ABSTRACT
This study provided an empirical analysis of causality between financial development and economic growth in Nigeria. Time series data from 1981 to 2019 relevant to the study were collected from the Central Bank of Nigeria statistical bulletin, Volume 30. The ordinary least squares (OLS) method of multivariate regression was utilized in analyzing the semi-log model. The Augmented Dickey-Fuller unit root test was employed to establish the stationarity of the variables while the Autoregressive Distributed Lag (ARDL) model was used for testing for the existence of long-run and short-run equilibrium conditions while the Granger causality test was applied to ascertain the direction of influence between financial development indicators and economic growth in Nigeria. Financial development indicators used in the study were financial depth (measured by broad money supply to GDP ratio), private sector credit to GDP ratio, stock market development (measured by market capitalization to GDP ratio), banking sector development (measured by total banks assets to GDP ratio), savings rate (proxied by national savings to GDP ratio) and informal finance which was proxied by the ratio of currency outside the banks (measured by M1 to M2 ratio). On the other hand, economic growth was measured by real gross domestic product. In consonance with the demand following hypothesis, the results of the Granger causality test revealed a causal relationship from real gross domestic product to financial depth, private sector credit ratio, market capitalization ratio and banking sector ratio. The ARDL bounds test indicated that a long-run cointegrating relationship existed between financial development indicators and economic growth in Nigeria. From the ARDL estimates, it was found that financial depth had a negative and significant influence on economic growth in the short run with positive but insignificant influence in the long run. Also, the private sector credit ratio had a negative influence on economic growth in both the long-run and short-run, but it was only significant in the short-run. In the long-run and short-run, the market capitalization ratio had a positive and significant influence on economic growth. Again, savings rate and informal finance (measured by the rate of currency outside the banks) were found to exert a negative and significant influence on economic growth in both the long-run and short-run. It is therefore recommended that government carry out subsequent efforts towards developing the financial sector in conformation with global standards. As such, factors that could hinder the growth of the flow of financial resources to economically productive sectors should be mitigated and controlled.
TABLE OF CONTENTS
Title
Page . . . . i
Certification . . . . ii
Declaration . . . . iii
Dedication . . . . iv
Acknowledgements . . . . v
List
of Tables . . . . viii
List
of Figures . . . . ix
Abstract . . . . x
CHAPTER
1: INTRODUCTION
1.1 Background to the Study 1
1.2 Statement of the Problem 3
1.3 Objectives of the Study 6
1.4 Research
Questions 6
1.5 Research
Hypotheses 7
1.6 Scope
of the Study 8
1.7 Significance of the Study 8
1.8 Limitations
of the Study 9
1.9 Operational
Definition of Terms 9
CHAPTER 2: LITERATURE
REVIEW
2.1 Conceptual Framework 11
2.1.1 Concept of financial development 13
2.1.2 The
functional role of financial system 17
2.1.3 Concept
of economic growth 18
2.1.4 Linkages
between financial development and economic growth 19
2.1.5 Financial
development and economic performance in Nigeria 21
2.1.6 Financial
reforms of the consolidation era; its implication for
financial
sector development in Nigeria 22
2.1.7 Capital
market based financial development and economic growth 23
2.1.8 Financial
integration: an aid to financial development 24
2.2 Theoretical
Framework 25
2.2.1 Demand
following and supply-leading hypotheses 25
2.2.2 The
feedback mechanism 27
2.2.3 Goldsmith
theory 28
2.2.4 Mckinnon's
complementarity hypothesis 29
2.2.5 Shaw’s
hypothesis 30
2.2.6
Neo-classical growth theory 32
2.3 Empirical
Framework 33
2.4 Summary
of Literature 58
2.5 Gap
in Literature 65
CHAPTER 3: METHODOLOGY
3.1 Research
Design 68
3.2 Nature
and Sources of Data 68
3.3 Method
of Data Analysis 68
3.4 Model Specification 69
3.5 Description of Model Variables 70
3.6 Techniques of Data Analysis 72
CHAPTER 4: PRESENTATION
OF DATA, ANALYSIS AND DISCUSSIONS
4.1 Presentation
of Data 75
4.2 Descriptive
Statistic 83
4.3 Empirical
Analysis and Discussion of Findings 84
4.3.1 Augmented
Dickey-Fuller (ADF) test for unit root 84
4.3.2 Granger
causality test 85
4.3.3 ARDL
bounds testing for cointegration 87
4.3.4 Error
correction model (ECM) 89
4.3.5 Diagnostic test 91
4.3.6 Test
of hypotheses 94
4.3.7 Discussion
of findings 96
CHAPTER 5: SUMMARY,
CONCLUSION AND RECOMMENDATIONS
5.1 Summary 100
5.2 Conclusion 101
5.3 Recommendations 102
5.4 Contribution
to Knowledge 103
REFERENCES
APPENDIXES
LIST OF
TABLES
2.1 Summary of empirical literature 59
3.1 Description of model variables and a priori expectation 71
4.1 Annual time series data used for the
study 75
4.2 Descriptive
statistic 83
4.3 ADF
unit root test results 85
4.4 Granger
causality test 86
4.5 Bounds
test results 87
4.6 Long-run coefficient estimates 87
4.7 Error correction model 90
4.8 Diagnostic test 92
LIST
OF FIGURES
1.1 Trend of market capitalization 5
2.1 Conceptual framework 13
4.1 Trend of real gross domestic product 76
4.2 Trend of broad money supply to GDP ratio 77
4.3 Trend of private sector credit to GDP
ratio 78
4.4 Trend of market capitalization to GDP ratio 79
4.5 Trend of banking sector assets to GDP
ratio 80
4.6 Trend of savings to GDP ratio 81
4.7 Trend of currency outside bank to M2 82
4.8 CUSUM test 93
4.9 CUSUM sum of squares 93
CHAPTER 1
INTRODUCTION
1.1
BACKGROUND
TO THE STUDY
Globally, economic growth which
manifests as positive changes in the value of goods and services remains an
important phenomenon. However, diverse economic factors and their interaction
with each other play critical roles in stimulating growth. Based on this
premise, the economic theory postulates that factors of production such as
labour, capital and land are fundamental drivers of growth. Furthermore, growth
theories added that technological changes are prominent sources of change in
the production function (Tyson, 2021). Nevertheless, over time, the
significance of a viable financial system was also recognized as a core driver
of economic prosperity which led to the introduction of financial sector
reforms of developing countries to facilitate economic growth through financial
system development. Hence, a lot of research efforts have been made towards
analyzing and understanding the connection between financial sector development
and economic growth.
Financial development entails the
capacity of financial institutions to effectively and efficiently attract and
mobilize financial savings for investment activities towards sustainable
economic growth. Based on the perceived causality between finance and growth,
every nations’ economy requires a sophisticated and viable financial system to
succeed. According to Haan, Pleninger and Sturm (2021), financial development
is crucial to economic growth because it connotes the establishment and
expansion of institutions, instruments and markets that facilitate investments
and growth. Hence, a developed financial system speeds up the trade of goods
and services, savings mobilization, resource allocation, and aids risk
diversification. Based on this premise, many developing countries, Nigeria
inclusive, have embraced strategic development plans that prioritize revamping
and modernization of their financial sectors. For instance, since the
mid-1980s, Nigeria has implemented reforms and policies within the context of
the Structural Adjustment Programme (SAP) proposed by the Bretton Woods
institutions in 1986. The essence of initiating these reforms is to create a
more efficient and stable financial sector, which would drive optimum
performance in the economy (Osisanwo, 2017; Soludo, 2007).
The
causality between financial development and economic growth is tagged as the
supply-leading and demand-following hypotheses (Karimo and Ogbonna, 2017). The
standpoint of the supply-leading hypothesis is that the development of the
financial system facilitates economic growth, implying that the development of
financial institutions and markets stimulates economic growth. Numerous
theoretical and empirical literature on the subject has shown that financial
development is important and causes economic growth (Bassey, Okoi and Imoh,
2021; Sambo, Sulong and Sambo 2021; Olaniyi, 2020). Conversely, the
demand-following hypothesis advances that economic growth stimulates financial
development based on the notion that an increase in demand for financial
services might prompt a rapid expansion in the financial sector as economic
prosperity is enhanced (Mittal, 2017; Puatwoe, 2017; Adusei, 2013).
Contemporary
finance researchers have extensively investigated the link between financial
liberalization and other macroeconomics variables, but the role of financial
development is not universally accepted. One of the oldest findings on the
relationship between financial development and economic growth is based on
Schumpeter (1912) who asserts that, the services provided by the financial
intermediaries are important for innovation and development. According to
Bagehot (1873) and Hicks (1969), development in the financial system played a
critical role in industrialising England through the facilitation of capital
mobilisation. Schumpeter (1912) harnesses the importance of the banking system
in economic growth; financial institutions support innovation and creativity
and thus enhance future growth by identifying and funding productive
investments. Therefore, it facilitates the creation of wealth, trade and the formation
of capital (Ahmed 2006). A further step taken by Fry (1978, 1980) and Galbis
(1977) suggested that, interventions to impose restrictions on the banking
system such as credit ceilings and high reserve requirements have a negative
impact on the development of the financial sector, which ultimately reduces
economic growth. In addition, (Levine 1997) suggested that aiding risk
management, improving liquidity and reducing transaction costs leads to
financial system development and thus encourages investments.
In Nigeria, the financial system
reforms characterized by the the1986 deregulation influenced the extent of
finance-driven economic growth (Nnanna, 2004). Nevertheless, the deregulation
of the financial system of Nigeria, coupled with rapid financial markets
globalization and the accelerated level of cross-border financial activities in
Nigeria has generated interest regarding the level of financial development in
the country. These have manifested in the level of growth in the financial
outlet, accelerate activities in the capital and money market, increased bank
branches, rapid use of credit and debit cards, increasing use of payment
technologies like ATMs (Automatic Teller Machine Technology) and electronic
transfer of deposits, expanding internet banking services, e-banking, and
increase in total deposits, (Okereke, 2011). In this regard, financial
development is expected to translate into economic growth, because persistent
growth of the financial sector would make funds available for investments.
Intuitively, a well-developed
financial system could drive efficiency with which a greater amount of capital
accumulation is facilitated and a greater amount of funds are allocated to
profitable investments. However, the controversy still exists in the literature
as to whether the development of the financial system has driven the expected
economic growth in Nigeria. Based
on the foregoing discussions, the study is designed to ascertain the causal
relationship between financial development and the economic growth of Nigeria.
1.2
STATEMENT OF
THE PROBLEM
Since the Structural Adjusted
Programme in 1986, Nigerian monetary authorities have embraced measures aimed
at developing the financial system and decelerating the incidence of financial
repression. These reforms have brought changes in Nigeria's financial sector to
encourage competition, strengthen the supervisory and regulatory framework, and
streamline public involvement in the financial system. Many new financial
instruments/assets and techniques have been developed and existing ones have
been modified, the financial markets have been adapted to meet new demands and
new circumstances. All these have been aimed at developing the financial
system. Unfortunately, the positivity expected from financial development and
economic growth nexus is yet to be seen in Nigeria. Figure 1.1 shows the trend
of market capitalization from 2007 to 2019.
Figure 1.1:
Trend of market capitalization (2007-2019)
Source:
Central Bank of Nigeria (CBN) Statistical Bulletin, Vol. 30, 2019.
In addition, notwithstanding the
improvements in the Nigerian banking sector, they are still plagued with cases
of the dismal performance of their role. For instance, a large proportion of
credit transactions in Nigeria still take place in the informal markets,
notwithstanding the government's efforts towards channelling credit to the
productive sector through the commercial banks. According to Michael (2016),
the underperformance of the banking sector was such that banking services are
available to about 40% of the population and more than 60% of the poor do not
gain access to formal finance and are propelled to depend on a narrow range of
some risky and expensive informal services which hinder their ability to
partake fully in financial markets to accelerate their income and contribute to
economic growth. Hence, the economy is still prostrate, banks lack efficiency
and effectiveness in lending.
These developments in the financial system
might continue to spur the lack of financial accessibility and restrict
economic units to low-return capital intensive activities. Already, there have
been profound fluctuations in total savings and investments in Nigeria,
implying that domestic production, a measure of economic growth will follow the
same pattern. Again, literature is faced with the puzzle as to whether
financial development influences economic growth or vice versa. For instance,
prior empirical works such as Haan, Pleninger and Sturm (2021); Rehman and Hysa (2021); Karimo and Ogbonna
(2017); Bidemi and Abidemi (2014); Matei
(2020) found a one-way causal flow from components of financial
development to economic growth, while studies like Nwakoby, Oleka and Ananwude (2019); Madichie,
Maduka, Oguanobi and Ekesiobi (2014); Hamdi, Hakimi and Sbia (2013) found a
one-way causal flow emanating from economic growth to financial development.
Similarly, empirical studies such as Fuinhas, Filipe, Belucio and Marques
(2019); Mittal (2017); Adusei (2013) and Odhiambo (2009) found evidence of a
bidirectional relationship between components of financial development and
economic growth while Bassey, Okoi and Imoh (2021) found no causal flow between
the two variables. Furthermore, Kapaya
(2020); Etale and Edoumiekumo (2020) and Iheonu, Asongu, Odo and Ojiem
(2020) explained that the actual causal flow between financial development and
economic growth is dependent on the measure of financial development. Based on
these problems, there is a need to trace the direction of influence between
financial development and economic growth in Nigeria.
1.3
OBJECTIVES
OF THE STUDY
The core objective of this study is
to ascertain the causality between financial development and economic growth in
Nigeria. The specific objectives are to:
1.
investigate the causal effect of financial depth
(measured by broad money supply to GDP ratio) on real gross domestic product in
Nigeria.
2.
ascertain the direction of influence between private
sector credit to GDP ratio and real gross domestic product in Nigeria.
3.
analyse the causal effect of stock market development
(proxied by market capitalization to GDP ratio) and real gross domestic product
in Nigeria.
4.
investigate the nature of causality between banking
sector development (proxied by total bank assets to GDP ratio) and real gross domestic product in
Nigeria.
5.
ascertain the causal effect between savings rate (measured
by total national savings to GDP ratio) and
real gross domestic product in Nigeria.
6.
determine the direction of causality between informal
finance measured by currency outside bank (M1 to M2 ratio) and real gross
domestic product in Nigeria and vice versa.
1.4 RESEARCH QUESTIONS
The study sought to answer the
following research questions:
1.
What is the direction of causality between financial
depth (measured by broad money supply to GDP ratio) and real gross domestic
product in Nigeria?
2.
How does private sector credit/GDP ratio influence real
gross domestic product of Nigeria and vice versa?
3.
What influence does market stock market development
(measured by capitalization to GDP ratio) have on real gross domestic product
in Nigeria?
4.
In what ways does banking sector development (proxied
by bank assets to GDP ratio) influence real gross domestic product of Nigeria?
5.
How does savings rate (proxied by total national
savings to GDP ratio) influence real gross domestic product of Nigeria?
6.
To what degree does ratio of informal finance measured
by currency outside bank (M1 to M2 ratio) influence real gross domestic product
in Nigeria and vice versa?
1.5 RESEARCH HYPOTHESES
The following hypotheses stated in
null form were tested:
Ho1: There is no significant causal relationship
between financial depth (measured by broad money supply to GDP ratio) and real
gross domestic product of Nigeria.
Ho2: There is no significant causal relationship between private sector
credit to GDP ratio and real gross domestic product in Nigeria.
Ho3: Stock market development (measured by market
capitalization to GDP ratio) has no significant causal influence on real gross
domestic product of Nigeria.
Ho4: Banking sector development (proxied by total
bank assets to GDP ratio) has no significant causal influence on real gross
domestic product of Nigeria.
Ho5: Savings rate (measured by gross savings to GDP ratio has no
significant influence on real gross domestic product of Nigeria.
Ho6: Informal finance measured by currency outside bank (M1 to M2 ratio)
has no significant causal influence on real gross domestic product of Nigeria.
1.6 SCOPE OF THE STUDY
The study investigated the causal relationship
between financial development and economic growth in Nigeria from 1981 –
2019. The choice of the period is
justified because it covers both the pre and post-deregulation era of the
Nigerian financial system. Also, it covered years (1981, 1982, 1983, 1984, 1991
and 2016) when the Nigerian economy recorded a negative real GDP growth rate
(recession). On the other hand, the indicators of financial development
considered for this study such as private sector credit to GDP ratio, broad
money supply to GDP ratio, bank assets to GDP ratio, market capitalization to
GDP, gross national savings to GDP ratio and informal finance covered key
subsectors of the financial system and these indicators have significant shocks
especially aftermath the financial liberalization in 1986 coupled with the
global financial downturn of 2008 and economic recession witnessed in 2016.
1.7 SIGNIFICANCE OF THE STUDY
The need to empirically investigate the
relationship that exists between financial development and economic growth is
very critical. Hence, the significance of this study has been highlighted below
as follows:
1.
Monetary
Authority: This study is relevant at this level of economic development
(characterized by the recession) when efforts are being geared towards
repositioning the financial system to enable it to play key roles in economic
growth. Hence, the monetary authority would understand the area of financial
policy development that would aid to curb the current economic crisis witnessed
in Nigeria. It will also aid policymakers and the government to understand the
structural changes that have taken place with the reform policies on the ground
in Nigeria.
2.
Investors:
Both domestic and foreign investors are interested in the functionality of the
economy. Hence, efforts towards developing the financial system for economic
growth would influence investment decisions across the country. As such, this
study will provide relevant information to investors to enhance investment
induced economic growth in Nigeria.
3.
Academia: It
will also provide required information that will be critical in formulating a
more targeted financial reform policy that will be of great benefit to Nigeria.
More so, the study would be an addition to the literature on the linkages
between finance and growth.
1.8 LIMITATIONS OF THE STUDY
The
limitations that were encountered during this study were time factors and lack
of funds. These two factors are economic resources and it is a clear fact that
economic resources are limited and scarce. However, the researcher applied the
principle of opportunity cost, the scale of preference and prudent utilization
of available resources to accomplish the study.
1.9 OPERATIONAL DEFINITION OF TERMS
The terms listed below occurred
frequently in this study. Therefore, explanations are provided as to the
intended meaning of these terms.
1.
Financial
development: Financial development is the capacity of financial
institutions to effectively and efficiently attract and mobilize financial
savings for investment activities towards sustainable economic growth.
2.
Formal
finance: Formal
finance refers to borrowings from recognized financial institutions such as banks and non-bank financial institutions.
3.
Informal
finance: Informal financial institutions
are financing activities that are
mostly. Legal but
their activities are often unrecorded, unregistered and unregulated by the
government. Informal finance is often measured by currency outside the bank.
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