Conceptual Exposition of the Effect of Inflation on Bank Performance

Abstract

Despite the fact that, banks can withstand the effects of inflation in the short run, since banking system mostly operates with reference to interest rate and maturity of financial instruments with less concern about the purchasing power of money. However, the banking system cannot absorb the shocks in the long run. The objective of this paper is to conceptually expose the effect of inflation on bank performance. To accomplish this objective, the paper reviews some theoretical and empirical works on the effect of inflation on financial sector performance. The paper found two divergent views. Thus, inflation has an adverse effect on banking sector performance and its spillover effect is very harmful to the overall economy. Inflation affect the purchasing power and bank exchange rate regime, opportunity cost of holding currency in the future, worsen loans policy, disrupt business plans and the equity holding performance of banks. While the other side of the argument states that inflation leads to an increase in bank performance as long as the banks can be able to anticipate future inflation and adjust interest rate to generate higher revenue than cost which leads to higher profit and performance as a result of adjusting the rate of interest.