EFFECT OF BANKING REGULATION ON THE PERFORMANCE COMMERCIAL BANKS IN NIGERIA

ABSTRACT

This study examines the effect of Banking Regulation via capital adequacy ratio and monetary policy variables on the performance of commercial Banks operating in Nigeria during 2000-2016. The monetary policy tools considered for the study were monetary policy rate and liquidity ratio, while profitability of commercial banks was measured by their return on assets (ROA). The data used for the study was Time series secondary data sourced from Nigeria Deposit Insurance Corporation Annual Report and Central Bank of Nigeria Statistical Bulletins. The data used for the study was analyzed with multiple regression analysis. The findings revealed that capital adequacy ratio and monetary policy rate had a positive and significant effect on commercial banks profitability while the effect of liquidity ratio was negative and insignificant. Hence, it was recommended among other things that Central Bank of Nigeria should maintain the policy rate at a level so that commercial banks would concentrate on their profitability by charging lower interest rate and providing handsome return to depositors.

TABLE OF CONTENTS

Title Page                                                                                                                                i

Declaration                                                                                                                             ii

Certification                                                                                                                           iii

Dedication                                                                                                                              iv

Acknowledgements                                                                                                                v

List of Tables                                                                                                                          viii

Abstract                                                                                                                                  ix

CHAPTER ONE

INTRODUCTION

1.1       Background of the Study                                                                                            1

1.2       Statement of problem                                                                                                 3

1.3       Objectives of the study                                                                                               5

1.4       Research Questions                                                                                                    5

1.5       Research hypothesis;                                                                                                  5

1.6       Significance of the study                                                                                            6

1.7       Scope of the study                                                                                                      6

1.8       Limitations of the study                                                                                              7

CHAPTER TWO

LITERATURE REVIEW

2.1       Conceptual Framework                                                                                              8

2.1.1    Concept of Regulation                                                                                                8

2.1.2    Reasons for the Regulation of Nigerian Banks                                                          11

2.1.3    The Concept of Capital Adequacy                                                                              12

2.1.4    Concept of monetary policy in Nigeria                                                                      17

2.1.5    Instruments of Monetary Policy                                                                                 20

2.1.6    Objectives or Goals of Monetary Policy:                                                                   24

2.1.7    The Concept of Financial Performance                                                                      25

2.2       Theoretical Framework                                                                                              26

2.3       Empirical Review                                                                                                       30

CHAPTER THREE

RESEARCH METHODOLGY

3.1       Research Design                                                                                                         37

3.2       Area of study                                                                                                              37

3.3       Sources of Data Collection                                                                                         37

3.4       Validity and Reliability of the instrument                                                                  38

3.5       Analysis Techniques                                                                                                   38

3.6       Model Specification                                                                                                   38

3.7       Description of variables                                                                                             39

3.7.1   Dependent variable                                                                                                      39

3.7`.2  Independent variables;                                                                                                    39

CHAPTER FOUR

PRESENTATION OF DATA, ANALYSIS AND DISCUSSION

4.1       Presentation of Data                                                                                                     40

4.2       Data Analysis and Discussion of Results                                                                     41

4.2.1    Descriptive Statistic                                                                                                  41

4.2.2    Regression Analysis                                                                                                   42

4.2.2.1  Discussion of Results and Hypotheses Testing                                                            43

CHAPTER FIVE

SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATIONS

5.1       Summary of Findings                                                                                                 46

5.2       Conclusion                                                                                                                  46

5.3       Recommendations                                                                                                      47

REFERNECES

APPENDIX

LIST OF TABLES

Table 4.1:        Aggregate data used for the analysis (2000 to 2016)                                     40

Table 4.2:        Descriptive Statistic                                                                                       41

Table 4.3:        Regression Results (Dependent variable, return on assets)                                     42

CHAPTER ONE

INTRODUCTION

1.1          Background of the Study

The intermediation role of banks can be said to be a catalyst for economic growth and development as investment funds are mobilized from the surplus units in the economy and made available to the deficit units. In doing this, banks provide an array of financial services to their customers. As a result of these sensitive activities of gathering of deposits and allocation of credits, banks are vulnerable to liquidity problems and loss of public confidence, (Soludo, 2004).

Beyond their intermediation functions, the performance of financial institutions and banks has significant implications for economic growth. Sound financial performance rewards the stakeholders for their investments and encourages additional investments. On the other hand, poor banking performance may result in banks’ failure and collapse which may also affect/hamper the economic growth of the country. According to Ezike and Oke (2013) due to the nature of banking and the crucial role of banks in capital formation, banks should be looked at more closely. Like in its developed  counterparts this was also one of the key functions of the Central Bank of Nigeria  (CBN)  which  led  to  banks’  consolidation  in  2004 (CBN, 2010).

Regulation of banks has been defined as a body of specific rules or agreed behavior either imposed by government or other external agency, or self imposed by explicit or implicit agreement within the industry that limit the activities and business operations of banks. Regulation is also defined as an administrative rule issued by an organization used to guide, control, direct the conduct of members of that organization. Banking regulation could come in various form. It could be in form of effecting changes in the capital base of banks to ensure capital adequatecy, effecting changes in monetary policy variables to monitor bank credit and avoid excess lending by banks which could hamper it's existence if not recovered, conducting on site and off site examination to ensure banks are carrying out operation in accordance with the laid down rules and regulations stipulated by the Regulatory authorities, all these changes in no doubt affect bank's performance (Ezike and Oke, 2013).

The study however centered on the use of monetary policy variables and capital adequacy ratio by the CBN to control, direct credit supply and also ensuring capital adequacy of banks. Capital adequacy ratio (CAR) is basically the proportion of the bank's tier1 and tier2 equity as a proportion of its risk weighted assets (loans). It is the proportion of a banks own equity in relation to its risk exposure. However, the capital adequacy ratio of banks in Nigeria currently stands at 10% and 15% for national/regional banks and banks with international banking license respectively. Basel Accord demand that banks should maintain a minimum capital adequacy ratio of 8% of risk-weighted assets. On the other hand, commercial banks is the avenue through which the monetary authorities like the CBN regulate the credit/money supply. The Central Bank defines money supply in two ways: narrow and broad money. Narrow money (M1) is defined to include currency in circulation plus current account deposits with commercial banks. Broad money measures the total volume of money supply in the economy and is defined as narrow money plus savings and time deposits with banks including foreign denominated deposits. These changes in no doubt adopted by the Central Bank of Nigeria in one time or the other in the course of regulation exercise, such as the increase of capital base of commercial banks in Nigeria from 2billion in 2000 to 25billion in 2004/2005 to ensure capital adequacy of banks and the change in monetary policy rate from 12% in 2012, to 14% in 2016, however, affect banks performance either positively or negatively. However, whether these changes significantly affect banks performance or not is a matter of investigation.

1.2       Statement of problem

Financial system are prone to periods of instability. In recent years, a number of financial crisis around the world (Southeast Asia, Latin America and Russia) have brought about a large number of bank failures. Some argue that this suggest a case for more effective regulation and supervision. Others attributes many of these crises to the failure of regulation. Advocates of the so-called free banking argue that the financial sector would work better without regulation, supervision and central banking .In the absence of government regulation, they argue, banks would have greater incentives to prevent failures. One of the earliest theories about regulation developed by economist George Strigler, contends that firms in regulated industries actually seek out regulation because it brings benefits in the form of monopolistic rents due to the fact that regulations often block entry into the regulated industry. Thus, some financial firms may lose money if regulation are lifted because they will no longer enjoy protected monopoly rents that increase their earnings. Edward Kane has argued that regulations can increase customers confidence, which in turn, may create greater customer loyalty toward regulated firms. When a country’s banks experienced major financial setbacks, usually the stakeholders such as the public, depositors, markets and the regulator –Central Bank will have to respond. The aim of the intervention is to prevent bank distress/failure. The setbacks are in terms of profitability, loans, deposits and continuous flow of liquidity to various sectors of the economy for the banks to maintain their role as engine of economic growth and development. The responses are that the public will tend to lose confidence not only in the affected banks but in the entire banking system. For example, depositors of affected banks may rush to withdraw their money for fear of loss and quest for safety. Other banks, that is, those that are not affected will equally experience the bank run/rush and the markets will make it very difficult for the banks to raise funds. The response by the regulatory authorities could take the form of either recapitalization to ensure capital adequacy or effecting changes in monetary policy variables to regulate money supply and limit excessive lending by banks. Financial problems in a banking system can cause great damages to a country if not timely and properly addressed, given its role as finance provider to other sectors of the economy and its ability to create liquidity. Banks do not operate in a vacuum, they operate within the framework of monetary and banking policies provided by the regulatory authority. Nigeria has over the years employed these policy, that is monetary and recapitalization policy at one time or the other to regulate and control capital adequacy and credit supply of banks. It is in no doubt that all these regulation moves significantly affects banks performance.

In view of this scenario, the basic problem to tackle by this research is to examine the effect of banking regulation through recapitalization and monetary policy on the performance of commercial banks in Nigeria ranging from the period of 2000-2016.

1.3       Objectives of the study

The broad objective of this study is to examine the effect of banking regulation on the performance of commercial banks in Nigeria ranging from the period of 2000 - 2016.

The specific objectives are;

        i.         To ascertain the effect of Capital adequacy ratio on banks profitability.

      ii.         To determine if Liquidity Ratio has a significant effect on banks profitability.

    iii.         To ascertain if Monetary Policy Rate has a significant effect on banks profitability.

1.4       Research Questions

        i.         To what extent does capital adequacy ratio affect banks profitability

      ii.         To what extent does liquidity ratio affect banks profitability?

    iii.         To what extent does monetary policy rate affect banks profitability?

1.5       Research hypothesis;

The following hypothesis were formulated to guide the study;

HO₁:     The capital adequacy ratio has no significant effect on banks profitability.

HO₂:   The liquidity ratio has no significant effect on banks profitability.

HO₃:   The monetary policy rate has no significant effect on banks profitability

1.6       Significance of the study

The purpose of this study is to examine the effect of banking regulation via monetary policy variables and capital adequacy ratio on the performance of commercial banks in Nigeria. However, the research work will be of interest and useful to :

1.    Regulatory and Supervisory authorities: It will provide a platform for the regulatory and supervisory authorities such as CBN and NDIC to appreciate the effect of their activities on commercial banks and underscore areas for improvement.

2.    Banking sector: The banking sector will be better improved by consummating the findings and recommendations from the study in stemming down the incidence of bank failure arising from fraud, non adherence to regulatory measures and poor management.

3. Students and Depositors: They will be well exposed on the various monetary and recapitalization policies available to bank regulators and how each influences the performance of commercial banks in particular and the economic growth in general. It will also be useful to undergraduates of management and related courses and potential researchers in this area.

1.7       Scope of the study

The research work will focus on the effect of banking regulation via monetary policy variables and capital adequacy ratio on the performance of commercial banks in Nigeria from the year 2000 - 2016. The scope is limited to commercial banks and not the entire banking system in Nigeria.

1.8       Limitations of the study

Inability to access vital information: One of the major problems which the researcher encountered was her inability to have access to some information and materials that would adequately guide her in this work, certain information was difficult to be obtained.

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