CHAPTER ONE
INTRODUCTION
1.1. BACKGROUND OF THE STUDY
Commercial banks play a major role in
the economy through their economic role of. financial intermediation that
performs both a brokerage and a risk transformation function (Hara, 2001).
Commercial banks are financial intermediaries that mobilize savings from
surplus economic units to deficit economic units. They are also special
financial intermediaries that mobilize funds between depositors and borrowers.
participating in an economy. How well they perform this intermediary function
has direct. linkage with banks profitability and economic health of a nation.
Profitability of banks. has relationships with growth and development of an
economy (Wainaina, 2013). The banking industry has been facing numerous lending
challenges. The explanation for this from a global context elicits varied
reasons.
Mulei (2003) points out that, this
challenge arises because of paucity of skills required to determine the
soundness of security valuation and the validity of legal charges associated
with loan collateral while (Berger,1995) alleges that, the evolution of the
banking industry has presented both challenges and opportunities for commercial
banking institutions. Association of profitable organization is a dream of every
individual, enterprise and government. Determinants of banks profitability in
one continent are different from another continent (Yuqi, 2008).
The performance of commercial banks can
be affected by internal and external factors which can be classified into bank
specific (internal) and external factors. The internal factors are individual
bank characteristics which affect the bank's performance, these factors are
basically influenced by the internal decisions of management and board. The
external factors are sector wide or country wide factors which are beyond the
control of the company and affect the profitability of banks (Ongore, 2013).
This study will focus on the effect of interest rates on the profitability of
commercial banks in Nigeria which are
beyond the control of the banks. In order to survive in the long run, it is
important for a bank to find out what are the determinants of profitability so
that it can take initiatives to increase its profitability by managing the
dominant determinants. Bank performance is also vitally important for all stake
holders, such as the owners, the investors, the debtors, the creditors,
depositors, bank managers, regulators and the government.
The performance of banks gives
directions to the stake holders in their decision making (Panayiotis,
Athanasoglou, Delis and Staikouras, 2006).
1.1.1
INTEREST RATES BACKGROUND
Although it is difficult to prove the
direction of the relationship between interest rates and profitability,
interest rates instability generally has an effect with financial performance
of commercial Banks. High interest rates will lead to increased commercial
banks interest income but also lead to low demand for the loans and hence
crowding out the increased interest income. Without interest rates stability,
domestic and foreign investors will stay away and resources will be diverted
elsewhere. In fact, econometric evidence of investment behavior indicates that
in addition to conventional factors (past growth of economic activity, real
interest rates, and private sector credit), private investment is significantly
and negatively influenced by uncertainty and macroeconomic instability (Sayedi,
2013). In addition to low (and sometimes even negative) growth rates, other
aspects of macroeconomic instability can place a heavy burden on the commercial
banks leading to reduced profitability (Gilchris, 2013).
Chen, Roll and Ross (1986) maintains
that these macroeconomic factors are significant in explaining firm performance
(profitability) and subsequent returns to investors. Simon (1997) found that
exchange rate and current account have direct and positive relationship with
inflation and both exchange rate and current account are the key factors that
badly affect the small economies. Herrero (2003) points out that deteriorating
local economic condition for instance low GDP, inflation, interest and exchange
rate cause bank failure In conclusion, interest rate volatility is expected to
affect financial performance of commercial banks whose role in an economy is
the economic resource allocation where they channel funds from depositors to
investors. Banks can only perform this vital role, if they generate necessary
income to cover their operational cost they incur in the due course. Although
it is difficult to prove the direction of the relationship between interest
rates and profitability, studies confirm that interest rates instability has
generally been associated with poor commercial banks financial performance in
elastic loan markets since high interest rates reduces the demand for loans
(Gilchris, 2013). Interest rate is the price a borrower pays for the use of
money they borrow from a lender/financial institutions or fee paid on borrowed
assets. Interest can be thought of as "rent of money". Interest rates
are fundamental to a capitalistic society and are normally
1.2 STATEMENT
OF THE PROBLEM
Interest rate
volatility has negative impact on the financial performance of commercial banks
posing challenge to commercial banks managers in their core function of credit
management and profitability (Baum, Mustafa, and Neslihan, 2009). The
volatility on interest rates is blamed on poor mmacroeconomic policies which
include excessive government spending, high inflation, and overvalued exchange
rates. Distortional macroeconomic policies are at times intentional since
politicians believe that high interest, inflation and overvalued exchange rates
are good for economic performance. In fact, when formulating macro economic
variables, the effect of the policies on commercial banks performance is
usually not a consideration (Williamson, 1990).
Interest rates in
Nigeria have been fluctuating over the last few years with the effect of
fluctuations remaining unknown (Otuori, 2013). The latest interest rates
volatility was the motivation behind this study as there was little information
about effect of same on commercial banks’ financial performance in Nigeria. In
addition, there is insufficient empirical evidence that commercial banks
financial performance is hindered by interest rates volatility and poor
macroeconomic variables at large. In addition, commercial banks’ profitability
for most of the Sub-Sahara African countries has been about 2 percent over the
last 10 years which is higher than that of commercial banks in developed countries
(Al-Tamimi and Hassan, 2010). A major research question is why commercial banks
profitability has remained high irrespective of the unfavourable interest rates
environment.
1.3.0 OBJECTIVE OF THE STUDY
To
determine the effect of interest rates on financial performance of commercial
banks in Nigeria
1.3.1 RESEARCH
QUESTIONS
1. What are the
major roles of interest rates on commercial banks in Nigeria?
2. What are the
Obstacles, if any that militate against interest rate on financial performance
of commercial banks?
3. What are the
strategies for effective interest rate on financial performance of commercial
banks in Nigeria?
1.3.2 RESEARCH HYPOTHESIS
H0 : Did
interest rate play a positive role in developing of commercial bank?
H1: Did interest
rate play a negative roles in developing of commercial bank?
H0 : Is there
any obstacles militating against interest rate on financial performance of
commercial banks in Nigeria?
H1: Is there any strategic plan for effective
interest rate on financial performance of commercial banks in Nigeria?
1.4. SIGNIFICANCE OF THE STUDY
Empirical evidence clearly shows that
studies focusing on Nigeria ’s financial sector are still scanty and limited.
Even those which have been carried out point to a need for further
investigation of the factors which have continued to cause poor financial
performance in the country, notwithstanding the reforms. Most of the evidence
in regard to commercial banks’ performance largely focus on the developed
economies environments and the conclusions may not be useful for Nigeria ’s
financial sector planning. Therefore the study will be important to various
stakeholders with interest in Nigeria ’s economy including the government,
citizens, the banks, foreign investors and academicians.
To the government and macroeconomic
policy makers, the study is significant to them since they will understand the
relationship between the effects of interest rates on bank performances. They
will have more knowledge and hence come up with better policies to ensure banks
financial performance is restored so as to boost economic growth. The Nigeria n
citizens will benefit from the implementation of the study findings and due to
improved access to financial services and favorable interest rates environment.
This will lead to improved lifestyles, high employment and increased
households’ incomes.
To the banks and foreign investors, they
will be able to plan and determine the most appropriate time to make
investments in financial sector based on interest rates prevailing.
To academicians, the study has added to
the existing body of knowledge on bank performance and form a basis for further
research.
1.5. SCOPE OF THE STUDY
This research work will base its work
majorly in Nigeria and some specific area will be used to analyze the project.
Commercial banks will be main influence
on interest rate and those details we be collected from First Bank Plc.
The
main case study of this study is First Bank plc Nigeria, which is one of the
best commercial banks in Nigeria.
1.6. LIMITATIONS OF THE STUDY
There are lots of constraints that
hinder the fast and devof this research work, a lots of problem were faced that
limitate against the work carried out,
such as:
Financial
Constraint: A lots of materials are needed for this work, but most of them are been sold at high price
that I'm unable to afford.
Time: There is
little time for this work, a lots are supposed to be done but due to the short
time we have somethings are reduce or not mention.
1.7.
OPERATIONAL DEFINITION OF TERMS
Interest
rate: This is amount yield on the amount saving or money
invest in a business or savings in a bank.
The additional money realize on any savings or investment is called
interest. Interest rate is the amount of rate to be calculated on any savings
made or investment, so as to know the
intereat on it.
Financial
Performance : This is the stability of a bank or
organization. The way an organization
maintain there financial activities for every accounting year. Through this we
know the performance of any bank or organization.
Commercial
Bank: This is also refers to as deposit bank in
Nigeria, commercial Bank is a bank that
accept deposit and payes it back as at when order by the customer through
cheque or withdrawal slip. There are
lots of other products in commercial Bank like funds transfer, safe custody and so on.
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