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ABSTRACT

The performance of any business firm not only plays the role to improve the market value of that specific firm but also leads towards the growth of the whole sector which ultimately leads towards the overall prosperity of the economy. Assessing the determinants of the performance of organizations has gained importance in the corporate finance literature; however,this study examines the determinants offinancial performance listed mega banks in Nigeria for a period of seven years. The population of this study comprises the 11 listed mega banks in Nigeria as at 31 December, 2013. A total of 8 banks that meet the criteria were duly selected as sample for the study. The audited annual reports (Balance sheet and Profit/Loss account) were obtained from Central Bank of Nigeria (CBN) and from selected mega banks’ annual publication reports.The result of random effect regression provides evidence that capital adequacy, bank size, cost income ratio and income diversification have significant impact on financial performance of the banks under study.Based on the findings, the study recommends among others that a policy that will encourages banks to engage in non-interest income activities should be put in place since non- interest income has positive impact on financial performance.
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TABLE OF CONTENTS

CHAPTER ONE: INTRODUCTION
1.1 Background to the Study……..…………………………………………………………………1 1.2 Statement of the Problem…………………………………..…………………………………..5 1.3 Research Questions….……………………………………………………………………………..8 1.4 Objectives of the Study……………………………………………………………………………..9 1.5Research Hypothesis……………………..……………………………………………………9 1.6Scope of the Study…………………..…………………………………………………….….10 1.7Significance of the Study……………………………..……………………………….…..….11 CHAPTERTWO: LITERATURE REVIEW 2.1 Introduction…………………………………………………………….…………………….14 2.2 Conceptualization……………………………………………………………………………14 2.3 General literature review……………………………………………………………………..25 2.4 Emperical review…….. ……………………………………………..………………………27
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2.5 Theoretical frame work………………………………………………………………………39 CHAPTERTHREE; METHODOLOGY 3.1 Introduction …………………………………………………………………………………..41 3.2 Research Design…………………………………………………………………….….…….41 3.3 Population and Sample Size of TheStudy…….…………………………….……….….……42 3.4 Sources and Methods of Data Collection……………………………………….…….….…..42 3.5 Modelspecification ……………………………… …………………………….….………..43 3.6 Variables Measurement……………………………..………………………………………..44 3.7 Technique of data analysis……………………………………………………………………44 3.8 Diagnostic Test…………………………………………………….……………….………..45 CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS 4.1 Introduction…………………………………………..………………………………………..47 4.2 Descriptive statistics……..…………………………..………………………………………..47
4.3 Correlation analysis…….…………………………..………………………………………….50
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4.4 Presentation and analysis of regression results………………………………………………51 4.5 Policy implication of the research findings….………………………………………………57 CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS 5.1 Summary of findings……..…………………………………………………………………58 5.2 Conclusion….……………………………………………………………………………….59 5.3 Recommendations…………………………………………………………………………..60 5.3 Limitations of the study……………………………………………………………………..61 5.3 Areas for further study.……………………………………………………………………..61 References………………………………………………………………………………………62
Appendices………………………..……………………………………………………………75

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CHAPTER ONE

1.1 Background to the study
As a key component of the financial system, banks play an important role in the operation of an economy. They channel funds from savers to borrowers for investment which increases economic growth rate and development of a country. The Central bank of Nigerian‟s resolve to carry out reforms in the banking sector was borne out of the past of the nation‟s banking industry. Between 1994 and 2003 due to insolvency problem, no fewer than 36 banks were closed. In 1995 and 1998, 4 and 26 banks were closed down respectively. Also in 2000, three ill banks were closed. In 2002 and 2003 at least one bank collapsed. The failed banks had two things in common – small size and unethical practices. Of the 89 banks that were in existence as at July 2004, when the banking sector reforms were announced, no fewer than 11 of them were in a state of distress. According to the CBN, between 69 and 79 of the banks were marginal or fringe players (Soludo, 2004).
The decade 1995 to 2005 were particularly traumatic for the Nigerian banking industry; with the magnitude of distress reaching an unprecedented level, thereby making it an issue of concern not only to the regulatory institutions but also to the policy analysts and the general public. Thus the need for a drastic overhaul of the industry was quite apparent. In furtherance of this general overhauling of the financial system, the Central Bank of Nigeria introduced major reform programmes that changed the banking landscape of the country in 2004. The main thrust of the reform agenda was the prescription of minimum shareholders’ funds of 25 billion forNigerian Deposit money bank not later than December 31, 2005. In view of the low financial base of these banks, they were encouraged to merge. Out of the 89 banks that were in operation before the reform, more than 80 percent (75) of them merged into 25 banks while 14 that could
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not finalize their consolidation before the expiration of the deadline were liquidated (Elumilade,2010; Afolabi, 2004). Following the increase in minimum capital requirements from 2 billion Naira ($17 million) to 25 billion Naira ($210 million), the Nigerian banking system consolidated and the number of banks dropped from 89 in 2003 to 24 by December, 2013. The total assets of the banking sector increased from NGN 2,767 billion ($23 billion) in 2003 to NGN 14,932 billion ($127 billion) in 2008. By the end of 2008, more than half of the 20 domestically owned Nigerian banks had subsidiaries in at least one other African country, compared to only two in 2002 (Alade, 2014). However, an assessment of the level of capitalization of an average bank prior to consolidation exercise indicates an equity base (Net worth) of N7.71 billion (US$0.06168 billion) rising to N38.83 billion (US$0.31064 billion) in2006, indicating a growth rate of 404 percent. The leverage ratio measured in terms of equity to total asset also declined from 18.28 per cent in 2004 to 14.52 per cent in 2006 for an average bank. This ratio compares favorably with the CBN minimum level of 10 per cent. The post consolidation ratio is also better in term of its distribution among the banks compared with the pre-consolidation ratio where more than 70 per cent of the equity and assets were concentrated in (the largest five banks) less than 5 percent of the existing banks. However, the intermediation activities of an average bank improved significantly by about 1,690 per cent from an average deposit base of N10.48 billion (US$0.08384) in 2004 to N188.48 billion (US$1.50784) in 2006 (Somoye, 2008).
As part of its ongoing banking industry reforms, the CBN reviewed the universal banking model which permitted banks to act as financial supermarkets. The implementation of the universal banking model was characterized by a number of worrisome features, including the following:
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inadequate capital and capacity to manage the wide range of business and products; excessive risk appetite and exposure, particularly to affiliate transactions (contagion risk); weak group corporate governance; complexity and opaque structures and processes; and inadequate regulatory/ supervisory capacity. The new banking model which is aimed at addressing these weaknesses categorized deposit money banks license to operate as regional, national or international (Mega) bank; their minimum capital requirements were specified as N10 billion, N25 billion and N50 billion for regional, national and international respectively. The regional banks are entitled to carry on banking operations within a minimum of 6 and maximum of 12 contiguous states, lying within not more than 2 geo-political zones of the federation and the Federal Capital Territory; national banks are authorized to carry on banking operations within every states of the federation, including the Federal Capital Territory while the international banks are permitted to carry on banking operations in all the states of the federation, as well as establishing offshore subsidiaries.A Mega bank (MB)is a bank that meet a minimum capital requirement of N50 billion and with a commercial presence outside its home country, by way of at least one branch or subsidiary. The failure of some DMBs to meet up with anticipated financial performance after consolidation requires a rethink to evaluate their performance thus this study is designed to evaluate the performance of Mega banks (MBs) using financial measures.
According to Hifza Malik, (2011), profitability is one of the most important objectives of financial management since one goal of financial management is to maximize the owners‟ wealth, and profitability is very important determinant of performance. A business that is not profitable cannot survive. Conversely, a business that is highly profitable has the ability to reward its owners with a large return on their investment. Hence, the ultimate goal of a business
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entity is to earn profit in order to make sure the sustainability of the business in prevailing market conditions. The determinants of banks profitability have attracted the interest of academic researchers, bank management, financial markets as well as bank regulators. There have been several studies on determinants of bank profitability which started with the early work by Short (1979). While the study of Smirlock (1985), Berger (1995), Kosmidou, Tanna, & pasiouras (2005), Dietrich and Wanzenried (2009) centered on individual countries, the works of Moulyneux and Thornton (1992), Goddard, Molyneux, & Wilson (2004), Al Hashimi (2007), Demirguc – Kunt and Huizinga (2000) and Heffernan and Fu (2008) focused on panel of countries. According to their studies, the factors determining the profitability of banks fall into two main groups. First, there is a group of determinants of profitability that is specific to each bank and that in many cases, are the direct result of managerial decisions (asset structure, asset quality, capitalization, financial structure, efficiency, size, and revenue diversification). The second group of determinants includes factors relating profitability to the industry structure and to the macroeconomic environment within which the banking system operates, such as industry concentration, economic growth, inflation, and interest rates (Almumani, 2013). Even though different studies were conducted on the determinants of banks performance, their results is not conclusive as far as the impacts of the factors are concerned.
In Nigeria, different studies were conducted on the determinants of deposit money banks (DMBs) performance such as Ani, Ugwunta, Ezeudu and Ugwuanyi (2012), Aremu, Ekpo and Moustapha (2013), and Aminu (2013) but the authors did not include important variables like income diversification. This study examines the determinants of MBs financial performance in Nigeria, taking into cognizance income diversification, this is due to the fact that the profitability
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of banks which depends solely on interest income may be highly affected by interest fluctuation and loan default risk. But, banks which diversify their income source can increase their profit since non-interest income may not be affected by interest fluctuation and loan default. In view of the aforementioned and ongoing performance determinants debate around the globe, a study on the performance determinants on MBs in Nigeria is desirable. This study dwells on Internal factors that affect MBs financial performance because our purpose is to test the impact of capital adequacy, credit risk, bank size, cost income ratio, and income diversification on MBs financial performance.
1.2 Statement of the Problems
The banking sector in particular is part of immune and repair system of an economy and successful operation of the industry can set energy for other industries and the development of an entire economy. To do so the banking industry is expected to be financially solvent and strong through being profitable in operation. Hence, not only measuring the financial performance of banks but also clear insight about determinants of profitability in the sector is then the problem to be investigated.
Over the years, the wellbeing, growth and successful operation of banks has attracted the interest of different academic researchers, managers, economists and other professionals. This is cardinal since identifying the key success factors of MBs financial performance allows for designing well- informed policies that may significantly improve the overall performance of the sector. A number of studies have examined the determinants of banks‟ performance in many countries around the globe. For instance, Almazari (2013), Almumani (2013), Ani, et.al(2012), Aremu, et.al (2013) among others. Although a lot of studies and literatures which examines the determinants of banks financial performance exist, these studies show different and even
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contradictory results. For instance, the impact of capital on profitability is seriously being debated among researchers. This is because while positive relationship had been found by studiesof Gilchris (2013), Ramalan (2011), and Ommeren (2011), other studies found a negative relationship between capital and profitability Saona, (2011), Ali, Akhtar, & Ahmed (2011). The capital adequacy risk poses great challenges to DMBs in Nigeria. This is because the first and second round stress test conducted by CBN discovered that ten capitalized banks were in serious risk problem due to inability of their balance sheet to absorb shocks associated with intermediary functions they plays in the economy. In line with the mixed findings on the relationship between capital adequacy and profitability and the stated problem, this study is set to fill the gap by examining capital adequacy and profitability of MBs in Nigeria by extending the period to 2013, this raises a question whether capital adequacy is among the determinants of the financial performance of MBs in Nigeria.
Despite the fact that there are many risks that affect financial performance of banks , but for the purpose of this study credit risk was considered most significant risks taking cognizance of banks intermediation activities in which income generated from it is expected to significantly contribute to the profitability of banks. Byeffective management of credit risk exposure banks not only support the viability and profitability of their own business but also contribute to systemic stability and to an efficient allocation of capital in the economy (Psillaki, Tsolas, and Margaritis, 2010). Credit risk management has a significant impact on the profitability of Nigerian banks (Kargi, 2011, Bashir and Hassan, 2003). Miller and Noulas (1997), Ramlall (2009), Vong and Chan (2009) and Sinha and Sharma (2014) found a negative relationship between credit risk and profitability. While Sufian (2011) found a positive significant relationship between credit risk and profitability. The mixed findings could be attributable to
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different techniques of analysis adopted by the researchers, difference in the period, policies and environments within which the studies is conducted. Therefore, the question still remain that to what extent does credit risk predicts financial performance of MBs in Nigeria.? Inefficiency of banks manifest in multifarious forms with adverse implications for the growth prospect of the banking system, ranging from inability to effectively perform the intermediation role, high cost of transactions and resultant inability for private investors to access loanable funds, financial crisis and the eventual loss of confidence in the banks due to financial distress. All these will negatively affect financial performance of MBs in Nigeria.Studies on the cost income ratio and profitability of banks are observed to be conducted in both developed and developing economies. The studies of Flamini, McDonald & Schumacher(2009), Hager, & Wael (2011)) found positive correlation between cost income ratio and profitability. On the other hand, studies of Syafri (2012), Zeitun (2012) and Almazari (2013), found negative effect of cost income ratio on profitability and most of the studies on the cost income ratio and profitability stopped at 2010. This study therefore fills the gap by widening and extending the period up to 2013. The literatures on the relationship between income diversification and financial performance are also conflicting. For instance Chiorazzo, Milani, & Salvini, (2008) and Elsas, Hackethal, Holzhauser (2010) concluded that revenue diversification enhances bank profitability via higher margins from non-interest businesses. On the contrary studies of DeYoung & Rice (2004), Morgan & Katherine (2003), Stiroh (2004), Stiroh & Rumble (2006) among others proved that greater diversification of the banking business does not necessarily translate into an improvement of the bank’s profitability but it may be detrimental to it.
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In Nigeria, Ani et al. (2012), Aremu et al. (2013), Soyemi et al. (2013) studied the determinants of DMBs profitability and did not include income diversification as an important variable that affect financial performance. Studies have shown that more diversification can yield better profits (Jiang et al., 2001). Banks that are able to effectively and efficiently utilize their sources of income other than interest income would have a competitive advantage in the industry and thus make superior profits. This therefore triggers the need in the Nigerian context to include such a variable in order to ascertain its behavior as one of the financial performance determinants. In light of the above, the result from previous studies have not been consistent in all respect and findings were mixed in some cases. It is on this premise that a research carried out to the existing body of knowledge by empirically examining the extent to which determinants significantly affects financial performance of MBs in Nigeria. 1.3 Resaerch Questions The following research questions are set;
i. Does capital adequacy has significant effect on financial performance of MBs in Nigeria ?
ii. Does credit risk has significant influence on financial performance of MBs in
Nigeria ?
iii. Does bank size has significant impact on financial performance of MBs in Nigeria ?
iv. Does cost income ratio has significant effect on financial performance of MBs in Nigeria ?
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v. Does income diversification has significant impact on financial performance of MBs in Nigeria ?
1.4 Objectives of the study
The general objective of this study is to examine the determinants of financial performance of MBs in Nigeria. Specifically, it seeks to:
i. assess the effect of capital adequacy on financial performance of Mega banks in Nigeria,
ii. examine the effect of credit risk on financial performance of Mega banks in Nigeria,
iii. evaluate the impact of bank size on financial performance of Mega banks in Nigeria,
iv. determine the effect of bank efficiency on financial performance of Mega banks in Nigeria,
v. assess the influence of income diversification on financial performance of Mega banks in Nigeria.
1.5 Hypotheses of the study On the basis of the above background and in line with the objectives of the study the following hypotheses have been formulated in null form for the study. Capital adequacy has no significant effect on financial performance of Mega banks in Nigeria, Credit risk has no significant effect on financial performance Mega banks in Nigeria,
Bank size has no significant effect on financial performance of Mega banks in Nigeria,
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Bank efficiency has no significant effect on financial performance of Mega banks in Nigeria, Income diversification has no significant effect on financial performance of Mega banksin Nigeria. 1.6 Scope of the study This study focused only on the determinants of financial performance of Mega banks in Nigeria. It also the scope of the study confined merely on the quantitative measure of determinants of MBs profitability in Nigeria without any overall performance measurement tool. The study focused on the determinants of MBs financial performance in Nigeria and is restricted to the relationship between return on assetand its determinants for a period of seven years from (2007 to 2013) that is post consolidation period which was characterized by the heat of the global financial crises.The ROA reflects the ability of a bank‟s management to generate profits from the bank‟s assets. It shows the profits earned per Naira of assets and indicates how effectively the bank‟s assets are managed to generate revenues, although it might be biased due to off-balance-sheet activities. This is probably the most important single ratio in comparing the efficiency andoperating performance of banks as it indicates the returns generated from the assets that bankowns (Tan et al. 2012). ROA is the most comprehensive accounting measure of a bank‟s overall performance (Birhanu 2012). Because of this, the bulk of studies employed ROA as performance measure, for instance, ( Mohana et al. 2012, Li Yuqi 2006, Sufian 2011, syafri 2012).
This study is limited to internal factors such as capital adequacy, credit risk, efficiency, bank size and income diversification that determine the financial performance of MBs in Nigeria. The choice of explanatory variables is based on their theoretical relationship with the dependent
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variable. Generally speaking, the chosen explanatory variables are expected to partly explain the variation of the dependent variable. 1.7 Significance of the study A study to establish the underlying factors responsible for financial performance of MBs in Nigerian is of paramount importance. The findings of this study is expected to contribute practically and theoretically to various stakeholders as well as provide a basis for policy formulation. Specifically,this study will fill the gap and potentially serve as a stepping stone for further research in the area. it will help policy makers in the banking sector to ascertain the adequacy of financial performance in order to take a prompt action where necessary. The result of the study will assist the regulatory agencies like central bank of Nigeria (CBN) and Nigerian Deposit Insurance Corporation (NDIC) in formulating policies and ensuring safety and soundness of the entire financial system in line with the best practice of banks around the globe. The result of this work will provide employees and shareholders with the information they need concerning variables that can affect their organization‟s financial performances. Practically, practitioners including bank managers, accountants, financial analysts, consultants, financial advisers, stock brokers and other professionals will find this work useful by providing them with an insight on internal determinants of financial performance which will serve as a guide when carrying out their consulting/ advisory services to their respective clients, prospective investors and other interested parties and the results of this study will serve as a guide to the members of board of directors in setting business goals and objectives.

 

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