MONETARY POLICY AND FINANCIAL PERFORMANCE OF DEPOSIT MONEY BANKS IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

The financial sector of the economy plays a huge role in the economic development of a nation and this cannot be overstressed. It is the channel through which idle funds are made available to the productive sector, thereby facilitating the use of surpluses in the economy to generate employment and promote economic welfare (Aurangzeb, 2012).  The financial sector provides strong confidence for depositors, thereby motivating and encouraging saving in the economy. A strong financial sector also helps to sustain an economy against external shock that may arise from fall in external capital flow. A strong and well-developed financial sector is needed to achieve a sustained growth (Aurangzeb, 2012). Akomolafe (2014), in his view, opined that sustainable economic growth is often associated with countries with strong financial sector. The study indicated that the recent incidence of banking and financial crises in the world, and its aftermath on the world economies give credence on the importance of the sector on the performances of an economy. More importantly, the financial sector also serves as the avenue through which the monetary policies of the government are carried out. The banking industry is one of the sectors that play an important role in the allocation of capital resources and risk sharing of future flows in any given economy or country. An efficient and effective banking industry in any economy is likely to facilitate increased growth and welfare, and it will smooth business cycles.

For instance banks provide money changing and payment processing services; transformation of assets in terms of their maturity, quality, and denomination and more recently management and control of risks. These functions give banks a central position within the process of saving and investment allocation. However, these functions make banks vulnerable to different sources of shocks, and they have a negative effect on the economy because of banks’ central role. Consequently, there is a case for strong regulations in a banking environment. Because of the type of functions banks perform there is need to have in place proper monetary policy involving issues such as barriers to entry, market concentration, the borrower-lender relationship, deposit insurance, and the taxation of financial intermediation in order to improve the performance of the financial sector (Ibrahim & Muritala, 2015).

The primary objective of Nigerian banks’ consolidation reform was to guarantee an efficient and a sound financial system. The reform was designed to enable the banking sector develop the required capacity to support the economic development of the nation by efficiently performing its functions as the head of financial intermediation (Lemo, 2005). Thus, it was to ensure the safety of depositors’ money, position banks to play active developmental roles in the Nigerian economy; become major players in the sub-regional, regional and global financial markets and compete favorably with international banks. The Central Bank of Nigeria’s (CBN) recent reform to consolidate the banking sector through drastic increase to 25 billion naira as minimum capital base of any bank led to a remarkable reduction in the number of banks from 89 to 24 in 2005; changed their mode of operations and their contributions to the nation’s economic development (Zhao & Murinde 2009).

The Nigerian banking sector had undergone a number of major changes over the last two decades caused by restructuring and liberalization of the financial sector as well as technological progress. Before 1987, the Nigerian monetary authorities restricted entry, controlled branch expansion and set both deposit and lending rates. This institutional framework led to a situation of virtually little or no competition in the sector, with the concentration of activities in the four largest banks. In 1990s, a lot of structural reforms were observed in the sector. There was a significant closure of banks, takeover of management and control by the Central Bank of Nigeria (CBN) and the Nigerian Deposit Insurance Corporation (NDIC). The mandatory capital level was increased to 500,000.00 naira, while the statutory minimum risk-weighted capital ratio remained at 8 percent on average, the number of banks in Nigeria shrank by approximately 22 percent between 1997 and 1999 (Asogwa, 2004).