THE FINANCIAL DEEPENING AND ECONOMIC GROWTH IN NIGERIA 1981- 2015 - Project Topics & Materials - Gross Archive

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THE FINANCIAL DEEPENING AND ECONOMIC GROWTH IN NIGERIA 1981- 2015
CHAPTER ONE

INTRODUCTION
1.1 Background to the Study
The search for ways of bettering the standard of living of citizens has opened the corridors for alternative view points on paradigms of economic growth and development. Financial deepening has been identified as one of those strategies whose implementation can quicken the pace of economic growth. However, the effect of this strategy needs to be determined and examined from time to time especially for developing economies. Financial Intermediation harness this investment process by mobilizing household and foreign savings for investment by firms; ensuring that these funds are allocated to the most productive use; and spreading risk and providing liquidity so that firms can operate the new capacity efficiently. Financial development thus involves the establishment and expansion of institutions, instruments and markets that aid this investment and growth process while financial deepening is the measurement of financial development which refers to the increased provision of financial services with a wider choice of services geared to all level of society. Mathematically, it is the ratio of money supply to Gross domestic product (GDP).
The Financial System consists of various institutions such as deposit money banks (commercial banks), merchant banks, Mortgage banks and instruments and regulators. Central Bank of Nigeria (1993) define Financial system as set of rules and regulations and the aggregation of financial arrangements, institutions, agents, that interact with each other and the rest of the world to foster economic growth and development of a nation. According to Nzotta (2004) the financial system serves as a catalyst to economic development through various institutional structures. The financial system play a key role in the mobilization and allocation of savings for productive use, provide structures for monetary management, the basis for managing liquidity in the system and also in the dwindling of risks faced by firms and businesses in their productive processes, improvement of portfolio diversification and the insulation of the economy from the vicissitudes of international economic changes. Additionally, the system provides linkages for the different sectors of the economy and encourages a high level of specialization expertise and economies of scale.
The Nigerian financial system can be broadly dichotomized into two sub-sectors, the informal and formal sectors. The informal sector has no formalized institutional framework, no formal structure of rates and comprises the local money lenders, thrifts, savings and loans associations and all forms of ‘isusu’ associations while the formal sector could be vividly distinguished into the money and capital market institutions. The money market is the short-term end of the market and institutions here deal on short term instruments and funds. The capital market encompasses the institutions that deal on long-term funds and securities. The regulatory institutions in the financial system are the Federal Ministry of Finance, the Central Bank of Nigeria as the apex institution in the money market, the Securities and Exchange Commission (SEC) as the apex.
There is a consensus that a well-functioning financial sector is a prerequisite for the efficient allocation of resources and the exploitation of an economy growth potential, the economic literature is less consensual on how and to what extent finance affects economic growth. This, invariably, culminated in the emergence of demand-led theory of finance-growth nexus. Among others, Robinson (1952) argues that where enterprise leads, finance simply follows, suggesting that it is economic development which creates the demand for financial services. There are two schools of thought of financial deepening on economic growth. The first one asserts that financial development plays a limited role in accompanying the development of real activity (Robinson, 1952; Lucas, 1988). This school considers that when the economy develops, the financial system develops. Robinson (1952), asserts that “where enterprises lead, finance follows” and, according to Lucas (1988), economists “badly over-stress” the role of financial factors in economic growth. Rajan and Zingales (1998) and Cameron (1967) opine that, although financial development is essential for growth, it is only “a lubricant but not a substitute for the machine”. The second school of thought accords an important role to financial development in boosting the processes of growth, innovation and economic development (Bagehot, 1873, Schumpeter, 1911, MacKinnon 1973, Levine 1996). These authors are of the opinion that causality proceeds from financial to economic development; it is only at a later stage that financial development leads on to growth.
In Nigeria, there has been an underdevelopment of the real sector and it has been envisaged that the reason for this is the lack of funds from the financial sector to this sector. The growth of many Asian economies was accomplished despite a domestic financial sector that could not be regarded as developed (Shan 2001). This observation also holds for China (Lardy, 1998). With an average real GDP growth of 13.5 percent between 2005 and 2007, China’s economic performance is extremely difficult to reconcile with the widespread view that its repressive financial system (in the McKinnon-Shaw sense) grossly distorts the optimal allocation of loanable funds and is, therefore, inefficient. In view of this puzzle, some empirical analysis is required at country level to scrutinize whether it is the development of the financial sector that leads to economic growth or vice versa.
Time series studies have been conducted on U.S, U.K, Japan, and Canada towards resolving the issue of determining the relationship between financial intermediation and economic growth and discovered that there is a positive relationship. (See: Wachtel and Rousseau (1998); and Lee. However, not much has been done on Africa, in general and Nigeria, in particular. The studies carried out on Nigeria have not clearly resolved the issue as most of them concluded that financial sector development did not promote economic growth while a few of them found evidence to support demand-leading hypothesis. For example, Onwummere J.U.J, V. Onudugo and Imo G. Ibe asserted that there is a positive relationship between financial structure and economic growth.  In addition there is problem of endogeneity which has not been carefully addressed in previous studies. This study intend to contribute to literature by examining the relationship between financial sector development and Nigeria’s economic growth, hence, addressing the country’s specific dimension to finance-growth debate. The study is different from previous studies in scope (number of years is considerably longer). The main objective of this research therefore, is to empirically investigate the nature of relationship between financial deepening and economic growth in Nigeria.
1.2    Statement of the Problem
The core question in economic growth that has preoccupied researchers is why countries grow at different rates. The list of possible factors continues to expand, apparently without limit. The positive link between the financial depth and economic growth is in one sense fairly obvious. Therefore, it would seem that policies to develop the financial sector would be to hike economic growth. The role of financial deepening is considered by many to be the key to economic development and growth. One critical factor that has begun to receive considerable attention more recently is the role of financial deepening in the growth process especially in the wake of the recent global economic and financial meltdown. While economists have generally reached an agreement on the central role of financial development in economic growth theoretically; empirical works harnessing this concept are conflicting. There is no doubt that financial analysts are in agreement on what constitutes economic growth and its measurement but the only bone of contention amongst them is agreeing on what actually is the relationship between financial deepening and economic development.
Recently, the impact of financial deepening on the growth of an economy generated a heated debate. While some studies opined that financial intermediation drives economic growth (Nieh 2009) Islam and Osman: 2011, Shittu 2012), others have argued that economy growth drives financial intermediary. Samson O. Odeniran, PhD and Elias A. Udeaja, PhD, argued that bi-directional casualty exists between financial deepening and economic growth. (Odhiambo: 2011) with many of these study applying causality test and ECM (Shittu, 2012, Odeniran&Udeaja). The present study departs from previous studies in that we investigate the extent of financial deepening on economic growth considering the fact that Nigeria still experience interest rate spread, trade openness, gross capital formation, inflation and broad money in the economy.
1.3 Research Questions
This study bridge the existing gap in the literature by empirically investigating the role of financial deepening in the economic growth of Nigeria by employing more variables and recent data.
More specifically, the study provided answers to the following research questions
i.     To what extent does financial deepening proxied by the ratio of Broad money supply to GDP affect economic growth in Nigeria?
ii.    How financial deepening proxied by the ratio of private sector credit to GDP influence economic growth in Nigeria?
1.4 Objectives of the Study
The main objective of this study is to examine the effect of financial deepening on economic growth in Nigeria. Specifically the study seeks to:
1. Examine the effect of the ratio of Broad money supply to GDP on economic growth in Nigeria.
2    Determine the effect of the ratio of private sector credit to GDP on economic growth in Nigeria.
1.5 Research Hypotheses
The research hypotheis to be tested in this study are stated below; t
H1: Broad Money supply to GDP has no significant effect on economic growth in Nigeria.
H2: Private sector credit to GDP has no significant effect on economic growth in Nigeria.
1.6 Scope of the Study
This research work examined financial deepening and economic growth from 1981to 2015. The period covered by this study (1981 to 2015) is the grey, boom and doom periods of capital market development in Nigeria. The study also scrutinizes the extent of financial deepening in Nigeria. The study is not a comparison of the Nigerian financial sector economic deepening with those of other countries. This is based on the fact focusing on a single country; it will be possible to keep substantial variability within the sample.
1.7 Relevance and significance of the Study
The research is significant to the following stakeholders:
Policy Makers: The effect of financial deepening on economic growth is important as this will inform and update Nigeria policy makers to give priority to all policies that affect financial deepening and find ways through which financial deepening can be made more effective and efficient. This study will help formulate policies capable of enhancing the development of the financial sector. According to Ndebbio(2000)[9], the financial sector is  the conduit through which financial deepening is manifested.
Investors: The result of the study would be of benefit to investment analysts and investors in examining the effectiveness of financial deepening and  thus evaluating the option available for accessing long term, short term, non-debt financial capital which enables investors to avoid over reliance on debt financing.
Researchers: Individuals or groups who want to study the effect of financial deepening on economic growth will find this work very useful because it carefully analyzed the impact of financial deepening on economic growth and proffered solutions on how financial deepening can be made more efficient. As a matter of fact, it adds to already existing empirical literature in the context of Nigeria.
Financial Institutions: This study will help the financial institution operators to understand the dynamics in financial policies thereby equipping them to participate in a more sustainable manner in the financial system. The financial institutions are the channels through which financial deepening is implemented to foster economic growth.

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