CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

The importance of monetary policy in the economic development of developing economies has continued to attract sustained scholarly and policy attention. The distortionary effects of interest rate controls, exchange rate misalignment, credit rationing, and other administrative constraints on the financial sector have generated a substantial body of research on the design and effectiveness of monetary policy instruments. A well-calibrated and credible monetary policy framework promotes financial intermediation, supports price stability, and underpins sustainable economic growth. In an increasingly interconnected global economy, the capacity of a central bank to deploy monetary instruments efficiently is essential both for capturing the gains of international trade and capital flows and for insulating the domestic economy from external shocks.

In Nigeria, this debate has taken on renewed urgency in the years following the global disruptions of the COVID-19 pandemic, the naira redesign episode of 2022–2023, and the far-reaching macroeconomic reforms introduced from mid-2023, including the unification of the foreign exchange windows and the removal of the petroleum subsidy. These shocks were accompanied by a historic monetary tightening cycle. Under the leadership of Governor Olayemi Cardoso, the Central Bank of Nigeria (CBN) raised the Monetary Policy Rate (MPR) from 18.75 per cent in July 2023 to a peak of 27.50 per cent by 2025, while the Cash Reserve Ratio (CRR) for deposit money banks was raised in steps to an unprecedented 50.00 per cent in September 2024, the highest level recorded in the Bank's history. (Central

Bank of Nigeria, 2024; Finance in Africa, 2025).

By late 2025 and into early 2026, as headline inflation moderated from a high of 34.80 per cent in December 2024 to 15.15 per cent in December 2025, the CBN began a cautious easing cycle, trimming the MPR to 27.00 per cent in September 2025 and further to 26.50 per cent in February 2026, even as the Cash Reserve Ratio remained anchored at elevated levels to continue mopping up liquidity (Central

Bank of Nigeria, 2025; African Business, 2026; Trading Economics, 2026).

This sequence of events provides a vivid illustration of the central question this study seeks to address: how do shifts in monetary policy instruments, particularly the monetary policy rate, the cash reserve ratio, the liquidity ratio, broad money supply, and the exchange rate, transmit into the lending behaviour of Nigerian commercial banks. Industry commentary on the 2024 tightening cycle estimated that Nigerian banks forfeited over ₦840 billion in income during the 2024 financial year alone as a direct consequence of the elevated CRR regime, underscoring the magnitude of the trade-off between liquidity sterilisation for price stability and the financial system's capacity to extend credit to the real sector. (Finance in Africa, 2025).

In the pursuit of improved living standards and macroeconomic stability, successive Nigerian governments have deployed both fiscal and monetary policy instruments to influence economic variables that drive growth and development. The focus of this study is to examine the impact of monetary policy on commercial bank lending in Nigeria, with First Bank of Nigeria Plc, the country's oldest and one of its most systemically significant deposit money banks, serving as the illustrative case.

Monetary policy may be defined as the deliberate use of instruments within the control of the monetary authority to regulate the value, supply, and cost of money and credit in pursuit of stable prices and sustainable economic growth (Central Bank of Nigeria, 1998). It remains the principal tool of macroeconomic stabilisation, encompassing measures designed to regulate the volume, cost, availability, and direction of money and credit so as to achieve specified macroeconomic objectives. In essence, it is a deliberate effort by the monetary authority, the Central Bank, to manage money supply and credit conditions in pursuit of defined economic goals, with the ultimate aim of promoting social welfare through sound regulation of the money stock (Ajayi, 1999).

Over the decades, Nigerian monetary policy has comprised a combination of measures taken by the monetary authority to influence, directly or indirectly, the supply of money and credit and the structure of interest rates, with the broad objectives of achieving sustainable economic growth, price stability, and external balance. While the operating environment has changed substantially, ranging from the regulated regime of the pre-1986 era, through the Structural Adjustment Programme's liberalisation reforms, to today's increasingly rules-based and inflation-targeting-oriented framework, the underlying strategic objectives of monetary policy have remained broadly consistent. The intermediate targets of policy have, however, evolved considerably. Until the late 1980s, the CBN's operations centred on narrow money as the principal monetary target. By 2006, the Minimum Rediscount Rate (MRR), the policy rate referenced in the original empirical model underlying this study, was formally replaced by the Monetary Policy Rate (MPR) as the CBN's primary signalling instrument, a shift that reflected the Bank's transition toward a more transparent, market-based framework for managing short-term interest rates (Finance in Africa, 2025).

Within this framework, the performance of the banking system, particularly with respect to loans and advances, can be assessed through the lens of two broad categories of monetary policy instruments: the portfolio control (direct) approach and market-based (indirect) intervention. Under direct monetary control, the authorities prescribe credit ceilings, interest rate bands, and sectoral allocation targets that banks must observe. Under indirect control, the CBN relies on operating variables such as open market operations, reserve requirements, and the policy rate, instruments that influence the monetary base and are expected to transmit, in a reasonably predictable manner, to the broader intermediate targets of money supply, credit, and interest rates.

A growing body of recent Nigerian scholarship has revisited this transmission process using more rigorous time-series techniques than were available when the original empirical work underlying this study was undertaken. Using an Autoregressive Distributed Lag (ARDL) framework over the 1987 to 2020 period, one study found that the monetary policy rate exerted a negative and statistically significant effect on bank lending in both the short and long run, while the liquidity ratio and inflation rate carried significant positive effects in the long run

Other recent work applying ARDL bounds testing to quarterly data from 2007 to 2021 found that the monetary policy rate, liquidity ratio, and cash reserve ratio each contributed positively to banking sector stability, suggesting that the relationship between monetary tightening and bank balance sheets is more nuanced than a simple contraction-of-credit narrative would imply, with the net effect depending heavily on the specific instrument, the time horizon, and the prevailing macro-financial environment. Similarly, a study spanning 1990 to 2022 using the Augmented Dickey-Fuller unit root test alongside ARDL estimation found that monetary policy variables, comprising the cash reserve ratio, monetary policy rate, lending rate, and broad money supply, significantly explained the performance of deposit money banks in both the short and long run.

It is against this backdrop, an evolving policy architecture, a much more aggressive tightening cycle than Nigeria experienced in earlier decades, and a growing but still inconclusive empirical literature, that the present study re-examines the impact of monetary policy on commercial bank lending in Nigeria, using First Bank of Nigeria Plc as its reference institution.

1.2 STATEMENT OF THE PROBLEM

Despite the deployment of an increasingly elaborate array of monetary policy tools, the volume of credit extended by commercial banks to the Nigerian economy has, for much of the period under review, not expanded in a manner sufficient to meaningfully accelerate investment, economic growth, and broad-based economic development. This concern has, if anything, intensified in the most recent policy cycle. Commentary on the 2023–2025 tightening episode has explicitly flagged a policy contradiction: while bank recapitalisation reforms initiated in 2024 were intended to strengthen banks' capacity to expand lending, the simultaneous imposition of a 50 per cent cash reserve ratio sterilised a substantial share of bank liquidity, leaving lenders managing balance sheet constraints rather than expanding credit to the real sector. (Finance in Africa, 2025).

As the apex regulatory authority, the Central Bank of Nigeria controls the activities of commercial banks principally through the formulation and issuance of monetary policy directives. The CBN's overarching objective is to regulate the volume of money in circulation in pursuit of specific social and economic goals, including price stability, exchange rate stability, and a sound and efficient financial system. Yet, notwithstanding the adoption of an expanding toolkit of measures, ranging from conventional instruments such as the cash reserve ratio and liquidity ratio to more recent innovations including standing facilities, asymmetric corridors, and targeted liquidity mop-up operations, the attainment of these stated socioeconomic goals has, to date, remained only partially realised.

Empirical findings on this question remain genuinely mixed even in the most recent literature. Some studies report that tightening instruments such as the monetary policy rate exert a significant negative effect on bank lending, others find that the cash reserve ratio and monetary policy rate have statistically insignificant effects on private sector credit once other variables are controlled for, and still others find that instruments traditionally assumed to be contractionary, such as the liquidity and cash reserve ratios, are positively associated with banking sector stability over the long run. This lack of empirical convergence, more than a decade and a half after the period originally covered by this study, indicates that the relationship between monetary policy and commercial bank lending in Nigeria remains an open and consequential research question rather than a settled matter.

Consequently, the effective implementation, compliance, enforcement, and ultimate achievement of the objectives underlying the Central Bank of Nigeria's monetary policy instruments continue to pose a substantive problem worthy of rigorous investigation. It is this problem, examined through the lens of commercial bank lending behaviour in Nigeria, that constitutes the focus of this research.

1.3 RESEARCH QUESTIONS

This study seeks to answer the following research questions:

i) What is the effect of the Minimum Rediscount Rate, and its successor the Monetary Policy Rate, on commercial bank lending in Nigeria?

ii) Has broad money supply any significant impact on commercial bank lending in Nigeria?

iii) What is the role of the exchange rate in shaping commercial bank loans and advances in Nigeria?

iv) How has the liquidity ratio of commercial banks enhanced or constrained bank lending in Nigeria?

v) To what extent has the cash reserve ratio of commercial banks influenced their loans and advances, particularly under the historically elevated 45–50 per cent regime observed between 2024 and 2026?

1.4 OBJECTIVES OF THE STUDY

The objectives of this research are as follows:

i) To critically examine and highlight the effect of the Minimum Rediscount Rate / Monetary Policy Rate on commercial bank lending in Nigeria.

ii) To ascertain the degree of impact that broad money supply has on commercial bank lending in Nigeria.

iii) To identify the role of the exchange rate in shaping commercial bank loans and advances.

iv) To examine and identify the relationship between the cash reserve ratio of commercial banks and their loans and advances.

v) To ascertain the extent to which commercial banks' liquidity ratio influences bank lending.