THE IMPACT OF FINANCIAL DEVELOPMENT ON ECONOMIC

GROWTH OF NIGERIA
(1980 - 2016)

DEPARTMENT OF FINANCIAL MANAGEMENT

SCHOOL OF MANAGEMENT TECHNOLOGY

 ABSTRACT

This paper empirically assessed the impact of financial development on economic

growth in Nigeria using time series data from 1980 – 2016. To achieve the
purpose of this research, multiple regression techniques were employed to
investigate the effect of financial development on economic growth of Nigeria. The
estimation method was employed in obtaining numerical estimate of the coefficient
in the method using Statistical Package for the Social Sciences (SPSS) to find out
the real GDP as a function of the Credit to private sector, Broad money supply,
Market capitalization and Inflation Rate. The regression result shows that
financial development explains about 95% changes on Nigerian economic growth.
This is obvious as Broad money supply, market capitalization, and foreign direct
investment are all elastic to the Nigerian gross domestic product. However,
recommendations were made to address the inadequate arrangement and improve
on the macroeconomic environment through the harmonization of monetary and
fiscal policies in order to ensure stability of the economic aggregates.

Keywords: Financial Development, Economic Growth, Economic Development,

Nigeria.
 TABLE OF CONTENTS
DECLARATTION
CERTIFICATION
DEDICATION
ACKNOWLEDGEMENTS
ABSTRACT
TABLE OF CONTENTS
LIST OF TABLES
CHAPTER ONE: INTRODUCTION
1.1 BACKGROUND OF THE STUDY
1.2 STATEMENT OF PROBLEM
1.3 OBJECTIVES OF THE STUDY
1.4 RESEARCH QUESTIONS
1.5 RESEARCH HYPOTHESES
1.6 SIGNIFICANCE OF THE STUDY
1.7 SCOPE AND LIMITATIONS OF THE STUDY
CHAPTER TWO: LITERATURE REVIEW
2.1 PREAMBLE
2.2 CONCEPTUAL FRAMEWORK
2.2.1 Financial Development in an Economy
2.2.2 The Functional Role of Financial System
2.2.3 Financial Structure and Growth
2.2.4 Economic Growth
2.2.5 The Benefits of Economic Growth
2.2.6 Determinants of Economic Growth/ Development
2.3 THEORETICAL FRAMEWORK
2.3.1 Demand Following and Supply Leading Hypothesis
2.3.2 Goldsmith Theory
2.3.3 Mckinnon's Complementarity Hypothesis
2.3.4 Shaw Financial Deepening Hypothesis
2.3.5 Efficient Market Hypothesis
2.3.6 Neo Classical Growth Theory
2.3.7 The Endogenous Growth Theory
 2.2.8 Financial Liberation Theory
2.4 EMPIRICAL REVIEW
CHAPTER THREE: RESEARCH METHODOLOGY
3.1 SOURCES OF DATA
3.2 METHOD OF DATA COLLECTION
3.3 RESEARCH DESIGN
3.4 PROCEDURE DATA ESTIMATION
3.5 MODEL SPECIFICATION
3.6 DEFINITION OF VARIABLES
CHAPTER FOUR: EMPIRICAL RESULT AND ANALYSIS
4.1 INTRODUCTION
4.2 PRESENTATION OF DATA
4.3 HYPOTHESES TESTING
4.3.1 Test of Model Significance - ANOVA
4.3.2 Test of Significance of the Explanatory Variables - T-tests
4.4 DISCUSSION OF RESULTS
4.4.1 Analysis of Results of the Model
CHAPTER FIVE: SUMMARY, RECOMMENDATION AND
CONCLUSION
5.1 SUMMARY OF FINDINGS
5.2 CONCLUSION
5.3 RECOMMENDATION
REFERENCES
 CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

Financial development in developing countries and emerging markets is part of the
private sector development strategy to stimulate economic growth and reduce
poverty. The Financial sector is the set of institutions, instruments, and markets. It
also includes the legal and regulatory framework that permits transactions to be
made through the extension of credit (OECD). Fundamentally, financial sector
development concerns overcoming “costs” incurred in the financial system. This
process of reducing costs of acquiring information, enforcing contracts, and
executing transactions results in the emergence of financial contracts,
intermediaries, and markets. Different types and combinations of information,
transaction, and enforcement costs in conjunction with different regulatory, legal
and tax systems have motivated distinct forms of contracts, intermediaries and
markets across countries in different times (Global Financial Development Report,
2014).

The Nigerian financial sector, like those of many other less developed countries, is
highly regulated leading to financial disintermediation which retarded the growth
of the economy (Adekunle et al., 2013). They also argued that the link between the
financial sector and the growth of the economy has been weak, stressing that the
real sector of the economy, most especially the high priority sectors which are also
said to be the economic growth drivers are not effectively and efficiently serviced
by the financial sector. As further revealed in Adekunle et al. (2013), the banks are
declaring billions of profit but yet the real sector continues to weaken, thereby
reducing the productivity level of the economy. Consequently, a good number of
studies have attempted the study of the relationship between financial development
and economic growth. However, these studies continued to produce conflicting
results, thus making the topic a great research burden. The impact of financial
development on economic growth has generated heated debate among economic
researchers especially in the recent times. While some studies such as Nieh et al.
(2009); and Shittu (2012), opined that financial development drives economic
growth, others Odhiambo (2011); and Odeniran and Udeaja (2010), have argued
that economic growth drives financial development.

According to Schumpeter (1911), a well-developed financial system engenders

technological innovation and economic growth through the provision of financial
services and resources to entrepreneurs who have the highest probability of
implementing innovative products and processes.

The process of financial Development may be defined as the expansion and

elaboration overtime of the financial structure (institutions, instrument and
activities). On the other hand, economic growth can be defined as a sustained
increased in the output of the economy often termed the Gross Domestic product
(GDP). According to Shah and Shah (2011). Economic development is subject to
availability of the physical and human capital while financial resources are needed
to ascertain the availability of these capitals.

Financial development in developing countries and emerging markets is part of the

private sector development strategy to stimulate economic growth and reduce
poverty. The Financial sector is the set of institutions, instruments, and markets. It
also includes the legal and regulatory framework that permits transactions to be
made through the extension of credit. Fundamentally, financial sector development
concerns overcoming “costs” incurred in the financial system. This process of
reducing costs of acquiring information, enforcing contracts, and executing
transactions results in the emergence of financial contracts, intermediaries, and
markets. Different types and combinations of information transaction and
enforcement costs in conjunction with Economic growth in a developing economy
rest on an efficient financial sector that pools domestic saving and mobilizes
foreign capital for productive investments. In the developing countries, industries
need more funds to increase their investment so that they can meet globalization
constraint.

Theoretical literature has offered conflicting predictions on the role of financial

development and economic growth. Schumpeter (1911), Gurley and Shaw (1955),
Goldsmith (1969), McKinnon (1973) And Shaw (1973) all argue that financial
repression which characterised the Less Developed Countries (LDCs) tend to
retard economic growth. The causality relationship between economic growth and
financial development is a controversial issue. Basically, the debate has been
centred on whether it is the financial development that leads the economic growth
or economic growth leads to financial development. This “financial development
economic growth puzzle” is complicated by another view that the relationship is
dynamic in nature. most of the related researches done in the past three decades
mostly focused on the role of financial development in stimulating economic
growth, and most work are cross country research none in the recent years focuses
specifically on Nigeria.

Hicks (1969) argue that in the nineteenth century, many private investment
projects were so large that they could no longer be financed by individuals or from
retained projects. The stock market then serves as an important tool in the
mobilization and allocation of savings among competing uses which are critical to
the growth and efficiency of the economy (Alile, 1984). Recent theoretical
literature on financial development and economic growth identifies three
fundamental channels through which capital markets and other financial market
and economic growth may be linked (Pagano, 1993): First, capital market
development increases the proportion of savings that is channelled to investments;
Second, capital market development may change the savings rate and hence, affect
investments; Third, capital market development increases the efficiency of capital
allocation.

The Financial sector is the set of institutions, instruments, and markets. It also
includes the legal and regulatory framework that permits transactions to be made
through the extension of credit. Fundamentally, financial sector development
concerns overcoming “costs” incurred in the financial system. This process of
reducing costs of acquiring information, enforcing contracts, and executing
transactions results in the emergence of financial contracts, intermediaries, and
markets. Different types and combinations of information, transaction, and
enforcement costs in conjunction with different regulatory, legal and tax systems
have motivated distinct forms of contracts, intermediaries and markets across
countries in different times (Adebiyi et al., 2009)

Financial sector development takes place when financial instruments, markets, and
intermediaries work together to reduce the costs of information, enforcement and
transactions (Adebiyi et al., 2009). A solid and well-functioning financial sector is
a powerful engine behind economic growth. It generates local savings, which in
turn lead to productive investments in local business. Furthermore, effective banks
can channel international streams of private remittances. The financial sector
therefore provides the rudiments for income-growth and job creation. The Global
Financial Development Report, a new initiative by the World Bank, highlights
issues that have come to the forefront after the crisis and presents policy
recommendation to strengthen systems and avoid similar crisis in the future. By
gathering data and knowledge on financial development around the world, the
GFDR report aims to put into spotlight issues of financial development and hopes
to present analysis and expert views on current policy issues. A good measurement
of financial development is crucial in evaluating the progress of financial sector
development and understanding the corresponding impact on economic growth and
poverty reduction.

However, in practice, it is difficult to measure financial development given the

complexity and dimensions it encompasses. Empirical work done so far is usually
based on standard quantitative indicators available for a longer time period for a
broad range of countries; for instance, ratio of financial institutions’ assets to GDP,
ratio of liquid liabilities to GDP, and ratio of deposits to GDP (Adebiyi et al.,
2009).

However, since the financial sector of a country comprises a variety of financial

institutions, markets and products, these measures only serve as a rough estimate
and do not fully capture all aspects of financial development.

The World Bank’s Global Financial Development Database (GFDD) developed a

comprehensive yet relatively simple conceptual 4x2 framework to measure
financial development worldwide. This framework identifies four sets of proxy
variables characterizing a well-functioning financial system: financial depth,
access, efficiency, and stability. These four dimensions are then broken down for
two major components in the financial sector, namely the financial institutions and
financial markets.
1.2 STATEMENT OF PROBLEM

Apart from the positive relationship between financial development and economic
growth through the minimum capital base and liquidity ratio which has improved
the level of economic growth in Nigeria, result also recommends, amongst others,
that further development of the financial Sector should be oriented towards the
development of the private sector. This is, by identifying the reasons for the
problems of economic growth in Nigeria and highlighting the recommendations for
solving the problems.

The Nigerian financial sector, like those of many other less developed countries, is
highly regulated leading to financial disintermediation which retarded the growth
of the economy (Adekunle et al., 2013). They also argued that the link between the
financial sector and the growth of the economy has been weak, stressing that the
real sector of the economy, most especially the high priority sectors which are also
said to be the economic growth drivers are not effectively and efficiently serviced
by the financial sector. As further revealed in Adekunle et al. (2013), the banks are
declaring billions of profit but yet the real sector continues to weaken, thereby
reducing the productivity level of the economy. Consequently, a good number of
studies have attempted the study of the relationship between financial development
and economic growth. However, these studies continued to produce conflicting
results, thus making the topic a great research burden. The impact of financial
development on economic growth has generated heated debate among economic
researchers especially in the recent times. While some studies such as Nieh, et al.,
(2009); and Shittu, (2012), opined that financial development drives economic
growth, others Odhiambo, (2011); and Odeniran and Udeaja, (2010), have argued
that economic growth drives financial development.

Various empirical studies revealed positive relationship between financial

development and economic growth in some developing countries like South
Africa, Namibia, Botswana (Ashpala and Haimbod, 2003) but, in the context of
Nigerian economy, the study by Ayogu (2000) revealed negative relationship as
public investment retard economic growth.

It can be assumed that this year on year performance of the financial development
in terms of the economic growth before the meltdown is due to the improvement in
the economy, also the ability of the banks to be able to raise such huge amount of
capital from the public is dependent on the buoyancy of the real sector of the
economy, but it is not known if the happenings in the financial sector is
commensurate with the real sector and how does this play on the economy at large
or is it the economy that is responsible for the events in financial development. It is
expected that the various development on the financial economy have some input
on economic growth. The Nigeria economy is one of the largest in Africa, but
theoretical and empirical research have given little emphasis on the nature of
financial development and economic growth bearing in mind the recent downturn
in the financial development and how it affects the real sector of the economy and
this have generated a lot of controversies and further research needs to be carried
out on the nature of relationship between the financial sector and economic growth
in order to ascertain the link between financial development and economic growth.
The major question is that does the level of financial development in the financial
sector over the years commensurate with level of economic growth experienced,
what is the nature of the relationship between financial development and economic
growth and the factors for high and low growth rate in Nigeria; thus this study
therefore sought to examine the impact of financial development on economic
growth, and suggest recommendation for further growth process.

1.3 OBJECTIVES OF THE STUDY

The principal objective of this study is thus to examine the impact of financial
development on economic growth in Nigeria. Thus the objectives are aligned as
follows:

1. To examine the impact of Broad money supply on economic growth;

2. To assess the relationship between Credit to private sector and economic
growth in Nigeria;
3. To determine the extent to which Market capitalisation leads to economic
growth of Nigeria;
4. To ascertain the impact of Foreign direct investment on Nigerian economic
growth.
1.4 RESEARCH QUESTIONS

The following research questions shall be examined in the course of this study;

1. To what extent has the Broad money supply actually lead to economic
growth in Nigeria?
2. To what extent does Credit to private sector lead to high and low economic
growth in Nigeria?
3. Does the level of Market capitalisation bring about economic growth of
Nigeria?
4. How far does Foreign direct investment influence economic growth in
Nigeria?

1.5 RESEARCH HYPOTHESES

The research hypotheses to be tested in the study are stated below:

Ho1; There is no significant relationship between financial development and

economic growth in Nigeria;

HO2; There is no significant effect of broad money supply on economy of Nigeria;

HO3; Credit to private sector has no significant impact on Nigerian economy;

HO4; Market capitalization has no significant relationship with Nigerian economic

growth;

Ho5; There is no positive impact of Foreign direct investment on economic

growth in Nigeria

1.6 SIGNIFICANCE OF THE STUDY

This study is significant and unique because it investigates the relationship

between financial development and economic growth identifying the factor for
high and low growth rate in Nigeria. Thus, providing policy makers with the steps
the country can take or the policies to put in place in order to remove the obstacles
to economic growth in the country with emphasis.
This study will also be of help to other African countries in finding solutions to
their growth problem related to that of Nigeria.

1.7 SCOPE AND LIMITATIONS OF THE STUDY

The study of this paper is thus to examine empirically, the impact of financial
development on economic growth in Nigeria. This study only looked at a particular
part of the economy (the financial sector) which assesses the extent of financial
development and growth rate identifying various factors. This work did not cover
all the facets that make up the financial sector, but focus only on the capital market
and its activities as it impacts on the Nigerian economic growth. The empirical
investigation of the impact of the capital market on the economic growth in Nigeria
was restricted to the period between 1980 and 2016 due to the non-availability of
some important data.

1.8 ORGANIZATION OF THE STUDY

The study is divided into five (5) chapters and organized as follows: Chapter one
form the introduction part, this is where the main theme of the research is given. It
comprises of the statement of the problem, objectives of the study, research
questions and hypotheses, significance of the study, scope and limitation of the
study and organization of the study. Chapter two is the literature review of the
impact of financial development on the economic growth of Nigeria. Chapter three
forms the research methodology which includes sources of data, method of data
analysis and model specification. Chapter four is the data analysis while chapter
five includes the summary, conclusion and recommendations.

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