CBN Releases Working Paper on Strategies for Lowering Cost of Funds in Banks

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Wednesday, June 10, 2015 5.01PM/CBN

1.0 Introduction
Banks source funds from short term and long term sources. The costs incurred by banks in the process of sourcing funds include direct and indirect costs. These costs constitute major elements of determining banks’ lending rates along with credit risks of the loans and general liquidity conditions. It is clear that economic growth and development reduces cost of operations for any economic agent due to availability of social and economic infrastructure and healthy competition.

In Nigeria, lending rates have remained persistently high over the last two decades, raising concerns among policy makers, investors and other economic agents, about financing sustainable economic growth. Many reasons, including tight monetary policy, structural rigidities in the economy leading to high cost of raising funds by Deposit Money Banks (DMBs) are adjudged responsible for these high lending rates. For instance, increased overhead costs, contributions by DMBs to the Asset Management Corporation of Nigeria (AMCON) sinking fund and Payment of NDIC premium put additional pressure on banks’ earnings and the cost of funds. To mitigate these pressures, banks reduce deposit rates, re-price their loans, raise the Nigerian Interbank Offered Rates (NIBOR) due to sudden liquidity shortage, which may necessitate regulatory intervention to improve liquidity conditions. These additional costs may partly transmit to high lending rates which have remained under double digit over the years.

It is argued that, high cost of funds makes banking business very unviable and unprofitable because the resulting high interest rates increases credit risk (Raknerud and Bjorn, 2013). While, Nigerian banks are generally profitable much of the revenues could be traced to non-interest income such as foreign exchange market operations. Since banks are largely profitable even with lower loan portfolios, the regulatory authorities need to address the issue of vogue opportunities for banks outside the financial intermediation function. This study seeks to address the following questions: (1) what are the determinants of funding costs? and how to achieve lower lending rates. We employed both descriptive and econometric techniques to identify key determinants of banks cost of funds and high profitability.

To achieve these objectives, the rest of the paper is organized in Five Sections. Section 2 discusses stylized facts relating to banks’ cost of funds and lending rates. In Section 3, literature review, conceptual issues and theoretical framework are reviewed. Section 4 presents econometric analysis. Section 5 provides policy recommendations and conclusion.

2.0 Stylized Facts on Banks’ Cost of Funds and Lending Rates in the Nigeria

2.1 Developments in Banks’ Cost of Funds
The discovery of oil in 1956 in Nigeria led to increase in revenue to government and this led to huge expenditure to rebuild economic infrastructure after the civil war. Increased government expenditure fuelled inflation and increased the overall cost of doing business in Nigeria. In response, government approved the Udoji wage increase across all sectors of the economy including the banking sector. Poor infrastructure further increase the cost of doing banking business as banks had to provide their own electricity.

The growth in the number of banks in Nigeria in 1980s, without adequate capital led to aggressive mobilization of deposits associated with excessively high deposit rate at distressed rates. It became imperative for banks to charge high lending rates so as to make profit. In addition, illiquid banks began to accept excessively high interbank rates ranging between 25 and 35 per cent, necessitating an increase in retail interest rates in line with the tenets of the channel of the transmission mechanism.

The manufacturing sector in addition to the problem of poor infrastructure at the time had to face high lending rates, which required the government to intensify efforts to reduce the lending rates. Thus, under the direct monetary control regime, the CBN adopted interest rate fixing, selective credit control and spread between Minimum Rediscount Rate and lending rate which was fixed at four per cent above the MRR. However, the liberalization of interest rates in 1987, removed these controls and banks were expected to fix their interest rate by negotiating with their customers.


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