MARKET INTEREST RATES AND COMMERCIAL BANK PROFITABILITY:
(A CASE STUDY OF FIRST BANK OF NIGERIA PLC
1.1 BACKGROUND OF THE STUDY
The Commercial Bank System shares a very important characteristic with other members of the financial sector and the rest of the business community; the desire to maximize profits and expand its share of the market. Commercial banks are profit-making enterprises and as such they share with other businesses the same set of expectations concerning the health of the economy.
Banks act as financial intermediaries collecting deposits from one group and lending it out to another group. In this role they are able to convert short-term deposits into long-term loans. They bring together people who have money to lend and people who need money. They banks thus act as intermediaries collecting deposits and paying interest on them and making loans and charging interest on the loans made to their customers.
It will be observed that interest is the key element in the performance of this intermediation function of the commercial bank. At high interest rates the cost of borrowing will be increased and prospective borrowers will shy away from borrowing only to show up when the interests are down.
In periods of economic upturn, commercial banks add to the money stock and thereby help to expand the demand for goods and services. However, once the economy arrives at full employment of workers and resources, a continued expansion of loans and deposits simply add to the price level increase.
On the other hand, if banks contract loans in periods of mild economic decline experts hold that there is not likely to be a drop in the price level. Thus banks share the general business outlook on economic conditions. Commercial banks in the absence of regulations tend to intensify whatever phase of the business cycle is current. This, they do through their ability to create and destroy money when making loans and investments.
Klein stated that banks have a responsibility that transcends that of other business enterprises. They are responsible for the creation, destruction and administration of our economy. As a consequence, hey are also responsible to great extent for the welfare of the economy.
This dual responsibility to itself as a business enterprise and to the nation puts a tremendous burden on the individual commercial bank if it acts in the national interest it may hurt its competitive positive. If its lending policy is conservative during periods of prosperity and full employment, it reduces its potential profits since banking business in Nigeria and to evaluate their effect on bank profitability.
The banker is faced with the problem of maintaining a balance between solvency, liquidity and profitability. Consequently, the commercial bank’s major and immediate challenge is how to manipulate the economic variables in order to ensure an optimum balance between solvency, liquidity and profitability.
The commercial banks can also be distinguished form other financial institutions primarily because of the difference in nature of their deposits liabilities and corresponding differences in the characteristics of their assets. One unique feature of the commercial bank is that they have short term, highly volatile deposit and liabilities. That would be useful as money in the normal run of event. They have a greater potential for credit creation more than other financial institutions. Since they exist to serve human needs which arrives from environmental condition to stimulate economic activities to maximize profits and provide adequate liquidity level in the system.
It is in compliance with the above issues that First Bank of Nigeria Plc is being used as a typical example to emphasize.
1.2 STATEMENT OF THE PROBLEM
The Nigerian banking in recent times has witnessed so much fluctuation in market interest rates, which has called for concern. The market interest rate controversy has been addressed by experts with a lot of pessimism with different views regarding commercial banks profitability and the economy at large following the return from deregulation of interest rates to pegging in the 1991 budget.
Profitability of banking depends on the ability of the bank to arrange and perform its activities in order to trade off optimally between solvency, liquidity and profitability. This is by no means an easy task with the manipulation of several economic variables to the advantage of the bank. The problems associated with this can be expressed in question for as follows.
i. Are commercial banks in the country really profitable?
ii. Do market interest rates affect commercial banks profitability?
iii. If yes to what extend are effects and of what dimension, that is wither positive or negative.
1.3 OBJECTIVE OF STUDY
Any human endeavour that has no specified objective is bound to fall. For this reason therefore, this study will have as its objectives the following:
i. Determine how commercial bank in Nigeria carryout their activities.
ii. Ascertain through the aid of available literature, the method of evaluating the profitability of commercial banks in Nigeria.
iii. Determine factors that make commercial banks’ profitability with particular reference to interest rates.
iv. To evaluate specifically the profitability of First Bank of Nigeria Plc.
v. Attempt a suggestion of improving on the profitability.
vi. Develop strategies which banks could hedge themselves against interest rates fluctuations (if any) in order not to affect their profits.
1.4 SCOPE OF STUDY
The study is focused on commercial banking in Nigeria with First Bank of Nigeria Plc. as an example.
For the purpose of this study our analysis will be based on the bank’s performance trends. The study will cover a period of 5 (five) years (2000 – 2004) and strictly based on the analysis of the bank’s financial records over the period under review.
1.5 SIGNIFICANCES OF STUDY
The interest rates controversy as it affect commercial bank’s from the period of deregulation to the present day which coincides with our study period need empirical findings now. Just as any other empirical study, it will be made use of by the following bodies.
i. Government will use the findings as they affect commercial banks and know how their monetary policies will be manipulated in order not to throw the commercial bank off balance.
ii. Banks themselves will find the results of this work very rewarding since they will know the repercussions the interest rate fluctuations will have on their profit (if any). They will thus develop strategies to hedge themselves against the unfortunate effects of the fluctuating rates.
iii. Lastly, the general public that operates deposits with the commercial banks will find this study of paramount importance. They will form these findings be aware of the effects of interest rates differentials. On their deposits, it will thus serve as a decision making tool for them
1.6 RESEARCH HYPOTHESIS
i) H0: Deposit volume of a bank has no positive correlation
with its loans/advance.
H1: Deposit volume of a bank has positive correlation with
ii) H0: Commercial bank loans/advances have no significant
relationship with profitability.
H1: Commercial bank loan/advances have significant
relationship with profitability.
iii) H0: Market interest rate fluctuations adversely affect
commercial bank profitability.
H1: Market interest rate fluctuations do not adversely affect
commercial bank profitability.
1.7 DEFINITION OF TERMS
For the purpose of clarity some basic key terms are defined below.
INTEREST RATES: This is the price for loans of money made, deposits received and securities subscribed to.
REGULATION: Strict controls on interest rates
DEREGULATION: Liberalized interest rates determined freely by banks and the monetary theory.
INVESTMENT: Function of marginal efficiency of capital and rate of interest on loans of various maturities and risks.
COMMERCIAL BANK: Any person who transacts banking business in Nigeria and whose business includes the acceptance of deposits withdrawable by cheque.