TOXIC LOANS IN NIGERIA: LAX LENDING PRACTICES IN THE BANKING INDUSTRY AND THE COST OF FAILED DUE DILIGENCE

INTRODUCTION

Conversations surrounding toxic loans in Nigeria have become more pronounced due to the rising rate of Non-Performing Loans (NPLs) within the banking industry. In many instances, lax lending practices and inadequate due diligence have contributed significantly to the growth of toxic loans, thereby exposing financial institutions to substantial losses, sometimes eroding shareholders/depositors funds and ultimately undermining confidence in the banking sector.

In Nigeria, lending activities are regulated through a combination of legislations and regulatory guidelines such as the Central Bank of Nigeria Act 2007 (CBN), Banks and Other Financial Institutions Act (BOFIA 2020), the CBN Prudential Guidelines for Deposit Money Banks, the Regulatory Framework for Mobile Money Operations, and licensing requirements applicable to microfinance banks and fintech lenders. At the State level, statutes such as the Money Lenders Law of Lagos State, Cap M7, Laws of Lagos State 2009, regulate non-bank lending and are broadly replicated across other States.

Toxic loans, commonly referred to as NPLs, remain a persistent feature of Nigeria’s credit system. Under CBN prudential standards, loans are classified as non-performing where repayment of principal or interest is overdue for 90 days or more0F[1]. Beyond this technical definition, toxic loans also describe credit exposures that have become impaired such that recovering them seems almost impracticable mostly due to the bankruptcy of the obligor without any viable security or asset to be attached for purposes of full liquidation of such loans.

Nigeria’s exposure to toxic loans has historically been driven by cycles of credit expansion and asset quality deterioration, most notably during the 2009 banking crisis, which led to the establishment of the Asset Management Corporation of Nigeria (AMCON) to manage distressed assets.1F[2]

Today, lending and toxic loans are no longer limited to the traditional banks. It now extends to fintech companies, microfinance institutions, and newer systems like banking-as-a-service (BaaS). Before a loan request is approved, the lending institution is expected to conduct a credit check on the borrowing entity, which exercise was previously performed manually until the advent of technology. Now with the existence of technology, lenders are expected to deploy automated systems in addition to other non-automated due diligence searches to investigate credit histories of intending borrowers to decide who gets a loan.

It is against this backdrop that this article examines how Nigeria’s evolving regulatory framework and lending practices intersect with weak due diligence to produce toxic loan outcomes across both formal and informal credit markets.

 LAX LENDING PRACTICES AND FAILED DUE DILIGENCE

Lax lending practices refer to a situation where a lender applies weak, relaxed, or improperly enforced credit standards in the granting and management of loans. It reflects a breach of sound banking principles and regulatory expectations, which can sometimes increase the chances of loans not being paid back and also raises the risk of wider problems in the financial system.

A principal driver of toxic loans in Nigeria is the lack of proper due diligence at the point of giving out loans or the willful abandonment of the set regulatory guidelines for loan approval and disbursement. Traditional banks to a great extent still carry out proper credit risk assessments, including verification of income, credit history, and ability to repay before approving loans. However, many digital lenders now approve loans very quickly using automated systems that rely mainly on customer behavior data or transaction patterns. Because this information is not always verified or complete, it can and most times, lead to lending decisions that do not properly reflect a borrower’s true financial capacity, thereby increasing the risk of default. This of course raises significant legal and enforcement concerns when a default occurs. It is therefore necessary that credit must be properly structured at inception, as weak documentation undermines enforceability at the point of recovery. Where credit is extended without proper verification, documentation, and structured lending processes, recovery becomes procedurally uncertain and burdensome.

With this in place, a person who gives out loans whether through regulated institutions, fintech platforms, or informal arrangements without adequate borrower assessment and proper documentation materially increases the risk of default, dispute, and difficulty in recovering the same.

Largely, the interpretation suggests that Nigeria’s toxic loan challenge is not solely regulatory in nature but is also driven by gaps in lending discipline, weak or poor credit assessment systems, and inconsistent application of due diligence across lending channels.

THE BUSINESS ENVIRONMENT AND DUE DILIGENCE OUTCOMES

There are situations where loans become toxic notwithstanding that proper due diligence was conducted before its disbursement. Such predicaments are sometimes significantly influenced by macroeconomic conditions, including inflation, exchange rate volatility, and income instability. These factors weaken borrower repayment capacity, particularly in retail and micro-credit segments, and it is most prevalent where a loan is unsecured. While we understand that businesses rely on loans to augment their operating capital, it is also not in dispute that the lending institutions such as deposit money banks (DMBs) operate under the regulatory watch of the Central Bank of Nigeria (CBN). The CBN by its extant regulatory directive2F[3] mandated all DMBs to maintain their Loan-to-Deposit Ratio (LDR) at 50%. LDR refers to the ratio of Loans made available to customers by the DMBs to the amount of deposit recorded by the DMB. This means that the DMBs are required to at least lend 50 kobo for every 1 naira deposited with the Bank. This is a measure put in place to regulate the lending ecosystem and ensure that it remains within the range of the approved threshold. In this light, it is necessary for the DMBs to create a balance between compliance with the CBN’s regulatory directive on LDR and the CBN Prudential Guideline for DMB, 2010 to avoid regulatory sanction.

The approval and disbursement of loans by DMBs are designed to target borrowers operating in the real sectors of Nigerian economy, it is expected that the loans should be secured with collaterals whether movable or immovable to mitigate exposures in the event of default. Previously, DMBs were not inclined to accepting movable assets as security for loans, and that made access to credit facilities onerous for many genuine borrowers. This is due to the volatility or uncertainty of the existence of the movable asset when default occurs.

However, with the intervention of the Secured Transactions in Movable Assets Act 2017 (STMAA),  the STMAA established the National Collateral Registry and the CBN Governor is obligated to appoint a Registrar and such other staff who shall administer the operation of the Collateral Register3F[4]. Following the creation of this registry, it is required that where a charge is created over a movable asset there should be a security agreement and financing statement which should be registered at the collateral registry. The charge becomes perfected where the financing statement relating to it is registered at the registry4F[5]. Movable assets comprise of tangible and intangible assets other than real property. The collateral registry is expected to be a repository of all movable assets over which a security interest subsists. Apparently, it is expected that due diligence exercise by lenders should extend to this registry in addition to the regular repositories where due diligence searches are conducted. The creation of the collateral registry will help to mitigate the risk of dissipation of a charged movable asset which in turn will boost the lender’s confidence. For loans secured with movable assets, lenders are enjoined to ensure to sign a comprehensive security agreement with the borrower protecting their security interests, and as well ensure that the security agreement is properly registered at the collateral registry. With this measure in place, the charged asset cannot be dissipated by the borrower unless it is discharged with the lender’s consent.

Where adequate measures are put in place, loans secured with movable assets should not be seen as high financial risks. The lenders can protect or at least mitigate their exposures through a robust loan agreement by insisting on clauses that would authorize the lender to request for security augmentation or calling in the facility where the value of a borrower’s security depreciates below the loan portfolio of the debtor.

Meanwhile, for loans secured with immovable assets, the same perfection standard should be applied especially where legal charge is intended. Failure to register a supposed legal mortgage over an immovable asset will be treated as an equitable charge. It leaves the lender exposed to the Chargor/Mortgagor as the case may be, who can possibly dissipate the asset albeit fraudulent, and transfer a valid legal title to an unsuspecting third party who is an innocent purchaser for value and who took steps to register his interest. It is interesting to know that the court will not vitiate or set aside such sale where it is satisfied that the third party had no knowledge of the earlier unregistered charge. This position received affirmation from the court in the case of Kachalla v. Banki5F[6]. Similarly, where however, an equitable charge is intended to be created over an immovable asset, it is advisable that a Caveat Emptor be registered on such asset to deter the dissipation of the asset and ward off third party interests. This is in the light of the fact that often times, when equitable charge is created over an asset, a recalcitrant borrower still finds a way to dispose of the asset to an unsuspecting third party.

Just as it is the case with an unregistered legal charge, the innocent third party is acquiring it as a purchaser for value and such sale will not be vitiated by the court. See the case of Kachalla v. Banki (supra)6F[7]. But where a caveat emptor is placed on the asset at the relevant registries, a third party purchaser cannot be said to be without notice of the existing charge. This is because the law places a duty of care and caution on the purchaser to beware not the vendor because a vendor will always be tempted to sell even that which he no longer possesses. This was the decision of the court in the case of Owoade v. Asubiojo & Anor7F[8]. Accordingly, it is the purchaser who parts with liquid cash who is often at risk as the consequence in law is as stated by the apex Court in Anyaduba v. Nigerian Renowed Trading Co. Ltd8F[9] that no one gives what he does not have as aptly captured in the latin maxim – nemo dat quod non habet.”

Having exhaustively ruminated the lending ecosystem involving DMBs, we now turn our beam light to the digital lending platforms comprising Fintech companies. A substantial portion of digital lending operates as short-term survival credit, used to meet immediate consumption needs such as transport, utilities, and basic expenses. Repayment is often dependent on short income cycles, making such credit highly sensitive to economic shocks because they are mostly unsecured. At the same time in the event of default, enforcement mechanisms remain structurally constrained. While lenders may rely on automated recovery tools such as Global Standing Instruction (GSI) mandate on all BVN linked accounts and algorithmic penalties. Ultimately, enforcement action still depends most times on formal court processes, which are often slow and costly considering the debt value. In recent times, non-litigious approaches have been deployed by external debt recovery agents (DRA) to record high successes.

LEGAL AND FINANCIAL IMPLICATIONS OF FAILED DUE DILIGENCE

The consequences of weak due diligence are increasingly visible across Nigeria’s credit ecosystem. In the Fintech sector, rising default rates have triggered regulatory scrutiny, reputational damage, and in some cases, operational restrictions or market exit.

From a legal standpoint, loan recovery challenges remain central to the survival of micro lending institutions such as Fintech companies. Due to the low threshold of their approvable credit facility, loan recovery drive remains a major concern in the event of default because they are mostly unsecured and considering the cost implications for debt recovery.

Deposit Money Banks also face similar challenges, particularly in SME lending where credit facilities are usually secured with proceeds from business, account domiciliation and personal guarantee.

The implication of a lending lax is that the bank will be exposed to toxic non-performing loans and thereby inviting regulatory sanctions due to poor performance. This might as well threaten the continued existence of the financial institution as a going concern. This is similar to the predicament of the defunct Heritage Bank.

REGULATORY AND ENFORCEMENT FRAMEWORK

The Central Bank of Nigeria has introduced several regulatory interventions aimed at strengthening loan applications,9F[10] including enhanced credit reporting systems10F[11] which establishes a centralized credit information system that enables the collection and sharing of borrower credit data across financial institutions. licensing frameworks for digital lenders, and the Global Standing Instruction (GSI)11F[12] established under CBN regulatory directives issued in 2020 pursuant to the same statutory power mechanism to improve recovery efficiency, CBN Prudential Guidelines for Deposit Money Banks 2010, Secured Transactions in Movable Assets Act 2017, as well as the CBN directive on Loan-to-Deposit Ratio.

In addition, AMCON continues to acquire toxic loans from financial institutions,12F[13] the Act empowers the Corporation to acquire eligible bank assets and assume full legal control over their management, including restructuring, enforcement, and disposal of non-performing loans. while credit bureaus and the Credit Risk Management System (CRMS) support borrower tracking and information sharing across financial institutions pursuant to the Central Bank of Nigeria’s statutory mandate to maintain a sound financial system and its authority to collect and disseminate financial data.

However, enforcement gaps remain most pronounced in the fintech and digital lending space, where regulatory frameworks are still evolving in response to rapid market innovation. While traditional banks operate under strict supervision, digital lenders often function within a regulatory environment that is still adapting to emerging credit models.

Ultimately, effective mitigation of toxic loans depends not only on regulation but also on the efficiency of enforcement systems and consistency in due diligence practices across all lending channels.

CONCLUSION

Toxic loans in Nigeria are no longer confined to traditional banking institutions. They now span a diversified credit ecosystem comprising deposit money banks, microfinance institutions, fintech lenders, mobile money operators, and even banking-as-a-service platforms. While financial innovation has significantly expanded access to loan, it has also increased exposure to poorly assessed lending decisions that are difficult to enforce and costly to recover.

Ultimately, addressing toxic loans in Nigeria will require more than regulatory compliance. It will require a recalibration of lending culture, one that aligns innovation with cost effective enforceability, due diligence and digital efficiency with legal certainty in credit origination and recovery.

Please note that the foregoing does not in any way constitute legal advice. Kindly contact the authors for any legal advice on the subject matter:

List of Resources

1. Banks and Other Financial Institutions Act 2020 (BOFIA 2020)

2.  Central Bank of Nigeria Act 2007

3. CBN Prudential Guidelines for Deposit Money Banks (as amended)

4. CBN Guidelines on Licensing and Regulation of Digital Lending (2022)

5.  AMCON Act 2010

6.  Credit Reporting Act 2017

7. Moneylenders’ Laws (e.g. Moneylenders’ Law of Lagos State, Cap M7, Laws of Lagos State 2009)

8. LDR Regulatory dire

9. Secured Transactions in Movable Assets Act 2017

Judicial Authorities

1.Kachalla v. Banki

2.Owoade v. Asubiojo & Anor

3.Anyaduba v. Nigerian Renowed Trading Co. Ltd