The Financial System and Economic Growth in Nigeria

ABSTRACT This study examined the impact of the financial system with respect to banks and stock market on economic growth in Nigeria between 1991 and 2010. The debate among scholars on the comparative importance of banks and markets in promoting economic growth generated a lot of controversy. Some scholars argue that banks identify good projects, mobilize resources, monitor managers, and manage risk and so are better at promoting economic growth than the market. This gave rise to the bank-based financial system view. Others argue that the stock markets provide incentives for investors to acquire information, impose corporate control, and customdesign financial arrangements. According to these scholars, markets are better at promoting economic growth hence the market-based financial system view. In Nigeria, where its financial system comprises mainly banks and stock markets, focus has been on banks without adequate attention to the capital market. Policy makers tend to emphasize so much on banks in terms of reforms and individuals or companies depend so much on bank financing portraying Nigeria financial system as bank-based. With regard to this, the study sought to examine the bank-based and market-based financial systems and economic growth in Nigeria by assessing the impact of: (i) banks’ credit to private sector on economic growth in Nigeria, (ii) banks’ assets on economic growth in Nigeria, (iii) total value of shares traded on the stock exchange on economic growth in Nigeria, and (iv) market capitalization on economic growth in Nigeria. The ordinary least square method of analysis was employed to analyze the secondary data sourced from Central Bank of Nigeria Statistical Bulletin, Central Bank of Nigeria Annual Report and Statements of Account and Nigerian Stock Exchange Annual Reports and Statements of Account. Bank-based financial system proxied by banks’ credit to private sector and banks’ assets and Market-based financial system proxied by total value of shares traded and market capitalization served as the independent variables. Economic growth proxied by gross domestic product growth rate was used as the dependent variable. Results showed that (i) banks’ credit to private sector had a positive and significant impact on economic growth in Nigeria, (ii) banks’ assets had a positive and significant impact on economic growth in Nigeria, (iii) total value of shares traded had a positive and insignificant impact on economic growth in Nigeria, and (iv) market capitalization had a positive and significant impact on economic growth in Nigeria. These results showed that banks and market had positive impact within the period studied confirming the importance of both in promoting economic growth. The study therefore recommends that policy makers should make policies that will help develop both banks and market rather than focus on just one component of the financial system. Firms should be encouraged to raise long-term funds from the capital market rather than depend solely on bank financing.

TABLE OF CONTENTS

Title Page - - - - - - - - - i

Approval Page - - - - - - - - - ii

Declaration - - - - - - - - - iii

Dedication - - - - - - - - - iv

Acknowledgements - - - - - - - - v

Abstract - - - - - - - - - vi

List of Tables - - - - - - - - - xi

List of Figures - - - - - - - - - xii

CHAPTER ONE INTRODUCTION

1.1 Background of the Study 1

1.2 Statement of Problem 5

1.3 Objectives of the Study 6

1.4 Research Questions 6

1.5 Research Hypotheses 6

1.6 Scope of the Study 7

1.7 Significance of the Study 7

1.8 Limitation of the Study 8

 References 9

CHAPTER TWO REVIEW OF RELATED LITERATURE

2.1 Theoretical Framework 12

2.1.1 Financial Structure and Economic Growth 12

2.1.2 Competing Views on Financial Structure and Economic Growth 13

2.1.2.1 Bank-Based View and Economic Growth 13

2.1.2.2 Market-Based View and Economic Growth 16

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2.1.2.3 Financial System-Based View and Economic Growth 18

2.1.2.4 Legal System-Based View and Economic Growth 20

2.1.3 Overview of Financial Development and Economic Growth 20

2.1.3.1 Role of the Financial System 24

2.1.3.1.1 Clearing and Settling Payments 25

2.1.3.1.2 Providing Information and Monitoring Investment Projects 25

2.1.3.1.3 Managing Risks 26

2.1.3.1.4 Pooling Resources 27

2.1.4 Financial System Development Indicators 28

2.1.5 Overview of Economic Growth Theories 30

2.1.5.1 Classical Theory 30

2.1.5.2 Neo-Classical Theory 30

2.1.5.3 Harrod-Domar Growth Theory 31

2.1.5.4 New-Growth Theory 31

2.1.6 Overview of the Nigerian Financial System 32

2.1.6.1 Bank Development in Nigeria 33

2.1.6.1.1 Recapitalization and Consolidation of Banks 34

2.1.6.1.2 Bail-Out of Distressed Banks 36

2.1.6.2 Stock Market Development in Nigeria 37

2.2 Empirical Evidence on Financial System and Growth 38

2.2.1 Evidence on Bank-Based Versus Market Financial Systems 43

2.3 Summary of Literature Review 46

 References 50

CHAPTER THREE RESEARCH METHODOLOGY

3.1 Research Design 58

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3.2 Nature and Sources of Data 58

3.3 Model Specification 58

3.3 Description of Research Variables 60

3.4.1 Dependent Variable (Economic Growth) 60

3.4.2 Independent Variables 60

3.4.2.1 Credit to Private Sector 60

3.4.2.2 Bank Assets 60

3.4.2.3 Total Value of Shares Traded 61

3.4.2.4 Market Capitalization 61

3.4.3 Control Variables 61

3.5 Techniques of Analysis 61

 References 63

CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS

4.1 Introduction 65

4.2 Data Presentation 65

4.3 Determination of Research Variables 73

4.3.1 Economic Growth 73

4.3.2 Independent Variables 74

4.3.2.1 Credit to Private Sector as a Ratio of GDP 74

4.3.2.2 Bank Assets as a Ratio of GDP 75

4.3.2.3 Total Value of Shares Traded as a Ratio of GDP 76

4.3.2.4 Market Capitalization as a Ratio of GDP 78

4.3.3 Control Variables 79

4.3.3.1 Government Expenditure as Ratio of GDP 79

4.3.3.2 Gross Capital Formation as a Share of GDP 80

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4.4 Data Analysis 82

4.4.1 Test of Hypothesis One 82

4.4.2 Test of Hypothesis Two 83

4.4.3 Test of Hypothesis Three 84

4.4.4 Test of Hypothesis Four 86

4.5 Discussion of Research Findings 87

 References 91

CHAPTER FIVE: SUMMARY OF FINDINGS, CONCLUSION

 AND RECOMMENDATIONS

5.1 Summary of Research Findings 94

5.2 Conclusion 95

5.3 Recommendations 95

5.3.1 Recommended Areas for Further Studies 96

5.4 Contribution to Knowledge 97

 Bibliography 99

 Appendix 109