The objective of financial deregulation is to improve the broad economic performance towards sustained economic development through increased competitive efficiency within the financial system thereby channelling resources to the real sector of the economy. However, since the introduction of financial liberalization, Nigeria’s economy has failed to witness impressive results such as attraction of foreign investment and containing capital flight. Empirical evidence in Nigeria indicates that neither the domestic savings nor investment have increased remarkably since the introduction of the broad-based structural reform package.
Needless to emphasize that since 1986, the banking industry has witnessed considerable structural changes coupled with attracting due attention from the banking public as well as the regulators and monetary authorities. Liberalization, therefore, created a vista of expansion and intense competition within and between the commercial and merchant banks in the banking sector. From a total of 40 banks in the existence in 1986, the number had increased to over 120 by 1991. Despite this remarkable growth in the number of banks during the liberalization era, the sector’s capacity to supply credit to the economy has been constrained. This might not be unconnected with widespread distress in the banking sector that occurred in the early part of the 1990s.
Among the several factors adduced to have worsened, the deterioration in the financial state of distressed banks is insider abuse, mismanagement and outright fraud [7, 31]. Other factors are excessive competition which erodes franchise value , portfolio structure and composition and economic downturn, capital inadequacy (which is a critical factor inhibiting banks’ solvency and ability to supply credit , policy sequencing and instability .
Moreover, during this era of deregulation of the financial system, interest rates fluctuated greatly and the Naira depreciated continuously. This unusual volatility in interest and exchange rates severely constrained the banks’ ability to supply credit. For instance, the gap between the lending and savings deposit rates began to rise since 1994 and reached a high point of 17% in 1998. Similarly, exchange rate depreciated significantly from 21.9% in 1994 to 81.2% in 1995 and hovered around 85.6% in 1998. Subsequently, it became obvious that banks could no longer afford to offer the growing interest rates and borrowers could no longer repay the loans with the high interested rates. This culminated in a steady build-up of non-performing loans and advances, diminished supply of credit, capital erosion and above all liquidity crises in the banking industry.
Furthermore, the high rates of inflation aggravated the situation by making real interest rates to become negative. At that period, people preferred to invest their surplus funds in tangible goods than keeping their money in banks. This eventually created a process of dis-intermediation with depositors having preference for inflation hedges. The cumulative impacts of these distortions on the economy seemed enormous. Although real gross domestic product (GDP) growth rate was still positive in 1993 (during the era of chronic banking crisis), the growth per capita has been negative or at best very low.
Consequently, by 1993, seven banks consisting of six commercial banks and one merchant bank and 19 other banks in 1995 were taken over by the regulatory authorities and placed under the control of Interim Management Boards, while other banks experiencing deteriorating financial conditions were placed under close surveillance and imposed to various holding actions. In 1994, for the first time in decades, the Central Bank of Nigeria (CBN) ordered the closure of some banks and non-bank financial institutions considered to be “terminally distressed”. These included one commercial bank, three merchant banks and twenty finance houses. Furthermore, the number of banks adjudged to be technically insolvent rose from eight in 1990, to 34 in 1994 and to 54 in 1995. The systemic financial distress soon pervaded the primary mortgage institutions and community banks with reported cases of closure due to contravention of contractual obligations. Thus, the supervising authority for community banks declared that 200 of such banks were experiencing symptoms of financial failures as at September 1995 .
By 2002, the CBN adopted a medium-term policy framework to free monetary policy from the challenges of time inconsistency and reduce over-reaction to temporary shocks. By 2005, in order to sanitize and restructure the financial system, the CBN came with the banking sector consolidation aimed at recapitalizing the banks and achieving a stable and sustainable financial system that would energize the real sector of the economy. However, in 2009 with the emergence of the global financial crisis, the gains that were realized through the 2004/2005 Nigerian banking sector consolidation have been strained. The global financial meltdown adversely impacted the Nigerian financial industry particularly the banking sector. Obviously, a section of the banking sector was grossly affected as some banks were in dismal conditions and faced acute liquidity problems, due to their marked exposure to the capital market in the form of margin loans and share-backed lending, which stood at about N900 billion as at the end of December 2008. This amount represented about 12% of aggregate credit of the sector or 31.9% of shareholders’ funds.
The excessive exposure culminated in some weaknesses; specifically, liquidity problems were manifested by some banks towards the end of 2008. As part of its liquidity support, the CBN Discount Window was broadened in October 2008 to accommodate money market instruments such as commercial papers and bankers’ acceptances. As at June 2009, the banks’ total commitments under the expanded discount window (EDW) was over N2,688.84 billion, while the outstanding commitments was over N256 billion, most of which were owed by less than half of the banks in the system. When the CBN closed down the EDW and replaced it with the guaranteed inter-bank placements, it was discovered that the same banks were the main net-takers under the guarantee scheme, revealing that they had more deep-seated liquidity problems.
It was against this ugly scenario that the CBN took a bold step to strengthen the industry with a view to safeguarding depositors’ and creditors’ funds, securing the integrity of the industry and restoring public confidence. To this end, the CBN removed the Chief Executives/Executive Directors of the banks identified as the source of instability in the sector and injected the sum of N620 billion into the banks in order to contain a systemic crisis. Efforts was also put in place to recover the non-performing loans from banks’ debtors, while guaranteeing all foreign credits and correspondent banking liabilities of the affected banks.
From the foregoing, it would be difficult to infer whether or not financial liberalization has been beneficial, and also determine its relationship to resource mobilization, credit allocation, and economic growth in Nigeria. Also much criticism of financial liberalization has been based on the assumption that markets, if left unregulated, will work reasonably efficient. Another important critique has been predicated on one of the critical assumptions that for the financial liberalization and growth link to work, savings would increase following an increase in interest rate induced by liberalization, which spurs credit to private sector and invariably economic growth. However, there is no unanimous agreement on this issue. The relationship is complex not only because there are short- and long-term effects involved, but also financial liberalization is a process with many dimensions. Given all the ambiguities about the outcomes of the financial process, it is relevant to ask what systematic, country-specific evidence reveals on the questions of what happens to key macroeconomic and financial development variables following domestic and external financial liberalization in Nigeria? On the debate of the impacts of financial liberalization, it is critical to evaluate and ascertain within Nigeria’s context if liberalization has fostered effective mobilization of resources, efficient financial and credit allocation and ultimately economic growth considering the lingering issues of weak corporate governance and bank ethics, loans/credit appraisal and misappropriation, failing banks, and government take-over, bearish capital market and the derailing of public confidence in the financial system.
While numerous studies have been conducted, no consistent evidence exists for a significance relationship between financial liberalization and economic growth, in a positive or a negative direction. Results and evidence differ by countries/region, analytical method employed and time frame. This study aims at examining the relationship between financial liberalization and economic growth in Nigeria covering the period 1981–2013, and this will assist the policy makers on the nature of relationship between financial liberalization and economic growth in Nigeria.
The remainder of the paper is organized as follows. “Brief review of literature” section deals with the literature review. In “Underlying theory” section, the theoretical underpinnings of the paper are exposed, while the methodological framework of the study is pursued in “Methods and data” section. The empirical results are discussed in “Results and discussion” section, and “Conclusion” section concludes the paper.