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CHAPTER ONE

INTRODUCTION

BACKGROUND OF THE STUDY

Banks can hardly survive without a positive return on capital invested. Profitability is therefore the driven factor for activities of commercial banks. Consequently, banks engage in a variety of products and services for the achievement of this profit or to be profitable. The commonest and most important of these activities is the given out of loans to borrowers seeking financial accommodation.  In doing this, it is expected that the borrower pays back the principal and interest.  This interest in all bank services forms the bedrock of profitability in the banking sector. 

Banks are the intermediaries through which the surplus and deficit units in any economy interact to exchange financial value indirectly. When the surplus units make deposits in the banks, they are given out to loan seeking customers or investors preparing to embark on viable projects with an interest charge on the loan.  Consequent on the vital role of intermediation played by banks, the banking sector is highly regulated by the government. 

To carry out this regulation effectively, government employs monetary policies as the primary tool to regulate the banking sector.  Embedded in these monetary policies are the different types of instruments that are used to regulate the operations of banks in the economy.  Being an external factor to the banks, the tools could act as a militating or mitigating factor in boosting banks profitability.  The way and manner these factors are applied to banks vary from one country to the other and has traceable relationship to the state of the particular country’s economy.  In stable economies, these tools are spared of frequent manipulations and vice versa.  Economic activities, to a large extent, depend on these tools especially in countries where the capital market is still in its primordial stages of development.

In Nigeria, monetary policy tools have been subjected to various forms of gyrations in keeping with the fluctuations in economic indices.  Each time these policies change, bank operations are certainly affected.  However, whether these changes in monetary policy instruments significantly affect profitability of banks remains a matter for investigation.  The paper therefore, seeks to examine the impact of monetary policy instruments on  profitability of Zenith Bank Plc between 2005 and 2012.

Zenith Bank within twenty-two years has demonstrated its resilience irrespective of the business/economic cycle and witnessed exponential growth in virtually all areas (Zenith Bank, 2012). In spite of the monetary policies, this growth seems to be persistent. Is it that the monetary policies do not actually influence their operations? 

For the purpose of this study, the monetary policy instruments to be examined are; the Cash Reserve Rate (CRR), Liquidity Rate (LR), Interest Rate (IR), and Minimum Rediscount Rate (MRR).

STATEMENT OF THE PROBLEM

One of the most complex issues facing government is identifying the appropriate level and form of intervention in the banking sector. Its efficiency as a regulator is a significant determinant of the overall efficiency of the economy. The extent of regulatory intervention may also determine whether financial markets can develop to their full potential or not. Ultimately, any inefficiency must be funded by higher charges passed on to the community as cost arising from stringent regulation. The more sophisticated the monetary policy, the greater its vulnerability to failure of banks to deliver against its promises. 

When these failures occur, investment which is an important factor in economic growth is kept low.  Consequent upon this, trust and confidence in the financial system may go down and sourcing of funds from banks may face a downward trend due to increase in cost of loan.

The increase in cost of capital often deters prospective investors from engaging in new ventures as well as discourages customers of companies from optimal patronage of their products.  It therefore, stands to reason that increase in cost of capital results in cyclical effects in the economy.  In view of this, any review of monetary policy is often greeted with wide spread apprehension, that cuts across various sectors of the economy.

On the other hand, a decrease in the cost of capital tends to stimulate more aggressive investment in any economy.  The higher the volume of investment, the greater the competition.  Even though consumers of products from various companies stand to benefit from this situation in the short run, it may portend serious danger in the economy if it is allowed to stretch to the extreme.  As companies engage in stiff competition, weak ones (especially those that are disadvantaged technologically) may be driven out of business.  This may result in monopolies with their obvious consequences in the economy.

OBJECTIVES OF THE STUDY

The general objective of this study is to examine the impacts of monetary policy instruments on the profitability of commercial banks in Nigeria (2005-2012). However, the specific objectives are:

1.      To ascertain if Cash Reserve Rate (CRR) has significant effect on the Profit Before Tax of Zenith Bank Plc from 2005 – 2012.

2.      To determine if Liquidity Rate (LR) has significant effect on the Profit Before Tax of Zenith Bank Plc from 2005 – 2012.

3.      To examine if Interest Rate (IR) has significant effect on the Profit Before Tax of Zenith Bank Plc from 2005 – 2012.

4.      To ascertain if Minimum Rediscount Rate (MRR) has significant effect on the Profit Before Tax of Zenith Bank Plc from 2005 – 2012. 

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