Banking and Finance Project Topics

Financial Sector Reform: A Panacea to Capital Market Growth

Financial Sector Reform A Panacea to Capital Market Growth

Financial Sector Reform: A Panacea to Capital Market Growth

Chapter One

ย objective of the study

The broad objective of this study is to evaluate the financial sector reforms in the Nigerian economy and their impact on the growth of the capital market. Specifically, the study aims to:

  1. ย To examine the effect of financial sector reforms on capital market growth.
  2. To ascertain the long and short-term effects of the ongoing reforms to the capital market.

Chapter Two

ย Literature review

Conceptual review

ย The capital market

The ย capital ย market ย is ย a ย network ย of ย financial ย institutions ย ย and ย ย facilities ย ย that ย ย interact ย ย to ย ย mobilise and allocate long term savings in an economy. ย ย ย The ย ย ย long ย ย ย term ย ย ย funds ย ย ย are ย ย ย exchanged ย ย for ย ย financial ย ย assets ย ย issued ย ย by ย ย borrowers or traded by holders of outstanding eligible ย instruments. ย Therefore, ย it ย provides ย services ย that ย are ย essential ย to ย an ย economy ย mainly ย by ย contributing ย to ย capital ย formation ย through ย ย financial ย ย intermediation, ย ย financial ย ย advisory ย ย ย services ย ย ย and ย ย ย managerial ย ย ย skill development. ย In ย Nigeria, ย the ย capital ย market ย provides funds to industries and governments to meet their long term capital requirements for fixed investment like buildings, plants and other ย public ย infrastructure ย (Odoko, ย Adamu, ย Dina, ย Golit ย & ย Omanukwue, ย 2004). The Capital ย market ย is ย a ย market that involves ย buying ย and ย selling ย medium ย to ย long-term ย securities ย (i. ย e. ย ordinary ย shares, ย preference ย shares, ย bonds ย and ย debentures). ย According ย to ย Odoko ย et ย al,(2004) ย the ย market ย is ย sub ย divided ย into ย the ย commodity ย and ย stock ย market. ย The ย stock market trades in shares, bonds and funds like mortgage ย loans ย and ย project ย loans ย while ย the ย commodity ย ย market ย ย trades ย ย in ย ย agricultural, ย ย precious metals, etc. Through ย ย products ย ย offered ย ย by ย ย Collective Investment ย Schemes ย (CIS), The capital market also provides for indirect investments in securities. ย For ย businesses ย and ย governments ย to ย perform ย well ย and ย prosper, ย they require stable source of long term funds which ย isn’t ย available ย in ย the ย money ย market ย (the banking system). For instance, businesses need ย to ย expand ย their ย factories ย to ย remain ย competitive, ย ย and ย ย governments ย ย need ย ย provide ย such ย socio-economic ย infrastructures ย as roads, rails, hospitals, schools, bridges etc. to be relevant. This ย type ย of ย long ย term ย funding can only be provided by a vibrant capital market. ย Noteworthy ย ย roles ย ย of ย ย the ย ย capital ย ย market ย ย comprise ย pooling ย of ย resources ย as ย savings, ย liquidity ย formation, ย risk ย variation, ย enhanced ย information ย distribution ย and ย acquisition ย and ย corporate ย control ย motivation. ย When ย these ย functions are improved and effective, services of ย the ย capital ย market ย increase ย the ย rate ย of ย economic ย growth ย (Yadirichukwu ย & ย Chigbu, ย 2014; Okereke-Onyiuke, 2000). Operators ย ย ย ย in ย ย ย ย this ย ย ย ย market ย ย ย ย comprise: ย ย ย ย Brokers/Dealers, ย Issuing ย houses, ย Registrars, ย Underwriters, ย Trustees ย and ย Portfolio/fund ย managers. ย This ย market ย is ย sub-divided into two: The ย primary ย segment ย of ย the ย capital ย market ย is ย the ย market ย for ย fresh ย issue ย of ย securities by companies who need funds for business ย ย expansion ย ย or ย ย governments ย ย who ย ย need funds for infrastructure. The secondary market is a market for buying and selling of shares ย ย which ย ย the ย ย investors ย ย have ย ย already ย ย bought ย from ย the ย primary ย market, ย so ย the ย proceeds ย from ย sales ย go ย to ย the ย divesting ย shareholder ย and ย not the company whose share is being traded.

An overview of financial sector reform in Nigeria

The measures for the reform of the financial sector in Nigeria were adopted within an overall context of comprehensive Structural Adjustment Programs (SAP) comprising stabilization measures and other measure designed to institute market systems for efficient resource allocation. This implies the elimination or reduction of the excessive controls, which had been in vogue in the proceeding two decades to levels that could sustain growth and development. Financial and trade liberalization was the cornerstones of SAP The financial liberalization was designed to provide a more flexible policy framework for the management of the emerging adverse intemational economic developments. Such as the drastic decline in the price of crude oil, other minerals, primary commodity exports, and the growing protectionisen as well as the impact of rising interest rates on the country’s external debt burden. The reform was expected to promote financial savings, reduce the distortion in investment decisions and induce more effective intermediation between savers

The reforms in Nigeriaโ€™s banking sector, and the broader financial sector, emerged out of a need to expand and strengthen the sector, positioning it for growth and stability. These reforms occurred across several phases:

Phase I: Deregulation Era (1986-1993)

This period, known as the Structural Adjustment Program (SAP) era, marked the initial reforms in Nigeriaโ€™s banking sector. In 1986, one of the major reforms was the liberalization of credit allocation policies. By 1987, the sectors eligible for bank credit allocation had been streamlined to two categories: priority sectors, which included agriculture, manufacturing, exports, and solid minerals, and other sectors. Additionally, this phase saw the deregulation of banking licenses. The aim was to address the dominance of three major banksโ€”First Bank, Union Bank, and United Bank for Africa (UBA)โ€”and to encourage competition, creativity, and efficiency in banking services. However, this measure led to an increase in the number of banks and bank branches, eventually triggering a banking crisis marked by inadequate capital and a rise in non-performing loans within the sector. In January 1987, Nigeriaโ€™s banking sector introduced interest rate deregulation, allowing banks to set their own rates for deposits and loans, with a suggested 3% spread. By August that year, the restrictions on both lending and deposit rates were removed. However, this fully deregulated system faced backlash by November 1989, as producers raised concerns about the widening spreads and high lending rates. In response, the government intervened by lowering the minimum rediscount rate (MRR) from 18.5% to 15.5%, setting a maximum lending rate of 21%, and capping the spread at 7.5%. When banks expressed concerns that these caps would harm the industry, the government lifted the ceiling on lending rates in 1992 and increased the MRR to 17.5%, signaling a preference for higher interest rates. Consequently, banks raised lending rates by over 50% to 31.2%, while deposit rates only increased slightly. In 1993, with an additional MRR hike to 26%, banks increased lending rates again to 39.1%, while deposit rates saw minimal change. This significant spread of 22.4% frustrated the government, which then abandoned the market-based interest rate policy due to producer complaints. In 1989, a new auction system for treasury bills was also introduced. This allowed for competitive bidding and was intended to align treasury bill rates with other money market rates, curb inflation from government borrowing, and enhance the effectiveness of treasury bill rates as a monetary control tool.

Phase II: Re-regulation or Reform Lethargy (Systemic Distress Period) (1994-1998)

This phase marked a return to pre-reform policies, starting with a restriction on issuing new bank licenses. This move, along with other factors, led to a reduction in the number of banks and branches, effectively stalling the growth of the banking sector. In 1994, a shift away from gradual, market-based depreciation of the official exchange rate resulted in a sudden devaluation. To address the widening gap between the official and autonomous exchange rates, the Nigerian government devalued the naira in an attempt to align both rates. This disparity prompted the government to ban the Autonomous Foreign Exchange Market (AFEM) in 1994 and reintroduce exchange controls. However, in 1995, AFEM was reinstated to operate alongside the official exchange rate, with the government allowing the official rate for specific uses, like pilgrimages and sports events. This dual system created inefficiencies in resource allocation, particularly in the public sector. In 1994, due to a significant spread between deposit and lending rates, the government reintroduced interest rate controls, capping lending rates while allowing banks to reduce savings rates. The initial goal of deregulating interest rates was to enable market-driven efficiency and better resource allocation by mobilizing idle funds. Yet, policy reversals occurred when lending rates became unmanageable, defining this period by frequent shifts between regulated and deregulated approaches.

 

Chapter Three

ย Methodology

Research Design

This research basically adopts the scientific method of regression in order to get a reliable result which will validate the purpose of this study.ย ย Similarly, research is an investigation undertaken in order to discover new facts and get additional information. This study adopts an empirical analysis in evaluating the impact of financial sector reform on capital market. In the face of capital market reforms ย regression frameworks with OLS estimation method is used in the empirical analysis as well as trend analysis of stylized fats on some of the indicators of capital market growth, to show the performance of the market. It examines critically the research design, sample size, sample technique, research instrument adopted and procedure for data collection methods used in analysing the data and tested the tentative research hypothese

Model Specification

In an attempt to examine the impact of financial sector on the growth of capital market.The study adopts the Financial Liberalization Hypothesis (or theory) which is an economic theory that argues that removing government controls and restrictions on financial markets and institutions fosters greater efficiency, economic growth, and capital market development. Ronald McKinnon and Edward Shaw first propagated the financial liberalisation theory in 1973. Oshikoya (1992) stated that financial liberalisation theory argued that the economy grows through financial deepening and financial sector reform, while McKinnon (1973), Shaw ย (1973) and Jayati (2005) argued that money supply and interest rate determine financial liberation. The specify model is modify to include some variables.

CHAPTER FOUR

RESULTS AND DISCUSSION

 

Reference

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