ABSTRACT
There are increasing scholarly debates on the direction of policy to effectively improve the performance of commercial banks in Nigeria. Some scholars argue that bank performance is enhanced by improvements in the internal organization and managerial efficiency while others argue that industry wide factors are integral to bank performance. In recent times, the direction of literature has shown that macroeconomic factors play a significant role in determining bank profitability. This paper investigates the determinants of bank profitability in the light of bank specific variables and macroeconomic influences, using a panel of selected banks that account for over 60% of total bank assets in Nigeria. Findings show that bank profitability is largely determined by bank size, non interest income, expenses management and inflation for both internal organization of banking firms and external variables. Based on our findings we recommend bank’s management should effectively pursue policies that will enhance their balance sheet with regards to both internal organization and external influences.
TABLE
OF CONTENT
Title
Page i
Declaration
ii
Certification iii
Dedication iv
Acknowledgments v
Table of contents vi
List of Tables vii
Abstract viii
CHAPTER 1: INTRODUCTION
1.1 Background
to the Study 1
1.2 Statement
of the Problem 2
1.3 Objectives
of the Study 6
1.4
Research Questions: 7
1.5
Research Hypotheses 8
1.6
Scope of the Study 9
1.7 Significance of the Study 10
1.8 Limitations
of the Study 10
CHAPTER 2: REVIEW OF RELATED LITERATURE
2.1 Conceptual
Framework 11
2.1.1 Bank
performance indicators 12
2.2 Theoretical
Framework 16
2.2.1
Market structure theory and bank profitability 16
2.2.2
Structure conduct performance (SCP) hypothesis 17
2.2.3
Porter’s approach to resource base view (RBV) 19
2.2.4
An overview of the Nigerian financial system 22
2.2.5 Macro
economic reforms and policies in Nigerian banking industry 27
2.2.6 Global banking industry 34
2.2.7 The
determinants of commercial banks profitability 35
2.2.8
Bank specific factors/internal factors 36
2.2.9 Capital
adequacy 37
2.2.10 Credit
risk 39
2.2.11 Size
of deposit liabilities 39
2.2.12 Loans and advances 40
2.2.13 Expense management 41
2.2.14 Efficiency and productivity 42
2.2.15 Non-interest income 43
2.2.16 State of information technology (IT) 43
2.2.17
Bank size 44
2.2.18
Company-level determinants of bank profitability in Nigeria 45
2.2.19 External
factors/ macroeconomic factors 45
2.2.20 Growth
domestic product (GDP) 46
2.2.21 Interest rate policy 46
2.2.22 Exchange rate
(EXCH) 47
2.2.23 Inflation
rate (INF) 48
2.3 Empirical Review 49
2.4 Literature Gap 57
CHAPTER 3: MATERIALS AND METHODOLOGY
3.1
Research Design 58
3.2 Population of the Study 58
3.3 Method of Data Analysis 58
3.4 Model
Development 60
3.5 Model Specification 60
3.6 Description of Research
Variables 63
3.6.1. Dependent variables 64
3.7.2 Independent variables 65
3.7 Panel Unit Root 68
3.8 Regression Analysis 69
3.9 T-Statistic 70
3.10 Test
for Overall Significance of the Regression Model 71
3.10.1 Durbin-Watson Statistic
(DW) 71
CHAPTER 4: DATA PRESENTATION, ANALYSIS AND
INTERPRETATION
4.1 Presentation of Data 72
4.2 Data Analysis 77
4.3 Descriptive Statistics 77
4.4 Test of Hypotheses 80
4.4.1 Model equation one (1) selection 81
4.4.1.2 Model equation one (1) goodness of fit and
interpretation 82
4.4.1.3 Model equation One (1) specific variables
estimates interpretation 83
4.4.1.4 Test of the hypothesis 1 83
4.4.2 Model equation (2) internal variables selection 85
4.4.2.1 Hausman
test. 87
4.4.2.2 Model equation (2) goodness of fit and interpretation 88
4.4.2.3 Model equation (2)
specific variables estimates interpretation 89
4.4.2.4 Test of the hypothesis model equation (2) 89
4.4.3 Model equation (3) internal variables
selection 90
4.4.3.1 Model equation (3) goodness of fit and
interpretation 91
4.4.3.2 Model equation (3) specific variables estimates
interpretations 92
4.4.3.3 Test of
the hypothesis for model equation (3) 93
4.4.4 Model equation (4) external variables
selections 94
4.4.4.1 Model
equation (4) goodness of fit and interpretation 95
4.4.4.2 Model
equation (4) specific variables estimates interpretations 96
4.4.4.3 Test of
the hypothesis for model equation (4) 96
4.4.5 Model equation (5) external variables
selection 97
4.4.5.1 Model equation
(5) goodness of fit and interpretation 99
4.4.5.2 Model equation (5) external variables estimates
interpretations 99
4.4.5.3 Test of the hypothesis for model equation (5) 100
4.4.6 Model equation (6) external variables
selection 101
4.4.6.1 Model equation (6) goodness of fit and
interpretations 102
4.4.6.2 Model equation (6) external variables
estimates interpretations 103
4.4.6.3 Test of
the hypothesis for model equation (6) 103
4.5 Discussion of Results 104
4.5.1 Return on asset 104
4.5.2 Return on equity 105
4.5.3 Net interest margin 107
CHAPTER 5: SUMMARY, CONCLUSION AND RECOMMENDATIONS
5.1 Summary of Findings 111
5.2 Conclusion 112
5.2 Recommendations 113
5.4 Suggestions for Further Study 114
References 115
Appendices 124
LIST OF TABLES
4.1: Dataset on determinants of profitability of commercial banks in
Nigeria 73
4.2
Computed results of the descriptive statistics Nigerian commercial
Banks (2005-2015) 78
4.3:
Relationship between internal factors and banks’ performance (ROA) in Nigeria 80
4.4: The
Haussmann test for model equation 1 81
4.5: Effects of internal
factors on the performance (ROA) of banks in Nigeria 84
4.6 Relationship
between internal factors and banks’ performance (ROE) in Nigeria 85
4.7 The Hausman
test for model equation (2) 87
4.8 Relationship
between internal factors and banks’ performance (NIM) 90
4.9:
The Hausman test for model equation (3) for NIM 91
4.10: Effects of
internal factors of Nigerian banks on net interest margin 93
4.11
Relationship between external factors and banks’ performance (ROA) 94
4.12: The Hausman test for model equation (4) 95
4.13
Relationship between external factors and banks’ performance (ROE) 97
4.16: The
Haussmann test for model equation (5) 98
4.15: Relationship between external factors and
banks’ performance (NIM) 101
4.16: The
Haussmann test for model equation (6) 102
CHAPTER 1
INTRODUCTION
1.1 BACKGROUND TO THE STUDY
The Nigeria banks serve as the pillar of the economic as it plays an
important financial intermediary role; therefore, its health is very critical
to the health of the general economy at large. In the last twenty years there
has been a rapid decrease in the number of banks in Nigeria from 89 to 23, and
this has fostered rapid competitiveness among commercial banks in the country.
In the global world of business and finance, the task of each bank
operating is to make more profit which is a major indicator of performance is
becoming a challenge on a daily basis. In order for an organization like
commercial banks to operate optimally, it has to be able to measure its
profitability with regards to its inputs and outputs. Interestingly, most
organizational units are yet to come to terms with this indisputable fact
largely due to ignorance.
Hence, the primary goal of a bank’s management is to achieve a
profit, as the essential requirement for conducting any business (Bobáková,
2003). At the macro and micro-levels, a sound and profitable banking sector is
better able to withstand negative shocks and contribute to the stability of the
financial system. The importance of bank
profitability at both the micro and macro levels has made researchers,
academics, bank managements and bank regulatory authorities to develop
considerable interest on the factors
that determine bank profitability (Athanasoglou, Brissimis and Delis 2005).
The Federal Government of Nigeria (FGN) and the Central Bank of
Nigeria (CBN) have perennially sought permanent measures that would enhance the
profitability and stability of banks operating in the Nigerian banking industry
but this has not yielded any positive results. For instance, a financial sector
reform of 1987-1991 which was intended to enhance competition in the sector and
lead to a more efficient allocation of resources were implemented, and measures
to enhance prudential regulation and tackle bank distress (Oluranti, 1991).
Also, between 1990 and 2004, bank regulators increased the minimum share
capital requirement for banks operating in Nigeria five times, namely in 1991,
1997, 2000, 2001 and 2004 (Aburime and Uche, 2008). However, these measures were
unsuccessful in curtailing the spate of bank distress and failures in the 90s
and beyond (Uche, 1998.).
1.2 STATEMENT OF THE PROBLEM
The banking reform in Nigeria in 2005 that led to increase in minimum
shareholder funds from Two billion naira( N2b)
to Twenty five billion naira (N25b)
in shareholders led to reduction in number of banks from 89 to 25 due to merger
of banks who were unable to raise require capital. The new increase bank’s
capital fund N25b led to increase in bank’s shareholders who demand for adequate
return on their investment. To meet shareholders expectation banks increased their
lending rates without much regards to their asset quality, liquidity and the
efficient use of resources that will result in cost minimization.
According to Osuagwu, (2014), Bank profitability is an important
ingredient of financial development, its relevance spans through banking firm
performance to macroeconomic stability. 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 (Aburime and
Uche, 2008). 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, 1995a). 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,
McDonald and Schumacher 2009) 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 argued 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 study, 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, and/or macroeconomic
variables.
According to Haruna, 2013 the banking sector in particular is part
of immune and repair system of an economy and successful operation of the
industry can set energy for other industries and the development of an entire
economy. To do so the banking industry is expected to be financially solvent
and strong through being profitable in operation. Hence, not only measuring the
financial performance of banks but also clear insight about determinants of
profitability in the sector is then the problem to be investigated.
Over the years, the wellbeing, growth and successful operation of commercial
banks has attracted the interest of different academic researchers, managers,
economists and other professionals. This is cardinal since identifying the key
success factors of commercial banks financial performance allows for designing
well- informed policies that might significantly improve the overall
performance of the sector.
A number of studies have examined the determinants of banks
performance in many countries around the globe. For instance, Almazari (2013),
Almumani (2013), among others. Although a lot of studies and literature which
examined the determinants of banks financial performance exist, these studies
showed different and even contradictory
results. For instance, the impact of capital on profitability is seriously
being debated among researchers. This is because while positive relationship
had been found by studies of Ommeren (2011), other studies found a negative
relationship between capital and profitability (Vallelado and Saona, 2011), Ali, Akhtar, and Ahmed, 2011). The capital adequacy risk poses
great challenges to banks in Nigeria. This is because the first and second round stress test conducted
by Central Bank of Nigeria discovered that ten capitalized banks were in serious risk problem due to inability of
their balance sheet to absorb shocks associated with intermediary functions
they played in the economy. In line with the mixed findings on the relationship
between capital adequacy and profitability and the stated problem, this study
is set to fill the gap by examining capital adequacy and profitability of banks
in Nigeria by extending the period to 2015, this raises a question whether
capital adequacy is among the determinants of the financial performance of banks in Nigeria.
Despite the fact that there are many risks that affect financial performance of
banks , but for the purpose of this
study credit risk was considered most significant risks taking cognizance of banks intermediation activities in which
income generated from it is expected to significantly contribute to the profitability of banks. Credit
risk management has a significant impact on the profitability of Nigerian banks
(Kargi, 2011, Hassan and Bashir, (2003), Miller and Noulas (1997), Ramlall (2009),
Vong and Chan (2009) and Sinha and Sharma (2015) found a negative relationship
between credit risk and profitability. While Sufian, (2011) found a positive
significant relationship between credit risk and profitability. The mixed
findings could be attributable to different techniques of analysis adopted by
the researchers, difference in the period, policies and environments within
which the studies is conducted. Therefore, the question still remain that to what extent does credit risk predicts
financial performance of banks in Nigeria.? Inefficiency of banks manifest in
multifarious forms with adverse implications for the growth prospect of the banking system,
ranging from inability to effectively perform the intermediation role, high cost of
transactions and resultant inability for private investors to access loanable funds, financial crisis and the
eventual loss of confidence in the banks due to financial distress. All these will negatively affect financial
performance of banks in Nigeria. Studies on the cost income ratio and
profitability of banks are observed to be conducted in both developed and
developing economies. The studies of Flamini, McDonald and Schumacher (2009),
Hager and Wael (2011) found positive correlation between cost income ratio and
profitability. On the other hand, studies of Syafri (2012), Zeitun (2012) and
Almazari (2013), found negative effect of cost income ratio on profitability
and most of the studies on the cost income ratio and profitability stopped at
2010. The present study therefore will fill the gap by widening and extending
the period up to 2015.
In light of the above, the results from previous studies had not
been consistent in all respect and findings were mixed in some cases. It is on
this premise that a research carried out to the existing body of knowledge by
empirically examining the extent to which determinants significantly affect
financial performance of banks in Nigeria. At the end of the study, it would
enable the researcher to ascertain the true position of affairs in the Nigeria
banking environment.
1.3 OBJECTIVES OF THE STUDY
The general objective of this study is to examine the effect of bank-specific
and macroeconomic determinants on Nigerian commercial banking industry profitability
over the period 2005 – 2015 and to identify the significant determinants of
profitability. Specifically, it seeks to:
1.
Analyses the effect of capital adequacy on financial performance
of commercial banks in
Nigeria,
2.
Examine the effect of credit risk on financial performance of commercial banks in Nigeria,
3.
Evaluate the impact of bank
size on financial performance of commercial banks
in Nigeria,
4.
Determine the effect of customer deposit on
financial performance of commercial banks in Nigeria,
5.
Assess the influence of loans
and advances on financial performance of commercial banks in Nigeria.
6.
Examine the effect of total asset
on financial performance of
commercial banks in Nigeria
7.
Determine the effect of expense management on financial performance of commercial
banks in Nigeria
8.
Evaluate the effect of Inflation
on financial performance of
commercial banks in Nigeria
9.
Examine the effect of Interest rate
on financial performance of
commercial banks in Nigeria
10. Assess the influence of
Gross Domestic product Growth rate management on financial performance of commercial
banks in Nigeria
11. Analyze the effect of Exchange Rate on financial performance of commercial
banks in Nigeria
1.6
RESEARCH QUESTIONS:
In the study, the following research questions are set;
1.
To what extent does capital
adequacy affect financial performance of banks in Nigeria?
2.
What is the nature of influence
credit exert on financial performance of banks in Nigeria?
3.
Of what magnitude does bank
size have impact on financial performance of banks in Nigeria?
4.
To what degree does loan and
advances has influence financial performance of banks in Nigeria?
5.
In what degree do customer’s
deposit, impact on financial performance of banks in Nigeria?
6.
Do total assets have any
significant impact on financial performance of banks in Nigeria?
7.
How has expense management
ratio impacted on financial performance of banks in Nigeria?
8.
In what direction does
inflation rate impact on financial performance of banks in Nigeria?
9.
How has bank interest rate
impacted on financial performance of banks in Nigeria?
10. Does gross domestic product growth rate have any significant impact
on financial performance of banks in Nigeria?
11. How does exchange rate affect financial performance of banks in
Nigeria?
1.7
RESEARCH HYPOTHESES
In order to achieve the objective of the study, a number of
hypotheses were tested regarding the determinants of profitability in Nigeria
commercial banks based on different empirical research and theoretical reviewed
made. There are two general testable hypotheses with their sub hypothesis.
These testable hypotheses could be formulated as follows:
H01: Capital adequacy has no significant effect on
financial performance of banks in Nigeria.
H02: Credit risk has no significant effect on financial performance of banks
in Nigeria.
H03: Bank size has no significant effect on financial performance of banks
in Nigeria.
H04: loan and advance has no significant effect on financial
performance of Banks in Nigeria.
H05: Expense management has no significant effect on financial performance
of banks in Nigeria.
H06: customer’s deposit has no significant effect on financial performance
of Banks in Nigeria.
H07: Non-interest income has no significant effect on financial
performance of Banks in Nigeria.
H08: Total asset has no significant effect on financial performance of Banks
in Nigeria.
H09:
Gross Domestic Product growth has no significant effect
on financial Performance of banks
in Nigeria.
H010: Inflation growth has no significant effect on financial performance of Banks in Nigeria.
H011: Exchange rate has no significant effect on financial performance of Banks in Nigeria.
H012: Interest rate has no
significant effect on financial
performance of Banks in Nigeria.
1.6 SCOPE OF THE STUDY
This study undertakes to research into the determinants of profitability
of commercial banks in Nigeria. The study concentrate on Nigerian commercial
banks and their activities from 2005-2015. The study selected 10 Nigeria
commercial banks out of 23 banks premised on availability of data, years of establishment,
market size, data expense and precision of results. The banks selected are: are
First Bank of Nigeria Limited, Zenith Bank Plc, Guaranty Trust Bank Plc, United
Bank for Africa Plc, Access Bank Plc, Stanbic IBTC, Skye Bank Plc, Sterling Bank,
Wema Bank Plc and Diamond Bank Plc.
1.7 SIGNIFICANCE OF THE
STUDY
The finding of this study
is expected to contribute practically and theoretically to various stakeholders
as well as provide a basis for policy formulation. In addition, this work is relevant
in the following ways:
(i)
In Nigeria, banks are key providers
of funds, and their stability is of paramount importance to the financial
system, as such an understanding of determinants of their profitability and the
drivers of bank profitability for that matter is essential and crucial to the
stability of the economy
(ii)
This study will helps the
regulatory authorities formulate future policies aimed at improving the
profitability of the Nigeria banking sector.
(iii)
It will enable business
managers operate at optimum efficiency to keep up with the growing demand of their
services.
(iv)
Contribution to the body of
knowledge especially in the areas of improving the Nigerian commercial banking
financial performances.
(v)
To improve the growth and
development of the economy due to sound banking system evolving.
(vi)
To serve as impetus for other banks
that are lagging behind
to understand.
1.8
LIMITATIONS OF THE STUDY
The availability of data
for all the banks for the period under review was a great challenge to the
researcher which led to reduction of sample banks to ten.
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