Evaluating the Relationship Between Credit Risk and Bank Performance in Nigeria: Ardl Analytic Approach

Abstract

This study investigated the relationship between the upside potentials inherent in credit risk and the performance of deposit money banks (DMBs) in Nigeria. While credit risk is traditionally perceived as a threat to banking stability, emerging evidence suggests that it can also present opportunities for enhanced profitability if effectively managed. The study obtained data from the Nigerian Deposit Insurance Corporation where credit risk proxied by the ratio of non-performing loans to total loans (NPLTL) and average liquidity ratio (ALR) as explanatory variables, whereas return on assets (a proxy of bank performance) as dependent variable, spanning from 1990 to 2023. The Autoregressive Distributed Lag (ARDL) model was employed to estimate the models. Findings indicate that the ratio of non-performing loans to total loans and advances (credit risk) significantly affects bank return on assets, a proxy for deposit money banks' performance, whereas the average liquidity ratio has no significant impact on return on assets. From the findings, Deposit money banks should adopt a dynamic credit risk management practice; flexible risk management frameworks that allow them to exploit profitable lending opportunities while controlling potential losses, among others. The study contributes to the literature on the credit risk-bank performance nexus, given the ever-changing dynamic economic environment faced by Nigerian banks.