EFFECT OF INTEREST RATE POLICY ON BANK LENDING OF DEPOSIT MONEY

BANKS IN NIGERIA
CHAPTER ONE
INTRODUCTION
1.1 Background to the Study

The financial systems of most developing nations have come under stress as a result of the

economic shocks of the 1980s. The economic shocks largely manifested through indiscriminate

distortions of financial prices which includes interest rates, has tended to reduce the real rate of

growth and the real size of the financial system relative to nonfinancial magnitudes (Davidson and

Gabriel, 2009). Rasheed (2010), states that Nigerian economy saw different interest rates for

different sectors in 1970s through the mid-1980s (Regulated Regime, 1960 – 1985). The

preferential interest rates were based on the assumption that the market rate, if universally applied,

would exclude some of the priority sectors.

Interest rates were, therefore, adjusted periodically with ‘visible hands’ to promote increase in the

level of investment in the different sectors of the economy. For example agriculture and

manufacturing sectors were accorded priority, and the commercial banks were directed by the

Central Bank to charge a preferential interest rates (vary from year to year) on all loans and

advances to small-scale industries. Since 1986, the inception of interest rates deregulation, the

government of Nigeria has been pursuing a market determined interest rates regime, which does

not permit a direct state intervention in the general direct of the economy (Adebiyi and Babatope-

Obasa, 2004).

Deposit money banks are the most important savings, mobilization and financial resource

allocation institutions. Consequently, these roles make them an important phenomenon in

economic growth and development. In performing this role, it must be realized that banks have the

potential, scope and prospects for mobilizing financial resources and allocating them to productive

investments and in return promote their performance (Adofu and Audu, 2010).
 EFFECT OF INTEREST RATE POLICY ON BANK LENDING OF DEPOSIT MONEY
BANKS IN NIGERIA
Therefore, no matter the sources of the generation of income or the economic policies of the

country, deposit money banks would be interested in giving out loans and advances to their

numerous customers bearing in mind, the three principles guiding their operations which are,

profitability, liquidity and solvency (Adolphus, 2011).

The behaviour of interest rates to a large extent determines the economic activities of lending,

investment, savings and economic growth of a country. Lending by banks at a reasonable interest

rate determines the level of investment in an economy. If interest rate is high, investment will be

low and also if interest rate is low, investment will be high. There is therefore a need to promote

an interest rate regime that will ensure “Inexpensive” spending for investment and also encourage

bank lending. Before the deregulation of interest rates in Nigeria, the financial sector operated

under financial regulations and interest rate was generally high. (Babatope-Obasa, 2004)

Lending which may be on short, medium or long-term basis is one of the services that deposit

money banks do render to their customers. In other words, banks do grant loans and advances to

individuals, business organizations as well as government in order to enable them embark on

investment and development activities as a means of aiding their growth in particular or

contributing toward the economic development of a country in general (Felicia, 2011).

Bank lending is in terms of cash loans and overdraft granted to a customer by his bank. However,

practising bankers know that this view is too narrow and describe bank lending in view of

phenomenal developments which has taken place in the fields of finance, banking, commerce,

industry and general economic activities of the modern society. Lending is the act of granting

credit facilities to customer which may be in form of loans, overdrafts etc. Lending is a vital

function in banking operations because of its direct effect on economic growth and business

development (Rasheed 2010).

 EFFECT OF INTEREST RATE POLICY ON BANK LENDING OF DEPOSIT MONEY
BANKS IN NIGERIA
1.2 Statement of Problem

In order to curb the adverse effect of the 1980s financial repression, Nigeria government deregulated interest

rate in 1987 as part of the Structural Adjustment Programme (SAP) policy package. The official position

was that interest rate liberalization among other things, enhance the provision of sufficient funds for

investors, especially manufacturers (a priority sector) who were considered to be prime agents, and by

implication promoters, of economic growth. However, in a policy reversal, the government in January 1994

out-rightly introduced some measure of regulation into interest rate management. It was claimed that there

were “wide variations and unnecessary high rate” under the complete deregulation of interest rates.

Immediately, deposit rates were once again set at 12% to 15% per annum while a ceiling of 21% per annum

was fixed for lending a rate. The cap on interest rate introduced in 1994 was retained in 1993 with a minor

modification to allow for flexibility. The cap stayed in place until it was lifted in 1997, thus enabling the

pursuit of the flexible interest rate regime in which bank deposit and lending rate were largely determined

by the forces of demand and supply for funds (Omole and Falokun 1999).

The cap on interest rate adopted in 1994 was lifted in October 1996 and a flexible interest rate

regime largely determined by the forces of supply and demand for funds was put in place and this

has remained so, since late 1990s to date (CBN 2007). However, the problem has been that the

market-based approach to interest rate management in Nigeria has always been associated with

substantial interest rate volatility (CBN 2006).

In 1986, Nigeria interest rate was as low as at 2.5%, it rose to 8.9%. Auction markets for

government securities were introduced; capital adequacy standards were reviewed upward and the

extension of credit based on foreign exchange deposits was banned (Orji 2009). Nigeria’s interest

rate fluctuates over time as the Central Bank was to regulate and supervise all interest rate re-

administered.
 EFFECT OF INTEREST RATE POLICY ON BANK LENDING OF DEPOSIT MONEY
BANKS IN NIGERIA
The monetary authority introduced the indirect monetary instruments in order to control the

interest rate and the rate of inflation. The interest rate has doubled through the period of 1997 and

2007 attaining a peak of 24.62 (CBN; 2002).

This study becomes imperative because deposit money banks in Nigeria need to understand how

to manage these huge assets in terms of their loans and advances. For the banks to balance their

main objectives of liquidity, profitability and solvency, lending must be handled effectively and

the banks must behave in a way that there potential customers are attracted and retained. The major

problem of this study is therefore, the question of finding out the extent to which bank lending rate

affect profitability in Nigeria Deposit Money Banks.

Ordinarily, high interest rate should spur the desire for bank customers to want to deposit their

fund in bank vaults. Likewise, low interest rate should naturally discourage depositors. But most

oftentimes, this is not the case, hence this study seek to examine effect of interest rate policy on

bank lending of deposit money banks in Nigeria between 1986 to 2015.

1.3 Objective of the Study

The main purpose of this study is to investigate the effect of interest rate policy on bank lending

of deposit money banks in Nigeria between 1986 to 2015. The specific objectives of this study are:

i. To analyse the trend of interest rates in Nigeria over the years.

ii. To examine the impacts of interest rate on bank lending in Nigeria between 1986 – 2016

iii. To assess the effect of lending rate on the total loan and advances of DMB in Nigeria

1.4 Research Question/ Hypothesis

The study was carried out in such a way that it was able to answer the following questions:

1. What effect does Interest rates have on bank deposits in Nigeria?

2. Is there any significant relationship between interest rate and bank deposits in Nigeria?

3. Lending rate does not significantly affect the total loans and advances of DMB in Nigeria
 EFFECT OF INTEREST RATE POLICY ON BANK LENDING OF DEPOSIT MONEY
BANKS IN NIGERIA
1.5 Justification of the Study

This study is to fill the knowledge gap that is associated with a new phenomenon. The effect of

interest rate policy on bank lending of deposit money banks in Nigeria is therefore of great benefit

to the following:

Investors rely heavily on financial statements and reports prepared and published by the company

for any information about it. One of such reports is the annual report. Due to local legislations and

requirements, it has been observed that annual reports of most of companies have a separate section

on lending report. This section covers most of the mandatory disclosures like board functioning

and its independence, shareholders rights, conflict of interest, details of the various committees,

their constitution and frequency of meetings.

The particular nature of the Nigerian economy and the character of the operators in the economic

system dictate the current trends in development as an automatic element for corresponding

problem without appropriate empirical validities and isolated policy clarification.

Secondly, it is undoubtedly true that the effects of interest rate deregulation on commercial bank

lending would be useful in designing economic policy. This stems from the facts that verifications

in the size and composition of banks’ lending, generally play a significant role on transmitting the

influence of monetary policy on the economy.

The broad objective of this study centres around definite statement on the relative impact that

interest rate could have on banks’ lending in particular. Again it will be beneficial to researchers

who may be interested in this area of study; also it will serve as a reference point for future

researchers who will want to research more on the topic.

 EFFECT OF INTEREST RATE POLICY ON BANK LENDING OF DEPOSIT MONEY
BANKS IN NIGERIA
1.6 Scope of the Study

This study will related existed variables between interest rate and deposit money banks lending

such as Return on Assets, Return on Equity and the movement in share prices. This study covers

the period between 1986 - 2016. The period chosen enables us to extract the trends of banks

performance and interest rate deregulation in the Nigerian economy. This study will cover interest

rate, its effects on bank lending and its overall performance on the banking sector of Nigeria.

1.7 Limitation of the Study

The constraints that were encountered in the process of carrying out this research work are as

follows: This study limited itself to the population under investigation as well as distance as a

constraint to assess information. Also, the outright inability of some respondents to complete and

return the questionnaire to the researcher is one of the limitations of the study. Another limitation

to the study was traffic congestion for the researcher to meet them in their offices and for possible

return of the questionnaire. Therefore, the researcher resolved to seek friendly approach in order

to obtain the needed materials or information from the organization under study through the

administration of questionnaire.

This paper is organized as follows; section one is the introduction while section two reviews the

empirical and theoretical literature on interest rate margin and its impact on bank profitability;

section three discusses the models and methodology while section four provides data and empirical

evidence and the final section which is section five provides the summary, conclusion and

recommendations of the study.

 EFFECT OF INTEREST RATE POLICY ON BANK LENDING OF DEPOSIT MONEY
BANKS IN NIGERIA
1.8 Plan of the Study

This research work is divided into five (5) sections:

Chapter one discusses the background to the study, statement of the problem, research questions,

and objectives of the study, justification of the study, scope of the study as well as the plan of the

study which has already been carried out.

Chapter two contains the theoretical, methodological and the empirical literature review.

Chapter three contains the theoretical framework, research methodology, sources of data and test

of analysis.

Chapter four provides analysis of data collected in a detailed and concise manner, with a view to

bring out the central issues of the study.

Finally, chapter 5 concludes the study which contains the summary of all chapters and the

conclusions reached with recommendations for interest rates on the performance of banks.

1.8 Sources of Data

The Ordinary Least Square (OLS) estimator will be used in analyzing the data. This will be

used because of its consistency. The OLS is a method for estimating the unknown parameters in a

linear regression model. This method minimizes the sum of squared vertical distances between the

observed responses in the dataset and the responses predicted by the linear approximation.

This study will make use of secondary data sourced mainly from;

1. Economic and financial review on various issues by the Central Bank of Nigeria (CBN).

2. Various volumes of Statistical Bulletin from the Central Bank of Nigeria.

3. Annual report on various issues by Central Bank of Nigeria.

4. Data from the Federal Office of Statistics (FOS).

5. Economic and Business Review (published by Business Time, Lagos).

 EFFECT OF INTEREST RATE POLICY ON BANK LENDING OF DEPOSIT MONEY
BANKS IN NIGERIA
References

Adebiyi, M. A. and B. Babatope Obasa (2004). ‘Institutional Framework, Interest Rate Policy and

the Financing of the Nigerian Manufacturing Sub<Sector. African Development and

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Adofu, M. A. &Audu, S. I. (2010). An assessment of the effects of interest rate deregulation in

enhancing Agricultural productivity in Nigeria. Current Research Journal of Economic

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Adolphus, J. T. (2011). Modelling management rural lending and small business finance in

Nigeria. Global Journal of Management and Business Research.11 (7):30<46

Babatope-Obasa, 2004.The Structure of Nigerian Economy (1960-1997). Joanee Educational

Publishers, JoaneeOnisha. ISBN: 10- 9782784176.

CBN (1993): Perspectives of economic policy reforms in Nigeria, Research department, CBN,

Lagos.

CBN (2009). 50 years of Central Banking in Nigeria. A publication of Central Bank of Nigeria.

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Felicia, O. O. (2011). Determinants of Commercial Banks Lending Behaviour in Nigeria.

International Journal of Financial Research, 2(2), 1- 12.

Omole, D.A. and Falokun, G.O. (1999), “The Impact of Interest Rate Liberalization on the

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#88, African Economic Research Consortium, Nairobi.

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BANKS IN NIGERIA
Orji, A. (2009), “Private Domestic Savings Mobilization and Economic Growth in Nigeria” An

unpublished M.Sc research project submitted to the Department of Economics, University

of Nigeria, Nsukka.

Rasheed, O. A. (2010). Interest rate Determinants in Nigeria. International Research Journal of

Finance and Economics, 2(3), 1-12.

Rasheed, O. A. (2010). Interest rate determination in Nigeria. International Research Journal of

Finance and Economics, 2(3):1<12