Project Topics

THE EFFECT OF BAD AND DOUBTFUL DEBT ON THE LIQUIDITY OF UNITY BANK

THE EFFECT OF BAD
AND DOUBTFUL DEBT ON THE LIQUIDITY OF UNITY BANK PLC, KADUNASTATE

CHAPTER ONE

1.0      
INTRODUCTION

The word “bad and doubtful debt” is used in the
banking to refer to the portion of loans, advances and over drafts granted by
bank which has proved difficult and seemingly impossible to recover in full
from the respective committed customer. Such debt do not emerge instantaneously
but rather are a gradual result of “lending errors” by lending officers and
subsequent improper administrative handling of the facilities among other
factors.

The commercial banks are in the services industry.
They are aimed at providing financial assistance to individuals and corporate
bodies without underplaying the importance of profitability to the shareholders
and deposits alike. A bank is therefore expected to ensure that sufficient
liquidity of funds meet cash demand by its customer at short notices. This in
addition to maintaining sufficient profitability hold through proper and
efficient management.

A business has two  basic source of capital:

a)            
Owner’s Capital: That
is equity contributed by shareholders (including retained earnings) which is
essentially used for he purchase of the initial assets of the business and its
initial working capital.

b)            
Borrowed Funds:
Which refers to external fund required and injected into the business by
management subject to the articles and memoranda of Association. It is here
that the commercial bank play an important role by granting long and short term
loans and advances. It is in the process of granting those loans facilities
that error occurs. Losses resulting from such errors will be the focus of this
research.

Through the proper use of interest rate banks are
able to attract depositors of various terms. Such depositors include, short
term deposits ranging from 7 days to 6 months, long term, deposits current
account. This is regarded as special borrowing by the bank since the bank of
any purpose(s) could use any deposits without recourse to the depositors, and
such depositors are only payable on demand or at any agreed date. It is these
depositors, which provide the basis for banks lending to various customers.
This is subject of the reserve ratio set by the central bank of Nigeria (CBN).
The interest rates charged on loans by banks are usually higher than the rates
they pay on deposit and are determined by the federal government. It was the
interest rates chargeable and payable on 
loans facilities and deposits respectively.

The numbers of volume of good loan and advance seriously
determine the degree of profitable commercial banks. Consequently, profitable
commercial banks have to limit or eliminate the number of bad account in their
lending portfolio. It is necessary to note that all funds tied up in bad and
doubtful account are not accountable for further onward lending.

Also, with the advent of CBN prudential
guidelines, non performing loans and advances who interest have been
outstanding on these account are not reflected in the earnings of commercial
bank, but charged to interest suspense and charged income when realized. Bad
debt regarded as negative contributors to the profitability of commercial
banks.

So banks should be expected to be the most
relevant to provide for bad debts unless it is unavoidable.

Another dimension however is that critics are
quick in pointing out that the high bad or doubtful debts figures in final
accounts of commercial banks could be realistic. It is also alleged that banks
could use such provision to evade tax. It also demonstrate the incompetence of the
lending bankers in the management of loan able funds on the other hand, it is
held that this provisions shows the level of convenience by the bank officer
system. This views was expressed by the president of Association of
Shareholders of Wema Bank, Mr. Akintunde Asaw. He alleged that some of the
official of Wema Bank acted outside the specified authority and scheduled by
irregularly approving loans. He therefore gave the bank up to 1990 to recover
all irregular loans while assuring that those involved “regular disbursement”
of shareholders would be punished.

The final accounts is of most commercial banks in
Nigeria have provisions for bad and doubtful debts of various figures while the
funds of the level of such provisions id decreasing in the case of some
commercial banks for other, it is increasing.

This reflected in the comments made by the
Chairman of the Board Directors of such commercial banks. In the case of the
Bank of the North provision for bad and doubtful debts were N6.8 million
(1993), N6.7 million (1994) and N213.5 million (1995). This shows an increasing
trend from 1992 to 1995, which may not be connected with the allegation of the
President of shareholders of Wema Bank.

The view of the provisions for bad and doubtful
debts by banks in the country has necessitated on in-depth study into the
fundamental factors for such losses by the bank. Consequently, the fundamental
objective of this study is to identify the causes of bad and doubtful debts and
controls been employed by banks to minimize or eliminate such debts. In so
doing, we will be able to establish the efficiency of the control otherwise in
the banks lending system. Consequently, appropriate recommendations could be
made for improvement.

1.1      
HISTORICAL
BACKGROUND OF UNITY BANK

The bank was incorporated on 17th
September, 1957 with initial share capital of 12500 dividends into 1200
ordinary shares of N1 each. It started business in January, 1960 at two
branches located in Kano and Kaduna which operated to customers on 7th
and 5th January 1960 respectively.

The bank is wholly owned by the Northern States
of Government and Northern Nigeria Investment Corporation, a subsidiary of New
Nigeria Development Company )NNDC). By 1989, arrangements have been completed
to increase the N30 million share capital of the bank with N22.35 million fully
paid up to N100 million. The growth of the bank from 1960 – 1970 was steady
with a loss of 36,925 which was said to have veen reversed after four (4) year
of operations during which period they there in position to declare dividends.

In 1970, the issued share capital was N 2.7 million,
with 12 branches and staff compliment of little over 360 employees. Also the
total asset of the bank is increased to N30 million, deposits stood at N26
million loans and advance was N17 million.

Between 1971 and 1979, the bank opened a total of
31 branches, has branches in all states capital of the Northern States of the
Federation including Federal Capital territory, Abuja. Consequently, with the support and
patronage of northern states, marketing boards, Ahmadu Bello University Zaria,
a good number of manufacturing and commercial business, the bank continued to
grow since the 1980s. the staff strength increased to 200 employees, total
assets increased to N900 million while net profit exceeds N10 million. Loan,
advances and overdraft were also said to have witnessed tremendous growth
during the period.

The bank refers the following services to its
customers at both head office and branch levels varying only according to size
of each branch networks:

1.          
Personal loans, that
is short term loans for temporary commercial needs or purchase of consumer
durables;

2.          
Revaluing overdraft
facilities to meet working capital needs to customers;

3.          
Project finance which
could be for short/medium and long term loans needs for viable projects

4.          
Loans syndication
which is done with minimum delay;

5.          
Agricultural
financing

6.          
Domiciliary account
for customer and acceptance of deposits of the accounts as competitiveness
rates.

7.          
Housing/vehicle
scheme.

8.          
Finance advise on
how best the customers can handle their financial matters, establishing new
projects, acquisition, capital restructuring, mergers reorganization and equipment
leasing.

1.2      
STATEMENT
OF PROBLEM

Recent incessant and huge cash withdrawals by
individuals and corporate customers for commercial banks rapid increase in the
credit facilities extended by the banks to meet the demands created by the
Structural Adjustment Programme (SAP) and recent transfer of accounts by
governments parastatals and agencies of Central Bank of Nigeria (CBN) has
created liquidity problem and disparity in deposit (assets) versus loans and
advances (liabilities) ratio for the banks. Most of the commercial banks in the
country are now faced with the adverse situation of uncalled liabilities
(Loans, advances and bad and doubtful accounts) over total deposits available
to them. Consequently, the banks are forced to place a temporary embargo on
further expansion of credit facilities while increasing the deposits base by
intensifying exploitation, recalling some of the debts and importantly, recover
the huge figures in their bad and doubtful debt accounts, the fundamental
problem is therefore that of identifying and effectively utilizing the most
efficient and appropriate measures of recovering the bad debts and controlling
further losses due to errors inherent in the lending processes and procedures.

1.3      
AIMS
AND OBJECTIVES OF THE STUDY

The aims and objectives of this research study
are stated below:

1.        
To find out the
various causes of continuously increasing bad and doubtful debts portfolio in
commercial banks.

2.        
To find out the
control measure employed by the commercial bans to curb the emergences and
growth of such accounts respectively.

3.        
To establish the
effectiveness of otherwise of such control measures so employed by the banks.

4.        
To recommend
additional control measure toward helping the banks to drastically reduce the
level of losses (bad accounts).

1.4      
HYPOTHESIS

1.          
H1: There
is adequate security given to the loan/advances.

2.          
H0: There
is no adequate security given to the loan/advances.

3.          
H1: There
is financial regulation, which guides the management of the bank.

4.          
H0: There
is no financial regulation, with which guides the management of the banks.

1.5      
SIGNIFICANCE
OF THE STUDY

It is incontestable that the level of loanable
funds to commercial banks to large extent determines total credit that could be
granted to various customers. The increase in money supply in the Nigerian economy
of recent which was held, as one of the major of the depreciation of the naira,
and raising rate of inflation is traceable to increase in credit facilities
extended by financial intermediaries (especially commercial banks) to customer.
This was possible because of availability of fund to commercial banks through
enhanced attractive interest rates especially the decount of government department
and parastatals.

But the level of profitability of commercial
banks is a function of earnings accruing from expanded good credits granted to
customers. Recent withdrawals of nearly N4 billion from commercial banks to
central bank of Nigeria
has before credit liquidity problems for the banks and made inteisfy the search
for the deposit. So any deposits available to the bank call for judicious
application and adoption of central bank measures, which will ensure good
lending to the preclusion of emergence of bad accounts. Such measures will
certainly be of interest to the banks particularly loan officers and managers.

1.6      
SCOPE
OF THE STUDY

As earlier stated, the research is aimed at
finding out causes and control of bad account by  commercial banks and recommending effective
ways of minimizing or curbing the emergence of the growth of such accounts. For
the purpose of the study therefore, one bank is selected (Bank of the North
Ltd).

1.7      
DEFINITION
OF TERMS

–     
Bad Debt: This
is called an irrevocable debt of a company or organization or debt that cannot
be recovered.

–     
Banker:
A person in an important position in the bank. He is financial doctor that
stand as intermediary between the deficit and the surplus sector of the
economy.

–     
Collateral:
Security of customer as a guarantee for bank loan.

–     
Customer:
A person or corporate that have some sort of account with the bank, be it current
saving or deposit.

–     
Lending:
This is a term used to define the avenue which an organization give out
financial assistance to another organization for certain period.

–     
Retained Earnings:
Is an undistributed profit of an organization kept for the unforeseen
contingencies.

–     
Overdraft:
Is a chance of drawing of cheque more than what is the current account to a
certain extent. This facility is given by commercial banks to current account
owners.

–     
Advances:
This is the money paid down by the customer for the goods he wants to purchase.