EFFECT OF INTEREST RATE MARGIN ON THE PERFORMANCE OF DEPOSIT MONEY BANKS (DMBS) IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.1            Background of the Study

The financial systems of most developing nations have come under stress as a result of the economic shocks of the 1980s. The economic shock largely manifested through indiscriminate distortions of financial prices which includes interest rates, has tended to reduce the real rate of growth and real size of the financial system relative to non-financial magnitudes (Davidson and Gabriel, 2004). Rasheed (2010), states that Nigerian economy saw different sectors in 1970s through the mid-1980s (regulated regime, 1960-1985).

Since 1986, the inception of interest rate deregulation, the government of Nigeria has been pursuing a market determined interest rate regime, which does not permit a direct state intervention in the general direct of the economy (Adebiyi and Babatope-Obasa, 2004).

Deposit Money Banks are the most important savings mobilization and financial resource allocation institutions. Consequently, these roles make them an important phenomenon in economic growth and development. In performing this role, it must be realized that banks have the potential, scope and prospects for mobilizing financial resources and allocating them to productive investments and in return promote their performances. Therefore, no matter the sources of the generation of income or the economic policies of the country, Deposit Money Bank would be interested in giving out loans and advances to their numerous customers bearing in mind the three principles guiding their operations which are profitability, liquidity and solvency (Adolphus, 2011).

Depositors are paid some amount as interest for parting with their fund while borrowers are charged some amount as lending rates for making use of the funds. The difference between the lending and the deposit rate constitutes the margin. Net interest margin or interest rate margin and interest rate spread are used interchangeably in most literature. However, some authors prefer to use the term net interest margin when using ex-post data (difference between banks quoted lending and deposit interest rate) (see Enendu, 2003). In this study, to avoid ambiguity, ex-post data was used and interest rate margin was defined in broad term as the ratio of difference between interest income and interest expenses to total assets for individual banks. High margin increases banks profitability but tends to decline the efficiency of financial intermediation process, and efficient financial intermediation is a necessary condition for the achievement of price stability of the monetary authority and growth in the economy.

This margin has remained relatively high over the years in Nigeria with adverse implications for savings mobilization and investment. For instance, from January 2011 to June 2014, interest rate margin averaged 20.51 percentage points, compared with average consolidated deposit rate of 3.42 percent. High margin imply interest rate movement in two directions and corresponding consequences. A lower deposit rate encourages saving and therefore reduces bank deposit, resulting in scarcity of investible funds. On the other hand, high lending rates curtail borrowing and investment. In an economy like Nigeria where the bulk of intermediation is by the banks, the scenario could stifle investment and curtail growth in the economy.

1.2             Statement of the Problem

In orderto curb the adverse effect of the 1980s financial repression, Nigerian government deregulated interest rate in 1987 as part of the Structural Adjustment Programme (SAP) policy package. The official position was that interest rate liberalization among other things, enhance the provision of sufficient funds for investors especially manufacturers (a priority sector) who were considered to be prime agents by implication promoters of economic growth.

However, in a policy reversal, the government in January 1994 out-rightly introduced some measures of regulation into interest rate management. it was claimed that there were “wide variations and unnecessary high rate” under the complete deregulation of interest rates immediately, deposit rates were once set at 12% to 15% per annum while a ceiling of 1% per annum was fixed for lending rate. The Cap on interest rate introduces in 1994 was retained in 1993 with a minor modification to allow for flexibility. The Cap stayed in place until it was lifted in 1997, thus enabling the pursuit of the flexible interest rate regime in which bank deposit and lending rate were largely determined by the forces of demand and supply for funds (Omole and Falokun 1999).

Interest rate is crucial elements in the transmission of Monetary Policy actions to economic activities (Craig, 2000). The interest rate policy in Nigeria for example has changed within the time frame of regulated and deregulated regimes. However, impacts of these variables on the economic growth of Nigeria have remained controversial (Acha et al, 2011). In 1993, a new framework focused on the deregulation of interest rates; interest rates were very high and volatile. In 1994, due to high volatility of interest rate government decided to fix the Monetary Policy Rate at 13.5% (CBN, 1994) the Capital 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 were put in place and this has remained so since late 1990s to date (CBN, 2007) however, the problem has been that market based approach to interest rate management in Nigeria has always been associated with substantial interest rate volatility (CBN, 2006).

In 1986, Nigeria interest rate was as low at 2.5%, it rose to 8.9% (CBN, 1990). Auction markets for securities were introduced, capital adequacy standards were reviewed upward and the extension of credit based on foreign exchange deposits was banned (Hussainatus, 2008). Nigeria’s interest rate fluctuates overtime as the Central Bank was to regulate and supervise all interest rate administered. The monetary authority introduced the indirect monetary instruments in order to control the interest rate and the rate of inflation. The interest rate has doubled through the period of 1997 and 2007 attaining a peak of 24.62% (CBN, 2002).

     Ordinarily, high interest rate should spur the desire for bank vaults. Likewise, low interest rate should naturally discourage depositors. But most often times this is not the case, hence this study seeks to examine how interest rates affects the performance of Deposit Money Banks in Nigeria from 1980-2016.

1.3             Objectives of the Study

The broad objective of the study is to examine the effect of interest rate margin on the performance of Deposit Money Banks in Nigeria from 1980-2016.

The specific objectives include the following:

1.     To investigate the effect of interest rate margin on the performance of Deposit Money Banks in Nigeria.

2.     To determine the effect of Monetary Policy Rate (MPR) on the performance of Deposit Money Banks in Nigeria.

3.     To determine the effect of Lending Rate on the performance of Deposit Money Banks in Nigeria.

4.     To determine the effect of Deposit Rate on the performance of Deposit Money Banks in Nigeria.

1.4                      Research Hypotheses

From the objectives of the study, the following forms the research hypotheses 

H01: There is no significant effect of interest rate on the performance of Deposit Money Banks in Nigeria.

H02: There is no significant effect of Monetary Policy Rate (MPR) on the performance of Deposit Money Banks in Nigeria.

H03:  There is no significant effect of Lending Rate on the performance of Deposit Money Banks in Nigeria.

H04:  There is no significant effect of Deposit Rate on the performance of Deposit Money Banks in Nigeria.

1.5                      Significance of the Study

The significance of this study will be of immense benefit to the following groups:

Deposit Money Banks: interest rate unavoidably is an important factor in the survival of the industry especially as it concerns their profitability. as interest rate keeps on changing as can be seen from the unstable interest rate regime in Nigeria, such frequent changes could affect banks overall profitability. so with this study, it will be of immense benefit for the Deposit Money Banks to know how to run interest rate so that they can be able to enhance the confidence of the stakeholders, maximize shareholders wealth as well as being able to stay competitive in the financial market.

Central Bank of Nigeria (CBN): this study will help them to highlight on why interest rate policies fluctuate and show inconsistency from regulation to deregulation. It will also help them to know what measures to take in setting interest rate so that it will have a positive effect on performance of Deposit Money Banks in Nigeria.

The Government: this study will enable them to know the causes of lack of funds within the economy. It will help them to understand the impact of an effective monetary policy regime on the performance of Deposit Money Banks in Nigeria. It will also help them to know which policy to adopt so that DMBs will improve on their performance while will in turn increase the nation’s economy.  

The Bank and Depositors: interest rate has a long run effect on deciding whether bank customers deposits in banks or not and this will have effect on the nation’s economic development. most oftentimes, banks usually crave for customers deposits of fund into their banks, part of the ways they attract deposits is by offering high interest rate to depositors, so carrying a study on this area will be of great benefits to both the banks and depositors alike.

Economist, Researchers and Students: this study creates an understanding concerning the relationship between interest rate and banks performance. it will serve as a source of secondary data for further research and equally add to the existing stock of knowledge.        

1.6 Scope of the Study

          The scope of this study covers only a detailed discussion on the effect of interest rate margin on the performance of Deposit Money Banks (DMBs) in Nigeria from 1980-2016. The study focuses on Nigerian Deposit Money Banks which interest is mainly on four (4) of them. They includes; Zenith Bank Plc, Access Bank Plc, First Bank Plc and Union Bank Plc.

1.7 Limitations of the Study

The researcher encountered a number of problems which hindered the research work.

The study covers a stipulated range which is from 1980-2016. Also related materials or literatures were limited in supply as observed in the cause of this study. The study covers the Structural Adjustment Programme (SAP) and P-SAP period of 1986-1999 and 2000-2013 respectively and even extend to 2016.

The study investigated four variables which are interest rate, monetary policy rate, lending rate and deposit rate. Other variables could have been studied but due to limitation of time and other resources interest was focused mainly on the above mentioned variables.

The researcher faced some financial difficulties as