IMPACT OF INTEREST RATE DEREGULATION ON THE PROFITABILITY OF COMMERCIAL BANKS

ABSTRACT

This study examined the impact of interest rate deregulation on the profitability of commercial banks in Nigeria from 1980 to 2016. Interest rate deregulation, introduced in Nigeria as part of the Structural Adjustment Programme in 1987, replaced administratively fixed deposit and lending rates with a market-based system in which rates are determined through negotiation between banks and customers, subject to the Central Bank of Nigeria's monetary policy instruments, including the Monetary Policy Rate. While deregulation was intended to promote efficiency and competition within the banking sector, its actual effect on bank profitability has remained a subject of ongoing empirical debate, with recent Nigerian studies continuing to find mixed evidence on the direction and significance of this relationship. The study investigated the impact of interest rate deregulation on the profitability of commercial banks in Nigeria, determined the impact of the Monetary Policy Rate on the performance of commercial banks in Nigeria, determined the impact of the Lending Rate on the performance of commercial banks in Nigeria, and determined the impact of the Deposit Rate on the performance of commercial banks in Nigeria. An ex-post facto research design was adopted, using secondary time-series data obtained from the Central Bank of Nigeria Statistical Bulletin covering the 1980 to 2016 period, and analysed using Ordinary Least Squares regression techniques. The findings are expected to provide evidence-based insight for monetary policy authorities and commercial bank management on the relationship between interest rate policy and bank profitability in Nigeria.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Interest rate policy has long occupied a central place in Nigeria's monetary and financial sector reforms. Prior to 1987, interest rate management in Nigeria was a direct control function of the Central Bank of Nigeria (CBN), which administratively fixed minimum savings rates and maximum lending rates for financial institutions. The introduction of a market-based interest rate policy in 1987, as part of the broader Structural Adjustment Programme, marked a fundamental shift: banks were thereafter permitted to determine deposit and lending rates according to market conditions and negotiation with customers, subject to the CBN's continued use of indirect monetary policy instruments, chiefly the Monetary Policy Rate (MPR), to guide the overall direction of interest rates across the banking system.

Recent Nigerian empirical research continues to examine how this deregulated interest rate environment has shaped commercial bank profitability, with findings that remain genuinely mixed rather than settled. A 2025 study examining the impact of interest rates on the financial performance of deposit money banks in Nigeria, spanning a thirty-four-year period from 1991 to 2024 and using lending interest rate and deposit interest rate as key explanatory variables alongside inflation and exchange rate controls, employed Ordinary Least Squares regression on data drawn from the Central Bank of Nigeria's Statistical Bulletin to assess the relationship between these interest rate variables and Return on Assets, providing an up-to-date empirical benchmark for how lending and deposit rate movements relate to bank performance under the deregulated regime (Ebinum & Ehiedu, 2025). Complementing this, a 2024 study investigating the impact of monetary policy on the performance of deposit money banks in Nigeria over the 2008 to 2023 period, using money supply, the Monetary Policy Rate, cash reserve ratio, and maximum interest rate as monetary policy proxies, found that total private sector credit extended by deposit money banks had a significant relationship with money supply and the maximum interest rate specifically, while the cash reserve ratio and Monetary Policy Rate showed an insignificant relationship with bank credit performance over the period studied, a finding that illustrates how different interest rate and monetary policy instruments can have markedly different degrees of influence on bank outcomes even within the same deregulated framework (Obiaje & Umeokwobi, 2024).

These recent findings, spanning both the specific effect of lending and deposit rates and the broader influence of the Monetary Policy Rate as CBN's principal indirect control instrument, together illustrate that more than three decades after Nigeria's move to interest rate deregulation, the precise channels through which deregulated rates translate into commercial bank profitability remain empirically contested and continue to warrant close examination, particularly across the full historical arc of the deregulated era. It is against this background that this study examines the impact of interest rate deregulation on the profitability of commercial banks in Nigeria from 1980 to 2016, encompassing both the pre-deregulation and deregulation periods, and disaggregating the analysis across the Monetary Policy Rate, Lending Rate, and Deposit Rate specifically.

1.2 Statement of the Problem

More than three decades after Nigeria's adoption of a market-based interest rate policy in 1987, recent empirical research continues to produce mixed findings on how deregulated interest rates actually relate to commercial bank profitability, with some interest rate and monetary policy instruments showing significant relationships with bank performance measures while others show none within the same study period (Ebinum & Ehiedu, 2025; Obiaje & Umeokwobi, 2024). This inconsistency raises an important question about whether the specific components of Nigeria's interest rate regime, namely the Monetary Policy Rate, the Lending Rate, and the Deposit Rate, exert distinct and separately identifiable effects on commercial bank profitability, or whether their combined effect, examined together and across a longer historical horizon spanning both the regulated and deregulated eras, produces a clearer overall picture. Without a study that disaggregates these specific rate components while also spanning a sufficiently long historical period to capture the full transition from regulation to deregulation, policy makers and bank management continue to lack a complete, historically grounded basis for understanding how interest rate policy shapes commercial bank profitability in Nigeria. It is this gap that the present study seeks to address.

1.3 Objectives of the Study

The broad objective of the study is to examine the impact of interest rate deregulation on the profitability of commercial banks in Nigeria from 1980 to 2016. The specific objectives include the following:

1. To investigate the impact of interest rate deregulation on the profitability of commercial banks in Nigeria.
2. To determine the impact of Monetary Policy Rate (MPR) on the performance of commercial banks in Nigeria.
3. To determine the impact of Lending Rate on the performance of commercial banks in Nigeria.
4. To determine the impact of Deposit Rate on the performance of commercial banks in Nigeria.

1.4 Research Questions

1. What is the impact of interest rate deregulation on the profitability of commercial banks in Nigeria?
2. What is the impact of Monetary Policy Rate on the performance of commercial banks in Nigeria?
3. What is the impact of Lending Rate on the performance of commercial banks in Nigeria?
4. What is the impact of Deposit Rate on the performance of commercial banks in Nigeria?

1.5 Research Hypotheses

Ho1: Interest rate deregulation has no significant impact on the profitability of commercial banks in Nigeria.

Ho2: Monetary Policy Rate has no significant impact on the performance of commercial banks in Nigeria.

Ho3: Lending Rate has no significant impact on the performance of commercial banks in Nigeria.

Ho4: Deposit Rate has no significant impact on the performance of commercial banks in Nigeria.

1.6 Significance of the Study

This study will benefit the Central Bank of Nigeria and other monetary policy authorities by providing historically grounded evidence on how specific interest rate instruments relate to commercial bank profitability. It will benefit commercial bank management, by clarifying which components of the interest rate environment most strongly affect profitability and should therefore be prioritized in strategic planning. It will benefit financial analysts and investors assessing the banking sector, and will serve as a reference for future researchers examining interest rate policy and bank performance in Nigeria.

1.7 Scope of the Study

This study is limited to examining the impact of interest rate deregulation, the Monetary Policy Rate, the Lending Rate, and the Deposit Rate on the profitability of commercial banks in Nigeria, using secondary data covering the period from 1980 to 2016.

1.8 Limitations of the Study

The study is limited by its reliance on secondary, aggregate time-series data, which does not capture bank-specific or firm-level variation in how interest rate changes are experienced across individual commercial banks. The historical scope of the study, ending in 2016, does not capture more recent interest rate developments, though this reflects the study's specific historical focus rather than a data limitation.

1.9 Definition of Terms

Interest Rate Deregulation: The removal of direct government or central bank control over the interest rates banks may charge or pay, replaced by market-determined rates subject to indirect monetary policy instruments.

Monetary Policy Rate (MPR): The benchmark interest rate set by the Central Bank of Nigeria, used to guide the direction of interest rates across the banking system.

Lending Rate: The interest rate charged by commercial banks on loans extended to borrowers. Deposit Rate: The interest rate paid by commercial banks to customers on their deposits. Profitability: The extent to which a commercial bank generates financial gain relative to its expenses and investments, commonly measured through indicators such as Return on Assets.

REFERENCES

Ebinum, C. J., & Ehiedu, V. C. (2025). Impact of interest rates on the financial performance of deposit money banks in Nigeria. IIARD International Journal of Banking and Finance Research, 11(3), 270–296. https://doi.org/10.56201/ijbfr.vol.11.no3.2025.pg270.296

Obiaje, E., & Umeokwobi, R. (2024). Impact of monetary policy on the performance of commercial banks: Evidence from Nigeria: 2008–2023. Financial Economics Letters, 3(3), 25–35. https://doi.org/10.58567/fel03030003