IMPACT OF COMPETITION ON THE PROFITABILITY OF COMMERCIAL BANKS IN NIGERIA

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ABSTRACT

That the Banking Industry in Nigeria has always been profitable has never been in doubt. Again, that the Nigeria banking industry has been a very competitive one is also not a matter for contention as the result of several researchers measuring the competition in the banking industry have sufficient empirical evidence to substantiate this theory,  however, what has recently become a contentious issue is to determine what really drives banking profitability in the face of this cut-throat  competition  in Nigeria.  Not even  the banking consolidation reforms introduced  in Nigeria by the erstwhile Governor  of  the Central Bank of Nigeria, Professor Charles C. Soludo, in 2005 which highlighted the unprecedented competition in the Nigerian banking industrycan be agreed to the major determinate of banking profitability in Nigeria. Generally,  the impact of competition  on  the profitability of commercial banks in Nigeria has been a subject of great scholarly inquiry and continues to occupy a large body of empirical research. Competition in the banking industry is necessary as it promotes economic growth by increasing firms’  access  to external financing,  lowering the costs of providing banking products and  services, managing and mitigating banking risks, mobilizing savings and investment opportunities and adopting efficiency strategies for improving profitability. Petersen and Ranjan (1995) show theoretically that Commercial banks that wield substantial market share are more profitable in developed economies as they can lend even to young firms  whose  credit  records  may  be  opaque,  hence  leading  to  high  loan  volumes  and substantial  increase in both economic activities  and economic growth. However,  Cetorelli and Gamberra (2001) argue that, there is compelling evidence to suggest that the profitability of commercial banks in most developing economies (for which Nigeria is one) is a direct function of its banking efficiency and other ancillary variables and has no direct relationship with the market share of firms.Hence, the profitability of commercial banks in Nigeria can only be placed at the center of any developmental economic agenda, if it combines optimally the   determinates   of   banking   profitability   such   as   market   share,   efficiency   and concentration of commercial bank branches to respond to the dynamic changes in economic conditions, especially, those that affect delivery of financial services.  Our major objective in this research is therefore, to resolve the dilemma between the conflicting theories highlighted in the Structure  Conduct  Performance  Hypothesis  – SCP (which propagates  the ideals of significant market share) and the theories of Efficiency Structure Hypothesis -ESH, (which gives  credence  to  the  significance  of  banking  efficiency)  in  assessing  the  impact  of competition on profitability of commercial banks in a developing country like Nigeria.

CHAPTER ONE

INTRODUCTION

1.1       Background of the Study

Competition in the banking industry has been a subject of great scholarly inquiry and continues to occupy a large body of empirical research. That the Banking Industry in Nigeria has always been profitable since the early 1990s has never  been in doubt. That the Nigeria banking industry has been a very competitive one is also not a matter for contention as the results of several researchers measuring the competition in the banking  industry  have  sufficient  empirical  evidence  to  substantiate  this  theory, however, what has recently become a contentious issue  is to determine what really drives banking profitability in the face of this  cut-throat competition.  Not even the banking reforms introduced in 2005 which triggered unprecedented competition in the banking  industry  in  Nigeria  can  be  agreed  to  the  major  determinate  of  banking profitability  in Nigeria.  The  reforms  generally  entailed  the upward  review  of the minimum capital requirement of banks from N2billion to N25billion (an increase of approximately, 1,150%), a decrease in the number of commercial banks operating in Nigeria from 120 in 1993 to about 24 commercial banks post consolidation in 2010 and  a  dilution  in  the  ownership  structure  of  most  commercial  banks  as  they subsequently  became  publicly quoted  companies  on the Nigerian  Stock  Exchange (NSE).

Generally,  the  impact  of competition  on the profitability  of commercial  banks  in Nigeria has been a subject of great scholarly inquiry. Banking competition promotes economic growth by increasing firms’ access to external financing, lowering the costs of providing banking products and services, managing and mitigating banking risks, mobilizing savings and investment opportunities and adopting efficiency strategies for improving   profitability.   Petersen   and   Ranjan   (1995)   show   theoretically   that Commercial  banks  that  wield  substantial  market  share  are  more  profitable  in developing economies as they can lend even to young firms whose credit records may be opaque,  hence  leading  to  high  loan  volumes  and  substantial  increase  in both economic activities and economic growth.

However, Cetorelli and Gamberra (2001) argue that, there is compelling evidence to suggest  that  the  profitability  of  commercial  banks  is  a  function  of  its  banking efficiency and other ancillary variables and has no direct relationship with its market share. Hence, the profitability of commercial banks can only be placed at the center of any developmental  economic  agenda  if it combines  optimally the determinates  of banking  profitability  such  as  market  share,   efficiency  and  concentration  of branches of the commercial bank to respond  to the dynamic changes in economic conditions,  especially  those  that  affect  delivery  of financial  services.    Our  major objective in this research is therefore, to resolve the dilemma between the conflicting theories discussed in the  Structure  Conduct Performance  Hypothesis  – SCP (which propagates  the  ideals  of  significant  market  share)  and  the  theories  of  Efficiency Structure  Hypothesis -ESH, (which  gives credence  to the significance  of banking efficiency)  in assessing the impact of competition  on profitability  in a  developing country like Nigeria.

From public policy perspective,  competitiveness  of the banking sector is agreed  to represent a socially optimal target, since it reduces the cost of financial intermediation and  improves  delivery of  high quality  services  thereby  enhancing  social  welfare. Banking competition also promotes economic growth by increasing firms’ access to external  financing  (Beck,  Demirgüç-Kunt  and  Maksimovic,  2004;  Pagano,  1993). However,  Petersen  and  Ranjan  (1995)   show  theoretically  that  banks  wielding substantial market share tend to lend to young firms whose credit records may even be opaque, hence leading to high loan volumes.

In practice, Cetorelli and Gamberra (2001) argue that, although,concentrated banking

systems  offer  growth opportunities  for young firms, there is strong evidence  of a general  depressing  effect  on  growth  associated  with  banks’  exercise  of  market shareand  this impacts all sectors and firms in the economy.  Hence,  competition in banking should be placed at the center of any public policy agenda since it has the mechanism  to respond to the dynamic changes  in  economic conditions,  especially those that affect delivery of financial services. Relevant literature on the measurement of competition in the banking industry may be divided into two broad mainstreams, the  structural  approach  and  the   non-structural  approach  (Mugume,  2010).  The structural  approach  to  modeling  competition  is majorly made  up of the structure- conduct-performance (SCP) paradigm and the efficiency structure hypothesis (ESH)

as well as a number of other formal approaches which all have their roots in industrial organization theories.

However, sufficient theoretical and empirical evidence abounds that confirm that both the SCP, ESH and the other market concentration  indexes such as the  Herfindahl- Hischman index alone cannot be used to measure industry wide banking competition because they have deficiencies that inhibit their effective use as a measure of banking competition.Mugume (2010) stated some of these deficiencies to include a country’s:

  Macro-economic performance

    Financial stability

    Form and degree of taxation of financial intermediation products

    Quality of information and judicial systems

    Scale of banking operations

    Risk preferences

The author opines that because  of the highlighted  deficiencies  of the  Herfindahl- Hischman index, the use of these concentration measures present a poor indicator for the degree of competition in the banking industry especially, for developing countries, such  as  Nigeria(Mugume,  2010).  However,  concentration  ratios  as  measures  of competition do not also provide adequate and conclusive explanations of actual bank profitability and may lead to wrong inferences on competitive conditions (Hausman and Sidak, 2007). Instead, Baumol (1982) opines thatbanking competition should be assessed based on banking market contestability arising from the presence or absence of entry barriers into the industry.Mwenda and Mutoti (2011) remedied this bias by measuring banking competition in the Zambian banking sector using the H statistic model  developed  by  Panzar  and  Rosse(Simpasa,  2013).  Although,  there  was  a significant   improvement   over   the   results   of   Baumol   (1982)   using   banking concentration  ratios  to  measure  the  impact  of  competition,  the  authors  did  not condition the competitive index on changes in market conditions brought about by the entry of new foreign banks in the recent years and the privatization of the Zambian National Commercial Bank (ZNCB) that took place in 2007 (Simpasa, 2013).

Profitability  of Nigerian  commercial  banks has generally been buoyant,  driven  by earnings  on  bank  loans,  commission  n  turnover,  income  from  trading  treasury securities,realized gains on foreign exchange transactions and fee income which have all contributed significantly to these commercial banks’ profits. Banks’ return on assets (ROA) and the net interest margin (NIM) are the major proxies  used to gauge banking profitability  and  the  intensity  of  competitive  pressures  on  these  commercial  banks. Depending on the market shareof a bank in input and output markets respectively, it may be able toincrease output prices (lending rates) or decrease input prices (deposit rates)  with a view  to  increasing  its  profitability.  Bank management  can selectthe combination of inputs (time  deposits, fixed deposits, savings account deposits) and outputs (loans) at which profits can be maximized(DeBandt and Davis, 2000).

Inorder to avoid stating the obvious and to clarify our motives further, westart  by asking why a bank would not be able to maximize her profits. Let us consider four issues related to profit maximization: (Berger, 1995).

(a)       The role of diversification and risk preferences of the bank; (b)       The problems between shareholders and bank management; (c)       Imperfectcompetition and;

(d)       Inefficient use of inputs and outputs.

A first consideration relating to bank profit maximization concerns theconcept of risk and  its  diversification.  Shareholders  will  usually  prefer  to  balance  their  appetite formaximizing expected profits and minimizing costs with the amount of riskthey are willing  to  take.  Abstracting  from  speculative  motives,  shareholdersare  generally assumed  to be indifferent  to the distribution  of  profits,  receivinga  return on their investment in the bank either through an increase in thebank’s share price or through dividends  received.  If all the banks  operating  in the economy share the samerisk- return  preferences,  or  if  the   risk-return  relationship  can  be  described  bysome relatively simple  homothetic  continuous  function,  then there is noserious  problem with the fact that we may have to control fora bank’s risk preferences. Recent works by DeYoung (1998) have tried to incorporate risk intoa bank benchmarking exercise. Given that this  type of work is still in its infancy in developing countries, such as Nigeria, we refrainedfrom including risk and risk preferences in this research work.

Instead, we adoptedother controlvariables such as bank regulation and bank reputation that aim to proxy for banks’ risk-return preferences.A second consideration relating to banks’    profit    maximization,     concernsincentive     structures.Even     risk-neutral shareholders who are well-diversifiedmay have problems translating their claims on bank profits into actions requiredto  maximize  revenue  and minimize  costs. In the absence of completeinformation,  principal-agent  theory states that shareholders are unable    toadequately    monitor    bank    management    and    that    the    resulting managerialdiscretion   may   induce   sub-optimal   behavior,   i.e.   profits   are   not maximizedand/or costs are not minimized(Berger  and Humphrey, 1997). As long as shareholders  cannot  monitor  andpenalize  bank  management,  the  latter  may  show expense-preference  behavioror if the bank management is highly risk-averse, it  can adopt any other strategy that tends to reduce the profitability of the bank(Hannan and Mavinga, 1980). Thismeans that the asymmetric information between principal and agent that wasonce used by Diamond (1984) to explain the profitability of banks from a reduction in audit costs for lenders to non-financial can also be used to explainwhy banks  themselves  may  also  suffer  from  moral  hazards  and  other  compensation incentiveproblems in their profitability drive (Diamond, 1984).

Firstly, very few studies haveattempted  to test empirically the impact of principal- agent  conflicts  on  theperformance   of  banks  even  in  developed   countries  and specifically  in  European  banks.  (Molyneux  and  Forbes,  1995)  Translations  into empirical tests of theprincipal-agent conflicts described above where hidden actions by  or   hidden   knowledge   ofbank   management   which   resulted   in   suboptimal profitability  measures.  Secondly,  to  theextent  that  the  principal-agent  relationship results in moral hazard conflicts,this will only create problems if the principal (i.e. the shareholders) cannotinsure himself against excessive risk-taking by the agenti.e. the bank management (Meyer and Mugume, 2004).Avast amount of literature exists on ways to minimize the negativeeffects of these principal-agent problems but have not been considered in this research work.

Thirdly, price and non-price competition, the substitutability of bank’s products and

the  contestability  of  banking  markets  may  also  serve  to  ensure  that  a  bank’s optimalprofitability   is   not   achieved   by   putting   competitive   pressure   on   its management, providedthat the bank’s management compensation is not performance- based(DeBandt and Davis, 2000).

Whether compensation incentive problems areas important in determining why banks themselves may also suffer from moral hazardsas in developed banking economies as there are in developing economies is still questionable (Molyneux and Forbes, 1995). Although,these    identified    compensation    incentive    problems    may    lead    to suboptimalperformances  by banks, which is an anomaly to the cardinal objective in being in business, the extent to which these incentives problems affect a developing country such as the Nigeria bankingindustry is unclear. There are quite a few reasons to suspect that the incentive problemsthat can cause a bank to make lesser profits or experience  above-minimumaverage  costs  are  significantly  different  from  bank  to bank, or from country tocountry. This is because the thin line of separation between ownership  and  control  is  highly  similar  forcommercial  banks  across  developed countries,   especially   in  Europe   (Goldberg   and  Rai,   1996).Therefore,   even   if compensation  incentivesconstraints  can  help  explain  bank  performance,empirical testing of these incentives to determine whether they can explain differences in bank performanceis difficult to achieve and their empirical results to date, have so far been in conclusive.Also,  commercial banks’  profitability is usually related to changes in the environment and the behaviorof their competitors (Molyneux, Lloyd-Williams and Thorton, 1994; Goldberg and Rai, 1996; Levine, Laoyza and Beck, 2000).

Therefore, another consideration relating to banks’ profitmaximization relates to the market   share   of  the  individual   commercial   bank(Berger   and   Hannan,   1998). Economic   theory  also   tells  us  that  ina  perfectly  competitive   situation,   profit maximization  is  equivalent  to  costminimization.  In  practice  however,  we  do  not necessarily observe maximizationof profits and/or minimization of costs. Of course, exogenous  factors  such  asregulation  or  (economic)  shocks  can  cause  suboptimal performances for commercial banks.To theextent that these exogenous factors do not have similar effects on both cost minimizationand profit maximization, they can drive a wedge between  the two (Hannan and Mavinga, 1980).Imperfectmarket  structures can cause a  situation where commercial banks’ profits are maximized  at an output levelwhere  average costs are no longer minimized,  thus leading to achieving  sup- optimal  profitability  peaks  by  commercial  banks  (Vivex,  2001).This  sub-optimal profitabilityachievement  can thus be used to explainchanges  in  profitability  levels over time for firms as well as for commercial banks.

A bank may also produce at lower costs and with a higher profit than otherbanks if it makes  better  use  of  its  input  resources  and  transforms  them  into  outputs  inthe cheapest possible way. In the long run, every bank has to produceefficiently in order to survive banking competition. This brings us to the next factor driving maximization of banking profits in Nigeria, which is banking efficiency.

The   competitive   indices   for   efficiency   offer   a   practicalperspective   on   the

understanding  of  banking  competition  in  Nigeria  and  its  policy  implications.The broad conclusion from several research analyses is that over a longer period of time, commercial banks efficiency will begin to decline, underpinningthe growing intensity of competition,  particularly  in post financial  reform periods (Mugume,  2010).This suggests that thedegree of competition may be higher for commercial banks before banking reforms are introduced  than  after banking reforms are introduced  in their economies.  Also,  that  the  degree  of  competition  from  other  forms  of  financial intermediaries (capital markets, non-bank financial institutions, insurance companies) play a role in determining the degree of competition in banking system. It has also been shown, theoretically as well as empirically, that the degree of competition in the financial sector can matter in assessing economic development.

1.2 Statement of the Problem

In the face of slowing industry growth and so much competition, today’s commercial banks are under tremendous pressure to grow organically by gaining a proportionate portion  of  the  market  share.  A  financial  system’s  contribution  to  the  economy depends on the quantity and quality of its services and the efficiency with which it provides  them  (Mugume,  2010).  According  to  Mugume  (2010),  there  are  two plausible  theories  to  determining  the  market  shareof  competing  banks  towards measuring their profitability and it is crucial to determine which of these two theories more accurately describes their behavior with increasing profits, since the economic policy implications derivable from either of these theories are radically diverse. The first theory postulates that an increase in banks’ profitability is directly related to the total  efficiency  improvement  in  its  operations,  termed  the  Efficiency  Structure Hypothesis (ESH) theory.

The efficiency hypothesis further expatiates that an increase  in the total  revenueof banks’as    a    result    of    improved    efficiency    will    certainly    increase    that banks’profitability.The   other  theory,  the  Structure  Conduct   Performance   (SCP) Hypothesis explains that an increase in the profitability of commercial banks is caused by an increase in the market shareand that being in possession of a considerable share of the market, otherwise classified as possessing market power is attributable to the SCP Hypothesis (Smirlock, Gilligan and Marshall, 1984; Mugume, 2010).

Relevant literature also suggests that there exists a relationship between concentration and  efficiency and  between  market  share  and  profitability,  as  already  highlighted above. These relationships have generated competing hypotheses. On the one hand, the traditional collusion theorists, also called the structure-conduct-performance  – SCP hypothesis  (Bain,  1951)  postulates  that  banking  concentration  lowers  the  cost  of collusion between firms and results in higher normal profits. On the other hand, the efficiency theorists, proponents of the efficiency structure hypothesis -ESH(Demsetz,

1973) postulated an alternative explanation for the existence of a positive correlation existing between banking efficiency and profitability,  affirming that  only the most efficient firms in any industry can attain greater profitability and consequently their marketshares    can   become    more   concentrated    enhancing    their   profitability. He,(Demsetz,  1973)  concludes  that,  in such  circumstances,  the  observed  positive relationship existing between concentration and profitability is spurious as it simply proxies competition  for an already existing positive relationships  between superior efficiency, market share and concentration.(Gibson and Tsakalotos, 1994).

This  is the main problem  that this research work helps to resolve  – the  dilemma

between the conflicting theories of structure-conduct performance hypothesis (SCP) and the efficiency structure  hypothesis  (ESH) as to which of these  theories really drives profitability in Nigerian commercial banks. Is it the acquisition of a significant market  share  or  the  adoption  of  an  efficient  banking  approach  that  explains  the profitability of Nigerian commercial banks and other developing economies?

1.3 Objectives of the Study

The  overall  objective  of  this  study  is  to  empirically  investigate  the  impact  of competition  on the profitability  of commercial  banks  in Nigeria.  To  achieve  this objective, the study strives to accomplish the following specific objectives:

1.   Investigate the impact of market share on the profitability of commercial banks in Nigeria.

2.   Find out the impact of banking efficiency on the profitability of commercial banks in Nigeria.

3.   Investigate the impact of concentration on the profitability of commercial banks in Nigeria

1.4 Research Questions

This study strives to provide answers to the following research questions:

1.   What is the impact of market share on the profitability of commercial banks  in

Nigeria?

2.   What is the impact of banking efficiency on the profitability of commercial banks in Nigeria?

3.   What is the impact of banking concentration on the profitability of commercial banks in Nigeria?

1.5 Research Hypotheses

In order to achieve the above stated research objectives and also answer the research questions formulated above, the following research hypotheses have been tested:

1.   Market share does not have a significant and positive impact on the profitability of commercial banks in Nigeria.

2.   Banking  efficiency  does  not  have  a  significant  and  positive  impact  on  the profitability of commercial banks in Nigeria

3.   Banking  concentration  does not have  a significant  and positive  impact  on  the profitability of commercial banks in Nigeria.

1.6 Scope of the Study

This study covers the period 2005 – 2013 and gathers data from about 13 out of the 24 existing commercial banks in the country. 2005 is chosen as the commencement year for the scope of this study because it was the first year in which financial statements of commercial banks were prepared after the banking consolidation reforms which were embarked upon by the erstwhile Governor of the Central Bank of Nigeria -CBN, Professor Charles Soludo in 2004. The  consolidation reforms generally entailed the upward  review  of  the  minimum  capital  requirement  of  banks  from  N2billion  to N25billion  (an  increase  of  approximately,  1,150%),  adecrease  in  the  number  of commercial  banks  operating  in Nigeria  from 89 to 24 (post consolidation)  and  a dilution in the ownership structure of most of these banks as most commercial banks subsequently  became publicly quoted  companies  on the Nigerian Stock  Exchange. (Nannyanjo, 2012). The financial year ending December 31, 2013  fits our terminal date for the scope of this study because the data used in our analysis has already been published by as of April 31, 2014.The 2004 financial reforms were also expected to see to the emergence of a fewer number of commercial banks in Nigeria but with a significant   capital   base.   Mergers,   acquisitions   and   other   forms   of   business combinations   produced   the   resultant   24   commercial   banks   which   triggered unprecedented competition among the banks and the ultimate emergence of the five big banks in Nigeria due to their huge capital base.

These banks are: First Bank of Nigeria –(FBN), Guaranty Trust Bank –(GTB), Zenith International  Bank  â€“(ZIB),  United  Bank  of  Africa–(UBA)  and  Access  Bank  – Access.Apart from these 5 big banks the other high efficiency emerging banks that will be sampled in this study are: Ecobank International–(ECOBANK),  Skye Bank– (SKYE),  First  City  Monument  Bank–(FCMB),  Union  Bank  of  Nigeria–(UBN), Diamond  Bank–(DIAMOND),  Fidelity Bank –(FIDELITY),  Stanbic IBTC Bank – (STANBIC) and Sterling Bank –(STERLING). These 13 banks are chosen out of the

24  banks  in the  industry  because  in a  recent  study carried  out by the  Research

Department of FBN in 2013 comparing the market shares of commercial banks  in Nigeria for the financial year ending December 31, 2012 their combined value was: (Appendix 1)

Total Assets (TA)     86% of Industry value Total Deposits (TD)                           86% of Industry value Net Revenue from Funds (NRFF)      91% of Industry value Operational Expenses (OPEX)           87% of Industry value Profit before Tax (PBT)                     94% of Industry value

From the analysis above, it is obvious that the other 11 commercial banks that do not constitute a part of our sample merely control a minority value of the industry market share as highlighted below:

Total Assets (TA)                              14% of Industry value Total Deposits (TD)                           14% of Industry value Net Revenue from Funds (NRFF)      9% of Industry value Operational Expenses (OPEX)           13% of Industry value Profit before Tax (PBT)                     6% of Industry value

Broadly speaking, our knowledge about bank behavior, bank pricing of their products and services  in Nigeria  is still very limited. There is a gap in  empirical work on whether  competition  in  the  banking  industry  has  really  increased  in  this  era  of financial  reforms  in Nigeria (post banking  consolidation  reforms of 2004) or not. Although, there are good reasons to believe that changes in banking regulations may also affect the relationship between competition and profitability, it is not within the scope of this research work to consider the influence of banking regulations on the profitability of commercial banks in Nigeria.

1.7 Significance of the Study

While there has been a rapidly growing literature on banking profitability issues in developed countries, little attention has been paid to the profitability of commercial banks in developing countries,  yet there is an increasing  recognition that financial sector development  is a top priority for sustained  economic  growth in developing countries like Nigeria. This research work aims to contribute to the existing literature by analyzing the impact of competition on the profitability of commercial banks in Nigeria during the recent post consolidation era of 2004generally and specifically to the following researchers and stakeholders:

a.   Financial System Operators: The financial system of any economy is made of its financial markets (commercial banks) and other financial institutions (discount houses, insurance companies, bureau de change, stock broking firms, etc.) which are central to  its economic  development  and  growth.  Obviously,  the financial system tends to evolve around  a strong banking  system which can facilitate  a more efficient allocation of financial resources. The importance of a strong and competitive banking sector in a country’s economic growth and development is already well established in several banking competition literature (Beck, Levine and Loayza,  2000).  The  efficiency theory highlighted  in this research work if adopted and implemented by the financial system operators will help to grow the economy partly by widening access to external financing and channeling financial resources to the economic sectors that need them most. (Mugume, 2010). A well- developed  financial  system  which  results  from  a  healthy  competition  in  the banking industry can also help an economy cope better with exogenous shocks such  as  terms  of  trade  volatility  and  move  such  nations  away  from  natural resource-based  development  to other  competitive  and  viable  economic  growth alternatives.

b.  Bank Operators:It is necessary for every banking system to be competitive; this is to ensure that banks are effective forces for financial intermediation, channeling savings into investments that foster higher economic growth and  other ancillary functions of a commercial bank in an economy. However, it is also necessary to monitor  and  control  the  impact  of  market  share  on  the  competitiveness  of commercial banks which is a major independent variable in measuring the impact of competition on the profitability of commercial banks in Nigeria.

Bank Operators will therefore be more properly guided in adopting appropriate strategies towards increasing their share of the market with a view to increasing their profitability if they imbibe the recommendations in this research work.

c.   Bank  Regulators:A  high degree of competition  and efficiency in the  banking system can contribute to greater financial stability, product innovation and access by households  and  firms to  financial  services  which  can in turn  improve  the prospects  for economic  growth.  In this respect,  there  is a real  concern  that  a monopolistic or oligopolistic, inefficient and fragile banking sector in Nigeria is a major hindrance to economic development.  Identifying  the kind of reforms and environments  that may help to promote competition and efficiency in Nigeria’s banking system  is therefore very important to  the  regulators of the industry as highlighted in this research work. In the light of most recent regulatory changes affecting  the  United  States  of  America  (USA)  financial  industry,  the  policy relevance for USA regulators is more current than ever.  Such regulatory changes continue to have a significant impact on the market share of the banking industry and on bank’s  competitive  conduct. A deeper analysis of the economic role of bank competition which has been highlighted in this research work should thus contribute to our understanding of the responsibilities of bank regulators and the consequences   of  excessive  regulatory  actions   and  therefore,   support   more effective banking regulation. (Vittas, 1992)

d.  Policy  Makers:Financial   markets  and  institutions   are  central  to   economic development  and growth.  Increasingly,  scholars  acknowledge  that  a supportive policy  for   financial   sector   development   is  a  key   component   of  national development policy.  The responsibilities of these policy makers can be positively enhanced  if  they  understand  what  really  drives  competition  in  the  banking industry especially for developing countries like Nigeria, which this research work aims to espouse. A comparative analysis of the growth rates of different countries has  produced   convincing   evidence   that   having  a  deeper   financial   system contributes to economic growth and that knowledge is not merely reflected in the wealth  and  prosperity  of a nation  (Honohan  and  Beck,  2007).  Moreover,  the development of the financial sector which can be driven by the competitive nature of the commercial banking industry is fundamental to the conduct of  monetary policy. Countries with deep financial systems also seem to have a lower incidence of poverty than others with the same level of national income.

A detailed  analysis of the economic role of bank competition  which has  been highlighted in this research work should also contribute to our understanding of the  responsibilities  of  policy  makers  and  the  consequences  of  recommending stringent  policies  actions  and  therefore,  support  more  effective  policy making (Vittas, 1992). Policymakers will typically recommend measures aimed at fueling competition,  promoting  the  liberalization  of  financial  markets  and  removing barriers to entry (Vittas, 1992) as recommended in this research work.

e.   Bank Customers: For starters, bank customers can now hold their own against the  might  of  the  banking  industry.  The  democratization  of  information  and communication  has  turned  the  average  banking  customer  into  an  aware  and confident individual who is not shy of voicing an opinion in public, this is one of the positives of commercial banks adopting competitive measures. This evolution has brought about greater diversity in consumer need, along with the expectation of  fulfillment  since  banks  profitability  has  been  matched  to  total  customer deposits and returned a positive correlation as highlighted in this research work. Hence, every customer demands that his bank pay close attention to his unique requirements and customize its products, services and experience  to his  liking. Under severe competitive threat, the banks have no choice but to comply, else it risks losing business to a rival that will.

Fortunately,  the emergence  of online technology,  self-service  mechanisms  and social media has made it feasible for banks to gather customer  information  in granular detail and use that insight to restructure a defined basket of offerings into an almost unlimited  set of personalized  variants.  It  goes without saying that a flexible, agile and integrated  core banking  platform is absolutely necessary for realizing  this  goal.  This  is  why  bank  customers  should  know  the  impact  of competition  on the profitability of  their banks and hence their behaviors.Also, since customer expectations are not just confined to products, but extend to prices and  delivery  as  well,  which  are  important  ingredients  in  their  profitability assessment; there is a need to take appropriate action on that front. The pricing perspective implies that each competing bank must set fair and transparent prices and   they   can   attract   customers   and   boost   their   profitability   with   good deals. What’s more, the rising popularity of banking institutions to connect with their  customers  at  many  several  touch  points  is  only  a  testimony  that  the competitive battleground just got bigger!

f.   Research Analysts:Commercial  banking profitability studies highlighted in this research work apply the structure-conduct  performance (SCP) hypothesis  to the banking industry. According to the hypothesis, the degree of competition among firms in a banking market is influenced by the degree of concentration of their output (loans, assets and deposits) among a few  relatively large banks, since a more highly concentrated market structure is assumed to be conducive for more effective collusion and hence enhanced profitability among the commercial banks (Smirlock,   Gilligan   and   Marshall,   1984;   Molyneux,   Lloyd-Williams   and Thornton, 1994; Mugume, 2010). However, a conflicting version of the Efficiency Structure  Hypothesis (ESH) postulates that an increase in banks’ profitability is majorly attributable to the total efficiency improvement in its operations. In this research work, this hypothesis  will be tested by estimating measures  for bank performance (profitability) as a function of concentration  and  efficiency in the local market. If the market shareparadigm of the SCP reveals positive and more substantial empirical support, authorities will be advised to put more emphasis on promoting competition in the banking industry, regulating banking product prices in the industry and generally discouraging further mergers of banks.

However, if theESH theory which asserts that only efficient firms can attain an increase in market share and hence their profitability because of their superiority in producing and marketing products then authorities will be expected to put more emphasis  on promoting  competition  in  the banking  industry and  discouraging further banking consolidation reforms (Demsetz, 1973).  Therefore, a resolution of these conflicting theories, as attempted in this research work is a veritable ground for further research analysis especially for developing countries in Africa.

1.8 Limitations of the Study

Conducting  a research project of this nature may not be totally complete  without stating some obvious limitations. The major limitation in this research is the use of secondary data which may inherently contain errors that can affect the validity of our own   research   findings,   recommendations   and   suggestions.   This   limitation   is highlighted here for obvious reasons.



This material content is developed to serve as a GUIDE for students to conduct academic research


IMPACT OF COMPETITION ON THE PROFITABILITY OF COMMERCIAL BANKS IN NIGERIA

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