THE IMPACT OF FINANCIAL LIBERALIZATION ON THE PERFORMANCE OF DEPOSIT MONEY BANKS (DMBs) IN NIGERIA, 1975-2013

ABSTRACT

This study examines the overall impact of Financial Liberalization on the Performance of Deposit Money Banks (DMBs) in Nigeria. The study is specifically directed towards analyzing the rationale of executing a financial liberalization policy; preparing an account of the evolution, process and sequencing of the financial liberalization; and evaluating the impact of the various liberalization measures on key performance variables of DMBs. Most of the previous studies focused on the economic growth aspect of financial liberalization and yet, very little is known empirically about its impact on profitability, credit to the private sector and deposit growth of DMBs. To bridge this gap, a financial liberalization index has been developed to evaluate all of the three dimensions of DMBs in Nigeria. Time series annual data from the period 1975-2013 are employed. The time series annual property of the data is analysed using the Ordinary Least Squares (OLS) technique. The research utilizes an autoregressive distributed lag to co-integration approach (ARDL-ECM) to evaluate the impact. The result of the analysis of the study reveals that financial liberalization in Nigeria has brought a mixed impact. Financial liberalization does not lower profitability of DMBs in Nigeria due to high reserve ratio and heavy investment in stabilization securities. It is also found that deregulation fails to increase credit availability to the private sector as a result of increasing dosage of stabilization securities, high lending rates and the paucity of loan supply. Furthermore, accelerated deposit growth experienced by DMBs during the deregulation is occasioned by changes in the overall liberalization package, rising per capita income, government deficit spending and per capita bank branch. These results suggest that the government should fine tune the various policies in the liberalization package in order to enhance the performance of deposit money banks in Nigeria.

CHAPTER ONE

INTRODUCTION

1.1               Background to the Study

In a number of developing countries of the world the financial system is highly regulated. This is because of the pivotal position the financial industry occupies in these economies. An efficient system, it is widely accepted, is a sine qua non for economic growth and efficient functioning of a nation’s economy. Thus, for the industry to be efficient, it must be regulated in view of the failure of the market system to recognize social rationality and the tendency for market participants to take undue risks which could impair the stability and solvency of their institutions.

However, the highly controlled state of the financial system in developing countries pulled the private sector back from playing an active role in the economy. The government controlled the interest rates and credit ceilings, owned banks and other financial institutions, and framed regulations with a view to making it easy for the government to acquire financial resources at a low cost. Since the nominal interest rate was controlled and the real interest rate mostly remained negative, savings could not be encouraged. As a result, investment could not increase to the desired level. This ultimately slowed economic growth.

In 1973, McKinnon (1973) and Shaw (1973) identified this problem of financial repression in developing countries and argued for a liberalization of the financial system. The standard economic theory suggests that liberalization strengthens financial development, leads to a more efficient allocation of resources, higher level of investment and higher long-run economic growth of the economy (Levine, 2001; Bonfiglioli and Meadicino, 2004). On the other hand, financial repression forces financial institutions to pay low and often negative real interest rates, reduces private financial savings thereby reducing the resources available to finance capital accumulation.