ABSTRACT
The study analyzed the impact of interest rate spread on profitability of commercial banks in Nigeria. To achieve the broad objective, the study specifically investigated the effect of interest rate spread, gross domestic product, broad money supply, cash reserve ratio, non-performing loans, inflation rate and bank size on profit after tax and return on assets of commercial banks in Nigeria. Thus, profit after tax and return on assets were adopted as measures of profitability in the study. The scope for the study covered the period 2003 to 2017 (15 years) and ten (10) commercial banks listed on the Nigerian Stock Exchange were used as sample size for the study. Panel unit root test using the Levin, Lin and Chu unit root test was carried out to determine the stationarity of the variables. Kao residual panel cointegration test was carried out to determine whether or not the variables had long run equilibrium relationship amongst them. The researcher employed panel data analytical technique using pooled-effect, fixed-effect and random-effect approaches to determine how each of the explanatory variable influenced profitability and performance of commercial banks in Nigeria. Findings in the pooled-effect, fixed-effect and random-effect regression analyses were similar. To determine the most suitable of the regression results, the Hausman test was employed and it was discovered that the cross-section test variance was invalid and that the Hausman statistic was set to zero. The researcher accepted neither the fixed effect nor the random effect regression result as being consistent; rather the pooled effect (Ordinary Least Squares) regression result was accepted as most consistent. Findings revealed that interest rate spread had negative and insignificant impact on both profit after tax and return on assets of commercial banks in Nigeria. Broad money supply had insignificant impact on profit after tax and return on assets of commercial banks in Nigeria while non-performing loans had negative and significant impact on profit after tax and return on assets of commercial banks in Nigeria. Inflation rate and bank size had positive and significant impact on profit after tax but exhibited positive and insignificant impact on return on assets of commercial banks in Nigeria. The study recommended, amongst others, that Central Bank of Nigeria should lower the monetary policy rate in order to drive down the lending rate. As the lending rate falls, high interest rate spread in Nigeria would be reduced and the negative effect of interest rate spread on profitability of commercial banks would be reversed. More so, it was recommended that management of commercial banks in Nigeria should adopt stricter client profiling model to enable them take better decisions in granting loans to their customers. Information obtained from customers’ financial assets and financial consumption behaviours would help the banks to reduce rising non-performing loans syndrome within the banking sector. This would help in reducing the adverse effect on Non Performing Loans on commercial banks’ profitability and performance in Nigeria.
TABLE OF CONTENTS
Title Page i
Declaration ii
Certification iii
Dedication iv
Acknowledgements v
Table of Contents vii
List of Tables xii
List of Figures xv
Abstract xvi
CHAPTER 1:
INTRODUCTION
1.1 Background
to the Study 1
1.2 Statement
of the Problem 5
1.3 Objectives
of the Study 8
1.4 Research
Questions 9
1.5 Hypotheses 9
1.6 Scope
of the Study 10
1.7 Significance
of the Study 11
1.7.1 The
government 11
1.7.2 The
academia 11
1.7.3 Commercial
banks 11
1.8 Limitations
of the Study 12
1.9 Operational
Definition of Terms 12
CHAPTER 2: LITERATURE REVIEW
2.1 Conceptual
Framework 15
2.1.1 Interest
rate spread 15
2.2 Overview of
Interest Rate Spread in Nigeria 19
2.3 Interest Rate Spread and
Economy of Nigeria 21
2.3.1 Trends
of interest spread in Nigeria 24
2.4
Interest Rate Spread and Monetary
Policy 26
2.5 Interest
Rate Transmission Mechanism 27
2.5.1 Interest
rate channel 27
2.5.2 Exchange
rate channel 28
2.5.3 Asset
price channel 28
2.5.4 Credit
channel 29
2.5.5 Bank
lending channel 29
2.5.6 Balance sheet channel 30
2.6
Determinants of Interest Rate Spread 31
2.6.1
Exchange rate 32
2.6.2
Inflation rate 32
2.6.3 Broad
money supply 36
2.6.4 Bank
size 36
2.6.5 Cash
reserve ratio 37
2.6.6 Non-performing
loans 37
2.6.7 Monetary
policy rate 38
2.6.8 Liquidity ratio 38
2.7
Interest Rate Spread and Economic Growth 38
2.8
Overview of Nigerian Banking System 40
2.8.1
Trends in Nigerian banking system 43
2.8.2
Bank performance 44
2.8.3 Determinants
of bank performance 46
2.8.3.1 Internal
determinants 47
2.8.3.2 Macro-financial
determinants 50
2.8.3.3 External determinants 51
2.9 Theoretical
Framework 52
2.9.1 Theories of interest rate spread 52
2.9.2 Loanable funds theory 52
2.9.2.1 The major assumptions of the loanable fund
theory (LFT) are 53
2.9.2.2 How the loanable fund theory explained the
modeled variables 54
2.9.2.3 Demand for Loanable funds theory 55
2.9.2.4 Supply of Loanable funds theory 57
2.9.3 The classical theory 57
2.9.3.1 Demand-side theory 58
2.9.3.2 Supply-side theory 59
2.9.4 Keynesian liquidity preference theory 60
2.9.5 Expectations theory 65
2.10 Empirical Literature
on Interest Rate Spread 66
2.11
Summary of Review of Literature 99
2.12 Gap in Literature 100
CHAPTER 3: METHODOLOGY
3.1 Research
Design 102
3.2 Population
and Sample Size 102
3.3 Sources
of Data 103
3.4 Model
Specification 104
3.4.1 Variables definition and measurement 110
3.5 Method of Data Analysis 114
3.5.1
Unit root test 114
3.5.2
Cointegration test 115
3.5.3
Panel data analytical technique 115
3.5.4.1 t-statistic 118
3.5.4.2
F-statistic 119
3.5.4.3
R-squared 119
3.5.4.4
Durbin-Watson statistic 119
CHAPTER 4: DATA PRESENTATION, ANALYSIS AND DISCUSSION OF
FINDINGS
4.1 Data Presentation 120
4.1.1 Interest Rate Spread
(IRS) 121
4.1.2 Gross Domestic
Product Growth Rate (GDPGR) 122
4.1.3 Broad Money Supply
(M2) 123
4.1.4 Cash Reserve Ratio
(CRR) 124
4.1.5 Non-Performing Loans
(NPLs) 125
4.1.6 Inflation Rate (INF) 126
4.1.7 Bank Size (BS) 127
4.2 Trends in Profitability and Performance
of Selected Commercial Banks in Nigeria
129
4.3 Data Analysis 139
4.3.1 Descriptive
statistics 139
4.3.2 Unit root test 144
4.3.3 Cointegration test 146
4.3.4 Correlation matrix
analysis 147
4.3.5 Panel data regression
results 152
4.3.6 Panel data regression
results (return on assets model) 168
4.4 Summary
of Results in the Pooled-Effect, Fixed-Effect and Random-Effect
Models 183
4.5 Results
of Ordinary Least Squares (OLS) 187
4.6 Interpretation and Discussion of Findings 197
4.6.1 Interest Rate Spread (IRS) 197
4.6.2 Gross Domestic Product Growth Rate (GDPGR) 198
4.6.3 Broad Money Supply (M2) 199
4.6.4 Cash Reserve Ratio (CRR) 200
4.6.5 Non-performing
Loans (NPLs) 201
4.6.6 Inflation
Rate (INF) 202
4.6.7
Bank Size (BS) 202
4.7 Test of Hypothesis 203
CHAPTER 5: SUMMARY OF
FINDINGS, CONCLUSION AND
RECOMMENDATIONS
5.1 Summary of Findings 216
5.2 Conclusion 217
5.3 Recommendations 218
5.4 Contribution
to Knowledge 219
5.5 Areas of Further Research 220
References 222
Appendices
LIST OF TABLES
2.1: Interest Rate
Spread in Nigeria (1980-2017) 23
2.2: Data on
GDP in Nigeria 25
4.1: Data on Interest
Rate Spread (IRS), Gross Domestic Product Growth
Rate
(GDPGR), Broad Money Supply (M2), Cash Reserve Ratio
(CRR),
Non-Performing Loans (NPL), Inflation Rate (INF) and
Bank
Size (BS) in Nigeria. 120
4.2.1:
Trends of
Profitability and Performance of First Bank Plc 129
4.2.2: Trends in Profitability and Performance of
Guaranty Trust Bank
Plc 130
4.2.3: Trends in Profitability and Performance of
United Bank for Africa
Plc 131
4.2.4: Trends in Profitability and Performance of
Fidelity Bank Plc 132
4.2.5: Trends in Profitability and Performance of
Access Bank Plc 133
4.2.6: Trends in Profitability and Performance of
Zenith Bank Plc 134
4.2.7: Trends in Profitability and Performance of
Diamond Bank Plc 135
4.2.8: Trends in Profitability and Performance of
First City Monument
Bank Plc 136
4.2.9: Trends in Profitability and Performance of
Union Bank Plc 137
4.2.10: Trends
in Profitability and Performance of EcoBank Plc 138
4.3: Descriptive Statistics of the Variables 139
4.4: Levin, Lin and Chu
Unit Root Result 145
4.5a: Kao Residual Cointegration Test Result
(BP Model) 146
4.5b: Kao Residual
Cointegration Test Result (ROA Model) 147
4.6a: Correlation Matrix Result (Bank
Profitability Model) 148
4.6b: Correlation Matrix Result (Return
on Assets Model) 150
4.7a: Pooled-Effect Result (Bank
Profitability Model) 153
4.7b: Fixed-Effect Result (Bank
Profitability Model) 158
4.7c: Random-Effect Result (Bank
Profitability Model) 163
4.8a: Pooled-Effect Result (Return on
Assets Model) 168
4.8b: Fixed-Effect Result (Return on Assets
Model) 173
4.8c:
Random-effect
Result (Return on Assets Model) 178
4.9: Pooled-effect,
Fixed-effect and Random-effect Panel Data
Results
Summarized 183
4.10:
Hausman Test (Bank
Profitability Model) 185
4.11:
Hausman Test (Return
on Assets Model) 186
4.12:
Ordinary Least
Squares (OLS) Result for Bank Profitability Model 187
4.13:
Ordinary Least
Squares (OLS) Result for Return on Assets Model 192
4.14a:
Effect of interest
rate spread on commercial banks’ profitability
in
Nigeria 204
4.14b: Effect of interest rate spread on
commercial banks’ performance
in
Nigeria 204
4.15a: Effect of gross domestic product
growth rate on commercial
banks’
profitability in Nigeria 205
4.15b: Effect of gross domestic product
growth rate on commercial banks’
performance
in Nigeria 206
4.16a:
Effect of broad
money supply on commercial banks’ profitability
in
Nigeria 207
4.16b:
Effect of broad
money supply on commercial banks’ performance
in
Nigeria 208
4.17a:
Effect of cash
reserve ratio on commercial banks’ profitability in
Nigeria 209
4.17b:
Effect of cash
reserve ratio on commercial banks’ performance
in
Nigeria 209
4.18a:
Effect of
Non-Performing Loans on commercial banks’ profitability
in
Nigeria 211
4.18b:
Effect of
Non-Performing Loans on commercial banks’ performance
in
Nigeria 211
4.19a: Effect of inflation rate on commercial banks’
profitability in
Nigeria 213
4.19b: Effect of inflation rate on
commercial banks’ performance in
Nigeria 213
4.20a: Effect of bank size on commercial
banks’ profitability in Nigeria 214
4.20b:
Effect of bank
size on commercial banks’ performance in Nigeria 215
LIST OF FIGURES
2.1:
Trend of interest rate spread in Nigeria 24
2.3:
Trends in Nigerian banking system 43
CHAPTER
1
INTRODUCTION
1.1 BACKGROUND TO THE STUDY
The
banking sector could be described as one of the life-wires of every economy.
This is because of the intermediary roles the banking industry play as it
pertains to re-allocation of funds from the surplus sectors of the economy to
the deficit sectors of the economy. To re-allocate funds from the surplus
sector to the deficit sector, commercial banks mobilize deposits from their
customers and transmit such deposits as loans to customers that require them.
The commercial banks in the course of mobilizing deposits from their customers
are expected to pay interest on the money deposited with them especially on
savings accounts. This serves as incentives to bank customers and helps the
commercial banks to attract new savers thereby increasing the volume of deposits.
On the other hand, to grant loans to its customers, the commercial banks charge
interest rates on such loans.
The
interest rate charged by the commercial banks on lending is expected to cover
the risks which the banks are exposed to by granting of such loans. Usually, there exists a difference between
the interest rate paid by the banks in mobilizing deposits from their customers
and the interest rate charged by the commercial banks on loans granted to their
customers. It is this difference between the interest rate charged by the banks
on loans given to its customers and the interest paid to bank customers for
deposits made in the banks that constitute what is known as interest rate
spread (Obidike, Ejeh & Ugwuegbe, 2015). In fixing the lending (interest)
rate to be charged, the actions of the commercial banks are dependent on the
prevailing monetary policy rate set by the central bank (apex bank). The
central bank carries its role of setting the monetary policy rate (MPR) with a
view to regulating the lending activities of commercial banks and also as a way
of achieving a set of monetary policy objectives. Where the central bank of a
country sets a high monetary policy rate, it implies that the lending rate
charged (to be charged) by commercial banks ought to be higher than the
interest pay to the depositors and the overall implication of this is that
interest rate spread would also be high (all other things being equal). Given
the involvement of the central banks in setting interest rates, interest rate
spread could also be described as the difference between the monetary policy
rate (MPR) set by the central bank and maximum lending rate charged by the
commercial banks (Nampewo, 2013).
Nigerian
lending (interest) rate had been adjudged to be one of the highest in the world
(Maiga, 2017). It is data-proven that the nation’s lending (interest) rate had
remained within the double-digit threshold in the last ten and half years. For
instance, in 1999, commercial banks’ lending rate was 21.32 percent and the
lending rate reached its peak in 2002 at 24.85 percent within the study period.
In 2008, it declined to its lowest level at 15.14 percent but in 2014
commercial banks lending rate climbed to as much as 16.55 percent (CBN, 2015).
Placing it side by side with the savings deposit rates within the same periods,
available statistics showed that the savings deposit rates were 5.33 percent in
1999; 4.15 percent in 2002; 2.84 percent in 2008; and 3.38 percent in 2014.
This leaves the interest rate spread within these periods which rose at 15.99
percent, 20.70 percent, 12.30 percent and 13.17, percent respectively (CBN,
2016). Based on this scenario, it is incisive to note that the lending rate and
interest rate spread in Nigeria had remained above 10 percent. With the
nation’s monetary policy rate averaging
14 percent and a low-deposit rate in the last decade and half, many have argued
that there was no reason why the nation’s lending rate and interest rate spread
would not be high (Obamuyi, 2009).
The
fundamental question that arises is: Does the high interest rate spread in
Nigeria have any impact on commercial banks’ profitability and its performance?
To provide an answer to this all-important question, two schools of thought
have emerged. One school of thought has argued that with such high interest
rate spread as obtained in Nigeria, borrowings from commercial banks have been
made unattractive. The argument of the opponents of high interest rate spread
is premised on the fact that high interest rate spread makes the cost of
borrowing by firms and households to become very high. Interestingly, the
implication of a high interest rate spread is double-edged as it affects both
banks’ profitability and the performance of commercial banks. On commercial
banks’ profitability, a high interest rate discourages borrowing and thus
adversely affects the lending activities of the banks since the high cost of
borrowing scares away potential borrowers. With a reduction in the lending
activities of the banks comes a reduction in the profit which the banks would
have made if people had borrowed from them (Eke, Eke and Inyang, 2015).
This
is against the backdrop that a high interest rate spread has the implication of
undermining and crowding-out domestic investments thereby impeding commercial
bank profitability (Obamuyi, 2009). On the other side of the divide, proponents
of high interest rate spread have argued that high monetary policy rate
(leading to high lending rate) and the subsequent high interest rate spread are
aimed at mopping up the excess money in circulation thereby curbing
inflationary pressures in the economy. The argument of this school of thought
is premised on the understanding that with low monetary policy rate (and low
interest rate) there would be financial repression which would lead to
discouragement of savings mobilization and channeling of mobilized savings
through the financial system thereby leading to a decrease in the profitability
of the banks as well as reducing the quantity and quality of investments. With
banking sector profitability reduced and quantity and quality of investments
negatively affected (Soyibo and Olayiwola, 2000). The proponents of high
interest rate therefore argued that a high interest rate spread is needed to
reduce too much money in circulation which would hurt the economy rather than
improve the economy.
Curiously, even with the double-digit
interest rate spread, Nigerian GDP growth had been adjudged to be the sixth fastest
growing economy in the world and the largest economy in Africa (after the
rebasing exercise) as it has grown at an average growth rate of 7 percent in
the last decade and half (Alemaychou, 2010). This is substantiated by the
available data which suggests that Nigeria had recorded increases in her
economy especially after the adoption of the Structural Adjustment Programme in
1986. For example, in 1987, the nation’s economic growth measured by the real
gross domestic product stood at N15,
263.93 billion and the economy was said to have positively grown steadily as
the real GDP increased to N 22, 449.41
billion in 1999. The nation’s economy was said to have continued on the
positive growth path as the real GDP increased to N 23, 688.28 billion in 2000 and this trend continued as the real
GDP reached N 35, 020.55 billion in
2004. Continuing in this trajectory, the nation’s real GDP continued to record
impressive growth as it increased to N
37, 474.95 billion in 2005. Years 2006, 2007, 2008, 2009, 2010, 2011, 2012,
2013, 2014 and 2015 were not different as the nation’s real GDP increased to N39,995.50 billion, N 42,922.41 billion, N
46,012.52 billion, N 49,856.10 billion,
N 54,612.26 billion, N 57,511.04 billion, N59,929.89 billion, N
63,218.72 billion, N67,152.79 billion
and N69,023.93 billion, respectively
(CBN, 2016). However, a negative growth path was recorded in 2016 as the
nation’s real GDP declined to N67,931.24 billion but this was quickly
reversed again as the real GDP grew to N68,496.92
billion in 2017 (CBN, 2017). On the part of banking sector, the story is not
the same as it is being argued that only 30.7 million out of 85 million
Nigerians above 18 years of age have access to formal financial services. Thus,
an estimated 54 million of Nigerians above 18 years of age are still unbanked
or have resorted to informal institutions for financial services (IIFInS,
2010). To reverse this ugly trend, the Nigerian government had adopted many
strategies and policies aimed at achieving increased financial activities as a
way of increasing the profitability of the banking sector. For instance, the
Central Bank of Nigeria (CBN) had over the years come up with several policies
such as promotion of financial literacy campaign, streamlining of transaction
charges, strengthening of the law against the issuance of dud cheque to mention
but a few. All these policies and strategies are aimed at increasing the
confidence of Nigerians in the banking sector which is expected to increase its
profitability. Although commercial banks in Nigeria might have recorded
seemingly impressive performance but with the high interest rate spread as
obtained in the Nigerian financial space, commercial banks in Nigeria have not
been able to achieve their full potentials in terms of profitability.
Based
on the seemingly impressive growth of commercial banks in Nigeria, in
particular, as detailed above and the contending arguments as to whether high
interest rate spread positively influences or does not positively influence
commercial banks’ profitability, it becomes necessary to investigate whether
the high interest rate spread obtained in Nigeria has any impact on commercial
banks’ profitability. This forms the basis for carrying out this study.
1.2 STATEMENT OF THE PROBLEM
Although
the commercial banks in Nigeria have played key role in the mobilization of
funds from the surplus sectors of the economy to the deficit sectors as a way
to increase economic growth in Nigeria and maintain adequate profitability from
their business, the Nigerian financial system has remained ill-equipped,
inefficient and incapable of competing favourably with other financial systems
in the advanced economies of the world. This has been attributed to interest
rate policy in Nigeria and high cost of operations in the banking industry
occasioned by infrastructural deficiencies such as poor electricity supply
(Enyioko, 2012; Essays, 2013). As a result of this, lending rate has remained
high while savings deposit rate has not appreciated thereby leading to high
interest rate spread among commercial banks in Nigeria. This unfortunate
scenario has rendered borrowers and even savers alike mere “price-takers” in
the market such that as the interest rate spread increases, the cost of
borrowing increases, investors become wary of borrowing from the banks thereby
reducing commercial banks’ lending activities and profitability and this leads
to reduction in private investments potentials of the country (Obidike, Ejeh and
Ugwuegbe, 2015).
Having
realized that, impressive performance of the banking sector, in general, the
banking sector of Nigeria has not been operating at their full potentials; the
government has made efforts to enhance the ‘ease of doing business’ so as to
further boost sectoral performance (including banking sector performance) in
Nigeria. However, it has been argued that the efforts of the government would
amount to nothing if the interest rate spread in Nigeria continues to remain
high. As at 1981, the interest rate spread stood at 1.75 percent and the
single-digit interest rate spread remained in place until 1988 at 2.00 percent.
A double-digit interest rate spread was first recorded in Nigeria in 1989 with
the interest rate spread rising to as high as 10.40 percent. The difference
between the lending rate and savings deposit rate (interest rate spread)
assumed both single-digit and double-digit figures in the periods after 1989
but from 1998 the interest rate spread became completely double-digit as it
went up to 12.80 percent and remained within the double-digit threshold in all
the other years that followed as it reached a high rate of 13.55 percent in
2016 (CBN, 2016).
Previous studies such as Eke, Adetiloye,
Adegbite and Okoye (2014); Obidike et al,
(2015); Owusu-Antwi, Banerjee and Antwi (2017); and Musah and Anokye (2018) investigated
impact of interest rate spread on the performance of commercial banks. They had
varying results and findings. For instance, Eke et al (2014), found interest rate spread to have exerted
insignificant impact on commercial banks’ profitability while Obidke et al (2015), Owusu-Antwi et al (2017) and Musah et al (2018), found that interest rate
spread had significant effect on commercial banks’ profitability. However,
majority of previous studies such as Mujeri and Younus (2005), Novati (2010),
Banda (2010), Akinlo and Owoyemi (2012), Aikoli (2013), Nampewo (2013), Were
and Wambua (2013), Chelangat (2014), Aregu (2014), Njeri, Ombui and Kagiri
(2014), Churchill, Kwaning and Ababio (2014), Sheriff and Amoako (2014),
Wanjirumaina (2015), Achille (2016), Ibrahim (2016), Aremon, Kaburu and Ntam
(2017), Al Shubiri and Jamil (2017), Nabende (2018), and Mwamtambulo and Ntulo
(2018), investigated the determinants of
interest rate spreads in commercial banks. Among the factors found to be the
significant determinants of interest rate spread of commercial banks included
interest rate on deposit, non-interest income/total assets ratio, market bank
size share, statutory reserve requirements, non-performing loans (NPLs),
operating costs, inflation rate, gross domestic product, M2/GDP ratio
(financial deepening), discount rate, exchange rate, credit risk, treasury
bills rate, business risk, risk aversion and liquidity ratio. In all these
previous studies, emphasis was restricted to the determinants of interest rate
spread of commercial banks. With these previous studies, effect of interest
rate spread on the profitability of commercial banks was inconclusive. To fill
this gap, this study would specifically aim at investigating impact of interest
rate spread on commercial banks’ profitability in Nigeria, in the main. Again,
it has been the general belief within the Nigerian banking sector community and
researchers on financial issues that a wide spread between lending and deposit
rate has discouraged depositors from depositing their money in banks because
interest rate on deposit is small thereby hindering banks from mobilizing
adequate deposits that would be available as credit to Nigerian borrowers and
investors for investment purposes in the Nigerian investment environment. This
has posed a serious problem calling for attention. On the other hand, low
patronage of banks by borrowers due to high lending rate charged by banks have
reduced commercial banks’ business activities and as a result, it has reduced
their profitability. This is also begging for investigation to ascertain if
bank interest rate spread has negatively affected banks profitability or not.
These knotty issues have formed the need or motivation for the present study. By
the time the study is completed the researcher shall be in a position to
ascertain if interest rate spread in Nigeria has had a negative or positive
effect on commercial banks profitability in the Nigerian economy.
1.3 OBJECTIVES OF THE STUDY
The
broad objective of this study is to determine impact of interest rate spread on
bank profitability in Nigeria. The specific objectives of the study are:
(i) To
investigate the impact of interest rate spread on commercial banks’
profitability in Nigeria.
(ii) To
ascertain effect of interest rate spread on commercial banks’ performance in
Nigeria.
(iii)
To ascertain influence of
broad money supply on commercial banks’ profitability in Nigeria.
(iv) To
determine to what extent cash reserve ratio has influenced profitability of
commercial banks’ in Nigeria.
(v) To
determine to what degree inflation rate has impacted on the commercial banks’
profitability in Nigeria.
(vi) To
appraise to what magnitude non-performing loans have influenced the performance
of commercial banks’ in Nigeria.
(vii)
To analyze to what extent
bank size has impacted on commercial banks’ profitability in Nigeria.
1.4 RESEARCH QUESTIONS
The
present research is designed to address the following research questions.
(i) To
what extent does interest rate spread impact on the profitability of commercial
banks’ in Nigeria?
(ii) How
does interest rate spread influence performance of commercial banks’ in
Nigeria?
(iii)
To what degree does broad money supply
influence commercial banks’ profitability in Nigeria?
(iv) To
what extent does cash reserve ratio influence profitability of commercial
banks’ in Nigeria?
(v) To
what degree does inflation rate influence profitability of commercial banks’ in
Nigeria?
(vi) To
what magnitude does non-performing loans influence commercial banks’
performance in Nigeria?
(vii)
What is the impact of
bank size on commercial banks’ profitability in Nigeria?
1.5 HYPOTHESES
In
an attempt to investigate the impact of interest rate spread on commercial bank
profitability and its performance in Nigeria, this study was guided by the
following hypotheses;
(i)
Ho1: Interest
rate spread does not have a positive and significant impact on profitability of
commercial banks’ in Nigeria.
(ii)
Ho2: Interest
rate spread does not have a positive and significant effect on the performance
of commercial banks’ in Nigeria.
(iii)
Ho3: Broad
money supply does not have a significant influence on commercial banks’
profitability in Nigeria.
(iv)
Ho4: Cash
reserve ratio has no significant influence on profitability of commercial banks
in Nigeria.
(v)
Ho5: Inflation
rate has not significantly impacted on profitability of commercial banks’ in
Nigeria.
(vi)
Ho6:
Non-performing loans do not have a positive and significant influence on performance
of commercial banks in Nigeria.
(vii)
Ho7: Bank size
has not significantly impacted on commercial banks’ profitability in Nigeria.
1.6 SCOPE OF THE STUDY
This
study covers the period 2003 to 2017. The year 2003 is considered as the base
year for the study in order to capture the adoption of the year-on-year
interest rate policy regime in 2005. The Central Bank of Nigeria (CBN) adoption
of the year-on-year interest rate regime in 2005 marked the beginning of
quarterly review of the monetary policy rate (MPR) as against the traditional
monetary policy regime (which was used before 2005) which anchored the monetary
policy rate (MPR) on the 12 month moving average rate of inflation. The year
2017 is considered the end period for the study in order to accommodate the current
realities as it concerns interest rate spread in Nigeria. The conceptual scope
of the study interest rate spread, bank profitability and return on assets.
Interest rate spread is however decomposed into interest rate spread, gross
domestic product, broad money supply, cash reserve ratio, non-performing loans,
inflation and bank size.
1.7 SIGNIFICANCE OF THE STUDY
Interest
rate spread do influence directly or indirectly the decisions of depositors and
borrowers operating in domestic as well as international environment. This
study is therefore significant to the following:
1.7.1
The government
This study
will enhance the knowledge of government on how monetary policy rate which
drives the interest rate, spread impacts on the lending activities of the
commercial banks’ in Nigeria. This will enable the government (through
the Central Bank) to
make policies that will enhance the lending abilities of the commercial
banks through either by narrowing or increasing the interest rate spread. Where the
interest rate spread has devastating impact on economic growth, the government
would lower the monetary policy rate to reverse the negative implication and
vice versa.
1.7.2
The academia
This study will help other academicians,
researchers and scholars in formulating research questions and hypotheses that
would guide their study. Literature generated in the study will also help them
develop appropriate literature framework and theoretical framework for their
study as this study adds to the body of knowledge on the extent to which
interest rate spread impacts on the commercial banks’ profitability in Nigeria.
1.7.3 Commercial banks
This study will further broaden the
knowledge of commercial banks in Nigeria on the implications of increasing the
lending rate (thereby widening interest rate spread) and how it affects the
profitability of the commercial banks, in Nigerian context. This is against the
backdrop that the lending rate in Nigeria has largely been on the increase and
has led to widening of the interest rate spread which may lead to increase or
decrease in the profitability of commercial banks’ in Nigeria.
1.8 LIMITATIONS OF THE STUDY
This
study is constrained by the bank-specific nature of some of the variables such
as profit after tax, return on assets, bank size and non-performing loans.
Profit after tax, Return on assets, bank size and non-performing loans of
commercial banks in Nigeria vary from one bank to another bank which makes the
availability of an aggregate data on these variables dearth. With the dearth of
data on these variables, it becomes difficult to carry out the study within the
specified (chosen) period.
1.9 OPERATIONAL DEFINITION OF TERMS
The
under-listed terms are defined in the study in the context in which they are
used by the researcher:
(i)
Interest
Rate Spread: This refers to the difference between
the lending rate charged on loans granted by the commercial banks and the
deposit rate paid by the commercial banks on the deposits mobilized from
customers on annual basis.
(ii)
Broad
Money Supply: This refers to the volume of money in
circulation made up of cash, checking deposits, saving deposits, money market
securities, mutual funds and other time deposits. Thus, in this study, broad
money supply refers to M2 comprising M1 and “near moneys”.
(iii)
Inflation
Rate: This refers to the general increase in the
prices of goods and services in an economy on annual basis.
(iv)
Exchange
Rate: This refers to the amount at which the
Nigerian Naira exchanges for the American dollar on annual basis.
(v)
Maximum
Lending Rate: This refers to the highest interest
rate that could be charged by the banking sector (commercial banks) on loans and
advances granted to its customers.
(vi)
Maximum
Deposit Rate: This refers to the highest interest
rate that could be paid to the commercial banks’ customers by commercial banks
for deposits made by such customers.
(vii)
Deficit
Sector: This refers to any sector in the economy
where there is scarcity of investible funds.
(viii) Deposit Mobilization: This
refers to the ability of the commercial banks to attract and collect deposits
from their customers.
(ix)
Monetary
Policy Rate: This refers to the baseline interest
rate pegged by the Central Bank of Nigeria upon which all other interest rates
are determined.
(x)
Central
Banks: This refers to all apex banks on whose
shoulders the control and regulation of commercial banks (Deposit Money Banks)
rest upon.
(xi)
Domestic
Investments: This refers to all investments made
by the citizens of Nigeria within Nigeria.
(xii)
Economic
Growth: This refers to the year-on-year growth in
the gross domestic product in Nigeria.
(xiii) Financial Repression: This
refers to the existence of little or low financial activities which undermines
economic activities and negates economic growth.
(xiv) Savings Mobilization: This
refers to the ability of commercial banks to attract savings deposit from their
customers.
(xv)
Gross
Domestic Product: This refers to the value
of goods and services produced within a country such as Nigeria.
(xvi) Financial System: This
refers to all the financial institutions that operate within an economy.
(xvii) Commercial Bank
Profitability: This refers to the financial
performance of the banking sector in Nigeria measured by the return on assets
of commercial banks in Nigeria.
(xviii) Bank Size: The
ratio represent the ownership of assets by bank. High asset ownership enables
bank to offer more financial services at a low cost.
(xix) Cash Reserve Ratio: This
refers to the minimum percentage of deposit that a commercial bank must keep
with the central bank as stipulated by the Central Bank of Nigeria.
(xx)
Liquidity
Ratio: This refers to the ratio between the
liquid assets and the liabilities of a commercial bank.
(xxi) Non-performing Loan: This
refers to any loan on which the borrower neither makes interest payments nor
repays the capital.
(xxii) Credit Risk: This
refers to risk associated with the possibility that a borrower will fail to
meet its obligations with regards to the loan repayment terms.
(xxiii) Bank Performance: A
theoretical and empirical framework for the analysis of profitability,
competition and efficiency. Performance of banks, expressed in terms of
competition, concentration, efficiency, productivity and profitability.
(xxiv) Regulatory Spread:
The difference between bank lending rate and regulatory authority monetary
policy rate.
(xxv) Transaction Spread: The
difference between banks’ lending rate and banks deposit rate.
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