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This study assessed the impact of the liberalization of the Nigerian financial system on the structural changes witnessed in the system as a result of liberalization as well as the impact of the resulting structural change on economic growth using a three stage least in a system of three endogenous variables. System of equations was used to capture the transmission mechanism of financial liberalization as contained in the McKinnon and Shaw financial repression hypothesis with annual data from 1986 to 2012. The study found that the Nigeria financial system had undergone major changes in term of both nature and composition. Liberalization further helped in creating a diversified financial system which is vibrant and robust, though deposit money banks still dominate the sector in term of asset base and branch network. Also, this study found that financial structure has a positive impact on savings as well as on economic growth. In addition, both capital market-base and bank-based financial structure have similar impact on both investment and growth thereby relegating the capital market-base versus bank-based argument to the background and favour of the financial market-based view. Therefore, this study recommends that the liberalization of the Nigerian financial system should be sustained and economic policies should be directed at enhancing growth of the financial system.
1.1. Background to the Study
Several arguments have been put forward about ways of improving the standard of living through a sustained growth process. This development has elicited paradigm shift in economic growth strategies and policies especially in developing economics and new frontiers were being explored to achieve economic growth.
The important role of finance in the process of economic growth and development was brought to lime light by the works of Bagehot (1873) and Schumpeter (1911). They pointed out the productivity and growth enhancing effects of services provided by a developed financial sector. They posit that the industrial revolution in England was the result of a functioning financial system that was instrumental in mobilizing and allocating long-term capital to the productive enterprises of the country. They argued that financial intermediaries play a crucial role in fostering technological innovation and economic growth by providing basic services such as mobilizing savings, monitoring managers, evaluating investment projects, managing and pooling risks, and facilitating transactions.
The seminal works of McKinnon (1973) and Shaw (1973) supported
Schumpeter‟s view of promoting the development of financial sector to
achieve economic growth. They criticized the financial repressionists‟
view adopted by many governments in developing countries in the early
1970s. The traditional justification for financial repression is that it
is presumed to increase the rate of economic growth. This argument is
based on the assumption that money and real assets are perfectly
substitutable, that increasing returns in real asset markets relative to
money market instruments will induce a change in investor behaviour, so
shifting investment out of money market into capital investment.
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