Banking and Finance | The effect of financial reform on banking performance in an emerging market

The effect of financial reform on banking performance in an emerging market

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CHAPTER ONE

INTRODUCTION

1.1       BACKGROUN OF THE STUDY

 Financial institutions play the critical role of mobilizing savings from the surplus economic units and directing same to the deficit economic units for investment purposes. The financial system is the central nervous system of every economy, especially, a market economy. It comprises a number of separate but interrelated components all of which are essential to its effective and efficient functioning. The three main inter-related components include: Financial intermediaries (institutions) such as banks and insurance companies, which act as principal agents for assuming liabilities and acquiring claims (i.e accept deposits and make payments); the financial market in which financial assets are exchanged; and, the financial instruments which is necessary for the effective interaction of the intermediaries in the markets. These three components are inextricably intertwined. Banks need the payment system infrastructures (instruments) to exchange claims securely; and markets to provide the avenue for their intermediation activities. The banking system therefore functions more effectively and efficiently only when these three components are present and indeed robust. It is therefore against this back-drop of the very critical and strategic role which the banking system play in national economic development that makes the issue of banking reforms imperative although the reforms most times have been reactive rather than proactive, especially in Nigeria and other developing economies.

The Financial sector is in no doubt a very essential part of the economy of a nation and any reforms carried out in the financial sector extends to other parts of the economy representing a transformational moment for the economy and its people. Financial sector reforms however have been a regular feature of the financial system. The reforms have evolved in response to the challenges posed by developments in the system such as systemic crisis, globalization, technological innovation, and financial crisis. Financial reforms in Nigeria dates back to 1952 when the banking Ordinance was enacted. The deregulation of banking in 1986 provided the impetus for the Structural Adjustment Programme. The 1986 reform of the financial system saw a policy shift from direct control to a market based financial system, especially as regards monetary management, risk management and asset holding capabilities of the institutions. A number of other reforms followed including the consolidation policy in banking in the year 2005 and insurance in 2007.

For clarity, the financial sector does not only mean the banking sector, the banking sector only holds a major stake in the financial sector of the economy making it more pronounced than other sectors of the economy. We also have the Non-Bank Financial institutions (NBFI) which includes Insurance companies, Discount Houses, Unit trust, the capital market institution through which bond, stocks and other securities are traded, interest rates are determined and financial services are produced and delivered around the world. The money and capital markets, along with the financial system that support them, are an exciting area for study. The capital market has also experienced a lot of reforms over the years and is still in place, especially as regards the capital requirements of the operators, the operational and ethical standards of the institutions and the modalities of the market mechanism. The reforms in the system impacted positively on the growth of the financial system and the economy in general. What goes on daily in these markets and within the financial system, as a whole, has a powerful impact on the economy. Broad changes are forever remaking the financial market as new institutions, new methods, new problems and new services continually appear. The reforms often seek to act proactively to strengthen the system, prevent systemic crisis, strengthen the market mechanism, and ethical standards. Likewise recent reforms have also been evident in the banking sector with the abolishment of universal banking, reduction in the tenure of MD/CEO of banks, introduction of Asset Management Company with its sole responsibility of buying back toxic assets from banks currently in need and return capital to the banks, improve liquidity and prepare grounds for the Central Bank of Nigeria to exit from the affected banks

Financial reform is a possible change made to a household, system, firm, government, economies etc. in order to perform and operates in a more effective and efficient way within the context of stipulated regulatory policies

(Oke, 2008). The reform of financial markets and banks remain a persistent force in the growth and development of financial sector in developed economies, developing economies and emerging markets (Nigeria inclusive).

The reform of the financial sector could easily be traced to banks’ competitive actions, assisted with continuous rise in government regulations over the soundness of banks’ strong financial positions (John&kent,  2008). The financial markets and mostly banks remain the strategic engine of economic growth of developing, developed and emerging economies (Nigeria inclusive). It must be noted that Deposit Money Banks (DMBs) play financial intermediary roles in the mobilization of available resources from surplus economic units to satisfy the requirements of the deficit unit of the economy. The financial intermediary act being performed by DMBs, banking sub-sector to easily influence the direction of available resources, thereby greatly affecting the rate of economic development. Though, Banks mediate between demand for credit and supply of deposit globally, but for these to work effectively and efficiently, there should be a platform for fair and healthy competition, that must be tolerated in the sector; which would impliedly require reform in the financial sector and creating a perfect competitive situations, which would help to harmonize: numerous suppliers / buyers of roughly equal size, free flow of information and homogenous products and services etc., hence, in such situations, either government or banks are permitted to interfere in the market.

The financial reforms have helped to facilitate capital formation and generate growth in the economy, but the consistent and persistent financial intermediation roles of Banks have been able to foster national and international development via the means of channelling resources into sectors of priority for sustainable development. The development of Nigerian financial institution system could be characterized by changes in structure, growth and emerging challenges since the era of Structural Adjustment Programme in 1986 to date (see Ahmed, 1987; Lamberte, 1989; Soyinbo & Adekanye, 1992). It is believed that the financial system of developed economies, third world economies and emerging markets remained the framework within which the capital formation takes place through the intermediation of the financial institutions processes (Akingunola, 2006). Therefore, the reform of financial markets and banks in twenty-first century involves the processes of financial innovations, globalization and deregulation in advanced- economies banking sector; but operations of Other financial institutions if not checked might affect the performance of banks in any economy (See John &Kent, 2008; Obadeyi, 2013, CBN, 2014). However, the authorities via Central Bank of Nigeria (CBN) should intervene in the operation of the banking system in order to correct the shortcoming of price fixing mechanism so as to ensure that what is commercially rational for an individual bank also possesses approximate characteristics of social rationality as much as possible. Thus, the interest rate charge by bank is regulated to encourage savings mobilization and to ensure enough investment for rapid economic growth.

1.2     STATEMENT OF THE PROBLEM

Critically examining the nature of Nigeria’s financial sector challenges, arguments have been raised on the way and manner in which reforms was carried out by Lamido Sanusi, the past Central Bank of Nigeria (CBN) Governor, whose actions have been regarded as playing a one man show in a disintegrated gathering. However, the major problem posed in this study is on the question of both the long and short run possible effects of the recent financial sector reforms being carried out. By so doing, comparisons are done on reforms carried out before now and those done currently to actually determine the true state of Nigeria’s financial sector and how far it has helped in the economic development of the nation. Of the major problems are lacks of proper attention to the needs of the real sector of the economy, inadequate policy framework for financial development, weak regulatory supervision in a highly liberalized financial environment allowing banks become over confident, audacious, less transparent and less accountable in the handling of their diverse portfolios of services. There is undue preference by banks for financing general merchandise rather than manufacturing, agriculture, power, and the importation of finished goods rather than raw materials, plants and equipment. The real sector is a vibrant part of the economy that needs special attention but due to lack of funds, it has since been in a poor state.

The government has adopted policies aimed at achieving specified objectives, such as; interest rate ceilings and selective sectorial policies. Those policies were introduced with the intention of directing credit to priority sectors and securing “inexpensive “funding for their own activities (Fry, 1998). The ceiling on interest rate and quantity restriction on loanable funds for certain sectors ensures that a larger share of funds is made available for favoured sectors hindering financial intermediation since the financial markets will only be accommodating the credit demand of the government plan and ignoring risks. Regulatory agencies empowered with the task of monitoring the affairs of financial institutions have relaxed resulting to less transparency in financial records, inefficient operations and ultimately fraud and unethical practices.

1.3      RESEARCH QUESTIONS

The research therefore seeks to answer the following research questions;

i. To what extent does financial reform affect emerging market?

ii. How does financial reform help the banking performance in Nigeria?

iii. What are the impacts of banking performance on an emerging market?

1.4      JUSTIFICATION FOR THE STUDY.

This research work is needed in order to know if financial reforms have any impact on banking performance in an emerging market in Nigeria.

Related research works were carried out on this topic in different countries and different part of the Nigeria because of its importance to the economy. These research include :(see Obadeyi  2014; Iganiga 2010;  Dabo 2012; Ogunsakin  2015) all aiming at justifying the effect of financial reform on banking performance in an emerging  Market. These studies cannot claimed to be detailed enough when critically consider the importance of banking performance which is vital organ in the financial sector of an emerging market like Nigeria emerging market. Iganiga (2010) in his work on the evaluation of Nigerian financial sector reforms he uses behavioural models concluded that the monetary authorities should direct their efforts towards achieving a positive interest rate regime, increasing the scope of financial reform arsenal including financial instruments and improving the regulatory framework. There is need to lower lending rate in Nigeria. Furthermore, the study was carried out using lease square analytical tool. In contrast, this research was targeted on the effect of financial reform on banking performance in emerging market and using the simple linear regression as analytical tools in analyzing the effect of financial reform. 

The study carried out by Dabo (2012) focus on the impact of financial liberation on baking performance in Nigeria. Also the research work carried out by Obadeyi (2014), which can be said to be more similar to this study was out in the city of Lagos Nigeria. This study basically focuses on the banking in industry in Ilorin, kwara state, Nigeria. 

Therefore the beauty of this study is the compliment it would provide in addition to these previous studies while also providing a stepping stone for further research. 

1.5    OBJECTIVE OF THE STUDY.

The main objective of this study is to undertake a review of effect of financial reform on banking performance in an emerging market. The specific objectives were to;

i. examine how financial reform affects emerging market.

ii. investigate the true state of Nigeria financial reform on banking performance and how it helped in economic development.

iii. evaluate the impacts of banking performance on an emerging market.

1.6    HYPOTHESES

The following null hypothesis will enable this study achieve its objective;

Ho1: there are no significant relationship between financial reform and emerging market.

Ho2: there is no significant relationship between financial reform and banking performance in Nigeria

Ho3: there is no significant relationship between banking performance and an emerging market.

1.7    SCOPE OF THE STUDY

The research work is based mainly on The Effect of Financial Reform on the Banking Performance in an Emerging market Nigeria Experience. However due to financial inadequacy and time frame, the scope of this study is limited to central bank branch in Ilorin. This study will cover the periods of 2005 to 2015

1.8 DEFINITION OF TERMS

Capital Market: this is a market where buyer and sellers engage in trade of financial securities like share bond etc.

Performance: the profitability of the banking sector i.e how well or badly they are doing

Market Capitalization: this is the total market value of the share outstanding of company 

Traded Volume: the number of equities and bond traded in stock market for a particular year

All Share Index: the overall share performance of quoted companies both banking sector and nonbanking sector computed on a daily basis

Share: a part of ownership of a company

Bank: this is a financial intermediary (institutions) which act as principal agents for assuming liabilities and acquiring claims (i.e. accept deposits and make payments)

1.9   PLAN OF THE STUDY 

The report of this study would be organized into five chapters;

Chapter one, the introduction to the study.

Chapter two, the review of relevant literature.

Chapter three, the research methodology for the study.

Chapter four the data presentation and analysis.

And then the chapter five would be the summary of the study, conclusion and then recommendation.

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