ABSTRACT
This study evaluates the bank specific characteristics and profitability of listed deposit money banks in Nigeria. It also sought out to ascertain the relationship between bank size, credit risk, diversification and return on asset of listed deposit money banks in Nigeria. Basically the data used for this research was sourced from Nigeria stock exchange fact book and published annual report of bank as at December, 2019. All collected data were analyzed statistically using descriptive statistics, correlation matrix, ordinary least square regression technique. The result of the research shows that there is significant relationship between the bank size, credit risk, diversification and return on asset of listed deposit money banks in Nigeria. The study concluded that bank size negative impact on the return of asset and credit risk also has negative impact on return of assets and diversification also has a negative impact on return of asset of the listed deposit money banks in Nigeria. The study recommends that banks should take appropriate measures to increase the level of returns to yield more profit.
TABLE OF CONTENTS
Contents
Title Page - - - - - - - - - - i
Declaration - - - - - - - - - - ii
Certification - - - - - - - - - - iii
Dedication - - - - - - - - - - iv
Acknowledgements - - - - - - - - v
Abstract - - - - - - - - - - vii
Table of Contents - - - - - - - - - viii
CHAPTER ONE: INTRODUCTION
1.1
Background
to the Study - - - - - - - 1
1.2
Statement
of the Problem - - - - - - - 6
1.3
Research
Questions - - - - - - - 8
1.4
Objective
of the Study - - - - - - - 8
1.5
Research
Hypothesis - - - - - - - 9
1.6
Scope
of the Study - - - - - - - 9
1.7
Significance
of the Study - - - - -
- - 10
CHAPTER TWO: LITERATURE REVIEW
2.1
Introduction - - - - - - - - - 11
2.2
Concept
of Profitability - - - - - - - - 11
2.2.1 Bank-Specific characteristics and
profitability - -
- - 12
2.2.2 Bank-Size and Profitability- - - - - - - 12
2.2.3 Loan Ratio and Profitability - - - - - - 14
2.2.4 Credit Risk and Profitability - - - - - - - 15
2.2.5 Deposit Ratio and Profitability - - - - - - 17
2.2.6 Loan Loss Provision Ratio and Profitability- - - - 19
2.3 Industry Specific Determinants- - - - - - 20
2.4 Empirical Literature Review - - - - - - - 23
2.5 Conceptual Framework - -- - - - - - 29
2.6 Theoretical Framework - - - - -- - - 32
2.6.1 Structure Conduct Performance Theory- - - - - 32
2.6.2 Market Structure Theory - - - - - - - 33
2.6.3 Banking Efficiency Theory - - - - - - 35
2.6.4 Signaling Theory- -- - - - -- - - 36
CHAPTER THREE: RESEARCH METHODOLOGY
3.1
Introduction - - - - - - - - - 37
3.2
Research
Design - - - - - - - - 37
3.3
Population
of the Study - - - - - - - 37
3.1 Population of the Study Table - - - - - - - 38
3.4
Sampling
Size and Technique - - - - - - 38
3.2 Sample of the Study Table - - - - - - - 39
3.5
Sources
and Method of Data collection - - - - 39
3.6
Technique
of Data Analysis - - - - - - - 39
3.7
Variables
Measurement- - - - - - - - 40
3.8 Model Specification - - - - - - - 40
CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS
4.1 Introduction - - - - - - - - - 41
4.2 Descriptive
Statistics - - - - - - - - 41
4.1
Descriptive Statistics Table - - - - - - 41
4.3
Correlation Matrix - - - - - - - - 43
4.2
Correlation Matrix of the Dependent and Independent Variables Table- 43
4.4
Summary of Regression Result - - - - - - 44
4.3
Summary of Regression Result Table - - - - - 44
4.5 Test
of Hypotheses - - - - - - - - 45
4.6 Summary of Findings - - - - - - - 46
4.7 Policy Implication of Findings - - - - - - 46
CHAPTER FIVE: SUMMARY, CONCLUSIONS AND
RECOMMENDATIONS
5.1 Summary
- - - - - - - - - - 47
5.2 Conclusions - - - - - - - - - 48
5.3 Recommendations - - - - - - - - 49
References - - - - - - - - 50
Appendix- - - - - - - - - - 67
CHAPTER ONE
INTRODUCTION
1.1
Background to the Study
Bank profitability is an
important ingredient of financial development, at the firm level, a higher
return to a large extent reduces bank fragility. At the macro level, increased
profitability makes for a sustainable banking sector that can finance economic
growth and development. However, due to the intermediation role of the banking
system, higher returns may imply higher interest rates on loans. This informs a
reason why monetary authorities are always poised to regulating the banking
system. Increased regulations and counter deregulations have encouraged
competition in the banking sector, and hence exposed banks to increased
fragility. For example between 1990 and 2004, bank regulators have increased
the minimum share capital of banks operating in Nigeria five times (Uche,
2017). These reforms were all aimed at improving the balance sheet,
profitability and stability of banks in Nigeria, even though the outcomes
sometime differ from expectations.
Policy makers have often
resorted to increasing the minimum share capital to fix an imminent shortfall
in bank balance sheet, with the conviction that bank fragility is often allayed
by a strong capital base. This assertion has been supported by evidence;
whether there is a correlation between equity and profit margin has been widely
discussed in the literature (see Berger, 2015). Unfortunately, many country
level studies have relied more on bank-specific determinants, while ignoring
the influence of macroeconomic factors on bank profitability. If bank profits
are re-invested, it becomes a major source of equity capital and therefore
promotes stability. On the other hand, weak economic performance promotes the
deterioration of credit quality, and increases the probability of loan default
(Flamini, 2018). There have been increasing scholarly debates on the direction
of policy to effectively ensure the performance of the banking sector. Whilst
some scholars have argued that bank profitability is enhanced by the
improvements in the internal organization and managerial efficiency of the bank
itself, others argue that industry wide factors are integral to the
profitability of banks. In recent times, the direction of literature has shown
that macroeconomic factors also play significant role in determining bank
profitability. In this paper the ultimate goal is to explore the determinants
of bank profitability in a developing economy such as Nigeria: whether bank profitability
is determined by bank specific variables, industry related factors and/or
macroeconomic variables. Banking
industry provides the financial dealings necessary for economic developments.
The operations of deposit money banks are required for the real sectors to
operate and conduct businesses in the economy. Thus, the operations of deposit
money support the activities of the real sector of the economy. As a result,
regulatory and supervisory agencies are charged with the responsibility of
ensuring the regulation and management of the banking industry. A well-managed
banking industry guarantees a sound banking and payment systems and indicates
effectiveness in the monetary system of a nation.
The Nigerian banking
sector has witnessed a series of reforms aimed at stabilizing the banking
environment. A stable banking environment in Nigeria is required to attain high
operational efficiency and raise the profitability level of the deposit money
banks. A higher profitability level in the banking industry shows the path to
long-run survival of operating banks in the industry. Other parties that have
stake in the banks also show concern on the profitability of the operating
banks. Investors look at current and potential profits to guide their
investment decisions. Creditors and other suppliers of finance who are
concerned about working capital, liquidity, and solvency consider also the
potentials for continuing profitability.
Bank profitability
correlates with credit risk. This is because banks operate in an environment of
considerate risks and uncertainty. Credit risk is of concern because the risks
of a customer not fulfilling his obligations in full on due date can seriously
jeopardize the affaires of the banking business. Credit risk management in
banks is, therefore, necessary and essential corporate function (Ndoka and
Islami, 2016). For credit risk management to be effective, its policy must
maximize a bank’s risk adjusted rate of return by maintaining credit risk
exposure within acceptable limits. Maintaining the credit risk exposure has to
be for the entire portfolio as well as the risk in individual credits and
transactions.
Profitability in the
banking industry also correlates with bank size. Bank size plays an important
role in determining the level of activities of the bank within its functional
atmosphere and external environment. Size of a bank plays vital role in
competing through cost reduction and utilization of opportunities (Gatete,
2015). Again, the size of a bank can determine the level of its profitability.
When larger banks have a greater control of the domestic market and operate in
a non-competitive environment, lending rates remains high while deposit rates
remains low because they are perceived to be safer.
Banks have good reason to
believe profitability and size are related. Increasing bank size can increase
profitability by allowing banks to realize economies of scale. Thus, increasing
size allows banks to spread fixed costs over a greater asset base, thereby
reducing average costs. Furthermore, as the scale of operation increases, bank
uses specialized inputs such as loan officers with expertise in a particular
business line, resulting in greater efficiency.
Profitability in banks is also correlated with
diversification. Diversification is one
of the important strategies used in banks as financial institutions. Banks
strategically diversify credit portfolio in order to increase their
profitability and reduce the credit portfolio risk; investments in loan
screening and monitoring is, thus, necessary to minimize credit risks. Hence, Adzobu, Agbloyor, and
Aboagye (2017) suggest the need for banks to perform a careful assessment of the effects
of their lending policies geared towards increased sector diversification on
their monitoring efficiency and effectiveness. Profit is arguably the most
important motivation for doing business. The level of profit a firm can
reasonably make is driven largely by external influences as well as how the
internal mechanisms of the business entity are able to convert those influences
to opportunity for its advantage. Profitable banks are able to attract capital
investments easily and at lower cost, whereas less profitable banks find it
difficult to attract capital investment; and when they do, it is at a
prohibitive cost. Therefore, profit certainly has significant effect on the
ease and cost of raising capital [Rumler & Waschiczek, 2010). The importance of having a profitable banking
system cannot be overemphasized. One important role that banks play is in
transforming savings into investment for sustainable economic growth and
development. Therefore, developments in the banking sector are not only of
concern to the banks alone but to the whole economy. Efficient and profitable
banks are able to catalyse economic activities and development better than
non-profitable ones. Also, banks serve as financial intermediaries by taking
deposits from the surplus side of the economy and transforming them into
credits for the deficit side. Bank regulators in Nigeria increased the minimum
share capital of banks more than five times between 1990 and 2004 (Aburime
& Uche, 2008). The essence of these policies was to improve the stability
and profitability of banks, albeit with some unintended consequences. Sometimes
these regulations when implemented during periods of economic downturn can
disrupt the environment of banking, consequently affecting banks’ capacity to
remain profitable. The environment of
banking in Nigeria has been fraught with major macroeconomic shocks since the
post July 2004 National Economic Empowerment and Development Strategy (NEEDS)
programme which seeks amongst other things to, re-capitalize loan to total
assets ratio and total assets) on banks’ profitability. It also intends to
analyse the impact of banking industry concentration on banks’ profitability.
Given the fact that profitability plays a significant role in the
existence and operations of banks; the need to empirically examine the impact
of bank-specific characteristics on the profitability of deposit money banks in
Nigeria is necessary particularly that the Nigerian banking sector has
undergone series of reforms recently.
1.2 Statement of the Research Problem
Despite the vital roles
that profitability plays in the life of the banking industry, the profitability
status of deposit money banks in Nigeria in relation to credit risk, bank size,
and diversification have not attracted the much desired attention of the
regulatory authorities in Nigeria. This may be attributed to lack of thorough evaluation
of the bank-specific characteristics that plays important roles in profit
realization and overall profitability level of operating banks in Nigeria.
The empirical studies on
the impact bank-specific characteristics on profitability of banks concentrated
on developed economies (Dietrich &
Wanzenried,2011; Menicucci &
Paolucci, 2016; Anbar & Alper, 2011;
Ali, Akhtar, & Ahmed, 2011; Pervan, Pelivan, & Arnerić, 2015; Kundid,
Škrabić, & Ercegovac, 2011; Bouheni, Ameur, Cheffou, & Jawadi, 2014;
Maredza, 2014; Davydenko, 2011; Karakuza, 2017; Thota, 2013; Haliti, Ahmeti,
& Rudhani, 2016) whose results may not necessarily be applicable to the
economic and financial environments of Nigeria.
In Nigeria, the
empirical studies on the impact of bank-specific characteristics on
profitability of banks exists (Aburime, 2008; Osuagwu, 2014; Adeusi, Kolapo,
& Aluko, 2014; Obamuyi, 2013; Sayedi, 2014; Babalola, 2012; Aminu, 2013).
These studies, however, fail to capture the relevance of bank diversification
in the determination of the profitability of deposit money banks in
Nigeria. Most of the studies also fail
to recognize the relevance of bank size in their analysis.
The failure to include
diversification in their analysis is considered grossly inadequate. It is
against this backdrop that there is the need to empirically examine the impact
of bank – specific characteristics on the profitability of deposit money banks
in Nigeria.
1.3 Objective
of the Study
The main objective of
this study is to examine the impact of bank–specific characteristics on the
profitability of deposit money banks in Nigeria. And the specific objective are
to;
i.
examine the effect of
credit risk on profitability of deposit money banks in Nigeria;
ii.
examine the effect of bank
size on profitability of deposit money banks in Nigeria; and
iii.
examine the effect of
diversification on profitability of deposit money banks in Nigeria.
1.4 Research Hypotheses
The following hypotheses
were formulated in null form to guide the study.
i.
Ho1: there is no significant relationship between
credit risk and profitability of deposit money banks in Nigeria.
ii.
Ho2: there is no significant relationship between bank
size and profitability of deposit money banks in Nigeria.
iii.
Ho3: there is no significant relationship between
diversification and profitability of deposit money banks in Nigeria.
1.5 Scope of the Study
This study is conducted
to assess the impact of bank-specific characteristics on profitability of
deposit money banks in Nigeria. Only bank-specific characteristics are
considered. The characteristics are credit risk, bank size, and
diversification. The study will cover
five (5) years period from 2016 to 2020. The study five (5) years period
covered by the study is deemed long enough to provide adequate and wide range
of data required to impact of bank specific characteristics and profitability
of the listed deposit money banks (DMBs) in Nigeria.
1.6 Significance
of the Study
The result of this study
will be useful to managers in the sector. The results would assist management
in profitability assessment and improvements as resources would be channeled to
factors that have significant and positive impact on profitability. The
beneficiaries of this study are the investors and the stakeholders, the benefit
that will be achieved if the study gain acceptance is increase in bank capital
which will also reduce losses incurred
and increase in interest rate.
The result from this
study would enable investors to identify potential profitable banks in relation
to the variables considered so as to measure the profitability of different
portfolios and aid in overall investment decisions.
The result from this
study would enable effective policy makings since the study will aid the policy
makers in measuring the implications of the policies on profitability
especially as it relates to the variables considered.
Finally, the results
from this study would contribute to literature on the impact of bank-specific
characteristics on profitability of deposit money banks in Nigeria.
1.7 Historical Background of the Area of Study
First
Bank of Nigeria Plc dated back to 1894 when it was founded and incorporated as
a limited liability company on 31st March 1894 under the corporate name of the
bank of British West Africa (BBWA). At that time, it operation was in Lagos but
had its head office in Liverpool. The bank worked closely with the colonial
government to the extent of performing the traditional functions of a Central
Bank in the West Africa sub-region. As at year end 2009, the First Bank of
Nigeria Plc had a network of 558 branches throughout the federation. It had the
largest branch network in The industry and is considered by a significant
number of Nigerians as the safest bank in the country.
·
Vision
"To
be the clear leader and Nigeria's bank of first choice"
·
Mission
"To
remain true to our name by providing the best financial services possible"
·
Objectives:
i.
To revolutionize the Bank’s operations in
line with the dynamics of the operating environment;
ii.
To strengthen the bank’s brand, leverage
and upscale the customer’s experience; and
iii.
To project First Bank as sophisticated and
dynamic.
iv.
Having been around for over a century, we
realized there was the need to refocus and energize our brand in response to
contemporary realities of the business environment.
The
Bank is divided into four business units:
i.
Retail and Corporate Banking: offering a
range of retail, personal, commercial and corporate banking services and
products Investment and Capital Market Operation: offering investment and capital
market services, as well as provides registrar services to both listed and
private companies
ii.
Asset Management and Trusteeship: provides
individuals and financial institutions with assets management and advisory
services
iii.
Mortgage Banking: offers mortgage and home
ownership banking services to individuals and corporate institutions
Other
activities include insurance brokerage functions, private equity and venture
capital, as well as bureau de change business functions. First Bank of Nigeria
PLC operates through its 12 subsidiaries, including FBN Bank (UK) Limited, FBN
Capital Limited and First Trustees Nigeria Limited and others.
1.8 Definition of Key Terms
These are some terms use
in the write-up, which, I feel deemed to explain to the readers of the project
work, they are listed below.
Credit
Risk: Credit risk is the possibility of a loss resulting
from a borrower's failure to repay a loan or meet contractual obligations.
Traditionally, it refers to the risk that a lender may not receive the owed
principal and interest, which results in an interruption of cash flows and
increased costs for collection.
Deposit:
A deposit is a financial term that means money held at a bank. A deposit is a
transaction involving a transfer of money to another party for safekeeping.
However, a deposit can refer to a portion of money used as security or
collateral for the deli very of a good.
Deposit Ratio:
The loan-to-deposit ratio is used to assess a bank's liquidity by comparing a
bank's total loans to its total deposits for the same period. To calculate the
loan-to-deposit ratio, divide a bank's total amount of loans by the total
amount of deposits for the same period.
Loan: The term loan refers to a type of
credit vehicle in which a sum of money is lent to another party in exchange for
future repayment of the value or principal amount.
Loan
Ratio: The loan ratio is a financial term used by lenders to
express the ratio of a loan to the value of an asset purchased. In Real estate,
the term is commonly used by banks and building societies to represent the
ratio of the first mortgage line as a percentage of the total appraised value
of real property.
Profitability:
Profitability is defined by Wiyono & Sari Rahmayuni (2012) as the major
source of capital income that measures the corporate performance to express the
competitive position of banks in the banking market and quality management.
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