ABSTRACT
The study is situated against the backdrop of the sluggish growth rate of output in the economy and the important role the financial sector plays in driving economic growth in Nigeria. The principal objective of the study is to investigate the link between financial sector development and economic growth in Nigeria from 1981-2016. The study, therefore sought to investigate the effect of financial sector development on economic growth as well as investigate the nature of causal relationship between financial sector development and economic growth in Nigeria using cointegration tests to establish the long run relationship and granger causality test to determine the direction of causality between financial sector development and economic growth.Data from Central Bank of Nigeria statistical bulletin were used in the analysis. The study established that there exist a long run relationship between financial sector development and economic growth in Nigeria. The study recommends among other things that: The central bank must liaise with commercial banks and financial institutions in other to arrive at an equilibrium interest rate that clears the market for loanable funds.
TABLE OF CONTENTS
Title Page i
Declaration ii
Certification iii
Dedication iv
Acknowledgement v
Table of Contents vi
List of Tables viii
Abstract ix
CHAPTER 1: INTRODUCTION
1.1 Background
to the Study 1
1.2 Statement
of the problem 4
1.3 Research
Questions 8
1.4 Objectives
of the Study 8
1.5 Hypothesis
of the Study 8
1.6 Significance
of the Study 9
1.7 Scope
of the Study 9
CHAPTER 2: REVIEW OF RELATED LITERATURE
2.1 Conceptual
Framework 10
2.2 Theoretical
Review
14
2.3 Empirical
Review 22
2.4 Summary
of Empirical Literature 29
2.5 Gap
in Empirical Literature 30
CHAPTER 3: METHODOLOGY
3.1 The
method 32
3.2 Model
Specification 32
3.2.1
Model one 32
3.2.2
Model two
34
3.3 Estimation Technique 35
3.4
Estimation steps in ARDL
36
3.5
Other Test
36
3.6
Model Justification 36
3.7
Source of Data and Econometric Software 37
CHAPTER 4: RESULTS AND
ANALYSIS
4.1 Pre
Test 38
4.1.1
Unit root rest
38
4.2 Co-Integration
Test 39
4.3 Error
Correction Model 40
4.3.1
Dynamic short run error correction model 40
4.3.2
Static long run model
42
4.4
Post Test 43
4.4.1
Causality test 43
4.4.2 Hypothesis testing 44
4.4.3 Test
for autocorrelation
45
4.4.4 Test
for heteroscedasticity 45
4.4.5 Bounds test
46
4.5 Economic Implication
47
CHAPTER 5: CONCLUSION AND
RECOMMENDATIONS
5.1 Summary
of Findings 49
5.2 Conclusion 50
5.3 Recommendation 51
Reference 53
Appendices 58
LIST OF TABLES
1:
Summary of Empirical Literature 29
2: Unit
Root Test 38
3:
Co-integration 39
4:
Dynamic Short run Error Correction Model 40
5:
Static Long runs Model
42
6: Granger causality result 44
7:
Breuch-Godfrey Serial Correlation LM Test
45
8:
Heteroskedasticity Test: Breusch-Pagan-Godfrey 46
9:
Bounds Test
46
CHAPTER 1
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
In
Economics, the link between financial development and economic growth has been
issue of debate. Many researchers are of the view that the development of the
financial sector determines how it will be able to effectively and efficiently
discharge its major role of mobilizing fund from
the
surplus sector to the deficit sector of the economy, Studies by Shumpeter
(1911), Gurley and Shaw (1955) attest to this claim.
Financial development
takes place when financial instruments, markets, and intermediaries work
together to reduce the costs of information, enforcement and transactions. A
solid and well-functioning financial sector is a powerful engine behind
economic growth. It generates local savings, which in turn leads to productive
investments in local business. The financial sector therefore provides the
rudiments for income-growth and job creation.
In recognition of the
important role played by the financial sector in promoting
economic growth, monetary authorities
all over the world in general and
in Nigeria in particular have overtime carried out reforms aimed at
strengthening the financial sector to enable it perform its function as a
powerful engine behind economic growth.
Nigeria
has witnessed reforms in its financial sector between 1981-2016 going from the
deregulation of the financial sector during SAP 1986, the bank consolidation
era of 2004/2005 and the 2009/2010 banking reforms of the expanded discount
windows through which the CBN provides liquidity to the ailing banks for short
term need purposes.
CBN(2017)
stated that the Structural Adjustment Programme (SAP) was adopted in July, 1986
against the crash in the international oil market and the resultant
deteriorating economic conditions in the country. It was designed to achieve
fiscal balance and balance of payments viability by altering and restructuring
the production and consumption patterns of the economy, eliminating price
distortions, reducing the heavy dependence on crude oil exports and consumer
goods imports, enhancing the non-oil export base and achieving sustainable
growth.
Under
SAP, monetary policy was aimed at inducing the emergence of a market-oriented
financial system for effective mobilization of financial savings and efficient
resource allocation.
Ifeanyi
(2016) noted that despite the lofty goals and objectives set by the structural
adjustment policy of 1986, the policy failed to fundamentally position the
financial sectors of the economy to promote sustained economic growth. He
opined that financial system remained very weak even after the structural
adjustment policy with many banks having
low capital base and unable to compete
globally or finance heavy long term projects. This had a negative impact on the
economy.
The
operational environment for banks was further liberalized in 2001 with the
introduction of universal banking, while the supervisory framework of the
financial system was enhanced with the establishment of a new department in CBN
to supervise other financial institutions. In 2002, monetary policy implementation
was faced with some challenges as the problem of excess liquidity persisted,
and the demand pressure in the foreign exchange market intensified, CBN (2017).
The 2004/2005 CBN Banks consolidation policy
made commercial banks to increase their minimum paid-up capital to N25b, the
total number of banks decreased from 85 to 25. The major aim of the
consolidation was to promote the growth of larger banks with better capacity to
fund markets, Okoronkwo (2016).
Mustapha
(2017) noted that the excise yielded fruit by creating some very strong banks
that were at least capable of competing in the continent with a capacity to
fund long term project. He noted that the policy led to an increase in the
number of bank branches nationwide but he also pointed out that its impact on
economic growth remained very weak because of the low level of financial
inclusion in the country.
In pursuant of its reform
policies in the banking sector, the central bank of Nigeria in the year 2009/2010 introduced the Expanded Discount Window (EDW). This was a
financial support facility through which the CBN provides liquidity to the
ailing banks, for short-term fund needs purposes. Unfortunately, some of these
banks became regular customers to the EDW, borrowing with reckless abandon, and
were unable to pay back the funds because they were in precarious cash
positions. This abuse if left unchecked is unsafe for the future and continued
existence of the banking industry and will further the perpetration of the
little or unregulated lending policies which eventually would have plunged the
Nigerian economy into deeper crisis,
Okoronkwo (2016).
The
effect of the above reforms however will not be appreciated without relating it
with economic growth in light of the conflicting views.
The economic growth is a gradual and steady change in the long-run
which comes about by a general increase in the rate of savings and population,
Adekunle (2013). It has also been described as a positive change in the level
of production of goods and services by a country over a certain period of time.
Economic growth is measured by the increase in the amount of goods and services
produced in a country. An economy is said to be growing when it increases its
productive capacity which later yield more in production of more goods and
services, Adekunle (2013). Economic growth is usually brought about by
technological innovation and positive external forces. It is the yardstick for
raising the standard of living of the people. It also mean reduction of inequalities
of income distribution.
The
causality relationship between economic growth and financial development is a
controversial issue. The debate has been centered on whether it is the
financial development that leads to economic growth or economic growth that
leads to financial development. Several studies have continued to produce
conflicting results thus making the topic a great research burden.
Economists
such as Mckinnon and Shaw (1973); Greenwood and Jovanovic (1990) and Bencivenga
and Smith (1991) have stressed the importance of financial development on
economic growth. Lucas (1998), Kuznets (1995), Jung (1986), Ireland (1994) and
Robbinson (1952) opined that the importance of financial development on the
process of economic growth is overstated and that financial development follows
expansion of the real sector economy.
In
Nigeria, macro- economic instability has continued to be major problem as
reality on ground shows that her macroeconomic objectives have been quite
elusive despite the reform policies of government thereby making the economy
highly susceptible to general domestic and external shocks, Omofa (2017). Omofa (2017) citing Nwaogwugwu (2010) stated
that the macroeconomic performance in Nigeria over the past three decades has
been both unsatisfactory and disappointing because economic growth has been
stunted and often accompanied by sharp declines in rates of investment,
consistent high fiscal deficits and high rate of inflation. Domestic saving
rates have fallen dramatically, thereby contributing to unsustainable external
payment position. The study further stated that in attempt to correct external
imbalances through reduction in aggregate demand, government has further
compressed investment expenditures, completing the vicious circle of sluggish
growth, high unemployment rate and declining investment and savings rate.
This study aims at explaining the relationship
between financial development and economic growth in Nigeria in the light of
conflicting views.
1.2 STATEMENT OF THE PROBLEM
The relationship between financial development
and economic growth has been of great interest to policy makers and researchers
alike. The interest stems from the perceived importance of the financial
systems in the drive towards sustained economic growth and development in any
economy. Given the crucial role the financial sector plays in the allocation of
resources in any economy, the importance of vibrant and well developed
financial sector cannot be overemphasized.
Data
from the CBN statistical bulletin shows that over the years credit to the
private sector (a major determinant of financial development) as ratio of GDP
has fluctuated variously. Standing at about 5.9% in 1981, the value rose to about 10.1 in1993 before
declining to about 7.3 in the year 2000. Credit to the private sector rose
after the banking consolidation exercise of 2004- 2006 moving to about 20.1% in
the year 2012 by the year 2016 the value stood at about 20.8%.
Credit
to the private sector as ratio of GDP and broad money supply as ratio of GDP.
Similarly
broad money supply as percentage of GDP (another indicator of financial development) has
risen over the years. Similar to the
private sector credit, its rise became more prominent after the 2004
consolidation exercise reaching about 21.3% in the year 2016. The rise in the
value of these financial sector development indicators is testament to the
success of the 2004/2005 consolidation exercise.
However,
despite rising private sector credit and broad money supply, growth rate of GDP
has not been encouraging. Data from CBN statistical bulletin showed that the
growth rate of GDP has been on the decline of recent.
Source:
author compilation using data, from CBN
From
the above graph it is obvious that the growth rate of GDP has been fluctuating
over the years even as credit to the private sector and broad money has been on
the rise. This is quite surprising as increases in financial sector development
indicators are supposed to be positively correlated to economic growth all
things being the same. However, this has not been the case in Nigeria. Various
reforms carried out over the years have failed to drive economic growth to an
unprecedented level and financial inclusion have remained relatively low with
many people still without access to financial services and credit facility
which is badly needed in developing
economy such as ours.
There
is no shortage of works regarding the relationship between financial development and economic growth
although most of the works in these area has often focused exclusively on
developing countries(see Shaw (1973), Singh (1997) ). Of those that have focused
on the Nigeria economy, the findings have been conflicting with some of these
conflict rising from differences in methodology and estimation techniques
employed, Oriavwote and Eshenake (2012), Tabi et al (2011) .
While Oriavwote and Eshenake (2012) finds that
financial sector development has not significantly improved private sector
development, Tabi et al (2011) revealed that financial sector development has a
positive effect on economic growth in the long-run through efficient collection
and allocation of financial resources. They also found a long-run causality to
economic growth.
There
is also the argument that financial development contributes significantly to
the economic development of developed countries while the developing countries
have not fared well in this regard, Singh (1997).
According
to Adekunle (2013), the real sectors of the economy, which are said to be
economic growth drivers are not effectively and efficiently serviced by the
financial sector. The banks are declaring billions of profit, yet, the real
sectors continue to be weak thereby reducing the productivity level of the
economy. Most of the operators in the productive sector are folding up due to
the inability to get loan from the financial institutions or the cost of
borrowing was too outrageous.
If
the nation will achieve any sustainable and inclusive growth, then improvements
in the financial sector must translate into improved economic growth. This will
entail further improvement to strengthen the financial sector to enable it
perform effectively. It is therefore necessary that policy makers in Nigeria
must from time to time reevaluate the effect of certain reforms and the overall
development in the financial has on general economic growth.
In
the light of the above the following research questions will guide this study.
1.2 RESEARCH
QUESTIONS
1. Is there any long run relationship
between financial development and Economic growth?
2. What is the impact of financial
development on Economic growth in Nigeria?
3. What is the direction of causality
between financial development and Economic growth?
1.4 OBJECTIVES OF THE STUDY
The
principal objective of the study is to investigate the link between financial
development and economic growth in Nigeria from 1981-2016 marking reforms of
the Nigeria financial sector. This study intends to assess the impact of
financial development on economic growth in Nigeria bearing in mind the recent
reforms that occurred in financial sector of the country. The specific
objectives are aligned as follows:
1. To examine the long run relationship
between financial development and economic growth in Nigeria
2. To assess the impact of financial
development on economic growth.
3. To determine the direction of causality
between financial development and economic growth in Nigeria.
1.5 HYPOTHESIS OF THE STUDY
Ho1: There is no long run relationship between
financial development and economic growth.
Ho2:
There is no significant impact of financial development on economic growth in
Nigeria.
Ho3:
There is no causality between financial development and Economic growth in
Nigeria.
1.6 SIGNIFICANCE OF THE STUDY
The
study will serve as a good source of information for researchers. It will
provide insight to know whether financial development is a sufficient condition
for economic growth in Nigeria. The study is a valuable source of information
for policy makers as the convincing evidence that the financial development
influences long-run economic growth will hasten the need for research on
regulating and policy determinant of financial development.
The
study contributes to empirical literature on financial development and economic
growth in Nigeria.
1.7 SCOPE OF THE STUDY
The
study will focus on the financial sector of the economy. Precisely on the
financial development indicators to investigate how it impacts on the Nigerian economic
growth. A time series data covering the
period of 1981 to 2016 will be employed. The technique of analysis to be used
are: Augmented dickey fuller unit root test to test for stationarity of
variables, johansen co-integration test to establish the long run relationship,
autoregressive distributed lag model estimation and granger causality test to
determine the direction of causality between financial development proxies and
Nigeria economic growth.
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