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BANKING FINANCE

IMPACT OF MACRO ECONOMIC VARIABLE ON BANK PERFORMANCE

IMPACT OF MACRO ECONOMIC VARIABLE ON BANK PERFORMANCE

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IMPACT OF MACRO ECONOMIC VARIABLE ON BANK PERFORMANCE

ABSTRACT

This study was conducted to ascertain the effect of macroeconomic factors on bank performance. The studies that are now accessible have produced a variety of results. This study intended to contribute to the understanding of how Nigeria’s commercial banking sector’s financial performance is influenced by macroeconomic factors.

Between January 2006 and December 2015, the researcher conducted both a descriptive and a correlational analysis on all the commercial banks in Nigeria. Data was analysed with SPSS software version 21, and graphs and frequency tables were used to display the results.

Secondary information about quarterly bank performance was gathered from annual financial reports of the individual banks, while information about macroeconomic factors was gathered from the Central Bank of Nigeria and the Nigeria National Bureau of Statistics and was subjected to multiple linear regression analysis.

Financial performance was assessed using return on assets, whereas interest rates, exchange rates (USD/N), GDP, and inflation rates were each assessed using quarterly interest rates, GDP, and inflation rates, respectively. The study’s findings showed a significant (R=0.792) correlation between macroeconomic factors and the financial performance of commercial banks.

Additionally, an adjusted R-squared value of 0.585 was noted in the study. This suggests that macroeconomic factors account for 58.5% of the overall variation in the financial performance of the commercial banking industry in Nigeria.

The regression model was perfect, according to ANOVA statistics, as it had a significance level of 0.001. The study also found that while GDP and inflation rates have a beneficial impact on the financial performance of the commercial banking sector, interest rates and exchange rates have a negative impact.

In order to control their impact on the financial performance of the banking sector, the study advises Nigeria’s commercial banking sector to take macroeconomic factors including rates, interest rates, currency rates, and GDP into account while formulating policy.

The Nigerian government should develop policies through the Central Bank of Nigeria that foster an atmosphere where commercial banks can thrive since doing so will lead to economic expansion.

CHAPITER 1

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

There are many industries in Nigeria that support the economy. This study will concentrate on the financial transactions sector (banking sector), which is crucial to the growth of a nation’s economy since it acts as an intermediary in the financial system.

In order to promote economic growth, international and domestic investment, the reduction of poverty, and the creation of jobs, the strength of financial institutions is crucial (Kyalo, 2002).

By facilitating macroeconomic stability for long-term development, banking in Nigeria and financial services in general have been highlighted as a major pillar for achieving Vision 2030, the goal of making Nigeria a middle-income country (CBN, 2007).

Since banks are such important economic players, several parties, including the national government through the central bank of Nigeria, pay close attention to their stability and viability as operating businesses.

Scholars studying the current issue have focused on the relationship between macroeconomic conditions and corporate performance. It is frequently concluded that some fundamental macroeconomic variables, such as interest rate, GDP, inflation, and currency rate, are responsible for a firm’s performance.

Financial media confirmation demonstrates that investors frequently believe that macroeconomic and fiscal policy have a significant impact on the unpredictable nature of results.

As a result, macroeconomic factors have an impact on people’s investment decisions and motivate countless researchers to look into the connection between investment returns and macroeconomic factors (Gan et al., 2006).

The Nigerian financial industry is predominantly dominated by the country’s banks because the main market is still seen as being small and light (Ngugi et al., 2006). This has led to the country’s financial intermediation system relying heavily on banks, particularly commercial ones (Kamau, 2009).

According to Oloo (2009), the Nigerian banking sector has a link that embraces the entire nation’s economy. The existence and development of the primary segments of agriculture and manufacturing are basically dependent on this sector.

Only three banks failed to meet the CBN statutory requirement and were placed under it over the course of the past ten years, whereas 37 banks were placed under CBN statutory between 1986 and 1998 (Mwega, 2009), indicating a significant improvement in the performance of this industry.

1.1.1 Global Economic Factors

Macro-economic variables specifically relate to elements of general significance to the economic standing of nations in relation to one another on a regional or national level.

There is a wide area of study in microeconomics especially understanding how these factors relate with one another and their interaction impact on the economy as illustrated by (Fischer,1993).

These factors are economic output, unemployment, inflation, savings, and investment. They are closely watched and checked by the governments in place since they are major guides of economic activity performance. Microeconomics is focused with the expounding individual, whereas macroeconomics is a wide examination of the economy as a whole.

impact on the decision-making process at the individual, group, or corporate levels.

Governments, businesses, and consumers all pay close attention to macroeconomic factors, but because of how they affect the banking industry, they are given special attention by businesses. According to Kwon & Shin (1999), the most significant macroeconomic factors are GDP, currency exchange rate, interest rates, inflation, and market risk.

Since the variables stabilise over time and become favourable to the banks daily operations, Sharma and Singh (2011) discovered that there is a positive relationship between how they carry out investments over an extended period of time.

The GDP is the most comprehensive measurable indicator of a country’s overall economic performance and accurately captures all monetary value created for goods and services over a specific time period inside its boundaries. Inflation is the term used to describe an increase in the rate of prices over time.

Fiscal rules and policies, the consumer price index, commercial banking, and credit availability are all factors that often have an impact on pricing and can either cause it to rise or fall. The number of locals actively looking for work but not yet employed is referred to as the unemployment rate.

According to Mishkin (2004), some macroeconomic variables have a significant impact on economic growth zones. These factors include banking, the Consumer Price Index, and modifications to governmental laws.

1.1.2 Financial Results

Financial performance is an unbiased assessment of how effectively a company uses its resources to create income in its main business model. Performance refers to the overall quantifier of a firm’s overall financial standing over a specific period of time. It is frequently used to compare the performance of entities in the same sector or to compare the performance of sectors as a whole.

It is possible to employ different elements in the same line, including operating income, operating cash flow, and the entire income from a company’s daily operational activity.

A financial analyst or other interested party may also utilise financial statements to analyse growth rates, margins, and falling debt (Maria et al., 2002).

Earnings per share, return on equity (ROE), yield in sales, profit on investment (ROI), and sales growth are some of the common financial performance indicators used by most commercial banks. Earnings per share is the amount of a company’s profit allocated to each outstanding share of common stock.

The most widely used ratios for evaluating a company’s performance are return on assets (ROA), return on equity (ROE), return on investment (ROI), revenue growth, return on sales (ROS), market shares, stock price, liquidity, sales growth, and operational efficiency.

These ratios can be summarised as growth and profitability. The degree of a commercial bank’s financial performance may often be determined using ROE and ROA (Maria et al., 2002).

1.1.3 macroeconomic factors and financial performance

Due to the commercial banks’ trend towards high lending rates, project financing is severely hindered, which makes equally effective equity financing—despite their higher cost—take the lead. High Treasury bill rates promote spending on more governmental tools.

Bonds, stocks, and deposits compete with the Treasury bill for the investment of shareholders. Demand deposits and stock market instruments’ prices will eventually fall as demand for them declines.

Thus, the anticipated relationship between Treasury bill rates and financial performance is adversely affected. It also has a favourable impact on loan rate expectations. 2002) (Maghyereh).

(Muchiri, 2012) Financial performance is affected by economic factors that have an impact on changing investment opportunities, pricing policies, and factors that affect speculative dividends.

Financial reporters’ confirmation demonstrates that shareholders generally draw the conclusion that macroeconomic measures and fiscal policy have a big impact continuously leading to the change in financial performance.

Earlier studies contend that the consumer prices index is a specific component made up of a number of macroeconomic variables, as Muchiri (2012) concluded. According to (Gan et al., 2006), these variables are the discount rate, price growth, and the goods market.

A study came to the conclusion that there was evidence of a detrimental impact among the variables. It is influenced by the foreboding risk of future profitability.

For instance, future productivity may suffer as a result of rising bills and higher production costs. On the other hand, some people think that higher prices brought on by the use of equity to control inflation may lead to higher stock values.

Sharma and Singh (2011) recommend that banks first obtain information about borrowers, which is very expensive, before extending loans to current potential or existing customers.

The allocation of the available funds is greatly influenced by the volatility of economic conditions, and the high likelihood that loan default would have obvious positive or negative impacts on their lending behaviour.

According to a study by Kwon and Shin (1999), banks drop their lending rates during recessions, as opposed to boom times when banks make the majority of their loans due to the low degree of macroeconomic volatility. The country’s entire economy is affected by the economic climate, which is a regular risk factor.

Macroeconomic aggregates, such as the total number of goods produced, the general rise in price levels, employment level, supply of money for trading, changes in the exchange rate, and industrial capacity utilisation, are used to measure the performance and development of economies.

1.1.4 Nigerian commercial banks

There are now only one mortgage finance company and 42 active and licenced commercial banks in Nigeria. Only 3 of Nigeria’s commercial banks are controlled by the government; the remaining commercial banks and the mortgage finance company are privately held by different private investors.

Out of the total, 14 commercial banks are owned by foreigners, whereas 25 are domestically owned by Nigerian residents as shareholders (CBN, 2015).

In commercial banks, individual depositors account for the majority of deposits. These banks then turn a profit by using these funds to make loans to other clients at higher interest rates.

According to a three-phase analysis by Athanasoglou et al. (2005), Nigeria’s financial sector has grown and developed significantly. The first phase is thought to have happened between the early 1970s and the 1980s. The financial sector at the time was characterised by financial restrictions, therefore the banking sector had already much surpassed it in terms of influence.

The administration in governance has had a significant role in allocating credit for investments and substantially produced a turnaround on the sector by utilising unwavering tools of monetary policy. (2005) Athanasoglou et al. The second phase was launched by structural adjustment plans and liberalisation in the late 1980s and early 1990s.

The rates of general price increases were moderated throughout this time, and principle account limits were still in place. A sector that starts off with modest interest rates that are different, increases the ability to get financial resources over larger investments, improves the impact of credit allocation, and spurs investment growth is one that is essential for financial sector reform.

The indirect tool of promoting monetary policy’s usage through liberalisation was also intended to serve as the catalyst for its formation.

The third phase of the financial sector’s development in the late 1990s was characterised by the age of invention, which included evolving fiscal tools.

Islamic banking, automated teller machines (ATMs), plastic money, and electronic money (e-money) are some of the new items that have entered this market since it began (Athanasoglou et al., 2005). The Companies Act, the Banking Act, and the Central Bank Act are a few of the Acts that govern Nigeria’s banking sector.

The Central Bank of Nigeria, the regulator, frequently dispenses extra provident processes as necessary under the Bank of Nigeria Act. According to CBN (2012),

the Acts and Regulations completely set the rules and controls controlling the entire banking sector. They also provide controls that are exciting in the direction of administration and reasonable facilities.

The banking sector in Nigeria has consistently enjoyed asset and financial performance expansion over the past few years. This has been fueled by growth strategies and the computerization of a large number of services to fulfil the intricate wants of the clients.

The sector in Nigeria and the rest of East Africa has greatly advanced and expanded as a result. The necessity for financial institutions to continuously adapt to the dynamic business environment and a new continuous flood requirement through a robust ICT platform is highlighted in the CBN annual supervisory report of 2015.

Although they will remain sufficiently flexible, consumers will continue to seek customised services, and this time around, demand will be higher than in the past. In order to stay competitive, banks will regularly and deliberately build new innovative products that use ICT.

According to CBN (2015), the retail market segment, which is expected to grow gradually, would see a down streaming as a result of the microfinance institution receiving deposit licencing.

1.2 STATEMENT OF THE PROBLEM

In order to promote economic activity, the banking sector’s profitability is essential. The financial success of commercial banks is impacted in a variety of ways by large organisational elements such the gross domestic product, interest rate, currency rate, inflation, and money supply.

Levine (1996) found that the effectiveness of financial sector intermediation has an impact on economic growth. Because of the stability of their financial systems, economies are better able to withstand harmful shocks (Bashir, 2003).

In order to ensure its long-term existence, a bank must identify the factors that are raising or lowering its returns. This enables the bank to take steps to boost its profitability by regulating the controlling variables (Athanasoglou et al., 2005).

The Nigerian banking system has held up well despite a difficult macroeconomic climate. It has had issues that are negatively affecting it, including rising price levels, unpredictable interest rates, and currency rate.

In addition to a growing current account deficit, the Nigerian naira has undergone a significant depreciation against the majority of traded international currencies in recent years.

When management actions reflect the cyclical character of the economy in their choices, these unfavourable macroeconomic events may cause serious issues in the banking business.

Due to cyclical variations, there is a chance that the banking system will encounter growing stress. Macroeconomic variables may occasionally provide reliable warning signs, but this is not always the case.

According to Demirgüç-Kunt and Detragiache (1998), a study of 65 banks in developing nations and one developed nation was conducted. Results showed that external variables significantly contributed to the banking sector crisis;

the Logit model was used for the 1980–1994 study period. Using balanced panel data and a sample of 10 large banks, Naceur (2003) investigated the profitability of the Tunisian banking industry.

The results showed that neither the annual growth rate of inflation nor the annual inflation rate had been significantly impacted. Data from fourteen Islamic banks were assessed in eight Asian nations over a five-year period beginning in 1993 (Bashir 2003).

The variables used had a very strong positive influence, supporting the linear estimation theory. Athanasoglou, Delis, and Staikouras (2006) evaluated the South-Eastern region’s 132 European banks during a four-year period beginning in 1998 using an uneven board.

The results showed profitable returns during periods of high inflation without obvious effects on GDP. Wong et al.’s (2006) research was carried out by relying on the practicable generalised least square (FGLS) method to forecast and demonstrate that asset returns have a major impact on GDP and inflation rates.

There is disagreement among the research that have been done and are available locally about the influence of macroeconomic dynamics on bank financial performance. Ongore (2013) recognised that minor macroeconomic factors have an impact on bank profitability.

The study used regression analysis to analyse the data and came to the conclusion that rising inflation rates had a negative impact on the profitability of commercial banks.

Even yet, the association was negligible at the 5% level. Desaro (2012) conducted study on the relationship between macroeconomic variables and the monetary performance of the commercial bank in Nigeria.

She found a positive association between the ROA and the GDP, money supply, lending rate, and inflation, and a negative correlation with the exchange rate. Other research projects carried out in Nigeria focused on particular macroeconomic factors.

For instance, Wamucii (2010) examined the connection between inflation and the financial performance of Nigerian commercial banks and found that the latter appeared to perform better as inflation rose. According to Kipngetich’s (2011) research, there is a positive correlation between interest rates and financial performance.

As can be seen from the discussion above, the influence of macroeconomic factors on the financial performance of commercial banks in Nigeria has not yet been thoroughly investigated.

Previous research has focused on a single macroeconomic component in certain cases, while other studies have looked at multiple variables and found contradictory conclusions.

By addressing the following question: What effect do macroeconomic variables have on the financial performance of commercial banks in Nigeria, the current study aims to close this research gap.

1.3 OBJECTIVES

Finding out how macroeconomic factors affect the financial performance of Nigeria’s commercial banking sector is the study’s main goal.

1.3.1 Particular Goals

The following are the study’s particular goals:

To specify the impact of Gross Domestic Product (GDP) on the monetary performance of Nigerian commercial banks

To investigate the impact of real interest rates on the financial health of Nigerian commercial banks

To assess how exchange rates affect the financial health of commercial banks in

To assess the effect of inflation on the financial health of Nigeria’s commercial banks.

1.4 SIGNIFICANCE OF THE RESEARCH

The findings of this study would advance knowledge of the macroeconomic factors influencing the Nigerian banking system. The study would be helpful to policy makers in the banking industry as a benchmark for formulating policies that can be effectively implemented for better and simpler regulation of the banking sector.

The study will be used by the government to develop policies and strategies for fostering stability in the nation’s financial institutions.

The study’s findings will continue to be significant to those who work for commercial banks as well as academics, researchers, policymakers, and professionals in the field of finance.

The study will be practically helpful to the shareholders of commercial banks since it will let them know whether the treasury top management responsible for increasing the value of their assets is making sound choices based on macroeconomic factors.

The research’s findings will also be very helpful to management in understanding the relationship between risk-adjusted returns and macroeconomic parameters.

This study will introduce academicians, scholars, and researchers to a previously unexplored area and pique their interest in trying to learn more about it.

Those who may be interested in conducting further research in this area will undoubtedly find this study to be an important point of reference for literature and research gaps.

This will serve as a helpful foundation for decision-making for government organisations like the CMA, the NRA, and policymakers, particularly when creating laws and policies that regulate the operations of commercial banks and fix interest rates.

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