EFFECT OF BAD AND DOUBTFUL DEBT ON THE PROFITABILITY OF DEPOSIT MONEY BANK IN NIGERIA

ABSTRACT

This research examined the effect of bad and doubtful debt on the profitability of deposit money bank in Nigeria. This study was a survey and a cross sectional design was adopted. A total of 100 employees from First Banks in Lagos State was adopted as a sample size for the study. Relevant conceptual, theoretical and empirical literature was reviewed.  Simple percentage was used to analysis the responses of the participants, while chi-square and Pearson Multiple Correlation was used to test the research hypotheses. The result revealed that there is a significant effect of bad and doubtful debts on the profitability of deposit money bank in Nigeria. The finding of the study also reveals that poor credit assessment is one of the factors that lead to debt of deposit money bank in Nigeria. The findings of the study also reveal that there is a significant relationship between bad debts on the profitability of deposit money bank in Nigeria. The finding of the study also reveals that adequate strict policies is one of the ways of reducing bad and doubtful debt in deposit money bank in Nigeria. The findings of the study reveal that effective monitoring and surveillance is one of the ways of reducing bad and doubtful debt in deposit money bank in Nigeria. It was therefore concluded that bad and doubtful debts significantly affect profitability of deposit banks in Nigeria. It was recommended that managers should pay more attention to improving capital adequacy since it positively enhances financial performance while reducing nonperforming loans by applying modern strategies and techniques for credit risk management.

CHAPTER ONE

INTRODUCTION

1. Background of the Study

In today's globe, banks stand as the biggest financial organisations, with branches and subsidiaries in every state of existence (Gizaw, Kebed& Selvaraj, 2015). Different types of banks differ greatly from one another. The goods and services that banks provide account for a large portion of this distinction (Howells & Bain, 2008). Commercial banks, for example, retain deposits, group them into loans, manage payment systems, etc. Credit risk is the possibility that a loan won't be repaid on time; banks give the economy the necessary cash in the form of loans and advances that may not always be returned (Isanzu, 2017). Since credit, loans, and advances are the bank's primary sources of revenue, credit risk and its management are thus of utmost importance.

Finance is a fundamental aspect of modern life, propelling economic growth. Countries without money or debt continue to live in poverty(Zhou et al., 2021). If someone can borrow money and store it, they can consume without their present source of income. Businesses can invest in debt when sales would otherwise prohibit it. Furthermore, when they have the capacity to borrow, fiscal authorities can aid in the macroeconomic stabilisation process.On the other hand, borrowing might result in vulnerabilities, as Nigerian deposit institutions' past suggests (Aribaba et al., 2022; Zhou et al., 2021). Reinhart and Rogoff (2009) assert that when debt levels above a particular threshold, financial crises become more probable and severe. This suggests quite clearly that debt can mount up to an unhealthy degree. One of the greatest methods to totally prevent bad debts is to refuse to lend money.Careful financing may assist manufacturing firms in efficiently managing their credit so they can stay in business. Investors in the economy are misled by manufacturing businesses' annual reports, which consistently indicate an increase in the provision for bad and doubtful loans.A number of failing manufacturing companies in the economy over the years have caused investors to lose trust in the company's capacity.

          Most companies don't make enough reserves for possible poor and unstable loans since they rely on credit sales as assets after extending credit. It is evident that such firms' financial statements would not be truthful and fair in this case since the quantity of trade debtors cannot be completely recognised (Aribaba et al.,  2022). In a similar vein, liquidity concerns are taken into account when authorising credit sales. Excessive investments in receivables, especially when the debtors pose a significant risk, are the cause of this. A business that struggles with liquidity suggests that taking out loans from other sources can be costly and that taking out more credit than is sensible might be dangerous.

Conversely, a tight or stringent credit policy, or no credit at all, leads to lower sales and profitability. Studies have indicated that loan sales might enhance a company's profitability and liquidity status if they are handled appropriately (Atuche, 2009). Therefore, when handled wisely and judiciously, debt is a two-edged sword that improves wellbeing. However, if used excessively and improperly, the results can be devastating.Overborrowing causes both individual families' and enterprises' manufacturing bankruptcy and financial catastrophe. It becomes challenging for a country with excessive debt for the government to deliver essential services to its people. In financial accounting and finance, "bad debt" refers to the part of receivables that are no longer collectable, usually from loans or accounts receivable. In accounting, bad debt is viewed as an expenditure (Zhou et al., 2021). Overborrowing is the root cause of manufacturing bankruptcy and financial disaster for both individual families and businesses. A nation with significant debt finds it difficult for its government to provide basic services to its citizens. The portion of receivables that are no longer recoverable, typically from loans or accounts receivable, is referred to as "bad debt" in financial accounting and finance. Bad debt is considered an expense in accounting(Inanga, 2001).

          There is a debtor-creditor connection when there is a legitimate and enforceable obligation to pay a certain amount of money. Additionally, it has to be considered that the debt in question has no value. This differentiation is broken down into levels that can be collected. It is necessary to assess the qualifying debt to determine if it is totally or partially worthless. Even if a debt is only half worthless, it can still be collectible in the future. A debtor's credit score, health, and other circumstances are all taken into account (Zhou et al., 2021). It seems sense to be concerned about the high and steadily growing debt levels, which begs the issue of what the real consequences of this sharp rise in debt levels are. When does its detrimental effect become apparent? A recognised account receivable that is not likely to be paid is referred to as a bad debt and should be quickly written off. On the other hand, a questionable debt has the potential to turn problematic in the future, therefore you might need to set aside funds for questionable accounts (Taku & Giles, 2017). According to Taku and Giles (2017), a precise bad debt accounting item for debtors can provide a helpful baseline for resolving debt-related difficulties. Bad debt is worthless to the creditor as it cannot be recovered. This occurs following every attempt to collect the loan. Bad debt usually arises when a debtor files for manufacturing bankruptcy or when the amount that may be recovered outweighs the expense of collecting the debt. When that happens, the company usually counts the debts as a cost.

          Increasing profits is one of the primary objectives of manufacturing organisations. Corporation tax, depositor interest, employee compensation, dividend payments to shareholders, and other expenses must all be made. Consequently, manufacturing companies can only contribute in a meaningful way if they turn a profit. Profitability is essential for a manufacturing company to stay in business and give its investors a reasonable return. But even in a riskier business climate, managers must also make sure that solvency ratios are more durable (Ogunbiyi, &Ihejirika, 2014). Profitability is a deposit banking's first line of defence against unanticipated losses as it fortifies its capital position and increases future profitability via the investment of retained earnings. A losing business will eventually run out of funds, endangering the interests of both debt and equity investors. Furthermore, as protecting and growing money for owners is the main objective of any profit-seeking organisation, the manufacturing firm's return on equity (ROE) must be greater than its cost of equity in order to produce shareholder value.Profitability is, therefore, the driving force behind all businesses and the main indicator of their success. Another distinctive feature of manufacturing businesses is their ability to raise capital. Manufacturing profitability is not just a measure of performance but also a necessary condition for successful competitive manufacturing and efficient application of monetary policy. The strength and stability of manufacturing enterprises, as well as financial crises, are largely determined by manufacturing profitability. The profitability of a manufacturer can be impacted by two things: internal and external debt (Mbabazize, Turyareeba, Ainomugisha &Rumanzi, 2020). The study motivated the interest of the researchers to examine how bad and doubtful debts affect the profitability deposit money bank in Nigeria.

1. Statement of the Problem

The fragile nature of the banking industry stems from the fact that client deposits account for almost 85% of their liabilities (Vasudevan et al., 2019). Customers' deposits are converted into loans by the banks, and for most banks, these loans are a significant source of revenue. Nonetheless, the banks and deficit entities are exposed to significant risks as a result of this move. These days, banks are putting forth a lot of effort to draw in the vast majority of non-customers. The bank's surplus and deficit units have increased as a result of this.Numerous banks have extended advances and loans that were unrecoverable in an effort to boost income and capture a sizable chunk of the market, which has resulted in a sharp increase in the amount of non-performing loans (NPLs) in their accounts. Banks and other stakeholders are starting to get concerned about this scenario (Tuladhar, 2017). The banking industry's recent actions are also distinctive; some are working hard to launch new deposit products with high interest rates, while others are attempting to draw in customers by cutting lending interest rates.The level of competition is sufficiently strong, although Nepal Rastra Bank is reducing the range of services offered by implementing new policies (such as limits on margin lending, distribution of gifts and prizes, and revised capital adequacy (Li & Zoa, 2014). Credit risk is one of the many hazards that affects banks' bottom lines. This thesis' main goal is to ascertain if credit risk affects Nepal's commercial banks' profitability.Poudel (2012) found that there is an inverse relationship between profitability and bad debt. It is of great interest to study the effectbad debiton profitability of commercial banks.

1. Objectives of the Study

The main objective of the study is to determine the effect of bad and doubtful debt on the profitability of deposit money bank in Nigeria. Other objectives of the study include;

1. To determine the effect of bad debts on the profitability of deposit money bank in Nigeria.
2. To evaluate the factors that lead to debt of deposit money bank in Nigeria
3. To ascertain if there is significant relationship between bad debts on the profitability of deposit money bank in Nigeria
4. To predict the ways of reducing bad and doubtful debt in deposit money bank in Nigeria.

Research Questions

The following questions will guide this study;

1. What is the determine the effect of bad debts on the profitability of deposit money bank in Nigeria?
2. What are thefactors that lead to debt of deposit money bank in Nigeria?
3. Is there a significant relationship between bad debts on the profitability of deposit money bank in Nigeria?
4. What arethe ways of reducing bad and doubtful debt in deposit money bank in Nigeria?

1. Research Hypotheses

The following were hypothesized in this study;

Hypothesis one

H01: There is no significant effect between bad debts on the profitability of deposit money bank in Nigeria.

H02: There is a significant effect between bad debts on the profitability of deposit money bank in Nigeria.

Hypothesis two

H01: There is no significant effect between debt ratios on the profitability of deposit money bank in Nigeria.

H01: There is a significant effect between debt ratios on the profitability of deposit money bank in Nigeria

Hypothesis three

H01:There is no significant effect between credit sales and profitability of deposit money bank in Nigeria

H01: There is a significant effect between credit sales and profitability of deposit money bank in Nigeria

Hypothesis Four

H01: There is no significant relationship between bad debts and the profitability of deposit money bank in Nigeria

H01: There is a significant effect between bad debts and the profitability of deposit money bank in Nigeria

1.6 Significance of the Study

The success and prosperity of the bank heavily depends upon the successful implementation and investment of collected resources, which develops the economy of the country. Good investment policy of the bank has positive impact on economic development of the country and vice versa. An investment in any funds is made to havesome positive return. Nobody is ready to bear risk without any return but to have returned one must be ready to face some risk. In Nepalese context, very few studies have been made and there is no specific magazines and articles on the topic. So the study will be more significant for the exploring and increasing stock investment.

This study is mainly concerned with position of profitability and credit risk indicators and impact of credit risk on profitability. This study is important for credit performance analysis of any banking sectors because it is only one measure to evaluate prosperity or recession of organization. After having the real knowledge of indicators of financial performance any shareholder can decide what they ought to do. Similarly, any concerning bodies will be benefited to study whole organization. So this study will be fruitful for those who want to know about selected sample banks in financial concern. Moreover, this study can also be used by government bodies, investors, competitors.

1. Scope of the Study

The study is limited on the effect of bad and doubtful debt on the profitability of deposit money bank in Nigeria. Data from this study were gotten from employees from all the first Bank in Lagos State.

1. Operational Definition of Terms

Debt: Debt is a sum of money owned by one person called debtor to the other person called the creditor. It is described as the obligation to make further payment. It is the credit received by a borrower from a pure lending or financial institution or a private money lender against a promise to make future payment. There are three types of debts, i.e. bad debt, good debt and doubtful debt.

Bad Debts: Bad debts are those which are not recoverable. Accordingly, they are written off as losses, they are debts which are considered unrecoverable and are written off in the profit and loss account of a particular concern. The losses arising from bad debts should be recognized as soon as possible and written off the value of the debtors. The reason for the customer’s failure to pay may be due to financial difficulties, his absconding or absolute misuse of fund.

Good Debts:This is a sure which is sure to be paid. It is a debt that is certainly recoverable. This is the best form of debt as the lender is adequately sure of receiving his interest and principal amount. Any bank would prefer this kind of debt. It does not only enhance their profitability but also ensure regulating of recovered money as loans and advance, to other investors in the country and hence ensure steady economic growth.

Doubtful Debt:Doubtful debt are those debt that have the potential or high chances of not being recovered. The question of doubtful debt is examined only at the end of each year when the accountant is measuring the income of the year against expenditure. An attempt is usually made to eliminate all those accounts considered bad of the remaining debtors, some may ultimately prove to be bad, but there may be reasonable grounds for hoping that all remaining debtors will settle accounts.