PRIME LENDING RATE AND AVERAGE LENDING RATE IN NIGERIA

PRIME LENDING RATE AND AVERAGE LENDING RATE IN NIGERIA

This study is set out to investigate the determinants of the prime lending rate and the average lending rate in Nigeria.

CHAPTER ONE: INTRODUCTION

Background of the Study

Over the past decades, the Nigerian government has been faced with the task of improving the general welfare of the Nigerian populace and ensuring inclusive growth where a greater number of Nigerians become partakers in the spoils of total output growth. The call for this has been severe in the last four years as the Nigerian economy slipped into recession for the first time since the return to democratic rule, in 2016 following the record of consecutive growth rate in her gross domestic product (a measure of economic growth) in two quarters as reported by the National Bureau of Statistics and the rising level of poverty as the reports by the Brookings Institution in 2018 revealed that Nigeria is the World Poverty Capital, haven overtaken India, with 87 million Nigerians living in extreme poverty and unable to afford $1.90 per day.

Long before the masterpiece written by Adam Smith in 1776 and entitled The Wealth of Nations, individuals have sort or traded ideas over the less stringent, shortest, and straightest route to prosperity and general welfare, with such argument without end.

Greenspan (2008) argued that three cardinal characteristics influence the growth of which the quality of the country’s institution that makes an economy work ranks second. The workability of an economy depends on institutions like financial institutions. The conduct of productive, investing, consumption activities depends on capital midwife by the financial institution through their intermediation role. Business investment has been identified from time immemorial as a stimulator of growth and general welfare. However, individuals with the need for capital are expected to pay a token different from the primary amount borrowed for use of credit provided by commercial banks termed interest rate.

Over the years, the interest rate in Nigeria has been managed by the monetary authority as a monetary and credit policy tool aimed at inflation control, investment inducement, and economic growth. The interest rate is the price paid for the use of money. It is the opportunity cost of borrowing money from a lender. It is an important economic price determined by various factors and useful in gauging financial market conditions.

The direction and magnitude of changes in market interest rate are primarily important to policymakers as it determines the growth path of the economy. The role and effect of interest rate are possible due to the link between the financial sector and the real sector of the economy, for example, the lending rate which translates into a cost of capital has direct implications for investment. The behavior of interest rate determines investment activities and hence economic growth of a country. Banks as intermediaries mobilize funds from surplus spending units to deficit spending units of the economy through deposit acceptance and in turn, channel them into productive economic activities. The extent to which this is done lies in the interest rate which in turn determines economic growth (Uchendu, 1993).

According to Omole & Falokun, (1999), interest rate policy is among the emerging issues in current economic policy in Nigeria given the role it is expected to play in a deregulated economy by inducing savings which can be a channel to investment and thereby increasing employment, output, and efficient financial resource utilization. Also, interest rates can have a substantial influence on the rate and pattern of economic growth by influencing the volume and disposition of saving as well as the volume and productivity of investment (Tayor, 2004).

Oresotu (1992) explained the functions of interest rates in which people decide whether to borrow, invest, save, and/or consume as:

• A consumption deferment due to incentives gotten from financial assets by savers.
• The interest rate as a component of the cost of capital affects the demand for and allocation of the loanable fund.
• The domestic interest rate in conjunction with the rate of return on foreign financial assets and goods are hedged against inflation.

The interest rate in Nigeria could be examined under two regimes; the regulated period characterized by a fixed rate and the deregulated period (SAP era) where the interest rate is freely determined by market forces of demand and supply.

Before 1993, a regime of the direct control of interest rates was adopted in Nigeria, most especially between 1974 and 1992. In this period, interest rate policy was driven by considerations of promoting overall investment and channeling credit to identified priority sectors (Nnana, 2001). However, many policy analysts contended that this practice promotes inefficiency and corruption in the system, as credit funds accessed for use in the priority sectors are often diverted to other sectors rendering the policy objective ineffective. Moreover, fixing interest rates in a regime where inflation rates are high and volatile, is more or less providing dis-incentives for investments. It was against this background, that a new policy framework focused on the deregulation of interest rates, the year 1993, the interest rate was very volatile and unduly high, to the extent that Monetary Policy Rate (MPR) was was adopted towards the tail end of 1992. However, in 26%, Treasury Bill Rate (TBR) stood at 26.80%, while other savings rates float between 28.2 – 23.6%: the highest rates in the period 1970 to 2008. In 1994, due to the high volatility of interest rates, the government decided to fix the MPR at 13.5%, TBR 12.5%, and other savings rates reacted to this shock as they declined to a range of between 13 and 14.27% from their 1993 position (CBN 1994). The cap on interest rate adopted in 1994 was lifted in October 1996 and a flexible interest rate regime largely determined by the forces of supply and demand for funds was put in place and this has remained so, since the late 1990s to date (CBN 2007). However, the problem has been that the market-based approach to interest rate management in Nigeria, has always been associated with substantial interest rate volatility (CBN 2006), calling to question the overall desirability of the strategy. A considerable number of studies (Omole and Falokun, 1999; Ojo, 2000; Nnanna, 2002; Adebiyi and Babatope-Obasa, 2004; Olakah and Oyaromade, 2007) have examined the problem and have identified domestic factors such as inflation, growth in equity and exchange rates as key factors explaining interest rate variability in Nigeria. However, most of these studies were largely descriptive, while those that employed econometric techniques did not take into consideration statistical properties of the series, as they relate to stationarity of the individual series and co-integration among linear combinations of the series, before applying the least square techniques in estimating their models. However, the problem has been that Nelson and Plosser (1982) and many other recent studies have shown that most economic series are not stationary, while Granger and Newbold (1974) had earlier reported that application of least square regression to equations containing non-stationary series results in spurious regression. They emphasized further that while coefficient estimates from such a model may appear to be of correct signs and magnitudes, deeper investigations often reveal flaws; meaning that standard inference procedures do not apply to regression models that contain non-stationary series.

Evidence from studies of interest rate determination in other climes, also suggests the need to examine the influence of external factors such as interest rates in other countries and the degree of openness of an increasingly deregulated economy like Nigeria. For example, Edwards and Khan (1995) in a study of the behavior of nominal interest rates in a small semi-open economy (Columbia), found evidence that the differentials between domestic nominal interest rates and world interest rates plus expected devaluation would lead to a higher domestic rate of interest. They also reported that excess supply of real money exerted significant negative pressure on nominal interest rates. On his own, Gochoco (1991) reported that the relative importance of domestic versus external factors in determining the domestic nominal interest rate depends on the degree of openness of the capital account. He noted that when capital flows are unrestricted, the domestic interest rate would be determined by the external factors via the uncovered interest parity relationship. If, however, the capital account was completely closed, the domestic interest rate would be determined predominantly by domestic conditions via the Fisher effect.

Statement of Problem

The Nigerian economy has been growing at an average rate of 6-7 percent in the last several years, and this growth rate is considered to be below potential given the enormous human, material, and natural resource endowments of the economy. The recent rebasing of the economy has further revealed the potentials of many sectors and provided a clearer picture of the growth potentials of the economy. In particular, the services sector is seen as a major driver of growth contributing about 50 percent of GDP. In the context of stimulating the economy, it is imperative that the availability, accessibility, and affordability of financing under a favorable interest rate regime would play a catalytic role in unleashing the growth potentials of the economy.

Interest rate developments in the economy in the last 5 years indicate that the problem of high lending rates, against the background of declining deposit rates, poses a key challenge to financial intermediation. The persistence of this problem had been observed by the Monetary Policy Committee in several communiques, particularly following the onset of the global financial crises of 2007/08, and the ensuring measures are taken to address liquidity challenges in the Banking system. Over, the last 5 years, lending rates have remained positive in real terms. The average maximum lending rate has hovered around 23 -26 percent. Similarly, the prime lending rate ranged between 16 -19 percent, given an average year-on-year inflation rate of 9.0 percent during the period.

Savings rates have largely remained negative in real terms. The average savings deposit rate between 2009 and 2014, was 2.13, percent while the 3-months deposit rate was 8.4 percent, indicating negative real rates. Deposit rates, however, marginally increased into the positive territory following the increase in CRR on public sector deposits in the third quarter of 2013. The tight monetary policy forced banks to offer remunerative rates to mobilize private sector deposits. Notwithstanding, the emerging picture shows persisting high lending rates, declining deposit rates, and the widening of the interest rate spread. This indicates inefficiencies in the intermediation process, attributable to infrastructure issues reflected in the high cost of mobilizing deposits, perverse incentives offered by the availability of cheap public sector deposits, rising credit risks reflected in high Non-Performing Loan (NPL) ratios, the paucity of investment outlets and high demand for treasury securities for liquidity management, and the underdeveloped capital markets.

The interest rate dynamics are also affected by the maturity structure of DMB deposit liabilities. Over the period, 2007- 2012, about 75 percent of DMB deposits are those maturing within 30 days, and a further 20 percent would mature in less than 360 days. Overall about 96 percent of DMB deposit liabilities in the Nigerian banking system would mature in less than one year, thereby constraining the ability of banks to make longer tenured loans. Given the underdeveloped corporate bonds market, the credit needs of the economy are met through a banking system characterized by short-term deposits. Accordingly, the pressure on credit particularly from the large corporate sector is likely to put upward pressure on the bank’s lending rates, and widen interest rate spreads.

In the past, several steps were taken to address the problem of high lending rates, and access to credit in Nigeria. These measures included the introduction of various development finance schemes and interventions by the Central Bank of Nigeria, including the Agricultural credit guarantee Scheme fund (ACGS) in 1978, Interest rate drawback program in 2002, the Commercial Agricultural Credit Scheme (CACS), Small and Medium Enterprises Equity Investment Scheme (SMEIS) in 2001, and the Microfinance policy in 2004. In 2010, the Bank, injected N500 billion as a special intervention fund under a quantitative easing program to ensure the flow of liquidity to the real economy at reasonable interest rates.

These measures were complemented by interventions to manage interbank liquidity and the use of treasury securities. Despite these measures, the phenomenon of high lending rates persists as reflected in the complaints of manufacturers, industrialists, and SME operators who consistently identify high lending rates as a key contributor to unfavorable business and investment climate in Nigeria. There is, therefore, clearly the need to revisit this problem to account for the persisting high lending rates, and to determine the interest rate thresholds beyond which growth and employment could be hampered.

Aim and Objectives of the Study

This study is set out to investigate the determinants of the prime lending rate and the average lending rate in Nigeria. The specific objectives of this include the following;

1. To examine the impact of the gross domestic product on the prime lending rate in Nigeria
2. To determine the influence of the broad money supply on the prime lending rate in Nigeria
3. To determine if alignment exists between the treasury bill rate and prime lending rate in Nigeria
4. To investigate if gross domestic product impacts on the average lending rate of commercial banks in Nigeria
5. To investigate the relationship between broad money supply and average lending rate in Nigeria
6. To examine the influence of the treasury bill rate on the average lending rate of commercial banks in Nigeria.

Research Questions

The following research questions will guide the study in its investigation.

1. Does gross domestic product exercise influence on the prime lending rate in Nigeria?
2. Does an alignment exist between the broad money supply and prime lending rate in Nigeria?
3. Are variations in the prime lending rate in Nigeria attributed to fluctuations in the treasuring bill rate?
4. To what extend does gross domestic product impact on the average lending rate in Nigeria?
5. Does a nexus exist between the broad money supply and the average lending rate in Nigeria?
6. Are changes in the average lending rate in Nigeria the resultant of fluctuation produced by the treasury bill rate?

Research Hypotheses

The outlined hypotheses crafted in their null form will provide direction for this investigation.

H₀₁: There is no significant relationship between gross domestic product and the prime lending rate in Nigeria.

H₀₂: Prime lending rate in Nigeria does not respond significantly to the dynamics of the broad money supply in Nigeria.

H₀₃: Prime lending rate responds insignificantly to variations in the treasury bill rate in Nigeria.

H₀₄: There is no significant relationship between gross domestic product and average lending rate in Nigeria.

H₀₅: There is no significant relationship between the broad money supply and the average lending rate in Nigeria.

H₀₆: Treasury bill rate does not significantly influence the average lending rate in Nigeria.

Scope of the Study

This study will be limited to two constituents of interest rate namely prime lending rate and average lending rate in Nigeria. The study will concentrate on deciphering the variables that cause fluctuation in the prime lending and average lending rates in Nigeria. The time horizon for this study will cover from 1981 to 2018.

Significance of the Study

This investigation will provide better intuition on the variables that shape or cause fluctuations in the constituents of interest rates in Nigeria with a focus on the prime lending rate and average lending rate. This study will be helpful or instrumental to policymakers in their operational activities of influencing economic activity activities in Nigeria through the medium of either the budget, taxation, money supply, or other tools in the toolbox of the apex monetary authority in Nigeria. This is because the outcome of the analysis that will be carried out will avail the fiscal and monetary authorities on the best path to ply in varying or influencing the prime lending rate and average lending rate in Nigeria. This paper will also be of immense benefit to succeeding researchers in the related study areas and add to the body of existing literature.

Organization of the Study

The study will be organized into the five chapters with the subsections of each chapter outlined below:

• Chapter One: Background to the study, statement of the problem, aim and objectives of the study, research hypotheses, significance, and organization of the study.
• Chapter Two: Theoretical review, empirical review, and evaluation of the literature reviewed.
• Chapter Three: Research design, source of data, model specification, and method of data analysis.
• Chapter Four: Presentation and analysis of data, discussion of findings
• Chapter Five: Summary of the study, conclusion, and recommendations hinged on empirical revelations.