The Impact of Monetary Policy on the Financial Performance of Deposit Money Banks in Nigeria

Chapter One

1.3 Objectives of the study

The general objective of the study is to determine the effect of monetary policy on the financial performance of Deposit Money Banks in Nigeria.

The specific objectives are as follows:

To establish the effect of Central Bank Rate (CBR) on the financial performance of Deposit Money
To establish the effect of Reserve Ratio Requirement on the financial performance of Deposit Money

CHAPTER TWO LITERATURE REVIEW

2.0 Introduction

This chapter reviews various theories that inform economic development and their macroeconomic effects, seeks to locate the place of our focus subject and its relevance to the finance discipline. A critical review of empirical studies is undertaken and an effort to evaluate contributions is made and pertinent knowledge gaps identified.

2.1 Conceptual Framework

Concept of Monetary Policy

Ezenduyi (2004) defines monetary policy as the policy which involve the adjustment of money stock (through different means) interest rate exchange rate as well as expectation to influence the level of economic activities and inflation in desired direction, targeting as the mapping up of excess liquidity armed at ensuring a non-inflationary macro-economic environment. Monetary policy can be defined as the instruments at the disposal of the monetary authorities to influence the availability and cost of credit/money with the ultimate objective of achieving price stability as demonstrated by Ibeabuchi, (2012). Onouorah, et al (2016) defined monetary policy as a rule and regulation imposed by the monetary authority into controlling the money supply inflation and achieves economic growth. Onyeiwu (2012) defines monetary policy as a technique of economic management to bring about sustainable economic growth and development has been the pursuit of nations and formal articulation of how money affects economic aggregate. Chigbu & Okonkwo (2014) held that monetary policy generally refers to the deliberate efforts of the government to use changes in money supply, cost of credit, size of credit and direction of credit to influence the level of economic activities to achieve desired macroeconomic stability in an economy.

Richard (1999) stated that the instrument tools of monetary policy have been classified broadly in two categories traditional and non-traditional quantitative instrument. Monetary policies, as adopted in Nigeria, have four broad objectives.

To maintain a high level of employment (full employment): Full employment means employment of labour, plant and capital at a tolerable capacity to achieve the set goals of national economic policy aimed at combating recession and economic
To maintain stable price level:Price level stability goal is related in an important sense to the control of inflation refers to a situation of sustained and rapid increase in the general level of prices, however, generated (Nnanna, 2006). According to Ibeabuchi (2012), inflation reduces real disposable income and consequently the purchasing power of

To maintain the highest sustainable rate of economic growth: This means both quantitative and qualitative increase in the total quantity of goods and services produced in the economy annually. Nnanna (2006) opined that economic growth is said to be achieved in a country in a situation where there is an increase in the income position of the citizens of the country and also a corresponding increase in the amount of goods and services which a given quantity of money can

To maintain the highest equilibrium in the balance of payments: A country’s balance of payment may be in total equilibrium of there exists between total payments and total receipts, that is, the avoidance of larger or chronic deficit or surplus in the balance of payments

2.1.2 Concept of Bank Profitability and Financial Performance

The profitability of a bank is determined by interior and exterior determinants (Sattar, 2014) which agrees with (Ongore, 2013; Al-Tamini et al., 2015). The interior determinants are called micro or bank specific determinants of profitability because they are initiated from bank accounts like balance sheet or profit and loss account. While on the other hand, the exterior determinants are the variables which are not in the control of banks’ management such as monetary policy interest rates. Chen et al. (1996) explained that these macroeconomic factors are significant in explaining firm performance (profitability) and subsequent returns to investment. Gilchris, (2013) agrees that the financial performance is commonly measured by ratios such as Return on Equity, Return on Assets. There are many different mathematical measures to evaluate how well a company is using its resources to make profit (Irungu, 2013). Financial performance can be measured using the following techniques; operating income, earnings before interest and taxes, net asset value (Gilchris, 2013). Irungu (2013) described financial performance analysis as the process of identifying the financial strengths and weakness of the firm by properly establishing the relationship between the items of the balance sheet and profit and loss account. It’s the process of identifying the relationship between the component parts of financial statements to ascertain an organization position, performance and prospects. Financial performance analysis can be undertaken by management, owners, creditors, investors (Chenn, 2011. Quarden (2009) argued that financial performance analysis helps in short term and long term forecasting and growth and can be identified with the help of financial ratios such as asset Utilization/efficiency ratios, deposit mobilization, loan performance, liquidity ratio, leverage/financial efficiency ratios, profitability ratios, solvency ratios and coverage ratios can be used to evaluate bank performance (Bekant, 2016). The performance of banks gives direction to shareholders in their decision making (Panayiotis et al., 2011). Wainaina, (2013) says the effect of macroeconomic factors in other sectors of the economy will always affect the banking sector and what goes on in the banking sector will affect the other sectors of the economy. Chen et al., (1996) maintains that these macro-economic factors are significant in explaining firm performance (profitability) and subsequent returns to investors. Gilchris (2013) agrees that financial performance is commonly measured by ratios such as return on equity, return on assets, return on capital, return on sales and operating margin. A firm has several objectives but profit maximization is said to be paramount among these (Damilola, 2012; KPMG, 2010; Raheman and Nasr, 2012). Profit is a tool for efficient resources allocation because it is the most appropriate measure of corporate performance under competitive market conditions (Pandey, 2010). Conceptually profit connotes the excess of revenue generated by a firm over its associated costs for an accounting period. Operationally the term profit is imprecise, as many variants exist. The term profit could refer to profit before tax, profit after tax, gross profit, net profit, profit per share, return on assets, among other variants (Damilola, 2012; Pandey, 2010). This imprecision has often posed decisional challenges to researchers who must select an appropriate variant to proxy profitability. However, the most commonly used variants as appropriate measure of profitability include Gross operating profit, Net operating profit, Return on Assets (Deloof, 2008; Teruel and Solano, 2011; Lazaridis and Tryfonidis, 2010; Raheman and Nasr, 2012). According to Okafor (2016) the profitability performance also can be accessed from both book value and market value perspectives.

2.1.3 Concept of Interest Rates

According to Keynes, interest rate is the reward for not hoarding but for parting with liquidity for a specific period of time. Keynes’ definition of interest rate focuses more on the lending rate.

Adebiyi (2009) defines interest rate as the return or yield on equity or opportunity cost of deferring current consumption into the future. Some examples of interest rate include the saving rate, lending rate, and the discount rate. Professor Lerner, in Jhingan (2008), defines interest as the price which equates the supply of ‘Credit’ or savings plus the net increase in the amount of money in the period, to the demand for credit or investment plus net ‘hoarding’ in the period. This definition implies that an interest rate is the price of credit which like other price is determined by the forces of demand and supply; in this case, the demand and supply of loanable funds.

Ibimodo (2010) defined interest rates, as the rental payment for the use of credit by borrowers and return for parting with liquidity by lenders. Like other prices interest rates perform a rationing function by allocating limited supply of credit among the many competing demands. Bernhardsen (2013) defined the interest rate as the real interest rate, at which inflation is stable and the production gap equals zero. That interest rate very often appears in monetary policy deliberations. However, Irving Fisher (1956) states that interest rates are charged for a number of reasons, but one is to ensure that the creditor lowers his or her exposure to inflation. Inflation causes a nominal amount of money in the present to have less purchasing power in the future. Expected inflation rates are an integral part of determining whether or not an interest rate is high enough for the creditor.

The real interest rate represents a fundamental valuation of temporary provision of capital (money) corresponding to a price level constant in time. It is also obvious from the above relation that if inflationary expectations change, nominal interest rates have to change aliquot at a constant real interest rate (Cottrell; 2010). The real interest rate concept is irreplaceable in the research into the mutual relations of inflation, because assuming that the creditors are rational, inflation and nominal interest rates influence each other. For similar reasons, the real interest rate is used in broader economic analyses. Expected inflation is an unobservable quantity. In an expose analysis, it can be replaced by the actual rate of inflation in the following period, which is equivalent to assuming rational expectations (Bencik; 2014).

Theoretically less satisfactory, but easier to apply, is the assumption of adaptive expectations; this replaces expected inflation in the future by actual inflation in the present. Inflation is very important, because when there is increased inflation over a long period of time, economic agents recognize the actual value of money, stop suffering from money illusion and accept increased nominal rates. Therefore, investment as the main link between the interest rates and the real economy is considered a function of the real interest rates, as standard (Bencik; 2014).

2.1.4 Monetary Policy in Nigeria

CBN act 1959 clearly states that the objectives to be achieved by the CBN act to include the following: (1) Full employment attainment, (2) Long term interest rate stability 3) Optimal exchange rate target pursuance. According to Onyeiwu (2012) the CBN monetary policy in use has been charged with authority of devising and enforcing monetary policy of the CBN act (1958). The development of monetary policy is categorized in two stages: (1) direct control era (1959-1986) and (2) market-based controls era (1986-date). Direct control phase was an exceptional time in Nigeria’s monetary management period. This is because it aligned with different changes in the structure of the economy. This includes economic base shift from agriculture to petroleum, civil war enforcement, the boom and crash in oil prices in both 1970s and 1980s, with the establishment of the structural adjustment programme. In this era, the monetary policies of the central bank was concentrated on putting in place and managing the rate of interest and exchange, discerning allocation to certain sectors, discount rate manipulations, finally moral suasion.

SAP commenced in 1986 and adjustments made to the CBN act in 1991 brought in a new era of implementation of monetary policy in Nigeria. This precisely guaranteed CBN goal autonomy and full instrument. Employing this method, CBN influences parameters in the economy indirectly via its OMO. The activities conducted are mainly on TB and REPOs serving a complimentary role with reserve requirements usage, Liquidity ratio and Cash Reserve Ratio. The above instruments set is employed to cause changes in the quantity base nominal anchor (monetary aggregates) employed in monetary programming.

In other way, the cash reserve ratio (CRR) is used as the price based nominal anchor in swaying the direction in the economy cost of fund. Movements in this rate is a signal to the banks’ monetary disposition, either it is pursuing a tightening or an expansionary monetary policy. They are generally placed within 26% and 8% range from 1986. The CBN latter established in 2006 the monetary policy rate (MPR) to replace CRR which states the rate of interest corridor added and subtract 2% point of existing MPR.

2.1.5 Monetary Policy Instruments

The instruments of monetary policy can be categorized into two namely:

Direct or quantitative instruments
Indirect of qualitative instruments

2.1.5.1 Direct Instruments or Qualitative Instruments of Monetary Policy Tools

Though there is an avalanche of instruments available for money and credit control, the instrument mix to be employed at any time depends on the goals to be achieved and the effectiveness of such instrument to a large extent hinges on the economic fortunes of the country.

Reserve Requirement: The Central Bank may require Deposit Money Banks to hold a fraction (or a combination) of their deposit liabilities (reserves) as vault cash and or deposits with it. Fractional reserve limits the amount of loans banks can make to the domestic economy and thus limit the supply of money. The assumption is that Deposit Money Banks generally maintain a stable relationship between their reserve holdings and the amount of credit they extend to the
Special Deposits: The central bank has the power to issue directories from time to time requiring all banks to maintain with it as special deposit an amount equal to the percentages of the institution’s deposits liabilities or the absolute increase in its deposit liabilities over an amount outstanding at a certain

Moral Suasion: Moral suasion simply means the employment by the monetary authority of friendly persuasive statement, public pronouncement outright appeal the monetary authority sometimes uses the less tangible technique to influence the lending policies of commercial banks. Consequences to the banking system and the economy as a whole, the Central Bank of Nigeria holds periodic meetings with the bankers committees and on other occasion meets formally or informally with the leaders in the banking community (CBN, 2013). With the leaders in the banking community – such contracts are geared towards the development of confidence between the central bank and other banks. It affords the central bank opportunity to discuss the improvement in standards and conducts in the banking industry.

Selective Credit Control: According to Nnanna (2006), this instrument is used to distinguish among the sectors of the economy into preferred and less preferred sectors. This is usually designed to influence the direction of credits in the economy so as to ensure that credits go to those sectors designed “preferred”. It is very useful where a country operates development plans like Nigeria. When plans are drawn up these credit controls will be integrated in the budget. In course of the government’s programme to revitalize agricultural production which is the most favored sector, credits to the favored sector is at lower interest rate while the least favored sectors pay the highest rate of interest.

Direct Credit Control: According to CBN (2013), the Central Bank can direct Deposit Money Banks on the maximum percentage or amount of loans (credit ceilings) to different economic sectors or activities, interest rate caps, liquid asset ratio and issue credit guarantee to preferred loans. In this way the available savings is allocated and investment directed in particular
Prudential Guidelines: The Central Bank may in writing require the Deposit Money Banks to exercise particular care in their operations in order that specified outcomes are realized (CBN, 2013). Key elements of prudential guidelines remove some discretion from bank management and replace it with rules in decision

2.1.5.2 Indirect Instruments or Quantitative Instruments of Monetary Policy

Fiduciary or paper money is issued by the Central Bank on the basis of computation of estimated demand for cash. To conduct monetary policy, some monetary variables which the Central Bank controls are adjusted-a monetary aggregate, an interest rate or the exchange rate-in order to affect the goals which it does not control. The instruments of monetary policy used by the Central Bank depend on the level of development of the economy, especially its banking sector. The commonly used instruments are discussed below (CBN, 2016):

Open Market Operations: The Central Bank buys or sells (on behalf of the Fiscal Authorities (the Treasury) securities to the banking and non-banking public (that is in the open market). One such security is Treasury Bills. When the Central Bank sells securities, it reduces the supply of reserves and when it buys (back) securities-by redeeming them-it increases the supply of reserves to the Deposit Money Banks, thus affecting the supply of money (CBN, 2013; Ibeabuchi, 2012; Ojo, 2013; & Solomon, 2013).

Lending by the Central Bank: The Central Bank sometimes provide credit to Deposit Money Banks, thus affecting the level of reserves and hence the monetary base (CBN, 2013).

Interest Rate: The Central Bank lends to financially sound Deposit Money Banks at a most favourable rate of interest, called the minimum rediscount rate (MRR). The MRR sets the floor for the interest rate regime in the money market (the nominal anchor rate) and thereby affects the supply of credit, the supply of savings (which affects the supply of reserves and monetary aggregate) and the supply of investment (which affects full employment and GDP) according to Obidike, Ejeh, &Ugwuegbe (2015)

Exchange Rate: The balance of payments can be in deficit or in surplus and each of these affect the monetary base, and hence the money supply in one direction or the other. By selling or buying foreign exchange, the Central Bank ensures that the exchange rate is at levels that do not affect domestic money supply in undesired direction, through the balance of payments and the real exchange rate. The real exchange rate when misaligned affects the current account balance because of its impact on external competitiveness (Akpan, 2013: Imoisi, Olatunji&Ekpenyong, 2013; Ibeabuchi, 2012; & Sanusi, 2009).
Rediscount Rate: The rediscount rate is the rate at which the central bank stands really to provide loan accommodation to commercial banks (CBN, 2013). As a lender of last resort, such lending by the central bank is usually at panel By making appropriate changes in the rate, the central bank controls the volume of total credits indirectly. This has the purpose of influencing the lending capacity of the commercial banks. During the periods of inflation, the central bank may raise the rediscount rate making obtaining of funds from the central bank more expensive. In this way, credit is made tighter. Similarly, in depression, when it is necessary to encourage commercial banks to create more credits, the central bank will lower the rediscount rate.

Cash Reserve Requirements: Ojo (2013) posit that the reserve requirement can be manipulated by the central bank to reduce the ability of commercial banks to make loans to the public by simply increasing the ratio or enhancing their lending position by decrease in the ratio. Reserve requirement is loan of the most powerful instruments of monetary control (CBN, 2013). A change in the required reserve ratio changes the ratio by which the banking system can expand deposit through the multiplier effect. If the required reserve ratio increases, the multiplier decreases and thereby reduces the liquidity position of the banking system.

CHAPTER THREE

RESEARCH METHODOLOGY

3.0 Area of Study

The area of study is Union Bank of Nigeria Plc. which was established in 1917 as a bank of the colonial bank. The bank was opened in February that year principally to service international trade of the companies and assists the colonial government. In 1925, the bank was renamed Barclays Bank (Dominion Colonial and Overseas) in 1954. In 1969 it changed its name again to Barclays Bank of Nigeria limited in compliance to the banking decree enacted them which made it mandatory for bank like other foreign business operating in the country, to register in Nigeria. The bank earnings per share increased from, 96 kobo to 142 kobo in 2002. While the banks deposit base amounted to N85.241 billion as against N8.06 billion in 2000, total assets of the bank increased from #1,049.7 billion in 2015 to N1,252.7 billion in 2016.

3.1 Research Design and Sources of Data

The section that could have referred to as either research design or research method is very critical to the entire research process. It is in this section that the research stamps his scientific status on the process. A research design therefore is a blue print or scheme that is used by the research for specific structure and strategy in investigating the relationship that exist among variables of the study as to enable time or her collect the data which will be used for the study. Research designs are basically of four types, which are “experimental, historical, survey and case study research design”. For the purpose of this study, the researcher adopted the case study approach in evaluating the effect of monetary policy on the performance of deposit money bank in Nigeria. Both primary and secondary sources of data were adhered to on the course of this study and the attitude and responses of those interviewed were noted.

CHAPTER FOUR

DATA ANALYSIS, FINDINGS AND DISCUSSION

4.0 Introduction

In this chapter, the data collected from questionnaire are presented, analysed and tabulated. Fifty questionnaires were prepared and distributed to the respondent drawn from lower and senior staff of Union Bank Plc.

The analysis were carried out using simple percentage method, the hypothesis will be analyse using the chi-square based on the analysis of the relevant questions.

CHAPTER FIVE

SUMMARY, CONCLUSIONS AND RECOMMENDATIONS

5.1 Summary

The general objective of this study was to determine the effect of monetary policy on the financial performance of Deposit Money Banks in Nigeria. Other specific objectives were to; establish the effect of Central Bank Rate (CBR) on the financial performance of Deposit Money Banks and establish the effect of Reserve Ratio Requirement on the financial performance of Deposit Money Banks.

A sample is a portion of the population selected for study. It is very important to select sample size that will give sufficient fair representation of the population. There are two basic way of making the sample size decision, one is by rule of thumb and the other one is by calculated method. In this research work, the rule of the thumb was used for this research where 50 workers of total population were selected as the sample size. The sample is also made up of senior and junior staff of the Union Bank Plc. This test will provide answers to the questions raised in the research problem. The questionnaires were administered based on the non-random selection of the persons as contained in the sample. This was done in such a way as to get the desired result. The questionnaire contains nineteen fifty (50) questions. . The formulated hypotheses were tested using chi-square (X²) test statistics which measures the significance of the difference between the observed set of frequencies.

The result of the analysis indicates that

5.2 Conclusion

The study examined the effect of monetary policy tools on the financial performance of Deposit Money Banks in Nigeria. The study found that monetary policy tools have no significant effect on the financial performance of Deposit Money Banks in Nigeria. Thus, the study concludes that monetary policy tools do not influence the financial performance of Deposit Money Banks in Nigeria.

The study assessed the effect of Treasury Bill Rate (T-Bill Rate) on the financial performance of Deposit Money Banks in Nigeria. The results showed that T-Bill Rate had a positive effect on the financial performance of Deposit Money Banks. Thus, the study concluded that T-Bill rates have a positive but insignificant affect the financial performance of deposit money banks in Nigeria.

The study examined the effect of Central Bank Rate on the financial performance of Deposit Money Banks in Nigeria. The results showed that Central Bank Rate had a negative effect on the financial performance of Deposit Money Banks. The study therefore concluded that Central Bank Rate has no significant affect the financial performance of Deposit Money Banks in Nigeria.

The study also assessed the effect of Cash Reserve Ratio on the financial performance of Deposit Money Banks in Nigeria. The results showed that Cash Reserve Ratio had a negative effect on the financial performance of Union Bank. Thus, the study concluded that Cash Reserve Ratio does not affect the financial performance of Deposit Money Banks in Nigeria.

The study examined the effect of bank size on the financial performance of Union Bank of Nigeria. The results showed that bank size had a weak positive effect on the financial performance of Deposit Money Banks. Thus, the study concluded that bank size affects the financial performance of firms in Nigeria.

5.3 Recommendations

Based on the findings made in this study, the following recommendations have been made to address some of the problems discovered:

The study recommends that Deposit Money Banks should put more emphasis on the internal factors to financial
These internal factors include capital adequacy, asset quality, management efficiency, earnings ability and liquidity

Monetary policy tools effect will be handled by the management through risk management policies for the

The study further recommends that while bank size was found to lead to better financial performance, it is important that banks understand the source of its funds and the costs associated with the
Findings emanating from the empirical analysis of this study proffered that monetary authority; the Central Bank of Nigeria (CBN) should adjust the monetary policy rate by reducing the cash reserve ratio which will increase liquidity to enable the Deposit Money Banks to discharge their lending and investment duties effectively to the
It is important that monetary and fiscal policies be complimentary and not working at variance. The co-intergration tests which show a disquilibrium by 41% which suggest that the level of cohesion in harmonizing policies are not adequate. The CBN and the Ministry of finance should work more closely to objectively articulate policies in the same economic direction.

The CRR should be complementing the Open Market Operations (OMO) in ensuring that excess liquidity or lack of it in the banking system is minimized, that way Money Supply (M2) will be more effective as a tool on measuring other performance
From the findings, the Liquidity Reserve Ratio (LRR) tends to impact more on bank turnover ratio. Because monetary effects of CRR changes are hard to be isolated from those of other policy measures. It means that the constraint of higher reserve requirements on bank lending seems more binding when initial excess reserves shrink below some threshold, restraining the subsequent loan expansion while leading to higher, more volatile market interest rates. The CBN should carefully and thoroughly consider the turnover effect in deciding the

5.4 Suggestions for Further Research

The study suggests that more studies be done in this area focusing on all banks in Nigeria as well as other financial institutions such as microfinance that also give loans. This can be done by focusing on all Deposit Money Banks in Nigeria and microfinance institutions. Studies should also be conducted on the topic using fairly longer time periods (more than 5 years) and smaller time intervals (say quarterly) of data collection as such studies may be useful in showing the trends as well as the long terms relationship between monetary policy and financial performance of Deposit Money Banks in Nigeria.

The study also recommends that further studies explore the relationship between monetary policy and financial performance of Deposit Money Banks with categories of small, medium and big banks. As has been noticed from the research data, bigger banks exhibited larger Net Interest Margins as compared to smaller banks.

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