CHAPTER ONE

INTRODUCTION

1.1     BACKGROUND OF THE STUDY

The Central Bank of Nigeriais responsible for implementing monetary policy, regulating and supervising banks, and operating the payments system. With these responsibilities come the authority to raise and lower national interest rates in the banking industry. Interest rate movements help balance inflation and keep the economy stable. When the economy slows and inflation is high, the CBN raises interest rates to change consumer behavior Interest has been variously defined both by conventional economists and Islamic economists. In conventional economic interest rate refers to that surplus income that is positive which a lender receives from the borrower over and above, the principal amount, as a reward for waiting or parting with the liquid part of his capital for a specified period of time.

Given the prominent role of the banking sector in the euro area’s financial system, it is of significantimportance for the ECB to monitor the degree of competitive behaviour in the euro area bankingmarket. A more competitive banking market is expected to drive down bank loan rates, adding to thewelfare of households and enterprises. Further, in a more competitive market, changes in the ECB’smain policy rates supposedly will be more effectively passed through to bank interest rates.

This study extends the existing empirical evidence, which suggests that the degree of bank competitionmay have a significant effect on both the level of bank rates and on the pass-through of market rates tobank interest rates. Understanding this pass-through mechanism is crucial for central banks. However,most studies that analyse the relationship between competition and banks’ pricing behaviour apply aconcentration index such as the Herfindahl-Hirschman index (HHI) as a measure of competition. Wequestion the suitability of such indices as measures to capture competition. Where the traditionalinterpretation is that concentration erodes competition, concentration and competition may insteadincrease simultaneously when competition forces consolidation. For example, in a market whereinefficient firms are taken over by efficient companies, competition may strengthen, while themarket’s concentration increases at the same time. In addition, the HHI suffers from a seriousweakness in that it does not distinguish between small and large countries. In small countries, theconcentration ratio is likely to be higher, precisely because the economy is small.

The main contribution of this paper is that it applies a new measure for competition, called the Booneindicator (see also Boone, 2001; Bikker and Van Leuvensteijn, 2008; Van Leuvensteijn et al., 2007).The basic notion underlying this indicator is that in a competitive market, more efficient companies arelikely to gain market share. Hence, the stronger the impact of efficiency on market shares is, thestronger is competition. Further, by analyzing how this efficiency-market share relationship changesover time, this approach provides a measure which can be employed to assess how changes incompetition affect the cost of borrowing for both households and enterprises, and how it affects thepass-through of policy rates into loan and deposit rates.Our study contributes also to the pass-through literature in the sense that it applies a newly-constructeddata set on bank interest rates for eight euro area countries covering the January 1994 to March 2006period.

This paper uses interest rate data that cover a longer period and that are based on more harmonized principles than those used by previous pass-through studies for the euro area. We find that strongercompetition implies significantly lower interest rate spreads for most loan market products, as weexpected. Using an error correction model (ECM) approach to measure the effect of competition on thepass-through of market rates to bank interest rates, we likewise find that banks tend to price their loansmore in accordance with the market in countries where competitive pressures are stronger.

Furthermore, where loan market competition is stronger, we observe larger spreads between bank andmarket interest rates (that is, lower bank interest rates) on current account and time deposits. Lowertime deposit rates in countries with stronger bank competition are confirmed by the ECM estimates.Apparently, the competitive pressure is heavier in the loan market than in the deposit markets, so thatbanks under competition compensate for their reduction in loan market income by lowering theirdeposit rates. Furthermore, in more competitive markets, bank interest rates appear to respond morestrongly and sometime more rapidly to changes in market interest rates.

1.2     STATEMENT OF PROBLEM

The fundamental problem of any government vogue is its economic or otherwise its implementation. a number of government monetary policy instruments have been designed and applied in Nigeria in the hope of achieving the desired result of stable price level, low level of unemployment, efficient banking system etc. but the applications of direct monetary instruments have not bring forth the desired objectives stated above hence, left the government without any other alternative than to turn to the direct monetary instrument. Therefore, the problem under study is the impact of rising interest rate on manufacturing sector. One of the principal function of the central bank of Nigeria (CBN) is to formulate and execute monetary policy to promote stability and soundfinancial system in Nigeria.Monetary policy was adopted when strategy shifted to demand management containing inflation preseure, balance of payment, imbalance and high deflect in the federal budget and the effect on the growth in money supply. Consistent with the monetary targeting problems of the Central Bank of Nigeria (CBN) focuses on liquidity management to achieve the objective by maintaining price and macro economic stability.Despite all these efforts that put are in place by Central Bank of Nigeria, the problem of monetary management have persisted and the main constraints continue to be the ineffective control and the uncertainty created by fiscal operation.

1.3     OBJECTIVE OF THE STUDY

• To identify if loan interest rates are lower, and deposit interest rates higher, in more competitive loan markets than in less competitive loan markets
• To assess long-run loan and deposit interest rate responses to corresponding market rates are stronger in more competitive loan markets than in less competitive loan markets
• To identify bank interest rates in more competitive markets adjust faster to changes in market interest rates than in less competitive markets

1.4. RESEARCH QUESTION

1. How does interest rates are lower, and deposit interest rates higher, in more competitive loan markets than in less competitive loan markets?
2. How does long-run loan and deposit interest rate responses to corresponding market rates are stronger in more competitive loan markets than in less competitive loan markets?

iii.      Is bank interest rates in more competitive markets adjust faster to changes in market interest rates than in less competitive markets?

1.5     SIGNIFICANCE OF THE STUDY

However, the research study will assist the economic to derive possible solution to the problem e.g. inflation using policies measures as adopted by the monetary authorities. Further, the research, x-rays that types of monetary policy measure which can be use to combat the problem of unstable economic and as a result will be a kind of it may be concerning of their field of study.

Government will benefit immensely on the research work as the research have put it down.

1.6     SCOPE OF THE STUDY

This project covers the impact of rising interest rate on manufacturing. A general overview of monetary policy and inflation in the Nigerian economy is the foundation upon which the project is developed.

1.7     LIMITATION OF THE STUDY

However, study of this nature is known to be subject to a number of problems or constrains, which are peculiar to the Nigerian society such as financial constraints.

This research work was not an exception the problem of visiting the Central Bank of Nigerian and some other places for data collection involved spending a lot of money or transport expenses.

Hence, the predicament of the overage students can therefore be imagined.

Furthermore, the issue of office protocols time limit, secrecy inadequate research materials also were some setbacks to the researchers in carrying out this research.

1.8     DEFINITION OF TERMS

The author considers it necessary to define the following terms as applied within the context of this project.

Asset portfolio: Arrangement of bank assets on order of its

liquidity and profitability.

Advances: These are monies lent by a bank generally in the form of an overdraft on a current account and also by means of a loan or personal loan.

Affidavit form: This is a written statement used as a legal proof.

Bank credit: Credit created by a bank increasing the size of the account of a depositor e.g. when making an advance.

Branch banking: the typical commercial bank in most countries is a very large institution with a large number of branches.