Commercial Banks‟ Pricing of Loans, Assets Quality and Financial Intermediation in Nigeria
Abstract
Despite the interest rate liberalization policy that gave rise to commercial banks’ pricing of loans models which is expected to enhance quality of banks assets and improve financial intermediation, poor assets quality of banks, bank failures and poor intermediation role of banks are still prevalent in Nigeria. Therefore, the focus of this study is to estimate commercial banks’ pricing of loans model and use the model to evaluate assets quality of banks and level of financial intermediation in Nigeria since the financial liberalization reforms of 1986 - 2002. Based on a sample of nine Deposits Money Banks (DMBs) with data sourced from their annual balance sheet and income statements of accounts from 2002 – 2016, the study used one-way fixed effect Least Squares Dummy Variable (LSDV) model to estimate the banks’ pricing of loans model. The estimated LSDV parsimonious model revealed R2 of 0.60 for the ‘low risk’ credit market. Most significant is the revelation that the coefficient of the credit risk variable is significantly negative in the ‘low risk’ and ‘high risk’ credit markets, contrary to the a priori theoretical expectation. This finding shows that the DMBs underprice credit risk to ‘buy’ market share in the spirit of relationship banking with support from non-interest income (fee–based products) that evolved due to product  innovations  brought  about  by  financial  liberalization.  These  attitudes  of  the  DMBs  are  in response to stiff competition provoked by financial liberalization which has adverse consequences for assets quality of banks that deteriorated and successively led to bank failures, high cost banks bailouts and low level of financial intermediation, with financial disintermediation and ‘inverted intermediation’ militating against economic growth. This study, therefore, recommends that Central Bank of Nigeria (CBN) should up-step its focus on prudential regulations with greater emphasis to macro-prudential regulations to enhance assets quality of banks, reduce bank failures and improve financial intermediation for economic growth.
CHAPTER 1
INTRODUCTION
1.1 Background to the Research
The relationship between financial liberalization reforms and economic growth has been widely discussed  and  documented  in  the  literature.  Consequently, there  is  considerable  degree  of agreement  among  economists  that  financial  liberalization  facilitates  economic  growth.  The theoretical  foundation  linking  liberalization  reforms  to  economic  growth  comes  from  the neoclassical  approach  to  efficient  distribution  of  financial  and  economic  resources.  This approach dominates the policy thinking and therefore, recommendations of multilateral financial institutions such as the International Monetary Fund (IMF), the World Bank (WB) and the Bank for International Settlement (BIS) in the last 2 decades. According to the theoretical postulation, the impact of liberalization on investment and economic growth is centered on competition which  promotes,  among  other  things:  financial  deepening,  expansion  of  financial  markets, resource  efficiency  in  mobilization  and  allocation  through  market-based  banks‟  pricing  of financial products, innovation as a result of technology developments. All these lead to economic growth and consumer welfare (Kaufman, 1972; Mackinnon, 1973; Shaw, 1973).
Following  these  theoretical  expectations,  policymakers  in  some  developing  and  emerging economies in Africa, Asia and Latin America such as Nigeria, Kenya, Malawi, Ghana, Malaysia, Indonesia, Chile and Venezuela, to mention a few, implemented interest rate deregulation policy in the 1980s and 1990s. Quite unexpectedly, a large strand of empirical studiesparticularly in developing  economies  reveals  findings  that  financial  liberalization  policies  had  resulted  in domestic banking crises  that highly correlate  with increase in banks‟ non-performing loans (NPLs)  and  macroeconomic  volatilities  in  real  Gross  Domestic  Product  (GDP),  inflation, exchange rate etc(Demirguc-Kunt and Detragiache, 1998; Kaminsky and Reinhart, 1999; Garba and Garba 2002).This contradiction provokes researchparticularly in developing economies like Nigeria,where banking problems erupted in the aftermath of liberalization reforms.
Financial liberalization reforms started in Nigeria with interest rate deregulation policy of the Structural Adjustment Program (SAP) in 1986. This was concluded in 2002 with Universal Banking System and Capital Account Deregulation reforms. According to the Central Bank of Nigeria (CBN), the driving force to interest rate deregulation (liberalization) policy shift is the desire  to  achieve;  enhanced  efficiency  in  the  mobilization  and  utilization  of  resources  for financial intermediation, restore macroeconomic stability, sustainable economic growth as well as develop an efficient framework for monetary management (Sanusi 2002).Thus, the interest rate deregulation reform allows commercial banks (known as Deposit Money Banks (DMBs) to use market forcesto set the lending rate for the credit markets without regulatory intervention.
Since I986 whenthe DMBs commencedthe market-based pricing ofloans,assets quality of the banks had successively declinedwith rise in NPLs.Over the years, both the proportion and level of NPLs in Nigeria had escalated, leading to banks insolvency and closure of many banks. For instance, in 2008 after banks consolidation, the DMBs were exposed to the tune of N1.6 trillion margin loans in capital market and oil and gas sectors which turned to NPLs (Sanusi (2010).  By 2009, the proportion of NPLs to total loans was 33% while the level of NPLs stood at N2.9 trillion.  These  proportion  and  level  of  the  NPLs  were  drastically  reduced  to2.88%  and N363.31billionrespectively  in  2014  when  the  Assets  Management  Corporation  (AMCON) purchased over N3 trillion banks NPLs to enhance bank intermediation (CBN 2016). However, by  2016  the  proportion  and  level  had  escalated  to  12.80%  and  N2.1  trillion  respectively, suggesting a fresh banking crisis in the post- AMCON era.
The phenomenal rise in NPLs and the corresponding fall in assets quality of banks over the years are  suspected  to  be  linked  to  portfolio  capital  surge  and  reversal.  The  capital  account deregulation  allowed  freecapital  flows  which  intensified  market  risk  in  the  Nigerian  Stock exchange Market (NSE) that resulted to accumulation of banks NPLs. For instance, the rise in NPLs was always preceded by portfolio equity net inflows, first in 2008 when the outflow was ($959.8) million and secondly, in 2005 when the net outflows was ($476.6) million.
Therapid  increase  in  proportion  and  level  of  NPLs  has  impeded  the  DMBs‟  capacity  to playeffectively their traditional role of financial intermediation for economic growth. In fact, since liberalization reform started,financial intermediation had never been achieved; instead, financial disintermediation and „inverted intermediation‟ have become common features of the Nigerian banking sector. From the financial statistics, it is obvious that the DMBs havefailed to effectively discharge their primary role of financial intermediation. For instance, the banks total assets grew significantly from N1.568 trillion in 2000 to N3.753 trillion in 2004 and by 2009, total banks assets stood at N17.52 trillion. Thisincreased rapidly to N31.68 trillion in 2017 (CBN statistical bulletin 2016). Likewise, total banks deposits grew from N11.49 billion in 1986 to N343.17 billion in 2000. By 2014 and 2016, total savings mobilization had risen to N11.9 trillion and N12.14 trillion respectively (CBN statistical bulletin 2017). Over the years, these rapid increases in banks assets and liabilities failed to stimulate growth in investment and employment in the real sector. This is evident by the decline in ratio of loans and advances to total deposits which stagnated from 83.3% in 1986 to 51% in 2000. The trend deteriorated further after consolidation when the ratio declined to 38% in 2013 and by2016 it increased to 75.9 %(CBN Statistical bulletin 2017).Disturbed by the low level of bank intermediation, the CBN in August
* PHD ECONS