CHAPTER ONE

INTRODUCTION
1.1 BACKGROUND TO THE STUDY

Banking is an economic activity, which deals with the intermediation of funds between the surplus
units and the deficit units of an economy and the channelling of such resources to profitable
investments. Banks also facilitate the provision of an efficient payment system. A sound, profitable,
efficient and well managed banking system contributes to the stability of the financial system and
protects a country from any undesirable crisis (Athanasoglu et al., 2006; Aburime, 2008; and
Ramlall, 2009). Alper and Anbar (2011) posit that an efficient banking sector can promote economic
growth, while credit insolvencies could result in systematic crisis. In Africa, banks are regarded as
dominant financial institution thus, their health condition is crucial to the general health of the
economy (Suffian, 2009). Therefore, having the knowledge of factors influencing commercial banks'
profitability is not only important but also essential in stabilizing the economy. The importance of
banks' profitability cannot be over emphasized. Profitability is considered as a crucial objective to
conduct a business without which money deposit banks will not be in business. With good profit
figures, banks are able ' to enhance the confidence of their stakeholders, maximize shareholders
wealth as well as being able to stay competitive in the financial market. However, to achieve their
desired level of profits, banks are confronted with several factors both internal and external. One of
such external factors is the interest rate.

Generally, interest rates are the rental payments for the use of credit by borrowers and return for
parting with liquidity by lenders (Ogunbiyi, 2014). Jimenez, Lopez & Saurina (2013) defines interest
as the amount a borrower pays in addition to the principal of loan to compensate the lender for the
use of the money while Interest rates are the expressions of interest as a percentage of the principal.
Whereas interest rate is a rate which is charged or paid for the use of money, an interest rate is often
expressed as an annual percentage of the principal. It is calculated by dividing the amount of interest
by the amount of principal. In general, interest rates rise in times of inflation, greater demand for
credit, tight money supply, or due to higher reserve requirements for banks. A rise in interest rates
for any reason tends to dampen business activity (because credit becomes more expensive) and the
stock market (because investors can get better returns from bank deposits or newly issued bonds than
from buying shares).

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According to Saunders (1999) an interest rate is a price, and like any other price, it relates to a
transaction or the transfer of a good or service between a buyer and a seller. This special type of
transaction is a loan or credit transaction, involving a supplier of surplus funds, i.e., a lender or saver,
and a demander of surplus funds, i.e., a borrower. Operationally, interest rates included lending
interest rates, saving interest rates and market interest rates. According to Bank of Sierra Leone
Annual Report (2017), the financial sector in Sierra Leone consists of the central bank, 13
commercial banks, (3 locally owned), 14 licensed microfinance associations, 17 community banks,
51 financial services associations, and 50 registered foreign exchange bureau. The Sierra Leone’s
banking system is overseen by its central bank, the Bank of Sierra Leone and twelve commercial
banks operated in the country. All commercial banks are headquartered in Freetown (Bank of Sierra
Leone Annual Report, 2017). According to World Bank’s Doing Business Report (2019), Sierra
Leone ranked 161 out of 190 economies for “getting credit”. The category was assessed by reference
to the movable collateral laws (that is, the strength of legal rights of borrowers and lenders in secured
transactions) and the credit information systems (the sharing of credit information).

Over the years, interest rates have remained a subject for critical assessment with diverse
implications for savings mobilization and investment promotion. Historically, the interest rate regime
in Sierra Leone has been very stochastic. According to Daily Monitor (2016), prominent business
people in the country, warned that Sierra Leone's interest rates were high and many companies are
going to go out of business as a result. Several companies have been struggling to meet debt
obligations and have been lobbying for the government to reign in on high-interest rates. The new
changes of banking practices after the seventies, kept on manipulating the economic markets
constructed by commercial banks, which controlled them to press net revenues for the challenge, and
consequently prompted a decrease in banking benefit. Similarly those new practices particularly over
the most recent two decades prompted the expansion of the dangers looked by these banks in all
nations, where the financial business risk is never again controlled to the dangers of borrowers, and
even past that to the experience of a few dangers, some of which result from the bank choices which
will increase or decrease the danger more, thus influencing its gainfulness.

Profitability is the ability for an organization to make profit from its activities. Agha (2014) defines
profitability as the ability of a company to earn profit. To measure the profitability, there are a
variety of ratios used of which Return on Asset, Return on Equity and Net profit Margin are the
major ones (Ongore & Kusa 2013). Conceptually, determinants of profitability comprises of return
on assets (ROA) and return on equity (ROE). Liquidity risk consider as the most significant factor
influence consistency and endurance of bank. Hence, if the bank had the option to deal with this risk,

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this mean it will have the option to execute the commitments towards the contributors.
Notwithstanding that, the liquidity in the bank will improve the benefit and afterwards lead to extend
the wealth of its investors. Additionally, credit dangers which results when the counterparty
disregards to meet its commitments appropriately and completely as per the agreed terms,
encouraging troubles because of this disappointment. However, operational risk speaks to the
misfortunes that outcome from the disappointment of internal procedures, work force and
frameworks. At long last, chances out of bank control are spoken to by market risk, which brought
about by macroeconomic factors, for example, a difference in financing costs, swelling rate,
instability of costs, money trade rates, etc.

1.2 STATEMENT OF THE PROBLEM

Commercial banks are the dominant players in the financial services sector in Sierra Leone. Interest
rates in the country’s banking sector keeps on varying and are influenced by various factors and can
thus greatly affect the profitability of banking institutions. According to Robinson (2010), banks
profitability are affected by unanticipated changes in interest rates. In Sierra Leone, the potential
impact of interest rates on commercial banks profitability has long been a concern for policy makers
and bankers and this led some banks to close down their banking operations (Mugume, 2011).
Commercial Banks in Sierra Leone in the recent past witness rising non-performing credit portfolios
sequel to the inability of their management to effectively manage risk and credit administration. That
problem resulted to high bad debts and a number of those commercial banks were classified as
distressed banks by the Central Bank of Sierra Leone in 2018 as was mentioned in the Government
Transition Report of 2018 (GTTR, 2018).

Due to unanticipated changes in interest rates, failure has been witnessed in different banks and
financial institutions that include all financial sectors in Sierra Leone consisting of the central bank,
13 commercial banks, (3 locally owned), 14 licensed microfinance associations, 17 community
banks, 51 financial services associations, and 50 registered foreign exchange bureau were included.
The Sierra Leone’s banking system is overseen by its central bank, the Bank of Sierra Leone and
twelve commercial banks operated in the country. All commercial banks are headquartered in
Freetown (Bank of Sierra Leone Annual Report, 2017). In addition, failure in the financial services
system as seen during the events unfolding after the sub-prime crisis in the United States also
motivated this study on performance of banks in Sierra Leone and the effects that regulation such as
control of interest rate can have on the same. Therefore, these factors have influenced the researcher
to conduct a study on interest rates and profitability of commercial banks.

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It is quite evident that the financial market in which commercial banks operate is quite dynamic and
is vulnerable to the economic tides in the given Sierra Leone environment. Within the last two years
dating back from 2016 to 2018, two banks were involved in bad debts that were politically motivated
and they included the Sierra Leone Commercial Bank, and the Rokel Commercial Bank. This has
been attributed to the increase in banks non-performing loans which has contributed significantly to
the financial limitations of those commercial banks to effectively meet their financial obligations to
its depositors and other stakeholders. For the financial year ended 2018, there were a number of bad
debts amounting to more than 15 billion Leones as a result of weak regulation by the Central Bank of
Sierra Leone. Therefore, it is with these considerations in light that the present study intends to
identify the various risks which commercial banks are exposed to while at the same time try to
provide alternative solutions which will be beneficial to the various players in the financial sector
with more emphasis on commercial banks.

Previous studies such as Mwangi (2014); Ndegwa et al., (2016) and Musa (2011) were conducted on
interest rates and financial performance. However, financial performance considers many factors and
thus the studies never concentrated well on profitability. Furthermore, some of these studies were
conducted in Microfinance institutions and not in commercial banks (Mwangi, 2014 and Ndegwa et
al., 2016). Furthermore, Mmasi (2013) conducted research on an investigation of the relationship
between interest rate and inflation. His study was not focused on profitability. Among other risks
faced by banks, credit risk plays an important role on banks’ financial performance since a large
chunk of banks’ revenue accrues from loans from which interest margin is derived (Kolapo, Ayeni &
Oke, 2012, p.31). Based on the information we have studied in the previous studies, we have realized
that it is of great interest to study the relationship between interest rates and profitability of
commercial banks. And there is no research that could clearly explain the relationship of interest
rates and profitability of commercial banks. Another factor leads us to the topic is that research in
Sierra Leone, as a complicated and stable financial market, has not been developed until now.

While the above studies provide valuable insights on interest rates and financial performance, none
of them was conducted in Sierra Leone and they only provide partial insight on the influence of
specific interest rates determinants and performance of commercial banks. This study is therefore
needed in closing this gap by investigating the relationship between interest rates regulations and
profitability of commercial banks in Sierra Leone focusing on the Rokel Commercial Bank.

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1.3 AIM OF THE STUDY
The study aim at accessing the interest rates regulations on the profitability of commercial banks in
Sierra Leone focusing on the Rokel Commercial Bank from 2012 to 2022.
1.3.1 OBJECTIVES OF THE STUDY
The specific objectives are:
1. To determine the effect of 'lending interest rates on the profitability of Rokel Commercial
Bank.
2. To find out the effect of saving interest rates on the profitability of Rokel Commercial Bank.
3. To assess the effect of market interest rates on the profitability of Rokel Commercial Bank
1.4. RESEARCH QUESTIONS
The specific objectives are:
1. What are the effect of 'lending interest rates on the profitability of Rokel Commercial Bank?
2. What are the effect of saving interest rates on the profitability of Rokel Commercial Bank?
3. What are the effect of market interest rates on the profitability of Rokel Commercial Bank?

1.5 SIGNIFICANCE OF THE STUDY

The study will aim at providing banks with a better understanding of the effects of interest rates on
profitability. From the outcome of this study, banks will be expected to influence matters of
regulation with policy makers, institute policy changes and, strategies to adopt in order to cope with
the likely effects of interest rates on their profitability.

The study will provide valuable insights to various stakeholders, Management of Commercial banks,
scholars and researchers, and the Government of Sierra Leone regarding best practices and policies
that will help address the challenges of risk management in commercial banks. This study will also
be beneficial to financial institutions especially commercial banks in Sierra Leone, as they would
utilize the finding of this study to swerve as a basis for policy formulation regarding risk
management and credit administration in their various banks. Thus, it will benefit banking
shareholders, stakeholders and the entire society.

1.5.1 Business People

This study will enable business people to get a clear insight and establish if indeed interest rate laws
that has led to the desired increase in access to credit and therefore profitability of their businesses.
The Management of Commercial banks will have advanced knowledge on interest rate management
in commercial banks in Sierra Leone. This advanced knowledge will help them formulate and

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implement such important policies which will ensure that the effective risk management in
commercial banks increases the revenues and give the firm a competitive edge. They will also be
able to address the outstanding challenges of effective risk management in commercial banks.

1.5.2 Government of Sierra Leone

This study will be very important to the Government of Sierra Leone in evaluating the effects of the
interest rates on financial institutions. The Government will be expected to be in a position to
evaluate whether interest rates are having the desired effect on the profitability and growth of
economy from the projected benefit of assumed increase in credit access. With the findings of this
study, the government should be in a position to take stock of positive and negative effects on the
economy and specifically whether it is aiding in stifling or spurring economic growth. Also since the
government has a responsibility to ensure that public utilities for public benefits are well protected.
Interest rates and its risk management in commercial banks have proved to be a difficult procedure
for public sector and even government itself. The successful completion of this study will furnish the
government with relevant information that will enable it to make strict measures and policies that
will help address the challenges of risk management in commercial banks. The study will provide
findings and recommendations that will aid the government with possible suggestions to the risk
management in commercial banks in Sierra Leone.
1.5.3 Researchers
The research will provide a better understanding of interest rates and how they affect the profitability
of banks. Out of this study, researchers are expected to be in a position to evaluate the need to
investigate correlation if any between interest rates and related macroeconomic factors of inflation
and foreign exchange rates, increase in informal lending, financial inclusion and to formulate
policies that can be adopted by governments to cope with negative effects if any of rate capping
laws. This study will benefit scholars and researchers, as it will expand their knowledge on risk
management in commercial banks and related areas. They will be able to come up with other
relevant areas of study within the study; moreover, this study is very helpful as a source of secondary
data for reviewing the literature.

1.6 SCOPE AND LIMITATIONS OF THE STUDY

1.6.1 SCOPE OF THE STUDY

This study have a specific delimitation of 2012-2022 accessing the interest rates regulations on the
profitability of commercial banks in Sierra Leone with Rokel Commercial Bank as a case study. In

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terms of content, lending interest rates, saving interest rates and market interest rates are the
independent variables. Dependent variable is profitability and will comprise of return on assets
(ROA), return on equity (ROE). Thus, the study will review secondary data as published in the
banks’ audited financial reports.

1.6.2 LIMITATIONS OF THE STUDY

The researchers is limited in terms of financial resources to cover the cost of printing and
administering of questionnaires, time for classroom work and the linkages between meeting the
supervisor’s demand and that of the respondents will pose a big issues owing to the nature of the
researcher’s work, during the research time.

The researchers would at times be faced with lack of sufficient funding to cover the cost for internet,
printing and distribution of questionnaires to respondents in the research area. Financial resources
has not only being a limitation but a major factor in the study. Limited resources may delay the
achievements of the study.
Also, the research will be conducted by new researchers (undergraduate students), hence, as new
researchers who lack adequate theoretical knowledge on the said topic coupled with the fact that
there is very few literature found on the current topic, as a result, it will be difficult for the
researchers to explicitly conduct the research without hindrance.

1.7 ORGANISATION OF THE WORK

Chapter one has introduced the topic of the research and laid down a background to the study, as
well as explaining the need for the study.

Chapter two covers the literature review in more depth, as well as the conceptual framework used in
this paper. And the legal framework available on the topic.

In chapter three, the research design, study area, population, sample size and data analysis will be
addressed.

Chapter four will present, discuss and analyse the data collected from the field, and identify a
number of key findings.

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Chapter five, the last chapter would summary, make conclusions and proffer recommendations for
further research, government and other stakeholders.