Nov 7, 2007 - Figure 22: Interest Income / Total Assets (Log) for First Bank Nigeria ..... minimum capitalization for banks to 25 billion Nigerian Naira (the .... US$3 billion from the capital market through initial public offerings (IPO) ...... by increasing leverage and thus lowering the equity – to – asset ...... Π* = ((HHI)(1 + λ))p*Y.
BANKING SECTOR REFORMS AND BANK PERFORMANCE IN NIGERIA, 1980 – 2010
BY
EZE SIMPSON OSUAGWU B.SC STATISTICS, M.SC ECONOMICS Mat. No: 949009024
A THESIS SUBMITTED TO THE SCHOOL OF POSTGRADUATE STUDIES, UNIVERSITY OF LAGOS, NIGERIA IN PARTIAL FULFILMENT FOR THE AWARD OF A DOCTOR OF PHILOSOPHY (Ph.D.) DEGREE IN ECONOMICS
SUPERVISORS
PROFESSOR NDUBISI NWOKOMA (Professor of Economics) DR WAKEEL ISOLA (Associate Professor of Economics)
NOVEMBER 2014
1
SCHOOL OF POSTGRADUATE STUDIES UNIVERSITY OF LAGOS, NIGERIA CERTIFICATION This is to certify that the Thesis: BANKING SECTOR REFORMS AND BANK PERFORMANCE IN NIGERIA, 1980 – 2010 Is a record of the original research carried out by
OSUAGWU, EZE SIMPSON
---------------------
(AUTHOR)
SIGNATURE
DATE
-----------------------------------
---------------------------------
---------------------
SUPERVISOR
SIGNATURE
DATE
------------------------------------
--------------------------------
---------------------
SUPERVISOR
SIGNATURE
DATE
-----------------------------------
--------------------------------
---------------------
INTERNAL EXAMINER
SIGNATURE
DATE
------------------------------------
--------------------------------
---------------------
EXTERNAL EXAMINER
SIGNATURE
DATE
(1)
(2)
2
DEDICATION
This thesis is dedicated to the Almighty God for seeing me through this extensive academic work, to my wife Celestina and my children, Ezenwa, Ikechukwu, Onyinyechi and Uchechi for going through the times with me.
3
ACKNOWLEDGEMENT I sincerely acknowledge the efforts of my supervisors; Professor Ndubisi Nwokoma and Dr. Wakeel Isola (Associate Professor) for holding the flashlight when there seem to be no light at the end of the tunnel. This immense academic work would not have been possible without their encouragement, critical appraisal and prompt response to my requests. I thank Professor Siyanbola Tomori (Emeritus) for teaching me Monetary Economics and accepting to be my first supervisor following my admission into the program before his retirement. I express my sincere appreciation to Mr. Jacob Ade Toluwase, who was the acting Head of Department when I was admitted into the program. He encouraged and offered me a graduate fellowship which culminated into my becoming a university lecturer. I will forever remain very grateful to him for the opportunity. He turned on the academic lamp in me. I wish to thank my academic colleagues and lecturers in the Department of Economics, University of Lagos; Dr. (Mrs) Risikat Dauda, Dr. (Mrs) Kemi Lawanson, Dr. Isaac Nwaogwugwu, Dr Adebayo Adebiyi (now with Central Bank of Nigeria), Dr. Funso Ayadi, Dr. Dele Balogun, Dr. (Mrs) Ngozi Nwakeze, Dr. (Mrs) M. Loto, Dr. Emeka Osuji, Dr. Akinleye, and Dr. Bright Eregha – your criticisms gave me the necessary challenge to improve on this work. My overall success wouldn’t have been possible without the support and guidance of my mother, Madam Rhoda Osuagwu, who always reminded me of a duty I owe my late father to complete every important task I have started. I thank my brother Commodore Ogechi Osuagwu (NN) for always providing the required leadership role the family needs at all times. I also thank my brother Engineer Uzoma Osuagwu and my sisters Ms. Commie Osuagwu and Mrs Blessing
4
Okoro for their support and encouragement. I thank my in-laws, cousins, nephews, nieces, friends and well-wishers from far and near, who have in one way or the other encouraged me to complete this huge academic task. Finally, to all my students, who over the years have participated and shared in my career as a university lecturer – you are the mirror through which I see myself as a teacher.
Eze Simpson Osuagwu Lagos, Nigeria (2014)
5
Abstract This study investigates the impact of banking sector reforms on bank performance in Nigeria drawing specifically from the interest rate deregulation of the Structural Adjustment Program (SAP) of 1986 and the recapitalization policy of the Central Bank of Nigeria in 2005. The method of analysis spans a period of 31 years from 1980 to 2010 using a cross sectional data of 5 banks that existed before (SAP) and a panel of 12 banks from 2001 to 2010 to estimate the impact of interest rates deregulation and recapitalization policy respectively on bank performance. The results obtained show that interest rates deregulation significantly affects bank performance on return on equity and through intermediation spread for return on assets and return on equity. Using Panzar-Rosse H-statistic, the study reveals that the market structure of the Nigerian banking industry is monopolistic competition and significantly affects bank performance. This finding implies that the products and services of various banks are similar but differentiated. However, this corroborates the result obtained on the test for Structure-ConductPerformance paradigm of no collusive behaviour among banks in order to influence the price of financial products and services, and the degree of independence in their decision making process. The empirical findings further show that there is no evidence of the Structure–Conduct– Performance (SCP) paradigm in the Nigerian banking industry. It is also observed that bank specific variables are the most important determinants of bank performance, although industry related and macroeconomic factors show mixed results. Monetary authorities can therefore use prudential guidelines to effectively manage the activities of the banking industry. Bank management on the other hand can effectively pursue policies that will enhance their balance sheet positions without regard to much external influence. Key Words: Banking Reforms, Bank Performance, Competition and Market Structure. 6
TABLE OF CONTENTS Contents
Page
Title Page
i
Certification
ii
Dedication
iii
Acknowledgements
iv
Abstract
vi
Table of Contents
vii
List of Tables
x
List of Figures
xi
Chapters 1 Introduction
1
1.1 Background to the Study
1
1.2 Statement of the Problem
5
1.3 Objectives of the Study
11
1.4 Significance of Study
12
1.5 Scope and Delimitations of the Study
13
1.6 Research Questions
13
1.7 Hypotheses
14
7
1.8 Operational Definition of Terms
14
1.9 Plan of the Study
17
2 Literature Review
18
2.1 Banking Sector Evolution in Nigeria
18
2.2 Evolution of Banking Reforms in Nigeria
25
2.3 Bank Performance indicators in Nigeria
33
2.4 Determinants of Bank Performance
36
2.5 Theoretical Literature on Market Power and Competition in Banking
42
2.6 Methodological Literature on Banking Reforms and Performance
44
2.7 Empirical Literature on Banking Reforms and Performance in Nigeria
48
2.8 Theoretical Framework
50
2.8.1 Basic Theoretical Model of Bank Performance
51
2.8.2 Panzar and Rosse Model
54
2.8.3 Structure – Conduct – Performance Model
55
3 Methodology
58
3.1 Method of Analysis
58
3.2 Model Specifications
60
4 Data Presentation and Analysis
68
4.1 Source of Data
68
4.2 Results of Empirical Analysis
69
4.2.1 The Effect of interest rate deregulation on Bank Performance in Nigeria
69
4.2.2 The impact of Market Structure on bank performance
85
4.2.3 Test of the Structure – Conduct – Performance Hypothesis
87
8
5 Discussions and Summary of Findings
89
5.1 Discussions
89
5.2 Summary of Findings
96
6 Conclusion & Recommendations/Contributions to Knowledge
98
6.1 Conclusion
98
6.2 Recommendations
100
6.3 Contributions to Knowledge
103
References
105
Appendix
118
9
LIST OF TABLES Table No. and Description
Page
1: The Nigerian Banking Sector Performance; Pre and Post Consolidation
34
2: Correlation Matrix
70
3: Correlation Matrix (Stylized)
71
4: Summary Statistics
72
5: Regression results for fixed effects model
75
6: Regression results for random effects model
76
7: Regression result for fixed effects parsimonious model
77
8: Regression results for random effects parsimonious model
78
9: Results of Panzar-Rosse H statistic model
85
10: Results for the test of structure-conduct-performance hypothesis
87
Appendix: Table A: Nigerian banking sector indicators
117
10
LIST OF FIGURES Figure No. and Description
Page
Figure (i): Distribution of return on assets for selected banks in Nigeria (1980-2010)
120
Figure (ii): Distribution of return on equity for selected banks in Nigeria (1980-2010)
121
Figure (iii): Distribution of net interest margin for selected banks in Nigeria (1980-2010) 122 Figure 1: Total Assets of Banks in Nigeria 1980-2010
123
Figure 2: Banking sector average intermediation spread 1980 – 2010
123
Figure 3: Net Interest Margin of AfriBank Nigeria (1980 – 2010)
124
Figure 4: Net Interest Margin of First Bank Nigeria (1980 – 2010)
124
Figure 5: Net Interest Margin of United Bank for Africa (1980 – 2010)
125
Figure 6: Net Interest Margin of United Bank for Africa (1980 – 2010)
125
Figure 7: Net Interest Margin of Wema Bank Nigeria (1980 – 2010)
126
Figure 8: Return on Asset of AfriBank Nigeria (1980 – 2010)
126
Figure 9: Return on Asset of First Bank Nigeria (1980 – 2010)
127
Figure 10: Return on Asset of United Bank for Africa (1980 – 2010)
127
Figure 11: Return on Asset of Union Bank Nigeria (1980 – 2010)
128
Figure 12: Return on Asset of Wema Bank Nigeria (1980 – 2010)
128
11
Figure 13: Return on Equity of AfriBank Nigeria (1980 – 2010)
129
Figure 14: Return on Equity of First Bank Nigeria (1980 – 2010)
129
Figure 15: Return on Equity of United Bank for Africa (1980 – 2010)
130
Figure 16: Return on Equity of Union Bank for Africa (1980 – 2010)
130
Figure 17: Return on Equity of Wema Bank Nigeria (1980 – 2010)
131
Figure 18: Interest Income / Total Assets (Log) for Access Bank (2000 - 2010)
132
Figure 19: Interest Income / Total Assets (Log) for Diamond Bank (2000 - 2010)
132
Figure 20: Interest Income / Total Assets (Log) for EcoBank (2000 - 2010)
133
Figure 21: Interest Income / Total Assets (Log) for Fidelity Bank (2000 - 2010)
133
Figure 22: Interest Income / Total Assets (Log) for First Bank Nigeria (2000 - 2010)
134
Figure 23: Interest Income / Total Assets (Log) for Guaranty Trust Bank (2000 - 2010)
134
Figure 24: Interest Income / Total Assets (Log) for Skye Bank (2000 - 2010)
135
Figure 25: Interest Income / Total Assets (Log) for Sterling Bank (2000 - 2010)
135
Figure 26: Interest Income / Total Assets (Log) for United Bank for Africa (2000 - 2010) 136 Figure 27: Interest Income / Total Assets (Log) for Union Bank Nigeria (2000 - 2010)
136
Figure 28: Interest Income / Total Assets (Log) for Wema Bank Nigeria (2000 - 2010)
137
Figure 29: Interest Income / Total Assets (Log) for Zenith Bank Nigeria (2000 - 2010)
137
12
Figure 30: Interest Expense / Total Assets (Log) for Access Bank Nigeria (2000 - 2010) 138 Figure 31: Interest Expense / Total Assets (Log) Diamond Bank Nigeria (2000 - 2010)
138
Figure 32: Interest Expense / Total Assets (Log) for EcoBank Nigeria (2000 - 2010)
139
Figure 33: Interest Expense / Total Assets (Log) for Fidelity Bank Nigeria (2000 - 2010) 139 Figure 34: Interest Expense / Total Assets (Log) for First Bank Nigeria (2000 - 2010)
140
Figure 35: Interest Expense / Total Assets (Log) Guaranty Bank Nigeria (2000 - 2010)
140
Figure 36: Interest Expense / Total Assets (Log) for Skye Bank Nigeria (2000 - 2010)
141
Figure 37: Interest Expense / Total Assets (Log) Sterling Bank Nigeria (2000 - 2010)
141
Figure 38: Interest Expense / Total Assets (Log) United Bank for Africa (2000 - 2010)
142
Figure 39: Interest Expense / Total Assets (Log) for Union Bank Nigeria (2000 - 2010)
142
Figure 40: Interest Expense / Total Assets (Log) for Wema Bank Nigeria (2000 - 2010)
143
Figure 41: Interest Expense / Total Assets (Log) for Zenith Bank Nigeria (2000 - 2010)
143
Figure 42: Staff Cost / Total Assets (Log) for Access Bank Nigeria (2000 - 2010)
144
Figure 43: Staff Cost / Total Assets (Log) for Diamond Bank Nigeria (2000 - 2010)
144
Figure 44: Staff Cost / Total Assets (Log) for EcoBank Nigeria (2000 - 2010)
145
Figure 45: Staff Cost / Total Assets (Log) for Fidelity Bank Nigeria (2000 - 2010)
145
Figure 46: Staff Cost / Total Assets (Log) for First Bank Nigeria (2000 - 2010)
146
13
Figure 47: Staff Cost / Total Assets (Log) Guaranty Trust Bank Nigeria (2000 - 2010)
146
Figure 48: Staff Cost / Total Assets (Log) for Skye Bank Nigeria (2000 - 2010)
147
Figure 49: Staff Cost / Total Assets (Log) for Sterling Bank Nigeria (2000 - 2010)
147
Figure 50: Staff Cost / Total Assets (Log) for United Bank for Africa (2000 - 2010)
148
Figure 51: Staff Cost / Total Assets (Log) for Union Bank Nigeria (2000 - 2010)
148
Figure 52: Staff Cost / Total Assets (Log) for Wema Bank Nigeria (2000 - 2010)
149
Figure 53: Staff Cost / Total Assets (Log) for Zenith Bank Nigeria (2000 - 2010)
149
Figure 54: Operating Expense / Total Assets (Log) Access Bank (2000 - 2010)
150
Figure 55: Operating Expense/Total Assets (Log) Diamond Bank (2000 - 2010)
150
Figure 56: Operating Expense / Total Assets (Log) for EcoBank (2000 - 2010)
151
Figure 57: Operating Expense / Total Assets (Log) for Fidelity Bank (2000 - 2010)
151
Figure 58: Operating Expense / Total Assets (Log) for First Bank (2000 - 2010)
152
Figure 59: Operating Expense/Total Assets (Log) Guaranty Trust Bank (2000 - 2010)
152
Figure 60: Operating Expense / Total Assets (Log) for Skye Bank (2000 - 2010)
153
Figure 61: Operating Expense / Total Assets (Log) for Sterling Bank (2000 - 2010)
153
Figure 62: Operating Expense/Total Assets (Log) United Bank for Africa (2000 - 2010) 154 Figure 63: Operating Expense / Total Assets (Log) Union Bank Nigeria (2000 - 2010)
154
14
Figure 64: Operating Expense/Total Assets (Log) Wema Bank Nigeria (2000 - 2010)
155
Figure 65: Operating Expense/Total Assets (Log) Zenith Bank Nigeria (2000 - 2010)
155
Figure 66: Operating Income/Total Assets (Log) Access Bank Nigeria (2000 - 2010)
156
Figure 67: Operating Income/Total Assets (Log) Diamond Bank Nigeria (2000 - 2010)
156
Figure 68: Operating Income / Total Assets (Log) for EcoBank Nigeria (2000 - 2010)
157
Figure 69: Operating Income/Total Assets (Log) Fidelity Bank Nigeria (2000 - 2010)
157
Figure 70: Operating Income / Total Assets (Log) First Bank Nigeria (2000 - 2010)
158
Figure 71: Operating Income/Total Assets (Log) Guaranty Trust Bank (2000 - 2010)
158
Figure 72: Operating Income / Total Assets (Log) for Skye Bank Nigeria (2000 - 2010)
159
Figure 73: Operating Income / Total Assets (Log) Sterling Bank Nigeria (2000 - 2010)
159
Figure 74: Operating Income/Total Assets (Log) United Bank for Africa (2000 - 2010)
160
Figure 75: Operating Income / Total Assets (Log) for Union Bank Nigeria (2000 - 2010) 160 Figure 76: Operating Income / Total Assets (Log) Wema Bank Nigeria (2000 - 2010)
161
Figure 77: Operating Income / Total Assets (Log) Zenith Bank Nigeria (2000 - 2010)
161
Figure 78: Total Equity / Total Assets (Log) for Access Bank Nigeria (2000 - 2010)
162
Figure 79: Total Equity / Total Assets (Log) for Diamond Bank Nigeria (2000 - 2010)
162
Figure 80: Total Equity / Total Assets (Log) for EcoBank Nigeria (2000 - 2010)
163
15
Figure 81: Total Equity / Total Assets (Log) for Fidelity Bank Nigeria (2000 - 2010)
163
Figure 82: Total Equity / Total Assets (Log) for First Bank Nigeria (2000 - 2010)
164
Figure 83: Total Equity/Total Assets (Log) Guaranty Trust Bank Nigeria (2000 - 2010)
164
Figure 84: Total Equity / Total Assets (Log) for Skye Bank Nigeria (2000 - 2010)
165
Figure 85: Total Equity / Total Assets (Log) for Sterling Bank Nigeria (2000 - 2010)
165
Figure 86: Total Equity/Total Assets (Log) United Bank for Africa (2000 - 2010)
166
Figure 87: Total Equity / Total Assets (Log) for Union Bank Nigeria (2000 - 2010)
166
Figure 88: Total Equity / Total Assets (Log) for Wema Bank Nigeria (2000 - 2010)
167
Figure 89: Total Equity / Total Assets (Log) for Zenith Bank Nigeria (2000 - 2010)
167
Figure 90: Non-Interest Income/Total Assets (Log) Access Bank (2000 - 2010)
168
Figure 91: Non-Interest Income/Total Assets (Log) Diamond Bank (2000 - 2010)
168
Figure 92: Non-Interest Income / Total Assets (Log) for EcoBank (2000 - 2010)
169
Figure 93: Non-Interest Income / Total Assets (Log) for Fidelity Bank (2000 - 2010)
169
Figure 94: Non-Interest Income / Total Assets (Log) for First Bank (2000 - 2010)
170
Figure 95: Non-Interest Income/Total Assets (Log) Guaranty Trust Bank (2000 - 2010)
170
Figure 96: Non-Interest Income / Total Assets (Log) for Skye Bank (2000 - 2010)
171
Figure 97: Non-Interest Income / Total Assets (Log) for Sterling Bank (2000 - 2010)
171
16
Figure 98: Non-Interest Income/Total Assets (Log) United Bank for Africa (2000-2010) 172 Figure 99: Non-Interest Income / Total Assets (Log) for Union Bank (2000 - 2010)
172
Figure 100: Non-Interest Income / Total Assets (Log) for Wema Bank (2000 - 2010)
173
Figure 101: Non-Interest Income / Total Assets (Log) for Zenith Bank (2000 - 2010)
173
Figure 102: Total Loans / Total Assets (Log) for Access Bank Nigeria (2000 - 2010)
174
Figure 103: Total Loans / Total Assets (Log) for Diamond Bank Nigeria (2000 - 2010)
174
Figure 104: Total Loans / Total Assets (Log) for EcoBank Nigeria (2000 - 2010)
175
Figure 105: Total Loans / Total Assets (Log) for Fidelity Bank Nigeria (2000 - 2010)
175
Figure 106: Total Loans / Total Assets (Log) for First Bank Nigeria (2000 - 2010)
176
Figure 107: Total Loans / Total Assets (Log) for Guaranty Trust Bank (2000 - 2010)
176
Figure 108: Total Loans / Total Assets (Log) for Skye Bank Nigeria (2000 - 2010)
177
Figure 109: Total Loans / Total Assets (Log) for Sterling Bank Nigeria (2000 - 2010)
177
Figure 110: Total Loans / Total Assets (Log) for United Bank for Africa (2000 - 2010)
178
Figure 111: Total Loans / Total Assets (Log) for Union Bank Nigeria (2000 - 2010)
178
Figure 112: Total Loans / Total Assets (Log) for Wema Bank Nigeria (2000 - 2010)
179
Figure 113: Total Loans / Total Assets (Log) for Zenith Bank Nigeria (2000 - 2010)
179
17
CHAPTER ONE 1.0
INTRODUCTION
1.1
Background to the Study The primary role of the banking sector in an economy is to intermediate funds from the
surplus units to deficit units – in other words to collect deposits from the public and give out loans to borrowers for investment purposes. However, due to the traditional intermediation role of the banking system, higher returns may imply higher interest rates on loans or little or no interest payment for deposits. This informs a reason why monetary authorities are always poised to regulating the banking system. Increased regulations and counter deregulations have encouraged competition in the banking sector, and hence exposed banks to increased fragility. For example between 1990 and 2004, bank regulators have increased the minimum share capital of banks operating in Nigeria five times (Aburime and Uche, 2008). Banking sector reforms are often implemented by monetary authorities to ensure that there is a healthy competition among banks and to strengthen their overall performance. The Nigerian banking sector was bedeviled by structural imbalances in the 1970’s and early 80’s (Lewis and Stein, 1997). Interest rate on deposits was controlled by monetary authorities and predominantly so low that it discouraged savings. High lending rates were prevalent because of uncompetitive pressures and bureaucratic bottlenecks, the existing banks had to use very high spread to make profit (Ikhide and Alawode, 2001). On the other hand, the banks were grossly inefficient, man hours were wasted for banking services – a customer would spend all his useful time to effect a minor bank transaction. There were few bank branches available in the major city centers and banking services were completely unattractive to the
18
public. As at 1980 only 740 bank branches existed for a population of over 60 million (CBN Statistical Bulletin 2010). The entire banking landscape in Nigeria was not open for private participation. Virtually all the existing commercial banks in Nigeria at the time were owned by either the federal government or by the state government or specifically established to affect a particular government policy. This inefficient banking system completely repressed financial market development and hence the flow of capital to ginger economic growth was severely hampered. In 1986 the Federal Government of Nigeria embraced the Structural Adjustment Program (SAP); allowing market forces to determine the level of interest rates in the banking system, devaluation of the exchange rate and outright liberalization of financial services ensued. Financial liberalization did not receive an instant public ovation. It was a relatively unheralded aspect of SAP, prompting scant commentary in the public debate over structural adjustment and little controversy among senior policy makers (Lewis and Stein, 1997). Although financial sector reform was initially regarded by Nigerian officials as a subsidiary measure, deregulation of the banking sector was ultimately among the more consequential measures in the adjustment package. However, liberalization opened up the banking space for private participation and the aftermath was an increase in the level of competition in the banking industry, therefore making it difficult for some banks to breakeven. According to Lewis and Stein (1997), before SAP the Nigerian banking industry was oligopolistic in structure, dominated by the “big three” commercial banks: First Bank of Nigeria PLC (then Standard Bank Ltd), United Bank for Africa and Union Bank of Nigeria PLC (then Barclays Bank Ltd). The economic justification of banking sector deregulation is based on the presumption that deregulation fosters bank 19
competition, which in turn may engender bank performance in terms of profitability and efficiency. Prior to the implementation of structural adjustment, the World Bank had urged the Nigerian government to deregulate the financial sector. In a 1983 report, the Bank offered an analysis predicated upon financial repression theory of McKinnon (1973) and Shaw (1973). The report criticized the government allocation of credit, public subsidies fostering negative real interest rates, the inadequate number of licensed banks and the “complexity and rigidity” of government regulations (World Bank, 1993). In response to the mounting pressure for liberalization from the banking industry and international institutions, the Central Bank of Nigeria (CBN) raised interest rates during 1984-86 and promised to systematically reform banking (Lewis and Stein, 1997). After the introduction of SAP, many bank and non-bank financial institutions (NBFI) came on stream all in a bid to make profit out of the liberalized financial environment. According to Ikhide and Alawode (2001), there is no doubt that the existence of an unstable macroeconomic environment and weaknesses in the institutional structure for banking could have existed prior to the operation of SAP, but the manner of the implementation of the reform may have facilitated the occurrence of an unfavorable banking environment, leading to banking crisis soon after. A fundamental goal of banking-sector reforms is to enhance the competitive conditions for financial services in the Nigerian economy. Apart from the deregulation of interest rates introduced under SAP in 1986, monetary authorities in 2004 bravely designed and implemented a shock-treatment type of banking-sector reform, which amounts to a “big bang.” (Kasekende et al.2009). In contrast to the gradualist approach to banking reform, Nigeria embarked on a big
20
bang style of banking-sector reform aimed at enhancing the competitiveness and survivability of banks. Specifically, the reform introduced in July 2004 was characterized by a raise in the minimum capitalization for banks to 25 billion Nigerian Naira (the Nigerian currency) by December 2005, a phased withdrawal of public funds from banks, which took effect in July 2004 and consolidation of banking institutions through mergers and acquisitions. In addition, bank regulation was revamped by incorporating and adopting a risk-focused and rule-based regulatory framework; adopting zero tolerance in the area of information reporting; introducing an electronic financial analysis and surveillance system (e-FASS) for automated submission of returns by banks and other financial institutions; collaborating with the Economic and Financial Crimes Commission (EFCC) in the establishment of the Financial Intelligence Unit (FIU) and the enforcement of anti–money laundering and other economic crime measures; and strictly enforcing the contingency planning framework for systemic banking distress during 2008. The new reforms also emphasized the liability of the boards of failed banks. It is to be noted that, after the recapitalization, all bank performance indicators for each major bank satisfied high-quality benchmarks of return on equity, capital strength, asset size, and soundness (Kasekende et al. 2009). In addition, following financial consolidation, the depth of the financial sector increased as credit to the private sector rose from 26.2 percent in 2006 to 67.8 percent in 2007 (CBN, 2010) . There was also an increase in savings from 1,082.0 billion in 2006 to 2,949.8 billion in 2007, of which commercial banks held 76 percent of the funds while other savings institutions—such as life insurance funds, pension funds, and microfinance banks (MFBs)— accounted for 24 percent (Central Bank of Nigeria, 2010) . During the same period, the number of bank branches increased from 3,468 to 4,579 across all the states in the country.
21
Consequently, the number of bank employees went up. By the end of 2008, the financial sector was the largest significant employer in Nigeria (Kasekende et al. 2009). Above all, the deregulation of interest rates under SAP and the recapitalization policy in the banking system did not completely bring about the soundness and resolute confidence to the banking system albeit some anomalies that further weakened bank performance. Profitability was eroded as the so called big banks emerging from the consolidation exercise were yet to engage in the necessary intermediation that will ginger savings and loanable funds for economic growth and overall financial prosperity, which to a large extent is supposed the ultimate goal of banking sector reforms.
1.2
Statement of the Problem. Although, there was evidence of structural imbalance in the banking system due to
stringent regulatory policies and the oligopolistic market structure, the overall macro-economy of Nigeria was hopeful in the 1970’s and early 1980’s, GDP was $93,181million (the nineteenth in the world as at 1980) (World Bank, 1993). However, the ruling military administration did not channel investments appropriately to guarantee a sound economy in the case of a shortfall emanating from oil price fluctuations. The sudden fall in oil prices in the mid 1980’s gave rise to an economic shock that affected the stability of the economy. The World Bank and International Monetary Fund (IMF) came in to remedy the situation for Nigeria with conditions for a monetary ‘lifeline’ including a structural adjustment package that required the Nigerian government among other things to allow market forces to determine interest rates and the devaluation of the exchange rate of the Nigerian Naira with respect to the United States dollar.
22
The IMF proposal was put forward by the military government in power calling for a national debate on the issue. Although many Nigerians opposed the idea, government had to accept the funds from IMF irrespective of the difficult conditions attached to the package in order to cushion the effects of the prevailing economic austerity. In the wake of the Structural Adjustment Program (SAP) the number of commercial banks increased from 29 in 1986 to 58 in 1990, the savings and lending rates moved respectively from 9.50 and 10.50 in 1986 to 18.80 and 25.50 in 1990 (see Appendix, Table 1). The licensing of new banks increased competition for banking services and the lax regulatory framework that followed deregulation encouraged many banks to overstep their bounds by not following guidelines in order to breakeven. The intermediation spread was widened and as a result banks moved away from their traditional role of intermediation for long term lending into arbitrage short term financing for imports. The devaluation of the exchange rate further put pressure on the banking system. SAP introduced a regime of dual exchange rate; one for the official market and the other for the public. This regime of uneven foreign exchange market caused a major imbalance in the banking system. Banks would buy foreign exchange at the official rate from the Central Bank and turn around to sell at the “black market” for a margin that was over 100 percent. Most banks found this very lucrative and abandoned their traditional intermediation role to seek quick profit through foreign exchange round tripping. Central Bank was forced to strengthen its prudential guidelines and the military government promulgated the Banks and Other Financial Institutions Decree (BOFID) of 1990 as a legal framework for the regulation of the banking system. Many banks had bad balance sheet emanating from poor performance and their inability to compete favorably in the deregulated market space led to massive bank failures.
23
Another major reform of the banking system was introduced in July 2004 as part of a home grown economic development agenda of the civil administration. One of the secondary objectives of the National Economic Empowerment and Development Strategy (NEEDS) was to strengthen the financial system. In order to do this the Central Bank announced an increase in the minimum capital base of banks from 2 billion to 25 billion Naira, with a deadline of December 31, 2005 for full compliance. The announcement of the reform with the attendant increase of the minimum capital requirement sent shockwaves through the banking industry. The idea of consolidation was quickly embraced by the banking community and the process of mergers and acquisition ensued. One of the major reasons given by the Central Bank was that many Nigerian banks cannot provide the necessary financing needed to grow the economy. Most had a capital base of less than US$10 million, and several had bad balance sheets. The banking sector was highly concentrated with the ten largest accounting for about half the industry ‘s total assets and liabilities, the remaining 79 banks were small but had heavy fixed and operating costs, resulting in very high average cost for the industry (Okonjo-Iweala, 2012). The attempts to cover these costs led to wide spreads between deposit and lending rates and to a focus on lucrative short-term arbitrage of foreign-exchange “round-tripping” rather than on lending to the real sectors. The number of deposit banks dropped from 89 in 2004 to 25 as at January 2006 through mergers and acquisitions and their minimum capital requirement increased from two billion to twenty five billion Naira. In a bid to meet this capital requirement, banks raised an equivalent of US$3 billion from the capital market through initial public offerings (IPO) and attracted over US$652 million in foreign direct investment (Okonjo-Iweala, 2012). The Nigerian banking industry witnessed an explosive growth following consolidation, between June 2006 and June 2008, the number of bank branches grew by 54 percent, the number of deposit accounts by 39
24
percent, total loans and advances by 197 percent, bank credit to the private sector grew by 60 percent in 2007 and another 90 percent in 2008. Credit to the private sector was able to finance large infrastructure projects and oil and gas projects. Some Nigerian banks became key players in the international market by opening branches in other West African countries and in major European capitals. However, the effect of the global financial crisis on the Nigerian capital market in 2008 took a toll on banks and exposed some of the anomalies in their dealings in trying to meet the requirements for minimum capitalization. Some of the bank CEO’s had used depositor’s funds to trade in the IPO’s, as the stock market bubble burst, the quality of bank loan portfolios fell. The financial sector was in deep crisis, but the biggest source of the problem could be traced to five banks: Afribank, Finbank, Intercontinental Bank, Oceanic Bank and Union Bank. These banks accounting for about 40 percent of the total bank credit, had 1.14 trillion Nigerian naira (the local currency) in bad loans, had very low cash reserves and essentially depended on the CBN discount window for continued support and operations (Okonjo-Iweala, 2012). Despite the structural problems in the banking sector of the Nigerian economy some analytical or research gaps also exist and these form the motivation for this study. Nevertheless, some studies have investigated the impact of deregulation on the performance of the banking system in Nigeria, for example Sobodu and Akiode (1998) investigating the performance of Nigerian banks in a deregulated economy finds that the efficiency of banks in the industry has declined significantly following deregulation. Lewis and Stein (1997) had earlier observed that the problem with banking reform in Nigeria is that sufficient attention has not been paid to political and institutional factors. Ikhide and Alawode, (2001) examined the sequencing of structural reforms using discriminant analysis and peer composite non parametric estimates and
25
identified a wrong sequencing process as a major factor in poor performance of banks. The lack of parametric estimation in these studies and the non-inclusion of variables external to the banking system makes the result inconsistent in the analysis of bank performance in relation to reforms because deregulation has been seen to permeate into the banking system through factors external to the operations of the bank (Athanasoglou et al. 2006). Hence, in order to capture the impact of banking sector reforms on bank performance, there is need to consider the influence of bank specific variables, macroeconomic variables as well as industry related factors. Considering the impact of macroeconomic variables on bank performance, Athanasoglou et al., (2006) find that bank profitability of South Eastern European Banks is sensitive to macroeconomic conditions, bank specific factors which relates to the internal organization of banks and factors affecting competition within the industry. This study therefore follows Athanasoglou et al. (2006) to fill the existing gap in the literature of bank performance in Nigeria by using parametric methods of estimation to capture the determinants of bank profitability following deregulation and incorporating those variables that are external to the banking system, which hitherto has been left out in previous studies. It was obvious that banks in Nigeria were under-performing, falling short of the basic requirements in Capital, Assets, Managerial Efficiency and Liquidity (CAMEL) before the recapitalization exercise (Ikhide and Alawode, 2001). The nature of the competition introduced into the banking sector in Nigeria following recapitalization policy has been partly the focus of some studies (Kasekende et al. 2009, Zhao and Murinde, 2011). To what extent did this competition affect the market structure of the banking system in Nigeria? This question has not been fully answered by any of these studies reviewed. In Zhao and Murinde, (2011) nonparametric Data Envelopment Analysis (DEA) was used to estimate bank productive efficiency
26
in Nigeria and the results were contradictory, although measured in three different time phases but for the final phase between 2001 – 2008, an increase in competition was found as a result of reform, and in Kasekende et al., (2009) it was found that competition stimulates productivity growth through improved performance. There have been conflicting results hence this study intends to ascertain the nature of competition in the banking sector as a result of the increase in bank’s capital base using parametric estimates for a more robust result. In the New Empirical Industrial Organization (NEIO) literature, the relationship between competition and performance in the banking sector includes structural and non-structural approaches (Bikker and Bos, 2005). The structural approach embraces the Structure-ConductPerformance (SCP) hypothesis, whereas the non-structural approach includes the Panzar and Rosse (P-R) model. The SCP model assumes that there is a relationship between the structure of the market and the firm’s pricing behavior to the firm’s profits and the degree of market power (Bikker and Bos, 2008). Bikker and Bos (2005) observe that a market with higher concentration is more likely to show collusive behaviour hence the oligopoly rents will increase profitability. This observation has been tested for the banking systems in South Eastern European countries (Athanasoglou et al., 2006), also for the banking system in Sub-Saharan Africa (Flamini et al. 2009) and Xiaoqing and Hefferman (2009) using panel data to test the efficient-structure and market power hypothesis for the Chinese banking system. To the best of the author’s knowledge at the time of this research, there is no country specific study that has applied a test of the SCP hypothesis to the banking system in Nigeria hence this study intends to do that. Apart from the focus on SCP of the banking system in Nigeria, a major feature that distinguished this study from other known studies is the inclusion of political conditions in the analysis of bank profitability. Because of the incessant changes in the political administration of
27
Nigeria; from military to civil, one would expect that the political system should have an impact on the performance of banks. Aghion et al. (2007) provide evidence that democracy has a positive impact on productivity growth in more advanced sectors of the economy including banks, possibly by fostering entry and competition. This study therefore intends to include a political indicator in the bank performance model for Nigeria. It is in the light of the above that a study on the effect of banking reforms on bank performance becomes very imperative. In order to understand the effect of interest rate deregulation and the market structure for financial services following recapitalization, there is need to empirically examine the efficacy of banking reforms in view of available data.
1.3 Objectives of Study The broad objective of this study is to investigate the effect of banking sector reforms on bank performance in Nigeria. Specifically, the study tends; i.
To examine the effect of interest rate deregulation on bank performance in Nigeria.
ii.
To determine the impact of market structure on bank performance following banking sector reforms.
iii.
To examine the structure-conduct-performance hypothesis on bank performance in Nigeria
28
1.4 Significance of the Study i.
Enable policy makers to know the impact of banking reforms on bank performance and provide a working framework for the understanding of the effect of macroeconomic variables on bank performance
ii.
Provide bank management an understanding of the bank specific variables to fine tune in order to improve bank performance
iii.
This study provides evidence for the market structure of the Nigerian banking sector especially following recapitalization. The recapitalization policy may have produced powerful firms in the banking sector but there is a need to understand whether cooperation among firms harm the industry or promote competition for a healthy banking sector.
iv.
This study has opened the research frontier for a panel analytic study to empirically identifying the nature of competition in the banking sector to further the research on banking reforms and bank performance in a developing country like Nigeria.
v.
Policy makers are confronted with the dilemma of interest rate fluctuations emanating from the fixing of market interest rates on financial instruments by banks with market power resulting from mergers, this anomaly can only be corrected if there is a clear sense of the interaction between market concentration and the performance of banks. This study provides an empirical evidence for the understanding of the structure – conduct – performance paradigm in the Nigerian banking sector.
29
1.5 Scope and Delimitation of the Study The scope of this study will be limited by data availability. Although twenty two banks exist in Nigeria as at 2010, which is the time-frame of this study, In the first step of the analysis data from five major banks (Afribank Nigeria PLC, First Bank of Nigeria PLC, Union Bank of Nigeria PLC, United bank for Africa PLC and Wema Bank of Nigeria PLC) that survived the financial turbulence in the economy from 1980 to 2010 was used to study the effect of interest rate deregulation on bank performance. In the second stage data from seven more banks (Access Bank, Diamond Bank, Eco Bank, Fidelity Bank, Guarantee Trust Bank, Skye Bank, Sterling Bank and Zenith Bank) was added to make a total sample of twelve banks from 2001 to 2010 to study the market structure of the Nigerian banking sector following banking reforms. This sample is not completely exhaustive but these twelve banks were the only banks with available data to complete the data requirements for the research. In order to accommodate the periodic changes in reform dummy variables have been used for the various periods of policy restructuring. There is an assumption that the financial year of all banks in Nigeria begins in January and end in December. The data for this study is secondary in nature and was obtained from the annual balance sheet of the sampled banks and from Central Bank of Nigeria’s statistical bulletin.
1.6 Research Questions i.
Does interest rate deregulation have any effect on bank performance in Nigeria?
ii.
What is the impact of market structure on bank performance in Nigeria?
iii.
What is the effect of the structure-conduct-performance paradigm on the banking sector in Nigeria?
30
1.7 Hypotheses The following null hypothesis will be tested for the realization of the objectives stated above; i.
Interest rate deregulation has no significant effect on bank performance.
ii.
Market structure has no significant effect on bank performance.
iii.
The structure-conduct-performance paradigm has no significant effect on bank performance.
The following are the respective alternative hypotheses; i.
Interest rate deregulation has a significant effect on bank performance.
ii.
Market structure has a significant effect on bank performance.
iii.
The structure-conduct-performance paradigm has a significant effect on bank performance
1.8 Operational Definition of Terms i.
Banking Sector Reforms: Policy instruments and decisions of monetary authorities used to regulate the banking sector. For the purpose of this study, first reform was the interest rate deregulation under the Structural Adjustment Program of 1986; allowing market forces to determine the interest rates on deposit and loans. Second reform is on the increase of the minimum capital for banks operating in Nigeria from two billion to twenty five billion Nigerian Naira with effect from 1st January 2006.
ii.
Deregulation: This refers to a government policy regime of removal of interest rate ceiling on bank deposits and loan rates, exchange rate devaluation, reduction of stringent reserve requirements, liberalization of credit controls, unrestricted entry and exit to the financial market and eliminating several market imperfections. The era of
31
deregulation came into the Nigerian financial system following the Structural Adjustment Program of 1986 which was a product of the International Monetary Fund – global financial reform agenda to ease the effect of a global financial repression in the 1970’s and 1980’s. iii.
Bank Performance: A measure of bank profitability and/or efficiency. In this study performance refers to a measure of bank profitability over a period of time. The estimates of profitability adopted in this study are return on assets, return on equity and net interest margin. Return on Assets (ROA) estimates the ratio of banks net income i.e. profit after tax to total assets. Return on Equity (ROE) estimates the ratio of profit after tax to total equity capital investment and Net Interest Margin (NIM) is the ratio of interest income from interest expense to total assets.
iv.
Bank Balance Sheet: This is the annual financial statement of accounts of the sampled banks. This book of accounts reflects the official business status of a bank and can be quoted for record and legal purposes. It is the most acceptable financial position of a bank in Nigeria.
v.
Competition:
This refers to the competitive position of a banking firm in the
industry, where the firm size is relative to its share of the market and that firms exercise their profit maximizing role without let or hindrance. The structure of the market and the manner the firm conducts itself can go a long way to determine its performance. Competitive market positions are strengthened by the level of concentration of firms in an industry. The competition for market advantages increases with the number of firms. Here we are interested in finding the relationship, whether a highly concentrated banking environment can cause a collusive behavior of
32
larger banks thereby giving them a monopolistic advantage of reaping higher profits or otherwise. vi.
Bank Specific factors: These are variables that are specifically endogenous to the banking system. They include bank input prices such as interest rate paid on demand and time deposits, the volume of output quantities such as loans and advances. They are generally microeconomic factors that relate to the bank in particular, such as, liquidity and credit information and overhead expenses. Also bank specific variables include fixed netputs – which measures the simultaneous interaction of bank’s input and output variables, such as net interest income.
vii.
Industry-related factors: This refers to inter-bank relationship estimates. These factors can be examined on the basis of Hirschman-Herfindahl index that measures concentration and market share based on balance sheet aggregates. The market share of individual banks is also included in order to distinguish between the structureconduct-performance paradigm and the efficient structure hypothesis.
viii.
Macroeconomic determinants: This refers to factors which, signifies the impact of monetary policy on the financial environment. To capture the effect of macroeconomic environment, we use inflation rate, ratio of banking sector credit to the private sector to gross domestic product which proxies for financial deepening, intermediation spread and the domestic currency rate of exchange to a major foreign currency , for example the United States dollar. Inflation captures the variability of the price level which is composite to the consumer price index.
ix.
Panel Data: This refers to a cross-sectional data that is commonly used for the estimation of information from multiple sites. This estimation technique gives the
33
researcher the means of studying a particular subject within multiple sites, periodically over a defined time frame. Within the social sciences, panel analysis has enabled researchers to undertake longitudinal analyses in a wide variety of fields. In Economics, panel data analysis has been used to study the behavior of firms and wages of people over time. With repeated observations of enough cross-sections, panel analysis permits the researcher to study the dynamics of change with short time series. Panel analysis can provide a rich and powerful study of a set of firms, if one is willing to consider both the spatial and temporal dimensions of the data. In this case the study entails the analysis of several banks within the same time frame.
1.9
Plan of the Study. This study is presented in six chapters. The first chapter is an introduction to the entire
work. This chapter identifies some of the problems encountered by monetary authorities and bank management in a bid to break-even in a deregulated financial system. The objectives, significance of the study, scope and delimitation of the study feature in this section. The second chapter focused on the review of related literature. The third chapter is on the methodology applied in this study. In the fourth chapter presents the data and empirical analysis accordingly. In the fifth chapter the results from analysis are discussed and a concise summary of the findings is presented. Finally, in the sixth chapter the study concludes with recommendations and contributions to knowledge.
34
CHAPTER TWO 2.0 LITERATURE REVIEW This chapter presents a review of several related literature for this study ranging from those that discussed the evolution of the banking sector in Nigeria through the various reforms in the banking sector and market structure of the Nigerian banking sector from inception. Although there are many studies on banking sector reforms and performance in Nigeria, very few have established credible scholarly review and academic flavor to warrant being included in a study of this magnitude. However, against all odds the author has tried to incorporate the literature that could help to elicit the intellectual discourse that would drive this study. A concise review of scholarly contributions in this area of study is broken down for the purpose of this study into several components based on the implications of the contents to the literature on theories, analytical techniques or methodology and empirical findings. 2.1 Banking Sector Evolution in Nigeria Although, the first bank office of African Banking Corporation opened August 1891 in Lagos, indigenous banking in Nigeria dates back to the British West Africa and the establishment of Bank of British West Africa (BBWA) in 1894. African Banking Corporation was acquired by Bank of British West Africa in 1894 to form what is now First Bank of Nigeria. Another Bank of Nigeria came into being in 1909, and three years later in 1912, Barclays Bank (now Union Bank) was established. Over one hundred bank offices were established in the banking boom between 1940 and 1950, but an attrition of 30 private banks due to poor management, low capital, debt overhang and the financial shock induced by the great depression of the 1930s. British and French Bank for Commerce and Industry was established in 1948 and later became the United Bank for Africa. Fully owned Nigerian banks came on stream; such as 35
Agbonmagbe (Wema Bank) was established in 1945, African Continental Bank was established in 1949 to lend to people of African descent because the foreign owned banks were actually discriminating against them. In 1956, following the independence of some erstwhile British colonies, beginning with the Gold Coast (1957, Ghana), the word British in the title of the BBWA was dropped, and it simply became the Bank of West Africa (Okigbo, 1981). In 1958 the Central Bank of Nigeria was established as a regulatory institution for banking and financial services. In 1964, the Bank of West Africa was approached by Standard Bank with a proposal for a merger as part of the grand design of the chairman of Standard Bank, Sir Cyril Hawker, for an all - Africa operation for the Standard Bank. The BWA merged with the Standard Bank of South Africa. By 1969 it took out Nigerian incorporation to become Standard Bank Nigeria Ltd. Meanwhile in 1972 under the first Nigerian Enterprises Promotion Decree (1972), banks were required to put at least 40% of their shares in the hands of Nigerian citizens. The Government acquired 36.1%, the Nigerian Public 12.9% leaving 51% in the hands of expatriate shareholders. The Nigerian citizen’s proportion was raised further to 60% by a new Decree in 1976 (Ojo, 1992) As at December 1977 there were 18 commercial banks (including the cooperative banks) operating in Nigeria. Until 1977, two broad classifications could be applied to the commercial banks depending on whether Nigerians hold a majority or minority interest in the institution. In 1972, there were only 367 bank branches operated by sixteen banks. By 1975, the number of bank branches had risen to 436 and by 1978 to 585, with eighteen banks firmly in operation. In 1990, there were 58 banks in Nigeria operating 1,169 urban, 765 rural and 5 foreign branch
36
offices. In 2004, the number of banks in Nigeria reached 90 operating in 2,227 branch offices – 1,500 urban, 722 rural and 5 foreign offices (CBN, 2010). Soyode and Oyejide (1975), has shown that before 1986 most of the branch offices of the commercial banks were concentrated in urban centers such as Lagos, Kaduna, Enugu, Port Harcourt and Ibadan. This pattern of bank concentration implies that banks follow business and not the other way round. Okigbo (1981) observed that Nigeria was grossly under-banked with one branch office for over 137,000 persons. The effect of a very low banking density is that the services do not penetrate into the normal business habits of the population. The financial system of which the banking sector constitutes the most important part seems to be outside the commercial life of the population. A second effect is that because of low density, the existing branches tend to be under considerable pressure to provide all ranges of services simultaneously. There is therefore very little room for specialization among the banks and their services tend to be rationed to a sector of the population. In 2001, the Central Bank of Nigeria introduced universal banking, thereby removing the operational distinction between commercial and merchant banks. The implication of this is that both commercial and merchant banks are referred to as Deposit Money Banks (DMBs) and they are to operate on a level playing ground. The implementation of monetary policy faced daunting challenges in the two years 2002 to 2003 mainly due to the problems of excess liquidity and increased demand pressure in the foreign exchange market. In the second half of 2002, monetary policy was relaxed to stimulate economic performance. Consequently, the minimum rediscount rate was reduced from 20.5% in June 2002 to 18.5% in July, and further to 16.5% in December 2002. In July 2002, the cash
37
reserve ratio was reduced from 12.5% to 9.5% for banks, which increased their lending to the real sector by a minimum of 20% over the level at the end of 2001. In order to moderate the level of interest rate, the Central Bank of Nigeria through a cooperative effort with the Federal Government and the Banks, was able to bring down lending rates from 31.27% to 25.7% in 2002. Under this arrangement, banks were expected to lend at a maximum of 4% above the minimum rediscount rate (MRR). At the end of 2002, major macroeconomic targets set in the medium term monetary policy framework indicated that aggregate bank credit grew by 56.6% as against the target growth rate of 57.9%. Credit to the Federal Government also grew astronomically from 96.6% to 6,320.6% at the end of 2002. In addition inflation rate overshot the target of 9.3% to settle at 12.9%, while a 3.3% growth rate was achieved in respect of the Gross Domestic Product (GDP) as against the policy target of 5.0%. The broad measure of money supply (M2) rose by 21.5% compared with the 15.3% targeted, while narrow money stock (M1) increased by 15.9% as against the 12.4% performance target for the year. The growth in broad money was induced by the sharp growth in credit to the Federal Government during the period. In furtherance of its statutory responsibility of ensuring a safe and sound financial system, the contingency plan for banking system distress resolutions, which was developed jointly with the Nigerian Deposit Insurance Corporation, became effective in July 2002. Also the Bank initiated a private sector funded “lifeline” facility that was accessed by banks with temporary liquidity problems. These, in addition to the Financial Sector Assessment Programme (FSAP) conducted jointly by the IMF and the World Bank to assess the soundness of Nigeria’s financial sector, based on international standards, were aimed at strengthening the financial system.
38
In 2003, the overall macroeconomic developments were mixed. Compliance with monetary and external policy targets fell short of expectation, but domestic inflation remained largely subdued, especially in the first part of the year. The rapid monetization of crude oil receipts and the expansionary fiscal dominance continued to pose a serious challenge for monetary policy management. As a result, the growth in monetary aggregates exceeded the targets for the year by wide margins, while the external reserves declined from US$7.99 billion in December 2002 to US$7.5 billion in November 2003. Bank deposit and lending rates moderated generally in 2003, influenced by the downward review of the MRR and the liquidity condition in the banking system. The exchange rate of the Naira remained relatively stable since July 2002 when the Dutch Auction System was re-introduced. In 2002, the CBN adopted a medium term perspective monetary policy framework spanning January 2002 to December 2003. The two-year monetary policy was aimed at saving the economy from the problem of time inconsistency and over-reaction, owing to temporary shocks. However, the performance of the domestic economy in 2003 was characterized by the same problems as in the previous year. Monetary expansion was excessive, giving rise to high demand pressure in the foreign exchange market and persistent depreciation of the Naira in all segments of the market. It is against this background that monetary policy in fiscal year 2004/2005 has been designed to focus on the achievement of price and exchange rate stability. The Central Bank of Nigeria (CBN) in July 2004 came up with a major policy reform that required banks licensed in Nigeria to increase their paid up capital to a minimum of N25billion (Twenty five billion Nigerian Naira) on or before December 31st 2005. The controversy
39
surrounding this requirement by the CBN gave rise to debates amongst stakeholders on the desirability and feasibility of such huge capital base. However, many of the banks resorted to private placements with high net-worth individuals and institutional investors to raise the shortfall to meet the requirement. The inadequacy of this option became very apparent when many of the banks led by Allstates Trust Bank and four others began to initiate and sign Memorandum of Understanding (MOU) for merger and acquisition purposes. Several other merger talks ensued; some smaller, weak and medium sized banks contemplated merger – an indication in this direction was the MOU signed by five banks: Trust Bank of Africa Limited, Prudent Bank PLC, Magnum Trust Bank PLC, EIB International Bank PLC, and NBM Bank to come together under the new name of Sterling Bank Group. The proposed merger announced by the quartet of Assurance Bank PLC, Guardian Express Bank PLC, Manny Bank PLC, and First Atlantic Bank PLC under the aegis of Astra Bank did not come to fruition. The second scenario was the desire of some medium to large size banks acquiring smaller and weaker banks. There also appears a third pattern of combinations of large-sized banks and notable players in the industry wanting to come together to form what appears to be mega banks. The MOU between United Bank for Africa PLC and Standard Trust Bank PLC came to pass, but the proposed merger talks between First Bank PLC and Guaranty Trust Bank PLC failed. Without doubt some of these negotiations succeeded and the target amount of N25 billion achieved or even overshot, and new bigger and more diversified mega banks emerged to make for the solid and internationally competitive banking system that is the dream of the Central Bank of Nigeria. In December 2006, the Minimum Rediscount Rate (MRR) was replaced with the Monetary Policy Rate (MPR). The MPR was brought down to 10.0 per cent from 14.0 per cent
40
(MRR), with a lending rate of 13.0 per cent and a deposit rate of 7 per cent. This summed up to 600 basis points and was a standing facility intended to stem volatility in interest rates, especially inter-bank rates. The CBN continued to apply the tools of reserve requirements and discount window operations. However, under the standing facility, discount window operations became less prominent. Subsequently, the corridor was abolished as the overnight standing deposit facility became unremunerated. The MPR became more effective than the MRR in steering interest rates and signaling a commitment to only lend to banks as a last resort. In order to further strengthen the money market, deepen it and ensure that treasury instruments were fully priced in the market place without moral hazard for the CBN; primary dealers were appointed to trade in such securities and underwrite them as situations demand. This action effectively broke the monopoly of discount houses in the primary market for treasury securities. An important element of Nigeria’s banking sector reform relates to the payment system and the interbank money market. Payment system reforms were also put in place when seven banks were appointed as settlement banks for the clearing of checks. Between 2006 and 2007, the value and volume of clearing checks grew from 14.9 million to 19.9 million and 16.4 million to 28.1 million, respectively, reflecting the shift from noncash transactions to the use of checks by individuals. To encourage the use of checks, writers of dishonored checks were subject to fines and prosecution, and these penalties would be enforced. The introduction of the Central Bank of Nigeria (CBN) interbank fund transfer system for transferring funds among banks increased the value of transactions by 56 percent. The nonpayment of interest on standing deposit facility also instilled confidence and encouraged banks to deposit and borrow funds between themselves and discount houses. Electronic commerce also expanded with the increased use of ATMs, the introduction of Point of Sale (POS) terminals, the issuance of debit and credit
41
cards, and Internet and mobile banking innovations, increased bank profitability through noninterest income. 2.2 Evolution of Banking Reforms in Nigeria The first banking ordinance under the British colonial rule was enacted in 1952. Before this time banking in Nigeria was coordinated by the colonial merchants whose interest was to facilitate trading and currency remittances between the colonies and the home country. The 1952 ordinance was an off-shoot of a report of the Patton Commission established in 1948 to provide a guideline for the banking industry following incessant bank failures, and to curb financial malpractices that characterized the banking sector. The 1952 ordinance actually launched the first phase of banking system regulation in Nigeria by defining the role and characteristics of banking in Nigeria. The ordinance came up with a broad definition of banking in Nigeria as a business that has banking as its title and open to the public for financial transactions. However, this was the first time banking was mentioned in a legal document for the purpose of regulating the banking business. The objective of the ordinance was to define the role of banking business in the Nigerian economy and prescribe minimum capital requirements for both domestic and foreign owned banks, establish standards for the supervision and conduct of banking, and the necessary reserve requirements for bank deposit management. According to Okpara (2011), under this phase of reform between 1952 – 1958, banks were required to obtain a license on the payment of a nominal capital of GBP25,000.00 with at least a paid – up capital of GBP12,500.00 but the foreign banks must have a paid – up capital of GBP100,000.00. A further stringent requirement was established for existing banks to maintain a reserve fund into which 20 per cent of the profit would be paid annually until the reserve fund equaled the paid-up capital and all capitalized expenditure must have been retired before any dividend pay-out. The banks were 42
further required to maintain adequate liquidity profile to retain their licenses. No bank was allowed to make unsecured loans against its own shares for more than GBP300.00 to any of its directors or to a company associated with any of its directors. The second phase of banking sector reform in Nigeria was a continuation of the 1952 ordinance which created the necessary conditions for banking supervision, examination and control of banks in the country by the government. The 1952 ordinance further provided the platform for the establishment of an indigenous Central Bank of Nigeria in 1958 with the appointment of Mr. Roy Pentelow Fetton as the governor from 1958 to 1963. The Central Bank of Nigeria Act of 1958 paved the way for bank examination and supervision in Nigeria. Since the 1958 Act, the mandates of the CBN (with modifications) have included to ensure monetary and price stability, issue legal tender currency in Nigeria, maintain external reserves to safeguard the international value of the legal tender currency. Furthermore to promote a sound financial system in Nigeria, act as a banker of last resort and provide economic and financial advice to the Federal Government. In essence, the Central Bank of Nigeria is the Monetary Authority of Nigeria, a regulatory institution for banks and other financial institution. The Central Bank ultimately became the monetary adviser to the Federal Government of Nigeria. The third phase of banking sector reforms in Nigeria came on the heels of the Companies and Allied Matters Act of 1968, which expressly stated that banks like other companies doing business in Nigeria be incorporated with a minimum share capital. In addition the Banking Regulation Act of 1969 provided for a maximum lending to any single individual or company not to exceed thirty three and a half per cent of the total sum of the paid-up capital and statutory reserves of bank, this was an increase from the twenty per cent provision stipulated under the Central Bank Act of 1958. However, the Act further provides that no bank should own any 43
subsidiary company and clients, and gave the apex bank extensive supervisory and regulatory power over all banks (Akinmoladun, 1992). Further amendments were made to the Banking Act of 1969, in 1970, 1972 and 1979 by decrees to strengthen the CBN for the subsequent indigenization program of the federal government and continued developments in the banking system (Okpara, 1997). The fourth phase of banking sector reforms in Nigeria was a product of the Structural Adjustment Program of 1986. This era spanned through 1990, when the Nigerian banking system became completely deregulated. The number of banks operating in Nigeria increased two folds from 1987 through 1990. So many privately owned indigenous and state banks emerged during this era to issue credit to both private and public sectors. Interest rate and foreign exchange deregulation was the crux of banking reforms during this era. Though the deregulation reforms in Nigeria started in the fourth quarter of 1986 with the setting up of a foreign exchange market in September 1986, the reforms pertaining to the banking industry proper did not commence until January 1987 (Ikhide & Alawode, 2001 and Asogwa, 2005). The banking reform under the structural adjustment program took the form of deregulation of interest rates for deposits and lending. Deregulation implies allowing market forces to determine the rate of interest any bank would charge instead of the previous regime where interest rates were predetermined by the monetary authorities. Monetary authorities also liberalized the entry of new banks into the financial market place, which led to the emergence of so many privately owned merchant and commercial banks. The exchange rate for the domestic currency was allowed to float at the foreign exchange market. At the initial stage, this exchange rate policy gave rise to a dual market for foreign exchange; the official rate was for bank and government foreign exchange transactions while the unofficial rate was controlled by the bureau de change and termed “black 44
market” by participants for transactions with the general public. There was an imbalance arising from the spread between the official and unofficial rates which became a dilemma for the banking sector and monetary authorities in the long run. Unfortunately, the dual exchange rate policy triggered high inflation and macroeconomic imbalances that gave rise to the failure of most of the new banks that came on stream following the liberalization within a very short period of existence. The foreign exchange regime was phenomenal at least in the growth of the number of banks that perceived this as a means of reaping easy profits through foreign exchange roundtripping. The increasing number of banking institutions overstretched the regulatory capacity of the CBN while the growing sophistication in the design and use of financial instruments heightened the risks of malpractices and fraud in the industry. In particular, mismanagement such as insiders’ abuse and poor credit appraisal systems, resulted in the accumulation of unpaid loans and advances, which eventually contributed to the distress situation experienced in the banking system in the early 1980’s and mid 1990’s and the revocation of the licenses of 26 banks in 1997 (Wilson, 2005). During this period the Nigerian Deposit Insurance Corporation was established in 1988 and commenced operation in January 1989. The fifth phase of banking reforms was to ensure a healthy banking system, which began with the promulgation of two new decrees in 1991 to enhance the regulatory powers and supervisory authority of institutions responsible for monetary policy formulation and guideline and to enable them manage the banking reform that emanates from the structural adjustment program – the Central Bank of Nigeria Decree 24 of 1991 and the Banks and Other Financial Institution Decree (BOFID) of 1991. The new banking sector regulatory reforms gave the Central Bank of Nigeria the authority to issue banking licenses and to revoke them. The decree also empowered the Central Bank to apply stringent prudential measures in handling ailing 45
banks. Nonetheless, by 1991 some of the reforms introduced in 1987 were reversed, the regime of interest rate cap and ceilings came back on stream; the ceiling for interest rate on lending was kept at 21% and deposit rate was capped at 13.5%. A maximum intermediation spread of 4% was recommended for all licensed banks, but as inflation ensued due to the flexible exchange rate mechanism, these measures became very difficult to maintain. Following the privatization of government owned banks in 1992, government began the process of divesting itself from the seven banks where it had 60% equity holding (Okpara, 2011). In 1993 the Open Market Operations as an indirect instrument of monetary control was introduced. The first discount house took off in 1993 known as Associated Discount House, subsequently others followed, and by 2003 there were 5 discount houses. The discount houses intermediate between the central bank and the other banks, off-loading government treasury securities from the CBN and auctioning same to the banks. Adegbite (2005) observe that where the banks couldn’t pick – up all of the treasury securities, the discount houses warehouse them. The sixth phase began in the late 1993 and spanned between 1994- 1998, with the reintroduction of regulations. During this period, the banking sector suffered deep financial distress which necessitated another round of reforms, designed to manage the distress. About 33 banks were recorded distressed in 1993 for the first time since the establishment of the central bank; and in 1995, the number of distressed banking institutions both commercial and merchant reached 60 (Okpara, 2011). This necessitated another reform measure in 1994, to grant permission and ensure that commercial banks in Nigeria start paying interest on demand deposits (current account) as deemed appropriate. The monetary authorities implemented a policy of using indirect instruments of credit control to grant loans to financial institutions based on their portfolio of foreign exchange held in foreign deposits. This measure was to support the cash 46
reserve ratio which before the reforms had been virtually stagnant. According to Adegbite (2005), to avoid undue interference by governments (both state and federal), banks were advised to desist from accepting deposit from government and all such deposits held by the commercial and merchant banks were withdrawn with immediate effect. The seventh phase of banking reform in Nigeria began in 1999 following the transition to a democratically elected government and spanned through 1999 – 2003. This era reinvigorated the process of liberalization of the financial sector, with the adoption of policies that establish a framework to tackle bank fragility and strengthen competition. The dichotomy between commercial and merchant banks was removed and the idea of universal banking ensued in 2001. The licensed banks were permitted to carry out both merchant banking and commercial banking under one shop. The eighth phase of banking reform in Nigeria literally began in 2004 and lasted through 2009. The second term of the Obasanjo administration embraced very heavy tactical economic reform program under the aegis of National Economic Empowerment and Development Strategy (NEEDS) launched in 2004. In this overall macroeconomic reform package was a banking reform strategy aimed at strengthening the financial sector and improve the availability of domestic credit to the private sector. To accomplish this goal, the Central Bank of Nigeria requested all deposit banks to raise their minimum capital to twenty five billion naira by the end of 2005. Banks failing to meet this requirement were expected to merge or face a revocation of their license at the beginning of January 2006. Balogun (2007) opined that the financial system was characterized by structural and operational weaknesses and that their catalytic role in promoting private sector led-growth has been jeopardized by lack of funds, but could be further enhanced through a more pragmatic reform. Ebong (2006) also stated that prior to this reform, 47
the banking system was characterized by low capital base, high non-performing loans, insolvency and illiquidity, over dependence on public sector deposits and foreign exchange trading, poor asset quality, weak corporate governance, a system with low depositors’ confidence. Above all, the Nigerian banking sector could not support the real sector of the economy at 25% of GDP compared to African average of 78% and 272% for developed countries. In his contribution to the debate on bank consolidation, Lemo (2005) noted that the banking industry had remarkable features of market concentration and documented that the top ten out of eighty-nine banks controlled more than 50% of the aggregate assets, more than 51% of the total deposit liabilities, more than 45% of the aggregate credits. Also the Central bank governor, Soludo (2004), described the industry as being generally characterized by small-sized and marginal players with very high overhead cost. The primary objective of the reform is to guarantee an efficient and sound financial system. This reform, the governor stated was designed to enable the banking system develop the required resilience to support the economic development of the nation by efficiently performing its functions as the fulcrum of financial intermediation. Thus, the reforms were to ensure the safety of depositors’ money, position banks to play active developmental roles in the Nigerian economy, and become major players in the sub-regional, regional and global financial markets (Adeyemi, 2007). The components of the 13points reform agenda announced by Governor of the Central Bank of Nigeria on July 6, 2004 includes an increase on the minimum capital requirement of all licensed banks from two billion naira to twenty five billion naira with a deadline of 31st December. 2005; consolidation of banks through mergers and acquisitions to ensure that there are no “single family” owned banks; phased withdrawal of public sector funds from banks with effect from July 2004; adoption of a risk-focused and rule-based regulatory framework; adoption of zero tolerance for weak corporate
48
governance; tackle banking firm corporate misconduct and lack of transparency; improve on the automation of the rendition process of returns by banks and other financial institutions through the electronic financial analysis and surveillance system (e-FASS); establish a hotline and confidential internet address for all Nigerians wishing to share any confidential information with the Governor of the Central Bank; strict enforcement of the contingency planning framework for systemic banking distress; establish an asset management company as an important element of distress resolution; promote the enforcement of dormant laws especially as enshrined in the Bank and Other Financial Institutions Act (BOFIA) of 1990 with specific reference to those relating to the issuance of dud cheques and the law relating to the fiduciary duties of the board of banks and vicarious liability in the case of bank failure; review and update the relevant laws and drafting of new ones relating to effective operations of the banking system; closer collaboration with the economic and financial crimes commission (EFCC) in the establishment of the financial intelligence unit (FIU) and the enforcement of the anti-money laundering and other economic crime measures; the rehabilitation and effective management of the federal minting and printing company. Ebong (2006) noted that of the thirteen elements, public discourse on the subject focused largely on two. These are the increase in the minimum capital requirement of banks from two billion naira to twenty five billion naira, and subsequent mergers and acquisitions for banks unable to meet the capital requirement on their own. Okpara (2011) stated that in a bid to comply with this minimum capital requirement banks adopted the following strategies – right issues for existing shareholders and capitalization of profits, public offers through the capital market and/or private placement, mergers and acquisitions, and a combination of the above mentioned strategies.
49
The final phase of the reform in the banking sector leading up to the time frame of this study was to cushion the effect of the financial crisis of 2007 – 2009, which hit hard on the banking system in Nigeria. The financial crisis dealt heavily on Nigerian banks because of over reliance on shareholders equity as a veritable source of financing the consolidation exercise, while most of the banks if not all banks participated in IPO’s and suddenly a crash of the stock market completely repressed the value of investor’s funds. The result was a weak balance sheet for most banks and inability to meet their financial obligations with depositors. Most of the steps taken by monetary authorities during this period bordered on the implementation of the previous 13 point agenda of the Central Bank. The implementation of the cash–less policy of electronic money transfer and the establishment of Asset Management Corporation of Nigeria for the management of the assets of failed banks. In the lead of the bold steps taken by the Central Bank was the the implementation of a maximum ten year policy for the Executive Directors and Chief Executive Officers of Banks in Nigeria. As at July 31, 2010 all Chief Executive Officers who have served in that capacity for at least ten years cease to function in that capacity and as such hand over to their second in the chain of command. Ultimately, all the reforms implemented restored the confidence of the public in the banking system and improved the level of corporate governance in the Nigerian baking system. 2.3 Bank Performance Indicators in Nigeria The bank consolidation exercise was a major turn-around of the banking system in Nigeria. All the major indicators of bank performance increased in significant folds following the consolidation exercise of 2005. Table 1 below presents percentage change in bank performance indicators before and after the consolidation exercise. At the time of this study the number of banks in Nigeria has been reduced to 22 through outright acquisitions and mergers. There is 50
evidence that concentration is still very high in the banking industry, about five banks controlled over fifty percent of the total assets of banks as at December 2010. However, the gain of recapitalization and the subsequent consolidation exercise is that a Nigerian bank is now ranked as one of the top five largest banks in Africa and many Nigerian banks now have a global reach in other African countries and major cities in the western hemisphere (Okonjo-Iweala, 2012). In terms of the measurement of our performance variables using return on assets (ROA), return on equity (ROE) and net interest margin (NIM), Table 2 below presents descriptive statistics for sampled banks from 1980 to 2010. The yardstick for measuring bank performance has been evaluated on the basis of Capital adequacy, Asset quality, Managerial efficiency and Liquidity (CAMEL), which are represented by proxy variables in this study. Table 1: The Nigerian Banking Sector Performance Pre and Post Consolidation Parameter
Pre-Consolidation Post-Consolidation % Increase (As at Dec. 2003)
Post (as at 2010)
Banks’ Total Assets (Naira Billion)
2,767.78
14,932.00
439
Number of Bank Branches
3,247
5,407
67
Number of Bank Shareholders
5,901,565
10,033,625
70
Number of Bank Depositors (‘000)
13,649
34,553
153
Total Bank Deposits (Naira Billions)
1,409
8,693
517
Employment in the Banking Sector
60,227
85,591
42
Credit to the Industrial Sector (N billions) 619.52
3,760.84
507
Credit to the Agric Sector (N billions)
114.30
84
1,107.38
277
62.10
Credit to the Telecoms Sector (N billions) 293.70 Source: Central Bank of Nigeria, 2010
51
The aggregate asset profile of Nigerian banks had an incremental growth rate between 1980 and 1990, total assets range between N16.3billion in 1980 to N39.6billion in 1986, but grew sporadically between 1990 and 2001 reaching over N200billion. However, there was an upward growth between 1990 and 2001 due to the liberalization of the sector and the sudden push between 2005 and 2008 following the recapitalization of banks (see Appendix). The average growth rate of total assets between 2005 and 2008 was 46.6%, there was a decline of 3.6% following the financial crisis of 2008. Total loans and deposits grew by 62.3% and 65% respectively between 2005 and 2008. Our five sampled banks had an average of over 51% of total bank assets between 1980 and 2001, for the second phase of our analysis the twelve sampled banks had on the average 75% of total bank assets between 2001 and 2010. Overall capital adequacy ratio for the banking sector stood at 21.5% between 2005 and 2008 and dropped to 2.2% in 2010 following the crisis that hit the financial system. On the asset quality, the ratio of non-performing loans to total loans increased 6.3% in 2008 to 27.6% in 2009 down to 15.7% in 2010, this is due to the establishment of the Asset Management Company to buy-back and manage the default loan portfolio of banks in Nigeria. Average return on asset of the banking system was 3.7% in 2008, in 2009 there was a decline of banking assets following the financial crisis and return on assets dropped to -8.9% in 2009 and moved upward to 3.0% in 2010. The average return on equity stood at 20.7% in 2008, then dropped to -222.8% in 2009 due to the financial crisis and moved up to 39.4% in 2010. The average net interest margin of banks in Nigeria was hovering between 58% and 53% from 2008 to 2010. On the liquidity ratios, the average loan to deposit ratio stood at 66.6% in 2008 and 56.6% in 2010, the average total asset to total deposit ratio dropped from 52.9% in 2008 to 39.2% in 2010.
52
2.4 Determinants of Bank Performance The measures of bank performance usually considered in the literature on the determinants of bank profitability are the return on assets (ROA), return on equity (ROE) and in some cases, the net interest margin (NIM). Bank profitability determinants are usually explained in the form of internal and external variables. The internal variables are those that determine bank’s management decisions and specifically affect policy objectives, such as liquidity risk, credit risk, bank size, financial leverage and expense management. The external variables are those that emanate from industry related factors and macroeconomic influences, which includes competition and the level of concentration, the level of unemployment, inflation rate and real per capita income. In the case of Nigeria, exchange rate may pose a macroeconomic influence on bank profitability because of the variation in the exchange rate of the domestic currency to the US dollar and other major currencies. Studies on the determinants of bank profitability and/or performance have been broadly distinguished into two categories; those that are based on country specific data and those that used a panel of countries. The studies by Molyneux and Thornton (1992), Demirguc-Kunt and Huizinga (1999, 2001), Abreu and Mendes (2002), Goddard et al. (2004), Beck et al. (2005), Athanasoglou et al. (2006), Micco et al. (2007), Pasiouras and Kosmidou (2007), and Flamini et al. (2009) investigate a panel data set of countries. Studies by Berger et al. (1987), Berger (1995), Neely and Wheelock (1997), Naceur (2003), Mamatzakis and Remoundos (2003), Naceur and Goaeid (2001, 2005), and Athanasoglou et al. (2008) focus their analyses on single countries. Although, results of the empirical analysis of these studies differ based on the specification of the model and the nature of the explanatory variables employed, there still exist
53
reasons to show the significance of bank specific factors, industry related effects and macroeconomic or environmental influence on bank performance. Empirical evidence by Bourke (1989), Demirguc-Kunt and Huizinga (1999), Abreu and Mendes (2002), Goddard et al. (2004), Naceur and Goaied (2001), and Pasiouras and Kosmidou (2007) indicate that banks that hold a high level of equity relative to their assets perform better in terms of profitability. These studies suggest that as bank’s capital ratios increase, the cost of funding tend to fall due to lower prospective bankruptcy costs. Furthermore, overhead costs are also an important determinant of profitability: the higher the overhead costs in relation to the assets, the lower the profitability of a bank (Athanasoglou et al., 2008). Molyneux and Thornton (1992) in the study on the determinants of bank profitability use a sample of 18 European countries during the period 1986-1989. They find a significant positive association between the return on equity and the level of interest rates in each country, bank concentration and government ownership. Abreu and Mendes (2002) investigate the determinants of banks’ interest margins and profitability for some European countries noting that well capitalized-banks face lower expected bankruptcy costs and this advantage “translate” into better profitability. The macroeconomic variables they employed in the study; unemployment rate show a negative but significant relationship, while inflation rate is observed to be a relevant factor in explaining bank profitability. Goddard et al. (2004) study the performance of European banks across six countries. They find a relatively weak relationship between size and profitability - measured by return on equity. Only banks in the United Kingdom show a significantly positive relationship between off-balance-sheet business and profitability. Even though competition among banks is thought to
54
have increased over the period, there is significant persistence of cumulative abnormal profit for the period, 1992-1998. Naceur and Goaied (2001) study the performance of Tunisian deposit banks (1980-95), and observe that productivity change, market capitalization, and bank portfolio composition are significant and positively related to return on assets, but not the size of the bank. In the same vein, using co-integration techniques, Chirwa (2003) studied eight banks in Malawi (1970-84) and finds a significantly positive long run relationship between concentration and performance; similarly for demand deposits. Pasiouras and Kosmidou (2007) find a positive and significant relationship between size and profitability of a bank. Other authors, such as Berger et al. (1987), provide evidence that costs can be reduced only slightly by increasing the size of a bank and that very large banks often encounter scale inefficiencies. Micco et al. (2007) find no correlation between the relative bank size and the return on assets for banks, i.e., the coefficient is always positive but never statistically significant. A major determinant of bank profitability is the credit risk or liquidity risk the bank is willing to undertake. Abreu and Mendes (2002), who examined banks in Portugal, Spain, France and Germany, find that the loans-to-assets ratio, as a proxy for risk, has a positive impact on the profitability of a bank. Bourke (1989) and Molyneux and Thornton (1992), among others, find a negative and significant relationship between the level of risk and profitability. This result might reflect the fact that financial institutions that are exposed to highrisk loans also have a higher accumulation of unpaid loans. These loan losses lower the returns of the affected banks. Furthermore, Beck et al. (2005) in assessing the effect of privatization on the performance of Nigerian banks from 1990 – 2001, controlled for the age of the bank, since
55
longer established banks might enjoy performance advantages over relative newcomers. Their results for the Nigerian market indicate that older banks did not perform as well as newer banks, which were better able to pursue new profit opportunities. Athanasoglou et al. (2008) include external determinants of bank profitability such as central bank interest rate, inflation, the GDP development, taxation, or variables representing market characteristics (e.g. market concentration). Most studies have shown a positive relationship between inflation, central bank interest rates, GDP growth, and bank profitability (e.g., Bourke, 1989; Molyneux and Thornton, 1992; Demirguc-Kunt and Huizinga, 1999). Nevertheless, there is some evidence that the legal and institutional characteristics of a country matter. The study of Demirguc-Kunt and Huizinga (1999) reports that taxation reduces bank profitability. Another study by Albertazzi and Gambacorta (2006) concludes that the impact of taxation on banking profitability is small because banks can shift a large fraction of their tax burden onto depositors, borrowers, or purchasers of fee-generating services. Overall, although fiscal issues are likely to exert a significant influence on the behavior of a bank, the taxation of the financial sector has received little attention. To measure the effects of market structure or industry related effects on bank profitability, the structure-conduct performance (market-power) hypothesis states that increased market power yields monopoly profits. According to the results of Bourke (1989) and Molyneux and Thornton (1992), the bank concentration ratio shows a positive and statistically significant relationship with the profitability of
a
bank
and
is,
therefore,
consistent with the traditional structure-conduct-performance paradigm. In contrast, the results of Demirguc-Kunt and Huizinga (1999) and Staikouras and Wood (2004) indicate a negative but statistically insignificant relationship between bank concentration and bank
56
profits. Likewise, the estimations by Berger (1995) and Mamatzakis and Remoundos (2003) contradict the structure-conduct performance hypothesis. Research on the determinants of bank profitability has focused on both the returns on bank assets and equity, and net interest rate margins. Flamini et al. (2009) in studying the determinants of commercial bank profitability in sub-Saharan Africa explored the impact on bank performance of bank-specific factors, such as risk, market power, and regulatory costs in addition the research has focused on the impact of macroeconomic factors on bank performance. Using accounting decompositions, as well as panel regressions, Al-Haschimi (2007) studies the determinants of bank net interest rate margins in 10 SSA countries. He finds that credit risk and operating inefficiencies (which signal market power) explain most of the variation in net interest margins across the region. Macroeconomic risk has only limited effects on net interest margins in the study. Gelos (2006) studies the determinants of bank interest margins in Latin America using bank and country level data. He finds that spreads are large because of relatively high interest rates (which in the study is a proxy for high macroeconomic risk, including inflation), less efficient banks, and higher reserve requirements. In a study of United States banks for the period 1989–93, Angbazo (1997) finds that net interest margins reflect primarily credit and macroeconomic risk. In addition, there is evidence that net interest margins are positively related to core capital, non-interest bearing reserves, and management quality, but negatively related to liquidity risk. Saunders and Schumacher (2000) apply the model of Ho and Saunders (1981) to analyze the determinants of interest margins in six countries of the European Union and the US during the period 1988–95. They find that macroeconomic volatility and regulations have a significant
57
impact on bank interest rate margins. Their empirical evidence supports an important trade-off between ensuring bank solvency, as defined by high capital to asset ratios, and lowering the cost of financial services to consumers, as measured by low interest rate margins. Saunders and Allen (2004) survey the literature on pro-cyclicality in operational, credit, and market risk exposures. Such cyclical effects mainly result from systematic risk emanating from common macroeconomic influences or from interdependencies across firms as financial markets and institutions consolidate internationally. They may ultimately exacerbate business cycle fluctuations due to adverse effects on bank lending capacity. Athanasoglou et al. (2006) in their study of the profitability behavior of the South Eastern European banking industry over the period 1998–02 observed that the enhancement of bank profitability in those countries requires new standards in risk management and operating efficiency, which, according to the evidence presented in the paper, crucially affect profits. A key result is that the effect of market concentration is positive, while the picture regarding macroeconomic variables is mixed. Athanasoglou, et al. (2008) apply a dynamic panel data model to study the performance of Greek banks over the period 1985–2001, and find some profit persistence, a result that signals that the market structure is not perfectly competitive. The results also show that the profitability of Greek banks is shaped by bank-specific factors and macroeconomic control variables, which are not under the direct control of bank management. Industry structure does not seem to significantly affect profitability.
58
2.5 Theoretical Literature on Market Power and Competition in Banking There are several theories in measuring competition and bank performance in modern industrial economics referred to as market power models. These theories assume that a bank maximizes profit by increasing the prices (price of outputs in the loan market) and are rewarded with higher profits (Bikker and Bos, 2008). The theoretical models are Iwata Model, Bresnahan Model, Panazar – Rosse Model and Structure – Conduct – Performance (SCP) Model. Iwata (1974) theory of bank performance is for the estimation of conjectural variation values for individual banks supplying a homogeneous product in an oligopolistic market. Bikker and Bos (2008) observed that some of the profitability determinants are interrelated and/or cannot be observed in practice and hence requires a set of limiting assumptions for identification problem. The Bresnahan (1982) theory of bank performance runs contrary to Iwata (1974) in the underlining assumption that all banks are equal and identical and make an aggregate analysis. The model assumes that banks maximize their profits by equating marginal cost and perceived marginal revenue. According to Bikker and Bos (2008) empirical applications of the Bresnahan model are scarce. The model has been estimated by Shaffer (1989 and 1993) for, respectively, the US loan markets and the Canadian banking industry. Panzar and Rosse (1987) theory of bank performance estimates competitive behavior of banks on the basis of the comparative static properties of reduced-form revenue equations based on cross-section data. Panzar and Rosse (P–R) show that if their method is to yield plausible results, banks need to have operated in a long-term equilibrium (that is to say, the number of banks needs to be endogenous to the model) while the performance of banks needs to be influenced by the actions of other market participants.
59
The Structure Conduct Performance (SCP) model asserts that banks are able to extract monopolistic rents in concentrated markets by their ability to offer lower deposit rates and to charge higher loan rates, as a result of collusion or other forms of non-competitive behavior. The more concentrated the market, the less the degree of competition. The smaller the number of firms and the more concentrated the market structure, the greater is the probability that firms in the market will achieve a joint price-output configuration that approaches the monopoly solution. Thus, firms in more concentrated markets will earn higher profits (for collusive or monopolistic reasons) than firms operating in less concentrated ones, irrespective of their efficiency (Bikker and Bos, 2008). Other theories that have established a relationship between financial market structure and bank performance include the financial repression hypothesis as espoused by McKinnon (1973) and Shaw (1973), asserts that bank regulation increases the cost of loanable funds because market forces are not allowed to play out in the banking system. The Modigliani – Miller theorem which suggests that there exist no relationship between capital structure (debt or equity financing) and the market value of a bank (Modigliani and Miller, 1958). The financing theory also suggest that increasing risk, by increasing leverage and thus lowering the equity – to – asset ratio (increasing leverage), leads to a higher expected return as entities will only take on more risks when expected returns will increase; otherwise, increasing risks have no benefits. This theoretical explanation is known as the risk-return trade off. This study will adopt market power theoretical models to explain the performance of banks in Nigeria because it enables the estimation of stochastic and environmental variables.
60
2.6 Methodological Literature on Banking Reforms and Performance The methodological literature on the impact of financial sector reforms on bank performance flows from three different perspectives; first on the method of estimating financial reform indicators, second on the parameters of estimating bank performance in this case profitability and thirdly on estimating the effect of reforms on bank competition, and financial market structure. Firstly, financial reforms can be estimated with macroeconomic variables, which include real interest rate and the real effective exchange rate. A number of empirical studies of financial liberalization have used real interest rate as a proxy for financial liberalization (Bandiera et al., 1997; Fry, 1997; Hermes et al., 1998). In Egesa (2010), the real interest rate is similarly used to indicate an increase in the level of financial liberalization since real negative rates are often indicative of financial repression, while positive real rates reflect movement towards less financial repression. The other reason why real interest rate is used as a measure for financial liberalization is because many of the domestic financial reforms undertaken during the structural adjustment program fed into real interest rates. As such real interest rates are deemed to reflect the wider picture of the domestic financial reform process. The real effective exchange rate is intended to capture developments in the economy that may affect bank performance especially through the level of non-performing loans. More importantly, the liberalization of interest rates and exchange rates are arguably some of the major milestones that were achieved during the early stages of financial liberalization. Secondly, recent literature on the measure of bank performance stem from a number of alternative approaches for the specification of inputs and outputs that are relevant to bank
61
production (Egesa, 2010; Dogan and Fausten, 2002). The more common is referred to as the intermediation approach which views banks as financial intermediaries. Oral and Yolalan (1990) used this approach to measure the relative profitability efficiency of a set of bank branches using their interest and non-interest incomes as outputs, and interest paid on deposits and expenses incurred by personnel, administration and depreciation-cost approaches tend to suggest similar classification of bank inputs and outputs with the principal exception being the classification of demand deposits as an output in most user-cost studies and as both an input and output when the value added approach is taken (Wheelock and Wilson, 1999). The intermediation approach measures bank’s inputs by the volume of deposits and other liabilities, bank’s output by the volume of loans and other assets. This approach considers banks as financial intermediaries between liability holders and fund beneficiaries (i.e. debtors). Grigorian and Manole (2002) argue that this approach is appropriate for large banks that purchase their funds in big chunks from other banks and assets are largely generated by the operation of bank premises as inputs. They also argue that for smaller banks, this approach fails to account for transaction services delivered to depositors underestimating the overall value added by the banking system. There are several variants of this approach. Berger and Humphrey (1997) used the value added approach which views banks as production units that produce loans and deposits using labour and capital. In this approach, both liabilities and assets have some output characteristics. Nonetheless, only those categories that have substantial value addition are treated as outputs while others are treated as either inputs or intermediate products depending on the individual attributes of each category. Another approach found in the literature is referred to as the user-cost approach. This approach described by Hancock (1991) uses the simple rule that the net revenue
62
generated by a particular asset or liability item determines whether the financial product is an input or an output. This approach emphasizes the profitability of a bank in relation to various expenditures. The activity-based production approach is the third variant, which treats the number of accounts and transactions processed as outputs produced with the application of labour and capital. In particular, studies that have adopted this approach have defined bank outputs as the number of accounts, various transactions measured in numbers; loan applications and customer service survey ratings. Bank inputs have been defined as rent, capital and operating costs, number of online terminals, marketing conditions or activity ranking and labour measured in number or as monetary expenses. The two main approaches that exist to evaluate the effects of financial market reforms; the first concentrates on macroeconomic variables that are closely related to the ultimate objectives of reforms - such as savings and investment rates, real growth and interest rates, and attempts to discern changes in their behaviour induced by financial sector reforms (Gelb (1989), Johnston and Pazarbasioglu (1995), Demetriades and Luintel (1996), Bandiera et al. (1997), Brissimis et al. (2008). The main drawback of this approach lies in the difficulty in isolating the effects of financial market reforms from those of other institutional or macroeconomic developments. An alternative approach is based on the analysis of the financial sector itself, and in particular on an assessment of changes in the structure and performance of the sector following reforms. To this end, one can attempt to estimate the effects on such variables as the profitability of the financial institutions operating in the country, which are subject to the same regulatory regime shifts and other disturbances (Grabowski et al (1994), Berger and Mester (1997), Humphrey and Pulley (1997), Athanasoglou et al. (2006), Egesa (2010).
63
In Nigeria a number of studies have applied non-parametric methods to estimate bank performance, using the Data Envelopment Analysis (DEA) approach to measure the operational efficiency of banks as decision making units (Zhao and Murinde, 2011; Ikhide and Alawode, 2001; Sobodu and Akiode, 1998). Ikhide and Alawode (2001) applied discriminant theory and non-parametric peer composite method as the framework for analyzing the sequencing of financial sector reforms and its impact on bank performance in Nigeria following SAP. Discriminant analysis classifies banks into two groups distressed and non-distressed and observe whether there is discrimination between the periods in their ratios using a chi-square test of hypothesis. The Peer group composite method constructs a score or index by determining a peer group baseline average score for each year to calculate a bank’s score on a ratio, the bank’s deviation from the baseline average is divided by the standard deviation of the peer group’s average ratio. A score above the average is assigned a negative sign for all ratios except capital adequacy and liquidity. The resulting scores for each bank’s ratio are added algebraically to form a composite score. Banks with high positive scores are considered strong, and those with large negative scores are considered weak. The flaw in these non-parametric theories is the inability to account for the influence of stochastic factors which is inherent in the heterogeneity of bank specific variables. This study follows the intermediation approach in the analysis of bank performance and the effect of banking sector reforms draws from the estimate of profitability of banking firms operating in Nigeria, which are subject to similar regulatory framework and environmental condition.
64
2.7 Empirical Literature on Banking Reforms and Performance in Nigeria In the Nigerian case, some empirical studies emerged following the deregulation of interest rates and the reforms implemented in the financial sector after the Structural Adjustment Program (SAP). Some of the studies combine both qualitative and quantitative measures of estimating the performance variables (Ikhide and Alawode, 2001; Sobodu and Akiode, 1998). These studies have applied non-parametric methods in their analysis of the impact of financial sector reforms and the order of financial liberalization on the growth and development of the banking system. Nevertheless, both studies have used the CAMEL (capital, assets, management, earnings and liquidity) rating component of performance estimation, the results although adequate to an extent but did not capture the influence of environmental factors or stochastic elements which includes institutional or political factors that affects the financial system during the period. However, the result points to the fact that there are indications that the performance of Nigerian banks tend to decline quite significantly during the period of deregulation compared with the period prior to SAP. Sobodu and Akiode (1998) further warned that the fact that theoretical expectation of enhanced industry performance was not realized should not be taken to imply the failure of the policy of deregulation. Enendu (2002), studying the determinants of commercial bank interest rate spread in a liberalized financial system using empirical evidence from Nigeria between 1989 and 2000, show that macroeconomic and monetary policy/financial regulation factors were more important determinants of commercial banks’ interest spread than bank level factors. He further stated that inflation rate, GDP, financial deepening, cash reserve requirement, risk and non-interest expenses were the most important factors that affected commercial banks’ profitability during the period.
65
Kasekende et al. (2009), in their study on restructuring for competitiveness in four selected African countries find that competition stimulates productivity growth either through general technical progress or through improved performance, or both. Competition is also postulated to exacerbate the moral hazard problem of financial institutions, especially banks. The main lesson for policymakers is that, in order to achieve a highly competitive financial services sector, African countries must undertake some fundamental reforms, especially with respect to banks and capital markets. In the case of Nigeria the paper postulates that reforms in Nigeria have engendered more competitiveness in the financial services sector. Overall, banks have been strengthened by the reforms and are now exploring new opportunities in markets beyond Nigeria into other parts of Africa. Zhao and Murinde (2011) studying bank deregulation and performance in Nigeria find evidence which suggest that deregulation and prudential re-regulation influence bank risk taking and bank productive efficiency directly (direct impact) and via competition (indirect impact). Moreover, a systematic examination on the interaction among banking reforms, competition, bank performance and the determining factors with respect to bank specific, industry related and macroeconomic influences is missing from all the studies that discussed the Nigerian banking system and reforms. This study seeks to fill the gap in the banking literature and to shed further light on the inconclusive evidence in the context of deregulation and the ultimate determinants of bank performance in the experience of banking in Nigeria during the period.
66
2.8
Theoretical Framework The theoretical framework for this study follows market power models established under
the new empirical industrial economics literature for the analysis of competition and profitability in the banking sector. The structure conduct performance (SCP) paradigm stipulates that as market concentration is increasing bank profitability should be decreasing if there is no collusive behavior amongst firms in the industry. However, if bank profit is increasing as concentration is increasing the implication is that firms in the industry are colluding to reap oligopoly profits. Another variant of market power model is the efficient-structure (EFS) hypothesis, which stipulates that higher market concentration may result when efficient firms generate high profits as a result of an increase in size and market share. In this case, market concentration in an industry is not a random occurrence but a product of superior efficiency possessed by some firms. Both SCP and EFS have been tested in Bourke (1989) and Molyneux (1993) for the Belgium, French, Italian, Dutch and Spanish banking markets. Berger (1995), Goldberg and Rai (1996) have examined the implications of the EFS hypothesis on market structure for the United States and European banking market respectively. Flamini et al. (2009) finds no direct effect of market concentration on bank profitability for subSaharan Africa banking markets due to the limitations of the proxy for concentration imposed on the profitability of banks in the region. This study did not use the traditional HirschmanHerfindahl Index (HHI) or three-firm concentration ratio because of incomplete information arising from data inconsistency. However, the study tested the existence of market power using the ratio of each bank’s total outstanding loans to the net domestic credit of the country as a measure of market concentration. The empirical derivation for the structure-conductperformance (SCP) and efficient-structure (EFS) hypotheses is shown in Bicker and Bos (2008). 67
The basic model of bank performance which highlights the choice of inputs and output for the banking firm in the context of market power theories deduced from literature as relevant for the analytical framework of this study is presented as follows; the Panzar-Rosse model for measuring competition and the structure-conduct-performance hypothesis for estimating the impact of concentration on bank performance. First, a road map is drawn for the determination of the theoretical perspectives of this study by specifying a basic model of bank performance.
2.8.1 Basic Theoretical Model of Bank Performance The two mainstreams for the appropriate definition of output and input in banking have being the intermediation theory and the production theory. The former assumes that a bank attracts deposits and other funds and transforms them into loans and securities (investments), using inputs such as labor, capital and materials. Interest payments are seen as part of the costs and the corresponding dual cost function includes not deposits but the interest rate paid on deposits as an input factor. Loans and investments are the output components. Examples of this view are found in Altunbas et al. (1994). The latter approach assumes that a bank provides services related to loans and deposits. In this view, interest payments are not regarded as banking costs. The output components comprise loans and deposits. Examples of this approach can be found in Resti (1997) among others. The theoretical perspective of this study follows the intermediation approach. Following Bikker and Bos (2008), this study assumes a basic model for a profit maximizing bank. The equilibrium conditions from this model can be used to test more extreme models, namely perfect competition and oligopoly behavior. Assume all costs to be variable costs (in the long run), and all outputs to be perfect complements with zero cross-price elasticity. 68
Let us also assume for now that all banks treat the output of its competitors as fixed, and all firms decide simultaneously how much to produce. For a bank i, we define profit Πi, the output vector Yi, the input vector Xi, the output price vector p, and the input price vector wi. Each bank i maximizes profit using transformation function T and pricing opportunity set H, which captures the bank’s assessment of its competitive position and concomitant willingness of customers to pay the prices charged by the bank. Part of the pricing opportunity set is Z, the level of equity. However, we do not have to estimate input-demand and output-supply functions, there is no need to further specify the transformation function T or the opportunity set H. In the output vector Yi, bank i faces the price p based on the inverse demand function f (Y ). Bank i then maximizes: Πi = pYi −wiXi, subject to T(Xi,Yi) = 0 H(p,Yi,wi,Zi) = 0 p=f
# $%& 𝑌𝑖
=𝑓 𝑌
where f(Y) is inverse market demand and N the number of banks. The corresponding Lagrangian system can be written as: L Πi = pYi - wiXi – ξT(0) – θH(0) …………………………………………………(1) Solving for p and X simultaneously yields the optimal output prices and input quantities (denoted by asterisks): P* = p(Yi, wi, Zi) Xi* = Xi* (Yi, wi, Zi) Profits are maximized if: )*$ )+$
= p* + Yi f’(Y)
)+ )+$
– wi
),$ )+$
= 0 ............................................................................ (2)
Let the optimal number of inputs Xi* depend on the demand for outputs Yi. 69
Multiplying Equation 2 by Yi yields: P*Yi - wi
),$∗ )+$
Yi = - (Yi)2f’(Y)
)+ )+$
………………………………………………..(3)
where revenue is denoted by p*Yi. Banks are assumed to face perfectly competitive input markets, but operate in output markets where price differentiation is potentially possible. Thus banks may compete via their output pricing strategies, by adjusting prices and fees according to market conditions. The extent to which they can influence prices depends on output quantities, input prices and other factors, all of which are given at the time of price setting. In the empirical analysis, disregard output prices which are subject to severe measurement problems according to Berger and Mester (1997), as they are not always required for the empirical analysis. Rewrite and rearrange Equation 3, in order to arrive at an equation that is more closely in line with what is found in the empirical literature on bank performance. Bikker and Bos (2008) defined λi as follows: )+ )+$
=1+
) 123 +0 )+$
= 1 + 𝜆𝑖 …………………………………………………….. (4)
where λi is known as the conjectural variation of firm i’s output. Substitution of λi in Equation 3 gives: P*Yi = wi
), ∗3
Yi = - (Yi)2f’(Y)(1+ 𝜆𝑖) ………………………………………. (5)
)+$
Dividing both sides by p*Yi and rearranging gives: 5∗+$6 7$
89 ∗3
8:3
5∗+$
+$
=-
+$ ;< + + +
5∗
(1 + 𝜆𝑖) ………………………………………….. (6)
Equation 6 can be written as: 5∗+$6 7$
89 ∗3
8:3
5∗+$
+$
= (MSi) −
& ?
1 + 𝜆𝑖 ………………………………. (7)
After multiplying by p*Yi Equation 6 becomes: 70
Π ∗$
= p*Yi - wi
), ∗3 )+$
Yi = (MSi) −
Therefore optimal profits Π ∗$
& ?
1 + 𝜆𝑖 p*Yi …………………..…. (8)
go up with increased market share MSi, with decreased price
elasticity of demand η, with increased conjectural variation λi, with increased output prices p∗, and with increased demand for Yi. Many models that study competition and efficiency can be classified according to this basic framework. This model contains a partial analysis, and focuses on a single right-hand variable in Equation 8, or on a combination of two of these variables.
2.8.2 Panzar and Rosse Model Following the theoretical concepts in Bikker and Bos (2008), the method developed by Panzar and Rosse (1987) estimates competitive behavior of banks on the basis of the comparative static properties of reduced-form revenue equations based on cross-section data. Panzar and Rosse (P–R) show that if their method is to yield plausible results, banks need to have operated in a long-term equilibrium (that is to say, the number of banks needs to be endogenous to the model) while the performance of banks needs to be influenced by the actions of other market participants. In equilibrium, the zero profit constraint holds at the market level. Multiplying Equation 8 with Yi/Yp∗, in order to obtain the price-cost margin (PCM), and summing the results over all banks i yields: PCM = =
893 3 5∗+$67$ 8:3
5∗+
$
+$
………………………………………………… (9)
+$ 2 (-1/𝜂)(1 +
+ 𝜆𝑖)
= HHI (-1/𝜂)(1 + 𝜆𝑖)
71
The last equality holds by approximation. HHI stands for the Herfindahl–Hirschman Index of market shares of banks weighted with their own market shares. Variables marked with an asterisk represent equilibrium values. Now let us assume that HHI and 𝜆 are strict functions of exogenous variables. Market power is then measured by the extent to which a change in factor input prices (∂wki ) is reflected in the equilibrium revenues (∂Ri* ) earned by bank i. Panzar and Rosse define a measure of competition, the ‘H-statistic’ as the sum of the elasticity of the reduced-form revenues with respect to the K input prices: H=
)5∗+ H G%& )FG
FG 5∗+
……………………………………………….. (10)
The estimated value of the H-statistic ranges between −∞ and 1. H is smaller than zero if the underlying market is a monopoly, it ranges between zero and unity for other types of competition such as oligopoly and monopolistic competition, and an H of one indicates perfect competition. Panzar–Rosse (P-R) developed a test to discriminate between these market structures. Shaffer (1983) demonstrated formal linkages between the Panzar–Rosse H-statistic, the conjectural variation elasticity and the Lerner index. Bikker et al. (2006a) provides an overview of 28 studies that apply the P–R method to the banking industry. In Mwenda and Mutoti (2011), the H-statistic is derived as the sum of the estimated input factor price coefficients or elasticity, that is, β1 + β2 + β3. The rationale for using the partial adjustment revenue equation is that this specification yields more robust results than the static revenue function. 2.8.3 Structure – Conduct – Performance Model The conduct or rivalry in a market is determined by the structure of the market, especially the number and the size distribution of firms, and the conditions of entry. This rivalry process is reflected on various measures of market performance (i.e. price levels and profits). Bourke 72
(1989), notes that management decisions and the economic environment are major determinants of bank performance. Bikker and Bos (2008) observe that in a market with a higher concentration, banks are more likely to show collusive behavior and their oligopoly rents increase performance (profitability). In this case, conduct is unobservable and is measured indirectly through market concentration. Although the SCP hypothesis lacks a formal underpinning, we can use our basic profit model to derive the SCP relationship. To derive our basic framework, sum Equation 5 over N firms: p*Y -
∗
), 3 J $%& 𝑤𝑖 )+$
Yi = -
J $%&
+$ K +
𝑓< +
+L
1 + (Σ𝜆𝑖𝑌𝑖 /(Σ𝑌𝑖 K )) …….. (11)
Dividing by p*Y gives: Π* = p*Y - wi
) ∗3 )+$
𝑌𝑖 = −((𝐻𝐻𝐼)
& ?
(1 + 𝜇)) …………………………… (12) +$
&
+
?
Where the Herfindahl – Hirschman Index, HHI = Σ( )K ,
= f’(Y)Y2/p*Y and 𝜇 = Σ𝜆𝑖𝑌𝑖 /
Σ𝑌𝑖 K Alternatively, the foregone rents for un-collusive behavior increases with market size. All in all, if we take η to be constant and µ to be an implicit function of HHI, we have developed a basic relationship between performance and structure that is consistent with the SCP relationship. Thus the basic equation (without control variables) becomes: Π* = ((HHI)(1 + 𝜆))p*Y …………………………………………….. (13) This model can be interpreted as the combined impact of 𝜆 and the HHI on bank performance. If there is presence of collusive behavior, 𝜆 > 0 and the impact of market share is more than proportional, and the rate of change of the profit function with respect to HHI will be greater 73
than 1. In the case of perfect competition an increase in market share has no impact on performance and since 𝜆 = -1, this means that the rate of change of profit with respect to HHI is equal to zero. Hence, we have derived a relationship between market structure and performance, allowing us to test the Structure-Conduct-Performance (SCP) hypothesis. To arrive at the basic SCP relationship, I have to make two additional assumptions. The first is that η, the price elasticity of demand is constant. If not, the interpretation of a coefficient for HHI – in the absence of a proxy for η – could be biased downward (upward) by increases (decreases) in the interest elasticity of demand over time. The second assumption concerns the individual firm’s conjectural variation µ, the extent to which it expects other firms to react to a change in output. Here, there are two options. The first is to assume that µ is constant and equal across firms, in which case it drops out of the above equation and we are left with a relationship between performance and concentration. The second option is to formalize the relationship between µ and HHI, under the presumption of collusive behavior, we can show that an increase in concentration HHI or in market share expected to increase awareness (µ) and thereby lead to more collusive behavior. Although this MSi still leaves us without a direct measure of µ, it does allow us to capture its impact through HHI. After all, the collusive oligopolist realizes a more than proportional increase in performance as a result of an increase in concentration.
74
CHAPTER THREE 3.0 METHODOLOGY This chapter examines the analytical framework for this study by stating the method of analysis, then specifying the models and the anticipated effects of the explanatory variables on the dependent variables. 3.1 Method of Analysis This study adopts the Panel Data Analysis approach. In a multiple regression panel data allows the estimation of different entities observed for different time periods. Panel data allows the researcher to control for variables that are not easily observable or measured like cultural factors or difference in business practices across companies; or variables that change over time but not across entities (i.e. national policies, federal regulations, etc.). That is, it accounts for individual heterogeneity. With panel data the researcher can include variables at different levels of analysis (i.e. banks) suitable for multilevel or hierarchical modeling. In this case many banks are observed at different time intervals to generate a panel of banks. There are two main methods of analyzing panel data that will be adopted for this study; the fixed effects method and the random effects method. The fixed-effects (FE) model is used when the interest is to analyze the impact of variables that vary over time. FE explores the relationship between predictor and outcome variables within an entity (firm, person or country etc.). Each entity has its own individual characteristics that may or may not influence the predictor variables (for example, being a male or female could influence the opinion toward certain issue; or the political system of a particular country could have some effect on trade or GDP; or the business practices of a company may influence its stock price). One primary assumption in the application of FE is that something within the individual may impact or bias
75
the predictor or outcome variables and hence there is a need to control for this. This is the rationale behind the assumption of the correlation between entity’s error term and predictor variables. Time-invariant characteristics are eliminated with Fixed Effects model estimation in order to assess the net effect of the predictors on the outcome variable. Another important assumption of the FE model is that those time-invariant characteristics are unique to the individual and should not be correlated with other individual characteristics. Each entity is different therefore the entity’s error term and the constant (which captures individual characteristics) should not be correlated with the others. If the error terms are correlated, then FE is not suitable since inferences may not be correct, hence it becomes necessary to model that relationship (probably using random-effects), this is the main rationale for the Hausman test. In the second instance, for the random effects model the variation across entities is assumed to be random and is not correlated with the independent variables included in the model. A distinctive feature between the fixed and random effects method of estimation is whether the unobserved individual effect embodies elements that are correlated with the regressors in the model, not whether these effects are stochastic or not [Greene, 2008, p.183]. If there is any reason to believe that differences across entities have some influence on the dependent variable then the random effects model is used. An advantage of random effects is that one can include time invariant variables (i.e. gender). In the fixed effects model these variables are absorbed by the intercept. The discussion on the empirical results is based on the model that best estimate the parameter. The first model is estimated for the effect of interest rate deregulation on bank performance using Fixed effects (within estimator) method and the Random effects generalized
76
least squares method and a Hausman specification test is applied to ascertain which of the methods is most plausible for the purpose of interpretation. Secondly, an estimate of the Panzar-Rosse model for measuring market structure using the Fixed Effects (within estimator) model which is also called Entity Demeaning estimator and the Random effect model using the Generalized Least Square (GLS) estimator, and applying the Hausman specification test to determine which of the methods is more robust for interpretation. There are a number of random effects method of estimation techniques such as the Swamy-Arora method and Nerlove method but for the purpose of this study, the Swamy-Arora GLS estimator is used in this case. Third, a test for the evidence of the structure-conduct-performance paradigm in the Nigerian banking sector using pooled ordinary least squares method and the fixed effects also called entity demeaning (within estimator) model and applied the F-statistic to test for the differing group intercept. Several diagnostic tests will be conducted to ascertain whether a particular model is a good fit.
3.2 Model Specifications: Model 1: To estimate the effect of interest deregulation on bank performance, a multiple linear regression model which specifies bank specific, industry related and macroeconomic variables as stated in Athanasoglou et al. (2006), Chirwa and Mlachila (2004), Brissimis et al. (2008) is applied; ∏it = c + ΣβjХitj + Σβk Хitk + Σβl Хitl + εit ……………………………………. (14) εit = νi
+ µit
77
where ∏it is the profitability of bank i at time t, with i = 1, ….., N; t = 1, …., T; c is a constant term, the Х’s are explanatory variables (grouped into bank-specific, industry-related and macroeconomic determinants, j, k and l respectively) and εit is the stochastic element, with νi capturing the unobserved heterogeneity of bank-specific effect and µit the idiosyncratic error. This econometric model follows a one way error component regression model, where νi ~ IIN (0, σ2ν) and independent of µit ~ IIN (0, σ2ν). Dummy variables are included to capture the effect of two banking reforms and political conditions discussed in this study: DREG = Deregulation dummy (1980 – 1987 = 0, 1988 – 2010 = 1.) DCAP = Bank capitalization dummy (1980 – 2004 = 0, 2005 – 2010 = 1) DPOL = Political conditions dummy (1980 – 1983 = 1(civil), 1984 – 1999 = 0 (military), 2000 – 2010 =1(civil)).
.Dependent Variables: The most common measures of profitability (∏i) employed are net income to equity or return on equity (ROE), net income to total assets or return on assets (ROA) and net interest margin (NIM). Most studies use only one of the measures, but I will perform the analysis with all the three profitability measures. The profitability of a bank has been measured by Return on Assets and Return on Equity in Athanasoglou et al. (2006), Egesa (2010), Flamini et al. (2009), Xiaoqing (Maggie) Fu and Hefferman (2009) to mention but a few. Net Interest Margin (NIM) as applied in Brissimis et al. (2008) represents the amount by which the interest earned on a bank’s portfolio exceeds the interest paid on deposits or borrowed funds. Net Interest Income is a traditional measure of intermediation spread, which is the difference between bank’s interest
78
income and interest expense. Studies that examine the determinants of NIM include Saunders and Schumacher (2000) and Maudos and de Guevara (2004). A potential weakness of NIM may be that, as banks move toward more fee-generating activities, NIM will decline in importance as a measure of performance. Explanatory Variables and Anticipated Effects on the Dependent Variable (a) Bank specific variables: Opportunity Cost of holding reserves with Central Bank (OPP) - Saunders and Schumacher (2000) argue that the existence of non – interest bearing reserve requirements increases the economic cost of funds over and above the published interest expenses. In this study, the ratio of non-interest-earning assets to total assets multiplied by the Treasury bill rate is used as a proxy for the opportunity cost of holding reserves (OPP), which is expected to be positive and significant to profitability. Ho and Saunders (1981) and Saunders and Schumacher (2000) define this as the ratio of non – interest bearing reserve assets to the total interest earning assets multiplied by the average Treasury bill rate. The ratio of operating expense to total assets (OEA) - This is the proxy for the average cost of non-financial inputs to banks (Fries and Taci, 2005). Operating expenses consist of staff expenses, which comprise salaries and other employee benefits (including transfers to pension reserves and administrative expenses). Athanasoglou et al. (2006) find a negative but significant effect of operating expenses on profitability of South Eastern European banks. Administrative expenses include various types of bank expenses associated with bank operations, such as the adoption of new information technology, depreciation, legal fees, marketing expenses, or nonrecurring costs related to bank restructuring. Provision for loan losses was not included in operating expenses. 79
The ratio of total loans to total assets (TLA) - This ratio measures credit risk, which reflect changes in the health of a bank’s loan portfolio (see Cooper et al. 2003), which may affect the performance of the institution. Duca and McLaughlin (1990), among others conclude that variations in bank profitability are largely attributable to variations in credit risk, since increased exposure to credit risk is normally associated with decreased firm profitability. The ratio of total deposit to total loans (DTL) as a measure of bank’s credit risk has shown a positive relationship to bank profitability (Flamini et al. 2009). Given that the portfolio of outstanding loans is non-tradable, credit risk is modeled as a predetermined variable in their specification (Flamini et al. 2009). Based on standard asset pricing arguments, a positive association between profits and bank risk is expected. Al-Haschimi (2007) finds a positive effect of credit risk on Sub-Saharan African net interest margins. The ratio of non-interest income to operating profit (NOP) - The coefficient of NOP could be positive or negative depending on the bank’s expertise or strategic objective (AlHaschimi, 2007). We could expect it to be positive if a bank has the technical ability to offer non- interest income product lines, i.e. fee based services, which permit the bank to achieve a higher level of efficiency from its resources (especially its human capital). We would expect it to be negative if the bank human capital resources and expertise is oriented more towards traditional commercial and industrial lending activities. Ratio of Demand Deposits to Total Deposits (DTD) – Is included to capture the impact of deposit mix on profitability. Having a higher proportion of demand deposits increases the level of liquidity and banks can utilize this source of financial capital (core deposits) without incurring higher interest cost (see Chen, 2009). The ratio of demand deposit to total deposit (DTD) is a measure of liquidity in the banking system.
80
The ratio of non-performing loans to total loans (NPL) is a measure of the strength of environmental variables on bank performance. A high ratio of non-performing loans reduces the revenue and profit accruing to a bank. This ratio also measures credit risk (Kumbakhar et al. 2001, Zhao and Murinde, 2011).
(b) Industry – related factors: The most important step in assessing banking market power is the choice of a competition measure. Claessens and Laeven (2004) argue that performance measures such as banks’ net interest margin or profitability do not appropriately indicate the competitiveness of a banking industry. These measures can be influenced by a number of factors such as firm specific performance and stability, the form and the degree of financial intermediation, the quality of institutions, and bank-specific factors. Beck (2008) also highlights that traditional indicators of competition based on market structure and concentration measures, such as the HirschmanHerfindahl index (HHI), as well as concentration ratios, are rather crude measures that do not take differentiation strategies into consideration. Hence, Soedarmono (2010) observe that such indicators only capture the actual market share without allowing inferences on the competitive behavior of banks. The HHI has been widely used in studies to capture the effect of competition and market concentration on banks performance (Xiaoquing (Maggie) Fu and Hefferman, 2009). Hence the HHI is used in this study to measure bank concentration.
(c) Macroeconomic determinants: Financial deepening is the ratio of Credit to Private Sector to GDP – A major aspect of the Structural Adjustment Programme (SAP) is the removal of restrictions on credit to favoured
81
sectors of the economy. This variable therefore measures the effect of liberalization of bank’s credit to the domestic economy on bank profits. However, if economic activities remain slow or declines, interest rate may decline thus lowering spread. Growth of GDP requires additional financing, which translates to demand for more loans and higher interest rate (Chen, 2009). Increase in the level of economic activities could mean competition, which in the banking industry could reduce intermediation spread. Exchange Rate (EXR) –. This variable measures the impact of environmental conditions on the banking system. The result may vary depending on whether a fixed or flexible exchange rate regime is adopted. However, as observed in Domac and Martinez-Peria (2003), adopting a fixed exchange rate diminishes the likelihood of a banking crisis in developing countries, hence profit is maximized. On the other hand, Arteta and Eichengreen (2002) earlier observed that countries with fixed and flexible exchange rates are equally prone to banking crisis, which implies low levels of profitability. Inflation Rate (INF) has been widely used as proxy for the effect of macroeconomic environment on bank performance (Athanasoglou et al. 2006, Chen 2009 and Flamini et al. 2009). The relationship between inflation rate and profitability is somewhat ambiguous and often depends on whether or not inflation is anticipated. Bourke (1989), Molyneux and Thornton (1992), found a positive relationship between inflation and bank performance. Whether inflation affects profitability depends on whether wages and other non-interest costs are growing faster than the rate of inflation. Demurgic Kunt and Huizinga (1999) also found positive relationship between inflation and Net interest margin. Spread (SPD) is the difference between the average market prime lending interest rates and the average interest rate on deposit. This variable will capture the effect of interest rate
82
deregulation on banks profitability since interest rate deregulation is a major aspect of SAP. This variable has been applied in Chirwa and Mlachila (2004) and it demonstrates a significant relationship with bank performance.
Model 2: To determine the effect of bank recapitalization on bank performane, we shall apply the empirical Panzar and Rosse H statistic model as stated in Bikker and Haaf (2002) using a reduced form revenue equation: lnIRit = α + βlnIEit + γlnSCit + δlnOEit + ζlnBSFit + ηlnOIit + ε ……………………….. (15) where IR is the ratio of total interest revenue (income) to total assets (II/TA), IE is the ratio of annual interest expenses to total assets (IE/TA), or the average funding rate, SC is the ratio of personnel expenses (staff cost) to total assets (SC/TA), OE is the ratio of physical capital expenditure and other expenses to total assets (OE/TA), and BSF are bank specific exogenous factors (without explicit reference to their origin from the cost or revenue function), OI is the ratio of other income to total assets (OI/TA), ε is a stochastic error term. IE, SC and OE are the unit prices of the inputs of the banks: funds, labour and capital, or proxies of these prices. In Equation (15), the H statistic is given by β + γ + δ. In order to verify whether the competitive structure has changed over time equation (15) can be applied to a pooled cross-section (across banks) and time series analysis over the time span 2001 – 2010. The dependent variable is the ‘ratio of total interest revenue to total assets’, as in Molyneux and Thornton (1992). The decision to consider only the interest part of the total revenue of banks is consistent with the underlying principles of the P-R model, that financial intermediation is the core business of most banks.
83
Bank-specific factors (BSF) are additional explanatory variables which reflect differences in risks, costs, size and structures of banks and should, at least theoretically, stem from the marginal revenue and cost functions underlying the P-R model in equation (15). The ratio of capital or equity to total assets (TE/TA) is used as a proxy for risk component. Total assets are used as a scaling factor. The coefficient for OI is probably negative as the generation of other income may be at the expense of interest income.
Model 3: To measure the relationship between market structure and bank performance that is consistent with the Structure Conduct Performance (SCP) paradigm, we adopt the model developed by Bikker and Bos (2008); Π* = ((HHI)(1 + λ))p*Y
………………………………………………….. (16)
Π* = α0 + α1HHI + α2 IE/TA + α3 OE/TA + α4NI/TA + α5TE/TA + α6TL/TA + ε ……. (17) where Π* is the ratio of annual interest income (II/TA) to total assets, HHI is the HirschmanHerfindahl index and is expected have a positive relationship. IE/TA is the ratio of annual interest expense to total assets with expected negative relationship. OE/TA is the ratio of operating expenses including personnel expenses or staff cost to total assets and is expected to be positive. NI/TA is the ratio of other non-interest income to total assets also expected to be positive. TL/TA is the ratio of total loans to total assets which takes into account the increasing role of banking activities in financial intermediation, it follows a positive sign. TE/TA is the ratio of total equity to total assets, used to account for the leverage reflecting differences in the risk preferences across banks and the expected relationship with the dependent variable is positive.
84
CHAPTER FOUR 4.0 Data Presentation and Analysis In this chapter the data for this study is presented, but there are constraints in the process of data collection; some of the banks examined do not have comprehensive annual reports for some years. Where they do have annual reports the financial year may differ from that of other banks. For the purpose of this research, the assumption is that the financial year of all the banks begin in January and end in December of a particular year. The panel data is unbalanced because of the unavailability of some data points. However, these data points are few and do not constitute any bias in the estimation. The result of data analysis is presented using the models specified for this study and a brief explanation of the results of the analysis. The analysis is broken down into three parts as stated in the model specification. There are three models to this study estimating the different hypothesis to be tested, so the analysis and results are presented as such. 4.1 Sources of Data The dataset for this study spans an annual period of 31 years, from 1980 to 2010. A major constraint is data availability, because some of the banks have not come into being before SAP, the study is divided into two timeframes. In the first case, there are five banks which began operation on or before 1980 namely First Bank PLC, Union Bank PLC, United Bank for Africa PLC, Afribank PLC (now Mainstreet Bank Ltd) and Wema Bank PLC that constitute our dataset for the estimation of model 1. In the second estimation, a sample of twelve banks which includes the top seven banks in Nigeria that began operation after SAP namely; Zenith Bank PLC, Access Bank PLC, Guaranty Trust Bank, Diamond Bank, Skye Bank, Fidelity Bank, EcoBank and Sterling Bank for the estimation of models 2 and 3 covering the period from 2001 to 2010. The entire data used to estimate all the bank specific variables identified for this study was obtained
85
from the annual reports of the various banks. However, the data for macroeconomic variables is obtained from Central Bank’s statistical bulletin for the various years. A major assumption is that the financial year of all the sampled banks run from January through December.
4.2 Results of Empirical Analysis The result of the empirical analysis of the specified models for this study is presented in this section. Several tests for the variables are conducted to determine if any variable would require a transformation to obtain a good fit for the model; a multicollinearity test, a test for heteroskedasticity and autocorrelation is carried out to find evidence of multicollinearity and whether the standard errors are potentially autocorrelated. A violation of these conditions negates the basic assumption of the ordinary least squares on which our multiple regression model is based. A unit root test of the stationarity of this panel data cannot be conducted because the data set is unbalanced. 4.2.1 Model 1: The effect of interest rate deregulation on Bank Performance in Nigeria First, a test for the presence of multicollinearity using the correlation coefficients of the variables to ascertain which of the variables will be relevant for the analysis of our model. Second, the relevant variables will be fitted in the model of a panel analytic study for the fixed and random effects estimation and several diagnostic tests will be conducted with a view to obtaining the most plausible measures of profitability as our estimation technique permits. Tables 2 and 3 present the result of multicolinearity test for all the variables used in the analysis. Variables with correlation coefficients of about 0.2 absolute basis points away from 1 or -1 may be considered multicollinear. In Table 3 a more robust multicollinearity test is conducted by dropping variables with possible collinear characteristics to detect the final variables to be
86
included in the study. Note that the dummy variable are recognized as control variables and hence were dropped from the correlation matrix in Table 3 for a more stylized correlation matrix. In the further analysis Stata uses the dummy variable for recapitalization as a control variable in the estimation of the panel because the variable exhibits characteristic that is homogenous across entities. However, in the process of estimating Panel fixed effects model Stata is able to detect multicollinear variables and drop same from the regression appropriately, while other diagnostic tests have been applied to the estimation for stylized and robust estimation results. Table 2: Correlation Matrix
Note: Data is normalized by taking the log of all dependent variables, market concentration variable and macroeconomic variables. Source: Bank Annual Report and Central Bank of Nigeria Statistical Bulletin for Various years.
The econometric analysis for this study is couched in three models based on the dependent variables. In the first model, the dependent variable is the return on assets, second is the return on 87
equity and third is the net interest margin. In other to normalize the dependent variables, the log values are used in the estimation. Similarly, log values of market concentration variable (Hirschman-Herfindahl index) and all the macroeconomic variables have been used in the estimation.
Table 4 provides the descriptive statistics of the variables used in this analysis. The minimum value of 0 indicates that no data point is available for the given observation hence our panel data is unbalanced. Aside from NOP which has a very wide data range with a standard deviation of 21.4 every other variable in the estimation falls within statistically acceptable range of values; in terms of the mean, standard deviation, minimum and maximum data points. Figures 1, 2 and 3 in the appendix A, show histogram of the distribution of return on assets, return on equity and net interest margin respectively. In order to achieve symmetry, data for the variables has been transformed to logarithmic scale. As can be seen from the histogram despite all the constraints of data availability a considerable level of symmetric distribution of the dependent variables has been achieved using the log transformation.
88
Table 4: Summary statistics: log of return on asset log of return on equity log of net interest margin Opportunity Cost of holding reserves with Central Bank Ratio of Demand Deposit to Total deposit Ratio of Non-Performing Loans to Total Loans Ratio of Non-Interest Income to Operating Profit Ratio of Operating Expenses to Total Assets Ratio of Total Loans to Total Assets Ratio of Total Deposit to Total Loans log of intermediation spread log of financial deepening log of Hirschman-Herfindahl index log of exchange rate of Nigerian naira to US dollar log of inflation rate Observations
mean -4.39 -1.69 -2.97 1.64
sd 0.78 0.91 0.50 1.22
min -8 -6 -5 0
max -3 3 -2 8
0.43
0.21
0
1
0.21
0.16
0
1
-1.25
21.41
-200
132
0.05
0.03
0
0
0.36 2.15
0.14 0.86
0 0
1 7
1.94 2.77 7.91 2.81
0.87 0.35 0.07 1.97
0 2 8 -1
3 4 8 5
2.69 155
0.78
2
4
Note: Data is normalized by taking the log of all dependent variables, market concentration variable and macroeconomic variables. Source: Bank Annual Reports and Central Bank of Nigeria Statistical Bulletin for Various years.
The estimation technique follows a panel regression, which provides the advantage of studying a cross section of the banking firms while observing the heterogeneity in the individual firms. Under panel data analysis the fixed and random effects methods of estimation have been applied consecutively. The Hausman specification test is used to ascertain which of the models is most appropriate. The fixed effects within estimator otherwise called entity demeaning model and the generalized least squares method for the random effects model is applied. The fixed effects model is often controlled for time invariant characteristics that will arise between firms in the model in order to reduce omitted variable bias. The random effects model therefore assumes that the differences across the banking firms in this estimation does not follow any predictive pattern 89
and are uncorrelated with the explanatory variables, hence time invariant variables can be included in the model unlike the fixed effects model. The base model for this study is as stipulated in the model specification. The bank performance function is broken down into three basic dependent variables namely return on asset, return on equity and net interest margin. The explanatory variables are the same for the three models of estimation. In the fixed effects “within” entity model shown in Table 5, there is evidence of multicollinearity which informs why the coefficients for market concentration variable lhhi and the macroeconomic variable lexr were dropped from the estimation output. However, to correct for this anomaly, a parsimonious model which excludes the macroeconomic variable linf, is applied in subsequent analysis to eliminate the bias. The results are presented in Tables 7 and 8 for the fixed and random effects estimation of a parsimonious model respectively. Table 6 reports the results of random effects generalized least squares estimation. The Hausman specification test reported below shows that the random effects model in Table 6 is a better estimate of the explanatory variable for return on asset and return on equity as measures of profitability compared to the fixed effects within estimation result in Table 5. Nevertheless, for the net interest margin, the fixed effects model in Table 5 is found to be a better estimator. The presence of multicollinear variables leads to a further step in the analysis to drop inflation rate as a variable, which most likely introduced the bias. The result of a parsimonious model that excludes inflation rate with a view to eliminating the collinear effect is presented in Tables 7 and 8 for the fixed and random effects model respectively. The relevant Hausman specification test is conducted to reveal that the random effects model is the most appropriate method of estimation for all the three profitability measures
90
used in this study. Result of the Hausman specification test is presented below. The overall discussion will focus on the result presented in Table 8 for the random effects estimation of a parsimonious model which excludes inflation rate as an explanatory variable. A further diagnostic test which eliminates the consideration of an ordinary least squares (OLS) as a method of estimation in this study is introduced; the Breusch-Pagan Lagrange Multiplier test decides whether a random effect regression is needed as opposed to a simple ordinary least squares. In this case, it is found that the random effects model is the most appropriate in all cases. In all the regression estimation presented in this study there is an assumption of the presence of heteroskedasticity standard errors. Nonetheless, a test of heteroskedasticity is presented below and the conclusion is that there is the presence of heteroskedascity consistent standard errors. Testing for heteroskedasticity The result of a modified Wald test for groupwise heteroskedasticity in fixed effect regression model is as follows; H0: sigma(i)^2 = sigma^2 for all i chi2 (28) = 2068.72 Prob>chi2 = 0.0000 The null hypothesis is homoscedasticity or constant variance. In this case, we reject the null hypothesis since Prob>chi2 is less than 0.05 and conclude that there is presence of heteroskedasticity.
91
Table 5: Regression results for fixed effects model (1) log of return on asset
(2) log of return on equity
-0.220***
-0.197**
(3) log of net interest margin -0.0682
(0.0730)
(0.0970)
(0.0451)
Ratio of Demand Deposit to Total deposit
-0.111 (0.317)
-0.115 (0.422)
0.0246 (0.189)
Ratio of Non-Performing Loans to Total Loans
-1.530***
-1.099
-0.357
(0.503)
(0.669)
(0.285)
0.00470*
0.00459
0.000958
(0.00242)
(0.00321)
(0.00153)
Ratio of Operating Expenses to Total Assets
11.34*** (3.273)
12.37*** (4.349)
9.611*** (1.895)
Ratio of Total Loans to Total Assets
-1.272 (0.867)
-2.015* (1.152)
-0.539 (0.438)
Ratio of Total Deposit to Total Loans
-0.290** (0.113) -0.3265 (0.0634) 0 (.)
-0.141 (0.150) -0.2158 (0.0533) 0 (.)
-0.124* (0.0640) -0.0005 (0.0254) 0 (.)
0
0
0
(.)
(.)
(.)
-0.0902 (0.275) -0.2056 (0.2256) 0.1766 (0.2123) -2.877*** (0.974) 141 0.303 0.052 5.585 0.000
-0.0975 (0.365) -0.3386 (0.2336) 0.1916 (0.2685) -0.401 (1.295) 141 0.145 -0.162 2.189 0.034
0.0446 (0.174) -0.0521 (0.1200) -0.1693 (0.1037) -2.957*** (0.567) 150 0.265 0.023 5.054 0.000
Opportunity Cost of holding reserves with Central Bank
Ratio of Non-Interest Income to Operating Profit
log of intermediation Spread log of Hirschman-Herfindahl index log of exchange rate of Nigerian naira to US dollar log of inflation rate Deregulation dummy Political conditions dummy Constant Observations R2 Adjusted R2 F Prob > F
Rmse 0.572 0.761 Note 1: Robust standard errors are displayed in parenthesis. Note 2: Omitted coefficients are multicollinear. Significance levels: * p
