FINANCIAL SECTOR DEVELOPMENT IN NIGERIA AND ECONOMIC PERFORMANCE

CHAPTER ONE

1.1       BACKGROUND TO THE STUDY

The relationship between economic growth and financial development has been the subject of both theoretical and empirical analysis in economic literature for a long period of time. Although there are numerous studies examining this relationship, there is no consensus on the effect of financial development on economic performance. A number of theories indicate that financial development leads to economic growth. Studies that support this view include those of Habibullah and End (2006); Galindo (2007), Ang (2008); Giuliano and Ruiz-Arranz(2009) and Nkoro and Uko (2013). These studies maintain that a well-structured financial sector creates strong incentives for investment and also fosters trade and business linkages and technological diffusion. This is mainly through mobilizing savings for productive investment which thus promotes economic growth. Another school of thought believes that economic performance translated to growth creates demand for financial services and therefore economic growth precedes financial development. Studies that advocate this view include Sunde (2013), Odhiambo (2008), etc. Another strand holds that financial advancement plays a minimal role, if any, on economic performance in relation to growth (Lucas, 1988) and Adusei (2012). However, in the recent past, there has been empirical evidence that there exist a bi-directional relationship between economic performance and financial development Fowowe (2010), Rachdi and Mbarek (2011).

The financial sector of any economy in the world plays a vital role in the development and growth of the economy. The development of this sector determines how it will be able to effectively and efficiently discharge its major role of mobilizing funds from the surplus sector to the deficit sector of the economy. This sector has helped in facilitating business transactions and economic development (Aderibigbe 2004).

A well-developed financial system performs several critical functions to enhance the efficiency of intermediation by giving information, reducing transactions and monitoring costs. If a financial system is well developed, it will enhance investment by identifying and funding good business opportunities, mobilizes savings, enables the trading, hedging and diversification of risk and facilitates the exchange of goods and services. All these result in a more efficient allocation of resources, rapid accumulation of physical and human capital, and faster technological progress, which in turn results in economic growth.  Development in the real sector, as noted by Ajayi (1995), influences the speed of growth of the financial sector directly, while the growth of the finance, money and financial institutions influence the real economy. 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 (Jhingan 2005). 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 performance is measured by macroeconomic variables which are translated to economic growth that ultimately measures 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 goods and services (Jhingan 2003). 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 implies reduction of inequalities of income distribution. Oluyemi (1995) regards the financial sector of any economy as an engine of growth that could greatly assist in the promotion of rapid economic transformation. It can be concluded that no economy can ever develop without an appreciable growth in the financial sector. An efficient financial system is essential for building a sustained economic growth and an open vibrant economic system. Countries with well-structured financial institutions tend to grow faster; especially the size of the banking system and the liquidity of the stock markets

tend to have strong positive impact on economic growth (Beck and Levine, 2002 in Nnanna, 2004)

1.2       STATEMENT OF PROBLEM

The Nigerian financial sector, like those of many other less developed countries, was highly regulated leading to financial disintermediation which retarded the growth of the economy. The link between the financial sector and the growth of the economy has been weak. The real sector of the economy, most especially the high priority sectors which are also said to be economic growth drivers are not effectively and efficiently serviced by the financial sector. The banks are declaring billions of profit but yet the real sector continues to get 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. The Nigerian banks have concentrated on short term lending as against the long term investment which should have formed the bedrock of a virile economic transformation. Since the adoption of the Structural Adjustment Programme (SAP) in 1986, in an attempt to quicken the recovery of the economy from its deteriorating conditions, a great deal of interest has been shown in the activities and development in the financial sector. This is so because the restructuring of this sector was a central component of the SAP reform.

It is evident that the empirical studies which focus on the link between financial development and economic growth show mixed results and this may be attributed to the estimation methodologies and quality and span of data used as well as the direction of causality. In Nigeria, there are few empirical studies that focus on the effect of financial development on economic growth using time series data. In addition, these studies do not examine the short-run and long-run effect of financial development on economic growth. While a significant number of empirical studies in which Nigeria is included use panel

 and cross-section data to examine the relationship between financial development and economic growth, there is no consensus on the findings. This may be due to the fact that these countries have different levels of financial and economic development. More so, the previous studies have not adequately addressed the problem of financial development as it affects economic growth. The research work, therefore, intends to complement the existing empirical studies by using time series approach with a view to shedding more light on this important relationship, by focusing on the effect of financial development on economic growth.

1.3OBJECTIVE OF THE STUDY

The broad objective of this study is to examine the effects of the financial sector development on economic performance in Nigeria. The specific objectives are:

1.To examine the trend of the financial development and Nigeria’s economic performance from (1986-2015).

2.To analyze the relationship between financial development and economic performance

3.To investigate the effect of financial development on economic growth.

1.4RESEARCH QUESTIONS

·  What is the trend of the financial development and Nigeria’s economic

Performance over the years ?

 Is there a relationship between financial sector and economic performance?

Does financial development affect economic growth?                                                   

1.5RESEARCH HYPOTHESES

: There is no relationship between financial sector and economic performance.

: There exists a relationship between financial sector and economic performance.

: Financial development does not affect economic growth.

: Financial development affects economic growth.

1.6SIGNIFICANCE OF STUDY

There have been several studies on the financial sector development and economic performance. However, most of the studies consider one component of the financial sector in relation to economic performance. Many studies have been conducted on Capital market and economic growth, banking credit and economic growth and likewise foreign direct investment and economic growth. The use of one component of the financial sector like banking credit or capital market as a representative of the entire financial sector is inadequate, because the essence of the financial sector which is that of intermediation cannot be solely performed effectively by one subsector of the financial system like banking or capital market neither can it be handled by foreign direct investment alone. Therefore, the gaps that prompted this study are, first, the fact that most studies conducted previously in Nigeria on the financial sector and economic growth used only one component of the financial sector. Taking one component of the financial sector to represent the whole financial sector will not be an adequate sample of the entire financial sector.

1.7   SCOPE OF STUDY

The main focus of the study is financial sector development and economic performance in Nigeria. Within the period (1985-2015), the country has witnessed a tremendous development in her financial sector. This period relevantly covers the era of liberal economic policies and also the advent of Structural Adjustment Programme (SAP) as it affects the economy as a whole. More so, the effect of the financial development will not be appreciated without relating it with economic growth.

  1.8 LIMITATIONS OF STUDY

The efficiency and effectiveness of this research work is limited among other things to estimations as well as data and information obtained from government and corporate bodies. The study is limited due to a number of constraints involving time and resources which make it mandatory for the researcher to make do with the most relevant macroeconomic and financial indicators.