THE IMPACT OF INTEREST RATE ON CAPITAL FORMATION IN NIGERIA

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THE IMPACT OF INTEREST RATE ON CAPITAL FORMATION IN NIGERIA

CHAPTER ONE

1.0 INTRODUCTION

1.1 BACKGROUND OF THE STUDY

In human societies, since the evolution of money, there have always existed those who possess money in excess of their immediate needs (surplus economic unit) and those whose current possession cannot finance their economic activities (deficit economic unit). The realization by the surplus economic unit that their excess can be used beneficially to meet the shortfalls experienced by the deficit economic unit led to the introduction of a credit system. This system was initially characterized by lenders (surplus units) and borrowers (deficit unit) having to search out themselves and deal directly… Direct financing (Akpan, 2009, Akpaniko and Acha, 2010). Indirect financing includes the aggregation of deposits from various households, firms and government by commercial banks for lending to the deficit uni;, the repayment of the loan is made to the bank which also stands ready to redeem deposits withdrawals by the surplus unit. And this is the basis for this thesis. This lending could be on short, medium and/or long term basis is a major service rendered by the commercial bank to their customers which includes: individual, firms and government to aid their economic activities for the development and growth of the national economy. Thus, banks lending activities generate economic growth through resources provision for real investment (Mckinnon, 2005). This brought about the acceptance and implementation of financial liberalization by many developing economies including Nigeria. Inspite of the well known liberalization and similar policies, economists remain divided in their opinion concerning the relationship between Nigerian commercial banks loan advance (LOA) and the determinants of their lending behavior.

Commercial banks are the most important savings mobilization and financial resources allocation institution. Eventually, those roles make them an important phenomenon in economic growth and development. In order for them to perform these roles, it must be realized that banks have the potential, scope and prospects of financial intermediation. Therefore, they must bear in mind the three (3) principles guiding their operation which are: profitability, liquidity and solvency. And the determinants of the commercial bank lending behavior includes: the Volume of deposits (Vd) their Investment portfolio (Ip), the presiding interest (lending) rate (Ir), Cash reserve requirement ratio (Rr), annual average exchange rate of the naira to dollar (Fx) and Liquidity ratio (Lr) . Though the lending practices of banks were strictly regulated under the close surveillance of the banks supervisory bodies, but the Structural Adjustment Programmed (SAP) introduced in 1986 brought about some relaxation of the stringent rules guiding banking practices. And the Bank and Other Financial Act Amendment (BOFIA) 1998 required banks to report large amount borrowing to the CBN. Other banks enectement stipulated that the bank loans should be directed to preferred sectors of the economy (manufacturing, agriculture and power and steel) in other to enhance economic growth and development. But considering all these regulation, banks resorted to prudential guidelines to avoid failures and achieve maximum profitability in their lending activities. Though, these depend on the type of bank, the capital base, deposit base and its density, the credit guidelines issued periodically by controlling authority, the banks‟ internal policies and advances accounts for the highest percentage of the total assets of the bank. The commercial banks in Nigeria need to understand how to manage these huge assets in terms of loans and advances; for them to balance their main objectives of liquidity, profitability and solvency. Thus lending must be handled effectively for the banks to remain attractive and retain their customers. The commercial banks lending has significantly played crucial roles in igniting industrialization in every economy, by facilitating the mobilization of capital which oils the wheels of economic production. And that well functioning banks spur technological innovations by identifying and funding entrepreneurs assessed to have brighter chances of successful implementing innovative products and production process. But the sound and viable functioning of commercial banks is adversely affected by the choice of certain policy instruments for the regulation of banking operations. Such includes a rigidly administered interest rate structure, Directed credit, unremunerated reserve requirements and stabilizing liquidity control measures, the volume of cash in the banks voult also determines its ability to grant advances. Since cheques have to be met in cash in many cases, they should stock reasonable quantity of cash to meet customers demand. Moreover the days of armchair (cheap profit) banking are over and that the increasing trend in bad debts and absence of basic business corporate advisor services in most commercial banks, suggest the apparent lack of use of effective lending and credit administrative techniques in these banks. Despite the fact that commercial banks in Nigeria witnessed the era of impressive profitability, characterized by high competition, huge deposits and varied investment opportunities, some tend to disregard the fact that their administration require considerable skill and dexterity on the part of their management. Where a bank grants advances in excess of its chasing ability, the bank soon runs into difficulty in meeting its customer‟s cash drawings. The same also applies to situation where loans and advances are give out by commercial bank without adequate or comisorable collateral and backups. Non-servicing of loans also reduce the profitability and liquidity levels of the affected banks. The recent bank reformation of 2009 revealed a lot in this line. Finally the objectives of the study to investigate the level of commercial banks loan advances in Nigeria and to also examine those various determinants of the commercial banks lending behavior

There had been administrative control on the Nation’s interest rates until July 31, 1987 when, in consonance with the spirit of the structural adjustment programme (SAP) of the federal government the central bank of Nigeria issues a circular on interest rates bordering on the deregulation of this financial sector of the economy.

As a signal to direction the central bank wanted the interest rate to go the minimum re-discount rate (MRR) was raised form 11to15% which how peaks at 18.5%.

The apex financial institution (CBN) declared that interest rates payable on deposit or chargeable on loans advances were hence forth to be determined by the inter play of the market forces of demand and supply. Nigeria being what they are agitate and speculative went to town some decrying the policy as the last straw that would break the back of our fragile economic, other textured the policy as the best and boldest steps ever taken towards the revamping of the ailing economy. This divergent views of the financial experts both in the academic and in banking sector about the likely impact of the interest rate deregulation motivated me to appraise the impact of if the deregulation on commercial banking operation.

Note able among those who bemoaned the deregulation of interest arte was Abiodum (1987) according to him deregulation a fragile economy like ours will have the overall effect of dampening it since the high interest rate will cause slow down investment as borrowing will be curtailed.

But this view was opposed by Iklude (1978) he was of the view that “interest rate deregulation will a fragile economy like ours will have the overall effect of dampening its since the high interest rate will cause slow down investment as borrowing will be curtailed.

But this view opposed by Iklude (1987) he was of the view that “interest rate deregulation will not only bring relief to the financially repressed economy but will ensure a real return on deposit which has over ie year been negative.

What these argument boiled down to was that interest rate deregulation would lead to efficient allocation of financial market resources because interest rate will now reflect relative scarcity and relative efficiency in different uses.

According to Abraham Nwankwo (1987)3 “Bigger banks will price small ones out at market by lending cheep to customers and paying them market rate on their deposits.

It is in the light of the controversies that accompanied the interest rate deregulation that promoted the deregulation on commercial bank lending operation.

STATEMENT OF THE PROBLEM

Interest rate deregulation like other stringent economy measured by the present administration has far reaching consequences on the nation’s banking industry and on the borrowing public.

Commercial banks that had lent huge sums of money before the deregulation of interest rate were in stormy water making their customers repay their loans at the new rate. The borrowing public complained that their banks had without prior notice unleashed high interest rate on them. They were at daggers drawn as the measure created had blood between the banks and their customers.

The interest rate deregulation with its high interest payable on loan and advances since it was impossible for most for them to get inflationary adjusted rate of return on their borrowed fund this ahs remained elusive for many borrowers.

Inspite of the deregulation customers complain that commercial bank pay very little interest rate for example on savings and charge borrower/ customers more than twice what they pay them on their savings accounts. This they complained was unfair as the return became negative when adjusted with the rate of inflation.

The general public also complained that banks (especially commercial and merchant banks) have been positing huge profit after tax inspite of the bitting effect of the economy. The banks credit ceiling was partly responsible for the state of the affairs invoking economic Alxim that the constant liquidity mop up on the banking sector by the apex financial institution was also responsible saying the more illiquid a bank is the more profitable it becomes”.

A performance appraisal of the impact of the deregulation is long over due at least to shade light on the above controversies surrounding the policy three years after its introduction thereafter the problem are hereunder stated in question as follows:

Did depositors react favourably by increasing the volume of their deposit after the deregulation?
Did commercial bank loans and advances deteriorate during the deregulation of interest rate?
How have commercial bank been surviving the directive of deregulation the interest rate in this sector of the economy?

OBJECTIVE OF THE SUDY

The study aims to determine and analyze the impact of interest rate deregulation in Nigeria specifically the study seeks to answer the following questions:

1. To find out whether the interest rate deregulation has effected the volume of commercial banks lending over the year.

2. To know whether the effect is statically different according to the size of the banks.

3. The study will also find whether there were loan losses (bad and doubtful) during the era of interest rate moderation than this period of deregulation.

4. The research is also aimed of finding whether commercial banks made more profit before or during the deregulation.

5. To know whether interest rate deregulation has contributed in enhancing commercial banks lending operation.

1.4 RESEARCH QUESTION

1. How can one find out whether the interest rate deregulation has effected the volume of commercial banks lending over the year?

2. Has this effect statically different according to the size of the banks?

3. Can the study also find out whether there were loan losses (bad and doubtful) during the era of interest rate moderation than this period of deregulation?

4. Is the researcher aimed at finding whether commercial banks made more profit before or during the deregulation.

5. Is interest rate deregulation contributed in enhancing commercial banks lending operation.

1.5 RESEARCH HYPOTHEIS

H0: One cannot find out whether the interest rate deregulation has effected the volume of commercial banks lending over the year.

H1: One can find out whether the interest rate deregulation has effected the volume of commercial banks lending over the year.

H0: This has no effect statically according to different size of the banks.

H1: This has great effect statically according to different size of the banks.

H0: The study cannot also find out whether there were loan losses (bad and doubtful) during the era of interest rate moderation than this period of deregulation.

H1: The study can also find out whether there were loan losses (bad and doubtful) during the era of interest rate moderation than this period of deregulation.

H0: Interest rate deregulation has no contributed in enhancing commercial banks lending operation.

H1: Interest rate deregulation has contributed much in enhancing commercial banks lending operation.

SIGNIFICANT OF THE STUDY

The study of this nature which is more of a performance appraised of the commercial banks lending operation during the deregulation is of great significance to group of persons institutions and governments.

The study will be of great importance to the banking sector of our economy because form the empirical view of the impact of interest rate deregulation on commercial banks CNB will also find the study valuable because it ill enable them have a generalized view of lending operation by commercial bank in a deregulation economy commercial banks management will form the research evolve aggressive survival strategies.

1.7 SCOPE OF THE STUDY

This study covers the impact of interest rate deregulation on commercial banks

lending operations in Nigeria

1.8 LIMITATIONS OF STUDY

I wish to state that this study was carried out within the limits imposed by time and financial constraints and as a result the study was limited to union bank of Nigeria Plc Enugu. Another constraints through human was the attitudes of most of the loan officers of the banks who completed the questionnaires some time the respondent never actually answer the questions. This state of affairs could be frustrating as some of the respondent were said to b for busy unnecessary administrative or bureaucratic bottle neck and utmost secrecy that characterize the banking industry in Nigeria are serious problem that plague research in this sector of the economy.

Another constraints were the attitude of customer respondent some of them never actually completed the questionnaires while some did so haphazardly rending the questionnaires almost useless.

Another constraint was the time schedules for the completion of the work and limited resources at the disposed at the researcher.

Finally in the light of the above constraints the generalization that was made about the impact of interest rate deregulation on commercial bank’s lending operation was limited by the above problem truthfulness in responses to the questionnaires as well sampling procedures used by the researcher.

1.9 DEFINITION OF TERMS

Entrepreneur: this refers to any individual who creates new business and manages it until it succeeds.

Investors: this is the process of creating a new business and managing it until it succeeds.

Business environment: this includes all the physical facilities, regulation, opportunities and risk there in.

Venture capital: this is the funds which investment institutions loan not for investment purpose.

Business – up capital: this is the capital needed for initial take off of business.

Business opportunities: this is a potentially profitable event.

Innovative: this is the development of a new product from an old one.

External reserves: External reserves are variously called International Reserves, Foreign Reserve or Foreign Exchange Reserves. While there are several definitions of international reserves, the most widely accepted is the one proposed by the IMF in its Balance of Payments Manual, 5th edition. It defined international reserves as consisting of official public sector foreign assets that are readily available to, and controlled by the monetary authorities for direct financing of payment imbalances, and directly regulating the magnitude of such imbalances, through intervention in the exchange markets to affect the currency exchange rate and/or for other purposes (CBN, 2007).

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