EMPIRICAL LITERATURE ON FINANCIAL SECTOR DEVELOPMENTS IN NIGERIAN ECONOMY

A substantial body of empirical work on finance and growth assesses the impact of the operations of the financial system on economic growth, whether the impact is economically large, and whether certain components of the financial system, e.g. banks and stock markets, play a particularly important role in fostering growth at certain stages of economic development. Patrick (1966), in his work postulates a bi-directional relationship between financial  evelopment and economic growth. Ever since, a large empirical literature has emerged to test this hypothesis (see Levine, 1997 for survey). Two

trends in this respect have emerged in the literature. The first tests the relationship between economic growth and financial development, adopting a single measure of financial development and testing the hypothesis on a number of countries using either cross-section or panel data techniques (Erdal, et. al, 2007 for survey). 

The second trend examined the hypothesis for a particular country using time series data/technique, as done by Murinde and Eng (1994) for Singapore; Lyons and Murinde (1994) for Ghana; Odedokun (1998) for Nigeria; Agung and Ford (1998) for Indonesia; Wood (1993) for Barbados, and James and Warwick (2005) for Malaysia. Other works by King and Levine (1993a, 1993b); Demetriades and Hussein (1996) and DemirgüçKunt and Maksimovic (1998), structured on the works of Bagehot (1873), Schumpeter (1912), Gurley and Shaw (1955), Goldsmith (1969), and McKinnon (1973), employed different econometric methodologies and data sets to assess the role of the financial sector in stimulating economic growth. The mounting empirical research, using different statistical methods and data have produced remarkable results. First, the results have shown that countries with well-developed financial systems tend to grow faster, especially those with 

(i)     large, privately owned banks that channel credit to the private sector, and

(ii)   liquid stock exchanges. The level of banking development and stock market liquidity exert positive influence on economic growth.

Second, well-functioning financial systems ease external financing constraints that obstruct firms and industrial expansion. Thus, access to external capital is one channel through which financial development matters for growth because it allows financially constrained firms to expand. The endogenous growth literature supports the fact that financial development positively affects economic growth in the steady state (Greenwood and Jovanovic (1990); Bencivenga and Smith (1991); Roubini and Sala-I-Martin (1992); Pagano (1993); King and Levine (1993b); Berthelemy and Varoudakis (1996); and Greenwood and Smith (1997). Over the last two decades, the literature has shown a growing body of new empirical approaches to treating the causality pattern based on time series techniques Gupta (1984); Jung (1986); Murinde and Eng (1994); Demetriades and Hussein (1996); Arestis and Demetriades (1997); and Kul and Khan (1999).

 In these studies, the focus is on the long-run relationship between financial sector development and real sector growth, using frameworks of bivariate and multivariate vector auto-regressive (VAR) models for different country samples. The outcome was that the causality pattern varies across countries according to the success of financial liberalization policies implemented in each country and the level of development of the financial sector. The Nigerian economy has from the mid-1980s been moving towards increased liberalization, greater openness to world trade and higher degree of financial integration. This policy stance and other reform measures, particularly the banking sector consolidation exercise of 2004/05 have led to enormous build-up of capital from both domestic and cross-border sources. 

Nigeria is, therefore, a veritable case for investigating the link between finance and growth for at least two reasons. First, there has been considerable increase in the activities of the financial markets prior to the recent global financial crisis, particularly with regard to private sector credit and stock market capitalization. Credit to the private sector, stock market capitalization and the all-share value index were all on the upswing up until the onset of the crisis. Second, Nigeria has an interesting history of financial sector reforms. However, this proposal is not an agenda for this paper, given that this is only an overview of developments in the two sectors – financial and real.