Impact of Banking Sector Reforms on Economic Growth in Nigeria

The study empirically examined the impact of banking sector reforms on economic growth in Nigeria using the annual time series data for forty six years (1970-2015). The major objective of the study was to examine how banking sector reforms impact on economic growth in Nigeria. The design of the study was ex-post facto and desk research design. Data for the study were sourced from Central Bank of Nigeria (CBN) statistical bulletin and International Monetary Fund (IMF) journals. The study was based on Financial Repression Hypothesis (FRH) by Mckinnon and Shaw (1973. The data were analyzed using Johnansen cointegration test and Granger-causality test for the period 1970 – 2015. Autoregressive Distributive Lag (ARDL) test was adopted in the study. From the ARDL test results, it was found that interest rate spread (INRS) was correctly signed in the model and adequately predictive of economic growth indicator studied while other exogenous variables {exchange rate (EXR), bank capital base (BCAB) and corporate governance disclosure index (CGDI)} studied did not impact positively on gross domestic product growth in Nigeria. The ARDL bound test revealed the existence of a long-run relationship among these variables. The speed of adjustment parameter as indicated by the coefficient of the Error Correction Mechanism (ECM) was significant with appropriate negative sign. The study concluded by recommending that, the policy of deposit and lending rate should be made reasonable as smaller spread between savings and deposits rates influences efficient financial intermediation. Finally, since corporate governance disclosure is seen as an indicator of the company’s openness index, companies should always make full disclosure, thereby not withholding any relevant information to external stakeholders Impact of Banking Sector Reforms on Economic Growth in Nigeria 231 1. Background to the Study Banks have, over the years, tried to respond to competition, systematic weaknesses, and macroeconomic instability by engaging in quite a lot of survival strategies. The Nigerian financial system has undergone several years of reforms, designed to position Nigeria as Africa’s financial hub. These reforms have resulted to financial widening characterized by big and reliable banks, an efficient payments systems and improved financial inclusion in the economy. Usually, the major aims of such reforms are to produce a safe, sound, strong, reliable and diversified banking system that will provide sustainable financial development for economic growth and equally ensuring that Nigerian Deposit Money Banks (DMBs) perform dynamic roles in the regional, national and international financial system (Emefiele, 2014 & Soludo, 2004). Reforms are inventions, fresh ways or schemes put in place to improve or change the old ways in which things were being done which are usually introduced either in response to changing developments, operational challenges or as proactive procedures both to strengthen the banking structure as well as avoid total crisis. Banking reforms therefore, is the totality of regulatory actions, policies or strategies, directives and incentives intended to ensure a diversified, strong and reliable banking system which will guarantee the safety of depositors’ money, perform dynamic developmental roles and become competent and competitive players within the economy. The various phases of reforms embarked upon in Nigerian banking sector were the un-guided liaise faire (1930-1959), the control or regulated era (1960-1985), the deregulated era (1986-1992), the re-regulated era (19931998), the banking consolidation (19992004), the banking reforms of 2009 and cashless policy of 2011 till date (Anyanwu, 2012). Therefore, reforms undertaken to achieve the following macroeconomic goals; mobilization and expansion of savings, promotion of interest rates that enhances growth, laying the foundation for economic growth, engendering healthy competition in the provision of services; promotion of investment culture and improved regulatory and surveillance framework in Nigeria. Consequent upon this, the research intends to bridge or fill the gap in economic literature and empirically determine the causal association between banking sector reforms and economic growth and whether banking reforms cause economic growth or banking reforms are a consequence of economic growth; which policy makers, economist, financial and development experts are yet to reach any consensus on this topical issue in Nigeria. In doing this, emphasis was laid on four basic banking reforms in Nigeriainterest rate reform, foreign exchange reform, recapitalization reform and corporate governance reform. This study is meant to cover selected reforms that have taken place in Nigeria, within the period of 1970 – 2015, both years inclusive in the analyses. 2. Statement of the Problem In spite of sundry reforms implemented so far, the Nigerian banking sector has not been able to measure up to its expectations as the driver of economic growth and development. Apparently, there have been wide interest rate margins, undue reliance on foreign exchange and its attendant fluctuations, unsustainable and weak capital base, internal control infractions and managerial weaknesses resulting to inadequate disclosure of financial statements. There has been excessive reliance on foreign exchange market through revenue from petroleum products. These have caused continuous fluctuations in exchange rate in the economy. Many of the banks conducted only limited lending to certain preferred sectors while engaging predominantly in more lucrative short-term illegal arbitrage foreign exchange “round-tripping” activities. Moreover, the banking system has undergone through several recapitalization with small or negligible impact to meet the challenges posed by liquidity, technical insolvency and operational crises as well as lack of public confidence in the system. 232 Innocent Obeten Okoi, Stephen I. Ocheni and Akaninyene Billy Orok 3. Objectives of the Study The general objective of the study is to examine the impact of banking sector reforms on economic growth in Nigeria. The specific objectives are to: i. Determine the relationship between interest rate spread and economic growth in Nigeria; ii. Analyze the effect of exchange rate on economic growth of Nigeria; iii. Assess the effect of banks’ capital base or size on the growth of the Nigerian economy; iv. Determine the relationship between corporate governance disclosure index and gross domestic product growth rate in Nigeria; 4. Financial Repression Hypothesis (Mckinnon –Shaw, 1973) The theory upon which this study shall be based principally is the Mckinnon (1973) and Shaw (1973) financial repression hypothesis, which holds that financial development correlates with economic development and growth if authorities were not to interfere in the operation of financial institutions. Also, banks have great influence on growth and development in a developing economy. Financial repression as defined by Fry (1988), is an indiscriminate distortion of financial prices, including interest rates and foreign exchange rates which reduces the real rates of growth and the real size of the financial system relative to non-financial magnitudes. Financial repression arises primarily when a country imposes ceilings on nominal deposit and lending interest rates at a low level in relation to inflation (Nzotta, 2009). Informed by the McKinnon-Shaw banking intermediation theory, the Central Bank of Nigeria (CBN) believes that the efficient functioning of a nation’s economy depends on the strength of its financial system (CBN, 2009). Although there exists an extensive body of literature on the link between financial sector development and economic growth, there is no consensus on the effect of explanatory variables on economic growth (Levine, 1999 & Fadare, 2010). • Relevance of Mckinnon-Shaw hypothesis to the Study: In their analysis (also referred to as complementarity hypothesis), they concluded that alleviating financial restrictions by allowing market forces to determine the real interest rates rise toward their competitive market equilibrium. This means that artificial ceilings on interest rates reduce savings, capital accumulation and discourage the efficient allocation of resources. In the views of the duo, market forces and financial liberalisation could bring an optimum financial structure and development as well as efficient moblisation of savings and credit allocation. The analyses also concluded that greater ease of entry into the banking sector encourages competition. This promotes the prospects for higher savings, investment supply of real credit and thus the potential for financial deepening. 4.1. Review of Empirical Literature Banking reforms have been an ongoing phenomenon around the globe right from the 1980s, but it is more intensified in recent times because of the effect of globalization. Apparently, the major constraints to successful financial reforms in Nigeria are, inconsistency in policy mix, inappropriate sequencing, inadequate regulation and supervision. Though, from the historical antecedents, the major ailment of the sector have been identified as maladapted banking system culture. That is, its institutional structure, culture, orientation and modes of operation of the main actors are mainly of foreign transplanted type, not appropriately adapted and oriented to suit local structural peculiarities, as well as being, not made relevant to the developmental needs of the economy concerned (Ojo, 2010). The Nigerian financial system is one of the biggest in Sub-Saharan Africa (SSA), consisting of banking and non-banking financial institutions. Banks are ordinarily catalytic and developmental institutions, for a developing economy like ours (Okoi and Stephen, 2014). In the banking institutions, we have twenty one (21) deposit money banks, over eight hundred and eigh