University of Nigeria Research Publications
NSIEN, Benjamin Frank
A
utho
r
PG/MBA/93/17418
Title
The Effect of Regulated Bank Rates on Commercial Banks Performance
Facu
lty
Business Administration
Dep
artm
ent
Banking and Finance
Dat
e
November, 1995
Sign
atur
e
THE EFFECT OF REGULATED BANK RATES ON COMMERCIAL BANKS PERFORMANCE
NSIEN, BENJAMIN FRANK (PG/MBA/93/17418)
DEPARTlMENT OF BANKING AND FINANCE , UNIVERSITY OF NIGERIA
ENUGU CAMPUS.
-
NOV. 1995.
TIIE EFFECT OF REGULATED BANK RATES
ON COMMERCIAL BANKS PERFORMANCE
BY
NSIEN, BENJAMIN FRANK
PGIMBN93/174 18
A PROJECT REPORT PRESENTED IN PARTIAL FULFILMENT OF THE
REQUIREMENTS FOR THE AWARD OF MASTER OF BUSINESS
ADMINISTRATION (MB A).
DEPARTMENT OF BANKING AND FINANCE
UNIVERSITY OF NIGERIA, ENUGU CAMPUS
NOVEMBER, 1995
CERTIFICATION
NSIEN, BENJAMIN FRANK, a post-graduate student in the Department of
. Banking and Finance and with Registration No.PGIMBAI93l17418 has
satisfactorily completed the requirements for the course and research work . t i
for the Degree of Master of Business Administration (MBA) in Banking and
Finance.
The work embodied in this project Report is the original contribution of the author.
--------- Prof. F.O. OKAFOR Prof. mafo for Head of Department Supervisor
DEDICATION
This work is dedicated to God Almighty
for his saving Grace and Guidance,
and to my Beloved parents, Brothers and Sisters
for their full support of my academic upliftment.
ACKNOWLEDGEMENT
I wish to express my profound gratitude to prof. F.0, Okafor, my Supervisor
for the guidance and useful suggestions for the completion of this work.1 am
particularly grateful to the fotlowing personafities -Mr. lmoh Akpan, Lecturer in the
Department of Banking and Finance, Universityof Uyo, Dr. (Mrs) Funmi Adegbite,
Senior Lecturer in the Department of Banking and Finance, ~n i ve rs i t~o f ~ a ~ o s , Mr.
Etuk Nssien Etuk, iecturer in the Department of Curriculum and Instruction,
Universityof Uyo, and theBank Managers for their immeasurable co-operation for
the success of this work.
My special thanks go to my parents, brothers and Sisters and my In-laws for
their financial and moral support and encouragement.
I am equally grateful to my brother- Mr. Joe Udo-Eshiet of the Union Bank
PLC, Calabar, Mr. John Udofa of the Co-operative Development Bank PLC Lagos,
and Mr. Godwin H. Udofia, Managing Director, Geohans Enterprises, Eket, Dr. &
Mrs. Des Wilson, Dr. & Mrs Kingsley Akpabio, Dr. & Mrs. Rufus Ubom, Mr. & Mrs.
Charles Bradford, Mr. ltimitang Etukudoh, Mr & Mrs. F.S. Okomoh and Barrister
. lmoh Abiasse. For their immense assistance.
Furthermore, I am deeply indebted to my pals and colleagues who helped me
in many ways to make this work a success.
Thanks also go to a host of my friends Miss Gladys Frank, Edidiong,Nsienetuk
and Mummy Fidex, Mayen Udoh, Comfort Ben, Akon Asuquo, Christy, Etim Edet,
Esther, Kufre, Florence, Ernern and Feli Joe, ldongesit, Uduak Benneth, Gladys
Onyenweonwu, Beatrice, Joy, Uduak Onukak, Rose, Nsebong Enoch, Ernest
v Okpot, Kennedy Akwawo, Joe Nsien, Norbert Brown, Victor Imose, Ebenezer
Akpabio, Ndueso Akpawan, Joshua Moses, Obiora Aquozor, Gabriel Ekpeyong
and Akan Ibok, Sonny Ekpo, Ubang who have in different capacities facilitated
the completion of this work.Largely, my praises and thanks to God Almighty who
in His infinite love, goodness and mercy sustained me to the end of this work.
TABLE OF CONTENTS vi
PAGES
CERTIFICATION
DEDICATION
ACKNOWLEDGEMENT
TABLE OF CONTENTS
LlST OF TABLES
LlST OF FIGURES : . . -
ABSTRACT
CHAPTER ONE:
1 .I. Introduction
I .2. Statement of problem :
1.3. Objectives of study :
1.4. Research Questions :
I .5 Significance of study :
I .6. Scope and Limitation of Study :
References
ii
iii
iv-v
vi-viii
ix
X
vi-xiv
vii CHAPTER TWO: REVIEW OF RELATED LITERATURE
2.1. Banking Development 8 - 1 0
2.2, The Role of Banks in an Economic System : 10 - 12
Commercial Banking:
2.3.1. Sources of Bank Capital
2.3.2. Functions of Bank Capital
2.3.3. Bank Sources of Funds I Income
2.3.4. Bank Asset and Liability Management :
2.3.5. Bank Profitability and Liquidity Management
2.4. Bankllnterest t-ates
2.4.1. Conceptual Issues In Interest rate
2.4.2. Interest rates (Deposit and Lending)
Structure in Nigeria from 19970 -1 994 :
2.4.3. Interest rate determination
2.4.4. Deregulation and Regulation of Interest rates :
2.4.5. The Implications of the CBNWs 1994 interest
rate policy on banking operations
lnterest rate Risk Management 2.4.6.
References:
CHAPTER THREE: RESEARCH DESIGN AND METHODOLOGY
3.1. Introduction 3 9
3.2. Data./ Information Base 3 9
Sources of Data
viii
3 9
Types of Data
3.3. Population and Sample:
3.4. Research Instrument
3.5. Method of data processing and Tools of Analysis :
CHAPTER FOUR: DATA ANALYSIS AND FINDINGS
4.1. Presentation of Data 43 - 51
4.2. Hypothesis Testing 5 1
4.3. Research Questions 51 - 60
4.4. , Analysis of Responses from Bank Managers and other Findings 60 - 63
CHAPTER FIVE: SUMMARY OF FINDINGS, RECOMMENDATIONSAND CONCLUSION
5.1 Summary of Findings 64 - 66
5.2. Recommendations . . . . 66 - 67
5.3. Conclusion 6 8
BIBLIOGRAPHY 69 - 71
LIST OF TABLES
TABLES
ix
PAGE
Growth in Banks and Bank branches 9
Selected Deposit and Lending rates (1 970 - 94) : 22
Specified Assets in Nigerian Commercial Banks: : 44
Analysis of Commercial Banks' deposit liabllitles by volume 47
Total investments of commercial banks 49
Classified Income Statement of selected commercial banks : 51
Liquidity position of commercial banks in Nigeria
as measured by Deposit and Cash ratios 52
Average rates of Deposit and Cash ratios 53
Average growth rat& of Deposit and Cash ratios : 54
Profitability level of some selected commercial banks as measured by Profit margin, Return on Equity and Return on Assets. : 55
Average rates of Profit margin, Return on Equity and Return on Assets 56
4.10. Average growth rates of Profit margin, Return on Equity and Return on Assets 56
4.4 1. Fee-based services offered by Nigerian cornmerclal banks : 59
LIST OF FIGURES
FIGURES PAGE
2.1. The supply of and demand for Loanable funds 24
4.1. Total specified Asset volume in Nigerian commercial banks 45
xi ABSTRACT
The study is focused on analysing/evaluating the adverse effect of regulation of
interest rates on commercial banks performance. It is widely claimed that, the
regulationofinterest rates havea negativeeffect on theliquidity position, profitability
level, and the overall performance of commercial banks, and at the same time
induces banks to become innovative by diversifying their 'income earning base.
Thus, the researcher set out to analyse the impact of regulated bank rates on the
liquidity position of banks as measured by the deposlt and cash ratios, determine
the effects of bank rates regulation on the overall performance of banks as
measured by the profit margin, return on equity and return o n assets. The study
also examined the effort of bank managers in diversifying their income base to
offset the acclaimed adverse effects of regulated rates on bank earnings and
evaluate the steps the bank managers have adopted to cushlon the negative effect
of bank rates regulation on the liquidity position. profitability level and the overall
performance of bank, Recommendations are made based on findings.
The work was based on both primary and secondary data. A total number of
thirty Bank managers were interviewed and also responded to thequestionnaire.
The primary data were obtained from the opinion and responses of the Bank
managers which included-oplnlon on the monetary policy of regulating bank/
interest rates, the effect interest rates regulation has on the banking operation;
bases for determination of interest rates (Deposit and lending rates); fee yielding
serviceslproducts offered by banks; steps taken by bank managers to curshion
the negative effect of interest rates regulation. and the information about illegal
banking practices/activities by bank managers as regards deposit and lending
rates (practice of interest rate short-change). The secondary data were extracted
xii
from Annual Reports of commercial banks, CBN statistical Bulletin, NSE facts
Book. The data included-specified Assets (Liquid Assets and cash), Deposit
liabilities, Total investments, Classified income statement (Gross Earnings, Profit
before tax, Net profit after tax, Total Assets, Shareholders' equity).
In the course of analysis, both the Descriptive and Analytkal tools were used.
The descriptive tools were tables, charts and CBN, comrr~ercial banks Annual
reports, while the Analytical tools used were percentages and ratios. The study
revealed that regulation of bank rates did not reduce the liquidity position of banks
and had no significant negative effect on the overall performances of banks. lnfact
the liquidity position of banks as'measured by deposit and cash ratios and the
profitability levels of the banks, as measured by profit margin, return on equity and
return on assets, were sound and solid, that Is better when the interest rates were
regulated than when theywerederegulated. In otherwords, the period of regulation
of interest rates had the highest averages rates and average growth rate of the
liquidity and profitability indices mentioned above compared to the period of
deregulation of interest rates. The only exception was the case of Return on Assets
which had higher average rate during deregulation of interest rates than when
interest rates were regulated. The study further revealed that bank rates regulation failed to induce banks
to diversify their income earning base. Rather than diversify their income earning
base from interest-based servlces~products to fee-based services/products, the
regulation of interest rates tended to encourage banks to indulge in illegal banking
activities or practices. An example of such practices was found to be "Interest
Rates Short-change", -A practice whereby banksdisplay the official interest rates
xiii at their offices but offer undertable rates which are higher and more attractive than
the official rates, in a bid to attract moredepositors. ,The banks instead of improving
their fee based products packages, depend solely on Deposit taking as the major
source of income. Thus putting a neglect to product innov i3 t' tons.
Therefore, the general assertion by Scholars, Writers, Authors and Researchers
that, the regulation of interest rates has a negative effect on the performance of
commercial banks in terms of liquidity position, profitability level and the overall
performance, and also that, interest rates regulation induces banks to diversify
their income earning base is a misconception considering the Nigeria case. The
study also revealed that, the regulation of interest rates has incited banks to be
more prudent in the management of theirfunds,assetsand liabilities, and theenfire
corporate affairs.
A greater majority (73.33%) of the Bank managers interviewed were of the
opinion that, the CBN should fix flexible interest rates that relates to the current
market condition and should be done in consultation with the Bank managers,
Bankers committee and Manufacturers Association of Nigeria, while the others
(26.66%) mostly new generation managers opted for a complete deregulation of
interest rates. Furthermore, the negative effects of interest rates regulation as
highlighted by the Bank managers included-discouragement in financial savings
by Depositors especially when clients could invest on fixed assets, also discourage
competition in the banking system.
Thestudy also revealed that, the Bankmanagers have adopted some strategies
aimed at cushioning the widely claimed negative effect of interest rates regulation
on banks performances. Some of the strategies include-aggressive marketing to
shore upcurrent account volume and other deposit liabilities, discouraging lending
xiv
to customers with no good record of credit worthiness and improvement of risk
assets quality, extending facilities to clients with.track record of performance,
providing Improved and high quality services, orientation towards customer's
enthusiasm and staff satisfaction and adoption of strategic management.
in all^, from the findings, it was recommended that government throughCBN
should fix flexible interest rates because of the imperfections in the Nigerian
market; that Bank managers, Bankers committee and Manufacturers Association
of Nigerian should be consulted by the Regulatory Authority (CBN) in the course
of fixing the interest rates; that Bank should improve on their fee-based services1
products rather than induiging in Illegal banking practices like "interest rates short
change"; that commercial banks should intensify their efforts in promoting or
financing export trade which yield fast and huge income. It was also recommended
that, commercial banks should abide by the Federal Government Monetary policy
as regards interest rates for it is a measure employed to stabilise the banking
system, check inflation and balance the economy as a whole. Further
recornrrrendation made was that, CBN should effectively monitor the trend of
events I activities in the commercial banks to avoid a situation where the interest
rate policy creates more problem than it is envisage to solve.
CHAPTER ONE :
GENERAL INTRODUCTION
World-wide it is being noted that the financial system (sector) of-a
country plays an important or catalytic role in the process of economic growth
and development of the.country. As economy grows, the financial system
becomes increasingly deep and broadened, its structure also becomes
increasingly sophisticated. The financial system thus include the banks and
.other non-bank institutions (that is, other financial institutions). In the process
of developing th economy, they offer wide range of portfolio options for savers
and issuable lnstruments for investors-a function often referred to as financial
intermediation which can be termed to be a process that involves the matching
of lenders and borrowersfor the purposeof accelerating the pace of Investment.
In essence, the financial system (sector) can be seen as a pivot for any
country's economic development.
Realising the vital role played by the financial sector in a developing
economy, coupled with the recognition of the economic depression in Nigeria,
the government fully pariicipated in promoting and stimulating activities in the
, . financial system. Thus, a goal of revamping the economy was set. The
Banking sector experienced /witnessed minimal control and deregulation of
activities I services by the government in 1986. Such activities./ Service
included among others-institutional liberalisation, deregulation of bank rates,
markets segmentation, foreign exchange market, credit control and liquidity
The important of deregulation on the economy and most especially on
2 the Banking sector cannot be overemphasised. ln.this era "Deregulation", the
banking industry became more competitive. Banks compete with one another
for patronage, for deposits, good staff and for prime allocation. There was an
upsurge in the number of new banks and other financial intermediarids,
creation of opportunities for imaginative bank management to exploit its talents
to the fullest, savings were mobilised as a result of upward revision of Interest
rates, banks and other financial Institutions improved on their capital and
Income earning bases. This period also witnessed significant improvement on
their capital and income earning bases, improvement in banking services,
increasing securitisatio;~ of financing operations, gradual emergence of
conglomerate banking and new products development (such as withdrawal
time minizing scheme, Time Saving Scheme, Bonus Scheme, Privacy
enhancement scheme, Trust schemes etc.) and effective innovation and
information technology (Installation ofdata processing, storage and information
retrieval facilities).
Also loan syndication was prominent within this period and finally the
incorporation of Nigeria Deposit Insurance corporation (NDIC) by the
Government to provide insurance cover for bank's deposit liabilities in case of
bank liquidation, providing financial assistance to banks in the course of
illiquidity problems faced by banks and also aiding the regulatory bodies
(Government and Central Bankof Nigeria (CBN) in formulating and implementing
monetary and fiscal policies.
In as much as the enumerated advantages could be attributable to the
deregulation era, it was not without its short comings. There was an adverse
3 effect of the deregulati~n of interest rates on the potential and prominent
investors (the manufacturers). These group of persons because of the high
interest rates on Loans resorted to capital market to source for their needed
funds. Thus, they tend to shift from the Interest-base capital to fees-base
capital. Banking services were only patronised by the depositors. This erd of
deregulation also witnessed a lot of financlal indiscipline among banks and
conspicuous flamboyant life style of the ~ a n k s and Bank officials. No
precaution was taken against the defects of deregulation.. This adverse effect
of deregulation latter caused a down turn in the economy. most especially in
the banking sector. Many banks lost momentum, became distressed and
most banks died a natural death.
Thus, in consideration of the ro-ole of banks as the financial intermediators
consequent upon the cdnstraints suffered by the manufacturers and other,
sectors of the economy, the government reversed its monetary policy by re-
introducing regulation into the financial system (banking sector) in 1994. The
regulations affected two key areas - the Interest rates and foreign exchange
management. Both deposit and lending rates were pegged and the right to deal
in foreign exchange restricted.
STATEMENT OF PROBLEM
Presently, the Nigerian financial system most especially the banking sector is
going through a kind of upheaval unparalleled in the banking history of the nation
since the introduction of the indigenization policy in 1972.
From 1987, Nigeria witnessed a boom in the banking sector. There was
massive economic improvement and development most especially in the financial
4 system. This was as a result of the introduction of deregulation policy which was
a priority area in the Structural Adjustment Programme (SAP) introduced in 1985.
The period "Deregulation eral'witnessed massive increase in the numberof banks
and variety ofthe financial institutions. The bank rates were unregulated. The rates
were determined by the forces of market demand and supply. Banks, corporate
firms, individuals were allowed the free hands to bid for appropriate rates. There
was adequate liquidity flow within the system and the entire economy. The period
also witnessed the advent of new banking products and finally, there was free
competition among the financial institutions, banking firms inclusive.
The government after considering that the economy was lopesided and that
there was too much cash (liquid funds) flow in the system which could bring
high rate of inflation re-introduced regulation in the banking sector in the areas
of bank rates and foreign exchange management. The right to deal in foreign
, exchange was restricted to few banks, while the interest rates were pegged at
15 percent for savingsldeposit and 21 percent for lending. This apply to both
the banks and other financial institutions. The maximum lending rate applies
to Loans and Advances, Bankers Acceptance, Commercial Paper and
Rediscount.
The adverse effect of the regulation policy on the banking sector cannot be
over-emphasised. ,There has been "deposit flight1' from banks as depositors
no longer have confidence in the banking services, banks have experienced
cash squeeze, thus, facing high rate of illiquidity, many banks have become
distressed while many have crashed out of the banking services. The question
now is - Does the bank rates regulation relate to the currerlt market condition?
5 Does the level of regulation ensures prudential operations, and if not, what
degree of freedom is required to foster competition and efficient banking? and
finally what are the effects on bank's liquidity and profitability most especially
to the commercial banks whose main banking services are deposits taking
and bank lending.
Thus, the researcher has in mind to critically analyse the effect of bank
rates regulation on the profitability of commercial banks, and possibly make
recommendations on the degree of regulation required to sustain a viable
banking system.
OBJECTIVE OF STUDY
The study has the following five main objectives:
Analysing the impact of regulated bank rateson the liquidity position of banks
as measured by the Deposit ratio and cash ratio.
Determining the negative effects of bank rates regulation on the overall
performance of banks as measured by Profit Margin, Return on Equity, and
Return on Assets.
To examine the steps bank managers have taken in diversifying their income
earning base to offset the adverse effects of regulated rates on bank
earnings.
Evaluating the steps in which the bank managers have adopted to cushion
the negative effect of bank rates regulation on the liquidity position, profitability
level and the overall performance of banks.
To make recommendations based on the findings, which would help the
policy makers in formulating and implementing monetary policies critical to
the financial system (banking sector).
RESEARCH QUESTIONS
Does the regulation of bank rates have the tendency to reduce the liquidity
position of banks as measured by the depositratio and cash ratio?
Does the regulation of bank rates have a negative effect on the overall
performance of banks as measured by the profit margin, return on equity and
return on assets?
Does the regulation of bank rates induce banks to diversify their income
earning base?
SIGNIFICANCE OF STUDY
The relevance of the study is obvious. To the government as policy makers,
a research of this nature will surely help them to design policies that will meet the
needs and wants of both actual and potential customers and operators of the
banking systemlsector.
To the bank management, the study will expose them to the possible
avenues of diversifying their Income earning base (divestment) as well as helping
them to design programmes that might attract depositors.
To the general public and potential customers, the study will help them realise
the need to patronise banks and support the financial sector which is the pivot or
machinery for economic development.
7 The study will also be useful to any researcher who rniaht want to research
further into the concept or Implications of bank rates regulation.
SCOPE AND LIMITATION OF STUDY
Due to the nature of the study, the research could be limited to only commercial
banks so as to avoid inconsistencies in evaluation.
Ten commercial banks were selected for the study. The study was limited to
the banks within the Lagos city since most banks have their headquarters or
operational sub-headquarters in Lagos.
REFERENCES
Okafor, F.O.; "Implications of Deregulation of Financial system on Financial Intermediation by banks", A paper delivered at the Annual Banking Seminar of the Chartered Institute of Bankers of Nigeria, October 17 - 21, 1994, PP. 5 - 7.
8 CHAPTER TWO -:
REVIEW OF RELATED LITERATURE
2.1. BANKING DEVELOPMENT
Gurley and Shaw (1956), are of the view that banks are usually the first
institutions to be established in the process of economic developmenti. This was
the case in Nigeria as the first commercial bank, African Banking corporation
opened office in 1 89Z2.
Consolidation of the banking sector started with the establishment of the Central
Bankof Nigeria in 1958, although it did not start full operations until July 1959. The
Central Bank of Nigeria Act. 1958, and the BankingAe1969, were enacted to
specify functional and organisational guidelines of banking operations in the
country; the former, setting up the Central Bank as the apex4nancial institution in
Nigeria, and the latter, remaining as the Sole operating banking law and legislation
in the country.
Apart from the surveilance efforts of the CBN, the introduction of treasury bills
and treasury certificates in 1959, and the establishment of the Nigerian Stock
Exchange 1961, helped to laya solid foundation for the basic fiqancial infrastructure
needed to sustain the process of consolidation in the banking sector.
The seed of indigenization prc
experiences of the war devonst~
Nigerians. That spirit was resp
promotion Decree, 1972, popularly cmea me lnalgenlzanon vecree, ~y wnlcn me
government sought increased local participation in the ownership, management
and control of all sectors of the Nigerian economy.
The goal of indigenization in the banking sector was basically to make' the
operations of banks more relevant to the needs of the economy by increasing t i e
local'content of the policy making machinery of the system. The Banking Industry
has gone through progressive and moderate expansion since the mid 1970's..
However, the industry has witnessed the greatest expansion since the mid
eighties.
The central bank of Nigeria (CBN) statistical Bulletin of December 1994 shows
the growth in banks and bank branches in table 2.1.
TABLE 2.1.- GROWTH IN BANKS AND BANK BRANCHES
End of Year
1987
1988
1989
1990
1991
1 992
1993
1994
Source: CBN statistical Bulletin Volume 4, No.6 December, 1994.
Merchant Total Number Commercial
No. of Banks
34
42
47
58
65
65
66
66
No. of Branches
1,483
1,655
1,855
1,939
2,070
2,275
2,484
2,484
ran chef Off ices
1,516
1,701
1,911
1,988
2,154
2,608
2,608
Banks No. of Banks
No. of Branches
16
24 ----.--
34
49
54
54
53
53
33 50
46
56
74
84
116
124
1 24
66
8 1
107
1 19
119
119
119
I 0 The total number of banks in 1994 remains at its previous (1 993) number.
The Monetaiy Authorities did not make any issuance of new banks licenses during
the year to enable the consolidation of the regulatory machinery for the industry.
In a financial post report, Funsho Owoyemi argued that: There is no bet&
incentive to attract capital into an industry than profit. In circumstances of free
movement of capital, investors will shift their resources to those industries where
profits exist, while industries characterised by losses will experience capital flight.
What is happening in the Nigerian Banking Industry today, is typical of this
economic dynamics, so it is purely an economic phenomenon and the trend will
continue as long as profits exist at levels judged to be adequate returns on'
investment3.
In order to maintain stability in earnings, banks have mapped out strategies for
survival. One of such strategies,. is the divestment into fee-based income/
services in an attempt to bid down the negativeeffect of interest rates (deposit and
lending) pegging which discourages financial savings and banks' loans investment.
2.2. THE ROLE OF BANKS IN AN ECONOMIC SYSTEM
It is generally agreed that the financial sector of an economy matters in
, economic development. It assists in the break-away from a depressed economic
performance to an accelerated growth. If the financial sector is depressed and
disturbed, it can intercept and destroy impulses of development.
Lewis (1 970), in his DBvelopment process states that development occurs in.
all directions simultaneously, growth and development runs into bottlenecks if
there is no appropriate balance between sectors. All sectors must expand as
income grows. The financial sector plays the role of an engine of growth and
11 development through the. process of financia! intermediaries-channelling funds
from surplus to deficit units of the economy thus encouraging 2roductive innovation.
8
between real ana rinanclal aeveloprnenrs especially In rerms or me roleoTTinanclaI
intermediary, monetization and capital formation in determining the path and pace
of economic development5.
loth argue strbngly th:
---A- :A&:".- I--.--Ll
They b 3tf nancial intermediaries are the rneansfor creating
credit ancl L I ~ I ISIIIILLII IY I U ~ I ldule funds which enables the borrowing and investing
units to 1
scale df wealtn ana Income, tnelr tinanclal structure usually becomes lncreaslng
' : rich in financial assets, institutions and markets.
diversify their porl.folios. They also believe that as countries rise along the a , , . , .. . a. . . A . .. .
:essful the sector is in building channels for the flow of financial operations,
lcating financial habits and discipline and developing human skillsfor carrying
mmnlnv finanrial n n n r ~ t i n n d
In the view of Hugh patrick (1966), the contribution cf the financial sector
development is a function of the quality and quantity of its services and the
efficiency with which the services are provided. This wmld depend on how
SUCC
incul
out CVI l l,.,lbA I,, IU, lYlUl "pl,LUII"I IU .
Thus, there is a convergence of views that the financial sector of an economy
(and by implication, the banks)does matter significantly in economicdevelopment.
By and large, deposit accounts at banks or similar institufions are the principal
mechanism for transferrinq pavments from one person to another, an important
:isions, reinvesting that
weairn ro prornore socleral rieeas.
- . . means of storing wealth and through lender's credit dec
, I * L ._ . -_- *- - - - ! - I - l - - - A -
12 It is therefore fair to say that the banks have contributed immenselv towards
iciency of the financial system and subsequently economic development
rowth of the nation through the numerous roles (such as financial
rdiqtinn w e m q n n - f i r d -A~t:mfiv+, v ~ l n m \ n1-tm-A .-.-A , - l -~++h~-mm~mL +h- ---A
the effi
and g~ t
htermtulallvl I, I I I ~ I 1ayr;lt IGI I r a I ~ u a u u ~ a u ~ y IVICSJ playcu l u ~ ~ l a u LI 11 u u y ~ I LI la yuuu
management of their asset and liability components7.
2.3. COMMERCIAL BANKING
2.3.1 .S(
Equity capital (or the owner's share ot a bank) is simply the difference between
the Total Assets and Total hbilitieson a bank's balance sheet. Thus, Equity capital
is made upof common stock, surpius, undistributed past profits or retained earning
and a variety of other contingency capital reserves set up from past earningss.
Notably, the surplus of a bank could result from the premium above par at which
the stock is sold when the bank isorganised and also, from the reinvested earnings
that are transferred gradually tosurplus. This is known as paYd in surplus. A bank
also has "earned surplus" wnicn results trorn me retention or earnings. Retained
earnings are first accumulated in a special account from which they are transferred
from time to time to earned surplus.
2.3.2. FUNCTIONS OF BANK CAPITAL
~roiectim. A bank needs capital to
Bank capital is much like capital provided for any business in that, it provides an
incentives and p loperate. In this respect, a bank
is no different f ru~ I I dl IY ULI IW LUI ~ U I ~ L I U I I. TUI IUS invested or re-invested by the
owners earn profits if the business is successful, and lost i f it fails. Thus, capital
encourages competent management while it protects creditorsg.
13 2 . 3 . 3 . t l ~ ~ ~ S U U K L t S U P I-UNLIS / INCOME
Banks have several avenues for sourcing of.funds. The funds could be L
generated by offering services and providing products to their numerous clients,
who inturn pay fees or interest to the bank.
The possiblt: I I ILWW udsed serviceslincome available to banks include:-
Interest bearing deposits, Loans and Securities.Thus, it cculd be said that, the
interest income of banks come from the interest recelpts or) Loans, Balances at
depository institutions, Federal funds sold and on sec~rities.~. Whereas the non-
interest (Fee) income I services comprises of:
- Credit card fees
- Electronic funds transfers
- Trust department operation/Trust income
- Deposit Service charges
- Correspondent banking
- Personal financial 3lanninq
>
- un-aalance sneer acr~vtr~esl~, etc.
2.3 A R A M K A S ~ F T A r u n I I A R I I IW MANAGFMFMT
to ensure that its level and rlsklness are compatlbie wltn tne ris~irerurn oDjecrlves
of the institution12.
14 Aggressive management of asset and liability portfolios dependson the degree
of certainty s earned on assets and paid
on liabilities. r o apply ww management (a strategy employed to maximlse -b
interest margin over the interest rate cycle -which involves adjusting the variable
and fixed rate components in linewith the phase of the Interest ratecycle toachieve
maximum profitability), banks must be able to predict flows and rates.
Banks must accurately predict levels of fixed rate funds that will be available. To
maximise interest maTgin, banks must,also be able to time movement In Interest
rates.
.e cycle is sufficiently long to accomplish the - .. . . . . . . .
Also, aggressive management of assets and liabilities requires the assurance
that the duration of the interest rat
required chanaes that. if the duration of the interest rate cvcle is not lona enouah
for a bar
may be poslrlve orneganve), rne DanK coulaexperlence a alsruprlon In aajusrmenrs
to obtain a planned gap arld declining interest rnargin13.
Thus, it has been identified that, thetwo major factors thatmakesdifficult and
very
i k to change its asset and liability structure and therefore gap size (which .,. I . 1.. ' I I . .. . I . A
vola
Reeu ma1 \ I =I r u), UCIII I c s a s s a t r I I ~ T I ~ ~ C I IICI 11 11 ~ t l LCI I I I U ~ C U iu U P ~ L I ~ut: 11 IT;
allocation offunds amona investmentalternatives. Apolled to commercial bankina,
the term refers to thedistribution offunds among cash, securrty investments, loans
ana orner assets. apeclatlsea areas or asset rnanagernenr lncluae ~ ~ q u ~ o ~ t y ,
15 portfolio and loan managemenll4.
make loans and investments) that promise the highest rateof return for the
The obvious soiution to the funds-allocation ~roblem is to orlrchase those -.\
assets (
level of rlsK wal a Dams rnanagemenr 1s preparea ro assume.
In as much as the managementoffunds in commercial banking is commendable,
it has been certified that, it is being complicated by several factors. -C 1
These include:-
(1) Prudence and Transaction Demand
(2) Legal consideration
(3) Liquidity consideration
14) Need to earn sufficient incnmeI5.
the activities involved in supplementing liquidity needs by activity seeking borrow - "
funds when needed.
According to Nnwakwo (199'Il. liabilitv manaaement concentrates on the
liability side of
basic thrust to purcnase Tunas oy ~ s s u ~ n g llamllrles In rne money rnarKers ro rneer
increased loan demand and other needs for liquidityi6.
'the balance sheet. It represents a distinct break with the past in its
16 Summarily, it coula oe nored that a kev to successful manaaement of financial
institutic Ins (banks) is earning a return on assets that exceeds the cost to the firm
r:.-.-4L.^^^ ---- 4- :-^I..A!--LL-:- z! ---L n.- - - 11- - P - - -. I - - I -4 of acqui~ 1 1 iy L I IUX a h s e t s , I ~ I L I U U I I I ~ lrlelr r l n a r l c l i i g cost. ancernerlnancrai assers
dominate the balance sheet of financial institutions (banks), the difference between
net interest rnargin,which is the focus
or assewamry rnanagemenr.
returns and costs can be measured by the
f MANAGEMENT
Liauidltv inanaaement is detlned as the allocation of liauid resources over time
for p
undc
implk3 L I IC ~ I U V I ~ I U I I UI I C ~ V U I d l L I I I I F ~ W I ICI I L I I ~ Y ale ~ l t ~ a u e u a r l u L I I ~ G U ~ I L I ~ I
of various financial risks especially that of insolvency.
w
~ayrnent of obligations due and for various investments that management
?rtakes to maxirnise shareholder wealthff. Liquidity management simply
;,.... +h.. ...a,,:-:-m A: ---A, -4 4:-..- ..*LA.-. 4L.-.. ---A-A --A 4 L - ---&.-I
The central problem in banking lies in the effective management of the conflict
between liquidity and profitability.
Ebong (1983) argued that the objective of maintaining sufficient liquidity is in
conflict with another prime bank objective, the objective of naximising profit.
He highlighted that in a bid to maintain liquidity requirements, bank hold sterile
or low income earning assets which reduces the general profitability of banks:
Converselv. if a bank Dursues Drorlt. 11 Invests In loans ana omer rlsuv Investments a .
but hold less of the riskless assets or float liquidity require~nents~~.
~ h u s , it could be seen that, the more ~lquld a bank IS, tne iower are ~ t s return on
equity and return on assets, all other things being equal. The implication is that,
17 large holdings of cash assets decrease profits because of t i e opportunity loss of
interest income. . t
In consideration of the investment portfolio, short-term securities carry lower
would be high because the default risk or interest rate risk is substantial and the
loan administration expense is high. Thus, loans that can readily be sold usually
^I^ -L...S L--- ^r^.l:L^ L- ... - 11 1 .--...- -------I:--- -- -. .---- 1---1
instr
lmpr
,uments which carry minimal spread. Amortised loans in contrast, may,
.eve liquidity eventhough they are frequently long term because the periodic
nents increase near-term cash flow.
capital have greater access to purchase funds. They also pay lower interest rates
and generally report lower returns in the short run. Promised yields on loans and
sec~~rities increase with the nerceived defa~~lt risk nf the r~nderlvina Issl~er.
Those banks that accuire low-default risk assets forgo the risk premium that
could be earned. Similarly, bankswith greaterequityfinancing exhibit lowerequity
rnr ~ltinli~rcand t h ~ IC n ~ n e r s t ~ lnwpr r ~ t ~ lrns nn en1 litv even with iriantiknl retl Irn nn , , ,U , . '~"Y,YU, ," . . I U " .JVI.VIU.Y I " . . - , I -L. . . I .V-. , -.,I..,, Y . V . . .....a I-.- .... --. .-.-.... -.. assets Thew hanks can horrnw funds more cheanlv becmse a areater ort ti on
of
18 immediatelyavailable funds are available at the lowest cost to meet the customers
need for liquidity and the demand to optimise interest earnings.
4
Also, the need for a rnore eRcient profit management is paramount in the
banking system. It determines the strength of an institution in the industry. This
is so in considering the impact of profit management on return on assets,
shareholders funds, liquicfity, taxation, dividend policy, Investment opportunities
etc. *-
Profit management is also considered in the area of interest income. Policies
on excess liquidity, credit and interest rate ceilings have mace banks veering from
their traditional source of income such as loans and advances into fee earning
outlets. Other strategies for a profit management include adequate cost control
system. That Is, maintaining low ovarhead costs as possible as could be done.
Thus, according to Olisanbu (1991) the paradox of profitability versus liquidity
arise from the banks' effort to cope with th
cash and the liquidity of earning assetsL-. nt: IUI LI 191 WLJVI=SL~:U LI I ~ L LI I~:~VIULIUI I
e two problems namely: the sterility of
20 u* :a ,.4h*...-.. .-*.~..L.A +hrn+*h~ -*I. .+:-".
to this problem is the maintenance of :. . enough cash assets and near cash assets
. to meet potential cash demands. Surplus cash invested to generate income. In
this way, the banks maintain both adequate liquidity and earnings. 2.4. BANK I INTEREST RATES
2.4.1. CONCE?TUA~ ISSUES-!N INTEREST RATES
According to Nishimura (1 974) rates of Interest are the prices of funds lent and
borrowed in the financial rnarket in the wider sense of the term. In the case of the
banks, interest are paid to customers for money deposited and also received
19 interest on money they lend to their customersz1.
From the inception of banking services in Nigeria, the interest rates have been ..b
determined periodically either through regulations by the regulatory bodies and
government or determined by the market forces of demand and supply of money.
At present, the banWinterest rates are fixed for both deposts and lending by the
banks and other financial institutions. Interest rates could be said to include
Deposit Interest-rate, tiiscount rate, Rediscount rates, money rate, legal. *-
rate of interest, Interest yields on s&curities, interest rates on ~overnmeni
securities, lnterest rates on other bonds and Debentures, call loan rates.
International Monetary Fund (1983) Surnrnarised underthree broad asoects the
basic functions of Interest rates i
takes decision as to whether t h ~ , ,..,,., ,,,,,.., ,...,,., ,,., ,. ,, ,, ,,,.,,,..,.
First, lnterest rates, as return on financial assets serve as incentive to savers,
making them defer present consumption to a future date. The relevant interest
rates in this case are the deposit rates corrected for price inflation (or more
precisely expected inflation rate). The interest rates here affect the availability of
, saving, and to the extent that deposit rate vary depending on the maturity of the F. . . 4 -, .. . " . I I, . 1 I I
trnanclal assets. I ney also lnrluence rne alrocarlon OT currenr savlng among me,
assets.
Second, interest rates; being a component of cost of cap'tal affect the demand
for and allocation of loanable funds. The applicable rate of interest in this case is
the bank lending rates, the changes which affect the cost of capital which
influences investors' willingness to invest in machinery and equipment (real
20 investment). In this way, the level of interest (lending) rate could influence growth
in financial instrument, output and employment.
4
Third, the domestic interest rate, in conjunction with the rate of return on foreign
financial assets, expected change in exchange rate, and expected inflation rate
determine the allocation of accumulated saving among domestic financial assets,
foreign assets, and goods that are hedged against inflatibn. The speculative
movement of funds intolcut of domesticlforeign assets depends on the relative
levels of interest ratesznd whichever is appropriate among exchange rate, inflation
rate and foreign interest ratesz2.
These broad roles of inlerest rates emphasize thelrsignificance in the structure
of basic prices and indicate the need for study about their determinants.
In the pre-SAP era, that is before the deregulation, the level of interest rates in
Nigeria were fixed and administratively determined as were exchange rates and
wages. The most important considerations which dominated Interest rate policy
at that time were the impact of interest rate changes on government expenditure
and the need to promote investment and growth in the private sector. lnorder to
keep the interest payment on public sector borrowing as lo\v as possible, interest
rates on government debt instruments were then fixed at low levels. Also, under
, a system of direct imposition of credit ceiling on banks and in the bid to channel
domestic credit to prioritized sector, discriminatory lending rates were fixed for
loans and advances granted by banks to different sectors reflecting the authorities
preferences. The attenda'nt problems which becomes unmanageable because of.
the deliberate policy to keep the rates below market determined rates contributed
largely to the factors that made deregulation a compelling etrategy to adopt.
- the determination of interest rates were made
Hence, interest rates were derequlated from the period of 1987 to 1993, that is,
through the market forces of
aemana rurana supply or money, rlnally, In I Y Y ~ , the interest rates deregulation
policy was reviewed considering the prohibitive Interest rates that prevailed in the
money market which had a negative effect on the economy. Thus, it was found
necessary by the Government and theRegu1atot-y bodies to re'ntroduce regulation
in +ha ar&a nf lntarnct mtac ~ n r l fnrninn nvrhw-irrn Thl~c- intarnct ratnc rnmrcr
Years
, -71
22 INTEREST RATES (DEP0SITANDLENDING)STRUCTURE IN NIGERIA FROM 1970 -1994
Lendin Rates F
- - - --
1989
1990
4991
1992
1993
1994
Source: Central Bank of Nigeria Statistical Bulletin Vol. 4, No.2 (December, 1994)
- -
9.25
14.90
13.40
18.90
19.60
15.71
20.80
23.60
15.00
9.50
75.30
12.1C
21.6C
20.50
17.90
22.30
23.263
15.00
9.75
15.10
13.70
21.40
22.10
20.10
22.30
23.99
15.00
10.00
15.80
14.30
21.20
23.00
m.10
20.50
28.02
15.00
9.50
14.00
14.50
16.40
18.80
14 29
16 10
16.66
13 51
10.50
17.50
16.50
26.80
25.50
20.01
29.80
36.09
21.00
12.00
19.20
17.60
24.60
27.70
20.80
31.20
18.32
20.00
2.4.3. INTEREST RATES (DEPOSIT AND LENDING RATES)
DETERMINATION
As earlier stated, interest rates are both the prices of credit and earning rates
on financial assets. One person's liability is another person's asset. Interest rates
as prices of credit are equivalent to interest rates as earning rates - it just depends
on whether one is borrowing or lending. Therefore it could be said that, money
deposited in a bank savings account attracts interest to the depositorwhile money
loaned out by banks k a n investment to the bank which equally attracts interest
receipts to the bank.
2.4.3.1. LENDING RATES
The determination of interest rates (lending rates) could be based on certain
factors such as:
(1) The supply of and demand for loanable funds.
(2) The changes in the general level of prices for goods and services, in flation or deflation23.
(1) THE SUPPLY OF AND DEMAND FOR LOANABLE FUNDS
Loanable funds are the Naira available for purchases of new financial assets at
a given time, They (Loanable funds) are subject to the laws of supply and demand
in that, if large amount of naira are available for investment, the interest rate will be
low and vice versa.
The supply of loanable funds consists of the savings of individual and business
firms and changes in the amount of money in the economy. Savings is the
difference between current income and current expenses including taxes and it's
24 usually the major source of loanable funds. Thus, money supply could be
increased by the Federal government by printing mot% currency and also increased
through the expansion of checking accounts in the banking system.
The demand for Ioanable funds comes primarily from those persons who wish
to borrow money to finance investment, That Is tosay, Itisdetermined by the credit
needs of all individual, businesses, government units, and foreign participants
relatives to various rates of interest. * -
here fore an increase in the demand for loanable funds without a corresponding
increase in the supply causes interest rates to rise until supply and demand are in
balance. Hence, "The general level of interest rates at anytime is primarily
determined by individual's desires for current expenditure relative to thelr income
(which determines savings) and the amountof investment opportunities available"24.
EXHIBIT 2.1.
Risk - free
rate Yo
ILLUSTRATION
funds (Borrower)
Exhibit 2.1 illustrates that, thedemand for loanable funds (DF) slopes downward
to the right, indicating that the borrowers demand greater amounts of loanable
funds at lower interest rates. The supply of loanable funds (SF) slopes upward to
the right indicating that more funds will be forthcoming from lenders at higher
interest rates. Thus, the intersection of the two curves determines the equilibrium
interest rate and the volume of loans.
(2) INFLATION
The expectation of future inflation alters the level of interest rates by changing
the supply of and demand for loanablefunds. When prices are expected to rise in
the future, there is an incentive ta purchase goods and services now rather than
later (at higher prices ). The effect Is reductionln savingsand increased investment'
in productive assets.
Therefore, people owning existing financial assets sell them to get money to
purchase physical 2 ssets, thereby pushing down the prices of financial assets
while pushing up (r(2ising) the rates of return (interest rates) paid on financial
assets. Lenders require higher interest rates because the naira (money) they will
receive in the future in repayment of the debt will have less purchasing power due
to inflation. The result is that interest rates are higher when high rates of inflation
are expected than \n, hen low rates of Inflation are anticipated.
Thus, in cognizance of the "lrvin Fishers" theory I equation, the observed
(nominal) interest rz.te is considered to be the sum of two factors-the real rate of
interest and the expected rate of Inflation. That is":
i = r + p e
where i = observed (nominal) market interest rate
r = real inter& rate
pe = expected inflation premium2%
Note: The real Interest rate is determined by the productivity of
26 investment in the economy and the preferences of individuals regarding present
consumption versu5 future consumption.
2.4.3.2. DEPOSlT RATES (EARNING RATES)
Deposits are classified into Demand, Savings and Time which normally
constitute the dominant liability item in the Balance Sheet of banks. Apart from the
importance derived from their proportionate share of total liabilities, deposits are
important because they are the principal source of "expenditure" for banks and their
relative structure more than any other thing determines the volume and natures
of commercial banks lending26.
Thus, the pricing of deposit accounts is more difficult to analyse, in that, many
different assumption may be employed regarding the construction of revenue and
cost statements. The general Equation that describes a deposit relationship is:
Profit = Earnings on D~;';sit Balance - Transaction cost -Fixed maintenance cost
where: Earning; on deposit balance = Rate x Average Balance
Transaction cost = Variable cost x Volume.
Banks can recover cost through the money they earn from using general
deposits in funding earnings assets or from charging service fee. Notably, the
general equation ignore cost recovery from service fees.
Hence, the alternative available to banks for determining earning rate on
deposits are:
(I) Money Market Rates:
Since the net yie d on earning ;assets exceeds money market rates, the values
27 of deposit funds will tend to be under stated. These rates are also highlyvolalile.
(2) Cost-of-fund rate:-
This rate reflects what the bank would pay for alternative sources of funds If
deposltswere not available. In periods of rising rates, the values of deposits would
be understated whil? being overstated in periods of declining rates.
(3) Return on Bank Portfolio:-
This rate is the nef current earnings after 'tax divided by the average earning
assets. It reflects the past value of sources of funds, not the current values.
(4) Weiqhted average of rates on expected portfolio mix:
The rate Is based on estimates and is subject to frequent changes if portfolio
rates are volatile27.
Summarily, since the choice of an appropriate earnings rate poses difficulty, it
should be based on the conditions that best reflect the bank portfolio conditions
over the period in which the earnings rate will be in effect.
2.4.4. DEREGULATION AND REGULATION OF INTEREST RATE
Deregulation of tt- e banking industry involvesthe systematic removal of regulatory
controls, structures and operational guidelines which may be considered inhibitive
of orderly growth, c~mpetition and efficient allocation of resources in the banking
industry. The Nigerian banking industry experienced the most intensive regulations
between 1958 and 1986. The regulatory framework was supported by major
legislations such as the Central Bank of Nigeria Act of 1958, Companies Act of
1968 and the Banking Act 7969as well as thevigorous applicationof the Exchange
28 Control Act of 1962:". While the regulations ensure the viability and stability of the
banking industry, ,!hey tended, through their prolonged use, to reduce the
competitiveness and efficiency of the industry. Thus, the basic elements of
deregulation in the banking industry since 1987 have been the deregulation of
interest rates, liberslisation of foreign exchange transactions and international
trade generally, the introduction of structural and institutional changes and some
simplification of the monetary control process. Thus, this section will dwell on the
regulation and deregulation of interest rates.
DEREGULATION OF INTEREST RATES
Deregulation of Interest rate started August 1987. Prior to this period, interest
rate was administratively determined. It was government policy to keep interest
rate as low as possible to encourage public borrowing to promote economic
growth. With the introduction of Structural Adjustment Programme (SAP), it
became imperative that interest rate be allowed to be responsive to the market
forcesof demand and supply. As at July 1987, interest rate was fixed on an average
of 12.6%. ByAugu'jt '87 it rose to 17.6%. The upsurge In lending rate stimulated
savings rates as well, which rose from 11 % to 12.0% for savings account and from
13.3% to 14.7%for Time deposits. At the end of December.87 lending rate moved
to 18.5% while sayings and Time deposit rates moved to 14.0% and 15.0%,
respectively.
It was observed that, 1988 was a year of monetary ease. Liquidity ratio was
reduce to 27.5% and minimum rediscount rate from 15.0% to 12.7%. 1988
witnessed excessb~e liquidity in the economy which led to excessive demand
power, hence inflationary pressure. The monetary polices adopted to curb
29 inflationary pressure in I989 included:
(1) Credit squeeze
(b) Minimum Rediscount rate raised to 13.25% to discouraged borrowing.(c)
Cash reserve ratio (raised by 7.0% across the board).
(d) Liquidity ratir:, raised from 27.5% to 30% for commercial banks and from
20% to 22.5% for merchant banks.
(e) Abolition of off-shore guarantee . .
(f) Payment of Interest on current Deposit Account
(g) Transfer of F02deral and Sate Government and their Agencies balances to
Central Bank of Nigeria.
The implementation of the above policies brought about serious liquidity
squeeze in'the economy hence, increase in Interest rates. In 1989, the measures
stimulated a rise in the interest rate from 17.7% to 21.2%. As at January '89, Fixed
Deposit rate went up to 17.25% and savings remained at 12%. To close the wide
gap between thelerding and savings rates, theauthoritycarneoutwith a policy that
the difference between prime lending rate and Saving I Deposit rate should not be
more than 4.Q% . Also, Treasury Bills Auction market was introduced for
discounting of Bills. The discount rate for Bill and Securities moved from 12.75%
to 17.5%. This reviewled to upward movement in all levels of interest rates
including lending rates.
30 The rapid upward movement in the interest rates was not favourable to
productlon and growth. Although the deposit rate was high enough to promote
rising flow of savings, the high lending rate hlndered the usage of the resources
rnobilised. In an attempt to economise on theresources that wasgetting increasingly
expensive, many firms especially the manufacturers abstained from borrowing
from banks while those who borrowed made loses or profit margins that could not
support production iiitiatives. Thus, long term financial requirement for expansion
was largely met thrmgh floatation of new equity and debentures in the capital
market. Much of bank lending went to distributive trade to the neglect of capital
development like investment in equipment and machinery. Despite the high
interest rates, inflat onary pressure surged on even in times of liquidity squeeze.
The inflationary rate was put at 50.0% In 1989 ending.
During 1990, all levels of interest ratesexceeded their 1987 level substantially.
Lending rate went :is high as 26.7% average, fixed deposit rate and savings rate
went to an average of 21.3% and 18.7% compared with 1989 rates of 220.3%,
17.25% and 12.0%. This period saw banks out bidding each other in an attempt to
ware deposits, herice the high rate for fixed deposit rate and savings, thereby
increasing comme-cia1 banks deposit liabilities. The smaller banks and the many
insolvent ones we-e always ready to mark up their Interest rate on deposits to
attract funds for settlement of maturing financial obligations. They also bid up the
interbank rate the-eby raising industrial cost of funds. The result was the high
lending rate which was to cover cost of deposits. Thus, the oligopolistic structure,
that is, supplier's market nature determined the interest rate rather than the market
forces. At the end of 1990, some improvements were recorded In the economy.
3 1
This was in respclnse to some measures adopted to boost the economy. As a
booster to manufacturing sector "Duty Draw back scheme" was introduced in
1990 with allocation of Nl00 million. Inflationary rate which was as high as 50% in
1989 was reduced to 16% by December 1990. ltwas further projected that by 1992,
it would be below 8%. The restrictive monetary and Fiscal policiescoupled with
stable exchange rate led to the Gross Domestic Product growth rate of 5.2% with
increased capacity utilization. Index of Agricultural performance rose by 7.2%
against 6.1 % in 198'3, while index of manufacturing improved marginally at a rate
of 0.8% to 7.16% ovar 1989, unemployment declined from 4.0% to 3.1 % between
December 1989 ard June 1990, balance of payment increased considerably
following improvem3nt in oil exports. The prudential Guideline of 1990 required
banks to make adequate provision for bad debt.
The improved report in 1990 was a combination of the various restrictive credit
and fiscal policies adopted in 1989. There was acceleration of money growth
whichresulted in c~rnulative increase in narrow money (MI) by 18.8% against
growth target of 13% for 'I 990. The broad measure (M2) recorded a significant
growth of 19.8% against 4.5% in 1989. This was an indication that the economy
was still excessively liquid which led to the introduction of stabilisation securities
in 1990.
In 1991, there were changes in the monetary policy which was a shift from direct
to indirect rnonetaw control with emphasis on reserve ratio, liquidity ratio, open
market operation and discount rate. Cash ratiowas reduced from 5% to 3.0%
which was based on all deposit liabilities rather than demand deposit alone.
Liquidity ratiowas maintained at 30.0% for commercial banks of which 20.0% was
32 in Treasury Bill hold ng. Ceilings on interest rate and on lending were removed.
Interest rate continued at Central Bank of Nigeria prime rate with a spread of 4.0%
subject to maximum of 21.0%. The difference between lending and savings rates
were not more than 5%29.
In the both years (1 992 and 1993), there was increased demand for money
which led to high interest rates. Interest rates ranges between 20.08% to 28.02%
for deposits, 16.1 0% to 16.66% for savings and 29.8% to 36.09% for lending. The
high interestrates w&a disincentive to the manufacturers. They resorted to the'
capital market for sourcing of long term funds. The economy was lopesided, there
was increased growth in the distributive trade while production sector was
experiencing retarded growth. The rate of inflation was high. The government in
the vein to revamp the economy and to reduce the high inflationary rate opted for
re-regulation of interast rates in 1994. The interest rates were pegged at 21 .O% for
lending and 15.0% for depositlsavings. See table 2.2 for selected interest rates
(Deposit and lending rates) during regulation and deregulation periods.
REGULATION OF INTEREST RATES
The enactment cf the Nigerian Banking Ordinance in 1952 introduced some
.forms of regulations into the Nigerian Banking scene. But the period 1958-1 986 is
being described as the r6girne of intensive banking regulation which some Acts.
such as Central Bank of Nigeria Act of 1958, Companies Act of 1968, Banking Act
of 1969 and the Exct- ange Control Act of I962 were enacted to regulate the banking
activities and servicss in Nigeria.
The Banking Act 3f 1969 generally provided for the regulation and control of the
monetary and financial system. Specifically, it made'provisionsfor the granting of
33 licenses to banks wiile imposing restrictions on the activities of licensed banks.
The Act also made provision for the Central Bank of Nigeria to exercise its powers
in maintaining monetary and financial stability in the economy, the stipulation of
liquidity and capital adequacy requirements, certain categories of investments
banks cannot undertake, as well as limit on interest rates and bank lending to the
private sector.
The direct regulation of interest ratesand stabilization securities were the tools
used by the.Central~2nk of Nigeria inthe pre-Structural Adjustment Programme
(pre-SAP) era to cal for special deposits from banks which was found to be a useful
supplement to cash and liquidity ratios. Up to July 1987, Interest rates were
determined administratively by fixing the ranges within which both the deposit and
lending rates were '.o be determined by banks. While, in the post-SAP era "1 987
to the present, that i s era cTderegulation ofthe banking system, interest rateswere
deregulated. The irerest rates were allowed to be determined by the market forces
of demand for and supply of money up till 1993 ending. This period "1 987 to 1993"
witnessed galloping increases in the interest rates. Interest charged by banks on
loanable funds were high which was in favour of the distributive trades while
impacting a negati~re effect on the productive sector.The manufacturers resorted
to sourcing of long term funds in the capital market due to the high cost of funds
in the money market (Banking sector). Thus, there was boom in the capital market.
Towards the end of 1993, the interest rates were skyrocketing, leading to high
price level and high inflationary rate. The Government in an effort to stabilise the
economy decided to re-introduce regulation in the area of interest rates, and foreign
exchange market in the 1994 National Budget.The implementation of the measures
34 (Interest rates and foreign exchange regulation) was immediate and effective.
Thus, the banking sector Is once again operating under a regulated system
(interest rates regulation) tagged by the Government and regulatory authorities as
"Guided dereguktion":
Hence, it is pertinent to note that the most popular tool of regulating the lending
activities of banks prior to SAP (and even now) was the specification of ceilings on
their credit expans on and indication of sectorial allocation of the permissible *-
quantum ofmuedit.
THE IIVPLICATIONS OF THE C.B.N'S 1994 INTEREST RATE
POLIC" ON BANKING OPERATIONS
The Monetary Policy Circular (MPC) No 28forfiscall994 on Interest rate policy
departed from the policy of interest rate deregulation which required that bank's
deposit and lending rate be determined by the forces of supply of and demand for
funds. That is to say, the era of fixed interest rate regime was revisited.
The C.B.N. decreed that bank's lending rates should with immediate effect, not
exceed 21% per amum, maintain SavingslDeposit rate of 12.0 to 15.0% per
annum.
The implication of the policy was that, the banks are only allowed a maximum
spread of four percent (4.0%) over their ~verage cost of funds (including
administrative cost). ~verage cost here refers to "heighted average". This means
that, where a bank's weighted average cost of funds ("WACOF"- including
administrative cost'], for instance, is 15%, such a bank's maximum lending rate is
pegged at 19% per annum (that is, 4% plus 15%). On the other hand, where a
35 bank's WACOF is 49%, such a bank can only add a maximum spread of two
percent (2.0%) and must lend at 21 % per annum. ~ a c h bank's maximum lending
rate is determined by its weighted average cost of fund.
2.4.6 INTEREST RATE RISK MANAGEMENT
Interest rate risk refers to the volatilily in net interest income and the value ofthe
bank attributable to changes in the level of interest rates. A bank that takes
substantial risk will s3e its net interest margin and market value of stock holder's
equity rare widely wh& rates increases or decreases. A bank that assumes little
interest rate riskwill observe little change in its performances due to rate changes.
Notably, unexpected changes in interest;.. rates significantly alters a bank's
profitability and market value of equity. Interest rate riskencompasses thisvolatility.
Depending on the cash flow characteristics of a bank's assets and liabilities,
interest changes ma., raise or lower net interest Income and market value of asset
and liabilities.
For example, consider a bank that makes 30 years fixed rate mortgage loans
and finances the loans primarily with 3-months to I-year deposits. The initial
spread between the yields on the mortgages and cost of deposits presumably
reflects both cost of doing business and the expected change in rates over the
investment horizon. If all interest rates increase above that expected, interest
expense on deposits will rise more than interest income on assets such that net
interest income and the value of the firm decline. If interest rates fall bellow that
expected, the difference between interest income and interest expense will widen
and the value of the firm will increase.31
36
In an effort to manage interest rate risk, banks must establish specific financial
goalsfor net interest income and the market value af stock holder'equity, measure
its risk exposure, ard formulate strategies to attain the goals. .
I Gurley, J. G a7d Shaw, E.S, "Financial Intermediaries and the Saving-
Investment process", Journal of Finance, May 1956, p.22
2. Adekanye, Femi, "The Nigeria Banking Handbook", Graham Burn, 1984, p.
3. Oweyemi, F., Financial Post Revlew, Vo1.3, No. 12, April 13, 1991, p.5.
4. Lewis, W.A., 3 e Development process, New Yark, 1970, p.
5. Gurley, J. G and Shaw, E. S., Op. Cit., p.28
6. Hugh, R., "Financial Development and EconomicGrowth in underdeveloped
ccuntries", Economic Development and Cultural change, No. .
7. Ahmed, Abduthadir,"The role of Banks in Achieving a self-reliant Economy",
C.B.N Bullion, Vo1.13, No.1, January I March 1989, p.2
8. Kamerschen, David R., "Commercial Banking", Money and Banking,
10th ed., (cincinnati, ohio: south western publishing company),
9. Ibid., p. 108.
10. Campbell et.21, Money, Banking and Monetary policy. Chicago, the Dryden
Press, 1988, pp. 152 and 163.
1 1. Gardner et.al., Managing financial institutions. An Asset 1 Liability Approach,
37 2nd ed, Chicago. Dryden Press, 1991, pp.301-305.
12. Ibid,p.13.
13. Johnson, F.P. and Johnson, R.D., Commercial Bank Management, - Chicago, Dryden Press, 1985, p.21
14. Reed eta!, Commercial Banking, Prentice Hall Inc., New Jersey, 1976, P.
15. Nwankwo, G.o. Bank Management Princilples and Practice, Lagos,
Malthouse press Ctd. 1991, p. 33. *-
16. Ibid, p. 39.
17. Gallingeret. al., Liquidity Analysisand Management, 2nd ed., Califonia New
York, Addison Wesley Publishing Company, 1991, p. 3.
18. Ebong, I.E., hlanagemen of Nigerla Banks- Constraints and Prospects,
Bl~llion, vol. 8, No. 4,1983, P.20.
19. ~ o c k , T.w., Eiank Management, 2nd ed. Orlando Florida, The Dryden
Press, 1988, pp.485-6.
20. Olisanbu, Errmanuel S.O., "Policy options and strategies for survival :
Liquidity and Profitability Management, "First Bank
Quarterly Review, December, 1991, pp. 2-5.
21. Nishimuras, S. Money and Banking in Japan, London, Macmillan Press Ltd.
22. Interest Rate policies in Developing countries" lnterrnational Monetary Fi~nd Occasional paper, No. 22, October 1993, Washington DC.
23. Schall et. al. Introduction to Financial Management, 4th ed., New york, VcGraw-Hill Book Cpmpany, 1986, p. 29.
24. Ibid. p. 30.
25. lbld.p.31.
- 26. Ojo, AdeT., and Adewunmi, Wole, Banking and Finance in Nigeria, Linslade-
United Kingdom, Greham Burn, 1982,p. 66.
27. Johnson, F.P. and Johnson, R.D. Op-cit, P. 457.
28. Ojo, M. 0, "Deregulation in the Nigeria Banking Industry"
A Review and Appraisal", C.B.N, Economic and Finance Review, .29 No. 1, March lgg'l, p. 1.
29. Oresotu, F.O. "Interest rates behavlour since deregutation" C.B.N. Bullion,
Vol. 15, No 1, JanuarytMarch 1991 ,p. 45-6,
30. Idem, Interest rate behaviour under a pragramrne of financila Reform: The
Nigeriz n case", C.B.N. Economlc and Financial Review, Vol. 30, No. 2, June 1992.
31. Koch, T.W. op.cit, p. 248.
39 CHAPTER THREE
3.0 - RESEARCH DESIGN AND METHODOLOGY
The study was based on data collected through Questinnaire, Interviews and
Desk research. Both primawand secondary data were collected. All data collected
were subjected to a ialysis for purposes of meaningful conclusion on the objective
of the study. 4. .
3.2 DATAI!NFOF!MATION BASE:
SOURCES OF DATA:
PRIMARY SOURCE OF DATA: Primary data for the study were collected1
gathered through Research questions, questionnaire, interviews. These were
administered to choosen sample of respondents ( the Bank Managers)
SECONDARY SOIIRCS OF DATA: Secondary data were obtained from Desk-
research, Chartered Institute of Bankers of Nigeria Seminar paper; Economic,
Business and Finawe Magazines and Journals, Newspapers, Reports, Texts and
Publications. Extracts from C.B.N. Annual Reports, Bullions, Statistical Bulletins
and NDlC Annual Reports, Commercial Bank's Annual Reports and Nigerian
Stock Exchange Facts Book.
TYPES OF DATA a
Two types of data were collected: Primary and Secondary data.
Primary Data -Primary data were obtained through interviews and questlannaire
administered by the reseacher to the Bank Managers.
The data obtained included:
40 (i) the "Bank managers" opinion on the monetary policy of regulating interest
rates.
(ii) The effect tha interest rates regulation has on the banking operation.
(iii) The bases fclr determination of interest rates (Deposit and lending rates).
(iv) The fees yielding serviceslproducts offered by the banks.
(v) The steps taken by the Bank managers 20 cushion the negative effect of
interest rates regulation on liquidity position, profitability level and overall
performance 01Jhe banks.
(vi) The durrent banking malpractic& with regard to deposit and lending rates.
Sec0ndarydata:These were data obtained from secondary sources. The
secondary data were derived from desk-research. They were mainly from
Reviewed Publications, Annual Reports, which the data included:
Published Frofit and Loss Accounts and Balance Sheet Statements of commercial hanks as the source while data extracted included:
Specified Assets - Liquid Assets and Cash
Deposit liabil'ties
Total investments
Classified Income Statement:
(a) Gross Zarnings
(b) Profit before tax
(c) Net prcfit after tax
(d) Total Assets
(e) Sharet older's Equity
4 1
3.3. POPULATION AND SAMPLE
The management personnel at the Headquarters of the commercial banks in - Nigeria constitutec the population of the study. Ten commercial banks were
selected and a total 3f thirty (30) Managers mostly heads of the various departments
participated in the study by responding to the questionnaire and interview.
3.4 RESEARCH INSTRUMENT
Interviews:
In the course of thisresearch, the researcher had series of interviews with the
Bank ~anagers. The researcher adopted unstructured research questions to
enable respondent.; express their views unhindered.
QUESTIONNAIRE:
The questionnai-es were specifically administered to the Bank Managers. The
return rate was pcor. Out of a total of 70 questionnaires distributed, only 30
respondents completed and returned their instrument. Out of the 30 respondents,
22 were seasoned managers while the remaining 8 were the new generation
managers. The questionnaire were in the form of:
(i) Open-ended questions: Where the respondent expressed hislher own
words without any choice constraint.
(ii) Multiple-choice questions: options were made to the respondent from which
they choose one that best expressed their opinion. The merit of this is
choice flexibility.
(iii) Dichotomous questions: Which constrained the respondents to choose
either of the alternatives "YES/NO1'. This had the advantage of easy coding and
editing for the rese acher.
42
3.5.' METHOD OF DATA PROCESSING AND TOOLS OF ANALYSIS
Since the perioj of analysis ranges from the year 1980 to 1993, Deposit and
cash ratios of commercial banks were extracted from the CBN statistical bulletins 5
fortest of liquidity position, whereas for test of profitability level only ten commercial
bankswhose Annual Reports wereavailable forthe periods considered were used.
For the procesing of the data collected, both Descriptive and Analytical tools
were used for the malysis.
The Descriptive tool include Tables, Charts, CBN and Commercial banks'
Annual ~ e p o r t S~mmary while the percentages and ratios were used as the
Analytical tools to' answer the research questions posed.
CHAPTER FOUR
DATA ANALYSIS AND FINDINGS
4.1. PRESENTATION OF DATA:
In this chapter, the reseacher analyses the data collected from secondary
sources such as in3ividual banks Annual Reports, CBN Statistical Bulletins, and
the Nigerian Stock Exchange Fact Books. All computations and evaluations are
based on simple aversges, percentages and ratios. The year 1980 - 1986 was the
period whereby Interest rates were regulated, while the year 1987 -7993 indicates
the period of Interest rates deregulation. Thus, comparison are made between the
two periods in the analysis.
4.1.1. BANKS' SPECIFIED ASSETS:
The specified bank assets which are considered most important for the study,
include Liquid Asscts and Cash. The volume of these assets has a strong bearing
on the earnings of the bank and on its soundness. Banks need to keep substantial
amount of liquid a~sets and cash for the sole purpose of meeting up its financial
obligations, (settlement of current liabilities) and keeping the bank afloat.
Table 4.1 gives the arnount~volume of specified assets of commercial banks for
the two periods - periods of Regulation and Deregulation of interest rates.
44 TABLE 4.1: SPECIFIED ASSETS IN NIGERIAN COMMERCIAL BANKS
(N'milliom)
PERIODS YEARS LIQUID CASH - ASSETS
1980 2434.8 1532.1
C
REGULATION 1933 5140.4 1266.7
TOTAL 35,570.9 9,502.6
DEREGULATION 1990 8702.4 3735.3
1991 6813.5 71 73.3
TOTAL E
Source: CBN Statistical Bulletin, June 1994.
45 From the table above, it could be observed that, in the period of lnterest rates
regulation, the specified assets grew at a very slow pace. thaiis increasing at a
decreasing rate, while during the period of completederegulation of interest rates, .-
there was significmt growth in the volume of the specified assets. The growth
increases at an inzreasing rate.
Thus, it was certified that, the malor factor that accounted for the significant
growth in the volume of the specified assetswas the deregulation of the Banking
system and Interest sates which led to a substantial increment in Deposit liabilities *+
'mobilised by banks.
The total liquid asset increased by 94.1 percent from its level of N35570.9 million
in the Regulation period to N69,042.4 million in the Deregulation period. Total cash
increased by 370,O percent from its level of N9,502.6 million in the Regulation
period to44,672.8 million in the Deregulation period. The period of deregulation of
Interest rateswitnsssed the greatest growth in the totalvolume of specified assets.
This is expressed graphically in figure 4.1.
Fig.4.1: TOTAL SPECIFIED ASSET VOLUME IN NIGERIA
COMIVIERCIAL BANKS
N'million 100 (volume)
80
=-- Regulation period
Deregulationn period
46 4.1.2. BANKS' DEPOSIT LIABILITIES BY VOLUME
Bank's Deposits comprises of Demand, Time and Savings deposits. tt is the
major source of income to the banks. The efforts of commercial banks at . mobilising deposP:s within the economy is assessed in terms of the aggregate
amount mobilised. It is therefore asserted that, interest rates exert considerable
influence on the volume of Banks; Deposits. When interest rates are higher or
deregulated, theviume of Deposits mobilised would be much, than when the rate
are lower or regul3ted.'In essence, the higher the interest rates, the greater the C
'volume of Deposits rnobilised and vice versa.
It could also he noted that,. the volume of other businesses that can be
undertaken by a bank depend greatly on the size/volume of mobilised deposits
among other factors.
Table 4.2 s h o ~ the total volume of Banks' Deposit liabilities mobilised under
each period of consideration, The Deposits mobilised i in the regulation period
increased at a dccreasing rate, while those (Deposits') mOblllSed durlng tne
deregulation pericd increased at an increasing rate.
The total de~osit liabilities of commercial banks increased by 80.5 percent
from its level of NE5,415.3 million in the regulation period to N336,171.3 million in
the deregulation period.
TABLE 4.2: 4,NALYSIS OF COMMERCIAL BANKS' DEPOSIT LIABILITIES BY VOLUME
(M' million) - PERIODS YEARS AMOUNT INCREMENT
REGULATION 7 982
1987 23,086.7 1988 29,065. I 5,978.4
DEREGULATION 1989 27,164.9 1 ,900.2
-
TOTAL 336,171.3
Source: CBN Statistical Bulletin, June 1994.
48 The major factors that accounted for the significant growth in total deposit
liabilities were the complete deregulation of the Banking system and high deposit .
rates. Also, the growth could be attributable to the increase in number of banks . from 29 in the regulation period to 66 in the deregulation period.
4.1.3 BANKS' TOTAL INVESTMENTS
Banks invest on Treasury Bills, Treasury certificates, ~tabilisation securities
and other investmenttiilhich could be undertaken by the banks. It is widely claimed
that, banks invest more when they have large volume of deposits, and banks could
only mobilise reasonable amount of deposits when the interest rates are
comparatively high.
Table 4.3 gives the aggregate level of investments undertaken by Nigeria
commercial banks in each period. It can be certified that much investments were
undertaken between 1990 to 1993. This was the period where the banking system
experienced high hterest rates for Deposits and bank lending. The banks were
able to amass larce volume of deposits because the interest rates were highly
attractive to the depositors. Agreater part of thls was channelled into investments
, and loans.
49 TABLE 4.3: TOTAL IF!?'ESTMENTS OF COMMERCIAL BANKS
(N'million)
PERIODS YEARS AMOUNT TOTAL
1981 2,350.2
REGULATION 1982 3,406.9
50
The aggregate level of investment increased by 70.0 per percent from itslevel
of40,431 .I million in the regulation period to N126,027.7 million in the deregulation
period. This was d3?n;tn thn in~ragcn in +ha n~ ~mhnr nf hrnnLe - 4.1.4 -- CLAS!311
COMME. .,.. ., ,. ..... , I
The Income S;
the items that are
tax, Total assets
Table.4.4 is a. aurnrnary irlcorne ararernenr or some seler-ren r.nmmercl;ll
banks, which is used for the detkmination of Profit Margin, Retu
Return on Equity.
The income statement was extracted from the Annu-' R~nnr+c nf cala,-+-d
banks that have been in opefation from 1980 to 1993 which
relevant to study.
I U I I \by", C.2 " I U U I U V L U U
is the period considered
TABLE 4.4: CLASSIFIED INCOME STATEMENTOFSELECTED COMMERClALBANKS(N'million~
YEARS GROSS PROFIT NET PROFIT TOTAL SHARE- EARNINGS BEFORE AFTERTAX ASSETS HOLDERS
TAX EQUITY
1980 595.6 189.5 98.2 8,176.4 171.8 1981 786.5 197.9 104.3 10.195.0 208.0
REGULATION 1982 1066.8 213.3 112.5 12,291.3 271.2 1983 1260.8 223.2 122.6 15,098.8 287.6 1984 1456.9 212.8 113.2 16,691.5 306.7 1985 1699.4 283.4 166.7 19,101.1 321.8 1986 2019.1 400.1 227.5 21,448.2 339.2
1987 2553.4 374.4 251 .I 25,457.3 378.7 1988 3288.5 429.5 267.4 28.774.6 408.9
DEREGULATION 1989 4346.4 446.8 2 67.0 38,195.9 441.7 1990 5637.0 90.8 (5.7) 39,579.9 470.3 1991 6999.4 (1 16.02) (147.1) 50,532.0 560.4 1992 10268.9 473.0 427.9 76,91 4.7 658.4
Source: Ba~iks Annual Reports 1980-1993, Nigeria Banking Almanac 1985186 and Nigerian Banking, Finance and Commerce 199311994
4.2 HYPOTHESIS TESTING
The researcher did not develop hypothesis rather Research Questions were
used. Research Questions were developed and tested, rejecting or accepting
each Research Questions as was appropriate.
4.3 RESEARCH QUESTIONS
RESEARCH QUESTION I
Does the regulation of bank rates have the tendency to reduce the liquidity
posftion of banks as measured by the deposit ratio and cash ratio?
Liquidity is the ability of an institutlon to meet it financial obligations as they fall
due.
Liquidity risk in the case of a bank, is a risk of loss from the bank not having
adequ- funds to meet deposit withdrawals and loans demand. Thus, the
52 adequaqof banks' liquidity is often gauged by the ratio of liquid assets to total
deposits (or to total assets) and cash ratio-which Is the ratio of cash to total deposit
..liabilities.
There is the wide notion by Scholars, Authors, Researchers that, the
regulafion of ban!: rates (interest rates) tends to reduce the liquidity position of
banks, but the Niqerian case is different. This is shown in tables 4.6 and 4.7.
TABLE 4.5 - LIQUIDITY POSITION OF COMMERCIAL BANKS IN
NIGERIA AS MEASURED BY DEPOSIT AND CASH RATIOS
(PERCENTAGE %) PERIODS YEARS DEPOSIT CASH
RATIO RATIO
1980 1981 1982
REGULATION 1983 1984 1985 I986
-- -
1987 1988 1989 1990
DEREGULATION 1991 1992 1993
53 TABLE 4.6 - AVERAGE RATES OF DEPOSIT AND CASH RATIOS
-~ -
PERIODS YEARS DEPOSlT RATIO CASH RATIO
REGULATION 1980-'86 35.39
DEREGULATION T 987-93 19.76
TABLE 4.7 - AVERAGE GROWTH RATES OF DEPOSIT AND CASH RATIOS
[PERCENTAGE-%)
PERIODS . YEARS DEPOSIT RATIO CASH RATIO
DEREGULATION 1987-'93 10.25 2.4
As earlier rnent oned, Deposit ratio is the ratio of total specified liquid assets to
total deposit liabilities. Liquid assets are assets that can be easily liquidifiedl
monetized, that is, that can be changed to cash. Therefore Deposit ratio measures'
the degreeof banks'liquidityand a higherpercentageof deposit ratio indicates that,
the volume of banks liquid assets is appreciably adequate for the settlement of its
financial obligatior~s (Deposit liabilities) as they fall due.
. Also , cash ratio measures the volume of cash at the banks' disposal which is
capable of meeting its financial obligations (Deposit liabilities). Thus, a higher
percentage indicates an improved liquidity position of the banks.
From table 4.6, the average rate of Deposit ratio "35.39%" in the period of
regulation of interest rates is comparatively greaterlhigher than, the average rate
of Deposit ratio"1 E .76%" in the period ofderegulation of interest rates. The average
rates ofcash ratios of 10.67% and 10.94% forthe two periods are almost the same.
54 In the case of average growth rates of deposit ratio and cash ratio, table 417
indicates that, the period of regulation of interest rates records the higher growth
rates of 14.73% and 3.6% respectively compared to the average growth rate of -
Deposit ratio of 11'3.25% and cash ratio of 2.4% in the period of deregulation of
interest rates.
Therefore, since a higher percentage of Deposit and Cash ratios indicates a
'healthy and imprclved liquidity posilion of banks which is manifested here in the
regulation period, a deduction from the analysis therefore shows that, the banks
liquidity position is moresound and solid or impressively better when there is
regulation of interest rates than when interest rates are deregulated. Thus, it is
concluded that the regulation of bank rates (interest rates) does not have the
tendency to reduce the liquidityposition of banks as measured by Deposit and cash
rat ios8
4.3.2 RESEARCH QUESTION - II Does the regdation of bank rates have a negative effect on the overall
performance of bmks as measured by the profit margin, return on equityand return
on assets?
The overall performance of banks might be measured in terms of their
profitability level. The profitability level of banks could be determined through
various bases, bc?t in this study, the bases considered relevant are Profit Margin,
Return an Equity arid ~ e t u r n on Assets. These are all earnings measured on
different bases. In the banking system, Profit Margin is a ratio of profit before tax
toGross Earnings, Return on Equity is a ratio of net profit after tax to Shareholder's
Equity, while Return on Assets is a ratio of Gross Earnings to Total Assets.
Scholars, Writers and Authors have asserted that the regulation of interest rates
55 negatively affects the performance of banks in terms of their profit-ability 1evel.A
deviation from thi.; assertion ensued in the Nigerian case.
Table 4.8. shows the profitability level of some selected commercial banks as
measured by the relevant indices (Profit Margin, Return on Equity and Return on
Assets). Comput3tion is extracted from table 4.4.
Tables 4.9 and 4.1 0 give both the average rates and averagegrowth rates of the
indices.
TABLE 4.8. , - PR~FITABILITY LEVEL OF SOME SELECTED
COMMERCIAL BANKSAS MEASURED BY PROFITMARGIN,
RETURN ON EQUITY AND RETURN ON ASSETS
[PERCENTAGE-%)
PERIODS YEARS . PROFIT RETURN ON RETURN ON '
MARGIN EQUITY ASSETS - -
1980 31.8 57 .O 7.0
1981 25.2 50.0 7.0
1982 20.0 41 .O 8.0
REGULATION 1983 17.7 43.0 8.0
1984 14.6. 37.0 8.0
1985 16.7 52.0 8.0
1986 19.0 67.0 9.0
DEREGULATION 1989 10.3 60.0 11 .O
1990 1.6 0.0 14.0
56 TABLE 4.9 - AVERAGE RATES OF PROFIT MARGIN, RETURN ON .
EQUITY AND RETURN ON ASSETS
(PERCENTAGE - %) - --
PERIODS YEARS PROFIT RETURN ON RETURNON . MARGIN EQUITY ASSETS
REGULATION 1980-'86 20.8 49.0 8.0
TABLE 4.1'0 AVERAGE GROWTH RATES OF PROFIT MARGIN,
RETURN ON EQUITY AND RETURN ON ASSETS (PERCE
PERIODS YEAR PROFIT RETURN ON RETURN ON MARGIN EQUITY ASSETS
-- -- -
REGULATION 1980-'86 3.7 9.0 I .O
DEREGULATION 1987-'93 2.7 4.0 I .O
In the banking .;ystem, higher rates of these
profitably sound and strong. This implies that, the banks make higher or huge
profit, invariably, iigh profit means high earnings on shareholder's equity and on
total assets.
From Table 4.3, the average rates of profit margin and return on equity of 20.8
percent and 49.W respectively in the period of regulation of Interest rates are
comparatively higher than the average rates of 7.1 percent and 46.0% of profit
margin and return on equity respectively when interest rates were deregulated.
Considering Return on Assets, the case is the reverse. Average rate of 12.0% in
the per idof deregulation of interest ratesis hlgherthan average rate of 8.0% in the
57 period of interest -ates regulation.
Table 4.10 ind cates the average rates at which the profitablity indices (Profit
Margin) Return or1 Equity and Return an Assets) grow. Profit margin grows at a . - higher rate "3.7% in the period of interest rates regulation compared to the growth
rate of 2.7% in tble deregulation period, having a difference of 1.0%. Same is
applicable to the growth rate of Return on Equity. During the period of regulation,
the Return on Eouity grows at a higher and faster rate of 9.0% as against the
average growth rate qf 4.Q% when interest rate is deregulated.
This means that higher earnings accrue to shareholders in the period of
regulation than in thederegulation period. Considering the average growth rate of
Return on Assets, there is no difference. The average growth rate of 1.0% is
applicable to the two periods. In otherword, Return on Assets grows at the same
rate of 1.0% In both the period of Interest I-ates regulation and deregulation.
The analysis :;Rows that, in the period of regulation of interest rates, Profit
Margin and Return on Equity earn higher average rates than in the deregulation
period. The exception is the case of Return on Assets which has a higher average
rate in the deregulation period than in the regulation period, but the fact that they
grow at the same rate of 1.0% goes a long way to certify that, the index "Return on
Assets"alanecannot impact great negative effect on the overall performance of the
banks.
On the basescf theanalysis, the assertion that regulation of bank rates [interest
rates) has a negative effect on the overall performance of banks as measured by
the Profit Margin, Return on Equity and Return on Assets is proven otherwise.
58 4.3.3. RESEARCH QUESTION - 111
Does the regu'ation of bank rates induce banks to diversify their income earning
base? . Banks derive their income through investments in both interest-based and fee-
based serviceslp-oducts. When interest ratesare deregulated, that is, determiried
by the market forces of demand for and supply of money, banks put more
emphasis on deposits mobilisation as a source of income which is interest-based
to the detriment or neglect of otherfee-based services, but when interest rates are
regulated, the reverse is believed to be the case. Thus, it is widely claimed that,
the regulation of kanwinterest rates induces banks to diversify their incomeearning
base.
From the survey carried out on the commercial banks, the researcher discovered
that, the claim is quite different from theactual practices in the banking institutions
in Nigeria. '
Total 4.1 I. s h ~ w s the fee-based serviceslproducts offered by the commercial
banks in Nigeria. Theseservices have been offered by commercial banks from the
inception of banking services in Nigeria. The only exception is the services of
electronic funds :ransfer which was an innovation during the era of deregulated
banking system ' I989 to 1993".
Leasing Financial Receivables
Personal Financial Planning
Correspondent Banking
Electronic Funds Transfer ,
Private Banking
Joint Veqtures
Export
59 TABLE 4 : l l - FEE-BASED SERVICES OFFERED BY N I G E M
COMMERCIAL BANKS
I
Source: Interview and Questionnaire
Consultancy and Advisory Services
The investigation led the researcher to discover that, the banks instead of
diversifying their income earning base to fee-yielding services 1 products, were
practising "Interest rates short-change".
The "Interest rates short-change" according to the bank managers is a practice
-
in the banking system whereby banks display the government stipulated interest
rates at their offices but charges the undertable interest rates which are higher than
I
the fixed rates. The reason advanced for such practice is to enhance their ability
of attracting more depositors thereby improving the banks' liquidity position. The
case of income base diversification was completely ruled out.
Thus, it is prec'selyconcluded that the reintroduction of interest rates regulation
policy in the banking system has failed in its' ultimate motive of inducing banks to
diversify their inccme earning base. Instead it aids the banks to go contrary to the
rules and policies of the regulatory body-Central Bank of Nigeria. .
Au.YSIS OF RESPONSES FROM BANK MANAGERS AND
The analysis would be based on the responses of the bank managers from the
questionnaire administered and interview conducted by 1
The first issue ra isd was, whether they "Banks Marlayers accept Central
Bank of Nigeria 'CBN" fixing interest rates for banks. Out of the thirty Bank
managers interviews, twenty-two (who were seasoned bank manager) accepted
that, the interest -ates should be regulated. They were of the opirtlon that, the
regulatory body"CBNn should fix flexible rates which must be subject to consultation
with the Bank Managers, Bankerscommittee and the Manufacturers Association
of Nigeria "MANn The other eight bank managers (mainly the new generation
managers) were wholly against the CBN fixing interest rates. They opted for
complete deregu ation of interest rates. Their opinion was that, interest rates
{Deposit and lending rates) should be allowed to be determined by the market
forces of demand for and supply of funds. '
The bank managers who were in favour of interest rates being regulated backed
up theiropinnion with the reason that, since there exist imperfect competition in the
Nigeria market, dsregulating the interest rates would result in boosting the health
and financial strelgth of the older, big and stronger banks to the detriment of the
smaller and weaker ones. That is to say, high interest rates would ensue and the
smaller and weaker banks in a bid to stay in business would source for funds at
all cost, thereby ending up accepting funds (Loans and Deposits) at cut-throat
6 1 rateslcosts whicl- they might not be capable of paying back. This unhealthy
condition would probably lead to distress and financial strangulation, forcing them
"the smaller and weaker banks" out of the markeWbusiness. Thus, regulating . .. interest rates w o ~ l d help make all the banks operate at optimum level.
Another issue was that, 'whether the regulation ofjnterest rates have any effect
I, on the Banking operation". The responses by the bank mangers indicated that,
interest rates regulation impact both negative and positive effects on the banking
operation. The rositive , .. effect advanced by the bank managers was that, the
fixedinterest rates. ensures that, the objectives of allowing easy access to cheap
funds by the man ~facturers is achieved.
The negative effects were as follows:
- That regulation of interest rates reduces profit margins, but suggested that,
this can be rnproved with.good strategies on the part of the banks.
- That financial savings are affected where clients could invest on fixed
assets.
- That, interest rates regulation discourages competition and innovation in the
banking optvations and services.
The researcher thinks differently of the last point of the negative effect which
expresses that, regulation of Interest rates discourages competition and innovations
in banking operations and services. The interest rates policy indirectly was meant
ased services to fee- to divert the bank's activities or attention from the interest-b;
based productslsr~rvices. he banksshould have been in the position of developing
or introducing mors fee-yielding serviceslproducts, but instead, indulges in charging
undertable interest rates higher than the CBN Official rates, just to enhance their
ability of attracting more depositors. The competition they are hammering on was
62 not only meant for deposits taking, that is, competina fordeoosits bv offerina hiahlv
attractiive rates, but also for banks to compe
numerous fee-yielding serviceslproducts, thus reaucing aepenaency on aeposrts
taking. In essence, the regulation of interest rates should even encourage the
banks to be highly innovative, motivating them towards creation of new-fee-yielding
services/products, thereby changing their old orientation of solely depending on
Depositor's monks as the major source of income.
The problem, uhich the researcher discovered that presses the banks most,
was the fact that. the banks are always skeptical about venturing into hlgh risk
investments (especially financing capital projects) other than deposits taking and
giving short terrr loans and advances. It is high time banks re-organise their
banking operations, channelling their efforts and investments to fee-yielding
serviceslproduct~;, thereby diversifying completely their income earning base.
The third issue of consideration was the "steps which the Bai
taken or adoptec to cushion the widely claimed negative effer;~ UI Ir I L ~ I W I ales
regulation on liquidity position, profitability level and overall performance of the
banks". The Bankmanagers responded by stating thesteps adopted to include the
following:
-
nk managers have
(A) For Liquidi:y position:-
(i) Agg-essive marketing designed to shore up current account volume
and other deposit liabilities. In otherword, intensifying marketing drive
targeted at net corporate/individual deposits.
(ii) Discwraging lending to all comers (especially those without good
track record of credit worthiness), and improvement of risk assets
63 quality.
(B) For profitab 'lity level:-
. (i) Extending facilities to clients with tract record of performance.
( i i ) Conc~ ntrating on already existing fee based activitieslservices.
(C) For overall performance:-
(i) Providing improved and high quality services which serves as a major
success factor:
(ii) Orientation towards customers customer's enthusiasm and staff
(iii) AdopVon of strategic management as a key result area.
The steps are good enough if'they are well implemented, but the step of
based activities 1 services to boost up concentrating on already existing fee
profitablity level is not ideal. Instead of concenntratmg on tne alreaay exlsting ones,
new ones (such as credit card services, Trust department operation and others)
should be introduced into the banking system.
64 CHAPTER FIVE
SUMMARY 01' FINDINGS. RECOMMENDATIONS AND CONCLUSION I
5.1 . SUMMARY OF FINDINGS:
- The following were the major findings of the study: -
1 Scholars, Writers, Authors and Researchers worldwide claim that, the C
regulation cf banklinterest rates tends to reduce the liquidity position of
banks.
This assertion deviates colisidering the case of Nigeria. The study has
revealed that, the liquidity position of banks(as measured by Deposlt and
Cash ratios) improved or was sound and solid much more when there was
regulation of interest rates than wl-
The year "I 985" recorded the highest p
was when intermt rates were regulatc
Deposit ratio (7.0%) was recorded in
deregulation of interest rates. Aggregare~y, me average rare or ueposlr ratlo
(35.39%) was higher in the period of interest rates regulation than (19.76%) of the '
period of deregulation of interest rate
"1 982" comparatively had the highe!
happened when iiterest rates wen
!s, showing a decline of 15.63%. Also, theyear
st percentage of cash ratio of'l6.7%. This also
2 regulated. The aggregate average rates of
?nth narinrlc T h m rant dzitinn nnrind rnrnrAnrl' t cash ratio were almost the same in .,, , UrUIULIVII , VVUIUYU
10.67 %while the deregulation period had 10.94%. From this,it could beseen that,
the claim is highly disputed when it comes to the case of Nigeria.
65
2. Another claim by Scholars, Writers, Authors and Researchers is that, '
Interest rates regulation impact a negative effect on the performance of '
banks with I-egards to their profitability level. The Nigerian case is different. - Taking Profit Margin, Return on Equity and Return on Assets as indices of
measuremont, the period of interest rates regulation exhibits a better and
impressive ~erforrnance because this is when the profitability indices stated
above have higher percentages of average rates, exception of Return on
Assets. La
Profit margin has average rate of 20.8 percent in the period of regulation of
interest rates compared to 7.1 p'ercent of the period of deregulation of interest
rates, showing a decline of 13.7 percent, Return on Equity49.0 percent compared
to 46.0 percent, s decline of 3.0 .percent, while Return on Assets 8.0 percent
compared to 12.C percent of the deregulation period, an increase of 4.0 percent.
Though the assertion is right considering only the issue of Return on Assets, but
the reverse is the case when considering Profit Margin and Return on Equity.
erest based servicesfproducts to based . . - - . . - -. . . . . .
3. The belief tiat, regulation of banWinterest rates induces banks to diversify
' their income earning base (from int
services / products) is a misconception ln the Ngerlan case. The banks, Instead
of expanding or improving on their nrnrl~~rt n ~ r k z m n c ctill ctirk tn thair n l A snA
already existing fee-yielding servic n
. which was originally meant to help tl
to encourage banks to indulgein illsyal ual lkllly aulvluczarl lla,plautkr?a 8 aa
"lnterest rates shortchange" - a practice whereby official rates are displayed at the
p . I " U " " L p.'AU,\Uybd d 1 I I I .,.I",\ L" 11 1 b I 1 "I" U l lU
eslproducts. The regulation of interest rates
he banks become innovative, instead, turn out
l m ~ m l h-nbi-m -n+i t , i+ i f ie l - -~n~~*t ;eme -11-h qe
66 offices but offering a complete different and higher rates just in a bid to attract
more depositors. Thus, the Nigerian case prove tha belief othekise (wrong).
. 4. Another finding worthy of consideration was the fact that with the regulation
of interest rates, commercial banks have been incited to be more prudent in the
management of their funds, assets and liabilities and the entire corporate affairs.
RECOMMENDATIONS
Based on the d 3ta m d findings of the study, the following recornmendatlons are
hereby offeied for the benefit of the Bank Managers, the Regulatory Authority
[Central Bank of Nigeria), the Government and the general health of the Nigerian
economy:
Ideally, the narket forces should del
with most developed economies. H
have made this policy difficult. Thus, what is perhaps feasible is 'Managed
Deregulaticn of interest rate", which impliedly suggest fixing of flexible
Interest rates.
The Federal Government through the Central Bankof Nigeria (CBN)should
modify its method of determining Interest rate structure to include
consultationswith the relevant sectors (Bank Managers, Bankers Committee
and ~anufacturers Association of P
structure to allow for profitability in comrnerclal aanlis; operanons, ana a
flexible structure with the reviews
In order to 'mprove their relative liq
-
digeria) and review of the operating 1 - - - 1 . - . 1 1 - - - - - _1 -
income ea4-ning base, shifting their emphasis to fee-based services1 . - products rather than depending solely on deposits taking. This is of
immediate necessity considering the recent changes in the FOREX
.. operations which formerly yit
such fee-bxed serviceslpro
department , operations, .- Hedg
arrangement for customers1clients etc.
4. The comrnnrcial banks should intensify their efforts in promoting or financing
exports trade because it yields fast and huge income. This venture will act
as a catalyst in the improvement of both the liquidity position and the
profitebility level of the banks.
5. The commxia l banks should comply with the Federal Government
monetary policy as regards interest rates because. it is a rneasureem~loved
to stabilise the banking system, c
as a whole In the same vein, the cenrrar tsanK OT lulgerla snouta also
effectively nonitor the trend of events and activities in the commercial
banks to avoid E
problems t'ian ii
5.3 CONCLUSION
The study has so far revealed that the regulation of interest ratesplays a greater . part in sannitising the banking system which invariably ennhnces stability and
viability in the banking industry.
It could be inferred that. in a develoninn emnnmv as in the case nf Nineria that
3gulation of interest rates creates a positive impact on the performance of
ommercial banks. This might be attributed to the imperfections in th market. C
Regulation of Interest rates is necessary to ensure that banks go into effective
iversification of *.heir income earning base, most especially towards improving or
nlarging their fee-based serviceslproducts packages, thereby reducing their
ependency on Deposit taking.
Conside'ring the recentwave of government intervention in the banking system
irough its monetary policies, it is perceived by experts, the researcher inclusive,
iat such measLre "lnterest rates regulation" will help banks to become more
inovative in the area of fee-yielding services/products. Also, it would stimulate
lanks into exploiiing other opportunities outside the banking industry.
Thacn \ A m 1 ~lrl holn in h~ ~ildinn a wiriln and ctahlo hankinn cvrtern I I IUdU ""VUIU I IUIy I, I "UIIU,, U .",I I," U, IU " L U Y , " YU, a,,,, 8 3 V J Y . " I I I.
Finally, since the Nigerian market is full of lrnnerfections. the researcher
concludes that what is feasible in Nigeria is a Mana
interest rates".
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Newyork: McGraw-Hill Book Company.
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'central ~ a h k c f Nigeria, Monetary Policy Circular No. 28.
Central Bank of Nigeria, CBN (1994): Statistical Bulletin Vol. 5, No. I.
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Bullior Vo1.8 No. 4 -.
Gurley, J,G. and Shaw, E.S. (1956) "Financial Intermediaries and the Saving-
Investment Processn. Journal of Finance (May).
Hugh, Patrick. "Financial Development and EconomicGrowth in under developed
countries. "Economic Development and cultural chanqe NO. 14, Vol. 2.
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