CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

Banks play an important role in financial system and the economy of a country. Banks among other financial institution are organizations which through its activities (Such as accepting or accepting and handling of deposit of its customer, making available loans to individuals and organizations based on request among others) contributes to a nation’s economic growth in particular and national development at large.

Ajayi (2014) refers to banks as “the linchpin of the economy of any country, they occupy central position in the country’s financial system and are essential agent in the development process. By intermediating between the surplus and deficit saving units within an economy, banks mobilize and facilitate efficient allocation of national saving thereby increasing the quantum of investment and national output”.

According to Chirwa and Mlachilla (2014) cited in Soyemi et al (2013) banks are financial intermediaries which play a key role in transforming deposits into financial assets; they channel funds from entities with surplus liquidity to those with deficit liquidity thereby facilitating capital formation and trade, bank also play a role in performing loans and creative accounting practices among many other very serious infractions by management of some of these banks.

According to Ekpung, Udude and Hope (2015) the existence of an effective banking sector is necessary for every economy because it creates the necessary environment of economic growth and development through its role in intermediating fund from surplus sector to deficit sector of the economic unit. Banking sectors are financial intermediaries, whose activities are for collection of saving and lending, thus standing in between the ultimate lender and borrower and matching the investment requirement of the lender.

The banking industry as regulated by central bank of Nigeria is made up of deposit money banks usually referred to as commercial bank and other financial institutions which include Micro-Finance bank, Finance Companies, Bureau De change, Discount house and Primary Mortgage Institution.

Soyemi, Akinpelu and Ogunleye (2013) state that the role of deposits money bank (DMBs) otherwise known as commercial banks is central to financial economic activity in an economy, especially in developing country like Nigeria.

Ongore (2013) posits that “the performance of commercial bank can be affected by internal and external factors which can be classified into bank specific (internal) and macroeconomic variable. The internal factors are individual bank characteristics which affect the bank performance these factors are influence by internal decision of the management and board, the external factors are sector wide or country wide factor which are beyond the control of the company and affect the profitability of the bank”.

In Nigeria, the type of government (military or democratic), environment (the society), and other institutions are external factors that could affect a bank. On this note, the central bank of Nigeria (CBN) as the apex of banking institute influences or affects the operation and survival of other banks. It is a significant external factor whose polices, principles and regulations in one way or the other affects the operation of other banks.

The central bank of Nigeria (CBN) is regarded as the central control unit of Nigeria banking system whose policies, principles and action influences or affects individual banks and the nation’s economic development. CBN is an institution established in 1958 and commenced operation in 1959. However, the major regulatory objectives of the bank as established in the CBN Act are to maintain the external reserve of the country, promotes monetary stability and a sound financial environment, and act as a banker of last resort and financial adviser to the federal government.

CBN act as financial adviser and “banker” to both the federal government and other banks. A major significant influence mechanism of CBN is the instrument of monetary policy in Nigeria to regulate external reserve, safeguard the international value of legal currency, promote and maintain monetary stability. Change in monetary policy affect the overall activities of the economic, such change affect the performance of the banking sector which will as well affect the profitability of the banking sector.

In furtherance, David and Lee (1978) states that commercial banks are the front line troops when it comes to implementing monetary policy because of this connection, they as a group are influence heavily by the action of the nation’s monetary policy maker. Monetary policy refers to the credit control measure, adopted by the central bank of a country. In another words, monetary policy enables central bank to control the supply of money as an instrument for achieving the objective of general economic policy.

According to Ajayi (2014) monetary policy involves the regulation of money supply and interest rate by the central bank in order to control inflation and stabilize currency. It is also a major economic stabilization weapon, which involve measure, designed to regulate and control the volume, cost availability and direction of money and credit in an economy to achieve some specified macroeconomic policy objective (Anyanwu 1997).

Claudio, Leonardo and Boris (2015) note that understanding the link between interest rate and bank profitability is important for evaluating the effect of monetary policy stance as captured by the interest rate structure i.e the level and slope of the yield curve on the soundness of financial sector, while monetary policy is not the only influence on the interest rate structure, it has a major impact on it: the central bank set the short term rate and influence longer term rate through direct purchase of securities and by guiding market participant expectation about short term rate.

According to Demirguc-kunts and Huizinga (1999) cited in Claudio et al (2015) to be among the first to relate bank profits to macroeconomic indicators such as real interest rates. They find the high real interest rate as associated with higher interest margin and profitability especially in developing countries where demand deposit frequently pay below market interest rate.

However, the financial intermediation function of the bank sector assume the need to satisfy the ultimate goals of the sector, the bank have private goals (profitability, liquidity and solvency) other than performing the intermediation function. Most financial intermediaries channel resource to productive investment even at lower level of interest rate,  this is among the factors that limit the performance of monetary policy. For instance the expansionary monetary is use to increase money supply in an economy but it lead to inflation.

In order to survive in long run in relations to the influence of CBN through its formulation and implementation of various polices, the deposit money bank is expected to take cognise of those factors that affect it financial performance via its profitability.

1.2     Statement of the Problem

The primary function of banking sector as a financial institution is to source for fund from the surplus unit to the deficit unit of the economy in relations to the institutions survival, economic growth and National development. However, banks major or primary goal, aims and or objectives is to survive through profit making more like other commercials organizations in other to survive and remain significant in a competitive environment. Profitability is important for financial intermediaries like banks because it show the strength and progress of the bank and it help to generate and radiate confidence in the bank.

However, as much as the bank can control its internal factor, it has no or limited control over its external factors such as Government and CBN in relations to policies formulation and implementation, as Bank operate within the framework of the monetary policy and banking regulation that is provides by the central bank of Nigeria. The CBN has employed different policies to regulate and control the cost, volume, availability and direction of money creation in order to achieve the objective of monetary policy which includes price stability, full employment, economic growth and reducing inequality of income and wealth.

Therefore, this study will ascertain the factors that influence the banking sector performance using bank’s deposit liabilities as proxy for bank performance.

1.3     Objective of the Study 

The main objective of this study is to examine the effect of monetary policy on the financial performance of deposit money banks in Nigeria. The specific objectives are to:

1.            estimate the effect of the liquidity ratio on the financial performance of deposit money banks;

2.            analyze the effect of lending rate on the financial performance of deposit money banks;

3.            analyze the impact of loans to deposit ratio on the financial performance of deposit money banks and

4.            estimate the effect of cash reserve ratio on the financial performance of deposit money banks.

1.4     Research Questions

1. What is the effect of the liquidity ratio on the financial performance of deposit money banks?

2. Does the lending rate have an effect on the financial performance of deposit money banks?

3. What effect does the loan to deposit ratio have on the financial performance of deposit money banks?

4. What is the effect of the cash reserve ratio on the financial performance of deposit money banks?

1.5     Hypotheses

The research hypotheses are: At 5% level of Significance

H01: liquidity ratio has no significant effect on the financial performance of deposit money banks in Nigeria.

H02: lending rate has no significant effect on the financial performance of deposit money banks in Nigeria.

H03: loans to deposit ratio has no significant effect on the financial performance of deposit money banks in Nigeria.

H04: Cash reserve ratio has no significant effect on the financial performance of deposit money banks in Nigeria.

1.6     Scope of the Study

The researcher will be restricted to Nigeria and the work will be both empirical and theoretical. This study examined the effect of monetary policy on the financial performance of deposit money banks in Nigeria. The study includes all the deposit money banks in Nigeria as captured by the Central Bank of Nigeria Statistical Bulletin 2015. The period of the study is 34 years (1981-2015) which were considered relevant to this study because of the availability and accessibility of the data as at the period this study was carried out.

1.7     Significance of the Study

This study is significant because it would provide information and recommendation to assist the government to come up with appropriate monetary policy that can enhance not only the performance of deposit money banks but the economy at large. The deposit money banks in Nigeria would be able to understand how changes and variations in monetary policy by the existing government are likely to affect or impact on their financial performance. This would enable them to take necessary approaches to react to variations in monetary policy.

1.8     Operational Definition of Terms

Net worth (NW): is the total asset minus total outside liabilities of an individual or a company. Net worth is used when talking about the value of a company or a personal finance for an individual’s net economic position.

Total credits: is the amount deposited in the account.

Deposit money banks: is any financial institution which has been legally authorized by a governing body of the State, Country, Nation (for example central banks Nigeria) to accept money in form deposits and also lend money to individuals for an agreed percentage.

Liquidity Ratio (LR): are the ratios that measure the ability of a company to meet its short term debt obligations. These ratios measure the ability of a company to pay off its short liabilities when they fall due.

Lending Rate (LR): is the amount charged, expressed as a percentage of principal, by a lender to a borrower for the use of assets. Lending rates are typically noted on an annual basis, known as the annual percentage rate (APR).

Loans-to-Deposits Ratio (LDR): is used to calculate a lending institution’s ability to cover withdrawals made by its customers.

Top of Form

BottomTop of FormBottom of FormCash Reserve Ratio (CRR): is a specified minimum fraction of the total deposits of customers, which deposit money banks have to hold as reserves either in cash or as deposits with the central bank. CRR is set according to the guidelines of the central bank of a country.

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