financial deepening and its influence on poverty …
TRANSCRIPT
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OKEREKE, SAMUEL FELIX
PG/M.SC/09/50580
PG/M. Sc/09/51723
AN ECONOMETRIC ANALYSIS OF THE IMPACT OF
FINANCIAL DEEPENING ON AGGREGATE WELFARE
IN NIGERIA
ECONOMICS
A THESIS SUBMITTED TO THE DEPARTMENT OF ECONOMICS, FACULTY OF
SOCIAL SCIENCES, UNIVERSITY OF NIGERIA, NSUKKA
Webmaster
Digitally Signed by Webmaster‘s Name
DN : CN = Webmaster‘s name O= University of Nigeria, Nsukka
OU = Innovation Centre
AUGUST, 2011
2
AN ECONOMETRIC ANALYSIS OF THE IMPACT OF
FINANCIAL DEEPENING ON AGGREGATE WELFARE
IN NIGERIA
BY
OKEREKE, SAMUEL FELIX
PG/M.SC/09/50580
A RESEARCH WORK SUBMITTED IN PARTIAL
FULFILLMENT OF
THE REQUIRMENT FOR THE AWARD OF MASTER OF
SCIENCE
(M.Sc) DEGREE IN ECONOMICS
DEPARTMENT OF ECONOMICS
SCHOOL OF POST-GRADUATE STUDIES
UNIVERSITY OF NIGERIA, NSUKKA
SUPERVISED BY: O.E ONYUKWU
AUGUST, 2011
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DEDICATION
I dedicate this research work to God Almighty for leading me so far in life. And to the
memory of my mother, Late Deaconess Glory N. F. Okereke who saw me picking the
form for this program but could not stay alive to see the dream come true.
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ACKNOWLEDGEMENT
This work and the program at large would not have been a success without the
suggestions, encouragement and other contributions I received from various angles.
I wish to express my immense gratitude to my supervisor Dr. O.E. Onyukwu whose
kindness, attention and co-operation throughout this research period were most
valuable.
In particular, I would like to thank Dr. Mrs. I. S. Madueme of the Department of
Economics, University of Nigeria, Nsukka and Dr Innocent (Oga SPG) for making
out times to read this work and made valuable comments. I would also recognize the
efforts of Dr. Moses Oduh, Mr. Emmanuel Nwosu, and Rev. Fr (Dr) H. E. Ichoku for
their direction and motivation.
I owe a great deal to Sir and Lady Steve Agbo (KSP), his entire family for not just
allowing me used the computers and printers but also for being a friend and mentor.
My appreciation equally goes to my friends and former colleagues, Denis Yunis (the
man from Cameroun), Chijioke Okogbue, Edith Agbo Ekene and Mr Innocent
Nkama, Aunty Chioma Onwugharam and Aunty Eunice.
I acknowledge with gratitude, the moral and financial supports from, Mr. Nwachukwu
Nnamdi of the First Bank, Nsukka, Mr. Emmanuel Ugwa of the Zenith Bank, Afikpo,
Mr. Stephen Ohaka, Mr. Ifeanyi Obijiaku of the PZ-cussons, Lagos, Mr. Okay Okore
(junior), Mr. Kingsley Obi of Eco Bank, Ekwulobia, Mr. Akachukwu Okoye of the
Diamond Bank, Mr. Uchenna Nwachukwu and Mr. Temitope Aluko both of Eko
Bank, Aba. Also, Mr. Victor Fakunye, Mr. Nwankwo Christian (Waja) and Miss Rita
Okonkwo I am deeply grateful to them for their efforts.
To a distinguished friend and brother, Comrade Kalu Nnanna Nwonyuku of the
National Hospital, Abuja, thanks for chatting a path in my life. To a beloved one,
Amarachi Onwugharam, thank you for your support, encouragement and for staying
by my side.
I have a darling father (my all time Boss) to thank, Prophet F.N. Okereke, my elder
sister, Mrs Joy Ekpe, my siblings; Amarachi, Onyinyechi, Sunday and Ihechi. You are
the source of my strength. Finally, I give God all the praise for being the ultimate
source of my possibilities.
Okereke, Samuel F.
August, 2011
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ABSTRACT
A general way of evaluating the economic welfare of country is through its household
per capita expenditure. Thus, the major purpose for this study is to investigate how the
recent financial deepening processes in Nigeria have impacted on aggregate welfare.
Private per capita consumption expenditure is used to measure aggregate welfare in
this study which serves as a macroeconomic measure of indicators of aggregate
welfare. Financial deepening can affect aggregate welfare in various ways and in
many outcomes. From the existing literature, the channels of influence through which
financial sector deepening affects aggregate welfare are indirectly through growth and
directly through increased access to financial services. Financial deepening is
represented by two variables, the degree of financial intermediation/development
(MS2/GDP) and the ratio of private sector credit to gross domestic product
(PSC/GDP). Three modelled equations, with justifications for each, were estimated
and analysed. With a time series data spanning from 1975 to 2010, a country specific
regression was used.
A dummy variable approach for structural differences was used for the analysis in the
first Model after the necessary conditions of non-stationarity and cointegration had
been satisfied, while the Autoregressive Distributed Lag-Error Correction Model
(ARDL-ECM) was used for the analysis of the second and third Models. The
empirical findings show that there are structural differences in the level of financial
deepening in the country between the pre and post recent financial reform periods in
Nigeria, the bank size represented by (DMBA/GDP) and bank branch distribution
represented by (NBBT) are the outstanding and significant determinants of financial
deepening in Nigeria. Lastly, financial deepening has no direct significant impact on
aggregate welfare, but can go through the financial accessibility indicator-bank branch
distribution.
The policy implications derive from the findings is that, the country should come up
with more policies to improve financial deepening/intermediation and there is need to
formulate financial reform policies that will have a proportionate beneficial welfare
impact on the poor.
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TABLE OF CONTENT
Title page………………………………………………………………………….. I
Certification………………………………………………………………………. II
Dedication………………………………………………………………………… III
Acknowledgement……………………………………………………………….. IV
Table of content…………………………………………………………………… V
CHAPTER ONE: INTRODUCTION
1.1 Background of the study………… …………………………………………… 1
1.2 Statement of problem…………………………… …………………………….. 8
1.3 Research questions……………………… …………………………………….. 10
1.4 Objective of the study………………………………………………………..... 10
1.5 Hypothesis of the study……………………………………………………...... 10
1.6 Policy relevance……………………….………………………………………. 10
1.7 The scope of the study………………………….……………………………... 11
1.8 Source of Data and Econometric Software Used …………………………….. 11
CHAPTER TWO: LITERATURE REVIEW
2.1 Conceptual Framework………………………………………………………. 12
2.2 Theories of framework deepening and its link to aggregate welfare………… 13
2.2.1 The Indirect channel through growth ...……………………………………. 14
2.2 2 The direct channel through access to financial services …………………... 16
2.3 Empirical literature………………………………………………………….... 19
2.3.1 Cross country evidence…………………………………………………….. 19
2.3.2 Country Specific Evidence ………………………………………………... 22
2.4 Efforts towards deepening the Financial system in Nigeria………………...... 23
2.5 Limitations of previous studies……………………………………………….. 24
CHAPTER THREE: METHODOLGY
3.1 Analytical framework……………………………………………………….... 25
3.2 The model…………………………………………………………………….. 26
3.2.1 Model specification……………………………………………………….... 26
3.2.1Model 1…………………………………………………….. ….………….... 28
3.2.1 Model 2……………………………………………………………………... 28
3.2.1 Model 3…… ……………………………………………………………….. 28
3.2.2 The ARDL-ECM……………………….…………………………………... 28
3.2.3 Unit root …………………………………………………………………..... 28
3.3 Estimation procedure………………………………………………………..... 29
3.4 Justification of the model…………………………………………………...... 29
3.5 Statistical criteria …………………………………………………………….. 30
3.6 Description of Variables……………………………………………………… 30
CHAPTER THREE: PRESENTATION AND ANALYSIS OF ECONOMETRIC
RESULTS
4.1 Unit root tests………………………………………………………………… 32
4.1.2 Trend properties of the variables………..………………………………….. 35
4.2 Result presentations...………………………………………………………… 37
4.3 Bound test for co-integration…………………………………………………. 40
4.4 Interpretation of ARDL results……………………………………………….. 41
4.5 Discussion of findings……………………………………………………….....42
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4.6 Implications of the findings…………….……………………………………... 43
4.7 Interpretation of Diagnostic tests……………………………………………… 43
CHAPTER FIVE: POLICY RECOMMENDATIONS AND CONCLUSION
5.1 Summary……………………………………………………………………….. 48
5.2 Policy recommendations……………………………………………………….. 48
5.3 Conclusions…………………………………………………………………….. 49
References
Abstract
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CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY:
In recent years, many studies have examined the link between financial deepening and
economic development as well as the link between financial development and poverty
reduction via economic growth from both micro and macro perspectives, example,
Levine (2004), Fitzgerald (2008), Nzotta and Okereke (2009), etc. In this study we depart
from the finance-growth nexus, but still from the macro angle to see if there is a direct
relationship between financial deepening and aggregate welfare. We will look at how
welfare is linked to financial sector deepening and the existing transmission mechanisms.
Few will doubt that income growth through access to financial services leads to
improvement in people‘s lives. Increased income allows people to enhance their living
standards and escape from extreme poverty. From the works of Claessen and Feijen
(2006), without a developed financial sector, for example, domestic savers and foreign
investors would be more hesitant to part with their money to otherwise sound
investments, resulting in lower economic output as measured by GDP and household
welfare. They sressed that a well-developed financial system enables firms to expand
production and provides households with the ability to obtain essential assets like a
house, insure against income shocks, start a company, receive cheaper remittances, and
enjoy a pension when they retire.
As such, the financial sector is an engine of economic growth and household welfare.
Most literature confirmed that financial market plays a vital role in the process of
economic growth and development by facilitating savings and channeling funds from
savers to investors, Nzotta and Okereke (2009). Financial intermediation of growth leads
to financial deepening, which refers to the greater financial resource mobilization in the
formal financial sector and the ease in liquidity constraints of banks and enlargement of
funds available to finance projects, Fisher (1933).
Direct measurement of how well the financial sector performs each of its functions is
difficult. As Ndebbio (2004) observed, it is not possible to observe directly the quality
and quantity of the monitoring services performed by a bank when it extends a loan, at
least not for a large country like Nigeria. Hence, researchers use proxies to measure
financial deepening. Typically used indicators of financial deepening are ratio of MS2
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(money) to GDP, ratio of private credit extended by commercial banks to GDP, and other
financial assets.
As Ndebbio (2004) observed, only countries with high per capita incomes can experience
rapid growth in financial assets. Such countries are none other than the developed
countries. But what is crucial here is what constitutes the financial assets that wealth-
holders must have as a result of high per capita income. Only when we can identify those
financial assets will we be able to approximate financial deepening adequately. In short,
and for our purpose, we borrow a lift from Ndebbio (2004) in asserting that financial
deepening simply means an increase in the supply of financial assets in the economy.
Therefore, the sum of all the measures of financial assets gives us the approximate size of
financial deepening. That means that the widest range of such assets as broad money,
liabilities of non-bank financial intermediaries, treasury bills, value of shares in the stock
market, money market funds, etc., will have to be included in the measure of financial
deepening. To simply pick the ratio of private sector credit to gross domestic product
(GDP), as done in this study, is because of lack of data on other measures of financial
assets likely to adequately approximate financial deepening in most Sub-Saharan African
countries.
In his study, Ndebbio (2004) noted that if the increase in the supply of financial assets is
small, it means that financial deepening in the economy is most likely to be shallow; but
if the ratio is big, it means that financial deepening is likely to be high. He further went
on to stressed that developed economies are characterized by high financial deepening,
meaning that the financial sector in such countries has had significant growth and
improvement, which has, in turn, led to the growth and development of the entire
economy.
One common problem affecting the growth of development economies is the issue of
―financial shallowness‖ which is seen by many economists as an outcome of the adoption
of inappropriate financial policy. In the 1980‘s, Nigeria alongside other African countries
experienced widespread financial liberalization, interest rate deregulation, the entry of
new banks and the likes, with the intention to deepen the financial sector but ended up
producing financial openness without much financial depth, Collier and Gunning (1999).
They further stressed that the legacy of financial liberalization in these countries was the
establishment of weak banking organizations that were unable to open up the
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opportunities created by liberalization. Reflecting this in Nigeria saw the country being
relegated to having less financial depth than other developing areas. As a result, banks
were vulnerable to systemic crisis and the systemic risks in the country high. Thus, the
Nigerian banking system was evidently limited in its resources mobilization with an
adverse effect on the economy which hit more on the poor since they are the most
vulnerable and hence financial deepening
This prompted the Central Bank of Nigeria (CBN) to come up with new banking reform
policies in 2005 in a bid to strengthen and increase the financial assets of banks. Banking
reforms are part of financial sector reforms, and financial sector reforms are propelled by
the need to deepen the financial sector and reposition it for growth to become integrated
into the global financial architecture and evolve a banking sector that is consistent with
regional integration requirement, savings mobilization and international best practices,
Nnanna et al (2004).The recent banking sector reforms which experienced consolidation
of banking institutions affected the level of financial deepening in the country.
Consolidation of banks has been the major reform policy instrument being adopted
recently in correcting deficiencies in the financial sector. It ushered in other reform
policies that followed including the bail-out of eight deposit money banks with huge non-
performing loans in 2009.
A review of the financial deepening indicators show that, the depth of the financial sector
as measured by the ratio of MS2 to GDP even though has been fluctuating but has
increased more than previous years. For the period of the study the ratio at the end of
2009 stood at 43.4 per cent and 38.9 per cent for 2010. Bank financing of the economy
measured by the ratio of private sector credit to GDP stood at 33.2 per cent though lower
than that 41.1 per cent of 2009. The intermediation efficiency indicator as measured by
the ratio of currency outside banks to broad money supply was 9.4 per cent compared
with 8.6 per cent at end of December, 2009. The size of the banking system relative to the
size of the economy indicated by the ratio of deposit money banks assets to GDP,
declined from 69.6 per cent at end of December 2009 to 58.8 per cent in 2010, (CBN
2010 annual report). Below is a chart showing the ratio of deposit banks assets to GDP
and a graph showing the ratio of broad money (MS2) to GDP, private sector credit to
GDP.
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30
40
50
60
70
2000 2002 2004 2006 2008 2010
DMBA_GDP
pe
r ce
nt
Source: computed by the author from the CBN bulletine
From the chart above, although there is a decrease in ratio of deposit money banks assets
to GDP in 2010, the increased in the ratio from 2007 to 2010 is higher than other years.
0
10
20
30
40
50
1975 1980 1985 1990 1995 2000 2005 2010
FD1 FD2
per c
ent
fd1=psc/gdp and fd2=ms2/gdp
Source: computed by the researcher,from CBN-bulletine
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The graph above shows that the finncial deepening indicators (MS2/GDP and PSC/GDP)
increased from between 2005 and 2006 indicating the recent banking reforms has
impacted on the level of financial deepening in the country.
This shows that in Nigeria, the banking system clearly dominates in the flow of funds and
has an important impact on the level of economic development, Nzotta and Okereke
(2009). They also opined that the reforms in the banking sector impacted positively on
the growth of the financial system. The system moved from a rudimentary one at
inception to a more sophisticated one in 2009 with diverse institutions and operations,
diversified financial assets and an enhanced regulatory framework. Also, Sanusi (2011)
opined that banks by their size were enabled to undertake funding of large ticket project,
especially in infrastructure, oil and gas sectors, through the new window in the enlarged
single obligor limits. With the larger size of the banks also engendered to improved
customer confidence, and the number of bank branches increased from 3,247 in 2003 to
over 5,837 in 2010 and employment in the sector rose from 50,586 in 2005 to 71,876 in
2010. Below is a chart showing total bank branch expansion in Nigeria, from 1975 to
2010. The chart shows that bank branch distribution has increased recently.
A CHART SHOWING NUMBER OF BANK BRANCHES IN NIGERIA
0
1000
2000
3000
4000
5000
6000
1975 1980 1985 1990 1995 2000 2005 2010
NBBT
nbbt=total no of bank branches in Nigeria
Source: computed by the researcher, from CBN- bulletine
However, welfare concerns in Nigeria were primarily related to its general lack of
development and the effects on the society of the economic stringency of the 1980s and
1990s. Given the steady population growth and the decline in incomes since 1980, it was
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difficult not to conclude that for the mass of the population at the lower income level,
there was profound aggregate welfare loss, Metz (2011). Studies have shown that
household per capita expenditure can provide insight into economic welfare or the living
conditions of the population, Akerele and Adewuyi (2011). The assessment of aggregate
welfare in the country becomes necessary as the financial sector deepens. Households are
important players in the financial sector, both as savers and borrowers. Financial sector
deepening ought to bring direct aggregate welfare improvement in an economy by
increasing returns on and reducing risks of the invested savings of the populace
particularly low income earners, since savings enable poor households to smoothen their
consumption. And by increasing consumption, the demand for goods and services
increases, thus, stimulating more agricultural and industrial production leading to more
jobs and higher economic growth.
It is incontrovertible, that one of the developmental challenges facing the country is how
to reduce the high level of poverty prevailing among her population. Given the current
rate of population and economic growth and the resultant fluctuations in private per
capita consumption expenditure in the country, the preoccupation does not come by
surprise. Indeed, the economy is expected to grow by a minimum of 7.0 per cent per
annum, if the millennium development goal of reducing the level of poverty by half is to
be achieved by 2015.
The poor in the country need to be empowered, for many Nigerians; access to even a
small amount of credit can make a considerable difference in their ability to earn a self
reliant income. Thus, as finance deepens in the country it is necessary to ascertain if the
CBN and other financial regulators have maintained a good balancing between regulating
the financial sector effectively for the determinants of financial deepening to work
effectively at all levels of the economy and providing a good environment that will
promote sufficient and widely accessible financial services with less systemic crises.
Studies have shown that, several indicators of aggregate welfare has fallen dramatically
in the aftermath of a disappointing financial sector reforms, severely affecting the most
vulnerable and poorest people and resulting in a substantial welfare loss, Honohan
(2004b), Jalilian and Kirkpatrick (2001). Although, high and sustainable economic
growth is central to improvement of aggregate welfare, studies by Asenso-Okyere et al
(1993) revealed that promotion of efficient, sufficient and widely accessible financial
services (rural banking inclusive) is a key to achieving pro-poor growth and welfare
gains.
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Financial deepening can affect aggregate welfare in various ways and in many outcomes.
The three aspects of welfare which could be affected by financial deepening, include;
vulnerability, investment and consumption smoothening, Gloede and Rungruxsirivorn
(2010). Studies have shown that it is not obvious whether financial deepening reduces or
increases vulnerability which is the probability to stay or fall below the poverty line.
According to Gloede and Rungruxsirivorn (2010), a higher amount of credit increases
also the risk of fallen which is well known from corporate finance under the leverage
ratio. Especially in the presence of the current financial crisis one might be tempted to
argue in such a way. In the other hand, there are channels where financial deepening can
improve aggregate welfare. These channels result from the intermediation function of the
financial sector, but the most important channel through which financial sector deepening
leads to direct aggregate welfare improvement is increased access to financial services.
Access to financial services-such as savings- through bank branch distribution can help
firms and households cope with economic shocks, Claessens and Feijen (2006). Most
literature has shown that firms‘ and households‘ access to financial services rises with
financial deepening, Beck et al (2006). A well functioning financial system creates strong
incentives for investment in order to increase productivity. Foster trade and business-
linkages in order to facilitate technology transfer and improved resources used. Provide
broad access to assets and markets in order to build up the asset base of the poor as well
as increase the returns to such assets. Remittances from abroad and domestic transfers are
important source of income for the poor, thus, reducing vulnerability. Where financial
sector deepening leads to lower costs, the poor will benefit from more secure and rapid
transfers, and easier access to transferred funds. Also, they enable the poor to draw down
accumulated savings and borrow to invest in income-enhancing assets and start micro
enterprises, thus, wider access to financial services, generates employment which
increase incomes and welfare gains. And enabling the poor to save in a secure place, the
provision of bank accounts and insurance allows the poor to establish a buffer against
shocks thus, reducing vulnerability and increase the ability of individual and households
to access basic services like health and education and thus having a more direct welfare
benefit impact, DFID (2004).
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The transmission mechanism works through - the expansion of bank branches especially
in rural areas which will in addition provide support services such as provision of training
and capacity building.
But there are skeptical views on whether financial sector deepening can lead to a
broadening of access to finance services with the resultant aggregate welfare benefits.
Most literature confirms that financial development policies do not serve the poor.
Greenwood and Jovanovic (1990), show that improvement in the financial system may
not automatically lead to improvement in income distribution. They argue that there is an
inverted U-shaped relationship between income inequality and financial deepening. Thus,
the study restricts its analysis of the link between financial deepening and aggregate
welfare using financial accessibility indicators such as, bank branch expansion, savings
rate and cost of acquiring credit. Based on the foregoing discussion, the study is designed
to answer this critical question; are there proportionate aggregate welfare benefits for all
income levels in an economy from financial reforms that strengthen the economy
generally?
1.2 STATEMENT OF PROBLEM:
Although a large body of studies have pointed out that financial deepening produces
faster average growth with welfare implications, Levine (1997, 2005) and Beck et al
(2000), Honohan (2004a), (2004b), Jalilian and KirkPatrick (2005), Beck et al (2007),
Odhiambo (2009) etc. Researchers have not yet determined whether the aggregate
welfare gains of financial deepening benefit the whole population equally or whether it
disproportionally benefits the rich or the poor. If financial deepening intensifies income
inequality, this income distribution effect will hamper the beneficial effects of financial
deepening on the poor.
Thus, theory predicts conflicting predictions on the aggregate welfare implications of
financial deepening. Scholars like Mendoza et al (2007) and others are of the opinion that
if financial reform policies that produce financial deepening are not accompanied with
proper and adequate regulatory framework, sound fiscal and macroeconomic stability,
then financial deepening can have sizeable consequences on the distribution of wealth
and adverse welfare effects.
They stressed that developing countries financial regulators fail to strike an appropriate
balance between regulating the sector effectively for the determinants of financial
deepening to be effective and providing a good environment for financial sector
16
deepening, Levine et al (2000), Holden and Prokopenko (2001), DFID (2004). In addition
some other studies followed a similar reasoning that the indicators of financial deepening
that worked for some developed and developing countries may not work for other
countries. According to these studies while there are large benefits from a well
functioning financial system, financial sector deepening also brings risk which may hit
more on the poor, Banerjee (2009), Zingales (2009). In the opinion of Mendoza et al
(2007), even though financial deepening leads to a significant increase in wealth
inequality in most developed countries, the aggregate welfare consequences are still
positive for these countries. By contrast, in countries with growing financial markets, the
aggregate welfare consequences are negative and the distribution of wealth does not
change much.
However, recent studies on finance deepening in Nigeria especially on recent deepening
efforts have concentrated more on its impact on economic growth, Ndebbio (2004),
Nnanna (2004) and Nzotta and Okereke (2009. These studies imply that once there is
growth it could have an impact on the whole economy. But economists are of the view
that the imperative of growth for welfare improvement does not mean that growth is all
that matters, Fields (2001). Access to financial services is crucial for welfare
improvement, Jalilian and Kirkpatrick (2001), Asenso-okere et al (1993).
Though it is true that in recent times, bank intermediation in formal banking has
improved in terms of speed of response to customers‘ needs and quality of service
rendered in Nigeria as a result of the efforts geared towards the deepening of the financial
system, Sanusi (2011), the same is not available to people in the rural areas. Bank branch
location is heavily biased towards the urban areas with good infrastructures that can fetch
good returns.
In addition, despite the improvements in the banking industry, they are still punctuated
with cases of under-performance of their role. A significant proportion of credit
transactions in Nigeria still take place in the informal markets, despite governments
efforts aimed at channeling credit to the productive sector through the deposit money
banks, Nnanna (2004). According to Soludo (2008), banking services are available to
about 40 percent of the population and more than 60 percent of the poor do not have
access to formal finance and are forced to rely on a narrow range of some risky and
expensive informal services which constraints their ability to participate fully in markets
to increase their income and contribute to economic growth. The business information
17
provider (Business Hallmark 6th
-12th
June,2011), revealed that two years after the CBN
launched the last bank reforms with N620 billion injected into eight banks, N1.7 trillion
toxic assets bought off, the economy is still prostrate, banks not lending and poverty
ravaging the land.
Moreover, at the period of this research, banks are pegging the minimum cash balance for
savings account at N2000 and N5000 in some cases and lending practices curtailed with
emphasis on risk minimization. Moreover, there is still high cost of capital (high interest
rates) and existing anomalies in lending for investment in agricultural production which
is one of the sectors expected to act as a catalyst towards a general aggregate welfare
improvemnet, Aderibigbe (2005). These developments may continue to increase the lack
of financial accessibility of the low income earners and confine them to low-return capital
intensive activities, so that despite being more risk averse they are less diversify. Already,
there have been profound fluctuations in the private consumption expenditure in Nigeria,
Odior and Banuso (2011), implying that private per capita consumption expenditure, a
measure of aggregate welfare will follow the same pattern. There is then a concern issue
that the recent banking sector reform-led financial deepening in Nigeria will have a
similar effect with that of deregulation/financial liberalization period which made
commercial bank accounts inaccessible to most Nigerians, Ayida, (2007), generating
severe welfare implications, which manifest indirectly through their relation with
macroeconomic policies, raising arguments whether financial sector deepening in Nigeria
is having a disproportionate aggregate welfare beneficial impact or broadening access to
financial services.
Thus, it is not clear whether the recent financial deepening processes in Nigeria will have
any aggregate welfare improvement. In view of this, there is the need to empirically
investigate the level of deepening that has occurred in Nigeria and the nature of the
impact on the aggregate welfare. As a result, the following research questions become
imperative.
1.3 RESEARCH QUESTION
I. What is the level of financial deepening that has occurred in Nigeria from 2005 to
2010.
II. What are the determinants of financial deepening in Nigeria?
III. Does financial deepening leads to aggregate welfare improvement in Nigeria?
18
1.4 OBJECTIVE OF THE STUDY: The main objective of this study is to answer one
critical question; are there aggregate welfare benefits from financial reform policies that
strengthen the economy? More specifically, the study intends;
a) To investigate the structural changes in the pre and post-consolidation
periods in Nigeria.
b) To analyze the factors determining the level of financial deepening in Nigeria.
c) To determine the nature of impact financial deepening has on aggregate welfare in
Nigeria.
1.5 HYPOTHESIS OF THE STUDY
a Ho: There are no structural changes in the level of financial deepening in the
Country after 2005.
b Ho: Macro-economic variables do not determine the level of financial deepening in
Nigeria.
c Ho: Financial deepening has no direct impact on aggregate welfare in Nigeria.
1.6 POLICY RELEVANCE:
The wake-up call for financial sector reform should be critically examined especially its
impact in all levels of the economy. This study is important at this level of economic
development when efforts are being made to reposition the financial sector to enable it
play key roles in economic development at all levels of income. It will also help policy
makers and government to know the structural changes that have taken place with the
reform policies on ground in Nigeria. It will also provide useful information that will be
relevance in formulating a more targeted financial reform policy that will be beneficial to
the poor. More so, the study would further add to the existing literature on the link
between finance and aggregate welfare.
1.7 THE SCOPE OF THE STUDY:
This country-specific study covers the periods 1975 to 2010. The choice is based on data
availability and to have enough observations for time series analysis.
1.8 SOURCE OF DATA AND ECONOMETRIC SOFTWARE:
The source of data will be from the CBN – statistical bulletin and the econometric
softwares to be used are Stata-10 and e-view 8.
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CHAPTER TWO
LITERATURE REVIEW
This section of the study gives the conceptual and theoretical frameworks; discuss
various literatures on the link between finance and poverty reduction with the review of
empirical literature.
2.1 CONCEPTUAL FRAMEWORK
Financial intermediation is defined as the extent to which financial institutions (banks)
bring deficit spending units and surplus spending units together. Such a joining of
spending units is likely to result in more deepening of the financial sector (Goldsmith
1969, Ghani 1992 Greenwood and Jovanovic 1990). Financial intermediation allows for
financial deepening.
According to Shaw (1973) financial deepening involves specialization in financial
functions and institutions and organized domestic institution and markets. For Nnanna
and Dogo (1998) the concept of financial deepening is usually employed to explain a
state of an atomized financial system (i.e.) a financial system which is largely free from
financial repression. According to Fisher (2001), financial deepening refers to the greater
financial resource mobilization in the formal financial sector and the ease in liquidity
constraints of banks and enlargement of funds available to finance projects.
There are many different ways in which the financial sector can be said to ‗deepen‘. For
example;(a) the efficiency and competitiveness of the sector may improve (b) the range
of financial services that are available may increase (c) the diversity of institutions which
operate in the financial sector may increase, (d) the amount of money that is
intermediated through the financial sector may increase,(e) the extent to which capital is
allocated by private sector financial institutions to private sector enterprises responding to
market signals may increase,(f) the regulation and stability of the financial sector may
improve and (e) particularly important from the welfare perspective more of the
population may gain access to financial services. DFID (2004).
Economic activities in the country can be greatly facilitated by modern banking services.
Financial deepening involves the introduction and intensive use of new financial
products. In this context, it is aimed at modernizing the banking system in order to avail
modern banking and financial services in the Nigerian financial market. Financial
deepening cost becomes high when the administrative costs of banks are high. One of the
main reasons for such high cost was the use of traditional management structure and
20
technology methods by these banks. In this scenario, financial deepening in Nigeria was
also aimed at reducing the administrative cost of the banks.
As such, there is no precise definition in the literature of financial sector deepening and
the theoretical and empirical articles reviewed in this study focus on the different aspects
and measures of financial deepening.
2.2 THEORIES OF FINANCIAL DEEPENING AND ITS LINK TO AGGREGATE
WELFARE:
The intellectual framework for financial reforms in developing countries in the 1980s was
provided by the works of Mckinnon (1973) and Shaw (1973). The Mckinnon-Shaw
paradigm contained two essential issues; (1) the financial sector is critical for economic
growth and (2) extensive government controls imposed on the financial sector prevents
financial deepening and impedes the contribution of the sector to development. The first
issue was not all that new, but only reiterated and re-affirmed ideas contained in the
works of earlier writers such as Gurley and Shaw (1955), Patrick (1966) and Goldsmith
(1969). The second issue was innovative, with the M-S thesis systematically detailing the
efficiency and output costs associated with direct sate intervention in the financial system
labeled ―financial repression‖. However, the general notion from their debate is that the
functions of financial institutions in the savings-investment process were spelt out as
being an effective element for the mobilization and allocation of capital by equilibrating
the supply of loan-able funds with the demand for investment funds and the
transformation and distribution of risks and maturities.
We measure the welfare gains from a financial sector reform through its impact on
financial deepening. From Townsend and Ueda (2006) a complex interaction emerges
between financial sector policy and financial deepening in an otherwise simple growth
model. Indeed, based on a model without any government intervention, they show that
regressions may not reveal a true causal link between financial deepening and its effect.
First, financial deepening is an endogenous variable. It is an aggregation of individual
decisions as shown in much of the theoretical literature, for example, Greenwood and
Jovanovic (1990). Second, in all these models, financial deepening occurs jointly with
economic growth and is a transitional phenomenon, before convergence to a long-run
steady state. Transitional dynamics means that the resulting macro data are not stationary.
This forces researchers to view the entire history as a one-sample draw, Townsend and
Ueda (2009). In the model, the financial sector is endowed with two functions, risk
sharing and an efficiency gain in production, as these are typically considered to be the
21
key functions of banks and other financial intermediaries. The financial sector in the
model requires both fixed costs for entry and variable costs for operations. These create
endogenous movements into intermediation: as they save and invest successfully,
households pass a key wealth threshold for participation in the financial system.
However, the popular Kuznets inverted U-hypothesis Kuznets (1955) brought out the
nature of influence that financial sector deepening has on households with low income.
The theory introduced an increase interest in the contribution that financial deepening can
make to income distribution in developing countries. Kuznets suggested that ―to the
extent that financial sector development facilitates more migration from low-income but
more egalitarian agricultural higher income but more unequal modern (industrial and
services) sector it may be expected to increase inequality‖. This he implied that economic
growth may increase inequality at the early stage of development but reduce it at the
mature stage of industrialization. The asset rich classes who can self finance or have easy
access to finance would reap the early harvest of industrialization and thus garner a
higher share of the economic pie, leaving the poor disadvantaged.
Many economists are then of the view that financial intermediary development will have
a disproportionately beneficial aggregate welfare impact. This according to Galor and
Zeira (1973) and Aghion and Bolton (1997) is because information asymmetries produce
credit constrains that are particularly binding on the low income earners as they do not
have the resources to fund their own projects, nor the collateral to access bank credit. As
only the rich are able to overcome these hurdles they serve to perpetuate the initial
distribution of wealth. Other contrary opinions are suggesting that financial sector
development will overcome these imperfections and reduces income inequality, Clarke et
al (2002).
Financial sector policy affects aggregate welfare both directly and indirectly. The direct
way that financial policy can influence the poor‘ income generation and income
stabilization is by increasing their access to financial services, while the indirect channel
works through growth.
2.2.1 THE INDIRECT CHANNEL THROUGH ECONOMIC GROWTH:
A major channel by which financial deepening supports welfare improvement is through
economic growth. The connection between the operation of the financial system and
economic growth has been one of the most heavily researched topics in development
economics. Hundreds of scholarly papers have been written to conceptualize how the
22
development and structure of an economy‘s financial system affect domestic savings,
capital accumulation, technological innovation and income growth or vice versa.
Many believe that economic growth improves aggregate welfare. The impact of growth
on aggregate welfare runs through a number of possible channels. First, economic growth
could generate jobs for the poor. Second, it has been suggested that a higher rate of
growth could reduce the wage differentials between skilled and unskilled labour at a later
stage of development, which benefits the low income earners and which will eventually
enable them to invest more in human capital, Galor and Tsiddon (1996), Perroti (1993).
Fourth, as capital accumulation increases with high economic growth, more funds would
become available to the low income earners for investment purposes Aghion and Boiton
(1997).
During the 1990‘s, the proliferation of quality data on income distribution from many
countries has allowed vigorous empirical testing of standing debates. Researchers such as
Datt and Ravallion (1992), Kekwani (2000) attempted to explain changes in poverty in
terms of a ―growth effect‖, stemming from a change in average income and a
―distribution effect‖ caused by shifts in the Lorenz curve holding average income
constant. They found the growth effect to explain the largest part of observed changes in
poverty. Economists also agreed that the imperative of growth for welfare improvement
should not be misinterpreted to mean that ―growth is all that matters‖. Fields (2001)
qualified that the extent of the impact of growth on poverty alleviation depends on the
growth rate itself and the level of inequality. Growth is a necessity but is in itself not
sufficient for welfare improvements, because besides growth poverty alleviation requires
additional elements. The poor households need to build up their asset base in order to
participate in the growth process. Also, growth needs to be more broad based and
inclusive to reach all segments of society including the poor. Inequality also matters for
welfare improvement and should be on the agenda, Kanbir and Lustig, (1999).
According to Lustig et al (2002), growth and distribution are interconnected in numerous
ways and the effectiveness with which growth translates into welfare improvements
especially poverty reduction depends crucially on the initial level of inequality.
FitzGerald (2006) critically viewed financial sector reforms and economic growth and
pointed that the potential contribution of financial deepening to economic growth is
considerable but cannot be taken for granted. It depends on the construction of the
appropriate institutional structure. Financial sector development according to him can
23
make an important contribution to economic growth and aggregate welfare and without it
development may be constrained even if other necessary conditions are met.
Levine (1997), (2004) identifies five basic functions of financial intermediaries which
give rise to these effects-savings mobilization, risk management, acquiring information
about investment opportunities, monitoring borrowers and exerting corporate control and
facilitating the exchange of goods and services. Scholars such as Claessens and Feijen
(2006) are of the opinion that financial deepening is associated with higher household per
consumption which is an indicator of aggregate welfare. In their opinion as GDP per
capita grows as a result of financial development, households benefit from higher
income, and can consume and invest more in the process. This obviously matters for
household welfare in terms of nourishment, health care, etc.
2.2.2 THE DIRECT CHANNEL THROUGH ACCESS TO FINANCIAL
SERVICES:
In the same manner that financial services increase income growth, expanding the supply
of financial services which can be accessed by the low income earners will increase
income growth for the poor thus having a direct welfare improvement, Jalilian and
Kirkpatrick (2001).
The provision of savings facilities can enable the low income earners to accumulate funds
in a secure place over time in order to finance a relatively large, anticipated future
expenditure or investment and can some times provide a return on their savings, DFID
(2004).
Financial sector deepening reduces information and transaction costs and therefore
allows more entrepreneurs (especially those less well off) to obtain external finance,
improves the allocation of capital and exerts a particular large impact on the poor.
Fields (2001) argued that much would be gained by developing credit and finance
markets since an undeveloped credit market contributes to continued welfare loss,
especially higher income inequality and slower economic growth.
Through better access to credit, the poor are given the opportunity to participate in more
productive endeavors in turn increasing their incomes. Jeanneney and Kpodar (2005)
noted that, progress in financial intermediaries is beneficial to the poor as it offers
genuine opportunities for their savings; Aderibigbe (2005) is of the opinion that easy
access to credit is more beneficial to the poor than interest rate subsidy. He argued that
targeted public sector credit programmes especially if they are subsidized benefit the non-
24
poor far more than the poor. Claessens and Feijen (2006) argued that financial services
can enable households to be more productive in many ways: Households can borrow for
investment not only in real assets—like fertilizer, a tractor, or a computer—but also for
education, health, and other services that add to their productivity and have high
economic returns. As such, access to financial services can enhance individuals‘ nutrition
and health, and can allow them to send their children to school. Self-employed women
with access to financial services are better able to control their economic destiny and gain
more influence in their households and communities, thus often aiding gender equality.
They further stressed that the benefits of financial sector deepening extend beyond
financing investment, and actually often start by offering better and cheaper payments
and savings services. These services allow firms and households to avoid the costs of
barter cash transactions, reduce the costs of remitting funds, and provide the opportunity
to accumulate assets and smooth income.
Similarly, insurance can provide protection against some types of shocks. These facilities
can reduce the vulnerability of the poor and minimize the negative impacts the shocks
can sometimes have on long-run income prospects. Eswaran et al (1990) argued that just
the knowledge that credit will be available to cushion consumption against income
shocks, if a potentially profitable but risky investment should turn out badly can make the
household more willing to adopt more risky technologies. For this same reason, access to
credit and other financial services is likely to decrease the proportion of low risk. Low-
return assets held by poor households for precautionary purpose can enable them invest in
potentially higher risk but higher return assets with overall long-term income enhancing
impacts, Deaton (1991).
There are however, also skeptical views on whether financial sector deepening can lead
to a broadening of access of financial services by the poor especially at early stages.
Some argue that it is primarily the rich and politically connected who would benefit from
improvements in the financial system, Haber (2004). Some support a non-linear
relationship between finance and income distribution. Greenwood et al (1990) show how
the interaction of financial and economic development can give rise to an inverted U-
shaped curve of income inequality and financial intermediary development.
In addition, there are equally disagreement over how to sequence financial sector
deepening in developing countries, in particular the relative importance of developing
25
domestic banks and capital markets and in developing domestic banks the relative
importance of large and small banks.
Justin Lin (2009) has recently argued that developing countries should make small, local
banks the mainstay of their financial system. He argued that what matters most is setting
up a financial sector that can serve the competitive sectors of an economy which in many
poor countries means focusing on activities dominated by small-scale manufacturing
farming and service firms.
Banerjee (2009) argued that a challenge that most developing countries face is to ensure
an adequate supply of risk capital. Small banks may not be in a position to play such an
important role but the stock market in principle can, by directly funding large firms to
reach a global scale and by enabling a venture capital model of funding high scale risk
new ideas.
Moss (2009) argued that stock markets cannot be expected to provide capital for the poor
or even small companies and that local community banks are better placed for serving
such clients. However, he argued that low-income countries are not faced with choosing
between a stock market and small community banks and that government wanting to
create an enabling environment for the private sector should focus on creating a legal and
financial framework to promote access to credit across the spectrum of demand.
Schoar (2009) while agreeing that a competitive banking sector plays an important role in
facilitating firm growth and competition and that equity markets can at best constitute a
small fraction of overall facilitating in developing countries, questioned promoting small
banks as a solution. She argued that scale matters for banks and tiny banks will not be
able to provide sufficient capital to allow small business to grow into large ones.
Levine (2009) agrees that the structure of financial institutions and markets in many
developed economies is inappropriate for many developing economies- which in his view
is supported by considerable evidence but often ignored by policy advisors- and that
appropriate form and function of financial institutions differ depending on a country‘s
legal and political system as well as on the types of economic activities occurring in the
country.
26
2.3 EMPIRICAL LITERATURE:
A substantial body of empirical work assesses the magnitude of the impact of financial
sector deepening, whether certain components of the financial sector (banks or stock
markets) play a particular important role in fostering growth and whether and what extent
financial sector deepening directly bring about aggregate welfare benefits.
2.3.1 CROSS-COUNTRY EVIDENCE:
To examine whether financial sector deepening has any significant impact on aggregate
welfare indicators indirectly through the growth channel, various cross country analysis
show that economic growth and aggregate welfare are needed strongly and positively
correlated, Dollar and Kraay (2002)Ravallion (2004), Ravallion and Chen (1997).
From the poverty angle, Ravallion and Chen (1997) show that a 10 percent increase in the
mean standard of living leads to an average reduction of 31 percent in the proportion of
the population below the poverty line-indicating that growth leads to a welfare
improvement.
Also, Jalilian and Kirkpatrick (2001) examined the link between financial sector
deepening and poverty reduction using data for a sample of 26 countries including 18
developing countries. They used Bank deposit money assets as a measure of financial
deepening. Their results suggest that a 1 percent change in financial deepening raises
growth in the incomes of the poor in developing countries by almost 0.4 percent-a
significant impact.
Honohan (2004a) showed a robust effect of financial depth (measured as the ratio of
private credit to GDP) on headcount poverty incidence. He found that financial sector
deepening is negatively associated with headcount poverty with a coefficient suggesting
that a 10 percent point change in the ratio of private credit to GDP should (even at the
same income level) reduce poverty ratios by 2.5 to 3 percentage point.
Dollar and Kraay (2002) also show that the average income of the poor in a country
defined as those who belong to the poorest quintile of society-rises proportionately with
the country‘s average income based on a data set of countries over 1950 to 1999. They
used such indicators as good rule of law, openness to international trade and financial
depth as determinants of growth and found that they have little systematic effect on the
income that accrues to the bottom quintile.
Other studies looked at the relationship between financial deepening and distribution of
income about which there are competing theories. Greenwood and Jovanovic (1990)
27
argued that there is an inverted u-shaped relationship between income inequality and
financial sector deepening.
Furthermore, although the validity of the Kuznets curve remains a contested issue, a
common empirical finding in the recent literature is that inequality at the country level
has weak correlation with rates of economic growth, Deininger and Squire (1998), Dollar
and Kraay (2002), Ravallion (2001).
Clarke et al (2002) empirically tested these alternative theories about the relationship
between financial sector deepening and income inequality using data from 91 countries
from 1960 to 1995. Their findings support the theory that there is a negative relationship
between financial sector deepening and income inequality rather than an inverted U-
shaped relationship. One of the factors that determine the elasticity of poverty to growth
is initial inequality, Kekwani et al (2000), Ravallion (1997), (2001). Based on data spells
constructed from two household surveys over time for 23 developing countries Ravallion
(1997) estimates the elasticity of poverty with respect to growth and found that the
elasticity declines shapely as the initial inequality rises. He found that for a country with
an initial Gini index of 0.25, one percentage point of growth is likely to lead to a 3.3
percentage point reduction in poverty incidence with much welfare improvement, while
for a country with an initial Gini index of 0.6, one percentage point of growth is likely to
only lead to a 1.8 percentage point reduction in poverty incidence.
A number of empirical studies examined a more direct relationship between financial
sector deepening and welfare indicators, Claessens and Feijen (2006) found that financial
deepening and household expenditures are highly related. Although causality is less clear
than in the case of income, they opined that there is evidence that financial deepening is a
leading indicator for increases in household consumption. The effect is substantial and
can be shown using several statistical methods. They estimated the elasticity of household
consumption with respect to private credit to be between 0.07-0.22, and found out that the
median growth in the private credit to GDP ratio for 178 countries was 1.6 percentage
points per year over the period 1980-2004. They further made an assumption that if
private credit grows by 1.6 percentage points annually for the next 10 years, this elasticity
implies that world household expenditure 10 years from now would be 1.1–3.6
percentage points higher than current levels.
They have further findings using panel data fixed effects regressions with over 4100
observations for 142 countries, they control for government consumption as a share of
28
GDP, trade as a share of GDP, and inflation. And found that 1, 5, and 10 year lagged
values of private credit to GDP have a significant impact on contemporaneous household
expenditure. In addition, they found that average private credit (logs) has a highly
significant impact on the growth of household consumption and average household
consumption (logs) in the period 1980-2004.
Li et al (1998) found that financial depth (measured as the ratio of broad money supply
[m2] to GDP) is associated with lower inequality and also higher income of the lower
80% of the population (i.e. the poor majority) based on data for 40 developed and
developing countries over 1947 to 1994, the regression results suggest that a one percent
standard derivation increase in financial depth would result in an increase of US $ 3,000
in the incomes of the poor but only an increase of US $1,600 in the incomes of the rich.
Beck et al (2004) used data on 52 developing and developed countries over the period
1960 and 1999, to assess whether there is a direct relationship between financial sector
development (measured by credit to the private sector) and changes in income
distribution. They found that the income of the poorest 20% of the population grows
faster (using GDP per capital) in countries with higher financial sector development and
that income inequality falls. Beck et al (2000) examined the influence of financial
intermediary development on income redistribution using the sources of growth linkage
(productivity growth, physical capital accumulation and private savings). While the
linkage between financial sector development and private savings/ capital accumulation
is found to be not robust to alternative specifications they found a robust and positive
relationship between financial development indicators and productivity growth.
Beck et al (2004) show that countries with better developed financial intermediaries
(measured as the ratio of private credit to GDP) experience faster declines in both poverty
and income inequality by disproportionately boosting the income of the poor, hence,
bringing about much welfare benefits.
Claessens and Feijen (2006) also examined whether financial sector deepening plays any
role in achieving millennium development goal (MDG) targets. They found evidence that
financial deepening and greater access to financial services indeed lead to income growth,
a reduction in poverty, undernourishment and better health, education and gender quality.
They concluded that financial services such as savings can help firms and households
cope with economic shocks which lead to improvement in household welfare.
Dehejia and Gatti (2002) found that an increase in access to credit leads to improvement
in household welfare by reducing the extent of child labour. He argued that this is
29
because, in the absence of developed financial markets, poor households with high levels
of income variability are found to resort substantially to child labour to diversify their
sources of income and reduce vulnerability to shocks.
2.3.2 COUNTRY SPECIFIC EVIDENCE:
Evidence from country specific studies shows that the financial sector reforms initiated in
the late 1990s in Pakistan created a favourable environment in which the poor and
middle-class have a better chance of receiving credit from formal institutions, Husain
(2004). In his study of the relationship between financial deepening, savings mobilization
and poverty reduction in Ghana, Quartey (2008) found that financial sector deepening has
a positive impact on poverty which is one of the indicators of aggregate welfare, although
the impact is insignificant in view of the fact that financial intermediaries have not
adequately channeled savings to the pro-poor sectors of the economy.
Burgess and Pande (2005) found that increased savings mobilization and credit provision
in rural areas contributed to welfare gains in rural India. They found that branch
expansion in rural India led to faster growth of non-agricultural output, growth of
agricultural wages and decline in poverty in states that started the period with a lower
level of financial sector deepening. The most important channel through which financial
sector deepening directly affects aggregate welfare is increased access to financial
services. Empirical evidence suggests that firms‘ and households access to financial
services rises with financial deepening. Beck et al (2007). However, studies by Morduch
(1998), Coleman (1999) questioned the rigor and validity of the findings of standard
impact assessments of microfinance institutions highlighting data and methodological
problems. In any case, it is difficult to derive from these studies aggregate results on the
impact of Micro Finance Institutions comparable to those produced by studies using more
formal financial sector deepening indicators, as the diversity of such arrangement and
providers prevents easy generalizations.
In Nigeria, few empirical studies have been carried out on the subject matter. Recently,
Osinubi and Akinyele (2006) carryout an in-depth study of domestic money bank lending
using secondary sourced time-series data from 1970-2003. They suggested that increases
in bank lending rates compound the problem of rising cost of funds in the performance of
the sector. Using endogenous growth model time series techniques and annual date from
1970-2002, Akpan (2004) explored the impact of financial deepening on the rate of
30
economic growth in Nigeria and the empirical results showed a positive impact in
Nigeria.
Nzotta and Okereke (2009) using stepwise least square regression method found that
financial reforms in Nigeria from 1986 to 2007 have a relatively low level of deepening
impact on the financial market. Similar results were shared by Nnanna and Dogo (1999),
and Ayida (2007) where the prime lending rate was used to examine the relationship
between the lending pattern and financial deepening in Nigeria.
2.4 EFFORTS TOWARDS DEEPENING THE FINANCIAL SECTOR IN
NIGERIA.
Nigeria like other African countries was faced with a series of economic problem. Some
of these were high inflation and unemployment, increasing poverty, low economic
growth, high fiscal deficits, and high balance of payment deficits, financial sector
repression and worsening terms of trade. The necessary conditions for growth and
efficient economic management prompted the need for adoption of a consistent,
appropriate macroeconomic policy framework and the existence of high quality
institutions. The introduction of the Structural Adjustment Programme (SAP) in July
1986 was an effort to set the macroeconomic policy framework right. The major financial
sector reform policies implemented were the deregulation of the interest rates, exchange
rate and the liberalization of entry and exit into banking business. Also there was the
establishment of the NDIC, strengthening the regulatory and supervisory institutions etc.
Even though some positive effects in the growth of financial institutions and financial
instruments were recorded during the SAP-era, the systemic risks and vulnerability of the
institutions became higher.
However, in July 2004, the mother of reforms came in Nigeria when 89 banks were
forced to emerge forming 25 universal banks. This was further reduced to 24 banks at the
end of December 2007 with the emergence of Stanbic Bank Plc and IBTC Bank to form
Stanbic IBTC Bank plc. The two major elements of the reform agenda are the
requirement for Nigerian banks to increase their shareholders funds to minimum of
N25billion by the end of December 2005 and consolidation through Mergers and
Acquisition (M and A). Insurance companies were equally mandated to increase their
shareholders funds by December 2007to N10billion for re-insurers, N3billion for general
31
insurers and N2billion for life insurer‘s operators. This exercise has brought about a
reduction in the number of insurance companies from 103 to 71.
2.5 LIMITATIONS OF PREVIOUS STUDIES
The evidence provided in the literature seems to suggest that the subject have become an
important empirical debate amongst researchers and policy makers. Most of the case
studies reviewed focused mainly on poverty. They used cross-section data on countries
that may be diverse, raising the possibility that the empirical findings could be distorted
by heterogeneity biases affecting both financial deepening and poverty. A major
weakness of such country analysis is that its results are only indicative of average trends.
However, some country specific studies did not consider the fact that financial deepening
indicators varies between periods and countires, the same is applicable for measures of
poverty. And, financial deepening is a macro concept while poverty is more of a micro
analysis. Therefore, such country specific finance poverty nexus will be more meaningful
if studied from the angle of finance aggregate welfare link.
Moreso, the effects of financial variables take time to transmit to other variables, most
studies except Odhiamboh did not use the ARDL-ECM in estimating the impact of
financial deepening on aggregate welfare indicators, which has numerous advantages as
specified in chapter three.
Studies on Nigeria have concentrated more on the link between financial deepening and
economic growth. None has gone further to examine the influence that financial
deepening has on aggregate welfare especially, as it concerns the low income earners.
Most of these studies used the traditional financial deepening proxy-MS2/GDP as an
explained variable, Nzotta and Okereke (2009), Nnanna and Dogo (1998), etc. There are
also very few empirical studies which focused on the issue of access to financial services
using bank branches as one way of expressing the impact of financial deepening on
aggregate welfare, which means that this important issue is often overlooked.
This research work fills the gaps that has been overlooked by the literature on country-
specific bias and intends to analyze access to financial services using number of bank
branches.
32
CHAPTER THREE
METHODOLOGY
Macroeconomic variables do not instantaneously transmit to other variables especially
social indicators. This is because when such impact is transmitted, it involves a time lag
between the transmitting variables and the admitting variables. This makes it very vital to
use a dynamic model to capture the essence of such relationship.
3.1 ANALYTICAL FRAMEWORK: Financial deepening as noted before means an
increase in the supply of financial assets in the economy. It is important to develop some
models of the widest range of financial assets, including money. The sum total of all the
financial assets is one broad measure that represents financial deepening. However, King
and Levine (2003) constructed some indicators of financial depth to measure the services
provided by financial intermediaries;
1) Ratio of liquid liabilities to GDP
2) Ratio of credit issued to the private sector to GDP
The range of financial assets to be considered in this study as measures of
financial deepening include, the ratio of private credit to GDP, ratio of broad money
(MS2) to GDP, prime lending rates (PLR), ratio of currency in circulation to money
supply – (expressing the banking habit) and the ratio of deposit money bank assets to
GDP.
Also, from recent existing literature, measures of aggregate welfare in this study will use
private per capita consumption as proxy following Odhiambo (2009), Gloede and
Rungruxsirivorn (2010). Due to unavailability of survey data on household access to and
utilization of financial services, it is not possible to carry out an impact assessment or an
econometric estimation of increased or decreased financial services access on aggregate
welfare. However, the underlying assumption of using private per capita consumption as
a measure of aggregate welfare is that if an individual has been able to access financial
services and repay loans on a continuous basis from/to a given rural financial institutions
that has attained high levels of outreach and sustainability, then it implies that the
individuals well being is improved. Financial access here is defined as the availability of
supply of quality financial services at reasonable costs, Asenso-Okyere et al (1993). The
different dimensions to access include; the dimension of availability to be measured by
bank branch distribution and the second dimension is the question of cost-at what price
are the financial services available?
33
3.2 THE MODEL:
This research work will adopt the ANCOVA model for objective one with the
introduction of dummy variable for objective one in the multiplicative form and the
ARDL model for objectives two and three. The multiplication form dummy will enable
us to differentiate between slope coefficients of the two periods (for objective one). We
shall adopt a single regression equation for objectives one and two and a different
equation for objective three; using OLS estimation because of its reliable traits as the best
unbiased estimator. Its error term has a minimum and equal variance. Hence, in
estimating the first and second objectives, PSC/GDP will appear as endogenous variable
in the financial deepening model and will appear as an explanatory/predetermined
variable in the aggregate welfare model. This is a case of simultaneity bias but in the
form of recursive model; thus, allow the application of OLS, Gujarati (1978).
3.2.1 MODEL SPECIFICATION:
Following Nzotta and Okereke (2009) the functional form specification in investigating
financial deepening is as follows;
PSC/GDP = f(COB/MS2,NBBT,INS, and Dummy)………1
Dummy. D = O period before consolidation (1975-2004), and D=1 period after
consolidation, (2005-2010).
PSC/GDP = f(FS/GDP, DMBA/GDP, NBBT, COB/MS2, PLR)…………………2
And following Quartey (2008), Odhiambo (2009), Gloede and Rungruxsirivorn (2010)
the aggregate welfare equation is;
PPCE = f (GDPPC, NBBT, RGDPGR, PSC/GDP, INF) ……………… (3)
Where PPCE = Private per capita consumption proxy for poverty reduction, and FD =
Financial deepening indicator- PSC/GDP.
Transforming equation 1 into a linear function; PSC/GDP= 0+ 1D1 + 2COB/MS2 +
3NBBT + 4INS + 5(D1COB/ MS2) + ut………..(4)
Were 0 = the constant or the intercept and 1= the differential intercept 6 =
differential slope coefficient for multiplicative case between the dummy and COB/MS2-
indicating by how much the slope coefficient of the reform periods differ from the slope
coefficient of the base period.
34
MODEL 1:
Transforming equation 4 yields
(PSC/GDP)= 0 + 1Dit + 2(COB/MS2) + 3(NBBTt) +
4 (INS)t + 5 (Di COB/MS2)t + Ut……..(5)
Equation 5 is model A for our objective one. The null hypothesis in equation (1) is 1 =
0 and 5 = 0 indicating that there are no structural changes between the two periods, i.e.
the financial deepening index for the two periods are the same.
Equation 2 can be transformed to the model below;
MODEL 2:
(PSC/GDP)t = 0 + 1(PSC/GDP)t-1 + 2 (FS/GDP) t-i + 3 (DMBA/GDP+-j) +
4(NBBT)t-k + 5(COB/MS2t-i) + 6(PLR)t-j + Ut ………………. 6
Equation 6 is model B for our objective two it assumes that all variables are well
behaved, which implies that the variables are stationary at order zero.
= Difference operator
= estimated coefficient
t-I,t-j,t-k,etc unknown lags to be determined.
μ = error term.
MODEL 3:
PPCEt = 0+ 1PPCEt-1 + 2 (GDPPC)t-q + 3(NBBT)t-u +Σ 4(∆FDt-v) +
5( INFt-x) + Vt ………............... (7)
, and otherwise equations 6 and 7 translate to;
(PSC/GDP)t = 0 + 1(PSC/GDP)t-1+ Σ 2(FS/GDP)t-i + Σ 3(DMBA/GDP+-j)
+Σ 4(NBBT)t-k + Σ 5(COB/MS2t-l) + Σ 6( PLR)t-m + ut…………… 8
PPCEt = 0+ 1PPCEt-1+ Σ 2(GDPPC)t-q + Σ 3(NBBTt-u) + Σ 4(∆FDt-v ) +
Σ 5( INFt-x) + Vt……… (9)
If the order of integration is ascertained, then investigation of the presence of a co-
integration amongst the variables will be tested. For models two and three, the F test is
used for testing the existence of long-run relationship. When long-run relationship exit, F
test indicates which variable should be normalized. The null hypothesis of no
35
cointegration among the variables in equations 8 and 9 is Ho: 1= 2= 3= 4
= 5= 6=0 and Ho : 1= 2= 3= 4= 5=0 against the alternative hypothesis, Hi:
1≠ 2≠3 4 ≠ 5≠ 5 ≠ 0 and H1 : 1≠ 2≠ 3≠ 4≠ 5≠0. The F test has a non-
standard distribution which depends on (1) whether the variables included in the model
are 1(0) or 1(1), (ii) the number of regressors and (iii) whether the model contains an
intercept and / or a trend. The test involves asymtotic critical bounds depending on
whether the variables are 1(0) or 1(1) or a mixture of the both. Two sets of critical values
are generated, with one set refers to as the 1(1) series and the other the 1(0) series.
Critical values for the 1(1) series are the referred to as the upper bound critical values
while that of the 1(0) series are reffred to as the lower bound series.
If the F test statistics exceed thier respected critical values we can conclude that there is
evidence of long-run relationship between the variable respective of their order of
integration and vice versa, Pesaran et al (2001).
If the residuals are stationary and a long run relationship is established, then the error
correction estimates can be obtained from equations 8 and 9. On that note, if the unit
roots test indicates evidence of co-integration, then equations 8 and 9 translates to an
error correction model (ECM) as shown below.
3.2.2 THE ARDL- ERROR CORRECTION MODEL: In order to ensure the
parsimonious nature of the model equation 8 and 9 translates to an Auto-regressive
Distributed leg (ARDL) model as stated bellows;
Δ (PSC/GDP)t =αo + α1(PSC/GDP)t-1 +
p
i 1
αi Δ Xt-k + α7 ECM t-I + µt …………10
∆ (PPCE)t = λo + λ1 PPCEt-1 +
q
j 1
λj ΔYt-k + λ6 ECMt-I + Vt ………………………11
Where ECMt-I the residual or error correction mechanism of the previous year.
α5 and λ 5 the speed of adjustment parameters.
Where Xt and Yt= all other explanatory variables defined above in the two equations.
3.2.3 UNIT ROOT TEST
The variables of this study shall be subjected to non-stationary test using the Augmented
Dickey fuller (ADF) and Phillips-perron testing procedures. The unit root test regression
equations with constants are;
36
Δ(PSC/GDP)t = αo + α1 (PSC/GDP)t-1 +
m
T
pi1
Δ (PSC/GDP) t =1 + µt ...............12
Δ(PPCE)t = λo + λ1(PPCE)t-1 +
m
j 1
δj Δ(PPCE)t -1 + Vt ……………………………13
Where Δ is the difference operator
Ut and vt = random terms that are iid
t = linear trend
k = no of lagged differences. From the above equations;
Ho =α1 = λ1 =1 (unit root)
H1 ≠ α1 ≠ λ1 < 1 (level stationarity)
3.3 ESTIMATION PROCEDURE
The time series properties of the data will be examined in order to avoid spurious results
emanating from the non-stationery of the data series and to analyze the dynamic structure
of the relationship. The estimation begins with a unit root test to conform the stationarity
states of the variables that entered the model. To do this the Augmented Dickey Fuller
and Phillips-Perron classes of tests are used. Co-integration regression is obtained from
the normalized coefficient of the model generated from the co-integration vector, should
co-integration exist the ECM model is estimated by applying the ECM version of ARDL
where the speed of adjustment to equilibrium will be determined.
3.4 JUSTIFICATION OF THE MODEL
This research work employed Ordinary Least Square (OLS) estimation because of its
reliable traits as the best unbiased estimator and because the equations are in recursive
form. Since the focus of the study is to establish the link between financial deepening and
aggregate welfare, based on the aforementioned theoretical postulates and following the
practices in most studies, an appropriate technique is to adopt the autoregressive
distributed Lag-error correction modeling (ARDL-ECM) and co-integration approach
popularized by pesaran et al (2001) as used in Sarkar (2007) and Odhiamboh (2009). This
approach has some advantages over the Engel-Granger and maximum likelihood based
approach by Johansen and Juselius co-integration technique. This residual based co-
integration tests are inefficient and can lead to contradictory results especially when there
are more than 1(1) variable under consideration. The ARDL modeling approach is
superior because it does not require pre-testing of the series to determine the order of
37
integration when the variables are of the mixed order of integration 1(0) and 1(1) or
mutually integrated and when there is structural break in the time series data just as in
this study. Also the ARDL modeling incorporates sufficient number of lags to capture the
data generating process and is highly suitable when the sample size is relatively small,
Pesaran et al (2001).
3.5 STATISTICAL CRITERIA
The following test will be conducted namely, student t test for the parameter relevance in
the model, F-test for the joint parameters‘ impact on the dependent variable, model
specification and functional misspecification test, serial correlation test and
heteroscedasticity test.
3.6 DESCRIPTION OF VARIABLES
PSC/GDP is the ratio of private sector credit to gross domestic product. It also measures
the financial depth, but captures the flow of credit to the private sector, i.e. it concentrates
on credits issued by intermediaries other than the central bank. The logic is that the more
private credit is available to an economy the more opportunities exist for continued
growth.
COB/MS2 is the ratio of currency outside bank to money supply, it measures the
intermediation rate (the banking habit).
DMBA/GDP is the ratio of deposit money banks‘ asset to gross domestic product. A
mature and well functioning financial system boosts the asset of banks.
FS/GDP is the ratio of total savings and time deposit with commercial banks to gross
domestic supply.
INF is the inflation rate. This captures the macroeconomic environment. High and
unpredictable inflation is thought to have a disproportionally negative impact on the poor
because the poor have relatively limited access to financial instruments that hedge against
inflation and are more likely to have a larger share of cash in their small portfolios,
Holden and Prokopenko (2001).
RGDPPC is the real GDP per capita, which captures the indirect effect. A large number
of studies have pointed out that financial deepening leads to welfare gains indirectly
through its effects on growth. This suggests that economic growth is an effective
instrument for aggregate welfare improvement.
Real GDP rate = RGDPt/POPULATIONt
38
PLR is the prime lending rate. It is an indicator of financial access-measures cost of
financial access. A high level of financial deepening should sustain and provide basis for
moderate lending rate in the economy.
PPCE is the private per capita consumption expenditure. This represents welfare
indicator for households. It is argued that consumption expenditures reflect not only what
a household is able to command based on its current income, but also whether that
household can access credit markets or household savings, Hentschel and Lanjouw
(1996).
Private per capita consumption expenditure = private consumption
expendituret/populationt.
NBBT is the number of bank branches in Nigeria. It is a measure of financial access.
INS defines the interest rate spread/margin and it varies and depends on the context in
which it is used. For the purpose of this paper, interest rate margin is the spread between
bank deposit and lending rates
39
CHAPTER FOUR
PRESENTATION AND ANALYSIS OF ECONOMETRIC RESULTS
4.1 UNIT ROOT TESTS: Before proceeding with the structural stability test and the
ARDL bounds test, the stationary status of all variables was tested to determine their
order of integration. This is to ensure that the variables are not 1(2) stationary so as to
avoid spurious results for the ARDL results. According to Pesaran et al (2001) if any
variable is 1(2) stationary the computed statistics are not valid because the ARDL bounds
test is based on the assumption that the variables are 1(0) or 1(1).
4.1.1 TREND PROPERTIES OF THE VARIABLES: computed by the researcher
Figure 1 (a) figure (b)
5
10
15
20
25
30
35
40
45
1980 1985 1990 1995 2000 2005 2010
PSC_GDP
10
20
30
40
50
60
70
80
1980 1985 1990 1995 2000 2005 2010
DMBA_GDP
Figure (c) figure (d)
4
8
12
16
20
24
1980 1985 1990 1995 2000 2005 2010
FSY
5
10
15
20
25
30
1980 1985 1990 1995 2000 2005 2010
PLR
40
Figure ( e ) figure ( f )
0
1000
2000
3000
4000
5000
6000
1975 1980 1985 1990 1995 2000 2005 2010
NBBT
0
4
8
12
16
20
24
1980 1985 1990 1995 2000 2005 2010
INS
Figure ( g ) figure ( h )
0
10
20
30
40
50
60
70
80
1980 1985 1990 1995 2000 2005 2010
INF
0
2
4
6
8
10
12
14
1980 1985 1990 1995 2000 2005 2010
PPCE
Figure ( i ) figure (l)
.0
.1
.2
.3
.4
.5
1975 1980 1985 1990 1995 2000 2005 2010
GDPPC
8
12
16
20
24
28
32
36
40
1980 1985 1990 1995 2000 2005 2010
COBM
41
TABLE 1: UNIT ROOTS TESTS RESULTS.
VARIABLES TREND ADF
PPERRON REMARKS LAG
level First
difference
Level First
difference
PSC/GDP Without -1.831 -3.383** 0.590 -3.885** 1(1) 1
DUM Without 0.000 -3.937** 0.000 -5.745** 1(1) 0
COB/MS2 Without -1.168 -2.669** -1.568 -4.892** 1(1) 1
PLR Without -1.852 -5.738** -2.184 -9.479** 1(1) 1
DMBA/GDP Without -2.210 -3.505* 0.255 -4.462** 1(1) 1
DUM*CICM Without -1.335 -4.648** -1.516 -6.708** 1(1) 1
INF Without -3.544* - -3.322* - 1(0) 1
FS/GDP Without 0.245 -2.729** 0.598 -4.440** 1(1) 1
GDPPC With -2.233 -4.467** 1.355 -5.716** 1(1) 1
PPCE Without 0.190 -1.862 2.803 -2.473* 1(1) 1
NBBT Without 2.702 -2.296* 4.127 -3.121** 1(1) 1
COB/MS2 Without -1.132 -2.836** -1.483 -5.260** 1(1) 1
** indicates significance at 1% level
*indicates significance at 5% level. Source: computed by the author
Critical values: (ADF) without trend (levels), 1% = -2.646, 5% = -1.950
― (first difference), 1% = -2.647, 5% = -1.950
With trend (levels), 1% = -4.297, 5% = -3.564
― (first difference), 1% = -4.306, 5% = -3.568
(PPERRON) (Level) 1% = -2.644, 5% = -1.950
(First difference) 1% = -2.646, 5%= -1.950
The financial deepening variable ( PSC/GDP), dummy, intermediation variable (
COB/MS2), NBBT, INS, DUM*COB/MS2 are found to be stationary at first difference
for model 1 as shown in table 1, while INF is found to be 1(0). Note, that PPCE is not
stationary at 1(1) using ADF but is 1(1) using Phillips-perron which is stronger than the
ADF.
42
4.2 RESULT PRESENTATION:
4.2.1 MODEL 1: The estimated long-run structural differences in the Nigeria
Financial Deepening and intermediation rate regression, the dummy variable
approach.
Table 2
Dependent variable, PSC/MS2
VARIABLE COEFFICIENT T-VALUE
CONSTANT 28.814 6.50
DUMMY 22.84 2.37
COB/MS2 -0.48 -3.26
DUMMY*COB/MS2 -1.457 -2.97
Table 3 COINTEGRATION RESULT
VARIABLE ADF PPERRON
Residual -3.573** -4.348**
Critical values: 1%= -2.646, 5%= -1.950, (both tests without constant)
Since the variables in model one are all integrated of order (1) we proceed for the
cointegration equation where the residual of the cointegration is stationary at 1 (0), this
suggest that the regression for all the variables in model one have to be done on their
respected levels of integration.
The cointegration result show that there is cointegration because the residual obtained
from the linear combination of the variable in question were stationary at 1% critical
value while the series that generated the residual were not stationary. We proceed for the
ECM-equation, the coefficient of the ECM (lagged residual from the cointegration
equation) is not significant though it coefficient less than one. There is slow adjustment to
equilibrium at 18%. Since there is cointegration, we estimate the short-run equation.
4.2.2 The estimated short-run structural differences in the Nigeria Financial
deepening and intermediation rate regression, the dummy variable approach.
Table 4 Dependent variable, PSC/MS2
VARIABLE COEFFICIENT T-VALUE
CONSTANT -0.117 -0.15
43
D(DUMMY) 35.456 2.17
D(COB/MS2)t 0.094 0.35
DDUMMY*COB/MS2)t -1.165 -2.23
ECMt-1 -0.180 -0.86
Both the intercept and the slope co-efficients are also statistically significant strongly
suggesting that the financial depending intermediation rate for the two periods 1975-2004
and 2005-2010 are different. The equations for the two periods are stated thus;
Financial deepening- intermedation rate – 1975-2004
PSC/GDP = -0.117 + 0.094 COB/MS2
Financial deepening- intermedation rate-2005-2009
PSC/GDP = (-0.117 + 35.456) – (1.165 + 0.094) COB/MS2
= 35.339 – 1.071 COB/MS2
The long-run and short-run equation results are expected. They suggest that the recent
banking reform in Nigeria has affected the level of financial deepening in the country,
since the 2005-2009 equations are higher than the 1975-2004 eqations.
Serial correlation test:
The durbin test is 2.0012 showing no sign of autocoreelation
Heteroscedasticity test:
Using the stata command for white heteroscedasticity test show that there is constant
variance of the error term (no heteroscedasticity). The p-value is 0.4361, with the null
hipothesis of no heteroscedasticity, since the p-value is not significant, we cannot reject
the null hypothsis of no heteroscedasticity.
Ramsey test for model specification:
With the null hypothesis that the model has no omitted variables from the p-value of
0.1434 we cannot reject the null hypothesis. This indicates that the model is correctly
specified. This confirm with the stata model specification link test of the long-run
equation (sec the appendic).
4.3 BOUND TESTS FOR COINTEGRATION:
In the first step of the ARDL analysis, the study tested for the presence of long-run
relationships. Cointegration analysis helps to clarify the long-run relationships between
integrated variables, pesaran et al (2001). The F-statistics (the normal joint Wald test)
44
tests the joint null hypothesis that the coefficients of the lagged level variables are zero
(i.e.no long-run relationship exists between them).
TABLE 5: RESULTS FROM BOUND TEST ON EQUATIONS 5 AND 6:
Model Test
statistics
value lag Significance
level
Bound critical
values*(restricted
intercept & no trend)
1(0) 1(1)
2 F-stat
3.57 1 1% 1.99 2.94
5% 2.27 3.28
3 ― 70.11 1 1% 2.08 3.00
5% 2.39 3.38
The F-statistic from the bound test for model 2 (see table 2) is greater than the bound
critical values (restricted intercept and no trend) showing evidence of cointegration for
the lagged level variables. The F-statistic from the bound tests for model 3 is significant
and greater than the respective critical values (restricted intercept and no trend) indicating
evidence of cointegration for the lagged level variables. This suggests that the regression
for all the variables in model two and three have to be done on their levels of integration.
Thus, we proceed to the stationarity test of the residuals of equations 5 and 6.
TABLE 6: COINTEGRATION RESULT
MODEL VARIABLES ADF PPERRON LAGS
2 Residual -4.3913** -6.325** 1
3 Residual -3.225** -7.141** 1
Critical values: ADF-1%=2.649, 5%=1.950
PHILLIP-PERRON-1%= -2.647, 5%= -1.950
Note: both tests were done without constant and, **(significance at 1% and 5%)
The result show that there is cointegration because the residual obtained from the linear
combination of the variable in question were stationary at 1% critical value reading from
lag length (1), while the series that generated the residual wre not stationary.
Since the study has established that long-run cointegration relationship existed, equations
five to six were estimated using the ARDL approach. The results obtained from the long-
run coefficient of the variables under investigation and their respective short-run
45
coefficient estimates obtained from the ECM version of the ARDL model were reported
in the appendix A in this order;
Table 7 The estimated long-run coefficient results of model 2
ARDL (1, 1), Dependent variable, PSC/GDP
VARIABLE COEFFICIENT T-VALUE
CONSTANT -4.892 -1.529
(PSC/GDP)t-1 0.315 1.942
(FS/GDP)t 0.953 3.358
(FS/GDP)t-1 -0.077 -0.289
(DMBA/GDP)t 0.229 3.108
(DMBA/GDP)t-1 -0.191 -1.984
(NBBT)t 0.00327 2.420
(NBBT)t-1 -0.00145 -1.023
(COB/MS2)t 0.180 1.607
(COB/MS2)t-1 -0.0000676 -0.00058
(PLR)t 0.094 1.201
(PLR)t-1 -0.266 -3.580
Table 8 The error correction model for model 2
ARDL(1,1) Dependent variable D(PSC/MS2)
VARIABLE COEFFICIENT T-VALUE
CONSTANT -0.545 -1.563749
D(PSC/GDP)t-1 -0.0247 -0.088610
D(FS/GDP)t 0.4199 1.423996
D(FS/GDP)t-1 -0.381 -1.269163
D(DMBAY,1)t 0.363154 4.302102
D(DMBA/GDP)t-1 0.025164 0.199249
D(NBBT)t 0.002907 2.100748
D(NBBT)t-1 0.003222 2.146631
D(COB/MS2)t -0.00029 -0.0028
D(COB/MS2)t-1 0.0158 0.138
D(PLR)t 0.0799 0.893
46
D(PLR)t-1 -0.249 -2.906
ECMt-1 -0.159 -0.416
Table 9 The estimated long-run coefficient results of model 3
ARDL (1, 1), Dependent variable, PPCE
VARIABLE COEFFICIENT T-VALUE
CONSTANT 0.853 2.814
(PPCE)t-1 1.166 16.585
(PCY)t 2.399 1.306
(PCY)t-1 3.879 2.0414
(NBBT)t 0.000836 2.351
(NBBT)t-1 -0.001525 -4.444
(PSC/GDP)t -0.0196 -0.883
(PSC/GDP)t-1 -0.0602 -2.995
(INF)t 0.00514 1.055
(INF)t-1 0.00033 0.07002
Table 10 The error correction model for model 3
ARDL (1, 1), Dependent variable D(PPCE)
VARIABLE COEFFICIENT T-VALUE
CONSTANT 0.126 1.185
D(PPCE)t-1 1.014 4.049
D(PCY)t -0.1194 -0.0612
D(PCY)t-1 2.099 1.032
D(NBBT)t 0.000791 2.0291
D(NBBT)t-1 -0.0017 -4.044
D(PSC/GDP)t 0.0111 0.447
D(PSC/GDP)t-1 -0.057 -2.33
D(INF)t 0.0048 1.044
D(INF)t-1 0.0038 0.791
ECMt-1 -0.557 -1.825
47
4.4 INTERPRETATION OF THE ARDL RESULTS:
4.4.1 The determinants of financial deepening model.
We found that the computed F – statistics exceed the critical bound at 1% and 5%
significance level. This implies that long-run relationship exist between financial
deepening and as determinants. Thus, we interpreted the short-run regression results
associated with the long-run relationship as given in table 5. The intermediaiton ratio
(COB/MS2) is negative as expected but is not significant. The deposit money bank asset
to GDP ratio is significant and obeys the expected sign. A one per cent increase in assets
of banks raises the financial deepening index by 36.3% in the short-run.
Prime lending rate is not significant and did not obey the expected sign; the positive sign
corresponds with the findings of Fadare (2010). This is not a surprise; a high level of
financial deepening should sustain and provides a basis for moderate lending rate in any
economy, Nzotta and Okereke (2009).
The financial savings to GDP ratio is significant in the long-run and is not significant in
the short-run, but obeyed the expected sign. The reason why most variables are not
significant could be due to the fact that the deepening process is still an on-going
exercise. The error correction coefficients at -0.159 is statistically insignificant, but have
correct sign and suggest a low speed of adjustment to equilibrium at 15.9%. The state of
financial deepening process in Nigerian could be the reason for ECM result.
The coefficient of multiple determinants (R-squared) with a high value 0.9101 implies
that 91.01% of the total variations in the financial deepening indicator are accounted for
by all the explanatory variables in the regression model. The significance of the F-value
implies that all the explanatory variables jointly exact significance influence on
PSC/GDP.
4.4.2 The impact of financial deepening on aggregate welfare model.
Here we tried to estimate the impact of financial deepening on aggregate welfare, using
the financial deepening indicator (PSC/GDP), financial accessibility indicator (number of
bank branches) and the growth effect. The results suggest that financial deepening in
Nigeria has no direct impact on aggregatve welfare.
However, the results suggest that past values of private per consumption has a significant
impact on current values of the dependent variable with a positive relationship, which is
theoritical. The number of bank branches in Nigeria (a measure of financial accesibility)
is significant both in the long-run and short-run and obeys the expected sign. A one per
48
cent increase in the number of bank branches in the country leads to a 0.08% increase in
the aggregate welare of the people.
The per-capital GDP is insignificant and positive which is expected, both in the short-run
and long-run. The financial deepening variable is not significant, but obeys the expected
sign. Thus, indicating that financial deepening has no direct impact on aggregate welfare.
Inflation is not significant and did not obey the expected sign. This is in conformity with
the findings of Fadare (2010) who gave the reasons that the currencies ultimately find
their way to the other foreign exchange markets where they are sold at a premium.
Moreover, the results show that t-ratio of the ECM term, though consistent with theory
(with the correct negative signs); is statistically not significant. The magnitude of the
ECM term is 55.7%, indicating a modrate adjustment towards equilibrium at each year
(period).
The coefficient of multiple determinants (R-squared) with value 0.6856 implies that
68.56% of the total variations in the aggregate welfare is accounted for by all the
explanatory variables in the regression model. The significance of the F-value implies
that all the explanatory variables jointly exact significance influence on the aggregate
welfare. The unexpected part of the result is the negative relationship between GDP per
capita and pivate per capita consumption expenditure.
4.5 DISCUSSION OF FINDINGS:
The stationarity test: The stationarity test revealed that all the variables are at first
difference as shown in table one, while inflation is found to be 1(0). The cointegration
test showed that there is evidence of cointegration between the variables in the first
model.
The ARDL-bound test: From the bound test results, there is evidence of cointegration
between the lagged level variables (using the restricted intercept and no trend).
The model for structural differences: This model is for objective. The result indicates
that there are structural differences in the level of financial deepening in the country
between the two periods-1975 to 2004 and 2005 to 2010 both in the short-run and long-
run. Showing that the level of financial deepening in the country from 2005 to 2010
exceed that of the period from 1975 to 2004. This finding was able to address the first
objective of the study, indicating that there are structural differences between the pre and
post-consolidation periods in Nigeria.
49
The determinants of financial deepening model: This is the model for the second
objective. The results show that the major determinants of financial deepening in the
country for the period of this study are the bank size represented by (DMBA/GDP) and
bank branch distribution represented by (NBBT). However, the magnitude of
(DMBA/GDP) is higher than that of the number of bank branches. This findings is in
conformity with existing literature that increase in the assets of financial institutions is a
major determinant of financial deepening in a country. The ratio of financial savings to
gross domestic product is significant in the longrun equation but not significant in the
short-run equation. The reason for this could be as a result of the panic created in the
banking industry recently due to CBN threat to nationalise some banks. Other
macroeconomic variables such as prime lending rate and the intermediation ratio
(COB/MS2) are not significant in both equations. Thus, are not yet key determinants of
financial deepening in Nigeria during the period of this study. However, the second
objective of the study was still achieved from these findings, indicating that some
macroeconomic variables are the major determinants of financial deepening in a country.
The impact of financial deepening on aggregate welfare model:
This is the model for the third objective and represents the main purpose for this study.
The results show that financial deepening has no direct impact on private per capita
consumption used as a measure of aggregate welfare. However, the results also indicate
that bank branch distribution has a significant impact on aggregate welfare. Moreover,
the GDP per capita used as a measure of the indirect effect through growth has no impact
on aggregate welfare. This is line with the findings of Honohan (2004a) who found that
growth has no significant impact on poverty which is one of the indicators of aggregate
welfare. Thus, the findings from this model did not achieve the stated objective (objective
three) that financial deepening has no direct impact on aggregate welfare.
4.6 IMPLICATIONS OF THE FINDINGS:
From the first model, the implications of the findings is that the recent reforms in the
banking sector has impacted positively on the country‘s financial deepening process.
Secondly, from the second model, the reason for the insignificancy of some
macroeconomic determinants of financial deepening has the following implications; the
intermediation rate (COB/MS2), although, the number of banks has increase recently,
these instutition have not sustained a high level of intermedation. The result of the prime
lending rate according to Fadare (2010) indicates that the banking reforms in the country
50
have not improved the lending pattern of banks. However, significancy of the
DMBA/GDP and NBBT indicate that the current deepening process has enhanced the
operations and spread of banks and this affected the assets of banks in the country and
thus, strong determinants of financial deepening. This corresponds with the findings of
Notta and Okereke (2009). Generally, from the analysis it is evident that there could be
relatively a low level of financial deepening process in Nigeria during the period of the
study. Many have argued that the process has not been a smooth one and the determinants
of financial deepening have not spread well in the country.
Lastly, from the findings of model three; the insignificant of inflation according to Fadare
(2010) could imply that the arbitraging activities in the multiple foreign exchange
markets caused continued depreciation of the local currency against foreign currencies
given rise to domestic inflation. However, a major implication here is that the only
channel by which financial deepening impact on aggregate welfare in Nigeria is through
bank branch expansion. Thus, as finance deepens, it facilitates the expansion of bank
branches which will improve the financial accessibility of the people and thus improves
the aggregate welfare. Also, one can infer that since the recent deepening process has not
been a smooth one, its impact on aggregate welfare is not yet pronounced. A major
aberration of the findings here is the insignificant of the GDP per capita. Though, many
have argued that the growth rate of the Nigerian economy do not reflect the real GDP
growth rate.
4.7 INTERPRETATION OF DIAGNOSTIC TESTS:
MODEL 1: The durbin-watson statistics (7, 34) = 1.854, showing evidence of no serial
correlation.
Heteroscedasticity test, p-value = 0.8928, showing evidence of no heteroscedasticity.
The Ramsey RESET test did not reject the null hypothesis that the model has no omitted
variables at a p-value of 0.0740.
MODEL 2: The sample forecast of the endogenous variable is made and the actual and
forecast value is reported in figure 2. The model is capable of tracking the historical
values of endogenous variables with reasonable accuracy. The fits were quite impressive
and they did track the actual data. The ability of the model to capture turning points was
remarkable. The model does forecast the actual variables well (ie, it has a good predictive
ability). This is contary to that of model 3, see figure 5
51
Figure 2: Plot of the forcast sample for model 2
-15
-10
-5
0
5
10
15
1980 1985 1990 1995 2000 2005 2010
FD1F
Forecast: FD1F
Actual: D(FD1,1)
Forecast sample: 1975 2010
Adjusted sample: 1978 2010
Included observations: 33
Root Mean Squared Error 1.190291
Mean Absolute Error 0.963230
Mean Abs. Percent Error 89.39112
Theil Inequality Coefficient 0.151421
Bias Proportion 0.000000
Variance Proportion 0.022815
Covariance Proportion 0.977185
Source: computed by the researcher
As shown in the appendix models 2 and 3 generally passed all diagnostic tests in the first
stage.
In the second stage short-run equation, model 2 showed that there is no evidence of
autocorrelation using the Bgodfrey test (LM test) since the dependent variable has it‘s
lagged as independent variable, we cannot use the normal durbin-watson test.
The model passed the normality test ( jarque bera normality test-0.772) which suggests
that the errors are normally distributed. It also passed the heteroscedasticity test, 0.418
indicating that the error terms are homoscedastic.
Using the stata model specification command, the model specification test cannot be
rejected at both 1% critical level and 5% critical level, (0.5139).
Stability test: We tested for the stability properties of the model using the cumulative sum
of residual (CUSUM) test and cumulative sum of Residual Square (CUSUMSQ) test. The
existence of parameter instability is established if the cumulative sum of the residuals and
CUSUM square go outside the area between the two critical (dotted) lines. It is estimated
at 5% critical level, from figures 2 it can be inferred that for the period under study,
stability is established, since the CUSUM and CUSUM Square did not go outside the
critical line.
52
Figure 3: Plot of cumulative sum of recursive residuals for model 2
-15
-10
-5
0
5
10
15
92 94 96 98 00 02 04 06 08 10
CUSUM 5% Significance
figure 4 Plot of cumulative sum of squares of recursive residuals
-0.4
0.0
0.4
0.8
1.2
1.6
92 94 96 98 00 02 04 06 08 10
CUSUM of Squares 5% Significance
Source: computed by the researcher
MODEL 3: The interpretation for the sample forecast is the same as in model 2, but the
model is not capable of tracking the historical value of the endogenous variable.
However, the equations in model 3 did not pass the normality test, showing that the errors
are not normally distributed, but they passed the serial correlation, heteroscedasticity and
model specification tests. The CUSUM test showed sign of stability of the model,
however, the CUSUM square showed an element of instability in 1995, 2003 and 2006.
These are periods that policy makers regard as the periods when the banking sector
suffered deep financial distress, and effects of the consolidation became pronounced,
Balogun (2007).
53
Figure 5 plot of sample forecast for model 3
-12
-8
-4
0
4
8
12
1980 1985 1990 1995 2000 2005 2010
PPCEF
Forecast: PPCEF
Actual: D(PPCE,1)
Forecast sample: 1975 2010
Adjusted sample: 1978 2010
Included observations: 33
Root Mean Squared Error 1.528352
Mean Absolute Error 1.278327
Mean Abs. Percent Error 6409.266
Theil Inequality Coefficient 0.572026
Bias Proportion 0.696770
Variance Proportion 0.086848
Covariance Proportion 0.216382
Figure 6 Plot of cumulative sum of recursive residuals for model 3
-15
-10
-5
0
5
10
15
90 92 94 96 98 00 02 04 06 08 10
CUSUM 5% Significance
Source: all computed by the researcher
54
Figure 7 Plot of cumulative sum of squares of recursive residuals for model 3
-0.4
0.0
0.4
0.8
1.2
1.6
90 92 94 96 98 00 02 04 06 08 10
CUSUM of Squares 5% Significance
Source: computed by the researcher
55
CHAPTER FIVE
POLICY RECOMMENDATION AND CONCLUSION
5.1 SUMMARY:
The study examines the impact of financial deepening on aggregate welfare in Nigeria,
using time series data spanning from 1975 to 2010. It used the dummy variable approach
for structural differences for the analysis in the first Model after the necessary conditions
of non-stationarity and cointegration had been satisfied, while the Autoregressive
Distributed Lag-Error Correction Model was used for the analysis in the last two Models.
The study also employed the Augmented Dickey-Fuller (ADF) and Phillip-Perron Unit
Root Test of stationarity for the cointegration and the ARDL bound test for cointegration.
The interpretation and the analysis of the empirical results has been done in chapter four,
but due to the critical nature of the findings (financial deepening having no significant
impact on aggregate welfare but has a negative sign in the lon-run and a positive sign in
the short-run) there is need to formulate financial reform policies that will have a
proportionate beneficial impact on the poor. The result findings in this study is not a
surprise, most scholars have earlier on asserted that financial deepening have a
disproportionate beneficial impact on the poor, especially in developing countries, see
chapter 2.
5.2 POLICY RECOMMENDATIONS:
Policy makers need to understand the basic financial needs of the poor and pursue
vigorously policies that have a direct beneficial impact on aggregate welfare. Since the
number of bank branches is significant and have a positive relationship with aggregate
welfare, policy makers need to undertake more measures to provide financial services to
the unbanked and the most vulnerable people, since the poor can only be encouraged for
enterpreneurship through the provision of financial services to enable them engage in
economic activities. This no doubt will go a long way in making them more self-reliant,
increase employment opportunities and household income.
Another policy implication of the findings that emerges from the results is that, it is
critical for the government to carry out subsequent efforts at deepening the financial
sector in such a way as to conform to the global development trend. This will tally with
the global development pattern which has shifted from transformation of production and
consumption pattern to aggregate societal empowerment.
56
5.3 CONCLUSIONS:
In all, the financial reform adopted by Nigerian banking system may have impacted
significantly on the financial system, but it seems not to have helped deepening the
system well.
From the analysis above, it is evident that there is relatively a low level of deepening of
the financial system in Nigeria during the period of the study. Part of the reform measures
adopted by the CBN in 2010 to clear the banks from the scourge of non-performing loans
that culminated in the bail out of the mostly affected banks created panic in the banking
system.
Also, financial deepening indicator has no impact on aggregate welfare in Nigeria. But
findings from the study support previous works that financial deepening has a direct
significant impact on aggregate welfare through bank branch expansion (financial
accessibility indicator). It is important to conclude that the more individuals have access
to financial services, the more their welfare improves. In addition, the reforms and policy
thrusts could have more significant impact on the system if the issue of systemic crisis
had reduced considerably.
57
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APPENDIX 1
Normality test for model 2
0
1
2
3
4
5
6
7
8
-0.8 -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6
Series: Residuals
Sample 1976 2010
Observations 35
Mean -6.66E-17
Median -0.034530
Maximum 0.633389
Minimum -0.720594
Std. Dev. 0.331591
Skewness 0.122834
Kurtosis 2.336867
Jarque-Bera 0.729310
Probability 0.694436
Normality test for model 3
0
2
4
6
8
10
-0.5 0.0 0.5
Series: Residuals
Sample 1978 2010
Observations 33
Mean 6.37E-18
Median -0.017732
Maximum 0.749017
Minimum -0.748894
Std. Dev. 0.365853
Skewness 0.031265
Kurtosis 2.702496
Jarque-Bera 0.127075
Probability 0.938439