Role Of Banks Financial Institutions In Economic Growth Economics Essay

Achieving high and sustainable rates of economic growing has long been the end of economic development in all states. In an attempt to advance growing several policies have been initiated by authoritiess to raise the life criterions of their population so as to free poorness.

However, the publicity of development needs a sufficient sum of capital stock and profitable investing that guarantees a sustainable growing in the economic system. In recent old ages, policies to better nest eggs mobilisation has progressively been suggested as appropriate since nest eggs rate can impact economic growing through funding productive investing. Therefore, the mobilisation of nest eggs is a necessary status for accomplishing high and sustainable rates of economic growing.

However, the statement sing the necessity of nest eggs for success is linked with another statement sing the effectivity of nest eggs in funding capital accretion and hence increasing investings ( Pagano, 1993 and Beck et Al, 2000 ) . This leads to the inquiry of the importance and function of fiscal sector in the complex relationship between nest eggs, investing and development. The interplay between fiscal sector development and macro-economic working on the one manus and nest eggs on the other, has been addressed in the economic development and development literature ( Levine, 1997, Westley, 2001 and Beck et Al, 2005 ) .

The argument on this issue remains relevant and controversial. The treatments occur in different dimensions, one of these being the relationship between nest eggs and growing. The 2nd dimension of the argument is the consequence of fiscal sector development in nest eggs, which leads to the of import inquiry of whether the involvement rate has any consequence on salvaging. A 3rd facet of the argument is the relationship between the banking sector and development, taking to the inquiry: does the banking sector development do economic growing or does growing cause or promote banking sector development?

In acknowledgment that Bankss play important functions in economic development of states, this survey seeks to turn to the above issues. First it examines the literature on banking sector development, measuring the impact of stock liquidness, involvement rates, loaning, and nest eggs on the GDP and the stimulation of economic growing. Second, it evaluates the importance of fiscal sector development by analyzing its impact on economic growing and investing, which is the chief beginning of growing.

Third, it will analyze the Nigerian Bankss and the economic system, analyzing its part to the growing of the Nigerian economic system and how the different banking sector reforms have impacted on its power and conversely to the economic development of Nigeria.

Research Aim

The research aims to analyze the function of banking sector development and economic growing in Nigeria, analyzing its liquidness base, imparting policies and assorted reforms of the sector, with a position to happening an account for the state ‘s unstable, slow and helter-skelter growing. In order to accomplish this purpose, this paper considers different statements and propositions in the literature and employs statistical and econometric tools to measure the tendencies that have on its ain prevailed in cardinal facets of the banking sector.


The following specific research aims were established in order to accomplish the aim of the research:

aˆ? To measure the place and construction of the Nigerian banking sector.

aˆ? To find the type and the nature of adopted reforms and liberalization policies and aims associated with them.

aˆ? To measure the impact of banking sector development on nest eggs, loaning and investing and therefore economic development of Nigeria.

Chapter TWO


2.1 Introduction

The fiscal sector plays a critical function in the economic development of any state. It links nest eggs and investings and hence, promotes economic growing, which is enhanced because a more efficient and well-structured fiscal sector helps to call up more nest eggs and increase productive investing that leads to economic growing.

Finance besides plays a important function in any economic system as companies must take invested financess to back up the undermentioned production of goods and services. Besides authoritiess frequently borrow to finance short-run and long-run deficits between outgos and grosss. Households every bit borrow from the fiscal sector to fund big purchases that exceed their existing incomes.

While self-finance through nest eggs is an option for companies and households, nevertheless, the services provided by these fiscal sector houses through the proviso of vehicles and instruments for these nest eggs, investing, loaning and adoption actions are by and large superior to self-finance through accumulated nest eggs.

In developing states, the functions of capital and the fiscal sector is even more important. This is because the people and authorities hope that their economic systems will turn quickly, so as to bring forth significantly higher per capita incomes and criterions of behavior. King and Levine, ( 1993 ) notes that an efficient fiscal sector i.e. one that encourages nest eggs, United States Marshals Services those nest eggs efficaciously, and allocates them to the investings that will bring forth larges increases in future merchandises and services can be an polar portion of scheme to accomplish rapid economic growing.

To underline the importance of the fiscal sector development the economic system and partially address sensed defects of the sector in supplying fiscal services, authoritiess has internationally intervened extensively in the operations of the fiscal services sector ( World Bank, 1989 ) .

Such intercessions have included: authorities ownership of Bankss, insurance companies and other fiscal mediators ; authorities restrictions on the applier by domestic and foreign endeavors into the fiscal services sector ; authorities appellation of sectors to which Bankss should impart ; authorities ordinance of involvement rates ; authorities strictures as to the signifiers and types of fiscal instruments that can be offered and authorities revenue enhancement of different instruments, minutess and income flows related to fiscal services.

The fiscal sector of an wealth encompasses houses such as Bankss, insurance companies, pension financess, stock securities firm houses that provide these and other fiscal services for the remainder of the economic system. However, this paper is entirely concerned with the banking sector.

2.2 The function of the fiscal sector

An effectual and efficient fiscal sector can better the allotment of resources within an economic system by bettering the mobilisation of resources from fiscal units with excess financess and easing the transportation of those resources from existent rescuers to those economic units with an investing or utilize demands that are in surplus of their ain nest eggs therefore, making wealth in the economic system. The importance of this procedure can non be underestimated because through this procedure, the resources of an economic system are better utilised, taking to a higher degree of existent income. As noted by Zahid ( 1995 ) the effectual operation of the fiscal sector leads to a higher mean returns on investing ensuing in higher nest egg rate, giving more liquidness to the fiscal sector which they can lend to profitable investings, which finally will increase the success rate of the economic system.

Ideally, the banking sector develops to function as an efficient mediator between depositors and investors, bring forthing market-clearing monetary values and involvements rates. Such a state of affairs has practical deductions for salvaging and growing. Harmonizing to Bencivenga and Smith ( 1991 ) the good activities of Bankss are accepting sedimentations, imparting therefore extinguishing the demand for self funding.

Bank activities include two important deductions for nest eggs and investing providing liquidness ; Bankss allow risk-averse rescuers to keep bank sedimentations instead than pure ( but unproductive ) assets. Of peculiar importance is that Bankss can save on liquid modesty retentions that do non lend to capital accretion. Besides by extinguishing self-financed capital investing, Bankss prevent the unneeded settlement of such investing by enterprisers who think that they need liquidness.

2.3 Banking sector development and economic growing

There is a considerable theoretical and empirical survey that establishes a nexus between banking sector development and economic growing. This is because the nature of the banking system is infinite and widely distribute where there are recent alterations in banking ordinances, services and instruments. The impact of these alterations spread over the boundary lines of one little regional economic system to international and planetary economic system.

In world, many developing states have non developed their fiscal systems and these have non been a precedence and hence non placed at the top of their development and growing dockets, unlike in developed economic systems it is recognised to be of important importance to their economic systems and as such respects the fiscal system as the bosom of the system because it harmonises economic activities and the efficient allotment of resources.

A broad scope of empirical grounds supports the position that banking development can straight impact economic development and growing and lower income inequality ( Jallian and Kirkpatrick, 2001 ; Westley, 2001 ) . This is in understanding with the observation of the World Bank ( 2001 ) that there is a possibility of a insouciant relationship between an effectively- operation banking system, macro-economic stableness, poorness decrease and economic growing.

Comparative research on the nexus between the banking system and economic growing shows that houses located in economic systems with well-developed banking sector and stock markets, have grown faster than those in economic systems with similar systems but which are less developed ( Demirguc-Kunt and Maksimovic, 1996 ; Levine and Zervous, 1996 and Rajan and Zingales, 1996 ) .

It can be said that fiscal development has a double impact on economic growing. On the one manus, the development of domestic fiscal markets may better the effectivity of capital accretion and on the other manus, fiscal intermediation can lend to lift in the nest eggs rates investing. This attack was emphasized by Goldsmith ( 1969 ) , who besides finds some positive correlativity between fiscal development and the degree of existent per capital GNP. He attributes this relationship to the positive impact that fiscal development has in promoting more efficient usage of the capital stock.

This was further corroborated by Greenwood and Jovanovic ( 1990 ) who showed that there is a positive two-way causal relationship between economic growing and fiscal development, indicating out that the procedure of growing stimulates higher engagement in fiscal markets thereby easing the creative activity and enlargement of fiscal establishments. While on the other manus fiscal establishments, by roll uping and analysing informations from assorted possible investors, let investing undertakings to be undertaken more expeditiously therefore stimulates investing and growing.

Banking sector development can besides be measured by the border between loaning and sedimentation involvement rates and by the per centum of non-performing loans in the economic system. This is because both are significantly and negatively related to economic growing as non-performing loans describe the measure and quality of information that the banking sector has collected and analysed which in bend affects its loaning to investors.

Financial sector development may be an indispensable requirement for economic growing, since well-functioning markets and fiscal establishments may cut down the dealing costs and asymmetric information jobs. At the same clip, fiscal establishments play an progressively polar function in placing investing chances, choosing the most profitable undertakings, mobilising nest eggs, easing trading and the variegation of hazard, every bit good as bettering corporate administration mechanisms.

Besides Becsi and Wang ( 1997 ) , found that the underdevelopment of the banking sector negatively impacts upon population and growing, whereas efficient banking sectors positively affect economic growing through the efficient allotment of resources to the most productive users. In add-on they revealed that curtailing the sedimentation rate and increasing modesty demands, cut down growing rates. Similarly, Levine ( 1997 ) supports the statement of a positive association between fiscal sector development and economic growing, reasoning that the development of fiscal establishments and markets is an indispensable portion of the growing procedure and non “ an inconsequential side show reacting passively to economic growing and industrialization ( p.689 ) .

The World Bank ( 2001 ) cited empirical surveies, which strongly suggested that betterments in fiscal agreements precede and contribute to economic public presentation. For illustration, King and Levine ( 1993a ) showed that the degree of fiscal development in 1960 was a important determiner of economic growing. Other recent surveies have tried to find whether fiscal development leads to better economic growing and public presentation. For illustration, Beck et Al, ( 2000 ) evaluated the long-run impact of the exogenic constituent of fiscal intermediary development on the beginnings of economic growing by utilizing cross-country sample with informations averaged over a period 1960-1995. They found that fiscal mediators have a big, positive consequence on entire factor productiveness growing and that the log-term links between fiscal development and both physical investing growing and private economy rates are weak.

Equally, Nidkumana ( 2001 ) investigated the links between fiscal development and economic development, happening that empirical research on the relationship between fiscal development and economic growing in Africa remains limited. However, the bing grounds suggests that fiscal development is positively related to the growing rate of existent income and farther indicates that fiscal systems are still comparatively under-developed in the bulk of African states.

Neimke ( 2003 ) used a theoretical and empirical attack to explicate the dynamic nexus between fiscal development and economic growing in the passage states. He found that both the theoretical accounts and the empirical consequences, point to fiscal establishments holding important effects for investing and the development of factor productiveness as the foundation for long-run positive growing. This is peculiarly true of Central and Eastern Europe every bit good as for the former Soviet Union economies that have inherited widely disused capital stock and are therefore enduring from crisp diminutions in their growing rates.

Beck et Al ( 2005 ) found that fiscal development boots the growing of industries that are of course composed of little houses, more than large-firm industries. Their work contributes to the literature on the mechanism through which the fiscal development encouragements aggregate economic growing. Besides corroborating that fiscal development facilitates economic growing by hiking the growing of houses that rely on external finance, they show that fiscal development Fosters economic growing by alleviating restraints on little house growing.

Fase and Abma ( 2003 ) examined the empirical relationship between fiscal development and economic growing in nine emerging economic systems in South-East Asia determination that fiscal development affairs for economic growing. The consequences indicate that betterment of the banking system in developing states may profit economic development and besides that the fiscal substructure is of huge importance for economic public assistance.

Analyzing the relationship between banking sector development and growing in the short and long term, Fisman and Love ( 2004 ) found that over the long tally, banking sector development supports and promotes economic growing through a deepening of markets and services that channel nest eggs to productive investing ; these positive facets of banking development lead to higher economic growing in the long-run.

Sing the function of banking sector development in both oil and non-oil exportation states, Nili and Rastad ( 2007 ) reported a lower degree of fiscal development for the oil economic systems when compared with the remainder of the universe. The survey besides shows that the failing of fiscal establishments contributes to the hapless public presentations of economic growing in oil economic systems and that this failing might be associated with the dominant function of authorities in entire investing and under-developed private sector.

For a quickly developing economic system like China, the development of the fiscal sector has significantly induced growing in the existent economic system. Harmonizing to Liang and Teng ( 2005 ) who investigated the relationship between fiscal development and economic growing over the period 1952-2001, found that fiscal development, physical capital stock, international trade and existent involvement rate are all economically and significantly related to economic growing. They besides suggested that in developing states it is critical to set up well-developed fiscal systems, peculiarly with sound fiscal intermediation and liberalised involvement rates, all of which are indispensable for the efficient allotment of recognition, which in bend can assist keep sustainable high economic growing.

Calderon and Liu ( 2003 ) examined the way of causality between banking sector development and economic growing on informations from 109 developing states and industrial states from 1960 to 1994. They found that the banking sector development by and large leads to economic growing and that there is a positive interaction between fiscal and economic growing. They besides reported that fiscal intensifying contributes more to the insouciant relationship in the development states. Financial intensifying propels economic growing through both a more rapid capital accretion and productiveness growing.

However, non all economic experts agree that the banking sector development plays any singular function in economic growing. For illustration, the Miller-Modigliani theorem ( 1961 ) argued that “ existent economic determinations are independent of the methods of funding, therefore go forthing merely a inactive function for the fiscal sector ” ( cited in Wang, 1997:47 ) . Besides Chandavarker ( 1992 ) concluded that “ none of the innovators of development economic sciences even list finance as a factor in development, therefore finance is viewed as servant to enterprise by reacting to the demand for the peculiar types of fiscal services generated by economic development ” ( p.134 ) .

Furthermore, Ram ( 1999 ) argues that the impact of bank development on economic growing is theoretically equivocal saying that there is a deficiency of important positive association between fiscal development and economic growing.

Shan, et Al ( 2001 ) take a different position sing the nexus between fiscal sector development and economic growing reasoning that recent experiences are relatively inconsistent with the widely held position. They noted that the rapid growing of many Asiatic economic systems in the 70s and 80s has been accomplished with domestic fiscal sectors that could non be regarded as developed. Furthermore, they argued that many OECD states embarked on fiscal reforms in the 1980s, yet nest eggs, investing and growing in them have non accelerated. Even where nest eggs has risen following fiscal deregulating, there is yet small empirical grounds refering a linkage between nest eggs and domestic environment ( Bodman, 1995 ) .

It could be argued that the functions of Bankss in economic growing of states are limited particularly in developing economic systems where imperfect information exists. The paradigm of asymmetric information between borrowers and loaners offers valuable penetrations into the signifiers that finance is likely to take ; as it will find who will be able to obtain finance, from whom and under what footings and conditions. This procedure will badly restrict entree to financess for those who need it and therefore decelerate the rate of economic activities. Therefore, Bankss engage in recognition rationing to counterbalance for this hazard by enforcing higher monetary values on borrowers which discourages borrowers with worthwhile investings from seeking loans, thereby worsens the rate economic activities in the state. In consequence the function of Bankss in economic growing is badly limited as recognition rationing discourages a pool of borrowers which undermines the markets ( Bhattacharya and Thakor, 1993 ) .

Though, De Gregorio ( 1993 ) suggests that the relationship between borrowing restraints and growing will finally depend on the importance of the consequence of borrowing restraints on the fringy productiveness of capital relation to their consequence on the volume of nest eggs. Guidotti and De Gregorio ( 1995 ) shows that a relaxation of borrowing restraints increases the inducements for human capital accretion which is likely to increase the fringy merchandise of capital hence may take to higher growing despite the decrease in nest eggs.