Omatseyin Fredrick Esq. LL.M Investment Law and Policy.
Financial institutions require security as collateral before granting loans to borrowers. Securities are collaterals in form of assets or property offered or pledged by individuals or corporate entities for the issuance of a loan from a bank and when the borrower fails to repay the loan, the bank can take steps to repossess the security given as a way of compensating for the unpaid loan. Securities are ways to protect the interest of the bank against any potential loss in event of the default of the borrower to repay the loan. Also, the impact of bank competition on bank performance remains a widely debated issue. At present, scholars investigate either the competition-stability or the competition-fragility relationships in the banking industry. This article aims to briefly discuss the types of securities that can be accepted for bank loans in Nigeria and the effect of Competition in the banking industry.
Type of Security Acceptable for Bank Loans
Nigerian law recognizes different types of collaterals for loans, which may be created over tangible or intangible assets in Nigeria. They can be taken in form of a mortgage, charge, pledge, lien, or assignment depending on the type of security. The security for the loans can either be equal to, less than or greater than the value of the loan applied for. Apart from considering the viability of the borrower’s source of repayment, the bank will also assess the quality of the borrower’s security to determine whether it possesses adequate net worth for the loan applied for. Some of the securities that can be used for bank loans in Nigeria include the followings:
- Real Estate– landed properties; constructed buildings; fixtures on land; leasehold on a property (intangible rights) are acceptable securities for bank loans in Nigeria. Real estate is the most recognized and widely used form of security for loans. The borrower will be required to deposit the title document such as Certificate of Occupancy, Deed of Conveyance, Deed of Assignment, Deed of Gift, Deed of Sub-Lease, and any other title deed to the bank. Security can be created either by legal or equitable mortgage or a charge. A legal mortgage involves a transfer of the legal title of the property to the bank as a security for the repayment of a loan. The transfer is subject to the condition that the title will revert to the applicant when the loan is repaid.
- An equitable mortgage creates a personal right against the borrower (mortgagor), which cannot be exercised without an order of the court. The bank can hold the title deeds as an equitable mortgage on behalf of the applicant and in the eventuality of the borrower’s defaulting in the repayment of the loan, the bank can perfect the title document by placing a lien on it in form of a legal mortgage.
- Shares, Stocks, and Bonds– security can be in form of shares of a company incorporated in Nigeria by a way of a mortgage or a charge. To perfect an equitable mortgage or charge over shares, the borrower (mortgagor) must deposit the share certificate with the secured lender (mortgagee) with or without a memorandum of deposit. While to perfect a legal mortgage, the mortgagee must be registered as a shareholder in the register of company members with an undertaking for a re-transfer of the shares to the mortgagor if the loan is discharged. An equitable mortgage is created by depositing the shares certificate with the bank or a security trustee appointed by the bank, and where it is created, the legal title to the shares is not transferred to the bank or security trustee.
- Cash Security-this form of security is the simplest form of security for bank loans, it is however not a common form of security in Nigeria. Cash security can be in form of cash deposits, fixed deposits, treasury bills, currents accounts, or savings accounts. This simply means that an individual can take a loan from the bank where an active account is maintained and in the event of default to discharge the loan, the bank can liquidate the account to recover the disbursed loan. The interest accrued on the loan usually differs from one bank to another. The security is granted in form of a charge on the money.
- Lien on Asset– it is also referred to as a joint registration of assets such as equipment, machines, and automobile in the bank and customers’ name. A lien is placed on assets that have been jointly financed by the bank and its customer until the loan is fully paid up.
- Domiciled Payment– this form of loan security is not popular in Nigeria. It is a form of security where bank customers involved in contracts with multinational companies or well-known companies used their Local Purchase Order or contract agreement to secure a loan. It is secured on the basis that the multinational company or known principal is ready to make payment upon completion of the contracted job.
- Machinery and Equipment– security for a loan can be granted over machinery and equipment in form of a mortgage, charge, or pledge. It is created by a transfer of title to the asset on the condition of re-possession upon discharge of the loan facility or sold if the applicant defaults in the loan repayment.
- Receivables-security can be granted over receivables such as insurance policies proceeds, debts, charges, mortgages, assignment of receivables by way of security, and contractual rights. This form of security granted can be by way of an assignment or charges.
- Intellectual property– security can be taken over intellectual property such as patents, trademarks, copyrights, or industrial design, by way of a fixed charge or an assignment, mortgage, or floating charge. The bank and borrower are required to execute a deed of agreement setting out the terms and conditions on which the security is to be granted. It is not a popular form of security in Nigeria.
- Stock Hypothecation– this is a form of security for a bank loan that is utilized mostly by traders and wholesale distributors of consumer goods. For this type of security, a special agreement is entered between the bank and the customer to have the goods financed, warehouse, and released in bits either in exchange for the cash equivalent of the goods worth or the cash equivalent of goods released previously to the customer’s bank account before more goods are released.
- Documentary Credit– this is a form of commercial lending where a seller of goods deposits the documents of shipping such as bill of lading to the bank to access credit granted to the buyer. To initiate this type of lending, the buyer will apply for a letter of credit from its bank in favour of the beneficiary, the seller. The bank can fund the letter of credit through a loan granted to the buyer where the bill of lading will serve as the security for such a loan. In this circumstance, the bank may be listed as the consignee of the goods contained in the bill of lading deposited with it.
Granting loans to borrowers are ways by which banks can increase profitability and also satisfy the credit needs of their customers. In taking out loans, the decision of the borrower is oftentimes influenced by factors such as the risk involved, the lending policy of the bank, and the interest rate. The important considerations for the lender before giving out a loan are usually security for the loan and viability of repayment source or bankability of the lending.
Effect of Competition on Banks in Nigeria
The traditional competition fragility view equates bank competition with instability as competition reduces market power and profit margins which in turn encourages bank managers to take higher risks. In contrast, the competition-stability view stipulates that competition leads to lower loan interest rates and consequently lower moral hazard and adverse selection problems and less risky loan portfolios. This study examines both paradigms using panel data from deposit money banks in Nigeria over a period of ten years (2005-2014). Results show that the overall relationship between competition and financial performance of banks is negative. The study, therefore, concludes that competition has a negative effect on the financial performance of banks in Nigeria. The study suggests that regulators should promote healthy competition among deposit money banks so as to reduce the negative effect of competition on bank financial performance. Managers should take measures to enhance profit margin by reducing expenses. Current efforts of the government in terms of improved power generation may help to cut cost of power borne by the banks. Managers should also ensure healthy loan portfolio by ensuring that only customers with high credit scores get loans.
In Nigeria, the past thirty years saw a process of liberalization, deregulation and unprecedented financial sector reforms whose main objectives were to increase competition and remove all remaining barriers to the liberalization of the banking industry in Nigeria. However, the stiff competition that follows these measures has raised concerns about the potential implications on the financial performance of the banks, particularly given the fallout of the 2005 bank consolidation exercise and the 2008 global financial crisis. While the 2005 consolidation exercise was designed to increase the competitiveness of the banks in terms of their capital base and thereby improve their financial performance, the 2008 global financial crisis severely eroded the financial performance of banks in Nigeria. A number of the banks were taken over by the government despite receiving bailout funds worth about N400 billion. The relationship between bank competition and bank performance remains a widely debated issue. At present, scholars investigate either the competition-stability or the competition-fragility relationships. The traditional competition-fragility view equates bank competition with instability as competition reduces market power and profit margins which in turn encourages bank managers to take higher risks. In contrast, the competition-stability view stipulates that competition, for example, low market power in the loan market, leads to lower loan interest rates and consequently lower moral hazard and adverse selection problems and less risky loan portfolios. This study examines both paradigms using panel data from deposit money banks in Nigeria over a period of ten years (2005-2014). It is interesting therefore to study which theory actually holds and the evolvement of this relationship over time across deposit money banks in Nigeria.
The banking industry in Nigeria has not fully recovered from the 2008 turmoil in the global financial system. The crisis impacted severely on the banking sector. This calls for a re-examination of the link between bank performance and changes in the competitive environment. The universal banking system implies the possibility for increase competition and harmonization of bank practices in Nigeria. This study investigates the relationship between competition and financial performance in the Nigerian banking systems between 2005 and 2014. In the banking system, there is a trade-off between competition and financial performance. The competition-fragility view considers more bank competition erodes market power, decreases profit margins, and results in reduced franchise value, encouraging banks to take on more risk to increase returns. The other view, competition-stability view, argues that more market power in the loan market may result in higher bank risk because, on the one hand, the higher interest rates charged to loan customers make it harder to repay loans and exacerbate moral hazard incentives of borrowers to shift into riskier projects and, on the other hand, it is possible that a highly concentrated banking market may lead to more risk taking if the banks believe that they are too big to fail in the context of protection by the government safety net. The main contribution of this study is to confirm if the idea of increasing competition among banks in Nigeria would result in enhance financial performance.
Competition among deposit money banks is reflected in a number of factors, including but not limited to market share, profit margin, risk and relative size of loan portfolio. Market share is defined as a bank total asset as a percentage of industry total asset. Market share is driven by competition in the industry. The aggressive banks tend to have a higher market share and vice versa. The size of a bank market share has an influence on its financial performance. It is not coincidental, therefore, that in Nigeria, First Bank, United Bank for Africa, Guaranty Trust Bank and Zenith Bank are in the forefront in terms of market share. This leads to the study first hypothesis, which states that: H1: Market share and financial performance are positively correlated.
Profitability can be defined as the final measure of economic success achieved by a firm in relation to the capital invested in it. This economic success is determined by the magnitude of the net profit accounting (Pimentel, Braga & Casa Nova, 2005). Achieving an appropriate return over the amount of risk accepted by the shareholders is the main objective of companies operating in capitalist economies. After all, profit is the propulsive element of any investment in different projects. The assessment of profitability is usually done through the Return on Asset (ROA) and Return on Equity (ROE), which is the ultimate measure of economic success. Profitability as a goal of the firm is highly affected by competition. Stiff competition in the industry may result in lower profitability and vice versa. However, competition may also improve profitability as managers find new levels of creativity and innovation to meet the expectations of stakeholders. This led to hypothesis two of this study, which states that: H2: Profit margin and financial performance are positively correlated.
The bank faces various risks such as interest risk, market risk, credit risk, off-balance risk, technology, and operational risk, foreign exchange risk, country risk, liquidity risk, and insolvency risk (Tandelilin, Kaaro, Mahadwartha, & Supriyatna, 2007). The bank’s motivation for risk management comes from those risks which can lead to bank failure or poor performance. Issues of risk management in the banking sector have a greater impact not only on the bank but also on economic growth and sustainable development in the banking industry. In the process of doing business, it is inevitable that the firm will be faced with unexpected and very often unpleasant surprises that threaten to undercut or, even worse, to destroy the business. That is the essence of risk and how a firm responds to it will determine whether it will survive and succeed or not. Risk management is a concept that has been used since the beginning of humankind, it is an evolving concept. The roots of risk management can be found in the corporate insurance industry. The risk has long been studied especially in the last years. It is one of those concepts that do not have a universal definition. Every scholar has a different approach to risk. Gallati (2003) defines risk as a condition in which there exists an exposure to adversity or a condition in which there exists a possibility of deviation from a desired outcome that is expected or hoped for. Other definitions (Bessis, 2002; Machiraju, 2008 & Schroeck, 2002) include the restriction that risk is based on real world events, including a combination of circumstances in the external environment. But unfortunately, this definition does not take into consideration the circumstances in the internal environment of the firm. Risk management of a bank will impact its performance. Risky banks tend to attract only risk-taking investors. The relationship of risk and returns has to be managed so that the investors do get the return associated and expected with the risk they are bearing. This leads to the third sets of the study hypotheses: H3: Bank risk and financial performance are positively correlated.
Banks exist not only to accept deposits from customers but also to grant loans to deficit sectors. Banks make their money from granting of loans and charging interest. This activity is highly influenced by competition in the industry because it is tied to the ability and capacity of the banks to generate sufficient return on shareholders’ investment. Adequate management of loan portfolio is critical for the survival, growth and development of banks. It is further suggested that regulators should promote healthy competition among deposit money banks so as to reduce the effect of competition on bank financial performance. Managers should take measures to enhance profit margin by reducing expenses. Current efforts of the government in terms of improved power generation may help to cut cost of power to the banks. Managers should ensure healthy loan portfolio by ensuring that only customers with high credit scores are giving facilities.
- Mondaq <https://www.mondaq.com/nigeria/securitization-amp-structured-finance/1075236/securitization–types-of-security-for-bank-loans-in-nigeria> Accessed on 25 January, 2023.
- Journal of Economics and Sustainable Development <https://core.ac.uk/download/pdf/234647239.pdf> Accessed on 26 January 2023.
This article is for information purposes and is not intended as a legal opinion or advice on any issue. Therefore, any usage of this article must be with the proper legal guidance as the position of the law may have changed.