The Impact Of Financial Development On Economic Growth In Nigeria

Project and Seminar Material for Economics

Abstract

The Nigerian financial system experienced series of reforms and amidst these reforms an important component of the sector, the financial market has demonstrated an impressive performance evidenced from its growth especially in the last decade. Coupled with this development, the Nigerian economy has also experienced growth which did not significantly translate into positive improvements in employment, and poverty reduction. This study examined the relationship between financial development and economic growth in Nigeria Annual data on some financial development indicators and real growth domestic product were collected and used for the study. The empirical results from causality test at lags 7 show that value of transaction and turnover ratio each drives real GDP with no reverse or feedback effect. Thus, this supports the evidence of unidirectional causal link from these two indicators to real gross domestic product. In essence, the general causality results reveal some evidence that financial development causes economic growth in Nigeria as shown by some of the financial development used in this study. The co-integration results imply that there exists a significant long-run relationship between financial market and economic growth. There exist four significant co integrating vectors or four different linear combinations of the financial market indicators that can drift together roughly at the same time with the RGDP.The study recommends among others the need for availability of more investment instruments such as derivatives, convertibles, future, and swaps options in the Nigerian financial market in order to boost the value of transactions. Also, it is recommended that all the tiers of government should be encouraged to fund their realistic developmental programmes through the financial market. This will help in boosting the activities of the financial market, as well as the financial sector. Hence, it will redirect the resources that may be used in other spheres of the economy.

Chapter One

Introduction

1.1. Background Of The Study

The importance of the financial sector in any economy cannot be overemphasized given the relationship between the sector and the rest of the economy.

In the era of globalization, efficient financial sector are essential to attract gains from the world market, and as well insulate the domestic economy from external shocks. The financial system could also respond to the domestic economy.

Furthermore, the importance of financial institutions in generating growth within the economy has been widely discussed in the literature, various schools of thoughts having views and ideas.

Schumpeter (1911), identified bank’s role in facilitating technological innovation through their intermediary role. He believed that efficient allocation of savings through identification and funding of entrepreneurs with the best chances of successful implementing innovation products and production process are tools to achieve this objective.

Several scholars therefore (McKinnon 1973, Shaw 1973, Fry 1988, King and Levine 1993) have equally buttressed the above postulation about the significance of banks to the growth of the economy.

In assessing the relationship, a larger number of recent empirical studies have relied on measures of sizes or structures to provide evidence of a link between financial system development and economic growth.

They used macro or sector level data such as the size of financial intermediation or of external finance relative to GDP and found that financial development has a significant impact on economic growth.

For the past few decades, theoretical discussions about the importance of financial development and the role that financial intermediation play in economic growth have remained controversial and thus occupied a key position in the literature of development finance.

Studies by Gurley and S haw (1967),Goldsmith(1969), Jayarante and Strahan (1996), Kashya and Stein (2000), Beck et al (2000,2003), Driscoll (2004),etc,suggests that financial development can foster economic growth by raising savings, improving allocative efficiency of loanable funds and promoting capital accumulation in both well developed and emerging economies.

However, in spite of recent findings that financial development and economic growth are clearly related, this relationship has occupied the minds of economists overtime; although the channels and even economists of causality have remained unresolved in both theory and empirics (Fitzgerald, 2006).

Bayoumi and Melander(2008),coupled with King and Levine (1993) established that the banking sector’s development in Europe was not only correlated with economic growth but was also a cause of long-term growth and as such we can also assert that the financial sector growth(growth of the banking sector), has a strong influence on economic growth in Nigeria.

Finally, the purpose of this paper is to analyze the relationship as well as analyze the results of the public sector so far and to ascertain whether it offers and provides an efficient and/or effective means of solving the problems facing economic growth in Nigeria.

A recent study however indicates that the banking sector plays a more important role than it was believed earlier (World bank, 1996; Almeyda, 1997).

1.2. Statement of the Problem

The banking sector (financial sector) is acknowledged to have huge potentials for employment generation and wealth creation in any economy.

In Nigeria, the sub-sector has stagnated and remained relatively small in terms of its contribution to gross national product (GNP) and creation of job opportunities.

However, several problems have limited the growth and effective contributions of the financial sector to the economic development in Nigeria. The growth of the real sector could be determined by the financial sector performance and this could impact on economic growth. But the financial system has been affected by several bouts of reforms and challenges. A number of banks were pruned down through the recapitalization programme.

Among the recapitalized banks five chief executives were accused of fraud and replaced hence the inconsistency in operation.

Equally, microfinance banks and insurance companies had their capital base reviewed. More recently, the central bank of Nigeria and its monetary policy committee reviewed the interest rates upwards to dampen the rate of inflation in Nigeria (ogboi, 2011). These are among several other reforms in the sector. More so, according to the Manufacturing Association of Nigeria (MAN) cited in Amefule(2011), Nigeria lost 1.9 million owing to harsh operating environment including finance related problems.

From the foregoing we are poised to answer the most fundamental questions about the impact of financial sector development on economic growth in Nigeria.

What will be the impact of financial sector growth/development on the Nigerian economic growth?
What will be the impact/effect of financial sector services on investment?

1.3 Objectives of the Study

To analyze the impact of financial sector growth/development on economic growth in Nigeria.
To assess the causal relationship between financial sector growth and economic growth (i.e. which is causing which).

1.4 Hypothesis of the Study

H0: Financial sector growth/ development have a significant impact on economic growth in Nigeria.
H1: There is a causal relationship between economic growth and financial sector growth.

1.5 Significance of the Study

Since the emerging of Nigeria as a nation in 1960 and her becoming a republic in 1963, virtually all facets of Nigerian economy have undergone huge change, while some sectors/areas of the economy changed for the better, some are still in their very bad condition.

Therefore, the most significant aspect of the study is the importance of both the commercial banks sectors and financial sector growth to the economic growth of Nigeria.

Hence, this research would provide an in-depth analysis, which would enable the populace to fully understand the nitty-gritty of the financial sector and ultimately enable them to be very much familiar with growth trends in the economy.

Furthermore, the development of the financial sector has been given priority by the Nigerian government in the successive development plans.

A review of the problems facing the financial sector is quite indispensible. Such a review will enable the sector face the ever-increasing demand upon it; and with such amazing knowledge we can therefore foster economic growth by adopting suitable economic policies.

Finally, since the essence of every research work is to build upon and add to the existing bank of knowledge, this study promises to build upon as well as add substantially to the deposit of knowledge and relative to area of financial sector growth as well as growth in the economy. It would also help us understand the strong bond between financial sector and economic growth.

1.6 Scope and Limitation of the Study

The study encompasses the role and contributions of financial system/sector on the economy. Also the study does not consider other sectors of the economy but explicitly devotes all its energy on the activities of the financial sector and how it stimulates growth.

Equally, in spite of all odds, this work contains informations which are reliable and authentic. Other possible limitations of the analysis is that credit ratio used in the study do not capture financial development that takes place outside of the banking system such as the stock or bond markets. However, it might be of lesser significance since financial development comes about mostly with the banking sector and other channels are still not very developed. Demirguc-Kunt, Levine (2008), asserts that a more general shortcoming, common for all studies of finance growth nexus, is the fact that according to the theory, financial institutions induces economic growth by reducing information and transactions costs, monitoring borrowers, managing risks or facilitating exchange of goods. Researchers, however, do not posses very good measures to assess how well a financial system provides these kinds of services to the economy.

Thus, the empirical proxies of financial development do not correspond that closely to the theory.

Finally, the study will cover a period of 25 years (1987-2011), and it is only based on this time frame that we shall base our analysis. Hence anything outside the time frame is unaccounted for in this study.

Chapter Five

Summary of Findings, Conclusion and Recommendations

5.1 Summary of Findings

The study examined the causal relationship and impact of financial development on economic growth in Nigeria using alternative sets of Financial development indicators. The findings of the study reveal the following: Theoretical and empirical literature reviewed in this study document three categories of evidences, they are: First, a unidirectional (one-way) causality from financial development to economic growth. Second, there is a unidirectional causality from growth to financial development. The third alternative is the co-evolution (bidirectional causality) between economic growth and financial development hypothesized in both early and some recent literature. For instance, a number of models argued that the process of growth has a feedback effect on financial markets by creating incentives for further financial development, which means that the two variables are endogenously determined. Our causality result is expected to confirm at least one of these arguments. It should provide evidence that indicate the argument our finding is consistent with.

The granger causality results at lags 7 reveals some evidence of causal links between financial development indicators and economic growth in Nigeria in the period under review. Specifically, the results from causality test at lags 7 show that value of transaction and turnover ratio each drives real GDP with no reverse or feedback effect. Thus, this supports the evidence of unidirectional causal link from these two indicators to real gross domestic product. In essence, the general causality results imply that financial development do cause economic growth in Nigeria. This result is consistent with the dominant view and is in line with those theories that support the finance – led growth hypotheses. That is it is in support of supply leading hypothesis, financial repression hypothesis and Harrod – Domar growth theory argument. This thesis, more or less,confirmed the conclusions of earlier works on the importance of the financialsystem which could be traced back to the works of Bagehot (1873), Schumpeter(1912), Hicks (1969), (McKinnon and Shaw, 1973), Fry (1988), Roubini and Sala-i-Marti (1992), Harrison et al (1999), Christopoulos and Tsionas (2004), Nieuwerburgh, et. al., (2005), Mishra, et. al., (2010), Odeniran and Udeaja, (2010) and Usman and Adejare, (2012). Results obtained from empirical studies conducted using data from Nigeria that were consistent with the supply-leading argument, include Aigbokhan (1996), Adam and Sanni (2005), Okpara (2010), Adelakun (2010) Afees and Kazeem (2010) and Kolapo and Adaramola (2012).

The co-integration result implies that there exists a significant long-run relationship between financial market and economic growth variables. There exist four vectors or four different linear combinations of the financial market indicators that can drift together roughly at the same time with the RGDP. The significant long run relationship is identified to be between market capitalization and RGDP as well as other variables.

This suggests that in the Long-run, economic growth determines financial development. This is in agreement with the demand following hypothesis, ie this result supports the demand led theory of finance – growth nexus. Empirical studies reviewed in this study confirming the existence of long run relationships between financial development and economic growth comprises; Levine and Zervos (1996), Agbawn (1998), Nieuwerburgh, et. al., (2005), Apergis et. al, (2007), Okpara (2010), Afees and Kazeem, (2010), Mishra, et. al., (2010), Ogege and Ezike (2012) and Kolapo and Adaramola (2012).

5.2 Conclusion

This study investigated the impact of the financial development on the growth of Nigerian economy. Empirically, we have been able to investigate the causal link between the capital performance indicators, with a number of the variables/indicators of financial reforms not generating the expected impact even though their direction of movement and pattern of effectiveness can be said to be shaped by some fundamental characteristics of the economy. At a more robust lag; ie lags 7, a one way causal relationship running from value of transaction
(VT) and turnover ratio (TOR) to RGDP is found. VT is significant at 1% level, while TOR at 10% level. We therefore, conclude that there is some evidence of causal relationships between financial development and economic growth in Nigeria as indicated by these indicators during our sample period. Results obtained were consistent with the supply-leading argument, giving rise to a conclusion in the work that financial development resulting from increases in financial institutions and financial resources, following financial liberalization, has stimulated growth in the real sector.

The co-integration result obtained shows the existence of a long run relationship between the growth of the economy proxied by real gross domestic product and the financial market indicators. The one period lag of the market all share index, capitalization, value of shares traded and turnover ratio, does not impact significantly on the growth of the RGDP. The study therefore, reached a conclusion that financial development and growth in Nigeria have a significant long run relationship; the variables are co – integrated. The economic implication of the finding suggests a need for more focus on the enhancement of the financial market so as to engender greater growth of the economy. This could be achieved through enlightment campaign on the importance of the financial market to the industrialists/small scale investors and more relaxation of the stringent entry requirements of the companies into the Nigerian Stock Exchange.

5.3 Policy Recommendations

In order for the Nigerian financial market to be pivotal force in the growth and development, of the Nigerian economy the following suggestions or recommendations are put forward.

The government is therefore advised to put up measures to stem up investors‟ confidence and activities in the market and more foreign investors should be encouraged to participate in the market for improvement in the declining market capitalization so that it could contribute significantly to the Nigerian economic growth.
Maintain state of the art technology like automated trading and settlement practice, electronic fund clearance and eliminate physical transfer of shares.
There is also need to restore confidence to the market by regulatory authorities through ensuring transparency and fair trading transaction and dealing in the stock exchange. It must also address the reported case of abuse and sharp practices by some companies in the market.
To boost the value of transactions in the Nigerian financial market, there is need for availability of more investment instruments such as derivatives, convertibles, future, and swaps options in the market.
Given the present political dispensation, all the tiers of government should be encourage to fund their realistic developmental programme through the financial market. This will help in boosting the activities of the financial market, as well as the financial sector. Also, it will redirect the resources that may be used in other spheres of the economy.