THE IMPACT OF MONETARY POLICY ON THE PROFITABILITY OF BANKS IN NIGERIA

CHAPTER ONE INTRODUCTION 1.1 Background of the Study The banking sector plays a pivotal role in the economic development of any nation by facilitating capital formation, financial intermediation, and economic growth. In Nigeria, Osho & Adelalu (2020) averred that banks are instrumental in mobilizing savings and directing them toward productive investments. However, when the economy is faced with challenges such as inflation, unemployment, increase interest rates this discourages investments causing decreased trade, as investor confidence are undermined caused market uncertainties, as well as disruptions in supply chains (Anamakiri, 2018). This macroeconomies variable in no doubt heavily affects the banking sector. Over the years, the CBN has employed various monetary policy instruments such as the Monetary Policy Rate (MPR), Cash Reserve Requirement (CRR), and Open Market Operations (OMO) to regulate the economy. These tools are designed to stabilize inflation, ensure exchange rate stability, and foster economic growth. Monetary policy refers to the actions taken by a central bank, such as the Central Bank of Nigeria (CBN), to control money supply, interest rates, and credit availability to achieve specific economic objectives. Ugwu, Peter & Udolu (2020) defined monetary policies as an attempt by the monetary authorities to emphasizes the level of aggregate economic policies as attempt by it to influences the level of aggregate economic activities by controlling the quantity and direction of money, and Credit availability. However, the effectiveness of these policies has significant implications for the financial sector's stability and the profitability of commercial banks. Owing that banks operate in a dynamic environment, where there is a change in monetary policies , Quan (2023) averred that this policy changes can create opportunities or pose challenges. For instance, a contractionary policy aimed at reducing inflation may increase interest rates, potentially limiting borrowing and reducing profit margins. Empirical studies by Afolabi, Adeyemi, Salawudeen, & Fagbemi (2020) have suggested a mixed relationship between monetary policy and bank operationin Nigeria. The authors argued that while policies that stabilize the economy can foster confidence, encourage investment, and ultimately benefit banks, on the other hand, inconsistent policy implementations and regulatory challenges may negatively affect banks' operations and efficiency. For example, sudden adjustments in the CRR can constrain banks' lending abilities, while unpredictable exchange rate policies can lead to foreign currency losses. Conversely, Boaten (2020) explained that the interaction between monetary policies and bank profitability whether in developed or developing countries is also shaped by external factors, including global economic trends and local economic conditions. For instance, during periods of high inflation or economic downturns, banks may struggle to maintain profitability due to reduced borrowing and heightened loan defaults. Whereas periods of economic growth and stable policies tend to provide a conducive environment for bank operations, changes in the Cash Reserve Requirement (CRR) often restrict the liquidity available to banks, reducing their capacity to extend loans and thereby impacting profitability. In Nigeria, Borhan, & Towpek (2018) pointed that monetary policy influences not only profitability but also banks' risk management practices. By controlling liquidity and credit availability, monetary policies directly affect the risk appetite of banks, particularly concerning their lending activities. Howbeit, striking a balance between profitability and risk remains a critical challenge for banks operating in Nigeria’s volatile economic environment. This study, therefore, seeks to investigate the impact of monetary policy on the profitability of banks in Nigeria. 1.2 Statement of the Problem it is no doubt that the profitability of banks is crucial for maintaining a stable financial system and fostering economic growth. However, in Nigeria, banks often face fluctuating profitability levels due to the volatile economic environment and inconsistent monetary policies. The Central Bank of Nigeria's efforts to manage inflation, stabilize the exchange rate, and promote economic growth through monetary policies have sometimes yielded unintended consequences for the banking sector. For instance, frequent adjustments in the Monetary Policy Rate (MPR) can create uncertainty in lending and borrowing, affecting banks’ interest income. Furthermore, studies on the impact of financial regulation on profitability as evaluated by return on asset and net interest margin undertaken by Ugwu et al. in 2020 and Mulwa in 2015, respectively, indicated an insignificant connection among the variables Existing studies have examined the relationship between monetary policy and bank profitability but have produced mixed results. For example, Akomolafe et al. (2015) found that interest rates and liquidity significantly affect the profitability of insurance companies, but similar studies focusing on deposit money banks have highlighted gaps in understanding how cash reserve requirements and exchange rate fluctuations specifically influence their profitability. This inconsistency suggests the need for a more targeted investigation into the interplay of these variables in the Nigerian banking context. Couple with the fact that the Nigerian banking industry has witnessed increasing operational costs and declining profit margins due to volatile macroeconomic factors, including inflation and currency devaluation (Adegbite & Aluko, 2020), the extent to which monetary policy variables such as money supply and liquidity mitigate or exacerbate these challenges remains underexplored. Bizarrely, there is a notable lack of recent empirical studies that integrate modern econometric models to evaluate the long-term effects of monetary policy on bank profitability. Many studies emphasize the theoretical aspects of monetary policy without providing sufficient empirical evidence on how these policies affect banks' bottom lines. This study aims to bridge this gap by providing empirical insights into how monetary policies influence the profitability of banks in Nigeria, thereby offering practical recommendations for policymakers and banking institutions. 1.3 Objectives of the Study The objectives of this study is focused on the impact of monetary policy on the profitability of banks in Nigeria. Specifically, the study seeks to: i. evaluate the impact of money supply on the profitability of deposit money banks in Nigeria. ii. assess the effect of cash reserve requirements on bank profitability. iii. examine the influence of interest rates on the profitability of banks. iv. analyze the effect of exchange rate fluctuations on the profitability of banks in Nigeria. 1.4 Research Questions i. What is the impact of money supply on the profitability of deposit money banks in Nigeria? ii. How do cash reserve requirements affect the profitability of banks in Nigeria? iii. What is the influence of interest rates on bank profitability? iv. How do exchange rate fluctuations impact the profitability of deposit money banks in Nigeria? 1.5 Research Hypotheses H₀1: The Monetary Policy has no significant impact on the profitability of banks in Nigeria. H₀2: Monetary Policy has no significant impact on Cost to Income Ratio of Nigerian DMBs 1.6 Significance of the Study Practically, the study is significant for policymakers, particularly the Central Bank of Nigeria (CBN). By understanding how different monetary policy instruments affect bank profitability, the CBN can design more effective policies that promote financial stability while ensuring banks' profitability. The findings of this study will also benefit banking institutions by highlighting the monetary policy variables that significantly influence their financial performance. This will enable banks to adopt proactive strategies in response to policy changes. Empirically, the study is relevant for academics and researchers, providing a foundation for future studies on monetary policy and its implications for the banking sector. It offers valuable insights that can guide further investigation into the subject. 1.7 Scope of the Study This study focuses on the impact of monetary policy on the profitability of banks in Nigeria. It examines key monetary policy instruments, including the Monetary Policy Rate (MPR), Cash Reserve Requirement (CRR), and Open Market Operations (OMO), and their effects on bank profitability. The study covers selected Deposit Money banks in Nigeria Listed on Nigeria Stock exchange from 2016-2023. 1.8 Operational Definitions of Terms Monetary Policy: These are actions undertaken by the Central Bank of Nigeria to control money supply, interest rates, and credit availability to achieve macroeconomic objectives. Profitability: This is ability of banks to generate income and maintain financial performance, measured using indicators such as return on assets (ROA) and net interest margin (NIM). Cash Reserve Requirement (CRR): The percentage of a bank's total deposits that must be held in reserve by the Central Bank of Nigeria as a regulatory measure.