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Background to the Study                                                                                                    

The theoretical argument that supports the link between financial development and growth is that a well developed financial system performs several critical functions to enhance the efficiency of intermediation by reducing information, transaction, and monitoring costs. A well developed financial system enhances investment by identifying and funding good business opportunities, mobilizes savings, enables trading, hedges and diversification of risks, and facilitates the exchange of goods and services. These functions result in a more efficient allocation of resources, rapid accumulation of physical and human capital, and faster technological progress, which in turn results to economic growth.

An efficient financial system is one of the foundations for building sustained economic growth and an open, vibrant economic system. In the early neoclassical growth literature, financial services played a passive role of merely channeling household savings to investors. Nevertheless, Demetrides and Andrianova (2004) as structured in the works of Goldsmith (1969) and Mickinnon (1973) were among authors who offered a contrary view. They proposed a more role for financial services in promoting growth. Ever since, substantial volume of theoretical and empirical literature has emerged, analyzing the role of finance in growth and development. The success of the financial

System throughout the world has been predicted on the initiation of financial sector reforms.

The Nigerian financial system can be broadly divided into two categories namely: the formal financial system and the informal financial system. The formal financial system can be further subdivided into capital and money market institutions and these comprise the banks and non-bank financial institutions. The informal sector comprises the local money lenders, the thrifts and savings associations etc. Prior to 1986 the activities of these institutions were regulated by the Federal Ministry of Finance (FMF), Central Bank of Nigeria (CBN), Nigerian Deposit Insurance Corporation (NDIC), Securities and Exchange Commission (SEC), National Insurance Commission (NIC), Federal Mortgage Bank of Nigeria (FMBN), and the National Board For Community Banks. But following the collapse of the world oil market in the late 1970s, there was a drastic reduction in earnings from crude oil as a result of which the country began to experience a severe economic downturn.                                                                                  In 1981, Nigerian government adopted various austerity measures such as price control and demand management policies. However, by December 1985, it became evident that austerity measures without a proper structural adjustment were inadequate response to the fundamental economic problems confronting the economy. Consequent upon the foregoing, the Nigerian government initiated a series of reform measures aimed at bringing about economic growth and stability in 1986. Paramount among these policies was the financial sector liberalization. The aim of initiating these reforms is to create a more efficient and stable system, which will facilitate optimum performance in the economy.  This  means providing a foundation for implementing effective stabilization policies and successfully mobilizing capital and putting it to effective use, which leads to achieving higher rates of economic growth (Johnston and Sundararajan, 1999). Many countries have experienced successful financial sector reforms which have been accompanied by improvements in economic growth and efficiency of the financial system, while other countries have faced financial crises and disruptions to economic growth.

The essence of emphasis on the development of the Nigerian financial sector is in the theory of financial repression which posits that efficient utilization of resources via a highly organized, developed and liberal financial system enhances economic growth. This thesis, more or less, confirmed the conclusions of earlier works on the importance of the financial system which could be traced back to the works of Schumpeter (1912) as put forward by Masten (2008) and Arcandi (2012). Further enhancements to this hypothesis were explored in the works of Galbis (2011).This school of thought is classified as supply-led theory of finance-growth nexus. While there is a near consensus that a well-functioning financial sector is a precondition for the efficient allocation of resources and the exploitation of an economy’s growth potential, the economic literature is less consensual on how and to what extent finance affects economic growth.                   This, invariably, culminated in the emergence of demand-led theory of finance-growth nexus. Recent developments in some economies around the world seem to provide support for this school of thought. Specifically, the rapid growth of many Asian economies was accomplished despite a domestic financial sector that could not be regarded as developed (Shan, 2001).This observation also holds for China (Lardy, 1998). With an average real GDP growth of 13.5 percent between 2005 and 2007, China’s economic performance is extremely difficult to reconcile with the widespread view that its repressive financial system grossly distorts the optimal allocation of loan able funds and is, therefore, inefficient. In view of this puzzle, some empirical analysis is required at country level to examine whether it is the development of the financial sector that leads to economic growth or vice versa. Time series studies have been conducted on U.S, U.K, Japan, Netherlands and Canada towards resolving this issue (See: Wachtel and Rousseau (2005); and Lee and Wong (2005)). However, not much has been done on Africa, in general and Nigeria, in particular.

1.2 Statement of Problem

The financial system play 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 (2009) 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. Yet, 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 Nigerian financial sector, like those of many other less developed countries, was highly regulated leading to financial disintermediation which retarded the growth of the economy. The link between the financial sector and the growth of the economy has been weak. The real sector of the economy, most especially the high priority sectors which are also said to be economic growth drivers are not effectively and efficiently serviced by the financial sector as posit by (Beck, 2011; Beck, 2013). The banks are declaring billions of profit but yet the real sector continues to be weak thereby reducing the productivity level of the economy. Most of the operators in the productive sector are folding up due to the inability to get loan from the financial institutions or the cost of borrowing was too outrageous. The Nigerian banks have concentrated on short term lending as against the long term investment which should have formed the bedrock of a virile economic transformation.

Since the adoption of the Structural Adjustment Programme (SAP) in 1986, in an attempt to quicken the recovery of the economy from its deteriorating conditions, a great deal of interest has been shown in the activities and development in the financial sector. This is so because the restructuring of this sector was a central component of the SAP reform.

In spite of all this authorities with their different reforms, they have not been able to address financial crises properly and also the studies carried out on Nigeria have not clearly resolved the issue as most of them concluded that financial sector development did not promote economic growth while a few of them found evidence to support demand-leading hypothesis. A closer examination of these previous studies reveals that conscious effort was not made to explore various proxies of financial development as most of them used only the ratio of broad money to national income (M2/GDP). Hence, these studies actually modeled the impact of financial deepening on economic growth in Nigeria. In addition, there is the problem of endogeneity, which has not been carefully addressed in previous studies according to Arcandi (2012).

1.3 Research Question

In the course of the research, the following questions will be addressed;

1 .To what extent has financial sector development impacted on economic growth of Nigeria?

2. Is there any long-run relationship between financial sector development and economic growth in Nigeria?

3. Is there any significant causal relationship between financial sector development and economic growth in Nigeria?

1.4 Objective of the Study

The objective of this paper is to examine the impact between financial sector development and economic growth of Nigeria.

The specific objectives of these studies are: to,

1. Empirically investigate the impact of financial sector development on Nigeria’s economic growth.

2. Evaluate the long-run relationship between financial sector development and Nigeria’s economic growth.

3. Examine if there is any causal relationship between financial sector development and Nigeria’s economic growth.

1.5 Research Hypotheses

The hypotheses to be tested in the course of this research work are:

Ho: That financial sector development does not have significant impact on the economic growth of Nigeria

Ho: That financial sector development does not have significant long- run relationship with the economic growth of Nigeria.

Ho: That financial sector development does not have causal effect on Nigeria’s economic growth

1.6 Significance of the Study

The Levine (2005) and Beck (2009) argue that the positive effect of financial development over economic growth can be explained by five mechanisms, whose operations reduce the negative impact of information asymmetries among economic agents and the transaction costs involved in their activities. According to them, financial system is important because of the following reasons:

1.  Provides means of payments that facilitates a greater number of transactions.   2.  Concentrates the savings of a large number of investors,                                               3.  Makes possible the allocation of resources to their most productive economic use, through the effective evaluation and monitoring of investment projects,    4.  Improves corporate governance, and                                                                    5 contributes to risk management

1.7 Scope and Limitations of the StudyThough the research would make reference to the related studies of other economies of the world with a view to reviewing related literature on the subject matter, data for this work shall only be on Nigeria economy. Such variables shall include those related in existing literature to budget deficits and inflation. It shall be collected between a wide range of time spanning over a period of thirty two years from 1981 to 2013.                       Data for this study shall be secondary, majorly from government own institutions like the Central Bank of Nigeria. Sometimes, for obvious policy cover ups, such data are intentionally manipulated by government to portray an acceptable picture of the economy. The researcher is therefore limited to outcomes of such data.

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