THE IMPACT OF MARGIN LOANS ON THE NIGERIA CAPITAL MARKET


Content

ABSTRACT

Margin loans have become phenomenal in stock markets around the world over the years. The impact of this facility on the level of activity in stock markets have now become evident. Empirical evidences attest to the fact that margin facilities influence the level of activity in the stock market during periods of economic boom and recession. Hence, this research work looked at the impact of margin loans on the Nigerian Capital Market from 2000 to 2010 with a model specification and regression analysis. The study aims at ascertaining: the effect of margin loans on the level of activity in the Nigerian Stock Market during periods of  boom and recession, the impact of margin loans on investors during economic boom and recession and the level of investors understanding of the terms and conditions attached to margin loan contracts. Data was collected via secondary sources of macroeconomic variables in particular.  The study confirmed that margin loans have a positive effect on the stock market and investors during periods of boom and the opposite during periods of economic downturn and further revealed that investors have little or no idea of the terms and conditions attached to margin loan contracts.

The study therefore recommends that investors should be properly oriented on the terms and conditions of a margin loan contract before the extension of such facilities to them and that the CBN should restructure margin debts/interests and that toxic assets in the market should be bought by the FGN in order to restore sanity and stability in the Nigerian Capital Market.

                             TABLE OF CONTENTS

                                                                                                  Page

Title Page                                                                                   i

Certification                                                                              ii

Dedication                                                                                 iii

Acknowledgement                                                                     iv

Table of Contents                                                                      v

Abstract                                                                                              vii

CHAPTER ONE: INTRODUCTION

1.0          Introduction                                                                                                    1

1.1          Background to the Study                                                                                1

1.2          Statement of the Problem                                                                               5

1.3          Objective of the Study                                                                                     5

1.4          Research Questions                                                                                        6

1.5          Statement of Research Hypothesis                                                                 7

1.6          Significance of the Study                                                                                7

1.7          Scope and Limitation of the Study                                                                 9

1.8          Plan of the Study                                                                                            10

1.9          Definition of terms                                                                                          10

 

CHAPTER TWO: LITERATURE REVIEW

2.0          Introduction                                                                                                    12

2.1          Margin Lending its Implication on the Stock Market                         12

2.2          Impact of Margin Loans on the Nigeria Stock Market                                    14

2.3          Impact of Margin Loans on the Nigeria Investors                                           16

2.4          Benefits and demerits of Margin Loans                                                          17

2.5          Implications of the Global Economic meltdown on the Nigeria

2.6          Capital Market                                                                                                19

2.7          Implication of Bank Losses on the Nigerian Capital Market                          22

2.8          Roles of the Central Bank of Nigeria                                                              25

2.7.1    Rationale for CBN’s position                                                                           28

2.9          Sources of Finance                                                                                        31

2.8.1    Fund Raising in the Nigerian Capital Market                                                34

2.10       Other Institutions                                                                                                       38

2.11       Available Opportunities in the Nigerian Money Market                                 40

2.12       Performance of Quoted Companies in the Nigeria Capital Market    42

2.13       Capital Market Reforms and Prospects of Enhancing Industrial

Capabilities through the Market                                                                    50

 

CHAPTER THREE: RESEARCH METHODOLOGY

3.0          Required Data for the Study                                                                           55

3.1       Model Specification                                                                                         55

3.2       Explanation of Variables                                                                                 56

3.3       Estimation Technique                                                                                     58

3.4       Evaluation of parametric Estimates                                                               59

3.5       Sources of Data                                                                                                           61

3.6       Reliability and Validity of Research Instrument                                             62

                                                                                                                                     

 

CHAPTER FOUR: PRESENTATION AND ANALYSIS OF DATA

4.0          Introduction to Empirical Analysis                                                                 63

4.1       Time Series Property of the Variables                                                 63

4.2       Data Presentation and Analysis                                                                     66

4.3       Statistical and Econometrics Tests of the Estimated Parameters                 71

 

CHAPTER FIVE: SUMMARY, CONCLUSION

AND RECOMMENDATION

5.0          Summary of major findings of the study                                                        74

5.1       Conclusion                                                                                                                  77

5.2       Policy Implementation and Recommendations                                               78

5.3       Limitation of the Study                                                                                               79

5.4       Area for Further Research                                                                              80

Biography

Appendix


CHAPTER ONE

INTRODUCTION

1.0       BACKGROUND TO THE STUDY

The capital market is a market for mobilizing long-term funds fro investments in capital projects. The main institution in the Nigerian market are the Nigeria stock exchange (NSE), Issuing Houses and Stock Brokering firms. Reminiscent of its role in the establishment of the money market in Nigeria, the CBN played a central role in the establishment of capital market institutions in Nigeria including the Securities and Exchange Commission. The Bank was also responsible for the issuance of the Federal Government Development Stock, which in the 1960s and 1970’s constituted a major capital market instrument.

 

On the other hand, a common phenomenon in capital markets around the world is the term most popularly known as “margin loan”. The online investment dictionary defines the term as “a loan from a broker to a client that essentially functions as a margin account. The funds may be used for any purpose, and the loan is secured with securities owned by the client.... Conversely, according to Bankole (2009), a margin loan (or a margin account) is a loan made by a brokerage house to a client that allows the customer to buy stocks on credit. The term margin itself refers to the difference between the market value of the shares purchased and the amount borrowed from the brokerage. Interest on the margin loan is usually calculated on the outstanding balance on a daily basis and charged to the margin account. As time goes by, the outstanding debt goes up and interest charges accumulate. Also, the brokerage holds the securities as collateral for the loan. A simple example of a purchase on margin might be an investor buying stocks with a market value of N100,000. But, only using N50, 000. of his own money. The other N50,000. being provided by the brokerage as a margin loan. Though this sounds straight forward but margin loans are not that simple. If one wants to trade on margin, the first step is to open a margin account. By law this requires an initial investment of (at least) N200, 000, but the amount could move (upwards or downwards) depending on the brokerage’s own rules with respect to opening the margin account.

This set up amount is known as the “minimum margin”. Once the account is open the investor can then borrow up to 50% of the price of any stock he wants to purchase. It is however noteworthy that the investor does not have to borrow the full 50% as the amount he borrows can be less than 50% (but not more). The 50% “down payment” is called the “initial margin”. And as long as stock prices stay stable or go up, the investor will keep making interest payments and other things will roll along smoothly (but then, this is not always the case).

Another fundamental issue that needs to be discussed is the term “maintenance margin”, in case the stock prices drop. According to the generally accepted best practice rules, anyone who buys stocks on margin must maintain a minimum of 25% of the total market value of the securities that are in the margin account (some brokerages demand even higher percentages). Falling stock prices could take an investor’s margin account below threshold and in which case, the brokerage house will require the investor to put in more cash or securities to bring his stake up to the minimum. Usually a call is made to the investor from the brokerage (when his margin account falls below threshold) for incremental funds, the call is known as “margin call”.

Undoubtedly, margin accounts allow an investor to gain control of a large block of stock at a minimal investment. Sophisticated investors will use a margin facility to increase their personal wealth by using the “leverage” provided by using borrowed money. However, if share prices go the wrong way (like they did recently), the investor with the margin loan is not only liable for money borrowed, but also maintaining his margin account. In this case, leverage is working the other way and falling share prices coming with the outstanding margin loan can cause an investor  significant financial hardship.

 

The extension of margin facilities to investors in the Nigerian capital market yielded great dividends and improved the general level of activities on the floors of the Nigerian stock exchange during periods of boom, however, the global economic recession quickly turned this success story into failures, by revealing the extent of exposures of investors so much that one begins to wonder whether they actually read the terms and conditions attached to these facilities before accepting them.

Sequel to this, commercial banks were immediately under enormous pressure as the actual margin lending was done by them through their stock broking outlets and subsidiaries, which implied that they were directly or indirectly affected by the recession and losses suffered by investors. Consequently, this led to a lot of “drama” in the Nigerian banking sector in 2009. The amount of losses recorded by commercial banks during this period brings up the question, “How effective are the collateral securities for margin lending?”

Furthermore, with the high level of exposure and losses revealed by the global credit crunch, the fate of investors and commercial banks is one question that has been lingering in the minds of a lot of people. Most financial analysts have also questioned the reliability and effectiveness the monetary policies of the Central Bank of Nigeria with respect to margin lending, as they opine that machineries should have been put in place to check the level of exposures of commercial banks and investors alike, and also the reliability of collateral securities for margin lending in the capital market.

 

1.2    STATEMENT OF THE PROBLEM

There has been a strong debate between regulatory authorities, bankers, shareholders and the public after banks consolidation and the global financial crisis in Nigeria about quantum of margin loans and its negative impacts on the Nigeria capital market. The regulators in this post consolidation era are interested in the stability of shares prices safety of investment in the capital market but without consideration of the risks, inadequate speculations on share prices initiated by modern smart bankers like the commercial banks in granting margin loans.  

Therefore, the problem here is to use multiple regression equation to determine whether there is a relationship between money supply and capital market indicators, if there is, whether the degree of linearity is such that capital market and margin loans issue could be largely a matter of economic failures through global financial crisis or business exigencies as opposed to the flex of legal muscle by the regulatory authorities and the public.

 

1.3   OBJECTIVES OF THE STUDY

Nigeria capital market situation provides an interesting study of the issue at hand. Since the capital is place o investments in any economy, it is against this backdrop, that the  objectives of the study are to empirically investigate the

   a) how margin loans have affected the activities in the Nigerian stock market during periods of boom.

   b) how margin loans have affected the activities in the Nigerian stock market during recession periods.

   c) To ascertain the impact of margin loans of investors during periods of boom.

   d) impact of margin loans on investors during periods of recession, and

   e) how much investors know about the terms and conditions attached to a margin loan contract.

 

1.4   RESEARCH QUESTIONS

The problems observed above gave rise to the following research questions:-

   i) How has margin loans affected the activities in the Nigerian capital market during periods of boom?

   ii) How has margin loans affected the activities in the Nigerian capital market during recession periods?

   iii) How has the global economic downturn affected holders of margin loan accounts (investors)?

   iv) What steps can be taken to minimize losses of margin facilities in the capital market during periods of economic downturn?

 

 

 

1.5  STATEMENT OF RESEARCH HYPOTHESIS

 For the accuracy of the study, the research hypotheses are stated thus:

Hypothesis I

H0:     Margin loans does not have any positive impact on the Nigeria economy.

H1:   Margin loans have positive impact on the Nigeria economy.

Hypothesis II

H0:     Bad loans and bad investment in the capital market does not erode the money supply in the economy.

H1:     Bad loans and bad investment in the capital market erode the money supply in the economy.

1.6    SIGNIFICANCE OF THE STUDY

Every stakeholder in the modern – day market based economy must recognize the importance of the capital market and its role towards the achievement of economic development in his country, as well as in building his personal economic profile. This can only be achieved when players are able to out-guess the market and are able to swim and cross over against all tides. But all these are possible when the stakeholders have thorough understanding of the dynamics and workings of the market, which this piece of work hopes to provide.

In lieu of these, this study is significant in the following areas:-

First, the study will help equip investors with knowledge of when and how to take margin facilities, thereby reducing their risk exposures and making significant returns on their investments. In other words it will assist investors in making good investment decisions as far as the acceptance and maintenance of margin facilities are concerned.

Similarly, institutional investors will equally benefit from the findings in this study by availing themselves of the knowledge to appropriately accept and maintain margin facilities, so as to make proper and informed judgments and /or decisions.

In the same vein, stockbrokers, investment analysts, financial advisers and portfolio managers will also gain from the wealth of knowledge of this study which will assist them in their area of specialization. That is, the investment advices and other services provided by these experts and specialists to their clients.

Furthermore, all stakeholders in the economy will have a better understanding of the market dynamics and how the economy is affected by it, as the capital markets is known to have been playing significant roles on the economic development of every nation. Hence, the use of it as a measure of the performance of the economy.

Lastly, through this study, students, researchers, stockholders/shareholders, investment analyst, portfolio managers, institutional and individual investors as well as those who have a stake in the economy will be stimulated and encouraged to conduct further research on this subject matter i.e. “margin loans and its effect on the Nigerian capital market”, since the concept is relatively new.

 

1.7    SCOPE AND LIMITATION OF THE STUDY

This study seeks to look at the impacts of margin loans in the Nigeria capital markets. Pre independence of the Nigeria economy are avoided due to lack of data. The study mainly concentrates on Margin loans and the investor in a period of boom, Margin loans and the investor in an economic downturn, The roles played by stock brokers and commercial banks in the issuance and management of margin facilities; and The roles of the apex bank (i.e. CBN).

In salvaging, the exposures brought about by the current global economic meltdown. The empirical analysis shall therefore be confined to a period of 10 years (2000-2009). The study makes use of secondary data. These data are sourced from various and current publications of the Central Bank of Nigeria (CBN), Nigerian stock exchange (Abuja) with respect to figures of the total amount of margin loans extended to investors by stock broking firms and commercial banks, the Federal Office of Statistic (FOS), the International Monetary Fund (IMF), International Financial Statistics (IFS), the Institutional Investors Magazine clippings from daily and weekly Newspapers and Economics textbooks.

1.8    PLAN OF THE STUDY

The study is divided into five chapters; Chapter One: Deals with introduction, the problem statement, objective of the study, source of data, justification of the study, scope of the study and source of data. Chapter Two: Deals with a review of the literature and surreys of some margin loans and capital market and investment theories. Chapter Three. Focus on methodology by which the research will be carried out by revealing the source and the of data to be used and the analytical techniques to be used in the study. Chapter Four: Presents models and interpretation. Chapter Five: Is directed to making reasonable suggestions, recommendations, Conclusion and Area for further study.

1.9    DEFINITION OF TERMS

The following terms were used in this study to mean the following:-

   i) MARGIN LOANS: A loan made by a brokerage house to a client that allows the client to buy stocks on credit.

   ii) MINIMUM MARGIN: The minimum amount required to open a margin account. Usually N 200, 000, but varies from broker to broker.

   iii) MARGIN CALL: A call from a brokerage demanding incremental funds from the investor (or account holder), where the amount in his account falls below minimum threshold (usually due to a sharp fall in share prices).

   iv) MARKET PLAYERS: This are the various parties that help to make activities happen in the capital market e.g. Stockholders, portfolio managers, analyst etc.

   v) STOCK BROKER: A person permitted to transact business on the floor of a stock exchange or over-the-counter.

   vi) CAPITAL MARKET: A market for securities (debt or equity) where business enterprises and government can raise long-term funds.

   vii) RETURN: Benefits accrued to margin facilities.

   viii) TRADING ACTIVITIES: The various acts of buying and selling of shares and securities on the floors of the Nigerian stock exchange.

   ix) LIQUIDITY: The rate at which transactions are turend into cash, i.e. how fast an activity can be paid in cash.

   x) PORTFOLIO: Institutions registered by the statutory regulatory agencies to manage the portfolios of their clients.

   xi) CAPITAL GAIN: The amount realised at the disposal of a security in excess of its original cost.

   xii) MARKET DYNAMICS: The ability of the market to behave and react to certain situations in the economy.

   xiii) INTEREST: Percentage paid by a margin account holder to the broker, which is charged based on the amount of margin loan he has taken, i.e. synonymous to bank interest charges on loans.

   xiv) MARGIN FINANCE: The percentage of the purchase price securities (that can be purchased on margin) that the investor must pay or with his or her own cash or marginable securities.

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