IMPLICATION OF INTEREST RATE ON BANK LENDING IN NIGERIA A CASE STUDY OF FIRST BANK

                                                       INTRODUCTION            

1.1       Background to the Study

One of the most regulated sectors in the Nigerian economy is
unarguably the banking industry. The reason includes the use of intervention by
authorities to short comings of the price fixing mechanism in the capitalist
system to ensure what is commercially rational for an industrial bank,
approximate social rationality. In the determination of interest rate it banks
and their customers are free to negotiate to arrive at the suitable interest
rate on both loans and advances. Despite the regulation, a number of challenges
still arose. The approach to banking was the use of direct control by the
central bank. The degree of compliance varied among banks. At times, withdrawal
of privilege or facilities was the case with banks that failed for comply, for
example most banks defaulted on ceilings imposed credit expansion and
allocation on sectional basis Ewert, R. (2000).

Interest rates are defined as the rental payment for the use
of credit by borrowers and return for parting with liquidity by lenders, (Ewert,
R. (2000). Like other prices, interest rates perform a rational function by
allocating limited supply of credit among the many competing demands. In the
(1987) budget announcement of the then president, General Ibrahim Babangida, it
was observed that the pegging of interest rate contrary to expectation,
commercial banks encourage savings and since investments are made out of
savings, the establishment of commercial especially in rural areas makes
savings possible, hence economic development is accelerated (Anyanwu 1997).

Socially, interest rate charged by banks could be regulated
to encourage savings mobilization, ensure and foster adequate investment for
rapid growth and development, bearing in mind the view of (Goldsmith 1969) that
the financial superstructure of an economy, accelerates economic performance to
the extent that it facilitate the migration of funds to the funds yield the
highest social return.

Interest rates play important role in
controlling major macroeconomic variables. The primary role of interest rate is
to help in the mobilization of financial resources and to ensure efficient
utilization of resources for the promotion of economic growth and development
(CBN 1970).

However, they are various states of
interest rates in the financial system. They are generally classified into two
categories: Deposit and lending rates. Deposits rate are paid to savings and
time deposits of different maturities, while lending rates are interest rates
charged on loans to customers and they vary according to cost of loanable funds
and lending margins.

A number of factors influence the
behaviour of interest rates in an economy. Prominent among these are the volume
of savings, inflation, investment, government spending, monetary policy and
taxation constitute the major source (supply) of credit while investment
represents the major demand  for credit.
Therefore, the level of savings partly determines the level of interest rates.
For instance, a decrease in the accumulation of loanable funds (savings) is
bound to exert an upward pressure on interest rates, just as the reverse
situation would tend to have a moderating effect. Usually, when the structures
of interest rate are changed, the resulting relative rates of return will
induce shift in the assets portfolio of both banks and the non-banks public
institutions. Hence, the direction and magnitude of changes in the market
interest rates are of primary importance to economic agents and the policy
makers.

Consequently, the Nigerian Economy
has been highly prone to interest rate volatility and fragility (CBN, 2000).
Interest rates of all instruments have experienced very volatile movements.
Inconsistencies have been the order of the day (Adewunmi, 1997)

Lending which may be on short, medium or long-term basis is
one of the services that commercial banks do render to their customers. In
other words, banks do grant loans and advances to individuals, business
organizations as well as government in order to enable them embark on
investment and development activities as a mean of aiding their growth in
particular or contributing toward the economic development of a country in
general.

Commercial banks are the most important savings, mobilization
and financial resource allocation institutions. Consequently, these roles make
them an important phenomenon in economic growth and development. In performing
this role, it must be realized that banks have the potential, scope and
prospects for mobilizing financial resources and allocating them to productive
investments. Therefore, no matter the sources of the generation of income or
the economic policies of the country, commercial banks would be interested in
giving out loans and advances to their numerous customers bearing in mind, the three
principles guiding their operations which are, profitability, liquidity and
solvency.

However, commercial banks decisions to lend out loans are
influenced by a lot of factors such as the prevailing interest rate, the volume
of deposits, the level of their domestic and foreign investment, banks
liquidity ratio, prestige and public recognition to mention a few.

Lending practices in the world could be traced to the period
of industrial revolution which increase the pace of commercial and production
activities thereby bringing about the need for large capital outlays for
projects Many captains of industry at this period were unable to meet up with
the sudden upturn in the financial requirements and therefore turn to the banks
for assistance. However, the emergence of banks in Nigeria
in 1872 with the establishment of the African Banks Corporation (ABC) and later
appearance of other banks in the scene during the colonial era witnessed the
beginning of banks lending practice in Nigeria. Though, the lending practices
of the then colonial banks were biased and discriminatory and could not be said
to be a good lending practice as only the expatriates were given loans and
advances. This among other reasons led to the establishment of indigenous banks
in Nigeria.

Prior to the advent of Structural Adjustment Programme (SAP)
in the country in 1986, the lending practices of banks were strictly regulated
under the close surveillance of the banks supervisory bodies. The SAP period
brought about some relaxation of the stringent rules guiding banking practices.
The Bank and Other Financial Act Amendment (BOFIA)  1998, requires banks to report large
borrowing to the CBN. The CBN also require that their total value of a loan
credit facility or any other liability in respect of a borrower, at any time,
should not exceed 20% of the shareholders funds unimpaired by losses in the
case of commercial banks.

1.2       Statement of the problem

 

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