IOSR Journal of Economics and Finance (IOSR-JEF) e-ISSN: 2321-5933, p-ISSN: 2321-5925.Volume 6, Issue 2. Ver. II (Mar.-Apr. 2015), PP 21-28 www.iosrjournals.org DOI: 10.9790/5933-06222128 www.iosrjournals.org 21 | Page Credit Risk and Bank Performance in Nigeria Olawale Femi Kayode, Tomola Marshal Obamuyi, James AyodeleOwoputi, Felix AdemolaAdeyefa 1Department of Banking and Finance, Rufus Giwa Polytechnics, Owo, Ondo State, Nigeria. 2A Professor in the Department of Banking and Finance, AdekunleAjasin University, AkungbaAkoko, Ondo State, Nigeria. 3A Principal Lecturer in the Department of Banking and Finance, Rufus Giwa Polytechnics, Owo, Ondo State, Nigeria. 4A Postgraduate Student in the Department of Banking and Finance, AdekunleAjasin University, AkungbaAkoko, Ondo State, Nigeria. Abstract: This study investigates the impact of credit risk on banks’ performance in Nigeria. A panel estimation of six banks from 2000 to 2013 was done using the random effect model framework. Our findings show that credit risk is negatively and significantly related to bank performance, measured by return on assets (ROA). This suggests that an increased exposure to credit risk reduces bank profitability. We also found that total loan has a positive and significant impact on bank performance. Therefore, to stem the cyclical nature of non-performing loans and increase their profits, the banks should adopt an aggressive deposit mobilization to increase credit availability and develop a reliable credit risk management strategy with adequate punishment for loan payment defaults. Keywords: Bank performance, Credit risk, Return on assets, Deposit mobilization, Non-performing loans, Random effect. I. Introduction The banking industry in Nigeria is in the business of providing financial capital to the business community as well as individual customers. Banks do this with the expectation of achieving targeted rates of returns on the extensions of credit over a period of time, and eventually reclaiming their principal with interest. Any extension of credit carries with it the risk of non-repayment, under the terms of the financial relationship between the financier and an individual or corporate organization. Based on this fact, banks have a strong vested interest in performing extensive due diligence, prior to committing funds, and on a regular basis to minimize credit risk and achieve an enhanced value for their organization. Since most banking assets are loans and advances, the process of assessing the quality of bank credit and its impact on the bank’s financial condition is critical. As rightly observed by Sulaimon (2001), it is unfortunate that one of the most serious deficiencies prevalent among Nigerian banks has been the inability of their management to identify problem assets. This, according to Ojo (2010), is borne, perhaps out of ignorance or intense desire to declare huge profits at the end of the financial year. As a result, balance sheets often do not reflect the banks’ true financial condition, while profit and loss account often overstate profits from whic h taxes and dividends are paid. Whenever the bank’s supervisors and regulators discover such deficiencies, the affected banks are often required to make up for the shortfall in provisions with adverse consequences for their financial statements. The profit for the emerging period is usually wiped off while the resultant losses would negatively affect the banks’ assets quality as well as their capital adequacy ratios. Assets quality reflects the state of existing and potential credit risks associated with loan and investment portfolio, real estate owned, and other assets, as well as those relating to off balance sheet transactions. The ability of management to identify, measure, monitor and control credit risk is central to asset quality because loans and advances constitute the largest risk assets carried by banks (Ojo, 2010). Consequently, a problem with the loan portfolio passes a guilty verdict on the management, and it is synonymous with a problem with the bank. Credit risk arises when an obligor fails to perform its obligations under a trading or loan contract or when its ability to perform such obligations is impaired resulting in an economic loss to the bank (CBN, 2000). It does not only arise when a borrower defaults on re-payment of a loan or settlement of principal and interest, but also when its repayment capability declines. Ojo (2010) defined credit risk as the probability that a payment will not be fully settled because the debtor becomes insolvent. The issue of credit risk in the bank lending activities is of serious concern to the bank authorities and regulators because of the high levels of perceived risks resulting from some of the characteristics of clients and their business environment, which can easily cause banks symptomatic distress. Given the strong association