FINANCIAL SECTOR REFORMS AND THE PERFORMANCE OF MACROECONOMIC VARIABLES IN NIGERIA

CHAPTER ONE

INTRODUCTION

Background to the Study

Financial sector constitutes a key sector of any economy. Its activities include the mobility of financial resources through institutions from surplus units, channeling of financial resources through intermediaries/institutions to deficit units, identification and funding of viable business opportunities, enabling trade, hedging and diversifying risk and facilitating the exchange of goods and services. Financial sector is strategic for the reason that it intermediates financial resources between households and firms. Economic reforms generally, refer to the process of getting policy incentives right and/or restructuring key implementation institutions. As part of economic reforms, financial sector reforms focus mainly on restructuring financial sector institutions and markets through various policy measures. As a component of the reform in the financial sector, banking sector reform seeks to get the incentives right for the sector to take the lead in enhancing the intermediation role of the banks and to enable them contribute to economic growth, thus solving some economic problems (Anyanwu, 2010).

In the early 1980s, Nigeria had started experiencing serious macroeconomic fluctuations. This was indicated in the declining consumption, increasing poverty and stagnation of income (Stephen, 2012). To stem this tide, Nigeria adopted a stabilization policy in 1986. The stabilization policy became an important issue to policy makers because it was obvious that a centrally planned economy is a contributing factor to the macroeconomic instability, therefore; one of the goals of the stabilization policy was to achieve full employment and price stability (Stephen, 2012). One of the strategies put in place in order to achieve this objective was privatization and commercialization of public enterprises.

The economic history of Nigeria is characterized by various kinds of economic crises, ranging from crisis in the balance of payments, debt crisis, unemployment crisis, energy crisis, and volatility in key macroeconomic variables such as broad money supply (M2), gross domestic product (GDP), exchange rate, interest rate, inflation rate and fiscal deficit. These crises resulted to fluctuation in key macroeconomic aggregates (Udah, 2011). The immediate response of policy makers was the use of fiscal and monetary policies to stabilize the macroeconomic environment. If the macroeconomic environment was relatively stable, it would then have bolstered the growth. To achieve growth and macroeconomic stability, the Nigerian government, in order to bolster the free market and privatization drive adopted varied, structural and in-depth fiscal and monetary policies to achieve the purpose. Government became more particular in instituting reforms in the financial sector, and especially targeted at the banking sector, with the aim of strengthening to lead the investment growth nexus as their main role is the channeling of funds from surplus to deficit spending unit.

Thus, the role of financial institutions is crucially important in the development of any economy. A healthy and vibrant economy requires a financial system that moves funds from people who save to people who have productive investment opportunities.

Research had found out that an important reason why many developing Countries experience slow rate of growth is that their financial system is underdeveloped (Mishkin, 2007).The  banking sector represents the core of the financial sector in Nigeria. Therefore, it is expected that reforms in the sector should be given prominence. As articulated by Omoreyo (1991), CBN (2004) and Balogun (2007), banking sector reform in Nigeria has been embarked upon to achieve the following objectives, among others: Market liberalization in order to promote efficiency in resource allocation, expansion of the savings mobilization base, promotion of investment and growth through market-based interest rates, improving of the regulatory and surveillance framework, fostering healthy competition in the provision of services and laying the basis for inflation control and economic growth.

Five distinct phases of banking sector reforms are easily discernible in Nigeria. The first occurred during 1986 to 1993 when the banking industry was deregulated in order to allow for substantial private sector participation. Hitherto, the landscape was dominated by banks which emerged from the Federal and State government with majority stakes. The second was the re-regulation era of 1993-1998, following the deep financial distress. The third phase was initiated in 1999 with the return of liberalization and the adoption of the universal banking sector consolidation as a major component and was meant to correct the structural and operational weakness that constrained the banks from efficiently playing the catalytic role of financial intermediation. Following from the exercise, the aggregate capital of the consolidated banks rose by 439.4 per cent between 2003 – 2009, while deposit level by 241.8 per cent. However, this was not reflected in the flow of credit to the real economy, as the growth rate of credit fell during this period, while actual credit did not reflect the proportionate contribution of the sector to the GDP (Balogun, 2007).

The current and fifth phase, was triggered by the need to address the combined effects of the global financial and economic crises, as well as banks’ huge exposures to oil/gas and margin loans, which were largely non-performing; corporate mis-governance and outright corruption, among operators in the system. This round of reform, therefore, seeks to substantially improve the banking infrastructure, strengthen the regulatory and supervisory framework, and address the issue of impaired capital and provision of structured finance through various initiatives, so as to provide cheap credit to the real sector, and financial accommodation for small and medium-scale enterprises (SME).  There has been a wave of restructuring and consolidation of the banking sector around the globe, particularly in the developed and the emerging market economies. This has been driven mainly by globalization, structural and technological changes, as well as the integration of financial markets. Banking sector consolidation has become prominent in most of the emerging markets, as financial institutions strive to become more competitive and resilient to shocks. It is also promoted by the desire to reposition corporate operations to cope with the challenges of an increasingly globalized system. It was based on the above premise that banking sector consolidation, through mergers and acquisitions, was embarked upon in Nigeria from 2004. The bank consolidation was focused on further liberalization of banking business; and proactively positioning the industry to perform the role of intermediation and playing a catalytic role in economic development. The reform was designed to ensure a diversified, strong and reliable banking sector which will ensure the safety of depositors’ money, play active development roles in the Nigerian economy, and be competent and competitive players in the African, regional and global financial system.

Following the banking sector consolidation, notable achievements were recorded in the financial sector among which was the emergence of 25 well capitalized banks from the former 89 banks. With this, regulators will oversee and focus on fewer banks, thereby fostering effectiveness and efficiency in supervision. The banks raised N406.4 billion from the capital market. In addition, the process attracted foreign capital inflow of US$652 million and £162,000 pound sterling. The liquidity engendered by the inflow of funds into the banks induced interest rate to fall significantly, while an unprecedented 30.8 per cent increase was recorded to the real sector in 2005 (CBN Annual Report, 2005). With a higher single obligor limit, Nigerian banks now had a greater potential to finance large value transactions. More banks now, have access to credit from foreign banks and the capital market has deepened. Ownership structure has been positively affected such that the problems of insider abuse and corporate governance have been reduced. Depositors’ confidence have improved due to “safety in bigness” perception by depositors. With virtually all banks now publicly quoted, there is wider regulatory oversight (Bilal, Asif Saced, Ammer  and Toquer, 2013).

With the inclusion of the security and exchange commission and the Nigerian Stock Exchange in the regulatory team, resources have been committed to the regulation of few and more stable banks in an efficient and effective manner. As a result of this,the banks have begun to enjoy economies of scale and, consequently, are passing on the benefit in the form of reduced cost of banking transactions. In general, the reform efforts had engendered stable macroeconomic environment evidenced by low inflation and relative stable exchange rates. Financial landscape has been produced as a result of the reforms, characterized by strong and large banks, improved financial infrastructure and efficient payment system. (Osamwonyi and Michael, 2014). According to Mbutor (2009), Nigeria banking reforms has unveiled a financial sector that is diversified, deep and integrated and to be one of the 20 largest economies by 2020. This is indicative on the fact that the banks were generally sound.

Statement of the Problem

The government of Nigeria has really worked hard to stabilize macroeconomic variables through the use of fiscal and monetary policies. It has applied virtually all the instruments of both policy measures but still the problem has persisted.

Nigeria’s economic history is replete with various types of crises and fluctuations in important macroeconomic variables. These include crises of electricity generation and distribution, insecurity, unemployment, domestic and external debt crisis, balance of payments disequilibrium and fluctuations in key macroeconomic variables such as broad money supply (M2), exchange rate, real GDP growth rate, inflation rate, etc. These crises caused distortion in key macroeconomic aggregates. The immediate response of policy makers is the use of stabilization policies (fiscal and monetary policies) to stabilize the macroeconomic environment. Monetary and fiscal policies are both accorded prominent roles in macroeconomic stabilization. However, the available statistics indicate that this has not always yielded the desired result (sustained economic growth and development), therefore calling to question the effectiveness of these stabilization tools.

During the past four decades, macroeconomic aggregates have witnessed various levels of fluctuations. The implication of this being low financial depth occasioned by decay in infrastructure and under-developed financial system, low level of private sector credit, high interest rate spread caused by high inflation and high level of non-preforming loans. (Francis,2013). Others were increase number of weak and poorly capitalized commercial banks with attendant bank failure/distress.

Of more interest to this work, is the role the financial sector reforms played in the macroeconomic stability of the country. Deep and robust financial sector reforms were embarked upon by the Country in this period with expected objective of macroeconomic stability. The disconnect and unresponsive movement of variables to reforms gave us reason for worry. The early part of the reform was followed with negative growth rate as well as high level of inflation and unemployment. Although growth rate of GDP became positive in the later period of the reform, inflation and unemployment were still high. Economic development indicators, for example, including life expectancy, literacy rate, school enrolment and completion, access to good drinking water, gender equality, and environmental balance were very far from desirable.

However, the financial sector reform had brought about stronger financial system. Banks were becoming more profitable, as deposit rates were growing and high levels of profit announced on annual basis. Theoretically, it is expected that as banks grow with more deposits, such would be borrowed for investment in the economy which would in turn lead to desirable growth of the macroeconomic variables.

In Nigeria, the nexus between the profitability of banks and the macroeconomic stability is not well defined. The current practical experience, which is a departure from theoretical giving, brings up reason for an in-depth empirical study to attempt to unveil reasons for observed departure from theory of the expected relationship between macroeconomic stability of the Country and profitability of banks which was the financial system reform goal.

1.3       Objectives of the Study

The main objective of this research is to test the causal relationship between financial sector reforms and selected macroeconomic variables in Nigeria. The specific objectives of the study include the following.

To empirically investigate the relationship between financial sector reforms and investment. To empirically investigate the relationship between financial sector reforms and unemployment rate. To empirically investigate the relationship between financial sector reforms and inflation To empirically investigate the relationship between financial sector reforms and growth To empirically investigate the structural changes between the pre-and -post financial sector reforms and the performance of macroeconomic variables in Nigeria.

1.4       Research Hypotheses

To evaluate the specific objectives, the following null hypotheses are formulated

H01 : There is no significant relationship between financial sector reforms and H02 : There is no significant relationship between financial sector reforms and                unemployment rate. H03 : There is no significant relationship between financial sector reforms and

Inflation

H04: There is no significant relationship between financial sector reforms and growth. H05: There is no significant structural change between the pre- and-post financial sector reforms and the performance of macroeconomic variables in Nigeria.

1.5       Significance of the Study

This work is significant at two levels: Theory and Practice. At the level of theory, the significance of this work will assist in making a contribution to the existing body of knowledge on the effect of financial sector reforms on the performance of macroeconomic variables. At the level of practice, it is hoped that evidence provided at the theory level; which may either support or reject the positive effect of financial sector reforms on the performance of macroeconomic variables will pave way for the adoption of appropriate policies and programme for the achievement of macroeconomic objectives.

Finally, this work will serve as a reference material to students of economics, policy makers and all  academics who may wish to embark on studies in similar or related areas. It will also be of immense help to the curious – general readers who might be interested in having at least a smattering knowledge of the subject matter.

1.6       Scope and limitation of the Study

The Study covers the period 1989 to 2013 during which we had several financial reform programmes as financial deregulation programme of 1986 to 1993, financial re-regulation programme of 1993 to 1998, the liberalization and the adoption of universal banking of 1999, financial market reforms and the bank consolidation programme of 2004. Thus our scope of study is limited to financial sector reforms of 2004 and performance of macroeconomic variables. In the course of conducting this study the major limitation was the inconsistency of data from various publications of the CBN and National Bureau of Statistics. The study was restricted to the investigation of the performance of selected macroeconomic variables in Nigeria- investment, unemployment rate, inflation rate and GDP growth rate.

 1.7      Justification for the Study

The main purpose of this research work is to review and analyze critically the financial sector reform and the performance of macroeconomic variables in Nigeria from 1989 to 2013. The objects of the research are bank profitability which is a measure of financial sector reforms and selected macroeconomic variables. It is assumed that the variables of observations will provide a deeper insight into the economic performance of Nigeria. Findings would form the basis for making recommendations that shall be useful by policy makers to adjust the appropriate regulations in order to address the issues that are related to the level of growth, inflation and unemployment. It is expected that the generalization of the findings will be possible and the observations that will be obtained will be applicable to different cases and environment.