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Seminar on Profitability Analysis of Selected Money Deposit Bank in Nigeria

Abstract

The result reveals that capital adequacy, nonperforming loan, loan to total asset and size have significant positive effect on profitability, while age was found to exert significant but negative effect on profitability. The study could not however establish significant positive effect of macroeconomic indicators (economic growth and interest rate) on profitability of deposit money banks while inflation rate has negative but insignificant influence on profitability. Arising from the findings, the study recommends that government should initiate and execute economic policies that will improve the profitability of deposit money banks in Nigeria given the key role of the sector to the economy while banks should also manage their specific variables that are likely to improve profitability.

Theoretical Framework

Many theoretical postulates exist on factors that drive profitability in the finance literature in general and those relating to the banking sector in particular. The notable ones among these theories are: portfolio theory, efficient structure theory, resource based theory, frictional theory, finance theory of profit (capital asset), Modigliani-Miller (1958) theorem, signaling hypothesis and arbitrage pricing theory. The portfolio theory emphasizes banks’ investment diversification into different classes of assets in bid to avoiding unsystematic risk. Banks attain efficient portfolio by taking into consideration the risk, and return profile of each class of asset and as well as the size of the portfolio which determines the level of investment in each class of asset. On the other hand, the efficient structure theory states that the ability of a bank to earn profit is predicated on efficiency, implying that efficient banks are able to make higher profit than those not efficient. Efficiency in this sense can be viewed via two approaches efficiency and scale efficiency. The X-efficiency states that banks’ ability to make profit is anchored in its ability to reduce costs. Such firms are inclined to gain larger market shares, which may manifest in higher levels on market concentration, but without any causal relationship from concentration to profitability (Athanasoglou, Delis&Staikouras, 2006). On the contrary, the scale efficiency of banks’ improved profitability is premised on economics of scale arising from size. These economies of scale that is attributable to larger size translate to reduction in operating cost as banks will be able to spread their operations over wide range of activities. The efficient structure theory like the portfolio theory largely assumes that bank’s performance is influenced by internal efficiencies and managerial decisions (Athanasoglou et al., 2006).

According to the resource-based theory, every investor commits his resources to a project with the aim of making profit. For profit to be made, firms need some resources that will allow a smooth operation to take place, which will give rise to profit. The theory that best explains this is the resource-based theory. This theory is credited toWernerfelt (1984). It perceives the firm to have a bundle of resources that it combines and utilizes to create capacities that will earn above average profit. The resources therefore serve as the strength to an individual bank that can be used to create competitive advantage. This theory gains its relevance to this study as banks have some common peculiar characteristics which allows for the generalization of the sampled banks to be valid and reliable for the entire population. The sources of strength identified in this study are:- liquidity, capital adequacy, age, nonperforming loan, loan to total asset, and size; all these represent the resources used by banks to create and maintain their competencies within their operation. The arbitrage pricing theoryemanated from the handiwork of Ross in (1977). This theory is based on linearity assumption between macroeconomic variables and expected returns on investment. It also states that market risk (beta risk) accounts for the degree of correlation to changes in each variable. The frictional theory of profit regards capital as substitution reward to investors for saving and investing their income rather than consuming or hoarding them. Investors/shareholders we therefore peruse through publicly released information like banks financial statement before investing their funds. The reason for this is for them to measure the security of their investment in the form of viability and stability. Investors will therefore consider companies that can pay dividend as reward for their investment. All these assumptions are realistic under static economy without occasional disturbance like inflation and war. However, in the case of occasional disturbance, firms can either make abnormal profit or abnormal loss depending on whether the disturbance is favorable or unfavorable. The finance theory of profit (capital asset) is traceable to foureconomists Sharpe, Litner, Treynor and Mossin independently between 1964 and 1966. It was developed so as to simplify the portfolio theory of profit by Makowitz. It states that market structure in which a firm operates does not determine profit but classes of risk it is exposed to. Therefore, in this study, non-performing loan is expected to affect profitability as it relates to the firms’ credit risk emanating from their core activities of financial intermediation of funds.

The Modigliani and Miller theory stipulates that companies having the same risk have identical market and book return on investment. This therefore implies that company that uses more of equity capital is faced with less risk and thus; attracts lower rate of return on investment in as much as the investors are risk averse (Hoffmann, 2011). Therefore, inverse relationship exists between capital adequacy ratio and profitability. This theory according to Kajola et al. (2018) is not applicable to Nigeria due to the imperfect nature of its operating environment. The signaling hypothesis is suitable to the Nigerian business environment that is characterized by imperfections. The theory holds that there exists information asymmetry between managers and investors in the sense that managers have the access to private information which investors do not have. According to Myers and Majluf (1984), firms need to release a part of the private information to investors and the public so as to attract more capital. This, according to Kajola et al., (2018), will lead to information symmetry between managers and shareholders and enable well capitalized banks to perform better. This theory therefore suggests a direct relationship between capital adequacy and performance.

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