Regulations, Bank Stability Measures and Stock Market

Abstract

Regulations directed at bank stability affect the entire financial system because of the strategic role banks play in the economy. The impact of regulations on bank performance have been examined. However, the use of bank regulatory stability indicators and aggregate financial regulatory instruments to account for stock market returns in Nigeria post-global financial crisis is limited, which is the gap this study seeks to fill. Data for this study was collected from investigated banks’ audited annual reports, the Central Bank of Nigeria Statistical Bulletin and Nigerian Stock Exchange official daily price list. Thirteen (13) banks listed in the Nigerian Exchange Limited for the 2010 to 2020 were investigated. The Difference Generalized Method of Moments was applied to the dynamic model to examine the effect of regulations, bank stability indicators on the returns of bank stocks. The Arrelano and Bond procedure was used to test for autocorrelation in the regression output, while the J.statistic enunciated by Hansen was employed to evaluate the existence or otherwise of over/under constraints in the instrumental variables incorporated in the estimation tool. E-view 9.0 econometric computer application was used for the analysis. This study found that bank liquidity ratio, an indicator of bank stability in this study positively and significance determines stock market returns. Also, capital adequency ratio, another bank stability indicator in this study positively and significantly drives stock returns. Similarly, monetary policy rate, an indicator used by the Central Bank of Nigeria to regulate aggregate liquidity positively and significantly influence bank stock returns. This study also revealed that the prescribed cash reserve ratio used by the Central Bank to regulate the capacity of banks to grant credits is negatively and significantly related to stock returns in Nigeria. This implies that a rise in cash reserve ratio limits the ability of banks to create credits, thereby reducing interest income from loans, thus reducing bank earnings. These findings imply that: (i) Investors should incorporate bank stability indicators and aggregate monetary policy regulatory instruments in their investment strategies if they hope to achieved maximum returns on investment. (ii) The regulatory authority can influence stock market performance through the concurrent utilization of bank stability indicators enunciated in Basel regulatory accord and monetary policy instruments (iii) The use of Cash reserve ratio as the regulatory instrument is potent in ensuring bank stability but it has adverse effect on bank stock returns because of its effect on interest income and earnings through its limitation on credit creations. Therefore, the central bank should reconsider the current cash reserve ratio and make it more friendly for banks' credit creation.