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INTEREST RATE DEREGULATION AND THE IMPACT ON PROFITABILITY OF COMMERCIAL BANKS
1.1 BACKGROUND OF THE STUDY
Before 1987, the interest rate management policy was one of the control functions by the Central Bank of Nigeria (CBN) which fixed the minimum savings rates and maximum lending rates for financial institutions. This was the area of administering interest rate regime following the introduction of a market based interest rate policy 1987 by the Central Bank of Nigeria (CBN), bank were allowed according to market conditions through negotiations with customers. Ever since then, there has been significant impact of such deregulation policy on theNigeriaeconomy especially on the profitability of commercial banks.
In directing bank to pay interest on current account deposits by the Central Bank of Nigeria (CBN) is in the context of the deregulation framework. This is implied by the negotiation between the banks and their customers on the interest rate payable on deposits for special purpose held for more than seven days. To further ensure tat customers are not exploited, the Central Bank of Nigeria (CBN) has furthered directed that the reducing balance method should be applied in calculating charges on loans payable in agreed installments.
Following the introduction of a marker base interest rate policy in 1987 by the Central Bank of Nigeria (CBN), banks were allowed to determine their deposit and lending rates according to market conditions through negotiation with their customers.
However, the minimum rediscount rate (MRR) continued to the fixed by the Central Bank in line with changes in overall economic conditions e.g. the minimum rediscount rate (MRR) which was fixed at 15 percent in August 1987 was reduced to 12.75 percent in December 1987 with the objective of stimulating investment and in the economy following the need to moderate monetary policy. In 1989, the minimum rediscount rate was raised to 13.25 percent in furtherance of the flexible interest rate policy. The bank introduced securities (treasury bills and certificates) in 1989.
Under the system, authorize dealer submitted competitive bids through which the issue rate emerged. The lack of responsiveness of the structure of deposit and lending rate to market fundamentals, particularly the decline in inflation in 1990 compelled the authorities in 1991 to fix a minimum speed of 4 percent points between the cost of funds of commercial and merchant bank and their maximum lending rates. The banks were therefore, directed to observe a minimum lending rate of 21percent and a minimum deposit rate of 13.5percent. the banking measure claiming that it was against the deregulatory posture of the government while the reported rates changed were within the guidelines. There was sufficient evidence that actual rates were higher. As if the benefits of the policy were largely 8 marginal. Hence, the ceilings on interest rates were remove in January 1992.
This policy was retained in 1993 in the course of the year interest rates were met only distorted and volatile but also rose to unprecedented levels. The behaviour of interest rate was traceable to a number of factors, which include the following.
1) The high rate of domestic inflation arising from the huge fiscal deficit of the federal government which was financed mainly by the Central Bank ofNigeria.
2) The undue discretion which the deregulation of interest rate conferred on lacy market arbitraging activities of market speculation.
3) Technical insolvency and serious cash flow problems on the part of some weak bank resulting in distress borrowing.
4) The use of stabilization securities and the system of allocation of foreign exchange both of which induced the sterilization of large funds at the Central Bank of Nigeria (CBN).
Also the deregulation of interest rate under Structural Adjustment Programme (SAP) resulted in narrowing rather then widening the loan deposit interest rate gaps. It is expected that this would promote increased savings as well as stimulate investment. The argument by some banks that their costs of funds have rises could only be considered tenable if the rates payable gap would not be quite so high as witnessed in 1989. as regards, the payment of interest on current account deposits, this should be welcomed by banks that are keen on competing to mobiles a deposit which is one of the main objective of interest rate deregulation. The provision whereby banks are allowed to negotiate with their customers still contravene the deregulatory since under structural adjustment programme while at the same time ensuring that customers are not unduly exploited and discouraged to save.
1.1.1 BRIEF HISTORY OF UNION BANK NIGERIA PLC
The history of Union Bank of Nigeria Plc stated with the opening of the colonial bank offices inLagos, Jos andPort Harcourtin 1917. In 1925, the bank was acquired by Barday Bank DCO (dominion colonial and overseas).
The bank developed and grew rapidly almost all part of the country. In compliance with the directive of the government in 1968, that all companies (including banks) must be incorporated locally in Nigeria, Barday Banks DCO was incorporated in Nigeria in 1969 and its name was consequently change to Barday Bank of Nigeria Ltd with its registered head office at 40 Marine, Lagos.
As a result of Nigeria enterprise promotion degree of 1972 and 1977, the federal government of Nigeria acquired 52% of the bank’s share, leaving 50% to Barday Bank International Limited (now Bardays Bank Plc) while the remaining 8% was taken up by Nigeria public.
Bardays Bank Plc sold 50% of it’s remaining shares toNigeriain 1979, thus reducing it equity holders to 20%. Following this development, the banks name was changed to Union Bank of Nigeria Ltd to reflect the new ownership structure i.e. federal government ofNigeria52% privateNigeriainvestors 28% and Bardays Bank 20%. With this new name, the bank is now an indigenous bank no longer a subsidiary Bardays Bank Plc, although Barday Bank Plc still offers technical and correspondent service as in the past.
1.2 STATEMENT OF THE PROBLEM
Since the introduction of market determined exchange rate via the SFEM in 1986, the main exchange rate has exhibited the feature of depreciation and instability negative effect on interest rate and continued depreciation of the naira in the forex market has had some adverse implication for interest rates and for commercial bank. It seems that the high interest rate resulting from the deregulation of exchange rate has affected the profitability of these banks.
Besides, the depreciation of the naira since 1986 raise the question as to what impact the interest rate policy has made on theNigeriaeconomy and the commercial banks.
1.3 OBJECTIVES OF THE STUDY
The objectives of this study among other things include;
a) To examine the interest rate policy inNigeriasince 1986
b) To examine the factors affecting interest rate in the economy.
c) To determine the impact of the deregulatory of interest rate on the profitability of commercial banks.
d) To identify the factors militating against sound interest rate policy should evolve.
1.4 RESEARCH QUESTIONS
The following questions are formulated for the purpose of this study.
ü What major developments have occurred in interest rate in theNigeriasince 1986?
ü What factors influence the determination of interest rate inNigeriaeconomy?
ü What impact has the interest rate deregulation policy made on the profitability of commercial banks inNigeria?
ü What factors militate against the effectiveness of interest policies inNigeria?
ü What impact has the interest deregulation made on theNigeriaeconomy generally?
1.5 SIGNIFICANCE OF THE STUDY
This study is significant in many respects. First, it will review the various interest rate policies implanted by theNigeriamonetary authorities since 1986. This review is very vital as it will reveal the flows in the formulation and implementation of policies. This will therefore provide the basis of recommendations for a sound interest rate policy in the economy.
Secondly, individual and economic agents will through this study understand the rationing function of interest rate in allocating limited supply of credit among the many competing demands for it.
Thirdly, the findings will serve as a guide to policy makers in the formulation of interest rate policy for the second development of the banking sector in particular and the economy in general.
The study will also be useful for academic purpose. It will serve as a data base for students who will carry out related studies in the future.
Finally the research findings can provide the basis for future study.
1.6 SCOPE AND LIMITATION OF THE STUDY
The scope of the study course the impact of interest rate deregulation policy inNigeriaon bank within particular reference to commercial bank. In carrying out the study, the researcher encountered some problems.
First, there was the problem of getting adequate information. This is because of un-cooperative attitude of most of the staff of Union Bank of Nigeria Plc. They considered the data and information demanded very confidential and so could not disclose them so much year of official, reprisal.
Lack of finance also constrained the effort of the researcher to make the study very expanded to include more commercial bank.
Finally, there is the problem of limited time to carry out study. Because of the demand placed on the researcher by other academic work, she did not have ample time to carry out the study in detail.
1.7 DEFINITION OF TERMS
Definition of some concept is necessary here for more understanding.
Minimum rediscount rate: this is the amount charged by the Central Bank ofNigeria for lending to bank in the performance of its function of a lender of last resort.
Saving deposit rate: this is the amount paid by bank for funds withdrawal after seven days notice. This restriction is however seldomly applied.
Deregulated interest rate: this is the interest that is market oriented.
Fixed deposit rate: this is the interest paid on deposit made for a fixed period of time like 90 or 180 days.
Maximum lending rate: this refers to the rate changed by banks for lending to customers with a low credit rating.
Real interest rate: this is the normal interest rate adjusted for expected inflation.
Nominal interest rate: this is the pure real value paid for the use of money or credit. It is often expressed as a percentage per annul.