CHAPTER ONE 

INTRODUCTION 

Background of the Study 

 The relevance of banking to the Nigerian financial system and indeed the entire economy cannot be over emphasized. Without banks economic activities would grind to a halt. Undoubtedly banks serve as catalysts to the growth and development of any nation, Nigeria inclusive.   The primary function of banking in an economy is to provide financial intermediation. Financial intermediation means the mobilization of funds from the surplus units at a cost for on-lending to deficit spending unit at a price, (Oboh, 2005). Through this process, deposits collected from surplus economic units are channeled to deficit unit in the form of loans and advances. Thus banks as financial intermediaries have two basic traditional functions: deposit mobilization and lending. But by far the most important function as far as banks are concerned is the lending function. 

 Lending has become a vital function in banking because of its direct effect on economic growth and development. This is being pursued in most countries particularly the developing ones where banks and lending activities have been usefully integrated into government policy formulation in the national economic development process. Thus the lending activity of banks as it affects economic growth and development has continued to gain prominence in the light of modern economy. 

 As agents of development, banks provide loans and advances including a variety of contingent facilities. The bulk of the funds deposited with banks constitute the bases for loans and advances to personal and business customers to facilitate their individual economic activities. Like any other business entity, banks are in business to make profit and as such they charge interest on credit extended and pay interest on funds deposited with them. The difference between the interest received and that paid is the gross margin which constitutes the profit of the banks (Rose, 2003).

 Lending is said to be the most profitable activity of banks. However, if lending decisions are not handled with care, it could turn out to be the most loss-making activity of a bank. The safety of any loan and advance is therefore of paramount importance to bank.

 Banks therefore ensure that there is a reasonable certainty that the loans granted are likely to be repaid by the borrower. In order to keep these risk factors under control, the bank lending function is closely regulated to ensure prudent policies and practices. Banks also control risk in the lending function by setting up written policies and procedures for processing each loan request. 

The bulk of loans and advances made by banks follow some basic principles which help to minimize the adverse effects of lending especially the incidence of bad debt. Banks lay great emphasis on the character, integrity and reliability of borrowers. There must be a reasonable certainty that the amount granted can be repaid form the operations of the firm. If the loan is granted to a personal borrower, the source of repayment must not be doubtful. The borrower must be able to provide acceptable security which will serve as something to fall back on if the expected source of repayment should fail 

All these safeguards are built into the lending programme to help reduce credit risk. Credit risk is the risk that the principal or the interest, or both or part thereof of the credit extended to a customer will not be repaid by him in accordance with the loan agreement, (Anyanwaokoro, 1996). When this happens, the bank will end up classifying the credit as bad debt, and in due course it will be written off. The long-run effect of this on the bank can be very detrimental with its attendant effect on the entire economy. This is what has happened to many Nigerian banks that were classified in the past as distressed by the Central Bank of Nigeria. 

It is therefore expected that a high degree of efficiency and effectiveness be maintained in the operations of banks especially in the area of loan-making considering its implication on the profitability, liquidity and safety objective of banks and the well being of the economy at large.

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