Risk Management, Non-Performing Loans and the Financial Performance of Deposit Money Banks in Nigeria

Abstract

The persistence of non-performing loans (NPLs) among Nigerian deposit money banks, despite comprehensive Central Bank of Nigeria (CBN) guidelines on credit risk management and loan classification, raises questions about how internal risk management practices translate into financial performance. Two concerns motivated the study. First, prior research has generally examined risk management, non-performing loans and financial performance as separate lines of enquiry rather than as an integrated system, leaving their combined effect on profitability comparatively unexamined within the Nigerian banking context. Second, much of the available evidence relies on subjective survey responses rather than audited financial data, leaving the objective, market-relevant channel comparatively under-examined. Consequently, the study examined the effect of risk management practices and non-performing loans on the financial performance of deposit money banks in Nigeria. Anchored on Credit Risk Theory, the study specified three models to assess the direct effect of risk management, the direct effect of non-performing loans, and their combined effect on financial performance. Risk management practices were proxied by the capital adequacy ratio (CAR) and loan loss provision (LLP); non-performing loans (NPL) were measured as the ratio of non-performing loans to total loans; and financial performance was measured using return on assets (ROA). An ex-post facto research design was adopted, and secondary data were extracted from the audited annual reports of ten purposively selected listed deposit money banks in Nigeria over the period 2015 to 2024, producing a balanced panel of 100 bank-year observations. Data were analysed using descriptive statistics, Pearson correlation, unit root tests and panel regression (pooled OLS, fixed effects and random effects), with the Hausman test used to select the appropriate estimator. Capital adequacy ratio exerted a positive and statistically significant effect on return on assets, while loan loss provision exerted a positive but insignificant effect; jointly, the risk management variables significantly explained variation in return on assets under the Fixed Effects Model (F = 22.142, p = 0.000; R² = 0.849). Non-performing loans exerted a negative but statistically insignificant effect on return on assets (β = −0.0965, p = 0.1427), and the combined model showed that risk management practices and non-performing loans did not jointly, significantly influence financial performance. The study concludes that effective risk management, and capital adequacy in particular, enhances the financial performance of deposit money banks in Nigeria largely irrespective of prevailing non-performing loan levels, and recommends that banks maintain optimal capital adequacy alongside efficient capital deployment, strengthen credit appraisal and loan monitoring systems, and adopt balanced loan loss provisioning strategies that protect asset quality without unduly compressing profitability.