Credit Risk Management Effectiveness and Profitability of Deposit Money Banks in Nigeria

Abstract

This study examines the effect of credit risk management on the profitability of 25 deposit money banks (DMBs) in Nigeria over the period 2016–2025, a decade marked by macroeconomic turbulence, regulatory tightening, and the full implementation of IFRS 9. Using a balanced panel of 250 bank-year observations and the System Generalized Method of Moments (GMM) estimator, the study investigates the individual and joint effects of the non-performing loan ratio (NPLR), loan loss provision ratio (LLPR), and capital adequacy ratio (CAR) on bank profitability, measured by return on assets (ROA) and return on equity (ROE). The findings reveal that NPLR and LLPR exert significant negative effects on ROA, with coefficients of -0.188 and -0.225, respectively. CAR displays an inverted U-shaped relationship with ROE, with an optimal capital adequacy level of approximately 17.1%. The interaction between NPLR and CAR is positive and significant, indicating that a strong capital buffer mitigates the adverse effect of NPLs on profitability. Conversely, the interaction between NPLR and LLPR is negative and significant, revealing that simultaneous high NPLs and aggressive provisioning have a compounding negative impact on ROA. The study concludes that credit risk management is a critical and multifaceted driver of bank profitability in Nigeria, and that effective credit risk management requires a dynamic equilibrium among NPLs, provisions, and capital. Based on these findings, the study recommends that bank management strengthen credit underwriting and early-warning systems to keep NPL ratios well below the 5% regulatory threshold, maintain a forward-looking provisioning culture aligned with IFRS 9, and optimise capital structure around the 17% CAR sweet spot rather than hoarding sterile buffers. Regulators are advised to enforce the 5% NPL limit with greater granularity, review capital adequacy guidelines to discourage over-capitalisation, and continue promoting full and transparent IFRS 9 implementation. Investors and analysts should integrate NPLR and LLPR trends into equity valuation models and treat CAR as a value driver, targeting banks operating in the 15%–18% CAR range for optimal risk-adjusted returns.