IMPACT OF FINANCIAL INTERMEDIATION ON NIGERIA ECONOMIC GROWTH

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

The role of financial intermediation has been exemplified in numerous literatures of finance. Besides the performance of specialized tasks, several theoretical models posit that they mitigate the costs associated with information acquisition and the conduct of financial transactions (Benston and Smith, Jr; 1975). In addition to these, several studies have revealed that financial intermediation does more than cost mitigation. It makes provision for insurances and risk sharing, stimulates the funding of liquidity needs through credit lines (Holmstrom and Tirole; 1998), and aids the creation of specialized products (Benstom and Smith. Jr; 1975).

The concept of financial intermediation is not relatively new. For decades, it has been a subject of study at both the macro-level, and the micro-level. At the macro-level, the significance of financial intermediation cannot be over-emphasised. However, there are mixed feelings about this. While some argue that it facilitate the efficiency of the financial system (Gromb and Vayanos; 2010, Anad and Subrahmanyam; 2008), others have also argued that it is passive in nature and serves as a conduit through which monetary policy is effected (Benstom and Smith. Jr; 1975) and contracts, not available in the financial market, are implemented (Holmstrom and Tirole; 1998). At micro-level, studies have shown that financial intermediation stimulates the restructuring and liquidation of distressed firms (Araujo and Minetti; 2007), as well as eliminating the inefficiencies associated with the absence of inter-temporal smoothing, as a result of incomplete market (Allen and Gale; 1997). Recently, the impact of financial intermediation on the growth of an economy generated a heated debate. While some studies opined that financial intermediation drives economic growth (Odedokun; 1998, Nieh; 2009, Islam and Osman; 2011), others have argued that economic growth drives financial intermediation. However, there are studies, which have argue that a bi-directional causality exists between financial intermediation and economic growth (Odhiambo; 2011). This study seeks to contribute to the body of literature by examining the relationship between financial intermediation and economic growth in Nigeria. Prior to June, 2004, there were eighty-nine commercial banks, among other financial intermediaries, with capitalization of less than 10 million USD and 3,330 branches, while the top ten banks accounted for about 50% of the industry’s total assets/ liabilities (Soludo; 2004: 5). Besides the poor capital base of these banks, there are other issues hindering the effective performance of these banks. Some of the issues include inefficiency in management, operational incompetency, poor corporate governance and unhealthy competition. Thus, these culminated in gross performance, which was below expectation. These hindered the financial sector from delivering financial services optimally to the satisfaction of both investors and customers.

Financial intermediation is affected by profitability (Tigran, 2012), liquidity and other macroeconomic factors such as inflation rate, exchange rate and money market interest rate (Folawewo and Tenant, 2008; Idries, 2010; Tigran, 2012). The Nigerian government at various levels has come up with financial reform measures to address the issue of rising magnitude of financial intermediation cost which have persisted despite policy reforms applied through the removal of credit ceiling, abolition of sectorial allocation of credit, financial liberalization policy, introduction of prudential regulation, bank capitalization, merger and acquisition and consolidation programmes. There has been serious concern on how such policies will increase the level of economic growth in Nigeria.

Therefore, there is a growing concern as to whether the cost of financial intermediation is having commensurate beneficial implication on economic growth in Nigeria. The main

objective of this study is to determine the implications of cost of financial intermediation on economic growth in Nigeria.

Statement of 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.

1.3       Objectives of the Study

The general objective of this study is to examine the effect of financial intermediation on economic development in Nigeria. However, the specific objectives of this study are:

To assess the effect of credit to private sector on economic development in Nigeria. To ascertain the effect of money supply on economic development in Nigeria To verify the effect of interest rate on economic development in Nigeria To determine the effect of credit delivery on economic development in Nigeria

1.4       Research Questions

In order to empirically test the above objectives, the following research questions arose. They are:

Does Credit to Private Sector have any significant effect on economic development in Nigeria? To what extent does money supply have positive and significant effect on economic development in Nigeria? Is there any significant effect of interest rate on economic development in Nigeria? Was there any effect of Credit delivery on economic development in Nigeria?

1.5       Research Hypotheses

The following hypotheses were stated in null forms in this study. They are:.

H0: Credit to Private Sector does not have any significant effect on economic development in Nigeria

      H1: Credit to Private Sector has significant effect on            economic development in Nigeria

H0: Money supply does not have positive and significant effect on economic development in Nigeria.

H1:       Money supply has positive and significant effect on economic development in       Nigeria

H0: Interest rate does not have any significant effect on economic development in Nigeria.

            H1: Interest rate has significant effect on economic development in Nigeria.

H0: Credit delivery does not have any effect on economic development in Nigeria.

H1: Credit delivery has effect on economic development in Nigeria

1.6       Significance of the Study

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.

1.7       Scope of the Study

The study will cover a period of 16 years (2000 – 2015), 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