Determinants of Bank Profitability in Nigeria: an Empirical Assessment 

By W. U Ani, D.O Ugwunta, I. J Ezeudu and G. O Ugwuanyi

Given the recent developments in the Nigerian banking industry, only a profitable banking sector is better able to withstand negative shocks and contribute to the stability of the financial system. This assertion compels an in depth investigation of the determinants of the profitability of deposit money banks in Nigeria.

This is the full version of this article.  For the abridged article as it appears in TABR March-April 2013 print edition, please click here.

INTRODUCTION

A profitable banking sector is better able to withstand negative shocks and contribute to the stability of the financial system. The profitability of a financial institution is affected by numerous factors. These factors include elements internal to each financial institution and several important external forces shaping earnings performance. In Nigeria, years 2004 and 2005 witnessed a forced consolidation exercise with a regulatory option of mergers and acquisitions. This exercise brought about a landmark change in the number of Nigerian banks as the banking system shrank to only twenty-five banks from a whopping eighty nine banks before the consolidation exercise. It is therefore important to understand the determinants of banking sector profitability in Nigeria. This is essentially important in the light of the above notable changes that have occurred in the operating environment of banks in Nigeria.

There is a wide body of studies and literature looking at the determinants of bank profitability.  This paper contributes to literature in a unique way. Our dataset, made up of 147 bank level observations consist of 71.43% of banks operating in Nigeria. This enhances the generalization of our result to all the banks operating in Nigeria before and after the major changes in the Nigerian banking environment. The rest of the paper is divided as follows. Highlights on the review of related literature are presented. Second, Methodological issues are discussed, presentation of the data and results are then analysed. Finally, conclusions.

DATA AND RESULTS

 The banks in the Nigerian banking industry include banks with very different sizes and business mixes as evidenced by the descriptive statistics below.

Source: Authors’ SPSS output.

Table 1 above shows descriptive statistics for the variables. ROA (profitability), size (natural Log of Total Asset), asset composition (ratio of Total Loans & Advances to Total Asset) and capital adequacy (ratio of Total Equity to Total Asset) have a positive mean value which ranges from 0.2299 for profitability to 7.4883 in size. The banks in the Nigerian banking industry include banks with varying sizes and business mixes. Capital adequacy and asset composition has the highest standard deviation of 29.89 and 53.65 respectively. This indicates that the observations in the data set are widely dispersed from the mean. It means that all the banks in the industry are consistent with increase in total equity as a result of the 2005 forced consolidation by the regulatory authority in Nigeria. This also implies that the consolidation exercise provided the banks with a lot of loanable funds which resulted in increased loans and advances. Thus there is greater variation in the data set of capital adequacy and loans and advances because of the size differences of deposit money banks operating in the Nigerian banking industry. Relationships among the study variables were tested using Pearson correlation and the outcomes are presented in table 2 below.

Model specification involves the determination of the dependent and explanatory variables which were included in the model and the expectations about the sign and the size of the parameters of the function, Koutsoyiannis (2003) and Onwumere (2008).

Source: Authors’ SPSS output. * are significant at 5%.

The correlation matrix above shows that size has a weak negative relationship with profitability (ROA) at -14.7%. This means that bigger banks have lower ROA. Capital adequacy and asset composition have a positive relationship with profitability. The strength of their relationship is indeed strong at 88.7% and 92.8% for capital adequacy and asset composition respectively. Although size has a negative relationship with profitability, the one tailed significance level 5% shows that all the independent variables are statistically significant. This result is strengthened as P* of 0.05 > .038, .000 and .000 for size capital adequacy and asset mix.

The size (nLog of Total Asset) has a significant negative relationship with profitability. This significant negative relationship shows that the size of a bank could significantly affect the profitability of the bank negatively. This is in consonance with the findings of Berger, et al. (1987), Boyd and Runkle (1993), Bourke (1989), Naceur (2003) and Javaid et al (2011).

Asset Composition (ratio of Total Loans and Advances to Total Asset) shows a positive and significant relationship with profitability. This suggests that with increase in inflation in the economy, the banks interest rate on all kinds of advances would increase and in this way the bank’s interest earnings would show significant increase. Assuming other variables remains constant, the higher the rate of transforming deposits into loans, the higher the profitability of the bank. Thus a positive relationship between the loans and advances of a bank with profitability is as expected and is as documented by (Imad, Qais and Thair, 2011). This result is consistent with the study of Athanasoglou et al. (2006). Also, Abreu and Mendes (2000) found a significant and positive relationship between asset composition and profitability

Capital Adequacy (ratio of Total Equity Total Asset) shows a positive correlation with profitability (ROA). In the presence of asymmetric information and bankruptcy costs, the way the assets are funded could affect the banks value. A well-capitalized bank may send a good signal to the market regarding its performance Imad, Qais and Thair, (2011).  Our result is in consonance with the findings of (Goddard, Molyneux and Wilson, 2004) that investigated profitability of European banks profitability.

The relatively high coefficient of multiple determination suggest that with a conservative coefficient of multiple determination of R² = 0.998 (table 3), the model summary shows that 99.8% of the variations in the profitability of Nigerian banks are explained by the banks internal factors in our model. These internal factors are the management controllable factors, the bank specific financial ratios representing size, asset composition and quality, and capital adequacy.

Table 3: Regression Coefficient.

Source: Authors’ SPSS output.

The regression result presented above reveals that not only do capital adequacy and asset composition have strong positive relationships with bank profitability, they also impacts significantly on bank profitability. Given that the t-Statistics of 92.089 and 114.533 > t* 2, we confirm a statistical significant impact of capital adequacy and asset composition captured as ratios of total equity and total loans and advances to total asset. This confirmation is strengthened with the perfect significance value 0.000 < the 0.05 significance value. Our result is in line with the findings of Javaid et al (2011); Imad, Qais and Thair (2011); Gull, Irshad and Zaman (2011); Goddard, Molyneux and Wilson (2004); Naceur (2003) whose empirical results found strong evidence that loans and equity are positively related and have strong influences on profitability.

Conclusion

Our econometric analysis revealed major outcomes in bank profitability in Nigeria. The major outcome of this study is that higher total assets may not necessarily lead to higher profits. The negative coefficient of size indicates that this relation might be negative due to diseconomies of scale suffered by banks due to uncontrollable increased size. Higher loans and advances contribute towards profitability. This reveals that more dependence on one major asset, may lead to profitability but with less significant impact on overall profitability. Overall we conclude that asset composition and capital adequacy are the major endogenous factors under the control of management that determines the profitability of banks in Nigeria.

Banks in Nigeria should endeavor to manage adequately the liquidity and profitability trade-off while diversifying their asset in a way to remain profitable and sustainable. However, further research is needed to clear the grey areas especially over a longer period of time. In addition variables such as cost efficiency, credit risk, and exogenous factors such as inflation, GDP and market concentration could also be incorporated to ascertain the determinants of bank profitability in Nigeria.

About the authors

Dr. Wilson Uchenna Ani is a lecturer in the Department of Banking and Finance, Michael Okpara University of Agriculture, Umudike, Abia State, Nigeria.  He is a qualified chartered accountant and he specializes in financial management corporate governance.  He is currently research fellow in Finance and Banking at the Michael Okpara University of Agriculture. He has authored many textbooks and articles.

doctorani2010@gmail.com  wilsonani2007@yahoo.com