Linkages between Formal and Informal Financial Institutions in South Eastern Nigeria

ABSTRACT

The study examined linkages between formal and informal financial institutions in South Eastern Nigeria. The area was purposively chosen because of the intense economic activities including borrowing and savings of both the formal and informal financial institutions in this area. The objectives of the study were: to identify the financial institutions in the area and describe the operations of the formal and informal financial institutions; identify areas that formal and informal institutions were linked and the institutional factors that facilitated such linkages; determine major constraints to linkages; determine strategies that would enhance linkages between formal and informal financial institutions and on the basis of the findings, make recommendations for policy and further research. Multistage random sampling procedure was used to get 36 formal and 38 informal financial institutions for the study. Two sets of structured questionnaire for formal and informal financial institutions were employed to collect primary data. Also secondary data were collected on the 2007 financial records from both sectors. The study was guided by two null hypotheses. Data generated were analyzed using descriptive statistics, probit regression and exploratory factor analysis. Thirty eight (38) informal and thirty six (36) formal financial institutions were identified. Of the twelve possible areas considered for linkages, the institutions were linked in 6 areas. Summary statistics on institutional factors that facilitated linkages found years of business experience, interest rate on loan, rate of loan recovery, and number of years of business operations, significant factors for linkages between financial institution. Financial institutions grouped 5 major constraints in linking with each other as poor legal and regulatory systems, lack of confidence, problem of communication, poor capacity building and institutional rigidities. The institutions grouped three (3) major strategies that would enhance linkages to be the provision of conducive legal and policy environment to ensure confidence and human/organizational upgrading of the informal sector. In the same way the informal institutions and institutional adjustment. Based on the constraints to linkages, the following recommendations were made; providing effective judicial system for protecting property rights with official recognition of informal financial institutions and their inclusion in regulated reforms; effective use of micro finance banks as second-tier regulatory body; provision of tax relief on profits granted to banks that allocate credit through informal sector; improving the ability of banks to reduce loan losses through the use of local sanction to enforce repayment; effective networking of all informal financial institutions; human upgrading though periodic staff training and adapting existing banks to the rural environment of informal financial institutions.

TABLE OF CONTENTS

Title Page……………………………………………………………………… i

Certification…………………………………………………………………… ii

Dedication…………………………………………………………………….. iii

Acknowledgement……………………………………………………………. iv

Abstract………………………………………………………………………. v

Table of Contents……………………………………………………………. ix

List of Tables………………………………………………………………… xi

List of Figures……………………………………………………………….. x

Acronyms……………………………………………………………………. xii

1.0 CHAPTER ONE INTRODUCTION

1.1 Background of the Study 1

1.2 Problem Statement 4

1.3 Objectives of the Study 6

1.4 Research Hypotheses 7

1.5 Justification of the Study 7

2.0 CHAPTER TWO LITERATURE REVIEW

2.1 Theoretical Framework 9

2.1.1 Theory of Vicious Circle of Poverty 9

2.1.2 Theory of Imperfect Information 10

2.1.3 Theory of Transaction Costs 11

2.1.4 Complementary Hypothesis 12

2.2.0 Conceptual Framework 13

2.2.1 Financial Development and Economic Growth 13

2.2.2 The Structure of the Nigeria Financial System 14

2.2.3 Small Enterprise Financing: Problems and Constraints 19

2.2.4 Features of Financial Institutions and Reasons for linkages 22

2.2.5 Meaning, Examples and objectives of Linkages 24

2.2.6 Linkages and Policy 26

2.2.7 Concept of Linkage Banking 28

2.2.8 Factors of Effective Linkages 33

2.2.9 Roles of Different Financial Sectors in Linkage 35

2.2.10 Categories of Linkages 37

2.2.11 Linkage Model 37

2.2.12 Linkage Motivation 45

2.2.13 Contracting Mechanics of Linkage 46

2.2.14 Outcome/Impact of Linkages 47

2.2.15 Financial System Development and Potential for Linkages 50

2.2.16 Constraints to Linkages 50

2.2.17 Strategies for Linkages of Financial Institution 52

2.2.18 Institutional Adjustments for Linkages 56

2.3 Empirical Framework 57

2.4 Analytical Framework 58

2.4.1 Binary Response Model (Probit Model) 58

2.4.2 Exploratory Factor Analysis 60

2.5 Summary of Literature Review 64

CHAPTER THREE METHODOLOGY

3.1 The Study Area 66

3.2 Sampling procedure/Sample Size 66

3.3 Data Collection 67

3.4.0 Data Analysis 67

3.4.1 Model Specification 68

3.5 A Priori Expectation 76

4.0 CHAPTER FOUR RESULTS AND DISCUSSION

4.1.0 Financial Institutions in the Study Area 77

4.1.1 Formal Financial Institutions 77

4.1.2 Informal Financial Institutions 78

4.2.0 Operations of Financial Institutions 79

4.2.1 Operation of the Formal Financial Institutions 79

4.2.2 Operations of Informal Financial Institutions 82

4.2.3 Areas of Linkages between Formal and Informal Financial Institutions 87

4.3. Institutional Factors that facilitate Linkages between Formal and 91 Informal Financial Institutions

4.4 Constraints to Linkages between Formal and Informal Financial 95 Institutions

4.4.1 Major Constraints to Linkages between Formal and Informal Financial 97 Institutions

4.4.2 Result of test of difference on Constraints to Linkages between Formal and Informal Financial Institutions. 103

4.5 Strategies for Facilitating Linkages between formal and Informal 105 Financial Institutions

4.5.1 Results of test of difference on Strategies in Facilitating Linkages between the Formal and Informal Financial Institutions 109

4.5.2 Ranking of Strategies 109

4.5.3 Major Strategies in Facilitating Linkages between formal and Informal Financial Institutions 111

5.0 CHAPTER FIVE SUMMARY, RECOMMENDATIONS, CONCLUSION AND SUGGESTION FOR FURTHER RESEARCH

5.0 Summary, Recommendation and Conclusion 117

5.1 Summary 117

5.2 Recommendations 122

5.3 Conclusion 123

5.4 Suggestions for Further Research 124

5.5 Limitations of the Study 124

References 125

Appendix I: Questionnaire for Formal Financial Institution 133

Appendix II: Question for Informal Financial Institution 144

Appendix III: Mean and Standard Deviation of Formal and Informal 156

Financial Institution Institutions on Constraints to Linkages 158

Appendix IV: Results of Varimax Rotated Constraints to Linkages by Informal Financial Institutions 160

Appendix V: Result of Varimax Rotated Constraints to Linkages by Informal Financial Institutions 162

Appendix VI: Result of Test of Difference on Constraints to Linkages between Formal and Informal Financial Institutions 164

Appendix VII: Mean, Standard deviation and t-test Analysis of Formal and informal Financial Institutions on Strategies for Facilitating Linkages 168

Appendix VIII: Rotated Component Matrix of Informal Financial Institutions on Strategies for Linkages with the Informal Sector 170

Appendix IX: Rotated Component Matrix of Informal Financial Institution on 171 Strategies for Linkages with the Formal Sector