Academic journal article Journal of Financial Management & Analysis

Adjustment of Portfolio Assets to Changes in Fundamental Determinants: Evidence from Nigeria's Leading Commercial Bank

Academic journal article Journal of Financial Management & Analysis

Adjustment of Portfolio Assets to Changes in Fundamental Determinants: Evidence from Nigeria's Leading Commercial Bank

Article excerpt

Introduction

Commercial bank is a financial institution where money and other valuables are kept for safe custody. The money kept with the bank is referred to as deposit and the depositor is entitled to his money when he is in need of it. But experience has shown that all depositors do not withdraw their money all at the same time. So, it becomes possible to keep some proportion of the deposit to meet the withdrawal needs of depositors, while the excess can be given out as loans and also invested in securities. It is the distribution of total deposit of the bank into cash reserves, loans and investments that constitutes bank portfolio. The issue before management is what proportions of the total deposit should be held as cash reserves, loans and investments, taking into consideration the need to maximize profit and ensure adequate liquidity for the depositors.

Portfolio management is one of the most challenging aspects of bank management. It is not simply a distribution of bank's funds, but a distribution, which must meet two important but conflicting objectives of profitability and liquidity. This is clearly indicated by (Crosse and Hempel)1 who argue that the primary aim of bank's portfolio policy is to obtain maximum return with minimum exposure to risk. In addition, they maintain that banks must be sufficiently liquid in order to meet, not only the legal reserve requirement, but also the net withdrawal of funds by depositors.

In order to fully understand the adjustment of assets in portfolio, there is need to adopt both theoretical and empirical methods of analysis. This study, therefore, uses both methods to analyze such behaviour in First Bank of Nigeria (FBN), which is a leading commercial bank in Nigeria, in terms of total deposit, capital base and branch network. The study covers the period 1980-2000, because that period provides the most current data for all relevant empirical variables. Such data were obtained from several issues of the bank's annual report and other sources such as Central Bank of Nigeria, Federal Office of Statistics in Nigeria, and International Monetary Fund.

Banks seek to maintain optimum portfolio structure at any given point in time. The desired holding or demand for any asset class in the portfolio of a bank is fundamentally determined by rate of returns on the asset, total deposit of the bank, and aggregate economic activity (gross domestic product). If desired holding deviates from actual, the bank is expected to adjust its portfolio assets until it approaches the desired level. The bank, therefore, is always in a process of asset adjustment as a result of changes in the determinants. It is the response of the assets in the portfolio to changes in the determinants that this study attempts to estimate and analyze, for the purpose of providing useful policy information to the management of FBN, and indeed, other banks in the country.

Evolution of Portfolio Analysis

The literature on portfolio determination is quite extensive. The school of thought pioneered by Bernoulli2 posits that portfolio performance can be evaluated in terms of expected utility from its assets. This proposition is explicit in his classical work on portfolio structure, which he based on the principle of expected utility maximization. In his opinion, the value of an asset in a portfolio depends on its utility and not on its price. The Bernoulli rule for asset selection in a portfolio has, however, been severely criticized, largely because his expected utility principle was derived from assumptions rather than real life behaviour. This criticism may have been neutralized by the innovation of Neumann and Morgenstern3, which has made it possible to derive the expected utility principle directly from a set of individual behaviours. In other words, they showed that utility index could be constructed to predict behaviour under conditions of risk by careful observation of real life activities. …

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