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CHAPTER ONE
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THE EFFECT OF MONETARY POLICY ON THE PERFORMANCE OF THE BANKING INDUSTRY
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1:7 METHODOLOGY
This study will employ content analysis technique of data collection,
time series data on the subject matter from secondary sources will be
collected and analysed. The data to be fitted into the model span over
a period of 15 years (1986 2000). The secondary sources include
extract form textbooks, dailies, CBN statistical Bullion, Bulletin,
Economic and financial review, Annual report and statement of
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account. There after, the data will be analysed using a simple linear
regression techniques of analysis and other statistical test.
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CHAPTER TWO
REVIEW OF RELATED LITERATURE
2:0 INTRODUCTION
The thrust of this chapter is to throw some light on monetary
management with specific focus on the concept, objectives
techniques, targets, indicators and transmission route of monetary
policy. Furthermore a brief attempt of review of evolution of
monetary policy in Nigeria will be undertaken, including a review of
concept of monetary influence and finally ascertain the effects of
monetary policy measure on banks in Nigeria.
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Nwanko (1987) is of the same view with Otiti when he said that
monetary policy is concerned with availability, cost and direction of
credit. Monetary policy is applied in order to limit money growth to
a level that is consistent with the absorptive capacity of the economy.
Other relevant definitions that seem appropriate in Nigerian context
are thus:
Monetary policy is a major economic stabilization weapon which
involves measures designed to regulate and control the volume, cost,
availability and direction of money and credit in an economy to
achieve some specified macro economic policy objectives (Anyawu
1994)
That is, it is a deliberate effort by the monetary authorities (the
Central Bank) to control the money supply and credit conditions for
the purpose of achieving certain broad economic objectives
(Wrightman 1976).
From the above foregoing numerous definition of the concepts of
monetary policy, it can be deduce that monetary policy refers to the
combination of measures or actions designed to regulate the value,
supply and cost of money in an economy, in consonance with the
expected level of economic activity. An excess supply of money
would result in an excess demand for goods and services, which
would cause rising price and or a deterioration of the balance of
payment position. On the other hand an inadequate supply of money
could induce stagnation in the economy thereby retarding growth and
development. Consequently the monetary authority must attempt to
keep the money supply growing at an appropriate rate to ensure
sustainable economy growth and maintain internal and external
stability. The discretionary control of the money stock by the
monetary authority thus involves the expansion or contraction of
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the rate of interest and may generate higher inflation if the growth is
not sufficient enough to inhibit it. Also in a situation where the
economy is experiencing inflation and slow economic growth a tight
monetary policy (to fight inflation) will reduce investment and growth
even further.
Therefore, the above conflict can be resolve as thus; in the event that
monetary policy objectives are not mutually attainable, trade offs
among them must be considered and each objective ranked with
respect to its relative importance. This ranking has to be the
responsibility of the monetary authorities (The Central Bank) and the
government based on the state of the economy.
In general the ultimate goals of monetary authorities in less developed
countries, consist of growth in national output (or economic growth
and development in the long-run) price stability (or moderate
inflation) and external balance (i.e. a sustainable balance of payment
and/or stable exchange rate). To achieve these ultimate objectives,
policy makers have identified variables that have stable, predictable
and strong relationships with ultimate goals, which are called
proximate targets (or goals). Variable that are under the control of the
monetary authorities and have effects on the proximate targets are
called monetary tools (or instruments).
The conventional wisdom is that the term of liquidity (or more
specifically the term of credit) and some measure of the quantity of
liquidity are possible proximate target variable. The most commonly
identified proximate target variables are interest rates (ie the terms of
credit) M1 (currency plus demand deposits) M2 (M1 plus time
deposits), M3 (M2 plus other deposits and near monies). DC
(aggregate domestic credit) and H (high - powered money) (Ascheim,
1970, Bruner, 1969 etc)
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On how monetary policy affect employment, Ojo and Ajayi (1981, pg.
222) argued that when unemployment increase from a define
minimum, an expansionary monetary policy could be use to combat it.
Firstly an expansion of money supply leads directly to increased
expenditure on good and services thereby ultimately requiring
increased employment to reproduce the extra goods and service.
Secondly, an increase in money supply could lead to a fall in interest
rates, implying a reduction in the cost of funds thereby increasing
investment expenditure and finally stimulating employment.
It has been pointed out that price instability cause the problems of
inflation and deflation with their unpleasant effects. Recently this
objective of price stability has been noted to be synonymous with that
of achieving a low rate of inflation. Many theories have been advance
as to the cause of inflation major among are
1. The monetarist propositions
2. The cost push theories of inflation and
3. The excess demand theories of inflation by Keynes
In shortages of supplies and monetary factors such as rise in
government expenditure, increases in money income and money
supply among others, the objective of price stability has been noted to
be of paramount importance since the converse may precipitate a
balance of payment crisis, impair the usefulness of money, exert
distorting and destabilizing effects on the domestic economy as well
as exacerbate the problem of income mal distribution. In a typical
developing economy like Nigerian, this objective can be assessed by
the annual percentage rates of change in the consumer price index or
the GDP deflator. The composite consumer price index which
incorporates the rural and urban areas seems to be more relevant and
widely used in the Nigerian context.
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year. Most of the third world countries Nigeria inclusive have been
experiencing perennial balance of payment difficulty. In the Nigeria
case, it's dependence on petroleum only as it's key export, the
downward trend in the demand and price of this product which is
exogenously determined as well as her high elasticity of demand
among other have negatively affected her balance of payments
position.
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in cheques which are deposited with banks. The resultant effect of this
transaction is an increase in the fund available in the banking system,
credit expansion. Fall in interest rates stimulate investment, higher
aggregate spending.
On the other hand when the CBN feels that there is excess liquidity
beyond the absorptive capacity of the economy, which may lead to
inflation. It can mop up the excess liquidity by selling the financial
instrument for instance bonds, treasury bills, certificates etc to the
banks and corporate institutions. The resultant effect of this is
decreases in the funds available to the financial sector, credit
contraction, rise in interest rates, discourage investment, lower
aggregate spending and ameliorate inflationary pressure. The
effectiveness of this policy instrument requires the existence of a well
develop financial system, integrated and interest sensitive financial
markets where the amount of government securities held by the bank
and non- banks public is large.
No wonder until June 1993, it has not been possible to effectively put
to operation this instrument in Nigeria mainly due to the undeveloped
nature of our financial system in general and money market in
particular.
Similarly, low volume of government securities and insensitivity of
interest rates to market forces impedes the effectiveness and efficiency
of this instrument in Nigeria.
However Nwanko (1980 pg 31) argued that open market operation do
not necessarily require an actual market, whether developed or
underdeveloped to operate effectively. According to him, all that is
required is that the government broker and the central bank have the
skill and dexterity to be able and willing to exercise and make open
market operation operative and effective. Nwanko further contended
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b. LIQUIDITY RATIO
The central banks also imposes upon the banks a minimum liquidity
ratio, being varied according to the needs of the situation it is
designed to enhanced the ability of banks to meet cash withdrawals on
them by their customers. Such liquidity ratio stands for the proportion
of specified liquid assets (such as cash, bills, and government
securities).
In the total assets of banks in the Nigerian context, this remained at 25
per cent until August 1987 when interest rate were deregulated
consequent to which it was raise to 30 percent and later lowered to
27.5 percent 1988 essentially it is now variable rather than fixed or
inflexible.
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Figure 1
MONETARY TOOLS
DIRECT
- Credit Ceilings
- Deposit ceilings
- Directed credit
- Exchange controls
- Stabilization securities
- Others
INDIRECT
- Omo
- CRR
- MRR
- Parity changes
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PROXIMATE TARGETS
- Interest rate
- M1, M2, M3
- DC
- H
ULTIMATE GOALS
- Outputs
- Price stability
- Sustainable balance of payment
- Exchange rate stability
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employment and rising price, differs not from the ones advanced
today. The relationship between money and price was first
emphasized in the sixteenth century. Later in the seventeenth and
eighteenth centuries a comprehensive theory on the relationship
between money, velocity, economic activity and trade was
development. The postulation was that money and velocity of
exchange are the determinants of economic activity and trade. Some
distinctions between money and trade was advanced (Locke 1700 and
on employment (law 1708). On the other hand, the problem of pricing
process was the main preoccupation of nineteenth century economist.
They devoted considerable time to discover the technique of optimal
allocation of productive recourses among competing uses as well as
determinant of the prices of productive resources and final products.
However they neglect the macro economic problem being deluded by
the assumption of full employment of resources. They are of the
opinion that production creates it's own demand as such depression is
simply a temporary departure from full employment. Therefore they
postulates that variation in money stock in the long run will bring
about change in the price level rather than to changes in employment
and output.
The late nineteenth century and early twentieth century witness a re-
awakening of interest in monetary economics and a renewed
emphasis on the problems affecting the level of economic activity.
Economists strive to develop an analytical framework for both price
movement and cyclical fluctuation in the economy. Thus lrvying
Fisher developed equation of exchange - a tool of economic analysis
used by economist of almost all theoretical learning today. Fisher
propounded that changes in money stock is the principal cause of
variations in gross national product rather than simply in prices, his
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They postulate that variation in money stock can only affect nominal
variable like wages, price level etc and such monetary policy is
irrelevant.
This was widely seen to be idealized picture of a world in which
during the course of the nineteenth century, there were quite marked
and often, it appear, relatively similar cycles around a normal
equilibrium levels of output. This was explained by a group of
economist, comprising such famous names as Wicksell, Hawtrew and
Dennis Robertson, as reflecting certain imperfections within the
economic system, especially and notably within the banking system
that prevented the economy adjusting as perfectly as indicated within
the simplified classical model. In particular, bankers like everyone
else, would find it hard to distinguish between these occasions when
an expansion would quickly exhaust itself in an inflationary impulse,
or might actually represent a real economic improvement, say as a
result of technological innovations and supply side improvement to
the productivity of capital and labour. Thus a purely monetary
expansion increasing bank reserves, would make bankers keen to
expand lending, and the fall in interest rates would make businessmen
willing to invest and expand more generally. This would cause a
period of high profit and prosperity and general optimism, leading to
further balance sheet expansion. Assuming that the expansion was not
caused by improved real conditions, say in the form of technological
productive advances, then the expansion would ultimately lead to
inflation, a drain of cash reserves and a falling away of profit margins
as wages and inputs prices rose relative to final prices. This might
then lead to a financial crisis or panic, which would lead bankers in
turn to become much more risk averse, conservative, and unwilling to
increase the size of their balance sheet. Leading then to a downturn
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generates three effects viz: the wealth effects, the cost of capital
effects and the credit rationing effects.
Considering the wealth effect, the fall in interest rate appreciates the
market value of individual wealth, which tends to induce consumption
and via the multiplier effect stimulate investment and aggregate
output.
For the cost of capital effect which postulates that the main
determinant of investment is the cost of borrowing, the decrease in
interest, all else being equal will make the cost of burrowing cheaper
and given the inverse relationship between investment and the rate of
interest, will induce investments which through multiplier, increases
aggregate output.
While the credit rationing effect operates through the attempt of
commercial banks to readjust their lending policy in respect of
changes in their reserves. With increase or excess reserves the
commercial banks tends to create more credit and as the additional
credit flows into the market, it depresses the rate of interest which
through the multiplier raises investment and output respectively.
In summary, the monetary transmission mechanism of Keynesians de-
emphasizes the role of money but involves an indirect linkage of
money with aggregate demand via the interest rate; Anyanwu (1994)
this can be symbolically depicted as thus:
OMORMS r IGNP
Where OMO is open market operation, R is commercial banks
reserve, MS is money supply, r is interest rate, I is investment and
GNP is the gross national products.
Moreover the link between net wealth of the private sector and
consumption was further analysed by Pigou (1947) and Patinkin
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(1951) in the form of "real cash balances effect" which implied that
variable in the real quantity of money could effect real aggregate
demand even if they did not change the rate of interest rate. On the
other hand, credit-rationing channel of monetary impulse was further
expatiated to show that under imperfect market, interest rates change
to borrowers by financial intermediaries, including commercial banks
would be regulated by non-market force so that lenders ration
available supply of credit by non-price mechanism. Under the
circumstances, Modigliani (1963) argued that demand for credit
limited not by willingness to borrow at the given rate but by the funds
available for rationing among the would-be borrowers.
Thus the dichotomy between the original classical and the Keynesians
models related to the prospective behaviour of agents in the economy
when faced with monetary balances. The classicalists saw an agent
using such excess cash balances quite generally for the purchases of
wide range of goods and assets; the Keynesians on the other hand saw
agents with excess balances placing these in alternative substitute
financial assets.
While the debate on the proper link between real and financial sector
continues, there appear to be a consensus among a group of economist
called monetarist or neo-Keynesians mainly the Yale school of
thought, that monetary policy operates through changes in market
price of equities "which represents claims on existing real assets. Thus
an expansionary monetary policy, for example raises the price of
equities (i.e. reduces the yield on equities) the margin between the
market valuation and the cost of reducing the existing capital goods
will stimulate new investment in these goods. Furthermore the work
of Tobin and Brainard (1968) regards the equity as the major link
between money and the level of economic activity. On the other hand,
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which before then was the ruling paradigm. These academicians were
called the new or modern quantity theorist because their postulations
aligned considerably with the tenets of the old quantity theory.
Moreover they are called monetarist because of their undaunted belief
in the supreme efficacy and efficiency of monetary policies.
The monetarist transmission mechanism recognized both direct and
indirect effects of changes of demand for and supply of money on
aggregate spending. The main argument of the monetarist is that
money is the most crucially regulatory instrument in the economy
(though not the only one as in the old quantity theory) and that money
has both direct impact on the economy and as well as indirect impact.
They went further to say that wealth holders can hold their wealth in a
different forms including money, therefore an increase in money
supply will eventually decompose itself as increase in the cash
balance of the various individuals and economy agents in the society.
As wealth holders realize excess money or liquidity and in attempt to
reed themselves of the excess balances to restore their desired level,
some of this spending will be on goods and services such as
machinery, house, personal computers and holdings. This then implies
the direct effect on spending of the increase in money supply also
refers to direct monetary transmission route.
Moreover as earlier noted, an increase in the money supply will also
tends to depressed interest rates and affects aggregate spending
indirectly. This is the indirect monetary influence on economic
activity as postulated by the monetarist. However, unlike the old
quantity theorist but much like the Keynesians the monetarist view
money as an asset and holding money like any other asset is a from of
wealth. Unlike the Keynesians who hold that only bonds are close
substitute for money, the monetarist view money as only one of the
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five forms in which wealth could be held, the other four being bonds,
equities, physical capital and human capitals thus infusing portfolio
theory into money demand analysis. The dichotomy between the
monetarist view on monetary influence and that of Keynesian is thus;
in Keynesian analysis wealth holders attempt to spend excess money
balances on bonds and so force down interest rates. While in the
monetarist analysis wealth holders attempt to spend their excess
balances on all types of assets, including goods this leads to both a fall
in interest rate and an increase in either the output or price of goods
and services.
The monetary are of the strong opinion that:
1. Variation in the stock of money is the primary cause of
exchanges in aggregate expenditure.
2. Fluctuations in the stock of money overtime and business cycle
are stable and predictable.
3. The most reliable measure of monetary impulse are the change
in the stock of money.
4. Monetary impulses are transmitted to the real economy through
a relative price mechanism (direct link) or land portfolio
adjustment mechanism (indirect link) which exerts a
considerable effect on many financial and real asset.
In summary monetarist are of the view that money and income are
directly correlated. Money variation affects long-run stock of real
capital and hence output. They expatiate further that fluctuation in
money national income is attributed largely to monetary policy whose
effect is transmission to national income both through the bond yield
and other channels Anyanwu (1994).
The monetarist transmission mechanism recognizes that money is not
just a close substitute for a small class of financial asset, but rather a
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OmoMsSpendingGNP
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(OMO), cash reserve and liquidity ratio, and discount rate, with the
key benchmark variable broad money supply (M2). The monetary
authority attempt to equate money demand and money supply and
therefore determine an optimal quantity of money consistent with
assumed target for GDP growth rate, inflation rate and external
reserve (Balance of Payment Position).
With the target of M2, the monetary authority hopes to achieve a
particular optimum level of based money (H) which has a give
relationship, represented by the money multiplier (m) with the broad
money supply (M2) the monetary base defined as the net monetary
liabilities of Central Bank has a high correlation with the money
stock. Assuming a stable money multiplier (m), CBN can control the
money supply (M2) by targeting bank reserves. Since this is the
variable which the authority can influence most directly with
instruments under its control. By targeting bank reserves through the
market base instruments the CBN expects to keep the base money (H)
and eventually broad money supply (M2) at optimum level adequate
for non inflationary economic and financial activities. Given that
broad money supply (M2), is a product of money multiplier (m) and
base money (H) as shown below
Equation 1: M2 = mH
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CHAPTER FOUR
DATA PRESENTATION AND ANALYSIS
4.1 PRESENTATION AND ANALYSIS FO REGRESSION RESULT
The data presented below, is a time series data which span over the
period of 15 years (1986 2000). This data will be filled in to the
model developed, in order to obtain the estimate of the co-efficient of
economic relationship of our interest.
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measures proxied by broad money supply (M2) (i.e. the target and
indicator of monetary policy) is thus:
Equation 4 DMPER = - 51.4 + 1.2 M2
(51.5) (0.2163)
bo = 51.4
b1 = 1.2
R2 = 0.67
DW = 2.03
S(bo) = 51.50
S(b1) = 0.2163
The result of the estimated equation above indicates that there exist a
positive linear relationship between the performance of the banking
industry and monetary policy. A unit increase in the monetary policy
target M2 comparable with he absorptive capacity of the economy will
yield more than a unit increase in deposit mobilization performance of
the banking industry (DMPER) conforming to our apriori expectations
and the alternative hypothesis. However the sign of the constant
coefficient (bo) is unexpected. The standard error values, in the
parentheses indicates that standard error of the constant S (bo) 51.5 >
1
/2 bo (-25.7), this shows that the value of the constant coefficient (bo)
i.e. 51.5 is not statistically significant from zero (i.e. we accept Ho:
bo = 0). While the standard error value of the variable coefficient of
M2 S(b1) 0.2163 < 1/2 b1 (0.6) which shows that the value of the
variable coefficient of M2 bi. (i.e. 1.2) is statistically significant from
zero (Hi: b1 0). From the foregoing analysis we reject our null
hypothesis Ho and adopt the alternative hypothesis.
Furthermore the value of the coefficient of determination R2 = 0.67,
indicates that 67 percent of the variation in deposit mobilization
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5:2 CONCLUSION
This research finding has show that the there is a causal positive
relationship between monetary policy and the performance of the
banking industry, which is proxied by deposit mobilization
performance of commercial bank (DMPER). The study observes that
in the period under study (1986-2000) the era of deregulation and
guided deregulation, deposit mobilization increase, financial
deepening was low, there is greater liquidity in the banking sector
indicating lower earning power, greater entry into the industry is also
noted and the development of other banks and non-banks financial
institutions was accelerated this aided the mobilization and
distribution process. From the foregoing analysis empirical conclusive
evidence abound that monetary policy exerted considerable influence
on the banking industry under the era of deregulation and guided
deregulation in Nigeria. The observe effect has helped to create the
enabling environment for bank to perform their primary function of
financial intermediation. Although monetary policy has influence
deposit mobilization performance, banks pattern and direction of
credit, entry and distress of bank, interest rate and spreads, assets
structure and liquidity, among other things however, the observed
effect has not been fully maximized. The major challenges to the
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THE EFFECT OF MONETARY POLICY ON THE PERFORMANCE OF THE BANKING INDUSTRY
REFERENCES
A. TEXT BOOKS
Anyanwu, J.C. (1994): Monetary Economics: theory, Policy and
Institutions, (Hybrid Publishers Ltd.)
Ajayi S.I. & Ojo O (1981): Money and Banking (George Allen &
Unwin, London).
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Educational Books Nig. Plc.).
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Introduction (Pitman London)
Bugg, D. Henderson, M.A. (1968): Modern Business Statistic (Pitman
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Fisher Irvy (1911): The Purchasing Power of Money
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B JOURNALS
Adewuyi, A.D. (2000): Absorptive Capacity and Macroeconomics
in Nigeria (Financial report, NISER,
Ibadan).
Ajakaiye, D.O. (1992): Challenges of the Nigerian Banking Sector;
A macroeconomic overview Economic and
Business review vol. 1, June pp. 9 18
(New Nigerian Bank Plc. Benin city).
Ayodele J. (1998): Regulation of the Banking industry in
Nigerian; An operators view point (CBN
Economic and financial Review vol. 32, No.
3).
Cacy, James, A. (1980): Choice of a monetary Policy Instrument
Current issues monetary theory and policy;
second edition (AHM publishing
corporation Illinois)
Central Bank of Nigeria (1998 2002): CBN Briefs (Research
department CBN publication).
Friedman Milton (1970): A theoretical framework for monetary
Analysis Journal of political Economy).
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C. NEWSPAPERS.
Ajakaiye D.O. (1992): Challenges of the Nigerian Banking sector;
A Macroeconomic Overview Economic
and Business Review vol. 1, June pp. 9 18
(New Nigerian Bank Plc., Benin City).
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