Effect of Cash Reserve Requirement on Banks’ Profitability: An Empirical Study of Deposit Money Banks in Nigeria

Abstract

This study empirically investigated the effects of cash reserve requirement on the profitability of deposit money banks in Nigeria. Specifically, it looks into the effects of the liquidity ratio, cash reserve ratio, and loan-to-deposit ratio on banks' return on equity (ROE), as well as the relationship between money supply and banks’ profitability (ROE). An ex-post facto research design was employed, using data sourced from the Central Bank of Nigeria (CBN) and the Nigeria Deposit Money Banks audited financial statement for the period spanning 2000 to 2023. The analysis was conducted using descriptive statistics and multiple regression techniques. The results show that the liquidity ratio (0.402721, p = 0.5145) has a positive but statistically insignificant effect on ROE. The cash reserve ratio (-0.083036, p = 0.6776) shows a negative and also statistically insignificant impact, while the loan-to-deposit ratio (-1.032393, p = 0.1915) similarly has a negative and insignificant influence on ROE. However, the study found that money supply (0.524831, p = 0.0016) has a significant and positive relationship with banks’ return on equity. Based on these findings, the study recommends that the Central Bank of Nigeria should adopt a stable and growth-oriented monetary policy, with a particular focus on managing money supply to enhance both banking sector profitability and overall economic development. Bank managers are advised to refine their liquidity strategies to prevent excessive conservatism, which can lock up resources and reduce profitability. Instead, they should aim for an optimal balance between liquidity and income generation. Given the negative but insignificant impact of the cash reserve ratio on ROE, policymakers may need to reevaluate reserve requirements, especially in times of economic pressure, to ensure they do not unduly hinder banks' ability to generate income.