CHAPTER ONE

1.1. BACKGROUND OF THE STUDY.

The importance of the financial sector in any economy cannot be overemphasized given the

relationship between the sector and the rest of the economy.

In the era of globalization efficient financial sector are essential to attract gains from the world

market and as well insulate the domestic economy from external shocks. The financial system

could also respond to the domestic economy.

Furthermore the importance of financial institutions in generating growth within the economy

has been widely discussed in the literature various schools of thoughts having views and ideas.

Schumpeter (1911) identified bank’s role in facilitating technological innovation through their

intermediary role. He believed that efficient allocation of savings through identification and

funding of entrepreneurs with the best chances of successful implementing innovation

products and production process are tools to achieve this objective.

Several scholars therefore (McKinnon 1973 Shaw 1973 Fry 1988 King and Levine 1993) have

equally buttressed the above postulation about the significance of banks to the growth of the

economy.

In assessing the relationship a larger number of recent empirical studies have relied on

measures of sizes or structures to provide evidence of a link between financial system

development and economic growth.

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They used macro or sector level data such as the size of financial intermediation or of external

finance relative to GDP and found that financial development has a significant impact on

economic growth.

For the past few decades theoretical discussions about the importance of financial

development and the role that financial intermediation play in economic growth have remained

controversial and thus occupied a key position in the literature of development finance.

Studies by Gurley and S haw (1967)Goldsmith(1969) Jayarante and Strahan (1996) Kashya and

Stein (2000) Beck et al (20002003) Driscoll (2004)etcsuggests that financial development can

foster economic growth by raising savings improving allocative efficiency of loanable funds and

promoting capital accumulation in both well developed and emerging economies.

However in spite of recent findings that financial development and economic growth are

clearly related this relationship has occupied the minds of economists overtime; although the

channels and even economists of causality have remained unresolved in both theory and

empirics (Fitzgerald 2006).

Bayoumi and Melander(2008)coupled with King and Levine (1993) established that the banking

sector’s development in Europe was not only correlated with economic growth but was also a

cause of long-term growth and as such we can also assert that the financial sector

growth(growth of the banking sector) has a strong influence on economic growth in Nigeria.

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Finally the purpose of this paper is to analyze the relationship as well as analyze the results of

the public sector so far and to ascertain whether it offers and provides an efficient and/or

effective means of solving the problems facing economic growth in Nigeria.

A recent study however indicates that the banking sector plays a more important role than it

was believed earlier (World bank 1996; Almeyda 1997).

1.2. STATEMENT OF PROBLEM.

The banking sector (financial sector) is acknowledged to have huge potentials for

employment generation and wealth creation in any economy.

In Nigeria the sub-sector has stagnated and remained relatively small in terms of its

contribution to gross national product (GNP) and creation of job opportunities.

However several problems have limited the growth and effective contributions of the financial

sector to the economic development in Nigeria. The growth of the real sector could be

determined by the financial sector performance and this could impact on economic growth. But

the financial system has been affected by several bouts of reforms and challenges. A number of

banks were pruned down through the recapitalization programme.

Among the recapitalized banks five chief executives were accused of fraud and replaced hence

the inconsistency in operation.

Equally microfinance banks and insurance companies had their capital base reviewed. More

recently the central bank of Nigeria and its monetary policy committee reviewed the interest

rates upwards to dampen the rate of inflation in Nigeria (ogboi 2011). These are among several

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other reforms in the sector. More so according to the Manufacturing Association of Nigeria

(MAN) cited in Amefule(2011) Nigeria lost 1.9 million owing to harsh operating environment

including finance related problems.

From the foregoing we are poised to answer the most fundamental questions about the impact

of financial sector development on economic growth in Nigeria.

1. What will be the impact of financial sector growth/development on the Nigerian

economic growth?

2. What will be the impact/effect of financial sector services on investment?

1.3. OBJECTIVES OF THE STUDY.

1. To analyze the impact of financial sector growth/development on economic growth in

Nigeria.

2. To assess the causal relationship between financial sector growth and economic growth

(i.e. which is causing which).

1.4. HYPOTHESIS.

H0: Financial sector growth/ development have a significant impact on economic growth in

Nigeria.

H1: There is a causal relationship between economic growth and financial sector growth.

1.5. SIGNIFICANCE OF THE STUDY.

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Since the emerging of Nigeria as a nation in 1960 and her becoming a republic in 1963

virtually all facets of Nigerian economy have undergone huge change while some

sectors/areas of the economy changed for the better some are still in their very bad

condition.

Therefore the most significant aspect of the study is the importance of both the commercial

banks sectors and financial sector growth to the economic growth of Nigeria.

Hence this research would provide an in-depth analysis which would enable the populace to

fully understand the nitty-gritty of the financial sector and ultimately enable them to be very

much familiar with growth trends in the economy.

Furthermore the development of the financial sector has been given priority by the Nigerian

government in the successive development plans.

A review of the problems facing the financial sector is quite indispensible. Such a review will

enable the sector face the ever-increasing demand upon it; and with such amazing knowledge

we can therefore foster economic growth by adopting suitable economic policies.

Finally since the essence of every research work is to build upon and add to the existing bank

of knowledge this study promises to build upon as well as add substantially to the deposit of

knowledge and relative to area of financial sector growth as well as growth in the economy.

It would also help us understand the strong bond between financial sector and economic

growth.

1.6. SCOPE AND LIMITATION OF THE STUDY.

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The study encompasses the role and contributions of financial system/sector on the

economy. Also the study does not consider other sectors of the economy but explicitly

devotes all its energy on the activities of the financial sector and how it stimulates growth.

Equally in spite of all odds this work contains informations which are reliable and authentic.

Other possible limitations of the analysis is that credit ratio used in the study do not capture

financial development that takes place outside of the banking system such as the stock or

bond markets. However it might be of lesser significance since financial development comes

about mostly with the banking sector and other channels are still not very developed.

Demirguc-Kunt Levine (2008) asserts that a more general shortcoming common for all

studies of finance growth nexus is the fact that according to the theory financial institutions

induces economic growth by reducing information and transactions costs monitoring

borrowers managing risks or facilitating exchange of goods. Researchers however do not

posses very good measures to assess how well a financial system provides these kinds of

services to the economy.

Thus the empirical proxies of financial development do not correspond that closely to the

theory.

Finally the study will cover a period of 25 years (1987-2011) and it is only based on this time

frame that we shall base our analysis. Hence anything outside the time frame is unaccounted

for in this study.

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