THE EFFECTS OF LENDING RATE ON COMMERICAL BANK PERFORMANCE

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CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
Lending rate management has been a contemporary issue among academics and
policy makers for a very long time. This started predominantly when the Gold standard
collapsed in the 1930‟s and subsequent emergence of the Bretton wood system of
adjustment peg from the 1940‟s, through the espousal of flexible Lending rate given by the
developing nation in 1970 and those carrying out structure reforms in the 1980‟s as well as
in the wake of the currency crises in developing economies in the 1990‟s.
The financial systems of most developing nations have come under stress as a result
of the economic shocks of the 1980s. The economic shocks largely manifested through
indiscriminate distortions of financial prices which includes interest rates, has tended to
reduce the real rate of growth and the real size of the financial system relative to
non-financial magnitudes (Davidson and Gabriel, 2009). Rasheed (2010), states that
Nigerian economy saw different interest rates for different sectors in 1970s through the
mid-1980s (Regulated Regime, 1960-1985). The preferential interest rates were based on
the assumption that the market rate, if universally applied, would exclude some of the
priority sectors. Interest rates were, therefore, adjusted periodically with „visible hands‟ to
promote increase in the level of investment in the different sectors of the economy. For
example agriculture and manufacturing sectors were accorded priority, and the commercial
banks were directed by the Central Bank to charge a preferential interest rates (vary from

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year to year) on all loans and advances to small-scale industries. Since 1986, the inception
of interest rates deregulation, the government of Nigeria has been pursuing a market
determined interest rates regime, which does not permit a direct state intervention in the
general direct of the economy (Adebiyi and Babatope-Obasa, 2004).
Lending rate policies in developing countries are often sensitive and controversial,
mainly because of the kind of structural transformation required, such as reducing imports
or expanding non-oil exports, which invariably imply a depreciation of the nominal
exchange rate. Such domestic adjustments, due to their short-run impact on prices and
demand, are perceived as damaging to the economy. Ironically, the distortions inherent in
an overvalued Lending rate regime are hardly a subject of debate in developing economies
that are dependent on imports for production and consumption. Lending which may be on
short, medium or long-term basis is one of the services that deposit money banks do render
to their customers. In other words, banks do grant loans and advances to individuals,
business organizations as well as government in order to enable them embark on
investment and development activities as a means of aiding their growth in particular or
contributing toward the economic development of a country in general (Felicia, 2011).
Commercial banks are the most important savings, mobilization and financial
resource allocation institutions. Consequently, these roles make them an important
phenomenon in economic growth and development. However, commercial banks decisions
to lend out loans are influenced by a lot of factors such as the prevailing interest rate, the
volume of deposits, the level of their domestic and foreign investment, banks liquidity
ratio, prestige and public recognition to mention just but a few.This study becomes
imperative because given that Commercial banks influence major saving factors and

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provides financial services that ginger growth and development of any society (Felicia,
2011).This research work, therefore, empirically investigates the effect of lending rates on
Nigerian banks performance using ordinary least square regression method of analysis on
secondary data covering the period (2003 – 2013).

1.2 Statement of the Problem
In Nigeria, the lending rate policy has undergone substantial transformation from
the immediate post-independence period when the country maintained a fixed parity with
the British pound, through the oil boom of the 1970s, to the floating of the currency in
1986, following the near collapse of the economy between 1982 and 1985 period. In each
of these periods, the economic and political considerations underpinning the exchange rate
policy had important repercussions for the structural evolution of the economy, inflation,
balance of payments and real income.
Despite various efforts by the government to maintain a stable exchange rate, naira
has continued to form the 80‟s (Benson and Victor, 2012). The deteriorating state of
Nigerian economy and the recent usage of high Exchange rate makes it pertinent to
empirically investigate the effect of Lending rates on Nigerian economic development.
In Nigeria, commercial banks need to understand how to manage their huge assets
in terms of their loans and advances. For the banks to balance their main objectives of
liquidity, profitability and solvency, lending must be handled effectively and the banks
must behave in a way that the potential customers are attracted and retained. The study

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focus on finding out the extent to which banks‟ lending rate affect profitability in Nigeria
Commercial Banks.

1.3 Objectives of the Study
The overall objective of this study is to examine the effect of lending rates on Nigerian
banks performance. The specific objectives are to:
i. Determine the impact of lending rate on the performance of banks in Nigeria.
ii. Evaluate the impact of monetary policy rate on the performance of banks in Nigeria.
iii. Ascertain the impact of exchange rate on the performance of banks in Nigeria.

1.4 Research Questions
In line with the specific objectives enumerated above, the following research questions
are raised:
i. To what extent has lending rate impacted on the performance of banks in Nigeria?
ii. To what extent has monetary policy rate impacted on the performance of banks in
Nigeria?
iii. To what extent has exchange rate impacted on the performance of banks in Nigeria?
1.5 Research Hypotheses.
The following null hypotheses are formulated in order to examine the effect of lending rate
on the performance of banks in Nigeria:
Hypothesis One
H0: Lending rate has no significant impact on the performance of banks in Nigeria.

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HI: lending rate has significant impact on the performance of banks in Nigeria
Hypothesis Two
H0: Monetary policy rate has no significant impact on the performance of banks in
Nigeria.
H1: monetary policy has significant impact on the performance of banks in nigeria
Hypothesis Three
H0: Exchange rate has no significant impact on the performance of banks in Nigeria.
H1: exchange rate has significant impact on the performance of banks in nigeria.

1.6 Significance of the Study
Evidently, lending rate instability is one of the economic problems that have
continued to dominate national discourse in recent times while exchange rate is considered
one of the drilling forces in economic development.
An understanding of the lending rate management on the growth of Nigeria
economy is crucial for the appreciation of trend and policies that the apex bank (CBN) will
use in re-designing an appropriate strategy in its stabilization efforts as to bring about a
stable lending rate.
Therefore, this study will be of immense importance to the government and
policy-makers alike especially in their efforts to fashion out sound and effective exchange
rate administration. Sound policies in lending rate administration, will no doubt, foster
improve international trade through exportation of goods and services etc.

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The study will prove useful for stakeholders to understand lending Rate
Management in determining the profitability of commercial banks and growth of the
economy.
The general public and civil society can also benefit from the research because it
will provide them with adequate information concerning activities of CBN as it relate to
lending rate management. The research findings and recommendations will form a base
that will be relied for further research work while contributing to existing body of
knowledge.

1.7 Scope of the Study
This research work seeks to evaluate the effect of lending rate on Nigerian banks
performance. Focus shall be on commercial banks lending rate, monetary policy rate and
exchange rate management and implementation that would contribute to the performance
of banks and growth of the economy. The study covered a period of thirty one (10) years
(2003-2013), being the year the monetary authority shifted from fixed exchange rate
regime to flexible exchange rate regime.
1.8 Definition of Terms
i. Exchange rate: This is the price of one country‟s currency in terms of another.
ii. Foreign exchange: Foreign exchange is a means of payment for international
transaction; it is made up of currencies of other countries that are freely acceptable
in settling international transactions.
iii. Dutch auction System (DAS): This is a method of exchange rate determination
through auctions where the bidders pay according to their bid rates.

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iv. Exchange control: This is a foreign exchange arrangement in which the government
purchase all coming foreign exchange and is the only source from which foreign
exchange can be purchased legally.

1.9 Organization of the study
Chapter one introduces the research work including the background of the study,
statement of the problem, objective of the study, research questions, hypotheses,
significance of the study, scope of the study, and structure of the study.
Chapter two critically reviews related literature. This encompasses the
introduction, the conceptual framework, the lending rate models, overview of lending
rates.
Chapter three examines the research methodology, the research design, the
population, the sample size, the nature and source of data, the method of data collection, the
techniques of data analysis.
Chapter four focuses on data presentation and analysis, test of hypotheses and
summary of findings.
Chapter five presents the summary and conclusion of the research work. It looks at
the recommendations, limitations of the study, suggestion for further research.