satisfy their needs by identifying key risks, obtaining consistently understandable, operational risk measures, choosing which risks to reduce and which to increase and by what means, and establishing procedures to monitor the resulting risk position.
The danger of capital misallocation and imprudent risk taking has become the leading source of problem in Nigeria banking industry, which has crippled some banks in Nigeria. There is need for bankers to be aware of the need to identify, measure, monitor and control all inherent risks in their day to day business transactions. They need to determine that they hold adequate capital against these risks.
Since inadequate risk management arising from lax corporate governance is core problem to most banks in Nigeria, thus a need arise that banks and other financial institution need to meet requirements for risk measurement and capital adequacy and reduce conflict between managers and shareholders which could harm the firm value in the short and long run. The business managers need reliable risk measures to direct capital to activities with the best risk/ reward ratios. They need the estimate of the size of potential losses to stay within limits imposed by readily available liquidity, provided by depositors, customers, creditors and regulators with a mechanism to monitor risk position and create incentives for prudent risk taking by division and individual. The identification of this and resulting consequences on bank performance has prompt this empirical research study.
The general objectives of the study is to ascertain the effect of risk management and corporate governance on bank performance, while the specific objectives are to determine the relationship between risk management and bank performance and to assess the impact of risk management and corporate governance on bank profitability and performance.
The narrow approach of corporate governance views the subject as the mechanism, through which shareholders are assured that managers will act in their interests. Shleifer and Vishny (1997) defined corporate governance as the methods by which suppliers of finance control managers in order to ensure that their capital cannot be expropriated and that they earn a return on their investment. Macey and O'Hara (2001) argue that a broader view of corporate governance should be adopted in the case of banking institutions. They also argue that because of the peculiar contractual form of banking, corporate governance mechanisms for banks should encapsulate depositors as well as shareholders.
In general, the literature on bank regulation emphasizes the stated purpose of regulation as that of maintaining the integrity of the market system. Recent attention is more focused on the role of government in the financial sector, government's intervention in pricing and allocating credit, and government's role in regulating and supervising financial intermediaries. Regulation is commonly associated with the resolution of market failure in provision of the public good of financial stability. The characteristic limitations imposed are not concerned with market structure per sec instead; the constraints imposed by bank regulators in many countries attempt the opposite action. Ciancanelli and Gonzales (2000) state that in banking sector the regulation and regulator represent external corporate governance mechanism. In the conventional literature on corporate governance, the market is the only external governance force with the power to discipline the agent. The existence of regulation means there is an additional external force with the power to discipline the agent; the force is quite different from the market. This implies that the power of regulation has different effects to those produced by market.
Bank regulation represents the existence of interest different from private interests of the firm. As a governance force, regulation aims to serve the public interest, particularly the interest of the customers of the banking services. An agent of the public interest regulator also enforces regulation itself. This agent does not have a contractual relationship either with the firm's principal or with the banking organizations because of different interests from the principal (Ciancanelli and Gonzales 2000).
Managers and owners of banks showing efforts and intention to implement good corporate governance will increase market credibility. Subsequently, they will collect funds at lower cost and lower risk. It can be argued that better corporate governance will lead to higher performance. Some empirical evidences support this argument. Black, Jang and Kim (2003) investigate the relationship between corporate performance and good corporate governance. They find positive relationship between corporate performance and corporate governance.
La Porta, R., F. Lopez de-Silanes, A. Shleifer, and R. Vishny, (2002) study firm's performance 7 developing countries. They find evidence that there is higher valuation of firms in countries with better protection of minority shareholders. Parallel with this study, Klapper and Love (2003) use firms-level data from 14 emerging stock markets and document that corporate governance provisions matter more in countries with weak legal environments. They also find that better corporate governance is highly correlated with better operating performance and higher market valuation.
A major objective of bank management is to increase shareholders' return epitomizing bank performance. The objective often comes at the cost of increasing risk. Bank faces various risk such as interest risk, market risk, credit risk, off balance risk, technology and operational risk, foreign exchange risk country risk, liquidity risk, and insolvency risk. The bank's motivation for risk management comes from risks which can lead to bank underperformance.
Issues of risk management in banking sector have greater impact not only on the bank but also on the economic growth. Strahan (2004) concludes that some empirical evidence indicates that the past return shocks emanating from banking sector have significant impact not only on the volatilities of foreign exchange and aggregate stock markets, but also on their prices, suggesting that bank can be a major source of contagion during the crisis.
Banks which better implement the risk management may have some advantages: (i) It is in line with obethence function toward the rule; (ii) It increase their reputation and opportunity to attract more wide customers in building their portfolio of fund resources; (iii) It increase their efficiency and profitability. Cebenyoan and Strahan (2004) find evidence that banks which have advanced in risk management have greater credit availability, rather than reduced risk in the banking system. The greater credit availability leads to the opportunity to increase the productive assets and bank's profit.
Bonin (2003) opined that a general method of stabilize the banking sector is by stopping banks from engaging in high risk taken by constraining them to sell deposit and purchase credit, Good hart et al (1998) add that the normal method of addressing loans risks is to assess intermediaries, check their credit policy and verify that they have sufficient funds as a buffer against delinquent loans. Hooks (2004) also advise regulators to constraint bank investment prospects to specific credit worthy groups using corporate governance through risk management department upholding efficient risk principle and practices. Spollen (2007) addressing risk management and control posited that companies should be aware of the necessity of maintaining a sound risk management where credit manager/ head gives detail to the board of directors and also authenticate the existence and compliance levels of risk control.
Sanusi Lamido (2010) argues that banking is not just about deposit mobilization and lending but about managing loans and other assets created from the pool of deposits with highest sense of diligence. He stated that banking is about risk analysis and strategic placement of fund to enhance maximum returns at minimal risk therefore the services of competent chief risk officers should be engaged who report directly to the board through the Managing Directors/ CEO.
Principal-agent theory (Jensen and Meckling 1976) is widely used to explain why closely-held firms have better economic performance than do publicly owned firms. The theoretical framework tends to suggest that public enterprises are inefficient due to the fact that there is a lack of capital market discipline. Because of the lack of market monitoring, managers attempt to pursue their own interests at the expanse of enterprises' interest. Thus, agency theory views that there is a relationship between ownership structure and economic performance: the cost of monitoring makes private or closely-held firms economically more efficient than publicly owned firms.
However, private-owned firms in banking sector potentially shift agency problem from conflict of managers versus owners into conflict of managers-owners versus other suppliers of funds (mutual owners).
In banking sector, the severity of the conflict between depositors and the managers very much depends on the credibility of the government and the regulatory agency. In economies in which there are extensive state-owned banks, the main corporate governance problem is the conflict between the government and taxpayers (as principals) and the managers and bureaucrats who control the bank. Levine (2003) argue that the manager are less risk averse than shareholders who have managed their portfolio well. Therefore, managers will undertake less risk than is optimal from the taxpayer's point of view, in order to mitigate such opportunism, the managers may be given little autonomy.
However, Arun and Turner (2002) also argue that the divestment policy of state-owned banks raises several corporate governance issues. If banks are completely privatized, then there must be adequate deposit insurance schemes and supervisory arrangements established in order to protect depositors and to prevent financial crash. On the other hand, if government only divests part of ownerships, there may be opportunities for the government as the dominant shareholder to expropriate minority, shareholders using banks to aid fiscal problems or support certain distributional cartels. Therefore, the question in this case is whether the government can credibly commit that it will not expropriate private capital owners.
Arun and Turner (2003) also ague that an integral part of banking reforms in developing economies is the privatization of banks. They suggest that corporate governance reforms may be a prerequisite for the successful divestiture of government ownership. Furthermore, they also suggest that the increased competition resulting from the entrance of foreign banks may improve the corporate governance of developing-economy banks.
Figure 1.1 presents a conceptual framework model of relationship between corporate governance, risk management, and bank performance. The figure shows that corporate governance influences performance in two ways; it directly influence performance, and it indirectly influences performance through forcing the risk management. The model also shows what type of bank ownership moderates the effect of corporate governance on both risk management and bank performance.
How the model works to explain and solve the research problems? What reasons behind the scheme? There is twofold essence in the model relevant to answering these questions. First, the model shows that ownership structure leads to corporate governance practices. Second, there are gaps between: corporate governance and risk management, corporate governance and bank performance, and risk management and bank performance.
The gaps in this model are defined as some inconsistent degrees of roles and interest amongst the parties. The gaps naturally appear in bank operations due to asymmetric information and agency problem. This model also assumes that: (1) Bank owners are only concerned about maximizing their wealth or return on their investments in the bank; (2) Business people are normally risk averse.
Agency theory suggests the firms to involve managers as insider ownership in order to align their interests. This mechanism shifts the conflict of interest toward owners or managers and public or depositors. Regulator protects the public interest by issuing riles to force owners and managers of the bank to be obethent toward the rules. This situation leads each party toward 'prisoners' dilemma. Each prisoner attempts to bear witness letting fall the others. Thus, they suffer more from harsh punishment.
Agency mechanism could not solve the multi-conflict sufficiently. It needs awareness of each party to change their perspective to concern the other party's interests as a constraint to their objectives and interests. In this perspective, they should focus on optimum result rather than maximum result due to the constraints. All parties (stakeholders) expect the bank to serve their interests for long run rather for short run. The banks should be viewed not only as financial intermediaries but also as interest intermediaries. Banks who serve better interest indicate that they implement better good corporate governance. Because the interest of owner is to earn better return on their investment (equity), they will attempt to implement better good corporate governance.
This study considers some financial ratios which are related to corporate governance such as Capital Adequacy Ratio, CBN determines that banks should reserve minimum level of CAR at least 80%, the higher the CAR the higher the degree of banks obethent function towards the rule which serve and protect the public interest. Yasuda (2004) find that the implementation of capital adequacy requirement reduces risk taking of commercial banks. This study adopts other capital ratios as exogenous variables to assess corporate governance as required by Central Bank of Nigeria (CBN) to evaluate bank's health.
(i) Loan to deposits ratio (LDR): Loan is represented by total loan in the Balance sheet while the deposits include demand deposit, time deposits, time deposits certificate of deposits savings issued securities, prime capital, loan capital and borrowing, the ratio shows the proportion of public contribution as a source of capital to finance bank's loan.
(ii) Cash Claim on Central Bank (CCC) ...
(iii) Loan Loss Provisioning (LLP) ...
(iv) Fixed Assets & Inventories to Capital (FAI) ...
Financial ratios employed to measure risk management are:
(v) Value at risk (VAR) is the ratio of value at risk of individual bank to Benchmark set by Central Bank of Nigeria (CBN) as regulatory agency i.e. 5%. The higher VAR suggest that bank address a bigger problem in risk exposure, thus the bank should manage risk carefully.
(vi) Non-Performing Loan Ratio (NPL) is the ratio of non -performing loan to total loan. It represents management risk taking bahaviour relative to all organization resources. Higher NPL indicates that bank take more risk in their operation and investment which tends to expropriate the public interest. CBN mandates all banks to maintain less than NPL 5% for both risk management and external good governance.
Financial ratios employed to measure Bank performance as objective of Shareholders interests are:
Return on Equity (ROE) ...
Net Profit Margin (NPM) ...
This research work is carried out in the Nigerian Banking industry comprises of central bank of Nigeria (CBN) as the apex bank and other various banks including commercial and merchant banks known as the main stream Deposit Banks (DMBS), Micro-Finance banks and mortgage banks.
However, the scope of the study is limited to WEMA Bank PIc, a commercial bank with the corporate Head office in Lagos and Six Regional Offices in Lagos, South South, South East, North West, North East, North Central geographical zone of the country.
This study is descriptive in nature. The indecies for measuring risk management are: capital risk, diversification risk, credit risk and reliability risk. While corporate governance is measured by the following indecies: audit and compliance, corporate governance policies and corporate governance practices, while bank performance variable is measured by return on equity, return on assets over performance against industry benchmark. Both risk management and corporate governance are independent variables which determine the Bank performance. As dependent variables, risk management also depends on corporate governance. The bank performance; dependent variable is determine by exogenous variables, such as return on equity, return on assets over previous years and also as compared with industry benchmarks (average). All the variables are measured using a well structure questionnaire on 5 point likert scale.
The population for the study consists of 3,054 employees of 151 branches Network of Wema Bank PIc, the management staff inclusive. The sample size is made up of the risk management staff. The risk management staff and officers including Branch managers, operation manager, risk officers, credit officers, audit and compliance officers, total (480) four hundred and eighty employees are chosen as the sample size, representing 15.7% of the Population.
Descriptive and inferential analytical statistical techniques were used as data were collected, edited, coded and organized into frequency distribution to obtain measures of central tendency, measures of variability, it also involves presentation of finding via distribution table, simple percentage and weighted mean.
The use of Descriptive non-parametric statistic method is justified by the nature of data questionnaire form, measuremeny made on interval or ratio scale for high precision. It is used to estimate population parameter from a representative sample drawn from the population, predict the population characteristics of population sample, test relevant hypothesis for the purpose of drawing conclusion. Decision rule: Accept Ho if the P. Value is greater than 0.05 level of significance.
Chi-square (X2) a non-parametric statistics test is employed to test the formulated hypotheses. This is the test of significance involving two or more nominal variable to determine whether a relationship exists or they are independent of each other. It is a test of whether the observed series of values differ-significantly from the expected value.
Decision Rule: Accept Ho if x2st < x2par
Finding: Since x2st > x2par i.e. x2 calculated is greater than the hypothesis x2 table value. (Ho) null hypothesis is rejected and (Hi) alternative hypothesis is accepted. Therefore there is significant and positive relationship between risk management and bank performance.
Decision Rule: Accept Ho if x^sup 2^st < x^sup 2^par
Finding: Since x^sup 2^st > x^sup 2^par i.e. x^sup 2^ calculated is greater than the table value. Null hypothesis (Ho) is rejected and (Hi) alternative hypothesis is accepted. Therefore effective risk management and corporate governance enhance bank profitability and performance.
Decision Rule: Accept Ho if x^sup 2^st > x^sup 2^par
Finding: Since x^sup 2^st > x^sup 2^par Ho is rejected and Hi is accepted. Therefore the bank performance depends largely on the risk management and corporate governance.
This study also employed other capital ratios as exogenous variables to assess corporate government and risk management as required by Central Bank of Nigeria CBN to evaluate by bank's health. The financial ratio are:
i. Loan to deposits ratio (LDR)
ii. Cash claim on central bank (CCC)
iii. Value at risk ratio (VAR).
iv. Non-performing loan ratio (NPL)
v. Return on Equity Ratio (ROE)
vi. Net profit margin (NPM)
The computation of these ratio is based on the past two years annual financial statements of Wema Bank PIc for the year ended 2008 and 2009. (appendix 3).
The above 2 Ratio proxy for evaluating corporate government. LDR Ratio of 39% and 51% for the year 2008 and 2009 respectively comply with CBN Directive to maintain LDR Less than 85% which indiciates that the bank maintain obethent function towards rules which protect public interests.
The Cash Claim on Central Bank (CC) 0.42:1 and 0.11:1 for the year 2008 and 2009 respectively indicate a positive relationship between risk management and bank performance and implementation of the capital adequacy requirement which reduces risk taking of commercial bank.
(iii) Value at Risk (VAR) is the ratio % value at risk of bank to benchmark
The bank higher VAR suggest that the bank address bigger problem in risk exposure, thus, need to manage carefully.
(iv). Non-Performing Loan Ratio (NPL) is the ratio of Non -performing loan to the total loan.
Value at Risk (VAR) Ratio and Non-Performing Loan Ratio are proxy for measuring risk management ability of the bank and CBN mandated all banks to maintain less NPL. The bank maintain NPL of 4% and 1% for year 2008 and 2009.
Both Return on Equity and Net Profit Margin are proxy for measuring bank performance as objective of shareholders. However, the bank run at loss on both year 2008 and 2009, thus maintain 1.3:1 and 3.9:1 respectively. This level the net loss incurred in the year 2008 and 2009.
However the ROE for the year 20087 and 2009 are 4:2:1 and 2:5:1 respectively as a result Effect Risk management and corporate governance.
1. The study finds that there is a positive relationship between bank performance and risk management.
2. It is also found and confirmed that better corporate governance leads to better risk management, a positive relationship between corporate governance and risk management. Both corporate government practices risk management are measured based in Linker scale especially for risk management, higher score of risk management means bank have better implementation in managing their risk, in term of capital risk, diversification risk, credit risk, reliability risk and the relationship indicates that good corporate governance may reduce the risk of bank.
3. Secondary data study finds that there is a non-linear relationship between corporate governance and bank performance, which is measured by proxy based on composite value of CAR, Capital Adequacy ratio determined by CBN as regulator with a minimum CAR of 80%, also other Capital and Assets ratios meet the regulators stipulations, customer and stakeholders will be less interested in bank which cannot meet these stipulations, thus become unhealthy and reduces its reputation, the public may perceived that the bank have no concern on implementing good corporate governance, However, any efforts to improve the ratios will need more cost than benefits.
Furthermore, when the capital and assets ratios of banks have fulfilled the stipulations the bank is categorized as healthy which in turn will attract public and customers to deposit their find into the bank. Both primary, secondary data study find that better corporate governance leads to better risk management.
A high percentage of success has been recorded in commercial bank as a result of better risk management that arise from better corporate governance, both enhance bank profitability and performance, improve return on equity than industry average (benchmark).
Efforts are made to determine the effects of risk managements on bank performance as it helps to stabilize cash flow, to reduce risk of insolvency, reduce depositors and public anxiety and maintain safety, liquidity and soundness of the bank. This is confirmed by hypothesis A which shows a significant positive relationship between risk management and bank performance.
Finally it was found that performance of bank depend largely on risk management and corporate governance that is why Wema Bank PIc combined experience, well trained and competent human capital and strategies to implement effective risk management and corporate governance policies and practice throughout their branches and their system as a whole, through the management, directors, committee and risk management group in their routine transactions.
The results can be concluded and inferred as follows:
i. There is a significant positive relationship between risk management and bank performance. The result confirms hypothesis A.
ii. Effective risk management and corporate governance enhance bank profitability and performance as there is improvement on return on equity when compared industry average or benchmark.
iii. That bank performance depend largely on risk management and corporate governance. The result confirms hypothesis C.
iv. Corporate governance has non-linear effect on bank performance as better corporate governance policies and practices is implemented which also determine risk management.
v. There is positive relationship between corporate governance practices and risk managements.
vi. There is a credit limit to which each branch manager can grant to each type of account holder above which must be subjected to the Head office for assessment and approval by risk management committee.
vii. Diversification of risk is encouraged as various credit facilities are granted to customer in short and medium term.
viii. The responses gotten showed Wema Bank adherence to central bank (CBN) regulations and stipulation in the area of capital adequacy, risk diversification credit control, audit and compliance, and corporate governance policies and practice.
In general, the findings from both primary and secondary data analysis are parallel: primary data shows support and strengthen findings for secondary data analysis.
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AKINDELE R.I. (Ph.D)*
Department of Management and Accounting
Faculty of Administration
Obafemi Awolowo University
* E-mail:- firstname.lastname@example.org