IMPACT OF INTEREST RATE ON COMMERCIAL BANK LENDING AND DEPOSIT MOBILIZATION IN NIGERIA, 1986-2017

ABSTRACT

There has not been a consensus on the efficacy of monetary policy instruments in achieving  the much  desired  macroeconomic objectives  in  Nigeria.  It  is  therefore against this background that this study sought to: (i) examine the impact of nominal interest rate on commercial bank deposit mobilization in Nigeria, (ii) determine the impact of nominal interest rate on commercial bank lending in Nigeria, (iii) examine the impact of real interest rate on deposit mobilization in Nigeria, and (iv) assess the impact of real interest rate on commercial bank lending in Nigeria. The study adopted the ex-post facto research design. Annual time’s series were collated from the Central Bank of Nigeria  (CBN) statistical bulletin for the period 1986  – 2017. Four  (4) hypotheses were formulated and tested using the Ordinary Least Squares (OLS). Commercial bank total credit granted (CBTCG) and commercial bank total deposit mobilized (CBTDM) were adopted as the dependent variables and nominal interest rate (NIR) and real interest rate (RIR) were the dependent variables for the hypotheses.  The  study  also  used  descriptive  statistics  on  the  dependent  and independent variables to complement the results. The result revealed that nominal interest (deposit) rate had positive and significant impact on commercial bank deposit mobilization in Nigeria; real interest (deposit) rate had positive and non-significant impact  on  commercial  bank  deposit  mobilization  in  Nigeria;  nominal  interest (lending) rate had negative and significant impact on commercial bank lending in Nigeria and real interest (lending) rate had negative and non-significant impact on commercial bank lending in Nigeria. The study thus concludes that interest rate regime is an important factor in determining the direction and volume of deposit and advances. The study recommends amongst others that since the main source of funds for commercial banks is deposit, banks should give due emphasis to their deposits and strive to increase them and banks should increase their deposit interest rates in order to mobilise deposits since there exists a positive relationship between savings and deposit interests rates.

1.1          Background of Study

CHAPTER ONE INTRODUCTION

In human societies, since the evolution of money, there have always existed those who possess money in excess of their immediate needs (surplus economic unit) and those whose current possession cannot finance their economic activities (deficit economic unit). The realization by the surplus economic unit that their excess possession can be used beneficially to meet the shortfalls experienced by the deficit economic unit led to the introduction of a credit system. This system was initially characterized by lenders (surplus units) and borrowers (deficit unit) having to search out themselves and deal directly (Akpan, 2009). Indirect financing includes the aggregation   of   deposits   from   various   households,   firms   and   government   by commercial banks for lending to the deficit unit; the repayment of the loan is made to the bank which also stands ready to redeem deposits withdrawals by the surplus unit. The major determinant between surplus economic unit and deficit economic unit agreeing for a deal is the cost of parting their excess possession (interest rate). Interest rates on bank loans and savings mobilisation are important determinants of the borrowing and deposit conditions in most economies (Borio and Fritz, 1995).

Interest rates are defined as the rental payments for the use of credit by borrowers or the return for parting with liquidity by lenders. An interest rate is a price and like other prices, it performs a rationing function  by allocating the limited supply of financial resources among the numerous competing demands for such resources (Ojo,

2001). The Institute of Chartered Accountants of Nigeria (2009) sees interest rate as the price one pays for money in the financial markets. It is that vital factor that is used to quantify the time value of money.

The role of interest rate in the process of economic development has remained a debated issue in developing countries. Financial liberalization was directed to reduce regulatory control over the institutional instruments and activities of agents in the financial sector. It increased the investment and raised interest rates. The low productivity of different sectors of economy suggested that it was more profitable to reinvest in bank deposits, thus reducing investment in the low productivity sector. The

financial repression leads to unproductive allocation of capital, low rate of returns to savers, high costs of financial intermediation, and inhibits growth of an economy (Roubini and Martin, 1992).

McKinnon and Shaw (1973) have showed that financial liberalization led to higher interest rates which equated the demand and supply of savings. The authors expressed their view that higher interest rates lead to increased savings and financial intermediation in improving the efficiency of savings and investment. The higher real interest rates increase the extent of financial intermediation which in turn raises the rate of economic growth in developing countries (Balassa, 1989).

Banks are statutorily vested with the primary responsibility of financial intermediation in order to make funds available to all economic agents. The intermediation process involves moving funds from surplus sectors or units of the economy to deficit sectors or units (Uremadu, 2002; Nnanna, Englama and Odoko, 2004). The extent to which this could be done depends on the level of development of the financial sector as well as the savings habit of the populace. Most banking activities are directed towards lending as credit has remained the backbone of banking operations. It is due to the fact that it provides the bulk profits of all banks profit volume. This lending could be on short, medium and/or long term basis and is a major service rendered by the commercial   banks   to   their   customers   which   include:   individuals,   firms   and government to aid their economic activities for the development and growth of the national economy. Thus, banks‘ lending activities generate economic growth through resources provision for real investment (Mckinnon, 2005). This brought about the acceptance and implementation of financial liberalization by many developing economies including Nigeria. In spite of the well-known liberalization and similar policies, economists remain divided in their opinion concerning the relationship between Nigerian commercial banks loan advance (LOA) and the determinants of their lending behavior (Muoghalu & Ezirim 2002).

Though the lending practices of banks were strictly regulated under the close surveillance of the bank‘s supervisory bodies, but the Structural Adjustment Programme (SAP) introduced in 1986 brought about some relaxation of the stringent rules guiding banking operations. The Bank and Other Financial Institution Act Amendment (BOFIA) 1998 required banks to report large amount borrowing to the

CBN. Other banks enactment stipulated that the bank loans should be directed to preferred sectors of the economy (manufacturing, agriculture and power and steel) in order to enhance economic growth and development. But considering all these regulations, banks  resorted to prudential  guidelines to avoid failures  and achieve maximum profitability in their lending activities. The commercial banks in Nigeria need to understand how to manage these huge assets in terms of loans and advance; for them to balance their main objectives of liquidity, profitability and solvency. Thus lending must be handled effectively for the banks to remain attractive and retain their customers.

The  commercial  banks‘  lending  has  significantly played  crucial  roles  in  igniting industrialization in every economy, by facilitating the mobilization of capital which oils the wheels of economic production (Cookey, 1997). But the sound and viable functioning of commercial banks is adversely affected by the choice of certain policy instruments for the regulation of banking operations. Such includes a rigidly administered interest rate structure, directed credit, unremunerated reserve requirements and stabilizing liquidity control measures; the volume of cash in the banks vault also determines its ability to grant advances (Ojo, 1976). Since cheques have to be met in cash in many cases, they should stock reasonable quantity of cash to meet customers demand. Moreover the days of armchair (cheap profit) banking are over and that the increasing trend in bad debts and absence of basic business corporate advisor services in most commercial banks, suggest the apparent lack of use of effective lending and credit administrative techniques in these banks. Despite the fact that commercial banks in Nigeria witnessed the era of impressive profitability, characterized by high competition, huge deposits and varied investment opportunities, some tend to disregard the fact that their administration require considerable skill and dexterity on the part of their management. Where a bank grants advances in excess of its crying ability, the bank soon runs into difficulty in meeting its customer‘s cash drawings. The same also applies to situation where loans and advances are given out by commercial  bank  without  adequate or commensurable collateral  and  backups. Non-servicing of loans also reduce the profitability and liquidity levels of the affected banks. The recent bank reformation of 2009 revealed a lot in this line (Alao, 2010)

As banks and other financial institutions play a key role in the expenditure decisions of firms and households. They are among the most important alternatives of funding and means of saving. As such, banks and bank behavior are critical components of the transmission mechanism of monetary policy. In particular, the interest rate channel of monetary policy, which operates when banks transmit the changes in the monetary policy  rate  to  their  customers‘  interest  rates,  depends  on  the  banks‘  reaction  to different shocks and to the state of the economy.

Domestic savings comprise of public and private savings. The contribution of public savings in domestic savings is negligible. Peaks and Valleys in income are inevitable. Saving provide a hedge against income variability. The accumulation of resources enables households to smooth consumption and provide food security and precautionary savings are particularly important among poor household (Gutz, 1999). Savings is seen a sacrifice of current consumption that provides for the accumulation of capital, which in turn, provides additional output that can potentially be used for consumption in the future (Gersovitz, 1988). In other words, savings is the difference between current earnings and consumption. It has been defined as ―deferred consumption‖  or part of income, which is not spent. Savings in an economy can assume one of several forms, these includes personal savings, corporate or business savings and government savings of these, the household savings or personal saving has been agreed to contribute the substantial part of the aggregate countries (Nwaobi,

2003).

Institutions in the financial sector like deposit money banks (DMBs) or commercial banks mobilize savings deposit on which they pay certain interest. To effectively mobilize savings in an economy, the deposit rate must be relatively high and inflation rate stabilized to ensure a high positive real interest rate which motivates investors to save from their disposable income. In Nigeria, the problem of mobilizing savings and deposits  has  always  been  the  bane  of  economic  growth  and  development.  In developing economies, savings rate has been declining since the first oil shock and in the early 1990s (Chete, 1999). However this trend conceals a large and increasing dispersion of savings rate, particularly among developing countries. The large heterogeneity in savings behavior is associated with country and time differences in

levels of development, growth performance, and fiscal and financial policies. The interest rate reform policy under financial sector liberalization was also to achieve efficiency in the financial sector and engendering financial deepening.

In Nigeria, the level of funds mobilization by banks is quite low due to a number of reasons, ranging from low savings deposit rates to the poor banking habits or culture of the people (Nnanna, Englama & Odoko, 2004). Also, another disincentive to funds mobilization according to these authors is the attitude of banks towards small savers. That is most banks target corporate customers and government deposits and pay little or no attention to the small savers. Admittedly, the services rendered to the small savers are more tasking on the banks, but there is need to encourage them to save. As a matter of fact, the funds from household savings are relatively cheaper and more stable than government deposits that are very volatile and expensive.

The economic realities in Nigeria have therefore considerably reinforced those forms of greater emphasis on domestic resource mobilization. In fact, the Nigerian data reveals a small volume of savings and a low voluntary savings rate (as low as 8%). In the past two decades, the country also witnessed an atmosphere of crisis and disappointment.  The  financial  reforms  are  likely  to  bring  about  considerable economic benefits, particularly through more effective mobilization of domestic savings and by efficient allocation of resources. Domestic savings had a very prominent role in order to sustain the growth of an economy because of increased external financial rigidity (Kasekende, et al., 1999).

High real interest rate (on bank deposits) stimulates financial  and total domestic savings and then stimulates the private investment (Athukorala, 1998). The deregulation policy of interest rate promotes the savings and investment and attained the efficient allocation of financial resources (Shrestha & Chowdhry, 2007).

1.2      Statement of Problem

For more than two decades ago, Nigerian economy witnessed the introduction of Structural Adjustment Program (SAP) which shifted emphasis from public sector to private  sector  (Onwumere  et  al.,  2011).  The  goal  was  among  other  things  to encourage  private  domestic  savings  mobilisation,  lending  for  private  domestic

investment and capital formation in order to enhance economic growth. By encouraging savings, resources were diverted from current consumption and invested in capital enterprises. Consequently, most countries both developed and developing have taken major steps to liberalize their interest rates as part of the reform of the entire   financial   system.   Such   liberalization   represents   a   policy   response, encompassing a package of measures to remove all undesirable state imposed constraints on the free working of the removal of interest rate ceiling and loosening of deposit and credit control (Killick & Marhn, 1990).

Unfortunately things have not worked out as expected. The initial optimism expressed about public sector reforms has not been met. Although the reform programme led to privatization and commercialization of many state enterprises including banks and improvement in some macroeconomic variables like interest rate, but not without its disappointing performances of banks to recoup savings from appropriate areas and lend to areas of concern in the economy. According to the Keynesians, interest rate increases investment while a rise in the rate of interest deepens investment. Anyawu (1993) reported that as soon as the Central Bank of Nigeria announced deregulation of interest rate in 1987.   Such rise helped in rendering borrowers insolvent while it is nothing but boomerang.

Fixed savings account interest rates can also have strong consequences on overall average bank deposit and in most cases it is also affected by bank specific lending interest rates since it is customer deposits that are lent to private sector business with the expectations of returns on borrowed capital, making nominal interest rates to have a back-effect on fixed savings interest rates. Nominal interest rates therefore likely to have an indirect causal effect on customer savings through fixed savings account interest rates which will probably be true since interest on savings are likely to be paid from returns on borrowed capital obtained from nominal interest on borrowed capital. Interest rates on bank loans and savings mobilisation are important determinants of the borrowing and deposit conditions in most economies (Borio and Fritz, 1995). Consequently, these rates are highly relevant for the determination of aggregate demand and supply.

Interest rate has contributed both positively and negatively on the economy (how people lend and borrow money) as it effect the demand for and allocation of available loanable funds. Hence, the need for this research work, to determine how people respond to lending and  borrowing when interest is high or low among banks in Nigeria. This study is important because the behavior of interest rates, to a large extent, determines the investment activities and hence economic growth of a country. It is therefore relevant and timely in view of the fact that there is still much ado empirically on the impacts of interest rates on lending and savings mobilization in Nigeria. It is obvious according to Umoh (2003) that an understanding of the nature of aggregate national savings and lending behavior is critical in designing policies to promote savings, investment and growth.

1.3       Objectives of the Study

The  main  objective  of  the  study  was  to  examine  the  impact  of  interest  rate  on commercial bank lending and deposit mobilization in Nigeria during the period of

1986-2017.

The specific objectives of this study include:

i.      To  evaluate  the  impact  of  nominal  interest  (deposit)  rate  on  commercial banks‘ deposit mobilization in Nigeria,

ii.      To examine the impact of real interest (deposit) rate  on deposit mobilization in Nigeria,

iii.      To determine the impact of nominal interest (lending) rate on commercial banks‘ lending in Nigeria, and

iv.      To assess the impact of real interest (lending) rate on commercial banks‘

lending in Nigeria

1.4       Research Questions

Our research questions derived from the objectives of the study include:

i.      What  extent  is  the  extent  of  nominal  interest  (deposit)  rates  impact  on commercial bank deposit mobilization in Nigeria?

ii.      What is the extent of real interest (deposit) rates impact on commercial banks‘

deposit mobilization in Nigeria?

iii.      what is the   extent of nominal lending rates impact on commercial banks lending in Nigeria?

iv.      What is the extent of the impact of real lending rate on commercial banks‘

lending in Nigeria?

1.5       Research Hypotheses

The following research hypotheses arose from the research questions above. These are:

i.      Nominal interest (deposit) rate did not have a positive and significant impact on commercial bank deposit mobilization in Nigeria.

ii.      Real interest (deposit) rate did not have a positive and significant impact on deposit mobilization in Nigeria.

iii.      Nominal interest (lending) rate did not have a positive and significant impact on commercial bank lending in Nigeria.

iv.      Real interest (lending) rate did not have a positive and significant impact on commercial bank lending in Nigeria.

1.6     Significance of the Study

This research work will go a long way to cater for the yearning needs and aspirations of  the  people  about  the  need  for  commercial  banks  to  re-examine  their  lending savings mobilization behaviour and propositions in the face of economic changes witnessing  sporadic  explosion  of  knowledge,   technological  breakthrough,  fast financial services, increasing needs of financial resources and paramount of all, the speedy pace of economic growth and development.

This re-examination is very necessary as the development of the Nigerian economy remains partly dependent upon increasing productivity of commercial banks in particular and the banking sector in general. The sector is expected to contribute in no small way, to the transformation of the Nigerian economy.

The  role  the  commercial  banks  are  expected  to  play  in  the  Nigerian  economy therefore makes it imperative to go into this research work. Over the years, emphases are shifted from the general commerce and other activities that are not of particular importance to growth and development of the economy, to activities like housing, agriculture  and  manufacturing.  Although  this  development  augured  well  for  the

economy and is one for which the commercial banks should be highly commended, certain features of their lending activities require some comments.

With this development, it is clear that bulks of the commercial banks credit is in the short term period. This makes them very unsuitable for productive use in the agricultural, manufacturing and industrial sectors which are themselves long term in nature. The need to re-structure the lending savings mobilisation pattern to suit the need of the Nigerian economy cannot be over-emphasized.

1.7       Scope of the Study

This study covers the period 1986-2017 due to availability of bank and time frame of banking sector reforms in Nigeria.. In carrying out this research, attention would be focused on commercial banks‘ aggregate loans and advances, aggregate savings mobilized and deposit and lending interest rate from the period when the economy was deregulated.

The post deregulation era started in 1986 driven by the structural Adjustment Programme (SAP), which marked the beginning of economic deregulation and lingering period of liberalization with the objectives of

         Restructuring  and  diversifying  the  economic  base  of  the  economy  and reducing the dependency on oil

         Achieving fiscal balance and reducing the deficit in the balance of payment in the medium term.

         Laying the foundation for non-inflationary growth in the medium and long term.

The  thrust  of  the  measures  for  deregulation  was  to  promote  competition  and efficiency through greater reliance on market forces. During this period of post deregulation  the  import  licensing was  abolished.    There  were partial  removal  of exchange control reduction of government borrowings and strengthening of the use of treasury bills as an effective tool of monetary control.

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