IMPACT OF FINANCIAL INTERMEDIATION BY DEPOSIT MONEY BANKS ON THE REAL SECTOR OF THE NIGERIAN ECONOMY (1980 – 2012)
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IMPACT OF FINANCIAL INTERMEDIATION BY
DEPOSIT MONEY BANKS ON THE REAL SECTOR OF THE NIGERIAN ECONOMY (1980 – 2012)
Abstract
The
objective of the study is to examine empirically the impact of financial
intermediation on the real sector of the Nigerian economy with the aim of
determining the impact of financial intermediation on the real sector growth.
Both theoretical and econometric analysis are used in this study to examine the
impact of financial intermediation on the real sector growth; using real GDP
growth rate as the dependent variable and credits to private sector (CPS), average
manufacturing capacity utilization (AMCU) and inflation rate (INFR) as independent
variables from 1980-2012. The study employs time-series methods of unit root
test, co-integration test and vector error correction (VEC) model. The study
establishes that credit to private sector contributes significantly to real
sector growth in Nigeria. The study also establishes that both average
manufacturing capacity utilization and inflation rate do exert any significant
effect on real sector growth in Nigeria. The Adjusted R-squared value is 0.99.
The study recommends that public policies to stimulate the supply of basic
infrastructure, reward DMBs for providing large loans to private sector,
improve security of lives and properties and discipline monetary and fiscal
policies in order to enhance real sector growth.
CHAPTER ONE
INTRODUCTION
1.1 Background to
the Study
The
function of deposit money banks is the mobilization of savings for investment.
The importance of banks in influencing economic growth within an economy is
widely acknowledged. Schumpeter (1932) as cited in Blum, Federmair, Fink and
Haiss (2002) identified bank’s role in facilitating technological innovation
through their intermediary roles. He believes that efficient allocation of
savings through identification and funding of entrepreneurs with the best
chances of successfully implementing innovative products and production
processes, are tools to achieve a real growth.
According
to Blum, etal (2002), financial intermediation is the process of transferring
the savings of some economic units to others for consumption or investment at a price. For financial intermediation
to take place there must be instruments and financial institutions operating
together with the objective of bringing about economic growth of the country. Black
(2002) defines financial intermediaries as firms whose main function is to
borrow money from one set of people and lend it to another. Financial Intermediary
institutions consist of banks and non-bank loan suppliers such as Finance
companies, mortgage lenders and development finance institutions.
Many
researchers have identified a theoretical relationship between financial
intermediation and the real sector (the output and services sector of the
economy), for instance, Smith (1976) cited in Blum, et al (2002) express the
view that the high density of banks in the Scotland of his times was a crucial
factor for the rapid development of Scottish economy. Schumpeter (1932) cited
in Blum, et al, (2002) argued that the creation of credit through the banking
system was an essential source of entrepreneur’s capability to drive real
sector growth by funding and employing new combinations of factor use.
Many
researchers (for example, Goldsmith, 1969; McKinnon, 1973; Shaw, 1973; Fry,
1988; and King and Levine 1993) have pointed out the significance of banks to
the growth of the economy. In examining the relationship, a number of recent
empirical studies (for example, Azege, 2004; Levine, 2005; and Ayadi, Adegbite,
2008) have relied on measures of size of financial intermediaries to provide
evidence of a link between financial system development and economic growth.
This used macro level data such as size of financial intermediaries relative to
Gross Domestic Product (GDP) to determine the impact of financial development
on economic growth. In particular, Ayadi, and Adegbeti (2008) established a
positive relationship between financial development and economic growth in
Nigeria for the period of 1986 – 2005.
Also
there are many other studies that investigate the relationship between
financial intermediation and real sector growth in Nigeria. Notable among them
are; Azege (2004); Ndebbio (2004); Ayadi, et al, (2008); Agu and Chukwu (2008);
Adbullahi (2009); and Nzotta and Okereke (2009), but the results of these
studies are divergent. The divergence seems to emanate from the different
estimation procedures and the data used for analysis. These results are
deficient in that they did not attempt to evaluate the causality between
financial intermediation and real sector growth in Nigeria. They merely examine
the correlation between financial intermediation and real sector. Another
observed weakness of these previous studies is that they did not discuss the
implications of the relationship that exist between finance and real sector
growth. These studies also did not give the specific implication of each
variable of financial intermediation on the real sector activities in Nigeria.
This means there is a gap in the literature which needs to be covered by
research.
This
study is an attempt to cover the gap that exists in this area of study by
examining empirically, the impact of financial intermediation by banks on the
real sector growth of the Nigerian economy.
1.2 Statement
of the Problem
The
financial intermediaries of the Nigerian economy are expected to be responsible
for financial resource mobilization and intermediation between the various
sectors of the economy. They are to redirect funds from the surplus sectors to
the deficit sectors of the economy. The financial intermediaries are supposed
to provide the funds used as capital inputs by producers in other sectors of
the economy as well as the final consumers. The impact of the delivery of these
financial services in the form of capital to the producers and individuals is
felt both in the short-run and in the long-run. Therefore, the financial
sector, especially the banking sector is very important in effective
functioning of the real sector of the economy.
The
real sector of the economy forms the main driving force of the economy. It is
the engine of economic growth and development. Largely, the real sector depends
on the banking sector for the provision of the required funds for investment
purposes. Thus, it means that an increase in the bank lending to the real
sector will increase the activities of the real sector and vice versa (Blum,
etal, 2002). Based on the assumption that the banking sector plays an important
role in financing the real sector, successive government in Nigeria have
carried out reforms and institutional innovations in the banking sector with
the aim of ensuring financial stability of the sector so as to influence the
growth of the economy and also to ensure that banks plays the critical roles of
financial intermediation in Nigeria. In particular, the bank consolidation
exercise in 1986 has drastically shaped and positioned the banking sector to
the important role of financing the real sector to bring about the growth of
the economy.
However,
despite the series of reforms and restructuring aimed at strengthening the
bank’s ability to efficient service delivery and branch networking and fund the
real sector, problems still persists such as; decline in domestic credit by the
banking sector to the private sector, there is also a considerable liquid
mismatch in the Nigerian economy (CBN, 2007).
Another
problem is that of high concentration of loans to few sectors of the Nigerian
economy to the detriment of other sector. According to CBN, (2007), there is a
high concentration of loans to oil and gas and communication sectors with
credit exposures within the banking sector remaining predominantly short-dated
(at less than 12 months) highlighting the bank relative lack of long dated
funding. Similarly, there is a significant mismatch (Hashim, 2011) between
where credit is supplied (by sector) and the main contributors to the GDP (by
sector). For example, although agriculture is the largest contributor to the
Nigerian’s GDP (42% of total GDP in 2007), only 3% of bank credit exposure is
to the agricultural sector in 2007. When compared to the communication sector
which contributed only 2.38% of total real GDP in 2007 was supplied with 24% of total credit to the
private sector in 2007 (CBN, 2007). Therefore, the problem remains that the
real sector is yet to be effectively linked to the financial intermediaries in
the country.
1.3 Research
Questions
The study attempts to answer the
following questions:
i)
To what extent does credit to the private
sector by DMB impact on the real sector growth in Nigeria?
ii)
To what extent does rate of average
manufacturing capacity utilization (AMCU) affect the real sector growth in
Nigeria?
iii)
To what extent does inflation rate of the
domestic economy affect the real sector growth in Nigeria?
1.4 Objectives
of the Study
The
broad aim of the study is to examine whether financial intermediation have any
impact on the real sector growth in Nigerian economy. The specific objectives
are:
i)
To determine whether the credit to the
private sector by deposit money banks (DMBs) have contributed to the growth of
the real sector in Nigerian economy.
ii)
To examine the impact of average
manufacturing capacity utilization (AMCU) on the real sector growth of the
Nigerian economy;
iii)
To investigate the effect of inflation rate
in the real sector growth in Nigerian economy.
1.5 Statement of
Hypothesis
This
study examines the impact of financial intermediation on the real sector of
Nigeria. To achieve this aim, the following null hypotheses are formulated:
i.
Credit to private sector by deposit money
banks (DMBs) has no significant impact on real sector growth in Nigeria;
ii.
Average manufacturing capacity utilization
has no significant effect on real sector growth in Nigeria;
iii.
Inflation rate has no significant influence
on real output growth in Nigeria.
1.6 Significance
of the Study
The
Nigerian financial sector particularly the banking sector have undergone
several reforms and restructuring aimed at improving the efficiency of
financial intermediation, financial deepening and the promotion of real sector
activities. Against this background, it becomes necessary to examine the impact
of financial intermediation on the real sector growth in Nigeria.
Again,
despite the fact that there were previous studies that investigated the
relationship between financial intermediation and real sector growth in
Nigeria, this very study is different and important because it tries to
overcome the deficiencies of previous studies by linking the real sector growth
with financial intermediation, as represented by credits to the private sector
by deposit money banks, average manufacturing capacity utilization and
inflation rates. This study is unique as no previous study has done this, as
far as this study knows. The study is also significant because it adds to
literature by empirically examining the significance of financial
intermediation in inducing real sector growth in Nigeria.
1.7 Scope and
limitations of the study
In
examining the role of financial intermediation on the real sector growth of the
Nigerian economy, the study makes use of time series data of the banking sector
in relation to the real sector for the period 1980 – 2012.
The
limitations of the study is that the period of time used in the analysis covers
only the period 1980 – 2012; and the variables for analysis are limited to credits
to private sector by deposed-money banks, average manufacturing capacity
utilization and inflation rates in the Nigerian economy. There could be other
variables that may be relevant to this study but they are not taken into
account.
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