COMMERCIAL BANKS’ INVESTMENT IN LOANS AND TREASURY BILLS AND THEIR OVERALL PROFITABILITY

TABLE OF CONTENTS

DECLARATION ……………………………………………………………………………………………………. ii

APPROVAL ………………………………………………………………………………………………………….. iii

DEDICATION ………………………………………………………………………………………………………. iv

ACKNOWLEDGEMENT………………………………………………………………………………………..v

TABLE OF CONTENTS ………………………………………………………………………………………. vi

LIST OF TABLES ………………………………………………………………………………………………… ix

ABSTRACT ……………………………………………………………………………………………………………..x

CHAPTER ONE ………………………………………………………………………………………………………1

INTRODUCTION ……………………………………………………………………………………………………1

1.1 Background to the study ……………………………………………………………………………………….1

1.2 Statement of the problem ………………………………………………………………………………………5

1.3 Purpose of the study ……………………………………………………………………………………………..6

1.4 Objectives of the study………………………………………………………………………………………….6

1.5 Hypotheses …………………………………………………………………………………………………………..6

1.6 Scope of the study ………………………………………………………………………………………………..7

1.6.1 Subject scope …………………………………………………………………………………………………….7

1.6.2 Geographical scope ……………………………………………………………………………………………7

1.6.3 Time scope ………………………………………………………………………………………………………..7

1.7 Significance of the study……………………………………………………………………………………….8

1.8 Conceptual framework ………………………………………………………………………………………….9

1.10 Structure of the study ………………………………………………………………………………………. 10

CHAPTER TWO ………………………………………………………………………………………………….. 12

vii

 

LITERATURE REVIEW …………………………………………………………………………………….. 12

2.0 Introduction ……………………………………………………………………………………………………… 12

2.1 Volume of investment in loans and profitability of commercial banks ………………….. 12

2.2 Relationship between lending rates and the profitability of commercial banks………. 17

2.3 Relationship between investment in Treasury bills and commercial banks’

profitability ……………………………………………………………………………………………………………. 21

2.4 Yield on TBs and commercial banks profitability ……………………………………………….. 25

2.5 Commercial banks Profitability………………………………………………………………………….. 26

METHODOLOGY ……………………………………………………………………………………………….. 30

4.0 Introduction ……………………………………………………………………………………………………… 30

4.1 Research design ………………………………………………………………………………………………… 30

4.2 Population and Sample ……………………………………………………………………………………… 30

4.3 Data source and collection …………………………………………………………………………………. 31

4.4 Measurement of variables ………………………………………………………………………………….. 31

4.5 Empirical Estimation Model and analysis …………………………………………………………… 32

4.6 Problems encountered during data collection………………………………………………………. 33

CHAPTER FOUR ………………………………………………………………………………………………… 34

DATA PRESENTATION AND DISCUSSION OF FINDINGS ……………………………. 34

4.0 Introduction ……………………………………………………………………………………………………… 34

Table 4.2: Estimation results using ROA as the dependent variable …………………………… 37

4.2.1 Relationship between the volume of commercial banks’ investment in loans and

their overall profitability in terms of ROA and ROE …………………………………………………. 37

viii

 

4.2.2 Relationship between commercial banks’ lending rates and their overall profitability

in terms of ROA and ROE ………………………………………………………………………………………. 39

4.2.3 Relationship between the volume of commercial banks’ investment in TBs and their

overall profitability in terms of ROA and ROE ………………………………………………………… 42

4.2.4 Relationship between commercial banks’ yields from TBs and their overall

profitability in terms of ROA and ROE ……………………………………………………………………. 43

4.2.5 Model Prediction ……………………………………………………………………………………………. 43

SUMMARY, CONCLUSIONS AND RECOMMENDATIONS ……………………………. 45

5.0 Introduction ……………………………………………………………………………………………………… 45

5.1 Summary……………………………………………………………………………. 45

 

52. Conclusion……………………………………………………………………………46

 

5.3 Recommendations …………………………………………………………………………………………….. 47

5.4 Areas for further research ………………………………………………………………………………….. 47

REFERENCES …………………………………………………………………………………………………….. 49

APPENDICES ………………………………………………………………………………………………………. 56

Appendix A: Introductory letters……………………………………………………………………………… 56

Appendix B: Dataset ………………………………………………………………………………………………. 58

 

 

 

 

 

 

ix

 

LIST OF TABLES

Table 4.1: Descriptive Statistics ………………………………………………………………………………. 35

Table 4.2: Estimation results using ROA as the dependent variable …………………………… 37

Table 4.3: Estimation results using ROE as the dependent variable ……………………………. 37

x

 

ABSTRACT

Investigating  the  determinants of  profitability  of  commercial banks has been one of  the

more  popular  topics  among  researchers  in  banking  studies.  Hence,  to  contribute  to  the

existing knowledge, this study sought to analyze the extent to which investment in loans

and  treasury  bills  influence  the  overall  profitability  of  commercial  banks  in  Nigeria,

using  a  data  set  comprising  95  observations  for  15  commercial  banks  over  the  period

1998-2005.  The  study  used  a  longitudinal  research  design,  based  on  quantitative  data

generated through document analysis of commercial banks’ monthly reports and returns

to  Bank  of  Nigeria.  Overall  Profitability  was  measured  using  two  profitability  ratios

namely:  Return  on  Assets  (ROA)  and  Return  on  Equity  (ROE)  while  the  independent

variables included: volume of loans, volume of TBs, lending rates and yield on TBs.

 

The study found Volume of Loans and TBs having a positive correlation while Lending

Rates and average yields on TBs revealed negative correlation with ROA as an element

of the dependent variable. With regard to ROE, Loan Volume, Lending rates and Volume

of TBs showed a positive relationship while average yields on TBs indicated a negative

correlation  with  this  element  of  the  dependent  variable.  However,  in  the  two  analyses,

commercial banks’ investment volume in loans was found to be the only variable that had

a statistically significant influence in accounting for profitability of commercial banks in

Nigeria.  On  the  basis  of  the  findings,  it  was  recommended  that  commercial  Banks  in

Nigeria  should  aim  at  committing  themselves  to  the  implementation  of  strategies  that

would  enhance  credit  creation  and  disbursement  while  ensuring  adequate  recovery

xi

 

mechanisms.  It was  also proposed  that additional  efforts  should be put  in educating  the

clientele about the banks’ loan products and prudent borrowing practices.

 

 

1

 

CHAPTER ONE

INTRODUCTION

1.1 Background to the study

Due to the crucial roles that banks hold in the financial sector, this research evaluates the

profitability  of  the  commercial  banks  in  Nigeria.  The  performance  evaluation  of

commercial  banks  is  especially  important  today  because  of  the  fierce  competition  and

globalisation  of  world  economies.  Evaluation  of  banks’  performance  is  important  for:

depositors,  shareholders,  investors,  bank  managers  and  regulators.  In  a  competitive

financial  market,  bank  performance  provides  signals  to  depositors  and  investors  with

regard  to  whether  to  invest  or  withdraw  funds  from  the  bank  (Abdus  &  Kabir  2000).

Similarly, it flashes direction to bank managers whether to improve its deposit service or

loan  service  or  both,  to  improve  its  performance.  For  that  reason,  identifying  the  key

success factors of commercial banks enables the design of policies that may improve the

profitability of the banking industry (Buyinza, 2010).

 

The importance of bank profitability  can be  appraised  at  the micro  and macro  levels of

the  economy.  At  the  micro  level,  profit  is  the  essential  prerequisite  of  a  competitive

banking  institution  and  the  cheapest  source  of  funds.  Indeed,  without  profits,  any  firm

cannot attract outside capital (Gitman, 2007). Thus, profits play a key role in persuading

depositors  to  supply  their  funds on  advantageous  terms.  By  reducing  the probability  of

financial  trouble,  impressive  profits  figures  also  help  reassure  a  bank’s  other

stakeholders,  viz:  investors,  borrowers,  managers,  employees,  external  product  and

service suppliers, and regulators (Anyanwaokoro, 1996). It is not merely a result, but also

a  necessity  for  successful  banking  in  a  period  of  growing  competition  in  financial

markets.  Hence,  the  basic  aim  of  a  bank’s  management  is  to  achieve  a  profit,  as  the

essential requirement for conducting any business (Bobakova, 2003).

In  Nigeria,  after  a  long  period  of  economic,  financial  management  and  political

instability, in 1987 the government adopted a rehabilitation and recovery programme to

rebuild  the  economy  and  restore  macroeconomic  stability  under  the  auspices  of  the

International  Monetary  Fund,  the  World  Bank  and  the  donor  community  at  large.

Financial  sector  reforms  in  Nigeria  were  implemented  as  part  of  the  stabilisation  and

beginning  in  1990,  a  number  of  reforms  were  implemented  in  the  financial  sector  in

order to achieve the main goals of increased efficiency and financial deepening. During

this  period  however,  developments  in  the  financial  system  were  disappointing  and  in

view of this, Nanyonjo (2001) argues that bank restructuring did not yield the expected

results.  According  to  her,  despite  some  improvement,  the  quality  of  commercial  bank

assets remained weak during the post reform period. By the end of June 1997, about 30

percent  of  all  commercial  bank  loans  in  Nigeria  were  non-performing.  This  not  only

reflected weak management and procedures, but also poor credit discipline. In addition,

profitability  of  several  banks  deteriorated  during  the  same  period  which  Nanyonjo

(2001)  attributes  to  the  presence  of  non-performing  loans  in  bank  portfolio.  This

indicator showed some worrisome signs, and hinted a progressive deterioration of bank

soundness.  As  a  result,  several  banks  indeed  experienced  solvency  and  liquidity

problems  and  were  closed  down  during  the  1998/1999  financial  year.  Therefore,

although  the  Government  of  Nigeria  through  the  Central  Bank  has  often  sought  for

permanent measures that would enhance the profitability and stability of banks operating

in the Nigeria’s banking industry, if the historical antecedents of financial sector reforms

are anything to go by; they have not completely succeeded in achieving this feat. Against

this  backdrop,  the  broad  aim  of  this  study  was  to  identify,  on  the  basis  of  empirical

evidence,  significant  determinants  of  bank  profitability  in  Nigeria.  However,  its  scope

was delimited  to volume of investment  loans  and treasury  bills, lending  rates  and  yield

on treasury bills as determinants of bank profitability.  As  postulated  by  intermediation  theories,  Loans  are  the  traditional  business  of  commercial banks. However,  in the case of  Nigeria’s banking  industry, the experiences  of the last two decades appear to have negatively impacted on this role. In the 1980s and  1990s, the  industry was  riddled with high  levels of  Non Performing Assets (NPA). The

ratio  of  NPA  to  total  loans  fluctuated  between  26%  and  39%  between  1995  and  1999

(Bank of Nigeria (BOU) Annual Supervision Report, 1999). As a result, many banks re-designed  their  investment  portfolio.  They  turned  to  other  safer  alternative  investments

than lending, such as the Treasury Bills (TBs). As a result, commercial banks investment

in TBs grew by 417% between 1995 and 1999 (BOU Annual Supervision Report, 1999),

compared  to  growth  in  loans  of  40%  for  the same  period.  Financial sector  reforms  and

aggressive  loan  recovery  efforts  resulted  into  substantial  reduction  of  the  NPAs  from

7.2%  in  2003  to  2.2%  in  2004  (BOU  Annual  Supervision  Report,  2004).  Nonetheless,

commercial  banks’  balance  sheets  reflect  a  strong  preference  for  liquid  and  low-risk

assets, which has implications for their soundness and overall profitability  (Tumusiime-

Mutebile, 2005).

Thus,  the  conventional  wisdom  in  the  Nigerian  banking  industry  is  that  investment  in

TBs  is  an  alternative source of  risk  free  income.  TBs  are  a  short-term  monetary  policy

instrument used by BOU  to control liquidity in  the  economy.  However, it  is  also a  risk

free asset for investors, attracting commercial banks to use it as an alternate investment to

loans. As at December 2003, the volume of commercial banks investment in TBs stood at

Shs 886 billion, exceeding the volume of loans for the same period, which stood at Shs

847 billion (BOU (Annual Supervision Reports, December  2003).

 

The  Yield  on  a  TB  is  a  function  of  the  interest  rate,  amount  invested  and  its  maturity

period. The interest rate on TBs and hence the Yield is volatile. For example, BOU uses

bi-monthly  auctions  to  sell  TBs.  A  Reference  rate  is  computed  for  each  Auction  as  a

moving  average  rate  for  the  last  three  consecutive  auctions,  based  on  the  91-  Day  TB.

The  average  TB  reference  rate  was  7.72%  during  the  Financial  Year  (FY)  1998/99,

sharply  rose  to  19.28%  in  FY  1999/00,  dropped  to 5.33%  in  FY  2001/02  and  hiked  to

18.58% in  FY 2002/03  (BOU Annual Report, 2002/2003).  On the other hand,  the  yield

from traditional lending activities is a function of the lending rate and the amount loaned.

The weighted average lending rate of commercial banks for the five year period between

FY 1998/99 and 2002/03 varied within a range of 22.96% as the highest in FY 1998/99

and 17.57% as the lowest in FY 2001/02 (BOU Annual Report, 2002/2003). The lending

rate is thus stable compared to the interest rates on TBs.   The  overall  profitability  of  an  investment  is  established  using  return  on  investment

ratios, which gives an indication of a business firm’s efficiency of operation (Van Horne,

1980).  Profitability  ratios  include  the  Return  on  Assets  (ROA)  and  return  on  Equity

(ROE).   ROA  compares net profits after taxes  to total  assets;  while ROE compares net

profits  after  taxes  to  the  Net  Worth  of  the  firm.    ROA  and  ROE  for  the  commercial

banking  industry has been  fluctuating over  the  years. For  example,  the  industry’s  ROA

was 4.21% in the year 2000, but had declined to 2.7% by 2002. ROE stood at 45.10% in

2000,  rose  to  50.85% in  2001,  fell  to  24.4%  in 2002  and  in 2004,  had  risen  to  37.4%.

(BOU Annual Supervision report, 2004).

1.2 Statement of the problem

Commercial  banks  in  Nigeria  are  increasingly  investing  in TBs  as  an  alternate  asset to

loans.  Volume  of  investment  in  TBs  grew  by  417%  over  the  period  1995  –  1999,

compared  to  growth  of  40%  in  loans over  the same  period,  and  in  2002  and 2003,  the

volume  of  TBs  exceeded  that of  loans.    Conversely,  the  average TB  reference  rate  was

7.72%  during  the  Financial  Year  (FY)  1998/99  and  sharply  rose  to  19.28%  in  FY

1999/00; while the weighted average lending rate of commercial banks for the five year

period between FY 1998/99 and 2002/03 varied within a range of 22.96% as the highest

in FY 1998/99 and 17.57% as the lowest in FY 2001/02.   Although  commercial  banks  have  relatively  increased  their  investment  in  TBs  as  an  alternate  investment  to their  traditional business of  extending  loans,  there  is  absence of  systematic  understanding  of  how  this  is  associated  with  the  overall  profitability  of  the  banks as measured in terms of ROA and ROE. This study therefore set out to analyze the  extent to which commercial bank’s volume of investment in loans and associated lending

rates  and  volume  of  investment  in  TBs  and  associated  yields  influences  the  overall  profitability of commercial banks in Nigeria

1.3 Purpose of the study

The study sought to establish the relationship between volume of investment in loans and

associated  lending  rates  and  volume  of  investment  in TBs  and  associated  yields on  the

overall profitability of commercial banks as measured in terms of ROA and ROE.

1.4 Objectives of the study

1. To establish  the  relationship  between  the  volume  of  commercial  banks’

investment in loans and their overall profitability in terms of ROA and ROE

1. To establish  the  relationship between commercial  banks’  lending  rates  and  their

overall profitability in terms of ROA and ROE

iii.  To  establish  the  relationship  between  the  volume  of  commercial  banks’

investment in TBs and their overall profitability in terms of ROA and ROE

1. To establish  the  relationship  between  commercial  banks’  yields  from  TBs  and

their overall profitability in terms of ROA and ROE

1.5 Hypotheses

1. The volume  of  investment  in  loans  affects  the  overall  profitability  of  commercial

banks in terms of ROA and ROE

2. Lending rates  impinge  on  the  overall  profitability  Commercial    banks  in  terms  of

ROA and ROE

3. Volume of    investment  in  TBs  influences  the  overall  profitability  of  commercial

banks in terms of ROA and ROE

4. The yield    from  TB  investments  has  an  effect  on  the  overall  profitability  of

commercial banks in terms of ROA and ROE

1.6 Scope of the study

1.6.1 Subject scope

The researcher studied the overall profitability of  commercial banks in Nigeria in terms

of ROE and ROA. The study  covered commercial banks  volume of  investment in  loans

and  associated  lending  rates  and  volume of  investment  in  TBs  and  associated  yields  as

variables that affect the overall profitability of commercial banks. All commercial banks

licensed in Nigeria as at 31st December 2004 were studied.

1.6.2 Geographical scope

The  Geographical  area  of  the  study  covered  Kampala  city  only,  since  all  commercial

banks  have  their  head  offices  in  Kampala.  The  study  covered  a  period  of  eight  years,

from 1998 to 2005.

1.6.3 Time scope

The time scope of the study was spread over eight years starting from 1998 to 2005. The

data  was  collected  from  all  commercial  banks  that  were  licensed  in  Nigeria  as  at  31st

December 2004.

1.7 Significance of the study

The findings were helpful in identifying some of  the determinants of banks profitability

in Nigeria and therefore provide vital information to bank managers, for the development

of  effective  strategies  for  enhanced  performance.  Profitability  of  banks  impacts  on

financial  sector  soundness  and  stability.  The  study  therefore  has  important  policy

implications  that  may  help  banking sector  regulatory  authorities  in  Nigeria  to  come up

with  future  policies  and  regulations  for  improving  and  sustaining  the  banking  industry

soundness and stability.

The outcomes of the study may also serve as useful pointers to macroeconomic issues for

further investigation by Nigeria’s economic authorities.

Thirdly, though similar studies have been conducted elsewhere (such as Athanasoglou et

al.,  2005),  the  United  States  of  America  (Berger  et  al.,  1987;  Berger,  1995b  and

Angbazo,  1997),  Tunisia  (Naceur  and  Goaied,  2001  and  Naceur,  2003)  and  Colombia

(Barajas  et  al.,  1999),  there  is  no  econometric  study  to  our  knowledge  that  has

exclusively  examined  determinants  of  bank  profitability  within  the  Nigerian  context;

therefore the present study fills an important gap in the existing literature and improve the

understanding of bank profitability in Nigeria.

1.8 Conceptual framework

Relationships  between  Nigeria’s  Commercial  banks’  investment  portfolio  in  loans

and TBs and the overall profitability of the banks in terms of ROE and ROA

There is a relationship between the volume  and associated  return of commercial banks’

assets and the overall profitability of the banks as measured in terms of ROE and ROA.

Commercial  banks  may  invest  in  either  loans  or  TBs  as  alternate  investment  options.

Loans  and  TBs  as  alternate  commercial  bank  assets  have  different  risk  and  return

profiles. Therefore, Commercial banks ‘ volume of loans and associated lending rates and

volume  of  TBs  and  the  associated  yields  should  have  a  relationship  with  the  overall

profitability  of  the  commercial  banks  in  terms  ROA  and  ROE.  This  hypothesis  draws

insights  from  portfolio  theories  (modern  and  classical),  which  analyze  the  risk-reward

characteristics  of  investment  portfolios.  The  conceptual  framework  below  builds  upon

this  literature  to  develop  a  model  to  evaluate  the  effect  of  commercial  banks  asset

allocations  in  volume  of  loans  and  associated  lending  rates,  and  volume  of  TBs  and

associated yields, on commercial banks’ overall profitability in terms of ROA and ROE.

For  simplicity,  the  model  focuses  on  only  establishing  relationships  among  the  above

named variables.

Conceptual Framework

Commercial banks’ investment in loans and TBs and their overall profitability in

Nigeria

Source: Variables developed from literature review are based on the works of De Young

&  Karin  (1999);  Wang  J.C.  (2003);  De  Young  &  Rice  (2003);  Allen  &  Santomero

(1996), Smith et al (2003), Van Horne (1980) and others.

1.10  Structure of the study

To achieve  its broad aim,  the study is organized into  five chapters and organized in  the

following  manner.  Chapter  one  provides  the  introduction,  including:  background  to  the

study, Statement of the problem, purpose and objectives of the study, research hypotheses

significance of  the  study,  scope  and  the  conceptual  framework.  Chapter  two  provides  a

Commercial Banks

₦5,000.00 – DOWNLOAD FULL PROJECT DOWNLOAD FULL PROJECT Added to cart

---

---

---

---

Related Project Topics :