Cointegration of Loans-Libre PDF

AFRICA DEVELOPMENT AND RESOURCES RESEARCH INSTITUTE (ADRRI) JOURNAL
ADRRI JOURNAL (www.adrri.org)

pISSN: 2343-6662 ISSN-L: 2343-6662 VOL. 7,No.7(2), pp 52-66, April, 2014

Cointegration Analysis of Customer Deposits and Bank Loans and Advances by the
Ghanaian Listed Banks.
Victor Curtis Lartey1 and Godfred Kwame Abledu2
1
Faculty of Business and Management Studies, Koforidua Polytechnic

Faculty of Applied Sciences and Technology, Koforidua Polytechnic
Correspondence: Email: vclartey@yahoo.com
Tel: +233208441868
Received: 5th April, 2014 Revised: 26th April, 2014 Published Online: 30th April, 2014
URL: http://www.journals.adrri.org/
[Cite as: Lartey, V. C. and Abledu, G. K. (2014). Cointegration Analysis of Customer Deposits and Bank
Loans and Advances by the Ghanaian Listed Banks. Africa Development and Resources Research
Institute Journal, Ghana: Vol. 7, No. 7(2), Pp. 52-66.]
Abstract
The objective of this paper was to model the long term relationship between loans and deposits;
therefore, a cointegration analysis was the ideal tool. The population of this study was made up of all
commercial banks listed on the Ghana Stock Exchange. These included CAL Bank Limited, Ecobank
Ghana Limited, Ecobank Transnational Incorporated, Ghana Commercial Bank Ltd., HFC Bank Ltd, SGSSB Ltd., Standard Chartered Bank Ltd., Trust Bank Ltd. and UT Bank Limited. In this study, purposive
sampling was used to select seven (7) out of the nine (9) banks listed on the Ghana Stock Exchange. The
results of both the Dickey-Fuller (DF) and the augmented Dickey-Fuiler (ADE) unit root tests of the null
hypothesis of nonstationarity of loans and deposits tested against the alternative hypothesis of
stationarity indicate that both loans and deposits are not stationary in their levels. The findings also
suggest that a positive relationship exists between deposits and loan. This confirms Obamuyi (2013) who
also found positive relationship between deposit mobilization and bank lending.
Keywords: customer deposits, bank loans, stationarity, cointegration analysis, VECM and panel data
analysis, unit root tests

INTRODUCTION
It is believed that how speedily and cheaply a financial system is able to channel funds from
surplus economic units to
deficit
units
for
productive
investments,
while ensuring
reasonable returns for the financial intermediaries, tells the efficiency of such financial system
(Obamuyi, 2013). Financial sector of an economy does matter in economic development (Shaw
1973); although Obamuyi (2012) observed that the financial systems of most developing
countries lack the sophistication required for economic growth.
Commercial banks are considered to remain dominant in the financial system of today in terms
of their shares of total assets and deposit liabilities. Their total loans and advances, a major
component of total credits to the private sector, are still on the increase in spite of the
major constraints posted by the government regulations, institutional constraints and other
macro economic factors (Olokoyo, 2011; Olumuyiwa et al, 2012). Haron and Azmi (2006)
believe that, most business organizations, especially in developing countries mainly depend
on bank loans as a source of capital and the ability of banks to give out loans depends much
on their ability to attract deposits. Freixas and Rochet (2008), as cited in Fouopi-Djiogap and
Ngomsi (2012), observed that bank loans are one of the most important long-term financing
sources in many countries today.
LITERATURE REVIEW
Diamond and Rajan, (1998) observed that Banks transform liquid assets like deposits into
illiquid assets like loans. This transformational process of banks activity is influenced by
some factors such as macroeconomic, bank level (Peek and Rosengreen, 1995) and industry
level characteristics (Boot and Thakor, 2000). According to Khalily, Meyer and Hushak (1987)
there are major factors which influence deposit functions of a bank. These include income,
interest rates, access to banking facilities, transaction costs, yields on alternate investments,
the quality of services provided to depositors, the awareness of banking services by the
public and perceptions of the safety of depositors. Other factors identified include the level of
income, customers satisfaction, service quality and demographic factors such as number of
dependants and location (Dadzie, Winston and Afriyie 2003) as cited in ( Haron and Azmi
2006); and (Obamuyi 2013). According to Boot and Thakor (2000), the level of banking industry
competition greatly influences bank lending strategy positively. The size of a bank is also
considered as an important determinant of bank lending decision (Berger and Udell, 2006,
Uchida et al. 2007). Large and complex banks tend to lend few loans to small scale firms (Berger
2

and Udell 2006). Small banks have comparative advantages in producing soft information
whereas large banks also have comparative advantages in lending based on hard information
Stein (Stein 2000).
Ladime et al, (2013) also observed a relationship between bank lending behaviour and a set
of macroeconomic indicators, industry and bank level characteristics. They concluded that
bigger banks seem to be in a better position to lend more than otherwise. This might be due to
enough resources they have to cushion lending. Similarly, high level of bank capital is found to
support much higher volumes of bank lending. In addition to the above, the macroeconomic
environment in which a bank operates matter for its lending decision. For instance, in the
period of economic boom, businesses demand for loans to take advantage of expansion and
banks investment opportunities equally rise. However, in periods of economic recession,
demand for credit falls. This provides a pro-cyclical relationship between economic growth
and bank lending Dellriccia and Marquez,
6 Ladime,
. Deposits play a pivotal
role in bank funding, as a major portion of a commercial banks assets is usually

financed through customer deposits (Bologna 2011).
The deposit taking and lending activities of banks decide to a very large extent, the profitability
of banks. This is because banks generate their income from the interest differentials from what
they pay for deposit and what they charge for their loans and advances. On the other hand,
and as Vohra and Sehgal (2012) argued, lending is one of the two principal functions of
banks, not only because of their social obligation to cater to the credit needs of different
sections of the community, but also because lending is the most profitable, for the interest
rates realized on loans have always been well above those realized on investments.
Obamuyi (2013) examined the extent to which banks in Nigeria have performed their
intermediation functions of deposit mobilization and granting of loans and advances and the
effects on their performance. The banks were found to have performed creditably well in
deposit mobilisation, as well as in granting of loan and advances, despite various sociocultural and institutional problems inhibiting financial sector development in Nigeria. They
concluded that the banks that mobilized huge amount of deposits and granted more loans
and advances were found to have higher profits than the others. This shows the positive
relationship between deposit mobilization and bank lending. According to Obamuyi (2013), as
Jayaratne and Morgan (1997) posit, lending and deposits move together because faster
3

deposit growth signals growing demand for loans. This confirms that banks generate their
incomes through the lending and investment activities .
The purpose of this study is to analyse the trend in customer deposits taken by the listed banks
in Ghana, and the loans and advances they have given out. It is also meant to describe the
relationship between the deposits taken and the loans and advances given to their customers
within 2005-2012.
METHODOLOGY
Research Design
The study is descriptive in nature. In descriptive research, a researcher begins with a welldefined subject and conducts a study to describe it accurately and the outcome is a detailed
picture of the subject (Neuman, 2007). The study adopts the longitudinal time dimension,
specifically the panel study type. Panel study is a powerful type of longitudinal research in
which the researcher observes exactly the same people, group, or organisation across multiple
time points. This study seeks to describe the relationship between the deposits taken by the
listed banks and the loan and advances given by them within the period 2005-2012.
The population of this study was made up of all commercial banks listed on the Ghana Stock
Exchange. These included CAL Bank Limited, Ecobank Ghana Limited, Ecobank Transnational
Incorporated, Ghana Commercial Bank Ltd., HFC Bank Ltd, SG-SSB Ltd., Standard Chartered
Bank Ltd., Trust Bank Ltd. and UT Bank Limited. In this study, purposive sampling was used to
select seven (7) out of the nine (9) banks listed on the Ghana Stock Exchange. The two banks
excluded were Ecobank Transnational Incorporated and Trust Bank Ltd. These banks were
excluded from the study because their financial statements were reported in currencies other
than the Ghana Cedis. Ecobank Transnational Incorporated reported in US Dollars while Trust
Bank Ltd reported in Gambian Dalasi. Including the above two banks in the research would
distort the analyses and comparison.
Instrumentation and Data Collection
Data was mainly collected from secondary sources. Data emanated from listed banks financial
reports, published and unpublished books, scholarly journals, business and financial news
papers and other magazines and corporate journals. As the study needs historical financial data,
which are from corporate reports, accessing publicly available data is assumed as the suitable
4

method for the accuracy of the data. As public data is accessible to everyone; the study made
use of the financial performance data which were of interest to the present research. Financial
reports and other relevant information of the listed banks for the period 2005-2012 were
retrieved from the internet, by search engines.
RESULTS AND DISCUSSIONS

The study utilizes annual data on loans and deposits of 7 listed banks in Ghana within period
2005 through to 2012. Since the objective of interest was to model a long term relationship
between loans and deposit, a cointegration analysis was the ideal tool. Three step procedures
were used to examine the cointegration of deposit and loan.
First, we test for linear cointegration. The reason is that linear cointegration is the easiest case to
analyze and most cointegration tests are built on the basis of linear regressions. In this study,
two popular cointegration tests were employed the augmented Engle-Granger (AEG, Engle and
Granger 1987) and Johansen tests (Johansen 1988, 1991).
Second, if linear cointegration is not found, we then go on to test for nonlinear cointegration.
The method adopted here is a two-step testing procedure that was initially proposed by
Granger and Hallman (1991) and Granger (1991). According to this procedure, we first used an
algorithm-the ACE-to transform the nonlinear Relationship into a linear form and then apply
the conventional cointegration tests to the transformed (and also linearized) relationship. As
Granger and Hallman (1991) and Granger (1991) argued, linear cointegration for the
transformed relationship can be characterized as nonlinear cointegration for the original
relationship. Finally, if nonlinear cointegration is not found, we conclude that loans and
deposits are not cointegrated. However, an important caveat must be issued here.
We used the Johansen (1991) procedure since it has been shown to have good finite sample
properties. The Johansen (1991) procedure is based on a vector error correction model (VECM)
to test for at least one long run relationship between the variables. For the VECM we first
determine the order of integration of the variables, making use of Augmented Dickey-Fuller
and the Phillips-Perron tests, and then applied the Johansen procedure. In conducting
cointegration tests, the time series are required to be nonstationary in their levels. Moreover, it
is important that all time series in the cointegrating equation have the same order of integration.
5

Consequently, the study first ascertained the time series properties of loans and deposits by
employing both the DF and ADF tests for stationarity. The equation estimated for the ADF test
takes the form:
m
X t =0 +1X t-1 + t+ i X t-1 +Dt
(1)
i=1
where et is a sequence of zero-mean p-dimensional white noise vectors, D is the difference

operator , m is the maximum lag length, and Dt seasonal dummies. The term Xt includes our
variables and is a p x 1 vector. The parameters are the p x p matrix G and denotes a p x p
matrix that contains the information about the rank and hence the long term relationship among
the variables. There are three possible cases to be considered Rank = p and therefore vector
Xt is stationary Rank =
implying absence of any stationary long run relationship among
the variables of Xt or Rank < p and therefore r determines the number of cointegrating
relationships.
The equation has an error correction representation where =a. The columns of matrix a are
called adjustment (or loading) factors and the rows of matrix are the cointegrating vectors
with xt being stationary even if Xt consists individually of I(1) processes. Johansen developed
two different tests of the hypothesis that there are at most r cointegrating vectors; the trace
statistic which tests the null hypothesis of at most r cointegrating relationships against a general
alternative in a likelihood ratio framework and the maximum eigenvalue statistic which tests
the hypothesis of r cointegrating relationships against the defined alternative of r+1
cointegrating relationships. The existence of at least one cointegrating vector in the system
indicates the presence of causality between loans and savings.
The causal relationship between loans and deposits is explored with Granger-causality test
based on VECM. This procedure is particularly attractive over the standard VAR because it
permits temporary causality to emanate from (1) the sum of the lagged coefficients of the
explanatory differenced variables and (2) the coefficient of the lagged error-correction term. In
addition, the VECM allows causality to emerge even if the lagged differences of the explanatory
variables are not jointly significant. It must be pointed out that the standard Granger-causality
test omits the additional channel of influence (z t-1). In this study, the causality tests are based on
the following VECM:

X t =zt- 1 + i X t-1 +
i=1
Yt =j zt- 1 + qi Yt-1 +
i=1
f i Yt-1 + D t + mt
(2)
l i Yt-1 + D t + et
(3)
j=1
i=1
where, zt-1 represents the error correction term lagged by one period, X is the gross customer
deposit, Y stands for gross bank loan, a, b,c, and d represent the optimal lag lengths obtained
from the Akaike Information Criterion (AIC).
As a preliminary step of the Cointegration analysis, we need to test for the order of integration
of the data for deposits and loans. Two popular unit-root procedures that we used are the
augmented Dickey-Fuller (ADF) and Phillips-Perron (PP) tests. The results suggest that the
series for each data are 1(1). That is, there is a unit root in the level of the series but none in the
first-difference series. We now proceed to test for linear cointegration of bank deposits and
customer loans. We made use of two cointegration methods-the Augmented Engle-Granger
(AEG, Engle and Granger 1987) and Johansen tests (Johansen 1988, 1991). Both tests are widely
used in empirical research. The AEG method is based on assessing whether there is a unit root
in the residuals from a single-equation regression involving the variables that are potentially
cointegrated. It is suitable for this study because customer deposits and bank loans constitute a
single equation regression). The Johansen test, on the other hand, is a system-based test and
enjoys greater power than the AEG Test as it incorporates system dynamics. It is developed to
test for the cointegrating rank (r) of a system written in a Vector Autoregressive (VAR) form.
The cointegrating rank (r), as the name implies, is the number of independent cointegrating
Johansen test is H0 : r r0 or r r0 where r0 is an integer.
relationships among the variables that constitute the system. The null hypothesis of the
Based on the formulation of the null hypothesis, two types of test statistics, trace and max , are
calculated. For both test statistics, if their computed values are greater than their respective 5%
critical values, the null hypothesis is rejected. The cointegrating rank (r) is determined when the
null hypothesis cannot be rejected for the first time as r0 runs through the integer sequence of 0,
1,2.

Table 1: Augmented Engle-Granger (AEG) test for linear cointegration.

Bank
Test Statistics
-1.634
ECO
-3.735
GCB
-1.634
CAL
-1.432
HFC
-2.639
SG-SSB
-2.335
SCB
-3.237
UTB
-1.831
CAL
-1.276
ECO
This table reports the test statistics from the augmented Engle-Granger (AEG) test. The
AEG test first runs a regression of customer deposits on bank loans and then conducts a
unit-root test and the augmented Dickey-Fuller (ADF) test on the residuals. If the ADF
test statistics is greater (in absolute value) than the conventional-level critical values, the
null hypothesis of no cointegration would be rejected. The critical values provided by
Engle and Yoo (1987) are: -4.80 (1%), -4.19 (5%) and -3.88 (10%). The lags used in the
ADF test are determined by the Akaike Information Criterion (AIC).
In equation (2) the rejection of the null hypothesis that gross saving does not Grangercause loan requires that the Xj's conjointly be statistically significant and/or (ii) the error
correction term (zt-1) be statistically significant. Similarly, in equation (3) the null
hypothesis that gross customer deposit does not cause gross bank loan is rejected
provided that the Xj's are jointly statistically significant and/or the error-correction term
(zt-1) is significant.
To compare the forecasting power of VAR model and error correction model, the root
mean square error (RMSE) is used The RMSE of the out-of sample forecast for vector
8

error correction model was 0.025 compared to 0.036 for the VAR model. This represents
a 44% reduction in the forecast errors when the error correction model is used.
Therefore, it appears that the error correction model which takes into account the longterm relationship outperforms the vector auto regression model.
Empirical Results
The data used in this study comprise Customer Deposits and Bank Loans by the
Ghanaian Listed Banks between 2005 and 2012. The results of both the Dickey-Fuller
(DF) and the augmented Dickey-Fuller (ADE) unit root tests are presented in Table 1.
The null hypothesis of nonstationarity between customer deposits and bank loans is
tested against the alternative hypothesis of stationarity. The results indicate that both
customer deposits and bank loans are not stationary in their levels. However, after first
differencing, the null hypothesis of no unit root is rejected in all of the cases. In all, the
results indicate one order of integration [1(1)] for deposit and loans. The nonstationarity
of the time series in their levels calls for the application of cointegration procedure to
avoid the problem of spurious regression. The critical values at the 5% level of
significance are -2.96 and -3.57, respectively for without trend and with trend. The 10%
critical values for without trend and with trend are -2.26 and -3.20, respectively. The lag
orders are determined by Akaike Information Criterion (AIC).
.
Table 2: Dickey-Fuller (DF) and the augmented Dickey-Fuller (ADE) unit root tests
DF
ADF
Lag
Order
Series
Level
Difference
Level
Difference
GDS
Tm
-1.82
7.70**
1.64
-3.13**
2
TT
GDI
Tm
-1.83
-8.63**
-1.54
3.85**
-1.78
6.98**
2.17
-3.62**
TT
-1.81
5.73**
-1.76
-5.33**
* Significant at 10% level, ** significant at 5% level,

= augmented Dickey-Fuller statistic,
Tm = without trend. DF Dickey-Fuller statistic, ADF
TT = with trend. GDS = Ratio of gross domestic deposits to GDP
and GDI = ratio of gross domestic loans to GDP.

Having determined the order of integration, the Johansen procedure was applied to
ascertain whether customer deposits and bank loans are cointegrated. The results of the
Johansen cointegration tests are presented in Table 3. The null hypothesis of no
cointegration between customer deposits and bank loans (i.e. r = 0) is rejected by both
the trace and maximal eigenvalue ( l max ) tests at the 5 percent significance level in all of
the cases. The fact that customer deposits and bank loans are found to be cointegrated
suggests that capital is immobile on the stock exchange market relative to the sample
data. The critical values for the trace test hypotheses r 1 and r 0 are 11.54 and 18.33
respectively. The critical values for the l max test hypotheses r 1 and r 0 are 11.54 and
23.83 respectively.
Table 3: Johansen Cointegration Test Results
Null: r 1
Null: r = 0
Trace
26.86**
l max
21.66**
Trace
l max
5.20
5.20
** indicates the rejection of the null hypothesis at the 5% significance level
The rank test results in this study are summarized in Table 4. For the case of the rank
test, we computed the autocorrelation adjusted test statistics. The null hypothesis of
this rank test is that the customer deposits and bank loans are not cointegrated, which is
in contrast to the alternative hypothesis that states that the two variables are
cointegrated. The null hypothesis is rejected in favor of the alternative hypothesis when
the critical value exceeds the test statistic; otherwise, the null hypothesis is supported.
As is shown by the * statistic in Table 4, the null hypothesis is rejected for all seven of
the listed banks examined in this study because the test statistics are larger than the
conventional critical values at the 1 percent significance level. According to the *
statistic, we observed cointegrating relationships between the customer deposits and
bank loans for all all seven of the listed banks. Therefore, this indicates that the rank test
employed in this study provides some evidence of the existence of long-run
relationships between the all seven of the listed banks examined. Based on the
cointegrational relationships previously identified above, it is possible to distinguish
between non-linear and linear cointegration using the rank sum linearity test developed
by Breitung (2001). It is evident from Table 4 that the null hypothesis of linear
10

cointegration is rejected at all conventional levels; thus, the rank sum linearity test
results for the TR2 also indicate that the cointegrating relationships can be non-linear.
Table 4: Results of the Cointegration and Non-Linearity Rank Tests
Bank
Rank Test ( * )
CAL
0.02718 ***
ECO
0.03412
6.78413 **
GCB
0.04313 ***
7.09212 **
HFC
0.07414 ***
3.03814 ***
SG-SSB
0.08211 ***
12.00316 ***
SCB
0.09714 ***
8.20518 **
UTB
0.07318 ***
2.90612 *
Linearity Test(T.R2)
15.62711
***
*** indicates significance at the 0.01 level; ** indicates significance at the 0.05 level; and * indicates
significance at the 0.1 level.
The results for the error-correction based Granger-causality tests are presented in Ta ble 5.
These tests are conducted with residuals from the cointegration equations. The results indicate
that causality runs from customer deposits and bank loans. The null hypothesis that customer
deposit does not Granger- cause loan is rejected because the error-correction terms are
statistically significant. This finding implicates the error-correction terms as the only channel of
influence since the lagged differences of deposit are not conjointly significant.
11

Table 5: F-Statistics for Bivariate Causality Tests Based on VECM

Deposit and Loan
Deposit Equation
zt- 1
F-Statistics
9.13*
DD
2.86
Loan Equation
zt- 1
0.07
DS
0.43
* indicates significance at the 0.1 level
CONCLUSION
The results of both the Dickey-Fuller (DF) and the augmented Dickey-Fuiler (ADE) unit root
tests of the null hypothesis of nonstationarity of loans and deposits tested against the alternative
hypothesis of stationarity indicate that both loans and deposits are not stationary in their levels.
The findings also suggest that a positive relationship exists between deposits and loan. This
confirms Obamuyi (2013) who also found positive relationship between deposit mobilization
and bank lending.
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14

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AFRICA DEVELOPMENT AND RESOURCES RESEARCH INSTITUTE (ADRRI) JOURNAL

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Faculty of Business and Management Studies, Koforidua Polytechnic

Correspondence: Email: vclartey@yahoo.com

AFRICA DEVELOPMENT AND RESOURCES RESEARCH INSTITUTE (ADRRI) JOURNAL

AFRICA DEVELOPMENT AND RESOURCES RESEARCH INSTITUTE (ADRRI) JOURNAL

. Deposits play a pivotal

role in bank funding, as a major portion of a commercial banks assets is usually

AFRICA DEVELOPMENT AND RESOURCES RESEARCH INSTITUTE (ADRRI) JOURNAL

AFRICA DEVELOPMENT AND RESOURCES RESEARCH INSTITUTE (ADRRI) JOURNAL

RESULTS AND DISCUSSIONS

AFRICA DEVELOPMENT AND RESOURCES RESEARCH INSTITUTE (ADRRI) JOURNAL

X t =0 +1X t-1 + t+ i X t-1 +Dt

where et is a sequence of zero-mean p-dimensional white noise vectors, D is the difference

implying absence of any stationary long run relationship among

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AFRICA DEVELOPMENT AND RESOURCES RESEARCH INSTITUTE (ADRRI) JOURNAL

Table 1: Augmented Engle-Granger (AEG) test for linear cointegration.

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* Significant at 10% level, ** significant at 5% level,

Tm = without trend. DF Dickey-Fuller statistic, ADF

TT = with trend. GDS = Ratio of gross domestic deposits to GDP

and GDI = ratio of gross domestic loans to GDP.

AFRICA DEVELOPMENT AND RESOURCES RESEARCH INSTITUTE (ADRRI) JOURNAL

** indicates the rejection of the null hypothesis at the 5% significance level

AFRICA DEVELOPMENT AND RESOURCES RESEARCH INSTITUTE (ADRRI) JOURNAL

AFRICA DEVELOPMENT AND RESOURCES RESEARCH INSTITUTE (ADRRI) JOURNAL

Table 5: F-Statistics for Bivariate Causality Tests Based on VECM

* indicates significance at the 0.1 level

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AFRICA DEVELOPMENT AND RESOURCES RESEARCH INSTITUTE (ADRRI) JOURNAL

Ladime J., Sarpong-Kumankoma E and Osei K. A. (2013). Determinants of Bank

AFRICA DEVELOPMENT AND RESOURCES RESEARCH INSTITUTE (ADRRI) JOURNAL

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