STRUCTURAL BREAKS AND ASYMMETRIC ANALYSES OF MONETARY POLICY,

CREDIT RISK BEHAVIOUR AND BANK STABILITY NEXUS IN NIGERIA

BY
SANUSI W. OLADELE
PhD PROPOSAL

A RESEARCH PROPOSAL PRESENTED TO THE SCHOOL OF

MANAGEMENT AND SOCIAL SCIENCES, IN PARTIAL FULFILMENT
OF THE REQUIREMENTS FOR THE AWARD OF DOCTOR OF
PHILOSOPHY (Ph. D) IN MANAGEMENT, ,
PAN-ATLANTIC UNIVERSITY,
LAGOSSTATE,
NIGERIA

JULY, 2023

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Contents
CHAPTER ONE..............................................................................................................................2
INTRODUCTION...........................................................................................................................2
1.1 Background to the Study...................................................................................................2
1.2 Statement of Problem........................................................................................................4
1.3 Research Questions...........................................................................................................6
1.4 Research Objectives..........................................................................................................6
1.5 Justification of the Study...................................................................................................7
1.6 Scope of the Study............................................................................................................7
CHAPTER TWO.............................................................................................................................8
LITERATURE REVIEW.................................................................................................................8
2.1 Theoretical Review...........................................................................................................8
2.1.1 Liquidity Theory........................................................................................................8
2.1.2 Credit Risk Theory.....................................................................................................8
2.1.3 Financial Distress Theory..........................................................................................9
2.1.4 Credit Business Circle Theory...................................................................................9
2.2 Empirical Literature........................................................................................................10
2.2.1 Monetary Policy and Risk Behaviors......................................................................10
2.2.2 Monetary Policy and Bank Stability........................................................................11
CHAPTER THREE.......................................................................................................................14
RESEARCH METHODOLOGY..................................................................................................14
3.1 Introduction.....................................................................................................................14
3.2 Empirical Model Specification.......................................................................................14
3.3 Estimating Techniques....................................................................................................15
3.4 Sources of Data...............................................................................................................15
REFERENCES..............................................................................................................................16

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 CHAPTER ONE

INTRODUCTION
1.1 Background to the Study
It is well recognized that credit markets significantly influence how monetary policy affects the
banking sector, which subsequently affects the actual economy. It is also proven that some
borrowers may be more susceptible to changes in lending conditions since an already shaky
economy may become even more constricted if interest rates rise. This creates the potential for
monetary policy's effects to be nonlinear. The credit channel mechanism of monetary policy
affects both the efficiency of the financial markets and their ability to satisfy the needs of both
borrowers and lenders. It also has an impact on the degree of rationing that borrowers experience
in the loan markets (Mandouh, 2020; Walsh, 2010). Increased agency fees, inefficient loan
distribution, and a negative impact on organization balance sheets are all consequences of higher
interest rates. Interest rate levels do not necessarily correspond to modifications in the credit
landscape. Understanding how weaknesses in the credit market affect the stability of the banking
sector and the channels by which the banking industry's monetary policy decisions are conveyed
to the real economy are crucial. These channels are the credit and balance sheet channels. Credit
effects contribute to the spread of monetary policy since participants to credit agreements
communicate inaccurate information (Mandouh, 2020; Walsh, 2010).

Credit and risk-taking channels should be distinguished from one another. The credit channel
deals with lending to creditworthy borrowers in the context of an expansionary monetary policy,
whereas the risk-taking channel deals with lending to riskier borrowers. Lending and balance
sheets channels both relate to how monetary policy has repercussions. While high interest rates
have a negative effect on borrowers' balance sheets, which is related to the lending channel, low
interest rates promote more lending (Diana and Carla, 2014). Given this, the relationship
between monetary policy and bank risk can be summed up as follows: the monetary authority
uses the tools through its monetary policy. One of the most crucial tools that Central Banks
employ to manage the performance of banks is the policy rate. 1 Low interest rates encourage
more lending, but high interest rates have a detrimental impact on borrowers' balance sheets,
which is connected to the lending channel (Diana and Carla, 2014). The monetary authority uses

1
There are other instruments that are used by central banks to affect the economy, like the money supply, if the
economy is dynamically inefficient. Also, the introduction of money can make everybody better off.

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the tools through its monetary policy, which is how the relationship between monetary policy
and bank risk can be summarized given this. Additionally, by altering risk perception, monetary
policy has an impact on the balance sheets of banks. The balance sheets of the bank are altered
and revalued as a result. In terms of the expansionary monetary policy, for instance, banks and
investors both desire greater yields as a means of achieving their objectives. The monetary policy
authorities therefore evaluate both routes while prioritizing the goals of financial stability (Kim,
2014). However, the monetary policy is not the only factor affecting banks' risk appetites. The
preferred inflation rate is the main factor that central banks consider when setting interest rates.
This happens in some developed and other developing countries. The majority of past studies
have concentrated on how low interest rates have a negative short-term influence on banks'
lending policies. In the long term, the fact that the result was favorable signaled a turning point.

Financial intermediation continues to be the primary objective of financial institutions and the
stability of that function is considered along with management of capital , liquidity risk, market
risk, interest rate risk, nation risk, foreign exchange risk, credit risk risk, and operational risk
(Jenkinson 2008; Suyanto 2021).. Poor credit risk management could lead to the demise of the
banking sector when there is a preponderance of credit defaulters (Accornero et al. 2018;
Kwashie et al. 2022; Malik et al. 2014), which would be disastrous for the performance of banks
and returns to equity investors (Khalid et al. 2021; Uwalomwa et al. 2015). The Central Bank of
Nigeria's (CBN) recapitalization policy for Nigerian banks, which was put into effect in July
2004, is one of the solutions to lessen the incidences of insufficient credit risk management. The
CBN's regulatory publication of Prudential Guidelines, Guidance Notes on the Regulatory Capital
Measurement and Management of Nigerian Banking System ( For the Implementation of Basel II/III in
Nigeria), are other options.Meanwhile, studies on the effect of monetary policy on lending and
economic growth have also been conducted, either using samples of commercial banks or
changing monetary policy in specific countries. Other academics have focused on capital flows
and how monetary policy affects them. There has been some research into how non-performing
loans affect economic growth. One might observe that the risk-taking channel of monetary policy
receives disproportionate attention in the literature, especially in the OECD economies.
Additionally, Mandouh (2020) studied how monetary policy affected bank risk in the banking
system in a few MENA nations. By examining how monetary policy influences credit risk
behaviors and bank stability in the Nigerian banking system, this study seeks to slightly stray

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from the norm. It will examine structural breaks and asymmetric impact of monetary policy on
risk behaviour and stability in the Nigerian banking sector.

1.2 Statement of Problem

The continued expansion and stability of the nation's current financial system are essential for
any economy's prosperity. Nigeria's financial sector is primarily composed of the money market,
the capital market, and the expanding mortgage market. In Nigeria, the mortgage and capital
markets are both lubricated by the money market. On the other hand, the capital market acts as a
crucial gauge and a driving force behind any economy's steady growth and development. The
world's most developed economies, the OECD are associated with the most developed money
markets and capital markets (Omorokunwa & Ogbeide, 2020). The stability of the banking sector
in Nigeria depends on deposit money banks' (DMBs') capacity to generate new money as well as
the risk associated with their functions as financial intermediaries. Deposit money banks accept
deposits from the adequate and sufficient units of the economy in order to assist the deficient
units of the economy in meeting their short- to medium-term obligations. Thus, there is a risk
associated with managing the deposit money bank's credit facilities. Failure of the deficient units
to pay back the loan by the due date may put them in default risk, which is first categorized as
doubtful debts and then as bad debt when the client is unable to pay after the bank has pursued
all available legal avenues to recover the loan. Because credit creation is one of the main sources
of income for deposit money banks, this could make it more difficult for them to remain in
business and consequently, impact on stability in the banking system entirely. Bank crises in the
early and late 1980s and in the most recent times were largely due to the gradual rise in non-
performing loans in Nigeria's deposit money banks. This continues to be a significant challenge
for bank management, as well as for regulators, shareholders, and other stakeholders. Since
nonperforming loans in the banking industry cannot be entirely prevented, they can be limited
within a reasonable range by efficient credit management (Omorokunwa & Ogbeide, 2020;
Catherine, 2020; Rehman, Muhammad, and Sarwar; 2019).

For instance, the dispute over the risk-taking channel of monetary policy is rooted in the global
financial crisis of 2008. The financial crisis showed that even the most advanced institutions are
vulnerable to unpredictability, which can lead to failures of both the local and international
financial markets and have a detrimental impact on the actual economy. The two primary reasons

5
of the crisis were cited as inadequate credit expansion and the deflation of a number of real estate
market bubbles (Aboyadana, 2021; Zsuca & akbostanci, 2016). These occurrences caused
volatility in the global credit market, which made it clear that a danger to the stability of the
global financial market already existed. Researchers and policymakers have both systematically
questioned the crisis's potential roots in an effort to identify the causes of the global financial
system's fragility. However, despite the paucity of empirical study in this area, there seems to be
agreement on a few elements that may have contributed to the crisis. The rise of complex
financial products, the lack of or inadequate regulatory and supervisory oversight, the failure of
macroprudential policies, and lax corporate governance frameworks are a few of these
(Aboyadana, 2021; Bruno, Shim, & Shin, 2017; Fahr & Fell, 2017).

According to Dell'Ariccia, Laeven, and Marquez (2014), the monetary authorities have also
come under fire for adopting unduly accommodative monetary policies in the five years before to
the crisis. Since those who oppose monetary policy argue that there is a greater incentive for
financial intermediaries to take more risk when the monetary environment is loose, such as when
there are low interest rates and loose liquidity for extended periods of time, this has sparked a
contentious debate among economists. Therefore, supporters of this position believe that
monetary policy was a key motivating factor that led to the financial crisis. When we take into
account that certain countries' monetary authorities further loosened the monetary condition to
address the crisis' impacts, the situation becomes even more divisive. As a result, the discussion
among researchers and in policy discourse over the connection between monetary policy and
financial stability has been more heated (Aboyadana, 2021). Furthermore, the financial industry's
rapid innovation has been seen as a tool for achieving financial system stability. Despite this,
there is a compelling case to be made that the effects of monetary policy must now be considered
when making policy choices aimed at maintaining financial stability (Bruno et al., 2017; Salle &
Seppecher, 2018). Decisions regarding monetary policy must also take financial stability into
account.

In the literature, the issue of how monetary policy affects banks' incentives to take risks has
taken center stage, giving rise to the concept of the "risk-taking channel." The term "risk-taking
channel" describes how risk is perceived and valued in relation to the current posture of
monetary policy. The focus has been on the relationship between policy stance and banks' risk

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appetite and risk perception. The main claim is that when interest rates are extremely low, banks
will choose to take on more risk, which would change the demand for credit. To put it another
way, the risk-taking channel implies that lending on low-quality portfolios will become riskier as
a result. Thus, monetary policy can increase imbalances in the economy, which can lead to
financial instability. A few approaches are mentioned. First off, it can have an impact on how
people value their earnings and cash flows, which in turn has an impact on how they assess risk.
Second, low interest rates might encourage banks to act aggressively in order to hit profit goals.
Thirdly, the risk-taking channel can be influenced by how policies are presented and the
monetary policy authority's reaction function, including the result of the notion that the latter's
reaction function is successful in reducing excessive downside risk.

However, there is a need to research the risk-taking channel of monetary policy in the Nigerian
environment, especially if we take into account context-specific factors and dynamics. We will
investigate the asymmetry relationship using the Non-linear ARDL as inspired by Shin, et al.
(2014), in order to fully understand the relationship between monetary policy, credit risk
behaviors, and bank stability in the banking system in Nigeria. As is clear from the literature, the
underlying relationship is likely to be nonlinear (Mandouh, 2020).

1.3 Research Questions

i. How does monetary policy influence credit risk behaviours in the banking sector in
Nigeria?
ii. What is the role of monetary policy on bank stability in the banking sector in Nigeria?
iii. Is there structural breaks and monetary policy shift influence on credit risk and bank
stability relationship in Nigeria?

1.4 Research Objectives

The broad objective of this study is to empirically investigate the structural breaks and
asymmetric nexus between monetary policy, credit risk behaviour and bank stability in Nigeria.

While the specific objectives are:

i. To empirically determine the asymmetric effect of monetary policy on credit risk

behaviours in the banking sector in Nigeria.

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 ii. To empirically investigate the asymmetric impact of monetary policy on bank stability in
the banking sector in Nigeria?

iii. Determine the extent to which structural breaks and monetary policy shift influence credit
risk and bank stability relationship in Nigeria.
1.5 Justification of the Study
The justification for this study is to clearly demonstrate how monetary policy assisted in
restoring the soundness of Nigeria's banking sector after the recent round of recessions witnessed
in the economy, and coupled with the exchange rate unification. The Central Bank of Nigeria and
other regulatory and oversight bodies have always aimed to create a sound, safe, and stable
financial system. As a result, it is commonly known that the banking industry is susceptible to
volatility and fragility brought on by endogenous policy initiatives, such as monetary policy, and
external shocks (Maxwell, 1995). However, Stiglitz (2003) and Kashayap and Stein (1994) had
demonstrated that a well-developed, stable, and robust banking sector is also necessary for
efficient financial intermediation and the effectiveness of monetary policy. This is incredibly true
since a strong banking sector can increase the effectiveness of monetary policy transmission.
Stability of the banking system was described by the Deutsche Bundesbank as "a steady state in
which the financial system effectively performs its key economic functions, such as resource
allocation, risk spreading, and payment settlement" in 2003.In order to understand how the
monetary policy affects credit risks and bank stability in their lending practices, it is crucial to
carefully study how the CBN might act to lower default risks.

1.6 Scope of the Study

The study will be conducted within the context of the Nigerian economy and will employ
quarterly time series data for the period span between 2010Q1 and 2021Q4; a period coincidental
after the Central Bank of Nigeria (CBN) issued circulars requiring the implementation of the
consistent accounting year-end to all banks and discount institutions in 2009 (CBN, 2009).

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 CHAPTER TWO

LITERATURE REVIEW
2.1 Theoretical Review
There are ideas connecting monetary policy to banking system stability. Here are a couple of
them in more detail
2.1.1 Liquidity Theory
According to Diamond and Dybvig's (1983), the liquidity theory asserts that bank runs can result
when banks are unable to promptly accommodate urgent consumer withdrawal requests. In this
instance, the stability of the banking system is threatened by banks that are prone to bank runs.
Therefore, central banks should constantly take action to allow banks to fulfill withdrawal
demands from depositors.

2.1.2 Credit Risk Theory

The main danger of a credit default—borrowers being unable to repay the loans they have
obtained from their banks—makes it difficult for banks to act as credit intermediaries (Coyle
2000). The Merton (1977) default model established credit risk theory, which links a firm's credit
risk to its capital structure in terms of its equity and debt obligations. Undoubtedly, the failure of
borrowers to meet their obligations to their banks will have an effect on the capital structure of
the banks. Central banks are also presented with the problem of ensuring that banks have
appropriate policies and procedures to safeguard them against late loans through the periodic
release of guidance to banks and the enforcement and implementation of punishments when the
rules are ignored. All of these moves by central banks are intended to prevent financial system
turmoil and to ensure that the terms and conditions of financial agreements are upheld by both
banks and their clients.

However, according to Owojori et al. (2011), banks are ready to raise interest rates for loans with
likely higher default risks. Bank financial performance and how effectively their credit risk
exposures are managed must be weighed equally. Further, it is anticipated that bank management
teams will look for and implement suitable approaches to control their credit risk exposures,
albeit within the constraints of their individual central banks' prudential rules and corporate
governance code (Almustafa et al. 2023).

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2.1.3 Financial Distress Theory
The financial performance of banks is crucially influenced by Baldwin and Scott's (1983) theory
of financial distress because healthy banks can continue to conduct their financial intermediation
activities. However, this idea contends that when banks start to demonstrate a propensity for
missing deadlines for payment, financial catastrophe is only around the corner. It is crucial for
banks to protect their financial stability from risky situations like systemic shocks brought on by
the occurrence of COVID-19 and inadequate risk and financial performance monitoring (Berger
and Pukthuanthong 2012, 2016; Proag 2014; Wruck 1990). The greatest challenge for a bank
may not be credit default so much as it may be the waning effects of credit default, such as being
unable to honor depositor withdrawals due to low liquidity, which may lead to a bank run (this is
a situation where depositors make unusual cash withdrawals from a bank out of fear that it will
become insolvent or bankrupt). This may eventually affect a bank's liquidity, cash reserve ratio,
and capital adequacy ratio, which may result in the bank failing. The recent and tragic
bankruptcy of Silicon Valley Bank (SVB) serves as a stark reminder of how important this
concept is to banks' capacity to manage credit risk, perform financially, and even remain in
business.

2.1.4 Credit Business Circle Theory

Ludwig and Hayek (1974), two economists from the Austrian School, are credited with
developing the credit business cycle theory. According to the hypothesis, business cycles are the
outcome of unsustainable bank credit growth brought on by extraordinarily low market interest
rates. It is anticipated that interest rate levels will have an impact on the financial system's
strength and stability. Low interest rates frequently result in the production of inferior assets,
which may cause a crisis in the banking system. The health and stability of the financial system
should not be harmed by the level of interest rates that central banks are expected to take into
account.

The connection between monetary policy and failed banks in developing nations was presented
by Cadet (2009). He pointed out that restrictive monetary policy raises the likelihood of bank
failure even while treasury bills exist as an alternative source of profit for banks in developing
nations. According to the portfolio regulation idea put forth by Markowitz in 1952 and endorsed
by Roger and Arnold in 1978, portfolio control is essential to preserving the stability and safety

10
of the financial system. Due to this, regulatory authorities are now insisting on the minimum
liquidity, capital, and prudential ratio standards.

2.2 Empirical Literature

2.2.1 Monetary Policy and Risk Behaviors
The effect of monetary policy on financial stability has been the subject of numerous research in
Nigeria. Oparah and James (2020) used quarterly data from 2008Q1 to 2016Q2 and the error
correction model (ECM) technique to examine the effect of monetary policy on the financial
stability of the banking industry in Nigeria. The findings indicated that exchange rates and open
market transactions were two ways in which monetary policy improved financial stability. Using
the error correction model (ECM) method, Hamilton et al. (2020) conducted a study on the
impact of monetary policy on banking system distress in Nigeria from 1989 to 2018. The
findings indicated that, in the long run, monetary policy—represented by the monetary policy
rate—had a negative impact on banking distress and, in the short run, a favorable impact.
Additionally, the exchange rate had a favorable impact on Nigeria's financial crisis. Using the
vector error correction method, Ajisafe et al. (2021) investigated the impact of monetary policy
on financial stability in Nigeria from 1986 to 2017. The findings indicated that monetary policy,
specifically the exchange rate, has a major impact on Nigeria's financial stability.

Using the general method of moment (GMM) technique, Atoi (2018) looked into the causes of
non-performing loans and their impact on banking stability in Nigeria from 2014Q2 to 2017Q2.
The outcome demonstrated that the factors driving non-performing loans were the lending rate,
the exchange rate, and the liquidity ratio, and that shocks to the non-performing loan market had
a negative impact on banking stability.

Using monthly data from 2006 to 2013, Ouhibi and Hammami (2015) examined the relationship
between monetary policy and financial stability among six (6) Southern Mediterranean nations
(Tunisia, Egypt, Morocco, Turkey, Lebanon, and Jordan). The outcome showed that monetary
policy strategy through short term interest rate had an impact on financial stability for countries
that implemented flexible exchange rates (such as Turkey, Tunisia, Egypt, and Morocco).

On the other hand, monetary policy through short term interest rates did not have a favorable
impact on financial stability in nations that implemented a regime of fixed exchange rates (such

11
as Lebanon and Jordan). Using monthly data from 2003 to 2009, Tabak et al. (2013) examined
the contribution of monetary policy on maintaining financial stability in Brazil. The estimate
method fixed effect panel was applied. The findings indicated a strong correlation between
Brazil's financial stability and monetary policy. Khataybeh and Al-Tarawneh (2016) used
monthly data from September 1993 to December 2012 and the vector autoregressive (VAR)
technique to empirically analyze the relationship between monetary policy and financial stability
in Jordan. The findings indicated that domestic lending and excess reserves both have a favorable
impact on financial stability. The granger causality test's findings suggested that credit granger
and surplus reserves were responsible for the stability of the financial system. Using the
generalized method of moment (GMM) technique, Ayomi et al. (2021) looked at the effects of
monetary policy and bank rivalry on banking default in Indonesia from 2009 to 2019. The results
showed that monetary policy through the benchmark rate had a favorable impact on the risk of
banking stability, whereas the credit interest rate had a negative impact.

The analysis of empirical studies revealed that various investigations into the effects of monetary
policy on financial and banking stability exist for Nigeria. For instance, Oparah and James
(2020) used quarterly time series on a relatively short time frame from 2008Q1 to 2016Q2, but
Hamilton et al. (2020) and Ajisafe et al. (2021) used annual time series data for their research. As
opposed to Oparah and James (2020), this study will use quarterly data over a period of 2010Q1
to 2021Q4. From the above reviews, it is evident that none of the authors had consciously
considered examining asymmetry nexus between monetary policy and financial fundamentals.
Additionally, this study will employ the non-linear autoregressive distributed lag (NARDL)
bounds testing approach to investigate the asymmetry relation between the financial
fundamentals in the study. The rationale behind the application of the NARDL technique is that it
could be applied for a mixture of I(0) and I(1) time series, and appropriate for asymmetric
effects.

2.2.2 Monetary Policy and Bank Stability

There is a wealth of literature on the impact of monetary policy on the stability of the banking
system. Worms (2001) discovered that as banks' ratio of short-term interbank deposits to total
assets drops, they are more likely to cut back on credit in response to tightening monetary policy
measures. Using the VAR methodology, Kassim et al. (2009) found that compared to

12
conventional banks, Islamic banks' balance sheet items were relatively more sensitive to changes
in monetary policy. This provided more evidence that monetary policy can affect how Islamic
banks operate.

According to Bernanke and Blinder's (1992) analysis of the federal funds rate, bank securities,
unemployment, bank deposits, prices, and bank credits, deposits decrease practically
immediately after a monetary policy contraction but loans show a more muted reaction.
Therefore, following a tightening of monetary policy, banks cut their securities to modify their
asset without reducing their credit. However, Kashayap and Stein (1994) demonstrated that
various banks responded differentially to monetary policy shocks using quarterly disaggregated
data. They found that small bank loans decreased as a result of monetary policy contraction, but
large banks either boosted their loans or showed no change when interest rates rose.

To better understand the relationship between bank portfolio behavior in maximizing profit and
the effectiveness of monetary policy, Zulverdi et al. (2006) employed an analytical model of
Indonesian bank portfolio behavior based on macroeconomic theory. They found that the number
of loans has a bad association with the policy rate, which is consistent with theory. Additionally,
they disclosed that a higher capital adequacy ratio will result in a decrease in loan volume since
banks will choose to invest in low-risk assets rather than make loans.

Mishkin (1996) suggested expansionary monetary policy and/or lending to banks to help
industrial countries recover from the financial crisis, but he added that the strategy may not work
well in developing countries in particular because it could exacerbate inflation and cause further
depreciation of the local currency. This was especially evident in Nigeria, where inflation and a
significant depreciation of the naira took place after a cash injection to deal with the
repercussions of the global financial crisis. Additionally, he asserted that a robust regulatory and
oversight system for banks would reduce excessive risk-taking, improve accounting standards,
and tighten transparency regulations in emerging countries.

A protracted period of exceptionally low interest rates increased banks' risk, according to
Altunbas et al. (2010). This situation leads to a rise in the number of non-performing loans as
more loans are made with looser criteria and, when they are due for repayment, are turned into
high-risk assets. According to Somoye (2006), interest rate management would be sufficient to

13
achieve both financial stability and sustainable growth. This opinion was shared by authors from
both emerging and developed economies.

Generalized least squares and a GMM panel regression model were employed by Maddaloni and
Peydro (2013) to identify the effects of the monetary policy rate on bank stability, bank balance
sheet strength, and banking prudential policies. They came to the conclusion that there is a close
relationship between monetary and prudential policies and suggested that monetary policy
should pay more attention to issues of financial stability while banking prudential supervision
and regulation should concentrate on risk taking incentives that may be brought on by low short-
term interest rates.

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 CHAPTER THREE

RESEARCH METHODOLOGY
3.1 Introduction
In this chapter, we discuss methodology and estimation related issues in relation to our study.
The equations are specified and the estimation technique is discussed. The sources of data are
also highlighted.
3.2 Empirical Model Specification
Objective 1: that empirically determines the asymmetric effect of monetary policy on credit risk
behaviours in the banking sector in Nigeria will be achieved following Aboyadana (2020). Thus,
our empirical model is thus stated as:

n n
Cr Ris k t= β0 + α 1 MnPo l t +α i ∑ FinVa r t +α j ∑ MacroEconVa r t + ε t - -3.1
i=1 j =1

n
Where, Cr Ris k t denotes credit risk, MnPo l t denotes monetary policy to be proxied by, ∑ FinVa r t a
i=1

n
number of financial sector fundamentals, ∑ MacroEconVa r t denotes other relevant macroeconomic
j=1

variables, and ε t is the error term.

Objective 2: that empirically investigate the asymmetric impact of monetary policy on bank
stability in the banking sector in Nigeria is specified below as Ajayi (1978) and Crockett (1973)
as cited in Bamidele et al. (2015);

n n
Bank Stabilityt =β 0 +α 1 MnPo l t + α i ∑ FinVa r t + α j ∑ MacroEconVa r t + ε t -3.2
i=1 j=1

Where, Bank Stabilityt denotes stability of banking industry in Nigeria, MnPo l t denotes monetary policy to
n n
be proxied by, ∑ FinVa r t a number of financial sector fundamentals, ∑ MacroEconVa r t denotes
i=1 j=1

other relevant macroeconomic variables, and ε t is the error term.

15
Objective 3: determining the degree of structural breaks and monetary policy shift influence on
credit risk and bank stability relationship in Nigeria.
To account for the potential of structural shift in the monetary policy – banking stability
relationship, we will extend ARDL model in (3.2) to include endogenous structural breaks
follows:
p q r v
Δ ln B ank Stabilit y t =α + ∑ λ1 i Δ ln B ank Stabilit y t −i+ ∑ λ2 i Δ ln M nPol t −i+ ∑ λ3 i Δ ln F inVa r t−1 + ∑ λ 5i Δ ln M acroE
i=1 i=0 i=0 i=0

φ 1 ln B ank Stabilit y t −1+ φ2 ln M nPo l t −1 + φ3 ln F inVa r t −1+ φ4 ln M acroEconVar t−1 +ε t 3.3

As shown in equation (3.3), the break(s) are captured with the inclusion of where is

a dummy variable for each of the breaks defined as for , otherwise . The

time period is represented by ; are the structural break dates where and
is the coefficient of the break dummy. All the other parameters have been previously defined.
3.3 Estimating Techniques
The empirical analysis of the study entails establishing the stationarity of the variables and
estimating the long-run nexus between the selected economic fundamentals using the ARDL and
the NARDL model. Thereafter, we will proceed to estimate the long- and short-run elasticities
using the ARDL and NARDL with or without the endogenous structural breaks.
3.4 Sources of Data
Utilizing high frequency data to capture short-term variation is necessary in order to assess how
monetary policy actions affect the stability of the banking system, consequently, the well-known
Principal Component Analysis (PCA) as the dependent variable and the monetary policy rate,
cash reserve requirement, nominal exchange rate of the naira, inflation rate, financial reform, and
other pertinent fundamentals as the independent variables, we intend to calculate a banking
system Stability Index and Credit Risk Index. The CBN Annual Reports, NDIC Annual Reports,
and the NBS Official Website will be used as the data's sources. Autocorrelation and
heteroscedasticity issues will be addressed by differencing and lagging the data.

16
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