Bank Performance versus Recession Indicators: A Linear Cointegration Approach

In this study, the researcher provides an empirical investigation of the nexus between banks’ performance and recession indicators. A sample size of 35 years was selected on annual data. A linear cointegration method was adopted after accounting for seasonality through logarithmic transformation. The results revealed that indicators of recession-exchange rate, inflation and interest rate maintain long run relationship with bank performance, and evidence of long run influence was established. Furthermore, we discover that within the purview of short run dynamic situation, inflation influences banks’ performance inversely, while exchange rate and interest rate increase with increase in banks’ performance. We therefore conclude that banks’ performance is driven by indicators of recession both in the short and in long run.


Introduction
Over the past decade, the credit quality of loan portfolios across most countries in the world remained relatively stable until the financial crises hit the global economy in 2007-2008. Since then, average bank asset quality deteriorated sharply due to the global economic recession.
The fact that loan performance is tightly linked to the economic cycle is well known and not surprising. Yet the deterioration of loan performance was very uneven across countries. For example, the Baltic countries which stand out in cross-country comparisons of GDP performance during the crisis had very large increases in non-performing loans (NPLs) even when controlling for the severity of the recession.
Thus, the 2007-2009 global financial turmoil affected banking systems around the world, including Nigeria.
Nevertheless, Nigerian banks have not performed relatively well. They for example, require capital injections at some point in time, and deposit guarantees have to be expanded. According to Kithinji and Waweru (2007), banking problems is back-dated as early as 1986 culminating in major bank failures (37 failed banks as at 1998) following the crises of 1986 to 1989, 1993/1994 and 1998; they attributed these crises to NPLs which is due to the interest rate spread.
According to (McNulty et al 2001), controlling NPLs is very important for both the performance of an individual bank and the economy's financial environment. Due to the nature of their business,

Bank Performance versus Recession Indicators: A Linear Cointegration Approach
Ashamu Sikiru Oyerinde 9 commercial banks expose themselves to the risks of default from borrowers. Prudent credit risk assessment and creation of adequate provisions for bad and doubtful debts can cushion the banks risk. It is established that when the level of nonperforming loans is very high, the provisions are not adequately protected (Waweru and Kalani, 2009). The occurrence of banking crises has often been associated with a massive accumulation of nonperforming assets which can account for a sizable share of total assets of insolvent banks and financial institutions. Therefore, the causes of loan defaults should be established so as to reduce the level of nonperforming loans.
From the foregoing, it seems there is negative relationship between recession and banks' performance.
However, management of recession in an economy helps improve the financial performance of banks, as interest on loans is the biggest income of banks, and increase the liquidity position of banks, protect the bank reputation and reduce loan losses. Also, Golden, Sam and Harry (1993) emphasized that since one of the most important aspects of lending is determining the customer desire to repay the loan, information in the credit file will give the credit officer document on the customer's repayment history. This is accomplished with the fact that commercial banks have measures in place to guard against loans, taking mortgages on landed properties, stock, bonds and other securities to fall on in time of default. This was debunked by Samuel (2011) who claimed that loan default has become an inevitable part of the banking or lending business in a recessive economy, there is high default risk because the income of borrowers has to be reduced. Accordingly leading to repression situation and consequently reducing the ability to honor obligations at maturities. The argument perhaps is do banks drive well in recession, when exchange rate and interest rate increase sporadically. Many studies have answered this question differently. This growing gap has inspired me to investigate the dynamic causations that exist between recession proxies and bank performance in Nigeria with the aim of justifying or expanding existing positions. The rest of the paper is organized as literature review, methodology and data, results, conclusion and recommendations

Literature Review
The Great Recession is strongly associated with the US real estate crisis and recent work has explored the link between real estate stresses and bank distress. Aubuchon and Wheelock (2010) find that both during the 2007-2010 and the 1987-92 episodes, bank failures were concentrated in regions with the largest declines in economic activity (as evident in declines in personal income or gross state product, and in increases in unemployment) and with the most severe stresses in the real estate market (as evident in declines in house prices and increases in delinquency rates). Beltratti and Stulz (2012) find that banks whose returns were more exposed to US real estate exhibited better stock performance during the crisis, but this effect they find to only be present in a subsample of very large banks (assets greater than $50 billion).
New England experience of the early 1990s has shown that even well-capitalized banks can fail, as capital buffers deteriorate rapidly when banks approach failure (Peek and Rosengren (1997)). In a more recent paper, Berger and Bouwman (2013) exploit an exogenous source of variation in the stock of capital buffers to study the effect of capital on two dimensions of bank performance, probability of survival and market share, and find the effect to vary across banking crises, market crises, and normal times. In particular, capital increases the probability of survival and market share of smaller banks for all three types of crises, but improves the performance of medium and large banks primarily during banking crises. Though these studies advance our understanding ECB Working Paper 1779, April 2015, 9 of bank capital's primary function as the buffer that stands between bank survival and failure, they do not speak to the root causes of the losses that capital buffers are set to absorb. Bank failure is normally attributed to excessive risk-taking by banks, and some studies have

Bank Performance versus Recession Indicators: A Linear Cointegration Approach
Ashamu Sikiru Oyerinde 10 modeled bank risk as an outcome variable of managerial quality and/or corporate governance. Wheelock and Wilson (2000) show that during the 1984-1993 banking crisis banks with low managerial quality were more likely to fail and less likely to be acquired. Laeven and Levine (2009) use an international sample of banks to study the effect of conflicts of interest between managers and shareholders on risk-taking during the early 2000s. They find that banks with more powerful owners tend to take greater risks and also find the impact of banking regulations to vary with shareholder concentration.
Cole and White (2012)  DeYoung and Torna (2013) focus on composition effects, and examine the degree to which the composition of a bank's income sources affected bank distress during the recent financial crisis.They show that for distressed banks the probability of bank failure increased with asset-based nontraditional activities (venture capital, investment banking and asset securitization), but declined with pure fee-based nontraditional activities (securities brokerage and insurance sales). DeYoung and Torna (2013) also show that banks with a substantial amount of asset-based nontraditional activities tended to take more risk on their traditional banking activities.

Model
The model adopted in this study follows the approach of Ratnovski and Huang (2009) Where: ba (bank asset), ex (exchange rate), inf (inflationary rate) and int (interest rate). The VAR (P) above is a four-dimension specification and it is plausible to represent it in a compacted form

Data Source
The data for this study are secondary and are were sourced from the CBN annual statistical bulletin over the period of 1980 to 2015

Descriptive Statistics Results
The descriptive statistics results are based on values of the mean, standard deviation, skewness, kurtosis and Jaque-Bera. These values are presented in table 1 below. interest rate and total asset are approximally three. Meaning they are mesokurtic. However, the probabilities of the Jarque-Bera statistics show that exchange rate interest rate and total asset are normally distributed while inflation does not follow a normal distribution. Source: Author's computation using E-view 9

Unit Root Test
From the above table, it is seen that at level exchange rate, inflation, and interest rate are stationary while the null holds for total asset that the series of total asset is not stationary or has a unit root. In the same token, at first difference exchange rate, inflation, and interest rate are stationary while total asset is not stationary.

Test of Cointegration on the Variables EX, INF, INT and TOT ASS
The cointegration technique introduced by Johansen was adopted in this study. The results however are reported in table 4   Note that * and ** imply significance at 1% and 5% respectively, the critical t-statistics @ 1% and 5% are 2.70 and 1.67 respectively. The degree of freedom is 33.
The ECM coefficient -0.001 or 0.1 percent as shown in table 5 has the right theoretical sign and significant at 5 percent. This means that any disequilibrium in the long run can be corrected at the rate of 0.1 percent. Also, these results show that there is long run influence or causality running from exchange rate interest rate and inflation to total asset. The short run dynamic results reveal that has. Meanwhile exchange rate and inflation have significant relationship with total asset.

Conclusion and Recommendation
Conclusively, recession has a negative significant relationship with bank performance in Nigeria. And on this note, it is recommended that monetary authority should formulate policies that will reduce the negative impact of recession on banks' performance since the Nigeria economy is bank driven.