Ratio Analysis as a Bank Lending Tool (A Case Study of Union Bank of Nigeria, Enugu)
Chapter One
OBJECTIVES OF STUDY:
The ratio has been defined as that technique that is possibly used to facilitate the comparison of significant figures thereby expressing the relationship in the form of percentages thus enabling the accounts of the borrower to be interpreted by bringing into focus salient features thereof (Spice and Peglers’ 1971). The analysis of service functions provided by lenders (financial institutions) is what this study is all about. The objectives, therefore included:
- To find out how ratio analysis helps financial institutions in lending. In other words, to find out how ratio analysis services as a vital tool for lending by commercial banks and institutionalized lenders.
- To ascertain if ratio analysis is of any use to bank managers in ascertaining the financial performance of a borrower.
- To explore the ratio analysis and find out their importance and how they can be used by bank managers in lending decisions.
- To show how a careful study, analysis, and use of financial ratios can help a lender obtain a good knowledge of the financial aspects of a borrower and thus aid lending.
CHAPTER TWO
LITERATURE REVIEW
CONCEPT OF BANK LENDING:
The Oxford Advanced Learner’s English Dictionary defines lending as “giving temporary of something” lending involves giving something for a period of time on the understanding it or its equivalent will be returned.
Lending is an essential function of commercial banking. It has to do with an extension of loans borrowers. Through lending, bank management strives to satisfy the legitimate credit needs of the community or credit markets that the bank services or intends to serve. Bank loans contribute materially to bank profitability by providing a higher return than most other bank assets and by being a key element in the creation and maintenance of depositor relationships. Bank lending tends to be influenced by more subtle and subjective factors such as an evaluation of the borrower’s character, the history of the borrower’s relationships with the bank and his possible influence on prospective new business. These differences emphasize the need to understand the basic concepts and types of lending and to have well-formulated loan policies and practices.
Well conceived lending polices and careful lending practices are essential if a bank is to perform its credit-creating function effectively and minimize the risk inherent in any extension of credit. A bank needs policies and practices specifying how much or what kinds of loans will be made to whom and under what circumstances. Therefore, a bank’s lending policies are in effect, screening devices by the directors and bank managers seek to limit the bank’s loans to the type and character that they think appropriate particularly when loan demand is pressing hard against a bank’s available funds (Howards 1980).
Bank credits are the essential means of creating and maintaining depositor relationships, particularly with business firms. Most banks lend only to firms that keep deposit balances at the bank and most firms maintain deposits primarily at banks that they believe are willing to fulfill their borrowing needs. Therefore, in order to service the credit needs of customers profitably, banks must be willing to assume a somewhat higher average risk on credits than on other bank assets.
CHAPTER THREE
METHOD AND DESIGN:
INTRODUCTION:
The project writer used the experimental survey method and the writer went further by interviewing the officials of Union Bank of Nigeria Plc, Ogui Road, Enugu. The survey method was used to gather relevant data. These data were summarized analysed and interpreted which enable the project writer to extract logical findings and draw conclusions for eventual solution of the problems of the study.
SOURCES OF DATA:
Data are the basic raw materials for statistical investigation and analysis. They are of two types:
- Primary data
- Secondary data
PRIMARY DATA:
This was collected through the use of well structured questionnaires which administered on the staff and management of Union Bank of Nigeria Plc, Ogui Road, Enugu.
SECONDARY DATA:
These are information already existing before conducting this research data. It constitutes a stepping stone in most research assignments for the research. The source of secondary data can be internal information from its own pool of records or external information extracted publications agencies and consultants. Due to the much quest for research project to have the academic background, secondary data were got from prominent libraries such as:
- University of Nigeria, Enugu Campus (UNEC) Library.
- Enugu State University of Science and Technology, (ESUT) Enugu Campus Library.
- Union Bank of Nigeria Plc, Enugu Library.
- National Library, Enugu.
- Institute of Management and Technology (IMT) Enugu Library.
Discussions with some lecturers and students also constitute sources of essential data.
RESEARCH POPULATION:
For easier collection of data, Union Bank of Nigeria Plc, Ogui Road, was ideally used as sample of the whole lot of lending commercial banks in the country could not be easily research reached. The evaluation made from this bank were used for generalization or prediction as to what is apparently financiable in all the commercial banks and finance houses in the country today.
However, the reason for the researcher’s restricted sample choice of the said bank is amiably aimed at adequate focus and representation of all the possible situation in the temporary Nigerian practice, irrespective of the size. In the institution used, forty-two (42) is the user selected, that is the entire staff of the advances department which form the sample size. Use staff selected are in better position to answer the questions, since some of the questions are financial and need expert knowledge in answering them. And it is their field of work and they have the knowledge of the topic.
CHAPTER FOUR
DATA PRESENTATION AND ANALYSIS ON FINDINGS AND DISCUSSION:
When all field investigation and desk studies have been carried out, the crucial stage that would reveal the use of financial statements as a factor for bank lending were presented and analysed. This would involve organizing the obtained data in a consumable form for necessary deductive hypothesis, judgment and decisions. In pursuit of this project research, the presentation, analysis and data and testing of hypothesis are done in this chapter using the investment of questionnaires and oral interviews.
CHAPTER FIVE
SUMMARY RECOMMENDATION AND CONCLUSION
SUMMARY OF F INDINGS
This section summaries some of the key findings of the research which relates to the main objective of this study. It is a common phenomenon to observe a high incidence of default in loan repayment among borrowers, which undermine the ability of banks to discharge their primary role of credit delivery. The researcher’s study dwelt extensively on the analysis of borrower’s financial statement in order to ascertain his credit worthiness before extending credit advances to avoid non-repayment of such credit advances in future time. And also to find out the factors responsible for such strong aversion towards loan repayment programme by the borrowers. This chain of indebtedness tend to weaken and affect the strength and resilience of the lending banks.
Again, the aim is also to find out the effectiveness of lending through a careful analysis of financial statements of the borrower by the bank (lender). Going by the high rate of bad debts recorded by banks, the high rate of bad debts recorded by banks, the necessity of sound lending is not far fetched. Bank lending tends to be influenced by more subtle and subjective factors such as an evaluation of the borrower’s character, the history of the borrower’s relationship with the bank and his possible influence on prospective new business. These differences emphasize the need to understand the basic concepts and types of lending and final payment to have well formulated loan policies and practices. The rate of repayment and final payment schedule should be established. Bank lending is of great importance to business groups or organizations and individuals for them to meet up their expected financial goals. And on the side of the bank, it lends where profit rate is high and risk of repayment and cost of administering loans are low. Bank is also expecting growth in terms of additional variety of services yielding and income as far as lending is concerned. Canons of lending should be considered effectively not be neglected when extending credit advances. The amount, purpose of the loan, business of the borrower, sources of repayment, security, the borrower’s character and capital resources should be considered effectively before extending loan to avoid non-recovery of such loan. After granting loans to customers, the bank as a creditor faces four possible states regarding the prospects of loan repayment. These are:
- The borrower remains able and willing to pay
- The borrower remains able but willing to pay.
- The borrower remains willing but becomes unable to pay.
- The borrower becomes both unwilling and unable to pay.
When the first stage which is the planned stage is achieved, the transaction is successful. Unfortunately, the best plans occasionally miscarry and the creditor finds himself in States ii, iii and iv above. Under these conditions, what will the bank do to recover its money? This is where the issue of security after properly analysing the financial statements of the borrower. The issue of bad and doubtful debt is very crucial to the ability of banks to continue to effectively meet their obligations of profitability, growth and development in Nigeria. Thus loan extension should be backed up with security comes in.
To make sound lending, some lending techniques were seen necessary. These include: analysis of financial statements lending based on trust, presentation of collateral that worth the amount needed by the borrower, etc. Lending techniques are all important, banks that hope for sound lending cannot side track a careful analysis of financial statements. Ratio analysis has helped banks in making sound lending. It helps in translating the information contained in the accounts of the borrower to more helpful and understandable form. It also provides decision makers with the additional required information to assess the past performance and the financial position of the borrower and also help form an opinion concerning likely future progress. To prove the necessity of a careful analysis of financial statements in aiding sound lending, three hypothesis were set and proved. These hypothesis include:
- The necessity of financial statement analysis in aiding sound lending.
- The necessity of CBN liquidity ratio requirement in meeting depositors claims.
- The necessity of high working capital ratio in prompt loan recoveries.
Analysis of the financial statements has reduced though not entirely stopped the bad loans recorded by banks Experience, Knowledge ad Education can assist to make the right decisions but the fact still remains that bad and doubtful debts are inevitable for banks as long as they remain in the banking business.
Financial statements analysis is a good step, which on paper look divine and inspiring but they are not to be strictly depended on the reason for this is not far-fetched. There are cases where loan defaults arise from financial statements which were carefully analysed and thought to be very strong and dependable. It could arise from the fact that figures are falsified in the financial statements or that the financial statements were not carefully analysed by the credit advances officers.
Based on the result of the investigations the following findings were made:
That some banks extend credit advances based on assessment of just a year’s financial strength profitability and future prospects. There is inadequate training in credit analysis and that some loan officers are not well equipped for the job they do. There are some bank managers whose requirements embedded in the set standards. Where it is certified that the financial statement of a borrower has been falsified, there should exist a penalty for such borrower and the certificate of practice of the defaulting accountant seized to deter others from such unhealthy behaviour. For banks to survive, the anti-social behaviiour engineered by selfishness, and greed by managers must be eliminated. There should equally exist proper training in credit advance analysis of loan officers. And there should exist a very helpful training in credit analysis. This will go a long way to aid the credit analysis which is thoroughly engaging the accounting ratios to properly analyse the financial statements.
Bank managers should be cautioned on their efforts to exhaust the limit given to them even while the financial statements of the customers they are lending to obviously which cannot carry that credit advance. Again, there is the need to see a series of at least two or three years.
Balance sheets: It is a statement at a given data which relates to one day in the life of business. It is to assess financial statements over a couple of years to watch the trend and progress of the company before extending credit advance.
Ratio analysis is very important in the assessing of financial statements of the respective borrower. It should not be neglected, again in order to minimize the increasing incidence of defaults in repayment of loan, it is being strongly recommended that the lending bank should demand and perfect their legal title on collaterals submitted by the borrower.
However, it is believed that the prevailing problems of non-repayment of loans and poor assessment of borrower’s financial statements which are assuming acute dimensions among borrowers and lenders will whittle down, if the above recommendations are religiously adopted.
CONCLUSION:
The world is presently going through severe economic recession which is of considerable magnitude. For Nigeria, the recession typifies the borrowing experience of a monoproduct economy which relies heavily on oil revenue. It is apparent that the role of the financial institutions in the financial life of the borrowers is quite commendable. However, based on the analysis, findings and discussions made from the study, there is no gain saying the fact that potential borrowers have not been responding positively in the repayment of these bank loans.
This research work covered the use of financial statement analysis for sound lending. Analysis of financial statement is found indispensable in banks. A careful analysis enables banks to lend wisely. In actual fact, while not being quite ignorant about the existence of financial statement analysis as an aid for sound lending; some banks fail to reap its full benefits through their ineffective implementation of its use and feel they have a duty to exhaust the limit of loanable funds accorded them and insist on doing so even when financial statements are clearly not strong enough. In Nigeria, some professional accountants and wealthy businessmen manipulate figures. This creates fear that auditors collaborate with borrowers to present false or window dressed annual financial statements. These accounts prepared audited accounts to suit the purposes of the businessmen who have employed them. Even where financial statements are analysed before lending, banks exhibit an unprofessional attitude to lending. Bank managers no longer regard their vow or oath of secrecy as anything to go by. The banks are regarded as objects of exploitation. The bank managers constitute themselves into major threats to corporate objectives. This unprofessional attitude is one cancer eating deep into the fabric of the banking industry.
Finally, it can be seen that the management of the Union Bank of Nigeria Plc, Ogui Road Branch Enugu, makes use of ratio analyzing the financial statements of the potential borrowers before extending the credit advances. These help them to have a sound lending and also to recovering the extending credit advances from their respective borrowers.
RECOMMENDATIONS:
Having recognized hitherto the problems in the light of the foregoing research findings, it may now be appropriate to make the underlisted recommendations that may, if adopted reduce the problems of non-recovery of credit advances from respective borrowers and thereby increase sound lending by the financial lenders. Lenders to avoid a situation where loan repayment programme unnecessarily tend to develop her-core problems of debt recovery. It might be good that the lending banks should regulate their interest rates charges in a manner that is feasible to give encouragement to the potential borrower for quick repayment. Banks should have audit personnel that will carry out an additional auditing of the annual financial statements of their borrower’s accountant. The bank could equally have an agreement with borrows whereby all auditing work is done by the bank’s own audit personnel. After careful analysis of the level of development in Nigeria, security lending as a panacea for ensuring recovery of bank credit advances must be recommended. It is dangerous to depend totally on financial statement analysis. There should be greatly involved in the an overwhelming evidence to indicate that the money is safe and recovery assured.
Banks should be greatly involved in the setting of accounting standards. Banks should have representatives in the Nigerian Accounting Standards Board (NASB) and thus have their own accounting standards.
BIBLIOGRAPHY
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- Central Bank of Nigeria (1993): Financial System ‘Annual Reports’ Vol. 5
- Ibid (1990) Monetary Policy Circular No. 27.
- Edwards, J. R. and Mellett, J. (1987): Accounting for Banking Students. London, Bankers Books Ltd. 2nd ed. p. 283.
- Emekekwue, Patrick (1994) Commercial Banking Enugu, New Generation Ventures Ltd. 1st. ed. p. 213.
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