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CHAPTER ONE

INTRODUCTION

1.1    Background to the study

Monetary policy is one of the major economic stabilization weapons which involve measures designed to regulate or control the volume, cost, availability and direction of money and credit in an economy to achieve some specific macro-economic policy objective. It is a deliberate attempt by the monetary authority (Central Bank) to control the money supply and credit condition for the purpose of achieving certain broad economic objective (Onouorah et al., 2011). Okpara (2010) defined monetary policy as a measure designed to influence the availability, volume and direction of money and credits to achieve the desired economic objectives.

Monetary Policy is an instrument given to the Central Bank of Nigeria (CBN) by the federal government that is, it is a function which is a documentary policy to control the aggregate demanded in the circulation or cost. The policy is to see to the stability in wages and prices of goods and services. It is also necessary to control the volume of money in circulation and to give the domestic money a value via other controls (Akanbi and Ajagbe, 2012).  It is also the control of money and bank credit in such a way as to affect aggregate demand in a direction that would continue to the achievement of healthy balance of payment, price stability and job opportunity (Anyanwu 1993). 

The central bank is responsible for the conduct of monetary policy to pursue those objectives. Central banks in the world such as the Central Bank of Nigeria (CBN) often employ certain monetary policy instruments like Bank Rate, Open Market Operation, Changing Reserve Requirements and other selective credit control instruments. Central bank also determines certain targets on monetary variables. Although, some objectives are consistent with each others, others are not, for example, the objectives of price stability often conflicts with the objectives of interest rate stability and high short run employment. The Central Bank of Nigeria (CBN) over the years, have instituted various monetary policies to regulate and develop the financial system in order to achieve major macroeconomic objectives which often conflict and result to distortion in the economy. Although, some monetary policy like cash reserve and capital requirements have been used to buffer the liquidity creation process of commercial banks through deposit base and credit facilities to the public.

Keeping an economy on track with respect to growth, employment, and price stability is a complicated business. Decisions of business leaders, labour leaders, and government officials, as well as the whims of nature and chance, all impact on the stability and efficiency of Nigeria‟s economic activity. Monetary policy is only one of the planks in the structure that houses our economic system, but it‟s an important one. The job of any economy is to transform available resources into products that are in demand, and a well-managed money supply plays a key role in making sure that this job is done smoothly.

The banking industries in any economy in the world are the most important sector because of their ability to mobilize funds from the savings to the deficit sector of the economy. They mobilize the largest amount of fund because of their ability to accept deposits of any kind from the public, government and its agencies as well as create credit through granting of loans, overdraft and project financing which are all element needs for economic performance to enhance economic growth and development (Onoh, 2002). 

The role of the banking industry in development process cannot be over-emphasized as they play so many functions.  The most important banking industry in Nigeria is the commercial banks. Commercial Banks are the front-line troops when it comes to implementing monetary policy. Because of this connection, they as a group are influenced heavily by the actions of the nation‟s monetary policy makers. In order to make profit, commercial banks invest customer deposits in various short term and long term investment outlet, however core of such deposits are used for loans. Hence, the more loans and advances they extend to borrowers, the more the profit they make (Solomon, 2012). 

Okpara (2009) added that banks in most economies are the principal depositories of the public's financial savings, the nerve centre of the payment system, the vessel endowed with the ability of money creation and allocation of financial resources and conduit through which monetary and credit policies are implemented. According to Okpara, the success of monetary policy, to a large extent, depends on the health of the banking institutions through which the policies are implemented. As a result of this central role of banks in the economy, their activities have to be kept under surveillance to ensure that they operate within the law in line with safe and sound banking practices so that the economy will not be jeopardized. Hence, governments generally legislate to influence and/or directly control banks‟ activities to suit the developmental objectives of the economy.

In Nigeria, the authority to carryout monetary policy is vested in the Central Bank of Nigeria (CBN) through decrees 24 and 25 1991. These laws, which replaced previous legislation on the matter, enjoin the CBN, under the guidance of the federal government to promote monetary stability and a sound financial system. CBN initiates monetary and banking policies and sends the proposal to the government for amendment, approval or rejection (Ayogu and Emunuga 2009).

Prior to 1986 direct monetary instruments such as selective credit controls, administered interest and exchange rates, credit ceilings, cash reserve requirements and special deposits to regulate the banking system were employed. The fixing of interest rates at relatively low levels was done mainly to promote investment and growth. Occasionally, special deposits were imposed to reduce the amount of excess reserves and credit creating capacity of the banks (Uchendu 2009 and Okafor 2009). In the words of Ologunde, Elumilade, and Asaolu (2006), interest rate along with monetary aggregates formed targets of monetary policy in Nigeria. Using the direct monetary policy measures, the monetary authorities directly influence items of the balance sheet of commercial banks. In such a system, interest rates are set and credits are allocated by monetary authorities in accordance with the government‟s economic plan. Under this system, the financial system, and especially financial market conditions, plays no role in the determination of financial prices or returns and allocation of credits. On the other hand, there is a causal nexus between indirect monetary policy and financial (banking performance) as both of them influence each other. The decontrol of interest rates and the use of indirect monetary policy are crucial steps towards the development of financial markets. The use of market – based instrument was not feasible at that point (direct monetary policy era 1960-1985) because of the underdeveloped nature of the financial market and the deliberate restraint of interest rate (Ajayi and Atanda, 2012).

Amassoma, Wosa and Olaiya (2012), opined that the adoption of Structural Adjustment Program (SAP) in Nigeria, offered a sea of policy change in monetary policy development in Nigeria. The deregulation exercise in the financial system, led to the adoption of indirect monetary policy with the open market operation as the primary tool which was complemented by reserve requirements, discount window operations, foreign exchange market intervention and injection/withdrawal of public sector deposits in and out of the DMBs. Thus, to strengthen the policy, the discount houses were established which served as the intermediary between the CBN and the banks in the sale and purchases of OMO instruments (Solomon, 2013).  In 1996, all mandatory credit allocations on banks by the CBN guidelines were abolished while in 1997 the minimum paid up capital of merchant and commercial banks was further raised to a uniform level of N500 million. In addition, the operational environment for banks was further liberalized in 2001 with the introduction of universal banking system. 

In the past decade, significant changes in the design and conduct of monetary policy have occurred around the world. Many developing countries, including Nigeria have adopted various policy measures to achieve targeted objectives. The monetary policy is essential to achieve desired objectives which traditionally include promoting economic growth, achieving full employment level, reduction in the level of inflation, maintenance of healthy balance of payment, sustenance of growth in the economy, increase in industrialization and economic stability. The smoothing of the business cycle, preventing financial crises and stabilizing long term interest rates and the real exchange rate have been identified recently as other supplementary objectives of monetary policy because of the weaving global financial crises which engulfed major developed and emerging economy in the world.

The major objectives of monetary policy since 2002/2003 have been to subdue inflation to a single-digit level and maintain a stable exchange rate of the naira. Attention has also been focused on the need for a more competitive financial sector geared towards improving the payments system. The CBN has also continued to ensure banking

soundness and financial sector stability, not only to ensure the effective transmission of monetary policy actions to the real sector but also to enhance the efficiency of the payments system. The measures taken to strengthen the banking sector and consolidate the gains of monetary policy included the introduction of a 13-point reform agenda in the banking sector in July 2004 (the key point of which was the 25 billion naira minimum capital base for DMBs (Ibeabuchi, 2007). 

The key feature of the monetary policy from 2007 till date which is the period after the banking crises exposed by the global financial crisis included: Zero tolerance on ways and means advances; Gradual rundown of CBN holding of TBs; Aggressive liquidity mop-up operationsfrequent OMO sales supported by discount window operations; Unremunerated reserve requirements; increased coordination between the Bank and the fiscal authorities; and uniform accounting report system for all banks (Solomon, 2013). 

In recent times Nigeria monetary policy has been based on a mediumterm perspective framework. The shift was to free monetary policy implementation from the problem of time inconsistency and minimize over-reaction due to temporary shocks. Policies have ranged from targeting monetary aggregates to monitoring and manipulating policy rates to steer the interbank rates and by extension other market rates in the desired direction (Uchendu 2009; Okoro, 2013). As at date inflation targeting and interest rate control among other policies are yearning for adequate attention by CBN as ways to have a tighter grip on monetary policy implementation in Nigeria.   

1.2           Statement of Problem

By manipulating monetary policy instruments such as credit and exchange rate, central banks affect the rate of growth of the money supply, the level of interest rate, security prices, credit availability and liquidity creation from the hand of commercial bank. These factors, in turn can exert monetary imbalances or shocks on the economy by influencing the level of investment, consumption, imports, exports, government spending, total output, income and price level in the economy (Mishra and Pradhan, 2008). The Nigeria economy has continued to witness slow growth when compared to its international counterparts such as Brazil and South Africa who are all considered as the same level some years back. The problem of ineffective credit delivery to the productive sectors remains an issue and thus raises doubt on the potency of monetary policy instruments in Nigeria.    

It has also been observed that although in Nigeria appreciable progress has been made in this regard since the introduction of various financial sector reform programs in 1986. Despite the fore going, the Nigerian monetary policy has continued to face several challenges. No wonder, the CBN is increasingly focusing more on the aspect of price stability, recognizing the relevance of macroeconomic stability for economic sustainable output and employment growth. In contrast economists have disagreed, however about whether price stability and money supply should be the central objective of macroeconomic policies or whether these policies should serve broader monetary policy goals. 

Evidence also showed that monetary policy changes on loan supply of less liquid banks, deposit base and induce banks ability to perform their expected roles within the financial system. The Nigerian situation has witnessed several form of banking distress in the last 30 years despite the consistent use of monetary policy and guidelines which thus raise the question of how effective monetary policy has been in regulating the banking industry.

 Monetary policy aims at controlling the activities of banks and other financial sectors in the economy, but in spite of the key position this control occupies in the economy, care had not been taken to really exploit the trend of events in the economy so as to come up with the appropriate regulation and deregulation policy. Recent studies have analysed the impact of market structure on profitability in the banking industry. In general, some of these studies have concluded that market structure does not significantly influence profit-ability. In contrast, most studies of pricing policy have found that 'the prices of bank services increase with the degree of monopoly in the banking sector (Akanbi and Ajagbe, 2012). In view of this, it is therefore pertinent to evaluate the impact of monetary policy on commercial banks 

Also, rationale for this study stems from the current financial turmoil which reminds that monetary shocks are not in a smooth process. In this regard, an appropriate analysis of monetary shock transmission mechanisms is of crucial importance for central banks. This is to determine the process through which monetary policy influence the entire economy within the financial system framework.

1.3 Objectives of the study

The specific objective of this study is to evaluate the impact of CBN monetary policy on commercial banks performance in Nigeria. Thus, the main objectives were to:

1.               Examine the impact of monetary policy on the cost and availability of credit in Nigeria.  

2.               Examine the effects of money supply on commercial banks loans and advances

3.               Examine the impact of liquidity ratio on commercial banks loans and advances in Nigeria.

4.               Examine the impact of cash reserve ratio on commercial banks loans and advances). 

1.4 Research Questions

The study will address the following questions:  

1.               Does monetary policy impact on the cost and availability of credit in Nigeria?  

2.               What effects does money supply has on loans and advances (credit)?

3.               To what extent do liquidity ratio impacts on loans and advances (credit) in Nigeria?

4.               How does change in cash reserve ratio impacts on credit availability (loans and advances).  

1.5 Research hypotheses 

The following hypotheses will be tested in this study:

1.           H0:  There is no significant relationship between Monetary Policy Rate (MPR) and availability of loans and advances in Nigeria

2.           H0:  There is no significant relationship between money supply and loans and advances in Nigeria

3.           H0:  liquidity ratio has no significant impact on credit availability (loans and advances) 

4.           H0:  Cash reserve ratio has no significant impact on credit availability (loans and advances).

1.6 Significance of the Study

The rationale for this study stems from the current financial turmoil which reminds that monetary policy implementation in various economies around the world is still faced with challenges. In this regard, an appropriate analysis of monetary policy implementation in Nigeria and its effect on the banking industry is important. This is to determine the extent of the success of monetary policy implementation in Nigeria as well as provide an insight for the authorities on way forward. 

The nature of banking business, which is highly geared and conducted with great secrecy when compared with other real sector business, has raised some eyebrow from the authorities and the public of late, which thus makes this study of great importance as it shows the effectiveness of monetary policy in ensuring the health of the banking industry. 

At present the financial authorities are embarking on another round of financial reform measures for the banking sector, this study will help provide a policy pathway for the authorities in achieving their monetary policy goals for the banking system.

Although monetary policy is used in all economies around the world, there remains peculiarities with its use which all depends on the level of development of the financial system, thus, this study will help government and CBN take a better view at the peculiarity of the Nigerian financial system and the monetary policy instrument that best suits its regulation and development.      

The study will also help regulatory agencies in the financial sector assess past loopholes and formulate stronger future policies to enhance monetary policy in Nigeria.  Furthermore, findings from the study will enlighten the public and the National Assembly on the need to ensure full autonomy of the CBN to enable it perform effectively.

1.7 Scope of the Study

This study focuses on the effectiveness of CBN monetary policy on banking industry in Nigeria during the period 1981-2013. Data will be collected from CBN statistical bulleting from 1981-2013. This period was chosen because the monetary authority started computing the statistical bulletin in 1981 and the last available data computed was in 2013.

1.8 Organization of the Study

The research work has been divided into five (5) different parts.

The first chapter gives a background to the study. This states the problems that will be solved in the course of the research, the objective of the study, significance of the study and self-imposed limitation of the study.

It also stated the research questions, the research hypothesis, scope of the study, organization of the study and definition of relevant concepts.

Chapter two gives other peoples finding in relation to the problem being researched, that is, literature review.

Chapter three is the research methodology. It includes the introduction, research design, sources of data, and specifications of models and method of data analysis. It also includes problems associated with data collected, data treatment techniques and the administration of the analysis.

Moreover, chapter four contains introduction, data presentation and discussion, data analysis, test of hypothesis and discussion of findings.

Finally, chapter five is the concluding chapter which consists of the following; summary of finding, recommendations and conclusion which will be relevant to finance and banking students, financial analyst, laymen in the field, investors and share holders.

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