MONETARY POLICY AND PERFORMANCE OF DEPOSIT MONEY BANKS IN NIGERIA

MONETARY POLICY AND PERFORMANCE OF DEPOSIT MONEY BANKS IN NIGERIA

The main purpose of the study is to determine the effect of monetary policy on the performance of Deposit Money Banks in Nigeria.

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CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

The need for government intervention in the working of economic variables to achieve macroeconomic objectives have been long established, this dates back to the 1930s as a result of Keynes (1936) “General Theory of Employment, Money, and Interest”, in response to the Great Depression of 1936 in Great Britain. Other economists (Pigou, 1933; Schumpeter, 1947; Friedman, 1956; 1963; 1968) have posited other theories on how the government should intervene in the management of a country’s economic variables to achieve general equilibrium in the economy.

Monetary policy is one of the intervention measures which have the objective of promotion of economic growth and development, full employment, price stability (low level of inflation), a healthy balance of payment, exchange rate stability, and general economic stability. These objectives have recently been expanded by Mishra and Pradhan (2008) to include smoothing of the business cycle, prevention of financial crisis, and long-term stabilization of interest rates and real exchange rates. Monetary policy measures are usually administered on behalf of the government by the monetary authority, in Nigeria, which is the Central Bank. In the view of Abata, Kehinde, & Bolarinwa (2012) monetary policy is the tool being used by the monetary authority (central bank) for the control of money supply to achieve desired macroeconomic objectives. They see monetary policy tools as instruments at the disposal of the monetary authority, which help to achieve macroeconomic stability.

Anyawu (1993) opined that monetary policy involves a discretionary effort by the monetary authority (central banks) to control the money supply and credit conditions to achieve macroeconomic objectives.

In Nigeria, monetary policy is administered by the Central Bank of Nigeria (CBN). The CBN uses policy instruments: Open Market Operations (OMO), cash reserve requirements, liquidity ratio, monetary policy rate (MPR), and moral suasion to achieve the objectives of monetary policy.

Deposit money banks (DMBs) are institutions that act as financial intermediaries in the economy. They mobilized deposits from where there is surplus and give this out as loans to areas where there is a shortage. Consequently, DMBs have the potential to increase the money supply in the economy through their role in mobilizing financial resources from where there is surplus and giving it out as loans to those in need of financial resources for investments.

Monetary policy and the ability of banks to attract deposits and give out loans are linked together. According to Olokoyo (2011), the volume of loans DMBs gives out depends on many factors such as their liquidity ratio, interest rate, the volume of customers’ deposit, their investments (domestic and foreign), the customer’s prestige and public recognition. While Ajie and Nenbe (2010) contended that reserves of the DMBs are influenced by the Central Bank through its monetary policy instruments. Hence, the main purpose of this study is to examine the relationship between monetary policy and the performance of DMBs in Nigeria.

1.2 Statement of the Problem

Monetary policy is one of the principal economic management tools that governments use to shape economic performance. Measured against a fiscal policy, monetary policy is said to be quicker at resolving economic shocks. Monetary policy objectives are concerned with the management of multiple monetary targets among them price stability, promotion of growth, achieving full employment, smoothing the business cycle, preventing financial crises, stabilizing long-term interest rates, and the real exchange rate. Experience shows that emphasis is usually placed on maintaining price stability or ensuring low inflation rates.

The Central Bank of Nigeria is responsible for the recommendation and implementation of monetary policy tools in Nigeria. The CBN recommends the CRR, CBR, and Treasury bill rates. Those tools are implemented through deposit money banks and they are aimed at stabilizing the price levels in the economy. The use of cash reserve ratio affects the level of liquidity in the deposit money banks. When commercial banks are faced with limited liquidity, they turn to other deposit money banks for inter-bank borrowing. Those funds are borrowed at the CBR and it is usually very high, which affects the interest expense for the borrowing bank and the interest income for the lending bank. The other way to increase liquidity in the bank will be to borrow by floating a debt instrument. The rate offered for the debt instrument is also tied to the treasury bills or treasury bonds issued by the government through the Central Bank. These effects of the monetary tools are expected to affect the financial performance of deposit money banks.

Several research studies have been done about Deposit Money Banks in Nigeria: Gitonga (2015) studied the relationship between interest rate risk management and profitability of deposit money banks in Nigeria; Kimoro (2015) surveyed the foreign exchange reserves risk management strategies adopted by the Central Bank of Nigeria and Mbotu (2015) did a study on the impact of the Central Bank of Nigeria rate (CBR) on deposit money banks’ benchmark lending interest rates. Ongore and Kusa (2013) study examined the effects of bank-specific factors and macroeconomic factors on the performance of deposit money banks in Nigeria during the period from 2001 to 2010. Kiganda (2014) carried out a study on the effect of macroeconomic factors on the profitability of deposit money banks in Nigeria with a focus on Union Bank.

This study has identified a gap in the current literature and research concerning monetary policy and its effect on the financial performance of deposit money banks. The literature reveals that while there is much effort by the government to influence the money supply by instituting various policy tools, and analysis on the effects of those tools on deposit money banks’ financial performance, which are the most used channel of transmission of the policies, is inconclusive. This study will, therefore, be motivated to fill the knowledge gap on the effects of the various monetary policy tools on the financial performance of deposit money banks in Nigeria between 1980 and 2018.

Several researchers have studied the relationship between monetary policy and banks’ performance, (Punita and Somaiya, 2006; Van den Heuvel, 2006; Yonnus and Akita, 2009; Abdurrahman, 2010; Ajayi and Atanda, 2012; Akanbi and Ajagbe, 2012; Enyioko, 2012; Olweny and Chiluwe, 2012; Ekpung, Dude, & Uwalaka, 2015; Ndugbu and Okere, 2015; Udeh, 2015; Onodugo, Okoro, Amujiri, & Onodugo, 2016; Ndubuaku, Ozioma, Chiaka, & Onyemere, 2017). However, none of these researchers considered the trend and pattern of monetary policies and financial performance of deposit money banks in Nigeria while looking, at the same time, the effect of monetary policy on the financial performance of deposit money banks. The objective of this study is to examine the nature, trend, and pattern of selected monetary policy instruments, trend, and pattern of the financial performance of money deposit banks (MDBs) and the effect of monetary policy on the financial performance of deposit money banks in Nigeria between 1980 and 2018.

1.3 Purpose of the Study

The main purpose of the study is to determine the effect of monetary policy on the performance of Deposit Money Banks in Nigeria. The specific objectives are as follows:

1. To determine the effect of Monetary Policy Rate (MPR) on the Return on Assets (ROA) of Deposit Money Banks in Nigeria.
2. To investigate the effect of Cash Reserve Ratio (CRR) on the Return on Assets (ROA) of Deposit Money Banks in Nigeria.
3. To examine the effect of Liquidity Ratio (LR) on the Return on Assets (ROA) of Deposit Money Banks in Nigeria.

1.4 Research Questions

The following research questions are formulated to guide the study.

1. Does Monetary Policy Rate (MPR) have any effect on Return on Assets (ROA) of Deposit Money Banks in Nigeria?
2. Does Cash Reserve Ratio (CRR) have any effect on Return on Assets (ROA) of Deposit Money Banks in Nigeria?
3. Does Liquidity Ratio (LR) have any effect on Return on Assets (ROA) of Deposit Money Banks in Nigeria?

1.5 Research Hypotheses

Given the above objectives and research questions, this study evaluates the following hypotheses:

H_O1: There is no significant relationship between the Monetary Policy Rate (MPR) and the Return on Assets (ROA) of Deposit Money Banks in Nigeria.

H_A1: There is a significant relationship between Monetary Policy Rate (MPR) and the Return on Assets (ROA) of Deposit Money Banks in Nigeria.

H_O2: There is no significant relationship between Cash Reserve Ratio (CRR) and the Return on Assets (ROA) of Deposit Money Banks in Nigeria.

H_A2: There is a significant relationship between Cash Reserve Ratio (CRR) and the Return on Assets (ROA) of Deposit Money Banks in Nigeria.

H_O1: There is no significant relationship between Liquidity Ratio (LR) and the Return on Assets (ROA) of Deposit Money Banks in Nigeria.

H_A1: There is a significant relationship between Liquidity Ratio (LR) and the Return on Assets (ROA) of Deposit Money Banks in Nigeria.

1.6 Significance of the Study

The study helps us understand the impact of an effective monetary policy regime on the performance of the Deposit Money Banks. It would aid the regulators to carefully plan and forecast the effects of its policies to meet its objectives of economic growth and full employment. To bankers, it would expose the relationship existing between our relevant variables, which will be of interest to them in their respective banks. This would also benefit the academic community which would avail them the opportunity of conducting further research on the topic of similar areas.

The study is expected to contribute to the existing literature in the field of monetary policies. Future scholars can use this research as a basis for further research in the area of monetary policy theories.

The study will also enlighten management teams of a commercial bank on the short-term and long-term effects of the monetary policy implementations by the Central Bank. This will greatly help them in designing the risk management measures to employ given anticipated changes in monetary policies.

1.7       Definition of Terms

1.7.1    Cash Reserve Ratio (CRR)

This refers to the proportion of total deposit liabilities that the commercial and merchant banks are expected to keep as cash in vaults and deposits with the Central Bank of Nigeria.

1.7.2    Deposit Money Banks (DMBs)

Deposit Money Banks are commercial banks that accept deposits from their customers, give loans to their customers, and derive profit from the difference in the interest rates paid and charged to depositors and borrowers respectively.

1.7.3    Financial Performance (FP)

Financial Performance analysis refers to analytical tools to measure the strength and weaknesses of a firm about its balance sheet and profit and loss statement. Examples of bank financial performance tools and ratios include operating income, earnings before interest and taxes, Total Asset value. Financial performance analysis is carried out to ascertain the profitability position and performance of a firm. Management, owners, creditors, or investors can conduct it.

1.7.4    Liquidity Ratio (LR)

This refers to the proportion of total deposit liabilities that the commercial and merchant banks are expected to keep as liquidity. Liquidity is the ability of a bank to meet its current obligations when they are due and is normally a short-term debt measure

1.7.5    Monetary Policy (MP)

Monetary policy refers to the measures taken by the Central Bank to regulate and control the supply of money and credit in an economy to achieve some desired macroeconomic policy objectives and to counter all undesirable inflationary trends in the economy.

1.7.6    Monetary Policy Rate (MPR)

Minimum Rediscount Rate (MRR) now known as Monetary Policy Rate (MPR) is the rate at which the central bank provides loan accommodation to commercial banks.

1.7.7    Return on Assets (ROA)

ROA measures the relationship of net income to a firm’s total assets. It reveals the ability of a firm in utilizing its assets to gain a net profit.

1.8  Limitations of the Study

This study focuses on the effect of monetary policy on the performance of deposit money banks (DMBs) in Nigeria for over 38 years (1980 – 2018).

The study will cover the following variables: monetary policy Rate (MPR), cash reserve ratio (CRR), liquidity ratio (LR), and return on assets (ROA).

1.9  Organization of the Study

The research project is structured as follows: Chapter one provides the research background, statement of the study, objectives of the study, research questions, research hypotheses, and significance of the study, scope, limitations, and organization of the study. Chapter two provides the literature review in terms of theories supporting the study, the empirical review as well as the conceptual framework. Chapter three presents the methodology of the study which gives information on the research design, target population, data collection instruments, and data analysis. Chapter four comprise of data analysis, presentation, and interpretation. Chapter five constitute the discussion, conclusion, and recommendation of the study.