Impacts Of Monetary Policy On The Performance Of Deposit Money Banks In Nigeria

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ABSTRACT

DMBs are the major conduit for the monetary authority monetary policy transmission in Nigeria and the effectiveness of the monetary policy in the economy is contingent on their performance. Consequently, the study was carried out to determine the impact of monetary policy on the performance of DMBs in Nigeria. Annual data of the 17 DMBs in Nigeria was used for the period of 2013 to 2019. A causal research design was adopted with a census sampling technique. Monetary Policy Rate (MPR), Exchange Rate (EXR), Money Supply (M2), Cash Reserve Ratio were used as proxies for monetary policy (the explanatory variables) while Return on Equity (ROE) was used as a proxy for DMBs performance (the explained variable), and bank size (M) was used as a moderating variable to determine the moderating impact on the relationship between monetary policy and performance of DMBs in Nigeria. Diagnostic tests conducted include the Shapiro Wilk normality test, the Harris-Tzavalis Unit Root test, Pearson Product Moment Correlation test, Breusch-Pagan and Hausman tests for the determination of the appropriate model. The study made used of panel regression model and the random effect model was adopted based on the Hausman test conducted. The findings of the analysis revealed that MPR, EXR and CRR have negative impacts on the performance of DMBs in Nigeria however, only EXR is not significant at the 5% level of significance while M2 has a significant positive impact on performance. The moderating variable of bank size also showed a weak significant positive impact on the performance at 10% level of significance with the effect of moderating the magnitude of all the monetary policy instruments. Also, significant positive interactions were discovered between MPR and bank size as well as M2 and bank size. It was therefore recommended that the monetary authority should tread with caution in manipulating the monetary instruments to achieve certain macroeconomic objectives so as not to impact heavily on DMBs performance while DMBs management were advised to be conscious of the monetary policy and strategize ways to improve in their performance, amidst adverse policy prescriptions, which is only possible with a competent management team.

 

 

 

 

 

 

 

TABLE OF CONTENTS

 

 

 

 

 

Title Page

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i

Declaration

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Certification

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Dedication

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Acknowledgement

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Abstract

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Table of Contents

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List of Table

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CHAPTER ONE: INTRODUCTION

 

 

 

 

 

 

 

1.1

Background of the Study

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1.2

Statement of the Problem

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1.3

Objectives of the Study

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1.4

Research Hypotheses -

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1.5

Significance of the Study

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1.6

Scope of the Study

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1.7

Limitations of the Study

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1.8

Organization of the Study

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1.9

Definition of Terms

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CHAPTER TWO: LITERATURE REVIEW

 

 

 

 

 

 

2.1

Introduction

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2.1

Conceptual Framework

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2.2.1

The Concept of Financial Performance and Measurement

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2.2.2

The Concept of Monetary Policy

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2.3

Theoretical Construct -

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2.4

Performance Perspective

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2.4.1

The Agency Theory

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2.4.2

The Market Power Theory

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2.4.3

Structural Contingency Theory-

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2.5

Policy Perspective

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2.5.1

The Classical Theory -

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2.5.2

The Keynesian Theory

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2.5.3

The Monetarist Theory-

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2.6

Relationship between Monetary Policy and Performance-

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2.7

Determinant of Financial Performance-

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2.7.1

Capital Adequacy-

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2.7.2

Asset Quality- -

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2.7.3

Management Competency-

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2.7.4

Earnings Quality

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2.7.5

Liquidity Management.

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2.7.6

Liquidity Management.-

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2.7.7

Macro Environment-

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2.8

Instruments of Monetary Policy-

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2.8.1

Open Market Operation (OMO)-

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2.8.2

Monetary Policy Rate-

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2.8.3

Reserve Requirements-

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2.8.4

Discount Window Operations-

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2.8.5

Exchange Rate-

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2.8.6

Moral Suasion -

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2.9

The Nigerian Banking Industry

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2.10

Empirical Review

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2.10.1

Developed Economies

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2.10.2

Developing Economies-

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CHAPTER THREE: RESEARCH METHODOLOGY

 

 

 

 

 

3.1

Introduction   -

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3.2

Research Design

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3.3

Population and Sampling Design-

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3.4

Analytical Model

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3.5

Operationalization and Measurement of Variables-

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3.6

Data Collection-

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3.7

Data Analysis Tool-

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3.8

Diagnostic Tests

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CHAPTER FOUR: DATA ANALYSIS, PRESENTATION AND INTERPRETATION

4.1

Introduction

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4.2

Descriptive Statistics

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4.3

Data Diagnostic-

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4.4

Normality Test

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4.5

Impact of Monetary Policy on the Performance of DMBs in Nigeria-

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4.5.1    The Moderating Effect of Bank Size on the Relationship Between Monetary

 

 

Policy Performance of DMBs in Nigeria.-

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4.5.2

The Moderating and Interacting Effect of Bank Size on the Relationship Between

 

 

Monetary Policy Performance of DMBs in Nigeria.-

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CHAPTER FIVE: SUMMARY, CONCLUSIONS AND RECOMMENDATIONS

 

5.1

Introduction

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5.2

Summary of the Study

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5.3

Conclusion

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5.4

Policy Recommendations

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5.4.1

Policy Recommendations Relevant to the Monetary Authority-

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5.4.2

Policy Recommendations Relevant to Management and DMBs Owners-

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5.4.3

Suggestions for Further Research-

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References

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CHAPTER ONE

INTRODUCTION

 

1.1         Background of the Study

Prior to Nigeria’s banking reform of 2004, there were plethora of commercial banks, known today as legacy banks, in the country which were characterised by poor performances either due to inefficient management, inadequate capital, poor utilization of available resources or poor supervision by the regulatory authority. 1999 saw the liberalization and the adoption of the universal banking model. While the 2004 recapitalization reform led to massive consolidations, the recapitalization was meant to correct structural and operational weaknesses that were commonplace in the sector which had also hampered efficient financial intermediation and significantly affected performance.

The reform brought about a great change in the sector. Consequently, it became even clearer that the banking industry is an important sector which must not fail because it is charged with the responsibility of allocating capital resources as well as risk distribution of future flows in an economy, globally. Therefore, banks are the biggest intermediaries through which the surplus and deficit units in any economy interact to exchange financial value indirectly. When the surplus units make deposits in the banks, they are given out as loans to customers or investors (deficit units) with an interest or profit (in the case of Jaiz and Taj banks) charge on the loan;

 

Therefore, since DMBs are the pivotal medium for the administration of monetary policy due to its role in any financial system cum economy, the Nigerian government saddle the Central Bank of Nigeria (CBN) with the responsibility of regulating its activities which is partly because any bankruptcy that could happen in the financial sector has a contagion

For the CBN to carry out its regulatory functions effectively, it employs monetary policies as the primary tools to regulate the banking sector. The monetary policies are made up of different types of instruments that are used to regulate the operations of banks in any given economy; and since this is an external factor to the banks, the tools are meant to influence

 

 

banks’ activities which by extension impacts on its performance. The way and manner these factors are applied to banks vary from one country to the other and has a traceable relationship to the state of the particular country’s economy. In stable economies, the tools are rarely altered and vice versa. Economic activities, to a large extent, depend on these tools especially in countries where the capital market is not fully developed.

In  Nigeria,  monetary  policy  instruments  include  the  Cash  Reserve  Ratio  (CRR);  the Minimum Rediscount Rate (MRR) now Monetary Policy Rate (MPR) since 11th December, 2006; Liquidity Ratio (LR), Money Supply (M1, M2 and M3), and foreign exchange rate which have gone through various forms of changes in keeping with the fluctuations in economic indices. Each time these instruments change, bank operations are certainly affected. However, whether these changes in monetary policy have a significant impact on the performance of Deposit Money Banks (DMBs) depends on the outcomes of an investigation.

For instance, the Monetary Policy Rate (MPR) influences the rate of interest (Standing Lending Rate) charged on loans advanced to DMBs (through the Discount Window) by the monetary authority. The Monetary Policy Committee (MPC) determines and makes public the MPR whenever they meet, usually once in two months. A positive movement in

the MPR denotes a positive movement in the bank’s lending cost, thus; leading to a reduction in money lending. This consequently leads to decline in DMBs performance and vice versa.

Money supply and exchange rate are also regulated by the monetary policy in order to achieve certain desired objectives such as reduction in the level of inflation, promotion of economic growth, achieving full employment level, maintenance of healthy balance of payment, sustenance of growth in the economy, increase in industrialization and economic stability, etc. During low economic phases, money supply is increased by the Central Bank which in turn leads to a decline in interest and enhances the circulation of money (Meshak & Nyamute, 2016).

 

Like every other business, the continual survival of banks in an economy is contingent on its performance which in turn completely depends on its profitability. Banks’ profitability is usually assessed by the performance of the bank financially using Return on Assets (ROA), the Net Interest Margin (NIM), and the Return on Equity (ROE). However, DMBs performance in Nigeria has never remained the same. There have been fluctuations in their earnings, equities, assets, etc. just as there have also been series of movements in the monetary policy instruments. The MPR has fluctuated from 12% in 2013 and was highest in 2017 at 14%; it then dropped to 12.5% in 2020. The exchange rate (EXR: N/$) also experienced similar fluctuations, alongside the money supply and CRR, which is currently at N379.5/$1 in February, 2021 as against N155.2/$1 in December, 2013.

This study focusses on the impact of monetary policy on DMBs performance in Nigeria and the pertinent question to answer include whether CBN monetary policy instruments have any statistically significant impact on the performance of DMBs in Nigeria as well as the magnitude of such impact if it does exist. It is the answer to these questions that this research study seeks to provide.

 

1.2       Statement of the Problem

Globally, Deposit Money Banks (DMBs) are known to accept deposits with the key function of creating risk assets (loans) and as such the most effective medium for the administration of monetary policy by the monetary authorities. In regulating DMBs, Central Banks use different instruments in order to achieve its objectives. These instruments influence the interest rate which DMBs charge on loans and pay as interest on deposits.

 

Furthermore, unfavorable anticipated policy change leaves DMBs in a vulnerable state that is likely to have an effect on their profitability and hence financial performance and sometimes exposes the precarious situation of some DMBs, leading to taking over of its operation by CBN or other interested investors. For instance, in 2009, the outcome of the audit examination of Banks conducted by CBN revealed that at least 10 out of 24 banks were in grave liquidity problem. Their capital base had been eroded due to high level of non-performing loans, poor corporate governance practices, lax credit administration

 

process, and non-adherence to the banks’ credit risk management practices (Gololo, 2018).

 

The issue of asset quality problems, thinning spreads, critical corporate governance issues, risk management practices; challenges with services and diversified delivery channels; high cost of banking services etc. has continued to affect DMBs performance. This trend has affected Diamond bank Plc which led to its merger with Access Bank Plc in 2019, even though the purpose of reform and the use of monetary policy is to enhance stability and competitiveness of the banking sector, among other objectives.

Consequently, the concern as to whether monetary policy has any effect on the performance of DMBs has remained worrisome since they are the main medium through which monetary policy transmission takes effect; therefore, poor performance of the banks will certainly lead to poor transmission to the economy as a whole. Furthermore, if any of the monetary policy instruments impact on the performance of DMBs is not statistically significant, then it will be of a great concern to the monetary authority and policy makers.

 

There are quite a number of studies conducted on monetary policy and financial performance of commercial banks in third world countries but only a few studies have been completed in this area in Nigeria. However, some of those studies picked only one or two banks in Nigeria to analyse and most of the works were conducted using qualitative tools to analyse monetary policy and bank performances. Some used simple regression analysis but the few that used multiple regression analyses only concentrated on the profitability of one bank while others used Net profit Margin as a proxy for financial performance. All the studies in Nigeria failed to incorporate the repeated (time series) cross-section nature of the observations through the use of panel data model and thus, are inconclusive.

 

By studying the repeated cross section of observations, panel data are better suited to study the dynamics of change; it gives more informative data, more variability, less collinearity among variables, it relates to individual, firms, states, countries, etc., over time there is bound to be heterogeneity in these units. The techniques of panel data estimation can take such heterogeneity explicitly into account by allowing for subject-specific variables; it enables the study of more complicated behavioural model. It can also summarise the bias that might result if individuals or firm are aggregated; also, it enriches empirical analysis in ways that may not be possible if only cross section or time series data is used (Baltagi, 1983).

 

The interest of this study is to bridge the gaps in existing literature on the impact of monetary policy on DMBs’ performance in Nigeria. Furthermore, unlike previous studies, this study does not only consider bank size and its moderating influence on the relationship between monetary policy and DMBs’ performance in Nigeria but also included all the DMBs that have been doing business in Nigeria from 2013 to 2019 using panel data regression model. Therefore, this study will provide much reliable policy recommendations for policy makers in Nigeria and the world at large.

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