The Impact of Monetary Policy On The Performance of Banking Industry

THE EFFECT OF MONETARY POLICY ON THE PERFORMANCE OF THE BANKING INDUSTRY
CHAPTER ONE
1:1 BACKGROUND OF STUDY
A dynamic and effective banking industry is crucially important and

imperative to modern economy because it provides the enabling
environment necessary for accelerated economic growth and
development, through its indispensable role of mobilizing and
allocating financial resources from surplus units to deficits unit that
have consumption needs or have investment opportunities for the
funds. This profoundly stimulates investment, economic growth and
employment as well as international trade and payments. This is a
glaring indication that banks play a crucial and strategic role in the
overall operation of an economy, that is why every economy strives to
uphold its well being with supreme esteem. One of the strategies
employed by all economies to accelerate the soundness and
effectiveness of the banking industry, is the use of monetary policy
measure which anchors on the control of money stock (however
defined) in order to influence financial and economic activities.
The impact of monetary policy on the performance of the banking

industry precisely deposit mobilization have been widely investigated
in the research finding. The extent to which they can effectively
perform this function and consequently their effect on the level of
development has often been associated partly with the level of
liberalization of financial system. The financial repression hypothesis
in part, postulate that liberalization of policies on interest rates and
entry leads to greater access to formal finance and lower spread
between borrowing and lending rate (Aryectey, 1997).
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It is in appreciation of the imperative need and practical contribution

of monetary policy in accelerating the operation of the banking sector
and the consequent effect that is paramount to economic development
of Nigeria that provide the impetus for this research work. This study
primarily aims at assessing scientifically the performance of the
banking sector proxy by the deposit mobilization of the commercial
bank under the monetary stimulus. The questions this study seeks to
answer are;
a) How did the banking sector perform in response to the impulse of

monetary policy measure?
b) Did monetary policy increase deposit with banks?
c) What are the major channels through which monetary policy

impacts on the banking sector?
d) What are the factors, impeding the maximum impacts of monetary

policy to the real sector and the resultant feedback effect on the
banking industry?
The researcher attempts to proffer solutions to the above-enumerated

questions by:
Identifying and examining the relationship between

monetary policy and the performance of the banking
industry.
Assessing the observed impact of monetary policy proxied

by broad money supply (m2) (the indicator of effectiveness of
monetary policy) on the performance of banking industry
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proxied by deposit mobilization performance of the

commercial banks.
Estimating and evaluating the effect of M2 (monetary policy

indicator) on the deposit mobilization performance of
commercial banks in the period of deregulation and guided
deregulation (1986-2000).
1:2 STATEMENT OF PROBLEM

Monetary policy exerts a positive influence on the banking sector. Yet
the effect of monetary measures is not as effective as they should be in
Nigeria context. Since monetary policy is bank based the
enhancement of bank performance through the monetary policy is not
fully realised. The observed impact have fallen below the desired
target (Ezeuduji 1998). This is as a result of number of problems both
fundamental and structural, major among other challenges to the
effectiveness of monetary influence on the banking industry are;
firstly, inadequacy of the banking industry, it is required of the
monetary policy to improve the performance of the banking system
and in turn the bank are expected to enhance monetary management.
But the distress in the banking industry which has manifested in poor
management, capital inadequacy, Bad and doubtful debts, illiquidity
and poor earnings on assets rendered the system ill equipped in
responding to the prompting of monetary policy.
Secondly another critical factor that impede, the effectiveness of
monetary measures on the banking system in Nigeria is the mandatory
financing of persistent large government deficits by Central Bank. The
problem arises because such financing increase monetary base and
swells the level of excess liquidity of the banking system, the
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existence of large excess liquidity poses a problem for Omo being

design for mopping up such excess. Other disturbing problems
include the paucity of data on vital macro-economic variables,
conflicts of objectives, instrument policy harmonization and
implementation.
1:3 JUSTIFICATION OF THE STUDY

Monetary policy is a control mechanism on the smooth running of the
economy, it is unanimously agreed that monetary development affect
economic and financial performance. The committee in the Nigerian
financial system (1976) is of the view that banking system should:
1. Facilitate effective management of the economy
2. Provide non-inflationary support to the economy
3. Achieve greater mobilization of saving and its efficient and
effective channelling.
4. Ensure that no viable project is frustrated simply for lack of funds.
5. Insulate the economy as much as possible and as much as desirable
from the vicissitude of the international economic scenes
6. Effectively sustain the indigenisation (ownership control and
management) of the economy
7. Assist in achieving significant transformation of the rural sector,
8. Assist in achieving greater integration and linkages in agriculture,
commerce and industry.
However the observed effect of monetary measures in enhancing the
performance of the banking system is dismally below its potential
and the desired targets. Monetary policy has failed to eliminate the
prevailing distress in the banking sector so that it can effectively
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transmit monetary impulse on the real sector; similarly it has failed to

prevent the excessive growth in liquidity in the system.
What need to be done to eliminate the fundamental and structural
constraints impeding the maximum impact of monetary development
on economic and financial performance and in appreciation of the
indispensable and invaluable economic gain and welfare gain that
could be derive form a vibrant dynamic and sound banking system
especially in this period of diligent quest for rapid development in
Nigeria that has provided the impetus and justification for this
research study.
1:4 OBJECTIVE OF THE STUDY

This study examines the effect of monetary policy measure adopted in
Nigeria during the deregulation and guided deregulation period on the
performance of the banking industry. The specific objectives of this
study are:
1. To examine the relationship between monetary policy measure And
the performance of the banking industry
2. To identify the monetary transmission mechanism on banking and
economic activities
3. To determine whether the monetary measure employed in the
period of deregulation and guided deregulation (1986-2000)
has actually enhance the performance of the banking sector
proxied by deposit mobilization.
4. To x-ray some of the constraint, impeding the effects of monetary
promptings on economic and financial performance and in light
of the findings policy implications will be drawn and
suggestions would be made towards a more efficient
functioning of banking system.
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1:5 STATEMENT OF HYPOTHESIS

The tentative statement about monetary policy and the performance of
the banking industry is that, monetary policy exerts a positive impact
on the performance of the banking industry.
Ho (Null); Monetary policy proxied by broad money supply (M2) has

no impact on the performance of the banking industry proxied by
deposit mobilization performance (DMPER) of the commercial
bank.
Hi: (Alternative); Monetary policy proxied by broad money supply

exerts a positive impact on the performance of the banking
industry proxied by Deposit Mobilization Performance (DMPER)
of commercial banks.
1:6 SCOPE OF THE STUDY
This research study will focus on the effect of monetary measure on
the performance of banking industry during the deregulation period
1986 1992) and the guided deregulation period (1993 till date). This
study will precisely focus on the period 1986 to 2000.
1:7 METHODOLOGY
This study will employ content analysis technique of data collection,
time series data on the subject matter from secondary sources will be
collected and analysed. The data to be fitted into the model span over
a period of 15 years (1986 2000). The secondary sources include
extract form textbooks, dailies, CBN statistical Bullion, Bulletin,
Economic and financial review, Annual report and statement of
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account. There after, the data will be analysed using a simple linear
regression techniques of analysis and other statistical test.
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END NOTE CHAPTER ONE
Adewuyi A.D. (2000): Absorptive Capacity and Macroeconomics

in Nigeria (Financial report NISER,
Ibadan)
Ajakaiye D.O. (1992): Challenges of the Nigerian Banking Sector:

A Macroeconomic overview: Economic and
Business review vol. 1, June pp. 9 18
(New Nigerian Bank Plc, Benin city).
Anyanwu J.C. (1994): Monetary Economics; Theory, Policy and

Institutions. (Hybrid Publishers ltd)
Afolabi L. (1999): Monetary Economics (Heinemann

Educational Books Nig. Plc).
Ezeuduji U.F. (1998): The effect of Monetary Policy on the

performance of the banking industry. (CBN
Economic and Financial Review vol. 32,
No. 3)
Ojo, M.O. (1992): Evolution and performance of monetary

Policy in Nigeria in 1980s (CBN Research
Dept. Occasional paper No. 2).
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CHAPTER TWO
REVIEW OF RELATED LITERATURE
2:0 INTRODUCTION
The thrust of this chapter is to throw some light on monetary
management with specific focus on the concept, objectives
techniques, targets, indicators and transmission route of monetary
policy. Furthermore a brief attempt of review of evolution of
monetary policy in Nigeria will be undertaken, including a review of
concept of monetary influence and finally ascertain the effects of
monetary policy measure on banks in Nigeria.
2:1 MONETARY POLICY DEFINED

Several definitions abound on the concept of monetary policy just as
there are many authors on the subject matter.
Okeya defined it thus monetary policy deals with the discretionary
control of money supply by the monetary authorities in order to
achieve desired macro economic goals of the nation
Aston and Richard (1970), view monetary policy as the management
of the economy by influencing the level and composition of aggregate
demand by the manipulation of interest rate and the availability of
credit
While to Otiti monetary policy is measures designed to regulate and
control, the volume, cost and direction of money and credit in the
economy to achieve specific macro economy policy objectives
which can change from time to time depending on the economic
fortunes of a particular country. This definition emphasizes both the
supply and demand side of money and credit and at such it appears to
be the most ideal and acceptable definition of the subject matter.
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Nwanko (1987) is of the same view with Otiti when he said that
monetary policy is concerned with availability, cost and direction of
credit. Monetary policy is applied in order to limit money growth to
a level that is consistent with the absorptive capacity of the economy.
Other relevant definitions that seem appropriate in Nigerian context
are thus:
Monetary policy is a major economic stabilization weapon which
involves measures designed to regulate and control the volume, cost,
availability and direction of money and credit in an economy to
achieve some specified macro economic policy objectives (Anyawu
1994)
That is, it is a deliberate effort by the monetary authorities (the
Central Bank) to control the money supply and credit conditions for
the purpose of achieving certain broad economic objectives
(Wrightman 1976).
From the above foregoing numerous definition of the concepts of
monetary policy, it can be deduce that monetary policy refers to the
combination of measures or actions designed to regulate the value,
supply and cost of money in an economy, in consonance with the
expected level of economic activity. An excess supply of money
would result in an excess demand for goods and services, which
would cause rising price and or a deterioration of the balance of
payment position. On the other hand an inadequate supply of money
could induce stagnation in the economy thereby retarding growth and
development. Consequently the monetary authority must attempt to
keep the money supply growing at an appropriate rate to ensure
sustainable economy growth and maintain internal and external
stability. The discretionary control of the money stock by the
monetary authority thus involves the expansion or contraction of
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money, influencing interest rates to make money cheaper or more

expensive, depending on the prevailing economic conditions and
thrust of policy. In a nutshell, the aims of monetary policy are
basically to control inflation, maintain a healthy balance of payments
position in order to safeguard the external value of the national
currency and promote adequate and sustainable level of economic
growth and development.
2:2: OBJECTIVES OF MONETARY POLICY

Objectives of monetary policy refer to the ultimate macro-economic
goals, which can change from time to time depending on the
economic fortunes of a particular country.
Monetary policy is formulated and implemented for the purpose of
achieving generally the following objectives
a. The control of inflation and maintenance of relative price
stability
b. Attainment of high rate or full employment.
c. Maintenance of a healthy balance of payments position in order
to uphold the external value of national currency.
d. Achievement and enhancement of a high, rapid and sustainable
economic growth and development.
The achievement of the above enumerated policy objective is not
usually easy for various reason, including the transmission question,
stage of technological development and capacity, availability of
instruments and the relationship between the central bank government
relevant agencies and the private sector. Hence countries have adopted
different strategies in the conduct of monetary policy given peculiar
circumstances while some countries have attempted to target
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intermediate variables, on the assumption of the stability and

reliability of the relationship between changes in those variables and
economic activities, others have focused directly on the ultimate
goals. In developing countries like ours, the policy objectives could be
said to include the mobilization of adequate funds for developmental
projects and the diversification of the productive base of the economy.
Obviously, conflicts abound in the achievement of monetary policy

objectives. The relevant questions here are; does the multiple
objectives of monetary policy compactable? can they be achieved
simultaneously or does the pursuit of one objective lead us further
away from another?. Indeed, the objectives do conflict or are
incompatible. That is, the attainment of one may preclude the
attainment of another or others. In other words trade-offs do exist in
the attainment of policy objectives. Two types of conflicts in the
attainment of policy objectives exist Culbertson (1961). These are
necessary conflict and policy conflict.
Necessary conflict exists when the attainment of one objective
precludes the attainment of the other. That is, when the objectives are
inherently incompatible. For instance in the short run improvement in
employment may only be achieved at the cost of additional inflation
and vice versa. Full employment may also conflict with rapid
economic growth, which is dependent on the acceptance of innovation
and change, if maintenance of full employment encourages reliance in
the status quo. On the other hand policy conflict arises when monetary
policy has difficulty in pursuing both goals simultaneously or when
the government takes measures that would jeopardize the
simultaneous achievement of the objectives. For example, an easy
monetary policy designed to stimulate economic growth will lower
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the rate of interest and may generate higher inflation if the growth is
not sufficient enough to inhibit it. Also in a situation where the
economy is experiencing inflation and slow economic growth a tight
monetary policy (to fight inflation) will reduce investment and growth
even further.
Therefore, the above conflict can be resolve as thus; in the event that
monetary policy objectives are not mutually attainable, trade offs
among them must be considered and each objective ranked with
respect to its relative importance. This ranking has to be the
responsibility of the monetary authorities (The Central Bank) and the
government based on the state of the economy.
In general the ultimate goals of monetary authorities in less developed
countries, consist of growth in national output (or economic growth
and development in the long-run) price stability (or moderate
inflation) and external balance (i.e. a sustainable balance of payment
and/or stable exchange rate). To achieve these ultimate objectives,
policy makers have identified variables that have stable, predictable
and strong relationships with ultimate goals, which are called
proximate targets (or goals). Variable that are under the control of the
monetary authorities and have effects on the proximate targets are
called monetary tools (or instruments).
The conventional wisdom is that the term of liquidity (or more
specifically the term of credit) and some measure of the quantity of
liquidity are possible proximate target variable. The most commonly
identified proximate target variables are interest rates (ie the terms of
credit) M1 (currency plus demand deposits) M2 (M1 plus time
deposits), M3 (M2 plus other deposits and near monies). DC
(aggregate domestic credit) and H (high - powered money) (Ascheim,
1970, Bruner, 1969 etc)
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On how monetary policy affect employment, Ojo and Ajayi (1981, pg.
222) argued that when unemployment increase from a define
minimum, an expansionary monetary policy could be use to combat it.
Firstly an expansion of money supply leads directly to increased
expenditure on good and services thereby ultimately requiring
increased employment to reproduce the extra goods and service.
Secondly, an increase in money supply could lead to a fall in interest
rates, implying a reduction in the cost of funds thereby increasing
investment expenditure and finally stimulating employment.
It has been pointed out that price instability cause the problems of
inflation and deflation with their unpleasant effects. Recently this
objective of price stability has been noted to be synonymous with that
of achieving a low rate of inflation. Many theories have been advance
as to the cause of inflation major among are
1. The monetarist propositions
2. The cost push theories of inflation and
3. The excess demand theories of inflation by Keynes
In shortages of supplies and monetary factors such as rise in
government expenditure, increases in money income and money
supply among others, the objective of price stability has been noted to
be of paramount importance since the converse may precipitate a
balance of payment crisis, impair the usefulness of money, exert
distorting and destabilizing effects on the domestic economy as well
as exacerbate the problem of income mal distribution. In a typical
developing economy like Nigerian, this objective can be assessed by
the annual percentage rates of change in the consumer price index or
the GDP deflator. The composite consumer price index which
incorporates the rural and urban areas seems to be more relevant and
widely used in the Nigerian context.
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With respect to the objective of attaining a sustainable rate of

economic growth and development, two conditions are paramount in a
free enterprise economy. Firstly, an increase in the economys
production capacity and secondly, a corresponding demand for those
goods and services whose supply has increased.
Vaish (1973, pg, 433) argued that monetary policy can promote
sustained economic growth in two ways, firstly, by the monetary
authorities maintaining equilibrium between the total money demand
and economys total production capacity. According to him this could
be achieved by the monetary authorities adopting a flexible monetary
policy aimed at restricting bank credit when the total money demand
threatens to raise price and create conditions of un-sustained boom
and to expand credit when a deficiency of total money demand causes
decline in price, production and employment. Secondly, monetary
prompting can stimulate economic growth and development by
creating an enabling environment for saving and investment. This
could be done through a policy directed at maintaining price stability
in the economy, because capital formation is a function of saving
while savings cannot be accumulated in a situation where price
instability exist. In Nigerian basic series for measuring growth can be
the gross domestic products (GDP) or the index of industrial
production.
Finally, achieving a healthy balance of payment position has been one
of the desired goals in the economic policy package of most
developing nations. Several concepts abound regarding the balance of
payment but the most relevant here is the accounting balance.
Definitionally, the accounting balance of payment of a country is a
systematic record of all economic transaction between the residents of
that country and the rest of the world for a period of time usually a
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year. Most of the third world countries Nigeria inclusive have been
experiencing perennial balance of payment difficulty. In the Nigeria
case, it's dependence on petroleum only as it's key export, the
downward trend in the demand and price of this product which is
exogenously determined as well as her high elasticity of demand
among other have negatively affected her balance of payments
position.
2:3 INSTRUMENT OF MONETARY POLICY

The instrument or tool by which monetary authorities try to achieve
the above aforementioned objective can broadly be classified into:
a. Quantitative instrument (Traditional and non-traditional)
b. Qualitative instruments. Ramlett (1977)
2:3.1 QUANTITATIVE INSTRUMENTS

A. As the name implies, these instrument are quantitative in nature
impartial or impersonal tools that operate primarily by
influencing the cost, volume and availability of bank reserves. They
lead to the regulation of the supply of credit and cannot be used
effectively to regulate the use of credit in particular area or sectors of
the credit market, Anyawu (1994)
Quantitative tools are further categorize into traditional indirect
control or market weapon and non-traditional tools or direct control of
liquidity
i. TRADITIONAL OR MARKET WEAPONS
These are called market weapons because they rely on market forces
to transmit their effects to the economy. The market-based technique
used mainly in developed financial systems, relies on the power of the
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monetary authority as a dealer in the financial market to influence the

availability and the rate of return on financial assets. Thus affecting
both the desire of the public to hold money balances and willingness
of financial agents to accept deposits and lend them to users.
Under this system of indirect monetary control, only the operating

variables (which are related to the intermediate variable in a
predictable way) are controlled. The operating variables particularly
the monetary base or its components are managed while the market is
left to determine interest rates and credit allocation. The major
instruments for influencing the monetary base are open market
operation (OMO), reserve requirement and the discount rate,
specifically the example of this traditional or market weapons are;
open market operation (OMO), cash reserve requirement (CRR) and
liquidity ratio, minimum rediscount rate (MRR), parity change and
selective credit policies (see Jimoh 1991)
1. OPEN MARKET OPERATION (OMO),

These involve sale or purchase of government securities in the open
market that is, financial and money markets depending on weather the
economy is inflationary or deflationary respectively by the central
bank with a view to regulate the cost (interest rate) and the availability
of credit, in order to influence aggregate banking systems credit
operation. The use of this instrument whether it involves selling or
buying can have a tremendous impact on the quantity of bank
reserves.
Hypothetically. If the CBN intends to expand the existing stock of
credit facilities in the banking system, it may decide to purchase
government securities from the banks, corporate bodies and pay them
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in cheques which are deposited with banks. The resultant effect of this
transaction is an increase in the fund available in the banking system,
credit expansion. Fall in interest rates stimulate investment, higher
aggregate spending.
On the other hand when the CBN feels that there is excess liquidity
beyond the absorptive capacity of the economy, which may lead to
inflation. It can mop up the excess liquidity by selling the financial
instrument for instance bonds, treasury bills, certificates etc to the
banks and corporate institutions. The resultant effect of this is
decreases in the funds available to the financial sector, credit
contraction, rise in interest rates, discourage investment, lower
aggregate spending and ameliorate inflationary pressure. The
effectiveness of this policy instrument requires the existence of a well
develop financial system, integrated and interest sensitive financial
markets where the amount of government securities held by the bank
and non- banks public is large.
No wonder until June 1993, it has not been possible to effectively put
to operation this instrument in Nigeria mainly due to the undeveloped
nature of our financial system in general and money market in
particular.
Similarly, low volume of government securities and insensitivity of
interest rates to market forces impedes the effectiveness and efficiency
of this instrument in Nigeria.
However Nwanko (1980 pg 31) argued that open market operation do
not necessarily require an actual market, whether developed or
underdeveloped to operate effectively. According to him, all that is
required is that the government broker and the central bank have the
skill and dexterity to be able and willing to exercise and make open
market operation operative and effective. Nwanko further contended
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that partly because of the orthodox nature of the requirements above

and partly because of the undesirable side effects, particularly with
respect to security prices and government debts, other weapons viz:
special deposits and variable reserve requirement have been evolved
in Nigeria context. Further more he argued that the limited use of
OMO in most developing countries is because the monetary
authorities in these countries/economy are faced with the task of
stimulating economic growth along with the traditional function of
maintaining monetary stability.
PRIMARY EFFECT OF OMO

The general proposition that hold is thus when the CBN purchases
government securities on the open market and bids up their prices, it
is thereby bidding down interest rates. And the converse happens
when CBN sells government securities on the open market.
SECONDARY EFFECT OF OMO

The secondary effect of the open market purchase also work towards a
reduction of interest rates. As commercial bank reserves rise, the bank
will purchase securities and step up their lending activities the
purchase of securities once again tends to push up security price and
push down interest rate. And in their eagerness to make additional
loams, banks may reduce the interest rate they charge specifically,
they may shave their prime rate the (the interest rate charge by bank
on their least risky loans). And thus the conversed is the case when
CBN sells government securities on the open market.
Summarily an open market purchase or sell by the CBN has three
important, interrelated effects:
1. It increases/decreases the money stock
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2. It increases/decreases the availability of funds for the

commercial bank to lend
3. It increases/decreases interest rates.
2. DISCOUNT RATE POLICY OR THE REDISCOUNT RATE POLICY

OR BANK RATE
The discount rate is the rate of interest rate, the monetary authorities
(as lenders of last resort) charge the commercial banks on loams
extended to them. It is also the official minimum rate at which the
central bank would rediscount what is regarded as eligible bills (banks
bills or first class bill), if the central bank wishes to increases liquidity
and investment, it reduces the interest rate charge by commercial
banks thus resulting in attractive borrowing and hence expansion in
liquidity and investment.
On the other hand, if the central bank wishes to reduce liquidity in the
economy, it will raise the discount rate. This in turn, raises the interest
rate charge by commercial banks hence lower investment and
aggregate demand. Thus, other interest rates are geared to the discount
rate.
However the effectiveness of the discount rate policy is a function of
the inability of commercial bank to have access to liquid assets and or
must not keep excess reserves, other wise they would not need to go
to central bank in first place.
3. RESERVE REQUIREMENT/REQUIRED RESERVE RATIO

Commercial banks are required to maintain certain (or a minimum)
reserve requirement in order to control their liquidity and influence
their credit operations. These reserve requirements are usually
expressed as a percentage of customers deposits and they can be
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manipulated by the central bank to vary the ability of commercial

banks to make loans to the public by simply increasing the rates.
The reserve requirement include statutory cash reserve ratio, liquidity
ratio and variable cash requirements.
a. STATUTORY CASH RESERVE RATIO
In some countries, custom demand that banks should maintain a
minimum cash reserve ratio, in some others, the central bank has the
right to fix it by law. Such a requirement works only in one direction
i.e., in curbing an excess credit creation. In Nigerian, the cash ratios,
which is designed to raise or reduce the liquidity of banks, is applied
in a discriminatory manner, with the banks grouped into categories
according to size and the largest banks maintaining the largest ratios,
and vice versa.
b. LIQUIDITY RATIO
The central banks also imposes upon the banks a minimum liquidity
ratio, being varied according to the needs of the situation it is
designed to enhanced the ability of banks to meet cash withdrawals on
them by their customers. Such liquidity ratio stands for the proportion
of specified liquid assets (such as cash, bills, and government
securities).
In the total assets of banks in the Nigerian context, this remained at 25
per cent until August 1987 when interest rate were deregulated
consequent to which it was raise to 30 percent and later lowered to
27.5 percent 1988 essentially it is now variable rather than fixed or
inflexible.
c. VARIABLE CASH RESERVE REQUIREMENTS OR

DEPOSITS WITH THE CENTRAL BANK
This refers to the cash reserves or balances held by bank with the
central bank and which the central bank has the authority to vary
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according to the exigencies of the credit controls. Such deposits with

the central bank must not be less than prescribed proposition of the
banks deposit liabilities.
(ii). NON - TRADITIONAL INSTRUMENTS OR DIRECT

CONTROL OF BANK LIQUIDITY
These tools are non-market tools that strike directly at bank liquidity.
The direct control instrument places restrictions on a particular group
of institutions (especially deposit banks) by limiting their freedom to
acquire assets and liabilities. This method is employed mainly in
developing economics were financial infrastructure necessary for
operating indirect monetary control is absent or underdeveloped.
Examples of instruments of direct monetary control are quantitative
ceilings on bank credit selective credit controls, administered interest
rate and exchange rate, supplementary reserve requirements and
variable liquidity ratio.
1. SUPPLEMENTARY RESERVE REQUIREMENT OR
SPECIAL DEPOSITS;
The central bank, here requires banks to hold, over and above the
legal minimum cash reserves, a specified percentage of their deposits
in government securities (such as stabilization securities issued by the
central banks) hence it is called special deposits policy.
The main objective is to influence bank lending by freezing a certain
percentage of their assets.
2. VARIABLE LIQUID ASSETS RATIO

These banks are required to diversify their portfolio of liquid assets
holding.
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This implies that banks are required to redefine the composition of

their liquid assets portfolios of different times to reduce or increase
their credit base.
2:3.2 QUALITATIVE OR SELECTIVE CONTROLS/ INSTRUMENTS

B. These confer on the monetary authorities the power to regulate the
terms on which credit is granted in specific sectors. These powers or
control seek typically to regulate the demand for credit for specific
uses by determining minimum down payment and regulating the
period of time over which the loan is to be repaid. As the name of the
instrument, it is qualitative in nature and application put differently
they involve official interference with the volume and direction of
credit into those sectors of the economy which planners believe are of
crucial importance to economic development. These tools include
moral suasion and credit controls or guidelines.
1. MORAL SUASION
This involves the employment of persuasions or friendly persuasive
statements, public pronouncement or outright appeal in the part of the
monetary authorities to the banks requesting them to operate in a
particular direction for the realization of specific government
objectives.
Moral suasion is supposed to work through appeal and voluntary
action rather than by regulation and authority. However experience
has shown that it is the fear of threat of authoritative actions if appeals
are not compiled with that usually make the banks respond to moral
suasion rather than the notion of acting on appeals or being public
spirited or patriotic.
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2. SELECTIVE CREDIT CONTROLS OR GUIDELINES

Selective credit control or guideline involve administrative order
whereby the central banks, using guidelines, instructs banks on the
cost and volume of credit to specified sectors depending on the degree
of priority of each sector. Thus selective credit control is example of
the use of monetary policy to influence directly the allocation of
resources, indicating a lack of faith in the working of the free market.
Here, the central bank may resort to credit rationing by prescribing
absolute limit up to which specified sectors of the economy may be
authorized to get credit from the banking system or from particular
types of banks. The central bank might also insist on margin
requirement used for regulating stock market credit-a kind of direct
regulation of private transactions. Here the margin requirement is seen
as that part of the purchase price of securities that may not be
borrowed. This is mainly used in USA.
Another variant may be the regulations of consumer credit with
respects to specified goods and services. Here, a variety of restrictions
of banks advances are applied lightening them, relaxing them,
removing them and re-imposing them depending on specified
government objectives at each point in time.
Moreover monetary policy in an open economy also adopts an
additional tool - exchange rate i.e., the rate at which the local currency
is exchanged for other currencies. To date Nigeria has experimented
with four approaches in determining the naira exchange rate. These
are: pegging, managed float, import - weighted basket and freely
floating or market - determined (alias SFEM, later FEM and IFEM,
introduces in September 1986).
24 | P a g e
2:4 MONETARY POLICY INDICATORS:

Monetary policy indicators refer to the index of the effect of current
policy that is some variable or combination of variables to measure
the policy effect on the target variable (required to gauge the effect of
monetary policy).
In fact, to Eruner and Meizer (1969), the indicator of monetary policy
provide a scale that permits policy markers. to compare the thrust
of monetary policy on economic activity, that is, to characterize one
policy as more expansive than another or to characterize policies as
more or less expansive than before. This role of indicators is to allow
comparison and assessment of monetary policy.
The choice of monetary policy indicator requires some hypothesis
concerning the structure of the economy. The indicator must be.
a. Easily observable with little or no time lag
b. Quickly affected by the policy undertaken and
c. Related to the target and to the goal variable.
Since the monetary policy indicator measures the effect of the
immediate past policy and since the future course of policy will be
influence by the policy maker's judgement of this effect, the indicator
must yield at least qualitative correct results, otherwise, there is the
danger that a policy will continued when it, in fact, intensifies rather
than moderates the cyclical fluctuation in the goal variable
The possible variable indicator of monetary policy is
a. Total reserves
b. Money supply
c. The interest rate and
d. Free reserves i.e., the differences between excess reserves and
borrowed reserves Ranlett, (1977)
25 | P a g e
The problem of the appropriate monetary policy indicator is part of

the controversy between the monetarist and the Keynesians
They held a differing views and conclusion on the relative stability of
the economy as well as the appropriate indicator for conducting and
assessing monetary policy. Monetarist contend that monetary policy
should be set in terms of the growth of the money supply or some
monetary aggregates such as the monetary base (i.e. total reserves plus
currency outstanding in the hands of the public) and that the effect of
monetary promptings can best be measured or gauged by observing
those variable. On the other hand the Keynesians argue for monetary
policy to be in terms of the interest rate or free reserves, they are of
the opinion that the current policy effect should be gauged or judged
in terms of these variables.
Some economist held the view that monetary policy indicator should
be an exogenous variable, they contend that if an endogenous variable
is used as monetary policy indicator it might possibly be
overwhelmed or swamped by non-policy induced changes. Among the
aforementioned possible variables for use as an indicator of monetary
policy, three among them are endogenously determined; the interest
rate, free reserves and the money supply. The only exogenously
determined variable for use as an indicator of monetary policy is total
reserves.
However, the issue of the choice of appropriate indicator only
becomes a problem when there are several policy instruments and
policy variable that cannot be summarized by a single exogenous
variable. Mostly the choice is a function of which school of economic
thought one adheres to.
26 | P a g e
2:5 MONETARY POLICY TARGETS

In general, monetary authorities have ultimate goals that, in most less
developed countries; consist of growth in national output (or
economic growth and development in the long-run) price stability (or
moderate inflation) and external balance (i.e. a sustainable balance of
payments and/or stable exchange rates). The issue of monetary policy
target arises because firstly, it is not easy to achieve all of the ultimate
targets simultaneously without trade-offs. Secondly the ultimate target
of monetary policy represent the broad objective of economic policy
generally making the objective of Economic Policy General, Thus
Making The Establishment of The Impact of Monetary Policy On
These Set variables (price stability, output, growth and balance of
payments equilibrium) general difficult. Thirdly, it is not usually
possible to establish a direct link between monetary policy instrument
and the ultimate targets. Obviously, it is necessary for monetary
promptings to affect spending decisions if it is to be effective, but the
chain of causation from given policy action to its impact on aggregate
demand is circuitous and indirect and the speed of transmission may
not be rapid. Therefore, a strategy adopted to address the problem
posed by the indirect relationship between policy instruments and
ultimate targets is the targeting of intermediate variables. This requires
policy makers to select some proxy for the ultimate goal variable
with the idea that by forcing the proxy or proximate target variable
to move in a given direction or to take on a given value, the ultimate
goal variable will respond appropriately.
Thus, the target is the value that the monetary authorities shoot at in
determining their appropriate policies. It is a desired value of
endogenous variables chosen by a policy maker and which is
observable with little or no time lag. To Brunner and Meltzer (1960)
27 | P a g e
the target problem is. choosing optimal strategy or strategies to

guide monetary policy under the condition of uncertainty and lags in
the receipt of information about the more remote goal of policy.
The intermediate or proximate target of monetary policy varies from
country to country, and in the same country over time, depending on
the stability of the relationship between such target variables and
ultimate goals of policy. Generally, the following are the desirable
properties of proximate target variables
a. Readily observable/measurable with little or no lag
b. Rapidly affected by the monetary policy instrument and
c. Related to the ultimate goal variable unambiguously in the sense
that policies resulting in the target variable taking on certain
value must, in turn, result in the goal variable taking on certain
values.
In addition, the monetary authorities should be capable of affecting it
directly and in the right magnitude, and be able to neutralise the effect
of any change in the target variables that is not related to the policy. In
the choice of monetary policy targets variable, some theoretical
hypothesis regarding the inter relationship between the target variable
and the ultimate goal variable is necessary. Generally, the potential
variables for the intermediate or proximate target variable include
those for the indicator variable: interest rate, free reserves, the money
supply and total reserves the most likely ones are the monetary
aggregate (such as money supply and interest rates). In Nigeria the
broad money supply M2 is the proximate target variable of money
supply with money supply targeting for example, the introduction of
intermediate target allows a two stage process that focuses on the
appropriate level of money supply and the use of policy instruments
of limit monetary aggregates to that amount. Money supply growth
28 | P a g e
assumes greater significance as an intermediate variable where the

interest rate channel for monetary policy is not a powerful one
(because interest rate elasticity of the demand for credit are small).
While under interest rate targeting, the relevant interest rate is the
inter bank rate in over night funds, which is the rate that clears the
market for bank reserve balances.
The issue raised by the need for monetary policy to have sharper
focus, namely relative price stability as the major goal, as well as the
need to over come the problem of lags in monetary policy
transmission have generated keen interest in the targeting of the
ultimate objective, hence the strategy of inflation targeting
The relationship involving monetary tools, proximate and ultimate
goals are diagrammatically illustrated in figure 1 below
Figure 1
MONETARY TOOLS
DIRECT
- Credit Ceilings
- Deposit ceilings
- Directed credit
- Exchange controls
- Stabilization securities
- Others
INDIRECT
- Omo
- CRR
- MRR
- Parity changes
29 | P a g e
PROXIMATE TARGETS
- Interest rate
- M1, M2, M3
- DC
- H
ULTIMATE GOALS
- Outputs
- Price stability
- Sustainable balance of payment
- Exchange rate stability
The choice of the appropriate monetary instruments and proximate

targets would depend on the effectiveness, stability and certainty of
the relationship between monetary tools and proximate targets as well
as that between proximate target and ultimate goals.
THE CONCEPT OF MONETARY INFLUENCE

The role Money and monetary policy exerts on economic activity is a
subject of great controversy among economists. The extent to which
money and monetary policy influence financial and economic
activities has been widely discussed over the years and differing
conclusions have been reached by diverse economic school of
thoughts. There is unanimity of view among economists that monetary
development affect economic and financial performance put
differently most economist unanimously agree that changes in the
supply of and in the demand for money play a significant role in
determining the level of financial and economic activities. There have
30 | P a g e
been and continue to be mere disputes and differing views among

economist as regarding monetary transmission mechanism and the
extent of the impacts, that is, the results that might be expected to
follow when the money supply is changed. Perhaps by greater
government expenditure or by the banking sector granting more
credit, resulting to initial disequilibrium, between the demand and
supply of money. The areas of the dispute are both theoretical and
empirical in nature. In order to x-ray the impacts of money and
monetary policy on the banking industry, it would be instructive to
review the differing and changing views and conclusions on monetary
influence. These monetary impulse are effect directly as well as
indirectly through feedback effects from the economy. Usually when
the quantity of money supplied varies relative to money demands as a
result of monetary policy measures or other measure; it leads to
changes in relative price and wealth. While these are viewed as a
major channel of monetary influence, however, several variants
abounds over the years regarding the way these changes impact
aggregate spending in the economy.
Monetary theory studies the influence of the demand for and supply of
money upon price, interest, output, and employment. Over five
centuries many theories have been advance in an attempt to build an
ideal framework for analysing monetary influence. Economist have
for long recognised the relationship that exit between monetary policy
and economic activity. The philosophers and economist of the
sixteenth, seventeenth and eighteenth centuries were preoccupied with
economic problems much like ours today - less than full employment,
inflation and economic stagnation. The policy prescription advanced
then; to expand bank credit and the money stock during periods of
depression and the contraction of money stock during periods of full
31 | P a g e
employment and rising price, differs not from the ones advanced
today. The relationship between money and price was first
emphasized in the sixteenth century. Later in the seventeenth and
eighteenth centuries a comprehensive theory on the relationship
between money, velocity, economic activity and trade was
development. The postulation was that money and velocity of
exchange are the determinants of economic activity and trade. Some
distinctions between money and trade was advanced (Locke 1700 and
on employment (law 1708). On the other hand, the problem of pricing
process was the main preoccupation of nineteenth century economist.
They devoted considerable time to discover the technique of optimal
allocation of productive recourses among competing uses as well as
determinant of the prices of productive resources and final products.
However they neglect the macro economic problem being deluded by
the assumption of full employment of resources. They are of the
opinion that production creates it's own demand as such depression is
simply a temporary departure from full employment. Therefore they
postulates that variation in money stock in the long run will bring
about change in the price level rather than to changes in employment
and output.
The late nineteenth century and early twentieth century witness a re-
awakening of interest in monetary economics and a renewed
emphasis on the problems affecting the level of economic activity.
Economists strive to develop an analytical framework for both price
movement and cyclical fluctuation in the economy. Thus lrvying
Fisher developed equation of exchange - a tool of economic analysis
used by economist of almost all theoretical learning today. Fisher
propounded that changes in money stock is the principal cause of
variations in gross national product rather than simply in prices, his
32 | P a g e
view of the quantity theory is criticized by economist as a rough but

relatively valuable theory of income and output determination. Fisher
was one of the first economists to attempt an empirical verification of
his hypothesis. Alfred Marshal, John Maynard Keynes, Dennis H.
Robertson, Leon Walras, and AC Pigou formulated alternative cash
balance equations used today by economist to explain not only price
level fluctuation but also output and demand for money changes.
Other economist like Knut Wicksell, Rauph Hawtray and others, as
well as Fisher advanced reason in order to explain the volatile nature
of the economy - it's cyclical swing, they propounded that interest rate
is the prime cyclical move and advocated Central Bank control over
the interest rate in order to eliminate the re-current inflations and
recessions.
The depression period of the 1930 demonstrated the inadequacies of
these theories; however the early twentieth century economic model
were too elementary to combat problems of our technically advanced
society. The old theories reasoned too simply from cause to effect,
neglecting the manifold interrelation among variable. This brings
about concepts about the Keynesian revolution which completely
revolutionized our concepts about the determination of overall
economic activity. The Keynesian framework of analysis evolved
during the period of great depression when unemployment was the
main concern. Yet just as the past theories proved inappropriate and in
adequate in explaining the emerging new economic problems, so the
Keynesian model becomes inadequate especially in its explanation of
inflation. Similarly as we shuffle the epoch of the prosperous years
following the World War II the nature of our economic problems
change. The pre - occupation of this time was inflation and in the
1970's was "stagflation and in recent times both inflation and
33 | P a g e
unemployment. Many economists respond to the economic problems

by reformulating the analyses of the pre-Keynesian period synthesized
into the contemporary quantity theory of money.
Furthermore, on the issue of the concept of monetary influence, the
classical school of thought, which refers to the tradition of economic
thought that originated in Adam Smith and developed through the
work of David Ricardo, T.R Maithus, J.S Mill down to Alfred
Marshall and A.C Pigou (Bannock 1972) there hey-day was during the
year 1800-1850
The classical school argues that "money is a veil" that cover the
underlying real force in the economy. In their analysis, an increase in
the supply of money leading people to have more money initially in
their pockets or in their bank balances than they would want to have at
existing price and interest rates levels, would brings about a general
expansion of expenditures as people use their bank balances to buy a
wide range of goods and service. But classicalist view the level of real
output and the production of all goods, as being brought back swiftly
to an equilibrium level through change in relative market prices, such
latter shifts in relative price include importantly, variation in interest
rates, which were seen as equilibrating the level of savings
investment. With the mechanism of price shifting relating to each
other maintaining full equilibrium within the economic system, an
expansion of monetary balance would simply lead in fairly short order
to a generalized expansion in the overall level of price. In a class
view, monetary expansion leads directly and swiftly to a concomitant
change in the general price level. This implies that monetary
promptings will exact no impact on real variable in the real sector of
the economy like real rate of interest, rate of unemployment and
others.
34 | P a g e
They postulate that variation in money stock can only affect nominal
variable like wages, price level etc and such monetary policy is
irrelevant.
This was widely seen to be idealized picture of a world in which
during the course of the nineteenth century, there were quite marked
and often, it appear, relatively similar cycles around a normal
equilibrium levels of output. This was explained by a group of
economist, comprising such famous names as Wicksell, Hawtrew and
Dennis Robertson, as reflecting certain imperfections within the
economic system, especially and notably within the banking system
that prevented the economy adjusting as perfectly as indicated within
the simplified classical model. In particular, bankers like everyone
else, would find it hard to distinguish between these occasions when
an expansion would quickly exhaust itself in an inflationary impulse,
or might actually represent a real economic improvement, say as a
result of technological innovations and supply side improvement to
the productivity of capital and labour. Thus a purely monetary
expansion increasing bank reserves, would make bankers keen to
expand lending, and the fall in interest rates would make businessmen
willing to invest and expand more generally. This would cause a
period of high profit and prosperity and general optimism, leading to
further balance sheet expansion. Assuming that the expansion was not
caused by improved real conditions, say in the form of technological
productive advances, then the expansion would ultimately lead to
inflation, a drain of cash reserves and a falling away of profit margins
as wages and inputs prices rose relative to final prices. This might
then lead to a financial crisis or panic, which would lead bankers in
turn to become much more risk averse, conservative, and unwilling to
increase the size of their balance sheet. Leading then to a downturn
35 | P a g e
even so, those cyclical fluctuations took place around a full

employment equilibrium to which these economists saw the economy
reverting in due course, even if the various imperfection of
information within the system prevented such adjustment being rapid.
Moreover the "neo-classicalist" which is being used here to as a
designation for the body of thought which organized monetary theory
around a transaction or cash balance type of equation and which then
applied these equations to validate the classical quantity theory of
money Patinkin (1965). Ivying Fisher (1932) was among the early
writers to explain how money affects economic and financial
activities. Fisher like other neo-classicalist are of the opinion that in
the short-run monetary influence was initiated by interest rates that
were "sticky" initially though rising subsequently, however the long-
run transmission route was real cash balances. Therefore increasing
the quantity of money as a result of an increase in gold stock and rise
in reserves the short-run impact in Fisher's opinion would be an
upsurge of commodity prices following his assumption of fixed output
and velocity.
Furthermore, in Fishers assumption the upsurge of prices would be
preceded by the increase in interest rate that was considered as part of
the firms operating costs. Consequently the upsurge in commodity
prices would result to a rise in the firms profit followed by increase in
business investment loan demand, demand deposit, and money stock
which will culminate into further increase in commodity prices, profit
and investment. Eventually, in the process the excess reserves for
lending would be crowed out and this will cause a sudden rise in
interest rate that was sticky formerly more swiftly than the
commodity prices thereby resulting to a rise in the production cost
since interest rates was regarded as parts of the operating cost of
36 | P a g e
production. This in turn will bring about a decline in profit and

investment. If for any reason for instance an increase in gold stock
lead to an increase in excess reserve, then the interest rate falls to a
lower level, then the decline phase of the business cycle would be
reversed with money stock resuming growth and leading to upsurge in
prices of commodity and profit followed by rise in business
investment loan demand and further increases in demand deposits,
money stock, prices, profit and investment.
In his analysis of long-run transmission of monetary influence, Fisher
interchange, interest-investment channel with real cash balances.
Thus an increase wealth as a result of rise in money stock, people
would purchase goods and service in an effort to reduce their cash
balance. Since velocity (V) and output (T) in Fishers equation of
exchange (mv-pt) is fixed, a doubling of money stock (M) cannot
initiate increase in holding of goods and service but rather would lead
to the doubling of the price level (P). However, Fisher did not
advance adequate explanation for the substitution and wealth effects
expected from a change in quantity of money, thereby making his
position ambiguous.
Keynes in his analysis like Fisher on monetary transmission
mechanism was not expressly clear, resulting to divergence view and
interpretation by subsequent writers. Keynes (1936) accepted that a
variation in money supply relative to demand has both substitution
and wealth effects and regarded investment to quite responsive to
interest rate, his view on the effect of money on interest rate was not
clear-cut. Similarly he recognized price induced wealth effect (i.e.
changes in wealth associated with changes in absolute price level) and
interest rate reduce wealth changes (or change in wealth associated
37 | P a g e
with changes in yields) varying accounts abounds by his interpreters

on the extent he integrated then into his general theory.
Subsequent writers to Keynes, the Keynesian or post Keynesians in
their analysis postulate, that money is a close substitute for other
financial assets, for instance bonds Ajayi and Ojo (1981). They
recognised the cost of Capital (or interest rates) as the main process by
which monetary promptings influence the real economy. Thus the
change in the volume of money alters the rate interest usually
approximated by the long-term government bond rate, which affects
investment and possibly consumption. Therefore, interest rate was
viewed as the causational link between real and financial sector. Other
major route of monetary influence established by the post Keynesians
were the wealth effect on consumption expenditure and credit
rationing linkage between financial and real system. Therefore, within
the Keynesian framework of analysis, the transmission route of
monetary impulse, say as expansion ran entirely through interest rate.
Monetary expansion say an increase in money supply, would lend to
disequilibrium between desired and actual money balance. In the
wake of this individuals and groups in attempt to reduce the excess
money balances spend their excess cash balance on bonds and thereby
bidding up their prices and reducing the interest rates on liquid
financial instrument, leading on to a reduction in interest rate on
longer term bonds as people switched out of lower yielding liquid
assets into higher yielding linger bonds. Thus this attempt to strike a
balance between the desired and actual money balance of which
culminated into process of portfolio adjustment. This portfolio effects
which operates through the substitution of other financial assets for
money raises their price and reduces their rate of interest, which is
their yields. In the Keynesian analysis the decreases in the interest rate
38 | P a g e
generates three effects viz: the wealth effects, the cost of capital
effects and the credit rationing effects.
Considering the wealth effect, the fall in interest rate appreciates the
market value of individual wealth, which tends to induce consumption
and via the multiplier effect stimulate investment and aggregate
output.
For the cost of capital effect which postulates that the main
determinant of investment is the cost of borrowing, the decrease in
interest, all else being equal will make the cost of burrowing cheaper
and given the inverse relationship between investment and the rate of
interest, will induce investments which through multiplier, increases
aggregate output.
While the credit rationing effect operates through the attempt of
commercial banks to readjust their lending policy in respect of
changes in their reserves. With increase or excess reserves the
commercial banks tends to create more credit and as the additional
credit flows into the market, it depresses the rate of interest which
through the multiplier raises investment and output respectively.
In summary, the monetary transmission mechanism of Keynesians de-
emphasizes the role of money but involves an indirect linkage of
money with aggregate demand via the interest rate; Anyanwu (1994)
this can be symbolically depicted as thus:
OMORMS r IGNP
Where OMO is open market operation, R is commercial banks
reserve, MS is money supply, r is interest rate, I is investment and
GNP is the gross national products.
Moreover the link between net wealth of the private sector and
consumption was further analysed by Pigou (1947) and Patinkin
39 | P a g e
(1951) in the form of "real cash balances effect" which implied that
variable in the real quantity of money could effect real aggregate
demand even if they did not change the rate of interest rate. On the
other hand, credit-rationing channel of monetary impulse was further
expatiated to show that under imperfect market, interest rates change
to borrowers by financial intermediaries, including commercial banks
would be regulated by non-market force so that lenders ration
available supply of credit by non-price mechanism. Under the
circumstances, Modigliani (1963) argued that demand for credit
limited not by willingness to borrow at the given rate but by the funds
available for rationing among the would-be borrowers.
Thus the dichotomy between the original classical and the Keynesians
models related to the prospective behaviour of agents in the economy
when faced with monetary balances. The classicalists saw an agent
using such excess cash balances quite generally for the purchases of
wide range of goods and assets; the Keynesians on the other hand saw
agents with excess balances placing these in alternative substitute
financial assets.
While the debate on the proper link between real and financial sector
continues, there appear to be a consensus among a group of economist
called monetarist or neo-Keynesians mainly the Yale school of
thought, that monetary policy operates through changes in market
price of equities "which represents claims on existing real assets. Thus
an expansionary monetary policy, for example raises the price of
equities (i.e. reduces the yield on equities) the margin between the
market valuation and the cost of reducing the existing capital goods
will stimulate new investment in these goods. Furthermore the work
of Tobin and Brainard (1968) regards the equity as the major link
between money and the level of economic activity. On the other hand,
40 | P a g e
another group of non - monetarist often called new - Fisherians,

constitute a sub - group, including the USA Federal Reserves MIT
school of thought who argue that change in the quantity of money
have direct impact on short term interest rate which through the
process of portfolio substitutions, affect long-term interest rates,
equity yield and possibly other rates of return on real assets. This
process implies that the full effect of monetary impulse is subject to
long lag since it takes time for monetary promptings to be reflected in
long interest rates, equity yields and components of aggregate
demand.
While the non - monetary postulations imply that monetary policy is
less effective influencing aggregate spending in the economy
compares to fiscal policy. However the monetarist revivals led by the
Nobel Prize Laureate, Professor Milton Friedman and the Chicago
school in the United States (1970) and (1971) are of a different view.
Their postulations represented no more than a reversion of the earlier
classical views rather than the much more limited Keynesian
transmission route.
They reformulated the quantity theory of money to blend the older,

pre-Keynesian version with some tenets of Keynesian doctrine.
Unlike earlier quantity theorist, the monetarists view money more
than a medium of exchange. They subscribe to the idea that demands
for money is sensitive to interest rates like Keynesians; they reject the
earlier quantity theorists assumption of a constant velocity.
Nevertheless, they postulate that velocity is a stable function of,
among other things nominal incomes and interest rates, and can be
predicted. The monetarists revived and refurbished the quantity theory
in counter argument to the Keynesian and post Keynesian paradigm
41 | P a g e
which before then was the ruling paradigm. These academicians were
called the new or modern quantity theorist because their postulations
aligned considerably with the tenets of the old quantity theory.
Moreover they are called monetarist because of their undaunted belief
in the supreme efficacy and efficiency of monetary policies.
The monetarist transmission mechanism recognized both direct and
indirect effects of changes of demand for and supply of money on
aggregate spending. The main argument of the monetarist is that
money is the most crucially regulatory instrument in the economy
(though not the only one as in the old quantity theory) and that money
has both direct impact on the economy and as well as indirect impact.
They went further to say that wealth holders can hold their wealth in a
different forms including money, therefore an increase in money
supply will eventually decompose itself as increase in the cash
balance of the various individuals and economy agents in the society.
As wealth holders realize excess money or liquidity and in attempt to
reed themselves of the excess balances to restore their desired level,
some of this spending will be on goods and services such as
machinery, house, personal computers and holdings. This then implies
the direct effect on spending of the increase in money supply also
refers to direct monetary transmission route.
Moreover as earlier noted, an increase in the money supply will also
tends to depressed interest rates and affects aggregate spending
indirectly. This is the indirect monetary influence on economic
activity as postulated by the monetarist. However, unlike the old
quantity theorist but much like the Keynesians the monetarist view
money as an asset and holding money like any other asset is a from of
wealth. Unlike the Keynesians who hold that only bonds are close
substitute for money, the monetarist view money as only one of the
42 | P a g e
five forms in which wealth could be held, the other four being bonds,
equities, physical capital and human capitals thus infusing portfolio
theory into money demand analysis. The dichotomy between the
monetarist view on monetary influence and that of Keynesian is thus;
in Keynesian analysis wealth holders attempt to spend excess money
balances on bonds and so force down interest rates. While in the
monetarist analysis wealth holders attempt to spend their excess
balances on all types of assets, including goods this leads to both a fall
in interest rate and an increase in either the output or price of goods
and services.
The monetary are of the strong opinion that:
1. Variation in the stock of money is the primary cause of
exchanges in aggregate expenditure.
2. Fluctuations in the stock of money overtime and business cycle
are stable and predictable.
3. The most reliable measure of monetary impulse are the change
in the stock of money.
4. Monetary impulses are transmitted to the real economy through
a relative price mechanism (direct link) or land portfolio
adjustment mechanism (indirect link) which exerts a
considerable effect on many financial and real asset.
In summary monetarist are of the view that money and income are
directly correlated. Money variation affects long-run stock of real
capital and hence output. They expatiate further that fluctuation in
money national income is attributed largely to monetary policy whose
effect is transmission to national income both through the bond yield
and other channels Anyanwu (1994).
The monetarist transmission mechanism recognizes that money is not
just a close substitute for a small class of financial asset, but rather a
43 | P a g e
substitute for a large spectrum of financial and real assets. There is a

three-fold asset choice; holding money, holding financial asset,
holding real assets. This enables money to have a direct effect on
consumption as will as giving it the possibility of operating through
the Keynesian investment income consumption mechanism. Thus,
given an equilibrium position, an increase in money supply raises the
actual proportion of money relative to the desired proportion. People
react by getting rid of the excess balance. Transaction needs of
different sectors within the economy rise and increases in the purchase
of goods and a service for securities ensues. The transactions in
securities affect security prices and interest rates. The decline in
interest rates serves to facilitate real and financial asset adjustments
through the impact of changes in money on any specific interest rate is
both too brief and too weak to be captured statistically or identified as
a strategic variable affecting income mechanism transmission.
Therefore, the monetarists view the money supply as a strategic
variable affecting income directly. Symbolically the monetarist
transmission mechanism can be shown as thus:
OmoMsSpendingGNP
Where OMO is open market operation, Ms is money supply and GNP

is gross national product.
Meanwhile Goldsmith (1967) Mckinnon (1973) and Shaw (1973) hold
the view that there exist a positive relationship between developments
in the financial sector and variable in the real sector. Ikhide (1988)
affirmed this view in his work on the relationship between financial
development and capital formation. Indeed Ojo (1992) noted there is a
direct and consistent link between money supply and output.
44 | P a g e
The side of the picture is represented by the pessimism of Gurley

(1967). He did not dispute the usefulness of the development in the
financial sector but tried to point out alternatives the may be feasible.
The literature also shows a seeming consensus that money supply or
credit available in an economy has a positive relationship with output
(Ajayi and Ogo, 1993, Goarcher, 1986: Reynelds, 1988 and Anyawu,
1993). Osakwe (1993) thus rationalised the use of money supply and
bank credit to promote output. According to him there was a
conscious effort to reflate the economy in 1988. Bank credit and
money supply were increased. The move, which was expansionary in
nature, was aimed at promoting growth in output and employment in
spite of Osakwes, optimism, Ogwuma (1996) noted that the use of
monetary stimulus could generates inflationary pressures on the
exchange rate and balance of payment, this is in the face of low
productivity, foreign exchange constraint and technological
limitations.
Various differing views and conclusion abound among economics on

the exact monetary transmission mechanism on the economic and
financial activities. Nevertheless liquidity, credit and exchange rate
channels have been generally accepted as avenues via which monetary
impulse route its way to impact economic and financial performance.
(CBN Brief 1998).
Under the liquidity channel of monetary transmission, variation in the
money supply initiated by the various tools of monetary policy affect
interest rates, (both short term and long term). Through this route the
initial monetary impulse is transmitted to economic activities
(consumption, investment etc) through the effect of the changes in
interest rate on cost of capital.
45 | P a g e
The credit channel works by portfolio adjustment in banks, household

and firms balance sheets in favour of asset that have higher returns
during periods of monetary fluctuation on normal circumstance assets
commanding higher demand would be produced more and thus
stimulate the economy .A good example of credit channel is the bank
loan in which a credit squeeze forces bank to ration credit. This will
brings about the crowding out of customer relying on the bank loans
in the loan market. Thereby retarding the tempo of economic
activities.
2:8 MONETARY POLICY REGIMES IN NIGERIA

Monetary policy in Nigeria has been conducted under two regimes,
the era of regulation and that of deregulation accompanying the
adoption of economic reform measures aimed at improving the
functioning of the economy. During the era of regulation (up to 1986),
the framework for monetary management was the direct control or
approach. Direct control operates by placing quantitative ceilings on
bank credit and also limiting banks freedom to undertake certain
activities. Example of direct instrument includes credit ceiling sect
oral allocation of credit and direct regulation of interest rates. The
credit ceiling was extensively used to control money supply growth.
Supplemented by the use of reserve requirements and occasionally
other measures. The use of direct instrument was however, phased out
because of their declining effectiveness overtime, the distortion
introduced into the allocation of bank credit and the encouragement
given to disintermediation in the financial sector.
Conclusive empirical evidence abound that direct control introduced
distortions into the process of financial intermediation and that credit
46 | P a g e
ceiling, in particular by providing cheap finance for government

deficits, encourages fiscal indiscipline and therefore a major source of
monetary instability. Obviously the Nigeria monetary chronicles,
substantiate this fact. For instance the Balewa era gave a primacy of
place to indirect tools over direct tools of monetary control. Brown
(1962) observed during this period, the principal instrument of
monetary control in Nigeria is without doubt, the asset ratio. But
gradually, after the Balewa era direct (Control) instrument were
introduce de facto and given legal backing in 1968 Teriba, (1969 and
FGN, 1968) similarly the now dreaded stabilization securities was not
introduced until 1968. Teriba, (1969). Thus, it was not amazing that
Balewa administration observed strict fiscal discipline and enjoyed
more monetary stability than any government after it, even in absence
of the natural blessing of oil boom.
Moreover the use of credit ceilings does not promote competitive
initiatives among banking institutions and requires extensive
monitoring by the regulatory authorities to ensure compliance though
they may be policies of first choice when the financial market is very
thin or in crises, the use of direct tools beyond these situation would
endanger monetary stability and economic progress.
Thus, indirect monetary tools are to be favoured if economic progress
and monetary stability are the object of any monetary authority,
because they preserve the freedom of choice of operators in the
financial sector (wealth holders, financial intermediaries and
investors). Also they discourage fiscal indiscipline with all its adverse
effects by raising the cost to government, of financing any fiscal
deficit as the size of the deficit increases. They also promote
competitive initiatives among banks greater resource mobilization
47 | P a g e
allocation and consequently rapid development of the financial sector,

among others.
Therefore in appreciation of the above enumerated indispensable
benefits and in line with the policy of deregulation, the CBN adopted
the indirect method of monetary control or market- based approach,
which relies on the power of the monetary authorities to influence the
credit operations of banks through changes in bank reserves.
The main-market-based instruments are Open Market Operations
(OMO) and Discount Window Operations. Since 1993, OMO has
been the dominant instrument of liquidity management, with discount
rate and reserve requirements as the main adjustment instruments. As
earlier mentioned, the merit in market based techniques is their
flexibility to even - out swings in bank reserve relative to demand to
keep the inter-bank rate within the desired range. They also enhance
market competition, invocation and efficiency.
48 | P a g e
END NOTES: CHAPTER TWO
Adewuyi A.D. (2000): Absorptive Capacity and Macroeconomics

in Nigeria (Financial report NISER,
Ibadan)
Ayodele J. (1998): Regulation of the Banking Industry in
Nigeria; An operators viewpoint
Cacy James A. (1980): Choice of a monetary policy instrument

Current issues in monetary theory & policy
second edition (AHM Publishing
Corporation Illinois).
Central Bank of Nigeria CBN Briefs (Research dept. CBN

(1998 2002); Publication).
Ezeuduji U.F. (1998): The effect of Monetary Policy on the

Performance of the banking Industry (CBN
Economic and financial Review vol. 32. No.
3)
Friedman Milton (1970): A theoretical framework for monetary

Analysis Journal of political Economy).
Friedman Milton (1956): The quantity theory of money; A

Restatement (Milton Friedman, ed,
Studies in the quantity theory of money
(University of Chicago Press).
Fisher Irvy (1911): The purchasing power of money (Macmillan

London).
Friedman Milton (1980): Factors Affecting the level of interest

Rates (Current issues in monetary theory
and policy Illinois Corporation).
Goarcher O.T. (1988): An introduction to monetary Economics

(Financial Training Publishers).
49 | P a g e
Ijo A. (1991): Effects of deregulation Policy (Business

Concord).
Mohammed E.A. (1999): Deregulation and Development of the

financial sector in Nigeria (Faculty of
Social Science Delta State University
Publication).
Monye-Emina A.I. (1999): A Study of Economic Growth and money

Supply (Faculty of Social Science, Delta
State University Publication).
Modigllani Franco (1963): Monetary Mechanism and its interaction

with real phenomena (The Review of
Economics and Statistics).
Nwankwo G.O. (1987): Nigerian Financial System (Macmillan Press

Ltd, London).
Odozi V.A. (1992): Current Monetary and Banking policies in

Nigeria and prospects in the third Republic
(CBN Economic and financial review vol.
30, No. 1).
Ogunlowo A. (1992): How Monetary Policy instruments works

(National Concord Jan. 2, 1992).
Ogwuma P. (1997): An effective monetary Policy for Nation

Building: (Bullion vol. 21, No. 3).
Ojo, M.O. (1992): Monetary Policy in Nigeria in the 1980s

and prospects in the 1990s (Economic and
financial Review, vol. 30, No. 1).
Ojo, M.O. (1992): Evolution and performance of Monetary

Ojo, T.A. (1998): An Overview of the Nigerian Banking

System (CBN Economic and financial
review vol. 32. No. 3)
50 | P a g e
Onyekachi D.N. (2001): The impact of monetary policy instruments

on the lending operations of commercial
banks in Nigeria 1989 1998 (MBA thesis
Fed. University of Technology Akure).
Osakwe, J.U. (1993): Monetary and fiscal Policy under SAP

(the Nig. Journal of Economic and Social
Studies vol. 35 No. 1).
Park, Yung Chuf (1980):some current issues on the transmission

process monetary policy (Current issues in
monetary and policy. AHM Publishing
corporation Illinois).
Phillip H. Bahadur An Introduction to Modern Economics.

K. John L. (1994): (Long man Publishing New York).
Sanusi J.O. (2002): The evolution of monetary Management in

Nigeria and its impact on economic Devt.
(CBN Bullion Vol. 26 No. 1).
Vickers D. (1959): Studies in theory of money, 1960 1776

Chilton Company 1959).
Wonnacot and Wonnacot: Economic Text (Willey)
William E. Gibson (1970): Interest rates and monetary Policy

(Journal of Political Economy).
Yesufu, T.M. (1996): The Nigerian Economy, Growth without

development (Ibadan 1996)
51 | P a g e
CHAPTER THREE: METHODOLOGY

This chapter attempt to discuss the various ways or methods adopted
by this study for data collection and analysis, the sources of data, as
well as the theoretical framework and model specification employed
for the study.
3:1 PROCEDURE USED
This research work employed content analysis technique of inquiry to
obtain the relevant data used for analysis. Content analysis technique
of data collection is a tool of inquiry that involve reviewing and
analyzing the existing literatures and finding on a specific subject
matter. This study relied mainly in the use of secondary data, the
sources are indicated below.
3:2 SECONDARY DATA

Secondary data are data already compiled and used by some one else
or government agencies established for the compilation of such data
for economic planning. They include statistics on numerous topics and
may be published or unpublished. One of the paramount advantages
of using secondary data is that, they are always readily available,
standard, fairly accurate, less time consuming and cheap to get.
This study obtained its secondary data from the following sources:
Extract from textbooks, dailies, Central Bank of Nigeria (CBN)
statistical Bulletin, Bullion, Economic and financial review, annual
report and statement of accounts, and professional journals.
3.3 THEORETICAL FRAMEWORK AND MODEL SPECIFICATION

Here attempt is made to discuss the relationship between monetary
policy proxied by broad money supply M2 (monetary policy indicator
and target) and the performance of banking sector proxied by the
52 | P a g e
deposit mobilization performance of commercial Bank and there after

specify a mathematical relationship. A priori expectations from
economic theory suggest that monetary policy (proxied by M 2)
positively affects the performance of the banking industry (proxied by
Deposit mobilization). This is based on the hypothesis or postulations
of the following Finding.
Several authors and proponents of financial liberalization are of the
view that the more unfettered the financial system is, the greater is its
role in deposits mobilization distribution, Kindle Berger, (1974).
Some of the recent works on the role of banks (mainly deposit
mobilization and allocation) in the development process include those
by Susman (1975), Harris Et al (1994) Stiglitz and UY (1996) and
Aryeetey et al (1997).
Stiglitz and UY (1997) postulated that moderate repression (which
they called financial restraint) may indeed increase savings
mobilization. Aryeetey Et al (1997) postulate that liberalization of
restrictive policies in interest rates, and entry leads to greater access to
formal finance and lower spread between borrowing and lending rate
as well as diminishes the role of the informal sector. The general view
is that financial liberalization will stimulate development in the
financial system and hence improve resource mobilization.
Financial deregulation that accompanied the Structural Adjustment
Programme (SAP) was a means of ensuring enhanced performance
and more effective management of the financial system as well as
effective financial intermediate processes. The government presume
to achieve this objective through deregulatory monetary policy
measure which is a concerted effort at deregulation of the banking
system, with greater emphasis placed on indirect control and hence
market based monetary instruments such as open market operation
53 | P a g e
(OMO), cash reserve and liquidity ratio, and discount rate, with the
key benchmark variable broad money supply (M2). The monetary
authority attempt to equate money demand and money supply and
therefore determine an optimal quantity of money consistent with
assumed target for GDP growth rate, inflation rate and external
reserve (Balance of Payment Position).
With the target of M2, the monetary authority hopes to achieve a
particular optimum level of based money (H) which has a give
relationship, represented by the money multiplier (m) with the broad
money supply (M2) the monetary base defined as the net monetary
liabilities of Central Bank has a high correlation with the money
stock. Assuming a stable money multiplier (m), CBN can control the
money supply (M2) by targeting bank reserves. Since this is the
variable which the authority can influence most directly with
instruments under its control. By targeting bank reserves through the
market base instruments the CBN expects to keep the base money (H)
and eventually broad money supply (M2) at optimum level adequate
for non inflationary economic and financial activities. Given that
broad money supply (M2), is a product of money multiplier (m) and
base money (H) as shown below
Equation 1: M2 = mH
Thus through the deregulatory monetary prompting with (the market

base technique) an optimum level of M2 compatible with the
absorptive capacity of the economy with be achieved. And the
beneficial resultant effects are; it will minimize distortion into the
process of financial intermediation. Discourage fiscal indiscipline by
raising the cost to government, of any fiscal deficit as the size of the
deficit increases, promote competitive initiatives and above all create
54 | P a g e
the necessary and sufficient enabling environment that will

significantly enhances the performance of the banking industry which
include.
1. Mobilizing financial resources through interest rate measures and
innovative financial Packages
2. Stimulating investment, employment and economic growth
through credit and interest Measures.
3. Promoting international trade and payments by domestic monetary
and financial management
4. Contributing to economic stability by using cash and liquidity
ration and minimum rediscount rate etc.
Arising from the above analysis, the research hypothesis will be

categorised into null and alternative hypothesis. The study twill test
for the validity or otherwise of the null hypothesis where it is rejected,
the alternative hypothesis will be adopted in evaluating the impact of
the monetary measures on the performance of the banking industry.
The tentative statement will be tested thus:
Ho: (Null) Monetary policy proxied by broad money supply (M2)
has no impact on the performance of the banking industry
proxied by deposit mobilisation performance (DMPER) of
commercial banks.
Hi: (Alternative). Monetary policy proxied by broad money supply
(M2) exerts a positive impact on the performance of the banking
industry proxied by deposit mobilisation performance
(DMPER) of commercial banks.
55 | P a g e
3:4 SPECIFICATION OF MODEL

A model implies a structure for ordering thought, consisting a number
of elements abstracted from reality and some statements about the
relationship that exits between them.
3:4.1 THE SIMPLE MODEL

Based on the above observation the following simple banking
performance model specify to depend on monetary policy measures
can be expressed in its functional form for the purpose of estimation
as thus:
Equation 2 DMPER = F (M2+)
+
Where:
DMPER = Deposit mobilization performance
M2 = Broad money supply
A priori reasoning from economic theory as previously analysed
suggest that a positive relationship exit between the performance of
the banking industry proxied by deposit mobilization performance
(DMPER) and monetary policy measures proxied by Broad money
supply (M2). Therefore the sign under the explanatory variable is that
expected of its first partial derivative.
To make the model amenable for estimation and statistical
verification, equation 2, is recast in its empirical form as thus
Equation 3: DMPER = bo + b1 M2 + U
Where the variables are previously defined, bo and b1 are parameters

to be estimated.
U is the random error term with the usual properties, zero mean, non-
serial correlation.
56 | P a g e
The model is a simple equation model, linear in parameters and

variable and at such the method of estimation employ is a simple
linear regression technique of analysis (ols). To obtain the appropriate
equation, the data to be fitted into the model is time series data span
over a period of 15 years (1986 to 2000). The estimated equation of
the model are shown and analyzed in the following chapter.
57 | P a g e
END NOTES: CHAPTER THREE
A. Koutsoyianis (1977): Theory of Economics second Edition

(Macmillan Press Ltd; London).
Buggy, D., Henderson, M.A. Statistical Methods in the social

Et al (1968); Sciences (North Holland)
Goldberger, A.S. (1996): Econometric theory (Willey 1996).
Johnstar J. (1972): Econometric methods 2nd edition

(MacGrow-Hill).
Mohammed E. Ali (1999): Deregulation and development of the

Publication).
Money Emina A.I. (1999): A Study of Economic Growth and

money supply Faculty of Social Science,
Delta State University Publication).
58 | P a g e
CHAPTER FOUR
DATA PRESENTATION AND ANALYSIS
4.1 PRESENTATION AND ANALYSIS FO REGRESSION RESULT
The data presented below, is a time series data which span over the
period of 15 years (1986 2000). This data will be filled in to the
model developed, in order to obtain the estimate of the co-efficient of
economic relationship of our interest.
Table 1 Money supply and Deposit liabilities

Year M2 Deposit liabilities
Money (Million (million)
1986 25 18
1987 30 23
1988 43 29
1989 46 27
1990 65 39
1991 86 53
1992 129 75
1993 192 110
1994 268 143
1995 268 143
1996 267 214
1997 268 280
1998 325 314
1999 433 476
2000 447 702
Source: CBN Statistical Bulletin, Various issues.
The result of the estimated equation of the Simple Banking

performance model specified in chapter three is presented below. The
estimated equation of the model which relates the performance of the
banking sector proxied by Deposit mobilization performance of
commercial banks (DMPER) to deregulatory monetary policy
59 | P a g e
measures proxied by broad money supply (M2) (i.e. the target and
indicator of monetary policy) is thus:
Equation 4 DMPER = - 51.4 + 1.2 M2
(51.5) (0.2163)
bo = 51.4
b1 = 1.2
R2 = 0.67
DW = 2.03
S(bo) = 51.50
S(b1) = 0.2163
The result of the estimated equation above indicates that there exist a
positive linear relationship between the performance of the banking
industry and monetary policy. A unit increase in the monetary policy
target M2 comparable with he absorptive capacity of the economy will
yield more than a unit increase in deposit mobilization performance of
the banking industry (DMPER) conforming to our apriori expectations
and the alternative hypothesis. However the sign of the constant
coefficient (bo) is unexpected. The standard error values, in the
parentheses indicates that standard error of the constant S (bo) 51.5 >
1
/2 bo (-25.7), this shows that the value of the constant coefficient (bo)
i.e. 51.5 is not statistically significant from zero (i.e. we accept Ho:
bo = 0). While the standard error value of the variable coefficient of
M2 S(b1) 0.2163 < 1/2 b1 (0.6) which shows that the value of the
variable coefficient of M2 bi. (i.e. 1.2) is statistically significant from
zero (Hi: b1 0). From the foregoing analysis we reject our null
hypothesis Ho and adopt the alternative hypothesis.
Furthermore the value of the coefficient of determination R2 = 0.67,
indicates that 67 percent of the variation in deposit mobilization
60 | P a g e
performance of (DMPER) is influenced by monetary policy measures.

The Durbin Watson, test statistic DW = 2.03 indicates the existence
of no auto correlation.
4:2 ECONOMIC IMPLICATION OF THE REGRESSION RESULT

One of the implications of the above finding is that the performance of
the banking industry proxied by deposit mobilisation depends greatly
on the level of effectiveness of monetary policy. This is a glaring fact
that can not be disputed; an optimal quantity of money compatible
with the absorptive capacity of the economy will create the necessary
and sufficient enabling environment that will accelerate the
performance of the banking system and consequently the overall
development of the financial system.
Total saving in 1970 was N341.60m, it ros to 5.8b in 1980 and
N37.76B in 1991 by 1994 this value increase to N93.56B with
commercial banks accounting for N76.1b of this. The commercial
banks accounted for 99% of the total saving in 1970 with the
remaining 1 percent accounted for by saving with federal saving bank.
The rates for commercial banks fail to 89 percent in 1980, 79 percent
in 1990 and 70 percent in 1994. This trend indicates a more
diversified financial system in which other institution financial system
in which other institution such as people bank, community bank, and
merchant banks played some greater role in deposit mobilization in
the deregulation and guided deregulation period moreover the average
growth of saving between 1986 and 1994 the era of deregulation and
guided deregulation) was found to be 23 percent while the average for
the pre-deregulation/regulation period (1980-1988) was 16.0 percent.
This clearly indicates a greater mobilization in the deregulation
period.
61 | P a g e
The economic implication from the above analysis is thus;

guided-deregulation of the financial system (moderate repression)
through the indirect monetary policy techniques will positively
influence the performance of the banking industry such as : deposit
mobilization, diversification of the system, financial deepening, bank
credit to private sector, entry and distress of banks, interest rates and
spread, as well as the structure and development of other financial
institutions.
Similarly the causal relationship between the dependent and

independent variable as indicated by the coefficient of determination,
R2 = 0.67, is high. It implies that 67 percent of total variation in the
performance of the banking sector is accounted for by variation in the
monetary policy measure. The result is indicative of goodness of fit
of the model.
62 | P a g e
END NOTES: CHAPTER FOUR

A. Koutsoyianis (1977): Theory of Econometrics second edition
(Macmillan Press Ltd; London).
Goldberger A.S. (1996): Econometric theory (Willey).
Monye Emina A.I. (1999): A study of economic Growth and money

supply (Faculty of Social Science Delta
Mohammed E. Ali (1999): Deregulation and development of the

financial sector in Nigeria (faculty of Social
Science Delta State University Publication
63 | P a g e
CHAPTER FIVE: SUMMARY, CONCLUSION AND

RECOMMENDATIONS
5:1 SUMMARY OF FINDINGS

This project work has examined the effect of monetary policy on the
performance of the banking industry, which is proxied by deposit
mobilization performance of the commercial banks.
After underlining the relevance of the banking industry in promoting
investment, economic growth and development, explore how
monetary policy influence the banking industry. Against this
background, the concept of monetary influence on the financial and
real sector was reviewed in chapter two. This reviewed touched on the
evolution of thought on the link between monetary policy and
economic and financial activities. After reviewing the brief history of
thought in this regard since sixteenth century up to present, as well as
the differing views among the major school of thoughts which
include: classical and neoclassical school of thought, the Keynesians,
monetarist and the mainstream economist. This study observed that,
while economist unanimously agrees that monetary policy affects
economic performance, including banking activities, however there is
no unanimity on the causational channels and effectiveness of
monetary influence.
To illustrate how monetary policy has affected the banking industry in
Nigeria and consequently during the era of deregulation and guided
deregulation, the link of monetary policy with the banking industry
has been explored. It is observed that monetary policy in Nigeria has
influenced the banks largely though liquidity credit and exchange rate
channels.
64 | P a g e
Further more a simple banking performance model proxied by deposit

mobilization performance has been specified to depend on liberalized
monetary policy measures. The final result from the estimate and
evaluation of the model support the alternative hypothesis of a
positive relationship between the variables of our interest. This
findings observed that deposit mobilization substantially increase in
the deregulation and guided deregulation period this can partly be
attributed to the liberalized monetary policy measures employed
during this period. For policy purposes the findings of this study are
suggestive, any policy decision to influence the level of performance
of the banking industry with liberalized monetary policy measure will
yield the desired positive result.
Furthermore a brief reviewed of monetary regime in Nigeria has been
undertaking to show that prior to SAP, that is the period of regulation,
reliance was mainly on administrative or direct control, which is
accompanied by a lot of distortion and negative undesired effects in
the financial system. This lead to the introduction of SAP to rectify
the fundamental and structural drifts ushered in by regulation. The
SAP era (that is the deregulation period) emphasis has switched to
market factor or indirect control.
Similarly it has been observed that the influence of monetary policy

on the banking sector has not been as effective as expected. The
following factors are identified as the major factor impending the
effectiveness of monetary policy.
(a). Inadequacy of the banking industry-: While monetary policy is
required to improve the performance of the banking industry, the
banks in turn are expected to enhance monetary management. The
ineffectiveness of monetary policy has contributed some times to the
65 | P a g e
distress observed in Nigerians banking sector, the resulting distress

has impacted adversely on monetary management which operates
through the banks. More so the distress in the system has been
manifested in poor management which is encouraged by political
interference, insufficient numbers of professionally qualified staff and
corruption- ridden environment These in turn has lead to capital
inadequacy, bad and doubtful debt, liquidity and poor earning on
assets. Banks that are affected by these problems have been found to
be ill equipped in responding to promptings of monetary policy.
Consequently, they constitute constraints on effective monetary
management.
(b). Poor Response of the financial system to monetary policy control
measures:- The Nigerian experience shows that the control of bank
reserve either interest rates or reserve -operating procedures poorly
meet the expectations, this is because of the following reason: Firstly
the structure of base money, it is believe that reserve with deposit
banks which the CBN target with hope of controlling the money
supply formed a significant portion of the monetary base. However in
Nigerian experience this proof wrong, currency outside banks forms a
significant proportion of base money. Therefore the higher the rate at
which such money (currency with public) finds itself outside the
control of the banking system, the less effective it would imply for
monetary control. Secondly lack of transparency in the operation of
financial intermediaries, the overriding motives for profit may have
enforced the adoption of sharp practices and circumvention of
prudential and other monetary control guidelines by a good number of
intermediaries.
(e). Conflicts of objectives and instruments:-
66 | P a g e
The multi target characteristic of monetary policy itself poses a

problem. Thus any design of monetary policy assumes possible
conflicts of objective which are not achievable simultaneously,
thereby admitting trade-offs. Consequently, the instruments are used
cautiously in order to achieve the desired combinations of objective
therefore the cautions approach to maintain the delicate balance
among different objective make the use of some policy instruments
less vigorous than it would have been if there were only one objective.
(d). financing of large government budget deficit by the banking system:-

A critical factor that impedes the effectiveness of monetary policy on
the banking system in Nigerian is the mandatory financing of
persistent large government deficits by the central bank. The problem
arises because such financing increase monetary base and swells the
level of excess liquidity of the banking industry. The existence of
large excess liquidity poses a problem for open market operation. And
other monetary tools developed for mopping up such excess. Further
more, the mandatory role of the CBN to underwrite treasury securities
has also continued to constrain the banks ability to regulate the reserve
of the banking system. For instance the CBN has on a number of
occasions had to increase its holding of treasury securities because of
insufficient subscription from the public even when the policy stance
of bank would have called for a reduction in its portfolio.
(e). Weak database for monetary management:- One of the major
challenges to the successful implementation of monetary management
is the ability to predict with some degree of accuracy aggregates level
of money supply and likely response of economic agents to policy
stimulus. This requires the use of a model capable of mirroring the
relationship between the overall objectives, instruments, operating
67 | P a g e
procedures and accurate data for its evaluation. The Nigerian

experience shows that the database for guiding monetary management
over the year has been very weak in terms of accuracy, timeliness,
consistency and reliability. The attitude of economic agents including
government, to record keeping, undermines policy design and
implementation,
5:2 CONCLUSION
This research finding has show that the there is a causal positive
relationship between monetary policy and the performance of the
banking industry, which is proxied by deposit mobilization
performance of commercial bank (DMPER). The study observes that
in the period under study (1986-2000) the era of deregulation and
guided deregulation, deposit mobilization increase, financial
deepening was low, there is greater liquidity in the banking sector
indicating lower earning power, greater entry into the industry is also
noted and the development of other banks and non-banks financial
institutions was accelerated this aided the mobilization and
distribution process. From the foregoing analysis empirical conclusive
evidence abound that monetary policy exerted considerable influence
on the banking industry under the era of deregulation and guided
deregulation in Nigeria. The observe effect has helped to create the
enabling environment for bank to perform their primary function of
financial intermediation. Although monetary policy has influence
deposit mobilization performance, banks pattern and direction of
credit, entry and distress of bank, interest rate and spreads, assets
structure and liquidity, among other things however, the observed
effect has not been fully maximized. The major challenges to the
68 | P a g e
effectiveness of monetary influence on the banking system in the

effectiveness of monetary influence on the banking system in the
years ahead as at present are two fold: The first is to eliminate the
distress in the banking system so that it can transmit monetary
influence effectively to the real sector, which would in turn have a
beneficial feed-back effects on the banking sector. Satisfactory
progress has been made in the resolution of bank distress, however
sustained efforts are required in the restructuring of other financial
institutions in order to ensure a healthy and competitive financial
sector necessary for the transmission of monetary policy impulses to
the real sector of the economy. Besides, there is need to strengthen
CBNs supervisory capacity to cope with the expansion in the size
and structure of the financial sector, given the liberalization policy, in
order to plug the leakages in the effect of monetary influence and
thereby enhance its effectiveness.
The other major challenge is how to remove the constraint of fiscal
policy on monetary management; there is a compelling need to
insulate monetary policy from the pressure of financing the
government fiscal deficit through revenue generation and expenditure
reduction. Happily the government is becoming increasingly aware of
the adverse implications of the mandatory inflationary financing of its
fiscal deficit by CBN and has shown remarkable commitment to fiscal
prudence as evidence by the zero ways means advances since the
second half of 1999.
Measures taken to address this fundamental and structural drift couple
with a more discipline fiscal environment and gradual liberalization
will not only enhance the effectiveness of monetary policy but also
will equip the banks adequately to respond more to the promptings of
monetary policy.
69 | P a g e
5:3 RECOMMENDATIONS FOR FURTHER INVESTIGATIONS

No doubt this project work has widely covers some critirical issues in
respond of the subject matter. However it is necessary to state that this
study is not immune to limitations this arises from the fact that
knowledge is not static but rather it moves in a dialectical fashion. In
the light of future circumstances for the reliability of these findings
further investigation is imperative. Subsequent studies may wish to
consider other variables considered important but inadvertently
omitted here.
70 | P a g e
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75 | P a g e

The Impact of Monetary Policy On The Performance of Banking Industry

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THE EFFECT OF MONETARY POLICY ON THE PERFORMANCE OF THE BANKING INDUSTRY

1:1 BACKGROUND OF STUDY

A dynamic and effective banking industry is crucially important and

The impact of monetary policy on the performance of the banking

It is in appreciation of the imperative need and practical contribution

a) How did the banking sector perform in response to the impulse of

b) Did monetary policy increase deposit with banks?

c) What are the major channels through which monetary policy

d) What are the factors, impeding the maximum impacts of monetary

The researcher attempts to proffer solutions to the above-enumerated

Identifying and examining the relationship between

Assessing the observed impact of monetary policy proxied

proxied by deposit mobilization performance of the

Estimating and evaluating the effect of M2 (monetary policy

1:2 STATEMENT OF PROBLEM

existence of large excess liquidity poses a problem for Omo being

1:3 JUSTIFICATION OF THE STUDY

transmit monetary impulse on the real sector; similarly it has failed to

1:4 OBJECTIVE OF THE STUDY

1:5 STATEMENT OF HYPOTHESIS

Ho (Null); Monetary policy proxied by broad money supply (M2) has

Hi: (Alternative); Monetary policy proxied by broad money supply

END NOTE CHAPTER ONE

Adewuyi A.D. (2000): Absorptive Capacity and Macroeconomics

Ajakaiye D.O. (1992): Challenges of the Nigerian Banking Sector:

Anyanwu J.C. (1994): Monetary Economics; Theory, Policy and

Afolabi L. (1999): Monetary Economics (Heinemann

Ezeuduji U.F. (1998): The effect of Monetary Policy on the

Ojo, M.O. (1992): Evolution and performance of monetary

2:1 MONETARY POLICY DEFINED

money, influencing interest rates to make money cheaper or more

2:2: OBJECTIVES OF MONETARY POLICY

intermediate variables, on the assumption of the stability and

Obviously, conflicts abound in the achievement of monetary policy

With respect to the objective of attaining a sustainable rate of

2:3 INSTRUMENT OF MONETARY POLICY

2:3.1 QUANTITATIVE INSTRUMENTS

monetary authority as a dealer in the financial market to influence the

Under this system of indirect monetary control, only the operating

1. OPEN MARKET OPERATION (OMO),

that partly because of the orthodox nature of the requirements above

PRIMARY EFFECT OF OMO

SECONDARY EFFECT OF OMO

2. It increases/decreases the availability of funds for the

2. DISCOUNT RATE POLICY OR THE REDISCOUNT RATE POLICY

3. RESERVE REQUIREMENT/REQUIRED RESERVE RATIO

manipulated by the central bank to vary the ability of commercial

c. VARIABLE CASH RESERVE REQUIREMENTS OR

according to the exigencies of the credit controls. Such deposits with

(ii). NON - TRADITIONAL INSTRUMENTS OR DIRECT

2. VARIABLE LIQUID ASSETS RATIO

This implies that banks are required to redefine the composition of

2:3.2 QUALITATIVE OR SELECTIVE CONTROLS/ INSTRUMENTS

2. SELECTIVE CREDIT CONTROLS OR GUIDELINES

2:4 MONETARY POLICY INDICATORS:

The problem of the appropriate monetary policy indicator is part of

2:5 MONETARY POLICY TARGETS

the target problem is. choosing optimal strategy or strategies to

assumes greater significance as an intermediate variable where the

The choice of the appropriate monetary instruments and proximate

THE CONCEPT OF MONETARY INFLUENCE

been and continue to be mere disputes and differing views among

view of the quantity theory is criticized by economist as a rough but