Determinants Of Commercial Banks Profitability In Nigeria

Project and Seminar Topics with material for Banking and Finance

Abstract

The confidence reposed in the commercial banks in Nigeria is yet to improve despite all efforts by the Federal Government through the Central Bank of Nigeria as the profitability of many commercial banks is nothing to write home about. The study critically examines the factors that influence the profitability level of commercial banks in Nigeria. Panel data method was employed to analyze time series and cross-sectional data gathered from 2000 to 2013 on a sample of fourteen banks. Profitability is measured with return on assets as a function of some internal and external determinants, which includes; capital adequacy ratio, asset quality, management efficiency, liquidity ratio, inflation, and economic growth. The findings revealed that asset quality, management efficiency, and economic growth are the determinants of commercial banks’ profitability. They were found to be statistically significant on profitability in both the fixed effect and random effect models. Asset quality was highly significant in all the models; thus concluding that credit risk is a major determinant of commercial banks’ profitability.

Chapter One

Introduction

1.1 Background to the Study

In every economy the banking sector is considered to be the vital source of financing economic activities. As such, the profitability of this sector is inevitable in order to encourage economic activities.

The importance of bank profitability can be appraised at the micro and macro levels of the economy (Bobakova, 2003) at the micro level; profit is the essential pre-requisite of a competitive banking institution and the cheapest source of finds. It is not merely a result, but also a necessity for successful banking in a period of growing competition in finical market. Hence, the basic aim of a bank’s management is to achieve a profit as the essential requirement for conducting any business (Bobakova, 2003). At the macro level, a sound and profitable banking sector is better able to withstand negative shocks and contribute to stability of the finical system.

The importance of bank profitability at both micro and macro level has made researchers, a academics, banks management and banks regulatory authorities of develop considerable interest in the factor that determine commercial bank profitability (Athanasoglou etal, 2005).

An attempt to determine the factors that determine profitability has caused the sector some series of reforms right from colonial era till date in order to improve its performance.

Some of these reforms include; the sectoral credit allocation and interest rate cap of the 1970s and early 1980s, the small and medium industry enterprises equity investment schemes (SMIEEIS).

The rediscounting and refinancing facility initiated in 2002 (Economic and financial Review volume48/4 December, 2010) and in 1987-1991 financial sector reforms (intended to enhance competition in the sector, mobilize saving that would lead to more efficient allocation of resources) were implemented, encompassing elements of liberation such as the decontrolling of interest rates and measures to enhance prudential regulation to tackle bank distress (Oluranti, 1991). Also, between 1990 and 2004 bank regulators increased the minimum share capital requirement for bank operating in Nigeria five times, namely in 1991, 1997, 2000 and 2004 (Aburine and uche, 2006). However, these measures were unsuccessful in curtailing the spate of bank distress and failures in the 1990s and beyond (Oluranti 1991; uche, 1996; 1998; Back, et al).

Currently a set of banking sector reforms have been introduced to insure inter alia a strong and reliable banking sector (Okagbue and Aliko, 2005).

Unfortunately, if the historical antecedents of financial sector reforms in Nigeria are anything to go by, the current reforms may also not help to improve bank profitability and stability in Nigeria.

The federal government of Nigeria through the central bank of Nigeria (CBN) has perennially sought permanent measures that would enhance the profitability and stability of banks operating in the Nigerian banking industry. Against this backdrop, this study is aimed at clearly identifying the significant determinant(s) of commercial banks profitability in Nigeria.

1.2 Statement of Problem

The banking sector is one of the important sectors of an economy as it plays a major function of channeling funds from servers to investors. It has continued to attract attention of the government through the Central Bank of Nigeria. However, there have been different ways in which the federal governments of Nigeria through the Central Bank of Nigeria have been trying to restore the confidence of the masses in banking recapitalization exercise of 2005, and the nationalization of some commercial banks (Afribank, Bank PHB, and Spring Bank) in 2011. Despite all these efforts, the confidence of the masses is yet to be improved as the profitability of many commercial banks is nothing to write home about. This study therefore intends to proffer solution as it is geared towards ascertaining what factor(s) determines the profitability of Nigerian banks. This will help the regulatory authorities know where to center their concern. 1.3 Objectives of the Study

The broad objective of this study is to provide an understanding of the determinants of commercial banks profitability in Nigeria.

1.3 Objectives of the Study

The broad objective of this study is to provide an understanding of the determinants of commercial banks profitability in Nigeria. However, the specific objectives of the study are:

To assess the impact of banks liquidity on bank profitability
To examine the influence of shareholders fund on banks profitability
To assess the impact of total assets on banks profitability
To investigate the effect of number of branches on banks profitability

1.4 Research Questions

The study is undertaken to answer the following research questions:

What is the impact of banks liquidity on commercial banks profitability?
How does shareholders fund influence commercial banks profitability?
What is the role of total assets on commercial banks profitability?
Does the number of branches have effect on commercial banks profitability?

1.5 Significance of the Study

Since the banking sector is considered to be an important source of financing economic activities in every economy, it becomes necessary to device every means possible to identify determinants of commercial banks profitability.

This study is significant to all stakeholders such as managers of banks, regulators of banks (monetary authorities), depositors – investors, researchers, and the government of the country. The significance of this study can be seen in the following ways:

One, findings of this study are significant to managers of banks since the level of profitability of banks indicate the ability of banks to accommodate shock such as financial crisis. This profitability of banks can be compared to the overall banking situation because this serves as a good indicator to managers of banks to understand the strength of the banks against the overall banking industry. More so, banks that are unable to meet its customers’ demands leaves itself exposed to a systemic lack of confidence in the banking system.

Two, this research is also significant to the monetary authorities since it is a major role of the Central Bank of Nigeria to improve liquidity and financial stability in the Nigerian banking system due to the fact that a well funded banking sector is essential in order to maintain financial system stability and confidence in the country. With the findings of this study the monetary authorities will be able to strengthen their policies and advisory services in order to stabilize the banking sector.

Three, it is also significant to depositors/investors since bank performance (profitability) serves as an indicator whether to invest or withdraw their funds from the bank. They need past performance in terms profitability of the banks to know if it will be beneficial to deposits or invests to earn more returns that will enable them maximize their wealth. This study provides depositors as well as investors more and reliable information that will enable them to analyze the profitability of banks in order to know the strength of the commercial banks in Nigeria.

Four, this study is significant as a reference material to further researchers who may wish to carry out further research in this area. This is due to the fact that interested researchers in this area can consult this study as guide to further research in this area of studies.

Last but not the least, this study is also significant to the government of Nigeria. With this study the government may decide whether to adopt policies that will make the banking sector more investor friendly and profitable. As this will have multiple effects to the economy of Nigeria.

1.6 Scope of study

The study is limited to 14 commercial banks in Nigeria out of the 21 existing presently. Utilizing panel data for the period 2000-2013, the study adopts panel data regression. The period as well as its sample size should not be considered as a limitation, since it is the only sample period with complete information on pre – and post – consolidation of commercial banks profitability in Nigeria.

1.7 Limitations of Study

It is obvious that one has to confront some limitations on whatever study he or she is embarking upon. The major limitations confronting this study are inaccessibility of relevant materials and non – availability of adequate data. However, measure such as subscribing to get journals on the internet has been used to curb the problems of relevant materials and inadequate data.

Furthermore, the study used only two measures of profitability – Return on assets (ROA) and return on equity (ROE) which serves as a limitation this study finding, while there are numerous measures of profitability. In order to overcome this limitation, the study carefully used ROA and ROE as measures of commercial banks profitability because of its dominancy in finance studies as measures of commercial banks profitability or performance.

1.8 Organization of Study

The study is divided into five chapters. Chapter one deals with the study’s introduction and gives a background to the study. Chapter two reviews related and relevant literature. The chapter three gives the research methodology while the chapter four gives the study’s analysis and interpretation of data. The study concludes with chapter five which deals on the summary, conclusion and recommendation.

Chapter Five

Conclusion and Recommendations

This study empirically investigated the determinants of commercial banks’ profitability operating in the Nigerian banking industry using the panel regression analysis for fourteen commercial banks spanning 2000 to 2013. The internal determinants of profitability were structured from CAMEL model and the external determinants were macroeconomic stability and economic growth. From the findings in the fixed effect model, asset quality, management efficiency, and Nigeria’s economic growth are statistically significant on commercial banks’ profitability; hence suggesting that they are the major determinants of banks’ profitability. This showed that the internal determinants are asset quality and management efficiency while the external determinant is economic growth. Government policies in Nigerian banking sector must encourage banks to regularly raise their capital and provide the enabling environment that will accelerate economic growth in the country. The Central Bank of Nigeria should control inflation so as to ensure macroeconomic stability. Policies should be directed towards enhancing the efficiency of the financial institutions with the aim of intensifying the stability of the banking sector in Nigeria.

Also, banks should also have strong capitalization which in turn can help to reduce the expected cost of financial distress and possibly make capital adequacy have a better effect in the profitability of banks. Banks should ensure an effective credit administration and avoid mismatching of assets and liabilities. The limitation of this study is that it covers a period of 14 years on 14 banks out of the 21 commercial banks (Deposit Money Banks) presently operating in Nigeria. This study suggests that further research in this area should investigate whether monetary policies, financial risks and some macroeconomic variables apart from economic growth and inflation can determine bank profitability. Also, a wider coverage should be considered by increasing the number of banks in the sample and the span of study.

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