Impact of Financial Deepening on Nigeria Economy

The reforms in the financial system in Nigeria which heightened with the 1986 deregulation, affected the level of financial deepening of the country and the level relevance of the financial system to economic development. Nnanna and Dogo (1998) However, the rapid globalization of the financial markets since then and the increased level of integration of the Nigerian financial system to the global system have generated interest on the level of financial deepening that has occurred.

The financial system comprises various institutions, instruments and regulators. According to the Central Bank of Nigeria (2003) the financial system refers to the 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 (2004:169) the financial system serve as a catalyst to economic development through various institutional structures.

The systems vigorously seeks out and attracts the reservoir of savings and idle funds and allocate same to entrepreneurs, businesses, households and government for investments projects and other purposes with a view of returns. This forms the basis for economic development. The financial system plays 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.

It also assists in the reduction 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.

Nzotta further contends that the financial system, additionally, provides the necessary environment for the implementation of various economic policies of the government which is intended to achieve non-inflationary growth, exchange rate stability, balance of payments equilibrium foreign exchange management and high levels of employment. The Nigerian financial system can be broadly divided 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 ‘esusu’ associations. According to Olofin and Afandigeh (2008:48) this sector is poorly developed, limited in reach and not integrated into the formal financial system. Its exact size and effect on the economy remain unknown and a matter of speculation. The formal sector, on the other hand, could be clearly 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 institution in the capital market, Nigerian Deposit Insurance Corporation, (NDIC), National Insurance Commission (NAICOM) and the National Pensions Commission (PENCOM).

Financial reforms have been a regular feature of the Nigerian financial system. The reforms have evolved in response to the challenges posed by developments in the system such as systemic crisis, globalization, technological innovation, and financial crisis. The reforms often seek to act proactively to strengthen the system, prevent systemic crisis, strengthen the market mechanism, and ethical standards. Financial reforms in Nigeria dates back to 1952 when the Banking Ordinance was enacted. The deregulation of banking in 1986 provided the impetus for the Structural Adjustment Programme.

The 1986 reform of the financial system saw a policy shift from direct control to a market based financial system, especially as regards monetary management, risk management and asset holding capabilities of the institutions. A number of other reforms followed including the consolidation policy in banking 2005 and insurance 2007. The capital market has also experienced a lot of reforms over the years, especially as regards the capital requirements of the operators, the operational and ethical standards of the institutions and the modalities of the market mechanism.

The reforms in the system impacted positively on the growth of the financial system. The system moved from a rudimentary one at inception to a more sophisticated one in 2009 with diverse institutions and operators, diversified financial assets and an enhanced regulatory framework. The reforms have also tried to address the financial gaps in the system, remove rigidities in the system of credit allocation and control and achieve positive real interest rates and greater efficiency by the market operators in the intermediation process.

The process of financial sector reform consists of the movement from an initial situation of controlled interest rates, poorly developed money and securities market and under-developed banking system, towards a situation of flexible interest rates, an expanded role for market forces in resource allocation, increased autonomy for the central bank and a deepening of the money and capital markets. The link between financial sector stability and growth is, explained by increased market depth, which potentially increases market efficiency.

It also reduces risks through the elimination of weak institutions. Financial sector reforms/seeks to develop an efficient framework for monetary management. This encompasses efforts to strengthen operational capacities of the banking system, foster efficiency in the money and securities markets, over-haul the payments system and ensure greater autonomy to the central bank in formulating and implementing macroeconomic policies. Thus, there is the need to deepen the financial sector and reposition it for growth and integration into the global financial system in conformity with nternational best practices. One of the most important policy concerns in most countries is the effect of consolidation of financial institutions on financial system growth and development. The first major concern is the transmission mechanism. Consolidation could alter the credit allocation of the financial system by fostering the creation of larger banks having better access to the funds market. It also affects the availability and pricing of loans in response to changes in the market dynamics and the level of economic development. 2. STATEMENT OF THE RESEARCH PROBLEM

In both developed and developing countries, the relationship between financial development and economic growth has been the subject of a growing literature in recent years. The lack of efficient financial intermediation in developing countries like Nigeria is widely evidenced by the mismatch between institutional savings and investment. It is however clear that the need for investment in the real sector in Nigeria is indisputable. In the past this has been addressed through the introduction of development finance institutions and other such vehicles to provide credit at below market rates for the purchase of capital.

This resulted in carrying out tightly regulated financial systems which were motivated in principle by prudential considerations until the 80s. The Nigerian financial system is one of the largest and most diversified in Nigeria. The system became liberalized when structural adjustment programme was introduced in the 1980s. In recent years, the system has undergone significant changes in terms of the policy environment, number of institutions, ownership structure, depth and breadth of markets, as well as in the regulatory framework.

However, in spite of the far-reaching reforms of the past 25 years, the Nigerian financial system is not yet in a position to fulfill its potential as a propeller of economic growth and development. The financial system is relatively superficial and the apparent diversified nature of the financial system is suspicious. This is because although a wide variety of financial institutions and markets exist, commercial banks overwhelmingly dominate the financial sector and traditional bank deposits represent the major forms of financial saving.

Challenges still exist in both the capital market and money market as policy environment is still plagued by incessant reversals. 1. 3AIMS AND OBJECTIVES OF THE STUDY The main thrust of this study at this level of economic development when efforts are being made to reposition the financial system to enable it play key roles in economic development shall be to evaluate the impact of financial deepening on the economy over the years in Nigeria. However, the following specific objectives would also be achieved.

To examine in an empirical manner, the nature of financial deepening in Nigeria since the onset of financial reforms within the period under study. • To ascertain the critical factors that has affected the level of financial deepening in Nigeria over the years. • To ascertain if there is observable growth in the financial deepening index (money supply to GDP) ratio in Nigeria. • To examine the interrelationship between major components of financial deepening and gross domestic product over the period under study in Nigeria. Finally, to empirically investigate the over performance of financial deepening components on Nigeria economy during the period under study 3. SIGNIFICANCE AND JUSTIFICATION OF THE STUDY The justification for this study stems from the conclusion of Nnanna and Dogo (1998), the concept of financial deepening is usually employed to explain a state of an atomized financial system, that is, a financial system which is largely free from financial repression.

And also from the conclusion of Oloyede (2008) maintained that financial deepening results from the adoption of appropriate real finance policy, namely relating real rates of return to real stock of finance. This study is also justified by the desire to add to the existing body of knowledge of the impact of financial deepening on Nigeria economy. 1. 5 RESEARCH QUESTIONS • Is there any verifiable pattern in the financial savings of the system since 1986? • Is there any relationship between the lending pattern of banks and financial deepening? Is there any relationship between the level of financial deepening and savings? • To what extent the prime lending rate impacted on gross domestic product in Nigeria within the period under study? 6. RESEARCH HYPOTHESIS The hypothesis to be tested in the course of this research work is: H0 – That financial deepening does not have significant impact on the economic growth in Nigeria. H1 – That financial deepening has significant impact on the economic growth in Nigeria. 7. SCOPE AND LIMITATION OF THE STUDY The economy is a large component with lot of diverse and sometimes complex parts.

This study will only focus on major growth components such as the gross domestic product. This study will cover all the facets that make up financial deepening, but shall empirically investigate the effect of the major ones. The empirical investigation of the impact of the financial deepening on Nigeria economy shall be restricted to the period between 1975 and 2009. The study would also examine the nature of financial deepening in Nigeria since the onset of financial reforms, and ascertain the critical factors that has affected the level of financial deepening in Nigeria over the years. . METHODOLOGY OF THE STUDY The model used in this research is a simple macro econometric model. The Ordinary Least Square (OLS) technique shall be employed in obtaining the numerical estimates. The OLS method is chosen because it possesses some optimal properties (The optimal properties are BLU that is it Best to use, Linearity and it is Unbiased in nature); its computational procedure is fairly simple and it is also an essential component of most other estimation techniques. The estimation period covers the period between 1975 and 2009.

In demonstrating the application of Ordinary Least Square method, the multiple linear regression analysis will be used with gross domestic product (GDP) as a major components of economic growth while bank lending rate(BLR), financial savings(FS), value of cheques (VOC), deposit money Bank (DMS),Currency Outside Bank (COB) which serve as components of financial deepening will be the independent variables. The method would be applied with the use of Statistical Package for Social Sciences (SPSS).

The equations model has been designed to show relationship between financial deepening and economic growth. The formal discussion of the model is presented in chapter three. 9. DATA SOURCES The data used in this study were sourced from the Central Bank of Nigeria publications and those of the Bureau of statistics. The data was for the period 1975– 2009. The period chosen for the study encompasses the phases of the major reforms in the financial system and the period of consolidation of the banking and insurance systems in Nigeria. 1 . 0 ORGANISATION OF THE STUDY This study shall contain five chapters. The first chapter contains the introduction, the statement of the research problem, the research questions, aims and objectives of research, justifications and significance of the study, research hypothesis, scope and limitation of the study, research methodology, and sources of data and organization of the study. Chapter two shall contain the theoretical framework and literature review. The research methodology shall be explained in detailed in chapter three. Chapter four hall contain the data analysis and interpretation of the data. Finally chapter five shall contain the summary, conclusion and recommendation of the study. CHAPTER TWO LITERATURE REVIEW 2. 1 HISTORICAL VIEW OF FINANCIAL REFORM At the inception of comprehensive financial sector reform in 1987, the sector was highly repressed. Interest rate controls, selective credit guidelines, ceilings on credit expansion and use of reserve requirements and other direct monetary control instruments were typical features of the pre-reform financial system in Nigeria.

Entry into banking business was restricted and public sector-owned banks dominated the industry. The reform of the foreign exchange market which hitherto was also controlled began a year ahead of the general financial sector reform. In context, the financial sector reform was a component of the Structural Adjustment Program (SAP) which kicked off in 1986. Although the policy planks of SAP in Nigeria were the prototype prescriptions of the Breton Woods institutions, the program was sold to Nigerians by government as Nigeria’s alternative to IMF loan-based adjustment.

The introduction of the program was on the heels of the rejection of IMF loan package with its conditionalities, a decision that reflected the consensus of a nationwide debate. The major financial sector reform policies implemented were deregulation of interest rates, exchange rate and entry into banking business. Other measures implemented include, establishment of Nigeria Deposit Insurance Corporation, strengthening the regulatory and supervisory institutions, upward review of capital adequacy standards, capital market deregulation and introduction of indirect monetary policy instruments.

Four highly distressed banks were liquidated while the central bank took over the management of others. Government banks were also privatized. The details and the sequencing of the reform measures are contained in the Appendix. A peculiar feature of the reform program in Nigeria is the associated inconsistency in policy implementation. The reform of the foreign exchange market started in 1986 with the dismantling of exchange controls and establishment of a market-based autonomous foreign exchange market.

Bureaux de-change was allowed to operate from 1988. However a fixed official exchange rate has continued to exist alongside the autonomous market. In 1994 the gradual market-based depreciation in the official exchange rate was truncated by a sharp devaluation in a bid to close the widening gap between the official and the autonomous exchange rate. Unsatisfied with the observed further widening of the gap between the two exchange rates, government outlawed the autonomous foreign exchange market and reintroduced exchange controls in 1994.

But after a full year of exchange controls, the autonomous market was brought back in 1995 to co-exist with the fixed official exchange rate. A foreign exchange subsidy of about 300% still exists for some government favored consumption such as pilgrimage and sporting events for which the official rate applies. The continued operation of the official exchange rate brings with it a great deal of distortions in the domestic allocation of resources within the public sector. This is very pronounced in the vertical distribution of export earnings among the three levels of government.

The revenue from this foreign exchange rent to the federal government now constitutes one of its major revenue sources (Emenuga 1996a). Fiscal gains thus appear to be an incentive factor in retaining the current structure of the foreign exchange market. A similar pattern of policy reversals applies to the reform of interest rates. First introduced in 1987, the market-determined interest rates ruled until 1991 when interest rates were capped. But after only a year of controls, market forces were permitted once more to determine all interest rates in 1992 and 1993.

Since 1994, the pre-reform policy of controls has been retained. While indirect monetary instruments (open market operations) have been initiated since 1993, some measures of controls such as sectoral credit allocation guidelines have continued to be applied. In the sphere of bank licensing and regulation, the reform was ushered in with deregulation of bank licensing in 1987. This was immediately greeted with the establishment of many new banks, leading to the doubling of the number of operating banks within three years.

When the increase in the required banks paid up capital in 1989 and the reform of their accounting procedure (990) appeared insufficient to curb the “excesses” of the sector, government placed total embargo on bank licensing in 1991. This is yet to be lifted. Privatization of banks was suspended after applying the measure to a few banks. In fact, Government has drawn up plans to buy back its stakes in the major commercial banks, apparently in sympathy with the political class who have been deprived of one of their lucrative “spoils” through the divestiture.

The “de-privatization” is already being implemented for one of the three largest commercial banks. Some of the issues highlighted above point to the disorderly manner in which the reform has been implemented in Nigeria. In effect, the reform has not been a one-shot smooth process. This therefore complicates the task of assessing its outcome. The liberalization of bank licensing at the onset of the reform resulted in the establishment of many new banks. The number of operating banks almost doubled within three years into the reform and tripled in the fifth year.

It required official re-imposition of embargo on bank licensing in 1991 to halt this growth. Profitability of investment and access to credit and foreign exchange were among the major motives for bank ownership. The growth in the number of banks appears to have had only a marginal impact on the concentration of the industry. The share of the three largest banks in the total assets of the industry decreased from 37. 3% before the reform to an average of 34. 6% over the reform period, a reduction of only 2. 7% points despite the over 200% growth of operating institutions.

The new banks were generally small and undercapitalized, a situation that later led to an upward review of banks minimum operating capital. The competitiveness that resulted from the entry of new banks and the liberalization of interest rates brought about sharp rise in nominal deposit and lending rates. The increase was however moderated by the occasional reimposition of interest rate ceilings. Nevertheless, the average deposit and lending rates doubled in the third year of the reform (Table 14. 1) Surprisingly, the competition for deposits which drove nominal interest rates up could not ensure a cheaper cost of intermediation.

The nominal interest rate spread rather worsened from 2. 9% pre-reform average to 4. 0%. This is one indication that the reform did not improve the availability of loanable funds. Higher spread was one of the strategies employed by the banks for survival. The banking environment that emerged from the reform is a lot inefficient, undercapitalized, riskier, less liquid and generated lower return on assets relative to the pre-reform period (Sobodu and Akiode 1994). The incidence of fraud, and of non-performing loans also increased with the reform.

The quality of management is a major determinant of a bank’s long-term survival (Siems 1992; Pentalone and Platt 1987) and the dearth of qualified management personnel to meet the challenges of sudden growth in the industry contributed to the poor health of the banking industry (Ikhide and Alawode 1994). It was in 1991 that government promulgated the Bank and other financial institutions Decree (No. 24) and the Central Bank of Nigeria Decree (No. 25) which spelt out comprehensive guidelines for bank regulation, supervision and liquidation.

By this time the incidence of distress in the industry was already rampant. Although interest rates responded positively to financial liberalization, real rates behaved differently. For most of the reform years, real deposit rate was negative, and averaged -13. 5% compared to -7. 65 during financial repression (Table 14. 1). The high rates of inflation during the reform coupled with reimposition of interest rate ceilings brought about the negative real deposit rate. If financial savings is interest elastic, the negative real deposit rate would lead to poorer savings mobilization.

The relationship between real savings and interest rate was recently explored for Nigeria (Soyibo and Adekanye 1992) and the empirical evidence identified only a weak influence of real interest rate on real savings. It further shows that the era of financial liberalization could not make any difference to the tenuous link. Over the reform period the rate of real resource mobilization declined. The Savings/GDP ratio dropped from 15. 4% to 12. 4%. The growth of real savings also slowed down by 7. 5% points (Table 14. 2). These developments are in harmony with the econometric evidence.

The decline in real wage income during the reform could have also contributed to the fall in real savings. For instance, the index of real wage income for the middle level public service cadre declined from 100 in 1987 to 40 in 1990 and 34 in 1992 (Federal Ministry of Finance, Approved Budget, various issues). The expected increase in financial savings during the reform was only realized in the rural areas. Measured by the share of deposits mobilized in banks’ rural branches in the total deposits, rural savings increased from 1. 9% before the reform to 10. 8%.

This trend nets off the role of community banks and the People’s bank in rural credit mobilization. The two set of institutions were established to enable rural dwellers and the poor save and have access to credit at rates lower than the high rates that came with the financial reform. The privatization exercise which required investors to pay through banks contributed much to the growing culture of financial savings in the rural areas. This is a plausible explanation since the rate of rural savings growth only rose significantly in 1989 after the start of privatization in 1988.

Good as this growing culture of rural savings may be for breaking financial dualism, the economy would have been worse for it if the informal sector in Nigeria, from where savings now move to the formal sector is more efficient in resource use. This proposition will await empirical investigation for substantiation. In the first few years of the reform, the share of the banking system’s credit to the private sector improved and superseded the flows to government for the first time in five years. Later, government’s reliance on Central Bank’s financing for the soaring deficits overturned the table to its favor.

From 50. 7% average before the reform the share of the private sector in the total credit decreased to 49. 7% after the reform. In 1993 and 1994, only 34% of the total credit went to the private sector (Table 14. 2). The bulk of the credit that was channeled to the private sector was mainly directed toward short-term investment. Between 1987 and 1994, 50% of the private sector credits went to call money, 32. 5% to lending maturing within 12 months, 12% for 1–5 years maturity (medium-term) and only 4. % for long-term commitments exceeding five years (Central Bank of Nigeria, Annual Report and Statement of Accounts, various issues). Again much of the short-term private sector credits was invested in foreign exchange speculation. Through the incentives created by the retention of the overvalued official foreign exchange market together with the parallel market rate, politically “connected” rent-seekers emerged, buying foreign exchange from the official market and reselling in the parallel market at premium that in some cases was above 200% (Emenuga 1996a).

Bank loans were largely held in speculative balances (call money) because bid for foreign exchange was required to be backed with Naira cover (Sobodu and Akiode 1994). Other reasons for the short-term lending behavior of banks were the uncertainty that surrounded lending for real investment in the face of the unstable macroeconomic environment ( Soyibo 1994b) and the policy uncertainty that characterized the reform period. The banking system’s lending to the public sector was part of the financing facility for fiscal deficits.

The Structural Adjustment Program implemented from 1986–1994 did not include fiscal reform. Nor did the financial sector component of SAP include a reform of government borrowing from the financial system. Rather the reform which led to increases in nominal interest rates prompted government to rely more on Central Bank financing than previously. Since 1987 government has abandoned the issue of Federal Government Development Stocks (FDS), government’s long-term bond in preference for treasury financing possibly due to the high cost of servicing the debt.

The share of Central bank’s credit in the total deficit financing has consequently risen from 25. 4% in 1987 to 67. 9% between 1987 and 1994 (Table 14. 3). Also, due to the absence of a stabilization program, the size of government’s deficit increased during the reform years. Confronted with increasing costs of its fixed (budgeted) commitments as a result of inflationary forces during the reform, government easily found rescue in the mint (Emenuga 1996c). This operation was made smooth by the absence of central bank independence (Emenuga 1996b).

The ratio of deficits to GDP could therefore not improve through the reform but rather increased from 7. 0% to 9. 2% (Table 14. 3). With the deteriorating fiscal balance, and worse still, with a heavy reliance on Central Bank’s financed deficit, the explanation for the inflation rates which assumed unprecedentedly high levels during the reform becomes not far fetched. The average rate of inflation doubled over the reform period, rising from 16. 0% to 33. 6%. It has been shown empirically that the Central Bank-based deficit financing has been a strong causal factor in the domestic price instability. Ndebbio 1995). Exchange rate depreciation and “appropriate pricing of petroleum products” are additional causes of inflation during the reform. The depth of the financial sector, measured by the M2/GDP ratio, contrary to expectations, was not improved by the reform. It declined. The fall in financial deepening from 32. 6% to 26% implies that the growth of the financial sector lags behind the tempo of economic activities, suggesting that the financial sector may not have been the source of real GDP growth within the period.

Interestingly, despite the dashed expectations on the developments in the financial sector, the performance of the economy improved over the reform period. Negative trends in real GDP growth were reversed. Except for the first year of financial reform which was also the first full year of implementing the Structural Adjustment Program (1987) there were positive real GDP growth in the rest of the years. Overall, the economy improved from -2. 7 average annual growth to 5. 0% during the reform but to ascribe this impressive performance to financial liberalization would be dubious.

In 1985 and 1986, the immediate years preceding the reform, real GDP grew by 9. 4% and 3. 45 respectively whereas it dropped to -0. 6% in the first year of the reform (Table 14. 3). The channels through which the reform would have led to improved growth have been shown to have deteriorated during the reform. Real deposit rate, real savings, efficiency and depth in financial intermediation and credit flow to the private sector, became poorer during the reform. The rate of inflation also worsened. The growth in real GDP must have been influenced then by forces outside the financial sector.

Since the period of implementing the Structural Adjustment Program (SAP) encompassed that of the financial sector reform, the positive economic performance might be situated within the wider adjustment package. 2. 2 THE STRUCTURE OF THE NIGERIAN FINANCIAL SYSTEM The financial sector in Nigeria is made up of a wide array of institutions and instruments. It consists of the Central Bank of Nigeria which is the apex financial institution, Commercial and Merchant Banks, Development Finance Institutions, Thrift and Insurance organizations, a Stock exchange and a Securities and Exchange Commission and a virile informal financial sector.

The number of commercial and merchant banks have increased from 12 in 1960 (at independence) to about 120 at the end of 1992 with a branch network of 2391 out of which commercial banks account for 2275 (with 774 in the rural areas). At the end of 1985, (prior to the commencement of the structural adjustment programme), the ownership structure of the share capital in commercial banks indicated dominant ownership by government (Federal and State) accounting to 58. 6 per cent followed by private shareholders (22. per cent) and foreign interests (18. 9 per cent). Today with government divestiture of its ownership in major enterprises, the ownership structure has tilted in favour of private individuals with foreign interest playing only a supporting role. Commercial Banks dominate the Nigerian Banking industry; they account for 71. 2 per cent of total credit outstanding to the private sector as at the end of 1993. The pattern of investment in recent times are concentrated in ‘other assets’ followed by loans and advances and inter bank placements1.

Whereas commercial banks concentrate on the retail end of the financial system, merchant banks are supposed to transact wholesale banking business. Recently, merchant banks have relied on short term sources of funds, which is reflected in the preponderance of short-term loans in their portfolio. In addition to these, six development finance institutions also operate in the system. These are the Nigerian Agricultural and Cooperative Bank, the Nigerian Industrial Development Bank, the Nigerian Bank for Commerce and Industry, the Federal Mortgage Bank, the Nigerian Export-Import Bank (NEXIM) and the recently established Urban Development Bank.

As their names suggest, these are development finance institutions charged with the responsibility of providing loan and industrial finance by attracting foreign resources, mobilizing domestic savings and allocating investment funds efficiently. More often than not, they are established in recognition of unfulfilled credit needs of domestic industries. As of 1992, the share of the assets of these institutions (minus NEXIM and the Urban Development Bank) in the total assets of all financial institutions in Nigeria was put at about 1. 9 percent.

Specialized banks have been established with the onset of the structural adjustment programme to meet up with the ever increasing credit needs of segments of the society who are not adequately catered for by the existing arrangement. These are the Community banks whose capital requirements are provided by the communities in which they are located and the Peoples Bank which is supposed to provide for the needs of small and medium scale entrepreneurs in the society. Both of them are designed to provide credit facilities at grassroots level and thereby promote self reliance.

At the end of 1993, the Peoples Bank was operating 271 branches and 879 community banks. Thrift institutions have also achieved some prominence in the financial system. These comprise mainly of insurance companies, pension funds and the savings banks. In 1987, 87 insurance companies operated in the system out of which 68 were wholly indigenous and 19 were jointly owned by Nigerian and foreign interests. The asset share of insurance institutions in the total for all financial institutions was put at 2. 1 per cent in 1992.

The main pension institution in Nigeria is the National Provident Fund (NPF) which was established in 1961 as a compulsory savings scheme with the objective of running as a social security program by providing protection to contributors in their old age, invalidity or temporary loss of employment. The enabling act establishing the National Provident Fund requires it to invest its surplus funds “only in securities in Nigeria authorised by the Trustee Investment Act 1957 and 1962 and shall be restricted to securities created or issued by or on behalf of the Government of the Federation”.

Both employers and employees contribute to the Fund. The NPF commenced operation in 1962 and since then has been a major participant in the Capital market. The Federal Savings Bank, FSB, was established in 1974 with the aim of providing a ready means for the deposit of savings to encourage thrift. As a way of reaching savers in the rural areas, the scheme was initially tied to the Post offices whose network of branch distribution spanned the nation. However, as a result of its poor performance, the scheme is now operated as an independent savings institution directly supervised by the Central Bank of Nigeria.

The investment portfolio of FSB has found interest in such instruments as the Federal Government of Nigeria Development stocks and Treasury bills. Apart from these major financial institutions, the financial system is also inundated by a collection of young and small institutions that play a major role in the intermediation process2. These include finance companies, leasing companies, mortgage, savings and loan associations and venture capital companies.

Most of these have come into prominence in the wake of the financial innovation that pervaded the system with the onset of financial liberalization. Although their activities are mainly restricted to the urban areas, their characteristic single unit offices and share aggressiveness in the mobilization of savings and the creation of investment outlets mark them out as viable potentials for the fostering of enhanced intermediation given a well developed money and capital market. In 1992 alone more than 47 finance companies were granted licenses to operate.

As at 1993, about 752 finance houses were in operation although only 310 were licensed. Data available on 207 of these institutions showed an aggregate capital cum reserves of 1142. 2 million Naira and 5393 million Naira assets. The single largest source of their funds is loans. These amounted to 3161. 2 million Naira, or 58. 6% of the total (CBN, Annual Report, 1993). At a percentage of total domestic credit to the economy, this was slightly above 1. 0 per cent in 1993. As a percentage of credit by commercial banks to the economy this was approximately 4. per cent. Thus on a comparable note, finance companies have become important purveyors of credit in the financial system. Although they are not depository institutions, finance companies are allowed to borrow a minimum of 100,000 Naira from any person or corporate organization subject to certain statutory limitation on total outstanding borrowing. They are authorized to transact a general class of lending and leasing business to consumers, industrial, commercial and agricultural enterprises.

Discount houses are special non-bank financial institutions aimed at providing discounting/rediscounting facilities in government short term securities. In particular, it is expected that discount houses will promote the growth and efficiency of the money market, enhance the implementation of open market operations by facilitating the issue and sale of short dated government debt instruments by tender and also accommodate bank’s short term financial needs. Their main sources of funds are equity (paid-up capital and reserves), money on call, and overnight advances from the CBN.

By September 1992, approval-in-principle had been granted to three discount houses. The bureaux de change was set up in 1989 to act as dealers in the spot market for foreign exchange. The need to broaden the foreign exchange market at the onset of SAP and improve the access of small transactors to foreign exchange necessitated their establishment. The National Economic Reconstruction Fund (NERFUND) was set up in 1989. It is a funding mechanism aimed at bridging the gap in the provision of local or foreign funds to small and medium-scale enterprises.

It is jointly owned by the Federal government of Nigeria, the CBN and other foreign partners. 2. 2. 1Instruments of the Money Market The money market has been developed with two main objectives in mind: to provide the public and private sectors with means to raise short-term money and invest cash and to serve as a conduit for the management of liquidity and money by the monetary authorities. One is therefore not surprised that the money market did not come into existence until the establishment of the CBN in 1959.

The major institutions operating in the money market are the Treasury/Central Bank dealing in treasury bills, treasury certificates, government development stocks, (all Federal government borrowing instruments), the commercial banks, dealing mainly in bankers acceptances, certificates of deposits, and bankers unit funds and private companies dealing mainly in commercial papers. The interbank market has also become more prominent with the SAP. The size of the money market has increased substantially both in terms of the number and heterogeneity of instruments traded since 1987 when SAP began.

Today, mutual funds, Unit Trusts, Investment companies, operate both in the money and capital market (Ikhide and Alawode 1993). It is expected that with the establishment of the discount houses, the money marketwill grow even faster. Because of their relevance for indirect monetary control, a brief survey of the instruments of the money market is attempted here. 1. Inter bank funds-market. These are generally unsecured interbank placements of maturity from overnight to 90 days. In 1994, 95. 7 per cent of total placements was overnight.

The rates charged on call money rates vary over time and across institutions. Inter bank funds market are very sensitive to changes in interest rates as witnessed by the fall in the value of transactions between 1993 to 1994 when average rates for the 30 and 90 days maturity fell from 66. 2 and 63. 2 in December 1993 to 18- 21% in 1994 in response to the re-regulation of interest rates policy. 2. Treasury Bills (TBs). These are short term debts of the Federal Government. The Central Bank provides rediscount facility which makes the instrument highly liquid.

They are reserve eligible assets. Introduced in 1960, they dominate the money market. As at end of 1993, they constituted about 71. 2 per cent of total money market assets. They are now issued weekly and are held by banks and the non-bank public. Most of the outstanding treasury bills are held by the CBN who actually underwrites the issues. As at end of 1994, the CBN took up 85. 6 per cent of total issues. 3. Treasury Certificates (TCs). This is a medium-term instrument of one to two years maturity designed to bridge the gap between treasury bills and other medium term instruments.

Again, the CBN holds most of the outstanding issues because investors perceive its yield and maturity characteristics as unattractive relative to the risk-return profile on other short term instruments. CBN average holding in 1994 was about 89. 9 per cent. 4. Certificates of Deposit (CDs) were introduced in 1975 by banks as a financial innovation in response to the excess liquidity in the system at a time when government securities were in short supply (this was during the oil boom era). The maturity structure ranges from 90 days to 3 years, and the instruments are traded among banks.

Transactions in CDs started to take a plunge in 1992 after the peak performance of the late 1990’s. The decline can be traced to the preference by holders for shorter-term instruments in the face of highly volatile interest rates, unstable macroeconomic environment and the distress in the banking system which has increased the risk attached to CDs. Merchant banks remained the main holder as at 1994 with a monthly average issue of 348. 3 million Naira representing 79. 4 per cent of total issues. 5. Commercial Papers (CPs). Are negotiable short-term, unsecured (IOU’s) promissory notes issued by firms and non-bank financial intermediaries.

Issue of commercial paper constitutes the main supplement to bank loans for fulfilling seasonal credit requirements of the private sector. They are popular with both commercial and merchant banks. As at 1994, average holdings by the two financial institutions stood at 68. 5 and 31. 4 per cent respectively. 6. Bankers Acceptances (BAs) are short-term IOU’s typically issued in connection with foreign trade and guaranteed as to payment by a bank. Most holdings of BAs are by commercial and merchant banks. Investment in BAs by commercial and merchant banks which had remained at relatively modest levels up to 1993 rose significantly in 1994.

A major factor for this trend could have been the relatively unattractive nature of other short term instruments due to the re regulation of interest rates in 1994. 7. Unit Trust schemes are institutions established mainly for the mobilisation of the financial resources of small and big savers and management of such funds to achieve relatively high returns with minimum risks through efficient portfolio diversification. The first Unit Trust Scheme was launched in December 1990 and by end of 1992, ten unit’s schemes had been launched. 2. 2. 2 The Capital Market

The capital market in Nigeria can be divided into two: the non-securities segment and the securities segment. The non-securities segment consists of Savings Banks, Mortgage Banks, Development Banks and Insurance Companies. Their instruments consist of term loans, mortgages and leases. Mention must be made here of the Development companies which complement the activities of the development banks. Their history in most cases predate the establishment of some of the development finance institutions, they supply loan and equity capital for financing new and existing enterprises.

They cater for a wide range of industrial groups in both the public and private sectors. They started in most cases as regional development boards and have undergone different stages to become what they are today – public investment companies. At their inception, they were mainly established to administer and use funds made available to the marketing boards in such areas as agriculture and industry. Most popular among them today are, the Northern Nigeria Development Board, the Odua Investment Company Limited and the Central Investment Company Limited serving respectively the North, West and East.

Their investment in banking, commerce and manufacturing run into millions of Naira. Data is not readily available on the activities of these finance institutions but nevertheless they constitute an important segment of the capital market (Okigbo, 1991). The capital market proper consists of the securities segment. It is instructive to distinguish between the fixed interest securities market (debentures and bonds) and the shares market in Nigeria. The bonds market is dominated by the government whereas private enterprises dominate the shares market.

Only a few debentures are issued by the private enterprises. The conventional sources of funds for the purchase of fixed-interest securities are households, individuals and enterprises particularly financial institutions -commercial banks, savings institutions and the Central Bank. In general, two groups of transactors place their securities in the market – the government (Federal, State and Local governments) and the incorporated enterprises. Government securities dominate the market.

There were a number of legislative actions which supported the market for government securities. Among these were the Income Tax Management Act, 1961, which conferred tax free status on Pension and Provident Funds that maintain at least one third of their total investment in government securities (50 per cent for those approved after 1961); the Trustee Investment Act, 1962, which empowered trustees to invest in government stocks and industrial securities provided such securities are quoted on the stock exchange.

And since very few industrial securities are quoted on the stock exchange, the Trustee Investment Act, 1962, had the ultimate effect of forcing all Trust funds to be invested in Government stocks; the Insurance (Miscellaneous Provisions) Act 1964 which requires insurance companies to invest at least two-fifths of all funds from risk premium in Nigeria securities one-quarter of which must be held in Government stocks.

It is not surprising therefore that given these measures and the frequency of issues of government bonds, the demand for government loan bonds comes mainly from financial institutions such as commercial banks and savings-type institutions. Up to the late 1970’s, public issue of industrial securities were very limited. Issues of equity shares were more substantial than industrial bond issues both in terms of values and frequency of issue.

Two main events, the indigenization exercise executed through the Nigerian Enterprises Promotion Decree (NEPD), 1972, and 1977 and the privatization program under the current structural adjustment program have served as main impetus for the growth of the equity market between 1972 and 1990. A total of 57 equity securities valued at 146. 31 million Naira were traded on the new issues market between 1971 and 1977. Of this, 31 securities valued at 66. 18 million Naira were new issues. The privatization of erstwhile government concerns also gave a fillip to the growth of the market.

In 1990 alone, the Technical Committee on Privatization and Commercialization (TCPC) on behalf of the Federal government of Nigeria offered to the public a total of 563,373 million ordinary shares worth 6533. 639 million Naira in seven companies for privatization. All the issues were oversubscribed. Thus, over the years the size of the primary market has grown in absolute terms (volume) as well as in value. The issue of government stocks has dominated total issues while in relation to transactions in the market, the situation has not changed.

In terms of values, Government stocks also constitute the hub of the market. However, in terms of the number of listings and of the transactions, private (industrial securities) have been growing rapidly in importance particularly in the past decade. In terms of institutions the capital market consists of a primary market which is dominated by the investment (merchant) banks, brokers and dealers and venture capitalists and a secondary market dominated by the Stock Exchange.

While the primary markets main concern is with the primary issues, the secondary market handles already existing issues of the Exchange. Following from the report of the Bar-back committee set up in 1959 to advice on the desirability of setting up a stock market in Nigeria, the Lagos Stock Exchange now known as the Nigerian Stock Exchange (NSE) was established in 1960. The growth of the market was rather slow in its early years with only 6 equities quoted as at the end of 1966 in contrast to 3 in 1961.

An average of one equity was quoted for these years except for 1964 and 1965 when no equity was quoted at all. Government stock comprises the bulk of listing with 19 such securities quoted on the Exchange in 1966 as against just 5 in 1961, an average of 3 stocks were quoted for these years. On the whole a total of 60 securities were quoted at the end of 1966 with total transaction value of 18. 1 million Naira, Government and industrial securities accounting for 90. 1 per cent and 9. 9 per cent respectively. Many factors contributed to the low level of performance in these early years.

Some of the identified factors include the lack of infrastructural facilities, the low level of awareness about the role of a stock market, and the reluctance of many companies to seek quotation on the exchange. Some of these problems still, linger in the capital market today thirty years after the establishment of the stock exchange. For a Stock Exchange to mobilize savings effectively and channel such savings to the most deserving sectors while promoting national integration and unity, it has to develop suitable strategies for access to savers and users of funds spread across the length and breadth of the country.

The decision to decentralize the exchange in 1977 clearly had this objective in view. The establishment of trading floors in Kaduna and Port Harcourt was quickly followed by decision of the council of the Exchange on certain policies aimed at dispensing relevant supporting facilities for example, the licensing of new stock broking firms specifically for the new trading floors and the encouragement given to existing firms to appoint agents and attaches located in the hinterland. From the Securities and Exchange Commission report, there were only 20 stock brooking firms in Nigeria as at 1985.

The figure rose to 21 in 1986, and as 1992 the number had risen to 140. Similarly, from the three trading floors at Lagos, Port Harcourt and Kaduna, new trading floors were opened in Kano, 1989, Onitsha, 1990 and Ibadan in 1990. The exchange has dual listing requirements; firms listed on the second-tier market are subject to less stringent listing conditions. The dual listing facility is designed to accommodate small and medium scale enterprises. The Securities and Exchange Commission is the main regulatory agency in the capital market.

It licenses stockbrokers and issuing houses, and investigates cases of abuse and ‘insider’ trading. Presently there exists in the capital market a network of brokers, investment bankers and brokerage firms (Table 5). 2. 2. 3 Regulatory Agencies The main regulatory agencies of the Nigerian Financial system are the Central Bank of Nigeria (CBN), the Nigeria Deposit Insurance Corporation, the Securities and Exchange Commission, the Federal Mortgage Bank and the Federal Ministry of Finance. The CBN regulates investment intermediaries and all depository institutions except mortgage firms.

It performs banking supervision and examination through examining books of accounts, and statutory returns submitted by regulated institutions. It also grants licenses, imposes reserve requirements, prudential guidelines and monetary policy guidelines; because of its mandate for overall economic management, the Central Bank has pervasive oversight responsibility over the entire Nigerian financial system. The rapid growth of new banks and other financial institutions in recent years has overstretched the capacity of the Central Bank to supervise financial institution.

The Nigerian Deposit Insurance Corporation was set up in 1989 to provide limited insurance coverage on the deposit liabilities of all licensed banks (including mortgage institutions) to a maximum of 50,000 Naira per depositor. It also conducts periodic checks of the books of insured institutions. The Federal Mortgage Bank of Nigeria is the principal regulatory and licensing agency for mortgage institutions while the Securities and Exchange Commission (SEC) regulates operations in the capital market.

It licenses stockbrokers and issuing houses. The National Board of Community Banks processes applications for the establishment of Community Banks. The regulation of the activities of Bureaux de Change and Insurance Companies come under the ambit of the Federal Ministry of Finance. The activities of the Nigerian Industrial Development Bank and the Nigerian Agricultural and Cooperative Bank come under the supervision of the Federal Ministry of Industries and the Agricultural Ministry respectively.

Concerns have been expressed in recent times about the implications of this preponderance of regulatory institutions for effectiveness. Areas of overlap have been identified particularly between the CBN and NDIC. 2. 2. 4 Informal Financial Sector This survey of major financial institutions will not be complete without a reference to the informal financial sector in Nigeria. Informal financial arrangements are very pervasive in the rural areas where formal rural credit still accounts for a very low proportion of the credit needs of the rural dwellers.

The situation can be better appreciated when it is realized that well over 65 per cent of the population of Nigeria dwell in the rural areas and as of 1977, prior to the commencement of the rural banking program, most of these people did not have access to formal banking system. Most of these institutions concentrate on deposit mobilization and safekeeping services. In spite of several attempts to extend credit to the rural areas through the formal banking system. Most of these institutions concentrate on deposit mobilization and safekeeping service.

In spite of several attempts to extend credit to the rural areas through the establishment of such rural financial institutions like the Community banks and the People’s bank, these institutions still thrive vigorously in the rural areas and enjoy more patronage than the formal financial institutions. In the Nigerian context, it is pretty difficult to separate the act of deposit mobilization and safe keeping of assets from the provision of credit. Rural financial institutions are engaged in both although emphasis tends to be more on the former. Most prominent among them are the Rotating Credit and Savings Associations (ROSCAS).

Others go by different names such as Esusu, money lenders and money collectors, and pawnbrokers. Their characteristic low information and transaction costs coupled with the easy access that they provide to low income groups who may not have access to formal finance are some of the factors that have continued to ensure their survival even in a very competitive environment. Their tenacity is a testimony to the often canvassed fact that for the rural dweller, the availability of financial services is of prime importance and that availability of credit is more important than its price (Popiel, 1994). . 3 FINANCIAL SECTOR REFORMS IN NIGERIA Attempts at reforming the financial sector in Nigeria have fallen under five main headings – reform of the financial structure, monetary policy reforms, foreign exchange reforms, liberalization of capital movement and capital market reforms. a) Reform of the financial structure: generally, measures undertaken here are designed to increase competition, strengthen the supervisory role of the regulatory authorities and strengthen public sector relationship with the financial sector. In this direction, some measures undertaken include: Enhancing bank efficiency through increased competition and management by granting licenses to more banks to operate. Conditions for the licensing of new banks were relaxed. In response, the number of banks increased dramatically from 40 in 1986 to 120 in 1992. A comparable increase in the number of non-bank financial institutions occurred. * Strengthening banks supervision and increasing their viability through adequate regulations regarding minimum capital requirements, specifying the range of assets and liabilities they can acquire, introduction of uniform accounting standards for banks to ensure accuracy, reliability and comparability.

Two banking laws were promulgated with effect from June 1991, the CBN Decree No. 24 of 1991 and the banks and other financial institutions Decree (BOFID), No. 25, 1991. In addition, the Nigerian Deposit Insurance Corporation (NDIC) charged with the responsibility of insuring banks deposit against bank failures and ensuring safe and sound banking practices through effective monitoring and supervision of banks in collaboration with the CBN was established whereby banks granted domestic loans on the security of foreign exchange deposits held abroad or on domiciliary accounts.

There was also the introduction of an auction-based system for the issuance of treasury certificates aimed at promoting a greater reliance on market forces in the determination of yields on government debts instrument through market determined interest rates and the decision by the Federal government to sell its share-holdings in some commercial and market banks thereby reverting such banks to private ownership. b) Monetary policy reforms: designed mainly to stabilize the economy in the short run and to induce the emergence of a market-oriented financial sector. Such included: * Rationalization of credit controls: although credit ceilings on banks were not completely removed, the sector specific credit distributions target were compressed from 18 in 1985 to 2 in 1987 – priority (agriculture and manufacturing) and non-priority (others).

Other credit measures enacted were the elimination of exceptions within the ceiling on bank credit expansion, giving similar treatment to commercial and merchant banks in relation to required liquidity ratios and credit ceiling, the modification of cash reserve requirements which is now based on the total deposit (demand, savings, and time deposits), rather than on time deposits only, and the reintroduction of stabilization securities. These are non-negotiable and non-transferable debt instruments of the Central Bank which banks are mandated to purchase at intervals in order to control their excess reserves.

It was designed to mop-up the excess liquidity of the banking system. * Deregulation of interest rates: in January 1987, a partial deregulation of interest rates was attempted, but by August, all rates became market determined. The CBN adopted the system of fixing only its minimum rediscount rate to indicate the desired direction of interest rates changes. Interest rate liberalization was aimed at enhancing the ability of banks to charge market based loans rates and also guarantee the efficient allocation of scarce resources.

In 1989, banks were encouraged to pay interest on current account deposits. The rate to be paid was to be negotiated between banks and their customers. * The shift from direct to indirect system of monetary control: in June 1993, open-market operations (OMO) were introduced. Under the scheme, OMO was to be conducted exclusively through licensed discount houses, which are supposed to constitute the open market for government securities. The introduction of OMO was meant to replace the use of direct controls for managing liquidity in the economy. c) Foreign exchange market reforms: transactions in foreign exchange constitute an important aspect of financial sector activities. A second-tier foreign exchange market was established in 1986 as an auction forum for the sale and purchase of foreign exchange. Previously, the sale and purchase of foreign exchange was rigidly controlled through the use of import licenses and the exchange rate was fixed by fiat. This resulted in an overvaluation of the Naira with its attendant consequences. In order to restore appropriate exchange rates, the authorities began the auction sales of foreign exchange to licensed dealers.

A first-tier market was retained to take care of transactions related to government debt-servicing, contributions to international organizations and transfers to Nigerian missions abroad. In 1988, the government permitted the establishment of private foreign exchange and to accord recognition to small dealers in foreign exchange. (d) Liberalization of capital movement: with the deregulation of the foreign exchange, all existing restrictions on capital transfers were abolished. All that was needed was for evidence of importation and exportation to be provided to the Federal Ministry of Finance.

In addition, all applications for capital transfer abroad were to be backed by appropriate documents and settled at the appropriate exchange rate. (e) Capital market reforms: capital market reforms are in two parts. First, we have measures undertaken as part of the structural adjustment program which had some impacts on the capital market. Among such measures are: * interest rate deregulation * privatization: the privatization of erstwhile public institutions which started under the reform program debt conversion program: debt swaps were first developed as part of the restructuring program of Nigeria’s external debt which reached a crisis proportion with the structural adjustment program. Debt to equity swaps has had some impact on the capital market since they are a form of securitization. Second, there are reform measures aimed principally at the capital market. These include: * deregulation of the capital market: an inter-ministerial committee was set up in 1991 to examine ways of carrying out the proposed deregulation.

The main focus is the on-going deregulation of securities pricing with the intention of stimulating competition and enhancing investment in the market * the reconstitution of the Securities and Exchange Commission * tax policies: the reduction of the withholding tax on dividend, and the reduction of the fiscal burden with respect to the proceeds and yields from debt and equity, although much still needs to be done with regards to the latter * regulatory measures: these include measures aimed specifically at alleviating the difficulties involved in listing, disclosures and checking insider trading.

Since the concern of this work is mainly with monetary policy, we now devote the following section to the examination of monetary policy in Nigeria before the reform programme. 2. 4 THEORTICAL FRAMEWORK Finance affects economic growth, stagnation or even decline in any economic system. Financial resources are mobilized and channeled to economic activities by financial institutions or financial intermediaries who channel these resources from surplus economic units to deficit economic units. In doing this, they evolve appropriate structures necessary for the intermediation functions which they perform.

Various studies have shown that there is a strong and positive relationship between the financial sector and economic development. According to Porter (1966) the level of financial institution development is the best indicator of general economic development. Furthermore, Goldsmith (1969) contends that financial institution development is of prime importance for real development because the financial superstructure in the form of both primary and secondary securities accelerates economic growth and improves economic performance to the extent that it facilitates the migration of funds to the best user.

This refers to the place in the economic system where the funds will yield the highest social return. In his empirical study, as reported by Nzotta (2004) Goldsmith calculated the values of the financial interrelation ratio (FIR), the ratio of all financial instruments at a given time, to the value of the national wealth. He found that the ratios for developing countries were far lower than those of developed countries and concluded that because the development of financial institutions affects development, the low level of development of the financial superstructure affects development negatively.

The views above are supported by the development hypothesis theory. The supporters of this theory believe that the lack of a developed financial infrastructure restricts economic growth. Thus, the focus of policy at each point in time should be to ensure that the financial system operates efficiently such that the real sector will receive the necessary support. The acceptance of the hypothesis theory made economic theorists to conclude that a measure of intervention is important and in fact necessary for meaningful growth.

Various policies should thus be put in place to encourage and promote the activities of financial institutions in this regard. This gave rise to the financial repression theory. This theory is usually associated with the work of McKinnon (1973) and Shaw (1973). The implication of their studies is that financial development would contribute most significantly to economic growth, if monetary authorities did not interfere in the operations of financial institutions and the financial infrastructure generally.

The studies by McKinnon and Shaw observed that financial repression is correlated with sluggish growth in developing countries. Such economies, according to Nnanna and Dogo (1998) are typically characterized by high and volatile inflation and distorted interest and exchange rate structures, low savings and investments and low level of financial intermediation, as interest rates do not reflect the cost of capital- Various studies investigated the relationship between financial system structure and development and the level of economic growth in Nigeria.

These studies include Akinlo and Akinlo (2007) Ayadi et al (2007), Ndebbio (2004) Oyejide (1998) Edo (1995), Ogun (1986). The studies relied on money market indicators and established a positive and significant relationship between financial development and economic development. (Nwaogwugwu: 2008) Financial deepening is very often used in development studies and refers to the increased provision of financial services with a wider choice of services geared to the development of ail levels of society. The World Bank (1932) further contends that financial deepening encompasses the increase in the stock of financial assets.

From this perspective, financial deepening implies the ability of financial institutions in general, to effectively mobilize financial resources for development. This view accepts the fact that a financial system’s contribution to the economy depends on the quality and quantity of its services and the efficiency with which it performs them. Popiel (1990) conducted one of the most elaborate studies on financial deepening. According to him, financial markets are deep from a qualitative standpoint when: They offer savers and investors a broad range of financial instruments which differ in terms of liquidity, yields, maturities and degree of risk including debt instruments, equity instruments and in between quasi-equity instruments. • They encompass a diversity of sub-markets, trading in different financial instruments. • Mature, domestic financial markets are integrated into the international financial markets. • Are linked together through financial instruments. • Finally, the markets are linked together through various financial institutions which function as market makers and financial intermediaries.

The conclusions of Popeil above agree with the views of Shaw (1973) who contends that financial deepening is an outcome of the adoption of appropriate real finance policy and the broadening of the markets. The attempt to affect this in Nigeria resulted in the deregulation of the financial system in 1986 and the various reforms in the financial system since then. Financial deepening implies the ability of financial institutions to effectively mobilize savings for investment purposes. The growth of domestic savings provides the real structure for the creation of diversified financial claims.

It also presupposes active operations of financial institutions in the financial markets, which in turn entail the supply of quality (financial) instruments and financial services (Ndekwu. 1998: 14). The views above conform to the conclusions of a study by Nnanna and Doga (1999) that financial deepening represents a system free from financial repression. Their findings in this study is that policies of financial repression aimed at encouraging domestic investments through suppressing interest rates produced negative results.

Here, negative real interest rates did not encourage greater investments but rather encouraged the banks to be more risk averse and more hesitant to lend. On the other hand, when interest rates are more market oriented and less negative in real terms, bank lending increases and same to domestic investments and national savings. Financial deepening generally entails an increased ratio of money supply to Gross Domestic product Popiel (1990), Nnanna and Dogo (1999) and Nzotta (2004). Financial deepening is thus measured by relating monetary and financial aggregates such as M1, M2 and M3 to the Gross Domestic Product (GDP).

The logic here is that the more liquid money is available to an economy, the more opportunities exist for continued growth of the economy. How does this come about? Deep and mature financial markets are indispensable for economic development Olofin and Afangideh (2008) Arestic (2001) and Levine (2002). I t is also instructive to note that the study by Nnanna and Dogo found that the depth of the Nigerian financial market remained fairly shallow up to 1983. The financial deepening index grew between 1987 and 1997.

The results of their study showed a positive serial correlation between financial deepening and six explanatory variables. From the literature, we can summarize the reasons why financial deepening is poor in developing countries as including the low level of foreign direct investments, shallow capital market, distortions in interest rate, and weak association between financial openness and financial deepening. Ju and Wei, (2007), recently the low level of corporate governance in financial institutions has also sustained poor financial deepening in the system. (Nzotta,2006).

Moreover, in a world of friction less capital markets and various levels of country risks, the least developed financial system is completely bye-passed by international investment flows. Thus, a developing country with poor financial infrastructure may experience large outflows of foreign capital, Yan (2007). These issues explain why financial deepening is not progressing fast in Nigeria and most of the poor countries of sub-Saharan Africa and South East Asia. CHAPTER THREE 3. 0 RESEARCH METHODOLOGY 3. 1 INTRODUCTION This chapter investigates the relationship between financial deepening and Nigeria economy.

Furthermore, we shall utilize time series data to investigate the impact of financial reforms on the Nigeria economy. We believe that the appropriate variables for this study are gross domestic product as the dependent variable and bank lending rate, financial savings, value of cheques, deposit money Bank, Currency Outside Bank as the exogenous variables. Actual figures for these variables were sourced form different publications of the National Bureau of Statistics (NBS); Central Bank of Nigeria (CBN) among others covering the period 1975 to 2009 ( a period of 34 years) to ascertain the impact of financial deepening on Nigeria economy.

We adopted the ordinary least square method in estimating the model that is to be specified. This method will be chosen because it possesses some optimal properties (The optimal properties are BLUE that is, it is best to use, linearity, it is unbiased in nature and it is efficient) in estimating linear regression model. If financial saving, value of cheques and deposit of money bank to the economy leads to the growth of the gross domestic product, we aspect a positive relationship between financial deepening and Nigeria economy.

In the same vein, Bank lending rate and Currency outside bank are expected to have negative relationship with the gross domestic product, this is so because a rise in bank lending rate serves as a disincentive to investment and hence a reduction in real GDP. Also a huge currency outside bank control has a negative impact on the growth of the GDP. Based on the variables defined above, we test whether a statistically significant relationship exist between the exogenous variables and the gross domestic product. In order to achieve this objective, we employ the OLS method earlier mentioned.

The choice of this model is based on existing empirical evidence that it produces reliable and consistent estimates as long as the underlying assumptions. 3. 2 THEORETICAL MODEL Having defined the variables that will be used in establishing the relationship between bank lending rate, financial saving, value of cheques, deposit money bank, currency outside bank and gross domestic product, we need to quantify the magnitude of the variation among the explanatory variables. This is done with the use of multiple regressions. That is one regression equation is fitted fire one model. . 2. 1 MODEL SPECIFICATION Following the above, we specify a simple model based on the variables defined as follows: MODEL 1 GDP= ? 0+? 1BLR+? 2FS+? 3VOC+? 4DMB+? 5COB+µi Where GDP – Gross Domestic Product BLR – Bank Lending Rate FS – Financial Saving VOC-Value of Cheques DMS-Deposit Money Bank COB-Currency Outside Bank ?0, ? 1, ? 2, ? 3, ? 4 and ? 5- Parameters µi – Error term In line with economic methods, we specify our models expressing it as follows: GDP= ? 0+? 1BLR+? 2FS+? 3VOC+? 4DMB+? 5COB+µi ?0;gt;0? 10? 30? 5